10-Q 1 thq10-q93012.htm 10-Q THQ 10-Q 9.30.12
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, 2012
 
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 9, 2012 was approximately 6,856,771.


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,
2012
 
March 31,
2012
 
(Unaudited)
 
(Unaudited)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
36,269

 
$
75,977

Accounts receivable, net of allowances
6,730

 
15,994

Inventory
12,382

 
18,485

Licenses
10,209

 
21,927

Software development
80,738

 
105,220

Deferred income taxes
4,656

 
5,732

Income taxes receivable
339

 
687

Prepaid expenses and other current assets
16,435

 
46,011

Total current assets
167,758

 
290,033

Property and equipment, net
22,890

 
22,132

Licenses, net of current portion
37,380

 
42,594

Software development, net of current portion
23,216

 
25,348

Other long-term assets, net
14,170

 
12,687

TOTAL ASSETS
$
265,414

 
$
392,794

 
 
 
 
LIABILITIES AND STOCKHOLDERS' DEFICIT
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
57,430

 
$
42,905

Accrued and other current liabilities
49,794

 
83,693

Deferred revenue, net
33,958

 
144,686

Secured credit line
21,000

 
—

Total current liabilities
162,182

 
271,284

Other long-term liabilities
44,407

 
53,837

Convertible senior notes
100,000

 
100,000

Commitments and contingencies (see Note 7)

 


 
 
 
 
Stockholders' deficit:
 
 
 
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, 2012; 6,855,233 and 6,851,289 shares issued and outstanding as of September 30, 2012 and March 31, 2012, respectively
685

 
685

Additional paid-in capital
527,035

 
525,677

Accumulated other comprehensive income
11,415

 
16,026

Accumulated deficit
(580,310
)
 
(574,715
)
Total stockholders' deficit
(41,175
)
 
(32,327
)
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT
$
265,414

 
$
392,794

 Presentation gives effect to the Reverse Stock Split, which occurred on July 5, 2012.

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)
 
2012
 
2011
 
2012
 
2011
Net sales
$
107,357

 
$
146,004

 
$
241,044

 
$
341,157

Cost of sales:
 
 
 
 
 
 
 
Product costs
36,379

 
57,986

 
74,865

 
125,049

Software amortization and royalties
37,788

 
77,893

 
75,141

 
142,813

License amortization and royalties
4,179

 
23,156

 
9,928

 
31,295

Total cost of sales
78,346

 
159,035

 
159,934

 
299,157

 
 
 
 
 
 
 
 
Gross margin
29,011

 
(13,031
)
 
81,110

 
42,000

Operating expenses:
 
 
 
 
 
 
 
Product development
11,583

 
27,954

 
20,878

 
58,143

Selling and marketing
27,324

 
37,765

 
41,963

 
88,441

General and administrative
9,809

 
12,037

 
19,941

 
24,086

Restructuring
(297
)
 
6,082

 
1,092

 
5,942

Total operating expenses
48,419

 
83,838

 
83,874

 
176,612

 
 
 
 
 
 
 
 
Operating loss
(19,408
)
 
(96,869
)
 
(2,764
)
 
(134,612
)
Interest and other income (expense), net
700

 
2,467

 
(53
)
 
2,910

Loss before income taxes
(18,708
)
 
(94,402
)
 
(2,817
)
 
(131,702
)
Income taxes
2,272

 
(2,017
)
 
2,778

 
(872
)
Net loss
$
(20,980
)
 
$
(92,385
)
 
$
(5,595
)
 
$
(130,830
)
 
 
 
 
 
 
 
 
Loss per share — basic
$
(3.06
)
 
$
(13.52
)
 
$
(0.82
)
 
$
(19.15
)
Loss per share — diluted
$
(3.06
)
 
$
(13.52
)
 
$
(0.82
)
 
$
(19.15
)
 
 
 
 
 
 
 
 
Shares used in per share calculation — basic
6,854

 
6,834

 
6,853

 
6,833

Shares used in per share calculation — diluted
6,854

 
6,834

 
6,853

 
6,833

Presentation gives effect to the Reverse Stock Split, which occurred on July 5, 2012.
 
See notes to condensed consolidated financial statements.


4

THQ INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Amounts in thousands)
 
 
For the Three Months Ended
September 30,
 
For the Six Months Ended
September 30,
 
(Unaudited)
 
(Unaudited)
 
2012
 
2011
 
2012
 
2011
Net loss
$
(20,980
)
 
$
(92,385
)
 
$
(5,595
)
 
$
(130,830
)
 
 
 
 
 
 
 
 
Other comprehensive loss:
 
 
 
 
 
 
 
Foreign currency translation loss
811

 
(9,183
)
 
(3,497
)
 
(6,849
)
Reclassification of foreign currency translation adjustments included in net loss
(1,088
)
 
913

 
(1,147
)
 
913

Unrealized gain on investments, net of tax
117

 
83

 
33

 
241

Other comprehensive loss
(160
)
 
(8,187
)
 
(4,611
)
 
(5,695
)
 
 
 
 
 
 
 
 
Comprehensive loss
$
(21,140
)
 
$
(100,572
)
 
$
(10,206
)
 
$
(136,525
)
    
 
See notes to condensed consolidated financial statements.


5

THQ INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands) 
 
For the Six Months Ended
September 30,
 
(Unaudited)
 
2012
 
2011
OPERATING ACTIVITIES:
 
 
 
Net loss
$
(5,595
)
 
$
(130,830
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
4,125

 
5,564

Amortization of licenses and software development(1)
53,919

 
154,364

(Gain) loss on disposal of property and equipment
(25
)
 
211

Restructuring charges
1,092

 
5,942

Changes in deferred net revenue and related expenses
(43,613
)
 
(52,153
)
Amortization of debt issuance costs
—

 
187

Gain on investments
—

 
(270
)
Stock-based compensation(2)
1,428

 
3,339

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net of allowances
7,061

 
132,565

Inventory
6,032

 
10,730

Licenses
(5,621
)
 
(13,902
)
Software development
(56,404
)
 
(97,783
)
Prepaid expenses and other current assets
321

 
(4,389
)
Accounts payable
13,786

 
(28,318
)
Accrued and other liabilities
(29,998
)
 
(4,047
)
Deferred net revenue
729

 
(571
)
Income taxes
1,465

 
(3,089
)
Net cash used in operating activities
(51,298
)
 
(22,450
)
 
 
 
 
INVESTING ACTIVITIES:
 
 
 
Other long-term assets
1

 
1,186

Purchases of property and equipment
(3,742
)
 
(5,597
)
Net cash used in investing activities
(3,741
)
 
(4,411
)
 
 
 
 
FINANCING ACTIVITIES:
 
 
 
Proceeds from issuance of common stock to employees
—

 
21

Payment of debt issuance costs
—

 
(1,264
)
Borrowings on secured credit line
21,000

 
—

Net cash provided by (used in) financing activities
21,000

 
(1,243
)
Effect of exchange rate changes on cash
(5,669
)
 
(6,444
)
Net decrease in cash and cash equivalents
(39,708
)
 
(34,548
)
Cash and cash equivalents — beginning of period
75,977

 
85,603

Cash and cash equivalents — end of period
$
36,269

 
$
51,055

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


See notes to condensed consolidated financial statements. 

6

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

1.   Basis of Presentation
 
The condensed consolidated financial statements included in this Quarterly Report on Form 10-Q ("10-Q") present the results of operations, financial position and cash flows of THQ Inc. and its subsidiaries (collectively "THQ," "we," "us," "our," or the "Company").  In the opinion of management, the accompanying condensed consolidated balance sheets and related interim condensed consolidated statements of operations, and condensed consolidated statements of comprehensive loss 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, 2012 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, 2012 (the "2012 10-K").

At September 30, 2012, we had working capital of $5.6 million, including cash and cash equivalents of $36.3 million, and we had a total stockholders' deficit of $41.2 million. Development of quality products requires substantial up-front expenditures and thus we expect to utilize a substantial portion of our existing cash and cash equivalents and other working capital to develop our upcoming products. In addition to our cash and cash equivalents, we have an asset-based credit facility that, subject to the terms and conditions thereof, provides up to $50.0 million in financing that we have drawn against in order to fund our business operations. Although the asset-based credit facility provides up to $50.0 million in borrowings, the current available borrowing base reduces the potential for additional borrowing at this time. At September 29, 2012 we were in default under the terms of the asset-based credit facility; see "Note 6 — Debt" for further information.

On November 5, 2012, we announced the delayed releases of:
•
South Park: The Stick of Truth, which was originally scheduled for release on March 5, 2013, to early fiscal 2014 due to the need for additional development time; and
•
Company of Heroes 2 and Metro: Last Light, both of which are expected to ship in March 2013, later than initially planned.
Because of the calendar movement for the release of games, we will likely need to raise additional capital and may also need to defer and/or curtail currently planned expenditures, cancel projects currently in development, sell assets and/or pursue additional external sources of liquidity, which may not be available on financially attractive terms. We have engaged Centerview Partners LLC to assist us in evaluating strategic and financial alternatives intended to improve our overall liquidity, including raising additional capital, and preserve our ability to bring games to market during advantageous release windows and to help address our $100.0 million 5% convertible senior notes due August 2014 ("Notes"). There can be no assurance that the evaluation of strategic and financing alternatives will result in a transaction or financing, or that, if completed, said transaction and/or financing will be on attractive terms. Our inability to successfully complete a transaction or financing on attractive terms would have a material adverse impact on our ability to comply with the requirements of our credit and debt facilities (see "Note 6 — Debt") and to sustain our operations.

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

Reverse Stock Split. On January 25, 2012, we received a notification letter from NASDAQ notifying us that we were not in compliance with the $1.00 minimum bid price requirement (NASDAQ Marketplace Rule 5450(a)(1)) (the "Rule") because the bid price for our common stock closed below $1.00 over the prior 30 consecutive business days. To regain compliance with this requirement, we held a special meeting of stockholders on June 29, 2012 to solicit stockholder approval of a proposal to approve an amendment to our certificate of incorporation to effect a reverse stock split ("Reverse Stock Split"). On July 2, 2012, we announced the timing and details regarding stockholder approval of the Reverse Stock Split, which was effected on July 5, 2012 at a ratio of one-for-ten with no change in par value. No fractional shares were issued in connection with the Reverse Stock Split. Stockholders who otherwise were entitled to receive fractional shares were entitled to an amount in cash (without interest or deduction) equal to the fraction of one share to which such stockholder would otherwise be entitled multiplied by $5.75. On July

7

23, 2012, we received a letter from NASDAQ informing us that we had regained compliance with the Rule. All consolidated per share information presented in this 10-Q gives effect to the Reverse Stock Split.

Summary of Significant Accounting Policies. In the six months ended September 30, 2012, we did not have any material changes to our significant accounting policies.

In June 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 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. In December 2011, the FASB issued ASU 2011-12, "Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05" ("ASU 2011-12"). ASU 2011-12 defers the effective date of the specific requirement to present items that are reclassified out of accumulated other comprehensive income to net income alongside their respective components of net income and other comprehensive income. All other provisions of ASU 2011-05 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Our adoption of this pronouncement in the six months ended September 30, 2012 did not materially impact our results of operations, financial position or cash flows. We do not expect that the proposed deferral guidance will have a material impact on our consolidated financial statements when and if adoption is required.

In December 2011, the FASB issued ASU 2011-11, "Disclosures about Offsetting Assets and Liabilities" ("ASU 2011-11"). ASU 2011-11 creates new disclosure requirements about the nature of an entity’s rights of offset and related arrangements associated with its financial instruments and derivative instruments. The disclosure requirements are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods therein, with retrospective application required, which will be our quarter ending June 30, 2013. The new disclosures are designed to make financial statements that are prepared under U.S. Generally Accepted Accounting Principles more comparable to those prepared under International Financial Reporting Standards. 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, 2012 and 2011 contain the following number of weeks:
Fiscal Period
 
Number of Weeks
 
Fiscal Period End Date
Three months ended September 30, 2012
 
13 weeks
 
September 29, 2012
Three months ended September 30, 2011
 
13 weeks
 
October 1, 2011
Six months ended September 30, 2012
 
26 weeks
 
September 29, 2012
Six months ended September 30, 2011
 
26 weeks
 
October 1, 2011

2.   Balance Sheet Details
 
Inventory.  Inventory at September 30, 2012 and March 31, 2012 consisted of the following (amounts in thousands):
 
 
September 30,
2012
 
March 31,
2012
Finished goods
$
11,550

 
$
16,860

Components
832

 
1,625

Inventory
$
12,382

 
$
18,485

 
Inventory balances at September 30, 2012 and March 31, 2012 are net of reserves of $19.1 million and $21.1 million, respectively. The inventory reserve balance at September 30, 2012 consists primarily of reserves related to our uDraw Game Tablet ("uDraw").

Prepaid expenses and other current assets. Prepaid expenses and other current assets at September 30, 2012 and March 31, 2012 primarily consisted of product costs totaling $3.9 million and $33.4 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, 2012 and March 31, 2012 were product prepayments of $2.3 million and $1.1 million, respectively.

8


Property and equipment, net.  Property and equipment, net at September 30, 2012 and March 31, 2012 consisted of the following (amounts in thousands):
 
 
Useful lives
 
September 30,
2012
 
March 31,
2012
Building
30 yrs
 
$
730

 
$
730

Land
—
 
401

 
401

Computer equipment and software
3-10 yrs
 
52,321

 
53,624

Furniture, fixtures and equipment
5 yrs
 
6,366

 
7,570

Leasehold improvements
3-6 yrs
 
14,959

 
13,005

Automobiles
2-5 yrs
 
—

 
87

 
 
 
74,777

 
75,417

Less: accumulated depreciation
 
 
(51,887
)
 
(53,285
)
 Property and equipment, net
 
 
$
22,890

 
$
22,132


Depreciation expense associated with property and equipment amounted to $2.0 million and $4.1 million for the three and six months ended September 30, 2012, respectively, and $2.7 million and $5.6 million for the three and six months ended September 30, 2011, respectively.

Accrued and other current liabilities.  Accrued and other current liabilities at September 30, 2012 and March 31, 2012 consisted of the following (amounts in thousands):
 
 
September 30,
2012
 
March 31,
2012
Accrued liabilities
$
11,730

 
$
13,345

Settlement payment
4,200

 
4,000

Accrued compensation
7,649

 
13,117

Accrued third-party software developer milestones
7,222

 
15,201

Accrued royalties
18,993

 
38,030

Accrued and other current liabilities
$
49,794

 
$
83,693

 
Other long-term liabilities.  Other long-term liabilities at September 30, 2012 and March 31, 2012 consisted of the following (amounts in thousands):
 
 
September 30,
2012
 
March 31,
2012
Minimum license guarantees
$
30,000

 
$
36,405

Deferred rent
7,100

 
6,667

Accrued liabilities
6,703

 
7,127

Settlement payment
604

 
3,638

Other long-term liabilities
$
44,407

 
$
53,837

 
Settlement payments included in the tables above are payable to JAKKS Pacific, Inc. ("Jakks"). In the three months ended June 30, 2012 we paid $2.0 million and renegotiated the payment terms of the remaining liability. Under these renegotiated terms we paid $1.0 million on each of August 30, 2012 and October 30, 2012 and there are ten payments remaining of $0.4 million each that are due monthly beginning in February 2013, through to November 2013. Of the remaining settlement payment due to Jakks, $4.2 million is reflected in "Accrued and other current liabilities" and $0.6 million is reflected in "Other long-term liabilities" in our condensed consolidated balance sheets, reflecting the present value of the remaining consideration payable under the agreement between THQ and Jakks.  See "Note 14 — Joint Venture and Settlement Agreements" in the notes to the consolidated financial statements in our 2012 10-K for a discussion of the Jakks settlement payments.

3. Licenses and Software Development


9

Licenses. As of September 30, 2012 and March 31, 2012, the net carrying value of our licenses was $47.6 million and $64.5 million, respectively, and was reflected as “Licenses” and “Licenses, net of current portion” in our condensed consolidated balance sheets. At September 30, 2012, we had commitments of $0.1 million that are not reflected in our condensed consolidated balance sheet due to remaining performance obligations of the licensor. 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.

Software development. As of September 30, 2012 and March 31, 2012, the net carrying value of our software development was $104.0 million and $130.6 million, respectively, and was reflected as “Software development” and “Software development, net of current portion” in our condensed consolidated balance sheets. At September 30, 2012 we had commitments of $59.8 million that are not reflected in our condensed consolidated balance sheet due to remaining performance obligations of the external developers. Software amortization and royalties expense in the six months ended September 30, 2012 included a $5.2 million charge related to the write-off of capitalized software development due to the cancellation of an unreleased title and a $1.4 million charge related to a change in the development direction of another unreleased title. Additionally, software amortization and royalties expense in the six months ended September 30, 2012 included a net benefit of $2.3 million related to the June 1, 2012 transfer of the license we previously had to develop games based on the Ultimate Fighting Championship ("UFC"). The net benefit was the result of charges incurred related to the write-off of software development costs we had previously capitalized for the UFC game that was under development at the time of the license transfer, offset by a cash payment we received from the licensor upon the transfer of the license. All these actions were undertaken in connection with our realignment plans (see "Note 5 — Restructuring and Other Charges”). 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.

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.

We did not record any software development impairment charges in the three and six months ended September 30, 2012. In the six months ended September 30, 2011 we recognized a software development impairment charge of $0.6 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, 2012 and 2011 was $0.1 million and $0.4 million, respectively. As of September 30, 2012, the inception-to-date unrealized holding gain on our investment in Yuke's was $1.5 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, 2012 and March 31, 2012 consisted of the following (amounts in thousands):
 
 
September 30,
2012
 
March 31,
2012
Investment in Yuke's
$
4,694

 
$
4,641

Deferred financing costs
1,192

 
1,510

Other
8,284

 
6,536

Total other long-term assets
$
14,170

 
$
12,687

 

5.   Restructuring and Other Charges

10


Restructuring charges and adjustments are recorded as "Restructuring" expenses in our condensed consolidated statements of operations and generally include costs such as, severance and other employee-based charges in excess of standard business practices, costs associated with lease abandonments (less estimates of sublease income), charges related to long-lived assets, and costs of other non-cancellable contracts. 

Fiscal 2013 second quarter realignment and other associated charges. On July 19, 2012, we announced a consolidation of our two Quality Assurance teams into one location in order to reduce operating costs and centralize our resources at THQ Montreal.  As a result, our Phoenix, Arizona Quality Assurance Office will be closed by the end of fiscal 2013. Additionally, on August 20, 2012, we announced a personnel reduction in our marketing and production groups based in Agoura Hills, reflective of our ongoing strategy to create a more focused, agile and digitally-oriented organization. 

In connection with these actions, in the three months ended September 30, 2012, we incurred charges of $1.4 million related to cash severance and other employee-based charges (recorded within operating expenses in our condensed consolidated statements of operations). Additionally, we could incur up to $0.8 million in cash charges related to lease and other contract terminations and non-cash charges of up to $0.2 million related to long-lived assets. We expect the majority of these charges to be recorded in the quarter ended March 31, 2013. These amounts are preliminary and subject to change as we finalize our assessment of the charges and costs associated with the above items.
 
Fiscal 2013 first quarter realignment and other associated charges. On June 1, 2012, we entered into an agreement to transfer our license to develop future games based on the Ultimate Fighting Championship ("UFC"). This action resulted in the closure of the studio developing the UFC game that was under development at the time of the license transfer. The following table summarizes the components and activity under the fiscal 2013 first quarter realignment, classified as "Restructuring" in our condensed consolidated statements of operations, for the three and six months ended September 30, 2012, and the related restructuring reserve balances (amounts in thousands):

 
 
Three Months Ended September 30, 2012
 
Six Months Ended September 30, 2012
 
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
Beginning balance
 
$
996

 
$
—

 
$
996

 
$
—

 
$
—

 
$
—

Charges (benefit) to operations
 
(59
)
 
(173
)
 
(232
)
 
856

 
120

 
976

Non-cash write-offs
 
—

 
—

 
—

 
—

 
(293
)
 
(293
)
Cash payments, net of sublease income and other cash receipts
 
(149
)
 
173

 
24

 
(187
)
 
173

 
(14
)
Foreign currency and other adjustments
 
15

 
—

 
15

 
134

 
—

 
134

Ending balance
 
$
803

 
$
—

 
$
803

 
$
803

 
$
—

 
$
803


In connection with the transfer of the license we had with the UFC, we recorded a net benefit of $2.3 million (recorded within “Cost of sales — Software amortization and royalties” in our condensed consolidated statement of operations). The net benefit was the result of charges incurred related to the write-off of software development costs we had previously capitalized for the UFC game that was under development at the time of the license transfer, offset by a cash payment we received from the licensor upon the transfer of the license. Additionally, in the three and six months ended September 30, 2012, we incurred a benefit of $0.1 million and charges of $0.9 million, respectively, related to cash severance and other employee-based charges (recorded within operating expenses in our condensed consolidated statements of operations) associated with the closure of the studio that had been developing the UFC game that was under development at the time of the license transfer.

Additionally, in the six months ended September 30, 2012, we incurred a $5.2 million charge related to the write-off of capitalized software development due to the cancellation of an unreleased title and a $1.4 million charge related to a change in the development direction of another unreleased title (recorded within “Cost of sales — Software amortization and royalties” in our condensed consolidated statements of operations). These actions were taken in June 2012 in connection with an evaluation of our products under development by our new President, appointed on May 25, 2012.

We do not expect any significant future charges under the fiscal 2013 first quarter realignment, other than additional facility-related charges and adjustments in the event actual and estimated sublease income changes.

11


Fiscal 2012 fourth quarter realignment and other associated charges. On January 26, 2012, we initiated a plan of restructuring in connection with our updated business strategy in order to better align our operating expenses with the lower expected future revenue. The following table summarizes the components and activity under the fiscal 2012 fourth quarter realignment, classified as "Restructuring" in our condensed consolidated statements of operations, for the three and six months ended September 30, 2012, and the related restructuring reserve balances (amounts in thousands):

 
 
Three Months Ended September 30, 2012
 
Six Months Ended September 30, 2012
 
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
Beginning balance
 
$
409

 
$
—

 
$
409

 
$
536

 
$
—

 
$
536

Charges to operations
 
244

 
17

 
261

 
261

 
17

 
278

Non-cash write-offs
 
—

 
(17
)
 
(17
)
 
—

 
(17
)
 
(17
)
Cash payments, net of sublease income
 
(176
)
 
—

 
(176
)
 
(261
)
 
—

 
(261
)
Foreign currency and other adjustments
 
(13
)
 
—

 
(13
)
 
(72
)
 
—

 
(72
)
Ending balance
 
$
464

 
$
—

 
$
464

 
$
464

 
$
—

 
$
464


Since the inception of the fiscal 2012 fourth quarter realignment through September 30, 2012, total restructuring charges amounted to $1.5 million.

In connection with these actions, in the three and six months ended September 30, 2012, we incurred charges of $0.5 million and $0.3 million, respectively, related to changes in estimates of cash severance and other employee-based charges (recorded within operating expenses in our condensed consolidated statements of operations), and a $1.3 million gain 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 six months ended September 30, 2012, we incurred a benefit of $2.0 million related to the release of a license obligation that had been accrued at March 31, 2012 in connection with our negotiations with one of our previous kids' licensors (recorded within “Cost of sales — License amortization and royalties” expense in our condensed consolidated statements of operations). We do not expect any significant future charges under the fiscal 2012 fourth quarter realignment, other than additional facility-related charges and adjustments in the event actual and estimated sublease income changes.

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.  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, 2012, and the related restructuring reserve balances (amounts in thousands):

 
 
Three Months Ended September 30, 2012
 
Six Months Ended September 30, 2012
 
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
Beginning balance
 
$
2,109

 
$
—

 
$
2,109

 
$
2,341

 
$
—

 
$
2,341

Benefit to operations
 
(505
)
 
—

 
(505
)
 
(428
)
 
—

 
(428
)
Non-cash write-offs
 
—

 
—

 
—

 
—

 
—

 
—

Cash payments, net of sublease income
 
(284
)
 
—

 
(284
)
 
(584
)
 
—

 
(584
)
Foreign currency and other adjustments
 
14

 
—

 
14

 
5

 
—

 
5

Ending balance
 
$
1,334

 
$
—

 
$
1,334

 
$
1,334

 
$
—

 
$
1,334


Since the inception of the fiscal 2012 second quarter realignment through September 30, 2012, total restructuring charges amounted to $3.7 million.

12


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, 2012, and the related restructuring reserve balances (amounts in thousands):

 
 
Three Months Ended September 30, 2012
 
Six Months Ended September 30, 2012
 
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
Beginning balance
 
$
528

 
$
—

 
$
528

 
$
585

 
$
—

 
$
585

Charges to operations
 
7

 
—

 
7

 
13

 
—

 
13

Non-cash write-offs
 
—

 
—

 
—

 
—

 
—

 
—

Cash payments, net of sublease income
 
—

 
—

 
—

 
(52
)
 
—

 
(52
)
Foreign currency and other adjustments
 
(40
)
 
—

 
(40
)
 
(51
)
 
—

 
(51
)
Ending balance
 
$
495

 
$
—

 
$
495

 
$
495

 
$
—

 
$
495


Since the inception of the fiscal 2012 first quarter realignment through September 30, 2012, total restructuring charges amounted to $0.8 million.

There were no other significant charges recorded in the three and six months ended September 30, 2012 related to this realignment. In the three and six months ended September 30, 2011, we 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, 2012, and the related restructuring reserve balances (amounts in thousands):
 
 
Three Months Ended September 30, 2012
 
Six Months Ended September 30, 2012
 
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
Beginning balance
 
$
250

 
$
—

 
$
250

 
$
321

 
$
—

 
$
321

Charges to operations
 
26

 
—

 
26

 
76

 
—

 
76

Non-cash write-offs
 
—

 
—

 
—

 
—

 
—

 
—

Cash payments, net of sublease income
 
(43
)
 
—

 
(43
)
 
(171
)
 
—

 
(171
)
Foreign currency and other adjustments
 
1

 
—

 
1

 
8

 
—

 
8

Ending balance
 
$
234

 
$
—

 
$
234

 
$
234

 
$
—

 
$
234


Since the inception of the fiscal 2011 fourth quarter realignment through September 30, 2012, total restructuring charges amounted

13

to $0.6 million. In the three and six months ended September 30, 2012 we had a loss of $0.2 million related to accumulated foreign currency translation adjustments (recorded within "Interest and other income (expense), net" in our condensed consolidated statements of operations). There were no other significant charges recorded in the three and six months ended September 30, 2012 related to this realignment.

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, 2012 and 2011, and the related restructuring reserve balances (amounts in thousands):
 
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
 
2012
 
2011
 
2012
 
2011
Beginning balance
 
$
1,123

 
$
1,015

 
$
1,211

 
$
1,335

Charges to operations
 
146

 
386

 
177

 
243

Non-cash write-offs
 
—

 
—

 
—

 
—

Cash payments, net of sublease income
 
(91
)
 
(153
)
 
(190
)
 
(326
)
Foreign currency and other adjustments
 
23

 
48

 
3

 
44

Ending balance
 
$
1,201

 
$
1,296

 
$
1,201

 
$
1,296


Since the inception of the fiscal 2009 realignment through September 30, 2012, total restructuring charges amounted to $18.9 million.

The aggregated restructuring accrual balances at September 30, 2012 and March 31, 2012 of $4.5 million and $5.0 million, respectively, related to future lease payments for facilities vacated under all of our realignment plans (offset by estimates of future sublease income), and accruals for other non-cancellable contracts.  As of September 30, 2012, $2.3 million of the restructuring accrual is included in "Accrued and other current liabilities" and $2.2 million is included in "Other long-term liabilities" in our condensed consolidated balance sheet.  As of March 31, 2012, $1.9 million of the restructuring accrual was included in "Accrued and other current liabilities" and $3.1 million was included in "Other long-term liabilities" in our condensed consolidated balance sheet.  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 with Wells Fargo Capital Finance, LLC (“Wells Fargo”), which were amended pursuant to Amendment Number One to Credit Agreement and Security Agreement dated July 23, 2012 (collectively, as so amended, the “Credit Facility”). The Credit Facility provides for an asset based revolving credit facility providing for up to $50.0 million in aggregate principal amount of loans and other financing accommodations. The Credit Facility allows for up to $10.0 million to be used as a letter of credit subfacility. Although the Credit Facility provides up to $50.0 million in borrowings, the current available borrowing base reduces the potential for additional borrowing at this time. At September 29, 2012 we were in default under the terms of the Credit Facility (see discussion below).


14

The Credit Facility has a four-year term; however, it will terminate on June 16, 2014 if any obligations are then still outstanding under the Notes, as 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 revolving borrowings. Debt issuance costs capitalized in connection with the Credit Facility totaled $1.3 million; these costs are being amortized over the term of the Credit Facility. We are required to pay other customary fees, including an unused line fee based on usage under the Credit Facility as well as fees with respect to letters of credit.
During the three months ended September 30, 2012 we borrowed $21.0 million under the Credit Facility. In the three and six months ended September 30, 2012 interest expense was $0.2 million, and amortization of debt issuance costs related to the Credit Facility was $0.2 million. As of September 30, 2012 we had outstanding borrowings under the Credit Facility of $21.0 million. During the six months ended September 30, 2012, we established a letter of credit for $0.6 million under the Credit Facility that is related to a lease we have for one of our studio locations.

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 more fully described below, and entry of certain judgments against us. Upon the occurrence of a continuing event of default and at the option of the required lenders (as defined in the Credit Facility), all of the amounts outstanding under the Credit Facility may be declared to be immediately due and payable and any amount outstanding will bear interest at 2.0% above the interest rate otherwise applicable.  In the event loan availability on the Credit Facility is below 12.5% (16% beginning January 1, 2013) of the maximum revolver amount (the "Covenant Testing Level"), the Credit Facility requires, among other matters, that we maintain certain financial covenants.  In the event the financial covenants become applicable, we would be required to maintain an annual fixed charge coverage ratio, as defined in the Credit Facility, of at least 1.1 to 1.0.
The Credit Facility is guaranteed by most of our domestic subsidiaries and secured by substantially all of our assets. The Credit Facility contains financial reporting covenants and other customary affirmative and negative covenants, including, among other terms and conditions, 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.
At September 29, 2012, the last day of our fiscal 2013 second quarter, borrowings under the Credit Facility were $21.0 million. The borrowings are classified as a current liability and reflected in the “Secured credit line” line item in our condensed consolidated balance sheet. On October 15, 2012, we submitted to Wells Fargo a detail of our eligible accounts receivable and inventories as of September 29, 2012. Wells Fargo used that information to calculate the borrowing base certificate as of September 29, 2012. That borrowing base certificate was returned to us on October 16, 2012 and indicated we were over-advanced under the Credit Facility, thereby triggering the requirement that we maintain certain financial covenants and reduce the amount of our borrowings under the Credit Facility. As of September 29, 2012, we did not meet the applicable financial covenant and thus an event of default arose under the terms of the Credit Facility. On October 17, 2012, we repaid $5.6 million in borrowings under the Credit Facility in an effort to regain compliance under the Credit Facility as of that date. On October 17, 2012, after the repayment, borrowings outstanding under the Credit Facility were $15.4 million. Wells Fargo continued to fund our requests for borrowings under the Credit Facility, as evidenced by a $1.0 million borrowing made on November 2, 2012. On November 7, 2012, we were informed by Wells Fargo that because (i) loan availability was less than the Covenant Testing Level on one or more occasions as of and after September 29, 2012, and (ii) we failed to comply with the fixed charge coverage ratio for the quarter ended September 29, 2012, an event of default had occurred under the terms of the Credit Facility. We are currently in discussions with Wells Fargo regarding the asserted event of default and believe that we will reach an agreement with Wells Fargo with respect to such default; however, there can be no assurance that we will achieve an agreement. As of September 29, 2012, the default under our Credit Facility did not trigger a cross-default under the Notes.
 
Convertible Senior Notes

On August 4, 2009, we issued the 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. All share and per share information presented gives effect to the Reverse Stock Split, which occurred on July 5, 2012.
 
The Notes are initially convertible into shares of our common stock at a conversion rate of 11.7474 shares of common stock per

15

$1,000 principal amount of Notes, equivalent to an initial conversion price of approximately $85.13 per share.  At this conversion rate and upon conversion of 100% of the Notes outstanding at September 30, 2012, the Notes would convert into 1.2 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 1.5 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, 2012, 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, 2012; these costs are being amortized over the term of the Notes.

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, 2012 and 2011.

Capitalization of Interest Expense

We capitalize interest expense and related amortization of debt issuance 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 "Cost of sales — Software amortization and royalties" as part of the software development costs.  In the six months ended September 30, 2012 and 2011 we capitalized $3.2 million and $2.8 million, respectively, of interest expense and related amortization of debt issuance costs.

7.   Commitments and Contingencies
 
A summary of annual minimum contractual obligations and commercial commitments as of September 30, 2012 is as follows (amounts in thousands):
 
 
 
Contractual Obligations and Commercial Commitments (6)
Fiscal
Years Ending
March 31,
 
Licenses and
Software
Development (1)
 
Advertising (2)
 
Leases (3)
 
Debt (4)
 
Other (5)
 
Total
Remainder of 2013
 
$
45,027

 
$
5,004

 
$
7,464

 
$
21,000

 
$
1,981

 
$
80,476

2014
 
30,967

 
9,020

 
14,093

 
—

 
3,624

 
57,704

2015
 
13,600

 
970

 
12,620

 
100,000

 
424

 
127,614

2016
 
7,500

 
567

 
7,636

 
—

 
90

 
15,793

2017
 
7,500

 
509

 
4,721

 
—

 
—

 
12,730

Thereafter
 
—

 
375

 
11,948

 
—

 
—

 
12,323

 
 
$
104,594

 
$
16,445

 
$
58,482

 
$
121,000

 
$
6,119

 
$
306,640

 
(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, 2012 are $104.6 million. License commitments in the table above include $44.8 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, 2012 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 are based upon the specific arrangements we have with the respective licensors and range from fixed

16

amounts to specified percentages of projected net sales (ranging from 3%-8%) related to the respective licenses.

(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 $2.2 million are accrued and classified as "Accrued and other current liabilities" and "Other long-term liabilities," respectively, in our September 30, 2012 condensed consolidated balance sheet due to the 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 $2.1 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 or required repurchases of the Notes, we expect to pay $2.5 million in the remainder of fiscal 2013, $5.0 million in fiscal 2014, and $2.5 million in fiscal 2015, for an aggregate of $10.0 million in interest payments over the remaining term of the Notes (see "Note 6 — Debt"). Additionally, as of September 30, 2012 we had outstanding borrowings under the Credit Facility of $21.0 million (see "Note 6 — Debt").

(5)
Other.  As discussed more fully in "Note 14 — Joint Venture and Settlement Agreements" in the notes to the consolidated financial statements in our 2012 10-K, amounts payable to Jakks totaling $5.0 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, 2012 (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, 2012 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, 2012, we had $3.9 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 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.

Federal Securities Class Action Case

A purported class action lawsuit on behalf of purchasers of THQ common stock between May 3, 2011 and February 3, 2012 (the "Class Period"), styled Zaghian vs. THQ Inc., et al., was filed against the Company and certain executive officers of the Company on June 15, 2012, in the United States District Court for the Central District of California, Southern Division.  The complaint alleges that the defendants knowingly made materially false and misleading statements regarding the Company's uDraw GameTablet during the Class Period.  The complaint seeks unspecified damages, reasonable attorneys' and experts' fees and costs and other relief. On July 19, 2012, the court granted the parties' stipulation providing that the defendants do not have to answer or file a motion to dismiss until sixty (60) days after the filing of an amended complaint. On September 14, 2012, the Court appointed Mike Hernandez as lead plaintiff and his counsel Levi Korsinsky as lead counsel. Pursuant to the stipulation and order of the court, an amended complaint is to be filed within sixty (60) days of the Court's order appointing lead counsel or November

17

13, 2012.  The Company and the other defendants believe the complaint is without merit and intend to vigorously defend the pending lawsuit.

Shareholder Derivative Actions

Three derivative actions were filed against the Company, Brian Farrell, Paul Pucino and the independent members of the Board of Directors by three different purported THQ shareholders - Parker Hine, Jonathan Kaplan, and Basudeb Dey. The actions filed by plaintiffs Parker Hine and Basudeb Dey were filed in Los Angeles Superior Court on August 28, 2012 and October 10, 2012, respectively. The action filed by plaintiff Jonathan Kaplan was filed in the United States District Court for the Central District of California on September 21, 2012. The allegations in each complaint are similar and predicated on the allegations in the federal securities class action summarized above.

Additionally, 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
 
Subject to certain adjustments, as of September 30, 2012, the total number of shares of THQ common stock reserved for issuance under our Long-Term Incentive Plan (“LTIP”) was 1.9 million shares. 

9.  Income Taxes

We evaluate our deferred tax assets on a regular basis to determine if a valuation allowance is required. A cumulative taxable loss in recent years provides significant negative evidence in considering whether deferred tax assets are realizable. As we have had U.S. taxable losses in recent years, we can no longer rely on common tax planning strategies to use our U.S. tax losses and we are precluded from relying on projections of future taxable income to support the recognition of deferred tax assets. As such, the ultimate realization of deferred tax assets is dependent upon the existence of sufficient taxable income generated in the carryforward periods.

Our income tax expense for the three and six months ended September 30, 2012 was $2.3 million and $2.8 million, respectively, primarily related to foreign tax jurisdictions. These amounts represent effective tax rates for the three and six months ended September 30, 2012 of 12.1% (provision on a loss) and 98.6% (provision on a loss), respectively. 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 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. The rate for the three and six months ended September 30, 2012 and 2011 differs from the U.S. federal statutory rate of 35% primarily due to taxable losses in the U.S., which are fully offset by a valuation allowance.

Our unrecognized tax benefits increased by $0.1 million in the six months ended September 30, 2012, from $3.8 million at March 31, 2012 to $3.9 million at September 30, 2012, all of which would impact our effective tax rate if recognized. Due to inherent uncertainty we are not able to determine the timing and recognition of our unrecognized tax benefits. Additionally, due to the valuation of our deferred tax assets, any benefit recognized would not be realized in our effective tax rate for at least the next 12 months.

We conduct business internationally and, as a result, one or more of our subsidiaries files income tax returns in U.S. Federal, U.S. state, and certain foreign jurisdictions.  Accordingly, we are subject to examination by taxing authorities throughout the world, including Australia, China, France, Germany, Italy, Japan, Korea, Luxembourg, Netherlands, Spain, Switzerland, and the U.K.  Certain state and certain non-U.S. income tax returns are currently under various stages of audit or potential audit by applicable tax authorities and the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year.  We are no longer subject to U.S. Federal, state, and local or foreign jurisdiction income tax examinations by tax authorities for March 31, 2007 and prior years.    
 
At September 30, 2012, approximately 52% of our cash and cash equivalents were domiciled in foreign tax jurisdictions.  We expect to repatriate all or a portion of these funds to the U.S., and we may be required to pay additional taxes (such as foreign withholdings) in certain foreign jurisdictions, which we do not expect to be significant. We do not anticipate that such repatriation, in the short-term, would result in actual cash payments in the U.S., as the taxable event would likely be offset by the utilization of our net operating losses and tax credits.  However, the repatriation of foreign cash may be subject to certain restrictions and/or limitations which may hinder our ability to repatriate such cash to the U.S.

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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, 2012, we had no amounts accrued for interest and for the potential payment of penalties.

10.   Loss Per Share
 
All loss per share information presented gives effect to the Reverse Stock Split, which occurred on July 5, 2012. 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,
 
2012
 
2011
 
2012
 
2011
Net loss used to compute basic loss per share
$
(20,980
)
 
$
(92,385
)
 
$
(5,595
)
 
$
(130,830
)
 
 
 
 
 
 
 
 
Weighted-average number of shares outstanding — basic
6,854

 
6,834

 
6,853

 
6,833

Dilutive effect of potential common shares
—

 
—

 
—

 
—

Number of shares used to compute loss per share — diluted
6,854

 
6,834

 
6,853


6,833


As a result of our net loss for the three and six months ended September 30, 2012 and 2011, the result of the if-converted calculation applied to the Notes was antidilutive and as such we did not include the potential conversion of 1.2 million shares under the Notes in our diluted earnings per share calculation.

As a result of our net loss for the three and six months ended September 30, 2012 and 2011, 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 1.3 million and 1.0 million potential common shares that were excluded from the computation of diluted loss per share for the three and six months ended September 30, 2012 and 2011, respectively. Had we reported net income for these periods, an additional 0.1 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, 2012. An additional 21,000 and 19,000 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.

11.   Fair Value
 
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.  There is a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value.  We used the following methods and assumptions to estimate the fair value of our 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, 2012 (amounts in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents - Money market funds
$
88

 
$
—

 
$
—

 
$
88

Other long-term assets, net - Investment in Yuke's
4,694

 
—

 
—

 
4,694

Total
$
4,782

 
$
—

 
$
—

 
$
4,782


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The following table summarizes our financial assets measured at fair value on a recurring basis as of March 31, 2012 (amounts in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents - Money market funds
$
—

 
$
—

 
$
—

 
$
—

Other long-term assets, net - Investment in Yuke's
4,641

 
—

 
—

 
4,641

Total
$
4,641

 
$
—

 
$
—

 
$
4,641

 
During the six months ended September 30, 2012 we did not hold any Level 3 financial assets.

Financial Instruments
 
The carrying value of certain financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, and accrued royalties approximate fair value based on their short-term nature. 
 
The book value and fair value of the Notes at September 30, 2012 was $100.0 million and $53.0 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, 2012 and 2011, 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, 2012, we did not have any outstanding foreign currency exchange forward contracts related to balance sheet hedging activities. At March 31, 2012, we had foreign currency exchange forward contracts related to balance sheet hedging activities in the notional amount of $92.2 million with a fair value that approximates zero at March 31, 2012.  We estimated the fair value of these contracts using Level 1 inputs, specifically, inputs obtained in quoted public markets.  In the three months ended September 30, 2012, we did not enter into any foreign currency exchange forward contracts related to balance sheet hedging activities, and thus did not have a gain or loss. The net loss recognized from these contracts during the six months ended September 30, 2012 was $4.3 million. 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. Net gains and losses recognized from these contracts are included in "Interest and other income (expense), net" in our condensed consolidated statements of operations.

12.   Capital Stock Transactions

On July 31, 2007 and October 30, 2007, our board authorized the repurchase of up to $25.0 million of our common stock from time to time on the open market or in private transactions, for an aggregate of $50.0 million.  As of September 30, 2012 and March 31, 2012 we had $28.6 million, authorized and available for common stock repurchases.  During the six months ended September 30, 2012, we did not repurchase any shares of our common stock.  There is no expiration date for the authorized repurchases. 

13. Segment and Geographic Information

We operate in one reportable segment in which we are a developer, publisher and distributor of interactive entertainment software

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for video game consoles, handheld devices and PCs, including via the Internet. The following information sets forth geographic information on our net sales and total assets for the three and six months ended September 30, 2012 and 2011 (amounts in thousands):

 
North
America
 
Europe
 
Asia
Pacific
 
Consolidated
Three months ended September 30, 2012
 
 
 
 
 
 
 
Net sales to unaffiliated customers before changes in deferred net revenue
$
53,460

 
$
32,322

 
$
6,016

 
$
91,798

Changes in deferred net revenue
14,357

 
403

 
799

 
15,559

Net sales to unaffiliated customers
$
67,817

 
$
32,725

 
$
6,815

 
$
107,357

Total assets
$
109,690

 
$
122,614

 
$
33,110

 
$
265,414

Six months ended September 30, 2012
 
 
 
 
 
 
 
Net sales to unaffiliated customers before changes in deferred net revenue
$
76,785

 
$
44,328

 
$
9,210

 
$
130,323

Changes in deferred net revenue
72,290

 
29,676

 
8,755

 
110,721

Net sales to unaffiliated customers
$
149,075

 
$
74,004

 
$
17,965

 
$
241,044

 
 
 
 
 
 
 
 
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


Information about our net sales by platform for the three and six months ended September 30, 2012 and 2011 is as follows (amounts in thousands):

 
 
Three Months Ended
September 30,
 
Six Months Ended
September 30,
Platform
 
2012
 
2011
 
2012
 
2011
Consoles
 
 
 
 
 
 
 
 
Microsoft Xbox 360
 
$
38,240

 
$
36,098

 
$
52,220

 
$
87,640

Sony PlayStation 3
 
35,804

 
28,115

 
45,665

 
63,897

Nintendo Wii
 
58

 
15,503

 
3,254

 
34,527

Sony PlayStation 2
 
445

 
1,292

 
729

 
2,311

 
 
74,547

 
81,008

 
101,868

 
188,375

Handheld
 
 
 
 
 
 
 
 
Nintendo Dual Screen
 
2,233

 
17,677

 
5,700

 
38,961

Sony PlayStation Portable
 
582

 
1,974

 
1,223

 
4,096

Wireless
 
429

 
730

 
850

 
1,466

 
 
3,244

 
20,381

 
7,773

 
44,523

 
 
 
 
 
 
 
 
 
PC
 
14,007

 
18,221

 
20,682

 
27,951

Net sales before changes in deferred net revenue
 
91,798

 
119,610

 
130,323

 
260,849

Changes in deferred net revenue
 
15,559

 
26,394

 
110,721

 
80,308

Total net sales
 
$
107,357

 
$
146,004

 
$
241,044

 
$
341,157


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14. Subsequent Events

In October 2012, we made changes to our publishing organization in Australia. As we focus on wholly-owned intellectual properties and move away from affiliate label programs, we have moved from a direct sales model to a distributor model, and will be closing our Melbourne publishing office. This action could result in cash charges of up to $0.5 million related to severance, up to $0.4 million in cash charges related to lease and other contract terminations and non-cash charges of up to $0.3 million related to long-lived assets. We expect the majority of these charges to be recorded in the quarter ended December 31, 2012. These amounts are preliminary and subject to change as we finalize our assessment of the charges and costs associated with the above items.


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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 the exploration of strategic alternatives, actions being taken relating to certain defaults under the Credit Facility, industry prospects, our future economic performance including anticipated revenues and expenditures, restructuring activities, results of operations or financial position, and other financial items, our business plans and objectives, including our 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, 2012 (the "2012 10-K") and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2012.
 
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 ("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 Amazon, OnLive, Origin, and Valve.
 
Our titles span multiple categories, including action, adventure, fighting, role-playing, simulation, 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 mass market.  Our portfolio of key franchises currently includes:
•
games based on our owned intellectual properties including Company of Heroes, Darksiders, Homefront, and Saints Row; and new properties in development by Patrice Désilets and Turtle Rock Studios, and
•
core games based on licensed properties including Metro, South Park Digital Studios' South Park, and World Wrestling Entertainment ("WWE").

We develop our products using both internal and external development resources. The internal resources consist of producers, game designers, software engineers, artists, animators and game testers located within our internal development studios and corporate headquarters. The external development resources consist of third-party software developers and other independent resources such as artists, voice-over actors and composers.


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Our global sales network includes offices throughout North America and Europe. In the U.S. and Canada, we market and distribute games directly to mass merchandisers, consumer electronic stores, discount warehouses and other national retail chain stores. Internationally, we market and distribute games on a direct-to-retail basis in the territories where we have a direct sales force and to a lesser extent, in the territories where we do not have a direct sales force, third parties distribute our games. We also globally market and distribute games digitally via the Internet and, to a lesser extent, through high-end wireless devices, such as the iPhone, iTouch and iPad, as well as wireless devices run on the Google Android and Windows Mobile platforms.

Strategic Plan and Product Updates, Business Realignments, and Retention of Financial Advisor

Our strategy is focused on creating and marketing high-demand core games with a significant digital component. These connected experiences, in particular, are key to increasing customer engagement, retention, and monetization. A key part of our strategy is to build franchises for the next generation of consoles at or shortly after they are launched. To execute on our strategic plan, on July 23, 2012 we bolstered our management team by appointing a new Executive Vice President, Production, reporting directly to our President.

Business Realignment. On July 19, 2012, we announced a consolidation of our two Quality Assurance teams into one location in order to reduce operating costs and centralize our resources at THQ Montreal.  As a result, our Phoenix, Arizona Quality Assurance Office will be closed by the end of fiscal 2013. Additionally, on August 20, 2012, we announced a personnel reduction in our marketing and production groups based in Agoura Hills, reflective of our ongoing strategy to create a more focused, agile and digitally-oriented organization. 

Product Updates. On November 5, 2012, we announced the delayed releases of:
•
South Park: The Stick of Truth, which was originally scheduled for release on March 5, 2013, to early fiscal 2014 due to the need for additional development time; and
•
Company of Heroes 2 and Metro: Last Light, both of which are expected to ship in March 2013, later than initially planned.

Because of the calendar movement for the release of games, we will likely need to raise additional capital and may also need to defer and/or curtail currently planned expenditures, cancel projects currently in development, sell assets and/or pursue additional external sources of liquidity, which may not be available on financially attractive terms. See “Liquidity and Capital Resources” for further discussion.

Retention of Financial Advisor. We have engaged Centerview Partners LLC to assist us in evaluating strategic and financing alternatives intended to improve our overall liquidity, including raising additional capital, preserve our ability to bring games to market during advantageous release windows and to help address the Notes. There can be no assurance that the evaluation of strategic and financing alternatives will result in a transaction or financing, or that, if completed, said transaction and/or financing will be on attractive terms. Our inability to successfully complete a transaction or financing on attractive terms would have a material adverse impact on our ability to comply with the requirements of our credit and debt facilities and to sustain our operations.

Business Trends
 
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 come via online distribution methods, including, multi-player online games (both subscription and free-to-play), free-to-play micro-transaction based games, paid downloadable content ("DLC"), and digital downloads of full-games. Conversely, based on industry data, 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, 2012, reported retail software sales in the U.S. for the industry decreased 23% compared to the same period in 2011 according to the NPD Group; for the same period, across U.K., Germany, France, Spain and Benelux, aggregated retail software sales decreased 19% compared to the same nine-month period in 2011 according to GfK.  However, digital sales for the industry are expected to grow over 22% worldwide in calendar 2012 and almost double, over calendar 2011 levels, in the following five years to $71.1 billion worldwide according to the International Development Group, Inc.'s Forecast Update (August 2012). Accordingly, we plan to emphasize the digital components in our future core game releases. 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.

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Sales Concentration of Top Titles

The majority of money spent by consumers on video game software is spent on a few top titles. Because of the demand for “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.
  
Sales of Used Video Games
 
Several retailers, including one of our largest customers, GameStop, continue to 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 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.

Shifting Preferences in the Casual and Lifestyle Market

Over the past few years, our industry has seen a shift in preferences in the casual and lifestyle games market away from kids' and movie-based licensed console titles. We believe this shift is due to gameplay with online digital delivery methods, including games played online and on social networking sites such as Facebook, and through wireless devices. As discussed above, in response to this continued shift in preferences, we exited the market for video games based on licensed kids' and movie-based entertainment properties and uDraw. Approximately 9% and 36% of our net sales before the impact of changes in deferred net revenue in the six months ended September 30, 2012 and 2011, respectively, came from these types of games.

Results of Operations — Comparison of the Three and Six Months Ended September 30, 2012 and 2011

For the three and six months ended September 30, 2012, we reported a net loss of $21.0 million and $5.6 million, respectively, or $3.06 and $0.82 per diluted share, respectively, compared with a net loss of $92.4 million and $130.8 million, respectively, or $13.52 and $19.15 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. 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, 2012 and 2011 (amounts in thousands):

 
Three Months Ended September 30,
 
Increase/
(Decrease)
 
% Change
 
2012
 
2011
 
 
Net sales before changes in deferred net revenue
$
91,798

 
85.5
%
 
$
119,610

 
81.9
%
 
$
(27,812
)
 
(23.3
)%
Changes in deferred net revenue
15,559

 
14.5

 
26,394

 
18.1

 
(10,835
)
 
(41.1
)
Consolidated net sales
$
107,357

 
100.0
%
 
$
146,004

 
100.0
%
 
$
(38,647
)
 
(26.5
)%

 
Six Months Ended September 30,
 
Increase/
(Decrease)
 
% Change
 
2012
 
2011
 
 
Net sales before changes in deferred net revenue
$
130,323

 
54.1
%
 
$
260,849

 
76.5
%
 
$
(130,526
)
 
(50.0
)%
Changes in deferred net revenue
110,721

 
45.9

 
80,308

 
23.5

 
30,413

 
37.9

Consolidated net sales
$
241,044

 
100.0
%
 
$
341,157

 
100.0
%
 
$
(100,113
)
 
(29.3
)%

In the three and six months ended September 30, 2012, net sales before changes in deferred net revenue were primarily driven by sales of Darksiders II, as well as continued sales of Saints Row: The Third, initially released in the third quarter of fiscal 2012, including sales generated from its digital content offerings and full-game digital downloads. Also contributing to net sales before changes in deferred net revenue in the three and six months ended September 30, 2012 were sales of other catalog titles such as WWE '12.


25

Included in net sales before changes in deferred net revenue in the three and six months ended September 30, 2012 was $19.1 million and $32.5 million of digital revenue, which was 34% and 33% higher than the same periods last fiscal year. Digital revenue primarily consists of digital downloads of full-games and paid downloadable content.

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, 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 (titles released in fiscal years prior to the respective fiscal year) for the three and six months ended September 30, 2012 and 2011 (amounts in thousands):

 
Three Months Ended September 30,
 
Increase/
 
%
 
2012
 
2011
 
(Decrease)
 
Change
New releases
$
58,028

 
63.2
%
 
$
75,448

 
63.1
%
 
$
(17,420
)
 
(23.1
)%
Catalog
33,770

 
36.8

 
44,162

 
36.9

 
(10,392
)
 
(23.5
)
Net sales before changes in deferred net revenue
91,798

 
100.0
%
 
119,610

 
100.0
%
 
(27,812
)
 
(23.3
)
Changes in deferred net revenue
15,559

 
 
 
26,394

 
 
 
(10,835
)
 
(41.1
)
Consolidated net sales
$
107,357

 
 
 
$
146,004

 
 
 
$
(38,647
)
 
(26.5
)%
 
Six Months Ended September 30,
 
Increase/
 
%
 
2012
 
2011
 
(Decrease)
 
Change
New releases
$
58,945

 
45.2
%
 
$
164,477

 
63.1
%
 
$
(105,532
)
 
(64.2
)%
Catalog
71,378

 
54.8

 
96,372

 
36.9

 
(24,994
)
 
(25.9
)
Net sales before changes in deferred net revenue
130,323

 
100.0
%
 
260,849

 
100.0
%
 
(130,526
)
 
(50.0
)
Changes in deferred net revenue
110,721

 
 
 
80,308

 
 
 
30,413

 
37.9

Consolidated net sales
$
241,044

 
 
 
$
341,157

 
 
 
$
(100,113
)
 
(29.3
)%

Net sales of our new releases decreased $17.4 million and $105.5 million in the three and six months ended September 30, 2012, compared to the same periods last fiscal year. The decrease in the three and six months ended September 30, 2012 was due to a decrease in the number units sold of new releases, as we only had one new release in the current period compared to the release of several new titles in the same periods last fiscal year. This decrease was partially offset by a higher average net selling price on Darksiders II compared to the titles released in the same periods last fiscal year.

Net sales of our catalog titles decreased $10.4 million and $25.0 million in the three and six months ended September 30, 2012, compared to the same periods last fiscal year. The decreases were primarily due to fewer catalog units sold.

Net Sales by Territory
 
The following table presents our net sales by territory for the three and six months ended September 30, 2012 and 2011 (amounts in thousands):


26

 
Three Months Ended September 30,
 
Increase/
 
%
 
2012
 
2011
 
(Decrease)
 
Change
North America
$
53,460

 
58.2
%
 
$
68,757

 
57.5
%
 
$
(15,297
)
 
(22.2
)%
Europe
32,322

 
35.2

 
40,145

 
33.6

 
(7,823
)
 
(19.5
)
Asia Pacific
6,016

 
6.6

 
10,708

 
8.9

 
(4,692
)
 
(43.8
)
International
38,338

 
41.8

 
50,853

 
42.5

 
(12,515
)
 
(24.6
)
Net sales before changes in deferred net revenue
91,798

 
100.0
%
 
119,610

 
100.0
%
 
(27,812
)
 
(23.3
)
Changes in deferred net revenue
15,559

 
 
 
26,394

 
 
 
(10,835
)
 
(41.1
)
Consolidated net sales
$
107,357

 
 
 
$
146,004

 
 
 
$
(38,647
)
 
(26.5
)%

 
Six Months Ended September 30,
 
Increase/
 
%
 
2012
 
2011
 
(Decrease)
 
Change
North America
$
76,785

 
58.9
%
 
$
156,500

 
60.0
%
 
$
(79,715
)
 
(50.9
)%
Europe
44,328

 
34.0

 
75,375

 
28.9

 
(31,047
)
 
(41.2
)
Asia Pacific
9,210

 
7.1

 
28,974

 
11.1

 
(19,764
)
 
(68.2
)
International
53,538

 
41.1

 
104,349

 
40.0

 
(50,811
)
 
(48.7
)
Net sales before changes in deferred net revenue
130,323

 
100.0
%
 
260,849

 
100.0
%
 
(130,526
)
 
(50.0
)
Changes in deferred net revenue
110,721

 
 
 
80,308

 
 
 
30,413

 
37.9

Consolidated net sales
$
241,044

 
 
 
$
341,157

 
 
 
$
(100,113
)
 
(29.3
)%

Net sales in North America in the three and six months ended September 30, 2012 decreased $15.3 million and $79.7 million compared to the same periods last fiscal year. These decreases were primarily due to fewer overall units sold compared to the same periods last fiscal year, partially offset by a higher average net selling price on Darksiders II compared to the titles released in the same periods last fiscal year.

Net sales in Europe in the three and six months ended September 30, 2012 decreased $7.8 million and $31.0 million 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, 2012 decreased our reported net sales in this territory by $2.9 million and $3.9 million, respectively. The decreases in the three and six months ended September 30, 2012 were primarily due to fewer units sold of Darksiders II compared to the number of units sold of titles we released in the same periods last fiscal year. These decreases were partially offset by a higher average net selling price on Darksiders II in the three months ended September 30, 2012 and higher average net selling prices overall in the six months ended September 30, 2012 compared to the same periods last fiscal year.

Net sales in the Asia Pacific territory in the three and six months ended September 30, 2012 decreased $4.7 million and $19.8 million compared to the same periods last fiscal year. Changes in foreign currency translation rates during the three months ended September 30, 2012 were immaterial. Changes in foreign currency translation rates during the six months ended September 30, 2012 decreased our reported net sales by $0.2 million. The decreases in the three and six months ended September 30, 2012 were primarily due to fewer overall units sold, and to a lesser extent lower average net selling prices, compared to the same periods last fiscal year.

Cost of Sales
 
Cost of sales decreased $80.7 million, or 50.7%, and $139.2 million, or 46.5%, in the three and six months ended September 30, 2012, respectively, compared to the same periods last fiscal year.  As a percent of net sales, cost of sales decreased 35.9 points and 21.3 points in the three and six months ended September 30, 2012, respectively, compared to the same periods last fiscal year.

Cost of Sales - Product Costs (amounts in thousands)
 
September 30, 2012
 
% of net sales
 
September 30, 2011
 
% of net sales
 
% Change
Three Months Ended
$36,379
 
33.9%
 
$57,986
 
39.7%
 
(37.3)%
Six Months Ended
$74,865
 
31.1%
 
$125,049
 
36.7%
 
(40.1)%
 
Product costs primarily consist of direct manufacturing costs, including platform manufacturer license fees, net of manufacturer

27

volume rebates and discounts. In the three and six months ended September 30, 2012, product costs as a percent of net sales decreased 5.8 points and 5.6 points, respectively, compared to the same period last fiscal year. The decrease in product costs as a percent of net sales in the three and six months ended September 30, 2012 was primarily due to the current quarter recognition of net sales and product costs related to Saints Row: The Third and UFC Undisputed 3. These titles were initially released in the second half of fiscal 2012 and have had lower product costs relative to their net sales compared to the performance of products recognized in the same period last fiscal year. This was partially offset by uDraw, which had higher product costs per unit compared to the same period last fiscal year. Additionally, the decrease in product costs as a percent of net sales in the three and six months ended September 30, 2012 was also due to an increase in our sales mix of digitally delivered revenue which does not have associated product costs.

Cost of Sales - Software Amortization and Royalties (amounts in thousands)
 
September 30, 2012
 
% of net sales
 
September 30, 2011
 
% of net sales
 
% Change
Three Months Ended
$37,788
 
35.2%
 
$77,893
 
53.3%
 
(51.5)%
Six Months Ended
$75,141
 
31.2%
 
$142,813
 
41.9%
 
(47.4)%
 
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 i) the cancellation of an unreleased game and ii) changes in the development direction on another unreleased game, as well as a net benefit associated with the June 2012 transfer of the license we previously had with the UFC and the related game cancellation this fiscal year, and excluding charges associated with game cancellations and impairments in the prior fiscal year (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, 2012 decreased 6.2 points and 6.9 points, respectively, compared to the same periods last fiscal year. The decrease in the three months ended September 30, 2012 was primarily due to Red Faction: Armageddon, which was recognized in the three months ended September 30, 2011 and had higher development costs relative to its net sales, compared to the mix of titles included in net sales in the same period this fiscal year. The decrease in the six months ended September 30, 2012 was primarily due to titles such as Red Faction: Armageddon, Homefront, and UFC Trainer that were recognized in the 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 period this fiscal year.

Cost of Sales - License Amortization and Royalties (amounts in thousands)
 
September 30, 2012
 
% of net sales
 
September 30, 2011
 
% of net sales
 
% Change
Three Months Ended
$4,179
 
3.9%
 
$23,156
 
15.9%
 
(82.0)%
Six Months Ended
$9,928
 
4.1%
 
$31,295
 
9.2%
 
(68.3)%
 
License amortization and royalties expense consists of royalty payments due to licensors, which are expensed at the higher of (1) the contractual royalty rate based on actual net product sales for such license, or (2) an effective rate based upon total projected net sales for such license.  Net sales from our licensed properties represented 34% and 38% of our total net sales in the three and six months ended September 30, 2012, respectively, compared to 47% and 48% of our total net sales in the three and six months ended September 30, 2011.

License amortization and royalties expense in the six months ended September 30, 2012 included a $2.0 million benefit related to the reduction of a license obligation that was accrued as of March 31, 2012 as a result of negotiations with one of our previous kids' licensors (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, 2011, license amortization and royalties expense included a $16.0 million charge related to a license abandoned as part of our fiscal 2012 second quarter business realignment. Excluding these items, license amortization and royalties expense as a percent of net sales in the three and six months ended September 30, 2012 decreased by 1.0 point and increased by less than a point, respectively, compared to the same periods last fiscal year. The decrease in the three months ended September 30, 2012 was primarily due to the smaller mix of net sales from licensed products in the current period compared to the same period last fiscal year. The slight increase in the six months ended September 30, 2012 was primarily due to the mix of licensed products recognized in the current period, such as UFC Undisputed 3, which had higher effective license rates compared to the mix of licensed products recognized in the same period last fiscal year. This was partially offset by the smaller mix of net sales from licensed products in the six months ended September 30, 2012 compared to the same period last fiscal year.


28

Operating Expenses

Our operating expenses decreased $35.4 million or 42.2% and $92.7 million, or 52.5% in the three and six months ended September 30, 2012, respectively, compared to the same periods last fiscal year.

Product Development (amounts in thousands)
 
September 30, 2012
 
% of net sales
 
September 30, 2011
 
% of net sales
 
% Change
Three Months Ended
$11,583
 
10.8%
 
$27,954
 
19.1%
 
(58.6)%
Six Months Ended
$20,878
 
8.7%
 
$58,143
 
17.0%
 
(64.1)%
 
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 decreased $16.4 million and $37.3 million in the three and six months ended September 30, 2012, respectively, compared to the same periods last fiscal year.

Included in the three and six months ended September 30, 2012 was $0.5 million and $1.0 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).  Included in the three and six months ended September 30, 2011 was $4.5 million and $7.9 million, respectively, of cash severance charges and other employee-based costs recorded related to our business realignments. Excluding these charges, product development expense decreased $12.4 million and $30.3 million in the three and six months ended September 30, 2012, respectively, compared to the same periods last fiscal year.  These decreases were primarily due to a reduction in expenditures resulting from our studio closures and a reduction in the number of games under development.

Selling and Marketing (amounts in thousands)
 
September 30, 2012
 
% of net sales
 
September 30, 2011
 
% of net sales
 
% Change
Three Months Ended
$27,324
 
25.5%
 
$37,765
 
25.9%
 
(27.6)%
Six Months Ended
$41,963
 
17.4%
 
$88,441
 
25.9%
 
(52.6)%
 
Selling and marketing expenses consist of advertising, promotional expenses, and personnel-related costs. Selling and marketing expenses decreased $10.4 million and $46.5 million in the three and six months ended September 30, 2012, respectively, compared to the same periods last fiscal year. The decrease on a dollar-basis in the three and six months ended September 30, 2012 was primarily due to a reduction in spending in support of future releases, as well as a decrease in personnel related costs, compared to the same periods last fiscal year. Additionally, the decrease on a dollar-basis in the six months ended September 30, 2012 reflected reduced spending on new releases as we released fewer new titles in the current period compared to the same period last fiscal year.

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 1.8 points and 1.7 points in the three and six months ended September 30, 2012, respectively, compared to the same periods last fiscal year. The decrease in the three months ended September 30, 2012 was primarily due to a decrease in marketing support for future releases compared to the same period last fiscal year, as well as a decrease in personnel related costs. The decrease in the six months ended September 30, 2012 was primarily due to decreased marketing support for our portfolio of catalog titles relative to their net sales compared to the same period last fiscal year.

General and Administrative (amounts in thousands)
 
September 30, 2012
 
% of net sales
 
September 30, 2011
 
% of net sales
 
% Change
Three Months Ended
$9,809
 
9.1%
 
$12,037
 
8.2%
 
(18.5)%
Six Months Ended
$19,941
 
8.3%
 
$24,086
 
7.1%
 
(17.2)%
 
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. The decrease of $2.2 million and $4.1 million in general and administrative expenses in the three and six months ended September 30, 2012, respectively, as compared to the same periods in the last fiscal year was primarily due to lower personnel related costs.


29

Restructuring
 
Restructuring charges generally include costs such as, severance and other employee-based charges in excess of standard business practices, costs associated with lease abandonments less estimates of sublease income, charges related to long-lived assets, and costs of other non-cancellable contracts.  In the three months ended September 30, 2012 restructuring charges and adjustments reflected a net gain of $0.3 million consisting primarily of adjustments to sublease assumptions in connection with our fiscal 2012 second quarter realignment. In the six months ended September 30, 2012 restructuring charges and adjustments reflected a net expense of $1.1 million, and consisted primarily of adjustments to sublease assumptions in connection with our fiscal 2013 first quarter realignment. 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. For further information related to our realignment 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 the Notes and our Credit Agreement and Security Agreement (as amended, collectively, the “Credit Facility”) with Wells Fargo Capital Finance, LLC. For further discussion of the Notes and the Credit Facility, see “Note 6 — Debt” in the notes to the condensed consolidated financial statements included in Part I, Item 1.

Interest and other income (expense), net in the three months ended September 30, 2012 was a net gain of $0.7 million, primarily reflecting the removal of accumulated foreign currency translation adjustments related to foreign entities that were closed in connection with our realignment plans. Interest and other income (expense), net in the six months ended September 30, 2012 was expense of $0.1 million, primarily reflecting foreign currency transaction losses which were partially offset by the impact of the removal of accumulated foreign currency translation adjustments related to the foreign entities that were closed in connection with our realignment plans. 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.
 
Income Taxes
 
In the three and six months ended September 30, 2012, we had income tax expense of $2.3 million and $2.8 million, respectively.  Income tax expense in both periods relates primarily to a valuation allowance for certain foreign net operating losses, as well as income earned in foreign jurisdictions, which is not reduced by carryforward losses in the U.S. 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. The effective tax rate differs significantly from the federal statutory rate; this difference is primarily due to taxable losses in the U.S. that are fully offset by a valuation allowance.

Liquidity and Capital Resources

Financial Condition
 
At September 30, 2012, we had working capital of $5.6 million, including cash and cash equivalents of $36.3 million. Our working capital was reduced by $24.2 million related to the non-cash deferral of revenue, net of related expenses, as of September 30, 2012.

As described above, we have delayed the release of South Park: The Stick of Truth, which was originally scheduled for release on March 5, 2013, to early fiscal 2014 due to the need for additional development time and the release of Company of Heroes 2 and Metro: Last Light, both of which are expected to ship in March 2013, later than initially planned. Because of the calendar movement for the release of games, we will likely need to raise additional capital and may also need to defer and/or curtail currently planned expenditures, cancel projects currently in development, sell assets and/or pursue additional external sources of liquidity, which may not be available on financially attractive terms. We have engaged Centerview Partners LLC to assist us in evaluating strategic and financing alternatives intended to improve our overall liquidity, including raising additional capital, preserve our ability to bring games to market during advantageous release windows and to help address the Notes. There can be no assurance that the evaluation of strategic and financing alternatives will result in a transaction or financing, or that, if completed, said transaction and/or financing will be on attractive terms. Our inability to successfully complete a transaction or financing on attractive terms would have a material adverse impact on our ability to comply with the requirements of our credit and debt facilities

30

and to sustain our operations. Our ability to sustain our operations and meet our liquidity needs could also be affected by various risks and uncertainties described in "Part II, Item 1A. Risk Factors."

Sources and Uses of Cash (amounts in thousands)
 
September 30,
2012
 
March 31,
2012
 
Change
Cash and cash equivalents
$
36,269

 
$
75,977

 
$
(39,708
)
Percentage of total assets
14
%
 
19
%
 
 


 
 
Six Months Ended September 30,
 
 
 
2012
 
2011
 
Change
Net cash used in operating activities
$
(51,298
)
 
$
(22,450
)
 
$
(28,848
)
Net cash used in investing activities
(3,741
)
 
(4,411
)
 
670

Net cash provided by (used in) financing activities
21,000

 
(1,243
)
 
22,243

Effect of exchange rate changes on cash
(5,669
)
 
(6,444
)
 
775

Net decrease in cash and cash equivalents
$
(39,708
)
 
$
(34,548
)
 
$
(5,160
)
 
Generally, our primary sources of internal liquidity are cash and cash equivalents. In addition, as further discussed below, we may elect to sell 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. Our principal uses of cash are for product purchases of discs and cartridges along with associated manufacturer's royalties, payments to external developers and licensors, costs of internal software development, and selling and marketing expenses. In the six months ended September 30, 2012 our cash and cash equivalents decreased $39.7 million, from $76.0 million at March 31, 2012 to $36.3 million at September 30, 2012. The decrease in our cash balance was primarily due to investments in software development and payments of other liabilities, partially offset by borrowings under the Credit Facility. For further information regarding the movement in our cash balance during the six months ended September 30, 2012, refer to the condensed consolidated statement of cash flows for that period which is included in Part I, Item 1.

Our business is cyclical and thus our working capital needs are impacted by seasonality and the timing of new product releases. 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. During the three months ended September 30, 2012, we borrowed $21.0 million under the Credit Facility. In addition, in order to expedite collections on our accounts receivable, 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).

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, 2012, to expedite our receivables collections from Walmart, we sold $6.1 million and $7.5 million, respectively, of accounts receivable under the Purchase Agreement, without recourse, that would have otherwise been collected subsequent to September 30, 2012. The loss related to interest recognized on this transaction for the three and six months ended September 30, 2012 is classified in "Interest and other income (expense), net" in our condensed consolidated statements of operations and was an immaterial amount. 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 an asset based revolving credit facility providing for up to $50.0 million in aggregate principal amount of loans and other financing accommodations. The Credit Facility allows up to $10.0 million of the total to be used as a letter of credit subfacility. Although the Credit Facility provides up to $50.0 million in borrowings, the current available borrowing base reduces the potential for additional borrowing at this time. At September 29, 2012 we were in default under the terms of the Credit Facility (see discussion below).


31

The Credit Facility has a four-year term; provided, however, it will terminate on June 16, 2014 if any obligations are still outstanding 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. 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 with respect to letters of credit.
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 a continuing event of default and at the option of the required lenders (as defined in the Credit Facility), all of the amounts outstanding under the Credit Facility may be declared to be immediately due and payable and any amount outstanding will bear interest at 2.0% above the interest rate otherwise applicable.  In the event loan availability on the Credit Facility is below 12.5% (16% beginning January 1, 2013) of the maximum revolver amount (the "Covenant Testing Level"), the Credit Facility requires, among other matters, that we maintain certain financial covenants.  In the event the financial covenants become applicable, we would be required to maintain an annual fixed charge coverage ratio, as defined in the Credit Facility, of at least 1.1 to 1.0.
The Credit Facility is guaranteed by most of our domestic subsidiaries and secured by substantially all of our assets. The Credit Facility contains financial reporting covenant and other customary affirmative and negative covenants, including, among other terms and conditions, 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.
During the three months ended September 30, 2012, we borrowed $21.0 million under the Credit Facility. In the three months ended September 30, 2012 interest expense was $0.2 million and amortization of debt issuance costs related to the Credit Facility was $0.2 million; these amounts were capitalized as part of our in-process software development costs. As of September 30, 2012 we had outstanding borrowings under the Credit Facility of $21.0 million. During the six months ended September 30, 2012, we established a letter of credit for $0.6 million under the Credit Facility that is related to a lease we have for one of our studio locations.

At September 29, 2012, the last day of our fiscal 2013 second quarter, borrowings under the Credit Facility were $21.0 million. The borrowings are classified as a current liability and reflected in the “Secured credit line” line item in our condensed consolidated balance sheet. On October 15, 2012, we submitted to Wells Fargo a detail of our eligible accounts receivable and inventories as of September 29, 2012. Wells Fargo used that information to calculate the borrowing base certificate as of September 29, 2012. That borrowing base certificate was returned to us on October 16, 2012 and indicated we were over-advanced under the Credit Facility, thereby triggering the requirement that we maintain certain financial covenants and reduce the amount of our borrowings under the Credit Facility. As of September 29, 2012, we did not meet the applicable financial covenant and thus an event of default arose under the terms of the Credit Facility. On October 17, 2012, we repaid $5.6 million in borrowings under the Credit Facility in an effort to regain compliance under the Credit Facility as of that date. On October 17, 2012, after the repayment, borrowings outstanding under the Credit Facility were $15.4 million. Wells Fargo continued to fund our requests for borrowings under the Credit Facility, as evidenced by a $1.0 million borrowing made on November 2, 2012. On November 7, 2012, we were informed by Wells Fargo that because (i) loan availability was less than the Covenant Testing Level on one or more occasions as of and after September 29, 2012, and (ii) we failed to comply with the fixed charge coverage ratio for the quarter ended September 29, 2012, an event of default had occurred under the terms of the Credit Facility. We are currently in discussions with Wells Fargo regarding the asserted event of default and believe that we will reach an agreement with Wells Fargo with respect to such default; however, there can be no assurance that we will achieve an agreement. As of September 29, 2012, the default under our Credit Facility did not trigger a cross-default under the Notes.

At September 30, 2012, approximately 52% of our cash and cash equivalents were domiciled in foreign tax jurisdictions.  We expect to repatriate all or a portion of these funds to the U.S., and we may be required to pay additional taxes (such as foreign withholdings) in certain foreign jurisdictions, which we do not expect to be significant. We do not anticipate that such repatriation, in the short-term, would result in actual cash payments in the U.S., as the taxable event would likely be offset by the utilization of our net operating losses and tax credits.  However, the repatriation of foreign cash may be subject to certain restrictions and/or limitations which may hinder our ability to repatriate such cash to the U.S.

Cash Flow from Operating Activities.  Cash used in operating activities was $51.3 million in the six months ended September 30, 2012, compared to $22.5 million in the same period last fiscal year.  The change in cash flow from operating activities was primarily

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the result of higher cash collections of receivables in the six months ended September 30, 2011 which was related to releases that occurred late in the fourth quarter of fiscal 2011. This was partially offset by a decrease in investment in software development.

Cash Flow from Investing Activities.  Cash used in investing activities was $3.7 million in the six months ended September 30, 2012, compared to $4.4 million in the same period last fiscal year.  The change in cash flow from investing activities was primarily due to a decrease in purchases of property and equipment.
 
Cash Flow from Financing Activities.  Cash provided by financing activities in the six months ended September 30, 2012 was $21.0 million compared to cash used in financing activities of $1.2 million in the same period last fiscal year. The change in cash flow from financing activities was primarily due to borrowings under the Credit Facility.
 
Effect of Exchange Rate Changes on Cash.  Changes in foreign currency translation rates decreased our reported cash balance by $5.7 million.
 
Key Balance Sheet Accounts
 
At September 30, 2012, our total current assets were $167.8 million, down from $290.0 million at March 31, 2012. In addition to cash and cash equivalents, our current assets primarily consisted of:

Accounts Receivable. Accounts receivable decreased $9.3 million, from $16.0 million at March 31, 2012 to $6.7 million at September 30, 2012. The decrease was primarily due to lower sales volumes in the second quarter of fiscal 2013 as compared to the fourth quarter of fiscal 2012. Accounts receivable allowances were $47.8 million at September 30, 2012, a $22.6 million decrease from $70.4 million at March 31, 2012. 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% at September 30, 2012 and 2011. 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 $6.1 million, from $18.5 million at March 31, 2012 to $12.4 million at September 30, 2012. The decrease in inventory was primarily due to the timing of releases. Inventory turns, excluding the impact of changes in deferred costs, on a rolling twelve-month basis were 15 and 14 at September 30, 2012 and March 31, 2012, respectively.

Licenses. Our investment in licenses, including the long-term portion, decreased $16.9 million, from $64.5 million at March 31, 2012 to $47.6 million at September 30, 2012. The decrease was primarily due to the recognition of previously deferred license amortization and royalties expense.

Software Development. Capitalized software development, including the long-term portion, decreased $26.6 million, from $130.6 million at March 31, 2012 to $104.0 million at September 30, 2012. The decrease was primarily due to the recognition of previously deferred software amortization and royalties expense. Approximately 90% of the software development asset balance at September 30, 2012 is for titles that have expected release dates in the remainder of fiscal 2013 and beyond.

Total current liabilities at September 30, 2012, were $162.2 million, down from $271.3 million at March 31, 2012. Current liabilities primarily consisted of:

Accounts Payable. Accounts payable increased $14.5 million, from $42.9 million at March 31, 2012 to $57.4 million at September 30, 2012. The increase in accounts payable was primarily due to the timing of product development milestone payments.

Accrued and Other Current Liabilities. Accrued and other current liabilities decreased $33.9 million, from $83.7 million at March 31, 2012 to $49.8 million at September 30, 2012. The decrease was primarily due to payment of obligations.

Our liabilities at September 30, 2012 also consisted of:

Other Long-term Liabilities. Other long-term liabilities decreased $9.4 million, from $53.8 million at March 31, 2012 to $44.4 million at September 30, 2012. The decrease was primarily due to renegotiations with one of our licensors, as well as movements of 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, 2012 (see “Note 6 — Debt” in the notes to the condensed consolidated financial statements in Part I, Item 1).
 

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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, 2012 is as follows (amounts in thousands):
 
 
 
Contractual Obligations and Commercial Commitments (6)
Fiscal
Years Ending
March 31,
 
Licenses and
Software
Development
(1)
 
Advertising (2)
 
Leases (3)
 
Debt (4)
 
Other (5)
 
Total
Remainder of 2013
 
$
45,027

 
$
5,004

 
$
7,464

 
$
21,000

 
$
1,981

 
$
80,476

2014
 
30,967

 
9,020

 
14,093

 
—

 
3,624

 
57,704

2015
 
13,600

 
970

 
12,620

 
100,000

 
424

 
127,614

2016
 
7,500

 
567

 
7,636

 
—

 
90

 
15,793

2017
 
7,500

 
509

 
4,721

 
—

 
—

 
12,730

Thereafter
 
—

 
375

 
11,948

 
—

 
—

 
12,323

 
 
$
104,594

 
$
16,445

 
$
58,482

 
$
121,000

 
$
6,119

 
$
306,640

 
(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, 2012 are $104.6 million. License commitments in the table above include $44.8 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, 2012 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 are based upon the specific arrangements we have with the respective licensors and range from fixed amounts to specified percentages of projected net sales (ranging from 3%-8%) related to the respective licenses.

(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 $2.2 million are accrued and classified as "Accrued and other current liabilities" and "Other long-term liabilities," respectively, in our September 30, 2012 condensed consolidated balance sheet due to the 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 $2.1 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 or required repurchases of the Notes, we expect to pay $2.5 million in fiscal 2013, $5.0 million in fiscal 2014, and $2.5 million in fiscal 2015, for an aggregate of $10.0 million in interest payments over the remaining term of the Notes (see "Note 6 — Debt").

As of September 30, 2012 we had outstanding borrowings under the Credit Facility of $21.0 million (see "Note 6 — Debt").

(5)
Other.  As discussed more fully in "Note 14 — Joint Venture and Settlement Agreements" in the notes to the consolidated financial statements in our 2012 10-K, amounts payable to Jakks totaling $5.0 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, 2012 (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, 2012 condensed consolidated balance sheet.

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(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, 2012, we had $3.9 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 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.

Critical Accounting Estimates

There have been no material changes to our critical accounting estimates as described in Part II, Item 7 to our 2012 10-K, under the caption “Critical Accounting Estimates.”

Recently Issued Accounting Pronouncements

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



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

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

Interest Rate Risk

At September 30, 2012, our $36.3 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, 2012 was $0.1 million and is included in "Interest and other income (expense), net" in our condensed consolidated statements of operations.

At September 30, 2012, we had outstanding borrowings under the Credit Facility of $21.0 million.

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, 2012 and 2011, 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, 2012, we did not have any outstanding foreign currency exchange forward contracts related to balance sheet hedging activities. The contracts we did have during the six months ended September 30, 2012, consisted primarily of AUD, CAD, EUR, and GBP; the net loss recognized from these contracts during that period was $4.3 million and is included in "Interest and other income (expense), net" in our condensed consolidated statements of operations.

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


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

We do not hedge foreign currency translation risk. A hypothetical 10% adverse change in foreign currency translation rates would result in a reduction of reported net sales of approximately $9.2 million and a decrease in reported income from operations before income taxes of approximately $0.3 million for the six months ended September 30, 2012. A hypothetical 10% adverse change in foreign currency translation rates would result in a reduction of reported total assets of approximately $16.7 million. These estimates assume an adverse shift in all foreign currency exchange rates, which do not always move in the same direction; actual results may differ materially.

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

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

Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures, have concluded that as of September 30, 2012, 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 2013 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

Federal Securities Class Action Case

A purported class action lawsuit on behalf of purchasers of THQ common stock between May 3, 2011 and February 3, 2012 (the "Class Period"), styled Zaghian vs. THQ Inc., et al., was filed against the Company and certain executive officers of the Company on June 15, 2012, in the United States District Court for the Central District of California, Southern Division.  The complaint alleges that the defendants knowingly made materially false and misleading statements regarding the Company's uDraw GameTablet during the Class Period.  The complaint seeks unspecified damages, reasonable attorneys' and experts' fees and costs and other relief. On July 19, 2012, the court granted the parties' stipulation providing that the defendants do not have to answer or file a motion to dismiss until sixty (60) days after the filing of an amended complaint. On September 14, 2012, the Court appointed Mike Hernandez as lead plaintiff and his counsel Levi Korsinsky as lead counsel. Pursuant to the stipulation and order of the court, an amended complaint is to be filed within sixty (60) days of the Court's order appointing lead counsel or November 13, 2012.  The Company and the other defendants believe the complaint is without merit and intend to vigorously defend the pending lawsuit.

Shareholder Derivative Actions

Three derivative actions were filed against the Company, Brian Farrell, Paul Pucino and the independent members of the Board of Directors by three different purported THQ shareholders - Parker Hine, Jonathan Kaplan, and Basudeb Dey. The actions filed by plaintiffs Parker Hine and Basudeb Dey were filed in Los Angeles Superior Court on August 28, 2012 and October 10, 2012, respectively. The action filed by plaintiff Jonathan Kaplan was filed in the United States District Court for the Central District of California on September 21, 2012. The allegations in each complaint are similar and predicated on the allegations in the federal securities class action summarized above.

Additionally, 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 net sales, operating results and cash flows are described below. These risks are not presented in order of importance or probability of occurrence.

We require additional capital to fund our planned business operations.

Development of quality products requires substantial up-front expenditures and thus we expect to utilize a substantial portion of our existing cash and cash equivalents and other working capital to develop our upcoming products. In addition to our cash and cash equivalents, the company has an asset-based credit facility that, subject to the terms and conditions thereof, provides up to $50.0 million in financing that we have drawn against in order to fund our business operations. As described above in Part I, Item 2 in the "Liquidity and Capital Resources" discussion, on November 7, 2012, we were informed by Wells Fargo that because (i) loan availability was less than the Covenant Testing Level on one or more occasions as of and after September 29, 2012, and (ii) we failed to comply with the fixed charge coverage ratio for the quarter ended September 29, 2012, an event of default had occurred under the terms of the Credit Facility (see “We failed to comply with a financial covenant under the Credit Facility, and as a result, an event of default has occurred under the terms of the Credit Facility.” below). Also as described above in Part I, Item 2 in the "Liquidity and Capital Resources" discussion, we have delayed the release of South Park: The Stick of Truth, which was originally scheduled for release on March 5, 2013, to early fiscal 2014 due to the need for additional development time and the release of Company of Heroes 2 and Metro: Last Light, both of which are expected to ship in March 2013, later than initially planned. Because of the calendar movement for the release of games, the company will likely need to raise additional capital and may need to also defer and/or curtail currently planned expenditures, cancel projects currently in development, sell assets and/or pursue additional external sources of liquidity, which may not be available on financially attractive terms. We have engaged Centerview Partners LLC to assist us in evaluating strategic and financing alternatives intended to improve our overall liquidity, including raising additional capital, preserve our ability to bring games to market during advantageous release windows and to help address the Notes. There can be no assurance that the evaluation of strategic and financing alternatives will result in a transaction or financing, or that, if completed, said transaction and/or financing will be on attractive terms. Our inability to successfully complete a transaction or financing on attractive terms would have a material adverse impact on our ability to comply with the requirements

38

of our credit and debt facilities and to sustain our operations.

Repatriation of foreign cash may be subject to certain restrictions and/or limitations which may hinder our ability to repatriate such cash to the U.S.

At September 30, 2012, approximately 52% of our cash and cash equivalents were domiciled in foreign tax jurisdictions.  We expect to repatriate all or a portion of these funds to the U.S., and we may be required to pay additional taxes (such as foreign withholdings) in certain foreign jurisdictions, which we do not expect to be significant. We do not anticipate that such repatriation, in the short-term, would result in actual cash payments in the U.S., as the taxable event would likely be offset by the utilization of our net operating losses and tax credits.  However, the repatriation of foreign cash may be subject to certain restrictions and/or limitations which may hinder our ability to repatriate such cash to the U.S.

We failed to comply with a financial covenant under the Credit Facility, and as a result, an event of default has occurred under the terms of the Credit Facility.

At September 29, 2012, the last day of our fiscal 2013 second quarter, borrowings under the Credit Facility were $21.0 million. The borrowings are classified as a current liability and reflected in the “Secured credit line” line item in our condensed consolidated balance sheet. On October 15, 2012, we submitted to Wells Fargo a detail of our eligible accounts receivable and inventories as of September 29, 2012. Wells Fargo used that information to calculate the borrowing base certificate as of September 29, 2012. That borrowing base certificate was returned to us on October 16, 2012 and indicated we were over-advanced under the Credit Facility, thereby triggering the requirement that we maintain certain financial covenants and reduce the amount of our borrowings under the Credit Facility. As of September 29, 2012, we did not meet the applicable financial covenant and thus an event of default arose under the terms of the Credit Facility. On October 17, 2012, we repaid $5.6 million in borrowings under the Credit Facility in an effort to regain compliance under the Credit Facility as of that date. On October 17, 2012, after the repayment, borrowings outstanding under the Credit Facility were $15.4 million. Wells Fargo continued to fund our requests for borrowings under the Credit Facility, as evidenced by a $1.0 million borrowing made on November 2, 2012. On November 7, 2012, we were informed by Wells Fargo that because (i) loan availability was less than the Covenant Testing Level on one or more occasions as of and after September 29, 2012, and (ii) we failed to comply with the fixed charge coverage ratio for the quarter ended September 29, 2012, an event of default had occurred under the terms of the Credit Facility. We are currently in discussions with Wells Fargo regarding the asserted event of default and believe that we will reach an agreement with Wells Fargo with respect to such default; however, there can be no assurance that we will achieve an agreement. As of September 29, 2012, the default under our Credit Facility did not trigger a cross-default under the Notes.

We have incurred operating losses during the last five fiscal years. We have restructured our business operations in order to adjust our cost structure to better align with our expected future business; however, we may continue to incur losses in the future.

We have had operating losses during the last five fiscal years. In fiscal 2012, we exited development of traditional kids' and movie-based licensed console games and revised our strategy to focus on our premium core franchises and to expand our digital revenues. As part of this business realignment, we implemented initiatives to streamline our organization and reduce our cost structure. We expect these actions to result in annualized reductions in our expenditures that will align with our expected lower levels of future net sales and thus allow us to become profitable; however, in the event our future net sales or required expenditures differ from our expectations for any reason, we may continue to incur losses in the future. In addition, there can be no assurance that we will be able to grow our net sales in future years.

We may not be able to refinance or generate sufficient cash to service and/or pay the Notes.

On August 4, 2009, we issued the Notes. The Notes pay interest semiannually, in arrears on February 15 and August 15 of each year and are due August 15, 2014, unless earlier converted, redeemed or repurchased. If we fail to maintain our listing with any U.S. national securities exchange, the holders of the Notes may require us to repay the principal prior to the maturity date. Our ability to make principal and interest 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 refinance the Notes or maintain a level of cash flows from operating activities sufficient to permit us to pay the principal or interest on the Notes. In addition, if the Notes are converted to common stock, our current stockholders will suffer dilution in their percentage ownership. The conversion price is $85.13 and depending upon the performance of our stock, it is very unlikely that the Notes will be converted and thus will become due and payable on August 15, 2014.


39

As described above in Part I, Item 2 in the "Liquidity and Capital Resources" discussion, on November 7, 2012, we were informed by Wells Fargo that because (i) loan availability was less than the Covenant Testing Level on one or more occasions as of and after September 29, 2012, and (ii) we failed to comply with the fixed charge coverage ratio for the quarter ended September 29, 2012, an event of default had occurred under the terms of the Credit Facility. As of September 29, 2012, the default under our Credit Facility did not trigger a cross-default under the Notes.

Our operating results may be adversely impacted by worldwide economic uncertainties.

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 are sensitive to general economic conditions and economic cycles.  In the recent past, general worldwide economic conditions have experienced a downturn due to slower economic activity, concerns about inflation, increased energy costs, decreased consumer confidence, reduced corporate profits and capital spending, and adverse business conditions. Any continuation or worsening of the current global economic and financial conditions could materially adversely affect (i) our ability to raise, or the cost of, needed capital, (ii) our ability to properly budget and forecast for future net sales and expenditures, and (iii) demand for our current and future products. We cannot predict the timing, strength, or duration of any economic slowdown or subsequent economic recovery, worldwide, or in the video game industry.

Our business is "hit" driven. If we do not deliver "hit" games, our net sales, operating results and cash flows could 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. It is difficult to produce high-quality products and to predict prior to production and distribution what products will be well received, even if they are well-reviewed, high-quality titles. "Hit" products published by our competitors may take a larger share of consumer spending than anticipated, which could cause our product sales to fall below expectations. Consumers may lose interest in a genre of games we produce. 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 adversely impact our net sales, operating results and cash flows.

We depend on a relatively small number of franchises for a significant portion of our net sales.

Because we no longer develop traditional kids' and movie-based licensed console games and have revised our strategy to focus on our premium core franchises and to expand our digital revenues, we depend on a smaller number of franchises and titles for a significant portion of our net sales in the future. Due to this dependence on a limited number of franchises, the failure to achieve anticipated results by one or more products based on these franchises may significantly impact our business and financial results.

If our products fail to gain market acceptance, we may not have sufficient cash flow to pay our expenditures or to develop a continuous stream of new games.

Our business depends on generating net sales from existing and new products. The market for video game products is subject to continually changing consumer preferences and the frequent introduction of new products. As a result, video game products typically have short market lives, often less than six months. Our products may not achieve and sustain market acceptance sufficient to generate net sales to meet our cash needs and operating requirements.

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 cost structure is attributable to expenditures for personnel, facilities and external development. In the event of additional declines in our current expected net sales, we may not be able to dispose of facilities, reduce personnel, terminate contracts or make other changes to our cost structure without disruption to our operations or without significant cash 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 or cash flow. Moreover, reducing costs may hinder our ability to develop a sufficient number of software titles to publish in the future.

Failure to appropriately adapt to rapid technological and consumer preference changes or emerging digital channels may adversely impact our market share and our operating results.
 
Rapid technological and consumer preference 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 and appealing to consumers. Currently, our industry is experiencing an increasing shift to online content and digitally downloaded games. We

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believe that much of the growth in the industry is coming from online markets and digital distribution of games, paid downloadable content ("DLC"), multi-player online games via services such as Xbox Live Arcade and free-to-play micro-transaction based 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 or distribution channels, our market share and our operating results may suffer. Our future success in providing online experiences and other digital content will depend upon our ability to adapt to rapidly-changing technologies, develop applications to accommodate evolving industry standards, improve the performance and reliability of our applications, as well as anticipate future consumer preferences.

Connectivity issues related to digital sales and online gameplay could impact our ability to sell and provide online services and content for our games, and could impact our net sales, operating results and cash flows.

We rely upon various third-party providers, such as Microsoft's Xbox Live, Sony's PlayStation Network, and Valve's Steam platform 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 negatively impacted. In addition, we could experience similar issues related to services we host on our internally managed servers. Such issues also could impact our ability to provide online services, and could negatively impact our net sales, cash flows, and operating results.

Our inability to maintain, acquire or create new intellectual property that has a high level of consumer recognition or acceptance could adversely impact our net sales, operating results and cash flows.
 
We generate a portion of our net sales from owned intellectual property and, under our business plan, expect to continue to generate net sales from our 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 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, operating results and cash flows.

Some of our products are based on intellectual property rights licensed from third parties. Failure to retain or renew such licenses, or renewals of such licenses on less advantageous terms, could cause our net sales and operating results to decline.
 
Some of our products are based on or incorporate intellectual property and other character or story rights licensed from third parties. For example, we annually release games based on our license with the WWE. These license and distribution agreements are limited in scope and time, and we may not be able to retain the licenses during the entire term or be able to renew key licenses when they expire. The loss of a significant number of intellectual property licenses or relationships with licensors could have an adverse effect on our ability to develop new products and therefore on our net sales and operating results. Additionally, the failure of intellectual property we license to be, or remain, popularly received could impact the market acceptance of those products in which the intellectual property is included. Such lack of market acceptance could result in the write-off of the unrecovered portion of minimum royalty guarantees, which could harm our business and financial results. Furthermore, competition for these licenses may also increase the advances, guarantees, and royalties that must be paid to the licensor.

High development costs for games which do not perform as anticipated and failure of platforms to achieve significant market penetration could result in potential impairments of capitalized software development and/or license costs, which would negatively affect our operating results.
 
Video games played on consoles and certain online-enabled games are expensive to develop. 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 and/or costs, which would negatively affect our operating results.

Video game product development schedules are difficult to predict and can be subject to delays. Postponements in shipments can substantially impact our net sales, cash flows and operating results 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 net sales and cash flow and thus cause our operating results and cash position in any given quarter to be materially different from expectations given our reduced product line-up.


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We rely on external developers for the development of some of our titles.

Some of our games are developed by third-party developers. We do not have direct control over the business, finances and operational practices of these external developers. 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 negative 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.

Our business is dependent upon the success and availability of the video game platforms on which consumers play our games.
 
We derive most of our net sales from the sale of products for play on video game platforms manufactured by third parties, such as PS3, Xbox 360, and the Wii and DS. The following factors related to such platforms can adversely impact sales of our video games and our profitability:
 
Popularity of platforms.  Since the typical development cycle for our games is 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, cash flows and operating results.
 
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.
 
Success of new platforms. We must make substantial product development and other investments in a particular platform well in advance of introduction of the platform and may be required to realign our product portfolio and development efforts in response to market changes. Furthermore, development costs for new console platforms are greater than such costs for current console platforms if we do not have the ability to re-utilize development engines for new platforms. If any increase in development costs are not offset by higher net sales, operating results will suffer and our financial position will be harmed. If the platforms for which we develop new software products or modify existing products do not attain significant market penetration, we may not be able to recover our development costs, which could be significant, and our business and financial results could be significantly harmed.

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.

Transitions in console platforms could adversely affect the market for interactive entertainment software.

In 2005, Microsoft released the Xbox 360 and, in 2006, Sony and Nintendo introduced the PS3 and Wii, respectively. Nintendo has announced that it intends to launch its next-generation console, the Wii U, in all major regions by the 2012 calendar year-end holiday buying season. When new console platforms are announced or introduced into the market, consumers typically reduce their purchases of game console entertainment software products for current console platforms in anticipation of new platforms becoming available. During these periods, sales of game console entertainment software products we publish may slow or even decline until new platforms are introduced and achieve wide consumer acceptance. This decline may not be offset by increased sales of products for the new console platforms. As console hardware moves through its life cycle, hardware manufacturers typically enact price reductions and decreasing prices may put downward pressure on software prices. During platform transitions, we may simultaneously incur costs both in continuing to develop and market new titles for prior-generation video game platforms, which may not sell at premium prices, and also in developing products for current-generation platforms, which will not generate immediate or near-term revenue. As a result, our operating results during platform transitions may be more volatile and more

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difficult to predict than during other times, and such volatility may cause greater fluctuations in our stock price.

Our inability to enter into agreements with the manufacturers to develop, publish and distribute titles on their platforms, changes to the royalty rates and fees in such agreements, or delays in manufacturing our products could negatively impact our net sales, cash flow and results of 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, we pay a licensing fee to the hardware manufacturers for each copy of a product manufactured for that manufacturer's game platform. The platform licensors have retained the flexibility to change their fee structures and/or pricing for online gameplay and features for their consoles and the manufacturing of products. The control that platform licensors have over the fee structures and/or pricing for their platforms and online access makes it difficult for us to predict our costs in the medium-to-long term. Any increase in fee structures and/or pricing could have a significant negative impact on our business models and operating results.

Further, since each of the manufacturers publishes games for its own platform, and some also manufacture 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, COKeM, GameStop, Target, and Walmart, in aggregate accounted for approximately 43% of our consolidated gross sales before the impact of changes in deferred gross revenue in fiscal 2012. Sales to these customers are made on a purchase order basis without long-term agreements or other forms of commitments. A substantial reduction or termination of purchases by any of our significant customers could negatively affect our net sales, cash flows and operating results. In addition, if one or more of our significant customers experience deterioration in their business, or become unable to obtain sufficient financing to maintain their operations and pay their outstanding receivables to us, our business and financial results could be harmed.

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 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 which may significantly harm our business and financial results.

Increased sales of used video game products by retailers could reduce demand for new copies of our games.
 
Several retailers, including one of our largest customers, GameStop, continue to 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, retailers' continued sales of used games, rather than new games, may adversely impact our ability to sell new games and could adversely impact our net sales, operating results, and cash flow in any given quarter.

Software pricing and sales allowances may impact our net sales and profitability.
 
We establish sales allowances based on estimates of future price protection and returns with respect to current period product net

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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.

If we are unable to sustain premium pricing on current-generation titles, our operating results may suffer.

If we are unable to sustain premium pricing on current-generation titles for the Xbox 360, PS3 and the Wii for as long as those platforms remain current generation, whether due to competitive pressure, retailers electing to price these products at a lower price or otherwise, we may experience a negative effect on our margins and operating results. Additionally, 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. As a result, 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. Further, we make provisions for in-channel price reductions based upon certain assumed lowest prices and if competitive pressures force us to lower our prices below those levels, we may experience a negative effect on our margins and operating results.

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. 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 typically short, strong sales of our competitors' games could negatively impact the sales of our games.

Competition with other forms of home-based entertainment may reduce sales of our products.
 
We compete with other forms of entertainment and leisure activities. For example, we believe the overall growth in the use of the Internet, tablets and online services, including social networking, by consumers may pose a competitive threat if customers and potential customers spend less of their available time playing our core, higher-priced video games and more of their time using the Internet, including playing social networking games on the Internet, tablets or mobile devices..
 
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,

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political, regulatory and other risks.
 
In fiscal 2012, excluding the impact of changes in deferred net revenue, we derived 38.3% 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; reduced access to retail sales channels caused by financial stability of retailers; 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 $1.9 million in fiscal 2012.

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 calendar year-end holiday buying season. Other factors that cause fluctuations in our sales and operating results include:
 
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the timing of our release of new titles as well as the release of our competitors' products;
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the popularity of both new titles and titles released in prior periods;
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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;
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the competition in the industry for retail shelf space;
•
the fluctuations in size and rate of growth of consumer demand for titles for different platforms; and
•
the timing of the introduction of new platforms and the accuracy of retailers' forecasts of consumer demand.
 
We believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. We may not be able to maintain consistent profitability on a quarterly or annual basis. It is likely that in some future quarter, our operating results may be below the expectations of securities 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 limited 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

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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 adversely 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 an adverse effect on our growth operational results 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 or take such actions, our cash flows and 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.
 

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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 2011, the U.S. Supreme Court declared as unconstitutional California's proposed legislation (“Brown v. EMEA/ESA”), which sought to regulate the sale of violent video games to minors. However, 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, fraudulent transactions, 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 operating results may be significantly impacted.
 
As of March 31, 2012, we had federal and state net operating loss carryforwards of $584.6 million and $338.6 million, respectively, and federal and state R&D tax credit carryforwards of $26.1 million and $22.6 million, respectively. Under applicable tax rules, we may "carry forward" these NOLs and credits (collectively referred to as “tax attributes”) which in general circumstances may offset any current and future taxable income and thus reduce our income tax liability, subject to certain requirements and restrictions.  Therefore, we believe that these tax attributes 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 tax attributes 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 tax attributes.  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 tax attributes and there can be no assurance that we will be able to utilize our tax attributes.
 
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. The realignment of our business that took place starting in January 2012 could have an adverse impact on the effectiveness of our internal controls 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

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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, 2012.
 
Limitations upon Payment of Dividends
 
Our Credit Facility contains limitations on our ability to pay cash dividends. 

Item 3. Defaults Upon Senior Securities

The disclosure under “Item 5. Other Information” is incorporated by reference herein.

Item 5. Other Information

At September 29, 2012, the last day of our fiscal 2013 second quarter, borrowings under the Credit Facility were $21.0 million. The borrowings are classified as a current liability and reflected in the “Secured credit line” line item in our condensed consolidated balance sheet. On October 15, 2012, we submitted to Wells Fargo a detail of our eligible accounts receivable and inventories as of September 29, 2012. Wells Fargo used that information to calculate the borrowing base certificate as of September 29, 2012. That borrowing base certificate was returned to us on October 16, 2012 and indicated we were over-advanced under the Credit Facility, thereby triggering the requirement that we maintain certain financial covenants and reduce the amount of our borrowings under the Credit Facility. As of September 29, 2012, we did not meet the applicable financial covenant and thus an event of default arose under the terms of the Credit Facility. On October 17, 2012, we repaid $5.6 million in borrowings under the Credit Facility in an effort to regain compliance under the Credit Facility as of that date. On October 17, 2012, after the repayment, borrowings outstanding under the Credit Facility were $15.4 million. Wells Fargo continued to fund our requests for borrowings under the Credit Facility, as evidenced by a $1.0 million borrowing made on November 2, 2012. On November 7, 2012, we were informed by Wells Fargo that because (i) loan availability was less than the Covenant Testing Level on one or more occasions as of and after September 29, 2012, and (ii) we failed to comply with the fixed charge coverage ratio for the quarter ended September 29, 2012, an event of default had occurred under the terms of the Credit Facility. We are currently in discussions with Wells Fargo regarding the asserted event of default and believe that we will reach an agreement with Wells Fargo with respect to such default; however, there can be no assurance that we will achieve an agreement. As of September 29, 2012, the default under our Credit Facility did not trigger a cross-default under the Notes.
 

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).
 

 
 

48

3.5

 
Certificate of Amendment of Certificate of Incorporation of THQ Inc. effective July 5, 2012 (incorporated by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K filed on July 6, 2012).
 
 
 
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

 
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).
 

 
 
4.4

 
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


Second Amendment to Confidential License Agreement for the Wii Console (Western Hemisphere) effective as of October 12, 2012 between Nintendo of America Inc. and THQ Inc. (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on September 13, 2012).

 
 
 
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.

49

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.
 
11/13/2012
THQ INC.
 
 
 
 
 
 
 
By:
/s/ Brian J. Farrell
 
 
 
Brian J. Farrell,
 
 
 
Chairman of the Board and Chief Executive Officer
 
 
 
 
 
 
 
 
 
11/13/2012
THQ INC.
 
 
 
 
 
 
 
By:
/s/ Paul J. Pucino
 
 
 
Paul J. Pucino,
 
 
 
Executive Vice President, Chief Financial Officer and Chief Accounting Officer
 
 
 
 
 


50