10-K 1 thq10-k3312012.htm THQ 10-K 3.31.2012
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
____________________________________________________________________________

FORM 10-K
(Mark One)
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 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
___________________________________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
 
Name of each exchange on which registered:
Common Stock, $.01 par value
 
The NASDAQ Stock Market LLC
Preferred Stock Purchase Rights
 
The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act: None
____________________________________________________________________________

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No R

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No R

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 R No

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 R No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 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.
Large accelerated filer o
Accelerated filer R
Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No R

The aggregate market value of the voting and non-voting common equity held by non-affiliates, computed by reference to the price at which the common equity was last sold, as of the last business day of the registrant's most recently completed second fiscal quarter, October 1, 2011, was approximately $118.3 million.

The number of shares outstanding of the registrant's common stock as of June 1, 2012 was approximately 68,517,738.

DOCUMENTS INCORPORATED BY REFERENCE
The registrant's 2012 Proxy Statement is incorporated by reference into Part III herein.

   


 



THQ INC. AND SUBSIDIARIES
INDEX TO ANNUAL REPORT ON FORM 10-K
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
FOR THE FISCAL YEAR ENDED MARCH 31, 2012
ITEMS IN FORM 10-K


 
 
PAGE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 


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FORWARD-LOOKING STATEMENTS

The statements contained in this Annual Report on Form 10-K ("10-K") that are not historical facts may be "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, but are not limited to, statements regarding industry prospects, our future economic performance including anticipated revenues and expenditures, 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 "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-K.

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

PART I

Item 1.  Business

Introduction

We are a leading worldwide developer and publisher of interactive entertainment software focused on the core gamer on 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 Microsoft's Xbox LIVE Marketplace ("Xbox LIVE") and Xbox LIVE Arcade ("XBLA") and Sony's PlayStation Network ("PSN"), 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, inSANE, and Saints Row and new properties in development by Patrice Désilets and Turtle Rock Studios; and
core games based on licensed properties such as Games Workshop's Warhammer 40,000 universe, Metro, and World Wrestling Entertainment ("WWE").

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

Our global sales network includes offices throughout North America, Europe and Australia. 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

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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 through high-end wireless devices, such as the iPhone, iTouch and iPad.

We were originally incorporated in New York in 1989 as Trinity Acquisition Corporation, which changed its name in 1991 to T.HQ, Inc. following a merger with THQ, Inc., a California corporation. We were reincorporated in Delaware as THQ Inc. in 1997. Our principal executive offices are located at 29903 Agoura Road, Agoura Hills, California 91301, and our telephone number is (818) 871-5000. Our Internet address is http://www.thq.com.

Fiscal Periods

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 consolidated financial statements and accompanying notes are presented as ending on a calendar month end. Our current fiscal year ending March 31, 2013 and the fiscal years ended March 31, 2012, 2011 and 2010 contain the following number of weeks:
Fiscal Period
 
Number of Weeks
 
Fiscal Period End Date
Year ending March 31, 2013 ("fiscal 2013")
 
52 weeks
 
March 30, 2013
Year ended March 31, 2012 ("fiscal 2012")
 
52 weeks
 
March 31, 2012
Year ended March 31, 2011 ("fiscal 2011")
 
52 weeks
 
April 2, 2011
Year ended March 31, 2010 ("fiscal 2010")
 
53 weeks
 
April 3, 2010

Our Strategy

Our strategy is to develop a select number of titles with a significant digital component targeted at the core gamer. Our goal is to build franchises over time, by delivering a high-quality gaming experience, building a dedicated community around the title, and delivering a significant level of online services and digital content. Our focus is on building franchises based primarily on our owned intellectual properties such as Saints Row, Homefront, and new properties in development by Patrice Désilets and Turtle Rock Studios. We intend to launch new intellectual properties on new platforms as they emerge. Our current focus does not include casual games on social networks or handheld devices.

During fiscal 2012, we made a number of changes to our organization and product lineup. We discontinued a number of titles in our product pipeline that did not fit our strategic objectives, thus reducing future product development expenses. We reduced the number of internal development studios from eleven to five. We exited markets, sold or reconfigured games and product lines that did not meet internal profitability thresholds or were no longer central to our strategy. We negotiated with our kids' and movie-based licensors to reduce our future license commitments. We reduced costs and headcount in our corporate and global publishing organizations as well as our studios impacted by the changes in our product line-up. In January 2012, we implemented a plan of restructuring in order to better align our operating expenses with the lower expected revenues under the updated strategy. In connection with this realignment, we significantly reduced other future product development expenditures which do not align with our current strategy. The majority of the restructuring was completed by March 31, 2012. We expect remaining severance amounts of $5.0 million to be paid by September 30, 2012. These actions will have reduced headcount by approximately 370 people.

Consistent with our strategy, on June 1, 2012, we entered into an agreement to transfer our license to develop future games based on the Ultimate Fighting Championship ("UFC"). After the write-off of the capitalized software development related to the UFC game currently under development, we estimate that this will result in a small gain. We also expect this action to result in the closure of the studio developing the UFC game, which could result in additional cash charges of up to $1.1 million related to severance, up to $1.3 million in cash charges related to leased facilities and non-cash charges of up to $0.5 million related to long-lived assets. For additional information, refer to "Note 22Subsequent Events" in the notes to the consolidated financial statements included in Part II, Item 8 for further information.

Our Industry

The interactive entertainment software industry includes the economic sector involved with the development, marketing and sale of video, PC and online games. It encompasses dozens of job disciplines and employs thousands of people worldwide. Video games are a mainstream entertainment choice for both children and adults. According to the "2011 Essential Facts About the Computer and Video Game Industry" published by the Entertainment Software Association, 72% of American households play

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games; the average gamer is 37 years old and has been playing for 12 years; and 42% of all players are women.

The first modern video game platform was introduced by Nintendo in 1985. Since then, advances in technology have resulted in continuous increases in the processing power of the chips that power both the consoles and PC. Today's major video game consoles, the PS3, Xbox 360 and Wii, are not simply gaming platforms, but also function as multimedia hubs that can deliver high-quality digital movies and television programs. These consoles all have Internet connectivity, allowing players to play online against other players and to download games and content directly from the Internet to the gaming console. Video games are also played on PCs that contain powerful graphics cards, and on advanced handheld devices such as the PSP and DS. Additionally, both online gaming and mobile and tablet gaming have become popular platforms for video game players over the last several years and are expected to be fast growing segments of our business. We believe that the ongoing transition to the digital delivery of games represents a beneficial change to our business. Digital delivery in all of its forms allows for consumers to easily sample games before buying them; allows for a reduction in piracy due to the persistent internet connection in the game, and allows for direct opportunities to interact with our consumers and offer them new products and services. Accordingly, we plan to continue integrating a digital component into our franchises where applicable, thus creating an ecosystem which we believe will retain consumers and generate increased revenues.

Our Products

We primarily develop, market and sell video games and other interactive software and content for play on console platforms, handheld platforms, mobile devices, PCs and online. The following products generated 10% or more of our net sales, before the impact of changes in deferred net revenue, during the respective fiscal years:
in fiscal 2012, Saints Row: The Third, WWE '12;
in fiscal 2011, Homefront, uDraw, UFC Undisputed 2010, and WWE SmackDown vs. Raw 2011; and
in fiscal 2010, UFC 2009 Undisputed and WWE SmackDown vs. Raw 2010.

Our games are based on intellectual property that is either wholly-owned by us or licensed from third parties under extended terms. We develop our games using both internal development resources and external development resources working for us pursuant to contractual agreements. Whether a game is developed internally or externally, upon completion of development we extensively play-test each game, and if required, send the game to the platform manufacturer (Microsoft, Nintendo or Sony) for its review and approval. Our console-based and handheld-based video games are manufactured for us by the platform manufacturers (or their authorized vendors). We then market and distribute our games for sale throughout the world.

Creating and Acquiring Our Intellectual Property

Our business process begins with an idea. Inspiration for our interactive entertainment software comes from many sources—from our internal studios, our external studio partners, and from existing intellectual properties that we either license or acquire.

We create and acquire new intellectual properties that we own. We refer to these properties as our "owned intellectual property[ies]". Our owned intellectual property is generally created by one of our development studios or by a third-party developer with whom we contract. We have also acquired intellectual properties from other publishers or developers. The titles we create based on our owned intellectual properties may contain certain licensed content, such as music or rights to use a name or object (such as a brand-name vehicle). In this case, we enter into a license agreement with the content owner and pay either a fixed fee or royalty for the use of such content. Our owned intellectual properties include: Company of Heroes, Darksiders, Homefront, Red Faction, Saints Row, and new properties in development by Patrice Désilets and Turtle Rock Studios.

In addition to creating and acquiring our owned intellectual properties, certain of our titles are based upon licensed properties that have attained a high level of consumer recognition or acceptance. We have a relationship with Games Workshop and create games based on their Warhammer 40,000 universe and we have a relationship with WWE and create games based on their content. These intellectual property licenses generally grant us the exclusive use of the property for specified titles, on specified platforms and for a specified license term. The licenses are of varying duration, and we pay royalties to our property licensors generally based on our net sales of the title that includes the licensor's intellectual property. We typically advance payments against minimum guaranteed royalties over the license term. Royalty rates are generally higher for properties with proven popularity and less perceived risk of commercial failure.

Prior to June 1, 2012, we had a relationship with Zuffa, LLC to create games based on their UFC content. For further information related to the transfer of this license, refer to "Note 22Subsequent Events" in the notes to the consolidated financial statements included in Part II, Item 8 for further information.

Developing Our Products

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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. The external development resources consist of third-party software developers and other independent resources such as artists, voice-over actors and composers.

We make the decision as to which development resources to use based upon the creative and technical challenges of the product, including whether the intellectual property being developed into a game is licensed, an original concept that we created, or an original concept created by a third-party developer. Once we determine where a product will be developed, our product development team oversees the internal or external resources in its design, technical assessment and construction of each game.

The development cycle for a new game depends on the platform and the complexity and scope of the game. Our development cycles generally range from 9 to 36 months. This requires that we assess whether there will be adequate retailer and consumer demand for a game and its platform well in advance of its release.

The investments in our product development, prior to when a game reaches technological feasibility, and other non-capitalizable costs, are recorded as product development expenses in our consolidated statements of operations. In fiscal 2012, fiscal 2011, and fiscal 2010, we had product development expenses, net of amounts capitalized, of $89.5 million, $79.4 million, and $87.2 million, respectively. These amounts include severance paid to product development staff and related charges under our business realignments totaling $12.3 million, $1.7 million, and $0.7 million in fiscal 2012, fiscal 2011, and fiscal 2010, respectively.

Upon completion of development, each game is extensively play-tested to ensure compatibility with the appropriate hardware systems and configurations, and to minimize the number of bugs and other defects found in the products. If applicable, we also send the game to the manufacturer for its review and approval. To support our products after release, we provide online access to our customers on a 24 hour basis as well as operator help lines during regular business hours. The customer support group tracks customer inquiries, and we use this data to help improve the development and production processes.

Manufacturing Our Products

Our console-based and handheld-based video games are manufactured for us by the platform manufacturers or their authorized vendors. We contract with various DVD replicators for the manufacturing of our PC products.

The platform game manufacturing process begins with our placing a purchase order with a manufacturer. We then send the approved software code to the manufacturer (together with related artwork, user instructions, warranty information, brochures and packaging designs) for manufacturing. We order product units to meet the anticipated requirements of our customers, based upon our sales forecasts for a game. We do not manufacture our products ourselves, and we typically do not carry significant amounts of inventory to meet rapid delivery requirements of customers or to assure ourselves of a continuous allotment of goods from manufacturers. At the time our product unit orders are filled by the manufacturer, we typically become responsible for the costs of manufacturing and the applicable per unit royalty on such units, even if the units do not ultimately sell.

We are required by our platform licenses to provide a standard defective product warranty on all of the products sold. Generally, we are responsible for resolving, at our own expense, any warranty or repair claims. We have not experienced any material warranty claims, but there is no guarantee that we will not experience such claims in the future.

Marketing Our Products

Our marketing plans vary significantly by title and by target demographic but generally consist of a three-pronged media plan encompassing TV, print and online advertising. Some of our campaigns also include billboard advertising, event sponsorship, in-theater advertising and radio placements. Retail or channel marketing efforts for our games include pre-sell give-aways, displays and/or demonstrations at retailer-specific trade shows, and cooperative retail advertising campaigns.

We continue to take a more aggressive approach in what we term the "connected marketing" space. This includes how we build our brand in the online space via editorial opportunities; screen shot, trailer and other game content releases online; advertising; official game websites; and community outreach and management. Social media sites have grown in both their popularity and influence within our diverse target demographic. This new consumer immersion in social media has allowed us to create new ways to drive brand awareness and purchase intent via a medium that is both relevant and authentic to our target demographics' acquisition of information. Game trial, through consumer demos released at retail or online, or game demos available at kiosks stationed at sports or other entertainment events, has been a key driver of consumer demand for several of our core games. We believe the move toward digital distribution will provide consumers with multiple methods to sample products digitally (at lower prices) before committing to a purchasing decision, which could potentially drive increased consumer awareness and adoption of

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our products.

Publicity is another key driver of awareness for our portfolio, as well as for THQ, as a publicly-held company. We maintain strong relationships with a broad group of business, consumer, entertainment and games enthusiast reporters across the globe, working closely to secure positive editorial coverage across broadcast, print and online editorial outlets.

Distributing and Selling Our Products

In North America, our products are primarily sold directly to mass merchandisers, consumer electronics stores, discount warehouses and national retail chain stores. Our products are also sold to smaller, regional retailers, as well as distributors who, in turn, sell our products to retailers that we do not service directly, such as grocery and drug stores. Our North American sales activities are conducted by THQ sales representatives throughout the U.S., as well as by our representatives in Canada and Mexico.

Our international publishing activities are conducted via our offices throughout North America, Europe, and Australia. Our international offices market and distribute to direct-to-retail customers and through distributors in both their home territories and collectively, to over 80 territories outside of the U.S.

We utilize electronic data interchange with most of our major customers in order to (i) efficiently receive, process, and ship customer product orders, and (ii) accurately track and forecast sell-through of products to consumers in order to determine whether to order additional products from the manufacturers. We believe that the direct relationship model we use allows us to better manage inventory, merchandise and communications. We ship all of our products to our North American customers from warehouses located in Michigan, and we ship most of our products to our international customers from warehouses located throughout Europe and Australia.

As discussed in Part II—Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," we typically only allow returns for our PC products; however, we may decide to provide price protection or allow returns for our video games after we analyze: (i) inventory remaining in the retail channel, (ii) the rate of inventory sell-through in the retail channel, and (iii) our remaining inventory on hand. We maintain a policy of giving credits for price protection and returns, but we do not give cash refunds.

We also globally distribute games and content digitally via the Internet through PSN, Xbox LIVE, XBLA, and websites such as Amazon, OnLive, Origin, and Valve, and through high-end wireless devices, such as the iPhone, iTouch, and iPad. Publishers are 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 our 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. Accordingly, we plan to continue integrating a digital strategy into our franchises where applicable, thus creating an ecosystem which we believe will retain consumers and generate increased revenues.

Platform License Agreements

Before we can develop, market, or sell video games on a console or handheld platform, we must enter into a license agreement with the manufacturer of such platform. The current "platform manufacturers" are Microsoft, Nintendo and Sony. Each of these platform license agreements allows us a non-exclusive right to use, for a fixed term and in a designated territory, technology that is owned by the platform manufacturer in order to publish our games on such platform. We are currently licensed to publish, in most countries throughout the world, titles on Xbox 360; PS3, PlayStation 2, and PSP; and the Wii and DS. Additionally, we are authorized to develop and publish online content compatible with each console that utilizes online content. As each platform license expires, if we intend to continue publishing games on such platform, we must enter into a new agreement or an amendment with the platform manufacturer to extend the term of the agreement. Certain agreements, such as the licenses with Sony for the PS3 and with Microsoft for the Xbox 360, automatically renew each year unless either party gives notice by the applicable date that it intends to terminate the agreement.

Our platform licenses require that each title be approved by the applicable platform manufacturer. The platform manufacturers have the right to review, evaluate and approve a prototype of each title and the title's packaging and marketing materials. Once a title is developed and has been approved by the platform manufacturer, except for online content, the title is manufactured solely by such platform manufacturer or its designated vendor. The licenses establish the payment terms for the manufacture of each cartridge or disc made, which generally provide for a charge for every cartridge or disc manufactured, and also establish a royalty rate for delivery of online content compatible with such manufacturer's platform. The amounts charged by the platform manufacturers for both console discs and handheld cartridges include a manufacturing, printing and packaging fee as well as a royalty for the use of the platform manufacturer's name, proprietary information and technology, and are subject to adjustment by

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the platform manufacturers at their discretion.

The platform license agreements also require us to indemnify the platform manufacturers with respect to all loss, liability and expense resulting from any claim against the platform manufacturer involving the development, marketing, sale, or use of our games, including any claims for copyright or trademark infringement brought against the platform manufacturer. Each platform license may be terminated by the platform manufacturer if a breach or default by us is not cured after we receive written notice from the platform manufacturer, or if we become insolvent. Upon termination of a platform license for any reason other than our breach or default, we have a limited period of time to sell any existing product inventory remaining as of the date of termination. The length of this sell-off period varies between 90 and 180 days, depending upon the platform agreement. We must destroy any such inventory remaining after the end of the sell-off period. Upon termination as a result of our breach or default, we must destroy any remaining inventory within a minimum number of days as specified by the platform manufacturer.

Seasonality; Deferral of Revenue

The interactive entertainment software industry is highly seasonal, with sales typically significantly higher during the third quarter of our fiscal year, due primarily to the increased demand for interactive games during the year-end holiday buying season. Additionally, our net sales are impacted by the deferral and/or recognition of revenue from the sale of titles for which the online service is more-than-inconsequential to the overall functionality of the game and for which we have a continuing involvement. Such deferrals are recognized ratably over the estimated service period, generally six months, beginning the month after initial sale. As a result, the quarter in which we generate the highest shipping volume may be different than the quarter in which we recognize the highest amount of net sales. Our results can also vary based on a number of factors, including title release dates, consumer demand for our products, market conditions and shipment schedules.

Major Customers

Our largest customers worldwide include Best Buy, COKeM, GameStop, Target and Wal-Mart. We also sell our products to other national and regional retailers, discount store chains, specialty retailers and distributors. Excluding the impact of changes in deferred net revenue, GameStop and Wal-Mart each accounted for more than 10% of our gross sales in fiscal 2012. In fiscal 2011 we entered into two new "supplier" agreements with Wal-Mart, which includes both Wal-Mart and Sam's stores (one for our console products and one for our PC products). The supplier agreements address certain standard terms and conditions, such as payment terms, between us and Wal-Mart; however, the agreements do not contain any commitment for Wal-Mart to purchase, or for us to sell, any minimum level of products. We do not have any agreements with GameStop. With respect to both Wal-Mart and GameStop, as well as our other customers, the customer submits a purchase order for each purchase request, and that purchase order contains basic pricing and delivery terms for such purchase. None of the purchase orders individually, with any customer, accounted for more than 10% of the Company's consolidated net sales for fiscal 2012. A substantial reduction in purchases, termination of purchases, or business failure by any of our largest customers could have a material adverse effect on us.

Competition

As a publisher of interactive entertainment software, we consider ourselves to be part of the entertainment industry. At the most fundamental level, our products compete with other forms of entertainment, such as motion pictures, television, music, Internet and online services for the leisure time and discretionary spending of consumers. Our primary competition for sales of video games comes from Microsoft, Nintendo and Sony, each of which is a large developer and publisher of software for its own platforms, as well as other publishers and developers of interactive entertainment software, such as Activision/Blizzard, Electronic Arts, Sega, Take-Two Interactive Software, and Ubisoft. Additionally, certain large intellectual property owners, such as Disney, Viacom, and Warner Bros. have established video game units to develop and publish games based upon certain of the properties they own. In recent years, our competition has expanded to include online publishers of interactive entertainment, such as Zynga.

In addition to competing for video game sales, we compete for licenses and brand-name recognition, access to distribution channels, and effectiveness of marketing and price. We also face competition from our competitors for the services of talented video game producers, artists, engineers and other employees.

Employees

As of March 31, 2012, we employed approximately 1,088 people, of whom over 402 were outside the United States. We believe that our ability to attract and retain qualified employees is a critical factor in the successful development and exploitation of our products and that our future success will depend, in large measure, on our ability to continue to attract and retain qualified employees. None of our employees are represented by a labor union or covered by a collective bargaining agreement and we consider our relations with employees to be favorable.

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Financial Information About Geographic Areas

See Part II—Item 7, "Management Discussion and Analysis of Financial Condition and Results of Operations" and "Note 20 —Segment and Geographic Information" in the notes to the consolidated financial statements included in Part II—Item 8.

Available Information

We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission ("SEC"). Our SEC filings, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act are available to the public free of charge over the Internet at our website at http://www.thq.com or at the SEC's web site at http://www.sec.gov. Our SEC filings will be available on our website as soon as reasonably practicable after we have electronically filed or furnished them to the SEC. Information contained on our website is not incorporated by reference into this 10-K. You may also read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. You can view our Code of Business Conduct and Ethics, our Code of Ethics for Executive Officers and Other Senior Financial Officers and the charters for each of our committees of the Board of Directors free of charge on the corporate governance section of our website.

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 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 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, we have a $50.0 million credit facility that we expect to draw against in order to fund our business operations. We believe we have adequate resources to execute on our product plan and deliver our multi-year pipeline of games; however, there can be no assurance that we will be able to do so without additional capital. In the event our future net sales or required expenditures differ from our expectations for any reason, and our external liquidity sources, including our credit facility and vendor credit terms, are not sufficient to meet our operating requirements, we may need to defer and/or curtail currently-planned expenditures, cancel projects currently in development, and/or pursue additional funding or additional external sources of liquidity, which may not be available on financially attractive terms, if at all, to meet our cash needs.

Our stock currently fails to meet the Nasdaq continued listing requirements. If we fail to regain compliance with continued listing requirements, our stock may be delisted.

On January 25, 2012, we received a written notification from Nasdaq notifying us that we fail to comply with Nasdaq's Marketplace Rule 5450(a)(1) (the “Rule”) because the bid price for our common stock, over the last 30 consecutive business days, has closed below the minimum $1.00 per share requirement for continued listing. The notification had no immediate effect on the listing of our common stock. In accordance with Marketplace Rule 5810(c)(3)(A), we have a period of 180 calendar days, or until July 23, 2012, to regain compliance with the Rule. If at any time before July 23, 2012, the bid price of our common stock closes at or above $1.00 per share for a minimum of 10 consecutive business days, Nasdaq will provide written notification that we have achieved compliance with the Rule. If compliance with the Rule cannot be demonstrated by July 23, 2012, our common stock

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will be subject to delisting from The Nasdaq Global Market. In the event that we receive notice that our common stock is subject to being delisted from The Nasdaq Global Select Market, Nasdaq rules permit us to appeal any delisting determination by the Nasdaq staff to a Nasdaq hearings panel.

On June 29, 2012, at a special meeting, our stockholders will vote on a proposal to approve an amendment to our certificate of incorporation in order to effect a reverse stock split of our common stock at a ratio of one-for-three, one-for-five, or one-for-ten, such ratio and effective date to be determined in the sole discretion of the Board (the “Reverse Stock Split”). It is anticipated that the Reverse Stock Split will be effectuated on or about July 5, 2012. In the event that our stockholders fail to approve the Reverse Stock Split or if our stock price fails to increase above $1.00 per share for a minimum of ten consecutive business days following the Reverse Stock Split, or we fail to meet any of the other listing requirements in the future, we may not be able to maintain our Nasdaq listing, which could have a material adverse effect on the market for and the market price of our common stock.

We may not be able to refinance or generate sufficient cash to service and/or pay our convertible senior notes.

On August 4, 2009, we issued the convertible senior notes ("Notes"). The Notes pay interest semiannually, in arrears on February 15 and August 15 of each year and are due August 15, 2014, unless earlier converted, redeemed or repurchased. 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.

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 will 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 will 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 success 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

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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 cover our costs and allow us to become profitable. If our products fail to gain market acceptance, we may not have sufficient cash flows to develop a continuous stream of new games, which we believe is essential to covering costs and achieving future profitability.

We may not be able to adequately adjust our cost structure in a timely fashion in response to a sudden decrease in demand.
 
A significant portion of our 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 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

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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.

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

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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 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.


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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 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.


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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, 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:
 
the timing of our release of new titles as well as the release of our competitors' products;
the popularity of both new titles and titles released in prior periods;
the deferral or subsequent recognition of net sales and costs related to certain of our products which contain online functionality;
the profit margins for titles we sell;
the competition in the industry for retail shelf space;
fluctuations in the size and rate of growth of consumer demand for titles for different platforms; and

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the timing of the introduction of new platforms and the accuracy of retailers' forecasts of consumer demand.
 
We believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. We may not be able to maintain consistent profitability on a quarterly or annual basis. It is likely that in some future quarter, our operating results may be below the expectations of 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 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

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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.
 
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 net operating loss carryforwards of $584.6 million and federal R&D tax credit carryforwards of $26.1 million. Under applicable tax rules, we may "carry forward" these NOLs in certain circumstances to offset

17


any current and future taxable income and thus reduce our income tax liability, subject to certain requirements and restrictions. Therefore, we believe that these NOLs could be a substantial asset. However, if we experience an "ownership change," as defined in Section 382 of the Internal Revenue Code, our ability to use the NOLs could be substantially limited, which could significantly increase our future income tax liability. On May 12, 2010, we entered into a Section 382 Rights Agreement with Computershare Trust Company, N.A., as rights agent, in an effort to prevent an "ownership change" from occurring and thereby protect the value of the NOLs. There can be no assurance, however, that the Section 382 Rights Plan will prevent an ownership change from occurring or protect the value of the NOLs and there can be no assurance that we will be able to utilize our NOLs.
 
We cannot be certain of the future effectiveness of our internal control over financial reporting or the impact of the same on our operations and the market price for our common stock.
 
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to include in our 10-K our assessment of the effectiveness of our internal control over financial reporting. Furthermore, our independent registered public accounting firm is required to report on whether it believes we maintain, in all material respects, effective internal control over financial reporting. Although we believe that we currently have adequate internal control procedures in place, we cannot be certain that our internal control over financial reporting will be effective in the future. 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 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 1B. Unresolved Staff Comments

None.

Item 2.  Properties

Our principal corporate and administrative office is located in approximately 100,000 square feet of leased space in a building located at 29903 Agoura Road, Agoura Hills, California. Including this office, the following is a summary of the square footage of the principal leased offices we maintained as of March 31, 2012:

Purpose
North America
 
Europe
 
Asia Pacific
 
Total
Sales and administrative
105,314

 
44,402

 
13,799

 
163,515

Product development
335,517

 
6,057

 
28,548

 
370,122

Total leased square footage
440,831

 
50,459

 
42,347

 
533,637


We also own 10,820 square feet of space in Phoenix, Arizona, which serves as our data center.

Item 3.  Legal Proceedings

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

Item 4.  Mine Safety Disclosures

Not applicable.


18


PART II

Item 5.  Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

THQ's common stock is listed on the NASDAQ Global Select Market under the symbol "THQI." The following table sets forth, for the periods indicated, the high and low intraday sales prices of our common stock as reported by the NASDAQ Global Select Market:
 
Sales Prices
 
High
 
Low
Fiscal Year Ended March 31, 2012
 
 
 
Fourth Quarter ended March 31, 2012
$
0.86

 
$
0.48

Third Quarter ended December 31, 2011
2.51

 
0.67

Second Quarter ended September 30, 2011
3.60

 
1.61

First Quarter ended June 30, 2011
4.87

 
3.29

Fiscal Year Ended March 31, 2011
 
 
 
Fourth Quarter ended March 31, 2011
$
6.53

 
$
4.25

Third Quarter ended December 31, 2010
6.39

 
3.86

Second Quarter ended September 30, 2010
5.02

 
3.33

First Quarter ended June 30, 2010
8.29

 
4.03


The last reported price of our common stock on June 1, 2012, as reported by NASDAQ Global Select Market, was $0.65 per share.

On January 25, 2012, we received a written notification from Nasdaq notifying us that we fail to comply with Nasdaq's Marketplace Rule 5450(a)(1) (the “Rule”) because the bid price for our common stock, over the last 30 consecutive business days, has closed below the minimum $1.00 per share requirement for continued listing. The notification had no immediate effect on the listing of our common stock (see "Nasdaq Notice" included in the "Business Trends" section of Item 7 for further discussion).

Holders

As of June 1, 2012 there were approximately 284 holders of record of our common stock.

Dividend Policy

We have never paid cash dividends on our common stock. We currently intend to retain future earnings, if any, to finance the growth and development of our business and, therefore, we do not anticipate paying any cash dividends in the foreseeable future. Additionally, our Credit Agreement and Security Agreement with Wells Fargo Capital Finance, LLC restricts our ability to issue cash dividends (see "Note 9 — Debt" in the notes to the consolidated financial statements included in Item 8).

Stock Price Performance Graph

The following stock price performance information shall not be deemed to be "filed" with the Securities and Exchange Commission nor shall this information be incorporated by reference into any future filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that we specifically incorporate it by reference into a filing.

The following graph shows a five-year comparison of cumulative total stockholder returns for the period from March 31, 2007 through March 31, 2012, for the Company's common stock, NASDAQ Global Select Market Composite Index and the RDG Technology Index. The comparison assumes an initial investment of $100 in each on March 31, 2007. We have not paid any cash dividends and, therefore, the cumulative total return calculation is based solely upon stock price movement and not upon reinvestment of cash dividends.



19


The comparisons in the graph below are based on historical data and are not intended to forecast the possible future performance of THQ's common stock.

 
3/31/2007
 
3/31/2008
 
3/31/2009
 
3/31/2010
 
3/31/2011
 
3/31/2012
THQ Inc. 
$
100.00

 
$
63.76

 
$
8.89

 
$
20.50

 
$
13.34

 
$
1.64

NASDAQ Composite
$
100.00

 
$
89.92

 
$
64.23

 
$
99.43

 
$
118.58

 
$
128.96

RDG Technology Composite
$
100.00

 
$
97.13

 
$
67.37

 
$
107.44

 
$
123.76

 
$
142.82


Purchases of Equity Securities by the Issuer and Affiliated Purchases

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 March 31, 2012 and 2011 we had $28.6 million, authorized and available for common stock repurchases. During fiscal 2012 we did not repurchase any shares of our common stock. There is no expiration date for the authorized repurchases.

Item 6. Selected Consolidated Financial Data

The following table summarizes certain selected consolidated financial data, which should be read in conjunction with our consolidated financial statements and notes thereto and with Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein. The selected consolidated financial data presented below as of and for each of the fiscal years in the five-year period ended March 31, 2012 are derived from our audited consolidated financial statements. The consolidated balance sheets as of March 31, 2012 and 2011, and the consolidated statements of operations for fiscal 2012, 2011 and 2010, and the report thereon are included elsewhere in this 10-K.

20


STATEMENT OF OPERATIONS DATA
(Amounts in thousands, except per share data)

 
Fiscal Year Ended March 31,
 
2012
 
2011
 
2010
 
2009
 
2008
Net sales
$
830,841

 
$
665,258

 
$
899,137

 
$
829,963

 
$
1,030,467

Cost of sales:
 
 
 
 
 
 
 
 
 
Product costs
353,597

 
272,021

 
318,590

 
338,882

 
389,097

Software amortization and royalties
308,051

 
129,237

 
196,956

 
296,688

 
231,800

License amortization and royalties
74,632

 
118,287

 
110,503

 
102,773

 
123,580

Total cost of sales
736,280

 
519,545

 
626,049

 
738,343

 
744,477

 
 
 
 
 
 
 
 
 
 
Gross Profit
94,561

 
145,713

 
273,088

 
91,620

 
285,990

Operating expenses:
 
 
 
 
 
 
 
 
 
Product development
89,526

 
79,374

 
87,233

 
109,201

 
128,869

Selling and marketing
191,669

 
156,075

 
131,954

 
162,183

 
175,288

General and administrative
48,712

 
45,356

 
57,879

 
76,884

 
69,901

Goodwill impairment


 

 

 
118,799

 

Restructuring
6,803

 
602

 
5,671

 
12,266

 

Total operating expenses
336,710

 
281,407

 
282,737

 
479,333

 
374,058

 
 
 
 
 
 
 
 
 
 
Operating loss
(242,149
)
 
(135,694
)
 
(9,649
)
 
(387,713
)
 
(88,068
)
Interest and other income (expense), net
5,143

 
524

 
(2,056
)
 
483

 
15,433

Loss from continuing operations before income taxes
(237,006
)
 
(135,170
)
 
(11,705
)
 
(387,230
)
 
(72,635
)
Income tax expense (benefit)
5,500

 
928

 
247

 
46,226

 
(35,785
)
Loss from continuing operations
(242,506
)
 
(136,098
)
 
(11,952
)
 
(433,456
)
 
(36,850
)
Gain on sale of discontinued operations, net of tax

 

 

 
2,042

 
1,513

Net loss prior to allocation of noncontrolling interest
(242,506
)
 
(136,098
)
 
(11,952
)
 
(431,414
)
 
(35,337
)
Loss attributable to noncontrolling interest

 

 
2,935

 
302

 

Net loss attributable to THQ Inc
$
(242,506
)
 
$
(136,098
)
 
$
(9,017
)
 
$
(431,112
)
 
$
(35,337
)
Loss per share attributable to THQ Inc.—basic:
 
 
 
 
 
 
 
 
 
Continuing operations(a)
$
(3.55
)
 
$
(2.00
)
 
$
(0.13
)
 
$
(6.48
)
 
$
(0.55
)
Discontinued operations

 

 

 
0.03

 
0.02

Loss per share—basic
$
(3.55
)
 
$
(2.00
)
 
$
(0.13
)
 
$
(6.45
)
 
$
(0.53
)
Loss per share attributable to THQ Inc.—diluted:
 
 
 
 
 
 
 
 
 
Continuing operations(a)
$
(3.55
)
 
$
(2.00
)
 
$
(0.13
)
 
$
(6.48
)
 
$
(0.55
)
Discontinued operations

 

 

 
0.03

 
0.02

Loss per share—diluted
$
(3.55
)
 
$
(2.00
)
 
$
(0.13
)
 
$
(6.45
)
 
$
(0.53
)
Shares used in per share calculation—basic
68,369

 
67,910

 
67,522

 
66,861

 
66,475

Shares used in per share calculation—diluted
68,369

 
67,910

 
67,522

 
66,861

 
66,475


BALANCE SHEET DATA
(Amounts in thousands)
 
As of March 31,
 
2012
 
2011
 
2010
 
2009
 
2008
Working capital
$
18,749

 
$
220,158

 
$
371,641

 
$
189,604

 
$
396,505

Total assets
$
392,794

 
$
774,405

 
$
714,329

 
$
598,329

 
$
1,084,320

Total THQ Inc. stockholders' (deficit) equity(a)
$
(32,327
)
 
$
206,831

 
$
324,355

 
$
307,040

 
$
740,569

________________________

(a)
Based on amounts attributable to THQ Inc. (i.e., subsequent to the allocation of noncontrolling interest).

21



Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Our business is subject to many risks and uncertainties which may affect our future financial performance. For a discussion of our risk factors, see "Part I—Item 1A. Risk Factors."

Overview
 
The following overview is a top level discussion of our financial results, as well as trends that have, or that we reasonably believe will, impact our operations. Management believes that an understanding of these trends and drivers is important in order to understand our results for fiscal 2012, as well as our future prospects. This summary is not intended to be exhaustive, nor is it intended to be a substitute for the detailed discussion and analysis provided elsewhere in this 10-K and in other documents we have filed with the SEC.

Fiscal 2012 Summary

Current Product Updates

Several of our games, including: MX vs. ATV Alive; Red Faction: Armageddon; Warhammer 40,000: Space Marine; and uDraw performed significantly below our expectations and have generated significant losses. This resulted in the discontinuance of future products based on these intellectual properties, the reassessment of our continuing portfolio of games, and additional charges related to organizational changes (as further discussed below).
In fiscal 2012 we shipped approximately 4.2 million units of internally developed and owned intellectual property Saints Row: The Third. Saints Row is THQ's largest owned franchise, having shipped more than 11 million units globally. With its robust post-launch digital content, Saints Row: The Third also generated the highest digital revenue of any title in our history. We recently announced a standalone franchise extension, Saints Row: The Third-Enter The Dominatrix, scheduled for release in September 2012.
After a successful rebranding of the franchise, we shipped more than 2.2 million units of WWE '12 in fiscal 2012. WWE' 12 brings our franchise total of lifetime units sold to more than 52 million.
Our fiscal 2012 digital revenues, before the impact of changes in deferred net revenue, were 62% higher than in fiscal 2011.

Future Product Updates

We entered into a collaboration with South Park Digital Studios LLC, the joint venture between "South Park" creators Trey Parker and Matt Stone and Viacom Media Networks, and Obsidian Entertainment, Inc. to develop South Park: The Stick of Truth. The game is currently scheduled for release in fiscal 2013.
Patrice Désilets, creative director of the Assassin's Creed franchise, joined THQ in June 2011 to develop a new intellectual property out of our video game development studio in Montreal, Quebec.
We entered into an agreement with Turtle Rock Studios Inc., the creators of the multiple award-winning "Left 4 Dead," to publish a new core title scheduled to be released in calendar 2013.
We also entered into an agreement with Crytek, a leader in the creation of first person shooters, to develop the next installment of the Homefront franchise, scheduled for release in fiscal 2014.

Strategic Plan and Business Realignments

Our strategy is to develop a select number of titles with a significant digital component targeted at the core gamer. Our goal is to build franchises over time, by delivering a high-quality gaming experience, building a dedicated community around the title, and delivering a significant level of online services and digital content. Our focus is on building franchises based primarily on our owned intellectual properties such as Saints Row and Homefront. We intend to launch new intellectual properties on new platforms as they emerge. Our current focus does not include casual games on social networks or handheld devices.

During fiscal 2012, we made a number of changes to our organization and product lineup. We discontinued a number of titles in our product pipeline that did not fit our strategic objectives, thus reducing future product development expenses. We reduced the number of internal development studios from eleven to five. We exited markets, sold or reconfigured games and product lines that did not meet internal profitability thresholds or were no longer central to our go-forward strategy. We negotiated with our kids' and movie-based licensors to reduce our future license commitments. We reduced costs and headcount in our corporate and global publishing organizations as well as our studios impacted by the changes in our product line-up. In January 2012, we implemented a plan of restructuring in order to better align our operating expenses with the lower expected revenues under the updated strategy. In connection with this realignment, we significantly reduced other future product development expenditures

22


which do not align with our current strategy. The majority of the restructuring was completed by March 31, 2012. We expect remaining severance amounts of $5.0 million to be paid by September 30, 2012. These actions will have reduced headcount by approximately 370 people.

As a result of these strategic initiatives, we recorded charges affecting our operating loss totaling $117.6 million in fiscal 2012. These realignment charges include $6.8 million of costs associated with lease abandonments, write-off of fixed assets, as well as other non-cancellable contracts; non-cash charges of $74.7 million related to the write-off of capitalized software for games that have been cancelled or reconfigured; non-cash charges of $18.4 million related to impairment of licenses in connection with the cancelled games; and $17.8 million in cash charges related to severance and other employee benefits.

Consistent with our strategy, on June 1, 2012, we entered into an agreement to transfer our license to develop future games based on the Ultimate Fighting Championship ("UFC"). After the write-off of the capitalized software development related to the UFC game currently under development, we estimate that this will result in a small gain. We also expect this action to result in the closure of the studio developing the UFC game, which could result in additional cash charges of up to $1.1 million related to severance, up to $1.3 million in cash charges related to leased facilities and non-cash charges of up to $0.5 million related to long-lived assets. For additional information, refer to "Note 22Subsequent Events" in the notes to the consolidated financial statements included in Part II, Item 8 for further information.

With our revised product plan, lower cost structure, cash balance, existing credit facility and other sources of external liquidity, we believe we have adequate resources to execute on our plan and deliver on our strong multi-year pipeline of games.

Business Trends
 
The following trends affect our business:

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 have exited the market for video games based on licensed kids' and movie-based entertainment properties and uDraw. In fiscal 2012 and 2011, approximately 34% and 43%, respectively, of our net sales, before the impact of changes in deferred net revenue, came from these types of games.

Strategic Changes to Future Product Lineup

As discussed above, we made significant changes to our future product lineup to focus our resources on core games with a significant digital component that are best positioned for critical and commercial success. We reduced the number of games being developed, and therefore expect our revenues for fiscal 2013 to be significantly lower than fiscal 2012. As a result of the reduced number of products we expect to publish, each of our new releases will have more impact on our overall financial results.

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 twelve months ended December 31, 2011, retail software sales in the U.S. for the industry decreased 7.8% compared to the same period in 2010 according to The NPD Group; for the same period, across the U.K., Germany, France, Spain and Benelux, aggregated retail software sales decreased 7.4% compared to the same twelve-month period in 2010 according to GfK. However, digital sales for the industry are expected to grow over 20% worldwide in calendar 2012 and almost double, over calendar 2011 levels, in the following five years to $58.7 billion worldwide according to the International Development Group, Inc.'s Forecast Update (February 2012). Accordingly, we plan to continue integrating digital components into our core game franchises. 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.


23


Sales Concentration of Top Titles

The majority of money spent by consumers on video game software is spent on select top titles. Because of the demand for select “hit” titles and the costs to develop our games, we believe that it is important to focus our development efforts on bringing a select number of high-quality, competitive products to market.
  
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 of our titles include free access to online content through a code (included in the packaging) for initial purchasers. This structure creates a new revenue stream by offering second-hand buyers of these titles the opportunity to separately purchase the online content.

Nasdaq Notice

On January 25, 2012, we received a written notification from Nasdaq notifying us that we fail to comply with Nasdaq's Marketplace Rule 5450(a)(1) (the “Rule”) because the bid price for our common stock, over the last 30 consecutive business days, has closed below the minimum $1.00 per share requirement for continued listing. The notification had no immediate effect on the listing of our common stock.

In accordance with Marketplace Rule 5810(c)(3)(A), we have a period of 180 calendar days, or until July 23, 2012, to regain compliance with the Rule. If at any time before July 23, 2012, the bid price of our common stock closes at or above $1.00 per share for a minimum of 10 consecutive business days, Nasdaq will provide written notification that we have achieved compliance with the Rule. If compliance with the Rule cannot be demonstrated by July 23, 2012, our common stock will be subject to delisting from The Nasdaq Global Market. In the event that we receive notice that our common stock is subject to being delisted from The Nasdaq Global Select Market, Nasdaq rules permit us to appeal any delisting determination by the Nasdaq staff to a Nasdaq hearings panel.

On June 29, 2012, at a special meeting, our stockholders will vote on a proposal to approve an amendment to our certificate of incorporation in order to effect a reverse stock split of our common stock at a ratio of one-for-three, one-for-five, or one-for-ten, such ratio and effective date to be determined in the sole discretion of the Board (the “Reverse Stock Split”). It is anticipated that the Reverse Stock Split will be effectuated on or about July 5, 2012. In the event that our stockholders fail to approve the Reverse Stock Split or if our stock price fails to increase above $1.00 per share for a minimum of ten consecutive business days following the Reverse Stock Split, or we fail to meet any of the other listing requirements in the future, we may not be able to maintain our Nasdaq listing, which could have a material adverse effect on the market for and the market price of our common stock.

Results of Operations

Comparison of Fiscal 2012 to Fiscal 2011

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 consolidated statements of operations for fiscal 2012 and 2011 (amounts in thousands):

 
Fiscal Year Ended March 31,
 
Increase/
(Decrease)
 
% Change
 
2012
 
2011
 
 
Net sales before changes in deferred net revenue
$
835,896

 
100.6
 %
 
$
802,333

 
120.6
 %
 
$
33,563

 
4.2
%
Changes in deferred net revenue
(5,055
)
 
(0.6
)
 
(137,075
)
 
(20.6
)
 
132,020

 
96.3

Consolidated net sales
$
830,841

 
100.0
 %
 
$
665,258

 
100.0
 %
 
$
165,583

 
24.9
%
 
Fiscal 2012 net sales before changes in deferred net revenue were primarily driven by the release of our owned intellectual property title Saints Row: The Third, WWE '12, and catalog titles (titles released in fiscal years prior to the respective fiscal year).

24



Changes in deferred net revenue reflect the deferral and subsequent recognition of net revenue related to undelivered elements at the time of sale, such as online services that are offered in some of our games. The revenue deferrals are recognized as net sales as the undelivered elements are delivered or, over the estimated online service period of generally six months, as applicable. The changes in deferred net revenue are driven by the timing of the release of games that have undelivered elements, and the subsequent timing of the delivery of those undelivered elements. Generally, as it relates to revenue deferrals related to the online services, revenue deferred in the first half of our fiscal year would be recognized by the end of that fiscal year, and revenue deferred in the second half of the fiscal year would be partially recognized in that fiscal year with the remaining amounts of deferred revenue recognized in the following fiscal year.

Net Sales by New Releases and Catalog Titles
 
The following table presents our net sales of new releases (titles initially released in the respective fiscal year) and catalog titles for fiscal 2012 and 2011 (amounts in thousands):

 
 
Fiscal Year Ended March 31,
 
Increase/
 
%
 
2012
 
2011
 
(Decrease)
 
Change
New releases
$
644,258

 
77.1
%
 
$
604,618

 
75.4
%
 
$
39,640

 
6.6
 %
Catalog
191,638

 
22.9

 
197,715

 
24.6

 
(6,077
)
 
(3.1
)
Net sales before changes in deferred net revenue
835,896

 
100.0
%
 
802,333

 
100.0
%
 
33,563

 
4.2

Changes in deferred net revenue
(5,055
)
 
 
 
(137,075
)
 
 
 
132,020

 
96.3

Consolidated net sales
$
830,841

 
 
 
$
665,258

 
 
 
$
165,583

 
24.9
 %

Net sales of our new releases increased $39.6 million in fiscal 2012 compared to fiscal 2011 primarily due to the release of Saints Row: The Third which shipped significantly more units in fiscal 2012 than Homefront did in fiscal 2011. This increase was partially offset by performance of uDraw which sold fewer units and at lower average net selling prices in fiscal 2012 compared to fiscal 2011.

Net sales of our catalog titles decreased $6.1 million in fiscal 2012 compared to fiscal 2011 primarily due to a decrease in the number of catalog units sold.

Net Sales by Territory
 
The following table presents our net sales by territory for fiscal 2012 and 2011 (amounts in thousands):

 
 
Fiscal Year Ended March 31,
 
Increase/
 
%
 
2012
 
2011
 
(Decrease)
 
Change
North America
$
515,597

 
61.7
%
 
$
524,498

 
65.4
%
 
$
(8,901
)
 
(1.7
)%
Europe
247,614

 
29.6

 
219,938

 
27.4

 
27,676

 
12.6

Asia Pacific
72,685

 
8.7

 
57,897

 
7.2

 
14,788

 
25.5

International
320,299

 
38.3

 
277,835

 
34.6

 
42,464

 
15.3

Net sales before changes in deferred net revenue
835,896

 
100.0
%
 
802,333

 
100.0
%
 
33,563

 
4.2

Changes in deferred net revenue
(5,055
)
 
 
 
(137,075
)
 
 
 
132,020

 
96.3

Consolidated net sales
$
830,841

 
 
 
$
665,258

 
 
 
$
165,583

 
24.9
 %

Net sales in North America decreased $8.9 million in fiscal 2012 compared to fiscal 2011 primarily due to the performance of uDraw which sold fewer units, and at a lower average net selling price, in fiscal 2012 compared to fiscal 2011. The decrease was also due to lower net sales in fiscal 2012 of UFC Undisputed 3 compared to net sales of UFC Undisputed 2010 in fiscal 2011. These decreases were partially offset by net sales of Saints Row: The Third, which shipped significantly more units, and at a slightly higher average net selling price, in fiscal 2012 compared to Homefront in fiscal 2011.

Net sales in Europe increased $27.7 million in fiscal 2012 compared to fiscal 2011. The increase was primarily due to net sales of Saints Row: The Third, which shipped significantly more units in fiscal 2012 compared to Homefront in fiscal 2011. Also

25


contributing to the increase were net sales of Warhammer 40K: Space Marine, which did not have a comparable title released in fiscal 2011. We estimate that changes in foreign currency translation rates during fiscal 2012 increased our reported net sales in this territory by $4.3 million.

Net sales in the Asia Pacific territory in fiscal 2012 increased $14.8 million compared to fiscal 2011 primarily due to net sales of Saints Row: The Third, which shipped significantly more units, and at a higher average net selling price, in fiscal 2012 compared to Homefront in fiscal 2011. We estimate that changes in foreign currency translation rates increased our reported net sales in this territory by $6.1 million during fiscal 2012.

Cost of Sales
 
Cost of sales increased $216.7 million, or 41.7%, in fiscal 2012 compared to fiscal 2011.  As a percent of net sales, cost of sales increased 10.5 points in fiscal 2012 compared to fiscal 2011.

Cost of Sales - Product Costs (amounts in thousands)
Fiscal Year Ended March 31, 2012
 
% of net sales
 
Fiscal Year Ended March 31, 2011
 
% of net sales
 
% change
$353,597
 
42.6%
 
$272,021
 
40.9%
 
30.0%
 
Product costs primarily consist of direct manufacturing costs, including platform manufacturer license fees, net of manufacturer volume rebates and discounts. In fiscal 2012, product costs as a percent of net sales increased 1.7 points compared to fiscal 2011. The increase as a percent of net sales was primarily due to performance of uDraw in fiscal 2012 which had a lower average net selling price and higher product costs per unit compared to fiscal 2011.

Cost of Sales - Software Amortization and Royalties (amounts in thousands)
Fiscal Year Ended March 31, 2012
 
% of net sales
 
Fiscal Year Ended March 31, 2011
 
% of net sales
 
% change
$308,051
 
37.1%
 
$129,237
 
19.4%
 
138.4%
 
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. In fiscal 2012 and fiscal 2011, software amortization and royalties expense included charges associated with title cancellations and impairments totaling $75.3 million and $16.9 million, respectively (see "Note 5Licenses and Software Development" in the notes to the consolidated financial statements included in Part II, Item 8 for further information). Excluding these charges, software amortization and royalties expense as a percent of net sales in fiscal 2012 increased 11.1 points compared to fiscal 2011. The increase was primarily due to titles such as Homefront, Red Faction: Armageddon, and Warhammer 40K: Space Marine, that had higher capitalized development costs relative to their net sales in fiscal 2012, compared to the mix of titles included in net sales in fiscal 2011.

Cost of Sales - License Amortization and Royalties (amounts in thousands)
Fiscal Year Ended March 31, 2012
 
% of net sales
 
Fiscal Year Ended March 31, 2011
 
% of net sales
 
% change
$74,632
 
9.0%
 
$118,287
 
17.8%
 
(36.9)%
 
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 57% and 73% of our total net sales in fiscal 2012 and 2011, respectively.

In fiscal 2012 and fiscal 2011, license amortization and royalties expense included charges associated with title cancellations and impairments totaling $19.6 million and $36.2 million, respectively (see "Note 5Licenses and Software Development" in the notes to the consolidated financial statements included in Part II, Item 8 for further information). Excluding these charges, license amortization and royalties expense as a percent of net sales in fiscal 2012 decreased 5.7 points compared to fiscal 2011. The primary driver of this decrease was the larger mix of net sales from licensed products in the prior year period, which was primarily due to the release of UFC Undisputed 2010 in that period whereas net sales recognized in fiscal 2012 were driven by owned

26


intellectual properties such as Homefront and Saints Row: The Third.

Operating Expenses

Our operating expenses increased $55.3 million, or 19.7% in fiscal 2012 compared to fiscal 2011.

Product Development (amounts in thousands)
Fiscal Year Ended March 31, 2012
 
% of net sales
 
Fiscal Year Ended March 31, 2011
 
% of net sales
 
% change
$89,526
 
10.8%
 
$79,374
 
11.9%
 
12.8%
 
Product development expense primarily consists of expenses incurred by internal development studios and payments made to external development studios which are not eligible, or are in a phase of development that is not yet able to be capitalized as part of software development. Product development expense increased $10.2 million in fiscal 2012 compared to fiscal 2011.

Included in fiscal 2012 and 2011 was $12.3 million and $1.7 million, respectively, of cash severance charges and other employee-based costs recorded related to our business realignments (see "Note 8Restructuring and Other Charges" in the notes to the consolidated financial statements included in Part II, Item 8).  Excluding these charges, product development expense decreased $0.4 million in fiscal 2012 compared to fiscal 2011. The decrease in fiscal 2012 reflected a reduction in expenditures resulting from our studio closures and a reduction in the number of games under development; these decreases were partially offset by changes in the timing of our development cycles as more of our games during fiscal 2012 were in a phase of development that was not capitalizable to software development compared to fiscal 2011.

Selling and Marketing (amounts in thousands)

Fiscal Year Ended March 31, 2012
 
% of net sales
 
Fiscal Year Ended March 31, 2011
 
% of net sales
 
% change
$191,669
 
23.1%
 
$156,075
 
23.5%
 
22.8%
 
Selling and marketing expenses consist of advertising, promotional expenses, and personnel-related costs. Selling and marketing expenses increased $35.6 million in fiscal 2012 compared to fiscal 2011.

Included in fiscal 2012 and 2011 was $3.2 million and $0.2 million, respectively, of cash severance charges and other employee-based costs recorded related to our business realignments (see "Note 8Restructuring and Other Charges" in the notes to the consolidated financial statements included in Part II, Item 8).  Excluding these charges, selling and marketing expenses increased $32.6 million in fiscal 2012 compared to fiscal 2011; this increase was primarily due to promotional efforts supporting the launch of new releases such as Saints Row: The Third, Warhammer 40,000: Space Marine and Red Faction: Armageddon in fiscal 2012.

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 (excluding cash severance charges and other employee-based costs recorded related to our business realignments) as a percent of net sales increased 3.1 points in fiscal 2012 compared to fiscal 2011. The increase in fiscal 2012 was primarily due to the fiscal 2012 release of uDraw, which had higher levels of marketing support relative to its net sales compared to the uDraw release in fiscal 2011. Additionally, the increase was also due to higher marketing support for catalog titles on lower net sales from catalog titles in fiscal 2012, compared fiscal 2011.

General and Administrative (amounts in thousands)
Fiscal Year Ended March 31, 2012
 
% of net sales
 
Fiscal Year Ended March 31, 2011
 
% of net sales
 
% change
$48,712
 
5.9%
 
$45,356
 
6.8%
 
7.4%
 
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. Included in fiscal 2012 and 2011 was $2.3 million and $0.4 million, respectively, of cash severance charges and other employee-based costs recorded related to our business realignments (see "Note 8Restructuring and Other Charges" in the notes to the consolidated financial statements included in Part II, Item 8).  Excluding these charges, general and administrative expenses increased $1.4 million in fiscal 2012 compared to fiscal 2011; this increase was primarily due to recoveries of bad debt in the prior fiscal year.

27


 
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 fiscal 2012, restructuring charges and adjustments were $6.8 million. For further information related to our realignment plans and charges and the events and decisions that gave rise to such charges, see "Note 8Restructuring and Other Charges" in the notes to the consolidated financial statements included in Part II, Item 8. In fiscal 2011, restructuring charges and adjustments were minimal and reflected facility-related charges and adjustments due to changes in actual and estimated sublease income related to our fiscal 2009 realignment.

Interest and Other Income (Expense), net
 
Interest and other income (expense), net, consists of interest earned on our investments, gains and losses resulting from exchange rate changes for transactions denominated in currencies other than the functional currency, and interest expense, net of capitalization and amortization of debt issuance costs on our $100.0 million 5% convertible senior notes (“Notes”) and our Credit Agreement and Security Agreement (collectively, the “Credit Facility”) with Wells Fargo Capital Finance, LLC. For further discussion of the Notes and the Credit Facility, see "Note 9Debt" in the notes to the consolidated financial statements included in Part II, Item 8.

Interest and other income (expense), net in fiscal 2012 was income of $5.1 million and primarily consisted of foreign currency gains and a gain recognized from the March 2012 sale of our value PC product line. Interest and other income (expense), net for fiscal 2011 was income of $0.5 million and primarily represented foreign currency gains and interest income.

Substantially all interest expense for fiscal 2012 and fiscal 2011 was capitalized to software development.  (See "Note 21 — Quarterly Financial Data (Unaudited)" in the notes to the consolidated financial statements included in Item 8 for further discussion of our capitalization of interest expense on our Notes.)
 
Income Taxes
 
Income tax expense for fiscal 2012 was $5.5 million compared to $0.9 million in fiscal 2011. Income tax expense in all periods relates primarily to income earned in foreign jurisdictions, which is not reduced by carryforward losses generated in the U.S.  The increase in income tax expense is primarily due to $3.5 million of valuation allowances recorded in fiscal 2012 for deferred tax assets of entities in foreign jurisdictions which we are closing. Additionally, fiscal 2011 tax expense was offset by a $1.6 million benefit related to the recognition of previously unrecognized tax benefits. The effective tax rate differs significantly from the federal statutory rate primarily due to taxable losses in the U.S., and certain foreign jurisdictions, which are fully offset by a valuation allowance.

Comparison of Fiscal 2011 to Fiscal 2010

Net Sales

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

 
Fiscal Year Ended March 31,
 
Increase/
(Decrease)
 
% Change
 
2011
 
2010
 
 
Net sales before changes in deferred net revenue
$
802,333

 
120.6
 %
 
$
888,652

 
98.8
%
 
$
(86,319
)
 
(9.7
)%
Changes in deferred net revenue
(137,075
)
 
(20.6
)
 
10,485

 
1.2

 
(147,560
)
 
(1,407.3
)
Consolidated net sales
$
665,258

 
100.0
 %
 
$
899,137

 
100.0
%
 
$
(233,879
)
 
(26.0
)%

Fiscal 2011 net sales before changes in deferred net revenue were primarily driven by Homefront, WWE SmackDown vs. Raw 2011, UFC Undisputed 2010, uDraw, and our catalog titles.

Net Sales by New Releases and Catalog Titles

28



The following table presents our net sales of new releases and catalog titles for fiscal 2011 and fiscal 2010 (amounts in thousands):

 
Fiscal Year Ended March 31,
 
Increase/
(Decrease)
 
% Change
 
2011
 
2010
 
 
New releases
$
604,618

 
75.4
%
 
$
670,306

 
75.4
%
 
$
(65,688
)
 
(9.8
)%
Catalog
197,715

 
24.6

 
218,346

 
24.6

 
(20,631
)
 
(9.4
)
Net sales before changes in deferred net revenue
802,333

 
100.0
%
 
888,652

 
100.0
%
 
(86,319
)
 
(9.7
)
Changes in deferred net revenue
(137,075
)
 
 
 
10,485

 
 
 
(147,560
)
 
(1,407.3
)
Consolidated net sales
$
665,258

 
 
 
$
899,137

 
 
 
$
(233,879
)
 
(26.0
)%

Net sales of our new releases decreased $65.7 million in fiscal 2011 compared to fiscal 2010 primarily due to:
a decrease in units sold of games based on kids movie-based licensed games, which was primarily because in fiscal 2011 we did not release any new titles based on the Disney•Pixar brand;
a decrease in net sales from UFC Undisputed 2010 in fiscal 2011 compared to UFC 2009 Undisputed in fiscal 2010, resulting from fewer units sold and a lower average net selling price; and
a decrease in net sales of games based on our owned intellectual properties, due to titles released throughout fiscal 2010 such as Darksiders, Drawn to Life: The Next Chapter, MX vs. ATV Reflex, and Red Faction: Guerrilla, compared to net sales from the late fiscal 2011 release of Homefront.

These decreases in net sales of our new releases were partially offset by net sales in fiscal 2011 of uDraw and games based on new licensed properties such as Barbie: Groom and Glam Pups, Hot Wheels: Track Attack, JEOPARDY!, Pictionary, and Wheel of Fortune.

Net sales of our catalog titles decreased $20.6 million in fiscal 2011 compared to fiscal 2010 primarily due to a decrease in units sold.

Net Sales by Territory

The following table presents our net sales by territory for fiscal 2011 and fiscal 2010 (amounts in thousands):

 
Fiscal Year Ended March 31,
 
Increase/
(Decrease)
 
% Change
 
2011
 
2010
 
 
North America
$
524,498

 
65.4
%
 
$
555,062

 
62.5
%
 
$
(30,564
)
 
(5.5
)%
Europe
219,938

 
27.4

 
271,875

 
30.6

 
(51,937
)
 
(19.1
)
Asia Pacific
57,897

 
7.2

 
61,715

 
6.9

 
(3,818
)
 
(6.2
)
International
277,835

 
34.6

 
333,590

 
37.5

 
(55,755
)
 
(16.7
)
Net sales before changes in deferred net revenue
802,333

 
100.0
%
 
888,652

 
100.0
%
 
(86,319
)
 
(9.7
)
Changes in deferred net revenue
(137,075
)
 
 
 
10,485

 
 
 
(147,560
)
 
(1,407.3
)
Consolidated net sales
$
665,258

 
 
 
$
899,137

 
 
 
$
(233,879
)
 
(26.0
)%

Net sales in North America decreased $30.6 million in fiscal 2011 compared to fiscal 2010. The decrease was primarily due to:
a decrease in net sales from UFC Undisputed 2010 in fiscal 2011 compared to UFC 2009 Undisputed in fiscal 2010, resulting from fewer units sold and a lower average net selling price;
a decrease in units sold of games based on kids movie-based licensed games, which was primarily because in fiscal 2011 we did not release any new titles based on the Disney•Pixar brand; and
a decrease in net sales of games based on our owned intellectual properties, due to titles released throughout fiscal 2010 such as Darksiders, Drawn to Life: The Next Chapter, MX vs. ATV Reflex, and Red Faction: Guerrilla, compared to net sales from the late fiscal 2011 release of Homefront.
These decreases were partially offset by net sales of uDraw and net sales of games based on new licensed properties.

Net sales in Europe decreased $51.9 million in fiscal 2011 compared to fiscal 2010. The decrease was primarily due to:
a decrease in units sold of games based on kids movie-based licensed games, which was primarily because in fiscal 2011 we

29


did not release any new titles based on the Disney•Pixar brand;
a decrease in net sales of games based on our owned intellectual properties, due to titles released throughout fiscal 2010 such as Darksiders, Drawn to Life: The Next Chapter, MX vs. ATV Reflex, and Red Faction: Guerrilla, compared to net sales from the late fiscal 2011 release of Homefront;
a decrease in net sales from UFC Undisputed 2010 in fiscal 2011 compared to UFC 2009 Undisputed in fiscal 2010, resulting from fewer units sold and a lower average net selling price; and
a decrease in units sold of games based on the WWE license.
These decreases were partially offset by net sales of uDraw. We estimate that changes in foreign currency translation rates during fiscal 2011 decreased reported net sales in Europe by $4.8 million.

Net sales in the Asia Pacific territories decreased $3.8 million in fiscal 2011 compared to fiscal 2010 primarily due to a decrease in units sold of games based on our owned intellectual properties and games based on the WWE brand. These decreases were partially offset by increases in net sales from distribution arrangements. We estimate that changes in foreign currency translation rates during fiscal 2011 increased reported net sales in this territory by $5.5 million.

Cost of Sales

Cost of sales decreased $106.5 million, or 17%, in fiscal 2011 compared to fiscal 2010.  This dollar-basis decrease was primarily due to lower product costs and lower software development amortization resulting from the deferral of costs related to the changes in our deferred net revenue.  Also contributing to the dollar-basis decrease was a reduction in the number of units shipped in fiscal 2011 compared to fiscal 2010, primarily of kids' movie-based licensed games.  As a percent of net sales, cost of sales increased 8.5 points in fiscal 2011 compared to fiscal 2010; this increase was primarily due to impairment charges on kids movie-based licenses and higher product costs as a percent of net sales as further discussed below.

Cost of Sales—Product Costs (amounts in thousands)

Fiscal Year Ended March 31, 2011
 
% of net sales
 
Fiscal Year Ended March 31, 2010
 
% of net sales
 
% change
$272,021
 
40.9%
 
$318,590
 
35.4%
 
(14.6)%

Product costs primarily consist of direct manufacturing costs, including platform manufacturer license fees, net of manufacturer volume rebates and discounts. In fiscal 2011, product costs as a percentage of net sales increased 5.5 points compared to fiscal 2010. The increase as a percent of net sales was primarily due to lower average net selling prices on our titles sold in fiscal 2011 compared to fiscal 2010, particularly on UFC Undisputed 2010 compared to UFC 2009 Undisputed. Also contributing to the increase was a change in our sales mix in fiscal 2011 towards more catalog and distribution titles which generally have higher product costs relative to their net sales. Catalog titles made up a larger portion of our sales mix in fiscal 2011 due to the release of certain titles, late in the fourth quarter of fiscal 2011, for which the related revenue was deferred and will be recognized in the first half of fiscal 2012. Additionally, our sales mix in fiscal 2011 included uDraw, which has a higher product cost per unit relative to its average net selling price, compared to our software products.

Cost of Sales—Software Amortization and Royalties (amounts in thousands)

Fiscal Year Ended March 31, 2011
 
% of net sales
 
Fiscal Year Ended March 31, 2010
 
% of net sales
 
% change
$129,237
 
19.4%
 
$196,956
 
21.9%
 
(34.4)%

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. In fiscal 2011, software amortization and royalties expense as a percentage of net sales decreased 2.5 points compared to fiscal 2010. The decrease was primarily due to net sales of uDraw, which had low development costs.

Partially offsetting the decrease in software development amortization as a percent of net sales were higher title cancellation and impairment charges in fiscal 2011 compared to fiscal 2010. In fiscal 2011 we had charges totaling $9.9 million related to the cancellation of Company of Heroes Online and WWE Online (see "Note 8Restructuring and Other Charges" in the notes to the consolidated financial statements included in Item 8) and impairment charges of $7.0 million. In fiscal 2010 we had charges totaling $7.9 million related to titles that were cancelled in connection with the fiscal 2009 realignment plan.

30



Cost of Sales—License Amortization and Royalties (amounts in thousands)

Fiscal Year Ended March 31, 2011
 
% of net sales
 
Fiscal Year Ended March 31, 2010
 
% of net sales
 
% change
$118,287
 
17.8%
 
$110,503
 
12.3%
 
7.0%

License amortization and royalties expense consists of royalty payments due to licensors, which are expensed at the higher of (1) the contractual royalty rate based on actual net product sales for such license, or (2) an effective rate based upon total projected net sales for such license.  Also included in license amortization and royalties expense in fiscal 2010 is venture partner expense totaling $14.5 million (see "Note 2 — Summary of Significant Accounting Policies" in the notes to the consolidated financial statements included in Item 8 of the fiscal 2011 10-K).  Net sales from our licensed properties, excluding the impact of changes in deferred net revenue, represented 65% and 70% of our total net sales in fiscal 2011 and fiscal 2010, respectively.

Excluding one-time items recorded in fiscal 2010 that netted to a charge of $5.3 million in venture partner expense, and excluding the impact of changes in deferred net revenue and related costs, license amortization and royalties expense would have increased 3.5 points as a percent of net sales in fiscal 2011 compared to fiscal 2010. (See "Note 14 — Joint Venture and Settlement Agreements" in the notes to the consolidated financial statements included in Item 8 of the fiscal 2011 10-K for further discussion of the one-time items.)  This increase was primarily due to impairment charges of $30.3 million recorded in the three months ended December 31, 2010.  These impairments resulted from our reevaluation of sales expectations on kids movie-based licensed titles given the recent significant industry-wide slowdown in sales of console titles aimed at children, particularly movie-based kids titles. Also contributing to the increase in license amortization and royalties expense as a percent of net sales in fiscal 2011 compared to fiscal 2010 was a high effective license amortization rate on Megamind in fiscal 2011. These increases were partially offset by a change in our sales mix towards more owned intellectual properties in fiscal 2011 compared to fiscal 2010.

Operating Expenses

Our operating expenses were $281.4 million in fiscal 2011 and $282.7 million in fiscal 2010. Fiscal 2011 operating expenses included an 18.3% increase in selling and marketing expenses compared to fiscal 2010, primarily due to the launch of uDraw. These higher selling and marketing expenses were offset by decreases in product development, general and administrative, and restructuring expenses.

Product Development (amounts in thousands)

Fiscal Year Ended March 31, 2011
 
% of net sales
 
Fiscal Year Ended March 31, 2010
 
% of net sales
 
% change
$79,374
 
11.9%
 
$87,233
 
9.7%
 
(9.0)%

Product development expense primarily consists of expenses incurred by internal development studios and payments made to external development studios prior to products reaching technological feasibility. Once a product has reached technological feasibility the related development costs are capitalized to software development. Product development expense decreased $7.9 million in fiscal 2011 compared to fiscal 2010. The decrease was primarily due to a shift in our mix of products under development to a higher portion of technologically feasible products. The decrease was also due to a reduction in product development for the legacy wireless platforms which excludes our continued investment in the development of products for use on smart-phones.

Selling and Marketing (amounts in thousands)

Fiscal Year Ended March 31, 2011
 
% of net sales
 
Fiscal Year Ended March 31, 2010
 
% of net sales
 
% change
$156,075
 
23.5%
 
$131,954
 
14.7%
 
18.3%

Selling and marketing expenses consist of advertising, promotional expenses, and personnel-related costs. Selling and marketing expenses increased $24.1 million and by 8.8 points as a percent of net sales in fiscal 2011 compared to fiscal 2010. The increase on a dollar basis was primarily due to promotional efforts to support the launch of uDraw and increased advertising support for our catalog titles and our future releases. These increases were partially offset by lower personnel related costs.

The increase in selling and marketing expenses as a percent of net sales was primarily due to promotional efforts to support certain

31


titles that were released late in the fourth quarter of fiscal 2011 for which the related revenues were deferred. Also contributing to the increase as a percent of net sales was:
higher advertising support for UFC Undisputed 2010 in fiscal 2011 relative to its net sales compared to UFC 2009 Undisputed in fiscal 2010,
an increase in advertising support for our catalog titles in fiscal 2011 relative to their net sales compared to fiscal 2010, and
an increase in advertising support for our future releases.

General and Administrative (amounts in thousands)

Fiscal Year Ended March 31, 2011
 
% of net sales
 
Fiscal Year Ended March 31, 2010
 
% of net sales
 
% change
$45,356
 
6.8%
 
$57,879
 
6.4%
 
(21.6)%

General and administrative expenses consist of personnel and related expenses of executive and administrative staff and fees for professional services such as legal and accounting. General and administrative expenses decreased in fiscal 2011 by $12.5 million, compared to fiscal 2010. The decrease was primarily due to lower personnel related costs and lower legal costs due to litigation that was settled in fiscal 2010.

Restructuring

Restructuring charges include any of the costs associated with lease abandonments (less estimates of sublease income), write-offs of related long-lived assets due to studio closures, as well as costs of other non-cancellable contracts.  In fiscal 2011, restructuring charges and adjustments were minimal and primarily reflected facility related charges and adjustments due to changes in actual and estimated sublease income related to our fiscal 2009 realignment.  For further information related to our restructuring plans and charges and the events and decisions that gave rise to such charges, see "Note 8 — Restructuring and Other Charges" in the notes to the consolidated financial statements included in Item 8.

Interest and Other Income (Expense), net

Interest and other income (expense), net consists of interest earned on our investments, gains and losses resulting from exchange rate changes for transactions denominated in currencies other than the functional currency, and interest expense, net of capitalization and amortization of debt issuance costs on our $100.0 million 5% convertible senior notes ("Notes"). For further discussion of the Notes, see "Note 9 — Debt" in the notes to the consolidated financial statements included in Item 8.

Interest and other income (expense), net for fiscal 2011 was income of $0.5 million and primarily represented foreign currency gains and interest income, as substantially all interest expense for the year was capitalized to software development.  Interest and other income (expense), net for fiscal 2010 was an expense of $2.1 million, which primarily represented $3.8 million in interest expense which was not capitalized, and foreign currency losses, offset by interest income.  (See "Note 21 — Quarterly Financial Data (Unaudited)" in the notes to the consolidated financial statements included in Item 8 for further discussion of our capitalization of interest expense on our Notes.)

Income Taxes

Income tax expense for fiscal 2011 was $0.9 million, which primarily represents foreign taxes and U.S. state taxes offset by a $1.6 million benefit related to the release of a valuation allowance on previously unrecognized tax benefits, compared to income tax expense of $0.2 million in fiscal 2010. The change in income taxes is primarily attributable to income taxes incurred in foreign jurisdictions, which are not reduced by losses in the United States. The effective tax rate differs significantly from the federal statutory rate primarily due to losses in the United States that are fully offset by a valuation allowance to the extent that such losses are not subject to loss carry-back provisions.

Noncontrolling Interest

We sold our interest in THQ*ICE LLC (a joint venture with ICE Entertainment, Inc.) on April 30, 2010 and recognized an insignificant gain.  In fiscal 2010, we recognized $2.9 million of noncontrolling interest reflecting the loss allocable to equity interests in THQ*ICE LLC that were not owned by THQ.

Liquidity and Capital Resources


32


Financial Condition
 
At March 31, 2012, we had working capital of $18.7 million, including cash and cash equivalents of $76.0 million. Included in our working capital is a net reduction of $68.5 million related to the non-cash deferral of revenue, net of related expenses.

During our fiscal year 2012, we made a number of changes to our organization and product lineup. We discontinued a number of titles in our product pipeline that did not fit our strategic objectives, thus reducing future product development expenses. We reduced the number of internal development studios from eleven to five. We exited markets, sold or reconfigured games and product lines that did not meet internal profitability thresholds or were no longer central to our go-forward strategy. We negotiated with our kids' and movie-based licensors to reduce our future license commitments. We reduced costs and headcount in our corporate and global publishing organizations as well as our studios impacted by the changes in our product line-up. In January 2012, we implemented a plan of restructuring in order to better align our operating expenses with the lower expected revenues under the updated strategy. In connection with this realignment, we significantly reduced other future product development expenditures which did not align with our current strategy. The majority of the restructuring was completed by March 31, 2012. We expect remaining severance amounts of $5.0 million to be paid by September 30, 2012. These actions will have reduced headcount by approximately 370 people.

As a result of these strategic initiatives, we recorded charges affecting our operating loss totaling $117.6 million in fiscal 2012. These realignment charges include $6.8 million of costs associated with lease abandonments, write-off of fixed assets, as well as other non-cancellable contracts; non-cash charges of $74.7 million related to the write-off of capitalized software for games that have been cancelled or reconfigured; non-cash charges of $18.4 million related to impairment of licenses in connection with the cancelled games; and $17.8 million in cash charges related to severance and other employee benefits.

With our focused product plan, lower cost structure, cash balance, existing credit facility and other sources of external liquidity, we believe we have adequate resources to execute on our plan and deliver on our strong multi-year pipeline of games. Although we believe our current business plan is achievable, should we fail to achieve the sales, gross margin levels, and maintain the vendor credit terms we anticipate, or if we were to incur significant unplanned cash outlays, it would become necessary for us to obtain additional sources of liquidity or make further cost cuts (including future product development) to fund our operations, which could result in additional restructuring and impairment charges. However, there is no assurance that we would be able to obtain additional financing on favorable terms, if at all, or to successfully further reduce costs in such a way that would continue to allow us to operate our business. If for any reason our projections do not materialize, we may not be able to comply with the requirements of our credit facility as further discussed below. Our ability to achieve our business plan and anticipated levels of liquidity could also be affected by various risks and uncertainties described in "Part I, Item 1A. Risk Factors." 

Sources and Uses of Cash
(Amounts in thousands)
March 31,
2012
 
March 31,
2011
 
Change
Cash and cash equivalents
$
75,977

 
$
85,603

 
$
(9,626
)
Percentage of total assets
19
%
 
11
%
 
 


 
 
Fiscal Year Ended March 31,
 
 
(Amounts in thousands)
2012
 
2011
 
Change
Net cash used in operating activities
$
(1,511
)
 
$
(196,898
)
 
$
195,387

Net cash provided by (used in) investing activities
(4,759
)
 
96,987

 
(101,746
)
Net cash used in financing activities
(1,194
)
 
(11,872
)
 
10,678

Effect of exchange rate changes on cash
(2,162
)
 
9,008

 
(11,170
)
Net decrease in cash and cash equivalents
$
(9,626
)
 
$
(102,775
)
 
$
93,149

 
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 fiscal 2012 our cash and cash equivalents decreased $9.6 million, from $85.6 million at March 31, 2011 to $76.0 million at March 31, 2012. The decrease in our cash balance

33


was primarily due to investments in software development, payments of accounts payable and other liabilities, and capital expenditures, offset by collection of accounts receivable from late fourth quarter fiscal 2011 releases. For further information regarding the movement in our cash balance during fiscal 2012, refer to the Consolidated Statement of Cash Flows for that period which is included in Part II, Item 8.

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 fiscal 2012, in order to help fund our working capital needs during the holiday season, we borrowed and repaid $52.0 million under our Credit Facility (as discussed below) and we expect to borrow additional amounts during fiscal 2013, as needed. We did not borrow any funds during the three months ended March 31, 2012. 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. Prior to March 31, 2012, to expedite our receivables collections from Walmart, we sold $8.5 million of accounts receivable under the Purchase Agreement, without recourse, that would have otherwise been collected subsequent to March 31, 2012. In fiscal 2012 we recognized a loss of $0.2 million related to interest on the transaction, which is classified in "Interest and other income (expense), net" in our consolidated statements of operations. We expect to continue to sell our Walmart accounts receivable pursuant to the Purchase Agreement to further expedite collections.
 
Credit Facility.
On September 23, 2011, we entered into a Credit Agreement and a Security Agreement (collectively, the “Credit Facility”) with Wells Fargo Capital Finance, LLC (“Wells Fargo”). The Credit Facility provides for a $50.0 million revolving facility during its term. During fiscal 2012, the availability under the Credit Facility was increased to $75.0 million for the period from October 1, 2011 through December 14, 2011. The Credit Facility allows up to $10.0 million of the total to be used as a letter of credit subfacility.

The Credit Facility has a four-year term; provided, however, it will terminate on June 16, 2014 if any obligations are still outstanding 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 are required to pay other customary fees, including an unused line fee based on usage under the Credit Facility as well as fees in respect of letters of credit.
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 are currently due and payable and any amount outstanding bears interest at 2.0% above the interest rate otherwise applicable.  In the event availability on the Credit Facility is below 12.5% of the maximum revolver amount of $50.0 million, the Credit Facility would require that we maintain certain financial covenants.  During the year ended March 31, 2012, we had availability in excess of 12.5% and therefore we were not subject to the financial covenants.  In the event the financial covenants become applicable, we would be required to have EBITDA, as defined in the Credit Facility, of $9.8 million for the four quarters ended June 30, 2012. Beginning September 30, 2012, the EBITDA requirements are replaced with a requirement that we maintain an annual fixed charge coverage ratio of 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 customary affirmative and negative covenants, including, among other terms and conditions, and limitations (subject to certain permitted actions) on our ability to: create, incur, guarantee or be liable for indebtedness; dispose of assets outside the ordinary course; acquire, merge or consolidate with or into another person or entity; create, incur or allow any lien on any of their respective properties; make investments or capital expenditures; or pay dividends or make distributions.
During the year ended March 31, 2012 we borrowed $52.0 million under the Credit Facility, which was repaid as of December 31, 2011. In fiscal 2012 interest expense was $0.2 million and amortization of debt costs related to the Credit Facility was $0.2 million; these amounts were capitalized as part of in-process software development costs. There were no outstanding borrowings under the Credit Facility as of March 31, 2012.

34



As of March 31, 2012, we were in compliance with all applicable covenants and requirements in the Credit Facility.

At March 31, 2012, approximately 57% 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 United States, 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 United States, as the taxable event would likely be offset by the utilization of our net operating losses and tax credits. 

Cash Flow from Operating Activities.  Cash used in operations was $1.5 million in fiscal 2012 compared to $196.9 million in fiscal 2011. The change in cash flow from operations was primarily due to an increase in collections of receivables related to the timing of releases in the fourth quarter of fiscal 2012 and fiscal 2011 and a decrease in investments in software development and licenses. These changes were partially offset by an increase in cash used for payments of our obligations.
 
Cash Flow from Investing Activities.  Cash used in investing activities was $4.8 million in fiscal 2012 compared to $97.0 million cash provided by investing activities in fiscal 2011. The change in cash flow from investing activities was primarily due to proceeds from sales and maturities of short-term investments in fiscal 2011.
 
Cash Flow from Financing Activities.  Cash used in financing activities was $1.2 million in fiscal 2012 compared to $11.9 million in fiscal 2011. The change in cash flow from financing activities was primarily due to the repayment of our secured credit line in fiscal 2011.

Effect of exchange rate changes on cash.  Changes in foreign currency translation rates decreased our reported cash balance by $2.2 million.
 
Key Balance Sheet Accounts
 
At March 31, 2012, our total current assets were $290.0 million, down from $599.7 million at March 31, 2011. In addition to cash and cash equivalents, our current assets primarily consisted of:

Accounts Receivable. Accounts receivable decreased $145.6 million, from $161.6 million at March 31, 2011 to $16.0 million at March 31, 2012. The decrease was primarily due to lower sales volumes and timing of releases in the fourth quarter of fiscal 2012 and fiscal 2011, as well as expedited collections of receivables under the Purchase Agreement. Accounts receivable allowances were $70.4 million at March 31, 2012, a $17.2 million decrease from $87.6 million at March 31, 2011. Allowances for price protection and returns as a percentage of trailing nine-month net sales, excluding the impact of changes in deferred net revenue, were 8% and 11% at March 31, 2012 and 2011, respectively. The decrease was primarily due to improved sell-through of certain of our recent releases. 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 $13.4 million, from $31.9 million at March 31, 2011 to $18.5 million at March 31, 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 14 at March 31, 2012 and 2011, respectively.

Licenses. Our investment in licenses, including the long-term portion, decreased $53.7 million, from $118.2 million at March 31, 2011 to $64.5 million at March 31, 2012. The decrease is due to continued amortization related to sales of licensed products, as well as reductions related to negotiations with four of our kids' licensors which reduced our minimum license guarantees.

Software Development. Capitalized software development, including the long-term portion, decreased $141.9 million, from $272.5 million at March 31, 2011 to $130.6 million at March 31, 2012. The decrease in software development is primarily the result of amortization of released titles, a decrease in spend on software development, and the expensing of previously capitalized costs related to cancelled titles.

Total current liabilities at March 31, 2012, were $271.3 million, down from $379.5 million at March 31, 2011. Current liabilities primarily consisted of:

Accounts Payable. Accounts payable decreased $57.7 million, from $100.6 million at March 31, 2011 to $42.9 million at March 31, 2012. The decrease was primarily due to a decrease in product-related and advertising payables resulting from a lighter release schedule.

35



Accrued and Other Current Liabilities. Accrued and other current liabilities decreased $54.2 million, from $137.9 million at March 31, 2011 to $83.7 million at March 31, 2012. The decrease was primarily due to payment of obligations.

Our liabilities at March 31, 2012 also consisted of:

Other long-term liabilities. Other long-term liabilities decreased $34.2 million, from $88.0 million at March 31, 2011 to $53.8 million at March 31, 2012. The decrease was primarily due to the negotiations with four of our kids' licensors which reduced our minimum license guarantees, most of which were classified as long-term as of March 31, 2011.

Convertible Senior Notes. We issued the Notes on August 4, 2009 and the full principal amount of $100.0 million is outstanding as of March 31, 2012 (see "Note 9Debt" in the notes to the consolidated financial statements in Part II, Item 8).
 
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 March 31, 2012 is as follows (amounts in thousands):
 
 
Contractual Obligations and Commercial Commitments (6)
Fiscal
Years Ending
March 31,
 
License /
Software
Development
Commitments (1)
 
Advertising (2)
 
Leases (3)
 
Debt (4)
 
Other (5)
 
Total
2013
 
$
74,304

 
$
15,634

 
$
14,940

 
$

 
$
4,061

 
$
108,939

2014
 
20,429

 
4,056

 
14,088

 

 
4,062

 
42,635

2015
 
14,600

 
3,093

 
12,603

 
100,000

 
62

 
130,358

2016
 
7,651

 
2,961

 
7,727

 

 

 
18,339

2017
 
7,905

 
3,025

 
4,822

 

 

 
15,752

Thereafter
 
3,349

 
5,025

 
9,842

 

 

 
18,216

 
 
$
128,238

 
$
33,794

 
$
64,022

 
$
100,000

 
$
8,185

 
$
334,239

 
(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 March 31, 2012 are $128.2 million. License commitments in the table above include $59.9 million of commitments payable to licensors that are included in both "Accrued and other current liabilities" and "Other long-term liabilities" in our March 31, 2012 consolidated balance sheet because the licensors do not have any remaining significant performance obligations.

(2)
Advertising.  We have certain minimum advertising commitments under many of our major license agreements.  These minimum commitments generally range from 3% to 10% of net sales related to the respective license. Included in the table above in fiscal 2013, fiscal 2014, fiscal 2015, fiscal 2016, fiscal 2017, and thereafter, are advertising commitments of $1.3 million, $2.2 million, $2.3 million, $2.4 million,  $2.5 million, and $4.7 million, respectively, for a total of $15.4 million of advertising commitments that were cancelled in connection with the termination of the license agreement we had with Zuffa to make video games based on their UFC content (see "Note 22Subsequent Events" in the notes to the consolidated financial statements included in Part II, Item 8).

(3)
Leases.  We are committed under operating leases with lease termination dates through 2020.  Most of our leases contain rent escalations.  Of these obligations, $1.8 million and $3.1 million are accrued and classified as "Accrued and other current liabilities" and "Other long-term liabilities," respectively, in our March 31, 2012 consolidated balance sheet due to the abandonment of certain lease obligations in connection with our realignment plans (see "Note 5Licenses and Software

36


Development" in the notes to the consolidated financial statements included in Part II, Item 8). We expect future sublease rental income under non-cancellable agreements of approximately $2.5 million; this income is not contemplated in the lease commitments shown in the table above. Rent expense was $12.1 million, $13.5 million, and $13.9 million for fiscal years 2012, 2011, and 2010, respectively.

(4)
Debt.  We issued the Notes on August 4, 2009.  The Notes pay interest semiannually, in arrears on February 15 and August 15 of each year, beginning February 15, 2010, through maturity and are convertible at each holder's option at any time prior to the close of business on the trading day immediately preceding the maturity date.  Absent any conversions, we expect to pay $5.0 million in each of the fiscal years 2013 and 2014, and $2.5 million in fiscal 2015, for an aggregate of $12.5 million in interest payments over the remaining term of the Notes (see "Note 9Debt" in the notes to the consolidated financial statements included in Part II, Item 8).

(5)
Other.  As discussed more fully in "Note 14Joint Venture and Settlement Agreements" in the notes to the consolidated financial statements included in Part II, Item 8, amounts payable to Jakks totaling $8.0 million are reflected in the table above. The present value of these amounts is included in "Accrued and other current liabilities" and "Other long-term liabilities" in our consolidated balance sheet at March 31, 2012 (see "Note 4Balance Sheet Details" in the notes to the consolidated financial statements included in Part II, Item 8). The remaining other commitments included in the table above are also included as current or long-term liabilities in our March 31, 2012 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 March 31, 2012, we had $3.8 million of unrecognized tax benefits.  See "Note 16Income Taxes" in the notes to the consolidated financial statements included in Part II, Item 8 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. 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.

Critical Accounting Estimates

The Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of our consolidated financial statements and the reported amounts of net sales and expenses during the reporting period. The estimates discussed below are considered by management to be critical because they are both important to the portrayal of our financial condition and results of operations and because their application places the most significant demands on management's judgment, with financial reporting results relying on estimates about the effect of matters that are inherently uncertain. Specific risks for these critical accounting estimates are described in the following paragraphs. For all of these estimates, we caution that actual results may differ materially from these estimates under different assumptions or conditions.

37



Accounts receivable allowances. We derive revenue from sales of packaged software for video game systems and PCs and sales of content and services over the Internet and for wireless devices. Product sales are recognized net of allowances for price protection and returns and various customer discounts. We typically only allow returns for our PC products; however, we may decide to provide price protection or allow returns for our retail video game sales after we analyze: (i) inventory remaining in the retail channel, (ii) the rate of inventory sell-through in the retail channel, and (iii) our remaining inventory on hand. We maintain a policy of giving credits for price protection and returns, but do not give cash refunds. We use significant judgment and make estimates in connection with establishing allowances for price protection, returns, and doubtful accounts in any accounting period. Included in our accounts receivable allowances is our allowance for co-operative advertising that we engage in with our retail channel partners. Our co-operative advertising allowance is based upon specific contractual commitments and does not involve estimates made by management.

We establish sales allowances based on estimates of future price protection and returns with respect to current period product sales. We analyze historical price protection granted, historical returns, current sell-through of retailer and distributor inventory of our products, current trends in the video game industry and the overall economy, changes in customer demand and acceptance of our products, and other related factors when evaluating the adequacy of the price protection and returns allowance. In addition, we monitor the volume of our sales to retailers and distributors and their inventories, because slow-moving inventory in the distribution channel can result in the requirement for price protection or returns in subsequent periods. Actual price protection and returns in any future period are uncertain. While we believe we can make reliable estimates for these matters, if we changed our assumptions and estimates, our price protection and returns reserves would change, which would impact the net sales we report. In addition, if actual price protection and returns were significantly greater than the reserves we have established, the actual results of our reported net sales would decrease. Conversely, if actual price protection and returns were significantly less than our reserves, our reported net sales would increase. In circumstances when we do not have a reliable basis to estimate returns and price protection or are unable to determine that collection of a receivable is probable, we defer the sale until such time as we can reliably estimate any related returns and allowances and determine that collection of the receivable is probable.

Similarly, we must use significant judgment and make estimates in connection with establishing allowances for doubtful accounts in any accounting period. We analyze customer concentrations, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. Material differences may result in the amount and timing of our bad debt expense for any period if we made different judgments or utilized different estimates. If our customers experience financial difficulties and are not able to meet their ongoing financial obligations to us, our results of operations may be adversely impacted.

For further information, see "Note 3Accounts Receivable Allowances" in the notes to the consolidated financial statements included in Item 8.

Licenses. Minimum guaranteed royalty payments for intellectual property licenses are initially recorded on our consolidated balance sheets as an asset (licenses) and as a liability (accrued royalties) at the contractual amount upon execution of the contract if no significant performance obligation remains with the licensor. When a significant performance obligation remains with the licensor, we record royalty payments as an asset (licenses) and as a liability (accrued royalties) when payable rather than upon execution of the contract. Royalty payments for intellectual property licenses are classified as current assets and current liabilities to the extent such royalty payments relate to anticipated product sales during the subsequent year and long-term assets and long-term liabilities if such royalty payments relate to anticipated product sales after one year. Licenses are expensed to "Cost of sales — License amortization and royalties" in our consolidated statements of operations at the higher of (i) the contractual royalty rate based on actual net product sales related to such license, or (ii) an effective rate based upon total projected net sales related to such license.

Software Development.  We utilize both internal development teams and third-party software developers to develop our software. We capitalize software development costs once technological feasibility is established and we determine that such costs are recoverable against future net sales. We evaluate technological feasibility on a product-by-product basis. For products where proven game engine technology exists, the establishment of technological feasibility may occur early in the development cycle. We capitalize the milestone payments made to third-party software developers and the direct payroll and overhead costs for our internal development teams. Amounts related to software development for which technological feasibility is not yet met are charged as incurred to “Product development” expense in our consolidated statements of operations. Commencing upon product release, capitalized software development costs are amortized to "Cost of sales — Software amortization and royalties" in our consolidated statements of operations based on the ratio of current gross sales to total projected gross sales.

Licenses and Software Development 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

38


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. See "Note 5Licenses and Software Development" for further information related to license and software development impairments.

Revenue Recognition. We recognize net sales for packaged software when title and risk of loss transfers to the customer, provided that we have no significant remaining support obligations and that collection of the resulting receivable is deemed probable by management. Certain products are sold to customers with a street date (the earliest date these products may be sold by retailers). For these products we recognize net sales on the later of the street date or the sale date.

Some of our packaged software products are developed with the ability to be connected to, and played via, the Internet. In order for consumers to participate in online communities and play against one another via the Internet, we (either directly or through outsourced arrangements with third parties) maintain servers that support an online service we provide to consumers for activities such as matchmaking, roster updates, tournaments and player rankings. Generally, we do not consider such online service to be a deliverable as it is incidental to the overall product offering. Accordingly, we do not defer any net sales related to products containing limited online services.

For an individual product with an online service that is considered a deliverable and for which we have a continuing involvement in addition to the software product, we account for the sale as a "bundled" sale, or multiple element arrangement, in which we sell both the packaged software product and the online service for one combined price.
When vendor specific objective evidence ("VSOE") of the fair value of the online service does not exist, as we have not separately offered or charged for the online service, we recognize the revenue from sales of such software products ratably over the estimated online service period, generally six months, beginning the month after shipment of the software product. Costs of sales related to such products are also deferred and recognized with the related net sales and include product costs, software amortization and royalties, and license amortization and royalties.
When VSOE of the fair value of an undelivered online service component of our games exists, generally when we separately offer or charge for the online service, we separate the fair value of the online service component from the revenue recognized on the sale of the boxed product.  The fair value of the online service component, and the related specifically identifiable costs of the online service, such as license and developer royalties, if any, are deferred and recognized ratably over the estimated online service period, generally six months, beginning the month after shipment of the software product. 

Determining whether the online service for a particular game constitutes a deliverable is subjective and requires management's judgment. Determining the estimated service period over which to recognize the related net sales and costs of sales is also subjective and involves management's judgment.

Software is sold under a limited 90-day warranty against defects in material and workmanship. To date, we have not experienced material warranty claims.

Stock-based compensation. We estimate the fair value of stock options and our employee stock purchase plan on date of grant using the Black-Scholes option pricing model which requires the input of subjective assumptions, including the expected volatility of our common stock and an option's expected life. The fair value of our restricted stock and restricted stock units is determined based on the closing trading price of our common stock on the grant date. The amount of expense recognized represents the expense associated with the stock-based awards we expect to ultimately vest based upon an estimated rate of forfeitures. Our estimate of forfeitures is based on historical forfeiture behavior as well as any expected trends in future forfeiture behavior; this rate of forfeitures is updated as necessary and any adjustments needed to recognize the fair value of options that actually vest or are forfeited are recorded. The fair value for awards that are expected to vest is then amortized on a straight-line basis over the requisite service period of the award, which is generally the option vesting term. As a result, the financial statements include amounts that are based upon our best estimates and judgments relating to the expenses recognized for stock-based compensation.

Income taxes. The provision for income taxes is computed using the asset and liability method, under which deferred income tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. To the extent recovery of deferred tax assets is not likely based on our estimates of future taxable income in each jurisdiction, a valuation allowance is established. As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves: (i) estimating our current tax exposure in each jurisdiction including the impact, if any, of changes or

39


interpretations to applicable tax laws and regulations, (ii) estimating additional taxes resulting from tax examinations and (iii) making judgments regarding the recoverability of deferred tax assets.

The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. Our estimate for the potential outcome for any uncertain tax issue, including our claims for research and development income tax credits, requires judgment. We believe we have adequately provided for any reasonably foreseeable outcome related to these matters. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period in which they are resolved or when statutes of limitation on potential assessments expire. We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the "more likely than not" threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority.

Recently Issued Accounting Pronouncements

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, which will be our fiscal quarter ending June 30, 2012. The adoption is not expected to have a material impact on our results of operations, financial position or cash flows.

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.

In May 2011, the FASB issued ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs,” which results in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs.  Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements.  ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011, which was our quarter ended March 31, 2012. Our adoption did not materially impact our results of operations, financial position or cash flows.

Item 7A. 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 March 31, 2012, our $76.0 million of cash and cash equivalents were comprised of cash and time deposits and money market funds; none of our cash equivalents are classified as trading securities.  We generally manage our interest rate risk by maintaining

40


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 fiscal 2012 was $0.5 million and is included in "Interest and other income (expense), net" in our consolidated statements of operations.

At March 31, 2012, we had no outstanding balances under the Credit Facility.

Foreign Currency Exchange Rate Risk

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

Cash Flow Hedging Activities. From time to time, we hedge a portion of our foreign currency risk related to forecasted foreign currency-denominated sales and expense transactions by entering into foreign exchange forward contracts that generally have maturities less than 90 days. Our hedging programs reduce, but do not entirely eliminate, the impact of currency exchange rate movements in net sales and operating expenses. During fiscal 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 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 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 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. The contracts consisted primarily of AUD, CAD, EUR, and GBP. The net gain recognized from these contracts during fiscal 2012 was $0.8 million and is included in "Interest and other income (expense), net" in our 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.

The counterparties to these forward contracts are credit-worthy 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 $32.6 million and an increase in reported loss from continuing operations before income taxes of approximately $0.2 million for fiscal 2012. A hypothetical 10% adverse change in foreign currency translation rates would result in a reduction of reported total assets of approximately $21.8 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 8. Consolidated Financial Statements and Supplementary Data

The report of Independent Registered Public Accounting Firm, consolidated financial statements and notes to consolidated

41


financial statements follow below.

42




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of THQ Inc.,

Agoura Hills, California

We have audited the accompanying consolidated balance sheets of THQ Inc. and subsidiaries (the "Company") as of March 31, 2012 and April 2, 2011, and the related consolidated statements of operations, total equity (deficit) and cash flows for each of the years in the three-year period ended March 31, 2012. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of THQ Inc. and subsidiaries as of March 31, 2012 and April 2, 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 2012, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of March 31, 2012, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 8, 2012 expressed an unqualified opinion on the Company's internal control over financial reporting.

/s/ DELOITTE & TOUCHE LLP

Los Angeles, California
June 8, 2012

43



THQ INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
 
 
March 31,
2012
 
March 31,
2011
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
75,977

 
$
85,603

Accounts receivable, net of allowances
15,994

 
161,574

Inventory
18,485

 
31,905

Licenses
21,927

 
32,869

Software development
105,220

 
222,631

Deferred income taxes
5,732

 
8,200

Income taxes receivable
687

 

Prepaid expenses and other current assets
46,011

 
56,908

Total current assets
290,033

 
599,690

Property and equipment, net
22,132

 
28,960

Licenses, net of current portion
42,594

 
85,367

Software development, net of current portion
25,348

 
49,858

Deferred income taxes

 
516

Other long-term assets, net
12,687

 
10,014

TOTAL ASSETS
$
392,794

 
$
774,405

 
 
 
 
LIABILITIES AND (DEFICIT) EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
42,905

 
$
100,550

Accrued and other current liabilities
83,693

 
137,922

Deferred revenue, net
144,686

 
141,060

Total current liabilities
271,284

 
379,532

Other long-term liabilities
53,837

 
88,042

Convertible senior notes
100,000

 
100,000

Commitments and Contingencies (see Note 19)


 


 
 
 
 
Stockholders' (deficit) equity:
 
 
 
Preferred stock, par value $0.01, 1,000,000 shares authorized

 

Common stock, par value $0.01, 225,000,000 shares authorized as of March 31, 2012; 68,512,885 and 68,300,482 shares issued and outstanding as of March 31, 2012 and March 31, 2011, respectively
685

 
683

Additional paid-in capital
525,677

 
520,797

Accumulated other comprehensive income
16,026

 
17,560

Accumulated deficit
(574,715
)
 
(332,209
)
Total stockholders' (deficit) equity
(32,327
)
 
206,831

TOTAL LIABILITIES AND (DEFICIT) EQUITY
$
392,794

 
$
774,405

 
See notes to consolidated financial statements.

44


THQ INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
 
 
Fiscal Year Ended March 31,
 
2012
 
2011
 
2010
Net sales
$
830,841

 
$
665,258

 
$
899,137

Cost of sales:
 
 
 
 
 
Product costs
353,597

 
272,021

 
318,590

Software amortization and royalties
308,051

 
129,237

 
196,956

License amortization and royalties
74,632

 
118,287

 
110,503

Total cost of sales
736,280

 
519,545

 
626,049

 
 
 
 
 
 
Gross profit
94,561

 
145,713

 
273,088

Operating expenses:
 
 
 
 
 
Product development
89,526

 
79,374

 
87,233

Selling and marketing
191,669

 
156,075

 
131,954

General and administrative
48,712

 
45,356

 
57,879

Restructuring
6,803

 
602

 
5,671

Total operating expenses
336,710

 
281,407

 
282,737

 
 
 
 
 
 
Operating loss
(242,149
)
 
(135,694
)
 
(9,649
)
Interest and other income (expense), net
5,143

 
524

 
(2,056
)
Loss from continuing operations before income taxes
(237,006
)
 
(135,170
)
 
(11,705
)
Income tax expense
5,500

 
928

 
247

Loss prior to allocation of noncontrolling interest
(242,506
)
 
(136,098
)
 
(11,952
)
Loss attributable to noncontrolling interest

 

 
2,935

Net loss attributable to THQ Inc.
$
(242,506
)
 
$
(136,098
)
 
$
(9,017
)
 
 
 
 
 
 
Loss per share attributable to THQ Inc. — basic
$
(3.55
)
 
$
(2.00
)
 
$
(0.13
)
 
 
 
 
 
 
Loss per share attributable to THQ Inc. — diluted
$
(3.55
)
 
$
(2.00
)
 
$
(0.13
)
 
 
 
 
 
 
Shares used in per share calculation — basic
68,369

 
67,910

 
67,522

Shares used in per share calculation — diluted
68,369

 
67,910

 
67,522

 
 
 
 
 
 

See notes to consolidated financial statements.


45



THQ INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF TOTAL EQUITY (DEFICIT)
(Amounts in thousands, except share data)

Fiscal Years Ended March 31, 2010, 2011 and 2012
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Retained
Earnings
(Accumulated
Deficit)
 
Non-
Controlling
Interest
 
Total
Equity
(Deficit)
 
Shares
 
Amount
 
 
 
 
 
Balance at March 31, 2009
67,471,659

 
$
675

 
$
495,851

 
$
(2,392
)
 
$
(187,094
)
 
$
3,198

 
$
310,238

Exercise of options
121,714

 
1

 
554

 

 

 

 
555

Issuance of restricted stock, net
(16,836
)
 

 
(157
)
 

 

 

 
(157
)
Issuance of ESPP shares
134,928

 
1

 
616

 

 

 

 
617

Conversion of stock unit awards