10-Q 1 thq10-q93012.htm 10-Q THQ 10-Q 9.30.12
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________________________________________________________

 FORM 10-Q 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2012
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from  _______   to _______                  
 
Commission file number 0-18813
___________________________________________________________
THQ INC.
(Exact Name of Registrant as Specified in Its Charter)
 
 
Delaware
 
13-3541686
 
 
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
 
 
 
 
29903 Agoura Road
 
 
 
 
Agoura Hills, CA
 
91301
 
 
(Address of principal executive offices)
 
(Zip Code)
 
Registrant's telephone number, including area code: (818) 871-5000
___________________________________________________________
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  o
 
Accelerated filer  x
 
 
Non-accelerated filer  o
 
Smaller reporting company  o
 
 
(Do not check if a smaller reporting company)
 
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x

The number of shares outstanding of the registrant's common stock as of November 9, 2012 was approximately 6,856,771.



THQ INC. AND SUBSIDIARIES
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2



Part I — Financial Information

Item 1.  Condensed Consolidated Financial Statements

THQ INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
 
 
September 30,
2012
 
March 31,
2012
 
(Unaudited)
 
(Unaudited)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
36,269

 
$
75,977

Accounts receivable, net of allowances
6,730

 
15,994

Inventory
12,382

 
18,485

Licenses
10,209

 
21,927

Software development
80,738

 
105,220

Deferred income taxes
4,656

 
5,732

Income taxes receivable
339

 
687

Prepaid expenses and other current assets
16,435

 
46,011

Total current assets
167,758

 
290,033

Property and equipment, net
22,890

 
22,132

Licenses, net of current portion
37,380

 
42,594

Software development, net of current portion
23,216

 
25,348

Other long-term assets, net
14,170

 
12,687

TOTAL ASSETS
$
265,414

 
$
392,794

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

 
$
42,905

Accrued and other current liabilities
49,794

 
83,693

Deferred revenue, net
33,958

 
144,686

Secured credit line
21,000

 

Total current liabilities
162,182

 
271,284

Other long-term liabilities
44,407

 
53,837

Convertible senior notes
100,000

 
100,000

Commitments and contingencies (see Note 7)

 


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

 

Common stock, par value $0.01, 225,000,000 shares authorized as of September 30, 2012; 6,855,233 and 6,851,289 shares issued and outstanding as of September 30, 2012 and March 31, 2012, respectively
685

 
685

Additional paid-in capital
527,035

 
525,677

Accumulated other comprehensive income
11,415

 
16,026

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

 
$
392,794

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

See notes to condensed consolidated financial statements.

3


THQ INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
 
 
For the Three Months Ended
September 30,
 
For the Six Months Ended
September 30,
 
(Unaudited)
 
(Unaudited)
 
2012
 
2011
 
2012
 
2011
Net sales
$
107,357

 
$
146,004

 
$
241,044

 
$
341,157

Cost of sales:
 
 
 
 
 
 
 
Product costs
36,379

 
57,986

 
74,865

 
125,049

Software amortization and royalties
37,788

 
77,893

 
75,141

 
142,813

License amortization and royalties
4,179

 
23,156

 
9,928

 
31,295

Total cost of sales
78,346

 
159,035

 
159,934

 
299,157

 
 
 
 
 
 
 
 
Gross margin
29,011

 
(13,031
)
 
81,110

 
42,000

Operating expenses:
 
 
 
 
 
 
 
Product development
11,583

 
27,954

 
20,878

 
58,143

Selling and marketing
27,324

 
37,765

 
41,963

 
88,441

General and administrative
9,809

 
12,037

 
19,941

 
24,086

Restructuring
(297
)
 
6,082

 
1,092

 
5,942

Total operating expenses
48,419

 
83,838

 
83,874

 
176,612

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

 
2,467

 
(53
)
 
2,910

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

 
(2,017
)
 
2,778

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

 
6,834

 
6,853

 
6,833

Shares used in per share calculation — diluted
6,854

 
6,834

 
6,853

 
6,833

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


4


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

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

 
(1,147
)
 
913

Unrealized gain on investments, net of tax
117

 
83

 
33

 
241

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


5


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

 
5,564

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

 
154,364

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

Restructuring charges
1,092

 
5,942

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

 
187

Gain on investments

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

 
3,339

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

 
132,565

Inventory
6,032

 
10,730

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

 
(4,389
)
Accounts payable
13,786

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

 
(571
)
Income taxes
1,465

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

 
1,186

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

 
21

Payment of debt issuance costs

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

 

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

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

 
85,603

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

 
$
51,055

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


See notes to condensed consolidated financial statements. 

6


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

1.   Basis of Presentation
 
The condensed consolidated financial statements included in this Quarterly Report on Form 10-Q ("10-Q") present the results of operations, financial position and cash flows of THQ Inc. and its subsidiaries (collectively "THQ," "we," "us," "our," or the "Company").  In the opinion of management, the accompanying condensed consolidated balance sheets and related interim condensed consolidated statements of operations, and condensed consolidated statements of comprehensive loss and condensed consolidated statements of cash flows include all adjustments, consisting only of normal recurring items, necessary for their fair presentation in conformity with accounting principles generally accepted in the United States of America.  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates relate to accounts receivable allowances, licenses, software development, revenue recognition, stock-based compensation expense and income taxes.  Interim results are not necessarily indicative of results for a full year.  The balance sheet at March 31, 2012 has been derived from the audited financial statements at that date, but does not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements.  The information included in this 10-Q should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2012 (the "2012 10-K").

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

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

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

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

7


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

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

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

In December 2011, the FASB issued ASU 2011-11, "Disclosures about Offsetting Assets and Liabilities" ("ASU 2011-11"). ASU 2011-11 creates new disclosure requirements about the nature of an entity’s rights of offset and related arrangements associated with its financial instruments and derivative instruments. The disclosure requirements are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods therein, with retrospective application required, which will be our quarter ending June 30, 2013. The new disclosures are designed to make financial statements that are prepared under U.S. Generally Accepted Accounting Principles more comparable to those prepared under International Financial Reporting Standards. The adoption is not expected to have a material impact on our results of operations, financial position or cash flows.

Fiscal Quarter.  We report our fiscal year on a 52/53-week period with our fiscal year ending on the Saturday nearest March 31. For simplicity, all fiscal periods in our condensed consolidated financial statements and accompanying notes are presented as ending on a calendar month end.  The results of operations for the three and six months ended September 30, 2012 and 2011 contain the following number of weeks:
Fiscal Period
 
Number of Weeks
 
Fiscal Period End Date
Three months ended September 30, 2012
 
13 weeks
 
September 29, 2012
Three months ended September 30, 2011
 
13 weeks
 
October 1, 2011
Six months ended September 30, 2012
 
26 weeks
 
September 29, 2012
Six months ended September 30, 2011
 
26 weeks
 
October 1, 2011

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

 
$
16,860

Components
832

 
1,625

Inventory
$
12,382

 
$
18,485

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

Prepaid expenses and other current assets. Prepaid expenses and other current assets at September 30, 2012 and March 31, 2012 primarily consisted of product costs totaling $3.9 million and $33.4 million, respectively, that were deferred in connection with the deferral of related net revenue. Also included in prepaid expenses and other current assets at September 30, 2012 and March 31, 2012 were product prepayments of $2.3 million and $1.1 million, respectively.

8



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

 
$
730

Land
 
401

 
401

Computer equipment and software
3-10 yrs
 
52,321

 
53,624

Furniture, fixtures and equipment
5 yrs
 
6,366

 
7,570

Leasehold improvements
3-6 yrs
 
14,959

 
13,005

Automobiles
2-5 yrs
 

 
87

 
 
 
74,777

 
75,417

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

 
$
22,132


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

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

 
$
13,345

Settlement payment
4,200

 
4,000

Accrued compensation
7,649

 
13,117

Accrued third-party software developer milestones
7,222

 
15,201

Accrued royalties
18,993

 
38,030

Accrued and other current liabilities
$
49,794

 
$
83,693

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

 
$
36,405

Deferred rent
7,100

 
6,667

Accrued liabilities
6,703

 
7,127

Settlement payment
604

 
3,638

Other long-term liabilities
$
44,407

 
$
53,837

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

3. Licenses and Software Development


9


Licenses. As of September 30, 2012 and March 31, 2012, the net carrying value of our licenses was $47.6 million and $64.5 million, respectively, and was reflected as “Licenses” and “Licenses, net of current portion” in our condensed consolidated balance sheets. At September 30, 2012, we had commitments of $0.1 million that are not reflected in our condensed consolidated balance sheet due to remaining performance obligations of the licensor. License amortization and royalties expense in the three and six months ended September 30, 2011 included a $16.0 million charge related to the abandonment of a license for an unannounced game that was cancelled in connection with a studio closure.

Software development. As of September 30, 2012 and March 31, 2012, the net carrying value of our software development was $104.0 million and $130.6 million, respectively, and was reflected as “Software development” and “Software development, net of current portion” in our condensed consolidated balance sheets. At September 30, 2012 we had commitments of $59.8 million that are not reflected in our condensed consolidated balance sheet due to remaining performance obligations of the external developers. Software amortization and royalties expense in the six months ended September 30, 2012 included a $5.2 million charge related to the write-off of capitalized software development due to the cancellation of an unreleased title and a $1.4 million charge related to a change in the development direction of another unreleased title. Additionally, software amortization and royalties expense in the six months ended September 30, 2012 included a net benefit of $2.3 million related to the June 1, 2012 transfer of the license we previously had to develop games based on the Ultimate Fighting Championship ("UFC"). The net benefit was the result of charges incurred related to the write-off of software development costs we had previously capitalized for the UFC game that was under development at the time of the license transfer, offset by a cash payment we received from the licensor upon the transfer of the license. All these actions were undertaken in connection with our realignment plans (see "Note 5Restructuring and Other Charges”). Software amortization and royalties expense in the three and six months ended September 30, 2011 included charges of $17.5 million and $18.9 million, respectively, related to the write-offs of capitalized software development for unannounced games that were cancelled in connection with our realignment plans.

Impairment analysis. We evaluate the future recoverability of our capitalized licenses and software development on a quarterly basis in connection with the preparation of our financial statements.  In this evaluation, we compare the carrying value of such capitalized costs to their net realizable value, on a product-by-product basis.  The net realizable value is determined using Level 3 inputs, specifically, the estimated future net sales from the product, reduced by the estimated future direct costs associated with the product such as completion costs, cost of sales, and selling and marketing expenses.  Net sales inputs are developed using recent internal sales performance for similar titles, adjusted for current market trends and comparable products. As certain of our licenses extend for multiple products over multiple years, we also assess the recoverability of capitalized license costs based on certain qualitative factors such as the success of other products and/or entertainment vehicles utilizing the intellectual property, whether there are any future planned theatrical releases or television series based on the intellectual property and the rights holder's continued promotion and exploitation of the intellectual property.

We did not record any software development impairment charges in the three and six months ended September 30, 2012. In the six months ended September 30, 2011 we recognized a software development impairment charge of $0.6 million related to one of our titles.

4.   Other Long-Term Assets
 
Other long-term assets include our investment in Yuke's, a Japanese video game developer.  We own approximately 15% of Yuke's, which is publicly traded on the Nippon New Market in Japan.  This investment is classified as available-for-sale and reported at fair value with unrealized holding gains and losses excluded from earnings and reported as a component of accumulated other comprehensive income until realized.  The pre-tax unrealized holding gain related to our investment in Yuke's for the six months ended September 30, 2012 and 2011 was $0.1 million and $0.4 million, respectively. As of September 30, 2012, the inception-to-date unrealized holding gain on our investment in Yuke's was $1.5 million.  Due to the long-term nature of this relationship, this investment is included in "Other long-term assets, net" in our condensed consolidated balance sheets.
 
Other long-term assets as of September 30, 2012 and March 31, 2012 consisted of the following (amounts in thousands):
 
 
September 30,
2012
 
March 31,
2012
Investment in Yuke's
$
4,694

 
$
4,641

Deferred financing costs
1,192

 
1,510

Other
8,284

 
6,536

Total other long-term assets
$
14,170

 
$
12,687

 

5.   Restructuring and Other Charges

10



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

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

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

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

 
$

 
$
996

 
$

 
$

 
$

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

 
120

 
976

Non-cash write-offs
 

 

 

 

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

 
24

 
(187
)
 
173

 
(14
)
Foreign currency and other adjustments
 
15

 

 
15

 
134

 

 
134

Ending balance
 
$
803

 
$

 
$
803

 
$
803

 
$

 
$
803


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

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

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

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

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

 
$

 
$
409

 
$
536

 
$

 
$
536

Charges to operations
 
244

 
17

 
261

 
261

 
17

 
278

Non-cash write-offs
 

 
(17
)
 
(17
)
 

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

 
(176
)
 
(261
)
 

 
(261
)
Foreign currency and other adjustments
 
(13
)
 

 
(13
)
 
(72
)
 

 
(72
)
Ending balance
 
$
464

 
$

 
$
464

 
$
464

 
$

 
$
464


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

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

Fiscal 2012 second quarter realignment. On August 9, 2011, we announced a plan to realign our internal studio development teams and video games in development in order to better match our resources with our target portfolio of interactive entertainment and continue our transition away from traditional console games based on licensed kids' titles and movie entertainment properties.  The following table summarizes the components and activity under the fiscal 2012 second quarter realignment, classified as "Restructuring" in our condensed consolidated statements of operations, for the three and six months ended September 30, 2012, and the related restructuring reserve balances (amounts in thousands):

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

 
$

 
$
2,109

 
$
2,341

 
$

 
$
2,341

Benefit to operations
 
(505
)
 

 
(505
)
 
(428
)
 

 
(428
)
Non-cash write-offs
 

 

 

 

 

 

Cash payments, net of sublease income
 
(284
)
 

 
(284
)
 
(584
)
 

 
(584
)
Foreign currency and other adjustments
 
14

 

 
14

 
5

 

 
5

Ending balance
 
$
1,334

 
$

 
$
1,334

 
$
1,334

 
$

 
$
1,334


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

12



We do not expect any future charges under the fiscal 2012 second quarter realignment, other than additional facility-related charges and adjustments in the event actual and estimated sublease income changes.

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

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

 
$

 
$
528

 
$
585

 
$

 
$
585

Charges to operations
 
7

 

 
7

 
13

 

 
13

Non-cash write-offs
 

 

 

 

 

 

Cash payments, net of sublease income
 

 

 

 
(52
)
 

 
(52
)
Foreign currency and other adjustments
 
(40
)
 

 
(40
)
 
(51
)
 

 
(51
)
Ending balance
 
$
495

 
$

 
$
495

 
$
495

 
$

 
$
495


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

There were no other significant charges recorded in the three and six months ended September 30, 2012 related to this realignment. In the three and six months ended September 30, 2011, we incurred $27,000 and $1.7 million, respectively, of cash severance and other employee-based charges related to the notification to employees of position eliminations (recorded within operating expenses in our condensed consolidated statements of operations), and a $1.6 million loss related to accumulated foreign currency translation adjustments (recorded within "Interest and other income (expense), net" in our condensed consolidated statements of operations). Additionally, in the three months ended June 30, 2011, we incurred a $1.4 million charge related to the cancellation of an unannounced title in development at this studio (recorded within software development amortization in our condensed consolidated statements of operations). We do not expect any future charges under the fiscal 2012 first quarter realignment, other than additional facility related charges and adjustments in the event actual and estimated sublease income changes.

Fiscal 2011 fourth quarter realignment. In the fourth quarter of fiscal 2011, we performed an assessment of our product development and publishing staffing models. This resulted in a change to our staffing plans to better address peak service periods, as well as better utilize shared-services and more cost-effective locations. The following table summarizes the components and activity under the fiscal 2011 fourth quarter realignment, classified as "Restructuring" in our condensed consolidated statements of operations, for the three and six months ended September 30, 2012, and the related restructuring reserve balances (amounts in thousands):
 
 
Three Months Ended September 30, 2012
 
Six Months Ended September 30, 2012
 
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
 
Lease and Contract Terminations
 
Net Asset Impairments
 
Total
Beginning balance
 
$
250

 
$

 
$
250

 
$
321

 
$

 
$
321

Charges to operations
 
26

 

 
26

 
76

 

 
76

Non-cash write-offs
 

 

 

 

 

 

Cash payments, net of sublease income
 
(43
)
 

 
(43
)
 
(171
)
 

 
(171
)
Foreign currency and other adjustments
 
1

 

 
1

 
8

 

 
8

Ending balance
 
$
234

 
$

 
$
234

 
$
234

 
$

 
$
234


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

13


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

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

Fiscal 2009 realignment. During the twelve months ended March 31, 2009 ("fiscal 2009"), we updated our strategic plan in an effort to increase our profitability and cash flow generation.  We significantly realigned our business to focus on fewer, higher quality games, and established an operating structure that supports our more focused product strategy.  The fiscal 2009 realignment included the cancellation of several titles in development, the closure or spin-off of several of our development studios, and the streamlining of our corporate organization in order to support the new product strategy, including reductions in worldwide personnel. We do not expect any future charges under the fiscal 2009 realignment, other than additional facility related charges and adjustments in the event actual and estimated sublease income changes.
 
The following table summarizes the restructuring lease and contract termination activity under the fiscal 2009 realignment for the three and six months ended September 30, 2012 and 2011, and the related restructuring reserve balances (amounts in thousands):
 
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
 
2012
 
2011
 
2012
 
2011
Beginning balance
 
$
1,123

 
$
1,015

 
$
1,211

 
$
1,335

Charges to operations
 
146

 
386

 
177

 
243

Non-cash write-offs
 

 

 

 

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

 
48

 
3

 
44

Ending balance
 
$
1,201

 
$
1,296

 
$
1,201

 
$
1,296


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

The aggregated restructuring accrual balances at September 30, 2012 and March 31, 2012 of $4.5 million and $5.0 million, respectively, related to future lease payments for facilities vacated under all of our realignment plans (offset by estimates of future sublease income), and accruals for other non-cancellable contracts.  As of September 30, 2012, $2.3 million of the restructuring accrual is included in "Accrued and other current liabilities" and $2.2 million is included in "Other long-term liabilities" in our condensed consolidated balance sheet.  As of March 31, 2012, $1.9 million of the restructuring accrual was included in "Accrued and other current liabilities" and $3.1 million was included in "Other long-term liabilities" in our condensed consolidated balance sheet.  We expect the final settlement of this accrual to occur by August 1, 2015, which is the last payment date under our lease agreements that were vacated.

6.  Debt
 
Credit Facility
 
On September 23, 2011, we entered into a Credit Agreement and a Security Agreement with Wells Fargo Capital Finance, LLC (“Wells Fargo”), which were amended pursuant to Amendment Number One to Credit Agreement and Security Agreement dated July 23, 2012 (collectively, as so amended, the “Credit Facility”). The Credit Facility provides for an asset based revolving credit facility providing for up to $50.0 million in aggregate principal amount of loans and other financing accommodations. The Credit Facility allows for up to $10.0 million to be used as a letter of credit subfacility. Although the Credit Facility provides up to $50.0 million in borrowings, the current available borrowing base reduces the potential for additional borrowing at this time. At September 29, 2012 we were in default under the terms of the Credit Facility (see discussion below).


14


The Credit Facility has a four-year term; however, it will terminate on June 16, 2014 if any obligations are then still outstanding under the Notes, as more fully described below. Borrowings under the Credit Facility bear interest at a rate equal to an applicable margin plus, at our option, either a variable base rate or a LIBOR rate. The applicable margin for base rate loans ranges from 2.25% to 2.5% and for LIBOR rate loans ranges from 3.75% to 4.0%, in each case, depending on the level of our revolving borrowings. Debt issuance costs capitalized in connection with the Credit Facility totaled $1.3 million; these costs are being amortized over the term of the Credit Facility. We are required to pay other customary fees, including an unused line fee based on usage under the Credit Facility as well as fees with respect to letters of credit.
During the three months ended September 30, 2012 we borrowed $21.0 million under the Credit Facility. In the three and six months ended September 30, 2012 interest expense was $0.2 million, and amortization of debt issuance costs related to the Credit Facility was $0.2 million. As of September 30, 2012 we had outstanding borrowings under the Credit Facility of $21.0 million. During the six months ended September 30, 2012, we established a letter of credit for $0.6 million under the Credit Facility that is related to a lease we have for one of our studio locations.

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

On August 4, 2009, we issued the Notes.  After offering costs, the net proceeds to THQ were $96.8 million.  The Notes are due August 15, 2014, unless earlier converted, redeemed or repurchased.  The Notes pay interest semiannually, in arrears on February 15 and August 15 of each year, beginning February 15, 2010, through maturity and are convertible at each holder's option at any time prior to the close of business on the trading day immediately preceding the maturity date.  The Notes are our unsecured and unsubordinated obligations. All share and per share information presented gives effect to the Reverse Stock Split, which occurred on July 5, 2012.
 
The Notes are initially convertible into shares of our common stock at a conversion rate of 11.7474 shares of common stock per

15


$1,000 principal amount of Notes, equivalent to an initial conversion price of approximately $85.13 per share.  At this conversion rate and upon conversion of 100% of the Notes outstanding at September 30, 2012, the Notes would convert into 1.2 million shares of common stock.  The conversion rate is subject to adjustment in certain events such as a stock split, the declaration of a dividend or the issuance of additional shares.  Also, the conversion rate will be subject to an increase in certain events constituting a make-whole fundamental change; provided, however, that the maximum number of shares to be issued thereunder cannot exceed 1.5 million, subject to adjustment.  We considered all our other commitments that may require the issuance of stock (e.g., stock options, restricted stock units, warrants, and other potential common stock issuances) and have determined that as of September 30, 2012, we have sufficient authorized and unissued shares available for the conversion of the Notes during the maximum period the Notes could remain outstanding. The Notes will be redeemable, in whole or in part, at our option, at any time after August 20, 2012 for cash, at a redemption price of 100% of the principal amount of the Notes, plus accrued but unpaid interest, if the price of a share of our common stock has been at least 150% of the conversion price then in effect for specified periods. 

In the case of certain events such as the acquisition or liquidation of THQ, or delisting of our common stock from a U.S. national securities exchange, holders may require us to repurchase all or a portion of the Notes for cash at a purchase price of 100% of the principal amount of the Notes, plus accrued and unpaid interest.

Costs incurred related to the Notes offering amounted to $3.2 million and are classified as "Other long-term assets, net" in our condensed consolidated balance sheets at September 30, 2012; these costs are being amortized over the term of the Notes.

The effective interest rate, before capitalization of any interest expense and amortization of debt issuance costs, was 5.65% for the three and six months ended September 30, 2012 and 2011.

Capitalization of Interest Expense

We capitalize interest expense and related amortization of debt issuance costs as part of in-process software development costs.  Capitalization commences with the first capitalized expenditure for the software development project and continues until the project is completed. We amortize these balances to "Cost of sales — Software amortization and royalties" as part of the software development costs.  In the six months ended September 30, 2012 and 2011 we capitalized $3.2 million and $2.8 million, respectively, of interest expense and related amortization of debt issuance costs.

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

 
$
5,004

 
$
7,464

 
$
21,000

 
$
1,981

 
$
80,476

2014
 
30,967

 
9,020

 
14,093

 

 
3,624

 
57,704

2015
 
13,600

 
970

 
12,620

 
100,000

 
424

 
127,614

2016
 
7,500

 
567

 
7,636

 

 
90

 
15,793

2017
 
7,500

 
509

 
4,721

 

 

 
12,730

Thereafter
 

 
375

 
11,948

 

 

 
12,323

 
 
$
104,594

 
$
16,445

 
$
58,482

 
$
121,000

 
$
6,119

 
$
306,640

 
(1)
Licenses and Software Development.  We enter into contractual arrangements with third parties for the rights to exploit intellectual property and for the development of products.  Under these agreements, we commit to provide specified payments to an intellectual property holder or developer.  Assuming all contractual provisions are met, the total future minimum contract commitments for such agreements in place as of September 30, 2012 are $104.6 million. License commitments in the table above include $44.8 million of commitments payable to licensors that are included in both "Accrued and other current liabilities" and "Other long-term liabilities" in our September 30, 2012 condensed consolidated balance sheet because the licensors do not have any remaining significant performance obligations.

(2)
Advertising.  We have certain minimum advertising commitments under many of our major license agreements. These minimum commitments are based upon the specific arrangements we have with the respective licensors and range from fixed

16


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

(3)
Leases.  We are committed under operating leases with lease termination dates through 2020.  Most of our leases contain rent escalations.  Of these obligations, $2.3 million and $2.2 million are accrued and classified as "Accrued and other current liabilities" and "Other long-term liabilities," respectively, in our September 30, 2012 condensed consolidated balance sheet due to the abandonment of certain lease obligations in connection with our realignment plans (see "Note 5Restructuring and Other Charges"). We expect future sublease rental income under non-cancellable agreements of approximately $2.1 million; this income is not contemplated in the lease commitments shown in the table above.

(4)
Debt.  We issued the Notes on August 4, 2009.  The Notes pay interest semiannually, in arrears on February 15 and August 15 of each year, beginning February 15, 2010, through maturity and are convertible at each holder's option at any time prior to the close of business on the trading day immediately preceding the maturity date.  Absent any conversions or required repurchases of the Notes, we expect to pay $2.5 million in the remainder of fiscal 2013, $5.0 million in fiscal 2014, and $2.5 million in fiscal 2015, for an aggregate of $10.0 million in interest payments over the remaining term of the Notes (see "Note 6Debt"). Additionally, as of September 30, 2012 we had outstanding borrowings under the Credit Facility of $21.0 million (see "Note 6Debt").

(5)
Other.  As discussed more fully in "Note 14Joint Venture and Settlement Agreements" in the notes to the consolidated financial statements in our 2012 10-K, amounts payable to Jakks totaling $5.0 million are reflected in the table above. The present value of these amounts is included in "Accrued and other current liabilities" and "Other long-term liabilities" in our condensed consolidated balance sheet at September 30, 2012 (see "Note 2Balance Sheet Details"). The remaining other commitments included in the table above are also included as current or long-term liabilities in our September 30, 2012 condensed consolidated balance sheet.

(6)
We have omitted unrecognized tax benefits from this table due to the inherent uncertainty regarding the timing and amount of certain payments related to these unrecognized tax benefits.  The underlying positions have not been fully developed under audit to quantify at this time.  At September 30, 2012, we had $3.9 million of unrecognized tax benefits.  See "Note 9Income Taxes" for further information regarding the unrecognized tax benefits.

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

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

Litigation.

Federal Securities Class Action Case

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

17


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

Shareholder Derivative Actions

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

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

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

9Income Taxes

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

Our income tax expense for the three and six months ended September 30, 2012 was $2.3 million and $2.8 million, respectively, primarily related to foreign tax jurisdictions. These amounts represent effective tax rates for the three and six months ended September 30, 2012 of 12.1% (provision on a loss) and 98.6% (provision on a loss), respectively. In the three and six months ended September 30, 2011 we had a tax benefit of $2.0 million and $0.9 million, respectively, which primarily related to losses in foreign tax jurisdictions. These amounts represent effective tax rates for the three and six months ended September 30, 2011 of 2.1% and 0.7% (benefit on a loss), respectively. The rate for the three and six months ended September 30, 2012 and 2011 differs from the U.S. federal statutory rate of 35% primarily due to taxable losses in the U.S., which are fully offset by a valuation allowance.

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

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

18



Our policy is to recognize interest and penalty expense, if any, related to uncertain tax positions as a component of income tax expense.  As of September 30, 2012, we had no amounts accrued for interest and for the potential payment of penalties.

10.   Loss Per Share
 
All loss per share information presented gives effect to the Reverse Stock Split, which occurred on July 5, 2012. The following table is a reconciliation of the weighted-average shares used in the computation of basic and diluted loss per share for the periods presented (amounts in thousands):
 
 
For the Three Months Ended
September 30,
 
For the Six Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Net loss used to compute basic loss per share
$
(20,980
)
 
$
(92,385
)
 
$
(5,595
)
 
$
(130,830
)
 
 
 
 
 
 
 
 
Weighted-average number of shares outstanding — basic
6,854

 
6,834

 
6,853

 
6,833

Dilutive effect of potential common shares

 

 

 

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

 
6,834

 
6,853


6,833


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

As a result of our net loss for the three and six months ended September 30, 2012 and 2011, all potential shares were excluded from the computation of diluted loss per share, as their inclusion would have been antidilutive. As a result, there were 1.3 million and 1.0 million potential common shares that were excluded from the computation of diluted loss per share for the three and six months ended September 30, 2012 and 2011, respectively. Had we reported net income for these periods, an additional 0.1 million shares of common stock would have been outstanding in the number of shares used to calculate diluted loss per share for the three and six months ended September 30, 2012. An additional 21,000 and 19,000 shares of common stock would have been outstanding in the number of shares used to calculate diluted loss per share for the three and six months ended September 30, 2011.

11.   Fair Value
 
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.  There is a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value.  We used the following methods and assumptions to estimate the fair value of our financial assets:
 
                  Level 1 — Quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.  We do not adjust the quoted prices for these investments.
                  Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
                  Level 3 — Discounted cash flow analysis using unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities, as discussed further below.
 
Our policy is to recognize transfers between these levels of the fair value hierarchy as of the beginning of the reporting period.
 
The following table summarizes our financial assets measured at fair value on a recurring basis as of September 30, 2012 (amounts in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents - Money market funds
$
88

 
$

 
$

 
$
88

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

 

 

 
4,694

Total
$
4,782

 
$

 
$

 
$
4,782


19


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

 
$

 
$

 
$

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

 

 

 
4,641

Total
$
4,641

 
$

 
$

 
$
4,641

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

Financial Instruments
 
The carrying value of certain financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, and accrued royalties approximate fair value based on their short-term nature. 
 
The book value and fair value of the Notes at September 30, 2012 was $100.0 million and $53.0 million, respectively; the fair value was determined using quoted market prices in active markets.
 
We transact business in many different foreign currencies and are exposed to financial market risk resulting from fluctuations in foreign currency exchange rates, particularly the GBP and the Euro, which may result in a gain or loss of earnings to us. We utilize foreign currency exchange forward contracts to mitigate foreign currency risk associated with foreign currency-denominated assets and liabilities, primarily certain inter-company receivables and payables. Our foreign currency exchange forward contracts are not designated as hedging instruments and are accounted for as derivatives whereby the fair value of the contracts are reported as "Prepaid expenses and other current assets" or "Accrued and other current liabilities" in our condensed consolidated balance sheets, and the associated gains and losses from changes in fair value are reported in "Interest and other income (expense), net" in our condensed consolidated statements of operations.
 
Cash Flow Hedging Activities.  From time to time, we may elect to hedge a portion of our foreign currency risk related to forecasted foreign currency-denominated sales and expense transactions by entering into foreign currency exchange forward contracts that generally have maturities of less than 90 days.  Our hedging programs reduce, but do not entirely eliminate, the impact of currency exchange rate movements in net sales and operating expenses.  During the six months ended September 30, 2012 and 2011, we did not enter into any foreign exchange forward contracts related to cash flow hedging activities.
 
Balance Sheet Hedging Activities.  The foreign currency exchange forward contracts related to balance sheet hedging activities generally have a contractual term of one month or less and are transacted near month-end. Therefore, the fair value of the forward contracts are generally not significant at each month-end.
 
At September 30, 2012, we did not have any outstanding foreign currency exchange forward contracts related to balance sheet hedging activities. At March 31, 2012, we had foreign currency exchange forward contracts related to balance sheet hedging activities in the notional amount of $92.2 million with a fair value that approximates zero at March 31, 2012.  We estimated the fair value of these contracts using Level 1 inputs, specifically, inputs obtained in quoted public markets.  In the three months ended September 30, 2012, we did not enter into any foreign currency exchange forward contracts related to balance sheet hedging activities, and thus did not have a gain or loss. The net loss recognized from these contracts during the six months ended September 30, 2012 was $4.3 million. The net loss recognized from these contracts during the three and six months ended September 30, 2011 was $4.2 million and $2.7 million, respectively. Net gains and losses recognized from these contracts are included in "Interest and other income (expense), net" in our condensed consolidated statements of operations.

12.   Capital Stock Transactions

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

13. Segment and Geographic Information

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

20


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

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

 
$
32,322

 
$
6,016

 
$
91,798

Changes in deferred net revenue
14,357

 
403

 
799

 
15,559

Net sales to unaffiliated customers
$
67,817

 
$
32,725

 
$
6,815

 
$
107,357

Total assets
$
109,690

 
$
122,614

 
$
33,110

 
$
265,414

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

 
$
44,328

 
$
9,210

 
$
130,323

Changes in deferred net revenue
72,290

 
29,676

 
8,755

 
110,721

Net sales to unaffiliated customers
$
149,075

 
$
74,004

 
$
17,965

 
$
241,044

 
 
 
 
 
 
 
 
Three months ended September 30, 2011
 
 
 
 
 
 
 
Net sales to unaffiliated customers before changes in deferred net revenue
$
68,757

 
$
40,145

 
$
10,708

 
$
119,610

Changes in deferred net revenue
24,597

 
2,746

 
(949
)
 
26,394

Net sales to unaffiliated customers
$
93,354

 
$
42,891

 
$
9,759

 
$
146,004

Total assets
$
328,720

 
$
161,114

 
$
42,539

 
$
532,373

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

 
$
75,375

 
$
28,974

 
$
260,849

Changes in deferred net revenue
53,113

 
27,005

 
190

 
80,308

Net sales to unaffiliated customers
$
209,613

 
$
102,380

 
$
29,164

 
$
341,157


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

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

 
$
36,098

 
$
52,220

 
$
87,640

Sony PlayStation 3
 
35,804

 
28,115

 
45,665

 
63,897

Nintendo Wii
 
58

 
15,503

 
3,254

 
34,527

Sony PlayStation 2
 
445

 
1,292

 
729

 
2,311

 
 
74,547

 
81,008

 
101,868

 
188,375

Handheld
 
 
 
 
 
 
 
 
Nintendo Dual Screen
 
2,233

 
17,677

 
5,700

 
38,961

Sony PlayStation Portable
 
582

 
1,974

 
1,223

 
4,096

Wireless
 
429

 
730

 
850

 
1,466

 
 
3,244

 
20,381

 
7,773

 
44,523

 
 
 
 
 
 
 
 
 
PC
 
14,007

 
18,221

 
20,682

 
27,951

Net sales before changes in deferred net revenue
 
91,798

 
119,610

 
130,323

 
260,849

Changes in deferred net revenue
 
15,559

 
26,394

 
110,721

 
80,308

Total net sales
 
$
107,357

 
$
146,004

 
$
241,044

 
$
341,157


21


14. Subsequent Events

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


22



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

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

Overview
 
The following is a discussion of our operating results and financial condition, as well as material changes in operating results and financial condition from prior reported periods.  The discussion and analysis herein should be read in conjunction with our consolidated financial statements, notes to the consolidated financial statements, and management's discussion and analysis (which includes additional information about our accounting policies, practices and the transactions that underlie our financial results) contained in our Annual Report on Form 10-K for the fiscal year ended March 31, 2012 (the "2012 10-K") and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2012.
 
About THQ
We are a leading worldwide developer and publisher of interactive entertainment software for all popular game systems, including:
home video game consoles such as the Microsoft Xbox 360 and Xbox 360 Kinect (collectively referred to as "Xbox 360"), Nintendo Wii ("Wii"), and Sony PlayStation 3 ("PS3");
handheld platforms such as the Nintendo DS, DSi and 3DS (collectively referred to as "DS"), and Sony PlayStation Portable ("PSP");
wireless devices based on the Apple iOS (including the iPhone, iTouch and iPad), Google Android, and Windows Mobile platforms;
personal computers ("PCs"), including games played online; and
the Internet, including on social networking sites such as Facebook.

In addition to titles published on the wireless devices noted above, we also develop and publish titles (and supplemental downloadable content) for digital distribution via Sony's PlayStation Network ("PSN") and Microsoft's Xbox LIVE Marketplace ("Xbox LIVE") and Xbox LIVE Arcade ("XBLA"), as well as digitally offer our PC titles through online download stores and services such as Amazon, OnLive, Origin, and Valve.
 
Our titles span multiple categories, including action, adventure, fighting, role-playing, simulation, and strategy.  We have created, licensed and acquired a group of highly recognizable brands, which we market to a variety of consumer demographics ranging from products targeted at core gamers to products targeted to mass market.  Our portfolio of key franchises currently includes:
games based on our owned intellectual properties including Company of Heroes, Darksiders, Homefront, and Saints Row; and new properties in development by Patrice Désilets and Turtle Rock Studios, and
core games based on licensed properties including Metro, South Park Digital Studios' South Park, and World Wrestling Entertainment ("WWE").

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


23


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

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

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

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

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

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

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

Business Trends
 
The following trends affect our business:

Increasing Shift to Online Content and Digital Downloads

We provide our products through both the retail channel and through online digital delivery methods. Recently, the interactive entertainment software industry began delivering a growing amount of games, downloadable content and product add-ons by direct digital download through the Internet and gaming consoles. We believe that much of the growth in the industry will come via online distribution methods, including, multi-player online games (both subscription and free-to-play), free-to-play micro-transaction based games, paid downloadable content ("DLC"), and digital downloads of full-games. Conversely, based on industry data, we believe retail sales for the industry will continue to be a decreasing revenue source over the next several years. For the nine months ended September 30, 2012, reported retail software sales in the U.S. for the industry decreased 23% compared to the same period in 2011 according to the NPD Group; for the same period, across U.K., Germany, France, Spain and Benelux, aggregated retail software sales decreased 19% compared to the same nine-month period in 2011 according to GfK.  However, digital sales for the industry are expected to grow over 22% worldwide in calendar 2012 and almost double, over calendar 2011 levels, in the following five years to $71.1 billion worldwide according to the International Development Group, Inc.'s Forecast Update (August 2012). Accordingly, we plan to emphasize the digital components in our future core game releases. In the event our games are released with increasingly more undelivered elements at the time of sale, such as the online service present within some of our games, more of our revenue may be deferred, which will impact the timing of our revenue recognition but not our cash flow from operations.

24



Sales Concentration of Top Titles

The majority of money spent by consumers on video game software is spent on a few top titles. Because of the demand for “hit” titles and the costs to develop our games, we believe that it is important to focus our development efforts on bringing a select number of high-quality, competitive products to market.
  
Sales of Used Video Games
 
Several retailers, including one of our largest customers, GameStop, continue to focus on selling used video games, which provides higher margins for the retailers than sales of new games. This focus reduces demand for new copies of our games. We believe customer retention through compelling online play and downloadable content offerings may reduce consumers' propensity to trade in games. Additionally, certain titles include free access to online content through a code (included in the packaging) for initial purchasers. This structure creates a new revenue stream by offering second-hand buyers of these titles the opportunity to separately purchase the online content.

Shifting Preferences in the Casual and Lifestyle Market

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

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

For the three and six months ended September 30, 2012, we reported a net loss of $21.0 million and $5.6 million, respectively, or $3.06 and $0.82 per diluted share, respectively, compared with a net loss of $92.4 million and $130.8 million, respectively, or $13.52 and $19.15 per diluted share, respectively, in the same periods last fiscal year.

Net Sales
 
Our net sales are principally derived from sales of interactive software games designed for play on video game consoles, handheld devices, and PCs, including via the Internet. The following table presents our net sales before changes in deferred net revenue and adjusts those amounts by the changes in deferred net revenue to arrive at consolidated net sales as presented in our condensed consolidated statements of operations for the three and six months ended September 30, 2012 and 2011 (amounts in thousands):

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

 
85.5
%
 
$
119,610

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

 
14.5

 
26,394

 
18.1

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

 
100.0
%
 
$
146,004

 
100.0
%
 
$
(38,647
)
 
(26.5
)%

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

 
54.1
%
 
$
260,849

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

 
45.9

 
80,308

 
23.5

 
30,413

 
37.9

Consolidated net sales
$
241,044

 
100.0
%
 
$
341,157

 
100.0
%
 
$
(100,113
)
 
(29.3
)%

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


25


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

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

Net Sales by New Releases and Catalog Titles
 
The following table presents our net sales of new releases (titles initially released in the respective fiscal year) and catalog titles (titles released in fiscal years prior to the respective fiscal year) for the three and six months ended September 30, 2012 and 2011 (amounts in thousands):

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

 
63.2
%
 
$
75,448

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

 
36.8

 
44,162

 
36.9

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

 
100.0
%
 
119,610

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

 
 
 
26,394

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

 
 
 
$
146,004

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

 
45.2
%
 
$
164,477

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

 
54.8

 
96,372

 
36.9

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

 
100.0
%
 
260,849

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

 
 
 
80,308

 
 
 
30,413

 
37.9

Consolidated net sales
$
241,044

 
 
 
$
341,157

 
 
 
$
(100,113
)
 
(29.3
)%

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

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

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


26


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

 
58.2
%
 
$
68,757

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

 
35.2

 
40,145</