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THQ INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) 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 -------------------------------------------------------------------------------- Table of Contents 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 -------------------------------------------------------------------------------- Table of Contents 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. |