Back to GetFilings.com
1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
-------------
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] 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 (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
27001 AGOURA ROAD
CALABASAS HILLS, CA 91301
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 871-5000
--------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $.01 par value
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of Registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K. Yes [ ] No [X]
As of March 20, 2000, approximately 18,802,000 shares of Common Stock of
the Registrant were outstanding and the aggregate market value of voting Common
Stock held by non-affiliates was approximately $341,404,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the THQ Inc. 2000 Notice of Annual Meeting of Stockholders
and Proxy Statement, to be filed with the Securities and Exchange Commission
within 120 days after the close of the Registrant's fiscal year (incorporated
into Part III).
================================================================================
2
THQ INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
YEAR ENDED DECEMBER 31, 1999
ITEMS IN FORM 10-K
Page
----
Facing page
Part I
Item 1. Business. 1
Item 2. Properties. 14
Item 3. Legal Proceedings. 14
Item 4. Submission of Matters to a Vote of Security Holders. 15
Part II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters. 16
Item 6. Selected Financial Data. 17
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 19
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk. 28
Item 8. Financial Statements and Supplementary Data. 29
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure. 29
Part III
Item 10. Directors and Executive Officers of the Registrant. 30
Item 11. Executive Compensation. 30
Item 12. Security Ownership of Certain Beneficial Owners and
Management. 30
Item 13. Certain Relationships and Related Transactions. 30
Part IV
Item 14. Exhibits, Financial Statement Schedule and Reports on
Form 8-K. 31
Signatures 34
3
This Annual Report contains, or incorporates by reference, certain
statements that may be deemed "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. Such statements appear in
a number of places in this Report, including, without limitation, "Business" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations". All statements relating to our objectives, strategies, plans,
intentions and expectations, and all statements (other than statements of
historical facts) that address actions, events or circumstances that we expect,
believe or intend will occur in the future, are forward-looking statements.
Prospective investors are cautioned that any such forward-looking statements
involve risks and uncertainties, and that the actual results may differ
materially from those in the forward-looking statements as a result of various
uncertainties, including, without limitation, uncertainties relating to the
interactive entertainment software industry and other factors, as more
specifically set forth in our report on Form 8-K, filed on March 21, 2000 with
the Securities and Exchange Commission.
PART I
ITEM 1. BUSINESS
INTRODUCTION
We are a developer, publisher and distributor of interactive
entertainment software for the leading hardware platforms in the home video game
market. We currently publish titles for Sony's PlayStation, Sega Dreamcast,
Nintendo 64, Nintendo Game Boy and Game Boy Color, and personal computers
("PCs") in most interactive software genres, including action, adventure,
driving, fighting, puzzle, role playing, simulation, sports and strategy. Our
customers include Wal-Mart, Toys "R" Us, Target, Kmart Stores, Kay Bee Toys,
Electronics Boutique, Blockbuster, Best Buy, other national and regional
retailers, discount store chains and specialty retailers.
Our games are developed both internally and under contract with
independent developers, and are typically based on properties licensed from
third parties. We continually seek to identify and develop titles based upon
entertainment projects (such as movies, television programs and arcade games),
sports and entertainment personalities, or popular sports, trends or concepts
that have high public visibility or recognition or that reflect the trends of
popular culture. Other than games that we release on CD-ROM for use on PCs, all
of our products consist of cartridges and CD-ROMs manufactured for us by
Nintendo, Sony and Sega.
Over the past four years, we have experienced significant growth in net
sales and net income. During the year ended December 31, 1999, our net income
grew to $32.9 million from $21.9 million in 1998 (excluding in-process research
and development charge in 1998). In the year ended December 31, 1999, our net
sales increased to $302.4 million from $216.1 million in 1998, $89.6 million in
1997 and $50.3 million in 1996, representing a compound annual growth rate of
157%.
We are a Delaware corporation that was incorporated in 1997. We were
formerly incorporated in New York in 1989 under the name T.HQ, Inc. Our
principal executive offices
1
4
are located at 27001 Agoura Road, Calabasas Hills, California 91301, and our
telephone number is (818) 871-5000. Our web site is at www.thq.com.
THQ(R) is our registered trademark and trade name. Nintendo(R), Super
Nintendo Entertainment System(R) ("SNES"), Game Boy(R), Game Boy Color(R) and
Nintendo 64(R) are registered trademarks of Nintendo of America, Inc.
("Nintendo"). Sega(R), Genesis(R), Game Gear(R), Saturn(R) and Dreamcast(R) are
registered trademarks of Sega of America, Inc. ("Sega"). Sony PlayStation(R) and
Sony PlayStation 2(R) are registered trademarks of Sony Computer Entertainment
Inc. ("Sony"). Nintendo, Sony and Sega are referred to herein collectively as
the "manufacturers."
THE INTERACTIVE ENTERTAINMENT INDUSTRY AND TECHNOLOGY
The home interactive game market consists both of (i) cartridge-based,
CD-ROM-based and DVD-ROM based software for use solely on dedicated hardware
systems, and (ii) software distributed on CD-ROMs for use on PCs. Until 1996,
most software for dedicated platforms was sold in cartridge form. However,
CD-ROMs and DVD-ROMs have become increasingly popular because they have
substantially greater data storage capacity and lower manufacturing costs than
cartridges.
The first modern platform was introduced by Nintendo in 1985 using
"8-bit" technology. "8-bit" means that the central processing unit, or "chip,"
on which the software operates is capable of processing data in 8-bit units.
Subsequent advances in technology have resulted in continuous increases in the
processing power of the chips that power both the platforms and PCs. As the
technology of the hardware has advanced, the software designed for the platforms
has similarly advanced, with faster and more complex images, more lifelike
animation and sound effects and more intricate scenarios. The larger data
storage capacity of CD-ROMs (and subsequent DVD-ROMs in yet to be released
systems, Sony PlayStation 2, Microsoft X-Box and the Nintendo Dolphin) enables
them to provide richer content and longer play. The new Sony and Microsoft
systems will have a robust on-line hardware component hoping to take full
advantage of the advent of broadband networking. Currently, the non-portable
platforms being marketed are based primarily on 32-bit and 64-bit technology.
Portable platforms are less sophisticated technologically and do not require
television monitors.
The following table sets forth the year of release in the United States
of each of the manufacturers' platforms for which we have published titles and
the technology on which such platforms are based:
DATE OF U.S.
MANUFACTURER PRODUCT NAME INTRODUCTION TECHNOLOGY
- --------------------- ------------------- ----------------- ------------------
Nintendo NES 1985 8-bit
Nintendo Game Boy 1989 8-bit (portable)
Sega Game Gear 1991 8-bit (portable)
Sega Genesis 1989 16-bit
Nintendo SNES 1991 16-bit
Sega Saturn 1995 32-bit
Sony PlayStation 1995 32-bit
2
5
Nintendo Nintendo 64 1996 64-bit
Nintendo Game Boy Color 1998 16-bit (portable)
Sega Dreamcast 1999 128-bit
We believe that the success of a video game is dependent on the graphic
look and feel of the game, the depth and variation of game play and the
popularity of the property on which the game is based.
Sega launched its newest platform, Dreamcast, in Japan in the fall of
1998 and introduced it in the United States in the fall of 1999. Sony has
launched the successor to the PlayStation, the PlayStation 2, in Japan. The
PlayStation 2 is scheduled for launch in the U.S. market in late 2000. Nintendo
has plans to launch a new platform in 2001 called the Dolphin. Microsoft has
also announced a new platform, X Box, scheduled to debut in the fall of 2001.
While we have not formally committed to these platforms, it is likely that we
will publish for them. Software for new platforms requires different standards
of design and technology to fully exploit their capabilities. The introduction
of new platforms also requires that game developers devote substantial
additional resources to product design and development.
BUSINESS STRATEGY
Our goals are to expand our position as a leading provider of exciting,
high-quality interactive entertainment software on a variety of platforms,
intelligently take advantage of opportunities provided by the internet, and to
continue to emphasize profitability by maintaining strict cost controls and
managing the risks associated with software development. In order to achieve
these goals, management is focused on implementing the following strategies:
- BUILD CONTENT BY CAPITALIZING ON EXISTING BRANDS AND ACQUIRING
NEW ONES. Brand recognition and sustainable consumer appeal
allow THQ to exploit titles over an extended period of time
through the release of sequels and extensions and to re-release
such products at different price points. Brands represent
content over which we have control either by developing our own
proprietary titles or obtaining exclusive licenses to
established properties for extended time periods. We intend to
continue to capitalize on currently established brands such as
World Wrestling Federation (through a venture with JAKKS
Pacific), Nickelodeon's Rugrats, MTV Sports and Ricky
Carmichael's Championship Motocross, by launching new titles on
multiple hardware platforms. We also intend to increase our
product content through new brands such as Scooby Doo, Power
Rangers, Evil Dead and Summoner. It is our goal to expand our
library of brands, reaching a broad audience, while increasing
our focus on original content.
- TECHNOLOGY. We intend to publish for the next generation of
video game systems. The expansion of internal product
development to over 100 employees positions us to take advantage
of new game technology. Pacific Coast Power & Light Company, a
development studio acquired in May 1999, is focused solely on
development for the new PlayStation 2 platform. Heavy Iron
Studios, consisting of video game and feature film veterans, is
currently working on Evil Dead
3
6
(scheduled for release in the fall of 2000) for multiple
platforms. GameFx is now exclusively developing proprietary
tools for the new game platforms.
- ON-LINE GAMING / E-COMMERCE. We believe our recent acquisition
of Genetic Anomalies positions us to benefit from opportunities
on the Internet. Genetic Anomalies' "Collectible Bits"
technology has application to both on-line gaming and E-Commerce
environments. The potential for this technology is evidenced by
a competitor licensing it for one of their key franchises. We
plan to release our first on-line title, WWF: With Authority, in
mid-2000. Further, we will be examining opportunities for
bringing our mass-market brands to the Internet, while preparing
to take advantage of the on-line capabilities of new console
systems and broadband connectivity.
- EXPAND GLOBAL REACH. While our foreign sales increased to 24.7%
of total sales in 1999, we believe we can further expand our
presence in foreign markets. Industry estimates indicate that
the international market for interactive software is roughly
equal to the U.S. market. Our acquisition of Rushware
Microhandelsgesellschaft mbH and its subsidiaries (collectively
"Rushware") contributed to our international growth in 1999,
increasing market penetration in German speaking territories and
expanding our PC business. To further grow in global markets, we
intend to increase product offerings targeted to foreign
consumers with titles such as Mercedes Benz Truck Racing, TOCA
Touring Car Champions and Cultures. We are expanding our foreign
marketing and distribution capabilities by opening new sales and
marketing offices in France (November 1999) and Australia (March
2000). These new offices will bring THQ product direct to
retailers in France, Australia and New Zealand, allowing THQ to
potentially obtain higher sales and margins in these
territories.
- CONTINUE TO EXPLOIT THE GAME BOY COLOR PLATFORM. As the largest
independent domestic publisher of Game Boy titles (according to
the NPD's TRST data), we will continue to take advantage of this
platform. Our market position makes us an attractive partner for
licensors wanting to put their products on the Game Boy system,
as evidenced by our recent agreement with Fox Interactive for
The Simpsons, Buffy the Vampire Slayer, Croc, and Aliens
franchises. The relative low cost of developing games for the
Game Boy, combined with the platform's large installed base,
provides the opportunity to generate continuing sales and
profits from this system with less risk than other platforms.
- MAINTAIN COST CONTROLS AND MANAGE RISK. We minimize our fixed
expenses by using independent software developers, adopting
warehouse and shipping systems that closely link fulfillment
costs to sales volumes, and compensating sales employees and
representatives based on sales volumes. In addition, we attempt
to reduce the risks associated with excessive or obsolete
inventory by utilizing strict ordering and inventory controls.
4
7
We intend to continue pursuing potential acquisition transactions
consistent with these strategies. In addition, in order to create a closer
relationship with independent developers, we may from time to time make
investments or acquire minority interests in independent developers.
TITLES
We have released an aggregate of 207 titles as of December 31, 1999,
consisting of 13 Nintendo Entertainment System ("NES") titles, 64 Game Boy/Game
Boy Color titles, seven Sega Game Gear titles, 14 Sega Genesis titles, 47 Super
Nintendo Entertainment System ("SNES") titles, three Sega Saturn titles, 28 Sony
PlayStation titles, 13 Nintendo 64 titles and 18 PC titles. We continually seek
to acquire licenses to publish and distribute additional titles.
The following tables set forth, for each platform, the titles (i)
released by us in 1999 and anticipated to be released in 2000, and (ii) the date
of release (or anticipated release) of each title. We cannot assure you that
each of the titles anticipated for release in 2000 will be released when
scheduled, if ever.
5
8
RELEASE
TITLES RELEASED IN 1999 CATEGORY PLATFORM DATE
- --------------------------------------- ---------------------- -------------------- ---------
WCW Thunder Fighting PlayStation 1/99
WCW Nitro Fighting Nintendo 64 2/99
Penny Racers Racing Nintendo 64 2/99
Rugrats: The Movie Adventure Game Boy Color 4/99
Star Wars X-Wing Alliance*** Space Action PC CD-ROM 4/99
Star Wars Episode One: The Phantom Action PC CD-ROM 5/99
Menace***
Star Wars Episode One: Racer*** Racing PC CD-ROM 5/99
Logical Puzzle Game Boy Color 5/99
Rugrats Scavenger Hunt Board Game Nintendo 64 6/99
Ultimate 8 Ball Leisure Sports PlayStation 6/99
PC CD-ROM
X: Beyond the Frontier Strategy PC CD-ROM 6/99
Castrol Honda Superbike Sports PlayStation 8/99
Dark Secrets of Africa Strategy PC CD-ROM 8/99
Championship Motocross featuring Sports PlayStation 9/99
Ricky Carmichael
Sinistar: Unleashed Arcade PC CD-ROM 9/99
Road Rash 64 Action / Racing Nintendo 64 9/99
Destruction Derby Action / Racing Nintendo 64 9/99
Michael Owen's World League Sports Nintendo 64 9/99
Soccer
Extreme 500 Racing PC CD-ROM 9/99
Medicopter Flight Simulation PC CD-ROM 9/99
Bing II Business Simulation PC CD-ROM 9/99
Star Wars Episode One: The Action PlayStation 9/99
Phantom Menace***
Madden NFL 2000 Sports Game Boy Color 10/99
Rugrats: Time Travelers Adventure Game Boy Color 10/99
MTV Sports: Snowboarding Sports PlayStation 10/99
BASS Masters Classic Simulation Game Boy Color 11/99
Rugrats: Studio Tour Adventure PlayStation 11/99
Toy Story 2 Action Game Boy Color 11/99
WWF Wrestlemania 2000 Fighting Nintendo 64 11/99
Game Boy Color
Nuclear Strike 64 Action Nintendo 64 11/99
Indiana Jones*** Action / Adventure PC CD-ROM 11/99
BASS Masters 2000 Sports Nintendo 64 12/99
NHL 2000 Sports Game Boy Color 12/99
FIFA 2000 Sports Game Boy Color 12/99
Yoda Stories Adventure Game Boy Color 12/99
Brunswick Circuit Pro Bowling Sports Nintendo 64 12/99
Shao Lin Action / Adventure PlayStation 12/99
Micro Machines 1 & 2 Racing Game Boy Color 12/99
Extreme 500 Racing PlayStation 12/99
Soapy Pictures Lifestyle Simulation PC CD-ROM 12/99
6
9
ANTICIPATED
TITLES ANTICIPATED TO BE RELEASED RELEASE
IN 2000* CATEGORY PLATFORM DATE
-------------------------------------- ----------------- -------------------- ------------
Tiger Woods PGA Tour 2000** Sports Game Boy Color 1/00
Brunswick Pro Bowling** Sports PlayStation 2/00
WWF Smackdown!** Fighting PlayStation 3/00
Force Commander*** Action Game Boy Color Spring `00
Rugrats: Totally Angelica Adventure Game Boy Color Spring `00
Micro Machines V3 Racing Game Boy Color Spring `00
Triple Play 2001 Sports Game Boy Color Spring `00
Nascar 2000 Racing Game Boy Color Spring `00
Aidyn Chronicles: The First Mage Role Playing Nintendo 64 Summer `00
Danger Girl Action / PlayStation Summer `00
Adventure
MTV Sports: Skateboarding Sports PC CD-ROM Summer `00
(working title) Nintendo 64
Game Boy Color
Sega Dreamcast
TOCA Touring Car Championship Racing Game Boy Color Summer `00
WWF: With Authority Card Game Online Summer `00
Player Manager Sports Game Boy Color Summer `00
Management
NBA Live 2000 Sports Game Boy Color Fall `00
Felony Pursuit Action Sega Dreamcast Fall `00
PC CD-ROM
Power Rangers Lightspeed Rescue Adventure Game Boy Color Fall `00
Nintendo 64
PlayStation
Evil Dead Role Playing PlayStation Fall `00
Sega Dreamcast
PC
Summoner Role Playing PlayStation 2 Fall `00
MTV Sports: BMX Sports PlayStation Fall `00
Game Boy Color
MTV Sports: Snowboarding 2 Sports PlayStation Fall `00
Championship Motocross featuring Sports Game Boy Color Fall `00
Ricky Carmichael
Championship Motocross 2 Sports PlayStation Fall `00
Featuring Ricky Carmichael
Rugrats in Paris Action Game Boy Color Fall `00
PlayStation
Nintendo 64
WWF Fighting Nintendo 64 Fall `00
Sega Dreamcast
Game Boy Color
PlayStation
Mercedes Truck Racing Racing PC CD-ROM Fall `00
Cultures Strategy PC CD-ROM Fall `00
7
10
* Excludes titles we expect to release in 2000 but which we have not yet
publicly announced.
**Title released as of March 31, 2000.
***Titles for German speaking territories only.
INTELLECTUAL PROPERTY LICENSES
Our strategy includes the creation of exciting games based on licensed
properties that have attained a high level of consumer recognition or
acceptance. We believe that we enjoy excellent relationships with a number of
licensors, including WWF, Disney, Viacom/Nickelodeon, Time Warner and LucasArts.
We pay royalties to our property licensors that generally range from 6%
to 13% of our net sales of the corresponding title. We typically pay minimum
guaranteed royalties over the license term and advance payments against such
guarantees. License fees tend to be higher for properties with proven popularity
and less perceived risk of commercial failure. To the extent competition
intensifies for licenses of highly desirable properties, we may encounter
difficulty in obtaining these licenses. See "-- Competition." Licenses are of
variable duration, may be exclusive for a specific title or line of titles, and
may in some instances be renewable upon payment of certain minimum royalties or
the attainment of specified sales levels. Other licenses are not renewable upon
expiration, and we cannot assure you that we and the licensor will reach
agreement to extend the term of any particular license.
Our property licenses generally grant us exclusive use of the property
for the specified titles, on specified platforms, within a defined territory and
during the license term. However, licensors typically retain the right to
exploit the property for all other purposes, including the right to license the
property for use with other platforms. Our games based on a particular property
for use with one or more particular platforms may compete with games published
by other companies that are based on the same property but for a different
platform.
AGREEMENT WITH JAKKS PACIFIC, INC.
We have entered into an agreement with JAKKS Pacific, Inc. ("JAKKS"),
to govern our relationship with respect to the WWF license we jointly obtained
from Titan Sports, Inc. (now known as World Wrestling Federation Entertainment,
Inc. (the "WWF")) in June 1999. Our relationship with JAKKS was established to
develop, manufacture, distribute, market and sell video games pursuant to the
license from the WWF. We control the venture, therefore, all transactions and
balances are consolidated with the Company. The principal terms of this
operating agreement are as follows:
- - We will be responsible for funding all operations of the venture,
including all payments owing to the WWF.
- - For the period commencing November 16, 1999 and ending December 31,
2003, JAKKS will be entitled to receive a preferred payment equal to the
greater of a fixed guaranty, payable quarterly, or specified percentages
of the "net sales" from WWF licensed games (as defined) in amounts that
vary based on the platform. The payment of these amounts is guaranteed
by
8
11
us. We are entitled to the profits and cash distributions remaining
after the payment of these amounts. At December 31, 1999, we have
unearned preferred payments remaining for the initial four year period
of approximately $10.4 million.
- - For periods after December 31, 2003, the amount of the preferred payment
will be subject to renegotiation between the parties. An arbitration
procedure is specified in the event the parties do not reach agreement.
- - We will be responsible for the day-to-day operations of the venture. We
will continue to be responsible for development, sales and distribution
of the WWF licensed games, while JAKKS will continue to be responsible
for the approval process and other relationship matters with the WWF. We
will both continue to co-market the games.
PLATFORM LICENSES
Our business is dependent on our license agreements with the
manufacturers. All of these licenses are for fixed terms and are not exclusive.
Each license grants us the right to develop, publish and distribute titles for
use on such manufacturers' platforms, and requires that such titles be embodied
in products that are manufactured solely by such manufacturers.
The following table sets forth information with respect to our platform
licenses. In some instances, we have more than one platform license for a
particular platform.
NUMBER OF
MANUFACTURER PLATFORM TITLES TERRITORY EXPIRATION DATE(s)
- ----------------- --------------- ----------------- -------------------- --------------------
Nintendo Nintendo 64 Title-by-title(1) North America and May 2000
Latin America
Nintendo Nintendo 64 Title-by-title(1) Europe, Australia January 2001
and New Zealand
Nintendo SNES 6/contract yr. North America and October 2000
Latin America
Nintendo Game Boy 10/contract yr. Europe and certain August 2000
Asian countries
Nintendo Game Boy and Title-by-title(1) North America and March 2002
Game Boy Color Latin America
Sega Dreamcast Title-by-title(1) North America and October 2003
Latin America
Sega Dreamcast Title-by-title(1) Europe, Australia September 2003
and New Zealand
Sony PlayStation Title-by-title(1) U.S. and Canada August 2002
Sony PlayStation Title-by-title(1) Europe December 2005
- ----------
(1) This license does not set a maximum number of titles that we may publish
in the designated territory; however, each title must be approved by the
manufacturer prior to development of the software.
9
12
Nintendo charges us a fixed amount for each cartridge. This amount
varies based, in part, on the memory capacity of the cartridges. Sony charges a
royalty for every CD-ROM manufactured. The amounts charged by the manufacturers
include a manufacturing, printing and packaging fee as well as a royalty for the
use of the manufacturer's name, proprietary information and technology, and are
subject to adjustment by the manufacturers at their discretion. The
manufacturers have the right to review, evaluate and approve a prototype of each
title and the title's packaging.
In addition, we must indemnify the manufacturers with respect to all
loss, liability and expense resulting from any claim against the manufacturer
involving the development, marketing, sale or use of our games, including any
claims for copyright or trademark infringement brought against the manufacturer.
As a result, we bear a risk that the properties upon which the titles are based,
or that the information and technology licensed from the manufacturer and
incorporated in the products, may infringe the rights of third parties. Our
agreements with our independent software developers and property licensors
typically provide for us to be indemnified with respect to certain matters.
However, if any claim is brought by a manufacturer against us for
indemnification, our developers or licensors may not have sufficient resources
to, in turn, indemnify us. Furthermore, these parties' indemnification of us may
not cover the matter that gives rise to the manufacturer's claim.
Each platform license may be terminated by the manufacturer if a breach
or default by us is not cured after we receive written notice from the
manufacturer, or if we become insolvent. Upon termination of a platform license
for any reason other than our breach or default, the manufacturer has the right
to purchase from us, at the price paid by us, any product inventory manufactured
by such manufacturer that remains unsold for a specified period after
termination. We must destroy any such inventory not purchased by the
manufacturer. Upon termination as a result of our breach or default, we must
destroy any remaining inventory, subject to the right of any of our
institutional lenders to sell such inventory for a specified period.
SOFTWARE DESIGN AND DEVELOPMENT
After we identify and acquire a property from a licensor, we design and
develop a game with features intended to exploit the characteristics of the
property and to appeal to the game's target consumers. Our software development
process generally takes one of two forms.
INTERNAL DEVELOPMENT. The in-house development of product is currently
conducted by our Pacific Coast Power & Light, Heavy Iron and Genetic Anomalies
studios. GameFx has become our applied technology developer and is focused on
the development of proprietary tools for the coming generation of gaming
platforms. Our studios are staffed by producers, programmers, software
engineers, artists, animators and game testers.
EXTERNAL DEVELOPMENT. Our external development is supervised by our Vice
President -- Product Development. We contract with independent software
developers to conceptualize and develop games under our supervision. Our
agreements with software developers are usually entered into on a game-by-game
basis and generally provide for the payment of the greater of a fixed amount or
royalties based on actual sales. We generally pay our developers installments of
10
13
the fixed advance based on specific development milestones. Royalties in excess
of the fixed advance are based on a fixed amount per unit sold and range from
$.30 to $5.00 per unit for some developers, while others are based on a
percentage of net sales ranging from 7% to 20%. We generally obtain ownership of
the software code and related documentation. We may make strategic investments
in independent developers for the purpose of securing access to proprietary
software and talented developers.
Upon completion of development, each game is extensively "play-tested"
by us and sent to the manufacturer for its review and approval. Related artwork,
user instructions, warranty information, brochures and packaging designs are
also developed under our supervision. The development cycle for a new game,
including the development of the necessary software, approval by the
manufacturer and production of the initial products, typically has ranged from
nine to 18 months. This relatively long development cycle requires that we
assess whether there will be adequate retailer and consumer demand for a game
well in advance of its release.
MANUFACTURING
Sony, Nintendo and Sega are the sole manufacturers of the products sold
for use on their respective platforms.
The manufacturing process begins with our placing a purchase order with
a manufacturer and opening either a letter of credit in favor of the
manufacturer or utilizing our line of credit with the manufacturer. We then send
the software code and a prototype of the game to the manufacturer, together with
related artwork, user instructions, warranty information, brochures and
packaging designs, for approval, defect testing and manufacture. Nintendo
typically delivers cartridges to us within 30 to 45 days of its receipt of an
order and a corresponding letter of credit and Sony typically delivers CD-ROMs
to us within 10 to 20 days. We will order our first Sega Dreamcast product in
2000.
We are required by the platform licenses to provide a standard defective
product warranty on all of the products sold. Generally, we are responsible for
resolving, at our own expense, any warranty or repair claims. We have not
experienced any material warranty claims.
MARKETING, SALES AND DISTRIBUTION
We are dependent on the high name recognition of the properties on which
our games are based to attract customers and to obtain shelf space in stores.
Our sales activities are directed by our Senior Vice President -- Sales and
Marketing, who maintains contact with major retail accounts and manages the
activities of our independent sales staff and regional sales representatives.
UNITED STATES AND CANADIAN SALES. Our games are promoted to retailers by
display at trade shows, such as the annual Electronic Entertainment Expo (E3).
We also conduct print and cooperative retail advertising campaigns for most
titles and prepare promotional materials, including product videos, to increase
awareness among retailers and consumers.
11
14
Our marketing efforts for products released in 1999 included national
television, print, radio and Internet advertising campaigns. Products shipped in
1999 that received television support included WCW Thunder, Rugrats Scavenger
Hunt, Championship Motocross Featuring Ricky Carmichael, Road Rash 64, Rugrats
Studio Tour, MTV Sports: Snowboarding and WWF Wrestlemania 2000. Our games were
also supported by in-store retail promotions such as trailers, demo discs,
standees, over-size boxes, posters and pre-sell giveaways. International
marketing activities included television advertising for Rugrats and publicity
campaigns in gaming publications, magazines and newspapers included covers,
contests, product previews, reviews and game strategies. In addition, we
developed product-specific Internet sites and expanded on-line publicity and
advertising efforts.
Most of our sales are made directly to retailers. We distribute our
games primarily to mass merchandisers and national retail chain stores,
including Wal-Mart (representing 15% of net sales in 1999), Toys "R" Us
(representing 11% of net sales in 1999), Target, Kmart Stores, Kay Bee Toys,
Electronics Boutique, Blockbuster and Best Buy. Sales to our ten largest
customers collectively accounted for approximately 65% of our gross sales in
1998 and 54% of our gross sales in 1999. We do not have any written agreements
or other understandings with any of our customers that relate to their future
purchases, so our customers may terminate their purchases from us at any time.
We utilize electronic data interchange with most of our major domestic
customers in order to (i) efficiently receive, process and ship customer product
orders, and (ii) accurately track and forecast sell-through of products to
consumers in order to determine whether to order additional products from the
manufacturers. We ship our products to our domestic customers from a public
bonded warehouse in Southern California.
We supplement the efforts of our sales employees with independent sales
representatives. Our agreements with our representatives set forth their
exclusive territory, types of customers to be solicited, commission rate and
payment terms.
The domestic retail price for our titles generally ranges between $19
and $35 for Game Boy and Game Boy Color, between $19 and $49 for PlayStation,
between $20 and $60 for Nintendo 64, and between $10 and $50 for PC games.
GERMAN DISTRIBUTION. In December 1998, we acquired Rushware, a German
company that now serves as our distributor and publisher in Germany and other
German-speaking countries. This acquisition has increased the proportion of our
foreign sales that are made in German-speaking countries. It is our expectation
that we will eventually use Rushware to distribute our products throughout
continental Europe. We believe that this will enable us to realize higher
margins on our products distributed in these territories than if such products
were to continue to be distributed by third parties.
Rushware is a party to a License and Localization Agreement with
LucasArts that grants us the exclusive right to continue distributing, through
August 1, 2000, the PC and PlayStation products developed and published by
LucasArts in German-speaking Europe. This agreement also covers any titles that
LucasArts decides to publish in these territories for the Dreamcast
12
15
platform, and provides that any future titles that LucasArts decides to publish
in these territories may be added to the license. Rushware has been distributing
LucasArts products in German-speaking Europe since 1988.
OTHER FOREIGN SALES. We distribute our titles in all viable
international markets. In 1999, we had direct-to-retail operations in the UK and
Germany. As of January 2000, we have established direct relationships with
retailers in France via our new French office in Paris. We anticipate that by
July 2000 we will also have direct-to-retail relationships in Australia via our
new Australian office in Melbourne. Other European territories such as Italy,
Spain, Benelux, etc. are handled by the UK office through strategic distribution
relationships whereby we primarily supply finished goods as well as marketing
support. Other non-European territories such as Brazil, Singapore, Korea, etc.
are handled by international representatives in the US office through strategic
distribution and licensing agreements. While the majority of our sales occur in
the territories where we have direct relationships, we can supply a given title
in up to forty countries worldwide.
INTELLECTUAL PROPERTY RIGHTS
Each game we release embodies a number of separately protected
intellectual property rights of the manufacturer, the property licensor and, to
a lesser extent, us. The licensor of the property owns the trademarks, trade
names, copyrights and other intellectual property rights relating to the
property on which the game is based. The manufacturer owns the patents and
substantially all of the other intellectual property embodied in the product.
While we own the game software embodied in the product, we believe that such
software has little independent economic value. Accordingly, we must rely on the
manufacturer and the property licensor with respect to protection from
infringement of the property rights by third parties.
Each of the manufacturers incorporates security devices in its platforms
and products to prevent unlicensed use. In addition, Nintendo requires its
licensees to display the "Nintendo Seal of Approval" to notify the public that
the game has been approved by Nintendo for use with a Nintendo platform.
COMPETITION
The software industry is intensely competitive. We compete, for both
licenses to properties and the sale of software, with the manufacturers, each of
whom is the largest developer and marketer of software for its platforms. These
companies may increase their own software development efforts. As a result of
their commanding positions in the industry as the manufacturers of platforms and
publishers of software for their platforms, the manufacturers generally have
better bargaining positions with respect to retail pricing, shelf space and
purchases than do any of their licensees, including us.
In addition to the manufacturers, our competitors include Acclaim
Entertainment, Inc., Activision, Inc., Electronic Arts Inc., GT Interactive
Software Corp., Hasbro Inc., Midway Games Inc. and Microsoft Corporation. Each
of the manufacturers has a broader software line and greater financial,
marketing and other resources than us, as do some of our other competitors.
13
16
Accordingly, some of our competitors may be able to market their software more
aggressively or make higher offers or guarantees in connection with the
acquisition of licensed properties.
At various times, toy companies, large software companies, movie studios
and others have focused on the video game market, resulting in greater
competition for us. Additionally, many of our competitors are developing on-line
interactive games and interactive networks that will be competitive with our
interactive products. We will be "releasing" our first on-line game during 2000.
As competition for retail shelf space becomes more intense, we may need
to increase our marketing expenditures to maintain sales of our titles; and as
competition for popular properties increases, our cost of acquiring licenses for
such properties is likely to increase, resulting in reduced margins. Prolonged
price competition, increased licensing costs or reduced profit margins would
have a material adverse effect on us.
In addition, the market for our products is characterized by significant
price competition and we may face increasing pricing pressures from our current
and future competitors. Further, as the industry transitions from the current
platforms (Sony PlayStation and Nintendo 64) to the next generation platforms
(Sony PlayStation 2, Nintendo Dolphin and Microsoft X-Box), there may be price
erosion on the existing consoles. Accordingly, there can be no assurance that
competitive pressures will not require us to reduce our prices. Any material
reduction in the price of our products would adversely affect operating income
as a percentage of net revenue and would require us to increase unit sales in
order to maintain net revenue.
EMPLOYEES
As of December 31, 1999, we had 288 full-time employees, of whom 22 are
located in the United Kingdom, 73 are located in Germany and two are located in
France. None of our employees is represented by a labor union or covered by a
collective bargaining agreement, and we believe that relations with our
employees are good.
ITEM 2. PROPERTIES
Our executive offices occupy approximately 32,500 square feet of office
space at 27001 Agoura Road, Calabasas Hills, California, pursuant to a lease
expiring in September 2005. We lease additional office space for development
personnel in Calabasas, Santa Clara and Culver City, California, and in
Lexington, Massachusetts, for THQ UK's employees in Woking, England and for
Rushware's employees in Kaarst, Germany.
ITEM 3. LEGAL PROCEEDINGS
Two individual shareholders have filed essentially identical purported
class actions on February 18, 2000 and on March 2, 2000, respectively, in the
United States District Court for the Central District of California, alleging
that we and certain of our directors and senior officers violated Section 10(b)
of the Securities and Exchange Act of 1934 and SEC Rule 10b-5. Each
14
17
case seeks class action status on behalf of all individuals who purchased our
shares of common stock between October 26, 1999 and February 10, 2000. Each
complaint alleges that we issued false and misleading statements about our
financial results and prospects during the class period, and that the individual
defendant directors and officers participated in the alleged scheme so as to
sell their personal shares at inflated prices. We believe the claims are without
merit, and intend to vigorously defend against them.
While we are a party to other legal proceedings from time to time, such
legal proceedings have been ordinary and incidental to our business and have not
had a material adverse effect on us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of 1999.
15
18
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
The common stock is quoted on the NASDAQ National Market under the
symbol "THQI." The following table sets forth, for the periods indicated, the
high and low closing sales prices of our common stock as reported by the NASDAQ
National Market:
CLOSING SALES
PRICES
------------------------
HIGH LOW
----------- -----------
1999
First Quarter 20 9/16 11 11/16
Second Quarter 19 3/16 13 7/16
Third Quarter 28 13/16 17 15/16
Fourth Quarter 38 4/16 22 7/16
1998
First Quarter 14 7/16 8 1/16
Second Quarter 13 11/16 8 15/16
Third Quarter 15 11/16 7 9/16
Fourth Quarter 20 11/16 8 15/16
The last reported price of the common stock on March 20, 1999, as
reported by NASDAQ National Market, was $18.25 per share. As of March 20, 1999,
there were approximately 400 holders of record of the common stock.
DIVIDEND POLICY
We have never paid cash dividends on our capital stock. We currently
intend to retain future earnings, if any, to finance the growth and development
of our business and, therefore, we do not anticipate paying any cash dividends
in the future. Our principle banking agreements provide that at such times as we
have any outstanding borrowings or letters of credit under that facility, we
will not pay any cash dividends.
SECURITIES ISSUED IN PRIVATE TRANSACTIONS
In June 1998, in partnership with JAKKS Pacific, Inc., we signed an
exclusive agreement with Titan Sports, Inc. (now known as the World Wrestling
Federation Entertainment (the "WWF")) to publish electronic games based on the
World Wrestling Federation franchise on all hardware platforms. In connection
with this transaction, in August 1999 we issued to the WWF and a related party
warrants expiring December 31, 2009 to purchase an aggregate of 281,250 shares
of our common stock at $10.42 per share which had a fair value of $3.0 million
at the time of issuance. These warrants were issued pursuant to the exemption
from registration provided in
16
19
Section 4(2) of the Securities Act of 1933, as amended, for transactions not
involving a public offering.
On May 24, 1999, in connection with our acquisition of Pacific Coast
Power & Light Company ("PCP&L"), we issued an aggregate of 727,436 shares of our
common stock to certain stockholders of PCP&L pursuant to the exemption from
registration provided in Section 4(2) of the Securities Act of 1933, as amended.
On December 13, 1999, in connection with our acquisition of Genetic
Anomalies, Inc., we issued an aggregate of 220,048 shares of our common stock to
certain stockholders of Genetic Anomalies, Inc. pursuant to the exemption from
registration provided in Section 4(2) of the Securities Act of 1933, as amended.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE
DATA)
The following table presents certain selected consolidated financial
data for the years 1995 through 1999. The information presented for each of the
years ended December 31, 1997, 1998 and 1999 have been derived from, and are
qualified by reference to, our audited consolidated financial statements
included elsewhere herein. Those financial statements have been audited by
Deloitte & Touche LLP, independent auditors. The information presented for each
of the years ended December 31, 1995 and 1996 were derived from audited
financial statements that are not included elsewhere herein.
This selected consolidated financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and Notes thereto included
elsewhere herein.
17
20
STATEMENT OF OPERATIONS DATA
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales $ 33,250 $ 50,255 $ 89,579 $216,111 $302,357
Costs and expenses:
Cost of sales 19,501 29,301 48,127 100,019 134,563
Royalties and project abandonment 4,666 8,587 14,763 48,130 48,370
Product development 889 1,324 1,887 6,849 12,770
Selling and marketing 3,114 4,444 8,733 20,325 35,440
Payment to venture partner -- -- -- -- 6,119
General and administrative 4,323 4,378 5,633 10,436 14,969
In-process research and
development -- -- -- 7,232 --
-------- -------- -------- -------- --------
Total costs and expenses 32,493 48,034 79,143 192,991 252,231
-------- -------- -------- -------- --------
Income from operations 757 2,221 10,436 23,120 50,126
Interest income (expense) -- net (134) (316) 466 840 1,102
-------- -------- -------- -------- --------
Income before income taxes 623 1,905 10,902 23,960 51,228
Income taxes 22 8 1,954 9,342 18,287
-------- -------- -------- -------- --------
Net income $ 601 $ 1,897 $ 8,948 $ 14,618 $ 32,941
======== ======== ======== ======== ========
Net income per share -- basic $ .09 $ .18 $ .59 $ .86 $ 1.81
======== ======== ======== ======== ========
Net income per share -- diluted $ .08 $ .17 $ .55 $ .79 $ 1.63
======== ======== ======== ======== ========
Weighted-average number of
common shares -- basic 6,431 10,408 15,167 17,039 18,150
======== ======== ======== ======== ========
Weighted-average number of
common shares, stock options
and warrants -- diluted 8,001 11,117 16,267 18,453 20,194
======== ======== ======== ======== ========
BALANCE SHEET DATA
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
Working capital $ 7,082 $ 9,661 $ 31,472 $ 49,366 $ 94,401
Total assets $ 16,916 $ 22,847 $ 55,841 $127,743 $185,034
Lines of credit $ -- $ 5,355 $ -- $ 9,909 $ 16,702
Shareholders' equity $ 7,598 $ 11,044 $ 33,618 $ 63,004 $110,760
18
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We develop, publish and distribute interactive entertainment software
for the major platforms sold by Nintendo, Sony and Sega and for use on PCs. See
"Business -- Titles." The following table sets forth, for the periods indicated,
the percentage of our revenues derived from sales of titles for the platforms
indicated:
YEARS ENDED DECEMBER 31,
-------------------------
PLATFORM 1997 1998 1999
- -------- ---- ---- ----
Nintendo (excluding Game Boy) 42% 55% 35%
Nintendo Game Boy/Game Boy 23% 8% 17%
Color
Sony 22% 31% 37%
Sega 10% 1% --
PC 3% 5% 8%
Other -- -- 3%
Our business cycle generally commences with the securing of a license to
publish one or more titles based on a property. These licenses typically require
an advance payment to the licensor and a guarantee of minimum future royalties.
See "-- Recovery of Prepaid Royalties, Guarantees and Capitalized Development
Costs." After obtaining the license, we begin software development for the
title. Upon completion of development and approval of the title by the
manufacturer, we order products and generally cause a letter of credit to be
opened in favor of the manufacturer or obtain a line of credit from the
manufacturer. Products are shipped at our expense to a public warehouse in
California for domestic distribution, or to the United Kingdom or Germany for
foreign distribution. Foreign sales to distributors in countries other than the
United Kingdom and Germany are shipped at the customer's expense directly to the
customer's location. Both in the United Kingdom and in Germany, we sell directly
to our major retail accounts.
Unfilled sales orders are commonly referred to as "backlog." Since
substantially all of our product orders are fulfilled shortly after we receive
them, we do not believe that the amount of our unfilled sales orders as of the
end of a period is a meaningful indicator of sales in future periods.
Accordingly, we do not report the amount of our unfilled sales orders.
On May 24, 1999 and December 13, 1999, we completed mergers with Pacific
Coast Power & Light Company, a California corporation ("PCP&L") and Genetic
Anomalies, a Delaware corporation ("GA"), respectively. The mergers have been
accounted for as poolings of interests under Accounting Principles Board Opinion
No. 16. Accordingly, all prior period consolidated financial statements
presented have been restated to include the combined results of operations,
financial position and cash flows as if PCP&L and GA had always been part of our
company.
19
22
REVENUE FLUCTUATIONS AND SEASONALITY. We have experienced, and may
continue to experience, significant quarterly fluctuations in net sales and
operating results due to a variety of factors. The software market is highly
seasonal, with sales typically significantly higher during the fourth quarter
(due primarily to the increased demand for interactive games during the year-end
holiday buying season). Other factors that cause fluctuations include the timing
of our release of new titles, the popularity of both new titles and titles
released in prior periods, changes in the mix of titles with varying profit
margins, the timing of customer orders, the timing of shipments by the
manufacturers, fluctuations in the size and rate of growth of consumer demand
for software for various platforms, the timing of the introduction of new
platforms and the accuracy of retailers' forecasts of consumer demand. Our
expenses are based, in part, on our expectations of future revenues and, as a
result, operating results would be disproportionately and adversely affected by
a decrease in sales or a failure by us to meet our sales expectations. There can
be no assurance that we can maintain consistent profitability on a quarterly or
annual basis.
Profit margins may vary over time as a result of a variety of factors.
Profit margins for cartridge products can vary based on the cost of the memory
chip used for a particular title. As games have become more complex by providing
richer playing capabilities, the trend in the interactive entertainment software
industry has been to utilize chips with greater capacity and thus greater cost.
CD-ROMs have significantly lower per unit manufacturing costs than
cartridge-based products, generally resulting in higher royalties for CD-ROM
based products. We anticipate that the next generation of DVD based games will
follow a cost and royalty model similar to the CD-ROM based console model.
RECOVERY OF PREPAID ROYALTIES, GUARANTEES AND CAPITALIZED DEVELOPMENT
COSTS. We typically enter into agreements with licensors of properties and
developers of titles that require advance payments of royalties and/or
guaranteed minimum royalty payments. We cannot guarantee that the sales of
products for which such royalties are paid will be sufficient to cover the
amount of these required royalty payments. We capitalize our advances to
developers as prepaid royalties and capitalize internal software development
costs for each title incurred after the establishment of technological
feasibility of the title. Amortization of these payments and costs is determined
on a title-by-title basis based on the greater of (i) the ratio of current gross
revenues for a title to the sum of its current and anticipated gross revenues,
or (ii) the straight-line method over the estimated remaining economic life of
the title. We analyze these capitalized costs quarterly and write off associated
prepaid and deferred royalties and software development costs when, based on our
estimate, future revenues will not be sufficient to recover such amounts. As of
December 31, 1999, we had prepaid royalties and capitalized development costs of
$40.3 million. If we were required to write off prepaid royalties or capitalized
development costs in excess of the amounts reserved, our results of operations
could be materially and adversely affected.
DISCOUNTS, ALLOWANCES AND RETURNS; INVENTORY MANAGEMENT. In general,
except for PC titles, our arrangements with our distributors and retailers do
not give them the right to return products to us (other than damaged or
defective products) or to cancel firm orders. However, we sometimes negotiate
accommodations to retailers (and, less often, to distributors) when demand
20
23
for specific games falls below expectations, in order to maintain our
relationships with our customers. These accommodations include our not requiring
that all booked orders be filled, negotiated price discounts and credits against
future orders. We may also permit the return of products. Arrangements made with
distributors and retailers for PC titles do customarily require us to accept
product returns.
At the time of product shipment, we establish allowances based on
estimates of future returns, customer accommodations and doubtful accounts with
respect to such products. We base this amount on our historical experience,
retailer inventories, the nature of the titles and other factors. For the years
ended December 31, 1997, 1998 and 1999, we took provisions of approximately
$10.5 million, $20.8 million and $35.0 million, respectively, against gross
sales made during such periods. As of December 31, 1999, our aggregate reserve
against accounts receivable for returns, customer accommodations and doubtful
accounts was approximately $24.2 million.
The identification by us of slow-moving or obsolete inventory, whether
as a result of requests from customers for accommodations or otherwise, would
require us to establish reserves against such inventory or to write-down the
value of such inventory to its estimated net realizable value.
NET OPERATING LOSS CARRYFORWARDS. At December 31, 1999, we had
$9,259,000 of net operating loss ("NOL") carryforwards incurred since 1993 for
federal income tax purposes, and $638,000 for state. Various equity transactions
during 1996 resulted in an "ownership change" for purposes of Sections 382 and
383 of the Internal Revenue Code of 1986, as amended. As a result, the amount of
the NOL carryforwards available to reduce our federal income tax liability in
years in which we have taxable income is limited to an amount equal to
approximately $2.2 million per year through the year 2011, when the
carryforwards expire.
YEAR 2000 DISCLOSURE
Many computer programs used only two digits to identify years. These
programs were designed without consideration for the effect of the change in
century, and if not corrected, could have failed or created erroneous results at
the year 2000. Essentially all of our information technology-based systems, as
well as many non-information based systems, were potentially affected by the
Year 2000 issue.
In order to prepare for the Year 2000 issue, we implemented the
following remediation plan for technology-based systems:
1. Identification of all applications and hardware with potential Year
2000 issues.
2. For each item identified, perform an assessment to determine an
appropriate action plan and timetable for remediation of each item.
3. Implementation of the specific action plan.
4. Test each application upon completion.
5. Place the new process into production and conduct system integration
testing.
21
24
We successfully implemented the above remediation plan for all affected
information technology-based systems and other remediation plans related to
non-Management Information Systems and to products sold before the turn of the
century. Following the arrival of the Year 2000, we have not experienced any
problems with products or materials manufactured and/or supplied by third
parties. There was no interruption in our ability to order and deliver our
products and transact business with our suppliers and customers. We have
received no notification from customers regarding Year 2000 issues related to
products we have sold. We continue to monitor our systems, suppliers and
products for any unanticipated issues that may not yet have manifested.
The total cost of achieving Year 2000 compliance was approximately
$200,000. All costs related to achieving Year 2000 compliance are based on
management's best estimates.
EURO CURRENCY CONVERSION
On January 1, 1999, eleven of the fifteen member countries of the
European Union adopted the Euro as their common legal currency. The Euro trades
on currency exchanges and is available for non-cash transactions. From January
1, 1999 through January 1, 2002, participating countries can also maintain their
national ("legacy") currencies as legal tender for goods and services. Beginning
January 1, 2002, new Euro-denominated bills and coins will be issued, and legacy
currencies will be withdrawn from circulation no later than July 1, 2002. Our
operating subsidiaries in the United Kingdom and Germany have been affected by
the Euro conversion and have established plans to address any business issues
raised, including the competitive impact of cross-border price transparency. It
is not anticipated that there will be any near term business ramifications;
however, the long-term implications, including any changes or modifications that
will need to be made to business and financial strategies, are still being
reviewed. From an accounting, treasury and computer system standpoint, the
impact from the Euro currency conversion is not expected to have a material
impact on the financial position or results of operations of THQ and its
subsidiaries.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the
components of our net sales and our consolidated operating data as a percentage
of net sales:
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1998 1999
----- ----- -----
Domestic sales 84.4% 86.5% 75.3%
Foreign sales 15.6 13.5 24.7
----- ----- -----
Net sales 100.0% 100.0% 100.0%
Costs and expenses:
Cost of sales 53.7% 46.3% 44.5%
Royalties and project abandonment 16.5 22.3 16.0
Product development 2.1 3.2 4.2
Selling and marketing 9.7 9.4 11.7
22
25
Payment to venture partner -- -- 2.0
General and administrative 6.3 4.8 5.0
In-process research and development -- 3.3 --
---- ---- ----
Total costs and expenses 88.3% 89.3% 83.4%
---- ---- ----
Income from operations 11.7% 10.7% 16.6%
Interest income (expense) -- net 0.5 0.4 0.3
---- ---- ----
Income before income taxes 12.2% 11.1% 16.9%
---- ---- ----
Net income 10.0% 6.8% 10.9%
==== ==== ====
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1999 TO THE YEAR ENDED DECEMBER 31,
1998
The following table sets forth, for the years ended December 31, 1999
and 1998, the titles released during such periods for the platforms indicated:
YEARS ENDED DECEMBER 31,
------------------------------
1998 1999
------------- --------------
Nintendo 64 2 10
PC CD-ROM 5 11
PlayStation 8 9
SNES 1 --
Game Boy Color 5 12
------------- --------------
Total 21 42
============= ==============
Our net sales increased to $302,357,000 in the year ended December 31,
1999, from $216,111,000 in the same period of 1998, as a result of increased
foreign sales, a larger number of products shipped, and the market success of
key titles. For the year ended December 31, 1999, net sales of our Rugrats
titles, WCW titles and WWF titles, were $84,204,000 (27.8% of net sales),
$64,615,000 (21.4% of net sales), and $42,011,000 (13.9% of net sales),
respectively.
Our foreign net sales grew to $74,656,000 for the year ended December
31, 1999, from $29,132,000, in the same period of 1998, and increased as a
percentage of net sales to 24.7% from 13.5%. The increase in our foreign net
sales in 1999 was attributable to the addition of our Rushware subsidiary (which
added the LucasArts brand in Germany as well as European specific product) and
the success of key titles such as wrestling and Rugrats in certain foreign
markets.
Our cost of sales for the year ended December 31, 1999 decreased
slightly as a percentage of net sales to 44.5% from 46.3% in the same period of
1998, primarily as a result of the increase in PlayStation and CD-ROM product
sales which generally have more favorable gross margins than cartridge products.
Our royalty expense for the year ended December 31, 1999 decreased as a
percentage of net sales to 16.0% from 22.3% in the same period in 1998. Sales in
1999 consisted of some in-house titles carrying minor or no royalties, LucasArts
games in Europe which carry no royalties, and selected successful titles which
had favorable royalty rates.
23
26
Our product development expenses increased from $6,849,000 in 1998 to
$12,770,000 in 1999. This increase reflects the addition of three internal
studios during the year and an increase in our corporate product development
group to better manage our increased volume of titles in development.
For the year ended December 31, 1999, our selling and marketing expenses
increased by $15,115,000 compared to the year ended December 31, 1998, as a
result of several significant advertising and promotional campaigns to promote
our WWF titles, Rugrats, Championship Motocross and MTV Sports brands as well
increased warehouse expenses, infrastructure and personnel costs (both domestic
and foreign) incurred as a result of our growth in 1999.
For the year ended December 31, 1999, we incurred expense in the amount
of $6,119,000 to our venture partner, JAKKS Pacific. Pursuant to the arrangement
regarding the license with the WWF, THQ pays JAKKS Pacific a preferred return on
product sales and JAKKS Pacific shares in other income derived from the license.
Our general and administrative expenses for the year ended December 31,
1999 remained relatively constant as a percentage of net sales at 5.0% compared
to 4.8% for the same period of 1998, but increased in dollar terms by $4,533,000
over 1998. This increase can be attributed to the expansion of our corporate
offices, amortization of a new sales and financial accounting software package,
and a full year of general and administrative expenses for Rushware.
The in-process research and development charge of $7,232,000 incurred
during 1998 represents purchase costs relating to the acquisition of GameFx.
Purchased research and development includes the value of products in the
development stage and not considered to have reached technological feasibility.
The technology purchased was completed in 1999 and did not result in a
commercially successful product.
For the year ended December 31, 1999, interest income increased by
$262,000 compared to 1998, as a result of increased cash flows from operations
and higher average investment balances during the period.
During the year ended December 31, 1999 we recorded a tax provision of
$18,287,000, an increase of $8,945,000 over 1998. The effective tax rate for
1999 was 35.7% compared to 39.0% in 1998. The 1998 effective tax rate was
negatively impacted by the fact that the purchased in-process research and
development costs of $7,232,000 were not deductible for tax purposes. The
negative impact of the in-process research and development was offset by the
partial reversal of the valuation reserve against deferred tax assets. The 1999
effective tax rate was positively impacted by the reversal of the remaining
$2,461,000 valuation allowance.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1998 TO THE YEAR ENDED DECEMBER 31,
1997
The following table sets forth, for the years ended December 31, 1997
and 1998, the titles released during such periods for the platforms indicated:
24
27
YEARS ENDED DECEMBER 31,
------------------------------
1997 1998
------------- --------------
Nintendo 64 1 2
PC CD-ROM 2 5
PlayStation 7 8
SNES 10 1
Genesis 5 --
Game Boy Color 8 5
------------- --------------
Total 33 21
============= ==============
Our net sales increased to $216,111,000 in 1998, from $89,579,000 in
1997, primarily as a result of higher unit sales per title shipped. For the year
ended December 31, 1998, net sales of our WCW titles, Rugrats titles and Quest
64 release were $140,441,000 (65.0% of net sales), $17,741,000 (8.2% of net
sales) and $17,367,000 (8.0% of net sales), respectively.
Our foreign net sales grew to $29,132,000 for the year ended December
31, 1998, from $13,998,000, in the same period of 1997, yet decreased as a
percentage of net sales to 13.5% from 15.6%, as a consequence of our substantial
increase in domestic sales. Our foreign sales in 1998 were attributable to the
release of WCW titles, and World Cup 98 and Small Soldiers for the Game Boy
platform in foreign markets in 1998, as well as continued demand for previously
released titles.
Our cost of sales for 1998 decreased significantly as a percentage of
net sales to 46.3%, from 53.7% in 1997, primarily as a result of the increase in
sales of PlayStation titles (which generally have more favorable gross margins
than cartridge titles for Nintendo's platforms).
Our royalty expense for 1998 increased $33,367,000 over the same period
in 1997 and increased as a percentage of our net sales to 22.3% from 16.5% in
1997. The rise reflects the fact that license and development royalty rates on
the 32-bit and 64-bit games released in 1998 were higher than those typical for
older platforms.
Our product development expenses increased by $4,962,000 in 1998 as
compared to 1997. This was due in part to the increased costs associated with
the development of 32-bit, 64-bit, PC and on-line games, and also reflects
operating costs due to increased personnel in connection with the acquisition of
GameFx in May 1998.
Our selling and marketing expenses increased by $11,592,000 in 1998 over
1997, as a result of increased marketing efforts for new titles. This consisted
primarily of television, print and retail cooperative advertising and increased
warehouse expense (which is the result of increased sales volume). Selling and
marketing expenses as a percentage of our net sales were 9.4% in 1998 as
compared to 9.7% in 1997.
Our general and administrative expenses for 1998 decreased as a
percentage of net sales to 4.8%, from 6.3% for 1997, but increased in dollar
terms by $4,803,000 over 1997. This
25
28
increase occurred both domestically and internationally and was in response to
the growth we experienced in 1998.
The in-process research and development charge of $7,232,000 incurred
during 1998 represents purchase costs relating to the acquisition of GameFx.
Purchased research and development includes the value of products in the
development stage and not considered to have reached technological feasibility.
LIQUIDITY AND CAPITAL RESOURCES
Our principal uses of cash are product purchases, guaranteed payments to
licensors, advance payments to developers and the costs of internal software
development. In order to purchase products from the manufacturers, we typically
open letters of credit in their favor or obtain a line of credit from the
manufacturer. As of December 31, 1999, we had obligations with respect to future
guaranteed minimum royalties of $31,404,000.
Our cash and cash equivalents increased to $21,303,000 at December 31,
1999 from $19,063,000 at December 31, 1998. Cash used in operating activities
for 1999 was $7,109,000, reflecting our use of working capital to partially fund
our growth. As of March 20, 2000 our cash and cash equivalents were $35,878,000.
Accounts receivable at December 31, 1999 increased from December 31,
1998 as a result of increased sales volume and the later shipment of key titles
during the fourth quarter of 1999 compared to the same period of 1998. Prepaid
and deferred royalties and software development costs increased from December
31, 1998 as a result of our entering into several new licensing contracts and
the significant increase in the number of products in development at the end of
1999. See "--Recovery of Prepaid Royalties, Guarantees and Capitalized
Development Costs." Accrued royalties also increased, in part, as a result of
new contracts for licenses and product development. Additionally, increased
demand for certain titles sold in 1999 resulted in royalties due in excess of
the minimum guarantees on the related contracts. Inventory and related accounts
payable decreased during 1999 as the 1998 balance reflected the advanced
purchases of product relating to the expiration of the WCW license. Such product
was purchased prior to the termination date of the license (December 28, 1998)
and was sold during the first half of 1999.
The amount of our accounts receivable is subject to significant seasonal
variations as a consequence of the seasonality of our sales, and is typically
highest at the end of the year. As a result, our working capital requirements
are greatest during our third and fourth quarters. We believe that our cash on
hand, funds provided by operations, and our revolving credit facilities will be
adequate to meet our anticipated requirements for operating expenses, product
purchases, guaranteed payments to licensors and software development through
2000.
Our capital expenditures were $4,413,000 in 1999 reflecting a
significant investment in new operational and financial systems. We expect to
make capital expenditures of between $4,000,000 and $5,000,000 in 2000 as we
continue to invest in our business systems and next generation development
tools.
26
29
Net cash provided by financing activities for 1999 was $11,981,000, and
was provided by the short-term borrowings and the exercise of options and
warrants to purchase our common stock.
CREDIT FACILITIES. In December 1998, we entered into two trade finance
agreements (as amended) with Union Bank of California that established a
revolving credit facility. These agreements currently expire on June 1, 2000.
The principal agreement (as amended) permits us to borrow (and maintain
obligations under outstanding letters of credit) up to $43,000,000, subject to
the following:
- We may maintain outstanding letters of credit for product
purchases of up to $38 million in the aggregate through the end
of February 2000;
- We may maintain outstanding letters of credit for product
purchases of up to $25 million in the aggregate between March 1,
2000 and June 1, 2000;
- We may borrow up to $30 million through February 29, 2000, $25
million during March 2000, and $15 million during April and May
2000, (including amounts owing as a result of draws under
letters of credit), but we are required to not have any
borrowings for a period of at least 60 days during each year of
the term of the agreement.
Our other agreement with Union Bank is for our United Kingdom
subsidiary, T.HQ International Ltd., and permits that subsidiary to obtain
product purchase letters of credit of up to $7 million in the aggregate.
These credit facilities are secured by a lien on substantially all of
our assets and those of T.HQ International Ltd. Amounts outstanding under these
credit facilities bear interest, at our choice, at either a) the bank's prime
rate (8.5% at December 31, 1999) or b) the London Interbank Offered Rate (5.69%
at December 31, 1999) plus 1.85%. As of December 31, 1999, we had $16,702,000 in
outstanding borrowings under these credit facilities and had obligations in
respect of outstanding letters of credit of $8,134,000. As of March 20, 2000 we
had no outstanding borrowings and outstanding letters of credit amounted to
$1,800,000.
These agreements contain financial covenants, including the requirement
that we:
- maintain the ratio of our cash, cash equivalents and accounts
receivable, to our current liabilities (including advances by
the bank), at not less than 1.00:1.00 at the end of each
quarter;
- maintain minimum shareholders' equity;
27
30
- maintain the ratio of our total liabilities to our shareholders'
equity at not greater than 1.10:1.00 as of December 31, 1998 and
1.00:1.00 as of the end of each quarter thereafter;
- achieve operating profits of at least $1 each quarter; and
- maintain the ratio of the value of our inventory as of the last
day of any quarter, to our cost of goods sold for the four
consecutive quarters ending on that day (or four times our cost
of goods sold for the last quarter, if greater), at not more
than 1.00:10.50.
These agreements also contain customary non-financial covenants
including restrictions on the incurrence of debt and encumbrances and
limitations on sales of assets, mergers and acquisitions, dividends, capital
expenditures and annual lease obligations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain market risks arising from transactions in the
normal course of business, principally risk associated with interest rate and
foreign currency fluctuations.
INTEREST RATE RISK
Our interest rate risk is immaterial due to the short maturity of the
debt. We have no fixed rate debt.
FOREIGN CURRENCY RISK
We have not hedged our foreign currency exposure in the past. It is
possible that in the future we will enter into foreign currency contracts in
order to manage or reduce foreign currency market risk.
Our earnings are affected by fluctuations in the value of our
subsidiaries' functional currency as compared to the currencies of our foreign
denominated sales and purchases. The results of operations of our subsidiaries,
as reported in U.S. dollars, may be significantly affected by fluctuations in
the value of the local currencies in which we transact business. Such amount is
recorded upon the translation of the foreign subsidiaries' financial statements
into U.S. dollars, and is dependent upon the various foreign exchange rates and
the magnitude of the foreign subsidiaries' financial statements. During the
year ended December 31, 1999, our foreign currency translation loss
28
31
adjustment was $902,000. Currency transaction gains and losses for the years
ended December 31, 1997, 1998 and 1999 were not significant. A hypothetical 10%
change in the relevant currency rates at December 31, 1999 would not result in a
material gain or loss. In addition to the direct effects of changes in exchange
rates, which are a changed dollar value of the resulting sales and related
expenses, changes in exchange rates also affect the volume of sales or the
foreign currency sales price as competitors' products become more or less
attractive.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements and supplementary data, together with the
report of Deloitte & Touche LLP dated February 24, 2000, required by this Item
are included in Item 14 of this annual report and are incorporated herein by
reference.
Please note that the Financial Statements included herein reflect a
correction made to an inter-company consolidation error in our fourth quarter
financial results as previously announced on February 23, 2000. The correction
reduced both revenues and cost of goods sold by approximately $4,067,000, (3.1%
and 6.5%, respectively, for the quarter and 1.3% and 2.9%, respectively, for the
year), as compared to what was announced on February 23, 2000. The correction
does not impact earnings per share, net income, gross margins or operating
expenses. In addition, we have included in the Financial Statements the fair
market value of the warrants issued to the WWF. This addition resulted in an
increase of $3,063,000 million to deferred royalties net - of current portion
and to additional paid-in capital, as compared to what was included in the
Balance Sheet that was in our press release of February 23, 2000. This addition
does not impact the Statement of Operations.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
29
32
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required under this Item relating to members of the
Board of Directors and Executive Officers of THQ will be included in our 2000
Notice of Annual Meeting of Shareholders and Proxy Statement under the headings
"Election of Directors," "Executive Officers," "Key Employees," "Compliance with
Section 16 of the Securities Exchange Act of 1934" and "Director and Officer
Holdings," which will be filed within 120 days after the close of our fiscal
year, and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required under this Item relating to executive
compensation will be included in our 2000 Notice of Annual Meeting of
Shareholders and Proxy Statement under the heading "Executive Compensation,"
which will be filed within 120 days after the close of our fiscal year, and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required under this Item relating to security ownership
of certain beneficial owners and management will be included in our 2000 Notice
of Annual Meeting of Shareholders and Proxy Statement under the heading
"Principal Shareholders," which will be filed within 120 days after the close of
our fiscal year, and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required under this Item relating to certain
relationships and related transactions will be included in our 2000 Notice of
Annual Meeting of Shareholders and Proxy Statement under the headings
"Employment Agreements" and "Director and Officer Transactions," which will be
filed within 120 days after the close of our fiscal year, and is incorporated
herein by reference.
30
33
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES.
See Index to Financial Statements.
(b) REPORTS ON FORM 8-K.
None.
(c) EXHIBITS.
Exhibit Number Title
-------------- -----
3.1 Certificate of Incorporation (incorporated by
reference to Exhibit 3.1 to Post-Effective Amendment
No. 1 to the Registration Statement on Form S-3 filed
on January 9, 1998 (File No. 333-32221) (the "S-3
Registration Statement")).
3.2 Amendment to Certificate of Incorporation (incorporated by
reference to Exhibit 3.2 to Post-Effective Amendment No. 1 to the
S-3 Registration Statement).
3.3 Amended and Restated Bylaws (incorporated by reference to Exhibit
3.3 to the Quarterly Report on Form 10-Q for the fiscal quarter
ended June 30, 1998).
10.1* Amended and Restated Employment Agreement dated as of
June 30, 1999, between the Company and Brian J.
Farrell (incorporated by reference to Exhibit 10.1 to
the Company's Quarterly Report on Form 10-Q for the
fiscal quarter ended June 30, 1999 (the "1999 2nd
Quarter 10-Q")).
10.2* Employment Agreement dated as of January 1, 1999,
between the Company and Jeffrey C. Lapin
(incorporated by reference to Exhibit 10.2 to the
1999 2nd Quarter 10-Q).
10.3* Employment Agreement between Fred A. Gysi and the
Company dated October 1, 1997 (incorporated by
reference to Exhibit 10.6 to the Company's Annual
Report on Form 10-K for the fiscal year ended
December 31, 1998 (the "1998 10-K")).
10.4* Form of Severance Agreement with Executive Officers
(incorporated by reference to Exhibit 10.7 to the
1998 10-K).
31
34
Amended and Restated 1990 Stock Option Plan (incorporated by
10.5* reference to Exhibit 10.1 to the Registration Statement on Form
S-2 filed on December 23, 1996 (File No. 333-18641)).
10.6* Stock Option Agreement dated as of August 28, 1996,
between the Company and Brian J. Farrell
(incorporated by reference to Exhibit 10.31 to the
Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1996).
10.7* Amended and Restated 1997 Stock Option Plan (the "1997 Stock
Option Plan") (incorporated by reference to Exhibit 4.4 to the
Registration Statement on Form S-8 filed on May 14, 1999 (File
No. 333-78567)).
10.8* Form of Stock Option Agreement for the 1997 Stock
Option Plan (incorporated by reference to Exhibit 4.5
to the Registration Statement on Form S-8 filed March
19, 1999 (File No. 333-74715)).
10.9* Stock Option Agreement dated as of October 21, 1998, between the
Company and Jeffrey C. Lapin (incorporated by reference to
Exhibit 10.8 to the 1999 2nd Quarter 10-Q).
10.10* Form of Stock Option Agreement dated as of December
23, 1998, between the Company and Messrs. Lawrence
Burstein, Bruce Jagid and James Whims (incorporated
by reference to Exhibit 10.9 to the 1999 2nd Quarter
10-Q).
10.11 Trade Finance Agreement dated as of December 4, 1998, by and
between the Company and Union Bank of California, N.A. ("Union
Bank") (incorporated by reference to Exhibit 10.8 to the 1998
10-K).
10.12 Trade Finance Agreement dated as of December 4, 1998,
by and between T.HQ International, LTD. ("THQ
International") and Union Bank (incorporated by
reference to Exhibit 10.9 to the 1998 10-K).
10.13 First Amendment to Trade Finance Agreement dated as
of March 22, 1999, by and between the Company and
Union Bank (incorporated by reference to Exhibit
10.10 to the 1998 10-K).
10.14 First Amendment to Trade Finance Agreement dated as
of March 22, 1999, by and between THQ International
and Union Bank (incorporated by reference to Exhibit
10.11 to the 1998 10-K).
21 Subsidiaries of the Registrant.
32
35
23.1 Consent of Deloitte & Touche LLP.
27 Financial Data Schedule.
- ----------
*Management contract or compensatory plan or arrangement required to be
filed as an exhibit hereto pursuant to Item 14(c) of Form 10-K.
33
36
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
Dated: March 28, 2000 THQ INC.
By: /s/ Brian J. Farrell
---------------------------------
Brian J. Farrell, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ Brian J. Farrell Director, President and March 28, 2000
- -------------------------------- and Chief Executive Officer
Brian J. Farrell (Principal Executive Officer)
/s/ Lawrence Burstein Director March 28, 2000
- ----------------------------
Lawrence Burstein
/s/ Bruce Jagid Director March 28, 2000
- ----------------------------
Bruce Jagid
/s/ James L. Whims Director March 28, 2000
- ----------------------------
James L. Whims
/s/ Jeffrey C. Lapin Director and Vice Chairman March 28, 2000
- ------------------------------
Jeffrey C. Lapin
/s/ L. Gregory Ballard Director March 28, 2000
- ----------------------------
L. Gregory Ballard
/s/ Fred A. Gysi Vice President - Finance and March 28, 2000
- -------------------------------- Administration, Chief Financial
Fred A. Gysi Officer and Secretary
(Principal Financial Officer and
Principal Accounting Officer)
34
37
THQ INC.
INDEX TO FINANCIAL STATEMENTS
Page
----
INDEPENDENT AUDITORS' REPORT F-2
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets -- December 31, 1998 and 1999 F-3
Consolidated Statements of Operations for Each of the Three Years in the
Period Ended December 31, 1999 F-4
Consolidated Statements of Shareholders' Equity for Each of the Three Years
in the Period Ended December 31, 1999 F-5
Consolidated Statements of Cash Flows for Each of the Three Years in the
Period Ended December 31, 1999 F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-9
All financial statement schedules have been omitted since either (i) the
schedule or condition requiring a schedule is not applicable or (ii) the
information required by such schedule is contained in the Consolidated Financial
Statements and Notes thereto.
F-1
38
INDEPENDENT AUDITORS' REPORT
To the Shareholders of THQ Inc.,
Calabasas, California
We have audited the accompanying consolidated balance sheets of THQ Inc. and
subsidiaries (the "Company") as of December 31, 1998 and 1999, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended December 31, 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 1998
and 1999, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 1999 in conformity with accounting
principles generally accepted in the United States of America.
DELOITTE & TOUCHE LLP
Los Angeles, California
February 24, 2000
F-2
39
THQ INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
------------------------------------
1998 1999
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 19,063,000 $ 21,303,000
Accounts receivable -- net 59,521,000 96,641,000
Inventory 16,937,000 5,455,000
Prepaid and deferred royalties 5,321,000 23,478,000
Software development costs 3,011,000 11,640,000
Deferred income taxes 8,321,000 6,817,000
Income taxes receivable -- 965,000
Prepaid expenses and other current assets 1,556,000 2,226,000
------------- -------------
Total current assets 113,730,000 168,525,000
Property and equipment -- net 2,670,000 5,659,000
Deferred royalties -- net of current portion 375,000 3,371,000
Software development costs -- net of current portion 1,173,000 1,824,000
Deferred income taxes -- net of current portion 2,053,000 2,865,000
Other long-term assets 7,742,000 2,790,000
------------- -------------
TOTAL ASSETS $ 127,743,000 $ 185,034,000
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Lines of credit $ 9,909,000 $ 16,702,000
Accounts payable 18,664,000 13,170,000
Accrued expenses 11,576,000 12,998,000
Accrued royalties 15,945,000 31,254,000
Income taxes payable 8,270,000 --
------------- -------------
Total current liabilities 64,364,000 74,124,000
Accrued royalties -- net of current portion 375,000 150,000
Commitments and contingencies -- --
Shareholders' equity:
Common Stock, par value $.01, 35,000,000 shares
authorized; 17,878,481 and 19,007,124 shares
issued and outstanding as of December 31,
1998 and 1999, respectively 120,000 190,000
Additional paid-in capital 62,731,000 78,378,000
Accumulated other comprehensive income (loss) 60,000 (842,000)
Retained earnings 93,000 33,034,000
------------- -------------
Total shareholders' equity 63,004,000 110,760,000
------------- -------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 127,743,000 $ 185,034,000
============= =============
See notes to consolidated financial statements.
F-3
40
THQ INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended
December 31,
--------------------------------------------------------
1997 1998 1999
------------ ------------ ------------
Net sales $ 89,579,000 $216,111,000 $302,357,000
Costs and expenses:
Cost of sales 48,127,000 100,019,000 134,563,000
Royalties and project
abandonment 14,763,000 48,130,000 48,370,000
Product development 1,887,000 6,849,000 12,770,000
Selling and marketing 8,733,000 20,325,000 35,440,000
Payment to venture partner -- -- 6,119,000
General and administrative 5,633,000 10,436,000 14,969,000
In-process research and
development -- 7,232,000 --
------------ ------------ ------------
Total costs and expenses 79,143,000 192,991,000 252,231,000
------------ ------------ ------------
Income from operations 10,436,000 23,120,000 50,126,000
Interest income, net 466,000 840,000 1,102,000
------------ ------------ ------------
Income before income taxes 10,902,000 23,960,000 51,228,000
Income taxes 1,954,000 9,342,000 18,287,000
------------ ------------ ------------
Net income $ 8,948,000 $ 14,618,000 $ 32,941,000
============ ============ ============
Net income per share -- basic $ .59 $ .86 $ 1.81
============ ============ ============
Net income per share -- diluted $ .55 $ .79 $ 1.63
============ ============ ============
Shares used in per share
calculation -- basic 15,167,000 17,039,000 18,150,000
============ ============ ============
Shares used in per share
calculation -- diluted 16,267,000 18,453,000 20,194,000
============ ============ ============
See notes to consolidated financial statements.
F-4
41
THQ INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 1997, 1998 and 1999
Accumulated Retained
Additional Other Earnings
Common Common Paid-in Comprehensive (Accumulated
Shares Stock Capital Income (Loss) Deficit) Total
------------ ------------ ------------ ------------ ------------ ------------
Balance at January 1, 1997 11,558,617 $ 11,000 $ 34,558,000 $ (52,000) $(23,473,000) $ 11,044,000
Exercise of warrants and options 699,786 -- 1,293,000 -- -- 1,293,000
Stock compensation -- -- 21,000 -- -- 21,000
Issuance of common stock 3,934,853 -- 12,179,000 -- -- 12,179,000
Comprehensive income:
Net income -- -- -- -- 8,948,000 8,948,000
Other comprehensive income
Foreign currency translation -- -- -- 133,000 -- 133,000
adjustment
------------
Comprehensive income -- -- -- -- -- 9,081,000
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1997 16,193,256 11,000 48,051,000 81,000 (14,525,000) 33,618,000
Exercise of warrants and options 902,519 5,000 2,343,000 -- -- 2,348,000
Stock compensation -- -- 187,000 -- -- 187,000
Issuance of common stock 782,706 4,000 10,647,000 -- -- 10,651,000
Tax benefit related to the exercise of
employee stock options -- -- 1,603,000 -- -- 1,603,000
Reincorporation -- 100,000 (100,000) -- -- --
Comprehensive income:
Net income -- -- -- -- 14,618,000 14,618,000
Other comprehensive income
Foreign currency translation -- -- -- (21,000) -- (21,000)
adjustment
------------
Comprehensive income -- -- -- -- -- 14,597,000
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1998 17,878,481 120,000 62,731,000 60,000 93,000 63,004,000
(continued)
F-5
42
Accumulated Retained
Additional Other Earnings
Common Common Paid-in Comprehensive (Accumulated
Shares Stock Capital Income (Loss) Deficit) Total
---------- ------------- ------------- ------------- ------------- -------------
Balance at December 31, 1998 17,878,481 120,000 62,731,000 60,000 93,000 63,004,000
Exercise of warrants and options 1,128,643 8,000 4,855,000 -- -- 4,863,000
Issuance of warrants -- -- 3,627,000 -- -- 3,627,000
Stock compensation -- -- 464,000 -- -- 464,000
Tax benefit related to the exercise of
employee stock options -- -- 6,763,000 -- -- 6,763,000
Three-for-two stock dividend -- 62,000 (62,000) -- -- --
Comprehensive income:
Net income -- -- -- -- 32,941,000 32,941,000
Other comprehensive income
Foreign currency translation -- -- -- (902,000) -- (902,000)
adjustment
-------------
Comprehensive income -- -- -- -- -- 32,039,000
---------- ------------- ------------- ------------- ------------- -------------
Balance at December 31, 1999 19,007,124 $ 190,000 $ 78,378,000 $ (842,000) $ 33,034,000 $ 110,760,000
========== ============= ============= ============= ============= =============
See notes to consolidated financial statements.
F-6
43
THQ INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
--------------------------------------------------------
1997 1998 1999
------------ ------------ ------------
Cash flows from operating activities:
Net income $ 8,948,000 $ 14,618,000 $ 32,941,000
Adjustments to reconcile net income
to net cash (used in)
provided by operating activities:
Depreciation and amortization 492,000 909,000 1,656,000
Provision for doubtful accounts,
discounts and returns 10,509,000 20,838,000 35,009,000
Litigation settlement -- -- 564,000
Loss on sale of property and equipment -- 40,000 56,000
Loss on sale of investment securities -- 218,000 --
Unearned stock compensation 21,000 187,000 464,000
In-process research and development -- 7,232,000 --
Deferred income taxes (1,666,000) (8,708,000) 692,000
Changes in operating assets and liabilities,
net of effects from acquisitions:
Accounts receivable (27,343,000) (43,935,000) (72,703,000)
Inventory (441,000) (13,780,000) 11,200,000
Prepaid and deferred royalties and
software development costs (2,436,000) 2,702,000 (4,493,000)
Prepaid expenses and other current assets (11,000) (239,000) (680,000)
Accounts payable and accrued expenses 7,952,000 13,113,000 (3,147,000)
Accrued royalties 2,341,000 8,467,000 (6,228,000)
Income taxes payable 3,455,000 6,040,000 (2,440,000)
------------ ------------ ------------
Net cash (used in) provided by operating activities 1,821,000 7,702,000 (7,109,000)
------------ ------------ ------------
Cash flows used in investing activities:
Proceeds from sale of investment securities -- 863,000 --
Purchase of investment securities -- (1,081,000) --
Proceeds from sale of property and equipment -- -- 37,000
Acquisition adjustment -- -- 2,540,000
Acquisitions, net of cash acquired -- (2,369,000) --
Acquisition of equipment (1,006,000) (1,427,000) (4,413,000)
Other long-term assets 1,000 (2,010,000) (261,000)
------------ ------------ ------------
Net cash used in investing activities (1,005,000) (6,024,000) (2,097,000)
------------ ------------ ------------
Cash flows from financing activities:
Net increase (decrease) in short-term borrowings (5,355,000) 3,265,000 7,118,000
Net proceeds from issuance of common stock 12,179,000 -- --
Proceeds from exercise of warrants and options 1,293,000 2,348,000 4,863,000
------------ ------------ ------------
Net cash provided by financing activities 8,117,000 5,613,000 11,981,000
------------ ------------ ------------
F-7
44
Effect of exchange rate changes on cash
and cash equivalents 261,000 (156,000) (535,000)
------------ ------------ ------------
Net increase in cash and cash equivalents 9,194,000 7,135,000 2,240,000
------------ ------------ ------------
Cash and cash equivalents -- beginning of period 2,734,000 11,928,000 19,063,000
------------ ------------ ------------
Cash and cash equivalents -- end of period $ 11,928,000 $ 19,063,000 $ 21,303,000
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Income taxes $ 127,000 $ 12,417,000 $ 19,569,000
============ ============ ============
Interest $ 53,000 $ 171,000 $ 233,000
============ ============ ============
SUPPLEMENTAL SCHEDULE OF NON-CASH ACTIVITIES:
In 1998 and 1999, income taxes payable and additional paid-in capital include
tax benefits of $1,603,000 and $6,763,000, respectively, resulting from
disqualified dispositions of common stock by officers and employees of THQ
acquired through the exercise of stock options.
In 1999, we consolidated the venture with JAKKS Pacific resulting in the
consolidation of our $2,010,000 investment.
On August 2, 1999 we issued to the WWF and a related party warrants expiring
December 31, 2009 to purchase 281,250 shares of common stock at $10.42 per
share, which had a fair value at the time of issuance of $3,063,000. (See
Note 13).
On May 1, 1998 we issued 532,776 shares of common stock as part of the purchase
price for GameFx, Inc. This issuance increased common stock and additional
paid-in capital by $2,000 and $6,217,000, respectively, and was allocated among
the net assets acquired, part of which was written off as in-process research
and development. (See Note 12).
On December 2, 1998 we issued 249,930 shares of common stock as part of the
purchase price for Rushware Microhandelsgesellschaft mbH ("Rushware"). This
issuance increased common stock and additional paid-in capital by $2,000 and
$4,430,000, respectively, and was allocated among the net assets acquired. (See
Note 12).
DETAILS OF 1998 ACQUISITIONS:
GameFx, Inc. Rushware
------------ ------------
Fair value of assets acquired $ 7,492,000 $ 18,581,000
Liabilities assumed -- (12,567,000)
Value of common stock and stock
options issued (6,219,000) (4,432,000)
------------ ------------
Cash paid 1,273,000 1,582,000
Less cash acquired -- (486,000)
------------ ------------
Net cash paid for acquisitions $ 1,273,000 $ 1,096,000
============ ============
In 1999, we renegotiated the purchase of Rushware and received a
payment of $2,540,000 from the sellers.
F-8
45
THQ INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
BUSINESS. THQ Inc., a Delaware corporation, is a developer, publisher
and distributor of interactive entertainment software for the leading hardware
platforms in the home video game market. We currently publish titles for Sony's
PlayStation, Sega Dreamcast, Nintendo 64, Nintendo Game Boy and Game Boy Color,
and personal computers ("PCs") in most interactive software genres, including
action, adventure, driving, fighting, puzzle, role playing, simulation, sports
and strategy. Our customers include Wal-Mart, Toys "R" Us, Target, Kmart Stores,
Kay Bee Toys, Electronics Boutique, Blockbuster, Best Buy, other national and
regional retailers, discount store chains and specialty retailers.
Unless the context otherwise requires, references in this document to
"THQ" or the "Company" include THQ Inc. and all of its wholly owned
subsidiaries.
LICENSE AGREEMENTS. We have two license agreements with Sony pursuant
to which we have the non-exclusive right to utilize the Sony name and its
proprietary information and technology in order to develop and market software
for use with the 32-bit Sony PlayStation in the United States and Canada, and
Europe, respectively, which expire in August 2002 and December 2005,
respectively.
We have various license agreements with Nintendo pursuant to which we
have the non-exclusive right to utilize the Nintendo name and its proprietary
information and technology in order to develop and market software for use with
the 64-bit Nintendo 64, and with the Nintendo Game Boy portable game consoles.
The license agreements with Nintendo for such hardware platforms expire at
various times from 2000 through 2002.
We also have two license agreements with Sega pursuant to which we have
the non-exclusive right to utilize the Sega name and its proprietary information
and technology in order to develop and market software for use with the 128-bit
Sega Dreamcast in the United States and Canada, Latin America, Europe, Australia
and New Zealand, respectively, which expire in September 2003 and October 2003,
respectively.
Our business is dependent on these license agreements with Sony,
Nintendo and Sega. Substantially all of our products are manufactured by Sony,
Nintendo and Sega, who charge us a fixed amount for each CD-ROM or cartridge
manufactured, which charge includes a manufacturing, printing and packaging fee
as well as a royalty for the use of their respective names, proprietary
information and technology.
In addition, we must indemnify Sony, Nintendo or Sega as appropriate,
with respect to all loss, liability and expense resulting from any claim against
Sony, Nintendo or Sega involving the development, marketing, sale or use of our
titles, including any claims for copyright or trademark infringement brought
against Sony, Nintendo or Sega. As such, we bear the risk that the properties
and information and technology licensed from Sony, Nintendo or Sega and
F-9
46
incorporated in the software may infringe the rights of third parties.
Generally, we are entitled to indemnification from our software developers and
property licensors to cover our indemnification obligations to Sony, Nintendo or
Sega but no assurance can be given that, if any claim is brought against us, the
developers and/or licensors will have sufficient resources to indemnify us.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements
include the accounts of THQ Inc. and our wholly owned subsidiaries. All material
intercompany balances and transactions have been eliminated in consolidation.
FOREIGN CURRENCY TRANSLATION. Assets and liabilities of foreign
operations are translated at current rates of exchange while results of
operations are translated at average rates in effect for the period. Translation
gains or losses are shown as a separate component of shareholders' equity.
Foreign currency gains and losses result from exchange rate changes for
transactions denominated in currencies other than the functional currency. We
have not experienced significant foreign currency transaction gains or losses.
CASH EQUIVALENTS. We consider all highly liquid investments purchased
with maturities less than three months to be cash equivalents.
FAIR VALUES OF FINANCIAL INSTRUMENTS. The carrying value of our draws
on our line of credit from our banks are considered to approximate their fair
value because the interest rate of these instruments is based on variable
reference rates.
CONCENTRATIONS OF CREDIT RISK. Financial instruments which potentially
subject us to concentration of credit risk consist principally of cash and cash
equivalents and accounts receivable. We place cash and cash equivalents with
high credit-quality institutions and limit the amount of credit exposure to any
one institution. Most of our sales are made directly to mass merchandisers and
national retailers. Due to the increased volume of sales to these channels, we
have experienced an increased concentration of credit risk, and as a result, may
maintain individually significant receivable balances with such mass
merchandisers and national retailers. While we frequently monitor and manage
this risk, financial difficulties on the part of one or more of our major
customers may have a material adverse effect on us.
Sales (before returns and allowances) to a major customer represented
10%, 19% and 15% of gross sales in the years ended December 31, 1997, 1998 and
1999, respectively. This customer accounted for approximately 32% and 18% of
accounts receivable at December 31, 1998 and 1999, respectively. Sales (before
returns and allowances) to another major customer represented 19%, 13% and 11%
of gross sales in the years ended December 31, 1997, 1998 and 1999,
respectively. This customer accounted for approximately 12% and 15% of accounts
receivable at December 31, 1998 and 1999, respectively. We perform ongoing
credit evaluations of our customers and maintain an allowance for potential
credit losses.
F-10
47
INVENTORY. Inventory, which consists principally of finished products,
are stated at the lower of cost (moving weighted average) or market. We estimate
the net realizable value of slow-moving inventory on a title by title basis, and
charge the excess of cost over net realizable value to cost of sales.
PROPERTY AND EQUIPMENT. Property and equipment are stated at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets. Leasehold improvements are amortized over the
shorter of their useful lives or the remaining lease term. Property and
equipment consist of the following at:
December 31,
Lives 1998 1999
------------------------------------------------------
Furniture, fixtures and equipment 3-10 yrs $ 3,110,000 $ 8,150,000
Leasehold improvements 3-6 yrs 560,000 1,024,000
Less accumulated depreciation and
amortization (1,000,000) (3,515,000)
----------- -----------
$ 2,670,000 $ 5,659,000
=========== ===========
ROYALTIES, SOFTWARE DEVELOPMENT COSTS AND PROJECT ABANDONMENT LOSS.
Advance royalty payments for intellectual property licenses are recorded as
prepaid royalties. All minimum guaranteed royalty payments are initially
recorded as an asset (prepaid and deferred royalties) and as a liability
(accrued royalties) at the contractual amount upon execution of the contract.
Royalty payments for intellectual property licenses are classified as current
assets and current liabilities to the extent they relate to anticipated sales
during the subsequent year and long-term assets and long-term liabilities if the
sales are anticipated after one year.
We utilize both independent software developers (who are paid advances
against future royalties) and internal development teams to develop our
software. Under generally accepted accounting principles, such software
development costs are capitalizable when technological feasibility has been
established. Technological feasibility for console entertainment software has
been established by Sony, Nintendo and Sega for use with their respective
hardware platforms. We are currently capitalizing the costs of video games under
development at our Heavy Iron and PCP&L studios. At December 31, 1999, we had
capitalized in software development costs of $1,034,000 at our studios. During
1999 we recognized no amortization of capitalized software development costs.
Prepaid royalty and software development costs are expensed, as a part
of royalties expense, at the contractual royalty rate based on actual net
product sales. When, in management's estimate, future revenues will not be
sufficient to recover previously capitalized
F-11
48
advances or software development costs, we expense these items as project
abandonment losses. Such abandonment losses are solely attributable to changes
in market conditions or product quality considerations. Research and development
costs are expensed as incurred.
IMPAIRMENT OF LONG-LIVED ASSETS. We evaluate long-lived assets for
impairment whenever events or changes in circumstances indicate that the
carrying value of an asset may not be recoverable. If the estimated future cash
flows (undiscounted and without interest charges) from the use of an asset are
less than the carrying value, a write-down would be recorded to reduce the
related asset to its estimated fair value.
REVENUE RECOGNITION. Revenue is recognized when products are shipped,
provided that no significant vendor support obligations remain outstanding, and
provided that collection of the resulting receivable is deemed probable by
management. Although we generally sell our products on a no-return basis, in
certain circumstances we may allow returns, price concessions, or allowances on
a negotiated basis. We estimate such returns and allowances based upon
management's evaluation of our historical experience and current industry
trends. Such estimates are deducted from gross sales. Software is sold under a
limited 90-day warranty against defects in material and workmanship. To date, we
have not experienced material warranty claims. (See Note 5).
ADVERTISING. Advertising and sales promotion costs are generally
expensed as incurred, except for production costs associated with the media
campaigns which are deferred and charged to expense at the first run of the ad.
Advertising costs were $850,000, $5,659,000 and $10,108,000 in the years ended
December 31, 1997, 1998 and 1999, respectively.
STOCK BASED COMPENSATION. We account for our employee stock plans under
the intrinsic value method prescribed by Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees."
INCOME TAXES. Deferred income taxes are provided for temporary
differences between the financial statement and income tax bases of our assets
and liabilities, based on enacted tax rates. A valuation allowance is provided
when it is more likely than not that some portion or all of the deferred income
tax assets will not be realized.
BASIC AND DILUTED EARNINGS PER SHARE. The following table is a
reconciliation of the weighted-average shares used in the computation of basic
and diluted EPS for the years presented:
F-12
49
Years Ended
December 31,
-----------------------------------------------------
1997 1998 1999
----------- ----------- -----------
Net income used to compute basic
and diluted earnings per share $ 8,948,000 $14,618,000 $32,941,000
=========== =========== ===========
Weighted average number of shares
outstanding -- basic 15,167,000 17,039,000 18,150,000
Dilutive effect of stock options and
warrants 1,100,000 1,414,000 2,044,000
----------- ----------- -----------
Number of shares used to compute
earnings per share -- diluted 16,267,000 18,453,000 20,194,000
=========== =========== ===========
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS. In June 1998, the FASB
issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes the
accounting and reporting standards for derivative financial instruments and for
hedging activities. It requires that an entity measure all derivatives at fair
value and recognize them in the balance sheet as an asset or liability,
depending upon the entity's rights or obligations under the applicable
derivative contract. SFAS 133 as amended, is effective for financial statements
for periods beginning after June 15, 2000. We are currently evaluating the
potential impact of adopting SFAS No. 133.
PERVASIVENESS OF ESTIMATES. The preparation of financial statements in
conformity with generally accepted accounting principles 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 revenues and expenses
during the reporting period. Actual results could differ from those estimates.
The most significant estimates relate to prepaid and deferred royalties,
software development costs, accrued returns and allowances and the allowance for
doubtful accounts.
3. BUSINESS COMBINATIONS
On May 24, 1999 we completed a merger with PCP&L. In the merger, each
share of PCP&L was converted into 0.09008 shares of our common stock, or
approximately 727,000 shares. In addition, outstanding PCP&L employee stock
options were assumed by us and converted, at the same conversion rate, into
options to purchase approximately 196,000 shares of our common stock.
On December 13, 1999 we completed a merger with Genetic Anomalies,
Inc., a Delaware corporation ("GA"). In the merger, each share of GA was
converted into 0.0536 share of our common stock, or approximately 220,000
shares. In addition, outstanding GA employee stock
F-13
50
options were assumed by us and converted, at the same conversion rate, into
options to purchase approximately 45,000 shares of our common stock.
The mergers have been accounted for as poolings of interests under
Accounting Principles Board Opinion No. 16. Accordingly, all prior period
consolidated financial statements presented have been restated to include the
combined results of operations, financial position and cash flows as if PCP&L
and GA had always been part of our company.
All transactions between us, PCP&L and GA have been eliminated in the
consolidated financial statements. The results of operations for the separate
companies and the combined amounts presented in the consolidated financial
statements follow.
For the Years Ended December 31,
------------------------------------------------------------
Net sales 1997 1998 1999
------------- ------------- -------------
THQ Inc. $ 89,362,000 $ 215,060,000 $ 301,141,000
PCP&L 115,000 1,379,000 1,676,000
GA 102,000 222,000 565,000
Intercompany elimination -- (550,000) (1,025,000)
------------- ------------- -------------
Combined $ 89,579,000 $ 216,111,000 $ 302,357,000
============= ============= =============
For the Years Ended December 31,
----------------------------------------------------------
Net income (loss) 1997 1998 1999
------------ ------------ ------------
THQ Inc. $ 9,345,000 $ 15,989,000 $ 35,044,000
PCP&L (18,000) (348,000) (667,000)
GA (379,000) (473,000) (411,000)
Intercompany elimination -- (550,000) (1,025,000)
------------ ------------ ------------
Combined $ 8,948,000 $ 14,618,000 $ 32,941,000
============ ============ ============
4. CREDIT FACILITY
In December 1998, we entered into two trade finance agreements
(as amended) with Union Bank of California that established a revolving credit
facility. These agreements currently expire on June 1, 2000. The principal
agreement (as amended) permits us to borrow (and maintain obligations under
outstanding letters of credit) up to $43,000,000, subject to the following:
- We may maintain outstanding letters of credit for product
purchases of up to $38,000,000 in the aggregate through the
end of February 2000;
- We may maintain outstanding letters of credit for product
purchases of up to $25,000,000 in the aggregate between March
1, 2000 and June 1, 2000;
F-14
51
- We may borrow up to $30,000,000 through February 29, 2000, $25
million during March 2000, and $15,000,000 during April and
May 2000, (including amounts owing as a result of draws under
letters of credit), but we are required to not have any
borrowings for a period of at least 60 days during each year
of the term of the agreement.
Our other agreement with Union Bank is for our United Kingdom
subsidiary, T.HQ International Ltd., and permits that subsidiary to obtain
product purchase letters of credit of up to $7 million in the aggregate.
These credit facilities are secured by a lien on substantially all of
our assets. Amounts outstanding under these credit facilities bear interest, at
our choice, at either a) the bank's prime rate (8.5% at December 31, 1999) or b)
the London Interbank Offered Rate (5.69% at December 31, 1999) plus 1.85%. As of
December 31, 1999, we had $16,702,000 in outstanding borrowings under these
credit facilities and had obligations in respect of outstanding letters of
credit of $8,134,000.
These agreements contain financial covenants, including the requirement
that we:
- maintain the ratio of our cash, cash equivalents and accounts
receivable, to our current liabilities (including advances by
the bank), at not less than 1.00:1.00 at the end of each
quarter;
- maintain minimum shareholders' equity;
- maintain the ratio of our total liabilities to our
shareholders' equity at not greater than 1.10:1.00 as of
December 31, 1998 and 1.00:1.00 as of the end of each quarter
thereafter;
- achieve operating profits of at least $1 each quarter; and
- maintain the ratio of the value of our inventory as of the
last day of any quarter, to our cost of goods sold for the
four consecutive quarters ending on that day (or four times
our cost of goods sold for the last quarter, if greater), at
not more than 1.00:10.50.
These agreements also contain customary non-financial covenants
including restrictions on the incurrence of debt and encumbrances and
limitations on sales of assets, mergers and acquisitions, dividends, capital
expenditures and annual lease obligations.
Rushware Revolving Credit Facilities. Rushware was a party to three
separate revolving credit agreements with three German banks, each of which
permitted Rushware to borrow up to 5 million Deutsche marks (approximately $3
million) to finance the working capital requirements of Rushware and its
subsidiaries. These borrowings were secured by substantially all of the assets
of Rushware and its subsidiaries. Each of these agreements expired during 1999.
F-15
52
As of December 31, 1998, we had $3,856,000 in outstanding borrowings under this
credit facility. All Rushware borrowings were guaranteed by THQ Inc.
5. ACCOUNTS RECEIVABLE AND ACCRUED RETURNS AND ALLOWANCES
Accounts receivable is due primarily from domestic and foreign
retailers and distributors, including mass merchants and specialty stores.
Accounts receivable at December 31, 1998 and 1999 are composed of the following:
December 31,
-----------------------------------
1998 1999
------------ ------------
Accounts receivable -- domestic $ 66,407,000 $ 93,455,000
Other receivables -- domestic 280,000 1,469,000
Allowance for domestic returns and
doubtful accounts (15,008,000) (16,845,000)
Accounts receivable -- foreign 11,732,000 25,888,000
Allowance for foreign returns and doubtful accounts (3,890,000) (7,326,000)
------------ ------------
Accounts receivable -- net $ 59,521,000 $ 96,641,000
============ ============
The allowance for domestic accrued returns and allowances consists of
the following:
December 31,
----------------------------------------------------------
1997 1998 1999
------------ ------------ ------------
Balance at January 1 $ (2,772,000) $ (7,767,000) $(15,008,000)
Provision for discounts and
returns (10,172,000) (18,870,000) (28,072,000)
Actual discounts
and returns 5,177,000 11,629,000 26,235,000
------------ ------------ ------------
Ending balance $ (7,767,000) $(15,008,000) $(16,845,000)
============ ============ ============
The allowance for foreign accrued returns and allowances consists of
the following:
December 31,
-------------------------------------------------------
1997 1998 1999
----------- ----------- -----------
Balance at January 1 $(1,586,000) $ (372,000) $(3,890,000)
Rushware purchase as of
December 2, 1998 -- (3,717,000) --
Provision for doubtful accounts (337,000) (1,968,000) (6,937,000)
Actual doubtful accounts
F-16
53
(recoveries) 1,551,000 2,167,000 3,501,000
----------- ----------- -----------
Ending balance $ (372,000) $(3,890,000) $(7,326,000)
=========== =========== ===========
6. EMPLOYEE PENSION PLAN
We sponsor for our U.S. employees a defined contribution plan under
Section 401(k) of the Internal Revenue Code. The plan provides that employees
may defer up to 12% of annual compensation, and that we will make a matching
contribution equal to each employee's deferral, up to 4% of compensation. We may
also contribute funds to the plan in the form of a profit sharing contribution.
Expenses under the plan were $119,000, $400,000, and $477,000 in 1997, 1998 and
1999, respectively.
7. INCOME TAXES
The provision for income taxes consists of the following:
1997 1998 1999
------------ ------------ ------------
Current
Federal $ 2,760,000 $ 14,654,000 $ 13,642,000
State 821,000 3,275,000 2,897,000
Foreign 39,000 121,000 1,056,000
------------ ------------ ------------
3,620,000 18,050,000 17,595,000
------------ ------------ ------------
Deferred
Federal (1,283,000) (7,170,000) 121,000
State (383,000) (1,538,000) 755,000
Foreign -- -- (184,000)
------------ ------------ ------------
(1,666,000) (8,708,000) 692,000
------------ ------------ ------------
Provision for income taxes $ 1,954,000 $ 9,342,000 $ 18,287,000
============ ============ ============
A reconciliation of the provision for income taxes at the federal
statutory rate to the provision recorded in the accompanying financial
statements is as follows:
F-17
54
1997 1998 1999
------ ------ ------
Federal provision at statutory rate 35.0% 35.0% 35.0%
State taxes (net of Federal benefit) 4.0% 5.0% 5.0%
In-process research and development -- 10.0% --
Change in valuation allowance (21.7) (11.8) (5.2)
Foreign taxes and other, net 0.6 0.8 0.9
------ ------ ------
17.9% 39.0% 35.7%
====== ====== ======
The components of deferred income tax assets (liabilities) are as
follows:
December 31,
------------------------------------------------------------------------------------
1998 1999
------------------------------------------------------------------------------------
Federal State Federal State Foreign
------------ ------------ ------------ ------------ ------------
CURRENT
Deferred income tax assets:
Allowance for doubtful
accounts, discounts and
returns $ 5,263,000 $ 1,117,000 $ 5,896,000 $ 1,144,000 $ 184,000
License abandonment 2,258,000 339,000 5,356,000 1,039,000 --
State income taxes 1,213,000 -- 641,000 -- --
Other -- net 436,000 248,000 476,000 92,000 --
Net operating loss -- -- 821,000 57,000 --
------------ ------------ ------------ ------------ ------------
Total deferred income tax assets 9,170,000 1,704,000 13,190,000 2,332,000 184,000
Deferred tax liabilities:
Software development costs (1,418,000) (196,000) (7,103,000) (1,378,000) --
State income taxes (939,000) -- (408,000) -- --
------------ ------------ ------------ ------------ ------------
Deferred income taxes $ 6,813,000 $ 1,508,000 $ 5,679,000 $ 954,000 $ 184,000
============ ============ ============ ============ ============
NON-CURRENT
Deferred income tax assets:
Deferred compensation $ -- $ -- $ 133,000 $ 25,000 $ --
Net operating loss 4,021,000 413,000 2,420,000 168,000 --
Other -- net 80,000 -- 100,000 19,000 --
------------ ------------ ------------ ------------ ------------
Net deferred tax assets 4,101,000 413,000 2,653,000 212,000 --
Valuation allowance (2,461,000) -- -- -- --
------------ ------------ ------------ ------------ ------------
Deferred income taxes $ 1,640,000 $ 413,000 $ 2,653,000 $ 212,000 $ --
============ ============ ============ ============ ============
The valuation reserve decreased $2,231,000, $2,992,000 and $2,461,000
during 1997, 1998 and 1999, respectively.
F-18
55
As of December 31, 1999 we had federal and state net operating loss
carryforwards of approximately $9,259,000 (expiring from 2009 to 2011) and
approximately $638,000 (expiring in 2000), respectively.
At December 31, 1999 we had accumulated foreign earnings of $3,249,000.
We do not plan to repatriate these earnings, therefore, no U.S. income tax has
been provided on the foreign earnings. Additionally, we have not tax effected
the cumulative translation adjustment as we have no intention of repatriating
foreign earnings.
F-19
56
Various equity transactions during 1996 resulted in an "ownership
change" as defined in the Internal Revenue Code. As a result, the amount of our
net operating loss carryforward available to reduce our federal income tax
liability in future years in which we have taxable income will be limited to an
annual amount of approximately $2,225,000.
8. STOCK OPTION PLAN
We have two stock option plans (the "1990 Plan" and "1997 Plan"), which
provide for the issuance of up to 1,462,500 and 4,125,000 shares, respectively,
available for employees, consultants and non-employee directors. As of December
31, 1999, 13,428 options under the 1990 Plan and 830,962 options under the 1997
Plan were available for grant. Stock options granted under the option plans may
be incentive stock options or nonstatutory stock options. Options may be
granted under the option plans to, in the case of incentive stock options, all
employees (including officers) of THQ; or, in the case of nonstatutory stock
options, all employees (including officers) or non-employee directors of THQ.
The exercise price per share of all options granted under the plans in
1997, 1998 and 1999 has been the market price of the stock on the date of the
grant. Stock options issued by PCP&L and GA were issued at below market value.
These options were accounted for under APB 25 and we have recognized
compensation expense of $21,000, $187,000 and $464,000 for 1997, 1998 and 1999,
respectively. Generally, options granted become exercisable over three years and
expire within five years from the date of grant.
Weighted Average Number of
Stock Options Exercise Price Shares
------------- ---------------- ------------
Balance at January 1, 1997 $ 1.51 1,113,082
Granted $ 5.17 937,693
Exercised $ 1.62 (269,651)
Canceled $ 1.56 (37,037)
----------
Balance at December 31, 1997 $ 3.46 1,744,087
Granted $10.93 1,370,525
Exercised $ 2.11 (553,416)
Canceled $ 8.79 (78,937)
----------
Balance at December 31, 1998 $ 7.72 2,482,259
Granted $22.24 1,258,200
Exercised $ 5.48 (882,119)
Canceled $14.89 (155,942)
----------
Balance at December 31, 1999 $14.79 2,702,398
==========
Options exercisable at December 31, 1999 $ 9.37 599,339
Options granted and shares exercised relating to options granted
outside of our stock option plans during 1997, 1998 and 1999 are listed below.
Share exercise prices for these options equal the market price of our common
stock at the date of the grant.
F-20
57
Number of Number of Number of
Share Number of Shares Shares Shares
Grant Exercise Shares Exercised Exercised Exercised
Description Year Price Granted 1997 1998 1999
- ---------------------------------------------------------------------------------------------------------------------------------
Former executive 1994 $ 1.67 201,024 201,024
--------
Total options granted 1994 201,024
Executive officer 1995 $ 1.36 315,000 135,000 180,000
Outside consultants 1995 $ 1.27 67,500 3,752 56,250
Former employee severance package 1995 $ 1.25 112,500
Former employee severance package 1995 $ 0.69 45,000
--------
Total options granted 1995 540,000
Executive officer 1996 $ 2.22 450,000 150,000
Outside consultant 1996 $ 2.31 56,250 56,250
--------
Total options granted 1996 506,250
Pacific Coast Power & 1997 $ 0.37 35,919 16,768
Light Company
Genetic Anomalies 1997 $ 0.50 5,360
--------
Total options granted 1997 41,279
Employee director 1998 $ 11.17 300,000
Nonemployee directors 1998 $ 18.54 33,750
GameFx options 1998 $ 1.31 17,600 8,257
Pacific Coast Power & 1998 $ 0.39 107,706 24,425
Light Company
Genetic Anomalies 1998 $ 1.41 34,508
--------
Total options granted 1998 493,564
Pacific Coast Power & 1999 $ 0.74 48,175
Light Company
Genetic Anomalies 1999 $ 1.58 4,839
--------
Total options granted 1999 53,014
--------- ------- ------- -------
Total 1,835,131 396,026 236,250 199,450
========= ======= ======= =======
Balance outstanding at
December 31, 1999 856,423
=========
Options exercisable at December 31, 1999 578,759
=========
F-21
58
The following table summarizes information about stock options
outstanding at December 31, 1999:
Number Weighted Average Weighted
Range of Exercise Outstanding at Remaining Contractual Average Exercise
Price December 31, 1999 Life Price
--------------------- ----------------------- --------------------- --------------------
$ 0.37 - $ 4.33 772,518 6 $ 2.26
$ 4.55 - $ 9.83 933,867 3 $ 8.75
$10.00 - $14.92 766,359 5 $ 12.07
$17.17 - $25.79 793,877 5 $ 22.56
$26.17 - $28.54 292,200 5 $ 26.35
----------------------- --------------------- --------------------
3,558,821 5 $ 12.58
======================= ===================== ====================
Shares Weighted
Range of Exercise Exercisable at Average
Price December 31, 1999 Exercise Price
----------------- ------------------------ -------------------
$ 0.37 - $ 4.33 486,288 $ 2.37
$ 4.55 - $ 9.83 280,249 $ 8.18
$10.00 - $14.92 297,809 $ 11.31
$17.17 - $25.79 91,252 $ 18.80
$26.17 - $28.54 22,500 $ 28.54
------------------------- --------------------
1,178,098 $ 7.78
========================= ====================
The estimated fair value of the options granted in 1997, 1998 and 1999
was $3,336,000, $13,591,000 and $15,441,000, respectively. We apply Accounting
Principles Board Opinion No. 25 and related Interpretations in accounting for
stock option plans. Accordingly, no compensation cost for our stock option plans
has been recognized in 1997, 1998 or 1999. Had compensation cost for our stock
option plans been determined based on the fair value at the grant dates for
awards under the plans consistent with SFAS No. 123, Accounting for Stock Based
Compensation, our net income and earnings per share for the years ended December
31, 1997, 1998 and 1999 would have been reduced to the pro forma amounts
indicated below:
Years Ended
----------------------------------------------------------------
December 31, 1997 December 31, 1998 December 31, 1999
------------------- ------------------ -----------------
Net income:
As reported $8,948,000 $14,618,000 $32,941,000
Pro forma $7,713,000 $11,117,000 $26,113,000
Diluted net income per
share:
As reported $ .55 $ .79 $ 1.63
Pro forma $ .47 $ .60 $ 1.29
F-22
59
The fair market value of options granted under the stock option plans
during 1997, 1998 and 1999 was determined using the Black-Scholes option pricing
model utilizing the following assumptions:
Years Ended
----------------------------------------------------------------
December 31, 1997 December 31, 1998 December 31, 1999
------------------- ------------------ -----------------
Dividend yield 0% 0% 0%
Anticipated volatility 83% 87% 70%
Weighted average 6.0% 5.15% 5.53%
risk-free interest rate
Expected lives 4 years 4 years 4 years
9. RELATED PARTY TRANSACTIONS
In 1997, 1998 and 1999, we paid Inland Productions, Inc., a software
developer in which we acquired a 25% interest on July 1, 1996, $985,000,
$4,891,000, and $4,905,000, respectively. As of December 31, 1998 and 1999, we
owed Inland Productions, Inc. $166,000 and $137,000, respectively.
10. CAPITAL STOCK TRANSACTIONS
In February 1999, in settlement of litigation, we issued warrants
expiring March 19, 2000 to Millennium Partners to purchase 150,000 shares of
common stock at $16.08 per share. The fair value of the warrants at issuance was
$564,000.
During the years ended December 31, 1997, 1998 and 1999, the number of
warrants to purchase our common stock exercised were 34,000, 113,000 and 64,000,
respectively. We received proceeds from the exercise of such warrants totaling
$123,000, $827,000 and $766,000, in the years ended December 31, 1997, 1998 and
1999, respectively. At December 31, 1999 outstanding warrants were 387,000 at an
average exercise price of $12.01.
In connection with obtaining the World Wrestling Federation license
(See Note 13), in August 1999 we issued to the WWF and a related party warrants
expiring December 31, 2009 to purchase 281,250 shares of common stock at $10.42
per share having a fair value of $3,063,000 at the time of issuance.
On May 21, 1997, GA issued 53,603 shares and received proceeds of
$471,000.
On February 14, 1997, we completed a public offering of 3,375,000
shares of our common stock. In conjunction with the offering, we granted to the
underwriters an over-allotment option, exercisable within 30 days of February
11, 1997, to purchase up to 506,250 additional shares of the common stock at the
public offering price of $3.33 per share. On March 11, 1997, the underwriters
exercised their over-allotment option. All of these shares were newly
F-23
60
issued and sold on behalf of us. The net proceeds of the 3,881,250 shares sold
were approximately $11,708,000.
On July 23, 1998, and October 26, 1999, we announced three-for-two
stock splits, effected in the form of a 50% stock dividends, which were
distributed on August 24, 1998, and December 1, 1999, respectively, to
shareholders of record on August 20, 1998 and November 15, 1999, respectively.
The accompanying consolidated financial statements have been adjusted to give
effect to these stock splits for all periods presented.
On May 1, 1998, we issued 532,776 shares of common stock in connection
with the acquisition of GameFx, Inc. (See Note 12). In December 1998, we issued
249,930 shares of common stock as part of the purchase cost of Rushware
Microhandelsgesellschaft mbH. (See Note 12).
On May 24, 1999, we issued 727,436 shares of common stock as part of
the purchase price for Pacific Coast Power & Light Company. On December 13,
1999, we issued 220,048 shares of common stock in connection with the
acquisition of Genetic Anomalies, Inc. (See Note 3).
11. REINCORPORATION
On January 6, 1998, T.HQ, Inc. a New York corporation ("THQ New York"),
was reincorporated as a Delaware corporation. Pursuant to the reincorporation,
each share of THQ New York's common stock, par value $.0001 per share,
outstanding prior to the reincorporation was converted into one share of common
stock, $0.01 par value per share, of THQ Delaware.
12. OTHER LONG-TERM ASSETS
On July 1, 1996, we acquired a 25% interest in Inland Productions, Inc.
("Inland"), a software developer for home entertainment game systems. This
investment consisted of $300,000 in cash and 118,485 shares of common stock
valued at $300,000, and is included in other long-term assets in the
accompanying balance sheet. The investment exceeded our equity in the underlying
net assets by $613,000, which is being amortized over five years. The equity in
the operating results of Inland is not material to the results of operations.
On August 2, 1996, we acquired the business of Heliotrope Studios, Inc.
("Heliotrope"), an interactive software developer for personal computers. The
excess of the cost of the acquisition over the estimated fair value of assets
acquired (approximately $265,000) was included in other long-term assets in the
accompanying balance sheet. Such excess cost was being amortized over five
years. In 1998, the operation was closed and the remaining asset value of
$203,000 was expensed.
On May 1, 1998, we acquired all of the outstanding shares of an applied
technology company, GameFx, pursuant to a merger of GameFx with and into our
newly formed, wholly owned subsidiary. The consideration paid by us consisted of
(i) the issuance of 523,776 shares of common stock, (ii) the assumption of stock
F-24
61
options issued by GameFx to its employees that, if and when exercised, permit
the holders thereof to acquire approximately 22,275 shares and (iii)
approximately $1,273,000 in cash. The total acquisition cost was approximately
$7.5 million and was accounted for as a purchase. The purchase price was
allocated to certain intangible assets acquired and to purchased in-process
research and development ("R & D"). Purchased R & D includes the value of
products in the development stage and not considered to have reached
technological feasibility. In accordance with applicable accounting rules,
purchased in-process R & D is expensed. Accordingly, $7,232,000 of the
acquisition cost was expensed in the second quarter of 1998. Approximately
$260,000 of the purchase price was allocated to other intangible assets and is
being amortized over five years.
In December 1998, we acquired all of the outstanding shares of Rushware
Microhandelsgesellschaft mbH and its subsidiaries, Softgold Computerspiele GmbH
and ABC Spielspass GmbH ("Rushware") for consideration consisting of
approximately $1,582,000 in cash and 249,930 shares of common stock with a fair
value of $4,432,000 which was accounted for as a purchase. In 1999 we
renegotiated the purchase of Rushware and received a payment of $2,540,000 from
the sellers. Rushware, based in Germany, is a leading German distributor of
interactive entertainment software for personal computers. Rushware now serves
as our distributor and publisher in Germany and other German-speaking countries.
13. AGREEMENT WITH JAKKS PACIFIC, INC. AND TITAN SPORTS INC.
We have entered into an arrangement with JAKKS Pacific, Inc. ("JAKKS"),
to govern our relationship with respect to the WWF license we jointly obtained
from Titan Sports, Inc. (now known as World Wrestling Federation Entertainment,
Inc. (the "WWF")) in June 1999. Our relationship with JAKKS was established to
develop, manufacture, distribute, market and sell video games pursuant to the
license from the WWF. We control the venture, therefore, all transactions and
balances are consolidated with the Company. The principal terms of this
operating agreement are as follows:
- - We will be responsible for funding all operations of the venture,
including all payments owing to the WWF.
- - For the period commencing November 16, 1999 and ending December 31, 2003,
JAKKS will be entitled to receive a preferred payment equal to the greater
of a fixed guaranty, payable quarterly, or specified percentages of the
"net sales" from WWF licensed games (as defined) in amounts that vary
based on the platform. The payment of these amounts is guaranteed by us.
We are entitled to the profits and cash distributions remaining after the
payment of these amounts. At December 31, 1999, we have unearned preferred
payments remaining for the initial four year period of approximately $10.4
million.
- - For periods after December 31, 2003, the amount of the preferred payment
will be subject to renegotiation between the parties. An arbitration
procedure is specified in the event the parties do not reach agreement.
- - We will be responsible for the day-to-day operations of the venture. We
will continue to be responsible for development, sales and distribution
of the WWF licensed games, while JAKKS will continue to be responsible
for the approval process and other relationship matters with the WWF. We
will both continue to co-market the games.
The license agreement with the WWF extends through December 31, 2009,
with an option for a five-year automatic extension if we pay them a specified
minimum amount during the initial ten-year period of the agreement. As of
December 31, 1999, we have guaranteed royalty payments remaining for the initial
ten-year period of approximately $15 million. The
F-25
62
agreement provides for an accelerated earnout depending on the volume of WWF
video game sales.
14. COMMITMENTS AND CONTINGENCIES
ROYALTIES. At December 31, 1998 and 1999, accrued royalties were
$16,320,000 and $31,404,000, respectively. Royalties are classified as current
liabilities if initial sales are to commence within one year.
LEASES. We are committed under operating leases with lease termination
dates to 2005. Minimum future rentals pursuant to these leases as of December
31, 1999 are as follows:
FACILITIES EQUIPMENT
---------- ----------
2000 $2,398,000 $ 340,000
2001 2,115,000 175,000
2002 1,552,000 90,000
2003 1,203,000 68,000
2004 918,000 21,000
Thereafter 728,000 --
---------- ----------
$8,914,000 $ 694,000
========== ==========
Rent expense was $278,000, $490,000, and $1,648,000 in 1997, 1998 and
1999, respectively.
LEGAL PROCEEDINGS. Two individual shareholders have filed essentially
identical purported class action lawsuits on February 18, 2000 and March 2,
2000, respectively, in the United States District Court for the Central District
of California, alleging that we and certain of our directors and senior officers
violated Section 10(b) of the Securities and Exchange Act of 1934 and SEC Rule
10b-5. Each case seeks class action status on behalf of all individuals who
purchased our shares of common stock between October 26, 1999 and February 10,
2000. Each complaint alleges that we issued false and misleading statements
about our financial results and prospects during the class period, and that the
individual defendant directors and officers participated in the alleged scheme
so as to sell their personal shares at inflated prices. We believe the claims
are without merit, and intend to vigorously defend against them.
We are involved in routine litigation arising in the ordinary course
of our business. In the opinion of our management, none of the pending
litigation will have a material adverse effect on our consolidated financial
condition for results of operations.
F-26
63
15. OPERATIONS IN GEOGRAPHIC AREAS
We develop, market and distribute software products. The following
information sets forth geographic information on our sales and long-lived assets
for the years ended December 31, 1997, 1998 and 1999:
(in thousands of dollars) United United
States Kingdom Germany France Consolidated
-------- -------- ------- ------- ------------
Year ended December 31, 1997:
Sales to unaffiliated
customers $ 75,582 $ 14,000 $ (3) $ -- $ 89,579
======== ======== ======= ======= ========
Long-lived assets at
December 31, 1997 $ 2,244 $ 152 $ -- $ -- $ 2,396
======== ======== ======= ======= ========
Year ended December 31, 1998:
Sales to unaffiliated
customers $186,978 $ 23,881 $ 5,252 $ -- $216,111
======== ======== ======= ======= ========
Long-lived assets at
December 31, 1998 $ 6,134 $ 4,763 $ 1,063 $ -- $ 11,960
======== ======== ======= ======= ========
Year ended December 31, 1999:
Sales to unaffiliated
customers $227,701 $ 41,404 $33,252 $ -- $302,357
======== ======== ======= ======= ========
Long-lived assets at
December 31, 1999 $ 10,693 $ 1,962 $ 988 $ 1 $ 13,644
======== ======== ======= ======= ========
F-27
64
16. QUARTERLY FINANCIAL DATA (UNAUDITED)
Our summarized quarterly financial data is as follows:
Quarter Ended
---------------------------------------------------------------
(Amounts in thousands, except per share March June September December
data) 31 30 30 31
- --------------------------------------- -------- -------- --------- --------
Year ended December 31, 1997:
Revenues $ 11,839 $ 12,276 $ 16,397 $ 49,067
Expenses 11,184 11,308 14,687 41,498
-------- -------- -------- --------
Income (loss) before income taxes 655 968 1,710 7,569
Income taxes 4 66 410 1,474
-------- -------- -------- --------
Net income (loss) $ 651 $ 902 $ 1,300 $ 6,095
======== ======== ======== ========
Net income (loss) per share:
Basic $ .06 $ .07 $ .08 $ .38
======== ======== ======== ========
Diluted $ .06 $ .06 $ .08 $ .35
======== ======== ======== ========
Year ended December 31, 1998:
Revenues $ 48,784 $ 29,469 $ 26,350 $111,508
Expenses 39,377 33,185 22,921 96,668
-------- -------- -------- --------
Income before income taxes 9,407 (3,716) 3,429 14,840
Income taxes 3,029 1,088 1,254 3,971
-------- -------- -------- --------
Net income $ 6,378 $ (4,804) $ 2,175 $ 10,869
======== ======== ======== ========
Net income per share:
Basic $ .39 $ (.28) $ .13 $ .62
======== ======== ======== ========
Diluted $ .37 $ (.28) $ .13 $ .57
======== ======== ======== ========
Year ended December 31, 1999:
Revenues $ 78,805 $ 51,612 $ 44,310 $127,630
Expenses 63,022 44,413 37,514 106,180
-------- -------- -------- --------
Income (loss) before income taxes 15,783 7,199 6,796 21,450
Income taxes 6,299 3,294 2,119 6,575
-------- -------- -------- --------
Net income (loss) $ 9,484 $ 3,905 $ 4,677 $ 14,875
======== ======== ======== ========
Net income (loss) per share:
Basic $ .53 $ .22 $ .26 $ .80
======== ======== ======== ========
Diluted $ .48 $ .20 $ .23 $ .72
======== ======== ======== ========
F-28
65
EXHIBIT INDEX
Exhibit Number Title
-------------- -----
3.1 Certificate of Incorporation (incorporated by
reference to Exhibit 3.1 to Post-Effective Amendment
No. 1 to the Registration Statement on Form S-3 filed
on January 9, 1998 (File No. 333-32221) (the "S-3
Registration Statement")).
3.2 Amendment to Certificate of Incorporation (incorporated by
reference to Exhibit 3.2 to Post-Effective Amendment No. 1 to the
S-3 Registration Statement).
3.3 Amended and Restated Bylaws (incorporated by reference to Exhibit
3.3 to the Quarterly Report on Form 10-Q for the fiscal quarter
ended June 30, 1998).
10.1* Amended and Restated Employment Agreement dated as of
June 30, 1999, between the Company and Brian J.
Farrell (incorporated by reference to Exhibit 10.1 to
the Company's Quarterly Report on Form 10-Q for the
fiscal quarter ended June 30, 1999 (the "1999 2nd
Quarter 10-Q")).
10.2* Employment Agreement dated as of January 1, 1999,
between the Company and Jeffrey C. Lapin
(incorporated by reference to Exhibit 10.2 to the
1999 2nd Quarter 10-Q).
10.3* Employment Agreement between Fred A. Gysi and the
Company dated October 1, 1997 (incorporated by
reference to Exhibit 10.6 to the Company's Annual
Report on Form 10-K for the fiscal year ended
December 31, 1998 (the "1998 10-K")).
10.4* Form of Severance Agreement with Executive Officers
(incorporated by reference to Exhibit 10.7 to the
1998 10-K).
Amended and Restated 1990 Stock Option Plan (incorporated by
10.5* reference to Exhibit 10.1 to the Registration Statement on Form
S-2 filed on December 23, 1996 (File No. 333-18641)).
10.6* Stock Option Agreement dated as of August 28, 1996,
between the Company and Brian J. Farrell
(incorporated by reference to Exhibit 10.31 to the
Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1996).
10.7* Amended and Restated 1997 Stock Option Plan (the "1997 Stock
Option Plan") (incorporated by reference to Exhibit 4.4 to the
Registration Statement on Form S-8 filed on May 14, 1999 (File
No. 333-78567)).
10.8* Form of Stock Option Agreement for the 1997 Stock
Option Plan (incorporated by reference to Exhibit 4.5
to the Registration Statement on Form S-8 filed March
19, 1999 (File No. 333-74715)).
10.9* Stock Option Agreement dated as of October 21, 1998, between the
Company and Jeffrey C. Lapin (incorporated by reference to
Exhibit 10.8 to the 1999 2nd Quarter 10-Q).
10.10* Form of Stock Option Agreement dated as of December
23, 1998, between the Company and Messrs. Lawrence
Burstein, Bruce Jagid and James Whims (incorporated
by reference to Exhibit 10.9 to the 1999 2nd Quarter
10-Q).
10.11 Trade Finance Agreement dated as of December 4, 1998, by and
between the Company and Union Bank of California, N.A. ("Union
Bank") (incorporated by reference to Exhibit 10.8 to the 1998
10-K).
10.12 Trade Finance Agreement dated as of December 4, 1998,
by and between T.HQ International, LTD. ("THQ
International") and Union Bank (incorporated by
reference to Exhibit 10.9 to the 1998 10-K).
10.13 First Amendment to Trade Finance Agreement dated as
of March 22, 1999, by and between the Company and
Union Bank (incorporated by reference to Exhibit
10.10 to the 1998 10-K).
10.14 First Amendment to Trade Finance Agreement dated as
of March 22, 1999, by and between THQ International
and Union Bank (incorporated by reference to Exhibit
10.11 to the 1998 10-K).
21 Subsidiaries of the Registrant.
23.1 Consent of Deloitte & Touche LLP.
27 Financial Data Schedule.
- ----------
*Management contract or compensatory plan or arrangement required to be
filed as an exhibit hereto pursuant to Item 14(c) of Form 10-K.