-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, R5oNAJiNIm3pM9/VR9Nd4IwZMxfOXDOg5L7as7N+ZMbb3kC2FwmCx8txeKXIp9qv 9c41DBJJCSz1icDD2iKVEQ== 0000950148-99-000639.txt : 19990402 0000950148-99-000639.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950148-99-000639 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: THQ INC CENTRAL INDEX KEY: 0000865570 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 133541686 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-18813 FILM NUMBER: 99580167 BUSINESS ADDRESS: STREET 1: 5016 N PKWY CALABASAS STREET 2: SUITE 100 CITY: CALABASAS STATE: CA ZIP: 91302 BUSINESS PHONE: 8185911310 MAIL ADDRESS: STREET 1: 5016 N PKWY CALABASAS STREET 2: STE 100 CITY: CALABASAS STATE: CA ZIP: 91302 FORMER COMPANY: FORMER CONFORMED NAME: TRINITY ACQUISITION CORP/NY/ DATE OF NAME CHANGE: 19600201 10-K405 1 FORM 10-K405 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, 1998 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.) 5016 NORTH PARKWAY CALABASAS CALABASAS, CA 91302 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 591-1310 -------------------- 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 24, 1999, approximately 11,374,173 shares of Common Stock of the Registrant were outstanding and the aggregate market value of voting Common Stock held by non-affiliates was approximately $215,967,000. DOCUMENTS INCORPORATED BY REFERENCE Portions of the THQ Inc. 1999 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, 1998 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 28 Risk. 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. 29 Item 11. Executive Compensation. 29 Item 12. Security Ownership of Certain Beneficial Owners and Management. 29 Item 13. Certain Relationships and Related Transactions. 29 Part IV Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K. 30 Signatures 32
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/A, filed on March 10, 1999 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, Nintendo 64, Nintendo 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, Kay Bee Toys, Electronics Boutique, 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 and Sony. Over the past four years, we have experienced significant growth in net sales and net income. During the year ended December 31, 1998, our net income grew to $23.2 million (excluding in-process research and development charge) from $9.3 million in 1997. In the year ended December 31, 1998, our net sales increased to $215.1 million from $89.4 million in 1997, $50.3 million in 1996 and $33.3 million in 1995, representing a compound annual growth rate of 186%. Sales of Nintendo 64 and PlayStation products accounted for substantially all of our recent growth. 1 4 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 are located at 5016 North Parkway Calabasas, Calabasas, California 91302, and our telephone number is (818) 591-1310. 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) and Saturn(R) are registered trademarks of Sega of America, Inc. ("Sega"). Sony PlayStation(R) is a registered trademark of Sony Computer Entertainment Inc. ("Sony"). Nintendo and Sony 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 and CD-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 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 enables them to provide richer content and longer play. 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 Nintendo Nintendo 64 1996 64-bit Nintendo Game Boy Color 1998 16-bit (portable)
2 5 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 indicates it will be introduced in the United States in the fall of 1999. Sony has announced the successor to the PlayStation, unofficially titled the PlayStation 2, for launch in the U.S. market in late 2000. While we have not formally committed to either platform, 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 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: - Acquire and Develop Franchise Properties. We intend to increase the proportion of our product content over which we have control by either acquiring or developing our own proprietary titles or obtaining exclusive licenses to established properties for certain platforms. We refer to these properties as "franchise properties." Franchise properties that have brand recognition and sustainable consumer appeal allow us to exploit titles over an extended period of time through the release of sequels and extensions and to re-release products at different price points over time. Examples of current exclusively licensed properties are BASS Masters Classic, Brunswick Tournament of Champions Bowling, Nickelodeon's Rugrats and, through a joint venture with JAKKS Pacific, the World Wrestling Federation. - Expand Presence in PC Market. In 1997 and 1998, only 3% and 2%, respectively, of our revenues were derived from sales of PC titles. We intend to significantly expand our presence in the PC market by offering high quality, low priced games that appeal to mass market and casual game players with titles such as BASS Masters Classic, Brunswick World Tournament of Champions Bowling and WCW Nitro (each of which we released in the last half of 1998). We also intend to offer more complex, compelling gaming experiences to the enthusiast, or core gamer market, with titles such as Redjack: Revenge of the Brethren (which was released in September 1998) and Sinistar Unleashed (which is scheduled for release in the summer of 1999). In order to enhance our PC development capabilities, in May 1998 we acquired GameFx, Inc., an applied technology development studio. GameFx provides us with the capability to develop leading 3 6 edge products for the PC platform and to compete in the expanding market for 3-D accelerated games. Certain of our PC titles are playable over the Internet, and we expect that the same will be true for many of our PC titles under development. - Expand International Operations. We believe that there is a substantial opportunity to expand our presence in foreign markets. In 1997, foreign sales by the U.S. interactive software industry represented between 40% to 50% of the industry's total sales. However, our foreign sales accounted for only 30% of our total revenues in 1996, 16% in 1997 and 14% in 1998, respectively. We intend to increase our product offerings that appeal to foreign consumers and to expand our marketing and distribution capabilities in important foreign countries. In furtherance of this strategy, in December 1998 we acquired Rushware Microhandelsgesellschaft mbH and its subsidiaries (collectively "Rushware"), which are located in Germany. Rushware is a leading German distributor of interactive entertainment software for the PC, including computer accessories, and also publishes and localizes PC and console products. - Leverage Domestic Distribution. We identify and license titles originally developed in foreign territories with proven or anticipated consumer acceptance and publish localized versions of these products in the United States. This allows us to augment our product line while limiting our development risk. Examples of this include Quest 64, a role playing game developed in Japan for the Nintendo 64, The Granstream Saga, a role playing game developed in Japan for the PlayStation, and Broken Sword, an adventure game developed in the United Kingdom for the PlayStation. - Continue to Exploit the Game Boy Platform. The relatively low cost of developing games for the Game Boy platform, combined with that platform's large installed base, provides us the opportunity to generate continuing sales and profits from these games with limited risk. We believe that the successful introduction of Game Boy Color in 1998 has stimulated sales of software for this platform and that it will continue to do so for several years. Examples of titles we introduced in 1998 or expect to release in 1999 for the Game Boy are Small Soldiers, Rugrats, Disney/Pixar's "A Bug's Life" (for Game Boy Color) and Yoda Stories (for Game Boy Color). We expect that all of our new games for this platform will be for the Game Boy Color. - 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 165 titles as of December 31, 1998, consisting of 13 Nintendo Entertainment System ("NES") titles, 51 Game Boy titles, one Game Boy Color title, seven Sega Game Gear titles, 14 Sega Genesis titles, 47 Super Nintendo Entertainment System ("SNES") titles, three Sega Saturn titles, 19 Sony PlayStation titles, three Nintendo 64 titles and seven 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 1998 and anticipated to be released in 1999, 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 1999 will be released when scheduled, or at all. 5 8
RELEASE TITLES RELEASED IN 1998 CATEGORY PLATFORM DATE ----------------------------------------------- --------------------- ------------------------ ----------- WCW Nitro Fighting PlayStation 1/98 Pax Imperia: Eminent Domain Strategy Macintosh 1/98 Ray Tracers Driving PlayStation 2/98 NBA Live 98 Sports Super Nintendo 3/98 Broken Sword: Shadow of the Adventure PlayStation 3/98 Templars World Cup 98 Sports Game Boy 6/98 The Granstream Saga Role Playing PlayStation 6/98 Quest 64 Adventure/ Nintendo 64 6/98 Role Playing BASS Masters Classic: Tournament Sports PC CD-ROM 9/98 Edition Brunswick Circuit Pro Bowling Sports PlayStation 9/98 PC CD-ROM RedJack: Revenge of the Bretheren Adventure PC CD-ROM 9/98 Devil Dice Puzzle PlayStation 9/98 G. Darius Shooter PlayStation 9/98 Disney's Mulan Adventure Game Boy 10/98 WCW/NWO Revenge Fighting Nintendo 64 10/98 Small Soldiers Adventure Game Boy 10/98 Rugrats: Search for Reptar Adventure PlayStation 11/98 Game Boy WCW/NWO Nitro Fighting PC CD-ROM 11/98 Disney/Pixar's A Bug's Life Adventure Game Boy Color 12/98
6 9
ANTICIPATED TITLES ANTICIPATED TO BE RELEASED RELEASE IN 1999* CATEGORY PLATFORM DATE ---------------------------------------------- -------------------- ----------------------- ----------------- WCW/NWO Thunder** Fighting PlayStation 1/99 WCW Nitro** Fighting Nintendo 64 2/99 Penny Racers** Driving Nintendo 64 2/99 Rugrats: The Movie Action Game Boy Color Spring `99 Yoda Stories Adventure Game Boy Color Summer `99 Knights of Carnage Action / Fighting PlayStation Summer `99 Sinistar Unleashed Arcade PC CD-ROM Summer `99 Rugrats Scavenger Hunt Board Game Nintendo 64 Summer `99 Ultimate 8 Ball Sports PlayStation Summer `99 Shao Lin Fighting PlayStation Summer `99 Micro Machines I and II Driving Game Boy Color Summer `99 Toy Story 2 (working title) Adventure Game Boy Color Fall `99 Brunswick First Strike Bowling Sports PC CD-ROM Fall/Winter `99 Road Rash 64 Action / Adventure Nintendo 64 Fall/Winter `99 Danger Girl Action / Adventure PlayStation Fall/Winter `99 Nuclear Strike Action / Adventure Nintendo 64 Fall/Winter '99 Rugrats 2 (working title) Adventure PlayStation Fall/Winter '99 Game Boy Color Fall/Winter '99 BASS Master's Classic (working title) Sports Nintendo 64 Fall/Winter '99 PlayStation Fall/Winter '99 WWF Fighting Nintendo 64 Winter `99 Game Boy Color Winter `99
* Excludes titles we expect to release in 1999 but which we have not yet publicly announced. **Title released as of March 31, 1999. 7 10 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 Disney, Viacom/Nickelodeon, LucasArts and Dreamworks. We pay royalties to our property licensors that generally range from 6% to 25% 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 typically extend for two to three years, 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. 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. 8 11 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 November 1999 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 Sony PlayStation Title-by-title(1) U.S. and Canada August 2002 Sony PlayStation Title-by-title(1) Europe December 2005(2)
- ---------- (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. (2) Continues year-to-year after such date unless terminated by either party. Nintendo charges us a fixed amount for each cartridge. This amount varies based, in part, on the memory capacity of the cartridges. Sony also charges a per unit amount for each CD-ROM. 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 the 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. 9 12 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. Our in-house development is currently conducted by GameFx and is supervised by our Chief Technology Officer. GameFx, which we acquired in May 1998, is a developer of interactive software utilizing proprietary 3-D graphics technology. The first PC game developed by GameFx, Sinistar Unleashed, is expected to be released in the summer of 1999. We also intend to exploit GameFx's technology in other PC games as well as in selected games for other platforms. GameFx is 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 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 $8.00 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. 10 13 MANUFACTURING Sony and Nintendo 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 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. Our product marketing efforts for the games released in 1998 included national television, radio and print advertising campaigns in console and PC gaming publications. Quest 64, The Granstream Saga, Brunswick Circuit Pro Bowling and the WCW titles for the PlayStation and Nintendo 64 were featured at various live events and in nationwide Sony and Nintendo van tours. Prima Publishing further supported Quest 64, The Granstream Saga and the WCW titles at launch with strategy guides. 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 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 online publicity and advertising efforts. 11 14 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 19% of net sales in 1998), Toys "R" Us (representing 13% of net sales in 1998), Target, Kay Bee Toys, Electronics Boutique and Best Buy. Sales to our ten largest customers collectively accounted for approximately 67% of our gross sales in 1997 and 65% of our gross sales in 1998. 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 $40 and $70 for Nintendo 64, and between $20 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. 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 leading German distributor of interactive entertainment software for PCs, and its acquisition will significantly increase both the proportion of our business that consists of the distribution of products published by other companies and the proportion of our foreign sales that are made in German-speaking countries. The distribution business generally operates on lower gross margins than the publishing business, and thus may require a greater level of sales in order to cover overhead, requires us to maintain inventories of other companies' product and is dependent on license agreements with other companies. However, we believe that adding our titles to Rushware's existing publishing and distribution business will enhance Rushware's financial performance. 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, including the upcoming products based on "Star Wars: Episode One -- The Phantom Menace." This agreement also covers any titles that LucasArts decides to publish in these territories for the Dreamcast platform, and also provides that any future titles that LucasArts decides to publish in 12 15 these territories may be added to the license. Rushware has been distributing LucasArts products in German-speaking Europe since 1988. Other Foreign Sales. Historically, we have distributed our titles in the United Kingdom, Europe and Australia. In 1997, we expanded our sales to Brazil, Singapore and other countries. We sell our titles directly to major retailers in the United Kingdom and Germany, and to distributors for distribution in other countries. Products are shipped at our expense to a public warehouse in the United Kingdom or Germany for foreign distribution. Foreign sales to distributors in countries other than the United Kingdom and German-speaking countries are shipped at the customer's expense directly to the customer's location. In 1998 and prior years, sales in countries other than the United Kingdom, Europe and Australia have not constituted a material portion of our foreign sales. 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. 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. 13 16 We believe that large toy companies, in addition to large software companies, are increasing their focus on the software market, which will result in greater competition for us. In particular, many of our competitors are developing on-line interactive games and interactive networks that will be competitive with our interactive products. 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. 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, 1998, we had 219 full-time employees, of whom 16 are located in the United Kingdom and 77 are located in Germany. None of our employees are 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 17,400 square feet of office space at 5016 North Parkway Calabasas, Calabasas, California, pursuant to a lease expiring in July 2000. We are currently negotiating for new office space for our executive offices near our existing location. We also lease additional office space for development personnel in Calabasas, for sales and marketing personnel in Cupertino, California and Woking, England, for development personnel near Boston, Massachusetts, and for Rushware's employees in Kaarst, Germany. ITEM 3. LEGAL PROCEEDINGS While we are a party to 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. 14 17 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 1998. 15 18 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER 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 --------------- ---------------- 1998 First Quarter 21 5/8 12 1/8 Second Quarter 20 1/2 13 3/8 Third Quarter 23 9/16 11 5/16 Fourth Quarter 31 13 7/16 1997 First Quarter 6 3/16 3 15/16 Second Quarter 7 7/16 4 1/4 Third Quarter 8 9/16 6 5/16 Fourth Quarter 15 5/16 8 1/16
The last reported price of the common stock on March 24, 1999, as reported by Nasdaq National Market, was $18 per share. As of March 24, 1999, there were approximately 395 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 license agreement with Titan Sports, Inc. to publish electronic games based on the World Wrestling Federation franchise on all hardware platforms. In connection with this transaction, we have agreed to issue to Titan Sports, Inc. warrants expiring December 31, 2009 to purchase 187,500 shares of common stock at $15.63 per share. These warrants are being issued pursuant to the exemption from registration provided in Section 4(2) of the Securities Act of 1933, as amended, for transactions not involving a public offering. 16 19 On May 1, 1998, in connection with our acquisition of GameFx, we issued an aggregate of 355,184 shares of common stock to certain stockholders of GameFx. The shares of common stock were issued pursuant to the exemption from registration provided in Section 4(2), for transactions not involving a public offering. On December 3, 1998, in connection with our acquisition of Rushware, we issued 166,620 shares of common stock to the stockholder of Rushware pursuant to the exemption from registration provided in Section 4(2), for transactions not involving a public offering. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) The following table presents certain selected consolidated financial data for the years 1994 through 1998. The information presented for each of the years ended December 31, 1996, 1997 and 1998 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, 1994 and 1995 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, ----------------------------------------------------------------------- 1994 1995 1996 1997 1998 -------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net sales $ 13,289 $ 33,250 $ 50,255 $ 89,362 $215,060 Costs and expenses: Cost of sales 12,651 19,501 29,301 48,110 100,001 Royalties and project abandonment 6,081 4,666 8,587 14,758 48,120 Product development 888 889 1,324 1,610 5,092 Selling and marketing 6,864 3,114 4,444 8,670 20,262 General and administrative 4,172 4,323 4,374 5,379 9,897 In-process research and development -- -- -- -- 7,232 -------- -------- -------- -------- -------- Total costs and expenses 30,656 32,493 48,030 78,527 190,604 -------- -------- -------- -------- -------- Income (loss) from operations (17,367) 757 2,225 10,835 24,456 Interest income (expense) - net (112) (134) (316) 464 863 -------- -------- -------- -------- -------- Income (loss) before income taxes (17,479) 623 1,909 11,299 25,319 Income taxes 11 22 8 1,954 9,330 -------- -------- -------- -------- -------- Net income (loss) $(17,490) $ 601 $ 1,901 $ 9,345 $ 15,989 ======== ======== ======== ======== ======== Net income (loss) per share-- basic $ (5.83) $ .14 $ .28 $ .99 $ 1.49 ======== ======== ======== ======== ======== Net income (loss) per share-- diluted $ (5.83) $ .11 $ .26 $ .90 $ 1.38 ======== ======== ======== ======== ======== Weighted-average number of common shares-- basic 2,997 4,287 6,788 9,480 10,728 ======== ======== ======== ======== ======== Weighted-average number of common shares, stock options and warrants-- diluted 2,997 5,334 7,254 10,352 11,626 ======== ======== ======== ======== ========
BALANCE SHEET DATA
YEARS ENDED DECEMBER 31, -------------------------------------------------------------------- 1994 1995 1996 1997 1998 -------- -------- -------- -------- -------- Working capital $ 3,736 $ 7,082 $ 9,672 $ 31,462 $ 50,681 Total assets $ 15,531 $ 16,916 $ 22,840 $ 59,453 $128,917 Lines of credit $ -- $ -- $ 5,355 $ -- $ 9,909 Stockholders' equity $ 4,254 $ 7,598 $ 11,048 $ 33,527 $ 64,097
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 and Sony and for use on PCs. We released our first title for Nintendo Game Boy Color in late 1998. 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 1996 1997 1998 ---- ---- ---- Nintendo (excluding Game Boy) 43% 42% 59% Nintendo Game Boy/Game Boy Color 33% 23% 8% Sony 10% 22% 31% Sega 14% 10% -- PC -- 3% 2%
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. 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- 19 22 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. 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 PC title incurred after the establishment of technological feasibility of the title. (We have not incurred material internal development costs for console titles.) 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, 1998, we had prepaid royalties and capitalized development costs of $11.3 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 for specific items falls below expectations, in order to maintain our relationships with our customers. These accommodations consist of acquiescing to the customer's request that not all booked orders be filled or that not all shipped orders be accepted, 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. 20 23 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, 1996, 1997 and 1998, we took provisions of approximately $5.2 million, $10.5 million and $20.8 million, respectively, against gross sales made during such periods. As of December 31, 1998, our aggregate reserve against accounts receivable for returns, customer accommodations and doubtful accounts was approximately $18.9 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. Revenues and Expenses of Joint Venture. In June 1998, we announced that, in partnership with JAKKS Pacific, we had signed an exclusive agreement with Titan to publish WWF electronic games on all platforms. The games will be designed, developed, manufactured and marketed by a joint venture consisting of JAKKS Pacific and us. We will share equally with JAKKS Pacific any profits generated by this joint venture after we each recover the advances we pay to Titan. Net Operating Loss Carryforwards. At December 31, 1998, we had $11.5 million of net operating loss ("NOL") carryforwards incurred since 1993 for federal income tax purposes, and $4.6 million for state. Our public offering of common stock in February 1997 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 The inability of computers, software and other equipment utilizing microprocessors to recognize and properly process date fields containing a two-digit year is commonly referred to as the "Year 2000 Compliance" issue. As the year 2000 approaches, these systems may be unable to accurately process certain date-based information. We have reviewed all of our significant internal applications and we believe that no material modifications are necessary to ensure Year 2000 Compliance. We do not anticipate that our total cost of these Year 2000 Compliance activities will be material to our financial position or to our results of operations. We are in the process of communicating with others with whom we do significant business (including our major retail accounts and certain providers of product distribution information services) to determine their Year 2000 Compliance readiness and the extent to which 21 24 we are vulnerable to any third party Year 2000 issues. However, we cannot guarantee that the systems of other companies on which our systems rely will be timely converted. A failure to convert by another company, or a conversion that is incompatible with our systems, could have a material adverse effect on us. The worst case scenario if such problems occur, would be our inability to send or receive sales orders and record revenue. While we are not aware of any significant Year 2000 issues for which we will not be adequately prepared, there can be no assurance that our business, operating results or financial condition will not be adversely affected by issues surrounding the Year 2000 conversion. See "Business -- Marketing, Sales and Distribution." 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, -------------------------------------- 1996 1997 1998 --------- --------- --------- Domestic sales 70.4% 84.3% 86.5% Foreign sales 29.6 15.7 13.5 --------- --------- --------- Net sales 100.0% 100.0% 100.0% Costs and expenses: Cost of sales 58.3% 53.8% 46.5% Royalties and project abandonment 17.1 16.5 22.4 Product development 2.6 1.8 2.4 Selling and marketing 8.9 9.7 9.4 General and administrative 8.7 6.1 4.6 In-process research and development -- -- 3.4 --------- --------- --------- Total costs and expenses 95.6% 87.9% 88.7% --------- --------- --------- Income from operations 4.4% 12.1% 11.3% Interest income (expense)-- net (0.6) 0.5 0.4 --------- --------- --------- Income before income taxes 3.8% 12.6% 11.7% --------- --------- --------- Net income 3.8% 10.5% 7.4% ========= ========= =========
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, 1998 and 1997, the titles released during such periods for the platforms indicated: 22 25
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 8 5 ------------ ------------ Total 33 21 ============ ============
Our net sales increased to $215,060,000 in the year ended December 31, 1998, from $89,362,000 in the same period of 1997, as a result of higher unit sales per title shipped. For the year ended December 31, 1998, net sales of our WCW titles, Rugrats: Search for Reptar titles and Quest 64 release, were $140,441,000 (65.3% of net sales), $17,741,000 (8.2% of net sales), and $17,367,000 (8.1% 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 15.7%, 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 the year ended December 31, 1998 decreased significantly as a percentage of net sales to 46.5% from 53.8% in the same period of 1997, primarily as a result of the increase in PlayStation and CD-ROM product sales (which generally have more favorable gross margins then cartridge titles for Nintendo's platforms). Our royalty expense for the year ended December 31, 1998 increased as a percentage of net sales to 22.4% from 16.5% in the same period in 1997. This rise reflects the fact that royalty rates on 32-bit and 64-bit license and development contracts are higher than those typical for older platforms, as well as an industry-wide increase in royalty rates paid to licensors and developers for 32-bit and 64-bit games. For the year ended December 31, 1998, our product development expenses increased by $3,482,000 compared to the year ended December 31, 1997. This was due in part to the increased costs associated with the development of 32-bit, 64-bit and PC games, and also reflects operating costs due to increased personnel in connection with the acquisition of GameFx in May 1998. For the year ended December 31, 1998, our selling and marketing expenses increased by $11,592,000 compared to the year ended December 31, 1997, as a result of increased marketing efforts for new titles consisting primarily of print and retail cooperative advertising, increased warehouse expenses, and approximately $2 million for national television ad campaigns, as well 23 26 as increased infrastructure and personnel costs (both domestic and foreign), incurred as a result of our growth in 1998. Our general and administrative expenses for the year ended December 31, 1998 decreased as a percentage of net sales to 4.6% from 6.1% for the same period of 1997, but increased in dollar terms by $4,518,000 over 1997. This 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. As of March 31, 1999, we are still in the development process with respect to the product in research and development at the time of the acquisition. For the year ended December 31, 1998, interest income increased by $399,000 compared to 1997, as a result of increased cash flows from operations and higher average investment balances during the period. During the year ended December 31, 1998 we generated taxable income which resulted in a tax provision of $9,330,000, an increase of $7,376,000 over 1997. The effective tax rate for 1998 was 36.9% compared to 17.3% in 1997. The 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. COMPARISON OF THE YEAR ENDED DECEMBER 31, 1997 TO THE YEAR ENDED DECEMBER 31, 1996 The following table sets forth, for the years ended December 31, 1996 and 1997, the titles released during such periods for the platforms indicated:
YEARS ENDED DECEMBER 31, ------------------------ 1996 1997 --------- ---------- Nintendo 64 -- 1 PC CD-ROM -- 2 PlayStation 4 7 Saturn 3 -- SNES 11 10 Genesis 4 5 Game Boy 10 8 Game Gear 1 -- --------- ---------- Total 33 33 ========= ==========
24 27 Our net sales increased to $89,362,000 in 1997, from $50,225,000 in 1996, primarily as a result of higher unit sales per title shipped. For the year ended December 31, 1997, net sales of our WCW titles, Madden '98 titles and our Disney Game Boy re-releases (Lion King, Jungle Book, Aladdin and Duck Tales) were $36,181,000 (39.0% of net sales), $6,032,000 (6.8% of net sales) and $5,214,000 (5.8% of net sales), respectively. Foreign net sales were $13,998,000 (15.7% of net sales) for the year ended December 31, 1997, down slightly from $14,856,000 (29.6% of net sales) in 1996, because our 1997 releases WCW vs. NWO: World Tour, K-1 The Arena Fighters, and Vs. were only released in the United States in that year. We released each of these titles internationally in 1998. Our cost of sales for 1997 decreased significantly as a percentage of net sales to 53.8%, from 58.3% in 1996, 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 1997 increased $6,171,000 over the same period in 1996 but remained relatively constant as a percentage of our net sales. Our product development expenses increased by $286,000 in 1997 as compared to 1996, as a result of increased investment in internal product development during 1997, as well as increased product packaging costs for titles released in 1997. Our selling and marketing expenses increased by $4,226,000 in 1997 over 1996, as a result of increased marketing efforts for new titles. This consisted primarily of 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 9.7% in 1997 as compared to 8.9% in 1996. Our general and administrative expenses for 1997 decreased as a percentage of net sales to 6.1%, from 8.7% for 1996, but increased in dollar terms by $1,005,000 over 1996. The increased expenses were due in part to increased infrastructure and personnel costs in 1997 (as a result of the increased sales volume over 1996) and an increase in shareholder relations expenses. 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, 1998, we had obligations with respect to future guaranteed minimum royalties of $16,969,000. As of March 24, 1999, our cash and cash equivalents were $44,100,000. Our cash and cash equivalents increased to $19,019,000 at December 31, 1998 from $11,724,000 at December 31, 1997. Cash provided by operating activities for 1998 was $7,665,000, resulting primarily from $15,989,000 in net income. This amount was positively 25 28 impacted by approximately $20,838,000 in allowances provided for doubtful accounts, discounts and returns and $7,232,000 of in-process research and development and negatively impacted by $8,708,000 of deferred income tax assets recognized. Operating cash flow was also impacted as a result of changes in certain operating assets and liabilities. Accounts receivable increased from December 31, 1998 to December 31, 1997 as a result of the increased sales volume during the fourth quarter of 1998 compared to the same period of 1997. Prepaid and deferred royalties and software development costs increased from December 31, 1997 as a result of our entering into several new contracts for both properties and new product development. See "--Recovery of Prepaid Royalties, Guarantees and Capitalized Development Costs." Accrued royalties also increased, in part, as a result of new contracts for product development. Additionally, increased demand for certain titles sold in 1998 resulted in royalties due in excess of the minimum guarantees on the related contracts. Inventory and related accounts payable increased significantly during 1998 as a result of 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 will be sold during the sell off period, which ends in June 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 1999. Net cash used in investing activities during 1998 was $5,830,000, and was predominantly used for acquisitions and investments to further our position in the software industry. Our capital expenditures were $1,233,000 in 1998. We expect to make capital expenditures of between $750,000 and $1,500,000 in 1999. Net cash provided by financing activities for 1998 was $5,616,000 million, 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 with Union Bank of California that established a new revolving credit facility. These agreements expire on May 1, 2000. The principal agreement permits us to borrow (and maintain obligations under outstanding letters of credit) of up to $30,000,000, subject to the following: - We may maintain outstanding letters of credit for product purchases of up to $30 million in the aggregate between August 1 of any year and the end of February of the subsequent year; - We may maintain outstanding letters of credit for product purchases of up to $15 million in the aggregate between March 1 and July 31 of any year; 26 29 - We may maintain outstanding "standby" letters of credit up to $30 million in the aggregate; and - We may borrow up to $15 million (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 both standby and product purchase letters of credit of up to $5 million in the aggregate. These credit facilities are secured by a lien on substantially all of our assets and those of T.HQ International. Amounts outstanding under these credit facilities bear interest, at our choice, at either a). the bank's prime rate (7.75% at December 31, 1998) or b). the London Interbank Offered Rate (5.06% at December 31, 1998) plus 1.85%. As of December 31, 1998, we had $6,053,000 in outstanding borrowings under these credit facilities and had obligations in respect of outstanding letters of credit of $22 million. As of March 24, 1999 we had no outstanding borrowings and outstanding letters of credit amounted to $2,377,000. 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 shareholders' equity of not less than $50 million as of December 31, 1998, increasing by the greater of $10 million or 90% of after-tax profits as of the end of each subsequent year; - maintain the ratio of our total liabilities to our shareholders' equity at not greater of 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 1:12. 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. 27 30 Rushware Revolving Credit Facilities. Rushware is a party to three separate revolving credit agreements with three German banks, each of which permits 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 are secured by substantially all of the assets of Rushware and its subsidiaries and bear interest at a rate of 7.75%. Each of these agreements expires on March 31, 1999, and we are seeking to extend their terms. As of December 31, 1998, we had $3,856,000 in outstanding borrowings under this credit facility and had no obligations in respect of outstanding letters of credit. As of March 24, 1999 we had $5,499,000 in outstanding borrowings. THQ Inc. guarantees all borrowings under these facilities. 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 We have debt obligations at our German subsidiary that bear fixed interest rates and mature on March 31, 1999. We are negotiating with banks to refinance or extend the terms of the borrowing facilities. Our interest rate risk is immaterial due to the short maturity of the debt. If the terms of the debt are extended and continue to be at fixed rates our exposure to interest rate risk will increase. 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. We generate revenues and costs that fluctuate with changes in foreign currency exchange rates when transactions are denominated in currencies other than the local currency. The German and UK subsidiaries purchase some products denominated in US dollars, but sell product primarily in German Marks (or currencies that are closely tied to the Mark) and Pound Sterling. We have not historically hedged this risk. Based on the relative size and nature of our foreign operations we do not believe that a ten percent change in foreign currencies would have a material impact on our financial statements. 28 31 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Reference is made to the Financial Statements referred to in the accompanying Index, setting forth the consolidated financial statements of THQ Inc. and subsidiaries, together with the report of Deloitte & Touche LLP dated February 24, 1999. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 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 1999 Notice of Annual Meeting of Shareholders and Proxy Statement under the headings "Election of Directors," "Executive Officers," "Key Employees," "Late Filings" 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 1999 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 1999 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 1999 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. 29 32 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 1990 Stock Option Plan (incorporated by reference to Exhibit 10.1 to the Registration Statement on Form S-2 filed on December 23, 1996 (File No. 333-18641)). 10.2 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 (the "1996 10-K")). 10.3 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 March 19, 1999 (File No. 333-74715) (the "S-8 Registration Statement")). 10.4 Form of Stock Option Agreement for the 1997 Stock Option Plan
30 33 (incorporated by reference to Exhibit 4.5 to the S-8 Registration Statement). 10.5 Amended and Restated Employment Agreement dated as of December 31, 1996, between the Company and Brian J. Farrell (incorporated by reference to Exhibit 10.14 to the 1996 10-K). 10.6* Employment Agreement between Fred A. Gysi and the Company dated October 1, 1997. 10.7* Form of Severance Agreement with Executive Officers. 10.8* Trade Finance Agreement dated as of December 4, 1998, by and between the Company and Union Bank of California, N.A. ("Union Bank"). 10.9* Trade Finance Agreement dated as of December 4, 1998, by and between T.HQ International, LTD. ("THQ International") and Union Bank. 10.10* First Amendment to Trade Finance Agreement dated as of March 22, 1999, by and between the Company and Union Bank. 10.11* First Amendment to Trade Finance Agreement dated as of March 22, 1999, by and between THQ International and Union Bank. 21* Subsidiaries of the Registrant. 23.1* Consent of Deloitte & Touche LLP. . 27* Financial Data Schedule.
- ---------- *Filed herewith. 31 34 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 31, 1999 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 31, 1999 - --------------------------- and Chief Executive Officer Brian J. Farrell (Principal Executive Officer) /s/ Lawrence Burstein Director March 31, 1999 - --------------------------- Lawrence Burstein /s/ Bruce Jagid Director March 31, 1999 - --------------------------- Bruce Jagid /s/ James L. Whims Director March 31, 1999 - --------------------------- James L. Whims /s/ Jeffrey C. Lapin Director and Vice Chairman March 31, 1999 - --------------------------- Jeffrey C. Lapin /s/ L. Michael Haller Director and March 31, 1999 - --------------------------- Senior Vice President L. Michael Haller /s/ Fred A. Gysi Vice President - Finance and March 31, 1999 - --------------------------- Administration, Chief Financial Fred A. Gysi Officer and Secretary (Principal Financial Officer and Principal Accounting Officer)
32 35 THQ INC. INDEX TO FINANCIAL STATEMENTS
Page ----- INDEPENDENT AUDITORS' REPORT F-2 CONSOLIDATED FINANCIAL STATEMENTS Consolidated Balance Sheets -- December 31, 1997 and 1998 F-3 Consolidated Statements of Operations for Each of the Three Years in the Period Ended December 31, 1998 F-4 Consolidated Statements of Shareholders' Equity for Each of the Three Years in the Period Ended December 31, 1998 F-5 Consolidated Statements of Cash Flows for Each of the Three Years in the Period Ended December 31, 1998 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 36 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, 1997 and 1998, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. 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 generally accepted auditing standards. 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, 1997 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP Los Angeles, California February 24, 1999 F-2 37 THQ INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, -------------------------------- 1997 1998 ------------ ------------ ASSETS Current assets: Cash and cash equivalents $ 11,724,000 $ 19,019,000 Accounts receivable-- net 30,856,000 59,520,000 Inventory 1,425,000 16,937,000 Prepaid and deferred royalties 3,145,000 6,770,000 Software development costs 3,879,000 3,011,000 Deferred income taxes 1,666,000 8,321,000 Prepaid expenses and other current assets 478,000 1,548,000 ------------ ------------ Total current assets 53,173,000 115,126,000 Property and equipment-- net 1,163,000 2,451,000 Deferred royalties-- net of current portion 500,000 375,000 Software development costs-- net of current portion -- 1,173,000 Deferred income taxes -- 2,053,000 Other long-term assets 652,000 7,739,000 ============ ============ TOTAL ASSETS $ 55,488,000 $128,917,000 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Lines of credit $ -- $ 9,909,000 Accounts payable 6,580,000 18,659,000 Accrued expenses 4,372,000 11,017,000 Accrued royalties 7,284,000 16,594,000 Income taxes payable 3,475,000 8,266,000 ------------ ------------ Total current liabilities 21,711,000 64,445,000 Accrued royalties -- net of current portion 250,000 375,000 Commitments and contingencies -- -- Shareholders' equity: Common Stock, par value $.01, 35,000,000 shares authorized; 10,163,848 and 11,287,331 shares issued and outstanding as of December 31, 1997 and 1998, respectively 4,000 113,000 Additional paid-in capital 47,559,000 62,122,000 Accumulated other comprehensive income 81,000 60,000 Retained earnings (accumulated deficit) (14,117,000) 1,802,000 ------------ ------------ Total shareholders' equity 33,527,000 64,097,000 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 55,488,000 $128,917,000 ============ ============
See notes to consolidated financial statements. F-3 38 THQ INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, --------------------------------------------------- 1996 1997 1998 ------------ ------------ ------------ Net sales $ 50,255,000 $ 89,362,000 $215,060,000 Costs and expenses: Cost of sales 29,301,000 48,110,000 100,001,000 Royalties and project abandonment 8,587,000 14,758,000 48,120,000 Product development 1,324,000 1,610,000 5,092,000 Selling and marketing 4,444,000 8,670,000 20,262,000 General and administrative 4,374,000 5,379,000 9,897,000 In-process research and development -- -- 7,232,000 ------------ ------------ ------------ Total costs and expenses 48,030,000 78,527,000 190,604,000 ------------ ------------ ------------ Income from operations 2,225,000 10,835,000 24,456,000 Interest income (expense), net (316,000) 464,000 863,000 ------------ ------------ ------------ Income before income taxes 1,909,000 11,299,000 25,319,000 Income taxes 8,000 1,954,000 9,330,000 ------------ ------------ ------------ Net income $ 1,901,000 $ 9,345,000 $ 15,989,000 ============ ============ ============ Net income per share-- basic $ .28 $ .99 $ 1.49 ============ ============ ============ Net income per share-- diluted $ .26 $ .90 $ 1.38 ============ ============ ============ Shares used in per share calculation-- basic 6,788,000 9,480,000 10,728,000 ============ ============ ============ Shares used in per share calculation-- diluted 7,254,000 10,352,000 11,626,000 ============ ============ ============
See notes to consolidated financial statements. F-4 39 THQ INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Years Ended December 31, 1996, 1997 and 1998
Accumulated Retained Additional Other Earnings Preferred Common Common Paid-in Comprehensive (Accumulated Stock Shares Amount Capital Income (Loss) Deficit) Total --------- ---------- ------------ ------------ ------------ ------------ ------------ Balance at January 1, 1996 325 6,326,086 $ 4,000 $ 33,317,000 $ (360,000) $(25,363,000) $ 7,598,000 Exercise of warrants and options -- 408,172 -- 712,000 -- -- 712,000 Conversion of preferred stock to common stock (325) 191,576 -- -- -- -- -- Issuance of common stock -- 183,990 -- 529,000 -- -- 529,000 Comprehensive income: Net income -- -- -- -- -- 1,901,000 1,901,000 Other comprehensive income Foreign currency translation -- -- -- -- 308,000 -- 308,000 adjustment ------------ Comprehensive income -- -- -- -- -- -- 2,209,000 ------- ---------- ------------ ------------ ------------ ------------ ------------ Balance at December 31, 1996 -- 7,109,824 4,000 34,558,000 (52,000) (23,462,000) 11,048,000 Exercise of warrants and options -- 466,524 -- 1,293,000 -- -- 1,293,000 Issuance of common stock -- 2,587,500 -- 11,708,000 -- -- 11,708,000 Comprehensive income: Net income -- -- -- -- -- 9,345,000 9,345,000 Other comprehensive income Foreign currency translation -- -- -- -- 133,000 -- 133,000 adjustment ------------ Comprehensive income -- -- -- -- -- -- 9,478,000 ------- ---------- ------------ ------------ ------------ ------------ ------------ Balance at December 31, 1997 -- 10,163,848 4,000 47,559,000 81,000 (14,117,000) 33,527,000
(continued) F-5 40 THQ INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Years Ended December 31, 1996, 1997 and 1998
Accumulated Retained Additional Other Earnings Preferred Common Common Paid-in Comprehensive (Accumulated Stock Shares Amount Capital Income (Loss) Deficit) Total --------- ---------- ------------ ------------ ------------ ------------ ------------ Balance at December 31, 1997 -- 10,163,848 4,000 47,559,000 81,000 (14,117,000) 33,527,000 Exercise of warrants and options -- 601,679 5,000 2,343,000 -- -- 2,348,000 Issuance of common stock -- 521,804 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 -- -- -- -- -- 15,989,000 15,989,000 Other comprehensive income Foreign currency translation -- -- -- -- (21,000) -- (21,000) adjustment ------------ Comprehensive income -- -- -- -- -- -- 15,968,000 ------ ----------- ------------ ------------ ------------ ------------ ------------ Balance at December 31, 1998 -- 11,287,331 $ 113,000 $ 62,122,000 $ 60,000 $ 1,802,000 $ 64,097,000 ====== =========== ============ ============ ============ ============ ============
See notes to consolidated financial statements. F-6 41 THQ INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, ------------------------------------------ 1996 1997 1998 ------------ ------------ ------------ Cash flows from operating activities: Net income $ 1,901,000 $ 9,345,000 $ 15,989,000 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation and amortization 337,000 483,000 899,000 Provision for doubtful accounts, discounts and returns 5,203,000 10,509,000 20,838,000 Loss on sale of investment securities -- -- 218,000 In-process research and development -- -- 7,232,000 Deferred income taxes -- (1,666,000) (8,708,000) Changes in operating assets and liabilities, net of effects from acquisitions: Accounts receivable (12,586,000) (27,299,000) (43,979,000) Inventory 202,000 (441,000) (13,780,000) Prepaid and deferred royalties and software development costs 2,799,000 (2,417,000) 2,703,000 Prepaid expenses and other current assets (322,000) (4,000) (239,000) Accounts payable and accrued expenses (1,233,000) 7,707,000 12,802,000 Accrued royalties (649,000) 2,338,000 7,650,000 Income taxes payable -- 3,451,000 6,040,000 ------------ ------------ ------------ Net cash (used in) provided by operating activities (4,348,000) 2,006,000 7,665,000 ------------ ------------ ------------ Cash flows used in investing activities: Proceeds from sale of investment securities -- -- 863,000 Purchase of investment securities -- -- (1,081,000) Investment in joint venture -- -- (2,010,000) Acquisitions, net of cash acquired -- -- (2,369,000) Acquisition of equipment (314,000) (923,000) (1,233,000) Other long-term assets (578,000) -- -- ------------ ------------ ------------ Net cash used in investing activities (892,000) (923,000) (5,830,000) ------------ ------------ ------------ Cash flows from financing activities: Net increase (decrease) in short-term borrowings 5,355,000 (5,355,000) 3,268,000 Net proceeds from issuance of common stock -- 11,708,000 -- Proceeds from exercise of warrants and options 712,000 1,293,000 2,348,000 ------------ ------------ ------------ Net cash provided by financing activities 6,067,000 7,646,000 5,616,000 ------------ ------------ ------------ Effect of exchange rate changes on cash and cash equivalents 12,000 261,000 (156,000) ------------ ------------ ------------ Net increase in cash and cash equivalents 839,000 8,990,000 7,295,000 ------------ ------------ ------------ Cash and cash equivalents -- beginning of period 1,895,000 2,734,000 11,724,000 ------------ ------------ ------------ Cash and cash equivalents -- end of period $ 2,734,000 $ 11,724,000 $ 19,019,000 ============ ============ ============
F-7 42 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Income taxes $ 14,000 $ 127,000 $ 12,417,000 ============ ============ ============ Interest $ 375,000 $ 51,000 $ 142,000 ============ ============ ============
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES: At December 31, 1998, net income tax payable and additional paid-in capital include tax benefits amounting to $1.6 million resulting from disqualified dispositions of common stock by officers and employees of THQ acquired through the exercise of stock options. As of July 1, 1996 we issued 105,000 shares of common stock in lieu of cash to a former employee of ours. This transaction resulted in a reduction in accounts payable and accrued expenses and a like increase in additional paid-in capital in the amount of $229,000, the fair value of the stock issued on the date of issuance. Also on July 1, 1996, we issued 78,990 shares of common stock as part of the purchase price for a 25% interest in Inland Productions, Inc. ("Inland") increasing other long-term investments and additional paid-in capital by $300,000. On May 1, 1998 we issued 355,184 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 11.) On December 2, 1998 we issued 166,620 shares of common stock as part of the purchase price for Rushware Microhandelsgesellschaft mbH. 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 11.) DETAILS OF 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 ============ ============
See notes to consolidated financial statements. F-8 43 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, 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, Kay Bee Toys, Target, Electronics Boutique, 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 1999 through 2001. Our business is dependent on these license agreements with Sony and Nintendo. Substantially all of our products are manufactured by Sony and Nintendo, 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 or Nintendo as appropriate, with respect to all loss, liability and expense resulting from any claim against Sony or Nintendo involving the development, marketing, sale or use of our titles, including any claims for copyright or trademark infringement brought against Sony or Nintendo. As such, we bear the risk that the properties and information and technology licensed from Sony or Nintendo and incorporated in the software may infringe the rights of third parties. Generally, we are entitled to F-9 44 indemnification from our software developers and property licensors to cover our indemnification obligations to Sony or Nintendo 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. On March 10, 1998, we announced that our current license agreement with World Championship Wrestling will not be renewed. The license agreement expired on December 29, 1998, and permits us to continue to sell products on hand and in process at that date through June 29, 1999. Products released by us under this license accounted for 65% of our revenues in 1998 and are expected to account for a substantial portion of our revenues in 1999. In June 1998, in partnership with JAKKS Pacific, Inc., we obtained an exclusive, long-term license agreement with Titan Sports, Inc. ("Titan") to publish titles based on the World Wrestling Federation franchise on all hardware platforms. This license permits us to release our first WWF game after November 16, 1999. (See Note 9.) 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 transaction 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 transaction gains and losses result from exchange rate changes 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 advances 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 12%, 19% and 13% of gross sales in the years ended December 31, 1996, 1997 and 1998, respectively. In 1997 one other customer represented 10% of sales (before returns and allowances). In 1998 another customer represented 19% of sales (before returns and allowances). We perform ongoing credit evaluations of our customers and maintain an allowance for potential credit losses. F-10 45 Inventory. Inventory, which consists principally of finished products, are stated at the lower of cost (first-in, first-out basis) 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 1997 1998 ------------ ----------- ----------- Furniture, fixtures and equipment 5 yrs $ 1,634,000 $ 2,832,000 Leasehold improvements 3-5 yrs 49,000 560,000 Less accumulated depreciation and amortization (520,000) (941,000) ----------- ----------- $ 1,163,000 $ 2,451,000 =========== ===========
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 and Nintendo for use with their respective hardware platforms. 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. We also expense as project abandonment losses, also included in royalties expense, advances or capitalized software development costs when, in management's estimate, future revenues will not be sufficient to recover previously capitalized costs. Such abandonment losses are solely attributable to changes in market conditions or product quality considerations. Research and development costs are expensed as incurred. F-11 46 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 4.) 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. Effective January 1, 1998, we adopted Statement of Financial Accounting Standard No.128 ("SFAS"), "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 herein:
Years Ended December 31, ----------------------------------------- 1996 1997 1998 ----------- ----------- ----------- Net income used to compute basic and diluted earnings per share $ 1,901,000 $ 9,345,000 $15,989,000 ----------- ----------- ----------- Weighted average number of shares outstanding-- basic 6,788,000 9,480,000 10,728,000 Dilutive effect of stock options and warrants 466,000 872,000 898,000 =========== =========== =========== Number of shares used to compute earnings per share-- diluted 7,254,000 10,352,000 11,626,000 =========== =========== =========== Anti-dilutive options of 139,000 have been excluded from the December 31, 1998 calculation.
F-12 47 Recently Issued Accounting Pronouncements. Effective January 1, 1998, we adopted SFAS No. 130, "Reporting Comprehensive Income". SFAS No. 130 establishes standards for the reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general purpose financial statements. We adopted SFAS No. 131, "Disclosure About Segments of an Enterprise and Related Information." during the year ended December 31, 1998. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments. It also establishes standards for related disclosure about products and services, geographic areas and major customers. (See Note 13.) In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedge Activities". SFAS No. 133 establishes the accounting and reporting standard for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS 133 is effective for financial statements for periods beginning after June 15, 1999. We are currently evaluating the potential impact of 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. Reclassifications. Certain items in the 1996 and 1997 financial statements have been reclassified to conform to the 1998 presentation. 3. CREDIT FACILITY In December 1998, we entered into two trade finance agreements with Union Bank of California that established a new revolving credit facility. These agreements expire on May 1, 2000. The principal agreement permits us to borrow (and maintain obligations under outstanding letters of credit) of up to $30,000,000, subject to the following: F-13 48 - We may maintain outstanding letters of credit for product purchases of up to $30,000,000 in the aggregate between August 1 of any year and the end of February of the subsequent year; - We may maintain outstanding letters of credit for product purchases of up to $15,000,000 in the aggregate between March 1 and July 31 of any year; - We may maintain outstanding "standby" letters of credit up to $30,000,000 in the aggregate; and - We may borrow up to $15,000,000 (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 both standby and product purchase letters of credit of up to $5,000,000 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 (7.75% at December 31, 1998) or b). the London Interbank Offered Rate (5.06% at December 31, 1998) plus 1.85%. As of December 31, 1998, we had $6,053,000 in outstanding borrowings under these credit facilities and had obligations in respect of outstanding letters of credit of $22,000,000. 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 shareholders' equity of not less than $50 million as of December 31, 1998, increasing by the greater of $10 million or 90% of after-tax profits as of the end of each subsequent year; - maintain the ratio of our total liabilities to our shareholders' equity at not greater of 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 F-14 49 - 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 less than 1:12. 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 (See Note 11) is a party to three separate revolving credit agreements with three German banks, each of which permits 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 are secured by substantially all of the assets of Rushware and its subsidiaries and bear interest at a rate of 7.75%. Each of these agreements expires on March 31, 1999, and we are seeking to extend their terms. As of December 31, 1998, we had $3,856,000 in outstanding borrowings under this credit facility. All Rushware borrowings are guaranteed by THQ Inc. 4. ACCOUNTS RECEIVABLE AND ACCRUED RETURNS AND ALLOWANCES Accounts receivable are due primarily from domestic and foreign retailers and distributors, including mass merchants and specialty stores. Accounts receivable at December 31, 1997 and 1998 are composed of the following:
December 31, ------------------------------ 1997 1998 ------------ ------------ Accounts receivable-- domestic $ 33,787,000 $ 66,406,000 Other receivables-- domestic 133,000 280,000 Allowance for domestic returns and doubtful accounts (7,767,000) (15,008,000) Other accounts receivable-- foreign 5,075,000 11,732,000) Allowance for foreign doubtful accounts (10,000) (2,345,000) Allowance for foreign discounts and returns (362,000) (1,545,000) ------------ ------------ Accounts receivable-- net $ 30,856,000 $ 59,520,000) ============ ============
The allowance for domestic accrued returns and allowances consists of the following:
December 31, ---------------------------------------------- 1996 1997 1998 ------------ ------------ ------------ Balance at January 1 $ (2,859,000) $ (2,772,000) $ (7,767,000) Provision for discounts and returns (4,771,000) (10,172,000) (18,870,000) Actual discounts and returns 4,858,000 5,177,000 11,629,000 ------------ ------------ ------------ Ending balance $ (2,772,000) $ (7,767,000) $(15,008,000) ============ ============ ============
F-15 50 The allowance for foreign doubtful accounts consists of the following:
December 31, ------------------------------------------- 1996 1997 1998 ----------- ----------- ----------- Balance at January 1 $(1,380,000) $(1,294,000) $ (10,000) Rushware purchase as of December 2, 1998 -- -- (1,626,000) Provision for doubtful accounts (10,000) (4,000) (4,000) Actual doubtful accounts (recoveries) 96,000 1,288,000 (705,000) ----------- ----------- ----------- Ending balance $(1,294,000) $ (10,000) $(2,345,000) =========== =========== ===========
The allowance for foreign discounts and returns consists of the following:
December 31, ------------------------------------------- 1996 1997 1998 ----------- ----------- ----------- Balance at January 1 $ (311,000) $ (292,000) $ (362,000) Rushware purchase as of December 2, 1998 -- -- (2,091,000) Provision for discounts and returns (422,000) (333,000) (1,964,000) Actual discounts and returns 441,000 263,000 2,872,000 ----------- ----------- ----------- Ending balance $ (292,000) $ (362,000) $(1,545,000) =========== =========== ===========
5. 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 $161,000, $119,000, and $400,000 in 1996, 1997 and 1998, respectively. F-16 51 6. INCOME TAXES The provision for income taxes consists of the following:
1996 1997 1998 ------------ ------------ ------------ Current Federal $ 2,000 $ 2,760,000 $ 14,642,000 State 6,000 821,000 3,275,000 Foreign -- 39,000 121,000 ------------ ------------ ------------ 8,000 3,620,000 18,038,000 ------------ ------------ ------------ Deferred Federal -- (1,283,000) (7,170,000) State -- (383,000) (1,538,000) ------------ ------------ ------------ -- (1,666,000) (8,708,000) ------------ ------------ ------------ Provision for income taxes $ 8,000 $ 1,954,000 $ 9,330,000 ============ ============ ============
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:
1996 1997 1998 --------- --------- --------- Federal provision at statutory rate 35.0% 35.0% 35.0% State taxes (net of Federal benefit) -- 4.0% 5.0% In-process research and development -- -- 10.0% Change in valuation allowance (34.9) (21.7) (11.8) Foreign taxes and other, net -- -- (1.3) --------- --------- --------- 0.1% 17.3% 36.9% ========= ========= =========
F-17 52 The components of deferred income tax assets (liabilities) are as follows:
December 31, ----------------------------------------------------------------- 1997 1998 ------------------------------ ----------------------------- Federal State Federal State ----------- ----------- ----------- ----------- Current - ------- Deferred income tax assets: Allowance for doubtful accounts, discounts and returns $ 2,641,000 $ 566,000 $ 5,263,000 $ 1,117,000 License abandonment 652,000 140,000 2,258,000 339,000 State income taxes -- -- 1,213,000 -- Other -- net 540,000 56,000 436,000 248,000 ----------- ----------- ----------- ----------- Total deferred income tax assets 3,833,000 762,000 9,170,000 1,704,000 Deferred tax liabilities: Software development costs (2,260,000) (379,000) (1,418,000) (196,000) State income taxes (290,000) -- (939,000) -- ----------- ----------- ----------- ----------- Deferred income taxes $ 1,283,000 $ 383,000 $ 6,813,000 $ 1,508,000 =========== =========== =========== =========== Non-Current - ----------- Deferred income tax assets: Net operating loss $ 4,980,000 $ 473,000 $ 4,021,000 $ 413,000 Other -- net -- -- 80,000 -- ----------- ----------- ----------- ----------- Net deferred tax assets 4,980,000 473,000 4,101,000 413,000 Valuation allowance (4,980,000) (473,000) (2,461,000) -- ----------- ----------- ----------- ----------- Deferred income taxes $ -- $ -- $ 1,640,000 $ 413,000 =========== =========== =========== ===========
The valuation reserve decreased $21,000, $2,231,000 and $2,992,000 during 1996, 1997 and 1998, respectively. At December 31, 1998, net income taxes payable and additional paid-in capital include tax benefits amounting to $1.6 million resulting from disqualified dispositions of common stock by officers and employees of THQ acquired through the exercise of stock options. As of December 31, 1998 we had federal and state net operating loss carryforwards of approximately $11,489,000 (expiring from 2009 to 2011) and approximately $4,589,000 (expiring in 1999), respectively. At December 31, 1998 we had accumulated foreign earnings of $272,000. 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-18 53 The sale of 2,250,000 shares of common stock issued by us on February 11, 1997 resulted in an "ownership change" for the Internal Revenue Code purposes. 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. 7. STOCK OPTION PLAN We have two stock option plans (the "1990 Plan" and "1997 Plan"), which provide for the issuance of up to 975,000 and 1,650,000 shares, respectively, available for employees, consultants and non-employee directors. As of December 31, 1998, 8,965 options under the 1990 Plan and 188,524 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. F-19 54 The exercise price per share of all options granted under the plans in 1996, 1997 and 1998 has been the market price of the stock on the date of the grant. Generally, options granted become exercisable over three years and expire within five years from the date of grant.
Weighted Average Exercise Number of Stock Options Price Shares - ---------------------------------------- ---------------- ----------- Balance at January 1, 1996 $ 4.03 981,886 Granted $ 2.82 212,250 Exercised $ 2.06 (180,411) Canceled $ 6.48 (278,376) ----------- Balance at December 31, 1996 $ 2.27 735,349 Granted $ 7.80 625,124 Exercised $ 2.44 (179,762) Canceled $ 2.35 (17,998) ----------- Balance at December 31, 1997 $ 5.19 1,162,713 Granted $16.39 913,675 Exercised $ 3.17 (368,937) Canceled $13.18 (52,325) ----------- Balance at December 31, 1998 $11.57 1,655,126 =========== Options exercisable at December 31, 1998 $ 6.36 466,656 ===========
F-20 55 Options granted and shares exercised relating to options granted outside of our stock option plan during 1996, 1997, and 1998 are listed below. Share exercise prices for these options equal the market price of our common stock at the date of the grant.
Share Number Grant Exercise of Shares Number of Shares Number of Shares Number of Shares Description Year Price Granted Exercised 1996 Exercised 1997 Exercised 1998 - -------------------------------------- -------- ----------- --------- ---------------- ----------------- ---------------- Former Executive 1994 $ 2.50 134,016 134,016 --------- Total options granted 1994 134,016 Brian J. Farrell, President 1995 $ 2.04 210,000 90,000 120,000 Outside consultants 1995 $ 1.91 45,000 4,999 2,501 37,500 Former employee severance package 1995 $ 1.50 30,000 30,000 Former employee severance package 1995 $ 1.87 75,000 75,000 --------- Total options granted 1995 360,000 Brian J. Farrell, President 1996 $ 3.33 300,000 Outside consultant 1996 $ 3.46 37,500 37,500 --------- Total options granted 1996 337,500 Employee director 1998 $16.75 200,000 Nonemployee directors 1998 $27.81 22,500 GameFx options 1998 $ 1.97 14,805 --------- Total options granted 1998 237,305 --------- ------- --------- --------- Total 1,068,821 109,999 264,017 157,500 ========= ======= ========= ========= Balance outstanding at December 31, 1998 537,305 ========= Options exercisable at December 31, 1998 322,517 =========
F-21 56 The following table summarizes information about stock options outstanding at December 31, 1998:
Number Weighted Average Remaining Weighted Range of Exercise Price Outstanding at December 31, 1998 Contractual Life Average Exercise Price - -------------------------- ----------------------------------- ------------------------------ ----------------------------- $ 1.87 - $ 3.33 519,552 6 $ 2.80 $ 3.61 - $ 9.67 576,904 4 $ 7.57 $14.75 - $14.75 527,025 5 $14.75 $15.00 - $18.54 461,450 6 $16.61 $20.92 - $28.00 107,500 6 $26.97 --------- -- ------ 2,192,431 5 $11.02 ========= == ======
Shares Weighted Exercisable at Average Range of Exercise Price December 31, 1998 Exercise Price - -------------------------- ----------------- --------------- $ 1.87 - $ 3.33 478,264 $ 2.85 $ 3.61 - $ 9.67 228,409 $ 6.94 $14.75 - $14.75 -- $ -- $15.00 - $18.54 45,000 $15.71 $20.92 - $28.00 37,500 $25.05 ------- ------ 789,173 $ 5.82 ======= ======
The estimated fair value of the options granted in 1996, 1997 and 1998 was $1,094,000, $3,041,000 and $11,790,000, 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 1996, 1997 or 1998. 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, 1996, 1997 and 1998 would have been reduced to the pro forma amounts indicated below:
Years Ended ------------------------------------------------------- December 31, 1996 December 31, 1997 December 31, 1998 ----------------- ----------------- ----------------- Net income: As reported $ 1,901,000 $ 9,345,000 $ 15,989,000 Pro forma $ 1,123,000 $ 8,144,000 $ 12,682,000 Diluted net income per share: As reported $ .26 $ .90 $ 1.38 Pro forma $ .15 $ .79 $ 1.09
F-22 57 The fair market value of options granted under the stock option plans during 1996, 1997 and 1998 was determined using the Black-Scholes option pricing model utilizing the following assumptions:
Years Ended ------------------------------------------------------------------------ December 31, 1996 December 31, 1997 December 31, 1998 ----------------------- ----------------------- ------------------- Dividend yield 0% 0% 0% Anticipated volatility 83% 83% 87% Weighted average Risk-free interest rate 5.95% 6.0% 5.15% Expected lives 4 years 4 years 4 years
8. RELATED PARTY TRANSACTIONS In 1996, 1997 and 1998, we paid the law firm of Feder, Kaszovitz, Isaacson, Weber, Skala & Bass, of which Mr. Skala, a director of THQ through January 14, 1997, is a partner, approximately $215,000, $107,000, and $30,000, respectively. In 1996, 1997 and 1998, we paid Inland Productions, Inc., a software developer in which we acquired a 25% interest in on July 1, 1996, $775,000, $985,000, and $4,891,000, respectively. As of December 31, 1997 and 1998, we owed Inland Productions, Inc. $640,000 and $166,000, respectively. 9. CAPITAL STOCK TRANSACTIONS During 1996, all shares of preferred stock issued during 1995 were converted to common stock. During 1996, we issued 105,000 shares of common stock, at the fair market value of the stock on such date, in settlement of an accrued liability of $229,000 due to a former employee. During the years ended December 31, 1996, 1997 and 1998, the number of warrants to purchase our common stock exercised were 105,000, 22,746 and 75,000, respectively. We received proceeds from the exercise of such warrants totaling $149,000, $123,000 and $827,000, in the years ended December 31, 1996, 1997 and 1998, respectively. At December 31, 1998 outstanding warrants were 15,000 at an average exercise price of $6.83. In connection with obtaining the World Wrestling Federation license (See Note 1), we have agreed to issue to Titan Sports, Inc. warrants expiring December 31, 2009 to purchase 187,500 shares of common stock at $15.63 per share. F-23 58 On February 14, 1997, we completed a public offering of 2,250,000 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 337,500 additional shares of the common stock at the public offering price of $5.00 per share. On March 11, 1997, the underwriters exercised their over-allotment option. All of these shares were newly issued and sold on behalf of us. The net proceeds of the 2,587,500 shares sold were approximately $11,700,000. On July 23, 1998, we announced a three-for-two stock split, effected in the form of a 50% stock dividend, which was distributed on August 24, 1998, to shareholders of record on August 20, 1998. The accompanying consolidated financial statements have been adjusted to give effect to this stock split for all periods presented. On May 1, 1998, we issued 355,184 shares of common stock in connection with the acquisition of GameFx, Inc. (See Note 11.) In December 1998, we issued an additional 166,620 shares of common stock as part of the purchase cost of Rushware Microhandelsgesellschaft mBH. (See Note 11.) 10. 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. 11. OTHER LONG-TERM ASSETS On July 1, 1996, we acquired a 25% interest in Inland, a Software developer for home entertainment game systems. The investment consisted of $300,000 in cash and 78,990 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 as a long-term investment 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, Inc., a Delaware corporation ("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 355,184 shares of Common Stock, (ii) the assumption of stock options issued by GameFx to its employees that, if and when exercised, permit the holders thereof to acquire approximately 14,850 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, $7.2 million 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. GameFx had earned no revenues prior to our acquisition and had incurred only payroll and F-24 59 related costs that would not be material to our operations, therefore pro forma results are not included. In June 1998, we announced that, in partnership with JAKKS Pacific Inc. ("JAKKS Pacific") (a manufacturer and marketer of toys), we had signed an exclusive ten-year license agreement with Titan Sports Inc. ("Titan") to publish World Wrestling Federation electronic games on all platforms. The games will be designed, developed, manufactured and marketed by THQ/JAKKS Pacific LLC, a joint venture. We will oversee product development and sales, and THQ/JAKKS Pacific LLC will co-manage the marketing of the games. We expect that the first game produced under this license will be released near the end of 1999. We have a 50% ownership interest in this joint venture. Our investment of $2,010,000 as of December 31, 1998 is predominately initial funding as the joint venture had no operations as of December 31, 1998. 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 166,620 shares of common stock with a fair value of $4,432,000 which was accounted for as a purchase. 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. Our results of operations include one month of Rushware operations. The following unaudited pro forma financial information combines the consolidated results of operations as if the acquisition of Rushware had occurred as of the beginning of the periods presented. The pro forma amounts contained in the table below include adjustments for interest expense, assumed decrease in interest earned and additional common stock outstanding.
December 31, ----------------------------- (Dollars in thousands, except per share amounts) 1997 1998 -------------- -------------- Net sales $ 133,750 $ 237,449 Net income $ 10,130 $ 11,452 Basic income per common share $ 1.01 $ 1.04 Diluted income per common share $ 0.93 $ 0.96
The pro forma financial information does not necessarily reflect the operating results that would have occurred had the acquisition been consummated as of the above dates, nor is such information indicative of future operating results. The allocation of the purchase price is based on preliminary data and could change when final valuation information is determined. F-25 60 12. COMMITMENTS AND CONTINGENCIES Royalties. At December 31, 1997 and 1998, accrued royalties were $7,534,000 and $16,969,000, respectively. Royalties are classified as current liabilities if initial sales are to commence within one year. We entered into a joint venture agreement creating a new limited liability company (LLC) in which we hold a 50% ownership interest. On June 10, 1998, the LLC entered into a license agreement through December 31, 2009, with an option for a five year automatic extension if the LLC pays the licensor $27,000,000 in royalties during the initial ten year period of the agreement. The license agreement includes a total of $18,000,000 in guaranteed royalty payments, payable over the ten year initial term and $7,500,000 guaranteed payments over the five year renewal period, if applicable. We are responsible for $10,500,000 of the $18,000,000 guarantee royalty payments. The guarantee payments include a $3,000,000 advance, paid within 15 days after the agreements were executed, and ten minimum guaranteed installments of $1,500,000, due each January 30, starting in 2000 and ending 2009. We were responsible for funding $2,000,000 of the initial advance and are responsible for $1,000,000 of the first four and $750,000 of the next six of ten yearly installments. All unpaid guaranteed amounts as of December 31, 1998 are included in the totals of the "future annual minimum royalty guarantees" table noted below. The $7,500,000 renewal guaranteed will be payable in five yearly installments, of which we will be responsible for 50% of each yearly payment. We have agreed to issue to Titan warrants expiring December 31, 2009 to purchase 187,500 shares of common stock at $15.63 per share. Future annual minimum royalty guarantees, including the Titan license, are as follows: 1999 $ 17,594,000 2000 1,375,000 2001 1,000,000 2002 1,000,000 2003 750,000 Thereafter 3,750,000 -------------- Total $ 25,469,000 ==============
F-26 61 Leases. We are committed under operating leases with lease termination dates to 2003. Minimum future rentals pursuant to these leases as of December 31, 1998 are as follows:
FACILITIES EQUIPMENT ------------- ------------- 1999 $1,006,000 $346,000 2000 835,000 184,000 2001 564,000 83,000 2002 238,000 50,000 2003 0 43,000 ------------ ------------ $2,643,000 $706,000 ============ ============
Rent expense was $183,000, $258,000, and $490,000 in 1996, 1997 and 1998, respectively. F-27 62 13. 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, 1996, 1997 and 1998:
United United States Kingdom Other Consolidated -------- -------- -------- ------------ (in thousands of dollars) Year ended December 31, 1996: Sales to unaffiliated customers $ 35,399 $ 14,856 $ -- $ 50,255 ======== ======== ======== ======== Long-lived assets at December 31, 1996 $ 1,294 $ 82 $ -- $ 1,376 ======== ======== ======== ======== Year ended December 31, 1997: Sales to unaffiliated customers $ 75,365 $ 14,000 $ (3) $ 89,362 ======== ======== ======== ======== Long-lived assets at December 31, 1997 $ 2,163 $ 152 $ -- $ 2,315 ======== ======== ======== ======== Year ended December 31, 1998: Sales to unaffiliated customers $185,927 $ 23,881 $ 5,252 $215,060 ======== ======== ======== ======== Long-lived assets at December 31, 1998 $ 7,965 $ 4,763 $ 1,063 $ 13,791 ======== ======== ======== ========
F-28 63 14. QUARTERLY FINANCIAL DATA (UNAUDITED) Our summarized quarterly financial data is as follows:
Quarter Ended ---------------------------------------------------------------------------------- (Amounts in thousands, except per share data) March 31 June 30 September 30 December 31 - --------------------------------------- ----------------- ------------------- ------------------ ---------------------- Year ended December 31, 1996: Revenues $ 6,582 $12,087 $11,102 $ 20,484 Expenses 6,839 11,591 10,450 19,466 ----------------- ------------------- ------------------ ---------------------- Income (loss) before income taxes (257) 496 652 1,018 Income taxes 4 -- -- 4 ----------------- ------------------- ------------------ ---------------------- Net income (loss) $ (261) $ 496 $ 652 $ 1,014 ================= =================== ================== ====================== Net income (loss) per share: Basic $ (.04) $ .07 $ .09 $ .14 ================= =================== ================== ====================== Diluted $ (.04) $ .07 $ .09 $ .13 ================= =================== ================== ====================== Year ended December 31, 1997: Revenues $11,839 $12,265 $16,355 $ 48,903 Expenses 11,115 11,205 14,517 41,226 ----------------- ------------------- ------------------ ---------------------- Income before income taxes 724 1,060 1,838 7,677 Income taxes 4 66 410 1,474 ----------------- ------------------- ------------------ ---------------------- Net income $ 720 $ 994 $ 1,428 $ 6,203 ================= =================== ================== ====================== Net income per share: Basic $ .09 $ .10 $ .15 $ .62 ================= =================== ================== ====================== Diluted $ .08 $ .09 $ .13 $ .56 ================= =================== ================== ====================== Year ended December 31, 1998: Revenues $48,453 $29,325 $25,963 $111,319 Expenses 38,933 32,591 22,289 95,928 ----------------- ------------------- ------------------ ---------------------- Income (loss) before income taxes 9,520 (3,266) 3,674 15,391 Income taxes 3,028 1,083 1,248 3,971 ----------------- ------------------- ------------------ ---------------------- Net income (loss) $ 6,492 $(4,349) $ 2,426 $ 11,420 ================= =================== ================== ====================== Net income (loss) per share: Basic $ .63 $ (.41) $ .22 $ 1.04 ================= =================== ================== ====================== Diluted $ .57 $ (.41) $ .21 $ .95 ================= =================== ================== ======================
F-29 EX-10.6 2 EXHIBIT 10.6 1 EXHIBIT 10.6 October 1, 1997 Via: Facsimile Mr. Fred A. Gysi 1981 Westridge Road Los Angeles, CA 90049 Dear Fred: It is with pleasure that I offer you the position of Vice President - Finance and Administration at THQ Inc. As we discussed, I believe you would be an excellent addition to the THQ management team. If you accept, the terms of your employment would be as follows: 1. Annual base salary of $125,000 to be paid on a bi-weekly basis. Reviews are held annually. 2. An annual bonus targeted at 15 - 35 % of your base compensation, the exact amount of which will be determined by both your performance and the Company's. Payment of the bonus will generally be made during February assuming your employment extends through that time; no proration of bonus will apply if you are not employed by the Company at the end of the year. 3. Vacation time of three weeks per year. Eight paid holidays and two personal or floating days are also planned each year. 4. Participation in the Company's Group Health Insurance Plan, which currently includes life, medical, dental, and vision coverage in which you will be enrolled on the first of the month following your first 30 days of employment with the Company. Enrollment is subject to approval from the insurance company. 5. Participation in the Company's 401 (k) Plan. Employees are able to defer up to 12% of their annual compensation through the plan subject to IRS limitations, and the Company currently matches contributions up to 4% of eligible compensation. 6. Participation in the Company's profit-sharing plan, which generally provides for annual Company contributions. 2 7. An award of 40,000 stock options to be granted by the Board of Directors of THQ Inc. These options will vest ratably over the next three years. I am looking forward to working with you and to having you become a member of the team at THQ Inc. Yours very truly, Accepted and agreed this ___day of October, 1997 Brian J. Farrell By: /s/ Fred A. Gysi - ------------------------ ----------------------- President and Fred A. Gysi Chief Executive Officer cf/BF EX-10.7 3 EXHBIT 10.7 1 EXHIBIT 10.7 SEVERANCE AGREEMENT THIS SEVERANCE AGREEMENT (this "Agreement") is entered into as of the ___ day of _________, ______, by and between THQ INC., a Delaware corporation (the "Company"), and _______________________ (the "Executive"). W I T N E S S E T H WHEREAS, the Executive currently serves as a key employee of the Company and The Executive's services and knowledge are valuable to the Company in connection with the management of one or more of the Company's principal operating functions, departments, divisions or subsidiaries; and WHEREAS, the Board has determined that it is in the best interests of the Company and its stockholders to secure the Executive's continued services and to ensure the Executive's continued dedication and objectivity in the event of any threat or occurrence of, or negotiation or other action that could lead to, or create the possibility of, a Change in Control of the Company, without concern as to whether the Executive might be hindered or distracted by personal uncertainties and risks created by any such possible Change in Control; and WHEREAS, and to encourage the Executive's full attention and dedication to the Company, the Board has authorized the Company to enter into this Agreement. NOW, THEREFORE, the Company and the Executive hereby agree as follows: 1. Definitions. The terms defined in Annex I hereto shall have the respective meanings set forth therein. 2. Obligations of the Executive. The Executive agrees that in the event any Person attempts a Change in Control, The Executive shall not voluntarily leave the employ of the Company without Good Reason until the earlier of (a) such attempted Change in Control terminates, or (b) if a Change in Control shall occur, 90 days following such Change in Control. For purposes of the foregoing clause (a), Good Reason shall be determined as if a Change in Control had occurred when such attempted Change in Control became known to the Board. 3. Payments Upon Termination of Employment. 3.1 If during the Termination Period the employment of the Executive shall terminate other than by reason of a Nonqualifying Termination, the Company shall pay to the Executive (or to the Executive's beneficiary or estate), as compensation for services rendered to the Company: 3.1.1 Within 30 days following the Date of Termination, a cash amount equal to the sum of (i) the Executive's annual base salary from the Company and its affiliated companies through the Date of Termination, to the extent not theretofore paid, and (iii) any compensation previously deferred by the Executive (together with any interest and earnings thereon) and any accrued vacation pay, in each case to the extent not theretofore paid; plus 3.1.2 A cash amount equal to (i) one times the Executive's annual base salary from the Company and its affiliated companies in effect at the time the Change of Control occurs, 2 plus (ii) one times the Executive's annual bonus paid or payable, including by reason of any deferral, to the Executive by the Company and its affiliated companies in respect of the fiscal year of the Company immediately preceding the fiscal year in which the Change in Control occurs. Such aggregate amount shall be payable, at the election of the Executive (or the Executive's beneficiary or estate) either in a lump sum (subject to any applicable payroll or other taxes required to be withheld pursuant to Section 5 hereof) within 30 days following the date of Termination or in 12 equal monthly installments commencing 30 days following the date of Termination. The amounts payable pursuant to this Section 3.1.2, together with any amounts or benefits otherwise payable pursuant to this Agreement, shall be paid in lieu of any other amount of severance relating to salary or bonus continuation to be received by the Executive upon termination of employment of the Executive under any severance plan, policy or arrangement of the Company. 3.2 If during the Termination Period the employment of the Executive shall terminate other than by reason of a Nonqualifying Termination, the Executive shall also be entitled to the following: 3.2.1 If on the Date of Termination the Executive shall not be fully vested in the employer contributions made on his behalf under the Plan, the Company shall pay to the Executive within 30 days following the Date of Termination a lump sum cash amount equal to the value of the unvested portion of such employer contributions; provided, however, that if any payment pursuant to this Section 3.2.1 may or would result in such payment being deemed a transaction which is subject to Section 16(b) of the Securities Exchange Act, the Company shall make such payment so as to meet the conditions for an exemption from such Section 16(b) as set forth in the rules (and interpretive and no-action letters relating thereto) under Section 16. The value of any such unvested employer contributions shall be determined as of the Date of Termination; provided that if the common stock of the Company is traded on NASDAQ or any stock exchange on the Date of Termination, the value of a share of common stock of the Company shall be the closing price on NASDAQ or such stock exchange on the Date of Termination or, if such date is not a trading day, on the immediately preceding trading day. 3.2.2 For a period of 12 months commencing on the Date of Termination, the Company shall continue to keep in full force and effect all policies of medical, accident, disability and life insurance with respect to the Executive and his dependents with the same level of coverage, upon the same terms and otherwise to the same extent as such policies shall have been in effect immediately prior to the Date of Termination or, if more favorable to the Executive, as provided generally with respect to other peer executives of the Company and its affiliated companies, and the Company and the Executive shall share the costs of the continuation of such insurance coverage in the same proportion as such costs were shared immediately prior to the Date of Termination. 3.2.3 If on the Date of Termination the Executive shall not be fully vested with respect to any stock options previously granted to the Executive, on the Date of Termination all such stock options shall become immediately vested and exercisable (notwithstanding any provision of the Company's stock option plans to the contrary). Such options shall be exercisable for such period following the Date of Termination as is provided in the plan and/or agreement pursuant to which such options were granted. 2 3 3.3 If during the Termination Period the employment of the Executive shall terminate by reason of a Nonqualifying Termination, then the Company shall pay to the Executive within 30 days following the Date of Termination, a cash amount equal to the sum of (i) the Executive's full annual base salary from the Company and its affiliated companies through the Date of Termination, to the extent not theretofore paid, and (ii) any compensation previously deferred by the Executive (together with any interest and earnings thereon) and any accrued vacation pay, in each case to the extent not theretofore paid. 4. Limitation on Payments by the Company. Solely for the purposes of the computation of benefits under this Agreement and notwithstanding any other provisions hereof, payments to the Executive under this Agreement shall be reduced (but not below zero) so that the present value, as determined in accordance with Section 280G(d)(4) of the Code, of such payments plus any other payments that must be taken into account for purposes of any computation relating to the Executive under Section 280G(b)(2)(A)(ii) of the Code, shall not, in the aggregate, exceed 2.99 times the Executive's "base amount," as such term is defined in Section 280G(b)(3) of the Code. Notwithstanding any other provision hereof, no reduction in payments under the limitation contained in the immediately preceding sentence shall be applied to payments hereunder which do not constitute "excess parachute payments" within the meaning of the Code. Any payments in excess of the limitation of this Section 4 or otherwise determined to be "excess parachute payments" made to the Executive hereunder shall be deemed to be overpayments which shall constitute an amount owing from the Executive to the Company with interest from the date of receipt by the Executive to the date of repayment (or offset) at the applicable federal rate under Section 1274(d) of the Code, compounded semi-annually, which shall be payable to the Company upon demand. 5. Withholding Taxes. The Company may withhold from all payments due to the Executive (or his beneficiary or estate) hereunder all taxes which, by applicable federal, state, local or other law, the Company is required to withhold therefrom. 6. Reimbursement of Expenses. If any contest or dispute shall arise under this Agreement involving termination of the Executive's employment with the Company or involving the failure or refusal of the Company to perform fully in accordance with the terms hereof, the Company shall reimburse the Executive, on a current basis, for all legal fees and expenses, if any, incurred by the Executive in connection with such contest or dispute, together with interest in an amount equal to the prime or reference rate of the Company's principal bank from time to time in effect, but in no event higher than the maximum legal rate permissible under applicable law, such interest to accrue from the date the Company receives the Executive's statement for such fees and expenses through the date of payment thereof; provided, however, that in the event the resolution of any such contest or dispute includes a finding denying, in total, the Executive's claims in such contest or dispute, (i) the Company shall be entitled to deduct and withhold from any funds payable by the Company to the Executive the amount advanced to the Executive pursuant to this Section 6, and (ii) to the extent not reimbursed to the Company in such manner, the Executive shall be required to reimburse the Company, in twelve equal monthly installments commencing 30 days after such resolution, such amount. 7. Operative Event. Notwithstanding any provision herein to the contrary, no amounts shall be payable hereunder unless and until there is a Change in Control at a time when the Executive is employed by the Company. 8. Termination of Agreement. 3 4 8.1 This Agreement shall be effective on the date hereof and shall continue until terminated by the Company as provided in Section 8.2 hereof; provided, however, that this Agreement shall terminate in any event upon the first to occur of (i) the Executive's death, and (ii) termination of the Executive's employment with the Company prior to a Change in Control. 8.2 The Company shall have the right prior to a Change in Control, in its sole discretion, pursuant to action by the Board, to approve and cause the termination of this Agreement on such date as is fixed by the Board for such termination, which date shall be at least 90 days after notice thereof is given by the Company to the Executive in accordance with Section 11 hereof; provided, however, that no such action shall be taken by the Board during any period of time when the Board has knowledge that any Person has taken steps reasonably calculated to effect a Change in Control until, in the opinion of the Board, such Person has abandoned or terminated its efforts to effect a Change in Control; and provided further, that in no event shall this Agreement be terminated in the event of a Change in Control. 9. Scope of Agreement. Nothing in this Agreement shall be deemed to entitle the Executive to continued employment with the Company or its subsidiaries, and if the Executive's employment with the Company shall terminate prior to a Change in Control, the Executive shall have no further rights under this Agreement; provided, however, that any termination of the Executive's employment following a Change in Control shall be subject to all of the provisions of this Agreement. 10. Successors; Binding Agreement. 10.1 This Agreement shall not be terminated by any Reorganization of the Company irrespective of whether the Company is or is not the surviving or resulting corporation or as a result of any transfer of all or substantially all of the assets of the Company. In the event of any such Reorganization or transfer of assets, the provisions of this Agreement shall be binding upon the surviving or resulting corporation or the Person to which such assets are transferred. 10.2 The Company agrees that concurrently with any Reorganization or transfer of assets referred to in Section 10.1 in which either the Company is not the surviving Person or the surviving Person or successor or transferee is not deemed to assume this Agreement by operation of law, the Company will cause the surviving Person, successor or transferee unconditionally to assume, by written instrument delivered to the Executive (or his beneficiary or estate), all of the obligations of the Company hereunder. Failure of the Company to obtain such assumption prior to the effectiveness of any such Reorganization or transfer of assets shall be a breach of this Agreement and shall entitle the Executive to compensation and other benefits from the Company in the same amount and on the same terms as the Executive would be entitled hereunder if the Executive's employment were terminated following a Change in Control other than by reason of a Nonqualifying Termination. For purposes of implementing the foregoing, the date on which any such Reorganization or transfer becomes effective shall be deemed the Date of Termination. 10.3 This Agreement shall inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive shall die while any amounts would be payable to the Executive hereunder had the Executive continued to live, then, unless otherwise provided herein, all such amounts, shall be paid in accordance with the terms of this Agreement to such Persons appointed in writing by the Executive to receive such amounts or, if no Person is so appointed, to the Executive's estate. 4 5 11. Notices. 11.1 For purposes of this Agreement, all notices and other communications required or permitted hereunder shall be in writing and shall be deemed to have been duly given when delivered or five days after deposit in the United States mail, certified and return receipt requested, postage prepaid, addressed (i) if to the Executive, to the residence address of the Executive maintained from time to time by the Company; and if to the Company, to its chief executive office, attention Chief Executive Officer, with a copy to the Secretary of the Company; (ii) to such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 11.2 A written notice of the Executive's Date of Termination by the Company or the Executive, as the case may be, to the other, shall (i) indicate the specific termination provision in this Agreement relied upon, (ii) to the extent applicable, set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated, and (iii) specify the termination date (which date shall be not less than 15 days after the giving of such notice). The failure by the Executive or the Company to set forth in such notice any fact or circumstance which contributes to a showing of Good Reason or Cause shall not waive any right of the Executive or the Company hereunder or preclude the Executive or the Company from asserting such fact or circumstance in enforcing the Executive's or the Company's rights hereunder. 12. Full Settlement; No Mitigation; Resolution of Disputes. 12.1 The Company's obligation to make any payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Company may have against the Executive or other Persons. In no event shall the Executive be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Executive under any of the provisions of this Agreement and, such amounts shall not be reduced whether or not the Executive obtains other employment. 12.2 If there shall be any dispute between the Company and the Executive in the event of any termination of the Executive's employment, then, unless and until there is a final, nonappealable judgment by a court of competent jurisdiction declaring that such termination was for Cause, that the determination by the Executive of the existence of Good Reason was not made in good faith, or that the Company is not otherwise obligated to pay any amount or provide any benefit to the Executive and his dependents or other beneficiaries, as the case may be, under Sections 3.1 or 3.2 hereof, the Company shall pay all amounts, and provide all benefits, to the Executive and his dependents or other beneficiaries, as the case may be, that the Company would be required to pay or provide pursuant to Sections 3.1 and 3.2 hereof as though such termination were by the Company without Cause or by the Executive with Good Reason; provided, however, that the Company shall not be required to pay any disputed amounts pursuant to this section except upon receipt of an undertaking by or on behalf of the Executive to repay all such amounts to which the Executive is ultimately adjudged by such court not to be entitled. 13. Employment with Subsidiaries. Employment with the Company for purposes of this Agreement shall include employment with any corporation or other entity in which the Company has a direct or indirect ownership interest of 50% or more of the total combined voting power of the then 5 6 outstanding securities of such corporation or other entity entitled to vote generally in the election of directors. 14. Governing Law; Validity. The interpretation, construction and performance of this Agreement shall be governed by and construed and enforced in accordance with the internal laws of the State of Delaware without regard to the principle of conflicts of laws. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which other provisions shall remain in full force and effect. 15. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed to be an original and all of which together shall constitute one and the same instrument. 16. Miscellaneous. No provision of this Agreement may be modified or waived unless such modification or waiver is agreed to in writing and signed by the Executive and by a duly authorized officer of the Company. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. Failure by the Executive or the Company to insist upon strict compliance with any provision of this Agreement or to assert any right the Executive or the Company may have hereunder, including, without limitation, the right of the Executive to terminate employment for Good Reason, shall not be deemed to be a waiver of such provision or right or any other provision or right of this Agreement. The rights of, and benefits payable to, the Executive, his estate or his beneficiaries pursuant to this Agreement are in addition to any rights of, or benefits payable to, the Executive, his estate or his beneficiaries under any other employee benefit plan or compensation program of the Company. IN WITNESS WHEREOF, the Company and the Executive have executed this Agreement as of the day and year first above written. THQ INC. By: /s/ BRIAN J. FARRELL ---------------------------------- Brian J. Farrell, Chief Executive Officer EXECUTIVE: ________________________________________ Name: _________________________________ 6 7 ANNEX A CERTAIN DEFINED TERMS 1. "Board" means the Board of Directors of the Company. 2. "Cause means (i) a material breach by the Executive of those duties and responsibilities of the Executive which do not differ in any material respect from the duties and responsibilities of the Executive during the 90-day period immediately prior to a Change in Control (other than as a result of incapacity due to physical or mental illness), which breach is (a) demonstrably willful and deliberate on the Executive's part, (b) is committed in bad faith or without reasonable belief that such breach is in the best interests of the Company, and (c) is not remedied in a reasonable period of time after receipt of written notice from the Company specifying such breach; or (ii) the commission by the Executive of a felony involving moral turpitude. 3. "Change in Control" means the occurrence of either of the following: 3.1 The acquisition by any Person of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 30% or more of either (i) the Outstanding Company Common Stock, or (ii) the combined voting power of the Outstanding Company Voting Securities; provided, however, that the following acquisitions shall not constitute a Change in Control: 3.1.1 any acquisition of voting securities of the Company directly from the Company (including any acquisition resulting from the exercise of a conversion or exchange privilege in respect of outstanding convertible or exchangeable securities), unless such acquisition in connection with a Reorganization; 3.1.2 any acquisition by the Company of voting securities of the Company; or 3.1.3 any acquisition by an employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company; provided further that, for purposes of Section 3.1.2 of this Annex, if any Person (other than the Company or any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company) shall become the beneficial owner of 30% or more of the Outstanding Company Common Stock or 30% or more of the Outstanding Company Voting Securities by reason of an acquisition by the Company of another entity, and such Person shall, after such acquisition by the Company, become the beneficial owner of any additional shares of the Outstanding Company Common Stock or any additional Outstanding Company Voting Securities and such beneficial ownership is publicly announced, such additional beneficial ownership shall constitute a Change in Control. 3.2 The individuals who, at any time, constitute the Incumbent Board cease for any reason to constitute at least a majority of the Board. 4. "Code" means the Internal Revenue Code of 1986, as amended. 8 5. "Date of Termination" means (i) the effective date on which the Executive's employment by the Company terminates as specified in a prior written notice by the Company or the Executive, as the case may be, to the other, or (ii) if the Executive's employment by the Company terminates by reason of death, the date of death of the Executive. 6. "Exchange Act" means the Securities Exchange Act of 1934, as amended. 7. "Good Reason" means, unless the Executive expressly consents in writing, the occurrence of any of the following events after a Change in Control: 7.1 any removal or involuntary termination of the Executive from the Company otherwise than as expressly permitted by this Agreement; 7.2 a reduction by the Company in the Executive's rate of annual base salary as in effect immediately prior to such Change in Control or as the same may be increased from time to time thereafter, or the Company's failure to pay such salary; 7.3 any requirement of the Company that the Executive be based anywhere other than in the Los Angeles metropolitan area (or, if at the time of the Change of Control the Executive is based in another metropolitan area, any requirement of the Company that the Executive be based anywhere other than in that metropolitan area); 7.4 the failure of the Company to: 7.4.1 provide the Executive with employee benefit plans, compensation plans, paid vacation and other fringe benefits, and expense reimbursement, in accordance with the most favorable plans, practices, programs and policies of the Company and its affiliated companies in effect for the peer executives of the Company and its affiliated companies after the Change of Control; or 7.4.2 provide the Executive and the Executive's dependents welfare benefits (including, without limitation, medical, prescription, dental, disability, salary continuance, employee life, group life, accidental death and travel accident insurance plans and programs) in accordance with the most favorable plans, practices, programs and policies of the Company and its affiliated companies in effect for the peer executives of the Company and its affiliated companies after the Change of Control. 7.5 the failure of the Company to obtain the assumption agreement as contemplated by Section 10.2 of the Agreement. 8. "Incumbent Board" means (i) the individuals who, as of the date hereof, constitute the Board, and (ii) any individual who becomes a director of the Company subsequent to the date hereof whose election, or nomination for election by the Company's stockholders, is approved by the vote of at least a majority of the directors then comprising the Incumbent Board; provided, however, that no individual who was initially elected as a director of the Company as a result of an actual or threatened election contest, as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Exchange Act, or any other actual or threatened solicitation of proxies or consents by or on behalf of any Person other than the Board, shall be deemed to be a member of the Incumbent Board A-2 9 9. "Nonqualifying Termination" means a termination of the Executive's employment (i) by the Company for Cause, (ii) by the Executive for any reason other than a Good Reason, (iii) as a result of the Executive's death, or (iv) by the Company due to the Executive's absence from his duties with the Company on a full-time basis for at least 180 consecutive days as a result of the Executive's incapacity due to physical or mental illness. 10. "Outstanding Company Common Stock" means, as of any time, the shares of common stock of the Company outstanding as of that time. 11. "Outstanding Company Voting Securities" means, as of any time, the securities of the Company entitled to vote generally in the election of directors outstanding as of that time. 12. "Plan" means the Company's [401(k) Plan] or any successor plan. 13. "Person" means any individual, entity or group, and includes any "person" within the meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act. 14. "Reorganization" means reorganization, merger or consolidation. 15. "Termination Period" means the period of time beginning with a Change in Control and ending on the earlier to occur of (i) one year following such Change in Control, and (ii) the Executive's death. A-3 EX-10.8 4 EXHBIT 10.8 1 EXHIBIT 10.8 TRADE FINANCE AGREEMENT THIS TRADE FINANCE AGREEMENT ("Agreement") is made and entered into as of December 4, 1998, by and between THQ INC., a Delaware corporation ("Borrower"), and UNION BANK OF CALIFORNIA, N.A., a national banking association ("Bank"). SECTION 1. THE CREDIT 1.1 THE TRADE FINANCE CREDIT FACILITY. Bank will extend to Borrower a trade finance credit facility in an aggregate amount not to exceed Thirty Million Dollars ($30,000,000) (the "Trade Finance Credit Facility"). The Trade Finance Credit Facility shall terminate on May 1, 2000 and be subject to the following sublimits: (a) The Commercial L/C Line in an amount not to exceed (i) Thirty Million Dollars ($30,000,000) during the period from August 1 to and including February 28 (or February 29, in the case of a leap year) of each calendar year and (ii) Fifteen Million Dollars ($15,000,000) during the period from March 1 to and including July 31 of each calendar year; (b) The Clean Advance Line in an amount not to exceed (i) Twenty Million Dollars ($20,000,000) during the period from the date of this Agreement to and including February 28, 1999 and (ii) Fifteen Million Dollars ($15,000,000) thereafter; and (c) The Standby L/C Line in an amount not to exceed Thirty Million Dollars ($30,000,000) during the period from the date of this Agreement to and including May 31, 1999. 1.1.1 THE COMMERCIAL L/C LINE. Bank shall issue, for the account of Borrower, one or more irrevocable commercial letters of credit (individually, a "Commercial L/C" and collectively, the "Commercial L/Cs") and calling for drafts at sight covering the importation or purchase of game cartridges and CD roms (the "Commercial L/C Line"). Each Commercial L/C shall be drawn on such terms and conditions as are acceptable to Bank and shall be governed by the terms of (and Borrower agrees to execute) Bank's standard form of Commercial L/C application and reimbursement agreement. No Commercial L/C shall have an expiration date more than ninety (90) days from its date of issuance. No Commercial L/C shall expire later than July 31, 2000. 1.1.2 CLEAN ADVANCE LINE. Bank will also make available an amount that will not exceed the amount listed above (the "Clean Advance Line") for Borrower's working capital purposes; provided, however, that for at least sixty (60) consecutive days during each twelve (12) month period, commencing on the date of this Agreement, there shall be no advances outstanding under the Clean Advance Line. All advances under the Clean Advance Line must be made on or before May 1, 2000, at which time all unpaid principal and interest under the Clean Advance Line shall be due and 1 2 payable. Borrower may borrow, repay and reborrow all or part of the Clean Advance Line in accordance with the terms of the Clean Advance Note (as such term is defined hereinbelow). The Clean Advance Line shall be evidenced by a promissory note (the "Clean Advance Note") on the standard form used by Bank to evidence its commercial loans. Bank shall enter each amount borrowed and repaid in Bank's records and such entries shall be deemed to be the amount of the Clean Advance Line outstanding. Omission by Bank to make any such entries shall not discharge Borrower of its obligation to repay amounts borrowed in full with interest. 1.1.3 THE STANDBY L/C LINE. Bank shall issue, for the account of Borrower, one or more irrevocable, standby letters of credit (individually, a "Standby L/C" and collectively, the "Standby L/Cs"). Each such Standby L/C shall be drawn on such terms and conditions as are acceptable to Bank and shall be governed by the terms of (and Borrower agrees to execute) Bank's standard form of Standby L/C application and reimbursement agreement with respect thereto. No Standby L/C shall expire after May 31, 1999. 1.1.4 TRADE FINANCE CREDIT FACILITY SUBLIMITS. The aggregate amount available to be drawn under each sublimit listed above shall be reduced, dollar for dollar, by the aggregate amount of unpaid principal obligations under the respective sublimit. The aggregate of all unpaid advances and reimbursement obligations shall reduce, dollar for dollar, the maximum amount available under the Trade Finance Credit Facility. Borrower may reborrow or obtain new extensions of credit under each such sublimit until the expiration date of the Trade Finance Credit Facility, to the extent that Borrower has paid or otherwise satisfied prior borrowings or extensions of credit, subject to all terms and conditions in the Loan Documents. 1.2 TERMINOLOGY. As used herein, the following terms shall have the following meanings: (a) The term "L/C" shall mean all Commercial L/Cs and Standby L/Cs described above. (b) The term "Loan" shall mean all of the credit facilities described above. (c) The term "Loan Documents" shall mean all documents, instruments and agreements executed in connection with this Agreement. (d) The term "Note" shall mean all of the promissory notes described above. (e) The term "T.HQ International" shall mean T.HQ International, Ltd., a corporation organized and existing under the laws of the United Kingdom, and a wholly-owned subsidiary of Borrower. (f) The term "T.HQ International Agreement" shall mean that certain Trade Finance Agreement dated as of December 4, 1998, by and between T.HQ International and Bank, as at any time amended, supplemented or otherwise modified or restated. 2 3 1.3 PURPOSE OF THE LOAN. Each Commercial L/C shall be issued by Bank to finance Borrower's customary trade cycle. Each advance under the Clean Advance Line shall be used for Borrower's general working capital purposes. Each Standby L/C shall be issued by Bank to Imperial Bank, as beneficiary, in order to support Borrower's obligations to Imperial Bank with respect to certain existing commercial letters of credit previously issued by Imperial Bank. 1.4 INTEREST. The unpaid principal balance of the Loan shall bear interest at the rate or rates provided in the Note and selected by Borrower. The Loan may be prepaid in full or in part only in accordance with the terms of the Note and any such prepayment shall be subject to the prepayment fee provided for therein. 1.5 TRADE FINANCE FEES. All fees in connection with the Trade Finance Credit Facility will be in accordance with Bank's standard schedule of fees as published from time to time, except as follows: (a) The fees in connection with the issuance of each Commercial L/C shall be, for each three-month period or fraction thereof, the greater of (i) one-eighth of one percent (1/8 of 1%) or (ii) Ninety Dollars ($90.00); (b) The fees in connection with the payment of each Commercial L/C shall be the greater of (i) one-eighth of one percent (1/8 of 1%) per set of documents or (ii) Seventy Dollars ($70.00); and (c) The fees in connection with any amendment to a Commercial L/C shall be, for each three-month period or fraction thereof, the greater of (i) one-tenth of one percent (1/10 of 1%) or (ii) Sixty Dollars ($60.00). 1.6 LOAN COMMITMENT FEE. Borrower shall pay to Bank a commitment fee of Seventy-Five Thousand Dollars ($75,000) on or before the date of execution of this Agreement. No portion of such fee shall be reimbursable. 1.7 BALANCES. Borrower shall maintain its major depository accounts with Bank until the Note and all sums payable pursuant to this Agreement and the Loan Documents have been paid in full. 1.8 DISBURSEMENT. Upon the execution hereof, Bank shall disburse the proceeds of the Loan as provided in Bank's standard form Authorizations to Disburse executed by Borrower. 1.9 SECURITY. Prior to any extension of credit under the Loan, Borrower shall have executed a security agreement, on Bank's standard form, and a UCC financing statement, suitable for filing in the office of the Secretary of State of the State of California and any other state designated by Bank, granting to Bank a first priority security interest in such of Borrower's property as is described in said security agreement. The security agreement shall provide that upon the occurrence of an Event 3 4 of Default, Bank shall be entitled to exercise its remedies against the collateral described therein and to sell such collateral wherever and to whomever Bank deems necessary, in its reasonable discretion. Exceptions to Bank's first priority, if any, are permitted only as otherwise provided in this Agreement. At Bank's request, Borrower will also obtain executed landlord's and mortgagee's waivers on Bank's form covering all of Borrower's property located on leased or encumbered real property. 1.10 CONTROLLING DOCUMENT. In the event of any inconsistency between the terms of this Agreement and the Note or any of the other Loan Documents, the terms of the Note or such other Loan Documents will prevail over the terms of this Agreement. SECTION 2. CONDITIONS PRECEDENT Bank shall not be obligated to disburse all or any portion of the proceeds of or extend any credit under the Loan unless at or prior to the time for extending such credit, the following conditions have been fulfilled to Bank's satisfaction: 2.1 COMPLIANCE. Borrower shall have performed and complied with all terms and conditions required by this Agreement to be performed or complied with by it prior to or at the date of the making of such disbursement and shall have executed and delivered to Bank the Note and the other Loan Documents. 2.2 BORROWING RESOLUTION. Borrower shall have provided Bank with certified copies of resolutions duly adopted by the board of directors of Borrower, authorizing the execution, delivery and performance of this Agreement and the Loan Documents. Such resolutions shall also designate the persons who are authorized to act on Borrower's behalf in connection with this Agreement and to do the things required of Borrower pursuant to this Agreement. 2.3 TERMINATION STATEMENTS. Borrower shall have provided Bank with UCC termination statements executed by such secured creditors as may be required by Bank, suitable for filing with the Secretary of State in each state designated by Bank. 2.4 CONTINUING COMPLIANCE. At the time any L/C is to be issued or any disbursement is to be made, there shall not exist any event, condition or act which constitutes an Event of Default under Section 6 hereof or any event, condition or act which with notice, lapse of time or both would constitute an Event of Default; nor shall there be any such event, condition or act immediately after such credit extension were it to be made. SECTION 3. REPRESENTATIONS AND WARRANTIES Borrower represents and warrants that: 4 5 3.1 BUSINESS ACTIVITY. The principal business of Borrower is the development, publication and distribution of interactive software. 3.2 SUBSIDIARIES. Borrower's subsidiaries (those entities in which Borrower has either a controlling interest or at least a twenty-five percent (25%) ownership interest) and their addresses, and the names of Borrower's principal shareholders are as provided on a schedule delivered to Bank on or before the date of this Agreement. 3.3 AUTHORITY TO BORROW. The execution, delivery and performance of this Agreement, the Note and the other Loan Documents are not in contravention of any of the terms of any indenture, agreement or undertaking to which Borrower is a party or by which it or any of its property is bound or affected. 3.4 FINANCIAL STATEMENTS. The consolidated financial statements of Borrower and its subsidiaries, including both a consolidated balance sheet at September 30, 1998, together with supporting schedules, and a consolidated income statement for the nine (9) months ended September 30, 1998, have heretofore been furnished to Bank, and are true and complete and fairly represent the financial condition of Borrower and its subsidiaries during the period covered thereby. Since September 30, 1998, there has been no material adverse change in the financial condition or operations of Borrower and its subsidiaries taken as a whole. 3.5 TITLE. Except for assets which may have been disposed of in the ordinary course of business, Borrower and its subsidiaries have good and marketable title to all of the property reflected in the consolidated financial statements of Borrower and its subsidiaries delivered to Bank for the nine (9) months ended September 30, 1998, and to all property acquired by Borrower and its subsidiaries since the date of such financial statements, free and clear of all Liens (as such term is defined in subsection 5.1 hereof) except those specifically referred to in such financial statements. This representation and warranty shall not apply to the property of Rushware Microhandelsgesellschaft mbH and its two subsidiaries, SOFTGOLD Computerspiele GmbH and ABC Spielspass GmbH (collectively, the "Rushware Entities"). 3.6 LITIGATION. There is no litigation or proceeding pending or threatened against Borrower or any of its property which is reasonably likely to affect the financial condition, property or business of Borrower in a materially adverse manner. 3.7 DEFAULT. Borrower is not now in default in the payment of any of its material obligations (including, without limitation, any obligation to make royalty payments under any license agreement to which it is a party), and there exists no event, condition or act which constitutes an Event of Default under Section 6 hereof and no condition, event or act which with notice or lapse of time, or both, would constitute an Event of Default. 3.8 ORGANIZATION. Borrower is duly organized and existing under the laws of the jurisdiction of its organization, and has the power and authority to carry on the business in which it is engaged and/or proposes to engage. 5 6 3.9 POWER. Borrower has the power and authority to enter into this Agreement and to execute and deliver the Note and the other Loan Documents. 3.10 AUTHORIZATION. This Agreement and all things required by this Agreement have been duly authorized by all requisite corporate action of Borrower. 3.11 QUALIFICATION. Borrower is duly qualified and in good standing in any jurisdiction where such qualification is required. 3.12 COMPLIANCE WITH LAWS. Borrower is in compliance with all applicable laws, rules, ordinances and regulations which materially affect the operations or financial condition of Borrower. 3.13 REGULATION U. No action has been taken or is currently planned by Borrower, or any agent acting on its behalf, which would cause this Agreement or the Note to violate Regulation U or any other regulation of the Board of Governors of the Federal Reserve System or to violate the Securities and Exchange Act of 1934, in each case as in effect now or as the same may hereafter be in effect. Borrower is not engaged in the business of extending credit for the purpose of purchasing or carrying margin stock as one of its important activities and none of the proceeds of the Loan will be used, directly or indirectly, for such purpose. 3.14 CONTINUING REPRESENTATIONS. The foregoing representations and warranties shall be considered to have been made again at and as of the date each L/C is issued and each advance is made and shall be true and correct as of such date or dates. SECTION 4. AFFIRMATIVE COVENANTS Until the Note and all sums payable pursuant to this Agreement and the Loan Documents have been paid in full, unless Bank otherwise consents in writing, Borrower agrees that: 4.1 USE OF PROCEEDS. Borrower will use the Loan and its proceeds only as provided in subsection 1.3 above. 4.2 PAYMENT OF OBLIGATIONS. Borrower will pay and discharge promptly all taxes, assessments and other governmental charges and claims levied or imposed upon it or its property, or any part thereof; provided, however, that Borrower shall have the right in good faith to contest any such taxes, assessments, charges or claims and, pending the outcome of such contest, to delay or refuse payment thereof provided that adequately funded reserves are established by it to pay and discharge any such taxes, assessments, charges and claims. 6 7 4.3 MAINTENANCE OF EXISTENCE. Borrower will maintain and preserve its existence and assets and all rights, franchises, licenses and other authority necessary for the conduct of its business and will maintain and preserve its property, equipment and facilities in good order, condition and repair. Bank may, at reasonable times, visit and inspect any of the properties of Borrower. 4.4 RECORDS. Borrower will keep and maintain full and accurate accounts and records of its operations according to generally accepted accounting principles and will permit Bank's internal auditors to have access thereto, to make examination and photocopies thereof, and to make audits during regular business hours, but no more frequently than quarterly, unless an Event of Default has occurred and is continuing or there has been a material adverse change in Borrower's financial condition. Costs for such audits shall be paid by Borrower. 4.5 INFORMATION FURNISHED. Borrower will furnish to Bank: (a) Within sixty (60) days after the close of each fiscal quarter, except for the final quarter of each fiscal year, copies of the unaudited consolidated balance sheet of Borrower and its subsidiaries on Form 10-Q as of the close of such fiscal quarter, the unaudited consolidated income and expense statement of Borrower and its subsidiaries, with supportive schedules, and the consolidated statement of retained earnings of Borrower and its subsidiaries for such fiscal quarter, prepared in accordance with generally accepted accounting principles; (b) Within one hundred twenty (120) days after the close of each fiscal year, copies of the consolidated statement of financial condition of Borrower and its subsidiaries on Form 10-K, including at least the consolidated balance sheet of Borrower and its subsidiaries as of the close of such fiscal year, the consolidated income and expense statement of Borrower and its subsidiaries, with supportive schedules, and the consolidated statement of retained earnings of Borrower and its subsidiaries for such fiscal year, examined and prepared on an audited basis by independent certified public accountants selected by Borrower and reasonably satisfactory to Bank in accordance with generally accepted accounting principles applied on a basis consistent with that of the previous fiscal year; (c) Concurrently with the financial information furnished to Bank pursuant to subparagraph (a) of this subsection 4.5, copies of the unaudited consolidating balance sheet of Borrower and each of its subsidiaries as of the close of each fiscal quarter, and the unaudited consolidating income and expense statement of Borrower and each of its subsidiaries as of the close of each fiscal quarter, with supportive schedules, prepared in accordance with generally accepted accounting principles; (d) Concurrently with the financial information furnished to Bank pursuant to subparagraph (b) of this subsection 4.5, copies of the consolidating statement of financial condition of Borrower and each of its subsidiaries, including at least the consolidating balance sheet of Borrower and each of its subsidiaries as of the close of such fiscal year, and the consolidating income and expense statement of Borrower and 7 8 each of its subsidiaries, with supportive schedules, prepared in accordance with generally accepted accounting principles; (e) Within one hundred twenty (120) days after the close of each fiscal year, a copy of the projections of Borrower and its subsidiaries for the following fiscal year, in form and substance reasonably acceptable to Bank; (f) As soon as available, copies of such financial statements and reports as Borrower or any of its subsidiaries may file with any state or federal agency, excluding any state or federal income tax returns; (g) Such other financial statements and information as Bank may reasonably request from time to time; (h) Prompt written notice to Bank of any Event of Default under any of the terms or provisions of this Agreement or of any default under any other agreement, contract, document or instrument entered, or to be entered into with Bank; and of any litigation which, if decided adversely to Borrower or any of its subsidiaries, would have a material adverse effect on the financial condition of Borrower or any of its subsidiaries; and of any other matter which has resulted in, or is likely to result in, a material adverse change in the financial condition or operations of Borrower or any of its subsidiaries; (i) Prompt written notice to Bank of any default, whether resulting from the nonpayment of royalties or otherwise, that has occurred under the terms of any license agreement to which Borrower or any of its affiliates is a party; (j) Prompt written notice to Bank of any change in Borrower's chief executive officer, president, chief financial officer or any senior vice president; Borrower's name; and location of Borrower's assets, principal place of business or chief executive office; (k) Concurrently with the financial information furnished to Bank pursuant to subparagraphs (a) and (b) of this subsection 4.5, a copy of the agings of the accounts receivable of Borrower and its subsidiaries (which shall include, without limitation, detail as to any charges against reserves and current reserve position) and a copy of an inventory report for Borrower and its subsidiaries (which shall include, without limitation, detail as to any write-downs and returns), each in a form acceptable to Bank and certified as being true and correct by Borrower's Vice President Finance & Administration or other duly authorized officer of Borrower; and (l) Concurrently with the financial information furnished to Bank pursuant to subparagraphs (a) and (b) of this subsection 4.5, a written statement of Borrower's Vice President Finance & Administration or other duly authorized officer of Borrower, certifying that no Event of Default, and no event which, with the lapse of time or notice, or both, would become an Event of Default, has occurred and is continuing, or if an Event of Default or potential Event of Default has occurred and is continuing, setting forth the details of such Event of Default or potential Event of Default and stating the action which Borrower has taken, is taking or proposes to take with respect thereto. 8 9 4.6 CONSOLIDATED QUICK RATIO. Borrower shall not permit the ratio of (a) the sum of cash, Cash Equivalents and accounts receivable, in each case for Borrower and its subsidiaries, to (b) the consolidated current liabilities of Borrower and its subsidiaries (including advances made under the Clean Advance Line and outstanding at such time) to be less than 1.25:1.00 as at the end of any fiscal quarter. As used herein, the term "Cash Equivalents" shall mean (i) securities issued or directly and fully guaranteed or insured by the United States of America or any agency or instrumentality thereof (provided that the full faith and credit of the United States of America is pledged in support thereof), (ii) Dollar denominated time deposits and certificates of deposit of any commercial bank having a long-term unsecured debt rating of at least A or the equivalent thereof from Standard & Poor's Ratings Services, a division of McGraw-Hill, Inc. ("S&P"), (iii) commercial paper issued by any corporation organized under the laws of any state of the United States of America having a rating of at least A- or the equivalent thereof from S&P or at least P-1 or the equivalent thereof from Moody's Investors Service, Inc. ("Moody's") and (iv) investments in money market funds substantially all of which are comprised of securities of the types described in clauses (i) through (iii) hereinabove. 4.7 INVENTORY TURNOVER. Borrower shall not permit its level of Inventory Turnover to exceed thirty (30) days on a cumulative basis for any fiscal quarter. As used herein, the term "Inventory Turnover" shall mean (a) the value of the Inventory of Borrower and its subsidiaries as of the last day of each fiscal quarter, determined at the lower of cost or fair market value, on a first-in, first-out basis, in accordance with generally accepted accounting principles, divided by (b) the greater of (i) four (4) times the cost of sales for such Inventory for such fiscal quarter or (ii) the aggregate cost of sales for such Inventory for such fiscal quarter and the three (3) immediately preceding fiscal quarters, multiplied by (c) 365 days. As used in this Agreement, the term "Inventory" shall mean all present and future inventory in which Borrower or any of its subsidiaries has any interest, including but not limited to goods, machinery, equipment held by Borrower or such subsidiary for sale or lease or to be furnished under a contract of service and all of Borrower's or such subsidiary's present and future raw materials, work in process, finished goods and packing and shipping materials, wherever located, and any documents of title representing any of the above. 4.8 CONSOLIDATED SHAREHOLDERS' EQUITY. Borrower will achieve Consolidated Shareholders' Equity of not less than Fifty Million Dollars ($50,000,000) as at the end of the fiscal year ending December 31, 1998. Such Consolidated Shareholders' Equity shall increase as of December 31, 1999, and thereafter, as of the end of each successive fiscal year, by an amount not less than the greater of (a) Ten Million Dollars ($10,000,000) or (b) ninety percent (90%) of the consolidated net profit after taxes of Borrower and its subsidiaries for such fiscal year. As used in this Agreement, "Consolidated Shareholders' Equity" shall mean the consolidated net worth of Borrower and its subsidiaries as reflected in the quarterly consolidated balance sheet of Borrower and its subsidiaries on Form 10-Q and in the annual consolidated statement of financial condition of Borrower and its subsidiaries on Form 10-K. 9 10 4.9 CONSOLIDATED TOTAL LIABILITIES TO CONSOLIDATED SHAREHOLDERS' EQUITY. Borrower will maintain a ratio of Consolidated Total Liabilities to Consolidated Shareholders' Equity of not greater than 1.00:1.00 as at the end of each fiscal quarter. As used in this Agreement, "Consolidated Total Liabilities" shall mean the consolidated total liabilities of Borrower and its subsidiaries, as determined in accordance with generally accepted accounting principles, as shown on the liability side of the consolidated balance sheet of Borrower and its subsidiaries. 4.10 CONSOLIDATED OPERATING PROFIT. Borrower will achieve Consolidated Operating Profit of not less than One Dollar ($1) as at the end of and for each fiscal quarter. As used in this Agreement, "Consolidated Operating Profit" shall mean the consolidated net operating income of Borrower and its subsidiaries, as determined in accordance with generally accepted accounting principles, before provision for taxes and non-recurring expenses. 4.11 INSURANCE. Borrower will keep all of its insurable property, whether real, personal or mixed, insured by companies and in amounts approved by Bank against fire and such other risks as are customarily insured against by companies conducting similar business. Borrower will maintain workers compensation insurance, insurance against liability for damage to persons or property and insurance to cover loss of or to goods in transit to Borrower. Borrower will furnish to Bank statements of its insurance coverage, will promptly furnish other or additional insurance deemed necessary by and upon request of Bank to the extent that such insurance may be available and hereby assigns to Bank, as security for Borrower's obligations to Bank, the proceeds of any such insurance. All of such insurance shall be maintained in such amounts as is customarily obtained by companies conducting similar business with respect to like risks. Prior to any extension of credit, Bank will be named loss payee on all policies insuring collateral. All policies shall require at least ten (10) days' written notice to Bank before any policy may be altered or cancelled. 4.12 ADDITIONAL REQUIREMENTS. Borrower will promptly, upon demand by Bank, take such further action and execute all such additional documents and instruments in connection with this Agreement as Bank in its reasonable discretion deems necessary, and promptly supply Bank with such other information concerning its affairs as Bank may request from time to time. 4.13 LITIGATION AND ATTORNEYS' FEES. Borrower will pay promptly to Bank upon demand, reasonable attorneys' fees (including but not limited to the reasonable estimate of the allocated costs and expenses of in-house legal counsel and staff) and all costs and other expenses paid or incurred by Bank in collecting, modifying or compromising the Loan or in enforcing or exercising its rights or remedies created by, connected with or provided for in this Agreement or any of the Loan Documents, whether or not an arbitration, judicial action or other proceeding is commenced. If such proceeding is commenced, only the prevailing party shall be entitled to attorneys' fees and court costs. 10 11 4.14 BANK EXPENSES. Borrower will pay or reimburse Bank for all costs, expenses and fees incurred by Bank in preparing and documenting this Agreement, the Loan Documents and the Loan, and all amendments and modifications thereof, including but not limited to all filing and recording fees, costs of appraisals, insurance and attorneys' fees, including the reasonable estimate of the allocated costs and expenses of in-house legal counsel and staff. 4.15 ROYALTY PAYMENTS. Borrower will comply, and will cause each of its affiliates to comply, in all material respects with any and all license agreements to which Borrower or any such affiliate is a party. Without in any manner limiting the generality of the foregoing sentence, Borrower will pay, and will cause each of such affiliates to pay, all royalty and other payments required to be paid by Borrower or such affiliate under such license agreements when and as such payments become due. SECTION 5. NEGATIVE COVENANTS Until the Note and all other sums payable pursuant to this Agreement and the Loan Documents have been paid in full, unless Bank otherwise consents in writing, Borrower agrees that: 5.1 LIENS. Borrower will not create, assume or suffer to exist any mortgage, pledge, security interest, encumbrance, or lien (collectively, "Liens" and individually, a "Lien") (other than for taxes not delinquent and for taxes and other items being contested in good faith) on property of any kind, whether real, personal or mixed, now owned or hereafter acquired, or upon the income or profits thereof, except (a) Liens in favor of Bank, (b) minor encumbrances and easements on real property which do not affect its market, (c) Liens in favor of Imperial Bank securing reimbursement obligations of Borrower in respect of commercial letters of credit previously issued by Imperial Bank and (d) Liens upon equipment or other property created in connection with the acquisition by Borrower of such equipment or other property, provided, however, that (i) the indebtedness incurred to finance each such acquisition is permitted by this Agreement, (ii) each such Lien attaches only to the equipment or other property acquired with the indebtedness secured thereby and (iii) the indebtedness incurred to finance each such acquisition does not exceed Two Hundred Fifty Thousand Dollars ($250,000). 5.2 BORROWINGS. Borrower will not sell, discount or otherwise transfer any account receivable or any note, draft or other evidence of indebtedness, except to Bank or except to a financial institution at face value for deposit or collection purposes only and without any fee other than fees normally charged by the financial institution for deposit or collection services. Except as otherwise provided in this Agreement, Borrower will not borrow any money, become contingently liable to borrow money, nor enter any agreement to directly or indirectly obtain borrowed money, except (a) pursuant to agreements made with Bank and (b) pursuant to reimbursement agreements made with Imperial Bank in connection with commercial letters of credit previously issued by Imperial Bank. 11 12 5.3 SALE OF ASSETS, LIQUIDATION OR MERGER. Borrower will not liquidate, dissolve or enter into any consolidation, merger, partnership or other combination, nor convey, sell or lease all or the greater part of its assets or business, nor purchase or lease all or the greater part of the assets or business of another; provided, however, that Borrower may purchase all or the greater part of the assets or business of another so long as (a) no Event of Default or event which, with the lapse of time or notice, or both, would become an Event of Default, has occurred and is continuing or would result therefrom, (b) Borrower provides Bank with prior written notice thereof and (c) the sum of (i) the aggregate amount of all such acquisitions plus (ii) the aggregate outstanding principal amount of all loans, advances and guaranties permitted under subsection 5.4(c) hereof shall not exceed Five Million Dollars ($5,000,000) at any time. 5.4 LOANS, ADVANCES AND GUARANTIES. Borrower will not, except in the ordinary course of business as currently conducted, make any loans or advances, become a guarantor or surety, pledge its credit or properties in any manner or extend credit; provided, however, that (a) Borrower may guarantee certain working capital obligations of the Rushware Entities, or any of them, to one or more financial institutions, so long as the principal amount of the obligations of the Rushware Entities so guaranteed does not exceed, in the aggregate amount at any one time outstanding, the sum of Ten Million Dollars ($10,000,000), (b) Borrower may make, or permit to exist, loans or advances to T.HQ International, provided that the aggregate outstanding principal amount of all such loans or advances shall not exceed Nine Million Five Hundred Thousand Dollars ($9,500,000) at any one time and (c) on or after the date of this Agreement, Borrower may make loans or advances to, or guarantee the obligations of any of its affiliates (in addition to the loans or advances to T.HQ International permitted by subparagraph (b) hereof), provided that the sum of (i) the aggregate outstanding principal amount of all loans or advances so made, or obligations so guaranteed, plus (ii) the aggregate amount of all acquisitions permitted by subsection 5.3 hereof, shall not exceed Five Million Dollars ($5,000,000) at any time. 5.5 INVESTMENTS. Borrower will not purchase the debt or equity of another person or entity except (a) for savings accounts, money market accounts, sweep investment accounts and certificates of deposit of Bank, (b) for direct U.S. Government obligations and commercial paper issued by corporations with the top ratings of Moody's or S&P, provided that all such permitted investments shall mature within one (1) year of purchase, and (c) as permitted by subsection 5.3 of this Agreement. 5.6 PAYMENT OF DIVIDENDS. Borrower will not declare or pay any dividends, other than a dividend payable in its own common stock, or authorize or make any other distribution with respect to any of its stock now or hereafter outstanding. 5.7 RETIREMENT OF STOCK. Borrower will not acquire or retire any share of its capital stock for value. 5.8 PARENT AND SUBSIDIARY PROPERTY. Borrower will not transfer any property to its parent or any affiliate of its parent, except for value received in the normal 12 13 course of business as business would be conducted with an unrelated or unaffiliated entity. In no event shall management fees or fees for services be paid by Borrower to any such direct or indirect affiliate without Bank's prior written approval. 5.9 CAPITAL EXPENDITURES. Borrower and its subsidiaries shall not make capital expenditures in excess of Seven Hundred Fifty Thousand Dollars ($750,000) in any fiscal year, as reflected in the consolidated balance sheet of Borrower and its subsidiaries on Form 10-Q and in the consolidated statement of financial condition of Borrower and its subsidiaries on Form 10-K. Each such capital expenditure shall be needed by Borrower or any of its subsidiaries in the ordinary course of its business. 5.10 LEASE OBLIGATIONS. Borrower shall not, and shall not permit any of its subsidiaries to, incur new lease obligations as lessee which would result in aggregate lease payments made by Borrower and its subsidiaries for any fiscal year exceeding Six Hundred Thousand Dollars ($600,000). Each said lease shall be of equipment or real property needed by Borrower or any of its subsidiaries in the ordinary course of its business. SECTION 6. EVENTS OF DEFAULT Upon the occurrence of any of the following events ("Events of Default"), Bank, in its discretion, may cease extending credit hereunder and may declare all obligations hereunder and under the Loan Documents immediately due and payable; provided, however, that upon the occurrence of an Event of Default described in subsection 6.4, 6.5, 6.6, 6.7 or 6.8 hereinbelow, all principal and interest and any other amounts owing under the Loan Documents shall automatically become immediately due and payable. 6.1 PAYMENT DEFAULTS. Borrower shall default in the due and punctual payment of the principal of or the interest on the Note or any of the other Loan Documents; or 6.2 BREACH OF REPRESENTATIONS OR WARRANTIES Any representation or warranty made or deemed made by Borrower under this Agreement or any Loan Document to which it is a party shall prove to have been incorrect in any material respect on and as of the date made or deemed made; or 6.3 COVENANT DEFAULTS. Borrower shall default in the due performance or observance of any covenant or condition of any Loan Document to which it is a party and, in the case of the covenants set forth in subsections 4.2, 4.3, 4.4, 4.5, 5.1, 5.2, 5.5, 5.6, 5.7 and 5.8 and in the security agreement provided for in subsection 1.9 hereof only, but only if such default is capable of being cured, shall fail to cure such default within thirty (30) days; or 6.4 INSOLVENCY. Borrower shall become insolvent or fail to pay its debts as such debts become due; or 13 14 6.5 BANKRUPTCY. Borrower shall commence any voluntary proceeding under any laws relating to bankruptcy, insolvency, reorganization, arrangement, debt adjustment or debtor relief or shall consent to any relief in any involuntary proceeding under any laws relating to bankruptcy, insolvency, reorganization, arrangement, debt adjustment or debtor relief; or any contested involuntary proceeding under any laws relating to bankruptcy, insolvency, reorganization, arrangement, debt adjustment or debtor relief shall be commenced against Borrower and such involuntary proceeding shall not be dismissed or discharged within sixty (60) days of commencement; or 6.6 ASSIGNMENT FOR BENEFIT OF CREDITORS. There shall be an assignment by Borrower for the benefit of its creditors; or 6.7 APPOINTMENT OF RECEIVER. Borrower shall apply for or consent to the appointment, or commence any proceeding for the appointment, of a receiver, trustee, custodian or similar official for all or substantially all of Borrower's property; or any proceeding for the appointment of a receiver, trustee, custodian or similar official for all or substantially all of Borrower's property shall be commenced against Borrower or its property and shall not be dismissed or discharged within sixty (60) days of commencement; or 6.8 DISSOLUTION OR LIQUIDATION. Borrower shall be dissolved or liquidated in full or in part; or any proceeding for the dissolution or liquidation of Borrower shall be commenced against Borrower and not dismissed or discharged within sixty (60) days of commencement; or 6.9 FAILURE TO COMPLY. Borrower shall fail to comply with (a) any money judgment in an individual amount of Five Hundred Thousand Dollars ($500,000) or more, or in an aggregate amount of One Million Dollars ($1,000,000) or more, or (b) any order, non-monetary judgment, injunction, decree, writ or demand of any court or other public authority and, in the case of either subparagraph (a) or (b) of this subsection 6.9, such order, judgment, injunction, decree, writ or demand shall continue unsatisfied and in effect for a period of thirty (30) days without being vacated, discharged, satisfied or stayed or bonded pending appeal; or 6.10 LEGAL PROCESS. There shall be filed or recorded any notice of levy, notice to withhold, or other legal process for taxes other than property taxes against Borrower or against the property of Borrower in an individual amount of Five Hundred Thousand Dollars ($500,000) or more, or in an aggregate amount of One Million Dollars ($1,000,000) or more, and such notice or other legal process shall not be released, stayed, vacated, bonded or otherwise dismissed within thirty (30) days after the date of its filing or recording; or 6.11 DEFAULT CONCERNING BORROWING OF MONEY. Borrower shall default on any obligation concerning the borrowing of money that is outstanding in the aggregate amount of One Hundred Thousand Dollars ($100,000) or more; or 14 15 6.12 WRITS OF ATTACHMENT, ETC. The issuance against Borrower, or the property of Borrower, of any writ of attachment, writ of execution or other judicial lien in an individual amount of Five Hundred Thousand Dollars ($500,000) or more, or in an aggregate amount of One Million Dollars ($1,000,000) or more, and such writ or other judicial lien shall not be released, stayed, vacated, bonded or otherwise dismissed within thirty (30) days after the date of its issuance; or 6.13 DEFAULT UNDER T.HQ INTERNATIONAL AGREEMENT. An Event of Default shall occur under the T.HQ International Agreement and such Event of Default shall continue beyond any applicable grace period or shall not be waived. SECTION 7. MISCELLANEOUS PROVISIONS 7.1 ADDITIONAL REMEDIES. The rights, powers and remedies given to Bank hereunder shall be cumulative and not alternative and shall be in addition to all rights, powers and remedies given to Bank by law against Borrower or any other person, including but not limited to Bank's rights of setoff or banker's lien. 7.2 NONWAIVER. Any forbearance or failure or delay by Bank in exercising any right, power or remedy hereunder shall not be deemed a waiver thereof and any single or partial exercise of any right, power or remedy shall not preclude the further exercise thereof. No waiver shall be effective unless it is in writing and signed by an officer of Bank. 7.3 INUREMENT. The benefits of this Agreement shall inure to the successors and assigns of Bank and the permitted successors and assigns of Borrower, and any assignment of Borrower without Bank's consent shall be null and void. 7.4 APPLICABLE LAW. This Agreement and the Loan Documents shall be governed by and construed according to the laws of the State of California. 7.5 SEVERABILITY. Should any one or more provisions of this Agreement be determined to be illegal or unenforceable, all other provisions nevertheless shall be effective. 7.6 INTEGRATION CLAUSE. Except for documents and instruments specifically referenced herein, this Agreement constitutes the entire agreement between Bank and Borrower regarding the Loan and all prior communications between Borrower and Bank, whether verbal or written, shall be of no further effect or evidentiary value. 7.7 CONSTRUCTION. The section and subsection headings herein are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. 7.8 AMENDMENTS. This Agreement may be amended only in writing signed by all parties hereto. 15 16 7.9 COUNTERPARTS. Borrower and Bank may execute one or more counterparts to this Agreement, each of which shall be deemed an original and all of which, when taken together, shall constitute but one and the same agreement. SECTION 8. SERVICE OF NOTICES 8.1 NOTICES. Any notices or other communications provided for or allowed hereunder shall be effective only when given by one of the following methods and addressed to the respective party at its address given with the signatures at the end of this Agreement and shall be considered to have been validly given: (a) upon delivery, if delivered personally; (b) upon receipt, if mailed, first class postage prepaid, with the United States Postal Service; (c) on the next business day, if sent by overnight courier service of recognized standing; and (d) upon telephoned confirmation of receipt, if telecopied. 8.2 CHANGE OF ADDRESS. The addresses to which notices or demands are to be given may be changed from time to time by notice delivered as provided above. 16 17 THIS AGREEMENT is executed on behalf of the parties by duly authorized officers as of the date first above written. UNION BANK OF CALIFORNIA, N.A. By: /s/ ANN FORBES ------------------------------- Ann Forbes Title: Vice President ----------------------------- Address: Union Bank of California, N.A. Commercial Banking Group--Greater Los Angeles Division 445 South Figueroa Street, 10th Floor Los Angeles, California 90071 Attention: Ann Forbes Vice President Telecopier: (213) 236-7614 Telephone: (213) 236-7635 THQ INC. By: /s/ BRIAN J. FARRELL ------------------------------- Title: President and CEO ---------------------------- By: /s/ FRED A. GYSI ------------------------------- Title: VP of Finance and Administration and CFO ---------------------------- Address: THQ Inc. 5016 North Parkway Calabasas, Suite 100 Calabasas, California 91302 Attention: Fred Gysi Vice President Finance & Administration Telecopier: (818) 591-1615 Telephone: (818) 591-1310 17 EX-10.9 5 EXHIBIT 10.9 1 EXHIBIT 10.9 TRADE FINANCE AGREEMENT THIS TRADE FINANCE AGREEMENT ("Agreement") is made and entered into as of December 4, 1998, by and between T.HQ INTERNATIONAL, LTD., a corporation organized and existing under the laws of the United Kingdom ("Borrower"), and UNION BANK OF CALIFORNIA, N.A., a national banking association ("Bank"). SECTION 1. THE CREDIT 1.1 THE TRADE FINANCE CREDIT FACILITY. Bank will extend to Borrower a trade finance credit facility in an aggregate amount not to exceed Five Million Dollars ($5,000,000) (the "Trade Finance Credit Facility"). The Trade Finance Credit Facility shall terminate on May 1, 2000 and be subject to the following sublimits: (a) The Commercial L/C Line in an amount not to exceed Five Million Dollars ($5,000,000); and (b) The Standby L/C Line in an amount not to exceed Five Million Dollars ($5,000,000). 1.1.1 THE COMMERCIAL L/C LINE. Bank shall issue, for the account of Borrower, one or more irrevocable commercial letters of credit (individually, a "Commercial L/C" and collectively, the "Commercial L/Cs") and calling for drafts at sight covering the importation or purchase of game cartridges and CD roms (the "Commercial L/C Line"). Each Commercial L/C shall be drawn on such terms and conditions as are acceptable to Bank and shall be governed by the terms of (and Borrower agrees to execute) Bank's standard form of Commercial L/C application and reimbursement agreement. No Commercial L/C shall have an expiration date more than ninety (90) days from its date of issuance. No Commercial L/C shall expire later than July 31, 2000. 1.1.2 THE STANDBY L/C LINE. Bank shall issue, for the account of Borrower, one or more irrevocable, standby letters of credit (individually, a "Standby L/C" and collectively, the "Standby L/Cs"). Each Standby L/C shall be drawn on such terms and conditions as are acceptable to Bank and shall be governed by the terms of (and Borrower agrees to execute) Bank's standard form of Standby L/C application and reimbursement agreement with respect thereto. No Standby L/C shall expire after May 31, 1999. 1.1.3 TRADE FINANCE CREDIT FACILITY SUBLIMITS. The aggregate amount available to be drawn under each sublimit listed above shall be reduced, dollar for dollar, by the aggregate amount of unpaid principal obligations under the respective sublimit. The aggregate of all unpaid advances and reimbursement obligations shall reduce, dollar for dollar, the maximum amount available under the Trade Finance Credit Facility. Borrower may reborrow or obtain new extensions of credit under each such sublimit until the expiration date of the Trade Finance Credit Facility, to the extent that 2 Borrower has paid or otherwise satisfied prior borrowings or extensions of credit, subject to all terms and conditions in the Loan Documents. 1.2 TERMINOLOGY. As used herein, the following terms shall have the following meanings: (a) The term "L/C" shall mean all Commercial L/Cs and Standby L/Cs described above. (b) The term "Loan Documents" shall mean all documents, instruments and agreements executed in connection with this Agreement. (c) The term "THQ" shall mean THQ Inc., a Delaware corporation. (d) The term "THQ Agreement" shall mean that certain Trade Finance Agreement dated as of December 4, 1998, by and between THQ and Bank, as at any time amended, supplemented or otherwise modified or restated. 1.3 PURPOSES OF THE L/C. Each Commercial L/C shall be issued by Bank to finance Borrower's customary trade cycle. Each Standby L/C shall be issued by Bank to Imperial Bank, as beneficiary, in order to support Borrower's obligations to Imperial Bank with respect to certain existing commercial letters of credit previously issued by Imperial Bank. 1.4 TRADE FINANCE FEES. All fees in connection with the Trade Finance Credit Facility will be in accordance with Bank's standard schedule of fees as published from time to time, except as follows: (a) The fees in connection with the issuance of each Commercial L/C shall be, for each three-month period or fraction thereof, the greater of (i) one-eighth of one percent (1/8 of 1%) or (ii) Ninety Dollars ($90.00); (b) The fees in connection with the payment of each Commercial L/C shall be the greater of (i) one-eighth of one percent (1/8 of 1%) per set of documents or (ii) Seventy Dollars ($70.00); and (c) The fees in connection with any amendment to a Commercial L/C shall be, for each three-month period or fraction thereof, the greater of (i) one-tenth of one percent (1/10 of 1%) or (ii) Sixty Dollars ($60.00). 1.5 COMMITMENT FEE. Borrower shall pay to Bank a commitment fee of Twelve Thousand Five Hundred Dollars ($12,500) on or before the date of execution of this Agreement. No portion of such fee shall be reimbursable. 1.6 SECURITY. Prior to any extension of credit under this Agreement, Borrower shall have executed a security agreement, on Bank's standard form, and a UCC financing statement, suitable for filing in the office of the Secretary of State of the 2 3 State of California and any other state designated by Bank, granting to Bank a first priority security interest in such of Borrower's property as is described in said security agreement. The security agreement shall provide that upon the occurrence of an Event of Default, Bank shall be entitled to exercise its remedies against the collateral described therein and to sell such collateral wherever and to whomever Bank deems necessary, in its reasonable discretion. Exceptions to Bank's first priority, if any, are permitted only as otherwise provided in this Agreement. At Bank's request, Borrower will also obtain executed landlord's and mortgagee's waivers on Bank's form covering all of Borrower's property located on leased or encumbered real property. 1.7 CONTROLLING DOCUMENT. In the event of any inconsistency between the terms of this Agreement and any of the Loan Documents, the terms of such Loan Document will prevail over the terms of this Agreement. SECTION 2. CONDITIONS PRECEDENT Bank shall not be obligated to extend any credit under this Agreement unless at or prior to the time for extending such credit, the following conditions have been fulfilled to Bank's satisfaction: 2.1 COMPLIANCE. Borrower shall have performed and complied with all terms and conditions required by this Agreement to be performed or complied with by it prior to or at the date of the extension of such credit and shall have executed and delivered to Bank the Loan Documents. 2.2 BORROWING RESOLUTION. Borrower shall have provided Bank with certified copies of resolutions duly adopted by the board of directors of Borrower, authorizing the execution, delivery and performance of this Agreement and the Loan Documents. Such resolutions shall also designate the persons who are authorized to act on Borrower's behalf in connection with this Agreement and to do the things required of Borrower pursuant to this Agreement. 2.3 THQ GUARANTY. Borrower shall have provided Bank with a Continuing Guaranty, on Bank's standard form therefor and in the principal amount of Five Million Dollars ($5,000,000) (exclusive of accrued interest and Bank's expenses), duly executed by THQ. 2.4 TERMINATION STATEMENTS. Borrower shall have provided Bank with UCC termination statements executed by such secured creditors as may be required by Bank, suitable for filing with the Secretary of State in each state designated by Bank. 2.5 CONTINUING COMPLIANCE. At the time any L/C is to be issued, there shall not exist any event, condition or act which constitutes an Event of Default under Section 6 hereof or any event, condition or act which with notice, lapse of time or both would constitute an Event of Default; nor shall there be any such event, condition or act immediately after such credit extension were it to be made. 3 4 SECTION 3. REPRESENTATIONS AND WARRANTIES Borrower represents and warrants that: 3.1 BUSINESS ACTIVITY. The principal business of Borrower is the publication and distribution of interactive software. 3.2 SUBSIDIARIES. Borrower's subsidiaries (those entities in which Borrower has either a controlling interest or at least a twenty-five percent (25%) ownership interest) and their addresses, and the names of Borrower's principal shareholders are as provided on a schedule delivered to Bank on or before the date of this Agreement. 3.3 AUTHORITY TO BORROW. The execution, delivery and performance of this Agreement and the Loan Documents are not in contravention of any of the terms of any indenture, agreement or undertaking to which Borrower is a party or by which it or any of its property is bound or affected. 3.4 FINANCIAL STATEMENTS. The consolidated financial statements of THQ and its subsidiaries (including Borrower), including both a consolidated balance sheet at September 30, 1998, together with supporting schedules, and a consolidated income statement for the nine (9) months ended September 30, 1998, have heretofore been furnished to Bank, and are true and complete and fairly represent the financial condition of THQ and its subsidiaries (including Borrower) during the period covered thereby. Since September 30, 1998, there has been no material adverse change in the financial condition or operations of THQ and its subsidiaries (including Borrower) taken as a whole. 3.5 TITLE. Except for assets which may have been disposed of in the ordinary course of business, Borrower has good and marketable title to all of its property that is included in the consolidated financial statements of THQ and its subsidiaries delivered to Bank for the nine (9) months ended September 30, 1998 and to all property acquired by Borrower since the date of such financial statements, free and clear of all Liens (as such term is defined in subsection 5.1 hereof) except those specifically referred to in such financial statements. 3.6 LITIGATION. There is no litigation or proceeding pending or threatened against Borrower or any of its property which is reasonably likely to affect the financial condition, property or business of Borrower in a materially adverse manner. 3.7 DEFAULT. Borrower is not now in default in the payment of any of its material obligations (including, without limitation, any obligation to make royalty payments under any license agreement to which it is a party), and there exists no event, condition or act which constitutes an Event of Default under Section 6 hereof and no condition, event or act which with notice or lapse of time, or both, would constitute an Event of Default. 4 5 3.8 ORGANIZATION. Borrower is duly organized and existing under the laws of the jurisdiction of its organization, and has the power and authority to carry on the business in which it is engaged and/or proposes to engage. 3.9 POWER. Borrower has the power and authority to enter into this Agreement and to execute and deliver the Loan Documents. 3.10 AUTHORIZATION. This Agreement and all things required by this Agreement have been duly authorized by all requisite corporate action of Borrower. 3.11 QUALIFICATION. Borrower is duly qualified and in good standing in any jurisdiction where such qualification is required. 3.12 COMPLIANCE WITH LAWS. Borrower is in compliance with all applicable laws, rules, ordinances and regulations which materially affect the operations or financial condition of Borrower. 3.13 REGULATION U. No action has been taken or is currently planned by Borrower, or any agent acting on its behalf, which would cause this Agreement to violate Regulation U or any other regulation of the Board of Governors of the Federal Reserve System or to violate the Securities and Exchange Act of 1934, in each case as in effect now or as the same may hereafter be in effect. Borrower is not engaged in the business of extending credit for the purpose of purchasing or carrying margin stock as one of its important activities. 3.14 CONTINUING REPRESENTATIONS. The foregoing representations and warranties shall be considered to have been made again at and as of the date each L/C is issued and shall be true and correct as of such date or dates. SECTION 4. AFFIRMATIVE COVENANTS Until all sums payable pursuant to this Agreement and the Loan Documents have been paid in full, unless Bank otherwise consents in writing, Borrower agrees that: 4.1 PURPOSE OF L/C. Borrower will use the L/C only for the purposes provided in subsection 1.3 above. 4.2 PAYMENT OF OBLIGATIONS. Borrower will pay and discharge promptly all taxes, assessments and other governmental charges and claims levied or imposed upon it or its property, or any part thereof; provided, however, that Borrower shall have the right in good faith to contest any such taxes, assessments, charges or claims and, pending the outcome of such contest, to delay or refuse payment thereof provided that adequately funded reserves are established by it to pay and discharge any such taxes, assessments, charges and claims. 5 6 4.3 Maintenance of Existence. Borrower will maintain and preserve its existence and assets and all rights, franchises, licenses and other authority necessary for the conduct of its business and will maintain and preserve its property, equipment and facilities in good order, condition and repair. Bank may, at reasonable times, visit and inspect any of the properties of Borrower. 4.4 RECORDS. Borrower will keep and maintain full and accurate accounts and records of its operations according to generally accepted accounting principles and will permit Bank's internal auditors to have access thereto, to make examination and photocopies thereof, and to make audits during regular business hours, but no more frequently than quarterly, unless an Event of Default has occurred and is continuing or there has been a material adverse change in Borrower's financial condition. Costs for such audits shall be paid by Borrower. 4.5 INFORMATION FURNISHED. Borrower will furnish to Bank: (a) Within sixty (60) days after the close of each fiscal quarter, except for the final quarter of each fiscal year, copies of the unaudited consolidated balance sheet of THQ and its subsidiaries (including Borrower) on Form 10-Q as of the close of such fiscal quarter, the unaudited consolidated income and expense statement of THQ and its subsidiaries (including Borrower), with supportive schedules, and the consolidated statement of retained earnings of THQ and its subsidiaries (including Borrower) for such fiscal quarter, prepared in accordance with generally accepted accounting principles; (b) Within one hundred twenty (120) days after the close of each fiscal year, copies of the consolidated statement of financial condition of THQ and its subsidiaries (including Borrower) on Form 10-K, including at least the consolidated balance sheet of THQ and its subsidiaries (including Borrower) as of the close of such fiscal year, the consolidated income and expense statement of THQ and its subsidiaries (including Borrower), with supportive schedules, and the consolidated statement of retained earnings of THQ and its subsidiaries (including Borrower) for such fiscal year, examined and prepared on an audited basis by independent certified public accountants selected by THQ and reasonably satisfactory to Bank in accordance with generally accepted accounting principles applied on a basis consistent with that of the previous fiscal year; (c) Concurrently with the financial information furnished to Bank pursuant to subparagraph (a) of this subsection 4.5, copies of the unaudited consolidating balance sheet of Borrower and each of its subsidiaries as of the close of each fiscal quarter, and the unaudited consolidating income and expense statement of Borrower and each of its subsidiaries as of the close of each fiscal quarter, with supportive schedules, prepared in accordance with generally accepted accounting principles; (d) Concurrently with the financial information furnished to Bank pursuant to subparagraph (b) of this subsection 4.5, copies of the consolidating statement of financial condition of Borrower and each of its subsidiaries, including at least the consolidating balance sheet of Borrower and each of its subsidiaries as of the close of such fiscal year, and the consolidating income and expense statement of Borrower and 6 7 each of its subsidiaries, with supportive schedules, prepared in accordance with generally accepted accounting principles; (e) Within one hundred twenty (120) days after the close of each fiscal year, a copy of the projections of THQ and its subsidiaries (including Borrower) for the following fiscal year, in form and substance reasonably acceptable to Bank; (f) As soon as available, copies of such financial statements and reports as THQ or any of its subsidiaries (including Borrower) may file with any state or federal agency, excluding any state or federal income tax returns; (g) Such other financial statements and information as Bank may reasonably request from time to time; (h) Prompt written notice to Bank of any Event of Default under any of the terms or provisions of this Agreement or of any default under any other agreement, contract, document or instrument entered, or to be entered into with Bank; and of any litigation which, if decided adversely to THQ or any of its subsidiaries (including Borrower), would have a material adverse effect on the financial condition of THQ or any of its subsidiaries (including Borrower); and of any other matter which has resulted in, or is likely to result in, a material adverse change in the financial condition or operations of THQ or any of its subsidiaries (including Borrower); (i) Prompt written notice to Bank of any default, whether resulting from the nonpayment of royalties or otherwise, that has occurred under the terms of any license agreement to which Borrower or any of its affiliates is a party; and (j) Prompt written notice to Bank of any change in Borrower's chief executive officer, president, chief financial officer or any senior vice president; Borrower's name; and location of Borrower's assets, principal place of business or chief executive office. 4.6 CONSOLIDATED QUICK RATIO. Borrower shall not permit the ratio of (a) the sum of cash, Cash Equivalents and accounts receivable, in each case for THQ and its subsidiaries (including Borrower), to (b) the consolidated current liabilities of THQ and its subsidiaries (including Borrower) (including outstanding advances to THQ under the Clean Advance Line of the THQ Agreement and the aggregate face amount of all L/Cs issued on the account of Borrower and THQ under the THQ Agreement and outstanding at such time) to be less than 1.25:1.00 as at the end of any fiscal quarter. As used herein, the term "Cash Equivalents" shall mean (i) securities issued or directly and fully guaranteed or insured by the United States of America or any agency or instrumentality thereof (provided that the full faith and credit of the United States of America is pledged in support thereof), (ii) Dollar denominated time deposits and certificates of deposit of any commercial bank having a long-term unsecured debt rating of at least A or the equivalent thereof from Standard & Poor's Ratings Services, a division of McGraw-Hill, Inc. ("S&P"), (iii) commercial paper issued by any corporation organized under the laws of any state of the United States of America having a rating of at least A- or the equivalent thereof from S&P or at least P-1 or the equivalent thereof from Moody's 7 8 Investors Service, Inc. ("Moody's") and (iv) investments in money market funds substantially all of which are comprised of securities of the types described in clauses (i) through (iii) hereinabove. 4.7 CONSOLIDATED SHAREHOLDERS' EQUITY. Borrower shall cause THQ and its subsidiaries to achieve Consolidated Shareholders' Equity of not less than Fifty Million Dollars ($50,000,000) as at the end of the fiscal year ending December 31, 1998. Such Consolidated Shareholders' Equity shall increase as of December 31, 1999, and thereafter, as of the end of each successive fiscal year, by an amount not less than the greater of (a) Ten Million Dollars ($10,000,000) or (b) ninety percent (90%) of the consolidated net profit after taxes of THQ and its subsidiaries (including Borrower) for such fiscal year. As used in this Agreement, "Consolidated Shareholders' Equity" shall mean the consolidated net worth of THQ and its subsidiaries (including Borrower), as reflected in the quarterly consolidated balance sheet of THQ and its subsidiaries (including Borrower) on Form 10-Q and in the annual consolidated statement of financial condition of THQ and its subsidiaries (including Borrower) on Form 10-K. 4.8 CONSOLIDATED TOTAL LIABILITIES TO CONSOLIDATED SHAREHOLDERS' EQUITY. Borrower shall cause THQ and its subsidiaries to maintain a ratio of Consolidated Total Liabilities to Consolidated Shareholders' Equity of not greater than 1.00:1.00 as at the end of each fiscal quarter. As used in this Agreement, "Consolidated Total Liabilities" shall mean the consolidated total liabilities of THQ and its subsidiaries (including Borrower), as determined in accordance with generally accepted accounting principles, as shown on the liability side of the consolidated balance sheet of THQ and its subsidiaries (including Borrower). 4.9 CONSOLIDATED OPERATING PROFIT. Borrower will cause THQ and its subsidiaries (including Borrower) to achieve Consolidated Operating Profit of not less than One Dollar ($1) as at the end of and for each fiscal quarter. As used in this Agreement, "Consolidated Operating Profit" shall mean the consolidated net operating income of THQ and its subsidiaries (including Borrower), as determined in accordance with generally accepted accounting principles, before provision for taxes and non-recurring expenses. 4.10 INSURANCE. Borrower will keep all of its insurable property, whether real, personal or mixed, insured by companies and in amounts approved by Bank against fire and such other risks as are customarily insured against by companies conducting similar business. Borrower will maintain workers compensation insurance, insurance against liability for damage to persons or property and insurance to cover loss of or to goods in transit to Borrower. Borrower will furnish to Bank statements of its insurance coverage, will promptly furnish other or additional insurance deemed necessary by and upon request of Bank to the extent that such insurance may be available and hereby assigns to Bank, as security for Borrower's obligations to Bank, the proceeds of any such insurance. All of such insurance shall be maintained in such amounts as is customarily obtained by companies conducting similar business with respect to like risks. Prior to any extension of credit, Bank will be named loss payee on 8 9 all policies insuring collateral. All policies shall require at least ten (10) days' written notice to Bank before any policy may be altered or cancelled. 4.11 ADDITIONAL REQUIREMENTS. Borrower will promptly, upon demand by Bank, take such further action and execute all such additional documents and instruments in connection with this Agreement as Bank in its reasonable discretion deems necessary, and promptly supply Bank with such other information concerning its affairs as Bank may request from time to time. 4.12 LITIGATION AND ATTORNEYS' FEES. Borrower will pay promptly to Bank upon demand, reasonable attorneys' fees (including but not limited to the reasonable estimate of the allocated costs and expenses of in-house legal counsel and staff) and all costs and other expenses paid or incurred by Bank in collecting, modifying or compromising the obligations hereunder or in enforcing or exercising its rights or remedies created by, connected with or provided for in this Agreement or any of the Loan Documents, whether or not an arbitration, judicial action or other proceeding is commenced. If such proceeding is commenced, only the prevailing party shall be entitled to attorneys' fees and court costs. 4.13 BANK EXPENSES. Borrower will pay or reimburse Bank for all costs, expenses and fees incurred by Bank in preparing and documenting this Agreement and the Loan Documents, and all amendments and modifications thereof, including but not limited to all filing and recording fees, costs of appraisals, insurance and attorneys' fees, including the reasonable estimate of the allocated costs and expenses of in-house legal counsel and staff. 4.14 ROYALTY PAYMENTS. Borrower will comply, and will cause each of its affiliates to comply, in all material respects with any and all license agreements to which Borrower or any such affiliate is a party. Without in any manner limiting the generality of the foregoing sentence, Borrower will pay, and will cause each of such affiliates to pay, all royalty and other payments required to be paid by Borrower or such affiliate under such license agreements when and as such payments become due. SECTION 5. NEGATIVE COVENANTS Until all sums payable pursuant to this Agreement and the Loan Documents have been paid in full, unless Bank otherwise consents in writing, Borrower agrees that: 5.1 LIENS. Borrower will not create, assume or suffer to exist any mortgage, pledge, security interest, encumbrance, or lien (collectively, "Liens" and individually, a "Lien") (other than for taxes not delinquent and for taxes and other items being contested in good faith) on property of any kind, whether real, personal or mixed, now owned or hereafter acquired, or upon the income or profits thereof, except (a) Liens in favor of Bank, (b) minor encumbrances and easements on real property which do not affect its market, (c) Liens in favor of Imperial Bank securing reimbursement obligations 9 10 of Borrower in respect of commercial letters of credit previously issued by Imperial Bank and (d) Liens upon equipment or other property created in connection with the acquisition by Borrower of such equipment or other property, provided, however, that (i) the indebtedness incurred to finance each such acquisition is permitted by this Agreement, (ii) each such Lien attaches only to the equipment or other property acquired with the indebtedness secured thereby and (iii) the indebtedness incurred to finance each such acquisition does not exceed Two Hundred Fifty Thousand Dollars ($250,000). 5.2 BORROWINGS. Borrower will not sell, discount or otherwise transfer any account receivable or any note, draft or other evidence of indebtedness, except to Bank or except to a financial institution at face value for deposit or collection purposes only and without any fee other than fees normally charged by the financial institution for deposit or collection services. Except as otherwise provided in this Agreement, Borrower will not borrow any money, become contingently liable to borrow money, nor enter any agreement to directly or indirectly obtain borrowed money, except (a) pursuant to agreements made with Bank, (b) pursuant to reimbursement agreements made with Imperial Bank in connection with commercial letters of credit previously issued by Imperial Bank and (c) indebtedness owed to THQ as permitted by subsection 5.4 of the THQ Agreement. 5.3 SALE OF ASSETS, LIQUIDATION OR MERGER. Borrower will not liquidate, dissolve or enter into any consolidation, merger, partnership or other combination, nor convey, sell or lease all or the greater part of its assets or business, nor purchase or lease all or the greater part of the assets or business of another; provided, however, that Borrower may purchase all or the greater part of the assets or business of another so long as (a) no Event of Default or event which, with the lapse of time or notice, or both, would become an Event of Default, has occurred and is continuing or would result therefrom, (b) Borrower provides Bank with prior written notice thereof and (c) the sum of (i) the aggregate amount of all such acquisitions plus (ii) the aggregate outstanding principal amount of all loans, advances and guaranties permitted under subsection 5.4(b) hereof shall not exceed Five Million Dollars ($5,000,000) at any time. 5.4 LOANS, ADVANCES AND GUARANTIES. Borrower will not, except in the ordinary course of business as currently conducted, make any loans or advances, become a guarantor or surety, pledge its credit or properties in any manner or extend credit; provided, however, that (a) Borrower may guarantee certain working capital obligations of the Rushware Entities, or any of them, to one or more financial institutions, so long as the principal amount of the obligations of the Rushware Entities so guaranteed does not exceed, in the aggregate amount at any one time outstanding, the sum of Ten Million Dollars ($10,000,000) and (b) Borrower may make loans or advances to, or guarantee the obligations of any of its affiliates, provided that the sum of (i) the aggregate outstanding principal amount of all loans or advances so made, or obligations so guaranteed, plus (ii) the aggregate amount of all acquisitions permitted by subsection 5.3 hereof, shall not exceed Five Million Dollars ($5,000,000) at any time. As used herein, the term "Rushware Entities" shall mean, collectively, Rushware 10 11 Microhandelsgesellschaft mbH and its two subsidiaries, SOFTGOLD Computerspiele GmbH and ABC Spielspass GmbH. 5.5 INVESTMENTS. Borrower will not purchase the debt or equity of another person or entity except (a) for savings accounts, money market accounts, sweep investment accounts and certificates of deposit of Bank, (b) direct U.S. Government obligations and commercial paper issued by corporations with the top ratings of Moody's Investors Service, Inc. or Standard & Poor's Ratings Services, a division of McGraw-Hill, Inc., provided that all such permitted investments shall mature within one (1) year of purchase, and (c) as permitted by subsection 5.3 of this Agreement. 5.6 PAYMENT OF DIVIDENDS. Borrower will not declare or pay any dividends, other than a dividend payable in its own common stock, or authorize or make any other distribution with respect to any of its stock now or hereafter outstanding. 5.7 RETIREMENT OF STOCK. Borrower will not acquire or retire any share of its capital stock for value. 5.8 PARENT AND SUBSIDIARY PROPERTY. Borrower will not transfer any property to its parent or any affiliate of its parent, except for value received in the normal course of business as business would be conducted with an unrelated or unaffiliated entity. In no event shall management fees or fees for services be paid by Borrower to any such direct or indirect affiliate without Bank's prior written approval. 5.9 CAPITAL EXPENDITURES. Borrower shall not permit THQ and its subsidiaries to make capital expenditures in excess of Seven Hundred Fifty Thousand Dollars ($750,000) in any fiscal year, as reflected in the consolidated balance sheet of THQ and its subsidiaries (including Borrower) on Form 10-Q and in the consolidated statement of financial condition of THQ and its subsidiaries (including Borrower) on Form 10-K. Each such capital expenditure shall be needed by THQ or any of its subsidiaries in the ordinary course of business. 5.10 LEASE OBLIGATIONS. Borrower shall not permit THQ or any of its subsidiaries to incur new lease obligations as lessee which would result in aggregate lease payments made by THQ and its subsidiaries (including Borrower) for any fiscal year exceeding Six Hundred Thousand Dollars ($600,000). Each said lease shall be of equipment or real property needed by THQ or any of its subsidiaries in the ordinary course of its business. SECTION 6. EVENTS OF DEFAULT Upon the occurrence of any of the following events ("Events of Default"), Bank, in its discretion, may cease extending credit hereunder and may declare all obligations hereunder and under the Loan Documents immediately due and payable; provided, however, that upon the occurrence of an Event of Default described in subsection 6.4, 6.5, 6.6, 6.7 or 6.8 hereinbelow, all principal and interest and any other 11 12 amounts owing under the Loan Documents shall automatically become immediately due and payable. 6.1 PAYMENT DEFAULTS. Borrower shall default in the due and punctual payment of the principal of or the interest on the Note or any of the other Loan Documents; or 6.2 BREACH OF REPRESENTATIONS OR WARRANTIES Any representation or warranty made or deemed made by Borrower under this Agreement or any Loan Document to which it is a party shall prove to have been incorrect in any material respect on and as of the date made or deemed made; or 6.3 COVENANT DEFAULTS. Borrower shall default in the due performance or observance of any covenant or condition of any Loan Document to which it is a party and, in the case of the covenants set forth in subsections 4.2, 4.3, 4.4, 4.5, 5.1, 5.2, 5.5, 5.6, 5.7 and 5.8 and in the security agreement provided for in subsection 1.6 hereof only, but only if such default is capable of being cured, shall fail to cure such default within thirty (30) days; or 6.4 INSOLVENCY. Borrower shall become insolvent or fail to pay its debts as such debts become due; or 6.5 BANKRUPTCY. Borrower shall commence any voluntary proceeding under any laws relating to bankruptcy, insolvency, reorganization, arrangement, debt adjustment or debtor relief or shall consent to any relief in any involuntary proceeding under any laws relating to bankruptcy, insolvency, reorganization, arrangement, debt adjustment or debtor relief; or any contested involuntary proceeding under any laws relating to bankruptcy, insolvency, reorganization, arrangement, debt adjustment or debtor relief shall be commenced against Borrower and such involuntary proceeding shall not be dismissed or discharge within sixty (60) days of commencement; or 6.6 ASSIGNMENT FOR BENEFIT OF CREDITORS. There shall be an assignment by Borrower for the benefit of its creditors; or 6.7 APPOINTMENT OF RECEIVER. Borrower shall apply for or consent to the appointment, or commence any proceeding for the appointment, of a receiver, trustee, custodian or similar official for all or substantially all of Borrower's property; or any proceeding for the appointment of a receiver, trustee, custodian or similar official for all or substantially all of Borrower's property shall be commenced against Borrower or its property and shall not be dismissed or discharged within sixty (60) days of commencement; or 6.8 DISSOLUTION OR LIQUIDATION. Borrower shall be dissolved or liquidated in full or in part; or any proceeding for the dissolution or liquidation of Borrower shall be commenced against Borrower and not dismissed or discharged within sixty (60) days of commencement; or 12 13 6.9 Failure to Comply. Borrower shall fail to comply with (a) any money judgment in an individual amount of Five Hundred Thousand Dollars ($500,000) or more, or in an aggregate amount of One Million Dollars ($1,000,000) or more, or (b) any order, non-monetary judgment, injunction, decree, writ or demand of any court or other public authority and, in the case of either subparagraph (a) or (b) of this subsection 6.9, such order, judgment, injunction, decree, writ or demand shall continue unsatisfied and in effect for a period of thirty (30) days without being vacated, discharged, satisfied or stayed or bonded pending appeal; or 6.10 LEGAL PROCESS. There shall be filed or recorded any notice of levy, notice to withhold, or other legal process for taxes other than property taxes against Borrower or against the property of Borrower in an individual amount of Five Hundred Thousand Dollars ($500,000) or more, or in an aggregate amount of One Million Dollars ($1,000,000) or more, and such notice or other legal process shall not be released, stayed, vacated, bonded or otherwise dismissed within thirty (30) days after the date of its filing or recording; or 6.11 DEFAULT CONCERNING BORROWING OF MONEY. Borrower shall default on any obligation concerning the borrowing of money that is outstanding in the aggregate amount of One Hundred Thousand Dollars ($100,000) or more; or 6.12 WRITS OF ATTACHMENT, ETC. The issuance against Borrower, or the property of Borrower, of any writ of attachment, writ of execution or other judicial lien in an individual amount of Five Hundred Thousand Dollars ($500,000) or more, or in an aggregate amount of One Million Dollars ($1,000,000) or more, and such writ or other judicial lien shall not be released, stayed, vacated, bonded or otherwise dismissed within thirty (30) days after the date of its issuance; or 6.13 DEFAULT UNDER THQ AGREEMENT. An Event of Default shall occur under the THQ Agreement and such Event of Default shall continue beyond any applicable grace period or shall not be waived. SECTION 7. MISCELLANEOUS PROVISIONS 7.1 WITHHOLDING TAXES. Each payment of principal, interest and other amounts payable by Borrower pursuant to this Agreement or any of the other Loan Documents shall be free and clear of any deductions or withholdings for or on account of any present or future taxes, levies, imposts, duties or other charges of whatever nature imposed by any government, political subdivision, bank or taxing authority. Borrower shall pay to Bank such amounts as may be necessary in order that every payment made by Borrower hereunder or under any of the Loan Documents, after Borrower makes any required deductions or withholding for or on account of any taxes, levies, imposts, duties or other charges of whatever nature imposed by any government, political subdivision, bank or taxing authority outside the United States, shall not be less than the payment otherwise required by this Agreement and the Loan Documents. 13 14 7.2 INDEMNITY FOR TAXES. Without limiting Bank's rights under any of the other provisions of this Agreement or any of the Loan Documents, in the event that any taxes are assessed against Bank in connection with payments made to Bank by Borrower by virtue of the fact that Borrower is a non-United States person, then Borrower shall pay when due, and indemnify and hold Bank harmless from, such taxes, without reducing the net amount of such payments to be made to Bank below that amount which Bank would have received had such taxes not been assessed. If Bank requests, Borrower shall furnish to Bank a receipt evidencing payment of such tax or the tax return or other report filed with respect to such tax. The provisions of this subsection 7.2 shall survive repayment of Borrower's obligations hereunder. 7.3 ADDITIONAL INDEMNITY. Borrower shall pay, and indemnify and hold Bank harmless from, any present or future claim or liability for any registration, stamp, documentary, court or similar tax, fee or charge, or any penalties or interest with respect thereto, which may be assessed, levied or collected by the jurisdiction of Borrower's incorporation or by any governmental agency of such jurisdiction, or in connection with the execution, issuance, delivery, filing, registration or enforcement of this Agreement or any of the Loan Documents. If Bank requests, Borrower shall furnish to Bank a receipt evidencing payment of such tax or other amount, or the tax return or other report filed with respect to such tax or other amount. The provisions of this subsection 7.3 shall survive repayment of Borrower's obligations hereunder. 7.4 REGISTRATION. Borrower shall cause this Agreement and the Loan Documents executed by Borrower to be registered, notarized or otherwise formalized to the extent at any time required by the applicable law of the country and/or state of Borrower's incorporation, and shall pay, and indemnify and hold Bank harmless from, any liability for any stamp taxes or any registration, documentation or other types of fees, charges, taxes or fines in connection with any such registration, notarization or formalization. The provisions of this subsection 7.4 shall survive repayment of Borrower's obligations hereunder. 7.5 JURISDICTION, SERVICE OF PROCESS AND VENUE. Any suit, action or proceeding against Borrower with respect to this Agreement or any of the Loan Documents may be brought in (a) the Superior Court of the State of California, County of Los Angeles, (b) the United States District Court for the Central District of California or (c) any competent court in the United Kingdom, as Bank may elect in its sole discretion. Borrower hereby submits to the non-exclusive jurisdiction of such courts for the purpose of any such suit, action, proceeding or judgment. Borrower hereby irrevocably consents to the service of process in any suit, action or proceeding in any of the above-specified courts by the mailing thereof by Bank by U.S. mail, postage prepaid, to Borrower, 5016 North Parkway Calabasas, Suite 100, Calabasas, California 91302. Borrower agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Borrower hereby irrevocably waives any objection which Borrower now has or may hereafter acquire to the laying of venue of any action or proceeding arising out of or relating to this Agreement or any Loan Document in the 14 15 Superior Court of the State of California, County of Los Angeles or in the United States District Court for the Central District of California, and any objection on the ground that any such action or proceeding has been brought in an inconvenient forum. Nothing contained herein shall be deemed to limit the right or ability of Bank to serve any writs, processes or summonses in any other manner permitted under applicable law, or to obtain jurisdiction over Borrower in such other jurisdictions and in such other manner as may be permitted under applicable law, including but not limited to the right of Bank to bring any suit, action or proceeding against Borrower in the courts of the country of Borrower's incorporation. 7.6 JUDGMENT CURRENCY. Notwithstanding any judgment rendered against Borrower in a currency other than United States Dollars, whether in connection with a judicial proceeding or arbitration proceeding, Borrower shall not be relieved of any obligation with respect to any amount owed by it to Bank under this Agreement or the Loan Documents except to the extent of the amount in United States Dollars which, in accordance with normal banking procedures, Bank is able to acquire with such amount of such other currency on the business day following receipt of such amount by Bank. If the amount in United States Dollars so acquired is less than the amount due to Bank, then Borrower shall indemnify Bank by paying the difference between such amounts in United States Dollars. If the amount in United States Dollars so acquired is more than the amount due to Bank, Bank agrees to remit such excess to Borrower. The payment of any additional amount required of Borrower under this subsection 7.6 shall constitute a separate and independent obligation of Borrower, notwithstanding any award of judgment. 7.7 ADDITIONAL REMEDIES. The rights, powers and remedies given to Bank hereunder shall be cumulative and not alternative and shall be in addition to all rights, powers and remedies given to Bank by law against Borrower or any other person, including but not limited to Bank's rights of setoff or banker's lien. 7.8 NONWAIVER. Any forbearance or failure or delay by Bank in exercising any right, power or remedy hereunder shall not be deemed a waiver thereof and any single or partial exercise of any right, power or remedy shall not preclude the further exercise thereof. No waiver shall be effective unless it is in writing and signed by an officer of Bank. 7.9 INUREMENT. The benefits of this Agreement shall inure to the successors and assigns of Bank and the permitted successors and assigns of Borrower, and any assignment of Borrower without Bank's consent shall be null and void. 7.10 APPLICABLE LAW. Notwithstanding any conflict of law statutes or principles, this Agreement and the Loan Documents shall be governed by and construed according to the laws of the State of California. 7.11 SEVERABILITY. Should any one or more provisions of this Agreement be determined to be illegal or unenforceable, all other provisions nevertheless shall be effective. 15 16 7.12 INTEGRATION CLAUSE. Except for documents and instruments specifically referenced herein, this Agreement constitutes the entire agreement between Bank and Borrower regarding the Loan and all prior communications between Borrower and Bank, whether verbal or written, shall be of no further effect or evidentiary value. 7.13 CONSTRUCTION. The section and subsection headings herein are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. 7.14 AMENDMENTS. This Agreement may be amended only in writing signed by all parties hereto. 7.15 COUNTERPARTS. Borrower and Bank may execute one or more counterparts to this Agreement, each of which shall be deemed an original and all of which, when taken together, shall constitute but one and the same agreement. SECTION 8. SERVICE OF NOTICES 8.1 NOTICES. Any notices or other communications provided for or allowed hereunder shall be effective only when given by one of the following methods and addressed to the respective party at its address given with the signatures at the end of this Agreement and shall be considered to have been validly given: (a) upon delivery, if delivered personally; (b) upon receipt, if mailed, first class postage prepaid, with the United States Postal Service; (c) on the next business day, if sent by overnight courier service of recognized standing; and (d) upon telephoned confirmation of receipt, if telecopied. 8.2 CHANGE OF ADDRESS. The addresses to which notices or demands are to be given may be changed from time to time by notice delivered as provided above. 16 17 THIS AGREEMENT is executed on behalf of the parties by duly authorized officers as of the date first above written. UNION BANK OF CALIFORNIA, N.A. By: /s/ ANN FORBES ------------------------------ Ann Forbes Title: Fice President --------------------------- Address: Union Bank of California, N.A. Commercial Banking Group--Greater Los Angeles Division 445 South Figueroa Street, 10th Floor Los Angeles, California 90071 Attention: Ann Forbes Vice President Telecopier: (213) 236-7614 Telephone: (213) 236-7635 T.HQ INTERNATIONAL, LTD. By: /s/ BRIAN J. FARRELL ------------------------------ Title: President and CEO --------------------------- By: /s/ FRED A. GYSI ------------------------------ Title: VP of Finance and Administration and CFO --------------------------- Address: T.HQ International, Ltd. 5016 North Parkway Calabasas, Suite 100 Calabasas, California 91302 Attention: Fred Gysi Director Telecopier: (818) 591-1615 Telephone: (818) 591-1310 17 EX-10.10 6 EXHIBIT 10.10 1 EXHIBIT 10.10 [UNION BANK OF CALIFORNIA LOGO] FIRST AMENDMENT TO TRADE FINANCE AGREEMENT THIS FIRST AMENDMENT TO TRADE FINANCE AGREEMENT (this "First Amendment") dated as of March 22, 1999, is made and entered into by and between THQ INC., a Delaware corporation ("Borrower"), and UNION BANK OF CALIFORNIA, N.A., a national banking association ("Bank"). RECITALS: A. Borrower and Bank are parties to that certain Trade Finance Agreement dated as of December 4, 1998 (the "Agreement"), pursuant to which Bank agreed to extend credit to Borrower. B. Borrower and Bank desire to amend the Agreement, but subject to the terms and conditions of this First Amendment. AGREEMENT: In consideration of the above recitals and of the mutual covenants and conditions contained herein, Borrower and Bank agree as follows: 1. DEFINED TERMS. Initially capitalized terms used herein which are not otherwise defined shall have the meanings assigned thereto in the Agreement. 2. AMENDMENTS TO THE AGREEMENT. (a) Section 4.6 (Consolidated Quick Ratio) of the Agreement is hereby amended by substituting the ratio "1.00:1.00" for the ratio "1.25:1.00" appearing in the fifth line thereof. (b) Section 4.9 (Consolidated Total Liabilities to Consolidated Shareholders' Equity) of the Agreement is hereby amended to read in full as follows: "4.9 CONSOLIDATED TOTAL LIABILITIES TO CONSOLIDATED SHAREHOLDERS EQUITY. Borrower will maintain a ratio of Consolidated Total Liabilities to Consolidated Shareholders' Equity of not greater than (a) 1.10:1.00 as at the end of fiscal year ended December 31, 1998 and (b) 1.00:1.00 as at the end of each fiscal quarter thereafter. As used in this Agreement, `Consolidated Total Liabilities' shall mean the consolidated total liabilities of Borrower and its subsidiaries, as determined in accordance with generally accepted accounting principles, as shown on the liability side of the consolidated balance sheet of Borrower and its subsidiaries." 3. EFFECTIVENESS OF THIS FIRST AMENDMENT. This First Amendment shall become effective as of the date hereof when, and only when, Bank shall have received all of the following, in form and substance satisfactory to Bank: (a) A counterpart of this First Amendment, duly executed by Borrower; and (b) Such other documents, instruments or agreements as Bank may reasonably deem necessary. 4. RATIFICATION. Except as specifically amended hereinabove, the Agreement shall remain in full force and effect and is hereby ratified and confirmed. 2 5. REPRESENTATIONS AND WARRANTIES. Borrower represents and warrants as follows: (a) Each of the representations and warranties contained in the Agreement, as amended hereby, is hereby reaffirmed as of the date hereof, each as if set forth herein; (b) The execution, delivery and performance of this First Amendment and any other instruments or documents in connection herewith are within Borrower's corporate power, have been duly authorized, are legal, valid and binding obligations of Borrower, and are not in conflict with the terms of any charter, bylaw, or other organization papers of Borrower or with any law, indenture, agreement or undertaking to which Borrower is a party or by which Borrower is bound or affected; and (c) No event has occurred and is continuing or would result from this First Amendment which constitutes or would constitute an Event of Default under the Agreement. 6. GOVERNING LAW. This First Amendment and all other instruments or documents in connection herewith shall be governed by and construed according to the laws of the State of California. 7. COUNTERPARTS. This First Amendment may be executed in two or more counterparts, each of which shall be deemed an original and all of which together shall constitute one and the same instrument. WITNESS the due execution hereof as of the date first above written. THQ, INC. By: /s/ BRIAN J. FARRELL --------------------------------- Title: President and CEO ------------------------------ By: /s/ FRED A. GYSI --------------------------------- Title: VP of Finance and Administration and CFO ------------------------------ UNION BANK OF CALIFORNIA, N.A. By: ANN FORBES --------------------------------- Ann Forbes Title: Vice President ------------------------------ EX-10.11 7 EXHIBIT 10.11 1 EXHIBIT 10.11 [UNION BANK OF CALIFORNIA LOGO] FIRST AMENDMENT TO TRADE FINANCE AGREEMENT THIS FIRST AMENDMENT TO TRADE FINANCE AGREEMENT (this "First Amendment") dated as of March 22, 1999, is made and entered into by and between T.HQ INTERNATIONAL, LTD., a corporation organized and existing under the laws of the United Kingdom ("Borrower"), and UNION BANK OF CALIFORNIA, N.A., a national banking association ("Bank"). RECITALS: A. Borrower and Bank are parties to that certain Trade Finance Agreement dated as of December 4, 1998 (the "Agreement"), pursuant to which Bank agreed to extend credit to Borrower. B. Borrower and Bank desire to amend the Agreement, but subject to the terms and conditions of this First Amendment. AGREEMENT: In consideration of the above recitals and of the mutual covenants and conditions contained herein, Borrower and Bank agree as follows: 1. DEFINED TERMS. Initially capitalized terms used herein which are not otherwise defined shall have the meanings assigned thereto in the Agreement. 2. AMENDMENTS TO THE AGREEMENT. (a) Section 4.6 (Consolidated Quick Ratio) of the Agreement is hereby amended to read in full as follows: "4.6 CONSOLIDATED QUICK RATIO. Borrower shall not permit the ratio of (a) the sum of cash, Cash Equivalents and accounts receivable, in each case for THQ and its subsidiaries (including Borrower), to (b) the consolidated current liabilities of THQ and its subsidiaries (including Borrower) (including advances to THQ made under the Clean Advance Line of the THQ Agreement and outstanding at such time) to be less than 1.00:1.00 as at the end of any fiscal quarter. As used herein, the term 'Cash Equivalents' shall mean (i) securities issued or directly and fully guaranteed or insured by the United States of America or any agency or instrumentality thereof (provided that the full faith and credit of the United States of America is pledged in support thereof), (ii) Dollar denominated time deposits and certificates of deposit of any commercial bank having a long-term unsecured debt rating of at least A or the equivalent thereof from Standard & Poor's Ratings Services, a division of McGraw-Hill, Inc. ("S&P"), (iii) commercial paper issued by any corporation organized under the laws of any state of the United States of America having a rating of at least A- or the equivalent thereof from S&P or at least P-1 or the equivalent thereof from Moody's Investors Service, Inc. ("Moody's") and (iv) investments in money market funds substantially all of which are comprised of securities of the types described in clauses (I) through (iii) hereinabove." (b) Section 4.8 (Consolidated Total Liabilities to Consolidated Shareholders' Equity) of the Agreement is hereby amended to read in full as follows: "4.8 CONSOLIDATED TOTAL LIABILITIES TO CONSOLIDATED SHAREHOLDERS EQUITY. Borrower shall cause THQ and its subsidiaries (including Borrower) to maintain a ratio of Consolidated Total Liabilities to Consolidated Shareholders' Equity of not greater than (a) 1.10:1.00 as at the end of fiscal year ended December 31, 1998 and (b) 1.00:1.00 as at the end of each fiscal quarter thereafter. As used in this Agreement, 'Consolidated Total Liabilities' shall mean the consolidated total liabilities of THQ and its subsidiaries (including Borrower), as determined in accordance with generally accepted accounting principles, as shown on the liability side of the consolidated balance sheet of THQ and its subsidiaries (including Borrower)." 2 3. EFFECTIVENESS OF THIS FIRST AMENDMENT. This First Amendment shall become effective as of the date hereof when, and only when, Bank shall have received all of the following, in form and substance satisfactory to Bank: (a) A counterpart of this First Amendment, duly executed by Borrower; and (b) Such other documents, instruments or agreements as Bank may reasonably deem necessary. 4. RATIFICATION. Except as specifically amended hereinabove, the Agreement shall remain in full force and effect and is hereby ratified and confirmed. 5. REPRESENTATIONS AND WARRANTIES. Borrower represents and warrants as follows: (a) Each of the representations and warranties contained in the Agreement, as amended hereby, is hereby reaffirmed as of the date hereof, each as if set forth herein; (b) The execution, delivery and performance of this First Amendment and any other instruments or documents in connection herewith are within Borrower's corporate power, have been duly authorized, are legal, valid and binding obligations of Borrower, and are not in conflict with the terms of any charter, bylaw, or other organization papers of Borrower or with any law, indenture, agreement or undertaking to which Borrower is a party or by which Borrower is bound or affected; and (c) No event has occurred and is continuing or would result from this First Amendment which constitutes or would constitute an Event of Default under the Agreement. 6. GOVERNING LAW. This First Amendment and all other instruments or documents in connection herewith shall be governed by and construed according to the laws of the State of California. 7. COUNTERPARTS. This First Amendment may be executed in two or more counterparts, each of which shall be deemed an original and all of which together shall constitute one and the same instrument. WITNESS the due execution hereof as of the date first above written. T.HQ INTERNATIONAL, LTD. By: /s/ BRIAN J. FARRELL ---------------------------------- Title: President and CEO ------------------------------- By: /s/ FRED A. GYSI ---------------------------------- Title: VP of Finance and Administration and CFO ------------------------------- UNION BANK OF CALIFORNIA, N.A. By: /s/ ANN FORBES ---------------------------------- Ann Forbes Title: Vice President ------------------------------- EX-21 8 EXHIBIT 21 1 EXHIBIT 21 SUBSIDIARIES OF THQ INC. THQ International Ltd., a United Kingdom Corporation Black Pearl Software, Inc., an Illinois Corporation Malibu Games, Inc., a New York Corporation THQ Deutschland GmbH, a German Corporation GameFx Inc., a Delaware Corporation Rushware Microhandelsgesellschaft mbH, a German Corporation EX-23.1 9 EXHIBIT 23.1 1 EXHIBIT 23.1 Independent Auditors' Consent We consent to the incorporation by reference in Registration Statements No. 333-30655, 333-74747 and 333-74715 of THQ Inc. on Forms S-8 and Registration Statements No. 333-32221, 333-60277 and 333-70335 on Forms S-3 of our report dated February 24, 1999, appearing in this Annual Report on Form 10-K of THQ Inc. for the year ended December 31, 1998. DELOITTE & TOUCHE LLP Los Angeles, California March 31, 1999 EX-27 10 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS THE CONSOLIDATED STATEMENTS OF OPERATIONS AND CONSOLIDATED STATEMENTS OF CASH FLOWS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS FOUND IN FORM 10-K AS FILED WITH THE SEC ON MARCH 31, 1999. YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 19,019,000 0 78,418,000 18,898,000 16,937,000 115,126,000 3,391,000 940,000 128,917,000 64,445,000 0 0 0 113,000 63,984,000 128,917,000 215,060,000 215,060,000 100,001,000 100,001,000 90,603,000 20,838,000 109,000 25,319,000 9,330,000 15,989,000 0 0 0 15,989,000 1.49 1.38
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