-----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, PBnKOyVORrAJnLoXNZEOzj0URzz5adkcoOO1oS9HXzvag8qf+wPb2CFzjVFdvT0L 2C1WJo9t0696angRvUjryQ== 0000950148-98-000697.txt : 19980331 0000950148-98-000697.hdr.sgml : 19980331 ACCESSION NUMBER: 0000950148-98-000697 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NASD 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: 98579541 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 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, 1997 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 X As of March 20, 1998, approximately 6,888,560 shares of Common Stock of the Registrant were outstanding and the aggregate market value of voting Common Stock held by non-affiliates was approximately $144,187,000. DOCUMENTS INCORPORATED BY REFERENCE Portions of the THQ Inc. 1998 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, 1997 ITEMS IN FORM 10-K Page ---- Facing page Part I Item 1. Business. 1 Item 2. Properties. 13 Item 3. Legal Proceedings. 13 Item 4. Submission of Matters to a Vote of Security Holders. 13 Part II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters. 14 Item 6. Selected Financial Data. 15 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 17 Item 8. Financial Statements and Supplementary Data. 25 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 26 Part III Item 10. Directors and Executive Officers of the Registrant. 26 Item 11. Executive Compensation. 26 Item 12. Security Ownership of Certain Beneficial Owners and Management. 26 Item 13. Certain Relationships and Related Transactions. 26 Part IV Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K. 27 Signatures 31 3 The Annual Report of THQ Inc. (the "Company") on Form 10-K contains statements which constitute 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". Such forward-looking statements include statements regarding the intent, belief or current expectations of the Company and its management with respect to the matters discussed in this Report. 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 the Company's report on Form 8-K, filed on March 30, 1998 with the Securities and Exchange Commission. PART I ITEM 1. BUSINESS INTRODUCTION THQ Inc. (the "Company") develops, publishes and distributes interactive entertainment software ("Software") for the various hardware platforms ("Platform") that collectively dominate the home video game market. The Company historically has published titles for all major dedicated Platforms manufactured by Sony, Sega and Nintendo (the "Manufacturers"), and multimedia personal computers. The Company currently publishes titles for Platforms manufactured by Sony, Nintendo and multimedia personal computers. Current products published by the Company are in most interactive Software genres, including action, adventure, arcade, fighting, driving, strategy, simulation and sports. The Company's principal customers include Toys "R" Us, Wal-Mart, Kay Bee Toys and Target, other national and regional retailers, discount store chains and specialty retailers. The Company's titles are developed both internally and under contract with independent developers, and are typically based on properties licensed from third parties. The Company continually seeks to identify and exploit for development, titles based upon entertainment projects (such as movies, television programs and arcade games), sports and entertainment personalities, or popular sports, trends or concepts ("Properties") that have high public visibility or recognition or that reflect the trends of popular culture. Other than titles that the Company may release on CD-ROM for use on multimedia personal computers ("PCs"), all of the Company's products consist of cartridges and CD-ROMs manufactured for the Company by the Manufacturers. The Company achieved a turnaround in 1995, reversing two years of significant losses. Under new leadership, the Company focused its product strategy, improved inventory management and reduced fixed costs. As a result, the Company's revenues increased from $13.3 million in 1994 to $33.3 million, $50.3 million and $89.4 million in 1995, 1996 and 1997, respectively. 1 4 THE INTERACTIVE ENTERTAINMENT INDUSTRY AND TECHNOLOGY The home video game Software market consists both of (i) cartridge-based and CD-ROM-based Software for use solely on dedicated hardware systems manufactured by the Manufacturers, and to a significantly lesser extent, other vendors, 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 manufactured by the Manufacturers 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 the Company has published titles and the technology on which such Platforms are based:
DATE OF U.S. MANUFACTURER PRODUCT NAME INTRODUCTION TECHNOLOGY - ------------ ------------ ------------ ------------ 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
The Company believes that the success of Software is dependent on the graphic look and feel of the Software, the depth and variation of game play and the popularity of the Property on which the Software is based. As new Platforms are introduced, Software for such Platforms requires new standards of design and technology to fully exploit such Platforms' capabilities and requires that Software developers devote substantial resources to product design and development. 2 5 BUSINESS STRATEGY The Company's objective is to become a leading provider of exciting, high-quality Software that appeals to a broad range of consumers for use on a variety of Platforms. The Company's business strategy is based on the following: - Developing a portfolio of games, primarily for use on advanced Platforms, based on Properties that are proprietary or are exclusively licensed to the Company ("Franchise" Properties). Franchise Properties allow the Company to release titles based on such Properties on a variety of hardware Platforms, to create sequels to such titles and to re-release such titles at secondary and tertiary price points in the future. The Company's exclusively licensed Properties currently consist of Viacom / Nickelodeon's Rugrats (exclusive console rights), BASS, Masters Classic, Turner's World Championship Wrestling (contract expires December 29, 1998, and allows the Company to continue to sell products on hand and in process at that date through June 29, 1999) and Brunswick World Tournament of Champions. Currently, the Company's proprietary products are Pax Imperia, Dead Unity, SpeedTribes and Vs. - Identifying and licensing titles originally developed by others primarily in foreign territories with proven or anticipated consumer acceptance and publishing localized versions for advanced Platforms for distribution in the United States and other countries. This strategy enables the Company to more fully participate in the market for advanced Platform games while limiting risk. In 1996, the Company commenced publishing and distributing for the next generation Platforms, Sony PlayStation, and Sega Saturn titles under license from foreign independent Software developers, primarily from Japan. In 1998, the Company expects to publish approximately 11 additional titles acquired in such manner, including The Granstream Saga, Quest 64, RedJack: Revenge of the Bretheren and Shao Lin. - Publishing high quality Software for the large installed base of the Game Boy Platform for so long as the Company believes there is a significant market for such titles. The Company believes that the relatively low cost of development of titles for this Platform and reduced competition in this market creates an opportunity to generate continuing sales and profits from this segment of the video game market. Examples of such titles published by the Company include Disney's Jungle Book and Disney's Lion King and Universal Studio's Jurassic Park Lost World. Licenses acquired for titles currently under development include Disney's Mulan and Disney's A Bug's Life. While the Company historically has published titles for the 16-bit Platforms, it does not intend to publish any new titles after the release of its last Super Nintendo title in March 1998. - Expanding its presence in foreign markets that demonstrate (through an increasing installed base of Platforms) the potential for commercial success of the Company's titles. To accomplish this strategy in 1997, the Company hired a new Vice President of International Sales to lead this initiative. 3 6 - Managing the development and marketing of its titles in a manner that minimizes financial risk. The Company has experienced and expects to continue to experience fluctuations in its revenues, both on a quarterly basis and otherwise, as a result of numerous factors. The Company attempts to minimize its fixed expenses by such means as adjusting the relative use of employees and independent contractors who perform Software development, adopting warehouse and shipping systems that closely link product fulfillment costs to sales volume, and compensating sales representatives based on sales volume. In addition, by implementing strict product ordering and inventory controls, the Company attempts to reduce the risks associated with excessive or obsolete inventory. To further its strategy of obtaining or creating Franchise Properties, the Company has enhanced its development abilities by making certain strategic acquisitions. In 1993, the Company acquired Black Pearl Software, Inc. ("Black Pearl"), an independent Software developer. In August 1996, the Company consummated the acquisition of Heliotrope Studios, Inc. and retained the services of that company's principals (the "Heliotrope Acquisition") in order to develop and publish Pax Imperia: Eminent Domain which was released in 1997 and to develop other strategy games for the PC market. (See " -- Software Design and Development.") The Company may also rely upon strategic investments to facilitate access to proprietary Software and skilled developers outside the Company. In July 1996, the Company acquired a 25% interest in Inland Productions, Inc. ("Inland"), a recently formed Software developer. Inland is currently developing the Company's PlayStation and Nintendo 64 versions of Turner's World Championship Wrestling and PC and PlayStation versions of BASS Masters Classic. The Company seeks to acquire or invest in other Software development companies to further its development of Proprietary titles. TITLES The Company has released an aggregate of 134 titles as of December 31, 1997, consisting of 42 SNES titles, 44 Game Boy titles, 13 Nintendo Entertainment System titles, 12 Genesis titles, 6 Game Gear titles, 3 Saturn titles, 11 PlayStation titles, 2 PC CD-ROM titles and 1 Nintendo 64 title. The Company continually seeks to acquire licenses to publish and distribute additional titles. The following tables set forth, for each Platform, the titles (i) released by the Company in 1997 and anticipated to be released in 1998, and (ii) the date of release (or anticipated release) of each title. There can be no assurance that each of the titles anticipated for release in 1998 will be released when scheduled, or at all. 4 7
RELEASE TITLES RELEASED IN 1997 CATEGORY PLATFORM DATE - --------------------------- -------- ------------ ---------- Williams Arcade Greatest Hits Arcade Super Nintendo 1/97 Mega Drive 1/97 Williams Ms. Pacman Arcade Super Nintendo 2/97 Williams NBA Hangtime Arcade Super Nintendo 2/97 Mega Drive 2/97 Super Return of the Jedi Adventure Super Nintendo 2/97 Super Empire Strikes Back Adventure Super Nintendo 2/97 WCW vs. the World Fighting PlayStation 3/97 Disney's The Hunchback of Notre Arcade Game Boy 3/97 Dame - Topsy Turvy Games Strikepoint "Hex Mission" Action PC 4/97 PlayStation 4/97 Tokyo Highway Battle Racing PlayStation 4/97 K-1 The Arena Fighters Fighting PlayStation 4/97 Disney's The Jungle Book Adventure Game Boy 6/97 Disney's Aladdin Adventure Game Boy 6/97 Disney's The Lion King Adventure Game Boy 6/97 Disney's Ducktales Adventure Game Boy 6/97 Disney's Hercules Adventure Game Boy 7/97 Brunswick World Tournament of Sports Super Nintendo 8/97 Champions Bravo Air Race Racing PlayStation 9/97 Madden NFL 98 Sports Sega Genesis 9/97 Timon & Pumbaa Arcade Super Nintendo 10/97 Pax Imperia: Eminent Domain Strategy PC 10/97 NHL 98 Sports Sega Genesis 10/97 Disney's The Lion King Adventure Super Nintendo 10/97 Disney's The Jungle Book Adventure Super Nintendo 10/97 WCW vs NWO: World Tour Fighting Nintendo 64 11/97 Ghost in the Shell Shooter PlayStation 11/97 NBA Live 98 Sports Sega Genesis 11/97 Vs. Fighting PlayStation 12/97 Madden NFL 98 Sports Super Nintendo 12/97 Jurassic Park Lost World Adventure Game Boy 12/97 FIFA Road to World Cup 98 Sports Game Boy 12/97
5 8
ANTICIPATED TITLES ANTICIPATED TO BE RELEASED RELEASE 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 Spring '98 Quest 64 Adventure/ Nintendo 64 Spring '98 Role Playing The Granstream Saga Role Playing PlayStation Summer '98 BASS Masters Classic: Tournament Simulation PlayStation Summer '98 Edition PC Summer '98 RedJack: Revenge of the Bretheren Adventure PC Summer '98 Macintosh Disney's Mulan Adventure Game Boy Summer '98 Small Soldiers Adventure Game Boy Summer '98 Dead Unity Action PlayStation Summer '98 Adventure PC Brunswick Circuit Pro Bowling Sports PlayStation Summer '98 PC Summer '98 Shao Lin Fighting PlayStation Fall '98 SpeedTribes Action PlayStation Fall '98 PC Fall '98 WCW/NWO Live Fighting Nintendo 64 Fall '98 WCW/ NWO Nitro Fighting PC Fall '98 Disney's A Bug's Life Adventure Game Boy Fall '98 Yoda Stories Adventure Game Boy Fall '98 Rugrats Adventure PlayStation Fall '98 Game Boy Fall '98
* Excludes titles the Company expects to release in 1998 but which have not yet been publicly announced. ** Title released as of March 29, 1998. 6 9 INTELLECTUAL PROPERTY LICENSES The Company's strategy includes the creation of exciting games based on licensed Properties that have attained a high level of consumer recognition or acceptance. The Company believes it enjoys excellent relationships with a number of licensors, including Disney, Viacom / Nickelodeon and Lucas Arts. The Company pays royalties to its Property licensors that generally range from 5% to 12% of the Company's net sales of the title. The Company must 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, the Company 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 there can be no assurance that the Company and the licensor will reach agreement to extend the term. (See " --Management Discussion and Analysis-Overview -- Revenue Fluctuations and Seasonality.") The Company's Property licenses generally grant to the Company 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. Software published by third parties for use with other Platforms based on such Property may compete with titles offered by the Company. PLATFORM LICENSES The Company's business is dependent on its license agreements with the Manufacturers. All of such licenses are for fixed terms and are not exclusive. Each license grants to the Company 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 Manufacturer. 7 10 The following table sets forth information with respect to the Company's Platform Licenses. In some instances, the Company has more than one Platform License for a particular Platform.
NUMBER OF MANUFACTURER PLATFORM TITLES TERRITORY EXPIRATION DATE(S) - ------------ ------------ ----------------- ----------------- ------------------ Nintendo N64 title-by-title(1) North America and November 1999 Latin America Nintendo Game Boy 15/contract yr. North America and April 1999 Latin America Nintendo Game Boy 10/contract yr. Europe and certain June 2000 Asian countries Sony PlayStation title-by-title(1) U.S. and Canada June 1998 Sony PlayStation title-by-title(1) Europe December 2005(2)
- ---------- (1) This Platform License does not set a maximum number of titles that the Company may publish in the designated territory; however, each title must be approved by the Manufacturer prior to development of the Software. (2) Agreement continues year-to-year after such date unless terminated by either party. Nintendo charges the Company a fixed amount for each cartridge, which amount varies based, in part, on memory capacity and processor power. Sony similarly charges a per unit amount for each CD-ROM. These charges 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 all packaging used by the Company in connection with the products. In addition, the Company 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 Company's titles, including any claims for copyright or trademark infringement brought against the Manufacturer. As a result, the Company bears a risk not only that the Properties upon which the titles are based, but also the information and technology licensed from the Manufacturer and incorporated in the products, may infringe the rights of third parties. While the Company's agreements with its independent Software developers and Property licensors typically provide for indemnification of the Company with respect to certain matters, there can be no assurance that, if any claim is brought by a Manufacturer against the Company for indemnification, such developers or licensors would have sufficient resources to in turn indemnify the Company, or that such indemnification would cover the matter that gave rise to the Manufacturer's claim against the Company. Each Platform License may be terminated by the Manufacturer if a breach or default by the Company is not cured by the Company after receipt of written notice thereof from the Manufacturer, or if the Company becomes insolvent. Upon termination of a Platform License for any reason other than a breach or default by the Company, the Manufacturer has the right to 8 11 purchase from the Company, at the price paid by the Company, any product inventory manufactured by such Manufacturer for the Company that remains unsold for a specified period after such termination. Any such inventory not purchased by the Manufacturer must be destroyed. Upon termination as a result of a breach or default by the Company, any remaining inventory at such time must be destroyed, subject to the right of any institutional lender to the Company to sell such inventory for a specified period. SOFTWARE DESIGN AND DEVELOPMENT Once the Company identifies and acquires a Property from a licensor, the Company designs and develops a game with features intended to exploit the characteristics of the Property and to appeal to the target consumers for such game. The Company's Software development process generally takes one of two forms. Internal Software Development. The Company's in-house development is supervised by the Company's Vice President -- Software Development and is staffed by producers, programmers, Software engineers, artists, animators and game testers. The Heliotrope Acquisition enhanced the Company's internal development capabilities by adding a Software development team and related facilities in Connecticut. The Heliotrope team worked with the Company's other development staff to produce Pax Imperia: Eminent Domain for publication on CD-ROM for PCs. The Company uses a variety of advanced hardware and Software development tools, proprietary hardware emulator systems, and various graphics, animation, sound and compression applications. As of December 31, 1997, the Company had 38 development employees. External Software Development. The Company also contracts with independent Software developers to conceptualize and develop titles under the Company's supervision. As of December 31, 1997, the Company had contracted development efforts to 17 such developers. The Company generally pays independent developers certain advances against royalties based on specified development completion milestones. Royalties in excess of the advances are based on a fixed amount per unit sold and range from $.25 to $6.00 per unit. The Company generally obtains ownership of the Software code and related documentation. The Company's agreements with its independent Software developers are usually entered into on a title-by-title basis. The Company may make strategic investments in independent developers for the purpose of securing access to proprietary Software and talented developers. In June 1996, the Company acquired a 25% interest in Inland, the developer currently working on versions of Turner's World Championship Wrestling and BASS Masters Classics. Upon completion of development, each title is extensively "play-tested" by the Company and sent to the Manufacturer for its review and approval. Related artwork, user instructions, warranty information, brochures and packaging designs are also developed under the Company's supervision. The development cycle for new titles, 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 the Company to 9 12 determine whether there will be adequate retailer and consumer demand for a title well in advance of its release. MANUFACTURING Except for certain Genesis and SNES cartridges, the Manufacturers are the sole manufacturers of the products sold for use on their respective Platforms. After placing a purchase order with a Manufacturer and opening either a letter of credit in favor of the Manufacturer or line of credit with the Manufacturer, the Company sends to the Manufacturer the title's Software code and a prototype, together with related artwork, user instructions, warranty information, brochures and packaging designs, for approval, defect testing and manufacture. The Manufacturers currently deliver cartridges to the Company within 30 to 60 days, and CD-ROMs within 10 to 14 days, after their receipt of an order and a corresponding letter of credit, if required. MARKETING, SALES AND DISTRIBUTION The Company depends in large part on the high name recognition of the Properties on which its titles are based to attract customers and to obtain shelf space in stores. The Company's sales activities are directed by the Company's Senior Vice President -- Sales, which maintains contact with major retail accounts and manages the activities of the Company's independent regional sales representatives. The Company is required by the Platform Licenses to provide a standard defective product warranty on all of the products sold. Generally, the Company is responsible for resolving, at its own expense, any warranty or repair claims. The Company has not experienced any material warranty claims. United States and Canadian Sales. The Company's titles are promoted to retailers by display at trade shows, such as the annual Electronic Entertainment Expo (E3). The Company also conducts print and cooperative retail advertising campaigns for most titles and prepares promotional materials, including product videos, to increase awareness among retailers and consumers. Product marketing highlights for the Company's 1997 titles included national television, radio, and print advertising campaigns in console and PC gaming publications, worldwide. Bravo Air Race, Pax Imperia, Brunswick World Tournament of Champions, and the World Championship Wrestling titles for the PlayStation and Nintendo 64 were several titles featured at various live events and in nationwide Sony and Nintendo van tours. Prima Publishing further supported Pax Imperia, Vs., Ghost in the Shell, and the WCW titles at launch with strategy guides at retail. The Company's 1997 product line was launched with major in-store retail promotions such as demos, discs, posters, and pre-sell giveaways. International publicity campaigns in console and PC gaming publications, consumer and business magazines and newspapers delivered covers, contests, product preview, reviews and features. Additionally, the Company 10 13 developed product-specific web sites and expanded their online publicity and advertising efforts. The Company is considering supporting several new title launches with television advertising in 1998. Most of the Company's sales consist of direct sales to retailers. The Company distributes its titles primarily to mass merchandisers and national retail chain stores, including Toys "R" Us (representing 19% of net sales), Wal-Mart (representing 10% of net sales), Best Buy, Blockbuster Video, Kay Bee Toys, Electronics Boutique and Target. Sales to the Company's ten largest customers collectively accounted for approximately 54% of the Company's gross sales in 1996 and 67% of the Company's gross sales in 1997. The Company has no written agreement or other understanding with any of its customers that relate to future purchases by such customers, and thus, purchases by such customers may terminate at any time. The Company utilizes electronic data interchange with most of its 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. The Company ships its products to its domestic customers from a public bonded warehouse in Southern California. The Company's agreements with its independent regional sales representatives set forth the representatives' exclusive territory, types of customers to be solicited, commission rate and payment terms. Such representatives do not have contractual authority to obligate the Company. The domestic retail price for the Company's Software generally ranges between $19 and $35 for Game Boy, between $19 and $49 for PlayStation, between $50 and $70 for Nintendo 64, and between $30 and $50 for PCs. Foreign Sales. Historically, the Company distributed its titles in the United Kingdom, Europe and Australia. In 1997, the Company expanded its sales to Brazil, Singapore and other countries. The Company sells its titles directly to retailers in the United Kingdom and to distributors for distribution in other countries. Products are shipped at the Company's expense to a public warehouse in the United Kingdom for foreign distribution. Foreign sales to distributors in countries other than the United Kingdom are shipped at the customer's expense directly to the customer's location. INTELLECTUAL PROPERTY RIGHTS Each product and title typically embody a number of separately protected intellectual Property rights of the Manufacturer, the Property licensors and, to a lesser extent, the Company. The licensors of the Properties own the trademarks, trade names, copyrights and other intellectual Property rights relating to the Property on which the titles are based. The Manufacturer owns the patents and substantially all of the other intellectual Property embodied in the products. While the Company owns the game Software embodied in the products, the Company believes that such Software has little independent economic value. Accordingly, the Company must rely on the 11 14 Manufacturers and the Property licensors with respect to protection from infringement of these Property rights by third parties. Each of the Manufacturers incorporates security devices in their respective Platforms and products to prevent unlicensed use of its Platforms. In addition, Nintendo requires its licensees to display the "Nintendo Seal of Approval" to notify the public that the title has been approved by Nintendo for use with a Nintendo Platform. COMPETITION The interactive entertainment industry is intensely competitive. The ability of the Company to compete successfully is based on its ability to identify and obtain licenses to commercially marketable Properties, to develop appealing titles, to adapt its development capabilities with new technologies and to secure retail distribution. The Company competes, for both licenses to Properties and the sale of its titles, with the Manufacturers, each of which is the largest developer and marketer of Software for its Platforms. There can be no assurance that these companies will not increase their own development efforts. As a result of their commanding positions in the industry as primary manufacturers of dedicated interactive entertainment hardware and publishers of Software, the Manufacturers generally have better bargaining positions with respect to retail pricing, shelf space and purchases than do any of their licensees, including the Company. The Manufacturers often have lower suggested retail prices for their Software than do their licensees. Each of the Manufacturers has dozens of active licensees, each of which is also a competitor of the Company. Each of the Manufacturers and many of these other competitors (such as Acclaim Entertainment, Inc., Disney Interactive, Inc., Electronic Arts Inc., GT Interactive Software Corp., Microsoft Corporation and Midway Games Inc.) have broader Software lines and greater financial, marketing and other resources than the Company; these competitive advantages enable such competitors to market their Software more aggressively and make higher offers or guarantees in connection with the acquisition of licensed Properties. In addition, as competition for retail shelf space becomes more intense, the Company may need to increase marketing expenditures to maintain sales of its titles; and as competition for popular Properties increases, the cost of acquiring licenses for such Properties is likely to increase, resulting in reduced margins. In addition, the market for the Company's products is characterized by significant price competition, and the Company expects that it will face increasing pricing pressures from its current competitors. Accordingly, there can be no assurance that the Company will be able to provide products that compare favorably with the products of the Company's competitors or that competitive pressures will not require the Company to reduce its prices. Any material reduction in the price of the Company's products would negatively affect operating income as a percentage of net revenue and would require the Company to increase unit sales in order to maintain net revenue. 12 15 The Company believes that some large diversified entertainment companies, in addition to large Software companies, are increasing their focus on the interactive entertainment market, which will result in greater competition for the Company. In particular, many of the Company's competitors are developing on-line interactive games and interactive networks that will be competitive with the Company's interactive products. There can be no assurance that the Company will be able to compete successfully against current or future competitors or that competitive pressures faced by the Company will not materially and adversely affect its business, operating results and financial condition. EMPLOYEES As of December 31, 1997, the Company had 81 full-time employees. All but ten of such persons are located in the United States. None of the Company's employees is represented by a labor union or covered by a collective bargaining agreement. The Company believes that its relations with its employees are good. ITEM 2. PROPERTIES The Company's executive offices occupy approximately 13,400 square feet of office space at 5016 North Parkway Calabasas, Calabasas, California, pursuant to a lease expiring in July 2000. The Company also leases office space for sales and marketing personnel in Cupertino, California and Woking, England, and for development personnel in East Haven, Connecticut. The Company believes that its office facilities are adequate. ITEM 3. LEGAL PROCEEDINGS While the Company has been a party to legal proceedings from time to time, such legal proceedings have been ordinary and incidental to the Company's business and have not had a material adverse affect on the Company. 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 1997. 13 16 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS From February 20, 1995 until February 13, 1997, the Company's common stock ("Common Stock") was quoted on the Nasdaq SmallCap Market under the symbol "TOYH". On February 14, 1997, the Company's Common Stock began trading 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 the Common Stock as reported on the Nasdaq National Market or the Nasdaq SmallCap Market.
CLOSING SALES PRICES ---------------------------- HIGH LOW ------------- ------------ 1997 First Quarter 9 1/4 5 7/8 Second Quarter 11 1/8 6 3/8 Third Quarter 13 9 1/2 Fourth Quarter 23 12 1/8 1996 First Quarter 5 3/16 3 1/2 Second Quarter 6 1/4 3 3/16 Third Quarter 7 9/16 4 1/8 Fourth Quarter 10 3/8 7 1/16
As of March 20, 1998, there were approximately 6,888,560 shares outstanding, 368 holders of record and 5,850 beneficial owners of the Common Stock. DIVIDEND POLICY The Company has never declared or paid any dividends on the Common Stock and does not intend to pay any cash dividends on the Common Stock in the foreseeable future. The Company intends to retain its earnings, if any, for the future operation and expansion of its business. The Company's agreement with its domestic bank prohibits the Company from declaring or paying any dividend on, or making any distribution in respect of, the Company's capital stock. (See "Management's Discussion and Analysis of Financial Condition and Results of Operations --Liquidity and Capital Resources.") SECURITIES ISSUED IN PRIVATE TRANSACTIONS There were no securities issued in private transactions in 1997. 14 17 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) The following selected consolidated financial data of the Company for each of the years ended December 31, 1995, 1996 and 1997 have been derived from and are qualified by reference to the audited consolidated financial statements of the Company included elsewhere herein which have been audited by Deloitte & Touche LLP, independent auditors. The following selected consolidated financial data as of and for the periods ended December 31, 1993 and 1994 were derived from audited financial statements 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. 15 18 STATEMENT OF OPERATIONS DATA
YEARS ENDED DECEMBER 31, ------------------------------------------------------------ 1993 1994 1995 1996 1997 -------- -------- -------- -------- -------- (In thousands, except per share data) Net sales $ 37,478 $ 13,289 $ 33,250 $ 50,255 $ 89,362 Costs and expenses: Cost of sales 31,415 12,651 19,501 29,301 48,110 Royalties 6,028 2,327 3,641 7,977 14,158 Product development 1,392 888 889 1,324 1,610 Project abandonment 5,489 3,754 1,025 610 600 Selling 6,163 6,864 3,114 4,444 8,670 General and administrative 5,695 3,676 3,139 3,496 5,064 Operating interest 529 496 1,184 878 315 -------- -------- -------- -------- -------- Total costs and expenses 56,711 30,656 32,493 48,030 78,527 -------- -------- -------- -------- -------- Income (loss) from operations (19,233) (17,367) 757 2,225 10,835 Interest income (expense) - net (420) (112) (134) (316) 464 -------- -------- -------- -------- -------- Income (loss) before income taxes (19,653) (17,479) 623 1,909 11,299 Provision (benefit) for income taxes (3,413) 11 22 8 1,954 -------- -------- -------- -------- -------- Net income (loss) $(16,240) $(17,490) $ 601 $ 1,901 9,345 ======== ======== ======== ======== ======== Net income (loss) per share -- basic $ (10.80) $ (8.75) $ .21 $ .42 $ 1.48 ======== ======== ======== ======== ======== Net income (loss) per share -- diluted $ (10.80) $ (8.75) $ .17 $ .39 $ 1.35 ======== ======== ======== ======== ======== Weighted-average number of Common shares -- basic 1,504 1,998 2,858 4,525 6,320 ======== ======== ======== ======== ======== Weighted-average number of common shares, stock options and warrants -- diluted 1,504 1,998 3,556 4,836 6,901 ======== ======== ======== ======== ======== BALANCE SHEET DATA YEARS ENDED DECEMBER 31, ------------------------------------------------------------ 1993 1994 1995 1996 1997 -------- -------- -------- -------- -------- Working capital $ 11,046 $ 3,736 $ 7,082 $ 9,672 $ 31,462 Total assets $ 22,305 $ 15,531 $ 16,916 $ 22,840 $ 59,453 Advance from bank -- -- -- $ 5,355 -- Stockholders' equity $ 11,627 $ 4,254 $ 7,598 $ 11,048 $ 33,527
16 19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW In 1997, the Company developed, published and distributed Software for the major Platforms sold by the Manufacturers. Sales of Nintendo Software constituted 65% of the Company's sales, Sony PlayStation sales were 22%, Sega Software sales were 10%, and the remaining 3% were derived from PC titles. The Company achieved a turnaround in 1995, reversing two years of significant losses. Under new leadership, the Company focused its product strategy, improved inventory management and reduced fixed costs. As a result, the Company's revenues increased from $13.3 million in 1994 to $33.3 million, $50.3 million and $89.4 million in 1995, 1996 and 1997, respectively. While the Company historically has published titles for the 16-bit Platforms, it does not intend to publish any new titles after the release of its last Super Nintendo title in March 1998. The Company does not intend to publish any new titles for the Sega Platforms during 1998. The Company's business cycle generally commences with the securing of a license to publish one or more titles based on a Property. Such 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 securing the Property, the Company commences Software development for the title. Upon completion of development and approval of the title by the Manufacturer, the Company orders products and generally causes a letter of credit to be opened in favor of the Manufacturer or obtains a line of credit from the Manufacturer. Products are shipped at the Company's expense to a public warehouse in California for domestic distribution or in the United Kingdom for foreign distribution. Foreign sales to distributors in countries other than the United Kingdom are shipped at the customer's expense directly to the customer's location. The Company has unfilled sales orders the amount of which fluctuates from time to time, commonly referred to as "backlog." However, substantially all of the Company's product orders are fulfilled shortly after they are received. Accordingly, the Company does not believe that the amount of its unfilled sales orders as of the end of a period is a meaningful indicator of sales in future periods. Revenue Fluctuations and Seasonality. The Company has experienced and may continue to experience significant quarterly fluctuations in net sales and operating results due to a variety of factors, including the timing of releases of new titles by the Company, the popularity of both new titles and titles released in prior periods, fluctuations 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 retailer's forecasts of consumer demand. The Company's expenses are based, in part, on its expectations of future 17 20 revenues and, as a result, operating results would be disproportionately and adversely affected by a decrease in sales or a failure by the Company to meet its sales expectations. In addition, the Software market is highly seasonal, with sales typically significantly higher during the fourth quarter (due primarily to the increased demand for interactive games during the year-end holiday buying season). There can be no assurance that the Company can maintain consistent profitability on a quarterly or annual basis. On March 10, 1998, the Company announced that its current license agreement with World Championship Wrestling will not be be renewed. The current license agreement expires on December 29, 1998, and permits the Company to continue to sell products on hand and in process at that date through June 29, 1999. Products released by the Company under this license accounted for 39% of the Company's revenues in 1997 and are expected to account for a substantial portion of the Company's revenues in 1998. There can be no assurance that this development will not have a material adverse affect on the Company. Profit margins may vary over time as a result of a variety of other factors. Profit margins for cartridge products can vary based on the cost of the memory chip used for a particular title. As Software has grown more complex, the trend in the 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. However, such savings may be offset by typically higher development costs for titles published on CD-ROMs; such higher costs result from the creation of increased and enhanced content to take advantage of the greater storage capacity available on CD-ROMs. Recovery of Prepaid Royalties, Guarantees and Capitalized Development Costs. The Company typically enters into agreements with licensors of Properties and developers of titles that require advance payments of royalties and/or guaranteed minimum royalty payments. There can be no assurance that the sales of products for which such royalties are paid will be sufficient to cover the amount of these required royalty payments. The Company capitalizes its prepaid royalties, and capitalizes Software development costs upon the establishment of technological feasibility of the title under development. 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. The Company analyzes such capitalized costs quarterly and writes off as project abandonment losses those capitalized payments and costs (and expenses any unpaid guaranteed minimum royalties) when, based on the Company's estimate, future revenues will not be sufficient to recover such costs. As of December 31, 1997, the Company had prepaid royalties and capitalized development costs of $11.4 million. If the Company were required to write off a material portion of its prepaid royalties or capitalized development costs, the Company's results of operations could be adversely affected. Discounts, Allowances and Returns; Inventory Management. Although the Company's arrangements with its customers generally do not give such customers the right to return products to the Company (other than defective products) or to cancel firm orders, the Company often negotiates accommodations to retailers (and, less often, to distributors) when demand for specific 18 21 items falls below expectations for the purpose of maintaining its relationships with its customers. Such 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, credits against future orders and, less often, the return of products to the Company. It is the Company's practice to accept all returns of defective or damaged products. At the time of product shipment, the Company establishes provisions against the gross revenues generated by such shipment based on estimates of future returns of, other customer accommodations and doubtful accounts that may be granted with respect to, such products, based on the Company's historical experience, retailer inventories of the titles and other factors. For the year ended December 31, 1996 and 1997, provisions of $5.2 million and $10.5 million, respectively, were taken against gross sales made during such periods, and as of December 31, 1997, the Company's aggregate reserve against accounts receivable for returns, customer accommodations and doubtful accounts was $9.3 million. The identification by the Company of slow-moving or obsolete inventory, whether as a result of requests from customers for accommodations or otherwise, would require the Company to establish reserves against such inventory or to write-down the value of such inventory to its estimated net realizable value. XBAND Modem. Pursuant to an agreement between the Company and Catapult Entertainment, Inc. ("Catapult") entered into in April 1994, the Company was granted exclusive distribution rights for Catapult's modems (the "XBAND Modem") for use in connection with the Genesis and SNES systems in North America. The XBAND Modem enables video game players to compete against each other in real time from different locations through a communications network created and maintained by Catapult. The Company spent approximately $5.8 million through December 31, 1994, in connection with inventory purchases and the marketing and promotion of the XBAND Modem. In May 1995, the Company sold to Catapult the Company's XBAND Modem inventory and related accounts receivable for $3.2 million, of which $1.3 million was paid at such time and the balance was payable over a specified period (less the amount collected by the Company with respect to such receivables). Subsequently, Catapult filed for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code. Under Catapult's plan of reorganization, the Company received approximately 15% of its remaining claim against Catapult, or approximately $200,000, in December 1996. Because the Company determined in May 1995 that receipt of any additional payment by Catapult was highly uncertain, at such time the Company established a reserve in the amount of such remaining payments. As a result, substantially all of the amount received pursuant to the plan of reorganization is reflected in the Company's statement of operations for the year ended December 31, 1996. Net Operating Loss Carryforwards. At December 31, 1997, for federal income tax purposes the Company had $15.4 million of NOL carryforwards incurred since 1993. The Company's public offering of common stock in February 1997 resulted in an "ownership change" of the Company for purposes of Sections 382 and 383 of the Internal Revenue Code of 1986, as 19 22 amended. As a result, the amount of the NOL carryforwards available to reduce the Company's federal income tax liability in future years in which the Company has taxable income is limited to an annual amount equal to (i) the fair market value of the Company's capital stock immediately prior to the consummation of the offering on February 11, 1997, multiplied by (ii) the "long-term tax exempt rate" published by the Internal Revenue Service for the month in which the offering was consummated. Based upon a long-term tax exempt rate for February 1997 of 5.48% and an assumed market price of the Common Stock immediately prior to consummation of this offering of $8.56 per share (the last reported sale price of the Common Stock on February 10, 1997), such amount is approximately $2,225,000 per year. YEAR 2000 DISCLOSURE The inability of computers, software and other equipment utilizing microprocessors to recognize and properly process data fields containing a 2- digit year is commonly referred to as the "Year 2000 Compliance" issue. As the year 2000 approaches, such systems may be unable to accurately process certain date-based information. The Company has identified all significant applications that will require modification to ensure Year 2000 Compliance. Internal and external resources are being used to make the required modifications and test Year 2000 Compliance. The modification process of all significant applications is substantially complete. The Company plans on completing the testing process of all significant applications by December 31, 1998. In addition, the Company is in the process of communicating with others with whom it does significant business to determine their Year 2000 Compliance readiness and the extent to which the Company is vulnerable to any third party Year 2000 issues. However, there can be no guarantee that the systems of other companies on which the Company's systems rely will be timely converted, or that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have a material adverse effect on the Company. The total cost to the Company of these Year 2000 Compliance activities has not been and is not anticipated to be material to its financial position or to its results of operations for any given year. These costs and the date on which the Company plans to complete the Year 2000 modification and testing processes are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ from those plans. 20 23 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the components of the Company's net sales and its consolidated operating data as a percentage of net sales:
YEARS ENDED DECEMBER 31, --------------------------------- 1995 1996 1997 ----- ----- ----- Domestic sales 74.9% 70.4% 84.3% Foreign sales 25.1 29.6 15.7 ----- ----- ----- Net sales 100.0% 100.0% 100.0% Costs and expenses: Cost of sales 58.6% 58.3% 53.8% Royalties 10.9 15.9 15.8 Product development 2.7 2.6 1.8 Project abandonment 3.1 1.2 0.7 Selling 9.4 8.9 9.7 General and administrative 9.3 7.0 5.7 Operating interest 3.6 1.7 0.4 ----- ----- ----- Total costs and expenses 97.6% 95.6% 87.9% ----- ----- ----- Income from operations 2.4% 4.4% 12.1% Interest income (expense) -- net (0.5) (0.6) 0.5 ----- ----- ----- Income before income taxes 1.9% 3.8% 12.6% ----- ----- ----- Net income 1.8% 3.8% 10.5% ===== ===== =====
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 ============ ============
21 24 The Company's net sales increased to $89,362,000 in the year ended December 31, 1997, from $50,255,000 in the same period of 1996, primarily as a result of higher unit sales per title shipped. For the year ended December 31, 1997, net sales of the Company's WCW titles, Madden 98 titles and Disney re-releases (Lion King, Jungle Book, Aladdin, and Duck Tales), were $36,181,000 (39% of net sales), $6,032,000 (6.8% of net sales), and $5,214,000 (5.8% of net sales), respectively Cost of sales for the year ended December 31, 1997 decreased significantly as a percentage of net sales to 53.8% from 58.3% in the same period of 1996, primarily as a result of the increase in CD-ROM product sales, which generally have more favorable gross margins. 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 the same period of 1996 because the Company's WCW vs. NWONWO: World Tour, K-1 The Arena Fighters, and Vs. titles were shipped only in the United States. WCW vs. NWONWO: World Tour and K-1 The Arena Fighters are scheduled to ship in foreign markets in the first quarter of 1998. Vs. will be shipped later in the year. Royalty expense for the year ended December 31, 1997 increased $6,181,000 over the same period in 1996 but remained relatively constant as a percentage of net sales. For the year ended December 31, 1997, product development expenses increased by $286,000 compared to the year ended December 31, 1996, as a result of increased investment in internal product development during the period as well as increased product packaging costs relating to titles released in 1997 as compared to 1996. For the year ended December 31, 1997, selling expenses increased by $4,226,000 compared to the year ended December 31, 1996, as a result of increased marketing efforts for new titles consisting primarily of print and retail cooperative advertising and increased warehouse expenses which are the result of increased sales volumes. Selling expenses as a percentage of net sales were 9.7% in 1997 as compared to 8.8% in 1996. General and administrative expenses for the year ended December 31, 1997, decreased as a percentage of net sales to 5.7% from 7.0% for the same period of 1996, but increased in dollar terms by $1,568,000 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 costs. Operating interest, which consists of interest and fees paid to the Company's bank and fees paid to other issuers of letters of credit, decreased to $315,000 for the year ended December 31, 1997, from $878,000 for 1996. The decline is the result of a more advantageous banking arrangement (See " -- Credit Facilities") and the use of funds generated by the Company's common stock offering which was completed on February 14, 1997. (See " -- Liquidity and Capital Resources.") 22 25 COMPARISON OF THE YEAR ENDED DECEMBER 31, 1996 TO THE YEAR ENDED DECEMBER 31, 1995 The following table sets forth, for the years ended December 31, 1995 and 1996, the titles released during such periods for the Platforms indicated:
YEARS ENDED DECEMBER 31, ---------------------------- 1995 1996 ------------ ------------ PlayStation -- 4 Saturn -- 3 SNES 6 11 Genesis 2 4 Game Boy 10 10 Game Gear 6 1 ------------ ------------ Total 24 33 ============ ============
The Company's net sales increased to $50,255,000 in the year ended December 31, 1996, from $33,250,000 in the same period of 1995, primarily as a result of the increase in the number of new titles released in 1996. For the year ended December 31, 1996, net sales of the Company's Olympic Summer Games, Disney's Toy Story and NHL Hockey 97 titles were $6,631,000 (13.2% of net sales), $5,981,000 (11.9% of net sales) and $4,953,000 (9.9% of net sales), respectively. Foreign net sales grew to $14,856,000, (29.6% of net sales) for the year ended December 31, 1996, from $8,356,000, (26.2% of net sales) in the same period of 1995, as a result of an increase in the number of titles shipped and an increase in unit sales per title. The results for fiscal 1995 included sales of $1,200,000 and cost of sales of $600,000 resulting from the sale of the XBAND Modem inventory to Catapult. (See " -- Overview -- XBAND Modem.") Cost of sales decreased slightly as a percentage of net sales to 58.3% for the year ended December 31, 1996 as compared to 58.6% of net sales for 1995. The commencement in 1996 of the sale of higher-margin CD-ROM titles was mitigated by increased foreign sales, for which margins are generally lower, and a greater percentage of sales of SNES titles, for which margins are slightly lower. Royalty expense as a percentage of net sales increased to 15.9% for the year ended December 31, 1996 from 10.9% for 1995. License agreements for titles released in 1996 provided for royalties at higher rates, particularly the Company's licenses for Disney's Pocahontas and Disney's Toy Story and its titles for advanced Platforms. For the year ended December 31, 1996, product development expenses increased by $435,000 compared to the year ended December 31, 1995, as a result of increased investment in internal product development during the period as well as increased product packaging costs relating to the increase in titles released in 1996 as compared to 1995. Project abandonment expenses decreased by $415,000 in the year ended December 31, 1996, as compared to the same period of 1995 as a result of the Company bringing more of its 23 26 scheduled products to market and achieving a greater proportion of its minimum royalty guarantees. For the year ended December 31, 1996, selling expenses increased by $1,330,000 compared to the year ended December 31, 1995, as a result of increased marketing efforts for new titles consisting primarily of print and retail cooperative advertising, but remained relatively constant as a percentage of sales at 6.9% of net sales in 1996 as compared to 7.2% in 1995. General and administrative expenses for the year ended December 31, 1996, decreased as a percentage of net sales to 9.2% from 11.9% for the same period of 1995, but increased in dollar terms by $357,000 over 1995. The increased expenses were due in part to a charge of $375,000 in 1996 resulting from the bankruptcy of one of the Company's customers. Operating interest, which consists of interest and fees paid to the Company's bank and fees paid to other issuers of letters of credit, decreased to $878,000 for the year ended December 31, 1996, from $1,184,000 for the same period of 1995. The decline is the result of the Company's entering into more favorable agreements with the Company's domestic and European letter of credit providers. LIQUIDITY AND CAPITAL RESOURCES The Company's 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, the Company typically opens letters of credit in their favor or obtains a line of credit from the Manufacturer. As of December 31, 1997, the Company had obligations with respect to future guaranteed minimum royalties of $11,499,000, substantially all of which are payable within the subsequent twelve months. As of December 31, 1997, the Company had obligations with respect to open letters of credit of $10,080,000. Due to increased sales volume , accounts receivable increased significantly from December 31, 1996 to December 31, 1997. Prepaid and deferred royalties and Software development costs increased from December 31, 1996 as a result of the Company entering into several new contracts for both Properties and new product development. (See " -- Recovery of Prepaid Royalties, Guarantees and Capitalized Development Costs.") Since the Company records as a liability the entire guarantee of a contract at its inception, accrued royalties also increased significantly from December 31, 1996. Accounts payable and accrued expenses increased significantly from December 31, 1996 as a result of the timing of large product receipts in the last part of 1997. The amount of the Company's accounts receivable is subject to significant seasonal variations due to the seasonality of sales, and is typically highest at the end of the year. As a result, the Company's working capital requirements are greatest during its third and fourth quarters. The Company believes that the funds provided by operations and funds available under the Company's revolving credit facility with its bank, will be adequate to meet the Company's anticipated requirements for operating expenses, product purchases, guaranteed payments to 24 27 licensors and Software development through 1998. However, to the extent accounts receivable, inventories and guaranteed and advance payments increase as a result of growth of the Company's business, the Company could require additional working capital to fund its operations. The Company does not anticipate making material additional capital expenditures in 1998. For the year ended December 31, 1997, the Company spent $923,000 (primarily as a result of the installation of an upgraded computer network and accounting software package). The net proceeds of $11.7 million from the Company's public offering of Common Stock in February 1997 were used in part for general corporate purposes including obtaining new licenses for, and development expenses related to, new titles and the repayment of amounts outstanding under the Company's revolving credit facility. Credit Facilities. In July 1996, the Company terminated its factoring and credit agreement and entered into the Revolving Credit Facility with Imperial Bank. On September 22, 1997, the Company entered into a new agreement for a larger and lower cost banking facility with Imperial Bank. The new bank credit agreement is designed to mirror the seasonal trends of the Company's business, providing advances under the credit line of up to $23 million during the Company's peak selling season (October 1 to January 31), and up to $12 million outside of the peak season. Although the agreement contains certain covenants regarding financial and other matters, the Company's borrowings are no longer restricted to a formula based on receivables and inventory. Interest on the outstanding balance is payable at Imperial Bank's prime rate. The Line of Credit Facility matures on June 30, 1998 subject to earlier termination. As of December 31, 1997, the Company had no advances under the Line of Credit; however, open letters of credit at year end were $10,080,000. 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 20, 1998. Independent Auditors' Consent We consent to the incorporation by reference in Registration Statement No. 333-30655 of THQ Inc. on Form S-8 of our report dated February 20, 1998, appearing in this Annual Report on Form 10-K of THQ Inc. for the year ended December 31, 1997. DELOITTE & TOUCHE LLP Los Angeles, California March 27, 1998 25 28 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 the Company will be included in the Company's 1998 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 the Company's 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 the Company's 1998 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 the Company's 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 the Company's 1998 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 the Company's 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 the Company's 1998 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 the Company's fiscal year, and is incorporated herein by reference. 26 29 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. Filed on March 30, 1998. (c) EXHIBITS. Exhibit Number Title - ------ ----- 3.1 Certificate of Incorporation (Filed as Exhibit 3.1 to the Company's Registration Statement on Form S- 3 (File No. 333-32221), Amendment No.1, and incorporated herein by reference) 3.2 Amendment to Certificate of Incorporation (Filed as Exhibit 3.2 to the Company's Registration Statement on Form S-3 (File No. 333-32221), Amendment No.1, and d incorporated herein by reference) 3.3 Bylaws (Filed as Exhibit 3.3 to the Company's Registration Statement on Form S-3 (File No. 333- 32221), Amendment No.1, and incorporated herein by reference) 10.1 Amended and Restated 1990 Stock Option Plan, as amended (Filed as Exhibit 10.1 to the Company's Registration Statement on form S-2 (File No. 333-18641) and incorporated herein by reference) 10.2 Confidential Second Renewal License Agreement for Super Nintendo Entertainment System effective October 16, 1995, between Nintendo of America Inc. and the Company (Filed as Exhibit 10.2(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference) 10.3 Confidential First Renewal License Agreement for Gameboy effective January 1, 1995, between Nintendo of America Inc. and the Company (Filed as Exhibit 10.3(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference) 10.4 Confidential First Renewal International License Agreement for Super Nintendo Entertainment System effective February 6, 1995, between Nintendo Co., Ltd., and the Company (Filed as Exhibit 10.4(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference) 10.5 First Extension Letter dated June 5, 1996, and Second Extension Letter dated September 13, 1996 to Confidential First Renewal International License Agreement for Super Nintendo Entertainment System effective February 6, 1995, between Nintendo Co., Ltd., and the Company (Filed as Exhibit 10.5 to the Company's Registration Statement on Form S-2 (File No. 333-18641) and incorporated herein by reference) 27 30 10.6 Confidential First Renewal International License Agreement for Gameboy dated November 6, 1995, between Nintendo Co., Ltd., and the Company (Filed as Exhibit 10.5(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference) 10.7 Confidential License Agreement for Super Nintendo Entertainment System dated September 28, 1995, between Nintendo of America, Inc. and Black Pearl Software, Inc. (Filed as Exhibit 10.6(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference) 10.8 Confidential License Agreement for Gameboy dated April 4, 1994, between Nintendo of America, Inc. and Malibu Games, Inc. (Filed as an exhibit to the Company's Registration Statement on Form S- 2 (File No. 33-81632) which became effective December 7, 1995, and incorporated herein by reference) 10.9 Confidential First Renewal International License Agreement for Super Nintendo Entertainment System dated as of July 19, 1995, between Nintendo Co., Ltd., and Black Pearl Software, Inc. (Filed as Exhibit 10.8(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference) 10.10 Addendum dated September 28, 1995, together with Extension Letter dated July 9, 1996, and Second Extension Letter dated November 21, 1996, to Confidential International License Agreement for Game Boy dated July 19, 1993, between Nintendo Co., Ltd., and Black Pearl Software, Inc. (Filed as Exhibit 10.11 to the Company's Registration Statement on form S-2 (File No. 333-18641) and incorporated herein by reference) 10.11 License Agreement for Sega Genesis System dated as of October 20, 1994, between Sega Enterprises, Ltd., and the Company (Filed as Exhibit 10.10(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference) 10.12 Employment Agreement of Brian J. Farrell dated as of December 31, 1996, between the Company and Brian J. Farrell (Filed as Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, and incorporated herein by reference) 10.13 Stock Option Agreement dated as of February 15, 1995, between the Company and Brian J. Farrell (Filed as an exhibit to the Registration Statement on Form S-8 (Registration No. 333-00136) filed on January 11, 1996, and incorporated herein by reference) 10.14 401(k) Plan of the Company (Filed as an exhibit to Registration Statement on Form S-18 (File No. 33-35582-NY) of Trinity, and incorporated herein by reference. Amendments made since original filing were filed as exhibits to the Company's Proxy Statements dated April 24, 1992, April 30, 1993 and April 28, 1994, respectively, as are incorporated herein by reference and modification made to this document was filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by reference) 10.15 Form of Indemnification Agreement (Filed as an exhibit to the Company's Registration Statement on Form S-1 (File No. 33-47767) or Amendment No. 1, Amendment No. 2, Amendment No. 3 or Amendment No. 4 thereto and incorporated herein by reference) 10.16 Security and Loan Agreement dated June 7, 1996, by and between the Company and Imperial Bank (Filed as an exhibit to the Company's Quarterly Report on Form 10-Q 28 31 for the quarter ended June 30, 1996, and incorporated herein by reference) 10.17 First Amendment to Security and Loan Agreement dated June 7, 1996, by and between the Company and Imperial Bank (Filed as Exhibit 10.20 to the Company's Registration Statement on Form S-2 (File No. 333-18641) and incorporated herein by reference) 10.18+ Conversion, Manufacturing and Distribution Agreement dated as of March 8, 1995, by and between Electronic Arts Inc. and the Company (Filed as Exhibit 10.35 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference) 10.19+ Licensed Publisher Agreement dated November 10, 1995, by and between the Company and Sony Computer Entertainment Europe, a division of Sony Electronic Publishing Limited (Filed as Exhibit 10.42 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference) 10.20 Licensed Publisher-Supplemental Agreement dated April 11, 1996, by and between the Company and Sony Computer Entertainment Europe, a division of Sony Electronic Publishing Limited (Filed as Exhibit 10.23 to the Company's Registration Statement on form S-2 (File No. 333-18641) and incorporated herein by reference) 10.21 Sony PSX License Agreement dated June 29, 1994, by and between the Company and Sony Computer Entertainment of America, a division of Sony Electronic Publishing Company (Filed as Exhibit 10.24 to the Company's Registration Statement on Form S-2 (File No. 333-18641) and incorporated herein by reference) 10.22 Stock Purchase Agreement dated as of June 28, 1996, by and between the Company and Inland Productions, Inc. (Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, and incorporated herein by reference) 10.23 Stock Purchase Agreement dated as of August 2, 1996, by and between the Company and Heliotrope Studios, Inc. (Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, and incorporated herein by reference) 10.24 License Agreement dated December 29, 1995, between the Company and Turner New Media, Inc. (Filed as Exhibit 10.41 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference) 10.25 Stock Option Agreement dated as of August 28, 1996, between the Company and Brian J. Farrell (Filed as Exhibit 10.31 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996, and incorporated herein by reference) 10.26*+ Confidential License Agreement for Nintendo 64 dated November 4, 1996, between Nintendo of America, Inc. and THQ Inc. 10.27 Imperial Bank Line of Credit Agreement dated September 22, 1997. (Filed as exhibit 10 on the company's form 10Q for the nine months ended September 30, 1997, and incorporated herein by reference) 10.28 1997 Stock Option Plan, (Filed as Exhibit 10.1 to the Company's Registration Statement on form S-8 (File No. 333-30655) and incorporated herein by reference) 10.29*+ Employment Agreement of Fred A Gysi dated as of October 01, 1997, between the Company and Fred A. Gysi. 21* Subsidiaries of the Registrant 27* Financial Data Schedule - ---------- 29 32 *Filed herewith. + Confidential treatment requested as to portions of this exhibit. 30 33 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 27, 1998 THQ INC. By: /s/ Brian J. Farrell ----------------------------- Brian J. Farrell President 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 March 27, 1998 - ----------------------- Brian J. Farrell President, Chief Executive Officer, and Director /s/ Lawrence Burstein March 27, 1998 - ----------------------- Lawrence Burstein Director /s/ Bruce Jagid March 27, 1998 - ----------------------- Bruce Jagid Director /s/ Jeffrey C. Lapin March 27, 1998 - ----------------------- Jeffrey C. Lapin Director /s/ L. Michael Haller March 27, 1998 - ----------------------- L. Michael Haller Senior Vice President and Director /s/ Fred A. Gysi March 27, 1998 - ----------------------- Fred A. Gysi Vice President Finance (Chief Financial Officer) 31 34 THQ INC. INDEX TO FINANCIAL STATEMENTS
PAGE ---- INDEPENDENT AUDITORS' REPORT F-2 CONSOLIDATED FINANCIAL STATEMENTS Consolidated Balance Sheets -- December 31, 1996 and December 31, 1997 F-3 . Consolidated Statements of Operations for Each of the Three Years in the Period Ended December 31, 1997 F-4 Consolidated Statements of Shareholders' Equity for Each of the Three Years in the Period Ended December 31, 1997 F-5 Consolidated Statements of Cash Flows for Each of the Three Years in the Period Ended December 31, 1997 F-6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-8
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 35 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, 1996 and 1997, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. 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, 1996 and 1997 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP Los Angeles, California February 20, 1998 F-2 36 THQ INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS
DECEMBER 31, ----------------------------- 1996 1997 ------------ ------------ Current assets: Cash and cash equivalents $ 2,734,000 $ 11,724,000 Accounts receivable -- net 14,186,000 30,856,000 Inventory 1,013,000 1,425,000 Prepaid and deferred royalties 717,000 3,645,000 Software development costs 2,329,000 6,044,000 Deferred income taxes -- 1,666,000 Prepaid expenses and other current assets 485,000 478,000 ------------ ------------ Total current assets 21,464,000 55,838,000 Property and equipment -- net 581,000 1,163,000 Deferred royalties -- net of current portion -- 500,000 Software development costs -- net of current portion -- 1,300,000 Other long-term assets 795,000 652,000 ------------ ------------ TOTAL ASSETS $ 22,840,000 $ 59,453,000 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 3,304,000 $ 10,952,000 Accrued royalties 3,133,000 9,949,000 Income taxes payable -- 3,475,000 Advance from bank 5,355,000 -- ------------ ------------ Total current liabilities 11,792,000 24,376,000 Accrued royalties -- net of current portion -- 1,550,000 Commitments and contingencies -- -- Shareholders' equity: Common Stock, par value $.01, 35,000,000 shares authorized; 4,739,883 shares, and 6,775,899 shares issued and outstanding as of December 31, 1996 and 1997, respectively 4,000 4,000 Additional paid-in capital 34,558,000 47,559,000 Cumulative foreign currency translation adjustment (52,000) 81,000 Accumulated deficit (23,462,000) (14,117,000) ------------ ------------ Total shareholders' equity 11,048,000 33,527,000 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 22,840,000 $ 59,453,000 ============ ============
See notes to consolidated financial statements. F-3 37 THQ INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, ---------------------------------------------- 1995 1996 1997 ------------ ------------ ------------ Net sales $ 33,250,000 $ 50,255,000 $ 89,362,000 Costs and expenses: Cost of sales 19,501,000 29,301,000 48,110,000 Royalties 3,641,000 7,977,000 14,158,000 Product development 889,000 1,324,000 1,610,000 Project abandonment 1,025,000 610,000 600,000 Selling 3,114,000 4,444,000 8,670,000 General and administrative 3,139,000 3,496,000 5,064,000 Operating interest 1,184,000 878,000 315,000 ------------ ------------ ------------ Total costs and expenses 32,493,000 48,030,000 78,527,000 ------------ ------------ ------------ Income from operations 757,000 2,225,000 10,835,000 Interest income (expense), net (134,000) (316,000) 464,000 ------------ ------------ ------------ Income before income taxes 623,000 1,909,000 11,299,000 Provision for income taxes 22,000 8,000 1,954,000 ------------ ------------ ------------ Net income $ 601,000 $ 1,901,000 $ 9,345,000 ============ ============ ============ Net income per share -- basic $ .21 $ .42 $ 1.48 ============ ============ ============ Net income per share -- diluted $ .17 $ .39 $ 1.35 ============ ============ ============
See notes to consolidated financial statements. F-4 38 THQ INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
CUMULATIVE FOREIGN ADDITIONAL CURRENCY PREFERRED COMMON COMMON PAID-IN TRANSLATION ACCUMULATED STOCK SHARES AMOUNT CAPITAL ADJUSTMENT DEFICIT TOTAL ------ --------- ------ ----------- --------- ------------ ----------- Balance at January 1, 1995 -- 2,790,650 $4,000 $30,656,000 $(442,000) $(25,964,000) $ 4,254,000 Exercise of warrants and options -- 91,530 -- 48,000 -- -- 48,000 Issuance of preferred stock for cash 3,190 -- -- 2,613,000 -- -- 2,613,000 Conversion of preferred stock to Common Stock (2,865) 1,335,211 -- -- -- -- -- Net income -- -- -- -- -- 601,000 601,000 Foreign currency translation adjustment -- -- -- -- 82,000 -- 82,000 ------ --------- ------ ----------- --------- ------------ ----------- Balance at December 31, 1995 325 4,217,391 4,000 33,317,000 (360,000) (25,363,000) 7,598,000 Exercise of warrants and options -- 272,115 -- 712,000 -- -- 712,000 Conversion of preferred stock to Common Stock (325) 127,717 -- -- -- -- -- Issuance of Common Stock -- 122,660 -- 529,000 -- -- 529,000 Net income -- -- -- -- -- 1,901,000 1,901,000 Foreign currency translation adjustment -- -- -- -- 308,000 -- 308,000 ------ --------- ------ ----------- --------- ------------ ----------- Balance at December 31, 1996 -- 4,739,883 4,000 34,558,000 (52,000) (23,462,000) 11,048,000 Exercise of warrants and options -- 311,016 -- 1,293,000 -- -- 1,293,000 Issuance of Common Stock -- 1,725,000 -- 11,708,000 -- -- 11,708,000 Net income -- -- -- -- -- 9,345,000 9,345,000 Foreign currency translation adjustment -- -- -- -- 133,000 -- 133,000 ------ --------- ------ ----------- --------- ------------ ----------- Balance at December 31, 1997 -- 6,775,899 $4,000 $47,559,000 $ 81,000 $(14,117,000) $33,527,000 ====== ========= ====== =========== ========= ============ ===========
See notes to consolidated financial statements. F-5 39 THQ INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, ------------------------------------------ 1995 1996 1997 ----------- ----------- ------------ Cash flows from operating activities: Net income $ 601,000 $ 1,901,000 $ 9,345,000 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 240,000 337,000 483,000 Provision for doubtful accounts, discounts and returns 4,145,000 5,203,000 10,509,000 Deferred income taxes -- -- (1,666,000) Changes in operating assets and liabilities: Accounts receivable (5,875,000) (7,270,000) (20,726,000) Inventory and inventory deposits 779,000 202,000 (441,000) Prepaid and deferred royalties and Software development costs 2,592,000 2,799,000 1,548,000 Prepaid expenses and other current assets 99,000 (322,000) (4,000) Income tax refund receivable 201,000 -- -- Accounts payable and accrued expenses 1,040,000 (1,233,000) 7,707,000 Accrued royalties (3,628,000) (649,000) (1,627,000) Income taxes payable -- -- 3,451,000 Accrued returns and allowances (3,589,000) (5,316,000) (6,573,000) Income taxes payable -- -- -- ----------- ----------- ------------ Net cash provided by (used in) operating activities (3,395,000) (4,348,000) 2,006,000 ----------- ----------- ------------ Cash flows used in investing activities: Other long-term assets -- (578,000) -- Acquisition of equipment (239,000) (314,000) (923,000) ----------- ----------- ------------ Net cash used in investing activities (239,000) (892,000) (923,000) ----------- ----------- ------------ Cash flows from financing activities: Advances from bank -- 5,355,000 (5,355,000) Proceeds from exercise of warrants and options 48,000 712,000 1,293,000 Net proceeds from issuance of convertible preferred stock 2,613,000 -- -- Net proceeds from issuance of common stock -- -- 11,708,000 ----------- ----------- ------------ Net cash provided by financing activities 2,661,000 6,067,000 7,646,000 ----------- ----------- ------------ Effect of exchange rate changes on cash and cash equivalents 61,000 12,000 261,000 ----------- ----------- ------------ Net increase (decrease) in cash and cash equivalents (912,000) 839,000 8,990,000 ----------- ----------- ------------ Cash and cash equivalents -- beginning of 2,807,000 1,895,000 2,734,000 period ----------- ----------- ------------ Cash and cash equivalents -- end of period $ 1,895,000 $ 2,734,000 $ 11,724,000 =========== =========== ============ Supplemental disclosure of cash flow information: Cash paid during the period for income taxes $ 22,000 $ 14,000 $ 127,000 =========== =========== ============ Cash paid during the period for interest $ 230,000 $ 375,000 $ 51,000 =========== =========== ============
See notes to consolidated financial statements. F-6 40 NON-CASH TRANSACTIONS: As of July 1, 1996 the Company issued 70,000 shares of Common Stock in lieu of cash to a former employee of the Company. 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, the Company issued 52,660 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. See notes to consolidated financial statements. F-7 41 THQ INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION Business. THQ Inc., a Delaware corporation, develops and publishes interactive entertainment software ("Software") for the hardware platforms that collectively dominate the market ("Platforms"). Substantially all of the Company's products are based on licenses for popular cultural trends and high-recognition names ("Properties"). 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. The Company has two license agreements with Sony pursuant to which it has 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 June 1998 and December of 2005, respectively. The Company has various license agreements with Nintendo pursuant to which it has 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, 16-bit Super Nintendo Entertainment System ("SNES"), and with the Nintendo Game Boy portable game console. The license agreements with Nintendo for such hardware Platforms expire at various times through 1999 and 2000. On March 10, 1998, the Company announced that its current license agreement with World Championship Wrestling will not be renewed. The current license agreement expires on December 29, 1998, and permits the Company to continue to sell products on hand and in process at that date through June 29, 1999. Products released by the Company under this license accounted for 39% of the Company's revenues in 1997 and are expected to account for a substantial portion of the Company's revenues in 1998. There can be no assurance that this development will not have a material adverse affect on the Company. The Company's Software business is dependent on its license agreements with Sony and Nintendo. Substantially all of the Company's Software products are manufactured by Sony and Nintendo, who charge the Company a fixed amount for each Software 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, the Company 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 the Company's Titles, including any claims for copyright or trademark infringement brought against Sony or Nintendo. As such, the Company bears 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, the Company is F-8 42 entitled to indemnification from its Software developers and Property licensors to cover its indemnification obligations to Sony or Nintendo but no assurance can be given that, if any claim is brought against the Company, said developers and/or licensors will have sufficient resources to indemnify the Company. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation. The consolidated financial statements include the accounts of THQ Inc. and its wholly owned subsidiaries. All material intercompany balances and transaction have been eliminated. 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 translation gains and losses result from exchange rate changes denominated in currencies other than the U.S. dollar. The Company has not experienced significant foreign currency transaction gains or losses. Cash Equivalents. The Company considers all highly liquid investments purchased with maturities less than three months to be cash equivalents. Fair Values of Financial Instruments. The carrying value of accounts receivable and payables approximate the fair value due to their short-term maturities. The carrying value of the Company's advances from its bank is considered to approximate its fair value because the interest rate of this instrument is based on a variable reference rate. Inventory. Inventories, which consist principally of finished products, are stated at the lower of cost (first-in, first-out basis) or market. The Company estimates the net realizable value of slow-moving inventory on a title by title basis, and charges the excess of cost over net realizable value to cost of sales. Inventory deposits are prepayments to Software Manufacturers or deposits to lenders opening letters of credit on behalf of the Company for the manufacture of specific products. 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 which range from three to five years. Leasehold improvements are amortized over the shorter of their useful lives or the remaining lease term. Equipment consists of the following at:
DECEMBER 31, ------------------------------ 1996 1997 ----------- ----------- Furniture, fixtures and equipment $ 1,164,000 $ 1,634,000 Leasehold improvements 20,000 49,000 Less accumulated depreciation and amortization (603,000) (520,000) ----------- ----------- $ 581,000 $ 1,163,000 =========== ===========
F-9 43 Depreciation and amortization expense for the years ended December 31, 1995, 1996 and 1997 was $199,000, $238,000 and $483,000, respectively. Royalties and Software Development Costs. 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 years time. The Company utilizes both independent Software developers (who are paid advances against future royalties) and internal development teams to develop its Software. Under generally accepted accounting principles, such Software development costs are capitalizable when technological feasibility has been established. Technological feasibility for entertainment Software such as the Company's has been established by Sony, Nintendo, and Sega for use with their respective hardware Platforms. Amortization of prepaid royalty and Software development costs, as a part of royalties expense, is provided on a product-by-product basis commencing with the general release of each product, based on the greater of the ratio of current gross revenues for the product to the sum of its current and anticipated gross revenues, or the straight line method over the remaining estimated economic life of the product. The Company also expenses as project abandonment losses 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. Software development costs of $1,768,000, $2,390,000, and $7,955,000 were amortized in 1995, 1996, and 1997, respectively. Project abandonment losses related to Software development costs of $1,025,000, $509,000 and $35,000 were charged to expense in 1995, 1996, and 1997, respectively. Research and development costs are expensed as incurred. Revenue Recognition. Revenue is recognized when the product is shipped, provided that no significant vendor support obligations remain outstanding, and provided that the collection of the resulting receivable is deemed probable by management. Although the Company sells its products on a no-return basis, in certain circumstances the Company may allow returns, price concessions, or allowances on a negotiated basis. The Company estimates such returns and allowances based upon management's evaluation of the Company's historical experience and current industry trends. Such estimates are deducted from gross revenue. Software is sold under a limited 90-day warranty against defects in material and workmanship. To date, the Company has not experienced material warranty claims. (See Note 3). Income Taxes. Deferred income taxes are provided for temporary differences between the financial statement and income tax bases of the Company's 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. At December 31, 1997, the Company adopted Statement of Financial Accounting Standard No. 128 ("SFAS"), "Earnings per Share". SFAS 128 replaces the presentation of earnings per share ("EPS") with a presentation of basic EPS F-10 44 based upon the weighted-average number of common shares for the period. It also requires dual presentation of basic and diluted EPS for companies with "complex capital structures". EPS for the current and prior periods has been presented in conformity with the provisions of SFAS 128. 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, -------------------------------------- 1995 1996 1997 ---------- ---------- ---------- Net income used to compute basic and diluted earnings per share $ 601,000 $1,901,000 $9,345,000 ---------- ---------- ---------- Weighted average number of shares Outstanding -- basic 2,858,000 4,525,000 6,320,000 Dilutive effect of stock options and warrants 222,000 311,000 581,000 Dilutive effect assuming conversion of Preferred stock 476,000 -- -- ---------- ---------- ---------- Number of shares used to compute earnings per share -- diluted 3,556,000 4,836,000 6,901,000 ========== ========== ==========
Reclassifications. Certain items in the 1995 and 1996 financial statements have been reclassified to conform to the 1997 presentation. Recently Issued Accounting Pronouncements. In June 1997, the FASB issued 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. SFAS No. 130 requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. The Company does not expect the impact of SFAS No. 130 to be material in relation to its financial statements. In June 1997, the FASB issued SFAS No. 131, "Disclosure About Segments of an Enterprise and Related Information." SFAS No. 131 established standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosure about products and services, geographic areas and major customers. SFAS No. 131 is effective for financial statements for periods beginning after December 15, 1997. The Company does not expect the impact of SFAS No. 131 to be material in relation to its financial statements. In October of 1997, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 97-2 "Software Revenue Recognition" ("SOP 97-2"). This statement provides guidance on applying generally accepted F-11 45 accounting principles in recognizing revenues on software transactions. This Statement supersedes Statement of Position 91-1 "Software Revenue Recognition". This Statement is effective for transactions entered into in fiscal years beginning after December 15, 1997. Earlier application is encouraged as of the beginning of the fiscal year or interim period for which financial statements or information have not been issued. Retroactive application of the provisions of this statement is prohibited. The Company has evaluated its revenue recognition policies of the adaptation of SOP 97-2; and believes that such adoption will not have any impact. Pervasiveness of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates relate to prepaid and deferred royalties, Software development costs, accrued returns and allowances and the allowance for doubtful accounts. 3. ACCOUNTS RECEIVABLE, FACTORING AGREEMENT, DUE FROM FACTOR AND ACCRUED RETURNS AND ALLOWANCES Until July 18, 1996, the Company had a factoring and credit agreement (the "BNY Agreement") with BNY Financial Corporation ("BNY"), a wholly owned subsidiary of The Bank of New York. On July 18, 1996, the Company terminated its factoring and credit agreement with BNY and entered into a new financing and banking arrangement with Imperial Bank (the "Imperial Agreement"). On September 22, 1997, the Company entered into a new agreement for a larger and lower cost banking facility with Imperial Bank. The new bank credit agreement is designed to mirror the seasonal trends of the Company's business, providing advances under the credit line of up to $23 million during the Company's peak selling season, and up to $12 million outside of the peak season. The former agreement provided for advances of up to $9 million based on a formula of accounts receivable and inventory. Although the agreement contains certain covenants regarding financial and other matters, the Company's borrowings are no longer restricted to a formula based on receivables and inventory. Interest on the outstanding balance is payable at Imperial Bank's prime rate. The line of credit is collateralized by all tangible personal property including inventory and equipment. Accounts receivable are due primarily from domestic and foreign retailers and distributors, including mass merchants and specialty stores. Accounts receivable at December 31, 1996 and 1997 are composed of the following: F-12 46
DECEMBER 31, ----------------------------- 1996 1997 ------------ ------------ Accounts receivable -- domestic $ 13,428,000 $ 33,787,000 Other accounts receivable -- primarily foreign 5,004,000 5,075,000 Other receivables 112,000 133,000 Allowance for foreign doubtful accounts (1,294,000) (10,000) Allowance for foreign discounts and returns (292,000) (362,000) Allowance for domestic accrued returns and allowances (2,772,000) (7,767,000) ------------ ------------ Accounts receivable -- net $ 14,186,000 $ 30,856,000 ============ ============
The allowance for foreign doubtful accounts consists of the following:
DECEMBER 31, ------------------------------------------- 1995 1996 1997 ----------- ----------- ----------- Balance at January 1 $ (827,000) $(1,380,000) $(1,294,000) Provision for doubtful accounts (505,000) (10,000) (4,000) Actual doubtful accounts (recoveries) (48,000) 96,000 1,288,000 ----------- ----------- ----------- Ending balance $(1,380,000) $(1,294,000) $ (10,000) =========== =========== ===========
The allowance for foreign discounts and returns consists of the following:
DECEMBER 31, ------------------------------------------- 1995 1996 1997 ----------- ----------- ----------- Balance at January 1 $ (190,000) $ (311,000) $ (292,000) Provision for discounts and returns (766,000) (422,000) (333,000) Actual discounts and returns 645,000 441,000 263,000 ----------- ----------- ----------- Ending balance $ (311,000) $ (292,000) $ (362,000) =========== =========== ===========
The allowance for domestic accrued returns and allowances consists of the following:
DECEMBER 31, ------------------------------------------- 1995 1996 1997 ----------- ----------- ----------- Balance at January 1 $(3,574,000) $(2,859,000) $(2,772,000) Provision for discounts and returns (2,874,000) (4,771,000) (10,172,000) Actual discounts and returns 3,589,000 4,858,000 5,177,000 ----------- ----------- ----------- Ending balance $(2,859,000) $(2,772,000) $(7,767,000) =========== =========== ===========
F-13 47 4. EMPLOYEE PENSION PLAN The Company sponsors for its employees a defined contribution plan intended to qualify under Section 401(k) of the Internal Revenue Code (the "Plan"). The Plan, as amended in 1991, provides that employees may defer up to 12% of annual compensation, and that the Company will make a matching contribution equal to each employee's deferral, up to 4% of compensation. The Company may also contribute funds to the Plan in the form of a profit sharing contribution. Expenses under the Plan were $30,000, $161,000, and $119,000 in 1995, 1996 and 1997, respectively. 5. INCOME TAXES The provision for income taxes consists of the following:
1995 1996 1997 ----------- ----------- ----------- Current Federal $ 22,000 $ 2,000 $ 2,760,000 State -- 6,000 821,000 Foreign -- -- 39,000 ----------- ----------- ----------- 22,000 8,000 3,620,000 ----------- ----------- ----------- Deferred Federal -- -- (1,283,000 State -- -- (383,000) ----------- ----------- ----------- Provision for income taxes $ 22,000 $ 8,000 $ 1,954,000 =========== =========== ===========
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:
1995 1996 1997 ----- ----- ----- Federal provision at statutory rate 35.0% 35.0% 35.0% State taxes (net of Federal benefit) -- -- 4.0% Effect of net operating loss carryforward (31.5) (34.9) (21.7) ----- ----- ----- 3.5% 0.1% 17.3% ===== ===== =====
F-14 48 The components of deferred tax assets (liabilities) are as follows:
DECEMBER 31, ----------------------------------------------------------- 1996 1997 --------------------------- --------------------------- FEDERAL STATE FEDERAL STATE ----------- ----------- ----------- ----------- Deferred tax assets: Allowance for doubtful accounts, Discounts and returns $ 943,000 $ 212,000 $ 2,641,000 $ 566,000 Net operating loss 5,946,000 1,176,000 4,980,000 473,000 License abandonment 671,000 151,000 652,000 140,000 Other -- net 121,000 28,000 540,000 56,000 ----------- ----------- ----------- ----------- Total deferred tax assets 7,681,000 1,567,000 8,813,000 1,235,000 Deferred tax liabilities: Software development costs (897,000) (202,000) (2,260,000) (379,000) State income taxes (465,000) -- (290,000) -- ----------- ----------- ----------- ----------- Net deferred tax assets 6,319,000 1,365,000 6,263,000 856,000 Valuation reserve (6,319,000) (1,365,000) (4,980,000) (473,000) ----------- ----------- ----------- ----------- Deferred income taxes $ -- $ -- $ 1,283,000 $ 383,000 =========== =========== =========== ===========
The valuation reserve decreased $291,000, $21,000 and $2,231,000 during 1995, 1996 and 1997, respectively. As of December 31, 1997 the Company had federal and state net operating loss carryforwards of approximately $15,394,000 (expiring from years 2008 to 2009) and approximately $9,284,000 (expiring from years 1998 to 1999), respectively. The sale of 1,500,000 shares of Common Stock offered by the Company on February 11, 1997 resulted in an "ownership change" of the Company for purposes of Sections 382 and 383 of the Internal Revenue Code of 1986, as amended (the "Code"). As a result, the amount of the Company's net operating loss carryforward available to reduce the Company's federal income tax liability in future years in which the Company has taxable income will be limited to an annual amount equal to (i) the fair market value of the Company's capital stock immediately prior to the consummation of the offering on February 11, 1997, multiplied by (ii) the "long-term tax exempt rate" published by the Internal Revenue Service for the month in which the offering was consummated. Based upon a long-term tax exempt rate for February 1997 of 5.48% and an assumed market price of the Common Stock immediately prior to consummation of this offering of $8.56 per share (the last reported sale price of the Common Stock on February 10, 1997) such amount is approximately $2,225,000 per year. 6. STOCK OPTION PLAN The Company has two stock option plans (the "1990 Plan" and "1997 Plan") which provide for the issuance of up to 650,000 and 650,000 shares, respectively, available for employees, consultants and non-employee directors. An additional 5,154 options under the 1990 Plan and 250,750 options under the 1997 Plan were available for grant at December 31, 1997. F-15 49 Stock options granted under the option plans may be incentive stock options under the requirements of the Internal Revenue Code, or may be nonstatutory stock options, which do not meet such requirements. Options may be granted under the option plans to, in the case of incentive stock options, all employees (including officers) of the Company; or, in the case of nonstatutory stock options, all employees (including officers) or non-employee directors of the Company. The exercise price per share of all options granted under the plans in 1995, 1996 and 1997 has been the market price of the stock on the date of the grant. Generally, options granted become exercisable over three years and must be exercised within five years of the date of grant.
NUMBER OF STOCK OPTIONS SHARES - -------------------------------------------------------------- -------- Balance at January 1, 1995 (weighted average price of $22.51) 104,090 Granted at a weighted average price of $3.02 per share 609,833 Exercised at a weighted average price of $2.87 per share (16,666) Canceled at a weighted average price of $6.02 per share (42,666) -------- Balance at December 31, 1995 (weighted average price of $6.04 per share) 654,591 -------- Granted at a weighted average price of $4.23 per share 141,500 Exercised at a weighted average price of $3.09 per share (120,274) Canceled at a weighted average price of $9.72 per share (185,584) -------- Balance at December 31, 1996 (weighted average price of $3.41 per share) 490,233 -------- Granted at a weighted average price of $11.70 per share 416,750 Exercised at a weighted average price of $3.66 per share (119,841) Canceled at a weighted average price of $ 3.52 per share (11,998) -------- Balance at December 31, 1997 (weighted average price of $7.79 per share) 775,144 ======== Options exercisable at December 31, 1997 265,613 ========
During 1995, the Company granted 240,000 options outside of the option plans, which consisted of 140,000 options at $3.06 to Brian J. Farrell, the Company's president; 70,000 options to a former employee as a part of the employee's severance package (50,000 at $2.81 and 20,000 at $2.25); and 30,000 options at $2.87 to two outside consultants who have subsequently become employees of the Company. In 1996, the Company issued 200,000 options outside of the option plans to Mr. Farrell at an exercise price of $5.00 per share. Share exercise prices for these options equal the market price of the Company's Common Stock at the date of the grant. In 1996 and 1997 one of the two outside consultants exercised 3,333 and 1,667 shares, respectively. In 1997 Mr. Farrell exercised 60,000 shares, as well as the Company's former employee whom exercised 70,000 shares. F-16 50 The following table summarizes information about stock options outstanding at December 31, 1997:
NUMBER WEIGHTED AVERAGE WEIGHTED OUTSTANDING AT REMAINING AVERAGE DECEMBER 31, 1997 CONTRACTUAL LIFE EXERCISE PRICE - ----------------- ------------------ -------------------- 339,730 3 $ 2.91 291,580 7 $ 4.57 277,167 5 $ 9.29 171,667 5 $ 14.33 - ----------------- ------------------ -------------------- 1,080,144 5 $ 6.81 ================= ================== ==================== SHARES WEIGHTED EXERCISABLE AT AVERAGE DECEMBER 31, 1997 EXERCISE PRICE - ----------------- ------------------ 210,239 $ 2.89 187,458 $ 4.63 47,917 $ 7.51 11,667 $ 12.07 - ----------------- ------------------ 457,281 $ 4.32 ================= ==================
The estimated fair value of the options granted in 1995, 1996 and 1997 was $1,566,000 $1,094,000 and $3,041,000, respectively. The Company applies Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for its stock option plan. Accordingly, no compensation cost for the Company's stock option plan and has been recognized in 1995, 1996 or 1997. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant dates for awards under the plan consistent with FASB Statement No. 123, Accounting for Stock Based Compensation, the Company's net income and earnings per share for the years ended December 31, 1995, 1996 and 1997 would have been reduced to the pro forma amounts indicated below:
YEARS ENDED ---------------------------------------------- DECEMBER 31, DECEMBER 31, DECEMBER 31, 1995 1996 1997 ---------- ------------- ------------- Net income: As reported $ 601,000 $ 1,901,000 $ 9,345,000 Pro forma $ 2,000 $ 1,123,000 $ 8,144,000 Net income per common and common equivalent share: As reported $ .17 $ .39 $ 1.35 Pro forma $ -- $ .23 $ 1.18
F-17 51 The fair market value of options granted under the stock option plans during 1995, 1996 and 1997 was determined using the Black-Scholes option pricing model utilizing the following assumptions:
YEARS ENDED ------------------------------------------------ DECEMBER 31, DECEMBER 31, DECEMBER 31, 1995 1996 1997 ----------- ----------- ----------- Dividend yield 0% 0% 0% Anticipated volatility 83% 83% 83% Risk-free interest rate 5.3% - 7.5% 5.2% - 6.7% 5.9% - 6.1% Expected lives 4 years 4 years 4 years
7. MAJOR CUSTOMERS AND RELATED PARTY TRANSACTIONS Sales (before returns and allowances) to a major customer represented 12%, 12% and 19% of gross sales in the years ended December 31, 1995, 1996 and 1997, respectively. In 1996 one other customer represented 10% of sales (before returns and allowances). In 1997 another customer represented 10% of sales (before returns and allowances). The Company performs ongoing credit evaluations of its customers and maintains an allowance for potential credit losses. In 1995, 1996 and 1997, the Company paid the law firm of Feder, Kaszovitz, Isaacson, Weber, Skala & Bass, of which Mr. Skala, a director of the Company through January 14, 1997, is a partner, approximately $214,000, $215,000, and $107,000, respectively. As of December 31, 1996 and 1997, the Company had owing to Feder, Kaszovitz, Isaacson, Weber, Skala & Bass approximately $76,000 and $0, respectively. In 1996 and 1997, the Company paid Inland Productions, Inc., a Software developer in which the Company acquired 25% interest in on July 1, 1996 (See Note 9), $775,000, and $985,000. As of December 31, 1996 and 1997, the Company had owing to Inland Productions, Inc. $625,000 and $640,000, respectively. 8. CAPITAL STOCK TRANSACTIONS In the months of July, August and September 1995, the Company received aggregate net proceeds of $2,613,000 from the sales of certain of its convertible preferred stock pursuant to Regulation S under the Act. The preferred shares were convertible by the holders thereof into 1,462,928 common shares of the Company. These shares were redeemable at the Company's option upon 30 days' written notice, and earned dividends at the rate of 9% per annum, payable at the Company's option in cash or by issuance of common shares equal to the dividend amount divided by the average market price of the preceding five days. As of December 31, 1995, a total of 1,335,211 shares of common stock had been issued upon conversion. During 1996, all shares of preferred stock had been converted to common stock, a total of 1,462,928 shares of common stock were issued upon conversion. F-18 52 During 1996, the Company issued 70,000 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 and 1997, the number of warrants to purchase the Company's Common Stock exercised were 70,000, and 15,164, respectively. The Company received proceeds from the exercise of such warrants totaling $149,000 and $123,000, in the years ended December 31, 1996 and 1997, respectively. There were 74,864 warrants exercised during the year ended December 31, 1995. At December 31, 1997 outstanding warrants were 58,497 at an average exercise price of $22.98. On February 14, 1997, the Company completed a public offering of 1,500,000 shares of the Company's Common Stock. In conjunction with the offering, the Company granted to the underwriters an over-allotment option, exercisable within 30 days of February 11, 1997, to purchase up to 225,000 additional shares of the Common Stock at the public offering price of $7.50 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 the Company. The net proceeds of the 1,725,000 shares sold by the Company, were approximately $11.7 million. 9. OTHER LONG-TERM ASSETS On July 1, 1996, the Company acquired a 25% interest in Inland, a Software developer for home entertainment game systems. The investment consisted of $300,000 in cash and 52,660 shares of Common Stock valued at $300,000, and is included in other long-term assets in the accompanying balance sheet. The Company has contracted with Inland for the development of 32-bit and 64-bit versions of Turner's World Championship Wrestling and 32-bit and PC versions of BASS Masters Classic. The Company's investment exceeded its equity in the underlying net assets by $613,000, which is being amortized over five years. The Company's equity in the operating results of Inland is not material to the results of operations. On August 2, 1996, the Company acquired the business of Heliotrope Studios, Inc. ("Heliotrope"), an interactive Software developer for PC and an assignment of the distribution license and certain work-in-progress for a PC title (Pax Imperia: Eminent Domain) from Blizzard Entertainment, a division of Davidson Associates. In connection with the acquisition, the Company incurred costs of $115,000 and assumed certain liabilities (approximately $150,000) of Heliotrope. The excess of the Company's cost of the acquisition over the estimated fair value of assets acquired (approximately $265,000) has been included as a long-term investment in the accompanying balance sheet. Such excess cost is being amortized over five years. Because Heliotrope's assets and operations prior to the acquisition were insignificant, no pro forma information is presented. F-19 53 10. COMMITMENTS AND CONTINGENCIES Royalties. At December 31, 1996 and 1997, future minimum guaranteed royalties were $3,133,000 and $11,499,000, respectively. Royalties are classified as current liabilities if initial sales are to commence within one year. Leases. The Company is committed under operating leases with lease termination dates to 2003. Minimum future rentals pursuant to these leases as of December 31, 1997 are as follows: 1998 $ 558,000 1999 540,000 2000 538,000 2001 234,000 2002 154,000 2003 142,000 ----------- $ 2,166,000 ===========
Rent expense was $184,000, $183,000, and $258,000 in 1995, 1996 and 1997, respectively. F-20 54 11. OPERATIONS IN GEOGRAPHIC AREAS The Company is engaged in the development, marketing and distribution of Software products. The following information sets forth geographic information on the Company's sales, earnings (losses) from operations and identifiable assets for the years ended December 31, 1995, 1996 and 1997:
UNITED STATES EUROPE ASIA ELIMINATION CONSOLIDATED -------- -------- -------- -------- -------- (in thousands of dollars) Year ended December 31, 1995: Sales to unaffiliated customers $ 24,894 $ 8,356 -- -- $ 33,250 Transfers between geographic areas -- -- -- -- -- -------- -------- -------- -------- -------- Total net revenue $ 24,894 $ 8,356 -- -- $ 33,250 ======== ======== ======== ======== ======== Pretax earnings (loss) $ 1,621 $ (869) $ (4) $ (125) $ 623 ======== ======== ======== ======== ======== Identifiable assets at December 31, 1995 $ 13,681 $ 3,415 $ 2 $ (182) $ 16,916 ======== ======== ======== ======== ======== Year ended December 31, 1996: Sales to unaffiliated customers $ 35,399 $ 14,856 -- -- $ 50,255 Transfers between geographic areas -- -- -- -- -- -------- -------- -------- -------- -------- Total net revenue $ 35,399 $ 14,856 -- -- $ 50,255 ======== ======== ======== ======== ======== Pretax earnings $ 1,222 $ 668 $ 19 -- $ 1,909 ======== ======== ======== ======== ======== Identifiable assets at December 31, 1996 $ 17,163 $ 5,860 $ -- $ (183) $ 22,840 ======== ======== ======== ======== ======== Year ended December 31, 1997: Sales to unaffiliated customers $ 75,365 $ 13,997 -- -- $ 89,362 Transfers between geographic areas -- -- -- -- -- -------- -------- -------- -------- -------- Total net revenue $ 75,365 $ 13,997 -- -- $ 89,362 ======== ======== ======== ======== ======== Pretax earnings $ 8,538 $ 2,761 -- -- $ 11,299 ======== ======== ======== ======== ======== Identifiable assets at December 31, 1997 $ 52,067 $ 7,568 -- $ (182) $ 59,453 ======== ======== ======== ======== ========
F-21 55 12. QUARTERLY FINANCIAL DATA (UNAUDITED) The Company's summarized quarterly financial data are 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 before income taxes (257) 496 652 1,018 Income taxes 4 -- -- 4 ======== ======== ======== ======== Net income $ (261) $ 496 $ 652 $ 1,014 ======== ======== ======== ======== Net income per share: Basic $ (.06) $ .11 $ .14 $ .21 ======== ======== ======== ======== Diluted $ (.06) $ .11 $ .13 $ .19 ======== ======== ======== ======== 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 $ .13 $ .15 $ .22 $ .93 ======== ======== ======== ======== Diluted $ .12 $ .14 $ .20 $ .84 ======== ======== ======== ========
F-22 EX-10.26 2 EXHIBIT 10.26 1 EXHIBIT 10.26 CONFIDENTIAL LICENSE AGREEMENT FOR NINTENDO 64 VIDEO GAME SYSTEM (Western Hemisphere) THIS AGREEMENT is entered into between NINTENDO OF AMERICA INC., a Washington corporation with an address for notice purposes of 4820 150th Avenue N.E., Redmond, WA 98052 (Fax: 206-882-3585) ("NINTENDO") and T.HQ, INC., a New York/Delaware corporation with an address for notice purposes of 5016 N. Parkway Calabasas, Suite 100, Calabasas, CA 91302 (Fax: (818) 591-1615), Attention: President ("LICENSEE"). NINTENDO and LICENSEE acknowledge and agree as follows: 1. RECITALS 1.1 NINTENDO markets and sells a high-quality video game system, including hardware, software and an input controller, marketed by NINTENDO under its trademarks "Nintendo 64(copyright)" and "N64(trademark)", for playing video games. 1.2 LICENSEE desires to gain access to and rights to utilize highly proprietary programming specifications, development tools, trademarks and other valuable intellectual property rights in order to develop video game software and to purchase and sell such video game software from NINTENDO for play on the Nintendo 64 system, which system was developed by NCL and Silicon Graphic, Inc. 1.3 NINTENDO is willing to grant a license to utilize such proprietary information and intellectual property rights and to sell video game software to LICENSEE upon the terms and conditions set forth in this Agreement. 2. DEFINITIONS 2.1 "Artwork" shall mean the final art and mechanical formats for the Licensed Product including the Game Cartridge box, user instruction manual with consumer precautions and warranty, Game Cartridge label and inserts. 2.2 "Competing Systems" shall mean hardware platforms, whether marketed now or in the future, designed to play interactive video games, including, but without limitation: Apple/Bandai Pippin or Atmark, Atari Jaguar, Atari Lynx, 3DO Real, Matsushita M2, Phillips CD-1 Interactive Player, Sega Master System, Sega Genesis, Sega CD, Sega Game Gear, Sega CD/X, Sega Nomad, Sega Saturn, Sega Pico, Sony PSX/Playstation and SNK Neo Geo. 2.3 "Effective Date" shall mean the last date in which all parties shall have signed this Agreement. 2.4 "Exclusive Licensed Product" shall mean the audiovisual work tentatively entitled "WORLD CHAMPIONSHIP WRESTLING-TBD", in its current form and as hereafter developed, including any adaptation, translation, derivative, sequel or substantially similar game which is sold by LICENSEE as a Licensed Product under this Agreement. 2.5 "Game Cartridge(s)" shall mean interchangeable plastic cartridges adapted for use with the N64 System, housing the Game embodied in electronic memory devices or comparable medium authorized by NINTENDO for storing and playing Games on the N64 System. 2.6 "Game(s)" shall mean video game software compatible with the N64 System developed under this Agreement. NINTENDO 64 LICENSE AGREEMENT PAGE 1 2 2.7 "Guidelines" shall mean the "Nintendo 64 Packaging Guidelines" and the "Nintendo 64 Development Manual" setting forth trademark, copyright and related artwork standards, as published from time to time by NINTENDO. 2.8 "Independent Contractor" shall mean any third party agent, consultant, contractor or independent programmer, other than LICENSEE. 2.9 "Licensed Copyright(s)" shall mean various copyrights in printed materials, art or logo designs, trade dress, computer software, microcode, electronic circuitry and rights in integrated circuit layout designs employed in the N64 System. 2.10 "Licensed Intellectual Properties" shall mean individually, collectively or in any combination, the Licensed Inventions, Licensed Proprietary Information, Licensed Copyrights and Licensed Trademarks. 2.11 "Licensed Invention(s)" shall mean improvements and inventions concerning the N64 System, including inventions which are or may become the subject matter of various patents or patent applications. 2.12 "Licensed Product(s)" shall mean Game Cartridges (or comparable medium authorized by Nintendo) for employing the Licensed Intellectual Properties and having electronic memory devices storing the Games. 2.13 "Licensed Proprietary Information" shall mean any of the following information relating to the N64 System: (a) all current or future information, know-how, techniques, methods, information, tools, emulator boards, software development specifications, and/or trade secrets, (b) any patents or patent applications, (c) any business, marketing or sales data information, and (d) any other information or data relating to development, design, operation, manufacturing, marketing or sales. "Licensed Proprietary Information" shall include information disclosed to LICENSEE by NINTENDO, NINTENDO's affiliated companies, SGI, and/or other third parties working with NINTENDO. Such Licensed Proprietary Information shall include all confidential information disclosed, whether in writing, orally, visually, or in the form of drawings, technical specifications, software, samples, pictures, models, recordings, or other tangible items which contain or manifest, in any form, the Licensed Proprietary Information. Licensed Proprietary Information shall not include: (a) data and information which was in the public domain prior to LICENSEE's receipt of the same hereunder, or which subsequently becomes part of the public domain by publication or otherwise, except by LICENSEE's wrongful act or omission, (b) data and information which LICENSEE can demonstrate, through written records kept in the ordinary course of business, was in its possession without restriction on use or disclosure, prior to its receipt of the same hereunder and was not acquired directly or indirectly from NINTENDO under an obligation of confidentiality which is still in force, (c) data and information which LICENSEE can show was received by it from a third party who did not acquire the same directly or indirectly from NINTENDO and to whom LICENSEE has no obligation of confidentiality, and (d) data and information which is required to be disclosed by an authorized governmental or judicial entity, provided that LICENSEE shall notify NINTENDO at least thirty (30) days prior to such disclosure. 2.14 "Licensed Trademarks" shall mean registered and unregistered trademarks and trademark applications used in connection with the N64 System, including "Nintendo(R)", "Nintendo 64(R)", "N64(TM)", "Official Nintendo Seal of Quality(R)" and trade dress in the N64 System. 2.15 "Marketing Materials" shall mean marketing, advertising or promotional materials which incorporate the Licensed Intellectual Properties which are developed by or for LICENSEE to promote the sale of the Licensed Products. 2.16 "NCL" shall mean NINTENDO's parent company, Nintendo Co., Ltd. of Kyoto, Japan. 2.17 "Nintendo 64 System" and "N64 System" shall mean the 64-bit Nintendo 64 video game NINTENDO 64 LICENSE AGREEMENT PAGE 2 3 system, including the hardware, software and input controller marketed by NINTENDO and Nintendo Co., Ltd. 2.18 "Other Agreements" shall mean that certain Product Developer Non-Disclosure Agreement for Nintendo 64 entered into between NINTENDO and LICENSEE with an effective date of 11/4/96. 2.19 "Product Proposal" shall mean a written proposal which provides a detailed explanation of the Game. 2.20 "Schedule 1" shall mean the "Nintendo of America Inc. Price Sheet N64 Licensed Game Paks" attached to this Agreement and incorporated by reference into this Agreement. 2.21 "SGI" shall mean Silicon Graphics, Inc. and/or MIPS Technologies, Inc. 2.22 "Term" shall mean three (3) years from the Effective Date. 2.23 "Territory" shall mean all countries within the Western Hemisphere, including the United States, Canada, South America, Central America, Mexico and all applicable territories and possessions. 3. GRANT OF LICENSE; RESERVATION OF RIGHTS BY NINTENDO 3.1 Grant. For the Term and in the Territory, NINTENDO hereby grants to LICENSEE, and LICENSEE hereby accepts under the terms and conditions set forth in this Agreement, a nonexclusive license to employ the Licensed Intellectual Properties solely to develop and sell video games incorporated into Game Cartridges for play on the N64 System. Except as may be permitted under a separate written authorization from NINTENDO or NINTENDO Co., Ltd., LICENSEE shall not use the Licensed Intellectual Properties for any other purpose. 3.2 Reservation of Rights in the Licensed Intellectual Properties. LICENSEE acknowledges NINTENDO and Nintendo Co., Ltd.'s right, title, and interest in and to the Licensed Intellectual Properties and the goodwill associated with the Licensed Trademarks. LICENSEE will not at any time do or cause to be done any act or thing which in any way impairs or is intended to impair any part of such right, title, interest or goodwill. LICENSEE shall not represent that it has any ownership in the Licensed Intellectual Properties. Use of the Licensed Intellectual Properties shall not create any right, title or interest therein in LICENSEE's favor. 3.3 Reservation of Rights of Distribution Outside the Territory. LICENSEE shall market and sell the Licensed Products only in the Territory. LICENSEE shall not directly or indirectly export any Licensed Products from the Territory nor shall LICENSEE knowingly permit or assist any third party in doing so. 3.4 Reservation of Rights to Reverse Engineer. LICENSEE may utilize and study the design, performance and operation of the N64 System and the Licensed Proprietary Information solely for the purpose of developing software which is compatible with the N64 System for license under this Agreement. LICENSEE shall not, directly or indirectly, reverse engineer or aid or assist in the reverse engineering of all or any part of the N64 System, including the hardware, software, input controller and/or tools. For purposes of this Agreement, "reverse engineering" shall mean: (a) the x-ray electronic scanning and/or physical or chemical stripping of semiconductor components; (b) the disassembly, decompilation, decryption, simulation, debugging or code tracing of microcode; and/or (c) the disassembly, decompilation, decryption, simulation, debugging or code tracing of object code or executable code, specifically including, but not limited to, any NINTENDO supplied or developed libraries or microcode. The limitations set forth in this Section 3.4 shall not preclude LICENSEE from engaging in reverse engineering of any Game code which was developed solely by LICENSEE and related only to the Game and was not supplied by nor derived from any code supplied by NINTENDO. 3.5 Reservation of Rights of Electronic Transmission. LICENSEE shall not directly or indirectly NINTENDO 64 LICENSE AGREEMENT PAGE 3 4 duplicate, distribute or transmit Games via electronic means or any other means now known or hereafter devised, including without limitation, wireless, cable, fiber optic means, telephone lines, satellite transmission, microwave or radio waves or over a network of interconnected computers or other devices. Notwithstanding this limitation, LICENSEE shall not be prohibited from the electronic transmission of Games during the development process for the sole purpose of facilitating development; provided, however, that no right of retransmission shall attach to any such transmission, and, provided further, that LICENSEE shall use reasonable security measures, customary within the industry, to reduce the risk of unauthorized interception or retransmission of such transmissions. 3.6 Notification Obligations. LICENSEE shall promptly notify NINTENDO of the loss or unauthorized use or disclosure of any Licensed Proprietary Information and shall promptly act to recover any such information and/or prevent further breach of confidentiality obligations herein. 4. CONFIDENTIALITY 4.1 Disclosure of Proprietary Information. NINTENDO has and shall during the Term provide LICENSEE with highly proprietary development information, development tools, emulation systems, programming specifications and related resources and information constituting and incorporating the Licensed Proprietary Information to enable LICENSEE to develop video games for use with the N64 System. 4.2 Confidentiality of Licensed Proprietary Information. LICENSEE shall maintain all Licensed Proprietary Information as strictly confidential and will use such Licensed Proprietary Information only in accordance with this Agreement. LICENSEE shall limit access to the Licensed Proprietary Information to LICENSEE's employees having a strict need to know and shall advise such employees of their obligation of confidentiality as provided herein. LICENSEE shall require each such employee to retain in confidence the Licensed Proprietary Information pursuant to a written non-disclosure agreement between LICENSEE and such employee. LICENSEE shall use its best efforts to ensure that its employees working with or otherwise having access to Licensed Proprietary Information shall not disclose or make unauthorized use of the Licensed Proprietary Information. 4.3 Agent/Consultant Confidentiality. LICENSEE shall not disclose the Licensed Proprietary Information to any Independent Contractor without NINTENDO's prior written approval. Each approved Independent Contractor shall be required to enter into a written non-disclosure agreement with NINTENDO prior to receiving any access or disclosure of the Licensed Proprietary Information. 4.4 SGI as a Third-Party Beneficiary. LICENSEE hereby acknowledges and agrees that SGI shall be a third-party beneficiary of LICENSEE's confidentiality obligations as set forth in this Section 4. 5. DEVELOPMENT; QUALITY STANDARDS; ARTWORK; MANUFACTURING 5.1 Development and Sale of the N64 System Programs. During the Term, LICENSEE may develop Games and/or sell Licensed Products for the N64 System in accordance with this Agreement. 5.2 Exclusivity; Exclusive Licensed Product. For the Exclusive Licensed Product, LICENSEE agrees that, commencing on the Effective Date and continuing for a period of one (1) year from NINTENDO's first shipment of such Exclusive Licensed Product to LICENSEE, the Game incorporated into such Exclusive Licensed Product shall not be sold anywhere in the Territory by LICENSEE or by any third party for play on any Competing System. Except as provided herein with regard to the Exclusive Licensed Product, or as may otherwise be limited by the legitimate intellectual property rights of NINTENDO or any third party, LICENSEE shall retain all rights with regard to the adaptation of Games for development and sale in any other format, including on any Competing System. 5.3 Submission of Game Concept. Before commencing development of a Game, LICENSEE NINTENDO 64 LICENSE AGREEMENT PAGE 4 5 shall submit to NINTENDO for approval, a Product Proposal. Such Product Proposal must include a detailed explanation of the manner in which the Game will utilize and exploit: (a) the unique 3-D capabilities and high quality graphics display of the N64 System; (b) the complex, high-capacity processing speed of the N64 System; and (c) the dynamic interfaces and touch control features of the unique N64 System controller. For that purpose, the Product Proposal shall include: (a) a description of the proposed Game; (b) the development team profile, including information regarding any Independent Contractor which LICENSEE proposes to retain to work on the Game; (c) a description of any special hardware or software requirements; and (d) the anticipated completion date of the proposed Licensed Product. Subsequent to acceptance and approval of a Product Proposal, LICENSEE shall notify NINTENDO in writing of any material proposed changes in the Product Proposal and/or the proposed Licensed Product. From time to time, at approximately quarterly intervals or such other reasonable times NINTENDO may establish for purposes of ensuring utilization and exploitation of the N64 System in the manner set forth above, LICENSEE shall submit work-in-progress on the Game to NINTENDO for further review in accordance with the criteria set forth herein. NINTENDO shall not unreasonably withhold or delay any approval provided for herein. 5.4 Delivery of Completed Game. Upon completion of a Game, LICENSEE shall deliver to NINTENDO one (1) prototype of the Game in a format specified by NINTENDO, together with written user instructions and a complete screen text script. NINTENDO shall promptly evaluate the Game with regard to (a) its technical compatibility with and error-free operation on the N64 System; (b) the suitability of the Game content, taking into account reasonable standards set forth in the Guidelines; and (c) whether the Game achieves the objectives set forth in LICENSEE's approved Product Proposal. LICENSEE shall have satisfied the Game content suitability criteria by providing NINTENDO with proof that the Game has been provided with a certificate of a rating other than ADULTS ONLY (or its equivalent) from the Entertainment Software Ratings Board or comparable independent ratings body which reviews and certifies product for violent or sexual content. 5.5 Approval of Completed Game. NINTENDO shall, within a reasonable period of time after receipt, approve or disapprove such Game. If such Game is disapproved, NINTENDO shall specify in writing the reasons for such disapproval and state what corrections and/or improvements are necessary. After making the necessary corrections and/or improvements, LICENSEE shall submit a revised Game for approval by NINTENDO. The approval of any Game by NINTENDO shall not relieve LICENSEE of its sole responsibility for the development, quality and operation of the Game or in any way create any warranty for a Licensed Product by NINTENDO. NINTENDO shall not unreasonably withhold or delay any approval provided for herein. 5.6 Development and Quality of Artwork. In connection with the submission of a proposed Licensed Product to NINTENDO, LICENSEE shall submit all Artwork to NINTENDO. All Artwork shall conform to the requirements set forth in the Guidelines. Within fifteen (15) business days of receipt of the Artwork, NINTENDO shall approve or disapprove the Artwork based upon the Guidelines. If any of the Artwork is disapproved, NINTENDO shall specify in writing the reasons for such disapproval and state what corrections and/or improvements are necessary. After making the necessary corrections and/or improvements to the disapproved Artwork, LICENSEE shall resubmit new Artwork for approval by NINTENDO. NINTENDO shall not unreasonably withhold or delay its approval of any Artwork. 5.7 Appointment of NCL as Manufacturer. LICENSEE hereby appoints NCL, and NCL hereby accepts appointment, as manufacturer of the Licensed Products. LICENSEE shall purchase from NCL through NINTENDO all of its requirements for the Licensed Products. NCL shall have the sole responsibility for establishing and fulfilling all aspects of the manufacturing process, including selecting the location of and specifications for any manufacturing facilities, appointing suppliers and subcontractors, and managing all work-in-progress and finished goods inventory. NCL shall acquire and retain responsibility for all equipment, tooling, molds or masks used in connection with the manufacture of the Licensed Products. 5.8 Manufacture of Licensed Products. Upon approval of a Game and the Artwork and upon NINTENDO 64 LICENSE AGREEMENT PAGE 5 6 receipt from LICENSEE of an order in accordance with Section 7 herein, NCL will manufacture the Licensed Products for LICENSEE, including the Artwork. 5.9 Retention of Sample Licensed Products. NCL may, at its own expense, manufacture samples of the Licensed Products, only to the extent necessary, to be used by NINTENDO for archival purposes, legal proceedings against infringers of the Licensed Intellectual Properties, and for other lawful purposes. 6. PURCHASE PRICE; PAYMENT; DELIVERY OF COMPLETED LICENSED PRODUCT 6.1 Minimum Initial Orders. Upon placement of an initial order, LICENSEE shall order a minimum quantity of Ten Thousand (10,000) units of a Licensed Product. 6.2 Subsequent Minimum Orders. LICENSEE may subsequently order additional Licensed Product in a minimum quantity of Five Thousand (5,000) units per title. 6.3 Purchase Price. The purchase price to be paid by LICENSEE to NINTENDO for the Licensed Products shall be in accordance with NINTENDO's pricing schedule currently set forth in the attached Schedule 1. The purchase price includes the cost of manufacturing, printing and packaging the Licensed Products and a royalty for the use of the Licensed Intellectual Properties. Schedule 1 is subject to change by NINTENDO at any time without notice. 6.4 Payment. At the time an order is placed, LICENSEE shall provide to NINTENDO an irrevocable letter of credit in favor of NINTENDO and payable at sight, issued by a bank acceptable to NINTENDO and confirmed, at LICENSEE's expense, if requested by NINTENDO. The letter of credit shall be in United States dollars in an amount equal to the purchase price of the Licensed Products ordered. All associated banking charges are for LICENSEE's account. 6.5 Shipment and Delivery. The Licensed Products shall be delivered F.O.B. Japan, with shipment at LICENSEE's direction and expense. Orders may be delivered by NINTENDO in partial shipments, each directed to no more than two (2) destinations designated by LICENSEE in the Territory. Title to the Licensed Products shall vest in accordance with the terms of the applicable letter of credit. 7. MARKETING, SALE AND RENTAL OF THE LICENSED PRODUCTS 7.1 Marketing Materials. LICENSEE agrees that any Marketing Materials shall all be of high quality and shall comply with the Guidelines. 7.2 Submission of Proposed Marketing Materials. Prior to actual use or distribution, LICENSEE shall submit to NINTENDO for review and evaluation initial samples of all Marketing Materials. NINTENDO shall, within fifteen (15) business days of receipt of such samples, approve or disapprove of the quality of such samples. If any of the samples are disapproved as to quality, NINTENDO shall specify the reasons for such disapproval and state what corrections and/or improvements are necessary. After making the necessary corrections and/or improvements to the disapproved samples, LICENSEE may resubmit new samples for approval by NINTENDO as to quality. No Marketing Materials shall be distributed or utilized by LICENSEE without obtaining prior written approval as to quality by NINTENDO. NINTENDO shall not unreasonably withhold or delay its approval of the proposed Marketing Materials. 7.3 Warranty and Repair. With respect to the Licensed Product, LICENSEE shall provide to the original consumer a minimum ninety (90) day limited warranty, comparable to that offered by NINTENDO. LICENSEE shall also provide to the original consumer, either directly or indirectly through authorized service centers, reasonably accessible product service, including out-of-warranty service for a period of three (3) years following sale of the Licensed Product. In the event LICENSEE is unable to obtain sufficient quantities of repair parts for service obligations from defective and/or product returns, NINTENDO shall cooperate in NINTENDO LICENSE AGREEMENT PAGE 6 7 providing reasonable quantities of repair parts to LICENSEE at its standard cost. 7.4 Business Facilities; Sales of Game Cartridges. LICENSEE agrees to develop, maintain and utilize during the Term: (a) suitable office facilities within the Territory, adequately staffed to enable LICENSEE to fulfill all responsibilities under this Agreement; (b) necessary warehouse, distribution, marketing, sales, collection and credit operations to facilitate proper handling of the Licensed Product; and, (c) customer service and game counseling support, including telephone service, to adequately support the Licensed Product. 7.5 Defects; Recall. In the event of a material programming defect in the Licensed Product, which defect in the reasonable judgment of NINTENDO would significantly impair the ability of a consumer to play the Licensed Product, NINTENDO may require the LICENSEE to recall the Licensed Product and undertake suitable repairs or replacements prior to sale. 7.6 Rental. In the event LICENSEE elects to engage in the commercial rental of the Licensed Products within the Territory on such terms and conditions as LICENSEE shall determine, LICENSEE shall secure appropriate authorizations and/or assignments from the author(s) of the copyrightable elements in the computer programs for the Licensed Product. LICENSEE shall clearly provide notice on the Artwork for each Licensed Product of any rental right or reservation thereof. 7.7 Nintendo Promotional Materials, Publications and Events. At its option, NINTENDO may: (a) insert in the packaging for the Licensed Product promotional materials concerning Nintendo Power(R) magazine; (b) utilize screen shots, package art and related art and information regarding the Licensed Product in Nintendo Power(R) or other media or marketing programs which promote NINTENDO products; and (c) exercise public performance rights of the Licensed Product, related trademarks and art in NINTENDO sponsored contests, tours and events which generally promote NINTENDO products. 8. LICENSEE'S COPYRIGHTS AND TRADEMARKS 8.1 Copyright and Trademark Warranties: LICENSEE represents and warrants that, throughout the Territory, LICENSEE is either: (a) the sole owner of all right, title and interest in and to the trademarks, copyrights and Artwork used on or in association with the Licensed Products; or (b) the holder of sufficient right to the trademarks, copyrights and Artwork which have been licensed from a third party for use in the Licensed Product. 8.2 Licensee's Indemnification. LICENSEE shall indemnify and hold NINTENDO harmless from any claims, losses, liabilities, damages, expenses and costs, including, without limitation, reasonable attorneys' fees and costs, which result from: (a) a breach of any of the representations or warranties provided by LICENSEE herein; (b) any claim of infringement of any third party's intellectual property rights with respect to the Licensed Product, excluding claims based solely upon NINTENDO's trademarks, copyrights and patents; or, (c) any claim of bodily injury (including death) or property damage arising out of, or in connection with, the development, sale and/or use of any of the Licensed Products. NINTENDO shall give LICENSEE prompt written notice of the assertion of any such claim and provided, further, that LICENSEE shall have the right to select counsel and control the defense and/or settlement of any such claim, subject to the right of NINTENDO to participate in any such action or proceeding at its own expense with counsel of its own choice. 8.3 Insurance. LICENSEE shall, at its own expense, obtain a policy of general liability insurance by a recognized insurance company. Such policy of insurance shall be in an amount of not less than Five Million Dollars ($5,000,000 USD) and shall provide for adequate protection against any suits, claims, loss or damage or any alleged intellectual property infringements by the Licensed Products. Such policy shall name NINTENDO as an additional insured and may not be canceled without thirty (30) days prior written notice to NINTENDO. A Certificate of Insurance shall be provided to NINTENDO's Licensing Department within thirty (30) days of the Effective Date. If LICENSEE fails to maintain such insurance during the Term, NINTENDO NINTENDO 64 LICENSE AGREEMENT PAGE 7 8 may secure and maintain such insurance at LICENSEE'S expense. 9. LIMITATION OF LIABILITY 9.1 Disclaimer of Licensed Intellectual Properties. NINTENDO makes no representations, guarantees or warranties concerning the scope or validity of the Licensed Intellectual Properties, and does not warrant that the sale of the Licensed Products by LICENSEE will not infringe upon the patent, trade secret, copyright, mask work or trademark rights of another in the Territory. THE RISK OF INFRINGEMENT IS HEREBY ASSUMED BY LICENSEE. 9.2 Warranty Disclaimer. NINTENDO DISCLAIMS ANY AND ALL WARRANTIES OF THE LICENSED PRODUCTS AS BETWEEN NINTENDO AND LICENSEE AND AS BETWEEN NINTENDO AND ANY THIRD PARTY PURCHASERS FROM LICENSEE. LICENSEE PURCHASES AND ACCEPTS ALL LICENSED PRODUCTS FROM NINTENDO ON AN "AS IS" AND "WHERE IS" BASIS AND WITHOUT ANY WARRANTIES, EXPRESS OR IMPLIED. WITH RESPECT TO THE LICENSED PRODUCTS, NINTENDO DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A GENERAL OR PARTICULAR PURPOSE AND SHALL IN NO EVENT BE LIABLE FOR ANY INCIDENTAL AND/OR CONSEQUENTIAL DAMAGES OF LICENSEE, ITS RETAILERS OR CUSTOMERS. LICENSEE SHALL BE SOLELY RESPONSIBLE FOR PROVIDING WARRANTY AND REPAIR/PLACEMENT SERVICES FOR ANY DEFECTIVE LICENSED PRODUCTS. 10 INFRINGEMENT OF LICENSED INTELLECTUAL PROPERTIES AND LICENSEE'S TRADEMARKS AND COPYRIGHTS 10.1 Reporting. In the event: (a) any claim is asserted against either party alleging that any of the Licensed Intellectual Properties or a Licensed Product constitutes an infringement of another's rights; or, (b) either party discovers that any of the Licensed Intellectual Properties or LICENSEE's copyrights or trademarks used in connection with the Licensed Products have been infringed by a third party, then the party with such knowledge shall promptly notify the other party. 10.2 Licensed Intellectual Properties. NINTENDO shall have the sole right, at its expense, to commence and/or defend a legal action or negotiate a settlement relating to any alleged infringement by the Licensed Intellectual Properties. LICENSEE agrees to give reasonable assistance in any such legal action, but at no expense to it. NINTENDO shall be entitled to all of the recovery or damages collected as a result of such legal action or negotiated settlement. In the event of a legal action against LICENSEE alleging an infringement by the Licensed Intellectual Properties as incorporated into LICENSEE's Licensed Products which NINTENDO affirmatively elects in writing not to defend, LICENSEE may defend or settle such legal action, at its option and expense. NINTENDO agrees to provide reasonable assistance in defending any such legal action. LICENSEE agrees to keep NINTENDO fully informed with respect to developments in any such legal action and to provide NINTENDO reasonable notice of the terms of any proposed settlement and to consider any comments by NINTENDO before settlement is made. 10.3 Infringement of Licensed Products. LICENSEE shall take reasonable steps to abate any infringement of LICENSEE's copyrights and trademarks in the Licensed Products. LICENSEE shall also take all reasonable and necessary steps, including legal action, to defend against any alleged infringement caused by any of LICENSEE's software programs developed under this Agreement or any Artwork, title or designation used in conjunction with any of the Licensed Products. NINTENDO shall give to LICENSEE reasonable assistance and cooperation in any such legal action, but at no expense to NINTENDO. 11. TERM AND TERMINATION 11.1 Default or Breach. In the event that either party is in default or commits a breach of this Agreement which is not cured within thirty (30) days after receipt of written notice thereof, then this Agreement NINTENDO 64 LICENSE AGREEMENT PAGE 8 9 shall automatically terminate on the date specified in such notice. 11.2 Termination Other Than by Breach. Upon the expiration of this Agreement or its termination other than by LICENSEE's breach, LICENSEE shall have a period of one hundred eighty (180) days to sell any unsold Licensed Products. All Licensed Products in LICENSEE's control following expiration of such sell-off period, shall be destroyed by LICENSEE within ten (10) days. 11.3 Termination by LICENSEE's Breach. If this Agreement is terminated by NINTENDO as a result of a breach of its terms and conditions by LICENSEE, LICENSEE shall immediately cease all distribution, promotion or sale of any Licensed Products. All Licensed Products in LICENSEE's control as of such termination shall be destroyed by LICENSEE within ten (10) days. 11.4 Licensed Intellectual Property Rights. Upon expiration and/or termination of this Agreement, LICENSEE will cease all use of the Licensed Intellectual Properties for any purpose, and will not disclose to third parties any Licensed Proprietary Information. LICENSEE shall also return to NINTENDO all writings, drawings, models, data and other materials and things in LICENSEE's possession or in the possession of any past or present employee, agent or contractor receiving the information through LICENSEE, which constitute or relate to or disclose any Licensed Proprietary Information without making copies or otherwise retaining any such information. 11.5 Termination by Nintendo's Breach. If this agreement is terminated by LICENSEE as a result of a breach of its terms or conditions by NINTENDO, LICENSEE may continue to sell the Licensed Products in the Territory until the expiration of the Term, at which time the provisions herein relating to termination other than by default of LICENSEE shall apply to any unsold Licensed Products. 12. GENERAL PROVISIONS 12.1 Nonassignability/Sublicensing. This Agreement is personal to LICENSEE and may not be sold, assigned, delegated, sublicensed or otherwise transferred or encumbered, including by operation of law or by the sale or transfer of more than ten percent (10%) of the stock, assets or ownership interest or control of LICENSEE, without the prior written consent of NINTENDO. 12.2 Force Majeure. Neither party shall be liable for any breach of this Agreement occasioned by any cause beyond the reasonable control of such party, including governmental action, war, riot or civil commotion, fire, natural disaster, labor disputes, restraints affecting shipping or credit, delay of carriers, inadequate supply of suitable materials, or any other cause which could not with reasonable diligence be controlled or prevented by the parties. In the event of material shortages, including shortages of microcomputer chips necessary for production of the Licensed Products, NINTENDO reserves the right to allocate essential materials among itself and its licensees. 12.3 Waiver; Severability; Integration. The failure of any party to enforce any provision of this Agreement shall not be construed to be a waiver of such provision or of the right of such party to thereafter enforce such provision. In the event that any term, clause or provision of this Agreement shall be construed to be or adjudged invalid, void or unenforceable, such term, clause or provision shall be construed as severed from this Agreement, and the remaining terms, clauses and provisions shall remain in effect. This Agreement constitutes the entire agreement between the parties relating to the subject matter hereof, provided, however, that the Other Agreements shall remain in effect, except as may be modified by specific reference herein. All prior negotiations, representations, agreements and understandings are merged into, extinguished by and completely expressed by this Agreement. Any amendment to this Agreement shall be in writing, signed by both parties. 12.4 Governing Law: Venue. This Agreement shall be governed by, subject to and construed under the laws of the State of Washington. Any legal actions prosecuted or instituted by NINTENDO or by NINTENDO 64 LICENSE AGREEMENT PAGE 9 10 LICENSEE under this Agreement, with respect to any matters arising under or growing out of this Agreement, shall only be brought in a court of competent jurisdiction in King County, Washington and each party hereby consents to the jurisdiction and venue of such courts for such purposes. 12.5 Equitable Relief. LICENSEE acknowledges that in the event of its breach of this Agreement, no adequate remedy at law may be available to NINTENDO and that NINTENDO shall be entitled to seek injunctive or other equitable relief in addition to any relief available at law. 12.6 Attorney's Fees. In the event it is necessary for either party of this Agreement to undertake legal action to enforce any of the terms, conditions or rights contained herein, or to defend any such action, then the prevailing party in any such action shall be entitled to recover from the other party all reasonable attorneys' fees, costs and expenses relating to such legal action. 12.7 Notices. All notices required or permitted under this Agreement shall be sufficiently given when: (a) personally served or delivered; (b) deposited, postage prepaid, with a guaranteed air courier service, addressed as stated herein, or to such other person or address either party may designate in a notice; or, (c) by facsimile, with an original sent concurrently by first class U.S. mail. Notice shall be deemed effective upon the earlier of actual receipt or two (2) business days after transmittal. 12.8 Counterparts; Signature by Facsimile. This Agreement may be signed in counterparts, which shall together constitute a complete Agreement. A signature transmitted by facsimile shall be considered an original for purposes of this Agreement. IN WITNESS WHEREOF, NINTENDO and LICENSEE have entered into this Agreement on the dates set forth below. NINTENDO: LICENSEE: NINTENDO OF AMERICA INC. T.HQ, INC. By: [ILLEGIBLE] By: /s/ BRIAN J. FARRELL ----------------------------------- ----------------------------------- Its: Executive Vice President, Its: President Administration Date: 4/28/97 Date: 5/9/97 NINTENDO 64 LICENSE AGREEMENT PAGE 10 11 SCHEDULE 1 NINTENDO OF AMERICA INC. PRICE SHEET N64 LICENSE GAME PAKS
MEMORY CAPACITY NOA PRICE 32 Megabit $24.00 32 Megabit + E(2) ROM $26.00 64 Megabit $30.00 64 Megabit + E(2) ROM $32.00 96 Megabit $36.00 96 Megabit + E(2) ROM $38.00
PRICE INCLUDES AN INSTRUCTION MANUAL UP TO 40 PAGES. THERE WILL BE AN EXTRA CHARGE FOR MANUALS LARGER THAN 40 PAGES (INCLUDING THE FRONT AND BACK COVER). EXTRA PACKAGING (MUST BE ORDERED WITH PRODUCT ON SEPARATE PO)
Game Pak Box $.20 Instruction Manual (under 40 pages) $.35 Instruction Manual (over 40 pages) $.75 Game Pak Label $.10 Game Pak Poster $.15 Warranty Card $.07
ALL PRICES SUBJECT TO CHANGE WITHOUT PRIOR NOTICE 1/30/97 NINTENDO 64 LICENSE AGREEMENT PAGE 11 EX-10.29 3 EXHIBIT 10.29 1 EXHIBIT 10.29 [THQ LOGO] 5016 N. Parkway Calabasas, Suite 100 Calabasas, California 91302 Telephone: 818 591-1310 Fax: 818 591-1615 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 having you become a member of the team at THQ Inc. Yours very truly, Accepted and agreed this 2nd day of October, 1997 /s/ BRIAN J. FARRELL BY: /s/ FRED A. GYSI - --------------------------- ----------------------- Brian J. Farrell Fred A. Gysi President and Chief Executive Officer cf/BF 3 [THQ LOGO] 5016 North Parkway Calabasas, Suite 100 Calabasas, California 91302 Telephone: 818-591-1310 Fax: 818-591-1615 November 13, 1997 Via: Hand Delivered Fred A. Gysi 1981 Westridge Road Los Angeles, CA 90049 Dear Fred: As you know, when you joined THQ, a portion of your offer included options on 40,000 shares of THQ, subject to the grant of the board of directors of THQ. Since the stock has risen in value between the time of acceptance of your offer and the board of directors' grant to you of the options, the board of directors has authorized me to offer to you a bonus equal to the difference between the exercise price of your options ($14.50) and the price at the date of your acceptance ($12.375). The bonus will be payable on the first, second and third anniversaries of your continued employment based upon the following formula: if THQ stock is above $14.50 on your anniversary dates, 13,333 (which is the quotient of 40,000 shares divided by the normal 3 year option vesting) times the difference between $14.50 and $12.375. By way of example, if the stock price on October 2, 1998 is $16.00 per share, you will be entitled to the following bonus: 13,333 x (14.50-12.375)=$28,332.63. If THQ stock is trading between $12.375 and $14.50, the bonus will be computed by multiplying 13,333 times the difference between the closing price of the stock on the anniversary date less $12.375. By way of example, if the closing stock price is $13.50 on October 2, 1998, the bonus would be calculated as follows: 13,333 x (13.50 - 12.375) = $14,999.63. No bonus will be payable if the price of the stock on the relevant anniversary date is less than $12.375. This bonus is contingent upon your continued employment with THQ, and is in no way connected to the existing share option plan or annual performance bonus. Yours very truly, /s/ BRIAN J. FARRELL Brian J. Farrell President and Chief Executive Officer EX-21 4 EXHIBIT 21 1 EXHIBIT 21 SUBSIDIARIES OF THQ INC. THQ International Ltd., a United Kingdom Corporation Heliotrope Studios, Inc., a Connecticut Corporation Black Pearl Software, Inc., an Illinois Corporation Malibu Games, Inc., a New York Corporation THQ Deutschland GmbH, a German Corporation EX-27 5 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS, THE CONSOLIDATED STATEMENTS OF OPERATIONS, & 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, 1998. YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 11,724,000 0 38,995,000 10,000 1,425,000 55,838,000 1,684,000 521,000 59,453,000 24,376,000 0 0 0 4,000 33,523,000 59,453,000 89,362,000 89,362,000 48,110,000 48,110,000 30,417,000 4,000 52,000 11,299,000 1,954,000 9,354,000 0 0 0 9,354,000 1.48 1.35
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