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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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(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, 1996
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
T-HQ, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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NEW YORK 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
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $.0001 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 (ss.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. X
---
As of March 24, 1997, approximately 6,479,000 shares of Common Stock of the
Registrant were outstanding and the aggregate market value of voting Common
Stock held by non-affiliates was approximately $39,488,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the T-HQ, Inc. 1997 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).
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T-HQ, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
YEAR ENDED DECEMBER 31, 1996
ITEMS IN FORM 10-K
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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. 14
Part II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters. 15
Item 6. Selected Financial Data. 16
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 18
Item 8. Financial Statements and Supplementary Data. 26
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. 27
Item 11. Executive Compensation. 27
Item 12. Security Ownership of Certain Beneficial Owners and
Management. 27
Item 13. Certain Relationships and Related Transactions. 27
Part IV
Item 14. Exhibits, Financial Statement Schedule and Reports on
Form 8-K. 28
Signatures 32
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The Annual Report of T-HQ, 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 28, 1997 with the Securities and
Exchange Commission.
PART I
ITEM 1. BUSINESS
INTRODUCTION
T-HQ, 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 currently publishes titles for all major dedicated Platforms
manufactured by Sony, Sega and Nintendo (the "Manufacturers"), and in 1997
intends to release titles for the recently introduced Nintendo 64 Platform and
multimedia personal computers. The Company currently publishes products 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, Target and Best Buy, 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 project (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,
ToHQ's revenues increased from $13.3 million in 1994 to $33.3 million and $50.3
million in 1995 and 1996, respectively.
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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 enable them to provide richer content and longer
play. Portable Platforms manufactured by the Manufacturers are less
sophisticated technologically and do not require television monitors. Currently,
the non-portable Platforms being marketed are based primarily on 32-bit and
64-bit technology.
The following table sets forth the year of release in the United States
of each of the Manufacturers' Platforms for which the Company publishes titles
and the technology on which such Platforms are based:
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DATE OF U.S.
MANUFACTURER PRODUCT NAME INTRODUCTION TECHNOLOGY
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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
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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.
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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 BASS Masters Classic, Turner's World Championship Wrestling and
Brunswick's Tournament of Champions. Currently, the Company's
proprietary products are Pax Imperia: Eminent Domain and Dead Unity.
- Identifying and licensing titles originally developed 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 participate in the market for advanced Platform games while limiting
risk. In 1996, the Company commenced publishing and distributing Sony
PlayStation and Sega Saturn titles under license from foreign
independent Software developers, primarily from Japan. In 1997, the
Company expects to publish approximately 13 additional titles acquired
in such manner, including K1: The Arena Fighters, Ghost in the Shell and
Bravo Air Race.
- Publishing high quality Software for the large installed base of
16-bit and Game Boy Platforms 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 such Platforms and
reduced competition in these markets creates an opportunity to generate
continuing sales and profits from these segments of the video game
market. Examples of such titles published by the Company include
Disney's Toy Story and Disney's Pocahontas and LucasArts' Super Empire
Strikes Back and Super Return of the Jedi. Licenses acquired for titles
currently under development include Disney's Hunchback of Notre Dame and
Disney's Hercules (an animated feature film to be released in 1997). The
Company has also entered into agreements with Electronic Arts Inc., a
competing independent Software company, pursuant to which the Company
develops, publishes and distributes titles based on existing Electronic
Arts titles, primarily for SNES and Game Boy. Representative Electronic
Arts titles include Madden Football, FIFA International Soccer, NBA
Live, NHL Hockey and PGA Tour Golf.
- 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, the
Company established an office in the United Kingdom in 1992 to oversee
its operations in Europe and has developed strategic relationships with
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Japanese publishers, resulting in foreign sales constituting 26% and 30%
of the Company's revenues in 1995 and 1996, respectively.
- 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. See
"Risk Factors -- Revenue Fluctuations and Seasonality." 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 and retained the services of that
company's principals (the "Heliotrope Acquisition") in order to develop and
publish Pax Imperia: Eminent Domain for release 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
Since its inception, the Company has released an aggregate of 101 titles
as of December 31, 1996, consisting of 32 SNES titles, 36 Game Boy titles, 13
Nintendo Entertainment Systems titles, seven Genesis titles, six Game Gear
titles, three Saturn titles and four PlayStation titles. 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 1996 and anticipated to be released in 1997, 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 1997 will be
released when scheduled or at all.
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RELEASE
TITLES RELEASED IN 1996 CATEGORY PLATFORM DATE
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Disney's Pocahontas Adventure Game Boy 3/96
In the Hunt Arcade PlayStation 3/96
Saturn 5/96
NBA Live '96 Sports Game Boy 3/96
NHL Hockey '96 Sports Game Boy 4/96
Olympic Summer Games Sports SNES 5/96
Genesis 5/96
Game Boy 6/96
Disney's Toy Story Adventure Game Boy 5/96
SNES (U.K. only) 6/96
BASS Masters Classics: Pro Edition Simulation SNES 6/96
Genesis 12/96
Time Killers Arcade Genesis 7/96
Mohawk & Headphone Jack Adventure SNES 8/96
Battlezone/Super Breakout Arcade Game Boy 8/96
Robopit Action PlayStation 8/96
Saturn 9/96
Alone in the Dark: One-Eyed Jack's
Revenge Adventure Saturn 8/96
PlayStation 8/96
Disney's Pinocchio Adventure Game Boy 9/96
Genesis 11/96
SNES (U.K. only) 11/96
PGA European Tour Sports SNES 9/96
Mr. Do! Arcade SNES 9/96
Urban Strike Action Game Boy 10/96
Game Gear 10/96
Floating Runner Action PlayStation 10/96
Disney's Donald Duck and Maui
Mallard Adventure SNES (U.K. only) 12/96
Madden '97 Football Sports Game Boy 11/96
FIFA International Soccer '97 Sports Game Boy 11/96
NHL Hockey '97 Sports SNES 11/96
Sim City 2000 Simulation SNES 11/96
College Football USA '97... Sports SNES 12/96
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<TABLE>
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ANTICIPATED
TITLES ANTICIPATED TO BE RELEASED IN RELEASE
1997* CATEGORY PLATFORM DATE
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K-1: The Arena Fighters Fighting PlayStation Spring '97
WCW vs. The World Fighting PlayStation Spring '97
Disney's Hunchback of Notre Dame Adventure Game Boy Spring '97
Tazmania 2 Adventure Game Boy Spring '97
Demolition Derby XL Driving Saturn Spring '97
Krazy Ivan Action Saturn Spring '97
Super Empire Strikes Back Action SNES Spring '97
Super Return of the Jedi Action SNES Spring '97
Game Boy Spring '97
Strike Point: The Hex Missions Action PlayStation Spring '97
PC Spring '97
Adidas Power Soccer Sports Saturn Summer '97
Brunswick's Tournament of Champions Simulation SNES Summer '97
Disney's Timon & Pumbaa Action SNES Summer '97
Disney's Hercules Adventure Game Boy Summer '97
Ghost in the Shell Action PlayStation Summer '97
Pax Imperia: Eminent Domain Strategy PC Summer '97
Assault Rigs Action Saturn Summer '97
Sentient Action Saturn Summer '97
vs Fighting PlayStation Fall '97
Bravo Air Race Driving PlayStation Fall '97
FIFA World Cup Soccer '98 Sports Game Boy Fall '97
Madden Football '98 Sports Genesis Fall '97
SNES Fall '97
NHL Hockey '98 Sports Genesis Fall '97
SNES Fall '97
NBA Live '98 Sports SNES Fall '97
Genesis Fall '97
BASS Masters Classic: Pro Edition Simulation PlayStation Fall '97
PC Fall '97
World Championship Wrestling Fighting Playstation Fall '97
Nintendo 64 Fall '97
Tenka Action Saturn Fall '97
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* Excludes titles the Company expects to release in 1997 but which have
not yet been publicly announced.
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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, Electronic Arts and LucasArts.
The Company pays royalties to its Property licensors that generally
range from 2% to 38% 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 be renewable upon payment of
certain minimum royalties or the attainment of specified sales levels.
The Company's Property licenses generally grant to the Company
exclusive use of the Property for the specified titles, on specified Platforms,
within the 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.
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.
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MANUFACTURER PLATFORM NUMBER OF TITLES TERRITORY EXPIRATION DATE(S)
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Nintendo SNES 12/contract yr. North America and September and October 1997
Latin America
Nintendo SNES 20/contract yr. Europe and certain March and July 1997
Asian countries
Nintendo Game Boy 15/contract yr. North America and April and September 1997
Latin America and January 1998
Nintendo Game Boy 10/contract yr. Europe and certain March 1997 and January 1998
Asian countries
Sega Genesis 3/contract yr. U.S. and Canada October 1996(1)
Sega Game Gear 2/contract yr. U.S. and Canada March 1998(2)
Sega Saturn 3/contract yr. U.S. and Canada February 1998(2)
Sony PlayStation title-by-title(3) U.S. and Canada June 1998
Sony PlayStation title-by-title(3) Europe December 2005(2)
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(1) The Company has applied for, and consistent with past practice expects
to receive, a one- or two-year renewal of such license.
(2) Agreement continues year-to-year after such date unless terminated by
either party.
(3) 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.
The Company has applied for, and expects to receive, a license to
publish titles for use on Nintendo's Nintendo 64 Platform, on a title-by-title
basis. In November 1996, Nintendo approved the development by the Company of
Turner's World Championship Wrestling for this Platform.
Sega and Nintendo charge the Company a fixed amount for each
cartridge, which amount varies based, in part, on memory capacity and processor
power. Sega and Sony similarly charge 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
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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 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. Prior to the Company's acquisition in
1993 of Black Pearl, an independent Software developer (the "Black Pearl
Acquisition"), all of the Company's Software was developed by independent
developers. The Black Pearl Acquisition resulted from the Company's
determination that the internal development of certain Software permits better
control over its quality and timeliness, and this acquisition provided the
Company with Software development facilities, personnel and equipment permitting
the Company to commence internal Software development. The Company's in-house
development team 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 is currently
working 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, 1996, the Company had 22 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, 1996, the Company had contracted
development efforts to 10 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
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a fixed amount per unit sold and range from $.25 to $3.50 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.
Although the predominant portion of the Company's titles continue to
be developed by independent developers, approximately 27% of the Company's net
sales in 1995 and 9% of the Company's net sales for the year ended December 31,
1996 were derived from titles developed by the Company internally.
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 determine whether there will be adequate retailer
and consumer demand for a title well in advance of its release.
MANUFACTURING
Except for certain Genesis 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 a
letter of credit, 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 75 days, and CD-Roms within 15 to 30 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 marketing activities are directed by a
sales team, led 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
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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.
The Company's Game Boy titles licensed from Electronic Arts, such as
Madden '96, FIFA Soccer '96, PGA Tour '96 and NHL '96, were included in
Electronic Arts' print, television and point-of-purchase advertising. National
newspaper and radio promotions included editorial and advertising support in key
children's consumer and electronic gaming publications, such as Disney
Adventures, Nintendo Power, GamePro, Game Players and Electronic Gaming Monthly.
In 1996, the Company's marketing efforts for Olympic Summer Games included a
mail-in rebate program with Reebok Shoes.
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, Wal-Mart, Best Buy, Blockbuster
Video, Kay Bee Toys, Electronics Boutique and Sears. Sales to the Company's ten
largest customers collectively accounted for approximately 52% of the Company's
gross sales in 1995 and 54% of the Company's gross sales in 1996. 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 $20 and $70 for SNES, between $15 and $35 for Game Boy, between $20 and
$55 for Genesis and between $19 and $59 for PlayStation and Saturn.
Foreign Sales. In 1992, the Company commenced the sale of its titles
in the United Kingdom, Europe and Australia. The Company sells its titles
directly to retailers in the United Kingdom and to distributors for distribution
in Europe and in Australia. The Company is the exclusive distributor for
Disney's SNES and Game Boy products in the United Kingdom for such titles as
Disney's Toy Story, Disney's Pocahontas and Disney's Pinocchio. The Company
ships
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its products to its foreign customers from a public bonded warehouse in the
United Kingdom. The Company is currently negotiating with distributors for other
countries, including Japan.
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 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
12
<PAGE> 15
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.
The Company believes that 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, 1996, the Company had 48 full-time employees. All
but five 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 7,500 square feet
of office space at 5016 North Parkway Calabasas, Calabasas, California, pursuant
to a lease expiring in July 1998. The Company also leases office space for
marketing personnel in Cupertino, California and Epsom, England, and for
development personnel in Guilford, Connecticut. The Company believes that its
office facilities are adequate.
ITEM 3. LEGAL PROCEEDINGS
On January 13, 1997, a complaint was filed in Illinois state court by
Studio e, Inc. ("Studio e"), a video game Software development company, against
Inland, its two principals and the Company. The Company acquired 25% of Inland
in June 1996 shortly after its formation for consideration consisting of
$300,000 in cash and 52,660 shares of Common Stock with a value at such time of
approximately $300,000; and the Company has contracted with Inland for the
development of Turner's World Championship Wrestling for the Play Station and
Nintendo 64. The complaint alleges, among other things, that the defendants
misappropriated trade secrets of
13
<PAGE> 16
Studio e, caused delays in the development of one of Studio e's titles, and as a
result were responsible for Studio e's loss of future business. The complaint
seeks, among other remedies, to enjoin the Company's alleged use of Studio e's
trade secrets and damages in an unspecified amount. The complaint makes
additional allegations and seeks additional damages and other remedies against
Inland and Inland's principals. On March 12, 1997, the Company filed an answer
to the complaint denying all allegations of wrongdoing asserted against it. The
Company also filed a counterclaim against Studio e alleging trade defamation and
libel and intentional interference with prospective economic advantage and a
cross-claim for indemnification against Inland.
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 1996.
14
<PAGE> 17
PART II
ITEM5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
ALL REFERENCES TO SHARE AND PER SHARE AMOUNTS HAVE BEEN RESTATED TO
REFLECT THE ONE-FOR-FIFTEEN REVERSE STOCK SPLIT EFFECTIVE FEBRUARY 15, 1995.
Through approximately February 17, 1995, the Company's common stock,
$.0001 par value ("Common Stock"), traded on the Nasdaq National Market under
the symbol "TOYH." From February 20, 1995 until February 13, 1997, the Common
Stock was quoted on the Nasdaq SmallCap Market under the same symbol. 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.
<TABLE>
<CAPTION>
CLOSING SALES
PRICES
HIGH LOW
<S> <C> <C>
1995
First Quarter 9 3/8 2 3/4
Second Quarter 3 1/8 1 35/64
Third Quarter 4 3/4 1 15/16
Fourth Quarter 6 2 3/4
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
</TABLE>
As of March 24, 1997, there were approximately 417 holders of record
and 6,059 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."
15
<PAGE> 18
SECURITIES ISSUED IN PRIVATE TRANSACTIONS
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 Sock, and is included in other
long-term assets in the accompanying balance sheet. In this transaction the
Company relied upon the exemption from registration pursuant to Regulation D of
the Securities Act of 1933. The Company has contracted with Inland for the
development of 32-bit and 64-bit versions of Turner's World Championship
Wrestling and BASS Masters Classic.
On July 1, 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.
On August 28, 1996, the Company issued 200,000 options outside of its
stock option plan to its president, Brian J. Farrell at an exercise price of
$5.00 per share in consideration for his past services and the Company's
financial performance. Share prices for these options equal the market price of
the Company's Common Stock at the date of the grant.
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, 1994, 1995 and 1996 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, 1992 and 1993 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.
16
<PAGE> 19
STATEMENT OF OPERATIONS DATA
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1992 1993 1994 1995 1996
-------- -------- -------- -------- --------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Net sales $ 56,478 $ 37,478 $ 13,289 $ 33,250 $ 50,255
-------- -------- -------- -------- --------
Cost and expenses:
Cost of sales 31,521 31,415 12,651 19,501 29,301
Royalties 7,179 6,028 2,327 3,641 7,977
Product development 831 1,186 713 761 1,205
Project abandonment -- 5,489 3,754 1,025 610
Selling 4,237 4,843 5,909 2,393 3,441
General and administrative 5,948 7,221 4,806 3,988 4,618
Operating interest -- 529 496 1,184 878
-------- -------- -------- -------- --------
Total costs and expenses 49,716 56,711 30,656 32,493 48,030
-------- -------- -------- -------- --------
Income (loss) from operations 6,762 (19,233) (17,367) 757 2,225
Interest expense - net (76) (420) (112) (134) (316)
-------- -------- -------- -------- --------
Income (loss) before income taxes 6,686 (19,653) (17,479) 623 1,909
Provision (benefit) for income taxes 2,640 (3,413) 11 22 8
-------- -------- -------- -------- --------
Net income (loss) $ 4,046 $(16,240) $(17,490) $ 601 $ 1,901
======== ======== ======== ======== ========
Net income (loss) per share $ 2.79 $ (10.80) $ (8.75) $ .17 $ .39
======== ======== ======== ======== ========
Weighted-average number of
common and common equivalent
shares outstanding 1,448 1,504 1,998 3,482 4,911
</TABLE>
BALANCE SHEET DATA
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Working capital $25,036 $11,046 $ 3,736 $ 7,082 $ 9,672
Total assets 53,394 22,305 15,531 16,916 22,840
Advance from bank 14,868 -- -- -- 5,355
Long-term debt -- -- -- -- --
Stockholders' equity 26,064 11,627 4,254 7,598 11,048
</TABLE>
17
<PAGE> 20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company develops, publishes and distributes Software for the major
Platforms sold by the Manufacturers. For the year ended December 31, 1996, sales
of Nintendo Software constituted 76% of the Company's sales, Sega Software sales
were 14%, and the remaining 10% were derived from sales of Sony PlayStation
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 and
$50.3 million in 1995 and 1996, respectively.
Although there remains a large installed base of 16-bit Platforms, the
Company believes that growth in the Software market will be derived principally
from games developed for the more advanced Platforms. Accordingly, the Company
intends to devote an increasing portion of its resources to the development of
titles for 32-bit and 64-bit Platforms and PCs.
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.
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.
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
18
<PAGE> 21
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.
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, 1996, the Company had
prepaid royalties and capitalized development costs of approximately $3 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 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.
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<PAGE> 22
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, 1995 and 1996, provisions of approximately $4.1 million and
$5.2 million, respectively, were taken against gross sales made during such
periods, and as of December 31, 1996, the Company's aggregate reserve against
accounts receivable for returns, customer accommodations and doubtful accounts
was approximately $4.4 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. In 1993 and 1994, the Company incurred material charges to
income as a result of such write-downs, but has not experienced such problems
subsequent to those periods.
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, 1995, for federal
income tax purposes the Company had reported approximately $17.5 million of NOL
carryforwards incurred since 1993. 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. 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 will be limited to an annual amount equal to (i) the
20
<PAGE> 23
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
estimated to be approximately $2,225,000 per year.
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:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Domestic sales 83.6% 74.9% 70.4%
Foreign sales 16.4 25.1 29.6
----- ----- -----
Net sales 100.0% 100.0% 100.0%
Costs and expenses:
Cost of sales 95.2% 58.6% 58.3%
Royalties 17.5 10.9 15.9
Product development 5.4 2.3 2.4
Project abandonment 28.2 3.1 1.2
Selling 44.5 7.2 6.9
General and administrative 36.2 11.9 9.2
Operating interest 3.7 3.6 1.7
----- ----- -----
Total costs and expenses 230.7 97.6 95.6
----- ----- -----
Income (loss) from operations (130.7) 2.4 4.4
Interest expense-- net (0.8) (0.5) (0.6)
----- ----- -----
Income (loss) before income taxes (131.5) 1.9 3.8
----- ----- -----
Net income (loss) (131.6)% 1.8% 3.8%
===== ===== =====
</TABLE>
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:
21
<PAGE> 24
<TABLE>
<CAPTION>
Years Ended
December 31,
------------
1995 1996
<S> <C> <C>
PlayStation -- 4
Saturn -- 3
SNES 6 11
Genesis 2 4
Game Boy 10 10
Game Gear 6 1
-- --
Total 24 33
== ==
</TABLE>
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 $444,000 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 scheduled products to market and achieving a
greater proportion of its minimum royalty guarantees.
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<PAGE> 25
For the year ended December 31, 1996, selling expenses increased by
$1,048,000 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 $630,000 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. Additionally, warehousing
costs increased in 1996 as a result of the increased sales volume for the period
as compared to 1995.
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. See "--Liquidity and Capital Resources."
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1995 TO THE YEAR ENDED DECEMBER 31,
1994
The Company's net sales increased to $33,250,000 in the year ended
December 31, 1995, from $13,289,000 in the year ended December 31, 1994,
primarily as a result of an increase in the number of new titles released in
1995. The Company introduced 24 new Software titles in 1995 as compared to ten
new titles in 1994. Net sales of the Company's BASS Masters Classic titles
constituted $7,054,000, (21.2%) of sales in the year ended December 31, 1995.
Approximately $2,941,000 (22.0%) of net sales in 1994 consisted of the Company's
The Ren & Stimpy Show titles.
Foreign net sales grew to $8,356,000, or 25.1% of net sales in 1995,
from $2,175,000, or 16.4% of net sales in 1994, as a result of the increase in
the number of new titles released and increased emphasis on sales to foreign
customers.
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 declined dramatically, as a percentage of net sales,
from 1994 to 1995. In 1995, 92% of sales were generated by new titles, which
traditionally have higher profit margins, as compared to 56% in 1994. Close-out
sales (defined as sales at substantially reduced margins or at a loss) were not
material in 1995; however, close-out sales represented approximately 44% of net
sales in 1994. The Company attributes the decline in close-out sales to a
substantial improvement in the management of its inventory ordering. Cost of
sales as a percentage of net sales in 1994 was also adversely affected by a
reserve for discounts and allowances for the XBAND Modem in the amount of
approximately $2,000,000 established in that year.
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<PAGE> 26
Royalty expense was higher in 1994 than in 1995 because (i) license
agreements for titles released in 1994 provided for royalties at higher rates,
and (ii) many of the Company's royalty agreements for titles sold in 1994
provided for royalties on a per-unit basis, or provided for royalties payable by
the Company on gross sales prices before markdowns and allowances (which, as a
consequence of the substantial close-out sales in 1994, resulted in a higher
royalty rate).
Selling expense as a percentage of net sales decreased to 7.2% in
1995, from 44.5% in 1994, as a result of the higher sales volume in 1995 and the
Company's decision to discontinue marketing the XBAND Modem. Selling expense in
1994 included $2,679,000 for the XBAND Modem.
The decrease in general and administrative expenses in 1995 compared
to 1994 resulted from a continuation of cost reductions, which was offset in
part by a charge of $483,000 in 1995 resulting from the bankruptcy of one of the
Company's European customers.
The lower project abandonment charges in 1995 are the result of the
Company bringing a greater portion of its titles in development to market
successfully than in 1994.
The increase in operating interest in 1995 resulted from an increase
in the number of letters of credit opened in 1995, which is directly related to
the increase in sales volume, and increased costs of opening letters of credit
with lenders other than the Company's bank.
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 must open letters of credit in their favor. As of December 31, 1996, the
Company had obligations with respect to future guaranteed minimum royalties of
$3,133,000, substantially all of which was payable within the subsequent twelve
months. As of December 31, 1996, the Company had obligations with respect to
open letters of credit of $4,409,000.
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 proceeds from its recently completed offering,
together with funds provided by operations and funds available under the
Company's revolving credit facility with a bank (the "Revolving Credit
Facility"), will be adequate to meet the Company's anticipated requirements for
operating expenses, product purchases, guaranteed payments to licensors and
Software development through 1997. However, to the extent accounts receivable,
inventories and guarantees and advance payments increase as a result of growth
of the
24
<PAGE> 27
Company's business, the Company could require additional working capital to fund
its operations. The Company does not anticipate making material capital
expenditures in 1997.
For the year ended December 31, 1996, the Company's net cash used in
operating activities was $4,348,000, compared to $3,395,000 and $9,986,000 for
the same periods in 1995 and 1994, respectively.
For the year ended December 31, 1996, the Company's net cash used in
investing activities was $892,000 (primarily as a result of the Heliotrope
Acquisition and the Company's purchase of 25% of Inland), compared to $239,000
and $188,000 for the same periods in 1995 and 1994, respectively. For additional
information concerning the Company's acquisition and investments, see Note 9 of
Notes to Consolidated Financial Statements included elsewhere herein.
For the year ended December 31, 1996, the Company's net cash provided
by financing activities was $6,067,000, compared to $2,661,000 and $9,833,000,
for the same periods in 1995 and 1994, respectively. Financing activities were
primarily the receipt of the proceeds from the exercise of warrants and options
and bank borrowings in 1996, the issuance of convertible preferred stock in 1995
and the issuance of Common Stock in 1994.
Credit Facilities. In July 1996, the Company terminated its factoring
and credit agreement and entered into the Revolving Credit Facility. Under the
Revolving Credit Facility, the Company may draw down working capital advances
and open letters of credit in an aggregate amount not to exceed the lesser of
$9,000,000, or an amount equal to the sum of 70% of eligible accounts
receivable, 50% of eligible inventory and 51% of the amount of letters of credit
opened by the Company in favor of the Manufacturers. The portion of the
borrowing base that consists of eligible inventory may not exceed $1,500,000.
Advances under the Revolving Credit Facility bear interest at the bank's prime
lending rate plus 1.25%. The Company has granted the bank a security interest in
its domestic accounts receivable and inventories. The Revolving Credit Facility
matures on June 30, 1997, subject to earlier termination. As of December 31,
1996, the Company had advances under the Revolving Credit Facility of $5,355,000
and open letters of credit from its revolving credit lender of $2,726,000. On
February 14, 1997, upon completion of the Company's public offering of 1,500,000
shares of Common Stock, the Company repaid advances under its Revolving Credit
Facility in the amount of $1,384,000.
The Revolving Credit Facility contains customary covenants including,
among others, restrictions on the incurrence of debt, encumbrances on or sales
of assets, mergers and acquisitions, payments of dividends and capital
expenditures. Financial covenants include the maintenance of (i) a current ratio
of not less than 1.4 to 1, (ii) profitable operations on a fiscal year basis,
(iii) minimum tangible net worth of $7,000,000, (iv) a ratio of debt to tangible
net worth of not greater than 1.75 to 1, and (v) minimum working capital of
$5,000,000.
The Company has also entered into agreements with two additional
lenders (the "North American Lender" and the "European Lender") pursuant to
which such lenders have agreed to
25
<PAGE> 28
issue letters of credit ("L/Cs") on the Company's behalf to the Manufacturers
for the purchase of products for the Company's North American operations (up to
a maximum of $5,000,000) and the Company's European operations (up to a maximum
of $2,500,000), respectively. Each of these lenders receives a fee for the
issuance of such L/Cs, and each lender retains title to the products financed by
such lender until such time as such products are sold to the Company's
customers. The North American Lender has a security interest in the domestic
assets of the Company subordinate to the security interest of the Company's
bank. The term of the agreement with the North American Lender expires on March
13, 1997, subject to automatic renewals on such date and every nine months
thereafter, unless terminated by either party. The European Lender has a first
priority security interest in all of the Company's European subsidiary's
receivables, inventory and other assets. The agreement with the European Lender
may be terminated at any time by such lender. As of December 31, 1996, there
were no open letters of credit issued by the North American Lender and open
letters of credit in the amount of $1,683,000 issued by the European lender.
Public Offering. 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 overallotment option,
exercisable within 30 days of the date of February 11, 1997, to purchase up to
225,000 additional shares of the Common Stock at the public offering price. On
March 11, 1997, the underwriters exercised their overallotment 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, of $11.7
million, will be used 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. A portion
of the proceeds may also be used to fund acquisitions related to the Company's
business.
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 T-HQ,
Inc. and subsidiaries, together with the report of Deloitte & Touche LLP dated
February 7, 1997(March 11, 1997 as to Note 12).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
26
<PAGE> 29
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 1997 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 1997 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 1997 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 1997
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.
27
<PAGE> 30
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES.
See Index to Financial Statements.
(B) REPORTS ON FORM 8-K.
None
(C) EXHIBITS.
Exhibit
Number Title
3.1 Articles of Incorporation (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 to documents 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, and are incorporated herein by reference)
3.2 Bylaws, as amended (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 to documents 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, and are
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)
28
<PAGE> 31
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)
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 License Agreement for North American Sega Saturn System effective as
of February 26, 1996, between Sega Enterprises, Ltd., and the Company
(Filed as exhibit 10.13 to the Company's Registration Statement on
form S-2 (File No. 333-18641) and incorporated herein by reference)
10.13 Confidential License Agreement for Gameboy effective as of September
28, 1995, between Nintendo of America Inc. and Black Pearl Software,
Inc. (Filed as Exhibit 10.7(a) to the Company's Annual Report on Form
10-K for the year ended December 31, 1995, and incorporated herein by
reference)
10.14* Employment Agreement of Brian J. Farrell dated as of December 31,
1996, between the Company and Brian J. Farrell
29
<PAGE> 32
10.15 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)
10.16 401(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)
10.17 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)
10.18 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 for the quarter ended June 30, 1996, and
incorporated herein by reference)
10.19 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)
10.20+ 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)
10.21+ 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)
10.22 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)
10.23 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)
10.24 Termination Agreement and Mutual Release dated May 31, 1995, by and
between the Company and Catapult Entertainment, 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)
30
<PAGE> 33
10.25 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)
10.26 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)
10.27 License Agreement dated July 11, 1994, between the Company and
B.A.S.S., Inc. (Filed as Exhibit 10.38 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1995, and incorporated
herein by reference)
10.28 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)
10.29 Assignment of Rights dated as of July 23, 1996, between the Company
and Blizzard Entertainment (Filed as Exhibit 10.30 to the Company's
Registration Statement on Form S-2 (File No. 333-18641) and
incorporated herein by reference)
10.30 Financing Contract dated 1994 between Opal Finance Corporation and the
Company (Filed as Exhibit 10.31 to the Company's Registration
Statement on Form S-2 (File No. 333-18641) and incorporated herein by
reference)
10.31* Stock Option Agreement dated as of August 28, 1996, between the
Company and Brian J. Farrell
11* Statement of Computation of Net Earnings
21* Subsidiaries of the Registrant
23* Independent Auditor's Consent
27* Financial Data Schedule
- - ----------
*Filed herewith.
+ Confidential treatment requested as to portions of this exhibit.
31
<PAGE> 34
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
Dated: March 31, 1997 T-HQ, INC.
By: /s/ Brian J. Farrell
-------------------------
Brian J. Farrell
President
Pursuant uo 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
- - -------------------------- President, Chief Executive Officer, March 31, 1997
Brian J. Farrell and Director
/s/ Lawrence Burstein
- - -------------------------- Director March 31, 1997
Lawrence Burstein
/s/ Bruce Jagid
- - -------------------------- Director March 31, 1997
Bruce Jagid
/s/ Jeffrey C. Lapin
- - -------------------------- Director March 31, 1997
Jeffrey C. Lapin
/s/ L. Michael Haller
- - -------------------------- Senior Vice President March 31, 1997
L. Michael Haller and Director
/s/ Deborah A. Lake
- - -------------------------- Vice President Finance March 31, 1997
Deborah A. Lake (Chief Financial Officer)
32
<PAGE> 35
T-HQ, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
<S> <C>
INDEPENDENT AUDITORS' REPORT F-2
FINANCIAL STATEMENTS
Consolidated Balance Sheets -- December 31, 1995 and December 31, 1996 F-3
Consolidated Statements of Operations for each of the Three Years in the
Period Ended December 31, 1996 F-4
Consolidated Statements of Shareholders' Equity for each of the Three Years
in the Period Ended December 31, 1996 F-5
Consolidated Statements of Cash Flows for each of the Three Years in the
Period Ended December 31, 1996 F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-8
</TABLE>
All other 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 or in Management's Discussion and Analysis of
Financial Condition and Results of Operations.
F-1
<PAGE> 36
INDEPENDENT AUDITORS' REPORT
To the Shareholders of T-HQ, Inc.,
Calabasas, California
We have audited the accompanying consolidated balance sheets of T-HQ, Inc. and
subsidiaries (the "Company") as of December 31, 1995 and 1996, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended December 31, 1996. 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, 1995
and 1996 and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 1996 in conformity with generally
accepted accounting principles.
DELOITTE & TOUCHE LLP
Los Angeles, California
February 7, 1997
(March 11, 1997 as to Note 12)
F-2
<PAGE> 37
T-HQ, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
December 31,
---------------------------
1995 1996
------------ ------------
<S> <C> <C>
Current assets:
Cash $ 1,895,000 $ 2,734,000
Accounts receivable -- net 9,362,000 14,186,000
Inventory 1,150,000 1,013,000
Prepaid and deferred royalties 1,776,000 717,000
Software development costs 2,037,000 2,329,000
Income tax refund receivable 27,000 --
Prepaid expenses and other current assets 153,000 485,000
------------ ------------
Total current assets 16,400,000 21,464,000
Equipment -- net 516,000 581,000
Other long-term assets -- 795,000
------------ ------------
TOTAL ASSETS $ 16,916,000 $ 22,840,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 4,707,000 $ 3,304,000
Accrued royalties 1,752,000 3,133,000
Accrued returns and allowances 2,859,000 --
Advance from bank -- 5,355,000
------------ ------------
Total current liabilities 9,318,000 11,792,000
Commitments and contingencies -- --
Shareholders' equity:
Convertible preferred stock, par value $.01, 5,000 shares authorized
Common Stock, par value $.0001, 100,000,000 shares authorized; 4,217,391
shares, and 4,739,883 shares issued and outstanding as of December 31,
1995 and 1996, respectively 4,000 4,000
Additional paid-in capital 33,317,000 34,558,000
Cumulative foreign currency translation adjustment (360,000) (52,000)
Accumulated deficit (25,363,000) (23,462,000)
------------ ------------
Total shareholders' equity 7,598,000 11,048,000
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 16,916,000 $ 22,840,000
============ ============
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE> 38
T-HQ, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE THREE YEARS ENDED
DECEMBER 31,
------------------------------------------
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net sales $ 13,289,000 $ 33,250,000 $ 50,255,000
Costs and expenses:
Cost of sales 12,651,000 19,501,000 29,301,000
Royalties 2,327,000 3,641,000 7,977,000
Product development 713,000 761,000 1,205,000
Project abandonment 3,754,000 1,025,000 610,000
Selling 5,909,000 2,393,000 3,441,000
General and administrative 4,806,000 3,988,000 4,618,000
Operating interest 496,000 1,184,000 878,000
------------ ------------ ------------
Total costs and expenses 30,656,000 32,493,000 48,030,000
------------ ------------ ------------
Income (loss) from operations (17,367,000) 757,000 2,225,000
Interest expense, net (112,000) (134,000) (316,000)
------------ ------------ ------------
Income (loss) before
income taxes (17,479,000) 623,000 1,909,000
Provision for (benefit
from) income taxes 11,000 22,000 8,000
------------ ------------ ------------
Net income (loss) $(17,490,000) $ 601,000 $ 1,901,000
------------ ------------ ------------
Net income (loss) per share $ (8.75) $ .17 $ .39
============ ============ ============
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE> 39
T-HQ, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE THREE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
<TABLE>
<CAPTION>
Cumulative
Foreign Retained
Additional Currency Earnings
Preferred Common Common Paid-in Translation (Accumulated
Stock Shares Amount Capital Adjustment Deficit) Total
--------- --------- ------ ----------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1994 -- 1,509,168 $2,000 $20,825,000 $(726,000) $ (8,474,000) $ 11,627,000
Issuance of Common Stock for cash -- 1,278,148 2,000 9,818,000 -- -- 9,820,000
Exercise of options -- 3,334 -- 13,000 -- -- 13,000
Net loss -- -- -- -- -- (17,490,000) (17,490,000)
Foreign currency translation
adjustment -- -- -- -- 284,000 -- 284,000
--------- --------- ------ ----------- ----------- ------------ ------------
Balance at December 31, 1994 -- 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 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
========= ========= ====== =========== =========== ============ ============
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE> 40
T-HQ, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $(17,490,000) $ 601,000 $ 1,901,000
Adjustments to reconcile net income
(loss) to net cash used in operating
activities:
Depreciation and amortization 253,000 240,000 337,000
Provision for doubtful accounts,
discounts and returns 3,888,000 4,145,000 5,203,000
Changes in operating assets and liabilities:
Accounts receivable (2,127,000) (5,875,000) (7,270,000)
Inventory and inventory deposits 3,796,000 779,000 202,000
Prepaid and deferred royalties and
Software development costs 1,602,000 2,592,000 2,799,000
Prepaid expenses and other current assets 2,292,000 99,000 (322,000)
Income tax refund receivable 2,398,000 201,000 --
Accounts payable and accrued expenses 1,365,000 1,040,000 (1,233,000)
Accrued royalties (2,083,000) (3,628,000) (649,000)
Accrued returns and allowances (3,898,000) (3,589,000) (5,316,000)
Income taxes payable 18,000 -- --
------------ ------------ ------------
Net cash used in operating activities (9,986,000) (3,395,000) (4,348,000)
------------ ------------ ------------
Cash flows used in investing activities:
Other long-term assets -- -- (578,000)
Acquisition of equipment (188,000) (239,000) (314,000)
------------ ------------ ------------
Net cash used in investing activities (188,000) (239,000) (892,000)
------------ ------------ ------------
Cash flows from financing activities:
Advances from bank -- -- 5,355,000
Proceeds from exercise of warrants and
options 13,000 48,000 712,000
Net proceeds from issuance of
convertible preferred stock -- 2,613,000 --
Net proceeds from issuance of common
stock 9,820,000 -- --
------------ ------------ ------------
Net cash provided by financing activities 9,833,000 2,661,000 6,067,000
------------ ------------ ------------
Effect of exchange rate changes on cash 133,000 61,000 12,000
------------ ------------ ------------
Net increase (decrease) in cash (208,000) (912,000) 839,000
------------ ------------ ------------
Cash -- beginning of period 3,015,000 2,807,000 1,895,000
------------ ------------ ------------
Cash -- end of period $ 2,807,000 $ 1,895,000 $ 2,734,000
============ ============ ============
Supplemental disclosure of cash flow
information:
Cash paid during the period for income
taxes -- $ 22,000 $ 14,000
============ ============ ============
Cash paid during the period for interest $ 235,000 $ 230,000 $ 375,000
============ ============ ============
</TABLE>
F-6
<PAGE> 41
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.
F-7
<PAGE> 42
T-HQ, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Business. T-HQ, Inc., a New York 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
"T-HQ" or the "Company" include T-HQ, 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 of 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 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 January
1998. In November, 1996, Nintendo approved the development by the Company of
Turner's World Championship Wrestling for release on the recently introduced
64-bit Nintendo 64.
The Company has various license agreements with Sega pursuant to which
it has the non-exclusive right to utilize the Sega name and its proprietary
information and technology in order to develop and market Software for use with
the 32-bit Sega Saturn, 16-bit Sega Genesis, and the portable Sega Game Gear.
The license agreements with Sega for such hardware Platforms expire at various
times through 1998.
The Company's Software business is dependent on its license agreements
with Sony, Nintendo, and Sega. Substantially, all of the Company's Software
products are manufactured by Sony, Nintendo, and Sega, 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, Nintendo, or Sega as
appropriate, with respect to all loss, liability and expense resulting from any
claim against Sony, Nintendo, or Sega involving the development, marketing, sale
or use of the Company's Titles, including any claims for copyright or trademark
infringement brought against Sony, Nintendo, or Sega. As such, the
F-8
<PAGE> 43
Company bears the risk that the Properties and information and technology
licensed from Sony, Nintendo, or Sega and incorporated in the Software may
infringe the rights of third parties. Generally, the Company is entitled to
indemnification from its Software developers and Property licensors to cover its
indemnification obligations to Sony, Nintendo, or Sega, 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 T-HQ, 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.
Fair Values of Financial Instruments. The carrying value of accounts
receivable and trade 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 and Inventory Deposits. 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.
Equipment. Equipment is 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. Equipment consists of the following at:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1995 1996
----------- -----------
<S> <C> <C>
Furniture, fixtures and equipment $ 897,000 $ 1,164,000
Leasehold improvements 20,000 20,000
Less accumulated depreciation (401,000) (603,000)
----------- -----------
$ 516,000 $ 581,000
=========== ===========
</TABLE>
Depreciation expense for the years ended December 31, 1994, 1995 and
1996 was $209,000, $199,000, and $238,000, respectively.
F-9
<PAGE> 44
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 (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 to the extent they relate to anticipated sales
during the subsequent year. 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 $935,000, $1,768,000, and
$2,390,000 were amortized in 1994, 1995, and 1996, respectively. Project
abandonment losses related to Software development costs of $2,743,000,
$1,025,000 and $509,000 were charged to expense in 1994, 1995, and 1996,
respectively. Research and development costs are expensed as incurred and to
date have not been material.
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).
Primary and Fully Diluted Earnings Per Share. Net income (loss) per
share has been computed using the weighted-average number of common shares and
common share equivalents (which consists of warrants, convertible preferred
stock, and options, to the extent they are dilutive). The weighted-average
number of common shares and common share equivalents outstanding in the years
ended December 31, 1994, 1995, and 1996 were 1,998,000, 3,482,000, and
4,911,000, respectively. The difference between primary and fully diluted
earnings per share is not significant. As discussed in Note 12, subsequent to
December 31, 1996, the Company raised $11.7 million by issuing Common Stock. If
a portion of the proceeds of the offering had been used to eliminate debt under
the Company's borrowing agreements during 1996, earnings per share would have
been $ .43.
F-10
<PAGE> 45
Non-monetary Transactions. Prior to 1995, the Company exchanged its
products for advertising to facilitate the promotion of the Company's products.
The exchanges are valued at the lower of cost or fair market value of products
exchanged. The Company recorded expense related to these transactions of
$2,061,000 during 1994.
Reclassifications. Certain items in the 1994 and 1995 financial
statements have been reclassified to conform to the 1996 presentation.
Accounting Standard. In March 1995, the Financial Accounting Standards
Board issued Statements of Financial Accounting Standards ("SFAS") No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed of." This statement addresses the accounting for the impairment of
long lived assets, such as property and equipment, certain identifiable
intangibles and goodwill related to those assets. Long-Lived assets and certain
indentifiable intangibles are to be reviewed for impairment whenever events or
charges in circumstances indicate that the carrying amount may not be
recoverable. An impairment loss is recognized when the sum of the future cash
flows (undiscounted and without interest charges) is less than the carrying
amount of the asset. The effect of the adopting SFAS No. 121 during the year
ended December 31, 1996 did not have a material adverse effect on the Company's
financial statements.
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 ("Imperial Agreement"). The Imperial
Agreement permits the Company to draw down working capital advances and open
letters of credit in amounts determined by a formula based on 70% of eligible
accounts receivable, 50% of eligible inventory and 50% of the amount of letters
of credit opened by the Company in favor of its Manufacturers. The portion of
the borrowing base that consists of eligible inventory in the formula may not
exceed $1,500,000. The facility provides for maximum borrowings of $9,000,000,
with advances bearing interest at the bank's prime rate plus 1.25% (weighted
average rate of 9.5% as of December 31, 1996). The Company has granted Imperial
Bank a security interest in its domestic accounts receivable and inventories.
F-11
<PAGE> 46
The Imperial Agreement expires on June 30, 1997. Open letters of credit under
the Imperial Agreement totaled $2,726,000 at December 31, 1996.
The amended Imperial Agreement contains customary covenants including,
among others, restrictions on the incurrence of debt, encumbrances on or sales
of assets, mergers and acquisitions, payments of dividends and capital
expenditures. Financial covenants include the maintenance of (i) a current ratio
of not less than 1.4 to 1, (ii) profitable operations on a fiscal year basis,
(iii) minimum tangible net worth of $7,000,000, (iv) a ratio of debt to tangible
net worth of not greater than 1.75 to 1, and (v) minimum working capital of
$5,000,000.
The Company also has lines of credit with two additional lenders
pursuant to which such lenders have agreed to issue letters of credit on the
Company's behalf to Sony, Nintendo, and Sega for the purchase of Software for
the Company's domestic and European operations. The domestic and European lines
are $5,000,000 and $2,500,000, respectively. Each of these lenders receives a
fee for the issuance of such letters of credit, and each lender retains title to
the inventory financed by such lender until such time as that inventory is sold.
The domestic lender has a security interest in the domestic assets of the
Company, subordinated to Imperial Bank's priority security interest. The current
term of the agreement with the domestic lender expires on March 15, 1997, with
automatic renewals at such date and every six months thereafter, unless
terminated by either party. There were no open letters of credit with the
domestic lender at December 31, 1996. The European lender has a first security
interest in all of the Company's European subsidiaries' receivables, inventory,
and other assets. The agreement may be canceled at any time at the lender's sole
discretion. Open letters of credit under the agreement with the European lender
were $1,683,000 as of December 31, 1996.
Because BNY owned the Company's domestic receivables pursuant to the
BNY agreement, prior to the effective date of the Imperial agreement the
Company's domestic accounts receivables were presented net of advances from BNY
(see table following). In addition, because BNY assumed credit risk for the
Company's domestic receivables but did not assume risk of markdowns or
allowances, the Company's reserve for such markdowns and allowances was
presented as a liability in periods prior to the closing of the Imperial
Agreement. Because Imperial does not own the Company's domestic receivables,
advances from Imperial are now shown as a liability in the accompanying
financial statements, and reserves for markdowns and allowances are now
presented as a deduction from the Company's gross receivables.
Accounts receivable are due primarily from domestic and foreign
retailers and distributors, including mass merchants and specialty stores.
Accounts receivable at December 31, 1995 and 1996 are composed of the following:
F-12
<PAGE> 47
<TABLE>
<CAPTION>
December 31,
---------------------------
1995 1996
------------ ------------
<S> <C> <C>
Receivables assigned to factor $ 7,348,000 $ --
Advances from factor (2,085,000) --
------------ ------------
Due from factor 5,263,000 --
Accounts receivable -- domestic -- 13,428,000
Other accounts receivable -- primarily foreign 5,739,000 5,004,000
Other receivables 51,000 112,000
Allowance for foreign doubtful accounts (1,380,000) (1,294,000)
Allowance for foreign discounts and returns (311,000) (292,000)
Allowance for domestic accrued returns and
allowances -- (2,772,000)
------------ ------------
Accounts receivable -- net $ 9,362,000 $ 14,186,000
============ ============
</TABLE>
The allowance for foreign doubtful accounts consists of the following:
<TABLE>
<CAPTION>
December 31,
---------------------------------------
1994 1995 1996
----------- ----------- -----------
<S> <C> <C> <C>
Balance at January 1 $ (536,000) $ (827,000) $(1,380,000)
Provision for doubtful accounts (256,000) (505,000) (10,000)
Actual write-offs (recoveries) (35,000) (48,000) 96,000
----------- ----------- -----------
Ending balance $ (827,000) $(1,380,000) $(1,294,000)
=========== =========== ===========
</TABLE>
The allowance for foreign discounts and returns consists of the
following:
<TABLE>
<CAPTION>
December 31,
-----------------------------------
1994 1995 1996
--------- --------- ---------
<S> <C> <C> <C>
Balance at January 1 $(666,000) $(190,000) $(311,000)
Provision for discounts and returns (280,000) (766,000) (422,000)
Actual write-offs 756,000 645,000 441,000
--------- --------- ---------
Ending balance $(190,000) $(311,000) $(292,000)
========= ========= =========
</TABLE>
The allowance for domestic accrued returns and allowances, which is
recorded as a liability in the accompanying balance sheets for the periods ended
December 31, 1994 and 1995 and which is presented as a contra against accounts
receivable in the accompanying balance sheet for the period ended December 31,
1996, consists of the following:
F-13
<PAGE> 48
<TABLE>
<CAPTION>
December 31,
---------------------------------------
1994 1995 1996
----------- ----------- -----------
<S> <C> <C> <C>
Balance at January 1 $(4,120,000) $(3,574,000) $(2,859,000)
Provision for discounts and returns (3,352,000) (2,874,000) (4,771,000)
Actual write-offs 3,898,000 3,589,000 4,858,000
----------- ----------- -----------
Ending balance $(3,574,000) $(2,859,000) $(2,772,000)
=========== =========== ===========
</TABLE>
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 $61,000, $30,000, and $161,000 in
1994, 1995 and 1996, respectively.
5. INCOME TAXES
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
1994 1995 1996
------- ------- -------
<S> <C> <C> <C>
Current
Federal $ -- $22,000 $ 2,000
State -- -- 6,000
Foreign 11,000 -- --
------- ------- -------
11,000 22,000 8,000
------- ------- -------
Deferred
Federal -- -- --
State -- -- --
------- ------- -------
Provision for income taxes $11,000 $22,000 $ 8,000
======= ======= =======
</TABLE>
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:
<TABLE>
<CAPTION>
1994 1995 1996
------ ------ ------
<S> <C> <C> <C>
Federal provision at statutory rate (35.0)% 35.0% 35.0%
Effect of foreign income taxes and other .1 -- --
Effect of net operating loss carryforward
(utilized) not utilized 35.0 (31.5) (34.9)
------ ------ ------
0.1% 3.5% 0.4%
====== ====== ======
</TABLE>
F-14
<PAGE> 49
The components of deferred tax assets (liabilities) are as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------
1995 1996
------------------------- -------------------------
Federal State Federal State
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Deferred tax assets:
Allowance for doubtful accounts,
Discounts and returns $ 973,000 $ 216,000 $ 943,000 $ 212,000
Net operating loss 5,852,000 1,168,000 5,946,000 1,176,000
License abandonment 539,000 559,000 671,000 151,000
Other -- net 250,000 56,000 121,000 28,000
----------- ----------- ----------- -----------
Total deferred tax assets 7,614,000 1,999,000 7,681,000 1,567,000
Deferred tax liabilities: -- -- --
Software development costs (893,000) (573,000) (897,000) (202,000)
State income taxes (484,000) -- (465,000) --
----------- ----------- ----------- -----------
Net deferred tax assets 6,237,000 1,426,000 6,319,000 1,365,000
Valuation reserve (6,237,000) (1,426,000) (6,319,000) (1,365,000)
----------- ----------- ----------- -----------
Deferred income taxes $ -- $ -- $ -- $ --
=========== =========== =========== ===========
</TABLE>
A valuation reserve has been provided in 1995 and 1996 because of the
uncertainty regarding the realization of net deferred tax assets. The valuation
reserve decreased $291,000 and $21,000 during 1995 and 1996, respectively.
As of December 31, 1995 the Company had federal and state net
operating loss carryforwards of $17,488,000 (expiring from years 2008 to 2009)
and $12,695,000 (expiring from years 1997 to 1999), respectively, which have not
been recorded in the financial statements because of the uncertainty as to
realization. The December 31, 1996 tax return has not been prepared as yet and
as such, the net operating loss figures have not been updated for the 1996
taxable income. 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 estimated to be approximately $2,225,000 per year.
6. STOCK OPTION PLAN
The Company has a stock option plan (the "Option Plan") which provides
for the issuance of up to 650,000 shares available for employees, consultants
and non-employee
F-15
<PAGE> 50
directors. An additional 10,656 options were available for grant at December 31,
1996. Stock options granted under the Option Plan 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 Plan 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 plan in
1994, 1995 and 1996 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.
<TABLE>
<CAPTION>
Number of
Stock Options Shares
- - ------------------------------------------------------------ ---------
<S> <C>
Outstanding at January 1, 1994 ($13.20 -- $82.65 per share) 67,305
Granted at $3.75 -- $17.25 per share 102,423
Exercised at $3.75 per share (3,334)
Canceled at $31.95 -- $78.75 per share (62,304)
---------
Balance at December 31, 1994 ($13.20 -- $82.65 per share) 104,090
---------
Granted at $2.87 -- $9.30 per share 609,833
Exercised at $2.87 per share (16,666)
Canceled at $2.87 -- $17.25 per share (42,666)
---------
Balance at December 31, 1995 ($2.87 -- $78.675 per share) 654,591
---------
Granted at $3.50 -- $6.00 per share 141,500
Exercised at $2.87 -- $3.75 per share (120,274)
Canceled at $2.87 -- $82.65 per share (185,584)
---------
Balance at December 31, 1996 ($2.81 -- $11.70 per share) 490,233
---------
Options exercisable at December 31, 1996 286,744
---------
</TABLE>
Included in the 1994 stock option grants is an option granted to Jack
Friedman, the former president of the Company. This option was originally
granted on February 24, 1994 at the price of $13.95 per share. Upon the
resignation of Mr. Friedman and the re- negotiation of his employment agreement,
options previously granted in 1994 were repriced to the then current market
price of the stock of $3.75.
During 1995, the Company granted 240,000 options outside of the Option
Plan, 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 Plan 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.
F-16
<PAGE> 51
The following table summarizes information about stock options
outstanding at December 31, 1996:
<TABLE>
<CAPTION>
NUMBER WEIGHTED AVERAGE WEIGHTED
RANGE OF EXERCISE OUTSTANDING AT DECEMBER REMAINING CONTRACTUAL AVERAGE
PRICES 31, 1996 LIFE EXERCISE PRICE
- - --------------------- ----------------------- --------------------- --------------
<S> <C> <C> <C>
$2.81 - $ 3.82 694,576 4 $ 3.15
$5.00 - $ 6.00 270,000 5 5.13
$9.30 - $11.70 6,668 8 10.50
----------------------- --------------------- --------------
971,244 4 $ 3.75
======================= ===================== ==============
</TABLE>
<TABLE>
<CAPTION>
SHARES Weighted
EXERCISABLE AT DECEMBER Average
31, 1996 Exercise Price
----------------------- -----------------------
<S> <C>
414,641 $ 3.11
116,667 5.13
6,668 10.50
----------------------- -----------------------
537,976 $ 3.64
======================= =======================
</TABLE>
All stock options are granted at the fair market value of the
Company's Common Stock at the grant date. The weighted average estimated fair
value of the options granted in 1995 and 1996 was $599,000 and $778,000,
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 1994, 1995 or 1996. Had compensation cost for the Company's
stock option plan 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 and December 31, 1996 would have been reduced
to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
YEARS ENDED
--------------------------------------
DECEMBER 31, 1995 DECEMBER 31, 1996
----------------- -----------------
<S> <C> <C>
Net income:
As reported $601,000 $ 1,901,000
Pro forma $ 2,000 1,123,000
Net income per common and common equivalent share:
As reported $ .17 $ .39
Pro forma $ -- $ .23
</TABLE>
The fair market value of options granted under the stock option plan
during 1995 and 1996 was determined using the Black-Scholes option pricing model
utilizing the following weighted-average assumptions:
F-17
<PAGE> 52
<TABLE>
<CAPTION>
YEARS ENDED
--------------------------
DECEMBER 31, December 31,
------------ ------------
1995 1996
------------ ------------
<S> <C> <C>
Dividend yield 0% 0%
Anticipated volatility 83% 83%
Risk-free interest rate 5.3% - 7.51% 5.2% - 6.7%
Expected lives 4 years 4 years
</TABLE>
7. MAJOR CUSTOMERS AND RELATED PARTY TRANSACTIONS
Sales (before returns and allowances) to a major customer represented
18%, 12% and 12% of gross sales in the years ended December 31, 1994, 1995 and
1996, respectively. In 1994 one other customer represented 18% of sales (before
returns and allowances). In 1995 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 1994, 1995 and 1996, 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 $275,000,
$214,000, and $215,000, respectively. As of December 31, 1995 and 1996, the
Company had owing to Feder, Kaszovitz, Isaacson, Weber, Skala & Bass
approximately $181,000 and $76,000, respectively.
In 1996, the Company paid Inland Productions, Inc., a Software
developer which the Company acquired 25% interest in on July 1, 1996 (See Note
9), $775,000. As of December 31, 1996, the Company had owing to Inland
Productions, Inc. $625,000.
8. CAPITAL STOCK TRANSACTIONS
In 1993, the Company entered into an agreement with an independent
investor (the "Investor") pursuant to which the Investor posted a standby letter
of credit in the principal amount of $5,000,000, in favor of BNY as additional
collateral, expiring on February 28, 1994. Effective January 31, 1994, the
Company entered into an agreement with the Investor whereby the Investor
extended the expiration date of the standby letter of credit to December 31,
1994. As consideration, the Company reduced the exercise price of 100,000
warrants previously granted to the Investor to $12.15 per share (the then
current market value of the Company's stock), and granted the Investor an
additional 33,334 warrants to purchase the Company's Common Stock at $12.15 per
share.
In March 1994, the Company sold 133,334 shares of its Common Stock
pursuant to Regulation S resulting in net proceeds to the Company of $980,000.
In June 1994, the Company sold units consisting of 564,445 shares of Common
Stock and warrants to purchase an additional 282,222 shares of Common Stock at
$15.00 per share pursuant to Rule 506 of Regulation D of the Securities Act of
1993, as amended ("the Act"), resulting in net proceeds to the Company of
$4,624,000. In September, October, and November 1994, the Company sold an
aggregate of
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<PAGE> 53
478,704 shares of Common Stock resulting in net proceeds to the Company of
$3,328,000, in sales exempt from the registration requirements of the Act
pursuant to Registration S under the Act. In December 1994, the Company sold
units consisting of 101,665 shares of Common Stock and warrants to purchase
101,665 shares of Common Stock at $20.25 per share in private placements
pursuant to Regulation D under the Act, resulting in net proceeds to the Company
of $888,000, (collectively "the Financings").
The net proceeds received by the Company from the Financings were
utilized in part in connection with the marketing and inventory purchase
commitments related to the launch of the XBAND Videogame Modem (the "XBAND
Modem") (See Note 10), and for the completion of certain Software products under
development.
On July 1, 1995, the Company granted a warrant to the Company's
domestic letter of credit lender to purchase 60,000 shares of Common Stock at a
price of $1.93 per share. The warrant is exercisable until June 30, 1998.
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 approximately
1,462,000 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 in connection with this transaction. As of
February 1996, all shares of preferred stock had been converted to Common Stock,
a total of 1,462,928 shares of Common Stock were issued in connection with this
transaction.
As of July 1, 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, 1995 and 1996, the number of
warrants to purchase the Company's Common Stock exercised were 74,864, and
70,000, respectively. The Company received proceeds from the exercise of such
warrants totaling $149,000. There were no warrants exercised during the year
ended December 31, 1994. At December 31, 1996 outstanding warrants were 706,431
at an average exercise price of $16.81.
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 BASS Masters
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<PAGE> 54
Classic. The Company's investment exceeds 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 CD-ROM
and an assignment of the distribution license and certain work-in-progress for a
PC CD-ROM 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 60 months. Because Heliotrope's assets and
operations prior to the acquisition were insignificant, no pro forma information
is presented.
10. COMMITMENTS AND CONTINGENCIES
XBAND Modem Agreement. On April 23, 1994, the Company entered into a
letter of agreement with Catapult Entertainment, Inc. ("Catapult"), pursuant to
which ToHQ was the exclusive North American distributor of certain hardware
products developed by Catapult. The Company was required to spend a minimum of
$3,000,000 in 1994 and a minimum of $2,000,000 in the first quarter of 1995 to
market and sell the XBAND Modem, and the Company was also required to finance
all inventory purchases. By mutual agreement between the Company and Catapult,
approximately $2,679,000 was spent in marketing efforts by the Company through
December 31, 1994, on the XBAND Modem. Because of the slow sales of the XBAND
Modem and the potential for markdowns and returns, the Company reserved
approximately $2,000,000 (by charging such amount against net sales) for such
markdowns and reserves in 1994.
On May 31, 1995, the Company and Catapult entered into a new agreement
related to the marketing and distribution of the XBAND Modem, pursuant to which
Catapult purchased the Company's inventory and accounts receivable related to
the XBAND Modem for approximately $3,200,000. At the closing of the agreement,
Catapult paid approximately $1,100,000 owed by the Company to the manufacturer
of the XBAND Modem, and $100,000 to the Company. The remaining amounts owing to
the Company were to have been received upon the conclusion of equity financing
by Catapult. The Company recorded the cash received at the closing as sales of
the XBAND Modem in the year ended December 31, 1995 pursuant to the new
agreement. Subsequently, Catapult has 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,
the Company established a reserve for the remaining payments. As a result,
substantially all of the amount received pursuant to such plan of reorganization
is reflected in the Company's Statement of Operations for the year ended
December 31, 1996.
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<PAGE> 55
Studio-e Litigation. On January 13, 1997, a complaint was filed in
Illinois state court by Studio e, Inc. ("Studio e"), a video game Software
development company, against Inland, its two principals and the Company. The
Company acquired 25% of Inland in June 1996. (See note 9). The complaint
alleges, among other things, that the defendants misappropriated trade secrets
of Studio e, caused delays in the development of one of Studio e's titles, and
as a result were responsible for Studio e's loss of future business. The
complaint seeks, among other remedies, to enjoin the Company's alleged use of
Studio e's trade secrets and damages in an unspecified amount. The complaint
makes additional allegations and seeks additional damages and other remedies
against Inland and Inland's principals. On March 12, 1997, the Company filed an
answer to the complaint denying all allegations of wrongdoing asserted against
it. The Company also filed a counterclaim against Studio e alleging trade
defamation and libel and intentional interference with prospective economic
advantage, and a cross-claim for indemnification against Inland.
Royalties. At December 31, 1995 and 1996, future minimum guaranteed
royalties were $1,752,000 and $3,133,000, respectively. Royalties are classified
as current liabilities based upon contractual payment dates.
Leases. The Company is committed under operating leases with lease
termination dates to February 2001. Minimum future rentals pursuant to these
leases as of December 31, 1996 are as follows:
<TABLE>
<CAPTION>
<S> <C>
1997 $ 234,000
1998 171,000
1999 76,000
2000 72,000
2001 6,000
----------
$ 559,000
==========
</TABLE>
Rent expense was $251,000, $184,000, and $183,000 in 1994, 1995 and
1996, respectively.
11. OPERATIONS IN GEOGRAPHIC AREAS
The Company is engaged in the development, marketing and distribution
of Software products, and formerly was engaged in the development, marketing and
distribution of traditional toys and games which is considered to be a single
segment. 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, 1994, 1995 and 1996:
F-21
<PAGE> 56
<TABLE>
<CAPTION>
United
States Europe Asia Elimination Consolidated
-------- -------- -------- ------------------------
(IN THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1994:
Sales to unaffiliated customers $ 11,114 $ 2,175 -- -- $ 13,289
Transfers between geographic areas -- -- $ 84 $ (84) --
-------- -------- -------- -------- --------
Total net revenue $ 11,114 $ 2,175 $ 84 $ (84) $ 13,289
======== ======== ======== ======== ========
Pretax earnings (loss) $(16,017) $ (1,459) $ 108 $ (111) $(17,479)
======== ======== ======== ======== ========
Identifiable assets at
December 31, 1994 $ 12,136 $ 3,484 $ 113 $ (202) $ 15,531
======== ======== ======== ======== ========
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
======== ======== ======== ======== ========
</TABLE>
12. SUBSEQUENT EVENTS
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 overallotment option,
exercisable within 30 days of the date of February 11, 1997, to purchase up to
225,000 additional shares of the Common Stock at the public offering price. On
March 11, 1997, the underwriters exercised their overallotment 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, of $11.7
million, will be used 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. A portion
of the proceeds may also be used to fund acquisitions related to the Company's
business.
F-22
<PAGE> 1
EXHIBIT 10.14
AMENDED AND RESTATED
EMPLOYMENT AGREEMENT
DATED AS OF DECEMBER 31, 1996
BY AND BETWEEN T-HQ, INC.,
a NEW YORK CORPORATION (THE "COMPANY"),
AND BRIAN J. FARRELL (THE "EXECUTIVE")
________________________
The parties hereto desire to replace the Executive's existing
employment agreement with the Company with this Agreement and to provide for
the Executive's continued employment by the Company in accordance with the
terms and provisions set forth below:
NOW, THEREFORE, the parties agree as follows:
1. EMPLOYMENT: TERM.
The Company will continue to employ the Executive, and the
Executive will continue to work for the Company, as its President and Chief
Executive Officer until December 31, 2001, unless sooner terminated in
accordance with Section 7 hereof. Such period, together with the period of any
extension or renewal of such employment, is referred to herein as the
"Employment Period."
2. DUTIES.
During the Employment Period, the Executive shall serve as the
President and Chief Executive Officer of the Company and of its subsidiaries
and affiliated companies, and perform such further duties as shall, from time
to time, be reasonably delegated or assigned to the Executive by the Board of
Directors of the Company consistent with his position and abilities.
3. DEVOTION OF TIME.
During the Employment Period, the Executive shall: (i) expend
substantially all of his working time for the Company; (ii) devote his best
efforts, energy and skill to the services of the Company and the promotion of
its interests; and (iii) not take part in activities reasonably known by
Executive to be detrimental to the best interests of the Company.
EXECUTION COPY
<PAGE> 2
4. COMPENSATION.
4.1 In consideration for the services to be performed
by the Executive during the Employment Period hereunder, the Company shall
compensate the Executive at an annual base salary (payable at the normal pay
periods of the Company) during the Employment Period of $300,000, commencing
January 1, 1997. The base salary shall be subject to annual review commencing at
the end of 1997 and at the end of each year thereafter, and may be increased
(but not decreased) for subsequent years.
4.2 In addition to the annual base salary payable to the
Executive pursuant to the provisions of Section 4.1 hereof, the Executive is
also entitled to a bonus for each fiscal year of the Company commencing during
the Employment Period, equal to the lesser of (i) $300,000 or (ii) 4.5% of the
Company's net income before taxes for such year. Net income before taxes shall
be determined by the independent public accountants for the Company in
accordance with generally accepted accounting principles consistently applied.
4.3 Executive shall also be eligible for awards of
options and any other stock or equity based awards that may be available to
executives of the Company.
5. EXPENSES; ADDITIONAL BENEFITS; INDEMNIFICATION.
5.1 The Executive shall receive an automobile allowance
for the use of any automobile owned or leased by him, consistent with the
Company's past practices.
5.2 The Company shall pay directly, or reimburse the
Executive for, all other reasonable and necessary expenses and disbursements
incurred by him for and on behalf of the Company in the performance of his
duties under this Agreement. For such purpose, the Executive shall submit to
the Company itemized reports of such expenses in accordance with the Company's
policies.
5.3 The Executive shall be entitled to paid vacations
during the Employment Period in accordance with the Company's then prevalent
practices for executive employees; provided, however, that Executive shall be
entitled to such paid vacations for not less than four (4) weeks per annum.
5.4 The Executive shall be entitled to participate in,
and to receive benefits under, any employee benefit plans of the Company
(including, without limitation, pension, profit sharing, group life insurance
and group medical insurance plans) as may exist from time to time for its
executive employees. Subject to the limitation contained in Section 5.7 below,
the Company shall make the maximum pension and profit sharing contribution for
the Executive legally permitted to be made
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<PAGE> 3
by an employer and shall permit the Executive to contribute the maximum pension
and profit sharing contribution legally permitted to be made by an employee,
equaling an aggregate of $30,000 (the current maximum allowable payment) each
year during the Employment Period.
5.5 The Company shall provide to Executive, and (subject
to the limitation contained in Section 5.7 below) pay the premiums therefor,
insurance on Executive's life in an amount equal to $1,500,000 as well as
disability insurance for the Executive during the Employment Period and for a
period of twelve (12) months thereafter, each of which shall have the coverage
reasonably requested by Executive; provided, however, that the foregoing
coverage shall be subject to any insurance examinations of Executive required
by the insurer. Executive shall designate the beneficiaries under the
disability and life insurance policies.
5.6 As a director and officer of the Company, the
Executive shall be entitled to the benefits of all provisions of the Articles
of Incorporation of the Company, as amended, and the Bylaws of the Company, as
amended, that provide for indemnification of officers and directors of the
Company. No such provisions shall be amended in any way to limit or reduce the
extent of the indemnification available to Executive as an officer or director
of the Company.
5.7 The Company's share of the pension and profit sharing
contribution referenced in Section 5.4 and insurance premiums referenced in
Section 5.5 shall not exceed in any calendar year an aggregate of $30,000.
In addition, to the fullest extent permitted by law, the
Company shall indemnify and save and hold harmless the Executive from and
against any and all claims, demands, liabilities, costs and expenses, including
judgments, fines or amounts paid on account thereof (whether in settlement or
otherwise), and reasonable expenses, including attorneys' fees actually and
reasonably incurred (except only if and to the extent that such amounts shall
be finally adjudged to have been caused by Executives willful breach of the
express provisions of this Agreement) to the extent that the Executive is made
a party to or witness in any action, suit or proceeding, or if a claim or
liability is asserted against Executive (whether or not in the right of the
Company), by reason of the fact that he was or is a director or officer, or
acted in such capacity on behalf of the Company, or by reason of or arising out
of or resulting from entering into this Agreement or the rendering of services
by the Executive pursuant to this Agreement, whether or not the same shall
proceed to judgment or be settled or otherwise brought to a conclusion. The
Company shall advance to Executive on demand all reasonable expenses incurred
by Executive in connection with the defense or settlement of any such claim,
action, suit or proceeding, and Executive hereby undertakes to repay such
amounts if and to the extent that it shall be finally adjudged that the
Executive is not entitled to be indemnified by the Company under this Agreement
or under the provisions of the Articles of Incorporation or Bylaws of the
Company as of the date hereof that govern indemnification of officers or
directors of the Company (but giving effect to future amendments that broaden
or expand any such indemnification and obligations or right more favorably to
Executive). Executive shall also be entitled to recover any costs of enforcing
his rights under this Section (including,
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<PAGE> 4
without limitation, reasonable attorneys' fees and disbursements) in the event
any amount payable hereunder is not paid within thirty (30) days of written
request therefore by Executive. The rights of Executive under this Section
shall survive the termination of this Agreement and shall be applicable for so
long as Executive may be subject to any claim, demand, liability, cost or
expense against which this Section is intended to protect and indemnify him.
Notwithstanding anything contained in this Agreement to the
contrary, the Company shall, at no cost to the Executive, use its best efforts
to at all times include the Executive during the term of the Employment Period
and for a period of not less than four (4) years thereafter, as an insured
under any directors and officers liability insurance policy maintained by the
Company, which policy shall provide such coverage in such amounts as the Board
of Directors shall deem appropriate for coverage of all directors and officers
of the Company.
6. RESTRICTIVE COVENANT.
6.1 During the Employment Period and thereafter, the
Executive shall not reveal, divulge or make known to any person, firm,
corporation or other business organization, and shall not directly or
indirectly use for his own benefit, or for the benefit of anyone else, any
secret or confidential information used by the Company in its business,
including, without limitation, (i) pricing information, (ii) the terms of the
Company's existing contracts with suppliers, licensors and/or developers, (iii)
any material information pertaining to the Company's customers and their
requirements, and (iv) any other of the Company's trade secrets, all of which
shall be collectively referred to hereafter as the "Confidential Information."
6.2 The services of the Executive are unique,
extraordinary and essential to the business of the Company, particularly in
view of the Executive's access to Confidential Information. Accordingly, the
Executive agrees that if his employment hereunder shall at any time be
terminated voluntarily by the Executive, or by the Company for cause (as
defined in Section 7.3), the Executive will not at any time within twelve
months of such termination, without the prior written approval of the Board of
Directors of the Company, directly or indirectly engage in any business
activity competitive with the business of the Company. Furthermore, the
Executive agrees that, during such twelve month period, he shall not solicit,
directly or indirectly or knowingly affect to the Company's detriment any
relationship of the Company with any customer, supplier, licensor, developer or
employee of the Company or knowingly cause any customer, supplier, licensor or
developer to refrain from entrusting additional business to the Company. If
the employment of the Executive hereunder is terminated by the Company other
than for cause, the restraints on the Executive set forth in the preceding two
sentences shall be inapplicable. If this Agreement shall not be renewed by
either the Company or by the Executive prior to its scheduled expiration date
as recited in Section 1, such restraints will apply for the period from January
1, 2002 through March 31, 2002.
-4-
<PAGE> 5
6.3 In the event that any of the provisions of Section
6.1 and 6.2 hereof shall be adjudicated to exceed the time, geographic or other
limitations permitted by applicable law in any jurisdiction, then such
provision shall be deemed reformed in any such jurisdiction to the maximum
time, geographic or other limitations permitted by applicable law.
6.4 As used in this Section 6, the term "Company" shall
mean and include any and all subsidiaries of the Company which either now exist
or which may hereafter be organized.
6.5 The Executive hereby acknowledges and agrees that, in
the event he shall violate any provisions of this Section 6, the Company will
be without an adequate remedy at law and accordingly, will be entitled to
enforce such restrictions by temporary or permanent injunctive or mandatory
relief obtained in any action or proceeding instituted in any court of
competent jurisdiction without the necessity of proving damages and without
prejudice to any other remedies which it may have at law or in equity.
7. EARLIER TERMINATION.
7.1 The Executive's employment hereunder shall
automatically be terminated upon the death of the Executive or the Executive's
voluntarily leaving the employ of the Company. In addition, the Executive's
employment by the Company may be terminated by the Company as follows:
(a) Upon thirty (30) days' prior written notice
by the Company, in the event of the Executive's disability as set forth in
Section 7.2 below; or
(b) Upon thirty (30) days' prior written notice
by the Company, in the event that the Company terminates the Executive's
employment hereunder for cause as set forth in Section 7.3 below.
7.2 The Executive shall be deemed disabled hereunder, if
in the opinion of the Board of Directors of the Company, as confirmed by
competent medical advice, he shall become physically or mentally unable to
perform his duties for the Company hereunder and such incapacity shall have
continued for any period of six (6) consecutive months.
7.3 For purposes hereof, "Cause" shall be limited to the
following: (a) the Executive's willful malfeasance or gross negligence; (b)
any material misrepresentation or concealment of a material fact made by the
Executive in connection with this Agreement; or (c) the material breach of any
covenant made by the Executive hereunder.
Notwithstanding the foregoing, termination by the Company for
Cause shall not be effective until and unless (i) in the event of any acts or
circumstances alleged to be a basis for termination that is capable of cure by
the Executive, the Executive is given written notice
-5-
<PAGE> 6
by the Board of such alleged acts or circumstances, and such alleged acts or
circumstances shall not have been cured by the Executive within 20 days of
receipt of such notice to the satisfaction of the Board in the exercise of its
reasonable judgment (or, if within such 20-day period the Executive commences
and proceeds to take all reasonable actions to effect such cure, within such
reasonable additional time period (no longer than 60 days) as may be
necessary), (ii) notice of intention to terminate for Cause has been given by
the Company within four months after the Board learns of the act, failure or
event constituting "Cause" and (iii) the Board has voted (at a meeting of the
Board duly called and held as to which termination of Executive is an agenda
item) by a majority vote to terminate Executive for Cause after Executive has
been given notice of the particular acts or circumstances which are the basis
for the alleged termination for Cause and has been afforded at least 20 days
notice of the meeting and an opportunity to present his position in writing and
the Board has given notice of termination to Executive within three days
thereafter, and (iii) if Executive has commenced an expedited arbitration in
the manner prescribed below within 15 days after such notice of termination,
disputing the Company's right under this Agreement to terminate for Cause, the
Arbitrator shall have determined that the Executive is terminable for Cause.
Unless a majority of the Board at the time of the giving of such notice of
termination is then comprised of persons other than Jeffrey C. Lapin, Bruce
Jagid, Lawrence Burstein and L. Michael Haller, then upon the giving of such
notice of termination, Executive (x) shall be deemed suspended with pay until
he shall be deemed to have been terminated for Cause hereunder or until the
Arbitrator shall have determined that Executive is not terminable for Cause and
(y) while suspended, Executive shall cease to act as an executive of the
Company and shall depart the premises of the Company. If Executive or his
representative fails to file a demand for arbitration with the American
Arbitration Association and file the requisite fees pursuant to Rule 4 of the
national Rules within 15 days of receipt of notice of termination from the
Board, and diligently pursue such proceeding in accordance with the procedures
set forth in Section 15 hereof, such termination shall be conclusively presumed
to have been for Cause.
7.4 In the event that this Agreement shall be terminated
due to the Executive's death or disability, then the Company shall within 20
days of such termination pay to the Executive or his personal representative,
as the case may be, severance pay in a lump sum amount equal to his then annual
base salary, as set forth in Section 4 hereof, for a period of twelve months
from the date of such termination. If, however, subject to the provisions of
Section 7.5 hereafter, this Agreement shall be terminated for any other reason
whatsoever, then the Company shall not obligated to make any severance payments
whatsoever to the Executive hereunder, except the compensation set forth in
Section 4 hereof which shall have accrued but be unpaid at the effective time
of termination.
-6-
<PAGE> 7
7.5 Notwithstanding any other provision herein, in order
to protect the Executive against the possible consequences and uncertainties of
a Change of Control (as hereinafter defined) of the Company and thereby induce
the Executive to remain in the employ of the Company, the Company agrees that:
(a) If the Executive's employment is terminated
by the Company other than for "Cause" (as defined in Section 7.3 hereof) at any
time subsequent to a Change of Control or if the Executive voluntarily
terminates such employment within one hundred eighty (180) days subsequent to a
Change of Control (the "Evaluation Period"), then in either such event, the
Company shall pay to the Executive within ten (10) days after such termination
a lump sum payment in cash in an amount equal to 2.99 times the Executive's
base amount (as the term base amount is defined in Section 280G of the Internal
Revenue Code of 1986, as amended, and applicable regulations thereunder) at the
time of such Change of Control; provided, however, that at the option of the
Executive, exercisable upon written notice to the Company within ten (10) days
of termination of employment, such payment may be paid in equal monthly
installments over an eighteen (18) month period commencing on the first day of
the month immediately following that in which the Executive's employment was
terminated. For purposes of this Section 7.5, in the event the Executive
(during or after the Evaluation Period) shall resign from his employment with
the Company subsequent to any change in his title, nature of duties, employee
benefits, location or place of employment or working conditions, in each
instance without his prior consent, such resignation shall be deemed to be a
termination of employment by the Company other than for "Cause."
(b) All options, warrants and other rights
(collectively, the "Options") to acquire securities of the Company (including
those of its subsidiaries and affiliates) ("Securities"), whether pursuant to
employee benefit plans or otherwise, which shall have been granted to the
Executive prior to a Change of Control shall fully vest and become immediately
exercisable upon the occurrence of any such Change of Control. If subsequent
to a Change of Control, the Executive's employment is terminated by the Company
other than for "Cause or if such employment is voluntarily terminated by the
Executive during the Evaluation Period, then in either such event, all Options
shall be exercisable by the Executive in accordance with their respective
terms, as hereinabove modified.
(c) In lieu of exercising or retaining his right
to exercise any outstanding Options then held by the Executive, the Executive
may elect to surrender to the Company his rights in such outstanding Options
(whether or not then exercisable) then held by the Executive, and, upon such
surrender the Company shall pay to the Executive an amount in cash per share
equal to the aggregate of the difference between (i) the option prices of the
aggregate of the difference between (i) the option prices of the Securities is
subject to such surrendered Options and (ii) the greater of (A) the average
price per share paid in connection with such acquisition of control if such
control was acquired by the payment of cash or the then fair market value per
option share of the consideration paid for such Securities if such
-7-
<PAGE> 8
control was acquired for consideration other than cash, (B) the price per share
paid in connection with any tender offer of securities leading to control, or
(C) the mean between the high and low bid price of such Securities on NASDAQ or
any other national securities exchange upon which the Securities shall then be
listed on the date of termination of the Executive's employment.
(d) As used in this Section 7.5, a "Change of
Control" shall be deemed to have occurred upon the passage of (i) ten (10) days
following a public announcement that a person or group of affiliated or
associated persons have acquired, or obtained the right to acquire, beneficial
ownership of thirty percent (30%) or more of such outstanding Share; or (ii)
ten (10) days after a person or group of affiliated or associated persons has
(A) become the owner of at least 10% of the Share or has filed a Schedule 13D
or 13G with the Securities and Exchange Commission and (B) whose ownership
interest is deemed by the Company's Board of Directors to cause a material
adverse impact of the business or the prospects of the Company.
(e) The Company shall pay or reimburse the
Executive for all fees and disbursement of counsel, if any, incurred by the
Executive as a result of the termination of his employment by the Company
following a Change of Control or his voluntary termination of such employment
during the Evaluation Period (including, without limitation, those which may be
incurred by the Executive in seeking to obtain or reinforce any right or
benefit provided by this Agreement).
(f) The Executive shall be under no obligation to
mitigate the amount of any payment provided for under this Section 7.5 by
seeking other employment or otherwise nor shall such amount be offset by any
compensation which the Executive may receive from future employment or
otherwise.
8. NO REQUIREMENT OF RELOCATION.
The Company expressly agrees that the Executive, as a
condition of his employment, need not relocate his residence from the community
in which he presently resides. Any demand or requirement by the Company that
the Executive principally perform his duties at a location or office that
requires more than an additional hour of one-way commutation time than the
Executive currently experiences shall, in the absence of the Executive's
consent (which may be withheld for any reason), constitute a termination
without cause by the Company of the Executive's employment thereunder.
9. SERVICES AS DIRECTOR.
During the Employment Period, the Executive shall, if elected
or appointed, serve as a Director of the Company and/or any subsidiary of the
Company upon such terms as shall be mutually agreed upon by the Executive and
the Company.
-8-
<PAGE> 9
10. ASSIGNMENT.
This Agreement, as it relates to the employment of the
Executive, is a personal contract and the rights and interests of the Executive
hereunder may not be sold, transferred, assigned, pledged or hypothecated,
except as otherwise set forth herein. This Agreement shall inure to the
benefit of and be binding upon the Company and its successors and assigns,
including without limitation, any corporation or other entity into which the
Company is merged or which acquires all of the outstanding share of the
Company's capital stock or all or substantially all of the assets of the
Company.
11. RIGHT TO PAYMENTS.
The Executive shall not under any circumstances have any
option or right to require payments hereunder otherwise than in accordance with
the terms hereof. To the extent permitted by law, the Executive shall not have
any power of anticipation, alienation or assignment of payments contemplated
hereunder, and all rights and benefits of the Executive shall be for the sole
personal benefit of the Executive, and no other person shall acquire any right,
title or interest hereunder by reason of any sale, assignment, transfer, claim
or judgment or bankruptcy proceedings against the Executive.
12. NOTICES.
Any notice required or permitted to be given pursuant to this
Agreement shall be deemed given three (3) business days after such notice is
mailed by certified mail, return receipt required, addressed as follows: (i) if
to Executive, at 5016 North Parkway Calabasas, Calabasas, California 91302; and
(ii) if to the Company, 5016 North Parkway Calabasas, Calabasas, California
91302, Attention: Vice-President - Finance or at such other address as any such
party shall designate by written notice to the other party.
13. GOVERNING LAW.
This Agreement shall be governed by and construed and enforced
in accordance with the internal laws of California without reference to
conflicts of laws, principles or rules.
14. WAIVER.
The waiver by either party of a breach of any provision of
this Agreement shall not operate or be construed as a Agreement shall be held
to be invalid or unenforceable, such invalidity or unenforceability shall
attach only to such provision and not in any way affect or render invalid or
unenforceable any other provisions of this Agreement, and this Agreement shall
be carried out as if such invalid or unenforceable provisions were not embodied
therein.
-9-
<PAGE> 10
15. ARBITRATION.
In the event of any controversy, dispute or claim arising out
of or related to this Agreement or the Executive's employment by the Company,
the parties shall negotiate in good faith in an attempt to reach a mutually
acceptable settlement of such dispute. If negotiations in good faith do not
result in a settlement of any such controversy, dispute or claim, it shall be
finally settled by expedited arbitration in accordance with the National Rules
of the American Arbitration Association governing employment disputes, subject
to the following:
(a) The Arbitrator shall be determined from a
list of names of five impartial arbitrators each of whom shall be an attorney
experienced in arbitration matters concerning executive employment disputes,
supplied by the American Arbitration Association (the "Association") chosen by
Executive and the Company each in turn striking a name from the list until one
name remains.
(b) The Arbitrator shall determine whether and to
what extent any party shall be entitled to damages under this Agreement.
(c) The Arbitrator shall not have the power to
add to nor modify any of the terms or conditions of the this Agreement. The
Arbitrator's decision shall not go beyond what is necessary for the
interpretation and application of the provision of this Agreement in respect of
the issue before the Arbitrator. The Arbitrator shall not substitute his or
her judgment for that of the parties in the exercise of rights granted or
retained by this Agreement. The Arbitrator's award or other permitted remedy,
if any, and the decision shall be based upon the issue as drafted and submitted
by the respective parties and the relevant and competent evidence adduced at
the hearing.
(d) The Arbitrator shall have the authority to
award any remedy or relief provided for in this Agreement, in addition to any
other remedy or relief (including provisional remedies and relief) that a court
of competent jurisdiction could order or grant. In addition, the Arbitrator
shall have the authority to decide issues relating to the interpretation,
meaning or performance of this Agreement even if such decision would constitute
an advisory opinion in a court proceeding or if the issues would otherwise not
be ripe for resolution in a court proceeding, and any such decision shall bind
the parties in their continuing performance of this Agreement. The
Arbitrator's written decision shall be rendered within sixty days of the
hearing. The decision reached by the Arbitrator shall be final and binding
upon the parties as to the matter in dispute. To the extent that the relief or
remedy granted by the Arbitrator is relief or remedy on which a court could
enter judgment, a judgment upon the award rendered by the Arbitrator shall be
entered in any court having jurisdiction thereof (unless in the case of an
award of damages, the full amount of the award is paid within 10 days of its
determination by the Arbitrator). Otherwise, the award shall be binding on the
parties in connection with their continuing performance of this Agreement and
in any subsequent arbitral or judicial proceedings between the parties.
-10-
<PAGE> 11
(e) The arbitration shall take place in Los
Angeles, California.
(f) The arbitration proceeding and all filing,
testimony, documents and information relating to or presented during the
arbitration proceeding shall be disclosed exclusively for the purpose of
facilitating the arbitration process and for no other purpose and shall be
deemed to be information subject to the confidentiality provisions of this
Agreement.
(g) The parties shall continue performing their
respective obligations under this Agreement notwithstanding the existence of a
dispute while the dispute is being resolved unless and until such obligations
are terminated or expire in accordance with the provisions hereof.
(h) The Arbitrator may order a pre-hearing
exchange of information including depositions, interrogatories, production of
documents, exchange of summaries of testimony or exchange of statements of
position, and the Arbitrator shall limit such disclosure to avoid unnecessary
burden to the parties and shall schedule promptly all discovery and other
procedural steps and otherwise assume case management initiative and control to
effect an efficient and expeditious resolution of the dispute. At any oral
hearing of evidence in connection with an arbitration proceeding, each party
and its counsel shall have the right to examine its witness and to
cross-examine the witnesses of the other party. No testimony of any witness
shall be presented in written form unless the opposing party or parties shall
have the opportunity to cross-examine such witness, except as the parties
otherwise agree in writing.
(i) Notwithstanding the dispute resolution
procedures contained in this Section 15, either party may apply to any court
having jurisdiction (i) to enforce this Agreement to arbitrate, (ii) to seek
provisional injunctive relief so as to maintain the status quo until the
arbitration award is rendered or the Dispute is otherwise resolved, or (iii) to
challenge or vacate any final judgment, award or decision of the Arbitrator
that does not comport with the express provisions of this Section 15.
16. ATTORNEYS' FEES
The Company shall pay or reimburse the Executive for all
reasonable fees and disbursements of the Executives counsel in connection with
the negotiation and execution of this Agreement. In addition, in the event of
any arbitration or judicial proceeding hereunder, the prevailing party shall be
entitled to recover his or its reasonable attorneys fees and costs..
17. HEADINGS.
The Article, Section, paragraph and subparagraph headings are
for convenience of reference only and shall not define or limit the provisions
hereof.
18. ENTIRE AGREEMENT.
-11-
<PAGE> 12
This Agreement constitutes the entire agreement between the
parties with respect to the subject matter hereof and there are no
representations, warranties or commitments except as set forth herein. This
Agreement replaces the Executive's existing employment agreement in its
entirety and supersedes any other prior and contemporaneous agreements,
understandings, negotiations and discussions, whether written or oral, of the
parties hereto relating to the transactions contemplated by this Agreement;
provided, however, that it is the intention of the parties that this Agreement
shall be interpreted and applied in conjunction with the term of any option,
warrant or other right not in existence or hereinafter granted to the Executive
to acquire shares of capital stock of the Company. In the event of any
conflict, however, the terms of this Agreement shall govern and prevail. This
Agreement may be amended only in a writing executed by the parties hereto
affected by such amendment.
IN WITNESS WHEREOF, the undersigned have executed this
Agreement as of the date and year first above written.
T-HQ, INC., a New York Corporation
By: /s/ Deborah A. Lake
_______________________________________
Deborah A. Lake
Vice President, Finance
and Administration
/s/ BRIAN J. FARRELL
__________________________________________
BRIAN J. FARRELL
-12-
<PAGE> 1
EXHIBIT 10.31
STOCK OPTION AGREEMENT
DATED AS OF AUGUST 28, 1996
BY AND BETWEEN T-HQ, INC.,
A NEW YORK CORPORATION (THE "COMPANY"),
AND BRIAN J. FARRELL (THE "OPTIONEE")
This AGREEMENT, dated as of August 28, 1996 is made between T-HQ,
INC., a New York corporation, having its principal offices at 5016 North
Parkway Calabasas, Calabasas, California 91302, as the Company, and Brian J.
Farrell, as Optionee, having an address at 5016 North Parkway Calabasas,
Calabasas, California 91302.
W I T N E S S E T H
1. Grant of Option. In consideration for and recognition of
Optionee's past services to the Company and Optionee's contribution to the
improved financial performance and success of the Company, the Company hereby
grants to the Optionee, subject to the terms and conditions herein set forth,
the right and option (the "Option") to purchase from the Company, all or any
part of an aggregate of two hundred thousand (200,000) shares of common stock of
the Company, par value $.0001 per share (the "Common Stock"), at the exercise
price of $5.00 per share (equaling the market price per share of the Common
Stock on the date of this Agreement), such Option to be exercisable as
hereinafter provided.
2. Limitation on Exercisability of Option. This Option shall be
exercisable by the Optionee, in whole or in part, to the extent of the
following number of shares of Common Stock on the dates set forth below:
Date After Which Shares
Number of Shares Can Be Purchased
---------------- ----------------
66,667 Shares August 28, 1996
an additional
66,667 Shares August 28, 1997
an additional
66,666 Shares August 28, 1998
Notwithstanding anything to the contrary contained herein, this Option
shall automatically vest for the entire number of shares subject to the Option,
upon a "Change of Control," as such term is defined in the Optionee's
Employment Agreement with the Company, as the same may be amended and restated
from time to time.
3. Expiration of Option. This Option shall not be exercisable
after 5:00 p.m. (P.D.T.) on August 28, 2006.
<PAGE> 2
4. Non-Assignability of Option. Except as specified below, this
Option shall not be given, granted, sold, exchanged, transferred, pledged,
assigned or otherwise encumbered or disposed of by the Optionee, otherwise than
by will or the laws of descent and distribution, and, during the lifetime of
the Optionee, shall not be exercisable by any other person, but only by the
Optionee. Optionee may designate an individual who shall have the ability and
authority to exercise this Option on Optionee's behalf in the event of
Optionee's permanent and total disability within the meaning of Section
22(e)(3) of the Internal Revenue Code of 1986, as amended (the "Code").
5. Method of Exercise of Option. The Option granted hereunder
shall be exercised by the delivery by the Optionee to the Company at its
principal office (attention of the Secretary) of written notice of the number
of shares of Common Stock with respect to which the Option is being exercised,
and such notice shall be accompanied by payment of the full option price of
such shares. Payment of such option price shall be made by the Optionee's
delivery of his check payable to the order of the Company; provided, however,
that notwithstanding the foregoing provisions of this Section 5, at the
written request of the Optionee, shares acquired pursuant to the exercise of
the Option may be paid for in full at the time of exercise by the surrender of
shares of Common Stock (with a fair market value on the date of exercise
equaling the option price of the shares of Common Stock for which such Option
is exercised) held by or for the account of the Optionee at the time of
exercise to the extent permitted by subsection (c) (5) of Section 422 of the
Code and Section 16(b) of the Exchange Act of 1934, as amended, and the Rules
of the Securities and Exchange Commission, without liability to the Company.
6. Death or Termination of Employment or Services. If the
employment of the Optionee as an employee with, or the services of the Optionee
as a non-employee director for, the Company shall be terminated for any reason,
this Option shall continue until its expiration set forth in Section 3 hereof.
7. Investment Representation. The Optionee represents that at
the time of any exercise of this Option, to the extent that the offer and sale
by the Company of the shares of Common Stock are not registered under the
Securities Act of 1933, as amended (the "Securities Act"), such Common Stock
will be acquired for investment and not for resale or with a view to the
distribution thereof. Upon exercise of the Option and the issuance of any
shares thereunder, all certificates representing shares of Common Stock shall
bear on the face thereof substantially the following legend:
-2-
<PAGE> 3
"THESE SECURITIES HAVE NOT BEEN REGISTERED
UNDER THE SECURITIES ACT OF 1933, AS
AMENDED, OR ANY STATE SECURITIES LAWS.
THEY MAY NOT BE SOLD OR OFFERED FOR SALE
EXCEPT PURSUANT TO AN EFFECTIVE
REGISTRATION STATEMENT AS TO THE SECURITIES
UNDER SAID ACT AND ANY APPLICABLE STATE
SECURITIES LAW OR AN OPINION OF COUNSEL
REASONABLY SATISFACTORY TO T-HQ, INC. THAT
SUCH REGISTRATION IS NOT REQUIRED."
7. Registration Rights.
(a) If at any time the Company proposes to register
equity securities under the Securities Act in connection with the
public offering solely for cash on Form S-1, S-2 or S-3, the Company
shall promptly give the Optionee written notice of such registration
(a "Piggyback Registration"). Upon the written request of the
Optionee given within fifteen (15) days following the date of such
notice, the Company shall cause to be included in such registration
statement and use its best efforts to be registered under the
Securities Act all the shares of Common Stock that the Optionee shall
have requested to be registered. The Company shall have the absolute
right to withdraw or cease to prepare or file any registration
statement for any offering referred to in this Section without any
obligation or liability to the Optionee.
(b) If the underwriters' representative or agent with
respect to such registration shall advise the Company in writing that,
in its opinion, the amount of shares of Common Stock requested to be
included in such registration would materially adversely affect such
offering, or the timing thereof, then the Company will include in such
registration, to the extent of the amount and class which the Company
is so advised can be sold without such material adverse effect in such
offering: First, all securities proposed to be sold by the Company
for its own account; second, the shares of Common Stock requested to
be included in such registration by the Optionee and all other
securities being registered pursuant to the exercise of contractual
rights comparable to the rights granted in this Agreement pro rata
based on the estimated gross proceeds from the sale thereof; and
third, all other securities requested to be included in such
registration.
(c) The Optionee shall be entitled to have his shares of
Common Stock included in an unlimited number of Piggyback
Registrations pursuant to this Agreement.
-3-
<PAGE> 4
(d) Whenever required to effect a Piggyback Registration,
the Company shall, as expeditiously as practicable:
i) Prepare and file with the Commission a
registration statement with respect to such shares of Common
Stock and use the Company's reasonable efforts to cause such
registration statement to become effective.
ii) Prepare and file with the Commission such
amendments and supplements to such registration statement and
the prospectus used in connection with such registration
statement as may be necessary to comply with the provisions of
the Securities Act and rules thereunder with respect to the
disposition of all securities covered by such registration
statement. Pending such amendment or supplement the Optionee
shall cease making offers or sales of shares pursuant to the
prior prospectus. In the event that any shares of Common
Stock included in a registration statement subject to, or
required by, this Agreement remain unsold at the end of the
period during which the Company maintains the effectiveness of
such registration statement, the Company may file a
post-effective amendment to the registration statement for the
purpose of removing such shares from registered status.
iii) Furnish to the Optionee, without charge, such
numbers of copies of the registration statement, any pre-
effective or post-effective amendment thereto, the prospectus,
including each preliminary prospectus and any amendments or
supplements thereto, in each case in conformity with the
requirements of the Securities Act and the rules thereunder,
and such other related documents as any the Optionee may
reasonably request in order to facilitate the disposition of
shares owned by the Optionee.
iv) Use its reasonable efforts to register and
qualify the securities covered by such registration statement
under such other securities or Blue Sky laws of such states or
jurisdictions as shall be reasonably requested by any
underwriters' representative or agent and the Optionee.
v) Cooperate with the Optionee, and the
underwriters' representative or agent for such offering in the
marketing of the shares of Common Stock, including making
available the Company's officers, accountants, counsel,
premises, books and records for such purpose, but the Company
shall not be required to incur any material out-of-pocket
expense pursuant to this sentence. Such obligation shall
include making available for inspection by the Optionee, and
any of his representatives, all financial and other
information as shall be reasonably requested by them, and
provide the Optionee the reasonable opportunity to discuss the
business affairs of the Company with its principal executives
and independent public accountants who have certified the
audited
-4-
<PAGE> 5
financial statements included in such registration statement,
in each case all as necessary to enable them to exercise their
due diligence responsibility under the Securities Act;
provided, however, that information that the Company
determines, in good faith, to be confidential and which the
Company advises such person in writing, is confidential shall
not be disclosed unless such person signs a confidentiality
agreement reasonably satisfactory to the Company.
vi) Promptly notify the Optionee of any stop
order issued or threatened to be issued by the Securities and
Exchange Commission in connection therewith and take all
reasonable actions required to prevent the entry of such stop
order or to remove it if entered.
(e) It shall be a condition precedent to the obligations
of the Company to take any action pursuant to this Agreement with
respect to the shares of Common Stock that the Optionee requests to
register:
i) Furnish to the Company such information
regarding the Optionee, the number and nature of the
securities of the Company owned by it, and the intended method
of disposition of such securities as shall be required to
effect the registration of his shares of Common Stock, and to
cooperate with the Company in preparing such registration;
ii) Agree to sell his shares to the underwriters
at the same price and on substantially the same terms and
conditions as the Company or the other persons on whose behalf
the registration statement was being filed have agreed to sell
their securities, and to execute the underwriting agreement
agreed to by the Company.
(f) The Optionee, if so requested by the Company or the
underwriters' representative or agent in connection with an offering
of any securities covered by a registration statement filed by
Company, shall not effect any public sale or distribution of shares of
Common Stock or any securities convertible into or exchangeable or
exercisable for shares of Common Stock, including a sale pursuant to
Rule 144 under the Securities Act during the 15-day period prior to,
and during the 180-day period beginning on, the date such registration
statement is declared effective under the Securities Act by the
Commission.
-5-
<PAGE> 6
9. Adjustments Upon Changes in Capitalization.
(a) Except as may be otherwise provided in Section 2 of this
Agreement, in the event that the outstanding Common Stock is hereafter
changed by reason of reorganization, merger, consolidation,
recapitalization, reclassification, stock split-up, combination of
shares, stock dividends or the like, an appropriate adjustment shall
be made by the Stock Option Committee of the Company's Board of
Directors in the aggregate number of shares of Common Stock available
under this Agreement and in the number of shares and option price per
share subject to the outstanding Option. If the Company shall be
reorganized, consolidated or merged with another corporation, or if
all or substantially all of the assets of the Company shall be sold or
exchanged, the Optionee shall, at the time of issuance of the Common
Stock under such a corporate event, be entitled to receive upon the
exercise of his Option the same number and kind of shares of Common
Stock or the same amount of property, cash or securities as he would
have been entitled to receive upon the happening of such corporate
event as if he had been, immediately prior to such event, the holder
of the number of shares of Common Stock covered by this Option;
(b) Any adjustment in the number of shares of Common Stock
apply proportionate to only the unexercised portion of the Option
granted hereunder. If fractions of a share would result from any such
adjustment, the adjustment shall be revised to the next lower whole
number of shares.
10. No Rights as Stockholder. The Optionee shall have no rights
as a shareholder in respect to the shares of Common Stock as to which this
Option shall not have been exercised nor any payment made with respect to such
exercise as herein provided.
11. NonStatutory Option. This Option is not intended to be an
incentive stock option within the meaning of Section 422 of the Code.
12. Binding Effect. Except as herein otherwise expressly
provided, this Agreement shall be binding upon and inure to the benefit of the
parties hereto, their legal representatives, successors and assigns.
13. Governing Law. This Agreement shall be governed by and
construed in accordance with the internal laws of the State of New York without
reference to conflict of laws, principals or rules.
14. Notices. Any notice hereunder shall be delivered by hand or
by registered or certified mail, return receipt requested to a party at its
address set forth above, subject to the right of either party to designate at
any time hereafter, in writing, some other address.
15. Waiver. The waiver by either party of a breach of any
provision of this Agreement shall not operate or be construed as a Agreement
shall be held to be invalid or
-6-
<PAGE> 7
unenforceable, such invalidity or unenforceability shall attach only to such
provision and not in any way affect or render invalid or unenforceable any other
provisions of this Agreement, and this Agreement shall be carried out as if such
invalid or unenforceable provisions were not embodied therein.
16. Counterparts. This Agreement may be exercised in
counterparts, each of which shall constitute one and the same instrument.
-7-
<PAGE> 8
IN WITNESS WHEREOF, T-HQ, INC. has caused this Agreement to be
executed by an appropriate executive officer and the Optionee has executed this
Agreement, both as of the day and year first written.
THE COMPANY:
T-HQ, INC.
/s/Deborah A. Lake
----------------------------------
Name: Deborah A. Lake
Title: Vice President - Finance
and Administration
OPTIONEE:
/s/Brian J. Farrell
----------------------------------
Brian J. Farrell
-8-
<PAGE> 1
EXHIBIT 11
T-HQ, INC.
STATEMENT OF COMPUTATION OF NET EARNINGS PER
COMMON AND COMMON EQUIVALENT SHARES
<TABLE>
<CAPTION>
For the Three Years Ended
December 31,
----------------------------------
1994 1995 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net income (loss) used to compute
primary and fully diluted earnings (loss)
per share $(17,490,000) $ 601,000 $1,901,000
------------ ---------- ----------
Weighted average number of shares
outstanding 1,998,000 3,327,000 4,525,000
Dilutive effect of stock options and warrants -- 113,000 386,000
Dilutive effect assuming conversion of
preferred stock -- 42,000 --
------------ ---------- ----------
Number of shares used to compute primary
and fully diluted earnings (loss) per share 1,998,000 3,482,000 4,911,000
============ ========== ==========
Net earnings (loss) per share $ (8.75) $ .17 $ .39
============ ========== ==========
</TABLE>
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF T-HQ, INC.
T-HQ, 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
T-HQ Deutschland GmbH, a German Corporation
<PAGE> 1
Exhibit 23
INDEPENDENT AUDITOR'S CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
33-43909, 33-66954, 33-80757, 333-00180, 333-00182, 333-00184, 333-00136,
333-16975 of T-HQ, Inc. on Form S-8 of our report dated February 17, 1997
(March 11, 1997 as to Note 12), appearing in this Annual Report on Form 10-K of
T-HQ, Inc. for the year ended December 31, 1996.
Deloitte & Touche LLP
Los Angeles, California
March 28, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM (A) THE
CONSOLIDATED BALANCE SHEETS, THE CONSOLIDATED STATEMENTS OF OPERATIONS AND
CONSOLIDATED STATEMENTS OF CASH FLOWS AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH (B) FINANCIAL STATEMENTS FOUND IN FORM 10-K AS FILED WITH THE
SEC ON MARCH 31, 1997.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 2,734,000
<SECURITIES> 0
<RECEIVABLES> 18,544,000
<ALLOWANCES> 1,294,000
<INVENTORY> 1,013,000
<CURRENT-ASSETS> 21,464,000
<PP&E> 1,184,000
<DEPRECIATION> 603,000
<TOTAL-ASSETS> 22,840,000
<CURRENT-LIABILITIES> 11,792,000
<BONDS> 0
0
0
<COMMON> 4,000
<OTHER-SE> 11,044,000
<TOTAL-LIABILITY-AND-EQUITY> 22,840,000
<SALES> 50,255,000
<TOTAL-REVENUES> 50,255,000
<CGS> 29,301,000
<TOTAL-COSTS> 29,301,000
<OTHER-EXPENSES> 18,729,000
<LOSS-PROVISION> 10,000
<INTEREST-EXPENSE> 316,000
<INCOME-PRETAX> 1,909,000
<INCOME-TAX> 8,000
<INCOME-CONTINUING> 1,901,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,901,000
<EPS-PRIMARY> .39
<EPS-DILUTED> .39
</TABLE>
