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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): September 8, 1998
THQ INC.
(Exact name of registrant as specified in charter)
Delaware
(State or other jurisdiction
of incorporation or organization)
Commission file Number: 0-18813
13-3541686
(I.R.S. employer identification no.)
5016 North Parkway Calabasas
Calabasas, California 91302
(Address of principal executive
offices, including zip code)
(818) 591-1310
(Registrant's telephone number,
including area code)
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ITEM 5. OTHER EVENTS.
The Cautionary Statement Regarding Forward-Looking Statements and risk
factors filed by the Registrant as Exhibit 99.1 to the Registrant's Current
Report on Form 8-K dated March 30, 1998, and the description of Registrant's
business set forth in Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997, are hereby modified and superseded as follows:
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
AND RISK FACTORS
The Company's filings with the Securities and Exchange Commission, its
press releases and its other public statements may include, or may incorporate
by reference, certain statements that may be deemed "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. All statements
relating to the Company's objectives, strategies, plans, intentions and
expectations, and all statements (other than statements of historical facts)
that address actions, events or circumstances that the Company or its management
expects, believes or intends will occur in the future, are forward-looking
statements. The Company does not undertake to publicly update or revise any
forward-looking statement, whether as a result of new information, future events
or otherwise. All forward-looking statements involve risks and uncertainties
that could cause actual results to differ materially from historical results or
those anticipated in the forward-looking statements, including without
limitation risks and uncertainties relating to the following:
TERMINATION OF WCW LICENSE
In March 1998, the Company announced that its current license agreement
with Turner's World Championship Wrestling ("WCW") will not be renewed. The WCW
license agreement expires on December 29, 1998, and permits the Company to
continue to sell games on hand and in process at that date through June 29,
1999. Products released by the Company under this license accounted for 39% of
the Company's revenues in 1997, 87% of the Company's revenues in the first
quarter of 1998 and 25% of the Company's revenues in the second quarter of 1998.
In June 1998, the Company announced that, in partnership with JAKKS
Pacific, Inc. ("JAKKS Pacific"), a manufacturer and marketer of toys, it had
signed an exclusive license agreement with Titan Sports, Inc. ("Titan") to
publish electronic games based on the World Wrestling Federation ("WWF")
franchise on all hardware platforms ("Platforms"). The games will be designed,
developed, manufactured and marketed by a joint venture of the Company and JAKKS
Pacific. The Company will oversee product development and sale, and the Company
and JAKKS Pacific will co-manage the marketing of the games. The Company and
JAKKS Pacific will share equally any profits generated by this joint venture
after recoupment of advances paid by the Company and JAKKS Pacific to Titan.
The license agreement with Titan permits the joint venture to release its
first WWF game after November 16, 1999, and the Company expects that the first
game produced under this license will be released in late 1999. The term of the
license agreement expires on December 31, 2009, subject to a right of the joint
venture to renew the license for an additional five years under certain
conditions.
The Company has four additional games scheduled for distribution in 1998
and early 1999 under its WCW license. There can be no assurance that any of
these games, or any of the games to be released under the WWF license, will
attain the success in the marketplace attained by the WCW games previously
released by the Company. In addition, because the license fees payable under the
WWF license are higher than those payable under the WCW license, and because the
Company must share any profits from the WWF games with JAKKS Pacific, there can
be no assurance that the Company will earn profits from WWF games that are
commensurate with those generated by the Company's WCW games. Finally, since the
Company will not be selling any WCW games after June 1999, the Company's results
of operations may be materially and adversely affected by these developments.
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Since the WWF games will be published by a joint venture of which the
Company owns 50%, the revenues generated by such games will not be reflected in
the Company's consolidated net sales and the expenses of the joint venture will
not be included in the Company's consolidated operating expenses. Instead, the
Company will recognize its proportionate share of the joint venture's net income
or (under certain circumstances) net loss on a current basis.
ACQUISITION OF PROPERTIES AND DEVELOPMENT OF NEW TITLES
The Company's continuing profitability is a direct result of its ability to
timely develop and sell new interactive entertainment software titles ("Titles")
for use on particular hardware platforms. Consumer preferences for interactive
entertainment software ("Software") are difficult to predict, and few Software
titles achieve sustained market acceptance. If revenues from new Titles fail to
replace declining revenues from existing Titles, the Company would be materially
and adversely affected.
The development of new Titles is dependent in substantial part upon the
Company's identification and exploitation in a timely manner of Titles based
upon entertainment projects (such as movies, television programs and arcade
games), sports and entertainment personalities, or popular sports, trends or
concepts ("Properties") that have high public visibility or recognition or that
reflect the trends of popular culture. The determination of which Titles the
Company should develop is highly subjective and there can be no assurances that
any new Title will be successful. In addition, the Company is in competition
with numerous other Software companies for licenses to develop Software based on
such Properties. To the extent competition intensifies for licenses to highly
desirable Properties, the Company may encounter increased difficulty in
obtaining these licenses. The failure of the Company to accurately identify and
secure the rights to Properties that are or will become popular would have a
material adverse effect on the Company.
Properties often generate significant public interest for periods that are
unpredictable and short. Consequently, the Company's commercially successful
Titles may be marketable in material quantities for only a limited time, often
for less than six months. As is typical of Software, the life cycle of a Title
generally consists of a relatively high level of sales during the first few
months after introduction, followed by market saturation and a decline in sales.
Accordingly, substantially all of the Company's net sales for a particular year
are generated by Titles released in that year and in the latter part of the
prior year. In some instances, a sales decline may also be accompanied by
decreasing sales prices, which may result in credits or allowances to the
Company's customers. See "-- Discounts, Allowances and Returns; Inventory
Management." In addition, the development cycle for new Titles, including the
development of the necessary game software, approval by the Manufacturer and
production of the initial cartridges or CD-ROMs, typically has ranged from 9 to
24 months. During such period, the market appeal of a Title may decline. To the
extent the Company experiences delays in the development or shipments of new
Titles, or if new Titles are not successful in the market, the Company would be
materially and adversely affected.
For the reasons set forth above, there can be no assurance that the Company
will be able to release Titles scheduled for release within such scheduled time
period or at all, or that the Company will be able to secure the rights to new
Titles at a rate that will maintain the Company's current development and
release schedule.
DISCOUNTS, ALLOWANCES AND RETURNS; INVENTORY MANAGEMENT
Although the Company's arrangements with its distributors and retailers
generally do not give such customers the right to return manufactured products
embodying the Titles (the "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.
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, and other customer accommodations that
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may be granted with respect to, such Products, based on the Company's historical
experience, retailer inventories and the Titles and other factors. For the years
ended December 31, 1996 and 1997 and for the first six months of 1998,
provisions of approximately $5.2 million, $10.5 million and $5.6 million,
respectively, were taken against gross sales made during such periods, and as of
June 30, 1998, the Company's aggregate reserve against accounts receivable for
returns and customer accommodations was approximately $8.2 million.
The Company cannot predict the amount or nature of accommodations that will
be provided to its customers in future periods. Although the Company believes
its reserves are adequate with respect to such matters, there can be no
assurance that actual returns and other customer accommodations will not exceed
the reserves established. To the extent such accommodations were to exceed the
Company's reserves, the Company would be materially and adversely affected.
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.
While the Company believes that substantially all of its current inventory is
saleable in the ordinary course, there can be no assurance that in the future
the Company will not be required to incur charges related to slow-moving or
obsolete inventory.
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 the release 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 retailers' forecasts of
consumer demand. The Company's expenses are based, in part, on its expectations
of future revenues and, as a result, operating results would be
disproportionately and adversely affected by a decrease in sales or a failure by
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.
CUSTOMER CONCENTRATION AND CREDIT RISK
Sales to the Company's ten largest customers collectively accounted for
approximately 54% of the Company's gross sales in 1996, 67% of the Company's
gross sales in 1997 and 64% of the Company's gross sales in the first six months
of 1998. The Company has no written agreement or other understanding with any of
its customers that relates to future purchases, and thus such purchases could be
terminated at any time. A termination of or other adverse change in the
Company's relationship with any of its largest customers would have a material
adverse effect on the Company.
The Company's sales of Products are typically made on credit, with terms
that vary depending upon the customer and demand for such Products. Normally the
Company does not hold any collateral to secure payment by its customers, and
currently does not factor any of its receivables. Thus, the Company bears the
risk of its customers' and distributors' inability to pay such receivables or
the effect of any delay in such payment. Retailers and distributors compete in a
volatile industry and are subject to the risk of business failure. A business
failure by any of the Company's largest customers would have, and a business
failure by any of the Company's distributors or other retailers could have, a
material adverse effect on the Company.
RISKS ASSOCIATED WITH THE DEVELOPMENT AND MARKETING OF PC TITLES
In May 1998, the Company acquired GameFx, Inc. ("GameFx") which has games
under development for the PC market incorporating that company's proprietary 3-D
graphics technology. The Company also intends to exploit this technology in
selected games for other Platforms. Following this acquisition, the
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Company decided to discontinue the operations of Heliotrope Studios, Inc., a
software development studio acquired in 1996 that developed Pax Imperia: Eminent
Domain for the Company. As a result, the Company's internal Software development
is currently conducted solely at GameFx.
While certain key employees of GameFx have experience developing PC games,
GameFx has not previously released any such games and the Company's development
experience in this segment of the Software market has been limited to Pax
Imperia: Eminent Domain. The development and marketing of such games can be
expected to subject the Company to risks in addition to those encountered in the
development and marketing of console games, some of which may not be anticipated
by the Company. Such risks include the ability to accurately predict which
Titles have appeal to the purchasers of interactive games for PCs, greater
reliance on distributors in order to obtain retail distribution, and the greater
retailer returns experienced for PC games. There can be no assurance that the
Company will be able to successfully develop and market Titles for the PC
market.
RISKS ASSOCIATED WITH ACQUISITIONS
Consistent with its strategy to enhance distribution and product
development capabilities, the Company intends to continue to pursue acquisitions
of companies and intellectual property rights and other assets that can be
acquired on acceptable terms and which the Company believes can be operated or
exploited profitably. Some of these acquisitions could be material in size and
scope. There can be no assurance that the Company will be successful in
identifying suitable acquisitions. If any potential acquisition opportunities
are identified, there can be no assurance that the Company will consummate such
acquisitions or if any such acquisition does occur, that it will be successful
in enhancing the Company's business or be accretive to the Company's earnings.
As the Software business continues to consolidate, the Company faces significant
competition in making acquisitions and may in the future face increased
competition for acquisition opportunities, which may inhibit its ability to
complete suitable transactions. Future acquisitions could also divert
substantial management time, could result in short term reductions in earnings
or special transaction or other charges and may be difficult to integrate with
existing operations or assets.
The Company may, in the future, issue additional shares of the Company's
common stock (the "Common Stock") in connection with one or more acquisitions,
which may dilute its shareholders.
DEPENDENCE ON THE PLATFORM MANUFACTURERS
The Company is wholly dependent on the Manufacturers and its non-exclusive
licenses with the Manufacturers (the "Platform Licenses") for the right to
publish Titles for these Platforms and for the manufacture of its Titles. The
Company's Platform License for the PlayStation and Nintendo 64 require that the
Company obtain approval for the publication of new Titles on a Title-by-Title
basis. As a result, the number of Titles the Company is able to publish for
these Platforms, and thus the Company's revenues from Titles for these
Platforms, may be limited.
In the event that, at the end of the term of the current Platform License
with a Manufacturer, such Manufacturer chooses not to renew or extend such
agreement, or if a Manufacturer were to terminate such license for any reason,
the Company would be unable to publish additional Titles for such Manufacturer's
Platform, which would materially and adversely affect the Company.
Each of the Manufacturers is the sole manufacturer of the Products
published by the Company under license from such Manufacturer. Each Platform
License provides that such Manufacturer may raise prices for the Titles at any
time and include other provisions giving the Manufacturer substantial control
over the Company's release of new Titles. Furthermore, the relatively long
manufacturing cycle for cartridge-based Products (from 30 to 60 days) requires
the Company to accurately forecast retailer and consumer demand for its Titles.
Since each of the Manufacturers is also a publisher of Software for its own
Platforms, and also manufactures products for all of its other licensees, a
Manufacturer may give priority to its own products or those of other publishers
in the event of insufficient manufacturing capacity. If the Company experiences
unanticipated delays in the delivery of Products for these or any other reasons,
the Company would be materially and adversely affected.
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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 advances
to developers as prepaid royalties and capitalizes internal Software development
costs for each PC Title incurred after the establishment of technological
feasibility of the Title. (The Company has not incurred material internal
development costs for console Titles.) Amortization of these payments and costs
is determined on a title-by-title basis based on the greater of (i) the ratio of
current gross revenues for a Title to the sum of its current and anticipated
gross revenues, or (ii) the straight-line method over the estimated remaining
economic life of the Title. The Company analyzes such capitalized costs
quarterly and writes off associated prepaid and deferred royalties and Software
development costs when, based on the Company's estimate, future revenues will
not be sufficient to recover such amounts. If the Company were required to write
off prepaid royalties or capitalized development costs in excess of the amounts
reserved therefor, the Company's results of operations could be materially and
adversely affected.
CHANGES IN CONSUMER DEMAND AND TECHNOLOGY
During the approximately 20-year history of the Software industry, there
have been periods of significant growth in consumer interest, followed by
periods in which growth has substantially declined. The Company's sales are
dependent, among other factors, on the popularity and unit sales of Platforms
generally, as well as the relative popularity and unit sales of the Platforms of
the various Manufacturers. The relative popularity of Platforms has experienced
wide fluctuations in recent years. Unexpected declines in the popularity of a
particular Platform can be expected to have a material adverse effect on
consumer demand for Titles released or scheduled for release for such Platform.
The Software industry is characterized by rapid technological change. As a
result, the Company must continually anticipate and adapt its offerings to
emerging Platforms and evolving consumer preferences. The development of
Software for new Platforms requires substantial investment. Generally, such
development efforts must occur well in advance of the release of new Platforms
in order to introduce Titles on a timely basis following the release of such
Platforms. The development and marketing of Titles for new Platforms may require
greater financial and technical resources than are currently available to the
Company. In addition, there can be no assurance that the new Platforms for which
the Company develops Titles will achieve market acceptance and, as a result,
there can be no assurance that the Company's development efforts with respect to
such new Platforms will lead to marketable Titles or Titles that generate
sufficient revenues to recover their development and marketing costs. This risk
can be expected to increase in the future, as continuing increases in
development costs require corresponding increases in net sales in order for the
Company to maintain profitability. In addition, as the Company introduces CD-ROM
Titles for PCs, the Company's game Software must maintain compatibility with
such computers, their operating software and their hardware accessories. The
failure of the Company to timely develop Titles for new Platforms that achieve
significant market acceptance, to maintain net sales that are commensurate with
product development costs, or to maintain such compatibility would have a
material adverse effect on the Company.
The introduction of new Platforms and technologies can render existing
Software obsolete and unmarketable. More commonly, as more advanced Platforms
are introduced, consumer demand for Software for older Platforms diminishes.
There can be no assurance that, as a result of such reduced consumer demand for
Titles on older Platforms, the Company's Titles for such Platforms will generate
sufficient sales to make such Titles profitable. The Company intends to continue
to publish new Titles for older Platforms for so long as the Company believes
there is a significant market for such Titles.
A number of Software publishers who compete with the Company have developed
or are currently developing Software for use by consumers over the Internet.
While the Company believes that the market for such Software has not had a
material effect on the sales of its Products, future increases in the
availability of
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such Software or technological advances in such Software or the Internet could
result in a decline in Platform-based Software and thus have a material adverse
effect on the Company.
YEAR 2000 COMPLIANCE
The inability of computers, software and other equipment utilizing
microprocessors to recognize and properly process date fields containing a
2-digit year is commonly referred to as the "Year 2000 Compliance" issue. As the
year 2000 approaches, such systems may be unable to accurately process certain
date-based information. The Company has reviewed all significant internal
applications and believes that no material modifications are necessary to ensure
Year 2000 Compliance.
The Company is in the process of communicating with others with whom it
does significant business (including its major retail accounts and certain
providers of Product distribution information services) to determine their Year
2000 Compliance readiness and the extent to which the Company is vulnerable to
any third party Year 2000 issues. However, there can be no guarantee that the
systems of other companies on which the Company's systems rely will be timely
converted, or that a failure to convert by another company, or a conversion that
is incompatible with the Company's systems, would not have a material adverse
effect on the Company.
COMPETITION
The Software industry is intensely competitive. The Company competes, for
both licenses to Properties and the sale of Software, with the Manufacturers,
each of whom is the largest developer and marketer of Software for its
Platforms. There can be no assurance that these companies will not increase
their own Software development efforts. As a result of their commanding
positions in the industry as the manufacturers of Platforms and publishers of
Software for their Platforms, the Manufacturers generally have better bargaining
positions with respect to retail pricing, shelf space and purchases than do any
of their licensees, including the Company. In addition, each of the
Manufacturers and many of the Company's other competitors (such as Acclaim
Entertainment, Inc., Activision, Inc., Electronic Arts Inc., GT Interactive
Software Corp., Midway Games Inc. and Microsoft Corporation) have broader
Software lines and greater financial, marketing and other resources than the
Company. These competitive advantages enable such competitors to market their
Software more aggressively and make higher offers or guarantees in connection
with the acquisition of licensed Properties. In addition, as competition for
retail shelf space becomes more intense, the Company may need to increase
marketing expenditures to maintain sales of its Titles; and as competition for
popular Properties increases, the cost of acquiring licenses for such Properties
is likely to increase, resulting in reduced margins. Prolonged price
competition, increased licensing costs or reduced profit margins would have a
material adverse effect on the Company. There can be no assurance that the
Company will be able to compete successfully with the Manufacturers and their
other licensees in the future.
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., Activision, 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 intensifies, the Company may
need to increase marketing expenditures to maintain sales of its Titles; and as
competition for popular Properties increases, the cost of acquiring licenses for
such Properties is likely to increase, resulting in reduced margins.
In addition, the market for the Company's Products is characterized by
significant price competition and the Company may face increasing pricing
pressures from its current and future competitors. Accordingly, there can be no
assurance that competitive pressures will not require the Company to reduce its
prices. Any material reduction in the price of the Company's Products would
adversely affect operating income as a percentage of net revenue and would
require the Company to increase unit sales in order to maintain net revenue.
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The Company believes that large diversified entertainment companies, in
addition to large software companies, are increasing their focus on the Software
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 conditions.
DEPENDENCE ON KEY PERSONNEL
The Company relies to a substantial extent on the management, marketing,
sales, technical and software development skills of a limited number of
employees to formulate and implement its business plan, including the
development of its Titles. The Company's success depends upon, to a significant
extent, its ability to attract and retain key management and software
development personnel. Competition for such employees is intense and the process
of locating key personnel with the combination of skills and attributes required
to execute the Company's strategy is often lengthy. The loss of services of key
personnel could have a material adverse effect on the Company. The only officers
with whom the Company has employment agreements are Brian J. Farrell, its
President and Chief Executive Officer, and C. Noah Davis, its Chief Technology
Officer.
PROPRIETARY RIGHTS OF THE COMPANY
Other than its licenses from the Manufacturers to produce Titles and its
licenses to develop and/or publish Titles based on Properties owned or
controlled by others, the Company generally does not have any material
proprietary rights, technology or intellectual property.
As a result of the proprietary rights of the Manufacturers and the efforts
taken by the Manufacturers to protect such rights, the Company does not believe
that there is a material amount of unauthorized copying of the Company's
Products. However, unauthorized production occurs in the computer software
industry generally, and were a significant amount of unauthorized production of
the Company's CD-ROM Products for PCs to occur, the Company could be materially
and adversely affected.
FOREIGN SALES AND CURRENCY FLUCTUATIONS
For fiscal years 1996 and 1997 and the first six months of 1998, foreign
sales represented approximately 30%, 16% and 17%, respectively, of the Company's
net sales, and the Company expects that foreign sales will account for an
increasing portion of its net sales in future periods. Foreign sales are subject
to inherent risks, including unexpected changes in regulatory requirements,
tariffs and other barriers, difficulties in staffing and managing foreign
operations and the possibility of difficulty in accounts receivable collection.
There can be no assurance that these or other factors will not have an adverse
effect on the Company's future foreign sales.
Because the majority of foreign sales are made in U.S. dollars, the Company
does not believe that foreign currency fluctuations have had a material effect
on its results of operations. To the extent the Company's foreign sales increase
and such sales are not denominated in U.S. dollars, the Company reported sales
and results of operations could be materially and adversely affected by foreign
currency fluctuations. The Company has not engaged in any foreign exchange
hedging activities and does not have any current plans to engage in any such
activities.
VOLATILITY OF SHARE PRICE
The market price of the Common Stock has been, and is likely to continue to
be, highly volatile. In addition, there has been a history of significant
volatility in the market prices for shares of other companies engaged in the
Software industry. Factors such as the timing and market acceptance of new
Titles, the introduction of new Software by the Company's competitors, loss of
key personnel of the Company, variations in quarterly operating results or
changes in market conditions in the Software industry generally could have a
significant impact on the market price of the Common Stock. Thus, there can be
no assurance that the market price of the Common Stock will not continue to
experience extreme volatility.
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ANTI-TAKEOVER PROVISIONS; CERTAIN PROVISIONS OF DELAWARE LAW, CERTIFICATE OF
INCORPORATION AND BYLAWS
Certain provisions of Delaware law, the Company's certificate of
incorporation and the Company's bylaws could have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
attempting to acquire, control of the Company. Certain of these provisions allow
the Company to issue preferred stock with rights senior to those of the Common
Stock without any further vote or action by the holders of Common Stock. The
issuance of preferred stock of the Company could decrease the amount of earnings
and assets available for distribution to the holders of Common Stock or could
adversely affect the rights and powers, including voting rights, of the holders
of the Common Stock. In certain circumstances, such issuance could have the
effect of decreasing the market price of the Common Stock.
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BUSINESS
INTRODUCTION
THQ develops, publishes and distributes interactive entertainment software
for the leading hardware platforms in the home video game market. The Company
currently publishes titles for the PlayStation, Nintendo 64, Game Boy and
personal computers in most interactive software genres, including action,
adventure, driving, fighting, puzzle, role playing, simulation, sports and
strategy. The Company's customers include Wal-Mart, Toys "R" Us, Kay Bee Toys,
Target, Electronics Boutique, Best Buy, other national and regional retailers,
discount store chains and specialty retailers.
The Company's titles are developed both internally and under contract with
independent developers, and are typically based on properties licensed from
third parties. The Company continually seeks to identify and exploit for
development, Titles based upon entertainment projects (such as movies,
television programs and arcade games), sports and entertainment personalities,
or popular sports, trends or concepts 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 PCs, all of the Company's
products consist of cartridges and CD-ROMs manufactured for the Company by the
Manufacturers.
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, and (ii)
Software distributed on CD-ROMs for use on PCs. Until 1996, most Software for
dedicated Platforms was sold in cartridge form. However, CD-ROMs have become
increasingly popular because they have substantially greater data storage
capacity and lower manufacturing costs than cartridges.
The first modern Platform was introduced by Nintendo in 1985 using "8-bit"
technology. "8-bit" means that the central processing unit, or "chip," on which
the Software operates is capable of processing data in 8-bit units. Subsequent
advances in technology have resulted in continuous increases in the processing
power of the chips that power both the Platforms and PCs. As the technology of
the hardware has advanced, the Software designed for the Platforms has similarly
advanced, with faster and more complex images, more lifelike animation and sound
effects and more intricate scenarios. The larger data storage capacity of
CD-ROMs enables them to provide richer content and longer play. Currently, the
non-portable Platforms being marketed are based primarily on 32-bit and 64-bit
technology. Portable Platforms are less sophisticated technologically and do not
require television monitors.
The following table sets forth the year of release in the United States of
each of the Manufacturers' Platforms for which the Company has published titles
and the technology on which such Platforms are based:
<TABLE>
<CAPTION>
DATE OF U.S.
MANUFACTURER PLATFORM INTRODUCTION TECHNOLOGY
------------ -------- ------------ ----------
<S> <C> <C> <C>
Nintendo............................ NES 1985 8-bit
Nintendo............................ Game Boy 1989 8-bit (portable)
Sega................................ Game Gear 1991 8-bit (portable)
Sega................................ Genesis 1989 16-bit
Nintendo............................ SNES 1991 16-bit
Sega................................ Saturn 1995 32-bit
Sony................................ PlayStation 1995 32-bit
Nintendo............................ Nintendo 64 1996 64-bit
</TABLE>
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 goals are to expand its position as a leading provider of
exciting, high-quality Software for use on a variety of Platforms and to
continue to emphasize profitability by maintaining strict cost controls and
managing the risks associated with software development. In order to achieve
these goals, management is focused on implementing the following strategies:
- Acquire and Develop Franchise Properties. The Company intends to increase
the proportion of its Product content over which it has control by either
acquiring or developing its own proprietary titles or obtaining exclusive
licenses to established properties for certain platforms ("Franchise
Properties"). Franchise Properties that have brand recognition and
sustainable consumer appeal often allow the Company to exploit Titles
over an extended period of time through the release of sequels and
extensions and to re-release such products at different price points in
the future. Examples of current exclusively licensed properties are BASS
Masters Classic, Brunswick Tournament of Champions Bowling, Turner's
World Championship Wrestling and Nickelodeon's Rugrats. In addition, the
Company recently announced a joint venture to develop and distribute
games based on the World Wrestling Federation franchise.
- Expand Presence in PC Market. In 1997, only 3% of the Company's revenues
were derived from sales of PC titles. The Company intends to
significantly expand its presence in the PC market by offering high
quality, low priced games that appeal to mass market and casual game
players, with titles such as BASS Masters Classic, Brunswick World
Tournament of Champions Bowling and WCW Nitro and, by offering more
complex, compelling gaming experiences to the enthusiast, or core gamer
market, with titles such as Redjack: Revenge of the Brethren and
Excession. In order to enhance the Company's PC development capabilities,
THQ recently acquired GameFx, an applied technology development studio.
GameFx provides THQ with the capability to develop leading edge products
for the PC platform and to compete in the expanding market for 3-D
accelerated games. Certain of the Company's PC Titles are playable over
the Internet, and the Company expects that the same will be true for many
of its PC Titles under development.
- Expand International Operations. The Company believes there is a
substantial opportunity to expand its presence in foreign markets. In
1997, the interactive entertainment software industry's foreign sales
represented over 45% of the industry's total sales. However, the
Company's foreign sales accounted for only 16% and 17% of total revenues
in the year ended December 31, 1997 and in the first six months of 1998,
respectively. The Company intends to increase product offerings that
appeal to foreign consumers and expand its marketing and distribution
capabilities in territories such as Germany, France and Australia.
- Leverage Domestic Distribution. In addition to its Franchise Properties,
the Company identifies and licenses titles originally developed in
foreign territories with proven or anticipated consumer acceptance and
publishes localized versions of these products in the United States and
other countries. This strategy allows the Company to augment its product
line while limiting development risk. Examples of such titles include
Quest 64, a role playing game developed in Japan for the Nintendo 64, The
Granstream Saga, a role playing game developed in Japan for the
PlayStation, and Broken Sword, an adventure game developed in the United
Kingdom for the PlayStation.
- Continue to Exploit the Game Boy Platform. The relatively low cost of
developing properties for the Game Boy platform, combined with that
platform's large installed base, provides the opportunity to generate
continuing sales and profits with limited risk. The Company believes that
the introduction of Game Boy Color, announced by Nintendo for late 1998,
will continue to stimulate sales of software for the Game Boy platform
for several years. Examples of titles recently introduced or expected to
be introduced in 1998 for the Game Boy are Disney's Mulan, Disney/Pixar's
A Bug's Life, Nickelodeon's Rugrats and World Cup Soccer.
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- Maintain Cost Controls and Manage Risk. The Company minimizes its fixed
expenses by using independent software developers, adopting warehouse and
shipping systems that closely link fulfillment costs to sales volumes,
and compensating sales employees and representatives based on sales
volumes. In addition, the Company attempts to reduce the risks associated
with excessive or obsolete inventory by utilizing strict ordering and
inventory controls.
The Company intends to continue pursuing potential acquisition transactions
consistent with these strategies. In addition, in order to create a closer
relationship with independent developers, the Company may, from time to time,
make investments or acquire minority interests in independent developers.
TITLES
The Company has released an aggregate of 148 Titles as of June 30, 1998,
consisting of nine Nintendo Entertainment System ("NES") Titles, 45 Game Boy
Titles, seven Sega Game Gear Titles, 15 Sega Genesis Titles, 49 Super Nintendo
Entertainment System ("SNES") Titles, three Saturn Titles, 15 PlayStation
Titles, two Nintendo 64 Titles and three PC 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 1997 and 1998 and anticipated to be released in 1998 and in
the first four months of 1999, and (ii) the date of release (or anticipated
release) of each Title. There can be no assurance that each of the Titles
anticipated for release in 1998 and the first four months of 1999 will be
released when scheduled, or at all.
<TABLE>
<CAPTION>
CATEGORY PLATFORM RELEASE DATE
TITLES RELEASED IN 1997 AND 1998 -------- -------- ------------
<S> <C> <C> <C>
Williams Arcade Greatest Hits........... Arcade SNES 1/97
Sega Genesis 1/97
Williams Ms. Pacman..................... Arcade SNES 2/97
Williams NBA Hangtime................... Arcade SNES 2/97
Sega Genesis 2/97
Super Return of the Jedi................ Adventure SNES 2/97
Super Empire Strikes Back............... Adventure SNES 2/97
WCW vs. the World....................... Fighting PlayStation 3/97
Disney's The Hunchback of Notre Dame --
Topsy Turvy Games..................... Arcade Game Boy 3/97
Strikepoint "Hex Mission"............... Action PC 4/97
PlayStation 4/97
Tokyo Highway Battle.................... Racing PlayStation 4/97
K-1 The Arena Fighters.................. Fighting PlayStation 4/97
Disney's The Jungle Book................ Adventure Game Boy 6/97
Disney's Aladdin........................ Adventure Game Boy 6/97
Disney's The Lion King.................. Adventure Game Boy 6/97
Disney's Ducktales...................... Adventure Game Boy 6/97
Disney's Hercules....................... Adventure Game Boy 7/97
Brunswick World Tournament of Sports SNES 8/97
Champions.............................
Bravo Air Race.......................... Racing PlayStation 9/97
Madden NFL '98.......................... Sports Sega Genesis 9/97
Timon & Pumbaa.......................... Arcade SNES 10/97
Pax Imperia: Eminent Domain............. Strategy PC 10/97
NHL '98................................. Sports Sega Genesis 10/97
Disney's The Lion King.................. Adventure SNES 10/97
Disney's The Jungle Book................ Adventure SNES 10/97
WCW vs. NWO: World Tour................. Fighting Nintendo 64 11/97
Ghost in the Shell...................... Shooter PlayStation 11/97
NBA Live '98............................ Sports Sega Genesis 11/97
Vs...................................... Fighting PlayStation 12/97
Madden NFL '98.......................... Sports SNES 12/97
Jurassic Park Lost World................ Adventure Game Boy 12/97
</TABLE>
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<PAGE> 13
<TABLE>
<CAPTION>
CATEGORY PLATFORM RELEASE DATE
TITLES RELEASED IN 1997 AND 1998 -------- -------- ------------
<S> <C> <C> <C>
FIFA Road to World Cup '98.............. Sports Game Boy 12/97
WCW Nitro............................... Fighting PlayStation 1/98
Pax Imperia: Eminent Domain............. Strategy Macintosh 1/98
Ray Tracers............................. Driving PlayStation 2/98
NBA Live '98............................ Sports SNES 3/98
Broken Sword: Shadow of the Templars.... Adventure PlayStation 3/98
World Cup '98........................... Sports Game Boy 6/98
Quest 64................................ Adventure/Role Nintendo 64 6/98
Playing
The Granstream Saga..................... Role Playing PlayStation 6/98
BASS Masters Classic: Tournament
Edition............................... Simulation PC 9/98
</TABLE>
<TABLE>
<CAPTION>
TITLES ANTICIPATED TO BE RELEASED IN 1998 AND 1999*
- ---------------------------------------------------
<S> <C> <C> <C>
Brunswick Circuit Pro Bowling................ Sports PlayStation Summer '98
PC Summer '98
RedJack: Revenge of the Bretheren............ Adventure PC Summer '98
G. Darius.................................... Action PlayStation Summer/Fall '98
WCW/NWO Revenge.............................. Fighting Nintendo 64 Summer/Fall '98
Disney's Mulan............................... Adventure Game Boy Summer/Fall '98
Small Soldiers............................... Adventure Game Boy Summer/Fall '98
Devil Dice................................... Puzzle PlayStation Summer/Fall '98
Disney/Pixar's A Bug's Life.................. Adventure Game Boy Fall '98
Yoda Stories................................. Adventure Game Boy Fall '98
Rugrats...................................... Adventure PlayStation Fall '98
Game Boy Fall '98
Penny Racers................................. Driving Nintendo 64 Winter '98/'99
International Rally Championship............. Driving PC Winter '98/'99
WCW/Nitro.................................... Fighting PC Winter '98/'99
Nintendo 64 Winter '98/'99
WCW/NWO Thunder.............................. Fighting PlayStation Winter '98/'99
Dead Unity................................... Action/ PlayStation Winter/Spring '99
Adventure PC Winter/Spring '99
Shao Lin..................................... Fighting PlayStation Winter/Spring '99
Rugrats...................................... Adventure Nintendo 64 Winter/Spring '99
Excession.................................... Action PC Winter/Spring '99
</TABLE>
- ---------------
* Through the first four months of 1999. Excludes Titles the Company expects to
release but which have not yet been publicly announced.
INTELLECTUAL PROPERTY LICENSES
The Company's strategy includes the creation of exciting games based on
licensed Properties that have attained a high level of consumer recognition or
acceptance. The Company believes it enjoys excellent relationships with a number
of licensors, including Disney, Viacom/Nickelodeon, Lucas Arts and DreamWorks.
The Company pays royalties to its Property licensors that generally range
from 2% to 20% of the Company's net sales of the Title. The Company must
typically pay minimum guaranteed royalties over the license term and advance
payments against such guarantees. License fees tend to be higher for Properties
with proven popularity and less perceived risk of commercial failure. To the
extent competition intensifies for licenses of highly desirable Properties, the
Company may encounter difficulty in obtaining these licenses. See
"-- Competition." Licenses typically extend for two to three years, may be
exclusive for a specific Title or line of Titles, and may in some instances be
renewable upon payment of certain minimum royalties or the attainment of
specified sales levels. Other licenses are not renewable upon expiration, and
there can be no assurance that the Company and the licensor will reach agreement
to extend the term.
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<PAGE> 14
The Company's Property licenses generally grant the Company exclusive use
of the Property for the specified Titles, on specified Platforms, within a
defined territory and during the license term. However, licensors typically
retain the right to exploit the Property for all other purposes, including the
right to license the Property for use with other Platforms. Software published
by third parties for use with other Platforms based on such Property may compete
with Titles offered by the Company.
PLATFORM LICENSES
The Company's business is dependent on its license agreements with the
Manufacturers. All of such licenses are for fixed terms and are not exclusive.
Each license grants to the Company the right to develop, publish and distribute
Titles for use on such Manufacturers' Platforms, and requires that such Titles
be embodied in products that are manufactured solely by such Manufacturer.
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.
<TABLE>
<CAPTION>
NUMBER OF
MANUFACTURER PLATFORM TITLES TERRITORY EXPIRATION DATE(S)
- ------------ -------- --------- --------- ------------------
<S> <C> <C> <C> <C>
Nintendo Nintendo 64 Title-by-Title(1) North America and November 1999
Latin America
Nintendo Nintendo 64 Title-by-Title(1) Europe and certain January 2001
Asian countries
Nintendo Game Boy Title-by-Title(1) North America and January 2001
Latin America
Nintendo Game Boy 10 per contract yr. Europe and certain August 2000
Asian countries
Sony PlayStation Title-by-Title(1) U.S. and Canada August 2002
Sony PlayStation Title-by-Title(1) Europe December 2005(2)
</TABLE>
- ---------------
(1) This Platform License does not set a maximum number of Titles that the
Company may publish in the designated territory; however, each Title must be
approved by the Manufacturer prior to development of the Software.
(2) Continues year-to-year after such date unless terminated by either party.
Nintendo charges the Company a fixed amount for each cartridge, which
amount varies based, in part, on memory capacity. Sony similarly charges a per
unit amount for each CD-ROM. These charges include a manufacturing, printing and
packaging fee as well as a royalty for the use of the Manufacturer's name,
proprietary information and technology, and are subject to adjustment by the
Manufacturers at their discretion. The Manufacturers have the right to review,
evaluate and approve a prototype of each Title and all packaging used by the
Company in connection with the products.
In addition, the Company must indemnify the Manufacturers with respect to
all loss, liability and expense resulting from any claim against the
Manufacturer involving the development, marketing, sale or use of the Company's
Titles, including any claims for copyright or trademark infringement brought
against the Manufacturer. As a result, the Company bears a risk not only that
the Properties upon which the Titles are based, but also the information and
technology licensed from the Manufacturer and incorporated in the products, may
infringe the rights of third parties. While the Company's agreements with its
independent Software developers and Property licensors typically provide for
indemnification of the Company with respect to certain matters, there can be no
assurance that, if any claim is brought by a Manufacturer against the Company
for indemnification, such developers or licensors would have sufficient
resources to in turn indemnify the Company, or that such indemnification would
cover the matter that gave rise to the Manufacturer's claim against the Company.
Each Platform License may be terminated by the Manufacturer if a breach or
default by the Company is not cured by the Company after receipt of written
notice thereof from the Manufacturer, or if the Company becomes insolvent. Upon
termination of a Platform License for any reason other than a breach or default
by the Company, the Manufacturer has the right to purchase from the Company, at
the price paid by the Company, any product inventory manufactured by such
Manufacturer for the Company that remains unsold
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<PAGE> 15
for a specified period after such termination. Any such inventory not purchased
by the Manufacturer must be destroyed. Upon termination as a result of a breach
or default by the Company, any remaining inventory at such time must be
destroyed, subject to the right of any institutional lender to the Company to
sell such inventory for a specified period.
SOFTWARE DESIGN AND DEVELOPMENT
Once the Company identifies and acquires a Property from a licensor, the
Company designs and develops a game with features intended to exploit the
characteristics of the Property and to appeal to the target consumers for such
game. The Company's Software development process generally takes one of two
forms.
Internal Software Development. The Company's in-house development is
currently conducted by GameFx and is supervised by the Company's Chief
Technology Officer. GameFx, which the Company acquired in May 1998, is a
developer of interactive Software utilizing proprietary 3-D graphics technology.
The first PC game developed by GameFx, Excession, is expected to be released in
the spring of 1999. The Company also intends to exploit GameFx's technology in
other PC games as well as in selected games for other Platforms. GameFx is
staffed by producers, programmers, Software engineers, artists, animators and
game testers.
External Software Development. The Company's external development is
supervised by the Company's Vice President - Product Development. The Company
contracts with independent Software developers to conceptualize and develop
Titles under the Company's supervision. The Company's agreements with its
Software developers are usually entered into on a Title-by-Title basis and
generally provide for the payment of the greater of a fixed amount or royalties
based on actual sales. The Company generally pays its developers installments of
advances based on specific development milestones. Royalties in excess of the
advances are based on a fixed amount per unit sold and range from $.30 to $10.00
per unit. The Company generally obtains ownership of the Software code and
related documentation. The Company may make strategic investments in independent
developers for the purpose of securing access to proprietary Software and
talented developers.
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 assess whether there will be adequate retailer and
consumer demand for a Title well in advance of its release.
MANUFACTURING
The Manufacturers are the sole manufacturers of the products sold for use
on their respective Platforms.
After placing a purchase order with a Manufacturer and opening either a
letter of credit in favor of the Manufacturer or line of credit with the
Manufacturer, the Company sends to the Manufacturer the Title's Software code
and a prototype, together with related artwork, user instructions, warranty
information, brochures and packaging designs, for approval, defect testing and
manufacture. The Manufacturers currently deliver cartridges to the Company
within 30 to 60 days, and CD-ROMs within 10 to 14 days, after their receipt of
an order and a corresponding letter of credit, if required.
The Company is required by the Platform Licenses to provide a standard
defective product warranty on all of the products sold. Generally, the Company
is responsible for resolving, at its own expense, any warranty or repair claims.
The Company has not experienced any material warranty claims.
MARKETING, SALES AND DISTRIBUTION
The Company depends in large part on the high name recognition of the
Properties on which its Titles are based to attract customers and to obtain
shelf space in stores. The Company's sales activities are directed by
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<PAGE> 16
the Company's Senior Vice President - Sales, who maintains contact with major
retail accounts and manages the activities of the Company's independent sales
staff and regional sales representatives.
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 product marketing efforts for the Titles released during the
six months ended June 30, 1998 included national television, radio and print
advertising campaigns in console and PC gaming publications. Quest 64, The
Granstream Saga, Brunswick Circuit Pro Bowling and the WCW Titles for the
PlayStation and Nintendo 64 were featured at various live events and in
nationwide Sony and Nintendo van tours. Prima Publishing further supported Quest
64, The Granstream Saga and the WCW Titles at launch with strategy guides. The
Company's Titles released during the first half of 1998 were supported by
in-store retail promotions such as trailers, demo discs, standees, over-size
boxes, posters and pre-sell giveaways. International publicity campaigns in
gaming publications, magazines and newspapers included covers, contests, product
previews, reviews and game strategies. In addition, the Company developed
product-specific Internet sites and expanded online publicity and advertising
efforts. The Company has supported several new Title launches with national
television advertising in 1998.
Most of the Company's sales consist of direct sales to retailers. The
Company distributes its Titles primarily to mass merchandisers and national
retail chain stores, including Toys "R" Us (representing 19% of net sales in
1997 and 12% for the first six months of 1998), Wal-Mart (representing 10% of
net sales in 1997 and 14% for the first six months of 1998), Best Buy,
Blockbuster Video, Kay Bee Toys, Electronics Boutique and Target. Sales to the
Company's ten largest customers collectively accounted for approximately 67% of
the Company's gross sales in 1997 and 64% of the Company's gross sales in the
first six months of 1998. The Company has no written agreement or other
understanding with any of its customers that relate to future purchases by such
customers, and thus, purchases by such customers may terminate at any time.
The Company utilizes electronic data interchange with most of its major
domestic customers in order to (i) efficiently receive, process and ship
customer product orders, and (ii) accurately track and forecast sell-through of
products to consumers in order to determine whether to order additional products
from the Manufacturers. The Company ships its products to its domestic customers
from a public bonded warehouse in Southern California.
The Company's agreements with its independent regional sales
representatives set forth the representatives' exclusive territory, types of
customers to be solicited, commission rate and payment terms. Such
representatives do not have contractual authority to obligate the Company.
The domestic retail price for the Company's Software generally ranges
between $19 and $35 for Game Boy, between $19 and $49 for PlayStation, between
$49 and $65 for Nintendo 64, and between $19 and $49 for PCs.
Foreign Sales. Historically, the Company distributed its Titles in the
United Kingdom, Europe and Australia. In 1997, the Company expanded its sales to
Brazil, Singapore and other countries. The Company sells its Titles directly to
retailers in the United Kingdom and to distributors for distribution in other
countries. Products are shipped at the Company's expense to a public warehouse
in the United Kingdom for foreign distribution. Foreign sales to distributors in
countries other than the United Kingdom are shipped at the customer's expense
directly to the customer's location. Sales to countries outside the United
Kingdom, Europe and Australia have not constituted a material portion of the
Company's foreign sales.
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
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<PAGE> 17
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 Software 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 in a timely
manner, 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., Activision, 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 intensifies, the Company may
need to increase marketing expenditures to maintain sales of its Titles; and as
competition for popular Properties increases, the cost of acquiring licenses for
such Properties is likely to increase, resulting in reduced margins.
In addition, the market for the Company's Products is characterized by
significant price competition, and the Company may face increasing pricing
pressures from its current competitors. Accordingly, there can be no assurance
that competitive pressures will not require the Company to reduce its prices.
Any material reduction in the price of the Company's Products would adversely
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 some large diversified entertainment companies,
in addition to large Software companies, are increasing their focus on the
Software 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 June 30, 1998, the Company had 113 full-time employees. All but 11 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.
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PROPERTIES
The Company's executive offices occupy approximately 17,400 square feet of
office space at 5016 North Parkway Calabasas, Calabasas, California, pursuant to
a lease expiring in July 2000. The Company also leases office space for sales
and marketing personnel in Cupertino, California and Woking, England, and for
development personnel near Boston, Massachusetts.
LEGAL PROCEEDINGS
While the Company has been a party to legal proceedings from time to time,
such legal proceedings have been ordinary and incidental to the Company's
business and have not had a material adverse effect on the Company.
The Company has received an informal inquiry from the Commission relating
to trading in the Common Stock (including sales by directors and executive
officers) prior to the time that the Company was advised that the WCW license
agreement would not be extended beyond its current term. The Company is
cooperating with this inquiry.
REVOLVING CREDIT AGREEMENT
The Company has entered into an agreement with Imperial Bank that
established the Company's revolving credit facility (the "Revolving Credit
Facility"). In August 1998, the term of the Revolving Credit Facility was
extended through August 31, 1999. As of August 31, 1998, the Company had no
outstanding borrowings under the Revolving Credit Facility and had obligations
in respect of outstanding letters of credit issued by Imperial Bank of $4.7
million.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly cause this report to be signed on its behalf by
the undersigned, thereto duly authorized.
THQ INC.
By: /s/ FRED A. GYSI
------------------------------------
Fred A. Gysi Vice
President -- Finance
and Administration
Date: September 8, 1998
