<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
____________
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ______________
Commission file No.: 0-18813
----------------------------
THQ INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 13-3541686
-------------------------------- -------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
27001 Agoura Road, Calabasas Hills, CA 91301
(Address of Principal Executive Offices)
818-871-5000
(Registrant's Telephone Number, including Area Code)
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common stock, $0.01 par value: 20,184,057 shares (as of November 8, 2000).
<PAGE> 2
THQ INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
Part I - Financial Information Page
------------------------------ ----
<S> <C> <C>
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets -
September 30, 2000 and December 31, 1999 3
Consolidated Statements of Operations -
for the Three Months and Nine Months Ended
September 30, 2000 and 1999 4
Consolidated Statements of Shareholders' Equity -
for the Nine Months Ended September 30, 2000 and
the Year Ended December 31, 1999 5
Consolidated Statements of Cash Flows -
for the Nine Months Ended September 30, 2000 and 1999 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 19
Part II - Other Information
---------------------------
Item 1. Legal Proceedings 20
Item 2. Changes in Securities 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 23
----------
</TABLE>
2
<PAGE> 3
Part I - Financial Information
Item 1. Consolidated Financial Statements.
THQ INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 25,624,000 $ 21,454,000
Accounts receivable - net 38,009,000 97,014,000
Inventory 5,158,000 5,455,000
Prepaid and deferred royalties 18,438,000 21,891,000
Software development costs 22,070,000 11,640,000
Deferred income taxes 4,616,000 6,817,000
Income taxes receivable 14,040,000 965,000
Prepaid expenses and other current assets 10,155,000 2,225,000
------------ ------------
Total current assets 138,110,000 167,461,000
Property and equipment - net 9,196,000 5,746,000
Deferred royalties - net of current portion 2,508,000 3,371,000
Software development costs - net of current portion 275,000 1,824,000
Deferred income taxes - net of current portion 2,865,000 2,865,000
Other long-term assets 7,195,000 2,790,000
------------ ------------
TOTAL ASSETS $160,149,000 $184,057,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Lines of credit $ -- $ 16,702,000
Accounts payable 10,738,000 14,540,000
Accrued expenses 14,850,000 13,105,000
Accrued royalties 27,259,000 31,254,000
------------ ------------
Total current liabilities 52,847,000 75,601,000
Accrued royalties - net of current portion -- 150,000
Commitments and contingencies
Shareholders' equity:
Preferred stock, par value $.01, 200,000 shares authorized
but unissued -- --
Common stock, par value $.01, 35,000,000 shares authorized;
20,177,009 shares and 19,897,234 shares issued and
outstanding as of September 30, 2000 and December 31, 1999,
respectively 202,000 199,000
Additional paid-in capital 82,975,000 79,250,000
Accumulated other comprehensive loss (2,232,000) (842,000)
Retained earnings 26,357,000 29,699,000
------------ ------------
Total shareholders' equity 107,302,000 108,306,000
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $160,149,000 $184,057,000
============ ============
</TABLE>
See notes to consolidated financial statements.
3
<PAGE> 4
THQ INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- ---------------------------------
2000 1999 2000 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net sales $ 53,293,000 $ 44,610,000 $ 156,090,000 $ 175,748,000
Costs and expenses:
Cost of sales 19,680,000 18,386,000 62,067,000 76,225,000
Royalties and project abandonment 11,757,000 5,812,000 39,584,000 28,499,000
Product development 5,346,000 4,659,000 14,271,000 11,180,000
Selling and marketing 7,707,000 6,701,000 21,996,000 20,811,000
Payment to venture partner 1,343,000 -- 8,246,000 --
General and administrative 5,117,000 2,993,000 14,914,000 11,057,000
------------- ------------- ------------- -------------
Total costs and expenses 50,950,000 38,551,000 161,078,000 147,772,000
------------- ------------- ------------- -------------
Income (loss) from operations 2,343,000 6,059,000 (4,988,000) 27,976,000
Interest income, net 482,000 308,000 1,060,000 911,000
------------- ------------- ------------- -------------
Income (loss) before income taxes 2,825,000 6,367,000 (3,928,000) 28,887,000
Provision (benefit) for income taxes 1,510,000 2,124,000 (586,000) 11,719,000
------------- ------------- ------------- -------------
Net income (loss) $ 1,315,000 $ 4,243,000 $ (3,342,000) $ 17,168,000
============= ============= ============= =============
Net income (loss) per share - basic $ 0.07 $ 0.22 $ (0.17) $ 0.91
============= ============= ============= =============
Net income (loss) per share - diluted $ 0.06 $ 0.20 $ (0.17) $ 0.82
============= ============= ============= =============
Shares used in per share calculation - basic 20,137,000 18,992,000 20,043,000 18,917,000
============= ============= ============= =============
Shares used in per share calculation - diluted 21,709,000 21,337,000 20,043,000 21,060,000
============= ============= ============= =============
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 5
THQ INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the Year Ended December 31, 1999 and
the Nine Months Ended September 30, 2000
<TABLE>
<CAPTION>
Accumulated
Additional Other
Common Common Paid-in Comprehensive Retained
Shares Amount Capital Income (Loss) Earnings Total
----------- -------- ----------- ------------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1999 18,768,591 $129,000 $63,503,000 $ 60,000 $(1,627,000) $ 62,065,000
Exercise of warrants and options 1,128,643 8,000 4,955,000 -- -- 4,963,000
Issuance of warrants -- -- 3,627,000 -- -- 3,627,000
Stock compensation -- -- 464,000 -- -- 464,000
Tax benefit related to the exercise of
employee stock options -- -- 6,763,000 -- -- 6,763,000
Three-for-two stock dividend -- 62,000 (62,000) -- -- --
Comprehensive income:
Net income -- -- -- -- 31,326,000 31,326,000
Other comprehensive loss
Foreign currency translation
adjustment -- -- -- (902,000) -- (902,000)
------------
Comprehensive income -- -- -- -- -- 30,424,000
----------- -------- ----------- ------------ ----------- ------------
Balance at December 31, 1999 19,897,234 199,000 79,250,000 (842,000) 29,699,000 108,306,000
Exercise of warrants and options 279,775 3,000 3,012,000 -- -- 3,015,000
Stock compensation -- -- 304,000 -- -- 304,000
Tax benefit related to the exercise of
employee stock options -- -- 409,000 -- -- 409,000
Comprehensive loss:
Net loss -- -- -- -- (3,342,000) (3,342,000)
Other comprehensive loss
Foreign currency translation
adjustment -- -- -- (1,390,000) -- (1,390,000)
------------
Comprehensive loss -- -- -- -- -- (4,732,000)
----------- -------- ----------- ------------ ----------- ------------
Balance at September 30, 2000 20,177,009 $202,000 $82,975,000 $(2,232,000) $26,357,000 $107,302,000
=========== ======== =========== ============ =========== ============
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 6
THQ INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------------
2000 1999
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (3,342,000) $ 17,168,000
Adjustments to reconcile net income (loss) to net
Cash provided by operating activities:
Depreciation and amortization 2,547,000 1,163,000
Provision for doubtful accounts, discounts and returns 19,835,000 19,064,000
Loss on disposal of fixed assets 105,000 49,000
Stock compensation 304,000 307,000
Tax benefit from disqualified disposition 409,000 1,633,000
Deferred income taxes 2,177,000 (815,000)
Changes in operating assets and liabilities:
Accounts receivable 37,744,000 4,189,000
Inventory 39,000 11,563,000
Prepaid and deferred royalties and
software development costs (13,719,000) (9,753,000)
Prepaid expenses and other current assets (8,434,000) (2,618,000)
Accounts payable and accrued expenses (1,090,000) (6,506,000)
Accrued royalties 4,879,000 (9,222,000)
Income taxes payable (13,083,000) (7,453,000)
------------ ------------
Net cash provided by operating activities 28,371,000 18,769,000
Cash flows used in investing activities:
Proceeds from sale of property and equipment 75,000 30,000
Acquisition of property and equipment (5,741,000) (1,629,000)
Investment in Yuke's Co., Ltd. (See Footnote 6) (5,020,000) --
Decrease (Increase) in other long-term assets 38,000 (1,634,000)
------------ ------------
Net cash used in investing activities (10,648,000) (3,233,000)
Cash flows used in financing activities:
Net decrease in short-term borrowings (16,702,000) (9,586,000)
Proceeds from exercise of options and warrants 3,015,000 2,045,000
------------ ------------
Net cash used in financing activities (13,687,000) (7,541,000)
Effect of exchange rate changes on cash 134,000 (84,000)
------------ ------------
Net increase in cash and cash equivalents 4,170,000 7,911,000
Cash and cash equivalents - beginning of period 21,454,000 19,114,000
------------ ------------
Cash and cash equivalents - end of period $ 25,624,000 $ 27,025,000
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period:
Income taxes $ 5,369,000 $ 19,519,000
============ ============
Interest $ 190,000 $ 229,000
============ ============
</TABLE>
See notes to consolidated financial statements.
6
<PAGE> 7
THQ INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Unaudited Interim Financial Information. These financial statements have
been prepared by us, without audit, in accordance to the rules and regulations
of the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. While we believe that the disclosures
made are adequate to make the information presented not misleading, it is
recommended that these financial statements be read in conjunction with the
consolidated financial statements and the notes included in our Annual Report on
Form 10-K/A for the year ended December 31, 1999.
In our opinion, such unaudited financial statements include all
adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation of the results for the interim period. The results for the
three months and nine months ended September 30, 2000 are not necessarily
indicative of the results to be expected for the full year or for any other
interim period.
Basic and Diluted Earnings Per Share. The following table is a
reconciliation of the weighted-average shares used in the computation of basic
and diluted EPS for the years presented herein:
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
------------------------------ -------------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net income (loss) used to compute basic
and diluted earnings per share $ 1,315,000 $ 4,243,000 $ (3,342,000) $ 17,168,000
============ ============ ============ ============
Weighted average number of shares
outstanding - basic 20,137,000 18,992,000 20,043,000 18,917,000
Dilutive effect of stock options and warrants 1,572,000 2,345,000 -- 2,143,000
------------ ------------ ------------ ------------
Number of shares used to compute earnings
per share - diluted 21,709,000 21,337,000 20,043,000 21,060,000
============ ============ ============ ============
</TABLE>
Recently Issued Accounting Pronouncements. In June 1998, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards No. 133 ("SFAS 133") "Accounting for Derivative Instruments and
Hedging Activities", as amended by SFAS 137 "Accounting for Derivative
Instruments and Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133 - an Amendment of FASB Statement No. 133" and SFAS 138
"Accounting for Certain Derivative Instruments and Certain Hedging Activities -
an Amendment of FASB Statement No. 133" which establishes accounting and
reporting standards for derivative instruments and hedging activities. The terms
of SFAS 133 and SFAS 138 are effective as of the beginning of the first quarter
of the fiscal year beginning after June 15, 2000. We are currently evaluating
the potential impact of SFAS No. 133, No. 137 and No. 138.
7
<PAGE> 8
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB
101), which provides additional guidance in applying generally accepted
accounting principles to revenue recognition in the financial statements. We
have evaluated our revenue recognition policies pursuant to the adoption of SAB
101, and we believe that such adoption will not have any impact.
Reclassifications. Certain items in the 1999 financial statements have
been reclassified to conform to the 2000 presentation.
2. BUSINESS COMBINATION
On August 31, 2000 we completed the acquisition of Volition, Inc., a
Delaware corporation ("Volition"). In connection with this transaction, and
pursuant to an exemption from registration provided in Section 4(2) of the
Securities Act of 1933, as amended, we issued 890,110 shares of our common stock
to stockholders of Volition. We also assumed existing Volition employee stock
options that provide for the future issuance of 109,890 shares of our common
stock.
The acquisition has been accounted for as a pooling of interest under
Accounting Principles Board Opinion No. 16. Accordingly, all prior period
consolidated financial statements presented have been restated to include the
combined results of operations, financial position and cash flows as if Volition
had always been part of our company.
All transactions between Volition and us have been eliminated in the
consolidated financial statements. The results of operations for the separate
companies and the combined amounts presented in the consolidated financial
statements follow.
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
Net Sales September 30, September 30,
------------------------------- ---------------------------------
2000 1999 2000 1999
------------ ------------ ------------- -------------
<S> <C> <C> <C> <C>
THQ Inc. $ 53,259,000 $ 44,310,000 $ 156,039,000 $ 174,728,000
Volition 404,000 1,527,000 1,906,000 2,247,000
Intercompany elimination (370,000) (1,227,000) (1,855,000) (1,227,000)
------------ ------------ ------------- -------------
Combined $ 53,293,000 $ 44,610,000 $ 156,090,000 $ 175,748,000
============ ============ ============= =============
</TABLE>
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
Net Income (Loss) September 30, September 30,
------------------------------- ---------------------------------
2000 1999 2000 1999
------------ ------------ ------------- -------------
<S> <C> <C> <C> <C>
THQ Inc. $ 2,413,000 $ 4,711,000 $ (669,000) $ 18,065,000
Volition (728,000) 759,000 (818,000) 330,000
Intercompany elimination (370,000) (1,227,000) (1,855,000) (1,227,000)
------------ ------------ ------------- -------------
Combined $ 1,315,000 $ 4,243,000 $ (3,342,000) $ 17,168,000
============ ============ ============= =============
</TABLE>
8
<PAGE> 9
3. CREDIT FACILITY
On August 31, 2000, and as amended in October 2000, we entered into a
Revolving Credit Agreement with Union Bank of California and a syndicate of
other financial institutions. This agreement expires on July 1, 2001 and permits
us to borrow (and maintain obligations under outstanding letters of credit) up
to an aggregate of $50,000,000, subject to the following:
We may maintain outstanding letters of credit for product purchases and
outstanding borrowings in the aggregate for up to $35,000,000 for September;
$50,000,000 between October 1, 2000 and December 31, 2000; $35,000,000 for
January 2001; and $20,000,000 between February 1, 2001 and June 30, 2001.
In addition, outstanding borrowings cannot exceed $15,000,000 for
September; $30,000,000 from October 1 through October 31, 2000; $50,000,000 from
November 1, 2000 through December 31, 2000; $35,000,000 from January 1, 2001
through January 31, 2001; and $15,000,000 from February 1, 2001 to June 30,
2001.
We are also required to not have any outstanding borrowings for a
period of at least 60 days during each year of the agreement.
This credit facility is secured by a lien on substantially all of our
assets and contains customary financial and non-financial covenants. Amounts
outstanding under these credit facilities bear interest, at our choice, at
either a) the bank's prime rate (9.5% at September 30, 2000) or b) the London
Interbank Offered Rate (8.66% at September 30, 2000) plus 1.85%. As of September
30, 2000 we had approximately $32,496,000 in obligations with respect to
outstanding letters of credit and no outstanding borrowings.
4. ACCOUNTS RECEIVABLE
Accounts receivable are due primarily from domestic and foreign
retailers and distributors, including mass merchants and specialty stores.
Accounts receivable at September 30, 2000 and December 31, 1999 are composed of
the following:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
Accounts receivable -- domestic $ 42,544,000 $ 93,828,000
Other receivables -- domestic 857,000 1,469,000
Allowance for domestic returns and doubtful
accounts (13,766,000) (16,845,000)
Accounts receivable -- foreign 15,201,000 25,888,000
Allowance for foreign returns and doubtful
accounts (6,827,000) (7,326,000)
------------ ------------
Accounts receivable -- net $ 38,009,000 $ 97,014,000
============ ============
</TABLE>
9
<PAGE> 10
5. STOCK COMPENSATION
Pacific Coast Power and Light ("PCP&L"), which we acquired on May 24,
1999, and Genetic Anomalies ("GA"), which we acquired on December 20, 1999,
granted stock options to employees at prices below their respective fair market
values. The difference between the fair market value and the option grant price
is amortized and recognized over the option vesting period, generally four and
three years, respectively. For the three months ended September 30, 2000 and
1999, stock-based compensation of $101,000 and $102,000, respectively, was
amortized to expense. For the nine months ended September 30, 2000 and 1999,
stock-based compensation of $304,000 and $366,000, respectively, was amortized
to expense. As of September 30, 2000 and December 31, 1999 we had unamortized
stock-based compensation expense of $806,000 and $1,110,000, respectively.
On June 8, 2000, the Board of Directors approved the THQ Inc.
Nonexecutive Employee Stock Option Plan (the "Plan"). The Plan has primarily the
same attributes as the 1990 Amended and Restated Option Plan (the "1990 Plan")
and the 1997 Amended and Restated Option Plan (the "1997 Plan"), but
participation is reserved for employees who are not executive officers and under
the Plan, only nonqualified options will be granted. The Plan provides for the
issuance of up to 550,000 shares, of which no more than 20% is available for
awards to the non-executive officers or general managers of our subsidiaries or
divisions.
The 1990 Plan and the 1997 Plan provide for the issuance of up to
1,462,500 and 4,125,000 shares, respectively, available for employees,
consultants and non-employee directors. The exercise price per share of all
options granted under these plans since 1997 has been the market price of the
stock on the date of the grant. Generally, options granted become exercisable
over three years and expire within five years from the date of grant.
6. OTHER LONG-TERM INVESTMENTS
In February 2000, Inland Productions, Inc., re-purchased the 25%
interest we acquired in 1996, resulting in no material gain or loss. Our
original investment consisted of $300,000 in cash and 118,485 shares of common
stock valued at $300,000 and was included in other long-term assets in the
accompanying balance sheet at December 31, 1999.
On March 21, 2000, we acquired a minority equity interest in a Japanese
developer Yuke's Co., Ltd. ("Yuke's"). This investment consisted of $5,020,000
in cash and is included in other long-term assets in the accompanying balance
sheet. The agreement provides that for a certain period of time Yuke's will
create exclusively for us wrestling games for PlayStation and PlayStation 2
platforms for sale in North America and Europe. The value of Yuke's shares is
not readily determinable and the investment is carried at cost.
10
<PAGE> 11
7. STOCKHOLDERS RIGHTS PLAN
On June 20, 2000 the Board of Directors (the "Board") approved a
Stockholders Rights Plan (the "Plan"). Pursuant to the Plan, on June 21, 2000 we
made a dividend distribution of one preferred stock purchase right ("Right") for
each outstanding share of Common Stock as of the close of business on July 3,
2000. Each Right entitles the holder to buy one one-hundredth (1/100) of a share
of a new series of preferred stock at an exercise price of $100, subject to
adjustment. The Rights become exercisable 10 days after any person or group
acquires, or 10 business days after any person or group has announced its
intention to commence a tender offer for, 15% or more of the outstanding Common
Stock.
In the event that any person or group acquires 15% or more of our
outstanding Common Stock, each holder of a Right (other than such person or
group) will be entitled to purchase, at the exercise price, the number of shares
of Common Stock having a current market value equal to two times the exercise
price of the Right.
If we are acquired in a merger or other business combination, each
holder of a Right will be entitled to purchase, at the exercise price, a number
of shares of common stock of the acquirer having a current market value equal to
two times the exercise price of the Right.
We may redeem the rights for $.01 at any time until 10 days after the
acquisition of 15% of our Common Stock. At any time after a person or group has
acquired 15% or more but less than 50% of our Common Stock, we may exchange all
or part of the Rights for shares of Common Stock at an exchange ratio of one
share of Common Stock for each Right or 1/100 of such new series of preferred
stock per Right, subject to adjustment. The rights expire on June 21, 2010.
11
<PAGE> 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Quarterly Report contains, or incorporates by reference, certain
statements that may be deemed "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. Such statements appear in
a number of places in this Report, including, without limitation, "Management's
Discussion and Analysis of Financial Condition and Results of Operations." All
statements relating to our objectives, strategies, plans, intentions, and
expectations, and all statements (other than statements of historical facts)
that address actions, events, or circumstances that we expect, believe, or
intend will occur in the future, are forward-looking statements. Prospective
investors are cautioned that any such forward-looking statements involve risks
and uncertainties, and that the actual results may differ materially from those
in the forward-looking statements as a result of various uncertainties,
including, without limitation, uncertainties relating to the interactive
entertainment software industry and other factors, as more specifically set
forth in our Current Report on Form 8-K, filed on November 13, 2000 with the
Securities and Exchange Commission and incorporated herein by reference.
OVERVIEW
We develop, publish and distribute interactive entertainment software
for the major platforms sold by Nintendo, Sega and Sony and for use on PCs. The
following table sets forth, for the periods indicated, the percentage of our
revenues derived from sales of titles for the platforms indicated:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------- --------------------
Platform 2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Nintendo 64 14% 38% 17% 32%
PlayStation 26% 34% 44% 45%
Game Boy / Game Boy Color 32% 10% 27% 10%
PC CD-ROM 12% 14% 6% 11%
Dreamcast 15% -- 5% --
Other 1% 4% 1% 2%
</TABLE>
Our business cycle generally commences with the securing of a license to
publish one or more titles based on a property. These licenses typically require
an advance payment to the licensor and a guarantee of minimum future royalties.
After obtaining the license, we begin software development for the title. Upon
completion of development and approval of the title by the manufacturer, we
order products and generally cause a letter of credit to be opened in favor of
the manufacturer or obtain a line of credit from the manufacturer. Products are
shipped at our expense to a public warehouse in California for domestic
distribution or to warehouses in the United Kingdom, Germany, France or
Australia for foreign distribution. We then sell directly to our major retail
accounts both domestically and in the United Kingdom, Germany, France and
Australia. Foreign sales to distributors in other territories are shipped
directly to the customers' locations at their expense.
12
<PAGE> 13
Unfilled sales orders are commonly referred to as "backlog." Since
substantially all of our product orders are fulfilled shortly after we receive
them, we do not believe that the amount of our unfilled sales orders as of the
end of a period is a meaningful indicator of sales in future periods.
Accordingly, we do not report the amount of our unfilled sales orders.
Discounts, Allowances and Returns; Inventory Management. In general,
except for PC titles, our arrangements with our distributors and retailers do
not give them the right to return products to us (other than damaged or
defective products) or to cancel firm orders. However, we sometimes negotiate
accommodations to retailers (and, less often, to distributors) when demand for
specific games falls below expectations, in order to maintain our relationships
with our customers. These accommodations include our not requiring that all
booked orders be filled, negotiated price discounts and credits against future
orders. We may also permit the return of products. Arrangements made with
distributors and retailers for PC titles do customarily require us to accept
product returns.
At the time of product shipment, we establish allowances based on
estimates of future returns, customer accommodations and doubtful accounts with
respect to such products. We base this amount on our historical experience,
retailer inventories, the nature of the titles and other factors. For the nine
months ended September 30, 2000, and September 30, 1999, provisions of $19.8
million and $19.1 million, respectively, were taken against gross sales made
during such periods. As of September 30, 2000, our aggregate allowance against
accounts receivable for returns, customer accommodations and doubtful accounts
was $21 million.
The identification by us of slow-moving or obsolete inventory, whether
as a result of requests from customers for accommodations or otherwise, would
require us to establish reserves against such inventory or to write-down the
value of such inventory to its estimated net realizable value.
EURO CURRENCY CONVERSION
On January 1, 1999, eleven of the fifteen member countries of the
European Union adopted the Euro as their common legal currency. The Euro trades
on currency exchanges and is available for non-cash transactions. From January
1, 1999 through January 1, 2002, participating countries can also maintain their
national ("legacy") currencies as legal tender for goods and services. Beginning
January 1, 2002, new Euro-denominated bills and coins will be issued, and legacy
currencies will be withdrawn from circulation no later than July 1, 2002. Our
operating subsidiaries in the United Kingdom, Germany and France have been
affected by the Euro conversion and have established plans to address any
business issues raised, including the competitive impact of cross-border price
transparency. It is not anticipated that there will be any near term business
ramifications; however, the long-term implications, including any changes or
modifications that will need to be made to business and financial strategies,
are still being reviewed. From an accounting, treasury and computer system
standpoint, the impact from the Euro currency conversion is not expected to have
a material impact on our, or any of our subsidiaries', financial position or
results of operations.
13
<PAGE> 14
RESULTS OF OPERATIONS
Net loss for the nine months ended September 30, 2000 was $3,342,000
($0.17 per diluted share), as compared to net income of $17,168,000 ($0.82 per
diluted share) for the same period in 1999. The 2000 results were negatively
impacted by a one-time non-cash charge, as discussed below, totaling $9.8
million before taxes and $5.9 million after taxes ($0.29 per diluted share).
One-Time Non-Cash Charge
In May 2000, we incurred a one-time non-cash charge primarily related to
the write-off of products for which development has been discontinued or that
are not expected to earn out at contractual rates. Costs associated with this
one-time non-cash charge amounted to $9.8 million, $5.9 million after taxes, and
were recorded in the consolidated statement of operations in the second quarter
of fiscal year 2000 and classified as follows:
<TABLE>
<S> <C>
Cost of sales $ 572,000
Royalties and project abandonment 8,531,000
Product development 102,000
Selling and marketing 56,000
General and administrative 528,000
-----------
$ 9,789,000
===========
</TABLE>
Net Sales
The following table sets forth, for the periods indicated, the
components of our net sales and our consolidated operating data as a percentage
of net sales:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- ------------------
2000 1999 2000 1999
----- ----- ----- -----
<S> <C> <C> <C> <C>
Domestic sales 75.5% 58.3% 74.0% 73.9%
Foreign sales 24.5 41.7 26.0 26.1
----- ----- ----- -----
Net sales 100.0% 100.0% 100.0% 100.0%
Costs and expenses:
Cost of sales 36.9% 41.2% 39.8% 43.4%
Royalties and project abandonment 22.1 13.0 25.4 16.2
Product development 10.0 10.5 9.1 6.4
Selling and marketing 14.5 15.0 14.1 11.8
Payment to venture partner 2.5 -- 5.3 --
General and administrative 9.6 6.7 9.5 6.3
----- ----- ----- -----
Total costs and expenses 95.6% 86.4% 103.2% 84.1%
----- ----- ----- -----
Income (loss) from operations 4.4% 13.6% (3.2)% 15.9%
Interest income -- net 0.9 0.7 0.7 0.5
----- ----- ----- -----
Income (loss) before income taxes 5.3% 14.3% (2.5)% 16.4%
----- ----- ----- -----
Net income (loss) 2.5% 9.5% (2.1)% 9.8%
===== ===== ===== =====
</TABLE>
14
<PAGE> 15
Title Releases
The following table sets forth, for the three months and nine months
ended September 30, 2000 and 1999, the number of titles released during such
periods for the platforms indicated:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Nintendo 64 1 3 1 6
PlayStation 5 3 8 5
Game Boy Color 5 -- 12 2
PC CD-ROM 5 5 6 10
Dreamcast 2 -- 2 --
-- -- -- --
Total 18 11 29 23
== == == ==
</TABLE>
COMPARISON OF THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2000, TO THE
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1999
Our net sales increased to $53,293,000 in the three months ended
September 30, 2000, from $44,610,000 in the same period of 1999, as a result of
an increased number of titles being shipped. Revenues for the three months ended
September 30, 2000, included sales of WWF Royal Rumble for the Sega Dreamcast;
Rugrats Totally Angelica for the Game Boy Color; Power Rangers Lightspeed Rescue
for the PlayStation, Game Boy Color and the Nintendo 64 and continued strong
worldwide sales of WWF Smackdown for PlayStation. For the three months ended
September 30, 2000, net sales of titles for WWF, Power Rangers and Rugrats were
$14,059,000 (26.4% of net sales), $9,254,000 (17.4% of net sales) and $4,640,000
(8.7% of net sales), respectively. Revenues during the three months ended
September 30, 1999 were impacted favorably by the continuing sales of Rugrats
titles and the release of Road Rash for the Nintendo 64 and Championship
Motocross for the PlayStation.
Our net sales decreased to $156,090,000 in the nine months ended
September 30, 2000, from $175,748,000 in the same period of 1999, primarily as a
result of a decrease in unit volumes for titles released on the Nintendo 64 and
PlayStation platforms as the market transitions to a new generation of game
platforms.
For the nine months ended September 30, 2000 our foreign net sales
remained relatively constant as a percentage of net sales at 26.0%, versus 26.1%
in the same period of 1999, and decreased in dollar terms to $40,545,000 from
$45,896,000. Foreign net sales decreased to $13,070,000 (24.5% of net sales) for
the three months ended September 30, 2000 from $18,590,000 (41.7% of net sales).
This decrease is primarily related to the unfavorable impact of foreign currency
translation rates and a decrease in unit volumes for titles released on the
Nintendo 64 and PlayStation platforms as the market transitions to a new
generation of game platforms.
15
<PAGE> 16
Our cost of sales for the three months ended September 30, 2000
decreased as a percentage of net sales to 36.9% from 41.2% in the same period of
1999. Cost of sales for the nine months ended September 30, 2000, also decreased
as a percentage of net sales to 39.8% from 43.4% in the same period of 1999.
During 2000, we have sold a higher proportion of PlayStation and Game Boy Color
titles both which have higher gross margins than Nintendo 64 games.
Our royalties and project abandonment expense for the three months ended
September 30, 2000 increased as a percentage of net sales to 22.1% from 13.0%
for the same period of 1999. This increase is primarily due to a change in our
product mix from Nintendo 64 titles to other platforms which carry higher
royalty rates. Royalties and project abandonment expense also increased as a
percentage of net sales for the nine months ended September 30, 2000, to 25.4%
from 16.2% for the same period of 1999. This increase, in addition to our change
in product mix, is also due to a one-time charge (See "-- One-Time Non-Cash
Charge") during the second quarter related to the write down of certain products
for which development was discontinued or that were not expected to earn out at
contractual rates. Excluding this one-time non-cash charge, royalties and
project abandonment expense increased as a percentage of net sales for the nine
months ended September 30, 2000, to 19.9% of net sales as compared to 16.2% of
net sales for 1999. Royalties and project abandonment during the first nine
months of 1999 were impacted by LucasArts products released in Germany which
have lower margins but no explicit royalties.
Product development expense for the three months and nine months ended
September 30, 2000, increased $687,000 and $3,091,000 over the same periods of
1999. This increase is due to a greater number of titles currently in
development and the continued growth of our internal studios.
For the three months ended September 30, 2000, selling and marketing
expenses remained relatively constant as a percentage of net sales at 14.5%,
from 15.0% for the same period of 1999. Selling and marketing expense increased
slightly to $21,996,000 for the nine months ended September 30, 2000, from
$20,811,000 in the same period of 1999, and, as a result of lower domestic sales
volumes, increased as a percentage of net sales to 14.1% from 11.8%. During
2000, we anticipate that selling and marketing expenses will continue to be a
higher percentage of net sales than in the prior year due to more aggressive
advertising support for key titles.
THQ incurs an expense and pays JAKKS Pacific a preferred return on
product sales and other income derived from the WWF license. For the three
months and nine months ended September 30, 2000 the amount incurred for such
preferred returns was $1,343,000 and $8,246,000, respectively. Because the
license with the WWF was not effective until November 1999, there were no WWF
product sales in the first three quarters of 1999.
Our general and administrative expenses for the three months and nine
months ended September 30, 2000 increased by $2,124,000 and $3,857,000, compared
to the same periods of 1999, which represents an increase in percentage of net
sales to 9.6% and 9.5% from 6.7% and 6.3%, respectively. The increase occurred
in response to both the growth in our internal studios and the addition of our
two new foreign operations in France and Australia. We
16
<PAGE> 17
anticipate that, because of the seasonality of sales, general and administrative
expenses, as a percentage of net sales, should decline in the fourth quarter of
2000.
LIQUIDITY AND CAPITAL RESOURCES
Our principal uses of cash are product purchases, payments to licensors,
advance payments to developers and the costs of internal software development.
In order to purchase products from the manufacturers, we typically open letters
of credit in their favor or obtain a line of credit from the manufacturer.
Our cash and cash equivalents increased $4,170,000 from $21,454,000 at
December 31, 1999 to $25,624,000 at September 30, 2000, and were $20,548,000 as
of November 8, 2000. Cash provided by operating activities for the nine months
ended September 30, 2000 was $28,371,000, primarily due to the collection of
accounts receivable during the post-holiday season offset by an increase in
software development payments, payments for income taxes and prepayments for
product.
The amount of our accounts receivable is subject to significant
quarterly variations as a consequence of the seasonality of our sales and is
typically highest at the end of the year. These seasonal variations are
responsible for the substantial decrease in accounts receivable from December
31, 1999 to September 30, 2000 as the sales generated during the fourth quarter
of 1999 were collected.
Prepaid and deferred royalties decreased from December 31, 1999 as we
earned out royalties on a number of our major license agreements and also as a
result of the one-time non-cash charge. Software development costs increased
during the same time period due to a larger number of titles in production from
both internal and external developers. Accrued royalties decreased due to
royalty payments made in the first half of 2000 for sales from the fourth
quarter of 1999. As of September 30, 2000, we had obligations with respect to
future guaranteed minimum royalties of $27,259,000.
Income taxes receivable increased from December 1999 due to timing
differences that result between payment of estimated taxes and income tax
expense.
The decrease in our lines of credit is attributable to the collection of
accounts receivable during the past holiday season, as well as a reduction in
product purchases during the first nine months of 2000 as compared to those
incurred during the year-end holiday buying season. We expect that there will be
outstanding borrowings under the lines of credit at year end.
Accounts payable and accrued expenses decreased from December 31, 1999
as a result of a decrease in the purchases of product and the timing of
payments.
Our working capital requirements are greatest during our third and
fourth quarters. We believe that cash on hand, funds provided by operations, and
our borrowing capabilities will be adequate to meet our anticipated requirements
for operating expenses, product purchases, guaranteed payments to licensors and
software development through 2000.
17
<PAGE> 18
Net cash used in investing activities for the nine months ended
September 30, 2000 was $10,648,000 and was primarily utilized to invest in
Yuke's ($5,020,000) and additional capital expenditures ($5,741,000), consisting
primarily of the implementation of a new operational and financial system and
the acquisition of next generation development tools.
Net cash used in financing activities for the nine months ended
September 30, 2000 was $13,687,000, and was attributable to the repayment of
short-term borrowings.
Credit Facilities. On August 31, 2000, and as amended in October 2000,
we entered into a Revolving Credit Agreement with Union Bank of California and a
syndicate of other financial institutions. This agreement expires on July 1,
2001 and permits us to borrow (and maintain obligations under outstanding
letters of credit) up to an aggregate of $50,000,000, subject to the following:
We may maintain outstanding letters of credit for product purchases and
outstanding borrowings in the aggregate for up to $35,000,000 for September;
$50,000,000 between October 1, 2000 and December 31, 2000; $35,000,000 for
January 2001; and $20,000,000 between February 1, 2001 and June 30, 2001.
In addition, outstanding borrowings cannot exceed $15,000,000 for
September; $30,000,000 from October 1 through October 31, 2000; $50,000,000 from
November 1, 2000 through December 31, 2000; $35,000,000 from January 1, 2001
through January 31, 2001; and $15,000,000 from February 1, 2001 to June 30,
2001.
We are also required to not have any outstanding borrowings for a period
of at least 60 days during each year of the agreement.
This credit facility is secured by a lien on substantially all of our
assets and contains customary financial and non-financial covenants. Amounts
outstanding under these credit facilities bear interest, at our choice, at
either a) the bank's prime rate (9.5% at September 30, 2000) or b) the London
Interbank Offered Rate (8.66% at September 30, 2000) plus 1.85%. As of September
30, 2000, we had no outstanding borrowings under these facilities and had
obligations in respect of outstanding letters of credit for $32,496,000. As of
November 8, 2000 we had no outstanding borrowings and obligations in respect of
outstanding letters of credit were $38,073,000.
18
<PAGE> 19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain market risks arising from transactions in the
normal course of business, principally risk associated with interest rate and
foreign currency fluctuations.
INTEREST RATE RISK
Our interest rate risk is immaterial due to the short maturity of the
debt. We have no fixed rate debt.
FOREIGN CURRENCY RISK
Historically, we have not hedged our foreign currency exposure. It is
possible that in the future we will enter into foreign currency contracts in
order to manage or reduce foreign currency market risk.
Our earnings are affected by fluctuations in the value of our
subsidiaries' functional currency as compared to the currencies of our foreign
denominated sales and purchases. The results of operations of our subsidiaries,
as reported in U.S. dollars, may be significantly affected by fluctuations in
the value of the local currencies in which we transact business. Such amount is
recorded upon the translation of the foreign subsidiaries' financial statements
into U.S. dollars, and is dependent upon the various foreign exchange rates and
the magnitude of the foreign subsidiaries' financial statements. During the nine
months ended September 30, 2000, our foreign currency translation loss
adjustment was $1,390,000. We do not believe that a hypothetical 10% change in
the relevant currency rates at September 30, 2000 would result in a material
gain or loss. In addition to the direct effects of changes in exchange rates,
which impact the dollar value of the resulting sales and related expenses,
changes in exchange rates also affect the volume of sales or the foreign
currency sales price as competitors' products become more or less attractive.
-------------------------------------------
19
<PAGE> 20
Part II - Other Information
Item 1. Legal Proceedings
The legal proceedings previously disclosed in Part I, Item 3 of the
10-K/A for fiscal year ended December 31, 1999, filed on April 28, 2000 have had
developments in the third quarter. On September 11, 2000, our Motion to Dismiss
was granted with leave to amend and the plaintiffs so amended their complaints
on October 2, 2000. We filed a Second Motion to Dismiss on October 23, 2000. We
believe the claims are without merit, and intend to vigorously defend against
them.
Item 2. Changes in Securities
On August 31, 2000 we completed the acquisition of Volition, Inc., a
Delaware corporation ("Volition"). In connection with this transaction, and
pursuant to an exemption from registration provided in Section 4(2) of the
Securities Act of 1933, as amended, we issued 890,110 shares of our common stock
to stockholders of Volition. We also assumed existing Volition employee stock
options that provide for the future issuance of 109,890 shares of our common
stock.
Item 4. Submission of Matters to a Vote of Security Holders
We held our 2000 Annual Meeting of Shareholders on July 21, 2000. The
following matters were decided:
1. Six directors were elected:
<TABLE>
<CAPTION>
Votes Votes
For Withheld
---------- ---------
<S> <C> <C>
Brian J. Farrell 14,967,492 302,993
Jeffrey C. Lapin 14,960,494 309,991
Lawrence Burstein 14,947,496 322,989
Bruce Jagid 13,915,934 1,354,551
James L. Whims 14,963,135 307,350
L. Greg Ballard 14,971,754 298,731
</TABLE>
The above numbers have been corrected from the second quarter 10-Q filed
on August 14, 2000 due to an error in the number of votes received from the
transfer agent.
20
<PAGE> 21
2. An amendment to our 1997 Stock Option Plan was approved.
This amendment: (a) restricts the number of shares of common
stock for which new option grants may be made in any fiscal year
to any one single person to 300,000 shares, (b) authorizes our
Compensation Committee, in limited circumstances, to grant
replacement options for the tax and accounting benefit of the
company (provided that such replacement options shall not
include additional benefits and shall have an exercise price
that is not lower than the option being replaced), and (c) makes
certain technical, clarifying changes to the tax withholding and
adjustment provisions of the plan. The amendment was approved by
a vote of 14,372,341 for, 835,126 against, and 63,018
abstaining.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
<TABLE>
<CAPTION>
Number Title
<S> <C>
2 Agreement of Merger dated as of August 31, 2000, among
the Company, Volition Acquisition Company and Volition,
Inc. (incorporated by reference to Exhibit 2 to the
Registrant's Current Report on Form 8-K dated
September 15, 1999).
3.1 Certificate of Incorporation (incorporated by reference
to Exhibit 3.1 to Post-Effective Amendment No. 1 to the
Registration Statement on Form S-3 filed on January 9,
1998 (File No. 333-32221) (the "S-3 Registration Statement")).
3.2 Amendment to Certificate of Incorporation (incorporated by
reference to Exhibit 3.1 to Post-Effective Amendment No. 1
to the S-3 Registration Statement).
3.3 Amended and Restated Bylaws (incorporated by reference to
Exhibit 3 to the Registrant's Current Report on Form 8-K
dated June 22, 2000 (the "June 8-K")).
3.4 Certificate of Designation of Series A Junior Participating
Preferred Stock of THQ Inc. (incorporated by reference to
Exhibit A to the Stockholders Rights Agreement dated as of
June 21, 2000 between the Company and American Stock
Transfer & Trust Company, as Rights Agent ("Rights Agreement"),
which is Exhibit 4 to the June 8-K).
4.1 Rights Agreement (incorporated by reference to Exhibit 4 to the
June 8-K).
*10.1 Revolving Credit Agreement, dated as of August 31, 2000 by and between
the Company, the Lenders named therein, and Union Bank of California,
N.A. ("Union Bank"), as Agent.
</TABLE>
21
<PAGE> 22
<TABLE>
<S> <C>
*10.2 First Amendment to Revolving Credit Agreement, dated
as of October 23, 2000 between the Company, Union Bank
as Agent and as Lender, BNP Paribas, and Pacific
Century Bank, N.A.
*27 Financial Data Schedule.
99 Risk Factors (incorporated by reference to Item 5 of
the Registrant's Current Report on Form 8-K filed on
November 13, 2000 (File No. 001-15959)).
</TABLE>
*Filed herewith.
(b) Reports on Form 8-K
(i) Current Report on Form 8-K dated September 15,
2000, reporting under Item 2.
(ii) Current Report on Form 8-K dated November 13,
2000, reporting under Item 5.
22
