<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 June 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)
<TABLE>
<S> <C>
Delaware 13-3541686
------------------------------------------ ---------------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
</TABLE>
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: 19,239,935 shares (as of August 9, 2000).
<PAGE> 2
THQ INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
Part I - Financial Information Page
------------------------------ ----
<S> <C>
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets -
June 30, 2000 and December 31, 1999 3
Consolidated Statements of Operations -
for the Three Months and Six Months Ended
June 30, 2000 and 1999 4
Consolidated Statements of Shareholders' Equity -
for the Six Months Ended June 30, 2000 and
the Year Ended December 31, 1999 5
Consolidated Statements of Cash Flows -
for the Six Months Ended June 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 20
Part II - Other Information
Item 2. Changes in Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 24
----------
</TABLE>
2
<PAGE> 3
Part I - Financial Information
Item 1. Consolidated Financial Statements.
THQ INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 52,297,000 $ 21,303,000
Accounts receivable - net 14,088,000 96,641,000
Inventory 6,753,000 5,455,000
Prepaid and deferred royalties 19,291,000 23,478,000
Software development costs 14,277,000 11,640,000
Deferred income taxes 6,860,000 6,817,000
Income taxes receivable 12,574,000 965,000
Prepaid expenses and other current assets 2,721,000 2,226,000
------------- -------------
Total current assets 128,861,000 168,525,000
Property and equipment - net 8,459,000 5,659,000
Deferred royalties - net of current portion 2,553,000 3,371,000
Software development costs - net of current portion 601,000 1,824,000
Deferred income taxes - net of current portion 2,865,000 2,865,000
Other long-term assets 7,324,000 2,790,000
------------- -------------
TOTAL ASSETS $ 150,663,000 $ 185,034,000
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Lines of credit $ -- $ 16,702,000
Accounts payable 3,994,000 13,170,000
Accrued expenses 11,633,000 12,998,000
Accrued royalties 25,243,000 31,254,000
------------- -------------
Total current liabilities 40,870,000 74,124,000
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;
19,214,056 shares and 19,007,124 shares issued and
outstanding as of June 30, 2000 and December 31, 1999, respectively 192,000 190,000
Additional paid-in capital 81,150,000 78,378,000
Accumulated other comprehensive loss (1,500,000) (842,000)
Retained earnings 29,951,000 33,034,000
------------- -------------
Total shareholders' equity 109,793,000 110,760,000
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 150,633,000 $ 185,034,000
============= =============
</TABLE>
See notes to consolidated financial statements.
3
<PAGE> 4
THQ INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------- ---------------------------------
2000 1999 2000 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net sales $ 32,401,000 $ 51,612,000 $ 102,779,000 $ 130,417,000
Costs and expenses:
Cost of sales 15,502,000 27,064,000 42,387,000 57,839,000
Royalties and project abandonment 14,986,000 7,255,000 27,827,000 22,687,000
Product development 3,718,000 2,567,000 7,392,000 5,369,000
Selling and marketing 5,015,000 4,626,000 14,289,000 14,109,000
Payment to venture partner 1,600,000 -- 6,903,000 --
General and administrative 5,093,000 3,346,000 9,736,000 8,064,000
------------- ------------- ------------- -------------
Total costs and expenses 45,914,000 44,858,000 108,534,000 108,068,000
------------- ------------- ------------- -------------
Income (loss) from operations (13,513,000) 6,754,000 (5,755,000) 22,349,000
Interest income, net 517,000 414,000 572,000 599,000
------------- ------------- ------------- -------------
Income (loss) before income taxes (12,996,000) 7,168,000 (5,183,000) 22,948,000
Provision (benefit) for income taxes (5,227,000) 3,294,000 (2,100,000) 9,594,000
------------- ------------- ------------- -------------
Net income (loss) $ (7,769,000) $ 3,874,000 $ (3,083,000) $ 13,354,000
============= ============= ============= =============
Net income (loss) per share - basic $ (0.41) $ 0.21 $ (0.16) $ 0.74
============= ============= ============= =============
Net income (loss) per share - diluted $ (0.41) $ 0.20 $ (0.16) $ 0.68
============= ============= ============= =============
Shares used in per share calculation - basic 19,177,000 18,039,000 19,105,000 17,990,000
============= ============= ============= =============
Shares used in per share calculation - diluted 19,177,000 19,768,000 19,105,000 19,702,000
============= ============= ============= =============
</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 Six Months Ended June 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 17,878,481 $ 120,000 $ 62,731,000 $ 60,000 $ 93,000 $ 63,004,000
Exercise of warrants and options 1,128,643 8,000 4,855,000 -- -- 4,863,000
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 -- -- -- -- 32,941,000 32,941,000
Other comprehensive loss
Foreign currency translation
adjustment -- -- -- (902,000) -- (902,000)
------------
Comprehensive income -- -- -- -- -- 32,039,000
---------- ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1999 19,007,124 190,000 78,378,000 (842,000) 33,034,000 110,760,000
Exercise of warrants and options 206,932 2,000 2,389,000 -- -- 2,391,000
Stock compensation -- -- 203,000 -- -- 203,000
Tax benefit related to the exercise of
employee stock options -- -- 180,000 -- -- 180,000
Comprehensive loss:
Net loss -- -- -- -- (3,083,000) (3,083,000)
Other comprehensive loss
Foreign currency translation
adjustment -- -- -- (658,000) -- (658,000)
------------
Comprehensive loss -- -- -- -- -- (3,741,000)
---------- ------------ ------------ ------------ ------------ ------------
Balance at June 30, 2000 19,214,056 $ 192,000 $ 81,150,000 $ (1,500,000) $ 29,951,000 $109,793,000
========== ============ ============ ============ ============ ============
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 6
THQ INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-------------------------------
2000 1999
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (3,083,000) $ 13,354,000
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 1,616,000 648,000
Provision for doubtful accounts, discounts and returns 13,367,000 7,533,000
Loss on disposal of fixed assets 79,000 5,000
Stock compensation 203,000 264,000
Increase in deferred income taxes (53,000) (97,000)
Changes in operating assets and liabilities:
Accounts receivable 68,403,000 31,313,000
Inventory (1,445,000) 14,306,000
Prepaid and deferred royalties and
software development costs (4,411,000) (4,012,000)
Prepaid expenses and other current assets (551,000) (4,409,000)
Accounts payable and accrued expenses (10,095,000) (14,316,000)
Accrued royalties 1,677,000 (8,936,000)
Income taxes payable (11,392,000) (7,815,000)
------------ ------------
Net cash provided by operating activities 54,315,000 27,838,000
Cash flows used in investing activities:
Proceeds from sale of property and equipment 58,000 29,000
Acquisition of property and equipment (4,134,000) (514,000)
Investment in Yuke's Co., Ltd. (See Footnote 5) (5,020,000) --
Decrease (Increase) in other long-term assets 60,000 (223,000)
------------ ------------
Net cash used in investing activities (9,036,000) (708,000)
Cash flows used in financing activities:
Net decrease in short-term borrowings (16,702,000) (7,934,000)
Proceeds from exercise of options and warrants 2,391,000 671,000
------------ ------------
Net cash used in financing activities (14,311,000) (7,263,000)
Effect of exchange rate changes on cash 26,000 119,000
------------ ------------
Net increase in cash and cash equivalents 30,994,000 19,986,000
Cash and cash equivalents - beginning of period 21,303,000 19,063,000
------------ ------------
Cash and cash equivalents - end of period $ 52,297,000 $ 39,049,000
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period:
Income taxes $ 9,070,000 $ 18,182,000
============ ============
Interest $ 182,000 $ 214,000
============ ============
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES:
Tax benefit from disqualified disposition $ 180,000 $ 432,000
============ ============
</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, pursuant 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 thereto 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 to
present fairly the information set forth herein. The results for the three
months and six months ended June 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 Six Months Ended
June 30, June 30,
------------------------------- -------------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net income (loss) used to compute basic
and diluted earnings per share $ (7,769,000) 3,874,000 $ (3,083,000) 13,354,000
------------ ------------ ------------ ------------
Weighted average number of shares
outstanding - basic 19,177,000 18,039,000 19,105,000 17,990,000
Dilutive effect of stock options and warrants -- 1,729,000 -- 1,712,000
------------ ------------ ------------ ------------
Number of shares used to compute earnings
per share - diluted 19,177,000 19,768,000 19,105,000 19,702,000
============ ============ ============ ============
</TABLE>
Recently Issued Accounting Pronouncements. In June 1998, the FASB
issued SFAS No. 133, "Accounting for Derivative Instruments and Hedge
Activities." SFAS No. 133 establishes the accounting and reporting standard for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. SFAS 133 is effective for
financial statements for periods beginning after June 15, 2000. We are currently
evaluating the potential impact of SFAS No. 133.
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 December 13, 1999 we completed a merger with Genetic Anomalies,
Inc., a Delaware corporation ("GA"). In the merger, each share of GA was
converted into 0.0536 shares of our common stock, or a total of approximately
220,000 shares. In addition, outstanding GA employee stock options were assumed
by us and converted, at the same conversion rate, into options to purchase
approximately 45,000 shares of our common stock.
The merger 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 GA had
always been part of our company.
All transactions between GA 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 For the Six
Months Ended Months Ended
Net sales June 30, 1999 June 30, 1999
------------- -------------
<S> <C> <C>
THQ Inc. $ 51,541,000 $ 130,316,000
GA 121,000 151,000
Intercompany elimination (50,000) (50,000)
------------- -------------
Combined $ 51,612,000 $ 130,417,000
============= =============
</TABLE>
<TABLE>
<CAPTION>
For the Three For the Six
Months Ended Months Ended
Net income (loss) June 30, 1999 June 30, 1999
------------ --------------
<S> <C> <C>
THQ Inc. $ 4,044,000 $ 13,715,000
GA (120,000) (311,000)
Intercompany elimination (50,000) (50,000)
------------ ------------
Combined $ 3,874,000 $ 13,354,000
============ ============
</TABLE>
8
<PAGE> 9
3. CREDIT FACILITY
In December 1998, we entered into two trade finance agreements (as
amended) with Union Bank of California that established a revolving credit
facility. These agreements, which were due to expire on June 1, 2000, have been
extended to September 1, 2000. We are in the process of finalizing a new credit
facility arranged by Union Bank.
The principal agreement (as amended) permits us to borrow and maintain
obligations under outstanding letters of credit up to $43,000,000, subject
certain limitations. Our other Union Bank agreement (as amended) is for our
United Kingdom subsidiary, T.HQ International Ltd., and permits that subsidiary
to obtain product purchase letters of credit of up to an aggregate of $7
million.
These credit facilities are secured by a lien on substantially all of
our assets and contain customary financial and non-financial covenants. Amounts
outstanding under these credit facilities bear interest at our choice of either
a) the bank's prime rate (8.5% at December 31, 1999) or b) the London Interbank
Offered Rate (5.69% at December 31, 1999) plus 1.85%. As of June 30, 2000, we
had no outstanding borrowings under these facilities and had obligations in
respect of outstanding letters of credit for $214,000.
4. ACCOUNTS RECEIVABLE
Accounts receivable are due primarily from domestic and foreign
retailers and distributors, including mass merchants and specialty stores.
Accounts receivable at June 30, 2000 and December 31, 1999 are composed of the
following:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
------------ ------------
<S> <C> <C>
Accounts receivable -- domestic $ 19,816,000 $ 93,455,000
Other receivables -- domestic 1,228,000 1,469,000
Allowance for domestic returns and doubtful
accounts (12,640,000) (16,845,000)
Accounts receivable -- foreign 13,081,000 25,888,000
Allowance for foreign returns and doubtful
accounts (7,397,000) (7,326,000)
------------ ------------
Accounts receivable -- net $ 14,088,000 $ 96,641,000
============ ============
</TABLE>
9
<PAGE> 10
5. STOCK COMPENSATION
Pacific Coast Power and Light ("PCP&L"), which we acquired on May 24,
1999, and GA 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 June
30, 2000 and 1999, stock-based compensation of $101,000 and $141,000,
respectively, was amortized to expense. For the six months ended June 30, 2000
and 1999, stock-based compensation of $202,000 and $264,000, respectively, was
amortized to expense. As of June 30, 2000 and December 31, 1999 we had
unamortized stock-based compensation expense of $907,000 and $1,110,000,
respectively.
On June 8, 2000, the Board of Directors approved the THQ Inc.
Non-executive 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 to corporate officers and no more than 15% is available to other
officers who are not executive or corporate officers.
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 the "Risk Factors" section (pages 3 through 10) of our Registration
Statement on Form S-3, filed on June 30, 2000 with the Securities and Exchange
Commission, which is 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 Six Months
Ended June 30, Ended June 30,
-------------- --------------
Platform 2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Nintendo 64 7 % 43 % 19 % 30 %
PlayStation 48 % 22 % 53 % 48 %
Game Boy / Game Boy Color 41 % 16 % 24 % 11 %
PC CD-ROM 2 % 17 % 2 % 10 %
Other 2 % 2 % 2 % 1 %
</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 or France for foreign distribution. We sell directly to our major retail
accounts both domestically and in the United Kingdom, Germany and France.
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 six
months ended June 30, 2000, and June 30, 1999, provisions of $13.4 million and
$7.5 million, respectively, were taken against gross sales made during such
periods. As of June 30, 2000, our aggregate reserve against accounts receivable
for returns, customer accommodations and doubtful accounts was $20 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.
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<PAGE> 14
RESULTS OF OPERATIONS
Net loss for the three and six months ended June 30, 2000 was
$7,769,000 ($0.41 per diluted share) and $3,083,000 ($0.16 per diluted share),
as compared to net income of $3,874,000 ($0.20 per diluted share) and
$13,354,000 ($0.68 per diluted share) for the same periods in 1999. The 2000
results were negatively impacted by a one-time non-cash charge totaling $9.8
million before taxes and $5.9 million after taxes ($0.31 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 Six Months
Ended June 30, Ended June 30,
------------------- --------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Domestic sales 47.0 % 73.5 % 73.3 % 79.1 %
Foreign sales 53.0 26.5 26.7 20.9
----- ----- ----- -----
Net sales 100.0 % 100.0 % 100.0 % 100.0 %
Costs and expenses:
Cost of sales 47.8 % 52.4 % 41.2 % 44.4 %
Royalties and project abandonment 46.3 14.1 27.1 17.4
Product development 11.5 5.0 7.2 4.1
Selling and marketing 15.5 9.0 13.9 10.8
Payment to venture partner 4.9 -- 6.7 --
General and administrative 15.7 6.4 9.5 6.2
----- ---- ----- ----
Total costs and expenses 141.7 % 86.9 % 105.6 % 82.9 %
----- ---- ----- ----
Income (loss) from operations (41.7)% 13.1 % (5.6)% 17.1 %
Interest income--net 1.6 0.8 0.6 0.5
</TABLE>
14
<PAGE> 15
<TABLE>
<S> <C> <C> <C> <C>
----- ---- ----- ----
(40.1) 13.9 (5.0) 17.6
Income (loss) before income taxes
----- ---- ----- ----
Net income (loss) (24.0)% 7.5 % (3.0)% 10.2 %
====== ==== ====== ====
</TABLE>
TITLE RELEASES
The following table sets forth, for the three months and six months
ended June 30, 2000 and 1999, the number of titles released during such periods
for the platforms indicated:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------- ----------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Nintendo 64 -- 1 -- 3
PlayStation 1 1 3 2
Game Boy 6 3 8 3
PC CD-ROM -- 4 -- 4
-- -- -- --
Total 7 9 11 12
== == == ==
</TABLE>
COMPARISON OF THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2000, TO THE THREE
MONTHS AND SIX MONTHS ENDED JUNE 30, 1999
Our net sales decreased to $32,401,000 in the three months ended June
30, 2000, from $51,612,000 in the same period of 1999, as a result of fewer
titles being shipped and a decrease in unit volumes for titles released on the
Nintendo 64 and PlayStation platforms. Revenues for the three months ended June
30, 2000, included sales of Tomb Raider Starring Lara Croft and Rugrats Totally
Angelica for the Game Boy Color plus continued sales of WWF Smackdown! for the
PlayStation and WWF Wrestlemania 2000 for the Nintendo 64. For the three months
ended June 30, 2000, net sales of WWF titles and Rugrats titles were $16,507,000
(50.9% of net sales), and $5,302,000 (16.4% of net sales), respectively.
Revenues during the three months ended June 30, 1999 were impacted favorably by
the continuing sales of three wrestling games under the now expired license with
World Championship Wrestling ("WCW") plus the release of Rugrats Scavenger Hunt
for the Nintendo 64.
Our net sales decreased to $102,779,000 in the six months ended June
30, 2000, from $130,417,000 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.
Our foreign net sales increased to $17,157,000 for the three months
ended June 30, 2000, from $13,701,000 in the same period of 1999, and increased
as a percentage of net sales to 53.0% from 26.6%. This increase can be
attributed to the successful launch of WWF Smackdown! for PlayStation in the
European markets. Foreign net sales increased slightly to $27,475,000 for the
six months ended June 30, 2000, from $27,305,000 in the same period of 1999,
and, as a result of lower domestic sales volumes, increased as a percentage of
net sales to 26.7% from 20.9%.
15
<PAGE> 16
Our cost of sales for the three months ended June 30, 2000 decreased as
a percentage of net sales to 47.8% from 52.4% in the same period of 1999. Cost
of sales for the six months ended June 30, 2000, decreased as a percentage of
net sales to 41.2%, from 44.4% in the same period of 1999. During 2000, we have
had a higher proportion of PlayStation and Game Boy Color sales than Nintendo 64
sales, compared to sales in 1999. Both PlayStation and Game Boy Color products
have higher gross margins then Nintendo 64 products.
Our royalties and project abandonment expense for the three months
ended June 30, 2000 increased as a percentage of net sales to 46.3% from 14.1%
for the same period of 1999. Royalties and project abandonment expense increased
as a percentage of net sales for the six months ended June 30, 2000, to 27.1%,
from 17.4% for the same period 1999. This increase is primarily due to a
one-time non-cash charge during the second quarter related to the write down of
certain products for which development has been discontinued or that are 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 three months ended June 30, 2000, to 19.9% of net sales as
compared to 14.1% of net sales for 1999. Again excluding this one-time non-cash
charge, royalties and project abandonment expense was slightly higher as a
percentage of net sales for the six months ended June 30, 2000, at 18.8% of net
sales compared to 17.4% of net sales for the same period in 1999. This increase
is primarily related to a higher proportion of PlayStation product sales (which
generally have a higher royalty rate than Nintendo 64 product) during the
current period. Royalties and project abandonment during the first half 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 six months ended
June 30, 2000, increased $1,151,000 and $2,023,000 over the same periods in
1999. This increase is due to a greater number of titles currently in
development than were being developed in the same period for 1999. The continued
growth of our internal studios is also a factor in this increase.
For the three months and six months ended June 30, 2000, selling and
marketing expenses remained relatively constant with an increase of $389,000 and
$180,000 over the same periods of 1999, but increased as a percentage of net
sales to 15.5% and 13.9% from 9.0% and 10.8%, respectively. 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 titles being shipped
and more aggressive advertising support for key titles.
For the three months and six months ended June 30, 2000, we incurred
expense in the amount of $1,600,000 and $6,903,000, respectively, to our venture
partner, JAKKS Pacific. THQ pays JAKKS Pacific a preferred return on product
sales and other income derived from the WWF license. Because the license with
the WWF was not effective until November 1999, there were no WWF product sales
in the first or second quarters of 1999.
Our general and administrative expenses for the three months and six
months ended June 30, 2000 increased by $1,747,000 and $1,672,000, compared to
the same periods in 1999, which represents an increase in percentage of net
sales to 15.7% and 9.5% from 6.5% and 6.2%, 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 anticipate
16
<PAGE> 17
that because of the seasonality of sales, general and administrative expenses,
as a percentage of net sales, will decline in the second half of 2000.
LIQUIDITY AND CAPITAL RESOURCES
Our principal uses of cash are product purchases, guaranteed payments
to licensors, advance payments to developers and the costs of internal software
development. In order to purchase products from the manufacturers, we typically
open letters of credit in their favor or obtain a line of credit from the
manufacturer.
Our cash and cash equivalents increased $30,994,000 from $21,303,000 at
December 31, 1999 to $52,297,000 at June 30, 2000, and were $48,559,000 as of
August 9, 2000. Cash provided by operating activities for the six months ended
June 30, 2000 was $54,315,000, primarily due to the collection of accounts
receivable during the post-holiday season offset by a decrease in current
liabilities.
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 June 30, 2000 as the sales generated during the fourth quarter of
1999 were collected.
Inventory increased during the six months ended June 30, 2000, as a
result of product reorders for WWF titles and Game Boy Color titles.
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 the growth of our internal development
studios and a larger number of titles in production. Accrued royalties decreased
due to royalty payments made in the first half of 2000 for sales from the fourth
quarter of 1999. As of June 30, 2000, we had obligations with respect to future
guaranteed minimum royalties of $25,243,000.
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 a reduction in
product purchases during the first half of 2000 as compared to those incurred
during the year-end holiday buying season.
Accounts payable and accrued expenses decreased significantly from
December 31, 1999 as a result of the timing of large product receipts in the
last quarter of 1999 and the timing of payments on accounts payable.
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 six months ended June 30,
2000 was $9,036,000 and was primarily utilized to invest in Yuke's ($5,020,000)
and additional capital expenditures ($4,134,000), 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 six months ended June 30,
2000 was $14,311,000, attributable to the repayment of short-term borrowings.
Credit Facilities. In December 1998, we entered into two trade finance
agreements (as amended) with Union Bank of California that established a
revolving credit facility. These agreements, which were due to expire on June 1,
2000, have been extended to September 1, 2000. We are in the process of
finalizing a new credit facility arranged by Union Bank.
The principal agreement (as amended) permits us to borrow and maintain
obligations under outstanding letters of credit up to $43,000,000, subject
certain limitations. Our other Union Bank agreement (as amended) is for our
United Kingdom subsidiary, T.HQ International Ltd., and permits that subsidiary
to obtain product purchase letters of credit of up to an aggregate of $7
million.
These credit facilities are secured by a lien on substantially all of
our assets and contain customary financial and non-financial covenants.
Amounts outstanding under these credit facilities bear interest at our choice
of either a) the bank's prime rate (8.5% at December 31, 1999) or b) the London
Interbank Offered Rate (5.69% at December 31, 1999) plus 1.85%. As of June 30,
2000, we had no outstanding borrowings under these facilities and had
obligations in respect of outstanding letters of credit for $214,000. As of
August 9, 2000 we had no outstanding borrowings and outstanding letters of
credit were $4,539,000.
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 six
months ended June 30, 2000, our foreign currency translation loss adjustment was
$658,000. We do not believe that a hypothetical 10% change in the relevant
currency rates at June 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 2. Changes in Securities
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.
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 14,970,492 299,993
Jeffrey C. Lapin 14,960,494 309,991
Lawrence Burstein 14,955,996 314,489
Bruce Jagid 14,854,934 415,551
James L. Whims 14,963,135 307,350
L. Greg Ballard 14,971,754 298,731
</TABLE>
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 the 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 abstain.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
<TABLE>
<CAPTION>
Number Title
------ -----
<S> <C>
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).
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
Registrant's Current Report on Form 8-K filed on June 22, 2000
(the "June 8-K")).
4.1 Rights Agreement (incorporated by reference to Exhibit 4 to the
June 22, 2000).
10.1 Genetic Anomalies Amended and Restated 1997 Stock Option/Stock
Issuance Plan (the "GA Plan") (incorporated by reference to
Exhibit 4.4 to the Registration Statement on Form S-8 filed on
April 27, 2000 (File No. 333-35806) (the "GA S-8")).
10.2 Form of Incentive Stock Option Agreement for the GA Plan
(incorporated by reference to Exhibit 4.5 to the GA S-8).
10.3 Amended and Restated 1997 Stock Option Plan (incorporated by
reference to Exhibit A to Information Required in Proxy Statement
on Schedule 14A filed June 23, 2000).
27 Financial Data Schedule.
</TABLE>
20
<PAGE> 21
<TABLE>
<S> <C>
99 Risk Factors (incorporated by reference to pages 3-10 of
Registration Statement on Form S-3 filed on June 30, 2000 (File
No. 333-40698)).
</TABLE>
(b) Reports on Form 8-K
Current Report on Form 8-K dated June 22, 2000 reporting
under item 5.
21
<PAGE> 22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: August 14, 2000 THQ INC.
By: /s/ Brian J. Farrell
----------------------------------
Brian J. Farrell
President and Chief
Executive Officer
THQ INC.
By: /s/ Fred Gysi
----------------------------------
Fred Gysi
Senior Vice President
Finance and Administration
Principal Accounting Officer
22
