-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FIiXBCDwp0f7Iu4CCZysdBF4feHkRitM/b7gmhVkZn4iN0am782pHlEKw/sLNRx3 ZWdIAl0q6nb5koWePQY63w== 0000950148-99-002478.txt : 19991117 0000950148-99-002478.hdr.sgml : 19991117 ACCESSION NUMBER: 0000950148-99-002478 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991115 FILER: COMPANY DATA: COMPANY CONFORMED NAME: THQ INC CENTRAL INDEX KEY: 0000865570 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 133541686 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-18813 FILM NUMBER: 99752867 BUSINESS ADDRESS: STREET 1: 27001 AGOURA ROAD STREET 2: SUITE # 325 CITY: CALABASAS HILLS, STATE: CA ZIP: 91301 BUSINESS PHONE: (818) 871-5000 MAIL ADDRESS: STREET 1: 5016 N PKWY CALABASAS STREET 2: STE 100 CITY: CALABASAS STATE: CA ZIP: 91302 FORMER COMPANY: FORMER CONFORMED NAME: TRINITY ACQUISITION CORP/NY/ DATE OF NAME CHANGE: 19600201 10-Q 1 FORM 10-Q (09/30/1999) 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, 1999 [ ] 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, Suite 325, 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: 12,316,195 shares (as of November 10, 1999). 2 THQ INC. AND SUBSIDIARIES INDEX
Page ---- Part I - Financial Information Item 1. Consolidated Financial Statements: Consolidated Balance Sheets - September 30, 1999 and December 31, 1998 3 Consolidated Statements of Operations - for the Three Months and Nine Months Ended September 30, 1999 and 1998 4 Consolidated Statement of Shareholders' Equity - for the Nine Months Ended September 30, 1999 and the Year Ended December 31, 1998 5 Consolidated Statements of Cash Flows - for the Nine Months Ended September 30, 1999 and 1998 6 Notes to Consolidated Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Quantitative and Qualitative Disclosures about Market Risk 20 Part II - Other Information Item 5. Other Information 21 Item 6. Exhibits and Reports on Form 8-K 22 Signatures 23
2 3 Part I - Financial Information Item 1. Financial Statements. THQ INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (unaudited)
December 31, 1998 September 30, (Restated. 1999 See footnote 2) ------------- -------------- ASSETS Current assets: Cash and cash equivalents $ 26,787,000 $ 19,044,000 Accounts receivable - net 35,467,000 59,521,000 Inventory 5,194,000 16,937,000 Prepaid and deferred royalties 6,721,000 5,270,000 Software development costs 12,445,000 3,011,000 Deferred income taxes 8,471,000 8,321,000 Prepaid expenses and other current assets 4,277,000 1,551,000 ------------- ------------- Total current assets 99,362,000 113,655,000 Property and equipment - net 3,150,000 2,638,000 Deferred royalties - net of current portion 525,000 375,000 Software development costs - net of current portion 1,569,000 1,173,000 Deferred income taxes - net of current portion 2,717,000 2,053,000 Other long-term assets 8,856,000 7,739,000 ------------- ------------- TOTAL ASSETS $ 116,179,000 $ 127,633,000 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Lines of credit $ -- $ 9,909,000 Accounts payable and accrued expenses 22,199,000 29,888,000 Accrued royalties 7,715,000 15,944,000 Income taxes payable 513,000 8,270,000 ------------- -------------- Total current liabilities 30,427,000 64,011,000 Accrued royalties - net of current portion 525,000 375,000 Commitments and contingencies Shareholders' equity: Common stock, par value $.01, 35,000,000 shares authorized; 12,025,731 shares and 11,769,143 shares issued and outstanding as of September 30, 1999 and December 31, 1998, respectively 120,000 118,000 Additional paid-in capital 65,722,000 62,187,000 Accumulated other comprehensive income (105,000) 60,000 Retained earnings 19,490,000 882,000 ------------- -------------- Total shareholders' equity 85,227,000 63,247,000 ------------- -------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 116,179,000 $ 127,633,000 ============= ==============
See notes to consolidated financial statements. 3 4 THQ INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Three Months Ended Nine Months Ended September 30, September 30, ------------------------------ ------------------------------- 1998 1998 (Restated. (Restated. 1999 See footnote 2) 1999 See footnote 2) ------------ -------------- ------------- --------------- Net sales $ 44,289,000 $ 26,230,000 $174,606,000 $104,406,000 Costs and expenses: Cost of sales 18,382,000 11,220,000 76,212,000 45,195,000 Royalties and project abandonment 5,811,000 5,042,000 28,495,000 21,095,000 Product development 3,711,000 1,513,000 8,852,000 4,353,000 Selling and marketing 6,678,000 3,167,000 20,765,000 10,854,000 General and administrative 2,951,000 2,043,000 10,915,000 7,009,000 In-process research and development -- -- -- 7,232,000 ------------ ------------ ------------ ------------ Total costs and expenses 37,533,000 22,985,000 145,239,000 95,738,000 ------------ ------------ ------------ ------------ Income from operations 6,756,000 3,245,000 29,367,000 8,668,000 Interest income, net 304,000 255,000 954,000 724,000 ------------ ------------ ------------ ------------ Income before income taxes 7,060,000 3,500,000 30,321,000 9,392,000 Provision for income taxes 2,119,000 1,254,000 11,713,000 5,372,000 ------------ ------------ ------------ ------------ Net income $ 4,941,000 $ 2,246,000 $ 18,608,000 $ 4,020,000 ============ ============ ============ ============ Net income per share - basic $ 0.41 $ 0.20 $ 1.55 $ 0.36 ============ ============ ============ ============ Net income per share - diluted $ 0.37 $ 0.18 $ 1.42 $ 0.34 ============ ============ ============ ============ Shares used in per share calculation - basic 11,921,000 11,392,000 11,968,000 11,095,000 ============ ============ ============ ============ Shares used in per share calculation - diluted 13,209,000 12,221,000 13,118,000 11,958,000 ============ ============ ============ ============
See Notes to Consolidated Financial Statements. 4 5 THQ INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY For the Year Ended December 31, 1998 and the Nine Months Ended September 30, 1999 (Restated)
Accumulated Retained Additional Other Earnings Common Common Paid-in Comprehensive (Accumulated Shares Amount Capital Income (Loss) Deficit) Total ------------ ------------ ------------ ------------ ------------ ------------ Balance at January 1, 1998 10,645,660 $ 9,000 $ 47,578,000 $ 81,000 $(14,155,000) $ 33,513,000 (Restated. See footnote 2) Exercise of warrants and options 601,679 5,000 2,343,000 -- -- 2,348,000 Issuance of common stock 521,804 4,000 10,647,000 -- -- 10,651,000 Stock compensation -- -- 116,000 -- -- 116,000 Tax benefit related to the exercise of employee stock options -- -- 1,603,000 -- -- 1,603,000 Reincorporation -- 100,000 (100,000) -- -- -- Comprehensive income: Net income -- -- -- -- 15,037,000 15,037,000 Other comprehensive income Foreign currency translation adjustment -- -- -- (21,000) -- (21,000) ------------ Comprehensive income -- -- -- -- -- 15,016,000 ------------ ------------ ------------ ------------ ------------ ------------ Balance at December 31, 1998 11,769,143 118,000 62,187,000 60,000 882,000 63,247,000 Exercise of warrants and options 256,588 2,000 1,857,000 -- -- 1,859,000 Stock compensation -- -- 45,000 -- -- 45,000 Tax benefit related to the exercise of employee stock options -- -- 1,633,000 -- -- 1,633,000 Comprehensive income: Net income -- -- -- -- 18,608,000 18,608,000 Other comprehensive income Foreign currency translation adjustment -- -- -- (165,000) -- (165,000) ------------ Comprehensive income -- -- -- -- -- 18,443,000 ------------ ------------ ------------ ------------ ------------ ------------ Balance at September 30, 1999 12,025,731 $ 120,000 $ 65,722,000 $ (105,000) $ 19,490,000 $ 85,227,000 ============ ============ ============ ============ ============ ============
See notes to consolidated financial statements. 5 6 THQ INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Nine Months Ended September 30, -------------------------------- 1998 (Restated. 1999 See footnote 2) ------------ --------------- Cash flows from operating activities: Net income $ 18,608,000 $ 4,020,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,050,000 641,000 Provision for doubtful accounts, discounts and returns 19,064,000 3,870,000 Loss on disposal of fixed assets 47,000 -- Loss on sale of investment securities -- 218,000 In-process research and development -- 7,232,000 Increase in deferred income taxes (815,000) -- Changes in operating assets and liabilities: Accounts receivable 4,705,000 16,835,000 Inventory 11,563,000 (1,462,000) Prepaid and deferred royalties and software development costs (9,237,000) (1,182,000) Prepaid expenses and other current assets (2,546,000) (348,000) Accounts payable and accrued expenses (7,077,000) (6,140,000) Accrued royalties (11,005,000) (4,872,000) Income taxes payable (5,820,000) (7,020,000) ------------ ------------ Net cash provided by operating activities 18,537,000 11,792,000 Cash flows used in investing activities: Proceeds from sale of investment securities -- 863,000 Purchase of marketable securities -- (1,081,000) Investment in joint venture -- (2,010,000) Payment for purchase of GameFx, Inc. -- (1,275,000) Proceeds from sale of property and equipment 29,000 -- Increase in other long-term assets (1,630,000) -- Acquisition of equipment (1,497,000) (637,000) ------------ ------------ Net cash used in investing activities (3,098,000) (4,140,000) Cash flows (used in) provided by financing activities: Net decrease in short-term borrowings (9,586,000) -- Unearned compensation 45,000 -- Proceeds from exercise of options and warrants 1,859,000 1,711,000 ------------ ------------ Net cash (used in) provided by financing activities (7,682,000) 1,711,000 Effect of exchange rate changes on cash (14,000) 201,000 ------------ ------------ Net increase in cash and cash equivalents 7,743,000 9,564,000 Cash and cash equivalents - beginning of period 19,044,000 11,754,000 ------------ ------------ Cash and cash equivalents - end of period $ 26,787,000 $ 21,318,000 ============ ============
6 7 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period: Income taxes $ 19,513,000 $ 12,372,000 ============ ============ Interest $ 178,000 $ 20,000 ============ ============ SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES: Tax benefit from disqualified disposition $ 1,633,000 $ 620,000 ============ ============
NON-CASH TRANSACTIONS: On May 1, 1998 we issued 355,184 shares of common stock as part of the purchase price for GameFx, Inc. This issuance increased common stock and additional paid-in capital by $2,000 and $6,217,000, respectively, and was allocated among the net assets acquired, part of which was written off as in-process research and development. See notes to consolidated financial statements. 7 8 THQ INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Unaudited Interim Financial Information. The financial statements included herein 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 for the year ended December 31, 1998. 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 nine months ended September 30, 1999 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:
For the Three Months Ended For the Nine Months Ended September 30, September 30, --------------------------- --------------------------- 1999 1998 1999 1998 ------------ ------------ ------------ ------------ Net income used to compute basic and diluted earnings per share $ 4,941,000 $ 2,246,000 $ 18,608,000 $ 4,020,000 ------------- ------------- ------------- ------------- Weighted average number of shares outstanding - basic 11,921,000 11,392,000 11,968,000 11,095,000 Dilutive effect of stock options and warrants 1,288,000 829,000 1,150,000 863,000 ------------- ------------- ------------- ------------- Number of shares used to compute earnings per share - diluted $ 13,209,000 $ 12,221,000 $ 13,118,000 $ 11,958,000 ============= ============= ============= =============
8 9 Cash Equivalents. We consider all highly liquid investments purchased with maturities less than three months to be cash equivalents. 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. Reclassifications. Certain items in the 1998 financial statements have been reclassified to conform to the 1999 presentation. 2. BUSINESS COMBINATION On May 24, 1999, we completed a merger with Pacific Coast Power and Light Company, a California corporation ("PCP&L"). In the merger, each share of PCP&L was converted into 0.09008 shares of our common stock, or approximately 485,000 shares. In addition, outstanding PCP&L employee stock options were assumed by us and converted, at the same conversion rate, into options to purchase approximately 131,000 shares of our common stock. The merger has been accounted for as a pooling of interests 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 PCP&L had always been part of our company. All transactions between us and PCP&L have been eliminated in the combined financial statements. The results of operations for the separate companies and the combined amounts presented in the consolidated financial statements follow.
For the Three Months Ended For the Nine Months Ended September 30, September 30, ------------------------------ --------------------------------- Net sales 1999 1998 1999 1998 ------------ ------------ -------------- ------------- THQ Inc. $ 44,063,000 $ 25,963,000 $ 173,925,000 $ 103,742,000 PCP&L 226,000 367,000 1,286,000 1,214,000 Intercompany elimination -- (100,000) (605,000) (550,000) ------------ ------------ -------------- ------------- Combined $ 44,289,000 $ 26,230,000 $ 174,606,000 $ 104,406,000 ============ ============ ============== =============
9 10
For the Three Months Ended For the Nine Months Ended September 30, September 30, ------------------------------ --------------------------------- Net income (loss) 1999 1998 1999 1998 ------------ ------------ -------------- ------------- THQ Inc. $ 5,175,000 $ 2,426,000 $ 19,938,000 $ 4,569,000 PCP&L (234,000) (80,000) (725,000) 1,000 Intercompany elimination -- (100,000) (605,000) (550,000) ------------ ------------ -------------- ------------- Combined $ 4,941,000 $ 2,246,000 $ 18,608,000 $ 4,020,000 ============ ============ ============== =============
3. 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, 1999 and December 31, 1998 are composed of the following:
September 30, December 31, 1999 1998 ---------------- --------------- Accounts receivable -- domestic $ 34,959,000 $ 66,407,000 Other receivables -- domestic 427,000 280,000 Allowance for domestic doubtful accounts, discounts and returns (13,226,000) (15,008,000) Accounts receivable -- foreign 20,206,000 11,732,000 Allowance for foreign doubtful accounts (281,000) (2,345,000) Allowance for foreign discounts and returns (6,618,000) (1,545,000) ---------------- --------------- Accounts receivable -- net $ 35,467,000 $ 59,521,000 ================ ===============
4. STOCK COMPENSATION PCP&L granted stock options at prices below fair market value. The difference between the fair value and the option grant price is amortized and recognized over the option vesting period, generally four years. As of the nine months ended September 30, 1999 and 1998, stock-based compensation of $45,000 and $81,000, respectively, was amortized to expense. As of September 30, 1999 and December 31, 1998 we had unamortized and stock-based compensation expense of $306,000 and $430,000, respectively. 5. SUBSEQUENT EVENTS On October 26,1999, we announced a three-for-two stock split to be effected in the form of a 50% stock dividend payable on or about December 1, 1999 to stockholders of record on November 15, 1999. The accompanying consolidated financial statements have not been adjusted to reflect the effect of the stock split. 10 11 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 Report on Form 8-K/A, filed on March 10, 1999 with the Securities and Exchange Commission. 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:
Three Months Ended Nine Months Ended September 30, September 30, ------------------- -------------------- Platform 1999 1998 1999 1998 - -------- ------ ------ ------ ------ Nintendo 64 36% 43% 32% 45% PlayStation 36% 45% 45% 44% Game Boy Color/Game Boy 9% 5% 10% 8% PC CD-Rom 15% 5% 11% 1% Other 4% 2% 2% 2%
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. See "-- Recovery of Prepaid Royalties, Guarantees and Capitalized Development Costs." 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 the United Kingdom or Germany for foreign distribution. Foreign sales to distributors in countries other than the United Kingdom and Germany are shipped at the customer's expense directly to the 11 12 customer's location. Both in the United Kingdom and in Germany, we sell directly to our major retail accounts. 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. Revenue Fluctuations and Seasonality. We have experienced and may continue to experience significant quarterly fluctuations in net sales and operating results due to a variety of factors. The software market is highly seasonal, with sales typically significantly higher during the fourth quarter (due primarily to the increased demand for interactive games during the year-end holiday buying season). Other factors that cause fluctuations include the timing of our release of new titles, the popularity of both new titles and titles released in prior periods, changes in the mix of titles with varying profit margins, the timing of customer orders, the timing of shipment by the manufacturers, fluctuations in the size and rate of growth of consumer demand for software for various platforms, the timing of the introduction of new platforms and the accuracy of retailers' forecasts of consumer demand. Our expenses are based, in part, on our expectations of future revenues and, as a result, operating results would be disproportionately and adversely affected by a decrease in sales or a failure by us to meet our sales expectations. There can be no assurance that we can maintain consistent profitability on a quarterly or annual basis. Profit margins may vary over time as a result of a variety of factors. Profit margins for cartridge products can vary based on the cost of the memory chip used for a particular title. As games have become more complex by providing higher playing capabilities, the trend in the interactive entertainment software industry has been to utilize chips with greater capacity and thus greater cost. While CD-Roms have significantly lower per unit manufacturing costs than cartridge-based products, they generally have higher royalty rates. Recovery of Prepaid Royalties, Guarantees and Capitalized Development Costs. We typically enter into agreements with licensors of properties and developers of titles that require advance payments of royalties and/or guaranteed minimum royalty payments. We cannot guarantee that the sales of products for which such royalties are paid will be sufficient to cover the amount of these required royalty payments. We capitalize our advances to developers as prepaid royalties and capitalize internal software development costs for each title incurred after the establishment of technological feasibility of the title. Amortization of these payments and costs is determined on a title-by-title basis based on the greater of (i) the ratio of current gross revenues for a title to the sum of its current and anticipated gross revenues, or (ii) the straight-line method over the estimated remaining economic life of the title. We analyze such capitalized costs quarterly and write off associated prepaid and deferred royalties and software development costs when, based on our estimate, future revenues will not be sufficient to recover such amounts. As of September 30, 1999, we have prepaid royalties and capitalized software development costs of $21.3 million. If we were required to write off prepaid royalties or capitalized development costs in excess of the amounts reserved, our results of operations could be materially and adversely affected. 12 13 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 items falls below expectations, in order to maintain our relationships with our customers. These accommodations consist of acquiescing to the customer's request that not all booked orders are filled or that not all shipped orders be accepted, 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, 1999 and September 30, 1998, provisions of $19.1 million and $12.2 million, respectively, were taken against gross sales made during such periods. As of September 30, 1999, our aggregate reserve against accounts receivable for returns, customer accommodations and doubtful accounts was $20.1 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. 13 14 RESULTS OF OPERATIONS 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:
Three Months Ended Nine Months Ended September 30, September 30, ------------------- -------------------- 1999 1998 1999 1998 ------ ------ ------ ------ Domestic sales(1) 58.0% 89.7% 73.7% 84.9% Foreign sales(1) 42.0 10.3 26.3 15.1 ------ ------ ------ ------ Net sales 100.0% 100.0% 100.0% 100.0% Costs and expenses: Cost of sales 41.5% 42.8% 43.6% 43.3% Royalties and project abandonment 13.1 19.2 16.3 20.2 Product development 8.4 5.7 5.1 4.2 Selling and marketing 15.1 12.1 11.9 10.4 General and administrative 6.6 7.8 6.3 6.7 In-process research and development -- -- -- 6.9 ------ ------ ------ ------ Total costs and expenses 84.7% 87.6% 83.2% 91.7% ------ ------ ------ ------ Income from operations 15.3% 12.4% 16.8% 8.3% Interest income, net 0.7 .9 0.6 0.7 ------ ------ ------ ------ Income before income taxes 16.0 13.3 17.4 9.0 ------ ------ ------ ------ Net income 11.2% 8.6% 10.7% 3.9% ====== ====== ====== ======
(1) (These percentages were previously misreported in our press release dated October 26, 1999 as being 51.6% domestic and 48.4% foreign, and 74.1% domestic and 25.9% foreign for the three and nine months ended September 30, 1999, respectively.) Title Releases The following table sets forth, for the three months and nine months ended September 30, 1999 and 1998, the titles released during such periods for the platforms indicated:
Three Months Ended Nine Months Ended September 30, September 30, ------------------------ ------------------------- 1999 1998 1999 1998 -------- -------- -------- -------- Nintendo 64 3 -- 6 1 PlayStation 3 3 5 7 Game Boy -- -- 3 1 PC CD-Rom 6 3 9 4 Other -- -- -- 1 ------- -------- -------- -------- Total 12 6 23 14 ======= ======== ======== ========
14 15 COMPARISON OF THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1999, TO THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1998 Our net sales increased 69% to $44,289,000 in the three months ended September 30, 1999, from $26,230,000 in the same period of 1998, as a result of more titles being shipped, a growth in foreign sales, and strong continued sales from products released in past periods. For the three months ended September 30, 1999, net sales of Rugrats titles, Road Rash N64, and Championship Motocross Featuring Ricky Carmichael were $12,379,000 (28.0% of net sales), $7,740,000 (17.5% of net sales), and $5,792,000 (13.1% of net sales), respectively. Our net sales increased 67.2% to $174,606,000 in the nine months ended September 30, 1999, from $104,406,000 in the same period of 1998. As with the three months ended September 30, 1999, this increase was fueled in part by an increase in the number of titles released, the growth of our international operations, and continued demand for previously released titles. Our foreign net sales increased to $18,590,000 for the three months ended September 30, 1999, from $2,705,000 in the same period of 1998, and increased as a percentage of net sales to 42.0% from 10.3%. This growth in foreign sales is primarily attributable to our German publishing and distribution subsidiary Rushware Microhandelsgesellschaft mbH ("Rushware"), which we acquired in December 1998. Foreign net sales grew to $45,896,000 in the nine months ended September 30, 1999, from $15,787,000 in the same period of 1998, and increased as a percentage of net sales to 26.3% from 15.1%, due in large part to the sales of LucasArts' Star Wars titles and Rugrats titles. Our cost of sales for the three months ended September 30, 1999 decreased slightly as a percentage of net sales to 41.5% from 42.8% in the same period of 1998, primarily as a result of a higher percentage of PC CD-ROM product sales in our revenue mix (which generally have favorable gross margins). For the nine months ended September 30, 1999, cost of sales remained relatively constant as a percentage of net sales at 43.6%, versus 43.3% in the same period of 1998. Our royalty and project abandonment expense for the three months and nine months ended September 30, 1999 decreased as a percentage of net sales to 13.1% from 19.2% and to 16.3 % from 20.2% for the same periods of 1998. This decrease is primarily related to favorable royalty rates on certain titles sold during the third quarter of 1999, as well as not having developer royalty expenses for Road Rash N64, which was created by our internal development studio Pacific Coast Power and Light Company ("PCP&L"). For the three months and nine months ended September 30, 1999, product development expense increased $2,198,000 to 8.4% of net sales and $4,499,000 to 5.1 % of net sales, respectively. The increase was due primarily to expenses incurred by GameFx, a company acquired in May 1998 to develop high-end PC titles, increased activity at PCP&L, a company acquired in May 1999 to develop next generation console titles, and the opening of Heavy Iron Studios, an internal development division, in September 1999. For the three months and nine months ended September 30, 1999, selling and marketing expenses increased by $3,511,000 and $9,911,000 over the comparable periods of 1998 to 15 16 15.1% of net sales and 11.9% of net sales, respectively. This increase occurred in both our domestic and international operations. We have increased our domestic marketing efforts for new titles through print and retail cooperative advertising and national television ad campaigns. We have also increased our promotional activities during 1999 from that experienced in prior years. Our increased international marketing expenses reflect higher levels of support for international titles, as well as our acquisition of Rushware. Our general and administrative expenses for the three months and nine months ended September 30, 1999 decreased as a percentage of net sales to 6.6% from 7.8% and to 6.3% from 6.7% for the same periods of 1998, but increased in dollar terms by $908,000 and $3,906,000 over 1998. The increase occurred both in response to the tremendous growth we experienced in recent periods and as a result of the inclusion of Rushware's general and administrative expenses during the nine months ended September 30, 1999. The in-process research and development charge of $7,232,000 incurred during the second quarter of 1998 represents purchase costs relating to the acquisition of GameFx. Purchased research and development includes the value of products in the development stage and not considered to have reached technological feasibility. 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 $7,743,000 from $19,044,000 at December 31, 1998 to $26,787,000 at September 30, 1999, and were $23,819,000 as of November 10, 1999. Cash provided by operating activities for the nine months ended September 30, 1999 was $18,537,000, resulting primarily from net income of $18,608,000, which was not significantly affected by changes in operating assets, liabilities and non-cash items. 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. This seasonality is responsible for the substantial decrease in accounts receivable from December 31, 1998 to September 30, 1999 as the sales generated during the fourth quarter of 1998 were collected. Inventory and accounts payable decreased during the nine months ended September 30, 1999, as a result of sales of WCW titles that we had purchased prior to the end of 1998 in anticipation of the expiration of our WCW license. Prepaid and deferred royalties and software development costs increased from December 31, 1998. This was a result of our entering into several new contracts for both properties and new product development. See "-- Recovery of Prepaid Royalties, Guarantees and Capitalized Development Costs." Accrued royalties decreased as a result of royalty payments made in the 16 17 first quarter of 1999 for sales from the fourth quarter of 1998. As of September 30, 1999, we had obligations with respect to future guaranteed minimum royalties of $8,240,000. Accounts payable and accrued expenses decreased significantly from December 31, 1998 as a result of the timing of large product receipts in the last quarter of 1998 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 revolving credit facility will be adequate to meet our anticipated requirements for operating expenses, product purchases, guaranteed payments to licensors and software development through 1999. Net cash used in investing activities for the nine months ended September 30, 1999 was $3,098,000 and was primarily utilized for capital expenditures, including $892,000 for a new enterprise resource planning ("ERP") system and $605,000 for leasehold improvements related to the relocation of our corporate offices. We expect to make additional capital expenditures of between $250,000 and $750,000 in 1999, to be used primarily for additional costs related to our ERP system and for leasehold improvements and furniture and fixtures related to our corporate office move, which occurred in October 1999. Net cash used in financing activities for the nine months ended September 30, 1999 was $7,682,000, and was attributable to the repayment of short-term borrowings. As of September 30, 1999, we had no outstanding borrowings under our credit facilities with Union Bank and had obligations in respect of outstanding letters of credit for $11,627,000. As of November 10, 1999 we had no outstanding borrowings and outstanding letters of credit were $34,200,000. Revolving Credit Facilities. In August 1999 we entered into an amendment of our trade finance agreement with Union Bank of California to increase by $5,000,000 the amount by which we are permitted to borrow. This brings our total borrowing capacity to $50,000,000 during our peak selling season. YEAR 2000 DISCLOSURE GENERAL The year 2000 issue ("Year 2000") is the result of computer programs being written using two digits, rather than four to define the applicable year. Certain information technology systems and their associated software ("IT Systems"), and certain equipment that uses programmable logic chips to control aspects of their operation ("embedded chip equipment"), may recognize "00" as a year other than the year 2000. Some IT Systems and embedded chip equipment used by the company, and by third parties who do business with the company, contain two-digit programming to define a year. As the year 2000 approaches, these systems may be unable to accurately process certain date-based information. The year 2000 issue could result, at the company and elsewhere, in system failures or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions or to engage in other normal business activities. 17 18 READINESS PLAN We consider Year 2000 compliance imperative and have established a THQ Compliance Committee to insure Year 2000 issues are being adequately addressed by all of our departments. There is a plan setting forth the methodology, cost and schedules of our Year 2000 compliance program. In general, the plan addresses potential Year 2000 issues associated with our products and services, internal financial and management systems, computer hardware and software, office systems, equipment and facilities, and products purchased from outside suppliers. Inventory. We have developed a corporate-wide, uniform strategy for assessing and addressing the Year 2000 issues. We have completed an inventory of our hardware and software systems, electronic data interchange, telecommunications and other technical assets potentially subject to Year 2000 problems, such as security systems. For those items anticipated to have a significant effect on the business if not corrected, our Year 2000 program envisions repair or replacement and testing of such items. All information relative to each item is being tracked in a Year 2000 database. Most of this phase was completed during the first three quarters of 1999. We have completed a review of the readiness of embedded microprocessors in our products and believe that none of the products have Year 2000 date sensitive systems. Correction and Testing. During the fourth quarter of 1999 we will perform integration testing with our key third-party warehouses. We believe our current enterprise resource planning ("ERP") and electronic data interchange ("EDI") systems are Year 2000 compliant. However, we will perform integration tests in any event. Any integration issues, such as the failure of the EDI network, could be an ongoing risk. Customers and Suppliers. We have responded to all customer and partner requests for information on our Year 2000 compliance. However, we are very dependent upon Nintendo and Sony as key suppliers. If they have a problem processing orders we could be adversely affected. We have reviewed our EDI systems, and we believe that the only material action item is some minor document version updates with a customer (to be addressed in the fourth quarter of 1999). If EDI were to fail with our customers, our backup plan is to enter orders manually and invoice by paper (instead of EDI). We already perform this manual process for our smaller customers. COSTS Our costs for this project will be less than $200,000, since our systems were generally Year 2000 compliant before this project began. RISKS We expect to implement the changes necessary to address the Year 2000 issue for IT systems used within the company. We believe that, with modifications to existing software and conversions to new software, 18 19 the Year 2000 issue with respect to our IT systems is not reasonably likely to pose significant operational problems. However, if unforeseen difficulties arise or such modifications, conversions and replacements are not timely completed, or if the company's vendors' or suppliers' systems are not modified to become Year 2000 compliant, the Year 2000 issue could have a material adverse impact on our results of operations and financial condition. We are unable to assess the likelihood that we will experience significant operational problems due to unresolved Year 2000 problems of third parties with whom we do business. If third parties fail to achieve Year 2000 compliance, Year 2000 issues could have a material adverse impact on our operations. Similarly, there can be no assurance that we can timely mitigate our risks related to a supplier's failure to resolve its Year 2000 issues. If such mitigation is not achievable, Year 2000 problems could have a material adverse impact on our operations. CONTINGENCY PLAN We presently believe that the most reasonably likely worst-case Year 2000 scenarios would relate to the possible failure, in one or more geographic regions, of third party systems over which we have no control and for which we have no ready substitute such as, but not limited to, power and telecommunications services. Another worst-case scenario involving transportation supply-chain or a critical supplier of materials would be the partial or complete shutdown of transportation facilities or the supplier. The result could be an inability to provide us with critical materials on a timely basis. Contingency planning will consider alternatives where efforts to work with critical suppliers and vendors to ensure Year 2000 capability have not been successful. We are not in a position to identify or to avoid all possible scenarios. We are currently assessing scenarios and taking steps to mitigate the impacts of various scenarios if they were to occur. This contingency planning will continue through 1999 as we learn more about the preparations and vulnerabilities of third parties regarding Year 2000 issues. Due to the large number of variables involved, we cannot provide an estimate of the damage we might suffer if any of these scenarios were to occur. 19 20 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 foreign currency fluctuation. While our consolidated financial statements are prepared in United States dollars, a portion of our worldwide operations have a functional currency other than the United States dollar. In particular, we maintain operations in Germany and the United Kingdom, where the functional currencies are Deutschmarks and British Pounds, respectively. Most of our revenues are denominated in the United States dollar. Fluctuations in exchange rates may have a material adverse effect on our results of operations and could also result in exchange losses. The impact of future exchange rate fluctuations cannot be predicted adequately. To date, exchange rate fluctuations have not had a material impact on our earnings and we have not sought to hedge the risks associated with fluctuations in exchange rates, but may undertake such transactions in the future. We do not have a policy relating to hedging. There can be no assurance that any hedging techniques implemented by us would be successful or that our results of operations will not be materially adversely affected by exchange rate fluctuations. We generate revenues and costs that fluctuate with changes in foreign currency exchange rates when transactions are denominated in currencies other than the local currency. The German and United Kingdom subsidiaries purchase some products denominated in US dollars, but sell product primarily in German Marks (or currencies that are closely tied to the Mark) and Pound Sterling. We have not historically hedged this risk. Based on the relative size and nature of our foreign operations, we do not believe that a ten percent change in foreign currencies would have a material impact on our financial statements. ------------------------------------------- 20 21 Part II - Other Information Item 5: Other Information We have entered into an operating agreement JAKKS Pacific, Inc. ("JAKKS"), dated October 25, 1999, for THQ/JAKKS Pacific, LLC (the "Joint Venture"), the joint venture formed to develop, manufacture, distribute, market and sell video games pursuant to a license from the World Wresting Federation Entertainment, Inc. (the "WWF"). The principal terms of this operating agreement are as follows: 1. THQ will be responsible for funding all operations of the Joint Venture, including all payments owing by the Joint Venture to the WWF. 2. For the period commencing October 25, 1999 and ending December 31, 2003, JAKKS will be entitled to receive from the Joint Venture a preferred return, payable quarterly, equal to the greater of a specified dollar amount or specified percentages of the Joint Venture's "net sales" (as defined) in amounts that vary based on the platform. The Joint Venture's payment of the JAKKS preferred return is guaranteed by THQ. THQ will be entitled to cash distributions made by the Joint Venture after the payment of the preferred return. 3. For periods after December 31, 2003, the amount of the preferred return payable to JAKKS will be subject to renegotiation between the parties. An arbitration procedure is specified in the event the parties do not reach agreement. 4. THQ will be responsible for the day-to-day operations of the Joint Venture. THQ will continue to be responsible for development, manufacturing, distribution and sales of the Joint Venture's games, while JAKKS will continue to be responsible for relationship matters with the WWF. THQ and JAKKS will continue to co-market the games. 21 22 Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits.
Number Title ------ ----- 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 3.3 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1998). 27 Financial Data Schedule.
(b) Reports on Form 8-K. None. 22 23 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: November 15, 1999 THQ INC. By: /s/ BRIAN J. FARRELL ------------------------- Brian J. Farrell President and Chief Executive Officer THQ INC. By: /s/ FRED GYSI ------------------------- Fred Gysi Vice President Finance and Administration Principal Accounting Officer 23 EX-27 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS, THE CONSOLIDATED STATEMENTS OF OPERATIONS AND CONSOLIDATED STATEMENT OF CASH FLOWS AND IS QUALIFIED IN ITS ENTIRETY TO SUCH FINANCIAL STATEMENTS FOUND IN FORM 10-Q AS FILED WITH THE SEC ON NOVEMBER 15, 1999. 9-MOS DEC-31-1999 JAN-01-1999 SEP-30-1999 26,787,000 0 55,592,000 20,125,000 5,194,000 99,362,000 6,284,000 3,134,000 116,179,000 30,427,000 0 0 0 120,000 85,107,000 116,179,000 174,606,000 174,606,000 76,212,000 76,212,000 69,027,000 19,064,000 169,000 30,321,000 11,713,000 18,608,000 0 0 0 18,608,000 1.55 1.42
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