-----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, QFMzoiCGP66Zyk2hPAQPycJ/0c5QstW8y/dgDFQo4bkRIY12brmeuK5fGpqsaaDC BJ+r0vxgoThr1THMgAx5Aw== 0000950150-01-000105.txt : 20010402 0000950150-01-000105.hdr.sgml : 20010402 ACCESSION NUMBER: 0000950150-01-000105 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010329 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-K405 SEC ACT: SEC FILE NUMBER: 001-15959 FILM NUMBER: 1585140 BUSINESS ADDRESS: STREET 1: 27001 AGOURA ROAD STREET 2: SUITE # 325 CITY: CALABASAS HILLS, STATE: CA ZIP: 91301 BUSINESS PHONE: 8188715000 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-K405 1 a70675e10-k405.txt FORM 10-K405 FISCAL YEAR ENDED DECEMBER 31, 2000 1 ================================================================================ ---------------------------- OMB APPROVAL ---------------------------- OMB Number: 3235-0063 ---------------------------- Expires: March 31, 2003 ---------------------------- Estimated average burden hours per response: 430.00 ---------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____ TO _____ COMMISSION FILE NUMBER 0-18813 THQ INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) --------------- DELAWARE 13-3541686 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 27001 AGOURA ROAD CALABASAS HILLS, CA 91301 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 871-5000 --------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: Preferred Stock Purchase Rights SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, $.01 par value Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 26, 2001, approximately 20,989,000 shares of Common Stock of the Registrant were outstanding and the aggregate market value of voting Common Stock held by non-affiliates was approximately $768,395,000. ================================================================================ 2 THQ INC. INDEX TO ANNUAL REPORT ON FORM 10-K FILED WITH THE SECURITIES AND EXCHANGE COMMISSION YEAR ENDED DECEMBER 31, 2000
- ---------------------------------------------------------------------------------------------- ITEMS IN FORM 10-K PAGE ----------------------------------------------------------------- -------- Facing page PART I Item 1. Business. 1 Item 2. Properties. 14 Item 3. Legal Proceedings. 15 Item 4. Submission of Matters to a Vote of Security Holders. 15 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters. 16 Item 6. Selected Financial Data. 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 18 Item 7A. Quantitative and Qualitative Disclosures About Market Risk. 26 Item 8 Financial Statements and Supplementary Data 27 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 27 PART III Item 10. Directors and Executive Officers of the Registrant. 28 Item 11. Executive Compensation. 30 Item 12. Security Ownership of Certain Beneficial Owners and Management. 36 Item 13. Certain Relationships and Related Transactions. 37 PART IV Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K. 38 Signatures 40
3 This Annual 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, "Business" and "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, filed on November 13, 2000, with the Securities and Exchange Commission. PART I ITEM 1. BUSINESS INTRODUCTION We are a developer, publisher and distributor of interactive entertainment software for the leading hardware platforms in the home video game market. We currently publish titles for Sony's PlayStation and PlayStation 2, Nintendo 64, Nintendo Game Boy Color, and personal computers ("PCs") in most interactive software genres, including childrens, action, adventure, driving, fighting, puzzle, role playing, simulation, sports and strategy. Our customers include Wal-Mart, Toys "R" Us, Electronics Boutique, Target, Kmart Stores, Babbages Etc., Best Buy, Kay Bee Toys, other national and regional retailers, discount store chains and specialty retailers. Our games are based on intellectual property licensed from third parties or created internally. We continually seek to identify and develop titles based upon entertainment projects (such as movies and television programs), sports and entertainment personalities, popular sports and trends or concepts that have high public visibility or recognition or that reflect the trends of popular culture. Our games are developed both internally and under contract with independent developers. Other than games that we release on CD-ROM for use on PCs, all of our products consist of cartridges, CD-ROMs and DVDs manufactured for us by Nintendo and Sony. In the year ended December 31, 2000, our net sales increased to $347.0 million from $303.5 million in 1999, $216.7 million in 1998 and $90.2 million in 1997. During the year ended December 31, 2000, our net income was $18.2 million, as compared to our 1999 net income of $31.3 million. This change in net income reflects the impact of a platform transition year and an increase in development and overhead costs as we prepare for the next generation of console systems. We are a Delaware corporation that was incorporated in 1997. We were formerly incorporated in New York in 1989 under the name Trinity Acquisition Corporation, which changed its name in 1990 to T.HQ, Inc. through a merger with T.HQ, Inc., a California corporation. Our principal executive offices are located at 27001 Agoura Road, Calabasas Hills, California 91301, and our telephone number is (818) 871-5000. Our web site is at www.thq.com. THQ(R)is our registered trademark and trade name. Nintendo(R), Nintendo Entertainment System(R)("NES"), Super Nintendo Entertainment System(R)("SNES"), Game Boy(R), Game Boy -1- 4 Color(R), Game Boy Advance(R), Gamecube(R)and Nintendo 64(R)are registered trademarks of Nintendo of America, Inc. ("Nintendo"). Sega(R), Genesis(R), Game Gear(R), Saturn(R)and Dreamcast(R)are registered trademarks of Sega of America, Inc. ("Sega"). Sony PlayStation(R)and Sony PlayStation 2(R)are registered trademarks of Sony Computer Entertainment Inc. ("Sony"). Microsoft XBox(R)is a registered trademark of Microsoft Corporation ("Microsoft"). Nintendo and Sony are referred to herein collectively as the "manufacturers." THE INTERACTIVE ENTERTAINMENT INDUSTRY AND TECHNOLOGY The home interactive game market consists both of (i) cartridge-based, CD-ROM-based and DVD based software for use solely on dedicated hardware systems, and (ii) software distributed on CD-ROMs for use on PCs. Until 1996, most software for dedicated platforms was sold in cartridge form. Since then, CD-ROMs and DVDs have become increasingly popular because they have substantially greater data storage capacity and lower manufacturing costs than cartridges. The first modern platform was introduced by Nintendo in 1985 using "8-bit" technology. "8-bit" means that the central processing unit, or "chip," on which the software operates is capable of processing data in 8-bit units. Subsequent advances in technology have resulted in continuous increases in the processing power of the chips that power both the platforms and PCs. As the technology of the hardware has advanced, the software designed for the platforms has similarly advanced, with faster and more complex images, more lifelike animation and sound effects and more intricate scenarios. The larger data storage capacity of DVDs and other disk media for systems such as the Sony PlayStation 2 and the yet to be released Microsoft Xbox and the Nintendo Gamecube enables them to provide richer content and longer play. This new generation of systems are based primarily on 128-bit technology, however, the 32-bit and 64-bit technology platforms are still providing markets for software. The following table sets forth the year in which each of the manufacturers' platforms, for which we have published titles and technology, released in the United States:
DATE OF U.S. MANUFACTURER PRODUCT NAME INTRODUCTION TECHNOLOGY ------------ ------------ ------------ ----------------- Nintendo NES 1985 8-bit Nintendo Game Boy 1989 8-bit (portable) Sega Game Gear 1991 8-bit (portable) Sega Genesis 1989 16-bit Nintendo SNES 1991 16-bit Sega Saturn 1995 32-bit Sony PlayStation 1995 32-bit Nintendo Nintendo 64 1996 64-bit Nintendo Game Boy Color 1998 16-bit (portable) Sega Dreamcast 1999 128-bit Sony PlayStation 2 2000 128-bit
-2- 5 Sony launched the successor to the PlayStation, the PlayStation 2, in the U.S. market in October 2000. Nintendo has plans to launch the handheld Game Boy Advance platform in the summer of 2001, as well as another new console platform in the fall of 2001 called the Gamecube. Microsoft has also announced a new platform, Xbox, scheduled to debut in the fall of 2001. We have indicated that we will publish for these new platforms. Software for the new platforms requires different standards of design and technology to fully exploit their capabilities. The introduction of new platforms also requires that game developers devote substantial additional resources to product design and development. BUSINESS STRATEGY Our goals are to increase market share and expand our position as a leading provider of exciting, high-quality interactive entertainment software on a variety of platforms, to intelligently take advantage of opportunities provided by the Internet and wireless handheld devices, and to continue to emphasize profitability by maintaining strict cost controls and managing the risks associated with software development. In order to achieve these goals, management is focused on implementing the following strategies: - - Build Diversified Portfolio of Brands. Brand recognition and sustainable consumer appeal allow us to exploit titles over an extended period of time through the release of sequels and extensions and to re-release such products at different price points. Brands represent content which we believe have continuing value and over which we have control either by developing our own proprietary titles or by obtaining exclusive licenses to established properties for extended time periods. During 2000 we continued to support our key brands, World Wrestling Federation and Nickelodeon's Rugrats, with titles released on multiple platforms. We also launched four new brands, including Power Rangers, Scooby-Doo, Summoner and Evil Dead. We intend to continue to obtain new licenses with broad consumer appeal, as evidenced by our recent deal with Mattel for its Matchbox and HotWheels properties, and to further invest in internal brands by developing original content such as Red Faction, RMX racing and New Legends. - - Technology and Internal Development. We intend to publish for all of the next generation video game systems which we believe will attain a significant installed base of hardware. The expansion of our product development department to over 200 employees strengthens our position to take full advantage of new game technology. Our first PlayStation 2 product, Summoner, was available at the launch of the new hardware platform and was developed by our internal development studio, Volition, acquired in August 2000. Volition's mission is to bring original content to the PlayStation 2, PC and possibly other platforms, as evidenced by the expected Spring, 2001 release of Red Faction. Pacific Coast Power & Light Company is focused on bringing our motocross brand RMX 2002 to the PlayStation 2 and Xbox platforms. Heavy Iron Studios is currently working on Evil Dead and Scooby-Doo titles for next generation platforms. Helixe is developing games for Nintendo's Game Boy Advance platform. - - On-line Gaming/E-Commerce. Our first on-line title, WWF: With Authority, was released in February 2001. This title is currently accessible through the World Wrestling Federation Entertainment, Inc.'s (the "WWF") website. WWF: With Authority was developed by one of our internal studios, Genetic Anomalies. Genetic Anomalies' "Collectible Bits" technology has -3- 6 application to both on-line gaming and E-Commerce environments. Further, we are examining opportunities for bringing our mass-market brands to games playable over the Internet while preparing to take advantage of the on-line capabilities of new console systems and broadband connectivity. - - Wireless Gaming. We intend to leverage our handheld videogame expertise in delivering interactive entertainment experiences to cell phone and mobile device owners worldwide. In September 2000 we completed an agreement with Siemens AG's Information and Communication Mobile division to create games for Siemens' mobile devices. These devices range from WAP-enabled mobile phones to Windows-based devices with multimedia, wireless Internet and mobile phone capabilities. The first games under this new agreement are scheduled for worldwide release in 2001. We believe that many of our intellectual properties may have wireless game applications. - - Expand Global Reach. We believe we can expand our presence in foreign markets. Industry estimates indicate that the international market for interactive software is roughly equal to the U.S. market. Foreign marketing and distribution capabilities were expanded in 2000 with the opening of new sales and marketing offices in France and Australia. To further grow in foreign markets, we intend to continue to build brands that have global consumer appeal. Additionally, we will acquire or develop properties that primarily appeal to consumers in Europe and other non-U.S. territories. We will also seek applications of newer technologies (e.g. on-line gaming or wireless gaming) that have special appeal in territories outside of the U.S. - - Continue to Exploit the Game Boy Color and Publish for the Game Boy Advance Platforms. As the largest independent domestic publisher of Game Boy titles (according to the NPD's TRST data), we will continue to take advantage of this platform and its successor, the Game Boy Advance (scheduled to launch in June 2001). Our market position makes us an attractive partner for intellectual property holders wanting to put their products on the Game Boy systems as evidenced by our recent agreements with Nickelodeon for SpongeBob SquarePants, Rocket Power, The Wild Thornberrys and Jimmy Neutron and Mattel for the Matchbox and HotWheels franchises. The relative low cost of developing games for the Game Boy, combined with the platform's large installed base, provides the opportunity to generate continuing sales and profits from this system with less risk than other platforms. - - Enhance Margins, Maintain Cost Controls and Manage Risk. Our continuing objective is to be among the most profitable companies in the videogame industry. We believe this can be achieved by: - Continuing to shift more of our products to higher margin. - CD-ROM and DVD platforms. - Utilizing strict ordering and inventory controls to reduce the risk of excessive or obsolete inventory. -4- 7 - Proactively working with key customers to manage field inventories, reduce the need for allowances or price protection, accelerate cash collection and lower accounts receivable balances. - Carefully scrutinizing costs and incurring less overhead than our competitors. - Building an infrastructure of experienced management and financial and operating systems that can be leveraged as the company grows. We intend to continue pursuing potential acquisition transactions consistent with these strategies. In addition, in order to create a closer relationship with independent developers, we may from time to time make investments or acquire interests in independent developers. TITLES We have released an aggregate of 253 titles as of December 31, 2000 consisting of 13 NES titles, 82 Game Boy/Game Boy Color titles, 7 Sega Game Gear titles, 14 Sega Genesis titles, 47 SNES titles, 3 Sega Saturn titles, 41 Sony PlayStation titles, 17 Nintendo 64 titles, 4 Sega Dreamcast titles, 1 Sony PlayStation 2 title and 24 PC titles. We continually seek to acquire licenses to publish and distribute additional titles. The following tables set forth, for each platform, the titles (i) released by us in 2000 and anticipated to be released in 2001, and (ii) the date of release (or anticipated release) of each title. We cannot assure you that each of the titles anticipated for release in 2001 will be released when scheduled, if ever. -5- 8
TITLES RELEASED IN 2000 - ------------------------------------------------------------------------------------------ TITLE CATEGORY PLATFORM DATE - ------------------------------------------------------------------------------------------ Tiger Woods PGA Tour 2000 Sports Game Boy Color 1/00 Brunswick Pro Bowling Sports PlayStation 2/00 WWF SmackDown! Fighting PlayStation 3/00 Force Commander(1) Strategy PC CD-ROM 3/00 Jedi Power Battle Action/Adventure PlayStation 4/00 Rugrats: Totally Angelica Childrens Games Game Boy Color 5/00 Triple Play 2001 Sports Game Boy Color 5/00 CROC Action Game Boy Color 6/00 Tomb Raider Starring Lara Croft Action/Adventure Game Boy Color 6/00 Power Rangers Lightspeed Rescue Action Game Boy Color 6/00 Jay The Lion Adventure Game Boy Color 6/00 Nascar 2000 Racing Game Boy Color 7/00 X-Tension Strategy PC CD-ROM 7/00 Star Wars Episode One: Racer(1) Racing Sega Dreamcast 8/00 WWF Royal Rumble Fighting Sega Dreamcast 8/00 Cultures: Discovery of Vinland Strategy PC CD-ROM 9/00 Mercedes Truck Racing Racing PC CD-ROM 9/00 Player Manager 2001 Sports PC CD-ROM 9/00 Danger Girl Action/Adventure PlayStation 9/00 MTV Sports: Skateboarding Extreme Sports PlayStation 9/00 Featuring Andy Macdonald PC CD-ROM Game Boy Color Buffy the Vampire Slayer Action Game Boy Color 9/00 MTV Sports: Pure Ride Extreme Sports PlayStation 9/00 Disney's The Little Mermaid II Childrens Games PlayStation 9/00 Who Wants to Be a Millionaire Second Quiz/Board Games Game Boy Color 9/00 Edition Championship Motocross 2001 Sports Game Boy Color 9/00 Featuring Ricky Carmichael Power Rangers Lightspeed Rescue Action Nintendo 64 9/00 PlayStation MTV Sports: Skateboarding Extreme Sports Sega Dreamcast 10/00 Featuring Andy Macdonald Summoner Role Playing PlayStation 2 10/00 Ballistic Puzzle PlayStation 10/00 Chicken Run Adventure Game Boy Color 11/00 Rugrats in Paris - The Movie Childrens Games Game Boy Color 11/00 PlayStation Nintendo 64 WWF No Mercy Fighting Nintendo 64 11/00 WWF SmackDown! 2: Know Your Role Fighting PlayStation 11/00 Scooby-Doo! Classic Creep Capers Adventure Nintendo 64 11/00 Micro Machines V3 Racing Game Boy Color 11/00 TOCA Touring Car Championship Racing Game Boy Color 11/00 MTV Sports: Pure Ride Extreme Sports Game Boy Color 11/00 MTV Sports: T.J. Lavin's Ultimate BMX Extreme Sports Game Boy Color 11/00 Evil Dead: Hail to the King Adventure PlayStation 12/00 Sega Dreamcast Star Wars Episode One: Obi-Wan's Adventure Game Boy Color 12/00 Adventures
- ------------ (1) Titles for German speaking territories only. -6- 9
TITLES ANTICIPATED TO BE RELEASED IN 2001(1) - ------------------------------------------------------------------------------------------ TITLE CATEGORY PLATFORM DATE - ------------------------------------------------------------------------------------------ CROC 2(2) Adventure Game Boy Color 1/01 Action Man: Search for Base X(2) Action Game Boy Color 1/01 Championship Motocross 2001 Racing PlayStation 1/01 Featuring Ricky Carmichael(2) WWF: With Authority(2) Card Game Online 2/01 Scooby-Doo! Classic Creep Capers(2) Adventure Game Boy Color 2/01 SpongeBob SquarePants: Legend of The Childrens Games Game Boy Color 2/01 Lost Spatula(2) The Simpson's: Night of the Living Action Game Boy Color 3/01 Treehouse of Horror(2) Aidyn Chronicles: The First Mage(2) Role Playing Nintendo 64 3/01 Summoner(2) Role Playing PC CD-ROM 3/01 Rocket Power: Gettin' Air(2) Childrens Games Game Boy Color 3/01 MTV Sports: T.J. Lavin's Ultimate Extreme Sports PlayStation 3/01 BMX(2) Aliens: Thanatos Encounter(2) Action Game Boy Color 3/01 Evil Dead: Hail to the King Adventure PC CD-ROM Spring '01 Star Wars Episode One: Battle for Adventure Nintendo 64 Spring '01 Naboo Red Faction Shooter PlayStation 2 Spring '01 Player Manager 2001 Sports Game Boy Color Spring '01 Rugrats: Totally Angelica Childrens Games PlayStation Spring '01 Power Rangers Time Force Action Game Boy Color Spring '01 Championship Motocross 2002 Racing PlayStation 2 Spring '01 Featuring Ricky Carmichael (working title) Red Faction Shooter PC CD-ROM Summer '01 Rocket Power (working title) Childrens Games PlayStation Summer '01 B.A.S.S. Strike Sports Simulation PlayStation 2 Summer '01 WWF Double Cross (working title) Fighting Game Boy Color Summer '01 Power Rangers Time Force Action PlayStation Summer '01 Collin McRae Rally Racing Game Boy Color Summer '01 Scooby-Doo! 2 (working title) Adventure Game Boy Advance Summer '01 SpongeBob SquarePants (working title) Childrens Games PlayStation Summer '01 Game Boy Advance Fall '01 PC CD-ROM Fall '01 Rugrats (working title) Childrens Games Game Boy Advance Fall '01 PC CD-ROM Championship Motocross 2002 Racing Game Boy Advance Fall '01 Featuring Ricky Carmichael Xbox (working title) Rocket Power (working title) Childrens Games Game Boy Advance Fall '01 PC CD-ROM Power Rangers Time Force Action Game Boy Advance Fall '01 Pure Ride 2 (working title) Extreme Sports Xbox Fall '01 PlayStation 2 WWF Smackdown! 3 (working title) Fighting PlayStation 2 Fall '01 Tetris (working title) Puzzle Game Boy Advance Fall '01 PlayStation 2 Xbox PC CD-ROM WWF Raw is War Fighting Xbox Fall '01 New Legends Action / Adventure Xbox Fall '01
- ------------ (1) Excludes titles we expect to release in 2001 but which we have not yet publicly announced as well as titles we only distribute. (2) Title released as of March 26, 2001. INTELLECTUAL PROPERTY LICENSES Our strategy includes the creation of exciting games based on licensed properties that have attained a high level of consumer recognition or acceptance. We believe that we enjoy excellent relationships with a number of licensors, including the WWF, Disney, Viacom/Nickelodeon, Saban and LucasArts. We pay royalties to our property licensors that generally range from 3% to 20% of our net sales of the corresponding title. We typically advance payments against minimum guaranteed -7- 10 royalties over the license term. License fees tend to be higher for properties with proven popularity and less perceived risk of commercial failure. To the extent competition intensifies for licenses of highly desirable properties, we may encounter difficulty in obtaining these licenses. See "-- Competition." Licenses are of variable duration, may be exclusive for a specific title or line of titles, and may in some instances be renewable upon payment of certain minimum royalties or the attainment of specified sales levels. Other licenses are not renewable upon expiration, and it cannot be assured that we and the licensor will reach agreement to extend the term of any particular license. Our property licenses generally grant us exclusive use of the property for the specified titles, on specified platforms, within a defined territory and during the license term. Licensors typically however, retain the right to exploit the property for all other purposes including the right to license the property for use with other platforms. Our games based on a particular property for use with one or more particular platforms may compete with games published by other companies that are based on the same property but for a different platform. AGREEMENT WITH JAKKS PACIFIC, INC. We entered into an agreement with JAKKS Pacific, Inc. ("JAKKS") to govern our relationship with respect to the WWF license we jointly obtained from Titan Sports, Inc. (now known as World Wrestling Federation Entertainment, Inc.) in June 1999. Our relationship with JAKKS was established to develop, manufacture, distribute, market and sell video games, as well as sublicense product pursuant to the license from the WWF. We control the venture, therefore, all transactions and balances are consolidated with the Company. The principal terms of this operating agreement are as follows: - - We will be responsible for funding all operations of the venture including all payments owed to the WWF. - - For the period commencing November 16, 1999 and ending December 31, 2003, JAKKS will be entitled to receive a preferred payment equal to the greater of a fixed guaranty, payable quarterly, or specified percentages of the "net sales" from WWF licensed games (as defined) in amounts that vary based on the platform. The payment of these amounts is guaranteed by us. We are entitled to the profits and cash distributions remaining after the payment of these amounts. - - For periods after December 31, 2003, the amount of the preferred payment will be subject to renegotiation between the parties. An arbitration procedure is specified in the event the parties do not reach agreement. - - We will be responsible for the day-to-day operations of the venture. We will continue to be responsible for development, sales and distribution of the WWF licensed games, and JAKKS will continue to be responsible for the approval process and other relationship matters with the WWF. We will both continue to co-market the games. PLATFORM LICENSES Our business is dependent on our license agreements with the manufacturers. All of these licenses are for fixed terms and are not exclusive. Each license grants us the right to develop, -8- 11 publish and distribute titles for use on such manufacturers' platforms, and requires that such titles be embodied in products that are manufactured solely by such manufacturers. The following table sets forth information with respect to our platform licenses. In some instances, we have more than one platform license for a particular platform.
NUMBER OF EXPIRATION MANUFACTURER PLATFORM TITLES TERRITORY DATE(S) - ------------- -------------- -------------- ------------------------ ------------ Nintendo Nintendo 64 Title-by-title(1) North America and Latin May 2003 America Nintendo Nintendo 64 Title-by-title(1) Europe, Australia and January 2004 New Zealand Nintendo Game Boy Color Title-by-title(1) North America and Latin March 2002 America Nintendo Game Boy Color Title-by-title(1) Europe, Australia and October 2002 New Zealand Nintendo(2) Game Boy Advance Nintendo(2) Gamecube Sony PlayStation Title-by-title(1) United States, Canada August 2002 and Mexico Sony PlayStation Title-by-title(1) Europe, Australia and December 2005 New Zealand Sony PlayStation 2 Title-by-title(1) United States and Canada March 2003 Sony(2) PlayStation 2 Europe Microsoft(2) Xbox
Nintendo charges us a fixed amount for each Nintendo 64 and Game Boy Color cartridge. This amount varies based, in part, on the memory capacity of the cartridges. Sony charges a royalty for every CD-ROM or DVD manufactured. The amounts charged by the manufacturers include a manufacturing, printing and packaging fee as well as a royalty for the use of the manufacturer's name, proprietary information and technology, and are subject to adjustment by the manufacturers at their discretion. The manufacturers have the right to review, evaluate and approve a prototype of each title and the title's packaging. We anticipate that the Xbox and Gamecube will follow a cost and royalty model similar to the CD-ROM / DVD based console model. In addition, we must indemnify the manufacturers with respect to all loss, liability and expense resulting from any claim against the manufacturer involving the development, marketing, sale or use of our games, including any claims for copyright or trademark infringement brought against the manufacturer. As a result, we bear a risk that the properties upon which the titles are based, or that the information and technology licensed from the manufacturer and incorporated in the products, may infringe the rights of third parties. Our agreements with our independent software developers and property licensors typically provide for us to be indemnified with respect to certain matters. If any claim is brought by a manufacturer against us for indemnification however, our developers or licensors may not have sufficient resources to in turn, indemnify us. Furthermore, these parties' indemnification of us may not cover the matter that gives rise to the manufacturer's claim. - ------------ (1) This license does not set a maximum number of titles that we may publish in the designated territory; however, each title must be approved by the manufacturer prior to development of the software. (2) In negotiation; terms to be determined. -9- 12 Each platform license may be terminated by the manufacturer if a breach or default by us is not cured after we receive written notice from the manufacturer, or if we become insolvent. Upon termination of a platform license for any reason other than our breach or default, the manufacturer has the right to purchase from us, at the price paid by us, any product inventory manufactured by such manufacturer that remains unsold for a specified period after termination. We must destroy any such inventory not purchased by the manufacturer. Upon termination as a result of our breach or default, we must destroy any remaining inventory, subject to the right of any of our institutional lenders to sell such inventory for a specified period. SOFTWARE DESIGN AND DEVELOPMENT After we acquire a property from a licensor or develop a concept internally, we design and develop a game with features intended to exploit the characteristics of the property and to appeal to the game's target consumers. Our software development process generally takes one of two forms. Internal Development. The in-house development of product is currently conducted by our Pacific Coast Power & Light Company, Heavy Iron Studios, Genetic Anomalies, Inc., Volition, Inc. and Helixe studios. The head of each studio reports to our Vice Chairman / Chief Operating Officer. Our studios are staffed by producers, programmers, software engineers, artists, animators and game testers. External Development. Our external development is supervised by our Vice President -- Product Development. We contract with independent software developers to conceptualize and develop games under our supervision. Our agreements with software developers are usually entered into on a game-by-game basis and generally provide for the payment of the greater of a fixed amount or royalties based on actual sales. We generally pay our developers installments of the fixed advance based on specific development milestones. Royalties in excess of the fixed advance are based on a percentage of net sales ranging from 7% to 20% for some developers, while others are based on a fixed amount per unit sold and range from $.25 to $6.50 per unit. We generally obtain ownership of the software code and related documentation. We may make strategic investments in independent developers for the purpose of securing access to proprietary software and talented developers. Upon completion of development, each game is extensively "play-tested" by us and sent to the manufacturer for its review and approval. Related artwork, user instructions, warranty information, brochures and packaging designs are also developed under our supervision. The development cycle for a new game, including the development of the necessary software; approval by the manufacturer and production of the initial products, typically has ranged from eight to 24 months. This relatively long development cycle requires that we assess whether there will be adequate retailer and consumer demand for a game well in advance of its release. MANUFACTURING Sony and Nintendo are the sole manufacturers of the products sold for use on their respective platforms. The manufacturing process begins with our placing a purchase order with a manufacturer and opening either a letter of credit in favor of the manufacturer or utilizing our line of credit -10- 13 with the manufacturer. We then send the software code and a prototype of the game to the manufacturer, together with related artwork, user instructions, warranty information, brochures and packaging designs, for approval, defect testing and manufacture. Nintendo typically delivers cartridges to us within 30 to 60 days of its receipt of an order and a corresponding letter of credit and Sony typically delivers CD-ROMs / DVDs to us within 10 to 20 days. We are required by the platform licenses to provide a standard defective product warranty on all of the products sold. Generally, we are responsible for resolving, at our own expense, any warranty or repair claims. We have not experienced any material warranty claims. MARKETING, SALES AND DISTRIBUTION We are dependent on the popularity of our games based on licensed properties and positive awareness of our original game concepts to attract customers and to obtain shelf space in stores. Our domestic sales activities are directed by our Executive Vice President -- North American Publishing, who maintains contact with major retail accounts and manages the activities of our independent sales staff and regional sales representatives. United States and Canadian Sales. Our games are promoted to retailers by display at trade shows such as the annual Electronic Entertainment Expo (E3). We also conduct print and cooperative retail advertising campaigns for most titles and prepare promotional materials, including product videos, to increase awareness among retailers and consumers. Our marketing efforts for products released in 2000 included national television, print, radio and Internet advertising and promotional campaigns. Products shipped in 2000 that received television support included WWF SmackDown!, Power Rangers Lightspeed Rescue, Evil Dead: Hail to the King, Summoner, Rugrats in Paris, MTV Sports: Skateboarding featuring Andy Macdonald, MTV Sports: Pure Ride, WWF SmackDown! 2 and WWF No Mercy. Our games were supported by promotions such as trailers, demo discs, over-sized boxes, standees, posters, and pre-sell giveaways at retail; game kiosks at sporting and outdoor events; rebates and contests with national packaged goods companies and fast food restaurants and co-marketing efforts with the hardware manufacturers. Product public relations for 2000 included cover, feature, preview, review and round-up coverage in broadcast, print and online media targeting enthusiast, lifestyle and major mainstream outlets. Additionally, we increased our corporate public relation efforts, establishing relationships with the leading technology and business reporters. Some of our titles make up a substantial portion of our gross sales. The following includes games that generated more than 10% of our gross sales over the last three years. In 1998, sales for WCW/NWO Revenge for the Nintendo 64, WCW Nitro for the Sony PlayStation and WCW vs. NWO for the Nintendo 64 were 33.7%, 14.0% and 16.2%, of gross sales, respectively. In 1999, sales for WCW/NWO Thunder for the Sony PlayStation, WWF Wrestlemania for the Nintendo 64 and Rugrats: Search for Reptar for the Sony PlayStation were 12.7%, 12.9% and 11.5%, of gross sales, respectively. In 2000, sales for WWF SmackDown! on the Sony PlayStation, WWF SmackDown! 2 also on the Sony PlayStation and WWF No Mercy for the Nintendo 64 were 16.9%, 16.0% and 15.5%, of gross sales, respectively. Most of our sales are made directly to retailers. We distribute our games primarily to mass merchandisers and national retail chain stores including Wal-Mart (representing 17% of gross sales in 2000), Toys "R" Us (representing 16% of gross sales in 2000), Electronics -11- 14 Boutique, Target, Kmart Stores, Babbages Etc., Best Buy and Kay Bee Toys. Sales to our ten largest customers collectively accounted for approximately 54% of our gross sales in 1999 and 68% of our gross sales in 2000. We do not have any written agreements or other understandings with any of our customers that relate to their future purchases, so our customers may terminate their purchases from us at any time. We utilize electronic data interchange with most of our major domestic customers in order to (i) efficiently receive, process and ship customer product orders, and (ii) accurately track and forecast sell-through of products to consumers in order to determine whether to order additional products from the manufacturers. We ship our products to our domestic customers from a public bonded warehouse in Southern California. We supplement the efforts of our sales employees with independent sales representatives. Our agreements with our representatives set forth their exclusive territory, types of customers to be solicited, commission rate and payment terms. The domestic retail price for our titles generally ranges between $19 and $35 for Game Boy Color, between $19 and $49 for PlayStation, between $40 and $50 for PlayStation 2, between $20 and $60 for Nintendo 64 and between $10 and $50 for PC games. Foreign Sales. In 2000, we expanded our direct-to-retail operations to include France and Australia. In December 1998, we acquired Rushware (the name was subsequently changed to THQ Entertainment GmbH), a German company that now serves as our distributor and publisher in Germany and other German-speaking countries. When added to our growing operations in the United Kingdom, these activities have increased our proportion of foreign sales. Additionally, we believe that direct-to-retail operations enable us to realize higher margins on our products distributed in these territories than if such products were to continue to be distributed by third parties. Other Foreign Sales. We distribute our titles in all viable international markets. Other European territories such as Italy, Spain, Asia, Latin America and others are handled by our international offices through strategic distribution relationships whereby we primarily supply finished goods as well as marketing support. While the majority of our sales occur in the territories where we have direct relationships, we can supply a given title in up to sixty countries worldwide. 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 shipments by the manufacturers, fluctuations in the size and rate of growth of consumer demand for software for various platforms, the timing of the introduction of new platforms and the accuracy of retailers' forecasts of consumer demand. -12- 15 GEOGRAPHIC INFORMATION We operate in one reportable segment in which we are a developer, publisher and distributor of interactive entertainment software for the leading hardware platforms in the home video game market. The following information sets forth geographic information on our sales for the years ended December 31, 1998, 1999 and 2000:
SALES TO UNAFFILLIATED CUSTOMERS ($ IN THOUSANDS) -------------------------------------------------------- FOR YEAR ENDED ------------------------------------ 1998 1999 2000 -------- -------- -------- United States $187,583 $228,827 $270,116 United Kingdom 23,881 41,404 44,638 Germany 5,252 33,252 20,442 France -- -- 7,979 Australia -- -- 3,828 -------- -------- -------- Consolidated $216,716 $303,483 $347,003 -------- -------- --------
INTELLECTUAL PROPERTY RIGHTS Each game we release embodies a number of separately protected intellectual property rights of the manufacturer, the property licensor and, to a lesser extent, us. The licensor of the property owns the trademarks, trade names, copyrights and other intellectual property rights relating to the property on which the game is based. The manufacturer owns the patents and substantially all of the other intellectual property embodied in the product. While we own the game software embodied in the product, we believe that such software has little independent economic value. Accordingly, we must rely on the manufacturer and the property licensor with respect to protection from infringement of the property rights by third parties. Each of the manufacturers incorporates security devices in its platforms and products to prevent unlicensed use. In addition, Nintendo requires its licensees to display the trademarked "Nintendo Seal of Approval" to notify the public that the game has been approved by Nintendo for use with a Nintendo platform. COMPETITION The software industry is intensely competitive. We compete with hardware manufacturers, for both property licenses and sales. Each of these manufacturers is typically the largest developer and marketer for its platforms. These companies may increase their own software development efforts. As a result of their commanding positions in the industry as the manufacturers of platforms and publishers of software for their platforms, the manufacturers generally have better bargaining positions with respect to retail pricing, shelf space and purchases than do any of their licensees, including us. In addition to the manufacturers, our competitors include Activision, Inc., Electronic Arts Inc., Take-Two Interactive Software, Inc., Midway Games Inc., and Infogrames. Each of the manufacturers has a broader software line and greater financial, marketing and other resources than us, as do some of our other competitors. Accordingly, some of our competitors may be able -13- 16 to market their software more aggressively or make higher offers or guarantees in connection with the acquisition of licensed properties. At various times, toy companies, large software companies, movie studios and others have focused on the video game market resulting in greater competition for us. Additionally, many of our competitors are developing on-line interactive games and interactive networks that will be competitive with our interactive products. We released our first on-line game, WWF: With Authority, in February 2001. As competition for retail shelf space becomes more intense, we may need to increase our marketing expenditures to maintain sales of our titles. As competition for popular properties increases, our cost of acquiring licenses for such properties is likely to increase resulting in reduced margins. Prolonged price competition, increased licensing costs or reduced profit margins would have a material adverse effect on us. In addition, the market for our products is characterized by significant price competition, and we may face increasing pricing pressures from our current and future competitors. Further, as the industry continues to transition from the current platforms (Sony PlayStation, Nintendo 64 and Nintendo Game Boy Color) to the next generation platforms (Sony PlayStation 2), and the yet to be released next generation platforms (Nintendo Gamecube, Nintendo Game Boy Advance and Microsoft Xbox), there may be price erosion on the existing consoles. Accordingly, there can be no assurance that competitive pressures will not require us to reduce our prices. Any material reduction in the price of our products would adversely affect operating income as a percentage of net revenue and would require us to increase unit sales in order to maintain net revenue. EMPLOYEES As of December 31, 2000, we had 410 full-time employees, of whom 29 are located in the United Kingdom; 64 are located in Germany; 7 are located in France and 6 are located in Australia. None of our employees are represented by a labor union or covered by a collective bargaining agreement, and we believe that relations with our employees are good. ITEM 2. PROPERTIES Our executive offices occupy approximately 45,088 square feet of office space at 27001 Agoura Road, Calabasas Hills, California, pursuant to leases expiring in June 2002 and September 2005, respectively. We lease additional office space as follows:
COMPANY LOCATION OF OFFICES ------------------------------------- --------------------------- Pacific Coast Power and Light Company Santa Clara, California Heavy Iron Studios Culver City, California Volition, Inc. Champaign, Illinois Genetic Anomalies, Inc. Lexington, Massachusetts Helixe Lexington, Massachusetts T.HQ International, Ltd. Woking, England THQ Entertainment GmbH(1) Kaarst, Germany THQ France SARL Paris, France THQ Asia Pacific Pty. Ltd. Melbourne, Australia
- ------------ (1) Formerly known as Rushware. -14- 17 ITEM 3. LEGAL PROCEEDINGS On December 20, 2000, the United States District Court for the Central District of California granted our second Motion to Dismiss with prejudice in opposition to two essentially identical class action law suits filed against us on February 18, 2000 and on March 2, 2000, respectively. The law suits alleged that we, and certain of our directors and senior officers, violated Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. The Plaintiffs in the law suits did not appeal the ruling and time to file for such appeal has expired. While we are a party to other legal proceedings from time to time, such legal proceedings have been ordinary and incidental to our business and have not had a material adverse effect on us. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of 2000. -15- 18 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS The common stock is quoted on the NASDAQ National Market under the symbol "THQI." The following table sets forth, for the periods indicated, the high and low closing sales prices of our common stock as reported by the NASDAQ National Market:
CLOSING SALES PRICES ---------------------- HIGH LOW -------- ------- 2000 First Quarter 29 8/16 17 Second Quarter 20 8 14/16 Third Quarter 26 12/16 12 1/16 Fourth Quarter 24 8/16 17 8/16 1999 First Quarter 20 9/16 11 11/16 Second Quarter 19 3/16 13 7/16 Third Quarter 28 13/16 17 15/16 Fourth Quarter 38 4/16 22 7/16
The last reported price of the common stock on March 26, 2001, as reported by NASDAQ National Market, was $36.875 per share. HOLDERS As of March 26, 2001, there were approximately 320 holders of record of the common stock. DIVIDEND POLICY We have never paid cash dividends on our capital stock. We currently intend to retain future earnings, if any, to finance the growth and development of our business and, therefore, we do not anticipate paying any cash dividends in the future. Our principal banking agreements provide that at such times as we have any outstanding borrowings or letters of credit under that facility, we will not pay any cash dividends. SECURITIES ISSUED IN PRIVATE TRANSACTIONS On August 31, 2000, in connection with our acquisition of Volition, Inc. ("Volition"), we issued an aggregate of 890,110 shares of our common stock to certain stockholders of Volition pursuant to the exemption from registration provided in Section 4(2) of the Securities Act of 1933, as amended. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) The following table presents certain selected consolidated financial data for the years 1996 through 2000. The information presented as of December 31, 1999 and 2000 and for each -16- 19 of the years ended December 31, 1998, 1999 and 2000 have been derived from, and are qualified by reference to, our audited consolidated financial statements included elsewhere herein. Those financial statements have been audited by Deloitte & Touche LLP, independent auditors. The information presented for each of the years ended December 31, 1996 and 1997 were derived from audited financial statements that are not included elsewhere herein. This selected consolidated financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and Notes thereto included elsewhere herein.
STATEMENT OF OPERATIONS DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) - --------------------------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, -------------------------------------------------------- 1996 1997 1998 1999 2000 -------- ------- -------- -------- -------- Net sales $ 50,255 $90,227 $216,716 $303,483 $347,003 Costs and expenses: Cost of sales 29,301 48,127 100,019 134,563 140,699 Royalties and project abandonment 8,587 14,763 48,130 48,370 77,550 Product development 1,510 2,930 8,925 15,511 19,151 Selling and marketing 4,444 8,733 20,326 35,440 42,446 Payment to venture partner -- -- -- 6,119 17,707 General and administrative 4,378 5,605 10,107 14,970 19,530 In-process research and development -- -- 7,232 -- -- -------- ------- -------- -------- -------- Total costs and expenses 48,220 80,158 194,739 254,973 317,083 -------- ------- -------- -------- -------- Income from operations 2,035 10,069 21,977 48,510 29,920 Interest income (expense) -- net (315) 472 819 1,109 1,323 -------- ------- -------- -------- -------- Income before income taxes 1,720 10,541 22,796 49,619 31,243 Income taxes 8 1,954 9,343 18,293 13,054 -------- ------- -------- -------- -------- Net income $ 1,712 $ 8,587 $ 13,453 $ 31,326 $ 18,189 ======== ======= ======== ======== ======== Net income per share -- basic $ .15 $ .53 $ .75 $ 1.65 $ .91 ======== ======= ======== ======== ======== Net income per share -- diluted $ .14 $ .50 $ .63 $ 1.48 $ .84 ======== ======= ======== ======== ======== Shares used in per share calculation -- basic 11,298 16,057 17,929 19,040 20,091 ======== ======= ======== ======== ======== Shares used in per share calculation -- diluted 12,000 17,179 21,229 21,197 21,568 ======== ======= ======== ======== ========
BALANCE SHEET DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) - --------------------------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, -------------------------------------------------------- 1996 1997 1998 1999 2000 -------- ------- -------- -------- -------- Working capital $ 9,561 $31,614 $ 48,342 $ 91,860 $110,269 Total assets $ 22,904 $56,545 $128,218 $184,057 $229,942 Lines of credit $ 5,355 $ -- $ 9,909 $ 16,702 $ 15,473 Shareholders' equity $ 10,959 $33,842 $ 62,065 $108,306 $132,125
-17- 20 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW We develop, publish and distribute interactive entertainment software for the major platforms sold by Nintendo, Sony and for use on PCs. See "Business - -- Titles." The following table sets forth, for the periods indicated, the percentage of our revenues derived from sales of titles for the platforms indicated:
YEARS ENDED DECEMBER 31, ---------------------------------- PLATFORM 1998 1999 2000 ----------------------------------- -------- ------- -------- Nintendo (excluding Game Boy) 55% 35% 29% Nintendo Game Boy/Game Boy Color 8% 17% 20% Sony PlayStation 31% 37% 41% Sony PlayStation 2 -- -- 3% PC 5% 8% 3% Other 1% 3% 4%
Our business cycle generally commences with the securing of a license to publish one or more titles based on a property or agreement with a proven developer to create a game based on original content. 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 warehouses in the United Kingdom, Germany, France or Australia for foreign distribution. We then sell directly to our major retail accounts both domestically and in the United Kingdom, Germany, France and Australia. Foreign sales to distributors in other territories are shipped directly to the customers' locations at their expense. 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. On May 24, 1999, December 13, 1999 and August 31, 2000, we completed acquisitions of Pacific Coast Power & Light Company, a California corporation ("PCP&L"), Genetic Anomalies Inc., a Delaware corporation ("GA") and Volition, Inc., a Delaware corporation ("Volition"), respectively. The acquisitions have been accounted for as poolings 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, GA and Volition had always been part of our company. 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 -18- 21 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 shipments by the manufacturers, fluctuations in the size and rate of growth of consumer demand for software for various platforms, the timing of the introduction of new platforms and the accuracy of retailers' forecasts of consumer demand. 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 richer playing capabilities, the trend in the interactive entertainment software industry has been to utilize chips with greater capacity and thus greater cost. CD-ROMs and DVDs have significantly lower per unit manufacturing costs than cartridge-based products, generally resulting in higher royalties for CD-ROM and DVD based products. Recovery of Prepaid Royalties, Guarantees and Capitalized Development Costs. We typically enter into agreements with licensors of properties and external developers of titles that require advance payments of royalties and/or guaranteed minimum royalty payments. Advance royalty payments for intellectual property licenses are recorded as prepaid royalties. All minimum guaranteed royalty payments are initially recorded as an asset (prepaid and deferred royalties) and as a liability (accrued royalties) at the contractual amount upon execution of the contract. Payments made to external developers under development agreements with alternative future uses are capitalized. We also 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 at the contractual royalty rate based on actual net product sales or on the ratio of current units sold to total projected units whichever amount is greater. 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 analyze these 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 December 31, 2000, we had prepaid royalties and capitalized development costs of $23.9 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. 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. We sometimes negotiate accommodations to retailers (and, less often, to distributors), however 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. -19- 22 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 years ended December 31, 1998, 1999 and 2000, we took provisions of approximately $20.8 million, $35.0 million and $35.4 million, respectively, against gross sales made during such periods. As of December 31, 2000, our aggregate reserve against accounts receivable for returns, customer accommodations and doubtful accounts was approximately $31.5 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. In June 1998, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133, as amended, establishes accounting and reporting standards for derivative instruments including certain derivative instruments embedded in other contracts and for hedging activities. Under SFAS No. 133, certain contracts that were not formerly considered derivatives may now meet the definition of a derivative. We will adopt SFAS No. 133 effective January 1, 2001. We have calculated the impact of adopting SFAS No. 133, and we believe that such adoption will not have any impact on our financial position; results of operations or cash flows. 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 implemented the provisions of SAB 101 and its impact on our revenue recognition policy is immaterial. 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 and Germany 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 the financial position or results of operations of THQ and our subsidiaries. -20- 23 RESULTS OF OPERATIONS Net income for the year ended December 31, 2000 was $18,189,000 ($0.84 per diluted share), as compared to net income of $31,326,000 ($1.48 per diluted share) for the same period in 1999. The 2000 results were negatively impacted by a non-cash charge, as discussed below, totaling $9.8 million before taxes and $5.9 million after taxes ($0.27 per diluted share). Non-Cash Charge In May 2000, as part of our regular impaired asset review and also as a result of changing technology in the video game market, we incurred a write-off of $9.8 million or $5.8 million after tax. The write-off consisted of costs associated with prepaid development and related costs for products that had been discontinued or whose values were deemed unrecoverable through future undiscounted cash flows. The following costs were recorded in the consolidated statement of operations in the second quarter of fiscal year 2000 and classified as follows: 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 ==========
The component amount in Cost of sales is a write down of inventory to the lower of cost or market. The charge in Royalties and project abandonment relates directly to discontinued games or unrecoverable prepaid royalties. The charge in Product development and Selling and marketing consists of ancillary product and advertising costs while General and administrative contains an increase for Provision for doubtful accounts. -21- 24 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:
YEARS ENDED DECEMBER 31, -------------------------------- 1998 1999 2000 ------ ------ ------ Domestic sales 86.6% 75.4% 77.8% Foreign sales 13.4 24.6 22.2 ------ ------ ------ Net sales 100.0% 100.0% 100.0% Costs and expenses: Cost of sales 46.2% 44.4% 40.6% Royalties and project 22.2 15.9 22.4 abandonment Product development 4.1 5.1 5.5 Selling and marketing 9.4 11.7 12.2 Payment to venture partner -- 2.0 5.1 General and administrative 4.7 4.9 5.6 In-process research and development 3.3 -- -- ------ ------ ------ Total costs and expenses 89.9% 84.0% 91.4% ------ ------ ------ Income from operations 10.1% 16.0% 8.6% Interest income -- net 0.4 0.4 0.4 ------ ------ ------ Income before income taxes 10.5% 16.4% 9.0% ------ ------ ------ Net income 6.2% 10.3% 5.2% ====== ====== ======
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2000 TO THE YEAR ENDED DECEMBER 31, 1999 The following table sets forth, for the years ended December 31, 2000 and 1999, the titles released during such periods for the platforms indicated:
YEARS ENDED DECEMBER 31, ------------------------ 1999 2000 ---------- ----------- Nintendo 64 10 4 PC CD-ROM 11 6 PlayStation 10 12 PlayStation 2 -- 1 Game Boy Color 11 19 Dreamcast -- 4 ---------- ----------- Total 42 46 ========== ===========
Our net sales increased to $347,003,000 in the year ended December 31, 2000, from $303,483,000 in the same period of 1999, as a result of increased domestic sales, a larger number of products shipped, higher unit sales per title shipped and the market success of key titles. For the year ended December 31, 2000, net sales of our WWF titles, Rugrats titles and Power Rangers titles were $183,225,000 (52.8% of net sales), $46,907,000 (13.5% of net sales), and $18,765,000 (5.4% of net sales), respectively. Our foreign net sales grew to $76,887,000 for the year ended December 31, 2000 from $74,656,000 in the same period of 1999. They decreased however, as a percentage of net sales to 22.2% from 24.6% primarily as a consequence of our increase in domestic sales. The increase in our foreign net sales in 2000 was attributable to the addition of our French and Australian subsidiaries that were partially offset by expected decreases in our German net sales and unit volumes for titles released on the Nintendo 64 and PlayStation platforms. Overall European -22- 25 revenues were negatively impacted by a devaluation of key foreign currencies compared to the same period last year. Our cost of sales for the year ended December 31, 2000 decreased as a percentage of net sales to 40.6% from 44.4% in the same period of 1999. Our cost of sales decreased in 2000, because we sold a higher proportion of PlayStation; PlayStation 2 and Game Boy Color titles, all of which have higher gross margins than Nintendo 64 games. Our royalty expense for the year ended December 31, 2000 increased as a percentage of net sales to 22.4% from 15.9% in the same period of 1999. The 2000 results reflect the non-cash charge (as discussed above) as well as a change in our product mix away from Nintendo 64 titles to other platforms that generally carry higher royalty rates. There was also a decline in 2000 of LucasArts Star Wars Episode One games, which carry no royalties, from 1999 when sales peaked due to the release of the movie by the same name. Our product development expenses increased from $15,511,000 in 1999 to $19,151,000 in 2000. This increase reflects the increasing number of internally developed titles, the increase in the number of overall titles under development and the additional complexity and development time for "next generation" products. Our selling and marketing expenses for the year ended December 31, 2000 remained relatively constant as a percentage of net sales at 12.2% compared to 11.7% for the same period in 1999 but increased in dollar terms by $7,006,000 over 1999. This increase is a result of several significant advertising and promotional campaigns to promote our WWF; Rugrats; Power Rangers; Evil Dead, Summoner and MTV Sports brands, as well as increased warehouse expenses. We incur an expense for the payment of a preferred return to JAKKS Pacific Inc. on product sales and other income derived from the WWF license. For the year ended December 31, 2000, the amount incurred for such preferred return was $17,707,000. Because the license with the WWF was not effective until November 1999, there were no WWF product sales in the first ten months of 1999. For the year ended December 31, 1999, the amount incurred for such preferred return was $6,119,000. Our general and administrative expenses for the year ended December 31, 2000 increased as a percentage of net sales to 5.6% compared to 4.9% for the same period of 1999 and increased in dollar terms by $4,560,000 over 1999. This increase is attributed to higher volumes, increased licensing efforts, and additional backoffice activities to support four new platform launches in 2000 and 2001. For the year ended December 31, 2000, interest income increased by $214,000 compared to 1999 as a result of increased cash flows from operations and higher average investment balances during the period. During the year ended December 31, 2000, we recorded a tax provision of $13,054,000, a decrease of $5,239,000 over 1999 primarily due to lower pre-tax net income. In addition, the 1999 effective tax rate was positively impacted by the reversal of a $2,461,000 valuation allowance related to prior years net operating losses. -23- 26 COMPARISON OF THE YEAR ENDED DECEMBER 31, 1999 TO THE YEAR ENDED DECEMBER 31, 1998 The following table sets forth, for the years ended December 31, 1999 and 1998, the titles released during such periods for the platforms indicated:
YEARS ENDED DECEMBER 31, ------------------------ 1999 2000 ---------- ----------- Nintendo 64 2 10 PC CD-ROM 5 11 PlayStation 8 10 SNES 1 -- Game Boy Color 5 11 ---------- ----------- Total 21 42 ========== ===========
Our net sales increased to $303,483,000 in the year ended December 31, 1999 from $216,716,000 in the same period of 1998 as a result of increased foreign sales, a larger number of products shipped, and the market success of key titles. For the year ended December 31, 1999, net sales of our Rugrats titles; WCW titles and WWF titles were $84,204,000 (27.8% of net sales), $64,615,000 (21.3% of net sales) and $42,011,000 (13.8% of net sales), respectively. Our foreign net sales grew to $74,656,000 for the year ended December 31, 1999 from $29,132,000 in the same period of 1998 and increased as a percentage of net sales to 24.6% from 13.4%. The increase in our foreign net sales in 1999 was attributable to the addition of our THQ Entertainment subsidiary (which added the LucasArts brand in Germany as well as European specific product) and the success of key titles such as wrestling and Rugrats in certain foreign markets. Our cost of sales for the year ended December 31, 1999 decreased slightly as a percentage of net sales to 44.4% from 46.2% in the same period of 1998 primarily as a result of the increase in PlayStation and CD-ROM product sales which generally have more favorable gross margins than cartridge products. Our royalty expense for the year ended December 31, 1999 decreased as a percentage of net sales to 15.9% from 22.2% in the same period in 1998. Sales in 1999 consisted of some in-house titles carrying minor or no royalties, LucasArts games in Europe which carry no royalties, and selected successful titles which had favorable royalty rates. Our product development expenses increased from $8,925,000 in 1998 to $15,511,000 in 1999. This increase reflects the addition of three internal studios during the year and an increase in our corporate product development group to better manage our increased volume of titles in development. For the year ended December 31, 1999, our selling and marketing expenses increased by $15,114,000 compared to the year ended December 31, 1998 as a result of several significant advertising and promotional campaigns to promote our WWF titles; Rugrats; Championship Motocross and MTV Sports brands as well as increased warehouse expenses; infrastructure and personnel costs (both domestic and foreign) incurred as a result of our growth in 1999. For the year ended December 31, 1999, we incurred expenses in the amount of $6,119,000 to our venture partner, JAKKS Pacific Inc. Pursuant to the arrangement regarding -24- 27 the license with the WWF, THQ pays JAKKS Pacific Inc. a preferred return on product sales, and they also share in sublicense income derived from the license. Our general and administrative expenses for the year ended December 31, 1999 remained relatively constant as a percentage of net sales at 4.9% compared to 4.7% for the same period of 1998 but increased in dollar terms by $4,863,000 over 1998. This increase can be attributed to the expansion of our corporate offices, amortization of a new sales and financial accounting software package and a full year of general and administrative expenses for THQ Entertainment. The in-process research and development charge of $7,232,000 incurred during 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. The technology purchased was completed in 1999 and did not result in a commercially successful product. For the year ended December 31, 1999, interest income increased by $290,000 compared to 1998 as a result of increased cash flows from operations and higher average investment balances during the period. During the year ended December 31, 1999, we recorded a tax provision of $18,293,000, an increase of $8,950,000 over 1998 primarily as a result of higher net income before taxes. The effective tax rate for 1999 was 36.9% compared to 41.0% in 1998. The 1998 effective tax rate was negatively impacted by the fact that the purchased in-process research and development costs of $7,232,000 were not deductible for tax purposes. The negative impact of the in-process research and development was offset by the partial reversal of the valuation reserve against deferred tax assets. The 1999 effective tax rate was positively impacted by the reversal of the remaining $2,461,000 valuation allowance. 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 to $27,998,000 at December 31, 2000 from $21,454,000 at December 31, 1999. Cash provided by operating activities for 2000 was $16,136,000. As of March 26, 2001, our cash and cash equivalents were $71,566,000. Accounts receivable at December 31, 2000 increased from December 31, 1999 as a result of increased sales volume compared to the same period of 1999. Prepaid and deferred royalties and software development costs 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 non-cash charge (as discussed above). Accrued royalties decreased overall by $1,427,000. This is due primarily to payments made toward the minimum guarantee on the WWF license in the amount of $6,548,000 and partially off set by several new licensing contracts entered into in 2000. As of December 31, 2000, we had obligations with respect to future guaranteed minimum royalties of $11,013,000. Inventory increased during 2000 as the balances reflect the advanced purchases of product scheduled for release in January 2001 as well as the restocking of fourth quarter titles which will -25- 28 be shipped in the first quarter of 2001. Accounts payable and accrued expenses increased due to higher sales volumes and increased activity. The amount of our accounts receivable is subject to significant seasonal variations as a consequence of the seasonality of our sales and is typically highest at the end of the year. As a result, our working capital requirements are greatest during our third and fourth quarters. We believe that our cash on hand, funds provided by operations, and our revolving credit facilities will be adequate to meet our anticipated requirements for operating expenses, product purchases, guaranteed payments to licensors and software development through 2001. Income taxes payable increased from December 1999 due to timing differences that result between payment of estimated taxes. The decrease in our lines of credit is attributable to the cash provided by operating activities in 2000. Net cash used in investing activities was $2,129,000 and $12,947,000 at December 31, 1999 and 2000, respectively. In 1999, net cash used in investing activities consisted primarily of capital expenditures ($4,447,000) offset by a payment received ($2,540,000) from the seller of THQ Entertainment (formerly know as Rushware) as part of the renegotiated purchase price of THQ Entertainment. Net cash used in investing activities for 2000 included our investment in Yuke's Co. Ltd., a Japanese corporation, ($5,020,000) and additional capital expenditures ($7,877,000), consisting primarily of the implementation of a new operational and financial system and the acquisition of next generation development tools. We expect to make capital expenditures of between $5,500,000 and $6,500,000 in 2001 as we continue to invest in our infrastructure and next generation development tools. Net cash provided by financing activities was $12,081,000 and $3,076,000 at December 31, 1999 and 2000, respectively. In 1999, net cash provided by financing activities was primarily provided from the short-term borrowings and the exercise of options and warrants to purchase our common stock. In 2000, net cash provided by financing activities was provided from the exercise of options and warrants to purchase our common stock offset by a reduction in our short-term borrowings. Credit Facilities. On August 31, 2000 we entered into a Revolving Credit Agreement with Union Bank of California and a syndicate of other financial institutions. This agreement expires on July 1, 2001 and permits us to borrow (and maintain obligations under outstanding letters of credit) up to an aggregate of $50,000,000 subject to the following: We may maintain outstanding letters of credit for product purchases and outstanding borrowings in the aggregate for up to $40,000,000 for September 2000; $50,000,000 between October 1, 2000 and December 31, 2000; $40,000,000 in January 2001 and $25,000,000 between February 1, 2001 and June 30, 2001. In addition, outstanding borrowings cannot exceed $15,000,000 in September 2000; $30,000,000 from October 1 through October 31, 2000; $50,000,000 from November 1, 2000 through December 31, 2000; $35,000,000 from January 1, 2001 through January 31, 2001 and $15,000,000 from February 1, 2001 to June 30, 2001. -26- 29 We are also required to not have any outstanding borrowings for a period of at least 60 days during the term of the agreement. This credit facility is secured by a lien on substantially all of our assets and contains customary financial and non-financial covenants which limit the ability for us to incur additional indebtedness, pay dividends or make distributions, sell assets and enter into certain mergers or acquisitions. Amounts outstanding under these credit facilities bear interest, at our choice, at either a) the bank's prime rate (9.5% at December 31, 2000) or b) the London Interbank Offered Rate (6.56% at December 31, 2000) plus 1.85%. As of December 31, 2000, we had approximately $5,341,000 in obligations with respect to outstanding letters of credit and $15,473,000 in outstanding borrowings. ITEM 7A. 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 We have not hedged our foreign currency exposure in the past. 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, leaving us susceptible to changes in the dollar/Euro; dollar/British pound and dollar/German mark exchange rates. Therefore, 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. As of December 31, 2000, our foreign currency translation loss adjustment was $1,715,000. Currency transaction gains and losses for the years ended December 31, 1998, 1999 and 2000 were not significant. A hypothetical 10% change in the relevant currency rates at December 31, 2000 would not have a material impact on our financial statements. In addition to the direct effects of changes in exchange rates, which are a changed dollar value of the resulting sales and related expenses, changes in exchange rates also may affect the volume of sales or the foreign currency sales price as competitors' products become more or less attractive. -27- 30 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Financial Statements and supplementary data, together with the report of Deloitte & Touche LLP dated February 16, 2001, required by this Item are included in Item 14 of this annual report and are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. -28- 31 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS Our Board of Directors is comprised of the following six members. There are no family relationships among any of our directors or executive officers. BRIAN J. FARRELL (age 47) has been our President and Chief Executive Officer since January 1995 and a director since March 1993. Between October 1992 and January 1995, Mr. Farrell served as our Executive Vice President and Chief Operating Officer. From July 1991 to October 1992, Mr. Farrell served as our Vice President, Chief Financial Officer and Treasurer. From 1984 until joining us, Mr. Farrell was Vice President and Chief Financial Officer of Starwood Hotels & Resorts (then known as Hotel Investors Trust), a real estate investment trust ("Starwood"). Mr. Farrell was employed by Deloitte Haskins & Sells, a predecessor of Deloitte & Touche LLP, an international accounting firm and our current auditors ("Deloitte"), from 1978 to 1984 and is a certified public accountant. JEFFREY C. LAPIN (age 44) was appointed to Chief Operating Officer and Vice Chairman in August 2000. Mr. Lapin has been our Vice Chairman and an employee since October 1998 and a director since April 1995. From July 1996 through October 1998, Mr. Lapin was the President of House of Blues, Inc. Hospitality and Executive Vice President of House of Blues, Inc. Entertainment. From January 1995 to June 1996, Mr. Lapin was the President and Chief Operating Officer of Starwood, and from May 1991 to January 1995 Mr. Lapin was the President and Chief Executive Officer of Starwood. Mr. Lapin was a Vice President of Starwood from January 1988 to May 1991 and the Secretary of Starwood from September 1986 to May 1991. Mr. Lapin served as a Trustee of Starwood from September 1992 to June 1996. Prior to his employment by Starwood, Mr. Lapin was an attorney at Mitchell, Silberberg & Knupp in Los Angeles. LAWRENCE BURSTEIN (age 58) has been a director since July 1991. Since March 1996, Mr. Burstein has been President, director and a stockholder of Unity Venture Capital Associates Ltd., a private investment company. From 1986 through March 1996, Mr. Burstein was President, a director and a principal stockholder of Trinity Capital Corporation, a private investment company. Mr. Burstein is a director of Brazil Fast Food Corp., CAS Medical Systems, Inc., Gender Sciences, Inc., I.D. Systems, Inc. and Traffix, Inc. BRUCE JAGID (age 61) has been a director since April 1995. Mr. Jagid is an investor and also serves as President of Coining Technologies, Inc. From April 1991 to January 1999, Mr. Jagid was the Chairman and Chief Executive Officer of Ultralife Batteries, Inc., a manufacturer of lithium batteries. From 1970 to 1989 Mr. Jagid was President of Power Conversion Inc. Mr. Jagid is also a director of I.D. Systems, Inc. JAMES L. WHIMS (age 46) has been a director since April 1997. Since 1996, Mr. Whims has been a Managing Director of Techfund Capital I, L.P. and TechFund Capital II, L.P., venture capital firms concentrating on high-technology enterprises. From 1994 to 1996, Mr. Whims was Executive Vice President of Sony Computer Entertainment of America. From 1990 to 1994, Mr. Whims was Executive Vice President of The Software Toolworks Inc. -29- 32 L. GREGORY BALLARD (age 47) has been a director since April 1999. Since January 2000, Mr. Ballard has been the Chief Executive Officer at MyFamily.com, a leading community Internet company. Prior to that, from December 1996 until November 1999, Mr. Ballard was the President and Chief Executive Officer of 3Dfx. From May 1995 to November 1996, Mr. Ballard was the President of Capcom Entertainment, Inc., a videogame and multimedia entertainment company. From 1994 to March 1995, Mr. Ballard served as Chief Operating Officer and Chief Financial Officer of Digital Pictures, Inc., a video game company. From 1991 to 1994, Mr. Ballard was President and Chief Executive Officer of Warner Custom Music Corp., a multimedia marketing division of Time Warner, Inc. Previously, Mr. Ballard was President and Chief Operating Officer of Personics Corp., a predecessor to Warner Music. In addition, Mr. Ballard has worked for Boston Consulting Group and as an attorney in Washington, D.C. Mr. Ballard is also a director of MyFamily.com and Pinnacle Systems. Directors are elected annually by the stockholders and hold office until the next annual meeting and until their respective successors are elected and qualified. EXECUTIVE OFFICERS Our executive officers include Messrs. Farrell, Lapin, Gysi and Walsh and Ms. Locke. All of our executive officers are appointed by and serve at the discretion of the Board of Directors. FRED A. GYSI (age 46) was appointed Senior Vice President - Finance and Administration, Chief Financial Officer, Treasurer and Secretary in August 2000. Mr. Gysi has been our Vice President - Finance and Administration, Chief Financial Officer, Treasurer and Secretary since November 1997. From October 1996 to October 1997, Mr. Gysi was the Chief Financial Officer of HPM-Stadco, a manufacturing company. From August 1995 to October 1996, Mr. Gysi was the President and co-founder of GP Management Consulting, a provider of financial, operations and systems consulting services to emerging and middle market companies. From 1992 to 1995, Mr. Gysi was a partner at Collett & Levy, an accounting firm. Mr. Gysi was employed by Deloitte from 1980 to 1992 and was a partner of that firm from 1988 to 1992 and is a Certified Public Accountant. ALISON LOCKE (age 46) was appointed Executive Vice President - North American Publishing in August 2000. Ms. Locke was previously Senior Vice President - Sales and Marketing since February 1999. Ms. Locke serves as a strategic business manager in overseeing and building THQ's U.S. sales and marketing efforts as well as THQ's operations and MIS departments. From January 1995 to January 1999, Ms. Locke served as our Senior Vice President - Sales. From 1991 to January 1995, Ms. Locke served as our Vice President - Sales. Previously, Ms. Locke served as Vice President of Computer Product and Nintendo Game Sales for Data East USA Incorporated, an interactive entertainment company, and in various sales capacities with Activision Inc. and Broderbund Software, Inc. TIM F. WALSH (age 37) was appointed Senior Vice President - International Publishing in August 2000. Mr. Walsh had been our Vice President - International since January 1998. From May 1997 to January 1998 he was our Director of International. Mr. Walsh was Director of International and OEM Sales of Accolade, a publisher of video and PC game software from January 1996 to May 1997. From September 1993 to December 1995, Mr. Walsh held various positions at Time Warner Interactive. Mr. Walsh's prior experience includes positions in the productivity software industry from 1990 to 1993 and the music industry from 1986 to 1989. -30- 33 SECTION 16 (a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Pursuant to Section 16(a) of the Exchange Act and the rules issued thereunder, our executive officers and directors are required to file with the SEC and the Nasdaq Stock Market reports of ownership and changes in ownership of the Common Stock. Copies of such reports are required to be furnished to us. Based solely on our review of the copies of such reports furnished to us or on written representations to us that no such reports were required, we believe that during the year ended December 31, 2000, all of our executive officers and directors and all beneficial owners of more than 10% of our Common Stock filed on a timely basis all reports, if any, required by Section 16(a) of the Exchange Act. ITEM 11. EXECUTIVE COMPENSATION The following table summarizes the compensation for the fiscal years ended December 31, 1998, 1999 and 2000 of our Chief Executive Officer and our other most highly compensated executive officers whose cash compensation exceeded $100,000 in 2000 (the "Named Executives"):
LONG-TERM COMPENSATION ANNUAL COMPENSATION AWARDS ------------------------------------ --------- SHARES NAME AND PRINCIPAL OTHER ANNUAL UNDERLYING ALL OTHER POSITION YEAR SALARY(1) BONUS COMPENSATION(2) OPTIONS(3) COMPENSATION - ------------------------ ---- --------- -------- --------------- ---------- ------------ Brian J. Farrell 2000 $409,000 $400,000 100,000 $ 6,400(4) President and Chief 1999 $370,154 $360,000 -- 150,000 $ 6,000(4) Executive Officer 1998 $310,109 $300,000 -- 225,000 $ 6,000(4 Jeffrey C. Lapin(5) 2000 $275,000 $275,000 -- 70,000 $ 6,400(6) Vice Chairman and Chief 1999 $225,866 $225,000 -- 75,000 $ 6,000(6) Operating Officer 1998 -- -- -- 322,500 $40,000(7) Fred A. Gysi 2000 $193,333 $75,000 -- 30,000 $ 6,400(8) CFO, Senior V.P - 1999 $168,333 $50,000 -- 30,000 $ 6,000(8) Finance and 1998 $149,380 $40,000 -- 33,750 $ 6,000(8) Administration, Treasurer and Secretary Alison Locke 2000 $250,000 $210,000 -- 50,000 $ 6,400(9) Executive V.P.- North 1999 $196,692 $250,198 -- 60,000 $ 6,000(9) American Publishing 1998 $147,335 $286,910 -- 39,375 $ 6,000(9) Tim F. Walsh 2000 $196,876 $140,000 -- 45,000 $ 6,400(9) Senior V.P.- 1999 $150,577 $146,876 -- 45,000 $ 6,000(9) International 1998 $110,039 $121,876 -- 33,750 $ 6,000(9) Publishing
(1) Included in each Named Executive's salary are amounts that were deferred by such Named Executive pursuant to our Defined Contribution Plan. (2) Amounts shown do not include amounts expended by us pursuant to plans (including group life and health) that do not discriminate in scope, terms or operation in favor of our executive officers or directors and that are generally available to all salaried employees. The value of such benefits did not exceed the lesser of either $50,000 or 10% of the total annual salary and bonus reported for any individual named. (3) Awards of stock option grants have been adjusted to reflect the 50% stock dividends distributed in August 1998 and December 1999. (4) The amounts shown for 1998 and 1999 reflect matching contributions in the amounts of $6,000 made by us in accordance with our Defined Contribution Plan. The amount shown for 2000 reflects matching contributions in the amounts of $6,400 made by us in accordance with our Defined Contribution Plan. This amount does not reflect special awards and payments Mr. Farrell is entitled to receive if his employment is terminated as a result of a change in control of our company, which would have had a value of approximately $887,000 as of December 31, 1998, and $1,196,000 as of December 31, 1999 and 2000. See "Employment Agreement with Brian J. Farrell." -31- 34 (5) Mr. Lapin joined the Company in October 1998. (6) The amount shown for 2000 reflects a matching contribution in the amounts of $6,400 made by us in accordance with our Defined Contribution Plan. This amount does not reflect special awards and payments Mr. Lapin is entitled to receive if his employment is terminated as a result of a change in control of our company, which would have had a value of approximately $971,750 as of December 31, 2000. See "Employment Agreement with Jeffrey C. Lapin." (7) The amount shown reflects the amount paid to Mr. Lapin for consulting services rendered by him prior to Mr. Lapin becoming an employee. (8) The amounts shown for 1998 and 1999 reflect matching contributions in the amount of $6,000 made by us in accordance with our Defined Contribution Plan. The amount shown for 2000 reflects matching contributions in the amounts of $6,400 made by us in accordance with our Defined Contribution Plan. (9) The amounts shown for 1998 and 1999 reflect matching contributions in the amount of $6,000 made by us in accordance with our Defined Contribution Plan. The amount shown for 2000 reflects matching contributions in the amounts of $6,400 made by us in accordance with our Defined Contribution Plan. OPTION GRANTS IN LAST FISCAL YEAR The following table sets forth the number of stock options granted to each of the Named Executives during the fiscal year ended December 31, 2000. The table also sets forth the potential realizable value of such stock options in the year of their expiration at arbitrarily assumed annualized rates of stock price appreciation of five and ten percent over the full five-year term of the stock options. No gain to the Named Executives is possible without an increase in the price of our Common Stock, which will benefit all stockholders proportionately. Actual gains, if any, on stock option exercises and Common Stock holdings are dependent on the future performance of our Common Stock and overall stock market conditions. There can be no assurance that the potential realizable values shown in this table will be achieved.
INDIVIDUAL GRANTS --------------------------------------------------------------------- POTENTIAL REALIZABLE PERCENT OF VALUE AT ASSUMED TOTAL STOCK VALUE OPTIONS ANNUAL RATES OF SHARES GRANTED TO EXERCISE APPRECIATION UNDERLYING EMPLOYEES OR BASE FOR OPTION TERM(1) OPTIONS IN PRICE EXPIRATION -------------------- NAME GRANTED FISCAL YEAR PER SHARE DATE 5% 10% - ---------------- ---------- ----------- --------- ---------- -------- --------- Brian J. Farrell 100,000 7% $15.38 7/21/05 $424,783 $938,659 Jeffrey C. Lapin 70,000 5% $15.38 7/21/05 $297,348 $657,061 Fred A. Gysi 30,000 2% $15.38 7/21/05 $127,435 $281,598 Alison Locke 50,000 3% $15.38 7/21/05 $212,391 $469,330 Tim F. Walsh 45,000 3% $15.38 7/21/05 $191,152 $422,397
- ------------- (1) For the stock options indicated, these amounts represent the exercise price multiplied by the annual appreciation rate shown compounded annually for the term of each option, less the exercise price, multiplied by the number of options granted. The dollar amounts set forth under this heading are the result of calculations at the 5% and 10% rates set by the SEC and therefore are not intended to forecast possible future appreciation, if any, of our stock price. -32- 35 AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES The following table sets forth, for each of the Named Executives, certain information regarding the number of stock options exercised during the fiscal year ended December 31, 2000 and the value of stock options held at fiscal year end.
VALUE OF UNEXERCISED IN-THE-MONEY NUMBER OF SHARES UNDERLYING OPTIONS AT UNEXERCISED OPTIONS FISCAL AT FISCAL YEAR-END YEAR-END(1) SHARES --------------------------------------------- ------------- ACQUIRED ON REALIZED --------------------------------------------------------------- NAME EXERCISE VALUE EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - -------------- -------- ---------- ----------- ------------- ----------- ------------- Brian J.Farrell 64,000 $1,064,046 548,501 275,000 $9,426,783 $1,990,628 Jeffrey C. Lapin 20,000 $ 144,166 305,000 120,000 $3,698,324 $ 630,000 Fred A. Gysi -- -- 62,501 61,250 $ 865,052 $ 433,594 Alison Locke 13,125 $ 182,816 40,626 103,124 $ 325,333 $ 640,845 Tim F. Walsh -- -- 56,593 86,250 $ 757,291 $ 568,594
- ----------- (1) Calculated based on the excess of fair market value of our common stock on December 31, 2000 over the respective exercise prices of the options. DIRECTOR COMPENSATION Directors who are also employees and officers of our company are not paid any compensation for service as directors. Non-employee directors are compensated by cash payments comprised of $12,000 for the year plus $1,500 for attendance at each Board meeting held in person and $500 for attendance at each Board meeting held by telephone, and the grant of options pursuant to our 1997 Stock Option Plan. Pursuant to such plan, each non-employee director is granted options to purchase 3,750 shares of Common Stock on the first day of each fiscal quarter at a per share exercise price equal to the market price of a share of Common Stock on the date of grant. During 2000, each of the non-employee directors received grants under our 1997 Stock Option Plan of options exercisable for 15,000 shares of Common Stock. EMPLOYMENT AGREEMENT WITH BRIAN J. FARRELL Mr. Farrell received an annual base salary of $409,000 in year 2000, pursuant to his amended and restated employment agreement dated as of June 30, 1999 (the "1999 Farrell Employment Agreement"). Mr. Farrell also received an annual bonus in the amount of $400,000 in year 2000, pursuant to the 1999 Farrell Employment Agreement. Mr. Farrell and we entered into an amended and restated employment agreement effective January 1, 2001 (the "2001 Farrell Employment Agreement") that provides for Mr. Farrell's employment by us through December 31, 2006 (the "Farrell Employment Period"). The 2001 Farrell Employment Agreement provides for an annual base salary of $460,000, subject to annual review for possible increase, and an annual bonus equal to the lesser of his base salary for that year or 4.5% of our annual net income before taxes. Mr. Farrell may also be awarded a performance bonus at the discretion of the board of directors. We also agreed to grant Mr. Farrell stock options under our 1997 Stock Option Plan to purchase 125,000 shares -33- 36 of our common stock, with an exercise price per share equal to the fair-market value per share of our common stock on the date the options are granted. The options vest in three equal installments on the first of January of each of 2002, 2003 and 2004. Further, we are required to provide Mr. Farrell with a life insurance policy in the amount of $3 million, disability insurance for 80% of his base salary and a grantor trust established under Sections 671, et. seq. of the Internal Revenue Code (a Rabbi Trust). The 2001 Farrell Employment Agreement provides that if Mr. Farrell voluntarily terminates his employment without "good reason" or we terminate his employment for "cause," he will be precluded, during the twelve months following any such termination, from engaging in any business activities in competition with our business and from soliciting our employees. The 2001 Farrell Employment Agreement provides Mr. Farrell with the following payments and benefits in the event that the 2001 Farrell Employment Agreement is terminated by Mr. Farrell for "good reason" or by us without cause: (i) a lump sum payment equal to (A) the greater of three years' base salary or the salary payable during the then-existing balance of the Farrell Employment Period, plus (B) bonus compensation at the highest possible annual bonus for the greater of three years or the then-existing balance of the Farrell Employment Period; (ii) medical and dental insurance coverage until the end of the Farrell Employment Period; (iii) life and disability insurance coverage until the end of the Farrell Employment Period; (iv) various other perquisites as more fully described in the 2001 Farrell Employment Agreement; (v) the immediate vesting of all stock options, stock appreciation rights and restricted stock, if any, not fully vested at such time; (vi) the immediate vesting of Mr. Farrell's rights in all other employee benefit and compensation plans; (vii) payment of the fees and disbursements incurred by counsel to Mr. Farrell as a result of the termination of Mr. Farrell's employment; and (vii) appropriate office and secretarial assistance for six months after termination of Mr. Farrell's employment. If, within one year after a change of control, Mr. Farrell's employment is terminated by us other than for cause, or voluntarily by Mr. Farrell, then Mr. Farrell shall receive certain benefits, as more fully described in the 2001 Farrell Employment Agreement, in addition to those described above. A change of control includes such events as a person gaining 15% or more beneficial ownership in the Company, our current board members ceasing to comprise at least a majority of our board (with some exceptions), and/or a sale of all or substantially all of our assets or of business operations generating two-thirds of our consolidated revenues. EMPLOYMENT AGREEMENT WITH JEFFREY C. LAPIN Mr. Lapin received an annual base salary of $275,000 in year 2000, pursuant to the employment agreement, dated as of January 1, 1999 (the "1999 Lapin Employment Agreement"). Mr. Lapin also received an annual bonus in the amount of $275,000 in year 2000, pursuant to the 1999 Lapin Employment Agreement. Mr. Lapin and we entered into an amended and restated employment agreement effective January 1, 2001 (the "2001 Lapin Employment Agreement") that provides for Mr. Lapin's employment by us through December 31, 2006 (the "Lapin Employment Period"). The 2001 Lapin Employment Agreement provides for an annual base salary of $325,000, subject to annual review for possible increase, and an annual bonus equal to the lesser of his base salary for that year or 4.5% of our annual net income before taxes. Mr. Lapin may also be awarded a performance bonus at the discretion of the board of directors. We also agreed to grant -34- 37 Mr. Lapin a stock option under our 1997 Stock Option Plan to purchase 100,000 shares of our common stock, with an exercise price per share equal to the fair-market value per share of our common stock on the date the options are granted. The options vest in three equal installments on the first of January of each of 2002, 2003 and 2004. Further, we are required to provide Mr. Lapin with a life insurance policy in the amount of $3 million, disability insurance for 80% of his base salary and a grantor trust established under Sections 671, et. seq. of the Internal Revenue Code (a Rabbi Trust). The 2001 Lapin Employment Agreement provides that if Mr. Lapin voluntarily terminates his employment without "good reason" or we terminate his employment for "cause," he will be precluded, during the twelve months following any such termination, from engaging in any business activities in competition with our business and from soliciting our employees. The 2001 Lapin Employment Agreement provides Mr. Lapin with the following payments and benefits in the event that the 2001 Lapin Employment Agreement is terminated by Mr. Lapin for "good reason" or by us without cause: (i) a lump sum payment equal to (A) the greater of three years' base salary or the salary payable during the then-existing balance of the Lapin Employment Period, plus (B) bonus compensation at the highest possible annual bonus for the greater of three years or the then-existing balance of the Lapin Employment Period; (ii) medical and dental insurance coverage until the end of the Lapin Employment Period; (iii) life and disability insurance coverage until the end of the Lapin Employment Period; (iv) various other perquisites as more fully described in the 2001 Lapin Employment Agreement; (v) the immediate vesting of all stock options, stock appreciation rights and restricted stock, if any, not fully vested at such time; (vi) the immediate vesting of Mr. Lapin's rights in all other employee benefit and compensation plans; (vii) payment of the fees and disbursements incurred by counsel to Mr. Lapin as a result of the termination of Mr. Lapin's employment; and (vii) appropriate office and secretarial assistance for six months after termination of Mr. Lapin's employment. If, within one year after a change of control, Mr. Lapin's employment is terminated by us other than for cause, or voluntarily by Mr. Lapin, then Mr. Lapin shall receive certain benefits, as more fully described in the 2001 Lapin Employment Agreement, in addition to those described above. A change of control includes such events as a person gaining 15% or more beneficial ownership in the Company, our current board members ceasing to comprise at least a majority of our board (with some exceptions), and/or a sale of all or substantially all of our assets or of business operations generating two-thirds of our consolidated revenues. SEVERANCE AGREEMENTS The Company has entered into severance agreements (the "Severance Agreements") with each of its executives except for Messrs. Farrell and Lapin. Mr. Farrell's and Mr. Lapin's employment agreements provide for the payment of benefits upon each individual's termination following a Change of Control as discussed above in "Employment Agreement with Brian J. Farrell" and "Employment Agreement with Jeffrey C. Lapin." The Severance Agreements provide for the payment of benefits to the executives upon a "Change in Control." The executives agree to not voluntarily leave our company without "Good Reason" until the earlier of (a) such attempted Change in Control terminates, or (b) if a Change in Control occurs, 90 days following such Change in Control. -35- 38 A "Change in Control" is defined, subject to certain exceptions, as an acquisition by any person or group of persons of 30% or more of either (a) the outstanding Common Stock, or (b) the combined voting power of the outstanding securities entitled to vote for the election of directors. "Good Reason" is defined to include any of the following events after a Change in Control: (a) any removal or involuntary termination of the executive; (b) a reduction of the executive's rate of annual base salary as in effect immediately prior to the Change in Control or our failure to pay such salary; (c) a requirement that the executive relocate; (d) our failure to provide the executive with compensation, vacation and other fringe benefits, expense reimbursement, and welfare benefits in accordance with the most favorable plans and benefits in effect for the peer officers of our company after the Change in Control; and (e) our failure to maintain the effectiveness of the Severance Agreements after the Change of Control. The Severance Agreements provide that if an executive's employment is terminated within the year following a Change in Control for any other reason, such executive will be entitled to receive, among other benefits, a cash amount equal to (i) one times such executive's annual base salary paid to such executive at the time of the Change in Control, plus (ii) one times such executive's annual bonus paid or payable to such executive in respect of our fiscal year immediately preceding the fiscal year in which the Change in Control occurs. In addition, if on the date of termination such executive's stock options are not fully vested, all such stock options shall become immediately vested and exercisable for such period as provided in the plan and/or agreement governing such options. If Messrs. Gysi and Walsh and Ms. Locke were terminated in accordance with the foregoing they currently would receive $260,000, $350,000 and $485,000, respectively. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Compensation Committee in 2000 consisted of Messrs. Burstein and Whims. Each of Messrs. Burstein and Whims are non-employee Directors and neither have any direct or indirect material interest in, or relationship with, us outside of his position as a Director. To our knowledge, there were no other interrelationships involving members of the Compensation Committee or other Directors requiring disclosure. -36- 39 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT PRINCIPAL STOCKHOLDERS The following table sets forth information as to all persons who are, to our knowledge, the beneficial owners of 5% or more of our outstanding Common Stock as of March 26, 2001
AMOUNT AND NATURE OF TITLE OF BENEFICIAL PERCENT CLASS NAME AND ADDRESS OWNERSHIP OF CLASS - -------------- -------------------------------------------------- -------------- -------- Common Dresdner RCM Global Investors LLC 1,600,100(1) 7.6% Four Embarcadero Center, San Francisco, California 94111 Common Liberty Wagner Asset Management, L.P. ("WAM") 1,075,000(2) 5.1% WAM Acquisition GP, Inc., the general partner of WAM ("WAM GP") 227 West Monroe Street, Suite 3000, Chicago, Illinois 60606
- ---------- (1) Based on information set forth in Schedule 13G dated February 7, 2001 and filed with the Securities and Exchange Commission by Dresdner RCM Global Investors LLC. (2) Based on information set forth in Schedule 13G dated February 14, 2001 and filed with the Securities and Exchange Commission by Liberty Wagner Asset Management, L.P. -37- 40 BENEFICIAL OWNERSHIP OF MANAGEMENT The following table sets forth certain information with respect to beneficial ownership of our Common Stock as of March 26, 2001 by each of our directors as of that date, by the Named Executives and by all directors and executive officers as a group. Unless otherwise indicated below, each individual named in the table has sole voting power and sole investment power with respect to all the shares beneficially owned, subject to community property laws, where applicable.
TITLE OF NAME AND AMOUNT AND NATURE OF PERCENT CLASS ADDRESS(1) BENEFICIAL OWNERSHIP OF CLASS ---------- --------------------------- -------------------- -------- Common Brian J. Farrell 529,501 (2) 2.5% Common Jeffrey C. Lapin 262,000 (3) 1.2% Common Lawrence Burstein 121,202 (4) * Common Bruce Jagid 98,251 (5) * Common James L. Whims 120,147 (6) * Common L. Gregory Ballard 39,375 (7) * Common Fred Gysi 39,501 (8) * Common Alison Locke 10,002 (9) * Common Tim F. Walsh 41,596(10) * All Directors and Executive Officers 1,261,575(11) 5.9% as a group (9 individuals)
- -------------- * Less than 1%. (1) The address for each individual is c/o THQ Inc., 27001 Agoura Road, Calabasas Hills, California 91301. (2) Includes 498,501 shares of Common Stock issuable upon exercise of options exercisable within 60 days. (3) Includes 245,000 shares of Common Stock issuable upon exercise of options exercisable within 60 days. (4) Includes 105,004 shares of Common Stock issuable upon exercise of options exercisable within 60 days. (5) Includes 93,750 shares of Common Stock issuable upon exercise of options exercisable within 60 days. (6) Includes 60,000 shares of Common Stock issuable upon exercise of options exercisable within 60 days and 55,147 shares of Common Stock held of record by TechFund Capital L.P. ("TechFund"). Mr. Whims is a managing member of the general partner of TechFund and accordingly may be deemed to share beneficial ownership of the shares of Common Stock held of record by TechFund. Mr. Whims disclaims beneficial ownership of such shares. (7) All 39,375 shares of Common Stock issuable upon exercise of options exercisable within 60 days. (8) Includes 32,501 shares of Common Stock issuable upon exercise of options exercisable within 60 days. (9) All 10,002 shares of Common Stock issuable upon exercise of options exercisable within 60 days. (10) Includes 26,251 shares of Common Stock issuable upon exercise of options exercisable within 60 days. (11) Includes an aggregate of 1,110,384 shares of Common Stock issuable upon exercise of options within 60 days. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS We believe that there were no reportable relationships or transactions with management during the year ended December 31, 2000. -38- 41 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES. See Index to Financial Statements. (b) REPORTS ON FORM 8-K. Current Report on Form 8-K dated November 13, 2000, reporting under item 5. (c) EXHIBITS.
EXHIBIT NUMBER TITLE - ---------- ------------------------------------------------------------------ 2 Agreement of Merger dated as of August 31, 2000, among THQ Inc., Volition Acquisition Company and Volition, Inc. (incorporated by reference to Exhibit 2 to the Registrant's Current Report on Form 8-K dated September 15, 2000. 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 3.2 to Post-Effective Amendment No. 1 to the S-3 Registration Statement). 3.3 Amended and Restated Bylaws (incorporated by reference to Exhibit 3 to the Registrant's Current Report on Form 8-K, dated June 22, 2000 (the "June 2000 8-K")). 3.4 Certificate of Designation of Series A Junior Participating Preferred Stock of THQ Inc. (incorporated by reference to Exhibit A to the Stockholders Rights Agreement dated as of June 21, 2000 between the Company and American Stock Transfer & Trust Company, as Rights Agent ("Rights Agreement"), which is Exhibit 4 to the June 2000 8-K). 4.1 Rights Agreement (incorporated by reference to Exhibit 4 to the June 2000 8-K). 10.1* Amended and Restated Employment Agreement dated as of January 1, 2001, between the Company and Brian J. Farrell. 10.2* Amended and Restated Employment Agreement dated as of January 1, 2001, between the Company and Jeffrey C. Lapin. 10.3* Employment Agreement between Fred A. Gysi and the Company dated October 1, 1997 (incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998 (the "1998 10-K")). 10.4* Form of Severance Agreement with Executive Officers (incorporated by reference to Exhibit 10.7 to the 1998 10-K). 10.5* Amended and Restated 1990 Stock Option Plan (incorporated by reference to Exhibit 10.1 to the Registration Statement on Form S-2 filed on December 23, 1996 (File No. 333-18641)). 10.6* Stock Option Agreement dated as of August 28, 1996, between the Company and Brian J. Farrell (incorporated by reference to Exhibit 10.31 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996). 10.7* 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).
-39- 42
EXHIBIT NUMBER TITLE - ---------- ------------------------------------------------------------------ 10.8* Form of Stock Option Agreement for the 1997 Stock Option Plan (incorporated by reference to Exhibit 4.5 to the Registration Statement on Form S-8 filed March 19, 1999 (File No. 333-74715)). 10.9* Stock Option Agreement dated as of October 21, 1998, between the Company and Jeffrey C. Lapin (incorporated by reference to Exhibit 10.8 to the 1999 2nd Quarter 10-Q). 10.10* Form of Stock Option Agreement dated as of December 23, 1998, between the Company and Messrs. Lawrence Burstein, Bruce Jagid and James Whims (incorporated by reference to Exhibit 10.9 to the 1999 2nd Quarter 10-Q). 10.11 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")). 10.12 Form of Incentive Stock Option Agreement for the GA Plan (incorporated by reference to Exhibit 4.5 to the GA S-8). 10.13 Revolving Credit Agreement, dated as of August 31, 2000 by and between the Company, the Lenders named therein, and Union Bank of California, N.A. ("Union Bank"), as Agent (incorporated by reference to Exhibit 10.1 to the 2000 3rd Quarter 10-Q). 10.14 First Amendment to Revolving Credit Agreement, dated as of October 23, 2000 between the Company, Union Bank as Agent and as Lender, BNP Paribas, and Pacific Century Bank, N.A. (incorporated by reference to Exhibit 10.2 to the 2000 3rd Quarter 10-Q). 21 Subsidiaries of the Registrant 23.1 Consent of Deloitte & Touche LLP.
- ------------- * Management contract or compensatory plan or arrangement required to be filed as an exhibit hereto pursuant to Item 14(c) of Form 10-K. -40- 43 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: March 29, 2001 THQ INC. By: /s/ Brian J. Farrell ------------------------------------ Brian J. Farrell, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - ------------------------- ---------------------------------------- -------------- /s/ Brian J. Farrell Director, President and Chief Executive March 29, 2001 - ---------------------- Officer (Principal Executive Officer) Brian J. Farrell /s/ Lawrence Burstein Director March 29, 2001 - ----------------------- Lawrence Burstein /s/ Bruce Jagid Director March 29, 2001 - --------------- Bruce Jagid /s/ James L. Whims Director March 29, 2001 - ------------------ James L. Whims /s/ Jeffrey C. Lapin Director, Vice Chairman and March 29, 2001 - -------------------- Chief Operating Officer Jeffrey C. Lapin /s/ L. Gregory Ballard Director March 29, 2001 - ---------------------- L. Gregory Ballard /s/ Fred A. Gysi Senior Vice President, Finance & March 29, 2001 - ---------------- Administration, Chief Financial Officer and Fred A. Gysi Secretary (Principal Financial Officer and Principal Accounting Officer)
-41- 44 THQ INC. INDEX TO FINANCIAL STATEMENTS
PAGE ---- INDEPENDENT AUDITORS' REPORT F-2 CONSOLIDATED FINANCIAL STATEMENTS F-3 Consolidated Balance Sheets -- December 31, 1999 and 2000 Consolidated Statements of Operations for Each of the Three Years in the Period Ended F-4 December 31, 2000 Consolidated Statements of Shareholders' Equity for Each of the Three Years in the F-5 Period Ended December 31, 2000 Consolidated Statements of Cash Flows for Each of the Three Years in the Period Ended F-7 December 31, 2000 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-9
All financial statement schedules have been omitted since either (i) the schedule or condition requiring a schedule is not applicable or (ii) the information required by such schedule is contained in the Consolidated Financial Statements and Notes thereto. F-1 45 INDEPENDENT AUDITORS' REPORT To the Shareholders of THQ Inc., Calabasas, California We have audited the accompanying consolidated balance sheets of THQ Inc. and subsidiaries (the "Company") as of December 31, 1999 and 2000, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 1999 and 2000, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. DELOITTE & TOUCHE LLP Los Angeles, California February 16, 2001 F-2 46
THQ INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - -------------------------------------------------------------------------------------------------- DECEMBER 31, --------------------------------- 1999 2000 ------------- ------------- ASSETS Current assets: Cash and cash equivalents $ 21,454,000 $ 27,998,000 Accounts receivable -- net 97,014,000 135,048,000 Inventory 5,455,000 10,707,000 Prepaid and deferred royalties 21,891,000 8,756,000 Software development costs 11,640,000 11,818,000 Deferred income taxes 6,817,000 9,202,000 Income taxes receivable 965,000 -- Prepaid expenses and other current assets 2,225,000 4,557,000 ------------- ------------- Total current assets 167,461,000 208,086,000 Property and equipment -- net 5,746,000 10,607,000 Deferred royalties -- net of current portion 3,371,000 2,382,000 Software development costs -- net of current portion 1,824,000 949,000 Deferred income taxes -- net of current portion 2,865,000 581,000 Other long-term assets 2,790,000 7,337,000 ------------- ------------- TOTAL ASSETS $ 184,057,000 $ 229,942,000 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Lines of credit $ 16,702,000 $ 15,473,000 Accounts payable 14,540,000 22,956,000 Accrued expenses 13,105,000 23,448,000 Accrued royalties 31,254,000 29,869,000 Income taxes payable -- 6,071,000 Total current liabilities 75,601,000 97,817,000 ------------- ------------- Accrued royalties -- net of current portion 150,000 -- Commitments and contingencies -- -- Shareholders' equity: Common Stock, par value $.01, 35,000,000 shares authorized; 19,897,234 and 20,460,538 shares issued and outstanding as of December 31, 1999 and 2000, respectively 199,000 205,000 Additional paid-in capital 79,250,000 85,747,000 Accumulated other comprehensive loss (842,000) (1,715,000) Retained earnings 29,699,000 47,888,000 ------------- ------------- Total shareholders' equity 108,306,000 132,125,000 ------------- ------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 184,057,000 $ 229,942,000 ============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-3 47
THQ INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS - ----------------------------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, ------------------------------------------------ 1998 1999 2000 ------------ ------------ ------------ Net sales $216,716,000 $303,483,000 $347,003,000 Costs and expenses: Cost of sales 100,019,000 134,563,000 140,699,000 Royalties and project abandonment 48,130,000 48,370,000 77,550,000 Product development 8,925,000 15,511,000 19,151,000 Selling and marketing 20,326,000 35,440,000 42,446,000 Payment to venture partner -- 6,119,000 17,707,000 General and administrative 10,107,000 14,970,000 19,530,000 In-process research and development 7,232,000 -- -- ------------ ------------ ------------ Total costs and expenses 194,739,000 254,973,000 317,083,000 ------------ ------------ ------------ Income from operations 21,977,000 48,510,000 29,920,000 Interest income, net 819,000 1,109,000 1,323,000 ------------ ------------ ------------ Income before income taxes 22,796,000 49,619,000 31,243,000 Income taxes 9,343,000 18,293,000 13,054,000 ------------ ------------ ------------ Net income $ 13,453,000 $ 31,326,000 $ 18,189,000 ============ ============ ============ Net income per share -- basic $ .75 $ 1.65 $ .91 ============ ============ ============ Net income per share -- diluted $ .63 $ 1.48 $ .84 ============ ============ ============ Shares used in per share calculation -- basic 17,929,000 19,040,000 20,091,000 ============ ============ ============ Shares used in per share calculation -- diluted 21,229,000 21,197,000 21,568,000 ============ ============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-4 48
THQ INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - ------------------------------------------------------------------------------------------------------------------------------ YEARS ENDED DECEMBER 31, 1998, 1999 AND 2000 --------------------------------------------------------------------------------------- ACCUMULATED RETAINED ADDITIONAL OTHER EARNINGS COMMON COMMON PAID-IN COMPREHENSIVE (ACCUMULATED SHARES STOCK CAPITAL INCOME (LOSS) DEFICIT) TOTAL ---------- -------- ------------ -------------- ----------- ------------- Balance at January 1, 1998 17,083,366 $ 20,000 $ 48,821,000 $ 81,000 $(15,080,000) $ 33,842,000 Exercise of warrants and options 902,519 5,000 2,345,000 -- -- 2,350,000 Stock compensation -- -- 187,000 -- -- 187,000 Issuance of common stock 782,706 4,000 10,647,000 -- -- 10,651,000 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 -- -- -- -- 13,453,000 13,453,000 Other comprehensive income Foreign currency translation adjustment -- -- -- (21,000) -- (21,000) Comprehensive income -- -- -- -- -- 13,432,000 ---------- -------- ------------ --------- ------------ ------------- Balance at December 31, 1998 18,768,591 129,000 63,503,000 60,000 (1,627,000) 62,065,000 Exercise of warrants and options 1,128,643 8,000 4,955,000 -- -- 4,963,000 Issuance of warrants -- -- 3,627,000 -- -- 3,627,000 Stock compensation -- -- 464,000 -- -- 464,000 Tax benefit related to the exercise of employee stock options -- -- 6,763,000 -- -- 6,763,000 Three-for-two stock dividend -- 62,000 (62,000) -- -- -- Comprehensive income: Net income -- -- -- -- 31,326,000 31,326,000 Other comprehensive income Foreign currency translation Adjustment -- -- -- (902,000) -- (902,000) Comprehensive income -- -- -- -- -- 30,424,000 ---------- -------- ------------ --------- ------------ ------------- Balance at December 31, 1999 19,897,234 199,000 79,250,000 (842,000) 29,699,000 108,306,000
F-5 49
THQ INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Continued) - ------------------------------------------------------------------------------------------------------------------------------ YEARS ENDED DECEMBER 31, 1998, 1999 AND 2000 --------------------------------------------------------------------------------------- ACCUMULATED RETAINED ADDITIONAL OTHER EARNINGS COMMON COMMON PAID-IN COMPREHENSIVE (ACCUMULATED SHARES STOCK CAPITAL INCOME (LOSS) DEFICIT) TOTAL ---------- -------- ------------ -------------- ----------- ------------- Balance at December 31, 1999 19,897,234 199,000 79,250,000 (842,000) 29,699,000 108,306,000 Exercise of warrants and options 563,304 6,000 4,299,000 -- -- 4,305,000 Stock compensation -- -- 406,000 -- -- 406,000 Tax benefit related to the exercise of employee stock options -- -- 1,792,000 -- -- 1,792,000 Comprehensive income: Net income -- -- -- -- 18,189,000 18,189,000 Other comprehensive income Foreign currency translation Adjustment -- -- -- (873,000) -- (873,000) Comprehensive income -- -- -- -- -- 17,316,000 ---------- -------- ----------- ----------- ----------- ------------- Balance at December 31, 2000 20,460,538 $205,000 $85,747,000 $(1,715,000) $47,888,000 $ 132,125,000 ========== ======== =========== =========== =========== =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-6 50
THQ INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - -------------------------------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, ---------------------------------------------- 1998 1999 2000 ------------ ------------ ------------ Cash flows from operating activities: Net income $ 13,453,000 $ 31,326,000 $ 18,189,000 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 947,000 1,678,000 3,566,000 Provision for doubtful accounts, discounts and returns 20,838,000 35,009,000 35,387,000 Litigation settlement -- 564,000 -- Loss on disposal of property and equipment 40,000 63,000 114,000 Loss on sale of investment securities 218,000 -- -- Stock compensation 187,000 464,000 406,000 Tax benefit from disqualified disposition 1,603,000 6,763,000 1,792,000 In-process research and development 7,232,000 -- -- Deferred income taxes (8,708,000) 692,000 (112,000) Changes in operating assets and liabilities: Accounts receivable (43,755,000) (72,742,000) (74,770,000) Inventory (13,780,000) 11,200,000 (5,442,000) Prepaid and deferred royalties and software development costs 2,346,000 (24,269,000) 14,409,000 Prepaid expenses and other current assets (239,000) (670,000) (2,374,000) Accounts payable and accrued expenses 14,047,000 (3,086,000) 19,291,000 Accrued royalties 8,823,000 15,134,000 (1,427,000) Income taxes payable (receivable) 4,437,000 (9,203,000) 7,107,000 ------------ ------------ ------------ Net cash provided by (used in) operating activities 7,689,000 (7,077,000) 16,136,000 ------------ ------------ ------------ Cash flows used in investing activities: Proceeds from sale of investment securities 863,000 -- -- Purchase of investment securities (1,081,000) -- -- Proceeds from sale of property and equipment -- 39,000 64,000 Acquisition adjustment -- 2,540,000 -- Acquisitions, net of cash acquired (2,369,000) -- -- Acquisition of property and equipment (1,465,000) (4,447,000) (7,877,000) Investment in Yuke's Co., Ltd. -- -- (5,020,000) Increase in other long-term assets (2,010,000) (261,000) (114,000) ------------ ------------ ------------ Net cash used in investing activities (6,062,000) (2,129,000) (12,947,000) ------------ ------------ ------------ Cash flows provided by financing activities: Net increase (decrease) in short-term borrowings 3,265,000 7,118,000 (1,229,000) Proceeds from exercise of warrants and options 2,350,000 4,963,000 4,305,000 ------------ ------------ ------------ Net cash provided by financing activities 5,615,000 12,081,000 3,076,000 ------------ ------------ ------------ Effect of exchange rate changes on cash (156,000) (535,000) 279,000 ------------ ------------ ------------ Net increase in cash and cash equivalents 7,086,000 2,340,000 6,544,000 ------------ ------------ ------------ Cash and cash equivalents -- beginning of period 12,028,000 19,114,000 21,454,000 ------------ ------------ ------------ Cash and cash equivalents -- end of period $ 19,114,000 $ 21,454,000 $ 27,998,000 ============ ============ ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Income taxes $ 12,714,000 $ 19,569,000 $ 4,350,000 ============ ============ ============ Interest $ 196,000 $ 247,000 $ 354,000 ============ ============ ============
F-7 51 SUPPLEMENTAL SCHEDULE OF NON-CASH ACTIVITIES: In 1999, we consolidated the venture with JAKKS Pacific Inc. resulting in the consolidation of our $2,010,000 investment. On August 2, 1999, we issued to the World Wrestling Federation Entertainment (the "WWF") and a related party to the WWF, warrants, expiring December 31, 2009, to purchase 281,250 shares of common stock at $10.42 per share which had a fair value at the time of issuance of $3,063,000. (See Note 12). On May 1, 1998, we issued 523,776 shares of common stock as part of the purchase price for GameFx, Inc. We also assumed the stock options issued by GameFx, Inc. to its employees that, if and when exercised, permit the holders thereof to acquire approximately 22,275 shares of THQ stock. 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 Note 11). On December 2, 1998, we issued 249,930 shares of common stock as part of the purchase price for Rushware Microhandelsgesellschaft mbH. The name was subsequently changed to THQ Entertainment Gmbh ("THQ Entertainment"). This issuance increased common stock and additional paid-in capital by $2,000 and $4,430,000, respectively, and was allocated among the net assets acquired. (See Note 11) DETAILS OF 1998 ACQUISITIONS:
THQ GAMEFX, INC ENTERTAINMENT ------------ ------------ Fair value of assets acquired $ 7,492,000 $ 18,581,000 Liabilities assumed -- (12,567,000) Value of common stock and stock options issued (6,219,000) (4,432,000) ----------- ------------ Cash paid 1,273,000 1,582,000 Less cash acquired -- (486,000) ----------- ------------ Net cash paid for acquisitions $ 1,273,000 $ 1,096,000 =========== ============
In 1999, we renegotiated the purchase of THQ Entertainment and received a payment of $2,540,000 from the sellers. SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-8 52 THQ INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS Business. THQ Inc., a Delaware corporation, is a developer, publisher and distributor of interactive entertainment software for the leading hardware platforms in the home video game market. We currently publish titles for Sony's PlayStation and PlayStation 2, Nintendo 64, Nintendo Game Boy Color and personal computers ("PCs") in most interactive software genres including childrens, action, adventure, driving, fighting, puzzle, role playing, simulation, sports and strategy. Our customers include Wal-Mart, Toys "R" Us, Electronics Boutique, Target, Kmart Stores, Babbages Etc., Best Buy, Kay Bee Toys, and other national and regional retailers, discount store chains and specialty retailers. Unless the context otherwise requires, references in this document to "THQ" or the "Company" include THQ Inc. and all of its wholly owned subsidiaries. License Agreements. We have two license agreements with Sony pursuant to which we have the non-exclusive right to utilize the Sony name and its proprietary information and technology in order to develop and market software for use with the 32-bit Sony PlayStation in the United States and Canada, and Europe, respectively, which expire in August 2002 and December 2005, respectively. We also have a license agreement with Sony for use with the 128-bit Sony PlayStation 2 in the United States and Canada which expires in March 2003. We have two license agreements with Nintendo pursuant to which we have the non-exclusive right to utilize the Nintendo name and its proprietary information and technology in order to develop and market software for use with the 64-bit Nintendo 64 in North America and Latin America, and Europe, Australia and New Zealand which expire in May 2003 and January 2004, respectively. We also have a license agreement with Nintendo for use with the Game Boy Color portable game console in North America and Latin America, and Europe, Australia and New Zealand which expire in March 2002 and October 2002, respectively. Our business is dependent on these license agreements with Sony and Nintendo. Substantially all of our products are manufactured by Sony and Nintendo who charge us a fixed amount for each CD-ROM, DVD or cartridge manufactured. This charge includes a manufacturing, printing and packaging fee as well as a royalty for the use of their respective names, proprietary information and technology. In addition, we must indemnify Sony and Nintendo as appropriate, with respect to all loss, liability and expense resulting from any claim against Sony and Nintendo involving the development, marketing, sale or use of our titles, including any claims for copyright or trademark infringement brought against Sony and Nintendo. As such, we bear the risk that the properties and information and technology licensed from Sony and Nintendo and incorporated in the software may infringe the rights of third parties. Generally, we are entitled to indemnification from our software developers and property licensors to cover our indemnification obligations to Sony and Nintendo but no assurance can be given that, if any claim is brought against us, the developers and/or licensors will have sufficient resources to indemnify us. F-9 53 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation. The consolidated financial statements include the accounts of THQ Inc. and our wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation. Foreign Currency Translation. Assets and liabilities of foreign operations are translated at current rates of exchange while results of operations are translated at average rates in effect for the period. Translation gains or losses are shown as a separate component of shareholders' equity as Accumulated other comprehensive income (loss). Foreign currency gains and losses result from exchange rate changes for transactions denominated in currencies other than the functional currency. Foreign currency transaction gains and losses are not material. Cash Equivalents. We consider all highly liquid investments purchased with maturities less than three months to be cash equivalents. Fair Values of Financial Instruments. The carrying value of our draws on our line of credit from our banks are considered to approximate their fair value because the interest rate of these instruments is based on variable reference rates. Concentrations of Credit Risk. Financial instruments which potentially subject us to concentration of credit risk consist principally of cash and cash equivalents and accounts receivable. We place cash and cash equivalents with high credit-quality institutions and limit the amount of credit exposure to any one institution. Most of our sales are made directly to mass merchandisers and national retailers. Due to the increased volume of sales to these channels, we have experienced an increased concentration of credit risk, and as a result, may maintain individually significant receivable balances with such mass merchandisers and national retailers. While we frequently monitor and manage this risk, financial difficulties on the part of one or more of our major customers may have a material adverse effect on us. Sales (before returns and allowances) to a major customer represented 19%, 15% and 17% of gross sales in the years ended December 31, 1998, 1999 and 2000, respectively. This customer accounted for approximately 18% and 24% of accounts receivable at December 31, 1999 and 2000, respectively. Sales (before returns and allowances) to another major customer represented 13%, 11% and 16% of gross sales in the years ended December 31, 1998, 1999 and 2000, respectively. This customer accounted for approximately 15% and 20% of accounts receivable at December 31, 1999 and 2000, respectively. We perform ongoing credit evaluations of our customers and maintain an allowance for potential credit losses. Inventory. Inventory, which consists principally of finished products, are stated at the lower of cost (moving weighted average) or market. We estimate the net realizable value of slow-moving inventory on a title by title basis, and charge the excess of cost over net realizable value to cost of sales. F-10 54 Property and Equipment. Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of their useful lives or the remaining lease term. Property and equipment consist of the following at:
DECEMBER 31, --------------------------- LIVES 1999 2000 -------- ---------- ----------- Computer Equipment and Software 3-10 yrs $6,584,000 $12,534,000 Furniture, fixtures and equipment 5 yrs 1,739,000 2,293,000 Leasehold improvements 3-6 yrs 1,024,000 914,000 Less accumulated depreciation and amortization (3,601,000) (5,134,000) ---------- ----------- $5,746,000 $10,607,000 ========== ===========
Royalties, Software Development Costs and Project Abandonment Loss. Advance royalty payments for intellectual property licenses are capitalized and recorded as prepaid royalties. All minimum guaranteed royalty payments are initially recorded as an asset (prepaid and deferred royalties) and as a liability (accrued royalties) at the contractual amount upon execution of the contract. Royalty payments for intellectual property licenses are classified as current assets and current liabilities to the extent they relate to anticipated sales during the subsequent year and long-term assets and long-term liabilities if the sales are anticipated after one year. We utilize both independent software developers (who are paid advances against future royalties) and internal development teams to develop our software. We account for prepaid royalties relating to development agreements and capitalized software costs in accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed." Payments made to independent software developers under development agreements that have alternative future uses are capitalized to Software Development Costs. Internal development costs are also capitalized to Software Development Costs once technological feasibility is established. Technological feasibility is evaluated on a product by product basis. Technological feasibility for console entertainment software has been established by Sony and Nintendo for use with their respective hardware platforms. We are currently capitalizing the costs of video games under development at our Heavy Iron, PCP&L and Volition studios. At December 31, 1999 and 2000, we had capitalized software development costs of $1,034,000 and $2,560,000, respectively, at our studios. During 1999 and 2000, we amortized to expense $54,000 and $1,674,000, respectively, of internally developed capitalized software development costs. Prepaid royalties are expensed to Royalties and Project Abandonment expense at the contractual royalty rate based on actual net product sales or on the ratio of current units sold to total projected units whichever amount is greater. Capitalized software development costs are expensed to Royalties and Project Abandonment expense on the ratio of current units sold to total projected units. When, in management's estimate, future revenues will not be sufficient to recover previously capitalized advances or software development costs, we expense these items as project abandonment losses. Such abandonment losses are solely attributable to changes in market conditions or product quality considerations. Research and development costs are expensed to product development expense as incurred. Impairment of Long-lived Assets. We evaluate long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If the estimated future cash flows (undiscounted and without interest charges) F-11 55 from the use of an asset are less than the carrying value, a write-down would be recorded to reduce the related asset to its estimated fair value. Goodwill. Goodwill represents the excess purchase price over net assets acquired and is being amortized on a straight-line basis over 10 years. We review goodwill for impairment whenever events or changes in circumstances indicate that an asset's carrying value may exceed the undiscounted expected future cash flows to be derived from that asset. Whenever undiscounted expected future cash flows are less than the carrying value, the asset will be reduced to an amount equal to the net present value of the expected future cash flows and an impairment loss will be recognized. Revenue Recognition. Revenue is recognized when products are shipped provided that no significant vendor support obligations remain outstanding and that collection of the resulting receivable is deemed probable by management. Although we generally sell our products on a no-return basis, in certain circumstances we may allow returns, price concessions, or allowances on a negotiated basis. We estimate such returns and allowances based upon management's evaluation of our historical experience and current industry trends. Such estimates are deducted from gross sales. Software is sold under a limited 90-day warranty against defects in material and workmanship. To date, we have not experienced material warranty claims (See Note 5). 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 implemented the provisions of SAB 101 and its impact on our revenue recognition policy is immaterial. Advertising. Advertising and sales promotion costs are generally expensed as incurred, except for television airtime and print media costs associated with media campaigns which are deferred and charged to expense as the airtime or advertising space is used. Advertising costs were $5,659,000, $10,108,000 and $27,147,000 in the years ended December 31, 1998, 1999 and 2000, respectively. Stock-Based Compensation. We account for our employee stock plans under the intrinsic value method prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Income Taxes. Deferred income taxes are provided for temporary differences between the financial statement and income tax bases of our assets and liabilities, based on enacted tax rates. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred income tax assets will not be realized. F-12 56 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:
YEARS ENDED DECEMBER 31, ----------------------------------------- 1998 1999 2000 ----------- ----------- ----------- Net income used to compute basic and diluted earnings per share $13,453,000 $31,326,000 $18,189,000 =========== =========== =========== Weighted average number of shares outstanding -- basic 17,929,000 19,040,000 20,091,000 Dilutive effect of stock options and warrants 3,300,000 2,157,000 1,477,000 ----------- ----------- ----------- Number of shares used to compute earnings per share -- diluted 21,229,000 21,197,000 21,568,000 =========== =========== ===========
Recently Issued Accounting Pronouncements. In June 1998, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Under SFAS 133, certain contracts that were not formerly considered derivatives may now meet the definition of a derivative. We will adopt SFAS 133 effective January 1, 2001. We have evaluated the impact of adopting SFAS No. 133, and we believe that such adoption will not have any impact on our financial position, results of operations, or cash flows. Pervasiveness of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates relate to prepaid and deferred royalties, software development costs, accrued returns and allowances and the allowance for doubtful accounts. 3. BUSINESS COMBINATIONS On August 31, 2000, we completed the acquisition of Volition, Inc., a Delaware corporation ("Volition"). In the acquisition, each share of Volition was converted into 0.10989011 share of our common stock, or approximately 890,000 shares. In addition, outstanding Volition employee stock options were assumed by us and converted, at the same conversion rate, into options to purchase approximately 110,000 shares of our common stock. On December 13, 1999, we completed the acquisition of Genetic Anomalies, Inc., a Delaware corporation ("GA"). In the acquisition, each share of GA was converted into 0.0536 share of our common stock, or 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. On May 24, 1999, we completed the acquisition of Pacific Cost Power & Light Company, a California corporation ("PCP&L"). In the acquisition, each share of PCP&L was converted into 0.09008 shares of our common stock, or approximately 727,000 shares. In addition, F-13 57 outstanding PCP&L employee stock options were assumed by us and converted, at the same conversion rate, into options to purchase approximately 196,000 shares of our common stock. The acquisitions have been accounted for as poolings 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, GA and Volition had always been part of our company. All transactions between us, PCP&L, GA and Volition 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 are as follows:
YEARS ENDED DECEMBER 31, ------------------------------------------------- 1998 1999 2000 ------------- ------------- ------------- NET SALES THQ Inc. $ 215,060,000 $ 301,141,000 $ 346,951,000 PCP&L 1,379,000 1,676,000 ** GA 222,000 565,000 ** Volition 605,000 2,713,000 1,907,000 Intercompany elimination (550,000) (2,612,000) (1,855,000) ------------- ------------- ------------- Combined $ 216,716,000 $ 303,483,000 $ 347,003,000 ============= ============= ============= NET INCOME (LOSS) THQ Inc. $ 15,990,000 $ 35,044,000 $ 22,329,000 PCP&L (348,000) (667,000) ** GA (473,000) (411,000) ** Volition (1,166,000) (28,000) (2,285,000) Intercompany elimination (550,000) (2,612,000) (1,855,000) ------------- ------------- ------------- Combined $ 13,453,000 $ 31,326,000 $ 18,189,000 ============= ============= =============
** For fiscal year ended December 31, 2000, the results of operations for PCP&L and GA were included with THQ Inc. 4. CREDIT FACILITY On August 31, 2000, we entered into a Revolving Credit Agreement with Union Bank of California and a syndicate of other financial institutions. This agreement expires on July 1, 2001 and permits us to borrow (and maintain obligations under outstanding letters of credit) up to an aggregate of $50,000,000 subject to the following: We may maintain outstanding letters of credit for product purchases and outstanding borrowings in the aggregate for up to $40,000,000 for September 2000; $50,000,000 between October 1, 2000 and December 31, 2000; $40,000,000 for January 2001 and $25,000,000 between February 1, 2001 and June 30, 2001. In addition, outstanding borrowings cannot exceed $15,000,000 for September 2000; $30,000,000 from October 1 through October 31, 2000; $50,000,000 from November 1, 2000 through December 31, 2000; $35,000,000 from January 1, 2001 through January 31, 2001 and $15,000,000 from February 1, 2001 to June 30, 2001. We are also required to not have any outstanding borrowings for a period of at least 60 days during each year of the agreement. F-14 58 This credit facility is secured by a lien on substantially all of our assets and contains customary financial and non-financial covenants which limit the ability for us to incur additional indebtedness, pay dividends or make other distributions, sell assets and enter into certain mergers or acquisitions. Amounts outstanding under these credit facilities bear interest, at our choice, at either a) the bank's prime rate (9.5% at December 31, 2000) or b) the London Interbank Offered Rate (6.56% at December 31, 2000) plus 1.85%. As of December 31, 2000 we had approximately $5,341,000 in obligations with respect to outstanding letters of credit and $15,473,000 in outstanding borrowings. Under the previous credit facility at December 31, 1999, we had approximately $8,134,000 in obligations with respect to outstanding letters of credit and $16,702,000 in outstanding borrowings. 5. ACCOUNTS RECEIVABLE AND ACCRUED RETURNS AND ALLOWANCES Accounts receivable is due primarily from domestic and foreign retailers and distributors, including mass merchants and specialty stores. Accounts receivable at December 31, 1999 and 2000 consists of the following:
DECEMBER 31, ------------------------------ 1999 2000 ------------ ------------- Accounts receivable -- domestic $ 93,828,000 $ 137,865,000 Other receivables -- domestic 1,469,000 531,000 Allowance for domestic returns and doubtful accounts (16,845,000) (21,676,000) Accounts receivable -- foreign 25,888,000 28,186,000 Allowance for foreign returns and doubtful accounts (7,326,000) (9,858,000) ------------ ------------- Accounts receivable -- net $ 97,014,000 $ 135,048,000 ============ =============
The allowance for domestic accrued returns and allowances consists of the following:
YEARS ENDED DECEMBER 31, ---------------------------------------------- 1998 1999 2000 ------------ ------------ ------------ Balance at January 1 $ (7,767,000) $(15,008,000) $(16,845,000) Provision for discounts and returns (18,870,000) (28,072,000) (27,390,000) Actual discounts and returns 11,629,000 26,235,000 22,559,000 ------------ ------------ ------------ Ending balance $(15,008,000) $(16,845,000) $(21,676,000) ============ ============ ============
The allowance for foreign accrued returns and allowances consists of the following:
YEARS ENDED DECEMBER 31, ---------------------------------------------- 1998 1999 2000 ------------ ------------ ------------ Balance at January 1 $ (372,000) $ (3,890,000) $ (7,326,000) THQ Entertainment purchase as of December 2, 1998 (3,717,000) -- -- Provision for discounts and returns (1,968,000) (6,937,000) (7,997,000) Actual discounts and returns 2,167,000 3,501,000 5,465,000 ------------ ------------ ------------ Ending balance $ (3,890,000) $ (7,326,000) $ (9,858,000) ============ ============ ============
6. EMPLOYEE PENSION PLAN We sponsor for our U.S. employees, a defined contribution plan under Section 401(k) of the Internal Revenue Code. The plan provides that employees may defer up to 12% of annual compensation, and that we will make a matching contribution equal to each employee's deferral, up to 4% of compensation. We may also contribute funds to the plan in the form of a profit- F-15 59 sharing contribution. Expenses under the plan were $400,000, $477,000, and $1,137,000 in 1998, 1999 and 2000, respectively. 7. INCOME TAXES Income before provision for income taxes consisted of:
FOR YEARS ENDED ---------------------------------------------- 1998 1999 2000 ------------ ------------ ------------ United States $ 20,762,000 $ 45,776,000 $ 29,540,000 Foreign 2,034,000 3,843,000 1,703,000 ------------ ------------ ------------ $ 22,796,000 $ 49,619,000 $ 31,243,000 ============ ============ ============
The provision for income taxes consists of the following:
1998 1999 2000 ------------ ------------ ------------ CURRENT Federal $ 14,655,000 $ 13,648,000 $ 9,048,000 State 3,275,000 2,897,000 3,395,000 Foreign 121,000 1,056,000 712,000 ------------ ------------ ------------ 18,051,000 17,601,000 13,155,000 DEFERRED Federal (7,170,000) 121,000 209,000 State (1,538,000) 755,000 (200,000) Foreign -- (184,000) (110,000) ------------ ------------ ------------ (8,708,000) 692,000 (101,000) ------------ ------------ ------------ Provision for income taxes $ 9,343,000 $ 18,293,000 $ 13,054,000 ============ ============ ============
A reconciliation of the provision for income taxes at the federal statutory rate to the provision recorded in the accompanying financial statements is as follows:
1998 1999 2000 --------- --------- --------- Federal provision at statutory rate 35.0% 35.0% 35.0% State taxes (net of Federal benefit) 5.0 5.0 4.1 In-process research and development 10.0 -- -- Change in valuation allowance (11.8) (5.2) -- Preacquisition loss from Volition, Inc. 2.0 1.2 2.5 Foreign taxes and other, net 0.8 0.9 0.2 --------- --------- --------- 41.0% 36.9% 41.8% ========= ========= =========
F-16 60
DECEMBER 31, -------------------------------------------------------------------------------------- 1999 2000 ------------------------------------------ --------------------------------------- FEDERAL STATE FOREIGN FEDERAL STATE FOREIGN ------------ ---------- ----------- ------------ ---------- -------- CURRENT Deferred income tax assets: Allowance for doubtful accounts, discounts and returns $ 5,896,000 $1,144,000 $ 184,000 $ 7,855,000 $1,347,000 $ 294,000 License abandonment 5,356,000 1,039,000 -- 4,763,000 817,000 -- State income taxes 641,000 -- -- 846,000 -- -- Net operating loss 821,000 57,000 -- 905,000 -- -- Other -- net 476,000 92,000 -- 337,000 249,000 -- ------------ ---------- ----------- ------------ ---------- ----------- Total deferred income tax assets 13,190,000 2,332,000 184,000 14,706,000 2,413,000 294,000 Deferred income tax liabilities: Software development costs (7,103,000) (1,378,000) -- (6,601,000) (1,132,000) -- State income taxes (408,000) -- -- (478,000) -- -- ------------ ---------- ----------- ------------ ---------- ----------- Net current deferred income tax assets $ 5,679,000 $ 954,000 $ 184,000 $ 7,627,000 $1,281,000 $ 294,000 ============ ========== =========== ============ ========== =========== NON-CURRENT Deferred income tax assets: Deferred compensation $ 133,000 $ 25,000 $ -- $ 175,000 $ 30,000 $ -- Net operating loss 2,420,000 168,000 -- -- -- -- Other -- net 100,000 19,000 -- 321,000 55,000 -- ------------ ---------- ----------- ------------ ---------- ----------- Net non-current deferred income tax assets $ 2,653,000 $ 212,000 $ -- $ 496,000 $ 85,000 $ -- ============ ========== =========== ============ ========== ===========
The valuation allowance decreased by $2,992,000 and $2,461,000 during 1998 and 1999, respectively. As of December 31, 2000 we had federal net operating loss carryforwards of approximately $2,585,000 (expiring from 2009 to 2011). At December 31, 2000 we had accumulated foreign earnings of $4,327,000. We do not plan to repatriate these earnings, therefore, no U.S. income tax has been provided on the foreign earnings. If such earnings were distributed, U.S. income taxes would be partially reduced for taxes paid to the jurisdictions in which the income was earned. Additionally, we have not tax effected the cumulative translation adjustment as we have no intention of repatriating foreign earnings. 8. STOCK OPTION PLAN We have two stock option plans (the "1990 Plan" and "1997 Plan"), that provide for the issuance of up to 1,462,500 and 4,125,000 shares, respectively, available for employees, consultants and non-employee directors. As of December 31, 2000, no options under the 1990 Plan and 380,542 options under the 1997 Plan were available for grant. Stock options granted under the option plans may be incentive stock options or nonstatutory stock options. Options may be granted under the option plans to, in the case of incentive stock options, all employees (including officers) of THQ; or, in the case of nonstatutory stock options, all employees (including officers), consultants and non-employee directors of THQ. F-17 61 On June 8, 2000, the Board of Directors approved the THQ Inc. Non-executive Employee Stock Option Plan (the "NEEP Plan"). The NEEP Plan has primarily the same attributes as the 1990 Plan and the 1997 Plan, but participation is reserved for employees who are not executive officers and under the NEEP Plan only nonqualified options will be granted. The NEEP Plan provides for the issuance of up to 550,000 shares, of which no more than 20% is available for awards to our non-executive officers and no more than 15% is available for awards to the non-executive officers or general managers of our subsidiaries or divisions. As of December 31, 2000, 37,850 options were available for grant. The exercise price per share of all options granted under the plans in 1998, 1999 and 2000 has been the closing market price of the stock on the date of the grant. Stock options issued by PCP&L and GA were issued at below market value. These options were accounted for under APB Opinion No. 25 and we have recognized compensation expense of $187,000, $464,000 and $406,000 for 1998, 1999 and 2000, respectively. Generally, options granted become exercisable over three years and expire within five years from the date of grant.
WEIGHTED AVERAGE NUMBER OF STOCK OPTIONS EXERCISE PRICE SHARES - -------------------------------------------- -------------- --------- Balance at January 1, 1998 $ 3.46 1,744,087 Granted $ 10.93 1,370,525 Exercised $ 2.11 (553,416) Canceled $ 8.79 (78,937) --------- Balance at December 31, 1998 $ 7.72 2,482,259 Granted $ 22.24 1,258,200 Exercised $ 5.48 (882,119) Canceled $ 11.97 (282,416) --------- Balance at December 31, 1999 $ 15.11 2,575,924 Granted $ 15.78 1,518,959 Exercised $ 9.15 (251,665) Canceled $ 14.53 (429,915) --------- Balance at December 31, 2000 $ 15.92 3,413,303 ========= Options exercisable at December 31, 2000 $ 13.47 1,217,779
Options granted and shares exercised relating to options granted outside of our stock option plans during 1998, 1999 and 2000 are listed below. Share exercise prices for these options equal the market price of our common stock at the date of the grant.
WEIGHTED AVERAGE NUMBER OF STOCK OPTIONS EXERCISE PRICE SHARES - -------------------------------------------- -------------- --------- Balance at January 1, 1998 $ 1.61 848,116 Granted $ 8.04 508,026 Exercised $ 1.34 (236,250) --------- Balance at December 31, 1998 $ 7.72 1,119,892 Granted $ 2.46 62,204 Exercised $ 1.80 (199,450) Canceled $ 4.81 (26,072) --------- Balance at December 31, 1999 $ 15.11 956,574 Exercised $ 1.95 (211,639) Canceled $ 0.69 (30,432) --------- Balance at December 31, 2000 $ 6.11 714,503 ========= Options exercisable at December 31, 2000 $ 6.72 643,352
F-18 62 The following table summarizes information about stock options outstanding at December 31, 2000:
WEIGHTED NUMBER AVERAGE WEIGHTED RANGE OF OUTSTANDING AT REMAINING AVERAGE EXERCISE EXERCISE PRICE DECEMBER 31, 2000 CONTRACTUAL LIFE PRICE --------------- ----------------- ---------------- ---------------- $ 0.23 - $ 9.83 1,251,749 4 $ 5.75 $10.00 - $12.36 825,551 4 $11.10 $12.38 - $18.75 1,078,851 4 $17.00 $19.13 - $26.17 833,955 4 $24.42 $26.17 - $28.54 137,700 4 $26.56 ----------------- ---------------- ---------------- 4,127,806 4 $14.22 ================= ================ ================
SHARES RANGE OF EXERCISABLE AT WEIGHTED AVERAGE EXERCISE PRICE DECEMBER 31, 2000 EXERCISE PRICE --------------- ----------------- ---------------- $ 0.23 - $ 9.83 992,728 $ 5.34 $10.00 - $12.36 330,074 $11.08 $12.38 - $18.75 213,804 $16.87 $19.13 - $26.17 263,625 $24.68 $26.17 - $28.54 60,900 $27.05 ----------------- ---------------- 1,861,131 $11.13 ================= ================
The estimated fair value of the options granted in 1998, 1999 and 2000 was $13,606,000, $15,443,000 and $12,700,000, respectively. We apply APB Opinion No. 25 and related Interpretations in accounting for stock option plans. Accordingly, no compensation cost for our stock option plans has been recognized in 1998, 1999 or 2000. Had compensation cost for our stock option plans been determined based on the fair value at the grant dates for awards under the plans consistent with SFAS No. 123, Accounting for Stock-Based Compensation, our net income and earnings per share for the years ended December 31, 1998, 1999 and 2000 would have been reduced to the pro forma amounts indicated below:
FOR YEARS ENDED DECEMBER 31, ----------------------------------------- 1998 1999 2000 ----------- ----------- ----------- Net income: As reported $13,453,000 $31,326,000 $18,189,000 Pro forma $ 9,870,000 $24,625,000 $ 8,371,000 Diluted net income per Share: As reported $ .63 $ 1.48 $ .84 Pro forma $ .47 $ 1.16 $ .39
The fair market value of options granted under the stock option plans during 1998, 1999 and 2000 was determined using the Black-Scholes option pricing model utilizing the following assumptions:
FOR YEARS ENDED DECEMBER 31, ----------------------------------------- 1998 1999 2000 ------- ------- ------- Dividend yield 0% 0% 0% Anticipated volatility 87% 70% 73% Weighted average risk-free interest rate 5.15% 5.53% 6.12% Expected lives 4 years 4 years 4 years
F-19 63 9. RELATED PARTY TRANSACTIONS In 1998 and 1999, we paid Inland Productions, Inc., a software developer in which we acquired a 25% interest on July 1, 1996, $4,891,000 and $4,905,000, respectively. As of December 31, 1998 and 1999, we owed Inland Productions, Inc. $166,000 and $137,000, respectively. In 2000, Inland Productions, Inc., purchased the 25% interest we acquired in 1996 (See Note 11). 10. CAPITAL STOCK TRANSACTIONS On August 31, 2000, we issued 890,110 shares of common stock as part of the purchase price for Volition, Inc. On December 13, 1999, we issued 220,048 shares of common stock in connection with the acquisition of Genetic Anomalies, Inc. On May 24, 1999, we issued 727,436 shares of common stock as part of the purchase price for Pacific Coast Power & Light Company (See Note 3). In February 1999, in settlement of litigation, we issued warrants expiring March 19, 2000 to Millennium Partners to purchase 150,000 shares of common stock at $16.08 per share. The fair value of the warrants at issuance was $564,000. During the years ended December 31, 1998, 1999 and 2000, the number of warrants to purchase our common stock exercised were 113,000, 64,000 and 100,000, respectively. We received proceeds from the exercise of such warrants totaling $827,000, $766,000 and $1,608,000, in the years ended December 31, 1998, 1999 and 2000, respectively. At December 31, 2000, outstanding warrants were 281,000 at an average exercise price of $10.42 with an expiration date of December 31, 2009. In connection with obtaining the World Wrestling Federation license (See Note 12), in August 1999 we issued to the WWF and a related party to the WWF, warrants expiring December 31, 2009 to purchase 281,250 shares of common stock at $10.42 per share having a fair value of $3,063,000 at the time of issuance. On July 23, 1998, and October 26, 1999, we announced three-for-two stock splits, effected in the form of 50% stock dividends, which were distributed on August 24, 1998, and December 1, 1999, respectively, to shareholders of record on August 20, 1998 and November 15, 1999, respectively. The accompanying consolidated financial statements have been adjusted to give effect to these stock splits for all periods presented. On May 1, 1998, we issued 532,776 shares of common stock in connection with the acquisition of GameFx, Inc. In December 1998, we issued 249,930 shares of common stock as part of the purchase cost of THQ Entertainment (See Note 11). 11. OTHER LONG-TERM ASSETS On March 21, 2000, we acquired less than a 20% interest in a privately held 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 time period, under separate development agreements, Yuke's will create exclusively for us wrestling games for the PlayStation and PlayStation 2 in North America and Europe. The value of Yuke's shares is not readily determinable and the investment is carried at cost because we do not exercise significant influence over financial or other operating policies. F-20 64 In February 2000, Inland Productions, Inc., purchased the 25% interest we acquired on July 1, 1996. No material gain or loss was recognized as a result of this transaction. The equity in the operating results of Inland was not material to the results of operations for any period presented. In December 1998, we acquired all of the outstanding shares of THQ Entertainment GmbH (formerly known as Rushware Microhandelsgesellschaft mbH) and its subsidiaries, Softgold Computerspiele GmbH and ABC Spielspass GmbH for consideration consisting of approximately $1,582,000 in cash and 249,930 shares of common stock with a fair value of $4,432,000 which was accounted for as a purchase. In 1999, we renegotiated the purchase of THQ Entertainment and received a payment of $2,540,000 from the sellers. Goodwill, which resulted from the purchase transaction, net of accumulated amortization was $1,796,000 and $1,517,000 at December 31, 1999 and 2000, respectively. THQ Entertainment now serves as our distributor and publisher in Germany and other German-speaking countries. On May 1, 1998, we acquired all of the outstanding shares of an applied technology company, GameFx, pursuant to a merger of GameFx with and into our newly formed, wholly owned subsidiary. The consideration paid by us consisted of (i) the issuance of 523,776 shares of common stock, (ii) the assumption of stock options issued by GameFx to its employees that, if and when exercised, permit the holders thereof to acquire approximately 22,275 shares and (iii) approximately $1,273,000 in cash. The total acquisition cost was approximately $7.5 million and was accounted for as a purchase. The purchase price was allocated to certain intangible assets acquired and to purchased in-process research and development ("R & D"). Purchased R & D included the value of products in the development stage and not considered to have reached technological feasibility. In accordance with applicable accounting rules, purchased in-process R & D is expensed. Accordingly, $7,232,000 of the acquisition cost was expensed in the second quarter of 1998. F-21 65 12. AGREEMENT WITH JAKKS PACIFIC, INC. AND TITAN SPORTS INC. We entered into an agreement with JAKKS Pacific, Inc. ("JAKKS"), to govern our relationship with respect to the WWF license we jointly obtained from Titan Sports, Inc. (now known as World Wrestling Federation Entertainment, Inc.) in June 1999. Our relationship with JAKKS was established to develop, manufacture, distribute, market and sell video games, as well as sublicense product pursuant to the license from the WWF. We control the venture, therefore, all transactions and balances are consolidated with the Company. The principal terms of this operating agreement are as follows: - - We will be responsible for funding all operations of the venture, including all payments owing to the WWF. - - For the period commencing November 16, 1999 and ending December 31, 2003, JAKKS will be entitled to receive a preferred payment equal to the greater of a fixed guaranty, payable quarterly, or specified percentages of the "net sales" from WWF licensed games (as defined) in amounts that vary based on the platform. The payment of these amounts is guaranteed by us. We are entitled to the profits and cash distributions remaining after the payment of these amounts. At December 31, 2000, we have exceeded the minimum guarantee for preferred payments. - - For periods after December 31, 2003, the amount of the preferred payment will be subject to renegotiation between the parties. An arbitration procedure is specified in the event the parties do not reach agreement. - - We will be responsible for the day-to-day operations of the venture. We will continue to be responsible for development, sales and distribution of the WWF licensed games, while JAKKS will continue to be responsible for the approval process and other relationship matters with the WWF. We will both continue to co-market the games. The license agreement with the WWF extends through December 31, 2009, with an option for a five-year automatic extension if we pay them a specified minimum amount during the initial ten-year period of the agreement. As of December 31, 2000, we have essentially earned out the entire minimum guarantee specified in the license agreement. 13. 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. 14. COMMITMENTS AND CONTINGENCIES Royalties. At December 31, 1999 and 2000, accrued royalties were $31,404,000 and $29,869,000, respectively. Royalties are classified as current liabilities if initial sales are to commence within one year. F-22 66 Leases. We are committed under operating leases with lease termination dates to 2009. Minimum future rentals pursuant to these leases as of December 31, 2000 are as follows:
Facilities Equipment ---------- ---------- 2001 $2,476,000 $ 166,000 2002 1,780,000 114,000 2003 1,412,000 95,000 2004 959,000 48,000 2005 754,000 23,000 Thereafter 147,000 -- ---------- ---------- $7,528,000 $ 446,000 ========== ==========
Rent expense was $616,000, $1,834,000, and $2,220,000 in 1998, 1999 and 2000, respectively. Legal Proceedings. On December 20, 2000, the United States District Court for the Central District of California granted our second Motion to Dismiss with prejudice in opposition to two essentially identical class action law suits filed against us on February 18, 2000 and on March 2, 2000, respectively. The law suits alleged that we, and certain of our directors and senior officers, violated Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. The Plaintiffs in the law suits did not appeal the ruling and time to file for such appeal has expired. On February 13, 2001, the World Championship Wrestling, Inc. filed a civil action against us in the Superior Court in the state of Georgia. The law suit alleges a breach of contract relating to the Interactive License Agreement, dated as of December 29, 1995, between the WCW and us. The Plaintiffs in the law suit allege that we have not paid sufficient royalties due under the agreement for the Nintendo 64 game "Revenge." We intend to vigorously defend against this law suit. We do not believe this law suit will have a material impact on our financial statement. We are involved in routine litigation arising in the ordinary course of our business. In the opinion of our management, none of the pending litigation will have a material adverse effect on our consolidated financial condition or results of operations. F-23 67 15. SEGMENT AND GEOGRAPHIC INFORMATION We operate in one reportable segment in which we are a developer, publisher and distributor of interactive entertainment software for the leading hardware platforms in the home video game market. The following information sets forth geographic information on our sales and long-lived assets for the years ended December 31, 1998, 1999 and 2000:
UNITED UNITED (IN THOUSANDS OF DOLLARS) STATES KINGDOM GERMANY FRANCE AUSTRALIA CONSOLIDATED -------- ------- ------- ------ --------- ------------ Year ended December 31, 1998: Sales to unaffiliated Customers $187,583 $23,881 $ 5,252 $ -- $ -- $216,716 ======== ======= ======= ====== ====== ======== Long-lived assets at December 31, 1998 $ 6,218 $ 4,763 $ 1,063 $ -- $ -- $ 12,094 ======== ======= ======= ====== ====== ======== Year ended December 31, 1999: Sales to unaffiliated Customers $228,827 $41,404 $33,252 $ -- $ -- $303,483 ======== ======= ======= ====== ====== ======== Long-lived assets at December 31, 1999 $ 10,780 $ 1,962 $ 988 $ 1 $ -- $ 13,731 ======== ======= ======= ====== ====== ======== Year ended December 31, 2000: Sales to unaffiliated Customers $270,116 $44,638 $20,442 $7,979 $3,828 $347,003 ======== ======= ======= ====== ====== ======== Long-lived assets at December 31, 2000 $ 16,792 $ 1,957 $ 1,971 $ 320 $ 235 $ 21,275 ======== ======= ======= ====== ====== ========
F-24 68 16. QUARTERLY FINANCIAL DATA (UNAUDITED) Our summarized quarterly financial data is as follows:
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 -------- -------- ------------ ----------- Year ended December 31, 1999: Revenues $79,226 $ 51,912 $44,610 $127,735 Expenses 63,569 45,050 38,243 107,002 ------- -------- ------- -------- Income before income taxes 15,657 6,862 6,367 20,733 Income taxes 6,300 3,294 2,124 6,575 ------- -------- ------- -------- Net income $ 9,357 $ 3,568 $ 4,243 $ 14,158 ======= ======== ======= ======== Net income per share: Basic $ .50 $ .19 $ .22 $ .73 ======= ======== ======= ======== Diluted $ .45 $ .17 $ .20 $ .65 ======= ======== ======= ======== Year ended December 31, 2000: Revenues $70,390 $ 32,407 $53,293 $190,913 Expenses 63,315 46,236 50,468 155,741 ------- -------- ------- -------- Income (loss) before income taxes 7,075 (13,829) 2,825 35,172 Income taxes 3,130 (5,226) 1,510 13,640 ------- -------- ------- -------- Net income (loss) $ 3,945 $ (8,603) $ 1,315 $ 21,532 ======= ======== ======= ======== Net income (loss) per share: Basic $ .20 $ (0.43) $ .07 $ 1.06 ======= ======== ======= ======== Diluted $ .18 $ (0.43) $ .06 $ .99 ======= ======== ======= ========
F-25 EX-10.1 2 a70675ex10-1.txt EXHIBIT 10.1 1 EXHIBIT 10.1 AMENDED AND RESTATED EMPLOYMENT AGREEMENT DATED AS OF JANUARY 1, 2001 ("THIS AGREEMENT") BY AND BETWEEN THQ INC., A DELAWARE CORPORATION (THE "COMPANY"), AND BRIAN J. FARRELL (THE "EXECUTIVE") RECITALS WHEREAS, the Company and the Executive are parties to an Amended and Restated Employment Agreement dated as of June 30, 1999, under which the term of Executive's "Employment Period" thereunder will expire December 31, 2001; and WHEREAS the Board of Directors of the Company (the "Board") deems it to be in the best interests of the Company and its shareholders to assure the continued employment of Executive, and Executive desires to continue such employment, NOW, THEREFORE, in consideration of the foregoing and the mutual covenants contained therein, the parties agree as follows: 1. EMPLOYMENT: TERM. The Company will continue to employ the Executive and the Executive will continue to be employed by the Company as the Company's President and Chief Executive Officer ("CEO") during the term ("the Employment Term") which commences on January 1, 2001 and which shall, unless sooner terminated by the Company or Executive pursuant to Section 7, continue through December 31, 2006. 2. DUTIES, RESPONSIBILITIES. (a) During the Employment Term, Executive agrees to devote his entire business time, attention and energies to the business of the Company and its subsidiaries; provided however that Executive may engage in other activities that do not conflict with or interfere with the performance of his duties and responsibilities hereunder including without limitation (i) investing his assets or funds, so long as the business of any such entity in which he shall make his investments shall not be in direct competition with that of the Company, except that Executive may invest in an entity in competition with the Company if its stock is listed for trading on a national stock exchange or traded in the over-the-counter market and Executive's holdings represent less than 5% of its outstanding stock; or (ii) acting as a director, trustee, officer or upon a committee of any other firm, trust or corporation if such positions do not unreasonably interfere with the services to be rendered by Executive hereunder; or (iii) being involved in educational, civic or charitable activities which do not unreasonably interfere with the services to be rendered by Executive hereunder. During the Employment Term, the Executive shall, if elected or appointed, serve as a director of the Company. 2 (b) As CEO, Executive shall report solely and directly to the Board. The Executive shall at all times be the most senior executive of the Company. He shall have such senior executive powers, duties, authorities and responsibilities as are consistent with Executive's position and title and as have been historically performed by Executive, including acting as chairman of any meeting of the Board, supervising financing, acquisitions and similar transactions and strategic planning for the Company consistent with his title and position, supervising the chief operating officer of the Company and directly or indirectly all other employees of the Company, and managing all activities of the Company, including without limitation, corporate governance, organizational structure, and compensation. Without limitation on the foregoing, Executive shall have (i) complete senior management authority and responsibility with respect to the management and operations of the Company and its business, including implementation of the business strategy of the Company consistent with long-term strategy and policies approved by the Board, (ii) authority on behalf of the Company to employ and terminate employment of all Company personnel, and (iii) authority to execute contracts on behalf of the Company in the discharge of his duties and responsibilities. 3. COMPENSATION. As compensation for Executive's services to be rendered hereunder during the Employment Term, the Company will pay to Executive the following: 3.1 Base Salary. An annual base salary ("Base Salary") (payable in substantially equal installments at the Company's normal pay periods) during the Employment Term of $460,000. The Base Salary shall be subject to annual review commencing at the end of the first fiscal year of the Company ending during the Employment Term and at the end of each fiscal year thereafter, and may be increased (but not decreased) for subsequent fiscal years. 3.2 Bonus. (a) In addition to the Base Salary, the Executive is also entitled to a bonus (the "Bonus") for each fiscal year of the Company commencing during the Employment Term, equal to the lesser of (i) 100% of his annual Base Salary for that year, or (ii) 4.5% of the Company's net income before taxes for such year (pro rated for partial years). Net income before taxes shall be determined by the independent public accountants for the Company in accordance with generally accepted accounting principles consistently applied. (b) The Board in its sole discretion may also award to Executive a performance bonus at any time in such amount and in such form as the Board may determine (the "Performance Bonus") after taking into consideration other compensation paid or payable to Executive under this Agreement, as well as the financial and non-financial progress of the business of the Company and the contributions of the Executive toward that progress. (c) Any Bonus and Performance Bonus shall be payable within 60 days of the end of the fiscal year for which it is payable. (d) The Executive shall also be eligible for awards of stock options and any other stock or equity based awards that may be available to executives of the Company. 2 3 3.3 Grant. Executive will be awarded a grant (the "Grant") under the Company's 1997 Stock Option Plan as amended (the "LTIP") of stock options to purchase 125,000 shares of the Company's Common Stock, with an exercise price per share equal to the fair-market value per share of the Company's Common Stock on the date of the Grant. Except as provided herein, the Grant shall be made in accordance with the standard terms of stock options awarded under the LTIP and shall vest in three equal installments on the first, second and third anniversaries of the date of this Agreement. 4. LOCATION; EXPENSES; ADDITIONAL BENEFITS; INDEMNIFICATION. 4.1 Location. Executive's principal place of business shall be at the Company's headquarters in the Los Angeles Metropolitan area, and Executive shall not be required to relocate outside of the Los Angeles Metropolitan area. 4.2 Expenses. The Company shall pay directly, or reimburse the Executive for, all reasonable and necessary expenses and disbursements incurred by him for and on behalf of the Company in the performance of his duties under this Agreement. For such purpose, the Executive shall submit to the Company itemized reports of such expenses in accordance with the Company's policies. 4.3 Vacation. The Executive shall be entitled to paid vacations during the Employment Term in accordance with the Company's then prevalent practices for senior executive employees; provided, however, that Executive shall be entitled to such paid vacations for not less than four (4) weeks per annum. 4.4 Employee Benefit Plans. The Executive shall be entitled to participate in, and to receive benefits under, any employee benefit plans of the Company (including, without limitation, pension, profit sharing, group life insurance and group medical insurance plans) as may exist from time to time for its executive employees. Subject to the limitation contained in Section 4.7 below, the Company shall make the maximum pension and profit sharing contribution for the Executive legally permitted to be made by an employer and shall permit the Executive to contribute the maximum pension and profit sharing contribution legally permitted to be made by an employee each year during the Employment Period. 4.5 Life and Disability Insurance. The Company shall provide to Executive, and pay the premiums on, insurance on Executive's life in the amount of $3 million as well as, on an after-tax basis, long-term disability insurance for the Executive covering at least 80% of his Base Salary during the Employment Term and for a period of twenty-four (24) months thereafter, each of which shall have the coverage reasonably requested by Executive; provided, however, that the foregoing coverage shall be subject to any insurance examinations of Executive required by the insurer. Executive shall designate the beneficiaries under the disability and life insurance policies. 4.6 Perquisites. Executive shall be eligible for all perquisites made available by the Company from time to time during the Employment Term to other senior executives of the Company. Without limiting the generality of the foregoing, Executive shall be entitled to a 3 4 secretary, a car allowance and insurance in accordance with the Company's policy, or, if more beneficial to Executive, as provided by the Company to any of its senior executives. 4.7 Indemnification. As a director and officer of the Company, the Executive shall be entitled to the benefits of all provisions of the Certificate of Incorporation of the Company, as amended, and the Bylaws of the Company, as amended, that provide for indemnification of officers and directors of the Company. No such provisions shall be amended in any way to limit or reduce the extent of the indemnification available to Executive as an officer or director of the Company. In addition, and without limitation on the foregoing: (i) to the fullest extent permitted by law, the Company shall indemnify and save and hold harmless the Executive from and against any and all claims, demands, liabilities, costs and expenses, including judgments, fines or amounts paid on account thereof (whether in settlement or otherwise), and reasonable expenses, including attorneys' fees actually and reasonably incurred (except only if and to the extent that such amounts shall be finally adjudged to have been caused by Executive's willful breach of the express provisions of this Agreement) to the extent that the Executive is made a party to or witness in any action, suit or proceeding, or if a claim or liability is asserted against Executive (whether or not in the right of the Company), by reason of the fact that he was or is a director or officer, or acted in such capacity on behalf of the Company, or by reason of or arising out of or resulting from entering into this Agreement or the rendering of services by the Executive pursuant to this Agreement, whether or not the same shall proceed to judgment or be settled or otherwise brought to a conclusion. The Company shall advance to Executive on demand all reasonable expenses incurred by Executive in connection with the defense or settlement of any such claim, action, suit or proceeding, and Executive hereby undertakes to repay such amounts if and to the extent that it shall be finally adjudged that the Executive is not entitled to be indemnified by the Company under this Agreement or under the provisions of the Certificate of Incorporation or Bylaws of the Company as of the date hereof that govern indemnification of officers or directors of the Company (but giving effect to future amendments that broaden or expand any such indemnification and obligations or right more favorably to Executive). Executive shall also be entitled to recover any costs of enforcing his rights under this Section (including, without limitation, reasonable attorneys' fees and disbursements) in the event any amount payable hereunder is not paid within thirty (30) days of written request therefore by Executive. The rights of Executive under this Section shall survive the termination of this Agreement and shall be applicable for so long as Executive may be subject to any claim, demand, liability, cost or expense against which this paragraph 4.7 is intended to protect and indemnify him; and (ii) the Company shall, at no cost to the Executive, use its best efforts to at all times include the Executive during the Employment Term and for a period of not less than seven (7) years thereafter, as an insured under any directors and officers liability insurance policy maintained by the Company, which policy shall provide such coverage in such amounts as the Board of Directors shall deem appropriate for coverage of all directors and officers of the Company. 4 5 4.8 The Company's share of the pension and profit sharing contribution referenced in Section 4.4 and insurance premiums referenced in Section 4.5 shall not exceed in any calendar year an aggregate of $30,000. 5. CERTAIN ADDITIONAL PAYMENTS (a) Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any payment or distribution by the Company or its affiliated companies to or for the benefit of the Executive (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise, but determined without regard to any additional payments required under this Section 5) (a "Payment") would be subject to the excise tax imposed by Section 4999 of the Code, or any interest or penalties are incurred by the Executive with respect to such excise tax (such excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the "Excise Tax"), then the Executive shall be entitled to receive an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments. (b) Subject to the provisions of paragraph 5(c), all determinations required to be made under this paragraph 5(b), including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payment and the assumptions to be utilized in arriving at such determination, shall be made by the Company's public accounting firm (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company and the Executive within 15 business days of the receipt of notice from the Executive that there has been a Payment, or such earlier time as is requested by the Company. In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group effecting any Change in Control which may give rise to the Excise Tax, the Executive shall appoint another nationally recognized public accounting firm to make the determinations required hereunder (which accounting firm shall then be referred to as the Accounting Firm hereunder). All fees and expenses of the Accounting Firm shall be borne solely by the Company. Any Gross-Up Payment, as determined pursuant to this paragraph 5(b), shall be paid by the Company to the Executive within five days of the receipt of the Accounting Firm's determination. If the Accounting Firm determines that no Excise Tax is payable by the Executive, it shall furnish the Executive with a written opinion that failure to report the Excise Tax on the Executive's applicable federal income tax return would not result in the imposition of a negligence or similar penalty. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by the Company should have been made ("Underpayment"), consistent with the calculations required to be made hereunder. In the event that the Company exhausts its remedies pursuant to paragraph 5(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive. 5 6 (c) The Executive shall as soon as practicable notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Gross-Up Payment. Such notification shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the 30-day period following the date on which the Executive gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Executive shall: (1) give the Company any information reasonably requested by the Company relating to such claim, (2) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company, (3) cooperate with the Company in good faith in order effectively to contest such claim, and (4) permit the Company to participate in any proceedings relating to such claim; provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this paragraph 5(c) the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided further, that if the Company directs the Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Executive on an interest-free basis and shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance; and provided further, that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. 6 7 (d) If, after the receipt by the Executive of an amount advanced by the Company pursuant to paragraph 5(c), the Executive becomes entitled to receive, and receives, any refund with respect to such claim, the Executive shall (subject to the Company's complying with the requirements of paragraph 5(c)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by the Company pursuant to paragraph 5(c), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and the Company does not notify the Executive in writing of its intent to contest such denial of refund prior to the expiration of 30 days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. 6. EXCLUSIVE EMPLOYMENT, CONFIDENTIAL INFORMATION, ETC. 6.1 Non-Competition. Executive's employment hereunder is on an exclusive basis, and during the period of Executive's employment hereunder and thereafter, in the event of termination of employment by the Company for "Cause" or in the event of Executive's voluntary resignation without "Good Reason," for a period of 12 months following the date of such termination or resignation, as the case may be (the "Non-Compete Period"), Executive will not (x) directly or indirectly, engage, employ or solicit the employment of any person who is then or has been within six (6) months prior thereto, an employee of the Company or any of the Company's affiliates or predecessors, or (y) directly or indirectly engage in or participate as an officer, employee, director, agent of or consultant for any person, firm or corporation whose primary business is directly competitive with that of the Company. 6.2 Confidential Information. Executive shall not during the Employment Term or at any time thereafter use for Executive's own purposes, or disclose to or for the benefit of any third party, any trade secret or other confidential information of the Company or any of its affiliates or predecessors (except as may be required by law or in the performance of Executive's duties hereunder), and Executive will comply with any confidentiality obligations of the Company to third parties. Notwithstanding the foregoing, confidential information shall be deemed not to include information which (i) is or becomes generally available to the public other than as a result of a disclosure by Executive or any other person who directly or indirectly receives such information from Executive or at Executive's direction or (ii) is or becomes available to Executive on a non-confidential basis from a source which is entitled to disclose it to Executive. 6.3 Company Ownership. The results and proceeds of Executive's services hereunder, including, without limitation, any works of authorship resulting from Executive's services during Executive's employment with the Company or any of its affiliates or predecessors and any works in progress, shall be works-made-for-hire and the Company shall be deemed the sole owner throughout the universe of any and all rights of whatsoever nature therein, whether or not now or hereafter known, existing, contemplated, recognized or developed, with the right to use the same in perpetuity in any manner the Company determines in its sole discretion without any further payment to Executive whatsoever. If for any reason any of such results and proceeds shall not legally be a work-for-hire or there are any rights which do not accrue to the Company under the preceding sentence, then Executive hereby irrevocably assigns 7 8 and agrees to assigns any and all of Executive's right, title and interest thereto, including, without limitation, any and all copyrights, patents, trade secrets, trademarks and/or other rights of whatsoever nature therein, whether or not now or hereafter known, existing, contemplated, recognized or developed to the Company, and the Company shall have the right to use the same in perpetuity throughout the universe in any manner the Company determines without any further payment to Executive whatsoever. Executive shall, from time to time as may be requested by the Company, do any and all things which the Company may deem useful or desirable to establish or document the Company's exclusive ownership of any and all rights in any such results and proceeds, including, without limitation, the execution of appropriate copyright and/or patent applications or assignments. To the extent Executive has any rights in the results and proceeds of Executive's services that cannot be assigned in the manner described above, Executive unconditionally and irrevocably waive the enforcement of such rights. This paragraph 6.3 is subject to, and shall not be deemed to limit, restrict, or constitute any waiver by the Company of any rights of ownership to which the Company may be entitled by operation of law by virtue of the Company or any of its affiliates or predecessors being Executive's employer. 6.4 Return of Property. All documents, data, recordings, or other property, whether tangible or intangible, including all information stored in electronic form, obtained or prepared by or for Executive and utilized by Executive in the course of Executive's employment with the Company or any of its affiliates or predecessors shall remain the exclusive property of the Company; provided however that Executive may remove all such property which was prepared by or for Executive's personal use. 6.5 Injunctive Relief. The Company has entered into this Agreement in order to obtain the benefit of Executive's unique skills, talent, and experience. Executive acknowledges and agrees that any violation of paragraphs 6.1 through 6.4 hereof will result in irreparable damage to the Company, and accordingly, the Company may obtain injunctive and other equitable relief for any breach or threatened breach of such paragraphs, in addition to any other remedies available to the Company. 6.6 Survival; Modification of Terms. Executive's obligations under paragraphs 6.1 through 6.4 hereof shall remain in full force and effect for the entire period provided therein notwithstanding the termination of the Employment Term pursuant to Section 7 hereof or otherwise. Executive and the Company agree that the restrictions and remedies contained in paragraphs 6.1 through 6.4 are reasonable and that it is Executive's intention and the intention of the Company that such restrictions and remedies shall be enforceable to the fullest extent permissible by law. If it shall be found by a court of competent jurisdiction that any such restriction or remedy is unenforceable but would be enforceable if some part thereof were deleted or the period or area of application reduced, then such restriction or remedy shall apply with such modification as shall be necessary to make it enforceable. 7. TERMINATION 7.1 Disability or Death. In the event Executive becomes totally medically disabled at any time during the Employment Term and is not expected to be substantially able to perform Executive's duties for a six (6) consecutive month period, the Board at any time after such disability has in fact continued for 60 consecutive days, may determine ("the Disability 8 9 Determination") that the Company requires such duties and responsibilities be performed by another executive. The Executive's employment hereunder shall automatically terminate upon his death. 7.2 Voluntary Resignation. The Executive's employment hereunder shall automatically be terminated upon the Executive's voluntary resignation from the Company. 7.3 Termination for Cause. The Company may, at its option, terminate Executive's employment under this Agreement for "Cause" in the manner herein set forth, and the Company shall thereafter have no further obligations under this Agreement, including, without limitation, any obligation to pay Salary or Bonus or provide benefits under this Agreement for any period subsequent to termination. For purposes of this Agreement, "Cause" shall mean embezzlement, fraud or other conduct related to the Company which would constitute a felony, conviction of a felony, or if Executive materially breaches this Agreement (including, without limitation, Executive's continued failure (to the extent which would constitute "gross negligence") or refusal substantially to perform Executive's lawful obligations under Sections 2 or 6 hereof, except in the event of Executive's disability as set forth in paragraph 7.1). Notwithstanding the foregoing, termination by the Company for Cause shall not be effective until and unless (i) in the event of any act or circumstance alleged to be a basis for termination for "Cause", the Executive is given written notice by the Board of such alleged act or circumstance, and such alleged act or circumstance shall not have been cured by the Executive within 20 days of receipt of such notice, to the satisfaction of the Board in the exercise of its reasonable judgment (or, if within such 20-day period the Executive commences and proceeds to take all reasonable actions to effect such cure, within such reasonable additional time period (no longer than 60 days) as may be necessary), and (ii) notice of intention to terminate for Cause has been given by the Company within sixty (60) days after the Board learns of the act, failure or event constituting "Cause," and (iii) the Board has voted (at an in-person meeting of the Board duly called and held as to which termination of Executive is an agenda item) by a vote of at least 80% of the members of the Board to terminate Executive for Cause after Executive has been given notice of the particular acts or circumstances which are the basis for the alleged termination for Cause and has been afforded at least 20 days notice of the meeting and an opportunity to present his position in writing and to be present with his counsel at such meeting and to present his case thereat, and (iv) the Board has given notice of termination to Executive within three days after such meeting, and (v) if Executive has commenced an expedited arbitration in the manner prescribed below within 15 days after such notice of termination, disputing the Company's right under this Agreement to terminate for Cause, the Arbitrator shall have determined that the Executive is terminable for Cause. Upon the giving of such notice of termination, (x) Executive shall be deemed suspended with pay until he shall be deemed to have been terminated for Cause hereunder or until the Arbitrator shall have determined that Executive is not terminable for Cause and (y) while suspended, Executive shall cease to act as an executive of the Company and shall depart the premises of the Company. If Executive or his representative fails to file a demand for arbitration with the American Arbitration Association ("AAA") and pay the requisite fees pursuant to the national Rules of the AAA within 15 days of receipt of notice of termination from the Board, and diligently pursue such proceeding in accordance with the procedures set forth in Section 14 hereof, such termination shall be conclusively presumed to have been for Cause. 9 10 7.4 "Good Reason" Termination. (a) Executive may resign and terminate Executive's employment hereunder for "Good Reason" at any time during the Employment Term by written notice to the Company not more than sixty (60) days after the occurrence of the event constituting "Good Reason". Such notice shall state an effective date no earlier than 20 days after the date it is given. The Company shall have 15 days from the giving of such notice within which to cure. Good Reason shall mean any of the following, without Executive's prior written consent (other than in connection with the termination of Executive's employment for "Cause" (as defined above) or in connection with Executive's Disability): (i) the assignment to Executive by the Company of duties inconsistent with Executive's positions, duties, responsibilities, titles or offices, or the withdrawal of a material part of Executive's responsibilities or a change in Executive's reporting relationship, as set forth in Section 2; (ii) a reduction by the Company in Executive's Base Salary or Bonus set forth in Section 3 hereof (or other benefits set forth in Section 4 hereof) as in effect at the date hereof as the same may be increased from time to time during the Employment Term; (iii) the Company's requiring Executive to be based anywhere other than the Los Angeles metropolitan area, except for required travel on the Company's business to an extent substantially consistent with business travel obligations of other senior executives of the Company; (iv) the failure or delay of the Company to provide to the Executive any of the payments or benefits contemplated in Sections 3 and 4 hereof or any other material breach by the Company of its obligations hereunder; (v) the failure of the Company and Executive prior to July 1, 2006 to agree on a renewal or extension of this Agreement for a term of no less than three additional years; or (vi) the failure of the Board or its nominating committee at any time to nominate Executive for election or re-election by the shareholders of the Company to the Company's Board. (b) Termination Without Cause. The Company may terminate Executive's employment under this Agreement without "Cause" (as defined above in paragraph 7.3) at any time during the Employment Term by written notice to Executive; provided, however, that the Company may terminate Executive's employment pursuant to this paragraph only with the affirmative vote of eighty percent of the members of the Board. 7.5 Termination Payments, Etc. (a) In the event that Executive's employment terminates pursuant to paragraph 7.4(a) or 7.4(b) hereof, Executive shall be entitled to receive from the Company (at the Company's expense), subject to applicable withholding taxes: 10 11 (i) a lump sum payment, payable within 30 days of termination, equal to (x) Executive's annual Base Salary as provided in paragraph 3.1 on the date of termination, for the greater of three years or the entire balance of the Employment Term, and (y) bonus compensation at the annual rate of the highest Bonus and Performance Bonus amounts received by Executive during any prior fiscal year (but no less than $460,000), for the greater of 3 years or the entire balance of the Employment Term; (ii) medical and dental insurance coverage until the end of the Employment Term or, if earlier, the date on which Executive becomes eligible for substantially equivalent medical and dental coverage from a third party employer provided without cost to Executive; (iii) life and disability insurance coverage as set forth in paragraph 4.5 until the end of the Employment Term (the amount of such insurance to be reduced by the amount of any insurance provided by a new employer without cost to Executive); (iv) Executive's perquisites as provided in paragraph 4.6 until the end of the Employment Term, payable in accordance with the Company's then effective payroll practices; (v) all stock options, stock appreciation rights and restricted stock to the extent not yet fully vested and whether or not included in the Grant referred to in paragraph 3.3 shall become fully vested on the date of termination of Executive's employment; and all such stock options and stock appreciation rights shall be exercisable for their full stated term; (vi) immediate vesting of Executive's rights in all other employee benefit and compensation plans; (vii) fees and disbursements of Executive's counsel incurred as a result of the termination of Executive's employment; and (viii) provision of an appropriate office and secretarial assistance for at least six (6) months after the termination of Executive's employment. (b) The Executive shall be under no obligation to mitigate the amount of any payment or benefit provided for above under paragraph 7.5(a) by seeking other employment or otherwise, nor shall such payments be offset or reduced by any compensation which the Executive may receive from future employment or otherwise. (c) The payments and benefits provided for above in paragraph 7.5(a) are in lieu of any severance or income continuation or income protection under any Company plan that may now or hereafter exist and shall be deemed to satisfy and be in full and final settlement of all obligations of the Company for severance or income continuation or income protection to Executive under this Agreement. (d) Except as otherwise provided in paragraph 7.5(a)(ii) through 7.5(a)(vi) coverage under all the Company benefit plans and programs will terminate upon the termination 11 12 of Executive's employment except to the extent otherwise expressly provided in such plans or programs. 7.6 Death or Disability. If Executive dies prior to the end of the Employment Term or if the Board makes a Disability Determination, Executive or his beneficiary or estate shall be entitled to receive (in addition to amounts and benefits under any life insurance policy or disability program or policy) Executive's Salary up to the date on which the death or Disability Determination occurs and a pro-rated Bonus for the fiscal year in which the death or Disability Determination occurs. In addition, the vesting of all stock options, stock appreciation rights and restricted stock granted to Executive that are not exercisable as of the date on which the death or Disability Determination occurs shall be accelerated, and Executive or his beneficiary or estate shall be entitled to exercise such stock options and stock appreciation rights, together with all stock options and stock appreciation rights that are exercisable as of the date of death or Disability Determination, through the stated expiration date of such stock options and stock appreciation rights. In addition, in the event of such a termination the Company shall within 20 days of such termination pay to the Executive or his personal representative, as the case may be, severance pay in a lump sum equal to his then annual Base Salary for one year as set forth in paragraph 3.1 hereof. 7.7 Change of Control. Notwithstanding any other provision herein, in order to protect the Executive against the possible consequences and uncertainties of a Change of Control (as hereinafter defined) of the Company and thereby induce the Executive to remain in the employ of the Company, the Company agrees that in the event of a Change of Control this Agreement shall continue to be operative according to its terms except that: (a) If the Executive's employment is terminated by the Company other than for "Cause" (as defined in paragraph 7.3 hereof) within one year subsequent to a Change of Control or if the Executive voluntarily terminates such employment within one year subsequent to a Change of Control (the "Evaluation Period"), then in either such event, the Executive shall be entitled to the payments and benefits of paragraph 7.5 as if the termination had occurred under paragraphs 7.4(a) or 7.4(b). (b) In lieu of exercising or retaining his right to exercise any outstanding stock options then held by the Executive, the Executive may elect to surrender to the Company his rights in such outstanding options (whether or not then exercisable) then held by the Executive, and, upon such surrender the Company shall pay to the Executive an amount in cash per share equal to the aggregate of the difference between (i) the aggregate of the difference between the option prices of the shares of the Company's Common Stock subject to such surrendered options and (ii) the greater of (A) the average price per share paid in connection with such acquisition of control if such control was acquired by the payment of cash or the then fair market value per option share of the consideration paid for such shares if such control was acquired for consideration other than cash, (B) the price per share paid in connection with any tender offer of securities leading to control, or (C) the mean between the high and low bid price of shares of the Company's Common Stock on NASDAQ or any other national securities exchange upon which such securities shall then be listed on the date of termination of the Executive's employment. 12 13 (c) The Company shall pay or reimburse the Executive for all fees and disbursements of counsel, if any, incurred by the Executive as a result of the termination of his employment by the Company or his voluntary termination of such employment during the Evaluation Period following a Change of Control (including, without limitation, those which may be incurred by the Executive in seeking to obtain or enforce any right or benefit provided by this Agreement). (d) The Executive shall be under no obligation to mitigate the amount of any payment provided for under this paragraph 7.7 by seeking other employment or otherwise nor shall such amount be offset by any compensation which the Executive may receive from future employment or otherwise. (e) For purposes of this Agreement, a "Change in Control" with respect to the Company shall be deemed to have taken place if, at any time during the Employment Term, any of the following events occur: (i) Any person, as that term is used in Section 13(d) and Section 14(d)(2) of the securities Exchange Act of 1934, as amended (the "Exchange Act"), becomes, is discovered to be, or files a report on Schedule 13D or 14D-1 (or any successor schedule, form or report) disclosing that such person is, a beneficial owner (as defined in Rule 13d-3 under the Exchange Act or any successor rule or regulation), directly or indirectly, of securities of the Company representing 15% or more of the combined voting power of the Company's then outstanding securities entitled to vote generally in the election of directors; (ii) Individuals who, as of January 1, 2001, constitute the Board of Directors of the Company cease for any reason to constitute at least a majority of the Board of Directors of the Company, unless any such change is approved by a vote of at least 80% of the members of the Board of Directors of the Company (including Executive) in office immediately prior to such cessation; (iii) The Company is merged, consolidated or reorganized into or with another corporation or other legal person, or securities of the Company are exchanged for securities of another corporation or other legal person, and immediately after such merger, consolidation, reorganization or exchange less than a majority of the combined voting power of the then outstanding securities of such corporation or person immediately after such transaction are held, directly or indirectly, in the aggregate by the holders of securities entitled to vote generally in the election of directors of the Company immediately prior to such transaction; (iv) The Company in any transaction or series of related transactions, sells all or substantially all of its assets to any other corporation or other legal person and less than a majority of the combined voting power of the then-outstanding securities of such corporation or person immediately after such sale or sales are held, directly or indirectly, in the aggregate by the holders of securities entitled to vote generally in the election of directors of the Company immediately prior to such sale; (v) The Company and its affiliates shall sell or dispose of (in a single transaction or series of related transactions) business operations that generated two-thirds of the 13 14 consolidated revenues (determined on the basis of the Company's four most recently completed fiscal quarters for which reports have been filed under the Exchange Act) of the Company and its subsidiaries immediately prior thereto; (vi) The Company files a report or proxy statement with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934 disclosing in response to Form 8-K or Schedule 14A (or any successor schedule, form or report or item therein) that a change in control of the Company has or may have occurred or will or may occur in the future pursuant to any then existing contract or transaction; (vii) Any other transaction or series of related transactions occur that have substantially the effect of the transaction specified in any of the preceding clauses in this paragraph 7.7(e). (f) Notwithstanding the provisions of Section 7.7(e)(i) through 7.7(e)(vi) hereof, unless otherwise determined in a specific case by majority vote of the Board of Directors of the Company, a Change in Control shall not be deemed to have occurred for purposes of this Agreement solely because (i) the Company, (ii) an entity in which the Company directly or indirectly beneficially owns 50% or more of the voting securities or (iii) any Company-sponsored employee stock ownership plan, or any other employee benefit plan of the Company, either files or becomes obligated to file a report or a proxy statement under or in response to Schedule 13D, Schedule 14D-1, Form 8-K or Schedule 14A (or any successor schedule, form or report or item thereon) under the Exchange Act, disclosing beneficial ownership by it of shares of stock of the Company, or because of the Company reports that a Change in Control of the Company has or may have occurred or will or may occur in the future by reason of such beneficial ownership. 8. RABBI TRUST. As soon as practicable after commencement of the Employment Term, the Company shall establish a "grantor trust" within the meaning of sections 671, et. seq. of the Internal Revenue Code with terms reasonably acceptable to the Executive, for the purpose of protecting the payment, in the event of a Change in Control of the Company, of any unfunded obligations of the Company to the Executive. 9. SUCCESSORS; BINDING AGREEMENT. Neither of the parties hereto shall have the right to assign this agreement or any rights or obligations hereunder without the prior written consent of the other party. Subject to the foregoing, this Agreement shall inure to the benefit of and be binding upon the parties and their successors and assigns. 10. COUNTERPARTS. This Agreement may be executed in several counterparts, each of which shall be an original but together shall constitute one in the same instrument. 11. NOTICES. 14 15 Any notice required or permitted to be given under this Agreement shall be in writing and shall be deemed to have been duly given when (i) delivered personally; (ii) sent by facsimile or other similar electronic device and confirm; (iii) delivered by courier or overnight express; or (iv) three business days after being sent by registered or certified mail, postage prepaid, addressed as follows: If to the Company: THQ Inc. 27001 Agoura Road, Suite 325 Calabasas Hill, California 91301 Attention: Secretary If to Executive: Brian J. Farrell 768 Ravensburg Street Lake Sherwood, CA 91361 or to such other address as a party may furnish to the other party in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 12. GOVERNING LAW. This Agreement shall be governed by and construed and enforced in accordance with the internal laws of California without reference to conflicts of laws, principles or rules. 13. WAIVER. No waiver by either party hereto of any provision of this Agreement shall be deemed a waiver of any preceding or succeeding breach of such provision or as a waiver of any other provision hereof. 14. ARBITRATION. In the event of any controversy, dispute or claim arising out of or related to this Agreement or the Executive's employment by the Company, the parties shall negotiate in good faith in an attempt to reach a mutually acceptable settlement of such dispute. If negotiations in good faith do not result in a settlement of any such controversy, dispute or claim, it shall be finally settled by expedited arbitration in accordance with the National Rules of the American Arbitration Association governing employment disputes, subject to the following: (a) The Arbitrator shall be determined from a list of names of five impartial arbitrators each of whom shall be an attorney experienced in arbitration matters concerning executive employment disputes, supplied by the American Arbitration Association (the "Association") and chosen by Executive and the Company each in turn striking a name from the list until one name remains. (b) The Arbitrator shall determine whether and to what extent any party shall be entitled to damages under this Agreement. 15 16 (c) The Arbitrator shall not have the power to add to nor modify any of the terms or conditions of this Agreement. The Arbitrator's decision shall not go beyond what is necessary for the interpretation and application of the provision of this Agreement in respect of the issue before the Arbitrator. The Arbitrator shall not substitute his or her judgment for that of the parties in the exercise of rights granted or retained by this Agreement. The Arbitrator's award or other permitted remedy, if any, and the decision shall be based upon the issue as drafted and submitted by the respective parties and the relevant and competent evidence adduced at the hearing. (d) The Arbitrator shall have the authority to award any remedy or relief provided for in this Agreement, in addition to any other remedy or relief (including provisional remedies and relief) that a court of competent jurisdiction could order or grant. In addition, the Arbitrator shall have the authority to decide issues relating to the interpretation, meaning or performance of this Agreement even if such decision would constitute an advisory opinion in a court proceeding or if the issues would otherwise not be ripe for resolution in a court proceeding, and any such decision shall bind the parties in their continuing performance of this Agreement. The Arbitrator's written decision shall be rendered within sixty days of the hearing. The decision reached by the Arbitrator shall be final and binding upon the parties as to the matter in dispute. To the extent that the relief or remedy granted by the Arbitrator is relief or remedy on which a court could enter judgment, a judgment upon the award rendered by the Arbitrator shall be entered in any court having jurisdiction thereof (unless in the case of an award of damages, the full amount of the award is paid within 10 days of its determination by the Arbitrator). Otherwise, the award shall be binding on the parties in connection with their continuing performance of this Agreement and in any subsequent arbitral or judicial proceedings between the parties. (e) The arbitration shall take place in Los Angeles, California. (f) The arbitration proceeding and all filing, testimony, documents and information relating to or presented during the arbitration proceeding shall be disclosed exclusively for the purpose of facilitating the arbitration process and for no other purpose and shall be deemed to be information subject to the confidentiality provisions of this Agreement. (g) The parties shall continue performing their respective obligations under this Agreement notwithstanding the existence of a dispute while the dispute is being resolved unless and until such obligations are terminated or expire in accordance with the provisions hereof. (h) The Arbitrator may order a pre-hearing exchange of information including depositions, interrogatories, production of documents, exchange of summaries of testimony or exchange of statements of position, and the Arbitrator shall limit such disclosure to avoid unnecessary burden to the parties and shall schedule promptly all discovery and other procedural steps and otherwise assume case management initiative and control to effect an efficient and expeditious resolution of the dispute. At any oral hearing of evidence in connection with an arbitration proceeding, each party and its counsel shall have the right to examine its witness and to cross-examine the witnesses of the other party. No testimony of any witness shall be 16 17 presented in written form unless the opposing party or parties shall have the opportunity to cross-examine such witness, except as the parties otherwise agree in writing. (i) Notwithstanding the dispute resolution procedures contained in this Section 14, either party may apply to any court having jurisdiction (i) to enforce this Agreement to arbitrate, (ii) to seek provisional injunctive relief so as to maintain the status quo until the arbitration award is rendered or the Dispute is otherwise resolved, or (iii) to challenge or vacate any final judgment, award or decision of the Arbitrator that does not comport with the express provisions of this Section 14. 15. ATTORNEYS' FEES The Company shall pay or reimburse the Executive for all reasonable fees and disbursements of the Executive's counsel in connection with the negotiation and execution of this Agreement. In addition, in the event of any arbitration or judicial proceeding hereunder, the prevailing party shall be entitled to recover his or its reasonable attorneys fees and costs. 16. HEADINGS. The Article, Section, paragraph and subparagraph headings are for convenience of reference only and shall not define or limit the provisions hereof. 17. ENTIRE AGREEMENT. This Agreement constitutes the entire agreement between the parties with respect to the subject matter hereof and there are no representations, warranties or commitments except as set forth herein. This Agreement supersedes any other prior and contemporaneous agreements, understandings, negotiations and discussions, whether written or oral, of the parties hereto relating to the subject matter of this Agreement. This Agreement may be amended only in a writing executed by the parties hereto. 18. SEVERABILITY. If any provision of this Agreement, as applied to either party or to any circumstances, shall be adjudged by a court to be void or unenforceable, the same shall be deemed stricken from this Agreement and shall in no way affect any other provision of this Agreement or the validity or enforceability of this Agreement. 19. SUPERSEDES PREVIOUS AGREEMENT. Effective as of the date of this Agreement, this Agreement shall supersede and cancel all prior agreements relating to Executive's employment by the Company or any of its affiliates and predecessors, including, without limitation, the employment agreement between Executive and THQ Inc. dated as of June 30, 1999, and any amendments thereto. Notwithstanding the preceding sentence, this Agreement is not intended, and shall not be construed, to affect Executive's rights in any compensation or benefits that have been granted or accrued prior to the Effective Date. 17 18 IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the date and year first above written. Company: THQ Inc., a Delaware Corporation By: ------------------------------------- Its: ------------------------------------ Executive: ---------------------------------------- Brian J. Farrell 18 EX-10.2 3 a70675ex10-2.txt EXHIBIT 10.2 1 EXHIBIT 10.2 AMENDED AND RESTATED EMPLOYMENT AGREEMENT DATED AS OF JANUARY 1, 2001 ("THIS AGREEMENT") BY AND BETWEEN THQ INC., A DELAWARE CORPORATION (THE "COMPANY"), AND JEFFREY C. LAPIN (THE "EXECUTIVE") RECITALS WHEREAS, the Company and the Executive are parties to an Employment Agreement dated as of January 1, 1999, under which the term of Executive's "Employment Period" thereunder will expire December 31, 2001; and WHEREAS the Board of Directors of the Company (the "Board") deems it to be in the best interests of the Company and its shareholders to assure the continued employment of Executive, and Executive desires to continue such employment, NOW, THEREFORE, in consideration of the foregoing and the mutual covenants contained therein, the parties agree as follows: 1. EMPLOYMENT: TERM. The Company will continue to employ the Executive and the Executive will continue to be employed by the Company as the Company's Vice Chairman and Chief Operating Officer ("COO") during the term ("the Employment Term") which commences on January 1, 2001 and which shall, unless sooner terminated by the Company or Executive pursuant to Section 7, continue through December 31, 2006. 2. DUTIES, RESPONSIBILITIES. (a) During the Employment Term, Executive agrees to devote his entire business time, attention and energies to the business of the Company and its subsidiaries; provided however that Executive may engage in other activities that do not conflict with or interfere with the performance of his duties and responsibilities hereunder including without limitation (i) investing his assets or funds, so long as the business of any such entity in which he shall make his investments shall not be in direct competition with that of the Company, except that Executive may invest in an entity in competition with the Company if its stock is listed for trading on a national stock exchange or traded in the over-the-counter market and Executive's holdings represent less than 5% of its outstanding stock; or (ii) acting as a director, trustee, officer or upon a committee of any other firm, trust or corporation if such positions do not unreasonably interfere with the services to be rendered by Executive hereunder; or (iii) being involved in educational, civic or charitable activities which do not unreasonably interfere with the services to be rendered by Executive hereunder. During the Employment Term, the Executive shall, if elected or appointed, serve as a director of the Company. 19 2 (b) As COO, Executive shall report solely and directly to the Chief Executive Officer. The Executive shall at all times be the most senior executive of the Company. He shall have such senior executive powers, duties, authorities and responsibilities as are consistent with Executive's position and title and as have been historically performed by Executive. 3. COMPENSATION. As compensation for Executive's services to be rendered hereunder during the Employment Term, the Company will pay to Executive the following: 3.1 Base Salary. An annual base salary ("Base Salary") (payable in substantially equal installments at the Company's normal pay periods) during the Employment Term of $325,000. The Base Salary shall be subject to annual review commencing at the end of the first fiscal year of the Company ending during the Employment Term and at the end of each fiscal year thereafter, and may be increased (but not decreased) for subsequent fiscal years. 3.2 Bonus. (a) In addition to the Base Salary, the Executive is also entitled to a bonus (the "Bonus") for each fiscal year of the Company commencing during the Employment Term, equal to the lesser of (i) 100% of his annual Base Salary for that year, or (ii) 4.5% of the Company's net income before taxes for such year (pro rated for partial years). Net income before taxes shall be determined by the independent public accountants for the Company in accordance with generally accepted accounting principles consistently applied. (b) The Board in its sole discretion may also award to Executive a performance bonus at any time in such amount and in such form as the Board may determine (the "Performance Bonus") after taking into consideration other compensation paid or payable to Executive under this Agreement, as well as the financial and non-financial progress of the business of the Company and the contributions of the Executive toward that progress. (c) Any Bonus and Performance Bonus shall be payable within 60 days of the end of the fiscal year for which it is payable. (d) The Executive shall also be eligible for awards of stock options and any other stock or equity based awards that may be available to executives of the Company. 3.3 Grant. Executive will be awarded a grant (the "Grant") under the Company's 1997 Stock Option Plan as amended (the "LTIP") of stock options to purchase 100,000 shares of the Company's Common Stock, with an exercise price per share equal to the fair-market value per share of the Company's Common Stock on the date of the Grant. Except as provided herein, the Grant shall be made in accordance with the standard terms of stock options awarded under the LTIP and shall vest in three equal installments on the first, second and third anniversaries of the date of this Agreement. 2 3 4. LOCATION; EXPENSES; ADDITIONAL BENEFITS; INDEMNIFICATION. 4.1 Location. Executive's principal place of business shall be at the Company's headquarters in the Los Angeles Metropolitan area, and Executive shall not be required to relocate outside of the Los Angeles Metropolitan area. 4.2 Expenses. The Company shall pay directly, or reimburse the Executive for, all reasonable and necessary expenses and disbursements incurred by him for and on behalf of the Company in the performance of his duties under this Agreement. For such purpose, the Executive shall submit to the Company itemized reports of such expenses in accordance with the Company's policies. 4.3 Vacation. The Executive shall be entitled to paid vacations during the Employment Term in accordance with the Company's then prevalent practices for senior executive employees; provided, however, that Executive shall be entitled to such paid vacations for not less than four (4) weeks per annum. 4.4 Employee Benefit Plans. The Executive shall be entitled to participate in, and to receive benefits under, any employee benefit plans of the Company (including, without limitation, pension, profit sharing, group life insurance and group medical insurance plans) as may exist from time to time for its executive employees. Subject to the limitation contained in Section 4.7 below, the Company shall make the maximum pension and profit sharing contribution for the Executive legally permitted to be made by an employer and shall permit the Executive to contribute the maximum pension and profit sharing contribution legally permitted to be made by an employee each year during the Employment Period. 4.5 Life and Disability Insurance. The Company shall provide to Executive, and pay the premiums on, insurance on Executive's life in the amount of $3 million as well as, on an after-tax basis, long-term disability insurance for the Executive covering at least 80% of his Base Salary during the Employment Term and for a period of twenty-four (24) months thereafter, each of which shall have the coverage reasonably requested by Executive; provided, however, that the foregoing coverage shall be subject to any insurance examinations of Executive required by the insurer. Executive shall designate the beneficiaries under the disability and life insurance policies. 4.6 Perquisites. Executive shall be eligible for all perquisites made available by the Company from time to time during the Employment Term to other senior executives of the Company. Without limiting the generality of the foregoing, Executive shall be entitled to a secretary, a car allowance and insurance in accordance with the Company's policy, or, if more beneficial to Executive, as provided by the Company to any of its senior executives. 4.7 Indemnification. As a director and officer of the Company, the Executive shall be entitled to the benefits of all provisions of the Certificate of Incorporation of the Company, as amended, and the Bylaws of the Company, as amended, that provide for indemnification of officers and directors of the Company. No such provisions shall be amended 3 4 in any way to limit or reduce the extent of the indemnification available to Executive as an officer or director of the Company. In addition, and without limitation on the foregoing: (i) to the fullest extent permitted by law, the Company shall indemnify and save and hold harmless the Executive from and against any and all claims, demands, liabilities, costs and expenses, including judgments, fines or amounts paid on account thereof (whether in settlement or otherwise), and reasonable expenses, including attorneys' fees actually and reasonably incurred (except only if and to the extent that such amounts shall be finally adjudged to have been caused by Executive's willful breach of the express provisions of this Agreement) to the extent that the Executive is made a party to or witness in any action, suit or proceeding, or if a claim or liability is asserted against Executive (whether or not in the right of the Company), by reason of the fact that he was or is a director or officer, or acted in such capacity on behalf of the Company, or by reason of or arising out of or resulting from entering into this Agreement or the rendering of services by the Executive pursuant to this Agreement, whether or not the same shall proceed to judgment or be settled or otherwise brought to a conclusion. The Company shall advance to Executive on demand all reasonable expenses incurred by Executive in connection with the defense or settlement of any such claim, action, suit or proceeding, and Executive hereby undertakes to repay such amounts if and to the extent that it shall be finally adjudged that the Executive is not entitled to be indemnified by the Company under this Agreement or under the provisions of the Certificate of Incorporation or Bylaws of the Company as of the date hereof that govern indemnification of officers or directors of the Company (but giving effect to future amendments that broaden or expand any such indemnification and obligations or right more favorably to Executive). Executive shall also be entitled to recover any costs of enforcing his rights under this Section (including, without limitation, reasonable attorneys' fees and disbursements) in the event any amount payable hereunder is not paid within thirty (30) days of written request therefore by Executive. The rights of Executive under this Section shall survive the termination of this Agreement and shall be applicable for so long as Executive may be subject to any claim, demand, liability, cost or expense against which this paragraph 4.7 is intended to protect and indemnify him; and (ii) the Company shall, at no cost to the Executive, use its best efforts to at all times include the Executive during the Employment Term and for a period of not less than seven (7) years thereafter, as an insured under any directors and officers liability insurance policy maintained by the Company, which policy shall provide such coverage in such amounts as the Board of Directors shall deem appropriate for coverage of all directors and officers of the Company. 4.8 The Company's share of the pension and profit sharing contribution referenced in Section 4.4 and insurance premiums referenced in Section 4.5 shall not exceed in any calendar year an aggregate of $30,000. 5. CERTAIN ADDITIONAL PAYMENTS (a) Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any payment or distribution by the Company or its affiliated companies 4 5 to or for the benefit of the Executive (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise, but determined without regard to any additional payments required under this Section 5) (a "Payment") would be subject to the excise tax imposed by Section 4999 of the Code, or any interest or penalties are incurred by the Executive with respect to such excise tax (such excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the "Excise Tax"), then the Executive shall be entitled to receive an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments. (b) Subject to the provisions of paragraph 5(c), all determinations required to be made under this paragraph 5(b), including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payment and the assumptions to be utilized in arriving at such determination, shall be made by the Company's public accounting firm (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company and the Executive within 15 business days of the receipt of notice from the Executive that there has been a Payment, or such earlier time as is requested by the Company. In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group effecting any Change in Control which may give rise to the Excise Tax, the Executive shall appoint another nationally recognized public accounting firm to make the determinations required hereunder (which accounting firm shall then be referred to as the Accounting Firm hereunder). All fees and expenses of the Accounting Firm shall be borne solely by the Company. Any Gross-Up Payment, as determined pursuant to this paragraph 5(b), shall be paid by the Company to the Executive within five days of the receipt of the Accounting Firm's determination. If the Accounting Firm determines that no Excise Tax is payable by the Executive, it shall furnish the Executive with a written opinion that failure to report the Excise Tax on the Executive's applicable federal income tax return would not result in the imposition of a negligence or similar penalty. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by the Company should have been made ("Underpayment"), consistent with the calculations required to be made hereunder. In the event that the Company exhausts its remedies pursuant to paragraph 5(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive. (c) The Executive shall as soon as practicable notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Gross-Up Payment. Such notification shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the 30-day period following the date on which the Executive gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies the Executive 5 6 in writing prior to the expiration of such period that it desires to contest such claim, the Executive shall: (1) give the Company any information reasonably requested by the Company relating to such claim, (2) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company, (3) cooperate with the Company in good faith in order effectively to contest such claim, and (4) permit the Company to participate in any proceedings relating to such claim; provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this paragraph 5(c) the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided further, that if the Company directs the Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Executive on an interest-free basis and shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance; and provided further, that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. (d) If, after the receipt by the Executive of an amount advanced by the Company pursuant to paragraph 5(c), the Executive becomes entitled to receive, and receives, any refund with respect to such claim, the Executive shall (subject to the Company's complying with the requirements of paragraph 5(c)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by the Company pursuant to paragraph 5(c), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and the Company does not notify the Executive in writing of its intent to contest such 6 7 denial of refund prior to the expiration of 30 days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. 6. EXCLUSIVE EMPLOYMENT, CONFIDENTIAL INFORMATION, ETC. 6.1 Non-Competition. Executive's employment hereunder is on an exclusive basis, and during the period of Executive's employment hereunder and thereafter, in the event of termination of employment by the Company for "Cause" or in the event of Executive's voluntary resignation without "Good Reason," for a period of 12 months following the date of such termination or resignation, as the case may be (the "Non-Compete Period"), Executive will not (x) directly or indirectly, engage, employ or solicit the employment of any person who is then or has been within six (6) months prior thereto, an employee of the Company or any of the Company's affiliates or predecessors, or (y) directly or indirectly engage in or participate as an officer, employee, director, agent of or consultant for any person, firm or corporation whose primary business is directly competitive with that of the Company. 6.2 Confidential Information. Executive shall not during the Employment Term or at any time thereafter use for Executive's own purposes, or disclose to or for the benefit of any third party, any trade secret or other confidential information of the Company or any of its affiliates or predecessors (except as may be required by law or in the performance of Executive's duties hereunder), and Executive will comply with any confidentiality obligations of the Company to third parties. Notwithstanding the foregoing, confidential information shall be deemed not to include information which (i) is or becomes generally available to the public other than as a result of a disclosure by Executive or any other person who directly or indirectly receives such information from Executive or at Executive's direction or (ii) is or becomes available to Executive on a non-confidential basis from a source which is entitled to disclose it to Executive. 6.3 Company Ownership. The results and proceeds of Executive's services hereunder, including, without limitation, any works of authorship resulting from Executive's services during Executive's employment with the Company or any of its affiliates or predecessors and any works in progress, shall be works-made-for-hire and the Company shall be deemed the sole owner throughout the universe of any and all rights of whatsoever nature therein, whether or not now or hereafter known, existing, contemplated, recognized or developed, with the right to use the same in perpetuity in any manner the Company determines in its sole discretion without any further payment to Executive whatsoever. If for any reason any of such results and proceeds shall not legally be a work-for-hire or there are any rights which do not accrue to the Company under the preceding sentence, then Executive hereby irrevocably assigns and agrees to assigns any and all of Executive's right, title and interest thereto, including, without limitation, any and all copyrights, patents, trade secrets, trademarks and/or other rights of whatsoever nature therein, whether or not now or hereafter known, existing, contemplated, recognized or developed to the Company, and the Company shall have the right to use the same in perpetuity throughout the universe in any manner the Company determines without any further payment to Executive whatsoever. Executive shall, from time to time as may be requested by the Company, do any and all things which the Company may deem useful or desirable to establish or document the Company's exclusive ownership of any and all rights in 7 8 any such results and proceeds, including, without limitation, the execution of appropriate copyright and/or patent applications or assignments. To the extent Executive has any rights in the results and proceeds of Executive's services that cannot be assigned in the manner described above, Executive unconditionally and irrevocably waive the enforcement of such rights. This paragraph 6.3 is subject to, and shall not be deemed to limit, restrict, or constitute any waiver by the Company of any rights of ownership to which the Company may be entitled by operation of law by virtue of the Company or any of its affiliates or predecessors being Executive's employer. 6.4 Return of Property. All documents, data, recordings, or other property, whether tangible or intangible, including all information stored in electronic form, obtained or prepared by or for Executive and utilized by Executive in the course of Executive's employment with the Company or any of its affiliates or predecessors shall remain the exclusive property of the Company; provided however that Executive may remove all such property which was prepared by or for Executive's personal use. 6.5 Injunctive Relief. The Company has entered into this Agreement in order to obtain the benefit of Executive's unique skills, talent, and experience. Executive acknowledges and agrees that any violation of paragraphs 6.1 through 6.4 hereof will result in irreparable damage to the Company, and accordingly, the Company may obtain injunctive and other equitable relief for any breach or threatened breach of such paragraphs, in addition to any other remedies available to the Company. 6.6 Survival; Modification of Terms. Executive's obligations under paragraphs 6.1 through 6.4 hereof shall remain in full force and effect for the entire period provided therein notwithstanding the termination of the Employment Term pursuant to Section 7 hereof or otherwise. Executive and the Company agree that the restrictions and remedies contained in paragraphs 6.1 through 6.4 are reasonable and that it is Executive's intention and the intention of the Company that such restrictions and remedies shall be enforceable to the fullest extent permissible by law. If it shall be found by a court of competent jurisdiction that any such restriction or remedy is unenforceable but would be enforceable if some part thereof were deleted or the period or area of application reduced, then such restriction or remedy shall apply with such modification as shall be necessary to make it enforceable. 7. TERMINATION 7.1 Disability or Death. In the event Executive becomes totally medically disabled at any time during the Employment Term and is not expected to be substantially able to perform Executive's duties for a six (6) consecutive month period, the Board at any time after such disability has in fact continued for 60 consecutive days, may determine ("the Disability Determination") that the Company requires such duties and responsibilities be performed by another executive. The Executive's employment hereunder shall automatically terminate upon his death. 7.2 Voluntary Resignation. The Executive's employment hereunder shall automatically be terminated upon the Executive's voluntary resignation from the Company. 8 9 7.3 Termination for Cause. The Company may, at its option, terminate Executive's employment under this Agreement for "Cause" in the manner herein set forth, and the Company shall thereafter have no further obligations under this Agreement, including, without limitation, any obligation to pay Salary or Bonus or provide benefits under this Agreement for any period subsequent to termination. For purposes of this Agreement, "Cause" shall mean embezzlement, fraud or other conduct related to the Company which would constitute a felony, conviction of a felony, or if Executive materially breaches this Agreement (including, without limitation, Executive's continued failure (to the extent which would constitute "gross negligence") or refusal substantially to perform Executive's lawful obligations under Sections 2 or 6 hereof, except in the event of Executive's disability as set forth in paragraph 7.1). Notwithstanding the foregoing, termination by the Company for Cause shall not be effective until and unless (i) in the event of any act or circumstance alleged to be a basis for termination for "Cause", the Executive is given written notice by the Board of such alleged act or circumstance, and such alleged act or circumstance shall not have been cured by the Executive within 20 days of receipt of such notice, to the satisfaction of the Board in the exercise of its reasonable judgment (or, if within such 20-day period the Executive commences and proceeds to take all reasonable actions to effect such cure, within such reasonable additional time period (no longer than 60 days) as may be necessary), and (ii) notice of intention to terminate for Cause has been given by the Company within sixty (60) days after the Board learns of the act, failure or event constituting "Cause," and (iii) the Board has voted (at an in-person meeting of the Board duly called and held as to which termination of Executive is an agenda item) by a vote of at least 80% of the members of the Board to terminate Executive for Cause after Executive has been given notice of the particular acts or circumstances which are the basis for the alleged termination for Cause and has been afforded at least 20 days notice of the meeting and an opportunity to present his position in writing and to be present with his counsel at such meeting and to present his case thereat, and (iv) the Board has given notice of termination to Executive within three days after such meeting, and (v) if Executive has commenced an expedited arbitration in the manner prescribed below within 15 days after such notice of termination, disputing the Company's right under this Agreement to terminate for Cause, the Arbitrator shall have determined that the Executive is terminable for Cause. Upon the giving of such notice of termination, (x) Executive shall be deemed suspended with pay until he shall be deemed to have been terminated for Cause hereunder or until the Arbitrator shall have determined that Executive is not terminable for Cause and (y) while suspended, Executive shall cease to act as an executive of the Company and shall depart the premises of the Company. If Executive or his representative fails to file a demand for arbitration with the American Arbitration Association ("AAA") and pay the requisite fees pursuant to the national Rules of the AAA within 15 days of receipt of notice of termination from the Board, and diligently pursue such proceeding in accordance with the procedures set forth in Section 14 hereof, such termination shall be conclusively presumed to have been for Cause. 7.4 "Good Reason" Termination. (a) Executive may resign and terminate Executive's employment hereunder for "Good Reason" at any time during the Employment Term by written notice to the Company not more than sixty (60) days after the occurrence of the event constituting "Good Reason". Such notice shall state an effective date no earlier than 20 days after the date it is given. The 9 10 Company shall have 15 days from the giving of such notice within which to cure. Good Reason shall mean any of the following, without Executive's prior written consent (other than in connection with the termination of Executive's employment for "Cause" (as defined above) or in connection with Executive's Disability): (i) the assignment to Executive by the Company of duties inconsistent with Executive's positions, duties, responsibilities, titles or offices, or the withdrawal of a material part of Executive's responsibilities or a change in Executive's reporting relationship, as set forth in Section 2; (ii) a reduction by the Company in Executive's Base Salary or Bonus set forth in Section 3 hereof (or other benefits set forth in Section 4 hereof) as in effect at the date hereof as the same may be increased from time to time during the Employment Term; (iii) the Company's requiring Executive to be based anywhere other than the Los Angeles metropolitan area, except for required travel on the Company's business to an extent substantially consistent with business travel obligations of other senior executives of the Company; (iv) the failure or delay of the Company to provide to the Executive any of the payments or benefits contemplated in Sections 3 and 4 hereof or any other material breach by the Company of its obligations hereunder; (v) the failure of the Company and Executive prior to July 1, 2006 to agree on a renewal or extension of this Agreement for a term of no less than three additional years; or (vi) the failure of the Board or its nominating committee at any time to nominate Executive for election or re-election by the shareholders of the Company to the Company's Board. (b) Termination Without Cause. The Company may terminate Executive's employment under this Agreement without "Cause" (as defined above in paragraph 7.3) at any time during the Employment Term by written notice to Executive; provided, however, that the Company may terminate Executive's employment pursuant to this paragraph only with the affirmative vote of eighty percent of the members of the Board. 7.5 Termination Payments, Etc. (a) In the event that Executive's employment terminates pursuant to paragraph 7.4(a) or 7.4(b) hereof, Executive shall be entitled to receive from the Company (at the Company's expense), subject to applicable withholding taxes: (i) a lump sum payment, payable within 30 days of termination, equal to (x) Executive's annual Base Salary as provided in paragraph 3.1 on the date of termination, for the greater of three years or the entire balance of the Employment Term, and (y) bonus compensation at the annual rate of the highest Bonus and Performance Bonus amounts received 10 11 by Executive during any prior fiscal year (but no less than $325,000), for the greater of 3 years or the entire balance of the Employment Term; (ii) medical and dental insurance coverage until the end of the Employment Term or, if earlier, the date on which Executive becomes eligible for substantially equivalent medical and dental coverage from a third party employer provided without cost to Executive; (iii) life and disability insurance coverage as set forth in paragraph 4.5 until the end of the Employment Term (the amount of such insurance to be reduced by the amount of any insurance provided by a new employer without cost to Executive); (iv) Executive's perquisites as provided in paragraph 4.6 until the end of the Employment Term, payable in accordance with the Company's then effective payroll practices; (v) all stock options, stock appreciation rights and restricted stock to the extent not yet fully vested and whether or not included in the Grant referred to in paragraph 3.3 shall become fully vested on the date of termination of Executive's employment; and all such stock options and stock appreciation rights shall be exercisable for their full stated term; (vi) immediate vesting of Executive's rights in all other employee benefit and compensation plans; (vii) fees and disbursements of Executive's counsel incurred as a result of the termination of Executive's employment; and (viii) provision of an appropriate office and secretarial assistance for at least six (6) months after the termination of Executive's employment. (b) The Executive shall be under no obligation to mitigate the amount of any payment or benefit provided for above under paragraph 7.5(a) by seeking other employment or otherwise, nor shall such payments be offset or reduced by any compensation which the Executive may receive from future employment or otherwise. (c) The payments and benefits provided for above in paragraph 7.5(a) are in lieu of any severance or income continuation or income protection under any Company plan that may now or hereafter exist and shall be deemed to satisfy and be in full and final settlement of all obligations of the Company for severance or income continuation or income protection to Executive under this Agreement. (d) Except as otherwise provided in paragraph 7.5(a)(ii) through 7.5(a)(vi) coverage under all the Company benefit plans and programs will terminate upon the termination of Executive's employment except to the extent otherwise expressly provided in such plans or programs. 7.6 Death or Disability. If Executive dies prior to the end of the Employment Term or if the Board makes a Disability Determination, Executive or his beneficiary or estate 11 12 shall be entitled to receive (in addition to amounts and benefits under any life insurance policy or disability program or policy) Executive's Salary up to the date on which the death or Disability Determination occurs and a pro-rated Bonus for the fiscal year in which the death or Disability Determination occurs. In addition, the vesting of all stock options, stock appreciation rights and restricted stock granted to Executive that are not exercisable as of the date on which the death or Disability Determination occurs shall be accelerated, and Executive or his beneficiary or estate shall be entitled to exercise such stock options and stock appreciation rights, together with all stock options and stock appreciation rights that are exercisable as of the date of death or Disability Determination, through the stated expiration date of such stock options and stock appreciation rights. In addition, in the event of such a termination the Company shall within 20 days of such termination pay to the Executive or his personal representative, as the case may be, severance pay in a lump sum equal to his then annual Base Salary for one year as set forth in paragraph 3.1 hereof. 7.7 Change of Control. Notwithstanding any other provision herein, in order to protect the Executive against the possible consequences and uncertainties of a Change of Control (as hereinafter defined) of the Company and thereby induce the Executive to remain in the employ of the Company, the Company agrees that in the event of a Change of Control this Agreement shall continue to be operative according to its terms except that: (a) If the Executive's employment is terminated by the Company other than for "Cause" (as defined in paragraph 7.3 hereof) within one year subsequent to a Change of Control or if the Executive voluntarily terminates such employment within one year subsequent to a Change of Control (the "Evaluation Period"), then in either such event, the Executive shall be entitled to the payments and benefits of paragraph 7.5 as if the termination had occurred under paragraphs 7.4(a) or 7.4(b). (b) In lieu of exercising or retaining his right to exercise any outstanding stock options then held by the Executive, the Executive may elect to surrender to the Company his rights in such outstanding options (whether or not then exercisable) then held by the Executive, and, upon such surrender the Company shall pay to the Executive an amount in cash per share equal to the aggregate of the difference between (i) the aggregate of the difference between the option prices of the shares of the Company's Common Stock subject to such surrendered options and (ii) the greater of (A) the average price per share paid in connection with such acquisition of control if such control was acquired by the payment of cash or the then fair market value per option share of the consideration paid for such shares if such control was acquired for consideration other than cash, (B) the price per share paid in connection with any tender offer of securities leading to control, or (C) the mean between the high and low bid price of shares of the Company's Common Stock on NASDAQ or any other national securities exchange upon which such securities shall then be listed on the date of termination of the Executive's employment. (c) The Company shall pay or reimburse the Executive for all fees and disbursements of counsel, if any, incurred by the Executive as a result of the termination of his employment by the Company or his voluntary termination of such employment during the Evaluation Period following a Change of Control (including, without limitation, those which 12 13 may be incurred by the Executive in seeking to obtain or enforce any right or benefit provided by this Agreement). (d) The Executive shall be under no obligation to mitigate the amount of any payment provided for under this paragraph 7.7 by seeking other employment or otherwise nor shall such amount be offset by any compensation which the Executive may receive from future employment or otherwise. (e) For purposes of this Agreement, a "Change in Control" with respect to the Company shall be deemed to have taken place if, at any time during the Employment Term, any of the following events occur: (i) Any person, as that term is used in Section 13(d) and Section 14(d)(2) of the securities Exchange Act of 1934, as amended (the "Exchange Act"), becomes, is discovered to be, or files a report on Schedule 13D or 14D-1 (or any successor schedule, form or report) disclosing that such person is, a beneficial owner (as defined in Rule 13d-3 under the Exchange Act or any successor rule or regulation), directly or indirectly, of securities of the Company representing 15% or more of the combined voting power of the Company's then outstanding securities entitled to vote generally in the election of directors; (ii) Individuals who, as of January 1, 2001, constitute the Board of Directors of the Company cease for any reason to constitute at least a majority of the Board of Directors of the Company, unless any such change is approved by a vote of at least 80% of the members of the Board of Directors of the Company (including Executive) in office immediately prior to such cessation; (iii) The Company is merged, consolidated or reorganized into or with another corporation or other legal person, or securities of the Company are exchanged for securities of another corporation or other legal person, and immediately after such merger, consolidation, reorganization or exchange less than a majority of the combined voting power of the then outstanding securities of such corporation or person immediately after such transaction are held, directly or indirectly, in the aggregate by the holders of securities entitled to vote generally in the election of directors of the Company immediately prior to such transaction; (iv) The Company in any transaction or series of related transactions, sells all or substantially all of its assets to any other corporation or other legal person and less than a majority of the combined voting power of the then-outstanding securities of such corporation or person immediately after such sale or sales are held, directly or indirectly, in the aggregate by the holders of securities entitled to vote generally in the election of directors of the Company immediately prior to such sale; (v) The Company and its affiliates shall sell or dispose of (in a single transaction or series of related transactions) business operations that generated two-thirds of the consolidated revenues (determined on the basis of the Company's four most recently completed fiscal quarters for which reports have been filed under the Exchange Act) of the Company and its subsidiaries immediately prior thereto; 13 14 (vi) The Company files a report or proxy statement with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934 disclosing in response to Form 8-K or Schedule 14A (or any successor schedule, form or report or item therein) that a change in control of the Company has or may have occurred or will or may occur in the future pursuant to any then existing contract or transaction; (vii) Any other transaction or series of related transactions occur that have substantially the effect of the transaction specified in any of the preceding clauses in this paragraph 7.7(e). (f) Notwithstanding the provisions of Section 7.7(e)(i) through 7.7(e)(vi) hereof, unless otherwise determined in a specific case by majority vote of the Board of Directors of the Company, a Change in Control shall not be deemed to have occurred for purposes of this Agreement solely because (i) the Company, (ii) an entity in which the Company directly or indirectly beneficially owns 50% or more of the voting securities or (iii) any Company-sponsored employee stock ownership plan, or any other employee benefit plan of the Company, either files or becomes obligated to file a report or a proxy statement under or in response to Schedule 13D, Schedule 14D-1, Form 8-K or Schedule 14A (or any successor schedule, form or report or item thereon) under the Exchange Act, disclosing beneficial ownership by it of shares of stock of the Company, or because of the Company reports that a Change in Control of the Company has or may have occurred or will or may occur in the future by reason of such beneficial ownership. 8. RABBI TRUST. As soon as practicable after commencement of the Employment Term, the Company shall establish a "grantor trust" within the meaning of sections 671, et. seq. of the Internal Revenue Code with terms reasonably acceptable to the Executive, for the purpose of protecting the payment, in the event of a Change in Control of the Company, of any unfunded obligations of the Company to the Executive. 9. SUCCESSORS; BINDING AGREEMENT. Neither of the parties hereto shall have the right to assign this agreement or any rights or obligations hereunder without the prior written consent of the other party. Subject to the foregoing, this Agreement shall inure to the benefit of and be binding upon the parties and their successors and assigns. 10. COUNTERPARTS. This Agreement may be executed in several counterparts, each of which shall be an original but together shall constitute one in the same instrument. 11. NOTICES. Any notice required or permitted to be given under this Agreement shall be in writing and shall be deemed to have been duly given when (i) delivered personally; (ii) sent by facsimile or other similar electronic device and confirm; (iii) delivered by courier or overnight express; or 14 15 (iv) three business days after being sent by registered or certified mail, postage prepaid, addressed as follows: If to the Company: THQ Inc. 27001 Agoura Road, Suite 325 Calabasas Hill, California 91301 Attention: Secretary If to Executive: Jeffrey C. Lapin 2501 Cardigan Court Los Angeles, CA 90077 or to such other address as a party may furnish to the other party in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 12. GOVERNING LAW. This Agreement shall be governed by and construed and enforced in accordance with the internal laws of California without reference to conflicts of laws, principles or rules. 13. WAIVER. No waiver by either party hereto of any provision of this Agreement shall be deemed a waiver of any preceding or succeeding breach of such provision or as a waiver of any other provision hereof. 14. ARBITRATION. In the event of any controversy, dispute or claim arising out of or related to this Agreement or the Executive's employment by the Company, the parties shall negotiate in good faith in an attempt to reach a mutually acceptable settlement of such dispute. If negotiations in good faith do not result in a settlement of any such controversy, dispute or claim, it shall be finally settled by expedited arbitration in accordance with the National Rules of the American Arbitration Association governing employment disputes, subject to the following: (a) The Arbitrator shall be determined from a list of names of five impartial arbitrators each of whom shall be an attorney experienced in arbitration matters concerning executive employment disputes, supplied by the American Arbitration Association (the "Association") and chosen by Executive and the Company each in turn striking a name from the list until one name remains. (b) The Arbitrator shall determine whether and to what extent any party shall be entitled to damages under this Agreement. (c) The Arbitrator shall not have the power to add to nor modify any of the terms or conditions of this Agreement. The Arbitrator's decision shall not go beyond what is necessary for the interpretation and application of the provision of this Agreement in respect of the issue before the Arbitrator. The Arbitrator shall not substitute his or her judgment for that of 15 16 the parties in the exercise of rights granted or retained by this Agreement. The Arbitrator's award or other permitted remedy, if any, and the decision shall be based upon the issue as drafted and submitted by the respective parties and the relevant and competent evidence adduced at the hearing. (d) The Arbitrator shall have the authority to award any remedy or relief provided for in this Agreement, in addition to any other remedy or relief (including provisional remedies and relief) that a court of competent jurisdiction could order or grant. In addition, the Arbitrator shall have the authority to decide issues relating to the interpretation, meaning or performance of this Agreement even if such decision would constitute an advisory opinion in a court proceeding or if the issues would otherwise not be ripe for resolution in a court proceeding, and any such decision shall bind the parties in their continuing performance of this Agreement. The Arbitrator's written decision shall be rendered within sixty days of the hearing. The decision reached by the Arbitrator shall be final and binding upon the parties as to the matter in dispute. To the extent that the relief or remedy granted by the Arbitrator is relief or remedy on which a court could enter judgment, a judgment upon the award rendered by the Arbitrator shall be entered in any court having jurisdiction thereof (unless in the case of an award of damages, the full amount of the award is paid within 10 days of its determination by the Arbitrator). Otherwise, the award shall be binding on the parties in connection with their continuing performance of this Agreement and in any subsequent arbitral or judicial proceedings between the parties. (e) The arbitration shall take place in Los Angeles, California. (f) The arbitration proceeding and all filing, testimony, documents and information relating to or presented during the arbitration proceeding shall be disclosed exclusively for the purpose of facilitating the arbitration process and for no other purpose and shall be deemed to be information subject to the confidentiality provisions of this Agreement. (g) The parties shall continue performing their respective obligations under this Agreement notwithstanding the existence of a dispute while the dispute is being resolved unless and until such obligations are terminated or expire in accordance with the provisions hereof. (h) The Arbitrator may order a pre-hearing exchange of information including depositions, interrogatories, production of documents, exchange of summaries of testimony or exchange of statements of position, and the Arbitrator shall limit such disclosure to avoid unnecessary burden to the parties and shall schedule promptly all discovery and other procedural steps and otherwise assume case management initiative and control to effect an efficient and expeditious resolution of the dispute. At any oral hearing of evidence in connection with an arbitration proceeding, each party and its counsel shall have the right to examine its witness and to cross-examine the witnesses of the other party. No testimony of any witness shall be presented in written form unless the opposing party or parties shall have the opportunity to cross-examine such witness, except as the parties otherwise agree in writing. (i) Notwithstanding the dispute resolution procedures contained in this Section 14, either party may apply to any court having jurisdiction (i) to enforce this Agreement 16 17 to arbitrate, (ii) to seek provisional injunctive relief so as to maintain the status quo until the arbitration award is rendered or the Dispute is otherwise resolved, or (iii) to challenge or vacate any final judgment, award or decision of the Arbitrator that does not comport with the express provisions of this Section 14. 15. ATTORNEYS' FEES The Company shall pay or reimburse the Executive for all reasonable fees and disbursements of the Executive's counsel in connection with the negotiation and execution of this Agreement. In addition, in the event of any arbitration or judicial proceeding hereunder, the prevailing party shall be entitled to recover his or its reasonable attorneys fees and costs. 16. HEADINGS. The Article, Section, paragraph and subparagraph headings are for convenience of reference only and shall not define or limit the provisions hereof. 17. ENTIRE AGREEMENT. This Agreement constitutes the entire agreement between the parties with respect to the subject matter hereof and there are no representations, warranties or commitments except as set forth herein. This Agreement supersedes any other prior and contemporaneous agreements, understandings, negotiations and discussions, whether written or oral, of the parties hereto relating to the subject matter of this Agreement. This Agreement may be amended only in a writing executed by the parties hereto. 18. SEVERABILITY. If any provision of this Agreement, as applied to either party or to any circumstances, shall be adjudged by a court to be void or unenforceable, the same shall be deemed stricken from this Agreement and shall in no way affect any other provision of this Agreement or the validity or enforceability of this Agreement. 19. SUPERSEDES PREVIOUS AGREEMENT. Effective as of the date of this Agreement, this Agreement shall supersede and cancel all prior agreements relating to Executive's employment by the Company or any of its affiliates and predecessors, including, without limitation, the employment agreement between Executive and THQ Inc. dated as of January 1, 1999, and any amendments thereto. Notwithstanding the preceding sentence, this Agreement is not intended, and shall not be construed, to affect 17 18 Executive's rights in any compensation or benefits that have been granted or accrued prior to the Effective Date. IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the date and year first above written. Company: THQ Inc., a Delaware Corporation By: ------------------------------------- Its: ------------------------------------ Executive: ---------------------------------------- Jeffrey C. Lapin 18 EX-21 4 a70675ex21.txt EXHIBIT 21 1 EXHIBIT 21 Subsidiaries. THQ INC.
ENTITY NAME JURISDICTION - ----------- ------------ GameFx, Inc. Delaware Pacific Coast Power and Light Company California THQ Entertainment GmbH Germany T.HQ Deutschland GmbH (Formed on May 10, 1993) Germany T.HQ International, Ltd. United Kingdom THQ (Holdings) Ltd. United Kingdom THQ France SARL France Genetic Anomalies, Inc. Delaware Volition, Inc. Delaware THQ Asia Pacific Ltd. Pty. Australia
EX-23.1 5 a70675ex23-1.txt EXHIBIT 23.1 1 EXHIBIT 23.1 Independent Auditors' Consent We consent to the incorporation by reference in Registration Statement Nos. 333-30655, 333-74747, 333-74715, 333-78521, 333-78567, 333-83725 and 333-35806 of THQ Inc. on Form S-8 and Registration Statement Nos. 333-32221, 333-60277, 333-70335, 333-85269, 333-92361, 333-32526, 333-40698 and 333-47914 on Form S-3 of our report dated February 16, 2001, appearing in this Annual Report on Form 10-K of THQ Inc. for the year ended December 31, 2000. DELOITTE & TOUCHE LLP Los Angeles, California March 29, 2001 -----END PRIVACY-ENHANCED MESSAGE-----