THQ Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: THQI)") else Response.Write("(Nasdaq: THQI)") end if %> makes video games for the Sony PlayStation, Nintendo 64, Game Boy, and personal computers. After two money-losing years, Calabasas, California-based THQ returned to profitability in 1995 following a massive restructuring that involved changes in senior management. THQ's revenues increased 169% in three years, from about $33.3 million in 1995 to $89.4 million in 1997. In the first nine months of this year, the company's revenues totaled $103.7 million -- more than 2 1/2 times the same period last year. Meanwhile, earnings have risen from $601,000 in 1995 to $9.3 million in 1997. As of the end of the third quarter, this year's earnings are 45% ahead of the same period last year.

TMF: Considering the huge impact World Championship Wrestling (WCW) has had on your revenues and earnings, are you at all worried that the popularity of wrestling could wear off and if this would affect the company?

Farrell: I think we've been fairly consistent. This question obviously comes up all the time. Hits are sort of the nature of this business and part of our job is to diversify the portfolio, almost like stock investors diversify their portfolio. This year and last year -- and perhaps next year -- are big wrestling years, but we've made a lot of moves like Rugrats and things with our bowling property -- which seems to be selling very well -- that lessen our reliance on it. And there's new properties out there obviously; for example, we signed Danger Girl next year and some of the EA [Electronic Arts <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ERTS)") else Response.Write("(Nasdaq: ERTS)") end if %>] titles on the Nintendo 64, so it's never our goal to be reliant on any one title. It's just the nature of the business that when a hit happens, it generates a lot of revenues and profits -- that's just the nature of the business.

TMF: I'm just curious. Do you have any games with Jesse Ventura in them?

"We're looking to grow this company aggressively while also making sure that it's not growth for growth's sake, that it's profitable growth that has a strategic purpose."

Farrell: (Laughter.) I happened to be at the WWF [World Wrestling Federation] yesterday, and we were chatting about it, and they weren't sure if they had any rights. I think he's been out of the sport a little too long for his rights to be with anyone. It might be a comical thing.

TMF: Do you have any plans to release a wrestling game that can be played over the Internet?

Farrell: Yes, eventually. I mean, that's certainly part of our rights in the new deal with the WWF. As you probably know, one of the issues for a game like wrestling over the Internet is the latency issue. That's a bandwidth issue, technology issue. We will definitely have Internet-playable games. It's just a matter of us having to make sure it's a good quality game that delivers the right game experience, and the technology of the Internet now for the latency is just a real issue.

TMF: From your market research, is there a lot of demand for such a product?

Farrell: You know, it's interesting. There's always demand, but there's no business model. So, for example, our fishing game and bowling games are playable over the Internet as was Pax Imperia, our other PC products. But it's a required feature for free. There's no established business model to charge for it, and that's something that the whole industry is looking at. I think we'll eventually get there. So I think people do like to play over the Internet -- they just don't want to pay for it.

TMF: What do you expect will be the big hits this Christmas and also looking ahead to next Christmas?

Farrell: We just presented at one of the investment conferences on Tuesday -- the Gerard Klauer Mattison conference -- and we think our largest titles for this Christmas season will obviously be the WCW/NWO Revenge. We're very pleased with the response from retail initially on that, and I think we've said publicly and privately we think it's going to be one of the more popular titles on the Nintendo 64 this holiday season.

Rugrats, obviously, we have great expectations of. Sony <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SNE)") else Response.Write("(NYSE: SNE)") end if %>, when they were making their presentation at the Gerard Klauer conference, specifically referenced Rugrats as part of their strategic move to capture the younger demographic consumer, and we do have support, both on the marketing and advertising side from Sony with respect to Rugrats. And then things like A Bug's Life, which is the next Disney/Pixar film that launches around Thanksgiving time. We'll have that for the Game Boy color, and we believe we'll be one of the first -- if not the first -- third-party Game Boy color game out. We have fairly high expectations of that as well.

So those look to be the big titles. Then we have the bowling and fishing titles we just released, and Devil Dice, which got a lot of spin and seems to be building. So I think we have a very strong product line for the back half [of the year]. But I think the wrestling titles, Rugrats, and probably Bug's Life will be the most popular.

TMF: What are you seeing for next year then?

Farrell: '99 -- again, we're not going out of the wrestling business. Obviously, we will sequel Rugrats. I think as we look into the back half, Road Rash for the Nintendo 64 and the Nuclear Strike for the N64 might be real strong titles for us. We have something that looks pretty cool in development called Danger Girl, but again we're a year away now. But those are the ones we probably have the highest hopes for.

TMF: What are your plans for gaining market share and increasing shareholder value in the next three to five years?

Farrell: As usual, our business plan is just to continue to execute well and deliver great products to the market, deliver them on time and get full retail presence throughout the world. It's sort of interesting when I get that question, you reflect a little bit. When this management team took over, the market capitalization of THQ was about $4 million, and now it's probably $254 million. So I think we've demonstrated we understand how to increase shareholder value.

TMF: Are you looking to be an acquirer or an acquiree?

Farrell:: I've said a number of times I don't think a proper business strategy is to be an acquiree. The proper business strategy is to run and create a successful business, an attractive business. If it's an attractive business, it's attractive to shareholders, both individual and institutional, and it may someday be attractive to an acquirer. Our goal is to run a good business. If it is, it's attractive to everyone.

"When this management team took over, the market capitalization of THQ was about $4 million, and now it's probably $254 million."

TMF: Do you see acquiring companies in Europe or Japan to boost your sales?

Farrell: Japan is a tough market right now. I wouldn't put that on a high list of priorities. We have a number of partners in Japan from whom we get products and to whom we sell products, and those relationships are working. So I don't see an acquisition there really furthering our strategic goals. I think I've said before that we are looking at the European market. We have great expansion plans there, and like in any business decision, it's a buy-or-build situation. If we can buy something more economically than it would take to build it, we'll buy it. Otherwise, we'll just continue to expand internally as we have over the last few years.

TMF: Have you actually been approached recently by another company wanting to acquire you?

Farrell: As you might guess, it's our policy -- and everyone's policy -- never to respond to anything like that.

TMF: Right. Well, GameFx, which you did acquire, has not released any games to date. What can you tell us about GameFx's development capability and proprietary technology, and how will that set you apart from others?

Farrell: As your question mentions, it is the technology that sets GameFx apart. I am extremely pleased with that acquisition to date. At the European trade show in September, we showed behind closed doors their title Excession to the press and got a very positive response from it, which is not surprising. Their technology and what they're executing on is very, very good. As I said, when we acquired GameFx, we believed that 3D acceleration technology is the future of the games business, and we think we have a leading edge in that.

Obviously, Excession will be announced -- it's on our product release schedule for, I think, it's May next year. So the fact that we haven't released it -- that's what it's on our release schedule for. And they're also doing things very closely with Intel <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %> as a partner as well, so I think you'll see a number of things coming from us as the studio builds. Remember, there was only a team and a half when we bought it, and the idea is to build that into three to four teams over the next year and a half.

TMF: Do you think THQ's license-driven model and lack of franchise-rich, back-catalog branding are reasons for the company's relatively low P/E?

Farrell: It always could be. I mean, one always asks why we are trading at a discount to some of our peers whom we are clearly outperforming in the marketplace. But then you look at companies -- I won't specifically mention names -- but there are companies with rich, back-catalog branding that aren't really performing very well and haven't performed well or have been acquired by other entities.

So, yes, content is important but that's not the only way to be successful in this business. We're all about growing the business and earnings growth, and we'd like to acquire some content. We'll continue to do that, but as far as trying to explain why there is a low P/E or a relatively low P/E, that may be one of the reasons. It may be a size issue. But people are starting to take notice of THQ, both in the financial markets and in the game market itself.

TMF: Do you think the shares are undervalued?

Farrell: Oh, absolutely.

TMF: Switching gears, will you try to bundle PC games with graphics board companies or with PC makers?

"If it's an attractive business, it's attractive to shareholders, both individual and institutional, and it may someday be attractive to an acquirer. Our goal is to run a good business."

Farrell: Yes, that's one of the things that GameFx does do for us -- it gives us a very strong OEM strategy because their technology is exactly the kind of thing that those chip makers or chip bundlers look for. I also wouldn't rule out Compaq, Dell, Intel themselves, AMD -- I'm not saying that we have deals with all those people, but we certainly are talking to them about the kinds of things that GameFx can do.

TMF: One of our readers wanted to know why roughly 25% of your outstanding shares are short and if this is a telling sign of future problems?

Farrell: I don't focus on and I'm sure you don't want me to focus on who's buying and selling, who's long, who's short. I have noticed that there is a fairly significant short position but I'm not sure what we can do or not do about it. Certainly, it's not a telling sign of any future problems because that position has existed for the last several months and we've done nothing but exceed budgets, exceed forecasts, really ship tremendous products. So in terms of a sign of future problems, I think the future looks tremendously bright. Again, at this Gerard Klauer conference, the general industry sentiment was very positive in terms of software sales not only for this holiday season but also through '99 and perhaps through the Year 2000. So what these future problems are, I'm not sure what's indicated with that kind of thing.

TMF: What's your vision for the company? Where do you hope to be, in terms of revenues, in say five years?

Farrell: We've always set out a vision to be one of the top entertainment software companies in the world. That's our vision, and that's our plan. It's interesting about the five-year question because I think a year ago, I said we'd like to be $250 million within five years, and I think we're on track to be well ahead of that. That's sort of the THQ model: Let's set out achievable goals and then exceed them. That's what we're continuing to do -- to set exact sales goals for five years. Again, I wasn't very pressured with my $250 million [goal] a year ago, so I think I'll just hold my peace on that one. But we're looking to grow this company aggressively while also making sure that it's not growth for growth's sake, that it's profitable growth that has a strategic purpose.

TMF: Is there anything else you'd like to add?

Farrell: I'm sure there is, but if you have any other questions I'd be happy to respond.

TMF: Great. Thank you so much for your time.

Farrell: Thank you.

Related links:

• THQ website
• THQ message board

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