UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended December 29, 1996
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: 0-21876
FUNCO, INC.
(Exact name of registrant as specified in its charter)
Minnesota 41-1609563
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10120 West 76th Street
Eden Prairie, MN 55344
(Address of principal executive offices)
(612) 946-8883
(Registrant's telephone number, including area code)
Check whether the registrant: (1) 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
---- ----
On January 22, 1997, the registrant had 6,026,318 outstanding shares of common
stock, $ .01 par value.
FUNCO, INC.
INDEX
PART I - FINANCIAL INFORMATION PAGE NO.
- ------------------------------ --------
ITEM 1. Consolidated Financial Statements (Unaudited)
Consolidated Statements of Operations - Quarter and nine months
ended December 29, 1996 and December 31, 1995................... 3
Consolidated Balance Sheets - December 29, 1996 and
March 31, 1996................................................. 4
Consolidated Statements of Cash Flows - Nine months ended December
29, 1996 and December 31, 1995.................................. 5
Notes to Consolidated Financial Statements ......................... 6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ..................................... 7
PART II - OTHER INFORMATION
- ---------------------------
ITEM 1. Legal Proceedings................................................... 11
ITEM 6. Exhibits and Reports on Form 8-K ................................... 11
SIGNATURES ................................................................... 12
- ----------
Exhibit (11) Statement Re: Computation of Per Share Earnings................. 13
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
FUNCO, INC.
Consolidated Statements of Operations
(In thousands, except share and per share data)
(Unaudited)
Quarter Ended Nine Months Ended
------------------------------ ------------------------------
December 29, December 31, December 29, December 31,
1996 1995 1996 1995
------------ ------------ ------------ ------------
Net sales .............................. $ 46,461 $ 31,897 $ 85,738 $ 59,493
Cost of sales .......................... 30,095 19,339 54,650 35,084
----------- ----------- ----------- -----------
Gross profit ........................ 16,366 12,558 31,088 24,409
Operating expenses ..................... 9,433 9,027 20,945 20,099
General and administrative expenses .... 2,425 1,845 6,119 5,488
----------- ----------- ----------- -----------
Operating income (loss) ............. 4,508 1,686 4,024 (1,178)
Interest expense ....................... (18) (53) (29) (67)
Interest income ........................ 22 7 104 60
----------- ----------- ----------- -----------
Net income (loss) before income taxes 4,512 1,640 4,099 (1,185)
Income tax provision ................... 1,510 770 1,349 --
----------- ----------- ----------- -----------
Net income (loss) ................... $ 3,002 $ 870 $ 2,750 $ (1,185)
=========== =========== =========== ===========
Net income (loss) per share ............ $ 0.48 $ 0.15 $ 0.45 $ (0.20)
=========== =========== =========== ===========
Weighted average number of common and
common equivalent shares ............... 6,220,172 5,963,398 6,141,792 5,857,269
SEE ACCOMPANYING NOTES.
FUNCO, INC.
Consolidated Balance Sheets
(in thousands, except share data)
December 29, March 31,
1996 1996
------------ ---------
(Unaudited) (Note)
ASSETS
Current Assets
Cash and cash equivalents ....................................... $10,633 $ 5,783
Accounts receivable .............................................. 1,065 621
Inventories ...................................................... 18,164 9,775
Prepaid expenses ................................................. 1,458 1,668
------- -------
Total current assets .......................................... 31,320 17,847
Property & equipment, net of accumulated depreciation & amortization 6,564 7,662
Other assets, net of accumulated amortization ...................... 707 159
------- -------
Total assets .................................................. $38,591 $25,668
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable ................................................. $ 7,733 $ 3,195
Accrued liabilities .............................................. 8,485 3,634
Current portion of long-term debt and capital lease obligations .. 41 31
Deferred revenue ................................................. 883 622
------- -------
Total current liabilities ..................................... 17,142 7,482
Capital lease obligations .......................................... -- 3
Accrued rent ....................................................... 67 112
Shareholders' Equity
Common stock (issued: 5,991,053 and 5,877,887) ................... 60 59
Additional paid-in capital ....................................... 18,363 17,803
Retained earnings ................................................ 2,959 209
------- -------
Total shareholders' equity .................................... 21,382 18,071
======= -------
Total liabilities and shareholders' equity ......................... $38,591 $25,668
======= =======
Note: The balance sheet at March 31, 1996, has been derived from the audited
financial statements at that date but does not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
SEE ACCOMPANYING NOTES.
FUNCO, INC.
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Nine Months Ended
---------------------------
December 29, December 31,
1996 1995
------------ ------------
Operating Activities
Net income (loss) ................................................ $ 2,750 $ (1,185)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization .................................. 2,468 2,867
Deferred tax asset ............................................. (398) --
Net loss on disposal of property and equipment ................. 41 --
Changes in operating assets and liabilities:
Accounts receivable .......................................... (444) 207
Inventories .................................................. (8,389) (1,170)
Prepaid expenses ............................................. 61 (167)
Accounts payable ............................................. 4,538 3,679
Accrued liabilities .......................................... 4,806 1,271
Deferred revenue ............................................. 261 188
-------- --------
Net cash provided by operating activities .................. 5,694 5,690
Investing Activities
Additions to property and equipment .............................. (1,273) (479)
Increase in other assets ......................................... (73) (102)
-------- --------
Net cash used in investing activities ........................ (1,346) (581)
Financing Activities
Payments of obligations under capital leases ..................... (59) (204)
Net proceeds from issuance of common stock ....................... 561 56
-------- --------
Net cash provided by (used in) financing activities .......... 502 (148)
-------- --------
Increase in cash and cash equivalents ............................... 4,850 4,961
Cash and cash equivalents at beginning of period .................... 5,783 1,471
-------- --------
Cash and cash equivalents at end of period .......................... $ 10,633 $ 6,432
======== ========
SEE ACCOMPANYING NOTES.
FUNCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. The Company
Funco, Inc. (the Company) was incorporated in March 1988, and is engaged in the
business of providing interactive home entertainment, primarily through the
purchase and resale of new and previously played video games along with related
hardware and accessory items through its FUNCOLAND stores and mail order
operation. It also publishes a video game magazine, GAME INFORMER. The Company
operated 188 retail locations at December 29, 1996 compared to 182 retail
locations at December 31, 1995.
Note 2. Fiscal Year
The Company's fiscal year ends on a Sunday on or near March 31 which completes a
52 or 53 week reporting period. All quarters for fiscal 1997 and 1996 consist of
13 weeks with the following period ending dates:
Ending Date
------------------------------------------------
1997 1996
--------------------- -----------------------
First June 30, 1996 July 2, 1995
Second September 29, 1996 October 1, 1995
Third December 29, 1996 December 31, 1995
Fourth March 30, 1997 March 31, 1996
Note 3. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
solely of normal recurring accruals) considered necessary for a fair
presentation have been included.
The operating results for the quarter ended December 29, 1996, are not
necessarily indicative of the results that may be expected for the year ending
March 30, 1997 due to the seasonal nature of the Company's business.
Certain items in prior year's quarters have been reclassified to conform with
the 1997 presentation.
For further information, refer to the financial statements and footnotes thereto
included in the Company's annual report on Form 10-K for the year ended March
31, 1996.
Note 4. Sale of Common Stock
During the quarter ended December 29, 1996, a warrant for 85,000 shares issued
in 1992 to the underwriter of the company's initial public offering was
exercised at a price of $6.00 per share generating net proceeds to the Company
of approximately $500,000.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results of Operations
The following table sets forth certain items in the statements of operations
expressed as (i) percentage of net sales for the quarter indicated and (ii)
percentage changes from the prior year.
Percent Percent
Quarter Ended Inc (Dec) Nine Months Ended Inc (Dec)
--------------------------- --------- --------------------------- ---------
December 29, December 31, 1997 over December 29, December 31, 1997 over
1996 1995 1996 1996 1995 1996
------------ ------------ --------- ------------ ------------ ---------
Net sales ................... 100.0% 100.0% 45.7 100.0% 100.0% 44.1
Cost of sales ............... 64.8 60.6 55.6 63.7 59.0 55.8
----- ----- ----- ----- ----- -----
Gross profit ................ 35.2 39.4 30.3 36.3 41.0 27.4
Operating expenses .......... 20.3 28.3 4.5 24.4 33.8 4.2
General and admin. expenses . 5.2 5.8 31.4 7.1 9.2 11.5
----- ----- ----- ----- ----- -----
Operating income (loss) ..... 9.7 5.3 167.4 4.7 (2.0) N/A
Interest expense ............ -- (0.2) (66.0) -- (0.1) (56.7)
Interest income ............. -- -- 214.3 0.1 0.1 73.3
----- ----- ----- ----- ----- -----
Net income (loss) before .... 9.7 5.1 175.1 4.8 (2.0) N/A
taxes
Income tax provision ........ 3.3 2.4 96.1 1.6 -- N/A
----- ----- ----- ----- ----- -----
Net income (loss) ........... 6.5% 2.7% 245.1% 3.2% (2.0)% N/A
===== ===== ===== ===== ===== =====
Comparison of Third Quarter Fiscal 1997 to Third Quarter Fiscal 1996
Net sales for the quarter increased from $31,897,000 in 1996 to $46,461,000 in
1997, an increase of 45.7%. The Company operated 188 stores at the end of the
third quarter this year compared to 182 stores at the end of the same period
prior year. During the quarter, the Company opened 12 new stores.
The large sales increase for the quarter is the result of a revitalization of
the video game category primarily due to the introduction and growing market
penetration of Sony PlayStation, Nintendo 64 and Sega Saturn products. The
Company anticipates continued market growth for these next generation systems
into the next fiscal year.
Cost of sales for the quarter increased from $19,339,000 in 1996 to $30,095,000
in 1997, an increase of 55.6%. The dollar increase in cost of sales is primarily
due to the strong growth in sales. Cost of sales as a percentage of net sales
increased from 60.6% in 1996 to 64.8% in 1997. This increase occurred primarily
as sales mix for the quarter reflected proportionately higher sales of next
generation products, which are currently sold at higher cost percentages than
that of the earlier generation product offerings.
Operating expenses for the quarter increased from $9,027,000 in 1996 to
$9,433,000 in 1997, an increase of 4.5%. This increase is primarily due to
higher store payroll expense related to the quarter's increased sales volume
compared to the same period prior year. Operating expenses decreased as a
percentage of net sales from 28.3% in 1996 to 20.3% in 1997, as expenses
increased nominally while net sales increased by 45.7%.
General and administrative expenses for the quarter increased from $1,845,000 in
1996 to $2,425,000 in 1997, an increase of 31.4%. This dollar increase occured
primarily due to additional payroll costs. General and administrative expenses
decreased as a percentage of net sales from 5.8% in 1996 to 5.2% in 1997.
The Company generated operating income for the quarter of $4,508,000 compared to
operating income of $1,686,000 in the same period last year, an increase of
167.4%.
Interest expense for the quarter decreased from $53,000 in 1996 to $18,000 in
1997 as the Company reduced borrowings on its line of credit compared to the
prior year.
Interest income for the quarter increased from $7,000 in 1996 to $22,000 in
1997, an increase of 214.3%, primarily as the Company maintained higher levels
of cash and cash equivalents.
The Company generated net income before income taxes for the quarter of
$4,512,000 compared to net income before income taxes of $1,640,000 in the same
period last year, an increase of 175.1%.
The Company recorded income tax expense for the quarter of $1,510,000 compared
to income tax expense of $770,000 for the same period prior year.
As a result of the above factors, the Company generated net income for the
quarter of $3,002,000 compared to net income of $870,000 for the same period
prior year.
Comparison of Nine Month Period Fiscal 1997 to Nine Month Period Fiscal 1996
Net sales for the nine month period increased from $59,493,000 in 1996 to
$85,738,000 in 1997, an increase of 44.1%. The Company operated 188 stores at
the end of the nine month period this year compared to 182 stores at the end of
the same period prior year. Through the nine month period fiscal 1997 the
Company has opened 18 new stores and closed 3 of its lower performing stores.
The large sales increase for the nine month period is the result of a
revitalization of the video game category primarily due to the introduction and
growing market penetration of Sony PlayStation, Nintendo 64 and Sega Saturn
products. The Company anticipates continued market growth for these next
generation systems into the next fiscal year.
Cost of sales for the nine month period increased from $35,084,000 in 1996 to
$54,650,000 in 1997, an increase of 55.8%. The dollar increase in cost of sales
is primarily due to the strong growth in sales. Cost of sales as a percentage of
net sales increased from 59.0% in 1996 to 63.7% in 1997. This increase occurred
primarily as sales mix for the nine month period reflected proportionately
higher sales of next generation products, which are currently sold at higher
cost percentages than that of the earlier generation product offerings.
Operating expenses for the nine month period increased from $20,099,000 in 1996
to $20,945,000 in 1997, an increase of 4.2%. This increase is primarily due to
higher store payroll expense related to the nine month period's increased sales
volume compared to the same period prior year. Operating expenses decreased as a
percentage of net sales from 33.8% in 1996 to 24.4% in 1997, as expenses
increased nominally while net sales increased by 44.1%.
General and administrative expenses for the nine month period increased from
$5,488,000 in 1996 to $6,119,000 in 1997, an increase of 11.5%. General and
administrative expenses decreased as a percentage of net sales from 9.2% in 1996
to 7.1% in 1997, as expenses increased nominally while net sales increased by
44.1%.
The Company generated operating income for the nine month period of $4,024,000
compared to an operating loss of $1,178,000 in the same period last year.
Interest expense for the nine month period decreased from $67,000 in 1996 to
$29,000 in 1997 as the Company reduced borrowings on its line of credit compared
to the prior year.
Interest income for the nine month period increased from $60,000 in 1996 to
$104,000 in 1997, an increase of 73.3%, primarily as the Company maintained
higher levels of cash and cash equivalents.
The Company generated net income before income taxes for the nine month period
of $4,099,000 compared to a net loss before income taxes of $1,185,000 in the
same period last year.
The Company recorded income tax expense for the nine month period of $1,349,000
compared to no income tax expense for the same period prior year.
As a result of the above factors, the Company generated net income for the nine
month period of $2,750,000 compared to a net loss of $1,185,000 for the same
period prior year.
Seasonality and Quarterly Functions
The Company's business is seasonal with a majority of net sales generated in the
third and fourth fiscal quarters, which include the holiday selling season. In
addition to sales seasonality, the Company's quarterly results are also impacted
by new product introductions and by the number and timing of new store openings.
Because of the seasonality of the Company's business and the factors mentioned
above, results for any quarter are not necessarily indicative of the results
that may be achieved for a full fiscal year. Accordingly, the significant sales
and earnings achieved in the third quarter, and the resulting impact on
profitably for the nine month period may not be indicative of results attainable
in those periods in future years. The following table sets forth net sales by
quarter and the number of stores operating at each quarter end for the past
eleven quarters:
Net Sales (in thousands) Number of Stores Open at Quarter End
- -------------------------------------------------------------- --------------------------------------------------
Fiscal Fiscal
Quarter 1997 1996 1995 Quarter 1997 1996 1995
- ------------- ------------ ------------ ------------ ----------- -------- -------- ---------
First $18,862 $12,261 $10,072 First 173 181 125
Second 20,415 15,335 15,130 Second 176 178 154
Third 46,461 31,897 36,389 Third 188 182 181
Fourth - 21,889 18,774 Fourth - 173 182
Liquidity and Capital Resources
The Company's primary ongoing financing requirements are for new store expansion
and inventory. On an interim basis, the Company's financing requirements are
also impacted by quarterly operating results and seasonal fluctuations in
inventory levels.
During the nine months ended December 29, 1996, the Company generated $5,694,000
of cash from operating activities and used $1,346,000 of cash in investing
activities, including $1,273,000 for capital expenditures. For the nine months
ended December 31, 1995, the Company generated $5,690,000 of cash from operating
activities and used $581,000 of cash in investing activities. Inventory levels
increased by $8,389,000 during the nine months ended December 29, 1996 as
compared to an increase of $1,170,000 during the nine months ended December 31,
1995 primarily as the Company adjusted inventory levels of next generation
product to match anticipated sales demand.
The Company has a $3,000,000 credit facility with a commercial bank, seasonally
increasing to $10,000,000. The interest rate on outstanding borrowings under the
facility (8.50% at December 29, 1996) is equal to the bank's reference rate plus
one quarter of one percent. This facility is collateralized by substantially all
inventory, accounts receivable, equipment and general intangibles of the
Company. The facility requires the Company to maintain certain financial ratios
and achieve certain operating results. The Company currently has no borrowings
under this facility.
During the quarter ended December 29, 1996, a warrant for 85,000 shares issued
in 1992 to the underwriter of the Company's initial public offering was
exercised at a price of $6.00 per share generating net proceeds to the Company
of approximately $500,000.
During fiscal 1997, the Company plans to incur capital expenditures totaling
approximately $1,500,000, of which $1,273,000 has been incurred to date for new
store openings and other related store expenditures, corporate information
systems and general corporate expenditures. The Company incurred capital
expenditures of $478,000 in fiscal 1996.
The Company believes that cash from operations and funds available under its
revolving credit facility will provide sufficient funds for financing planned
store openings, working capital needs and other capital expenditures for at
least 12 months.
Forward Looking Statements
Statements contained above with respect to future sales prospects and expansion
plans are forward looking statements, and are subject to uncertainties from
factors including growth of the industry, the competitive environment, success
of the Company's existing operations, availability of new store sites and the
Company's ability to finance new store expansion.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company and its Chief Executive Officer were originally named as defendants
in a civil lawsuit filed on August 17, 1996 in the United States District Court,
District of Minnesota, entitled Christopher Cannon v. Funco, Inc. and David R.
Pomije. This was a putative class action in which the named plaintiff in the
Class Action Complaint purported to represent a class of all purchasers of the
Company's common stock during the putative class period of May 18, 1994 through
December 15, 1994. On October 18, 1996, the court dismissed the state common law
claims with prejudice and dismissed the federal securities claims without
prejudice, giving the plaintiff leave to file an Amended Complaint. The
plaintiff filed an Amended Complaint on January 6, 1997.
The Amended Complaint is a similarly styled class action suit and alleges the
Company's share price was artificially inflated, asserting various claims under
the Securities and Exchange Act of 1934 as amended. Plaintiff seeks damages in
an unspecified amount plus costs and attorney's fees. The Company and its Chief
Executive Officer continue to believe that the claim is entirely without merit,
deny liability and intend to defend the litigation vigorously. The Company and
its Chief Executive Officer intend to file a motion to dismiss the Amended Class
Action Complaint in its entirety.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits filed with this Form 10-Q:
(11) Statements Re: Computation of Per Share Earnings
(27) Financial Data Schedule: For SEC use
(b) No report on Form 8-K was filed by the registrant during the
quarter ended December 29, 1996.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Funco, Inc.
(Registrant)
Date: January 24, 1997 By: /s/ David R. Pomije
-------------------------------------
David R. Pomije
Chief Executive Officer
By: /s/ Robert M. Hiben
-------------------------------------
Robert M. Hiben
Chief Financial Officer