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 July 4, 1999
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 July 27, 1999, the registrant had 5,959,470 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 Income - Quarter ended July 4, 1999
and June 28, 1998.............................................. 3
Consolidated Balance Sheets - July 4, 1999 and March 28, 1999..... 4
Consolidated Statements of Cash Flows - Three months ended
July 4, 1999 and June 28, 1998................................. 5
Notes to Consolidated Financial Statements........................ 6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 7
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk........ 12
PART II - OTHER INFORMATION
- ---------------------------
ITEM 1. Legal Proceedings................................................. 12
ITEM 6. Exhibits and Reports on Form 8-K.................................. 12
SIGNATURES.................................................................. 13
- ----------
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PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
FUNCO, INC.
Consolidated Statements of Income
(in thousands, except share and per share data)
(Unaudited)
Quarter Ended
--------------------------
July 4, June 28,
1999 1998
----------- -----------
Net sales ............................................ $ 42,505 $ 32,894
Cost of sales ........................................ 28,133 21,264
----------- -----------
Gross profit ..................................... 14,372 11,630
Operating expenses ................................... 10,805 8,402
General and administrative expenses .................. 3,035 2,514
----------- -----------
Operating income ................................. 532 714
Interest income ...................................... 52 120
----------- -----------
Net income before income taxes ................... 584 834
Income tax provision ................................. 229 334
----------- -----------
Net income ....................................... $ 355 $ 500
=========== ===========
Basic Earnings Per Share:
- -------------------------
Basic net income per share ........................... $ 0.06 $ 0.08
Weighted average number of common shares ............. 5,929,029 6,195,452
Diluted Earnings Per Share:
- ---------------------------
Diluted net income per share ......................... $ 0.06 $ 0.08
Weighted average number of common
and common equivalent shares ...................... 6,340,739 6,549,895
SEE ACCOMPANYING NOTES.
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FUNCO, INC.
Consolidated Balance Sheets
(in thousands, except share data)
July 4, March 28,
1999 1999
--------- ---------
(Unaudited) (Note)
ASSETS
- ------
Current Assets
Cash and cash equivalents ................................ $ 4,282 $ 8,550
Accounts receivable ...................................... 2,573 2,020
Inventories .............................................. 30,662 28,485
Prepaid expenses ......................................... 2,600 2,948
Current deferred tax asset ............................... 640 640
--------- ---------
Total current assets .................................. 40,757 42,643
Net property and equipment .................................. 12,040 11,334
Long-term deferred tax asset ................................ 1,064 1,064
Other assets ................................................ 102 99
--------- ---------
Total assets ................................................ $ 53,963 $ 55,140
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Accounts payable ......................................... $ 8,556 $ 9,831
Accrued liabilities ...................................... 4,571 5,266
Deferred revenue ......................................... 937 994
--------- ---------
Total current liabilities ............................. 14,064 16,091
Accrued rent ................................................ 204 213
Shareholders' Equity
Common stock (issued: 5,959,103 and 5,894,760) ........... 60 59
Additional paid-in capital ............................... 15,741 15,238
Retained earnings ........................................ 23,894 23,539
--------- ---------
Total shareholders' equity ............................ 39,695 38,836
--------- ---------
Total liabilities and shareholders' equity .................. $ 53,963 $ 55,140
========= =========
Note: The balance sheet at March 28, 1999 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.
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FUNCO, INC.
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Three Months Ended
-----------------------
July 4, June 28,
1999 1998
--------- ---------
Operating Activities
Net income ...................................................... $ 355 $ 500
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization ................................ 1,106 839
Net loss on disposal of property and equipment ............... 68 6
Changes in operating assets and liabilities:
Accounts receivable ....................................... (553) 1,083
Inventories ............................................... (2,177) (5,802)
Prepaid expenses .......................................... 348 (1,184)
Accounts payable .......................................... (1,275) 3,751
Accrued liabilities ....................................... (704) (2,387)
Deferred revenue .......................................... (57) (196)
--------- ---------
Net cash used in operating activities .................. (2,889) (3,390)
Investing Activities
Additions of property and equipment ............................. (1,878) (380)
Increase in other assets ........................................ (5) --
Purchase of short-term investments .............................. -- (2,329)
--------- ---------
Net cash used in investing activities ..................... (1,883) (2,709)
Financing Activities
Net proceeds from issuance of common stock ...................... 504 74
--------- ---------
Net cash provided by financing activities ................. 504 74
Decrease in cash and cash equivalents .............................. (4,268) (6,025)
Cash and cash equivalents at beginning of period ................... 8,550 9,295
--------- ---------
Cash and cash equivalents at end of period ......................... $ 4,282 $ 3,270
========= =========
SEE ACCOMPANYING NOTES.
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FUNCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. The Company
Funco, Inc. (the Company) was incorporated in March 1988 and is a leading
national specialty retailer of 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(R) stores. The store
strategy is complemented by the Company's mail order operation, the FUNCOLAND
SUPERSTORE Web site and publication of GAME INFORMER(R), a video game magazine.
The Company operated 315 retail locations at July 4, 1999, compared to 252
retail locations at June 28, 1998.
Note 2. Fiscal Year
The Company's fiscal year ends on a Sunday on or near March 31st which completes
a 52 or 53-week reporting period. Fiscal 2000 is a 53-week reporting period with
the first quarter consisting of 14 weeks and all other quarters consisting of 13
weeks. Fiscal 1999 was a 52-week reporting period with each quarter consisting
of 13 weeks.
Ending Date
------------------------------------------
2000 1999
----------------- --------------------
First July 4, 1999 June 28, 1998
Second October 3, 1999 September 27, 1998
Third January 2, 2000 December 27, 1998
Fourth April 2, 2000 March 28, 1999
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.
Due to the seasonal nature of the Company's business, the operating results for
the quarter ended July 4, 1999 are not necessarily indicative of the results
that may be expected for the fiscal year ending April 2, 2000.
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
28, 1999.
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Note 5. Net Income per Share
The following table sets forth the computation of basic and diluted net income
per share:
Quarter Ended
--------------------------
July 4, June 28,
1999 1998
----------- -----------
Numerator:
Net income ...................................... $ 355,000 $ 500,000
=========== ===========
Denominator:
Denominator for basic net income
per share - weighted average shares ........... 5,929,029 6,195,452
Dilutive securities:
Employee and nonemployee director stock
options ....................................... 411,710 353,444
----------- -----------
Denominator for diluted earnings per share -
adjusted weighted average shares .............. 6,340,739 6,548,896
=========== ===========
Basic earnings per share ........................... $ 0.06 $ 0.08
=========== ===========
Diluted earnings per share ......................... $ 0.06 $ 0.08
=========== ===========
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 income
expressed as (i) percentage of net sales for the quarter indicated and (ii)
percentage changes from the comparable period prior year.
Percent
Quarter Ended Inc (Dec)
---------------------- ---------
July 4, June 28, 2000 over
1999 1998 1999
--------- --------- ---------
Net sales ................................ 100.0% 100.0% 29.2%
Cost of sales ............................ 66.2 64.6 32.3
--------- ---------
Gross profit ............................. 33.8 35.4 23.6
Operating expenses ....................... 25.4 25.5 28.6
General and admin. expenses .............. 7.1 7.6 20.7
--------- ---------
Operating income ......................... 1.3 2.2 (25.5)
Interest income .......................... 0.1 0.4 (56.7)
--------- ---------
Net income before taxes .................. 1.4 2.5 (30.0)
Income tax provision ..................... 0.5 1.0 (31.4)
--------- ---------
Net income ............................... 0.8% 1.5% (29.0)%
========= =========
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of First Quarter Fiscal 2000 to First Quarter Fiscal 1999
Net sales for the quarter increased from $32,894,000 in 1999 to $42,505,000 in
2000, an increase of 29.2%. The Company opened four new stores and closed one
store during the quarter and operated a total of 315 locations at the end of the
quarter this year compared to 252 locations at the end of the same period prior
year. Comparable store sales for the quarter increased a modest 0.3%. The strong
overall sales increase is primarily due to operating a greater number of stores
compared to prior year.
Cost of sales for the quarter increased from $21,264,000 in 1999 to $28,133,000
in 2000, an increase of 32.3%. 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
for the quarter increased from 64.6% in 1999 to 66.2% in 2000. This increase is
primarily due to a shift in sales mix from previously played product to lower
margin new product which accounted for 58% of sales for the first quarter,
compared to 54% for the same period last year.
Operating expenses for the quarter increased from $8,402,000 in 1999 to
$10,805,000 in 2000, an increase of 28.6%. This increase is primarily due to
higher store payroll and occupancy expense which occurred as the Company
operated a greater number of stores than in the same period prior year.
Operating expenses as a percentage of net sales decreased from 25.5% in 1999 to
25.4% in 2000.
General and administrative expenses for the quarter increased from $2,514,000 in
1999 to $3,035,000 in 2000, an increase of 20.7%. This increase occurred to
support the store base which grew to 315 locations from 252 locations at the end
of the same period in the prior year. General and administrative expenses
decreased favorably as a percentage of net sales from 7.6% in 1999 to 7.1% in
2000, due to leveraging as net sales increased by 29.2%.
The Company generated operating income for the quarter of $532,000 compared to
operating income of $714,000 for the same period prior year, a decrease of
25.5%.
Interest income for the quarter decreased from $120,000 in 1999 to $52,000 in
2000, a decrease 43.3% as the Company maintained lower levels of short-term
investments than prior year.
The Company generated net income before income taxes for the quarter of $584,000
compared to net income before income taxes of $834,000 in the same period prior
year, a decrease of 30.0%. As a result the Company recorded income tax expense
for the quarter of $229,000 compared to income tax expense of $334,000 for the
same period prior year.
Due to the above factors, the Company generated net income for the quarter of
$355,000, or $0.06 per share, compared to net income of $500,000, or $0.08 per
share, for the same period prior year.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Seasonality and Quarterly Fluctuations
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 factors including new product introductions and the number and timing of new
store openings. Growth of the store base may obscure the impact of seasonal
influences. 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. The following table sets
forth net sales by quarter and the number of stores operating at each quarter
end for the past nine quarters:
Net Sales (in thousands) Number of Stores Open at Quarter End
- -------------------------------------------- --------------------------------------------
Fiscal Fiscal
Quarter 2000 1999 1998 Quarter 2000 1999 1998
- -------- --------- --------- --------- -------- --------- --------- ---------
First $42,505 $32,894 $24,001 First 315 252 193
Second 35,299 26,760 Second 270 215
Third 82,889 67,036 Third 310 249
Fourth 55,591 45,519 Fourth 312 250
Liquidity and Capital Resources
The Company's primary ongoing financing requirements are for new store capital
expenditures 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 three months ended July 4, 1999, the Company used $2,889,000 of cash
for operating activities primarily for the purchase of inventory, and used
$1,883,000 of cash for investing activities, primarily for capital expenditures
relating to both new stores opened during the quarter and future store openings.
For the three months ended June 28, 1998, the Company used $3,390,000 of cash
for operating activities and used $2,709,000 of cash for investing activities.
The Company has a $5,000,000 unsecured revolving credit facility with a
commercial bank, seasonally increasing to $10,000,000. The interest rate on
outstanding borrowings under the facility (7.02% for the month ended July 4,
1999) is based upon LIBOR plus 200 basis points. The facility requires the
Company to maintain certain financial ratios and achieve certain operating
results. The Company had no borrowings under this facility at July 4, 1999 and
currently has no borrowings.
During fiscal 2000, the Company plans to incur capital expenditures of
approximately $7,650,000, of which $1,878,000 has been incurred to date, for new
store openings, store remodels and renovations, enhancements to store and
corporate information systems and general corporate purposes. The Company
incurred capital expenditures of $6,838,000 in fiscal 1999.
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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
YEAR 2000
Readiness Plan
The Company's year 2000 Readiness plan is primarily directed towards ensuring
that the Company will be able to perform its critical functions: (1) accurately
process sale and purchase transactions through its retail, mail order and web
site operations, (2) order and receive merchandise from vendors, (3) make
appropriate decisions as to inventory pricing and distribution and (4) assure
integrity of business operations, controls and financial reporting.
The Company is involved in an ongoing assessment of year 2000 readiness and is
undergoing a company-wide program of adapting its computer systems and
applications for the year 2000. Substantially all in-house developed software
has been written to be year 2000 compliant. Recently completed upgrades of
important applications, including inventory management, transfer management,
merchandise information and financial systems, were designed to be year 2000
compliant. Several less critical in-house applications and third party packages
require year 2000 modification. All of the Company's systems and applications
are included in the Company's ongoing year 2000 readiness efforts.
The Company is also in the process of assessing year 2000 issues associated with
its various business partners, including vendors and service providers, and is
actively working with these third parties to identify and mitigate common risks.
The Company is also engaged in the assessment of year 2000 issues affecting its
telephone and communication systems, distribution processes, utilities, alarm
systems and transportation services.
Risks
The variety, nature and complexity of year 2000 issues, the dependence on
technical skills and expertise of Company employees and independent contractors
and issues associated with the readiness of third parties are factors which
could result in the Company's efforts toward year 2000 compliance being less
than fully effective.
Failure to properly assess and correct year 2000 issues could result in
materially adverse financial consequences through an inability to adequately
process retail, mail order or web site transactions or, due to the failure of
the Company's systems, to provide accurate information for ordering, pricing or
distributing merchandise. Accurate financial reporting is dependent upon year
2000 compliance. Failures caused by vendors not being year 2000 compliant could
lead to delays in receiving product shipments and to a resulting loss of sales.
Year 2000 compliance difficulties on the part of financial institutions could
interfere with cash collections, payments and funding for the Company. In
addition to the above, the Company believes that other unidentified risks could
be associated with failure of year 2000 compliance by the Company or third
parties.
Readiness Progress
A summary of the Company's critical systems and progress toward year 2000
readiness is as follows:
Store systems include software applications and hardware that process
transactions in the retail stores and enable communication of information
between stores and the Company's corporate office. These systems include a new
third party software package which was installed in FUNCOLAND store locations
between August 1998 and April 1999. Each store's hardware configuration includes
a new server installed at the same time as the new software and generally
includes earlier installed hardware components. Although the
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
new software and new hardware are believed to be year 2000 compliant, full
testing is currently in process. Year 2000 readiness of the Company's store
systems is approximately 70% complete.
Financial systems primarily consist of a series of third party software modules
installed between March 1998 and August 1998. These systems are used for
accounting, control and financial reporting. These systems are currently being
tested to recognize transactions over a wide range of critical dates. Year 2000
readiness of the Company's financial systems is approximately 90% complete.
Corporate systems encompass in-house developed software applications and
recently upgraded systems performing functions including inventory management,
transfer management and merchandise information. These in-house developed
software applications were designed for year 2000 readiness, but are undergoing
comprehensive evaluation and testing. Year 2000 readiness of the Company's
corporate systems is approximately 40% complete.
Contingency Plan
Based on progress and efforts to date, the Company believes that its program of
assessment, testing and correcting, along with selected system upgrades, will
enable it to successfully meet the year 2000 challenge. The Company is in the
process of completing a formal contingency plan and in the event of failures
associated with year 2000 readiness, believes that adequate resources could
rapidly be directed toward correcting isolated internal failures. The plan
includes supplementing those systems and processes which are year 2000 ready
with alternate means of data collection, storage and retrieval. It also includes
alternative means of communication between the Company's corporate office,
distribution center, store locations, vendors and customers. The plan's
objective is to assure continuity in performing critical functions, but includes
risks associated with third party service providers.
Costs
As of July 4, 1999, the Company had incurred costs of less than $100,000 related
to year 2000 readiness, including testing, analysis and purchase of software
upgrades. Total costs associated with year 2000 readiness are expected to be
less than $500,000. However, there can be no assurance that costs will not
exceed this level. The Company does not expect to incur material costs
associated with the use of external resources.
Forward Looking Statements
Forward looking statements contained in this document which directly or
indirectly relate to future sales prospects and expansion plans are subject to
uncertainties from factors including growth of the industry, competitive
environment, general economic conditions, product availability, success of the
Company's existing operations, availability of new store sites and the Company's
ability to finance new store expansion. In addition, forward looking statements
contained in this document relating to Year 2000 readiness are subject to
uncertainties such as third party readiness and the Company's successful
completion of assessment and remediation efforts. For further discussion of
forward looking statements and factors which can impact the Company's operating
results, please refer to the Company's report on Form 10-K for the year ended
March 28, 1999, and other Company filings with the Securities and Exchange
Commission.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's operations are not currently subject to market risks relating to
interest rates, foreign currency exchange rates, commodity prices or other
market price risks of a material nature.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company and its Chief Executive Officer were named as defendants in a civil
lawsuit filed on August 17, 1995 in the United States District Court, District
of Minnesota, entitled Christopher Cannon v. Funco, Inc. and David R. Pomije.
The plaintiff purported to represent a class of all purchasers of the Company's
common stock during the putative class period 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, a similarly styled
class action lawsuit, alleging the Company's share price was artificially
inflated, asserting various claims under the Securities Exchange Act of 1934, as
amended, and seeking damages in an unspecified amount plus costs and attorney's
fees.
A settlement agreement was negotiated between the parties and was approved by
the court on April 30, 1999. The settlement had no material impact on the
Company's results of operations, financial condition or liquidity.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits filed with this Form 10-Q
10.1 Amendment to Credit Agreement effective June 30, 1999,
by and between the Registrant and Marquette Capital
Bank, N.A., and the Amended and Restated Promissory Note
10.2 Amendment to lease for corporate headquarters in Eden
Prairie, Minnesota effective June 1, 1999 and filed as
an exhibit to Form 10-K for fiscal year 1999, filed on
June 28, 1999, and incorporated herein by reference
10.3 Executive Employment Agreement with David R. Pomije
10.4 Executive Employment Agreement with Stanley A. Bodine
10.5 Executive Employment Agreement with Robert M. Hiben
10.6 Executive Employment Agreement with Jeffery R. Gatesmith
27 Financial Data Schedule
(b) No report on Form 8-K was filed by the registrant during the
quarter ended July 4, 1999.
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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: July 28, 1999 By: /s/ David R. Pomije
-------------------------------------
David R. Pomije
Chief Executive Officer
By: /s/ Robert M. Hiben
-------------------------------------
Robert M. Hiben
Chief Financial Officer
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