<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 1997
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 0-28072
West Coast Entertainment Corporation
(Exact name of registrant as specified in its charter)
Delaware 04-3278751
(State or other jurisdiction of (I.R.S. Employer I.D. No.)
incorporation or organization)
One Summit Square, Suite 200, Rte. 413 & Doublewoods Rd.
Langhorne, Pennsylvania 19047
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (215)968-4318
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) had been subject to
such filing requirements for the past 90 days.
Yes /X/ No / /
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
<TABLE>
<CAPTION>
Class Outstanding at December 4, 1997
----- -------------------------------
<S> <C>
Common Stock, $.01 13,682,953
par value per share
</TABLE>
<PAGE> 2
INDEX
<TABLE>
<CAPTION>
Part I. - Financial Information Page No.
<S> <C> <C>
Item 1. - Financial Statements
Consolidated Balance Sheets -
As of October 31, 1997 and January 31, 1997 3
Consolidated Statements of Operations-
Three and Nine Months Ended October 31, 1997 and 1996 4
Consolidated Statements of Cash Flows-
Nine Months Ended October 31, 1997 and 1996 5
Notes to Consolidated Financial Statements 6
Item 2. - Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Part II. - Other Information 19
</TABLE>
Item 1. - Legal Proceedings
Item 2. - Changes in Securities
Item 3. - Defaults Upon Senior Securities
Item 4. - Submission of Matters to a Vote of the Security Holders
Item 5. - Other Information
Item 6. - Exhibits and Reports on Form 8-K
<PAGE> 3
WEST COAST ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEET
(in thousands, except for par value)
<TABLE>
<CAPTION>
October 31 January 31,
1997 1997
--------- --------
(unaudited)
<S> <C> <C>
Assets:
Current assets:
Cash and cash equivalents $ 2,830 $ 1,311
Accounts receivable 1,566 1,899
Merchandise inventory 9,207 6,333
Prepaid expenses and other current assets 4,083 2,046
Receivable from officers 217 141
Deferred tax asset 2,330 --
--------- --------
Total current assets 20,233 11,730
Videocassette rental inventory, net of amortization 30,692 24,598
Furnishings, equipment and leasehold improvements, net 18,722 11,285
Other assets 2,310 2,998
Intangible assets, net of accumulated amortization 118,250 109,193
Deferred tax asset 160 160
--------- --------
Total assets $ 190,367 $159,964
========= ========
Liabilities and Stockholders' Equity:
Current liabilities:
Current portion of long-term debt $ 14 $ 19
Accounts payable 19,636 12,941
Accrued expenses and other liabilities 3,397 4,647
Income taxes -- 1,555
Deferred tax liability -- 566
--------- --------
Total current liabilities 23,047 19,728
Long-term debt (net of current portion) 65,002 32,802
Other long-term liabilities 287 299
--------- --------
Total liabilities 88,336 52,829
Stockholders' equity:
Common stock ($0.01 par value; 13,826 shares
as of October 31, 1997, of which 13,641 shares were
outstanding and 185 shares to be issued; and
13,770 shares outstanding at January 31, 1997) 138 138
Preferred stock ($0.01 par value, 2,000 shares
authorized, no shares issued) -- --
Additional paid in capital 104,027 103,947
Accumulated surplus/(deficit) (2,134) 3,050
--------- --------
Total stockholders' equity 102,031 107,135
--------- --------
Total liabilities and stockholders' equity $ 190,367 $159,964
========= ========
</TABLE>
See accompanying notes to financial statements
-3-
<PAGE> 4
WEST COAST ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
October 31, October 31,
------------------------ ------------------------
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Rental revenue $ 24,893 $ 16,402 $ 72,261 $ 33,752
Merchandise and other sales 4,660 2,079 12,809 4,818
Franchise fees 474 1,483 1,813 3,792
-------- -------- -------- --------
Total revenues 30,027 19,964 86,883 42,362
-------- -------- -------- --------
Operating costs and expenses:
Store operating expenses 14,902 9,780 42,160 18,784
Cost of goods sold 3,167 1,345 8,773 3,133
Amortization of videocassette and video game rental
inventory (Note 2) 7,484 3,752 18,943 6,956
General and administrative 3,657 2,931 11,147 7,623
Intangible amortization 1,866 1,046 4,866 2,029
Debt offering write offs (Note 6) -- -- 5,125 --
-------- -------- -------- --------
Total operating costs and expenses 31,076 18,854 91,014 38,525
-------- -------- -------- --------
Income (loss) from operations (1,049) 1,110 (4,131) 3,837
-------- -------- -------- --------
Interest expense 1,443 222 3,387 730
Other, net (18) (61) (82) (129)
-------- -------- -------- --------
Income(loss) before provision for income taxes and
extraordinary item (2,474) 949 (7,436) 3,236
Provision for income taxes (837) 418 (2,252) 1,421
-------- -------- -------- --------
Income(loss) before extraordinary item (1,637) 531 (5,184) 1,815
Extraordinary item (net of
income tax benefit of $156) -- -- -- (244)
-------- -------- -------- --------
Net income (loss) ($ 1,637) $ 531 ($ 5,184) $ 1,571
======== ======== ======== ========
Income(loss) per common share data (Note 5):
Income(loss) before extraordinary item ($ 0.12) $ 0.04 ($ 0.38) $ 0.19
======== ======== ======== ========
Extraordinary item -- $ -- -- ($ 0.02)
======== ======== ======== ========
Net income (loss) ($ 0.12) $ 0.04 ($ 0.38) $ 0.17
======== ======== ======== ========
Weighted average shares outstanding 13,826 12,460 13,812 9,493
======== ======== ======== ========
</TABLE>
See accompanying notes to financial statements
-4-
<PAGE> 5
WEST COAST ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine months ended
October 31
------------------------
1997 1996
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ (5,184) $ 1,571
Adjustments to reconcile net income to cash
flows provided by (used in) operating activities:
Amortization of debt financing costs 157 --
Amortization of videocassette rental inventory 18,943 6,956
Depreciation and amortization of furnishings,
equipment and leasehold improvements 1,336 680
Amortization of intangible assets 4,866 2,035
Deferred taxes (2,896) --
Changes in assets and liabilities:
Accounts receivable 333 (900)
Merchandise inventories (2,874) (2,168)
Prepaid expenses and other assets (2,319) (1,097)
Accounts payable 6,695 2,256
Accrued expenses and other liabilities (1,250) (2,437)
Income taxes (1,555) 499
-------- --------
Net cash provided by operating activities 16,252 7,395
-------- --------
Cash flows from investing activities:
Purchase of property and equipment (6,007) (818)
Purchase of videocassette rental inventory (22,083) (10,394)
Purchase of businesses, net of cash acquired (18,918) (62,804)
Changes in other assets related to acquisitions -- (1,500)
-------- --------
Net cash used in investing activities (47,008) (75,516)
-------- --------
Cash flows from financing activities:
Proceeds from long-term debt 32,200 17,100
Repayment of long-term debt (5) (10,273)
Proceeds from issuance of common stock, net 80 63,079
Shareholder distributions -- --
Changes in other assets related to financing -- (700)
-------- --------
Net cash provided by financing activities 32,275 69,206
-------- --------
Net increase in cash and cash equivalents 1,519 1,085
Cash and cash equivalents, beginning of period 1,311 611
-------- --------
Cash and cash equivalents, end of period $ 2,830 $ 1,696
======== ========
Supplemental cash flow data:
Interest paid $ 3,136 $ 731
======== ========
Income taxes paid $ 2,199 $ 1,078
======== ========
</TABLE>
See accompanying notes to financial statements
-5-
<PAGE> 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 1997 (unaudited)
1 Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and pursuant to the rules and regulations of
the Securities and Exchange Commission ("SEC"). Accordingly, they do not
include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. For
further information, refer to the consolidated financial statements and
footnotes included in West Coast Entertainment Corporation's (the
"Company's") Form 10-K filed with the SEC on May 1, 1997.
The preparation of financial statements in conformity with generally
accepted accounting principles 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 revenue and expenses
during the reported period. Actual results could differ from these
estimates.
In the opinion of management, all adjustments necessary for a fair
presentation of this interim financial information have been included.
Such adjustments consisted only of normal recurring items except for the
change in amortization of videocassette rental inventory described in
Note 2 below. The results of operations for the three and nine months
ended October 31, 1997 are not necessarily indicative of the results to be
expected for the year ending January 31, 1998.
Income per common share data has been calculated utilizing the weighted
average number of common shares outstanding after giving effect to the
0.340-for-1 reverse stock split, which was approved by the Board of
Directors on May 14, 1996, as if it had occurred as of February 1, 1996.
In addition, shares to be issued as contingent consideration in
conjunction with the May 1996 and Early Fall 1996 Acquisitions (Note 3)
have been considered outstanding since May 17, 1996.
2 Videocassette Rental Inventory
Videocassette rental inventory and related amortization are as follows (in
thousands):
<TABLE>
<CAPTION>
October 31, 1997 January 31, 1997
---------------- ----------------
<S> <C> <C>
Videocassette rental inventory $60,928 $ 35,891
Accumulated amortization (30,236) (11,293)
------- --------
$30,692 $ 24,598
======= ========
</TABLE>
Amortization expense related to videocassette rental inventory totaled
$7,484,000, $18,943,000, $3,752,000 and $6,956,000 for the three months
and nine months ended October 31, 1997 and October 31, 1996, respectively.
Effective August 1, 1997, the Company adopted an accelerated method of
amortizing its videocassette rental inventory. Under this new method,
videocassette rental inventory base stock (the first three copies of a
title in a particular store) is amortized over its economic life of 36
months to its estimated salvage value of $6. New release base stock, less
the $6 salvage value, is amortized 50% in the first six months, then
amortized on a straight-line basis to the $6 salvage value over the
remaining 30 months. All copies of new release videocassette rental
inventory in excess of 3 copies per store are amortized on a straight-
line basis during the first nine months to $10 and the balance is
amortized on a straight-line basis over the remaining 27 months to the
$6 salvage value.
The new method of amortization was adopted because the Company believes
accelerated expense recognition for new release videocassettes during the
first six months more closely matches the typically higher revenue
generated following a title's release and $6 represents a reasonable
salvage value for all tapes after 36 months.
The new method of amortization has been applied to videocassette rental
inventory that was held in inventory at August 1, 1997. The adoption of
the new method of amortization has been accounted for as a change in
accounting estimate effected by a change in accounting principle and,
accordingly, the company recorded an $803,000 pre-tax charge to operating
expense as of August 1, 1997. The application of the new method of
amortizing videocassette rental inventory increased amortization expense
for the three and nine months ended October 31, 1997 by $803,000 and
reduced net income by $506,000 and earnings per share by $.04.
Prior to August 1, 1997, videocassette rental inventory was amortized over
its useful economic life with no provision for salvage value. Base stock
was amortized over 36 months on a straight-line basis. New release
videocassettes were amortized as follows: base stock was amortized over
36 months on a straight-line basis and copies in excess of three per
store were amortized over nine months on a straight-line basis.
Videocassette rental inventory amortization expense resulting from the
allocation of purchase price to videocassette rental tapes of the acquired
entities is based on current replacement cost for bulk purchases of used
tapes as well as the assignment of a three year amortizable life which
serves to extend the remaining economic useful lives of videocassette
rental tapes acquired. Replacement cost for bulk purchases of used tapes
is significantly less than the cost of new tape purchases. As a result,
future amortization relating to these tapes, on a per tape basis, will be
significantly less than the amortization relating to new tape purchases.
In addition, to the extent the acquired tapes have book values lower than
newly purchased tapes, sales of the acquired
6
<PAGE> 7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
October 31, 1997 (unaudited)
tapes should result in higher operating income than sales of new tape
purchases. The favorable effects resulting from purchase accounting will
diminish with the passage of time and will not extend beyond the three
year period subsequent to acquisition which is the period over which these
tapes will be amortized.
3 Acquisitions
May 1996 Acquisitions
On May 17, 1996, the Company acquired 172 video specialty stores
(the "May 1996 Acquisitions"), including 13 stores owned by franchisees of
the Company. Taking into account certain adjustments and calculation of
certain contingent payments, the aggregate consideration of $83.9 million
was paid consisting of the following: $53.0 million in cash, approximately
$26.2 million in shares of common stock (2.1 million shares), and
approximately $4.7 million of acquisition costs. Of these amounts,
approximately $0.4 million represents remaining minimum contingent
consideration (of which approximately $0.1 million and $0.3 million
(19,734 shares) is to be paid in cash and stock, respectively).
Early Fall 1996 Acquisitions
Between August 26 and October 25, 1996, the Company acquired the assets of
21 video specialty stores (the "Early Fall 1996 Acquisitions"). Aggregate
consideration of $13.6 million was paid, consisting of the following: $8.2
million in cash, $4.9 million in shares of common stock (0.5 million
shares), and approximately $0.5 million of acquisition costs. The shares
(0.4 million) associated with one of these acquisitions are to be issued
in three equal installments (six, twelve and eighteen months from the
acquisition date) and the number of shares issuable will be increased in
certain cases by the difference between the share price at issuance date
and a formulaic common share price calculated as of the date of
acquisition. Additionally, 0.1 million shares associated with another
Early Fall 1996 Acquisition are to be issued. In both instances these
common shares and other common shares to be issued in installments have
been considered outstanding as of the beginning of the periods presented.
Late Fall 1996 Acquisitions
Between November 15 and December 3, 1996, the Company acquired the assets
of 47 video specialty stores (the "Late Fall 1996 Acquisitions"),
including 19 stores owned by franchisees of the Company for aggregate
consideration of $27.7 million consisting of the following: $14.4 million
in cash, $11.0 million in shares of common stock (1.0 million shares) and
approximately $2.3 million of acquisition costs.
June, 1997 Acquisitions
On June 16, 1997, and June 24, 1997 the Company acquired a total of 38
video specialty stores (the "June, 1997 Acquisitions"), including 5 stores
owned by a franchisee of the Company for aggregate consideration of $17.9
million consisting of $17.2 million in cash and approximately $0.7 million
of acquisition costs.
The excess of the cost over the fair value of the assets acquired is being
amortized over 20 years on a straight line basis. The results of
operations of the acquired stores have been included in
7
<PAGE> 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
October 31, 1997 (unaudited)
operations of the Company since the date of acquisition. The purchase
method of accounting was used to account for the acquisitions.
The following unaudited pro forma information presents the results of
operations as though (i) the May 1996 Acquisitions, Early Fall 1996
Acquisitions, Late Fall 1996 Acquisitions and June, 1997 Acquisitions
had occurred as of the beginning of the periods presented, (ii) each
entity included in the consolidated statement of operations had been
included in the Company's consolidated income tax returns and subject to
corporate income taxation as a C corporation during all periods
presented, and (iii) the borrowings under the Credit Facility had
occurred as of the beginning of the periods presented.
The following unaudited pro forma net income per share for the three
months and nine months ended October 31, 1996 and 1997 was calculated by
dividing the respective unaudited pro forma net income by the pro forma
weighted average number of shares of Common Stock outstanding after giving
effect to (i) the 0.340-for-1 reverse stock split approved by the Board of
Directors on May 14, 1996, and the shares issued in conjunction with the
Initial Public Offering on May 17, 1996 ("the Offering"), (ii) issuance of
shares in connection with the May 1996, Early Fall 1996 and Late Fall 1996
Acquisitions, (iii) repayment of outstanding debt at the date of the
Offering, and (iv) the impact of a detachable warrant with a primary
supplier of videocassettes and a portion of a convertible note which was
converted into shares of the Company's common stock as if the transactions
had occurred on the first day of the periods presented. The pro forma
weighted average number of common shares used to calculate pro forma net
income per share was 14,017,840 for the three and nine months ended
October 31, 1997 and 14,000,605 for the three and nine months ended
October 31, 1996.
<TABLE>
<CAPTION>
Unaudited
Pro Forma
------------------------------------------------------
Three Months Ended Nine Months Ended
October 31, October 31,
(in thousands, except per share data)
1997 1996 1997 1996
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Pro Forma revenues $ 30,027 $30,402 $ 93,174 $95,326
Pro forma net income (1,637) 1,484 (4,833) 5,408
Pro forma net income per share $ (0.12) $ 0.11 $ (0.34) $ 0.39
</TABLE>
4 Long Term Debt
On May 17, 1996 the Company obtained a $60,000,000 Credit Facility ("the
Facility") from a bank which consists of a 17 month revolving credit
facility followed by a three year term loan. In association with the
borrowing the Company paid a fee of $700,000 on May 17, 1996 which has
been recorded in other long term assets and will be amortized over the
term of the Credit Facility. Borrowings under the Facility are available
for working capital, capital expenditures, refinancing of existing
indebtedness, and for certain permitted acquisition financing.
On October 31, 1996 the Company received a commitment from the Bank to
increase the Credit Facility to $65,000,000 effective August 5, 1996. As
of October 31, 1997 the Company had $65,000,000 outstanding under the
Facility.
On December 15, 1997 the Company signed an amendment increasing the
Facility to $70,000,000 with current commitments from the participating
banks for $65,000,000 (the "Amended Facility"). The Amended Facility has
a five year term ending December 14, 2002.
8
<PAGE> 9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
October 31, 1997 (unaudited)
If the Company attains certain total debt to operating cash flow
ratios, as defined, the commitment reduces quarterly commencing
June 15, 1999 and continues through the end of the term on December 14,
2002. If such total debt to operating cash flow ratios are not attained,
the quarterly commitment reductions will start on December 15, 1998. Any
amounts in excess of the commitment, as it may be reduced from time to
time, must be repaid.
Borrowings under the Amended Facility are limited to a multiple of
operating cash flow, as defined, over the previous four quarters. At
December 15, 1997, this multiple is 4.50 times operating cash flow, and
reduces over the next four fiscal quarters to a low of 3.25 times
operating cash flow on October 31, 1998 and thereafter. At the Company's
option, interest rates vary from either the Bank's base rate, as defined,
to 1.5% above such base rate or from the Eurodollar rate, as defined, to
3.0% above such Eurodollar rate. The Company's weighted average borrowing
rate under the Facility was 8.34% for the three months ended October 31,
1997. Additionally, the Amended Facility provides for a commitment fee
payable quarterly, computed up to 0.5% of the unused portion of the
available facility during the previous quarter.
The Amended Facility is secured by a first security interest in
substantially all of the Company's assets, including the stock of its
subsidiaries, and provides for certain restrictive covenants, including
among others compliance with certain financial tests and ratios and
dividend restrictions.
5 Earnings Per Share
In February 1997, Statements of Financial Accounting Standards (SFAS) No.
128, "Earnings Per Share", was issued. This pronouncement will be
effective for the Company's year ending January 31, 1998 financial
statements. SFAS No. 128 supersedes the pronouncement of the Accounting
Principles Board (APB) No. 15. The statement eliminates the calculation of
primary earnings per share and requires the disclosure of Basic Earnings
Per Share and Diluted Earnings Per Share (formerly referred to as fully
diluted earnings per share). SFAS No. 128 would not have had a material
impact on the Company's calculation of earnings per share for the three
and nine months ended October 31, 1997. Basic Earnings Per Share and
Diluted Earnings Per Share would be the same for the three and nine months
ended October 31, 1997.
6 Debt Offering Write Offs
On July 1, 1997 the Company's private placement of debt securities (the
"Proposed Private Placement") and related acquisitions were indefinitely
delayed due to market conditions. The Company wrote off $5.1 million in
costs during the three months ended July 31, 1997 that were incurred in
connection with the Proposed Private Placement and related acquisitions.
9
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Three Months ended October 31, 1997 compared to Three Months ended October
31, 1996
Revenues
Revenues increased $10.0 million, or 50.0 %, from $20.0 million for the
three months ended October 31, 1996 to $30.0 million for the three months
ended October 31, 1997. This change reflected an increase of $8.5 million
in rental revenues, an increase of $2.5 million in merchandise sales and a
decrease of $1.0 million in franchise fee revenue. The increases in rental
and merchandise sales revenues are mostly attributable to the acquisition
of a total of 108 video specialty stores, consisting of 21 stores which
were acquired on the following dates: 5 on August 26, 1996; 14 on
September 30, 1996; 1 on October 1, 1996; and 1 on October 25, 1996; and
an additional 87 stores which were acquired after the end of such three
month period on the following dates: 45 on November 15, 1996; 1 on
December 1, 1996; 1 on December 3, 1996; 1 on March 21, 1997; 1 on April
10, 1997, 37 on June 16, 1997, and 1 on June 24, 1997.
Rental revenues increased $8.5 million, or 51.8%, from $16.4 million for
the three months ended October 31, 1996 to $24.9 million for the three
months ended October 31, 1997. This change is primarily attributable to
the inclusion of $9.0 million of rental revenues from the 108 video
specialty stores acquired since August 1, 1996 as described above. Rental
revenues for the Company's stores and the industry during the three months
ended October 31, 1997 were adversely impacted by weather and by the
release of titles that had not performed strongly at the box office.
Merchandise sales increased $2.5 million, or 119.0%, from $2.1 million for
the three months ended October 31, 1996 to $4.6 million for the three
months ended October 31, 1997, reflecting $1.7 million of merchandise
sales contributed by the 108 video specialty stores purchased since August
1, 1996 as described above. In addition, merchandise sales for the
Company's stores owned prior to said acquisitions increased by $0.8
million.
Franchise fee revenues decreased $1.0 million, or 66.7%, from $1.5 million
for the three months ended October 31, 1996 to $0.5 million for the three
months ended October 31, 1997. Approximately $0.1 million of this decrease
is due to the acquisition of 25 franchised stores (which is included in
the total 108 purchased) by the Company since August 1, 1996. The
remaining $0.9 million decrease is attributable to a decline in the number
of royalty payments received from franchisees due to both a decline in
their business and a decline in the number of franchisees who make
required payments.
As a result of the Company's acquisition activities and other developments
described above the mix of revenue sources changed to approximately 83.0%
rental, 15.3% merchandising, and 1.7% franchising during the three months
ended October 31, 1997 from approximately 82.0%, 10.5%, and 7.5%,
respectively, during the three months ended October 31, 1996.
Store Operating Expenses
Store operating expenses increased $5.1 million, or 52.0 %, from $9.8
million for the three months ended October 31, 1996 to $14.9 million for
the three months ended October 31, 1997. This $5.1 million increase is
primarily related to the acquisition of new stores as described above. As
a percentage of total revenues, store operating expenses increased 0.7
percentage points from 49.0% for the three months ended October 31, 1996
to 49.7% for the three months ended October 31, 1997. All of this increase
was caused by the reduction from 1996 to 1997 in the relative significance
of the Company's franchise operations (as measured by the decrease in
franchise revenues as a percentage of total revenues), since the franchise
business involves virtually no store operating expenses.
10
<PAGE> 11
RESULTS OF OPERATIONS (continued)
Cost of Goods Sold
Cost of goods sold increased $1.8 million, or 138.5%, from $1.3 million
for the three months ended October 31, 1996 to $3.1 million for the three
months ended October 31, 1997, primarily as a result of an increase in
merchandise sales volume due to the acquisition of the 108 video specialty
stores since August 1, 1996. As a percentage of merchandise sales, cost of
goods sold increased by 5.5 percentage points from 61.9% for the three
months ended October 31, 1996 to 67.4% for the three months ended October
31, 1997. This increase was primarily due to a change in sales mix caused
by the acquisition of the 108 video specialty stores and the impact of
"Liar Liar," a major title released in September 1997 which was sold at a
lower margin than other sell-thru titles.
Amortization of Videocassette and Video Game Rental Inventory
Amortization of rental inventory increased $3.6 million, or 94.7%, from
$3.8 million for the three months ended October 31, 1996 to $7.4 million
for the three months ended October 31, 1997 primarily as a result of the
acquisition of the 108 video specialty stores since August 1, 1996. As a
percentage of rental revenues this amortization increased 6.5 percentage
points from 23.2% for the three months ended October 31, 1996 to 29.7% for
the three months ended October 31, 1997. This is primarily due to the
diminishing benefits of purchase accounting for acquired stores and the
change in accounting for amortization of rental inventory as described in
Note 2.
General and Administrative Expense
General and administrative expenses increased $0.8 million, or 27.6%, from
$2.9 million for the three months ended October 31, 1996 to $3.7 million
for the three months ended October 31, 1997. The increase is primarily
related to the additional personnel and non-store operating costs which
were absorbed from the acquisition of the 108 video specialty stores since
August 1, 1996 as described above. As a percentage of total revenues,
however, general and administrative expenses decreased 2.2 percentage
points from 14.5% for the three months ended October 31, 1996 to 12.3% for
the three months ended October 31, 1997 primarily reflecting the ability
of the Company's administrative staff to operate an increasing number of
corporate stores and, to a lesser extent, the change in the mix of rental
revenues, merchandise sales and franchise fees. Franchising has higher
associated general and administrative costs than rental revenues and
merchandise sales.
Because of the indefinite delay in the Company's Proposed Private
Placement of debt securities and related acquisitions (Note 6), the
Company has begun to reduce its general and administrative costs from the
levels reached in contemplation of expansion. The effects of these changes
were partially reflected in the financial results of the three months
ended October 31, 1997 and should be fully realized in future quarterly
financial results.
Intangible Amortization
Intangible amortization expense increased $0.8 million, or 72.7%, from
$1.1 million for the three months ended October 31, 1996 to $1.9 million
for the three months ended October 31, 1997. As a percentage of total
revenues, intangible amortization increased 0.8 percentage points from
5.5% for the three months ended October 31, 1996 to 6.3% for the three
months ended October 31, 1997. These increases are entirely related to
amortization of goodwill associated with the acquisition of 108 video
specialty stores since August 1, 1996.
Interest Expense and Other
Net interest expense and other increased $1.2 million, or 600.0%, from
$0.2 million for the three months ended October 31, 1996 to $1.4 million
for the three months ended October 31, 1997. Interest expense
11
<PAGE> 12
RESULTS OF OPERATIONS (continued)
comprises almost all of this net amount. As a percentage of total
revenues, interest expense increased 3.7 percentage points from 1.0% for
the three months ended October 31, 1996 to 4.7% for the three months
ended October 31, 1997. The increase is attributable to additional
interest expense incurred in connection with the acquisition of video
specialty stores.
Net Income
As a result of the foregoing, net income decreased $2.1 million from $0.5
million of net income for the three months ended October 31, 1996 to a
$1.6 million net loss for the three months ended October 31, 1997.
Nine Months ended October 31, 1997 compared to Nine Months ended October
31, 1996
Revenues
Revenue increased $44.6 million or 105.4% from $42.3 million for the nine
months ended October 31, 1996 to $86.9 million for the nine months ended
October 31, 1997. This change reflected an increase of $38.6 million in
rental revenues, an increase of $8.0 million in merchandise sales and a
decrease of $2.0 million in franchise fee revenue. The increases in rental
and merchandise sales revenues are attributable to the acquisition of a
total of 280 video specialty stores, consisting of 172 stores which were
acquired on May 17, 1996, which were owned for only 24 weeks of the nine
months ended October 31, 1996, and an additional 108 stores which were
acquired after the end of such nine month period on the following dates: 5
on August 26, 1996; 14 on September 30, 1996; 1 on October 1, 1996; 1 on
October 25, 1996; 45 on November 15, 1996; 1 on December 1, 1996; 1 on
December 3, 1996; 1 on March 21, 1997; 1 on April 10, 1997; 37 on June 16,
1997; and 1 on June 24, 1997.
Rental revenues increased $38.6 million or 114.5% from $33.7 million for
the nine months ended October 31, 1996 to $72.3 million for the nine
months ended October 31, 1997. This increase is primarily attributable to
the revenues generated by the 280 video specialty stores acquired since
May 17, 1996 as described above.
Merchandise sales increased $8.0 million or 166.7% from $4.8 million for
the nine months ended October 31, 1996 to $12.8 million for the nine
months ended October 31, 1997 primarily attributable to the merchandise
sales contributed by the 280 video specialty stores purchased since May
17, 1996 as described above.
Franchise fee revenue decreased $2.0 million, or 52.6% from $3.8 million
for the nine months ended October 31, 1996 to $1.8 million for the nine
months ended October 31, 1997. Approximately $0.5 million of this decrease
is due to the acquisition of 39 franchised stores which is included in the
total 280 purchased by the Company since May 17, 1996. The remaining $1.5
million decrease is attributable to a decline in the number of royalty
payments received from franchisees due to a decline in their business and
a decline in the number of franchisees who make required payments.
As a result of the Company's acquisition activities and other
developments described above the mix of revenue sources changed to
approximately 83.2% rental, 14.7% merchandising and 2.1% franchising
during the nine months period ended October 31, 1997 from approximately
79.7%, 11.3%, and 9.0%, respectively, during the nine month period ended
October 31, 1996.
Store Operating Expenses
Store operating expenses increased $23.4 million, or 124.5%, from $18.8
million for the nine months
12
<PAGE> 13
RESULTS OF OPERATIONS (continued)
ended October 31, 1996 to $42.2 million for the nine months ended October
31, 1997. As a percentage of total revenues, store operating expenses
increased 4.2 percentage points from 44.4% for the nine months ended
October 31, 1996 to 48.6% for the nine months ended October 31, 1997.
Except as discussed below this increase was caused by the decrease from
1996 to 1997 in the relative significance of the Company's franchise
operations (as measured by the decrease in franchise revenues as a
percentage of total revenues), since the franchise business involves
virtually no store operating expenses. As a percentage of rental revenues
and merchandise sales, store operating costs increased 0.8 percentage
points from 48.8% for the nine months ended October 31, 1996 to 49.6% for
the nine months ended October 31, 1997. This increase is primarily due to
higher rent costs and payroll costs. Store salaries increased due to an
increase in store man hours. Management has implemented steps to reverse
this trend in man hours. Since the initial acquisition of 172 stores on
May 17, 1996, most of the additional 108 stores acquired are located in
large metropolitan areas which generally have higher occupancy costs.
Cost of Sales
Cost of goods sold increased $5.7 million, or 183.9%, from $3.1 million
for the nine months ended October 31, 1996 to $8.8 million for the nine
months ended October 31, 1997, primarily as a result of an increase in
merchandise sales volume due to the acquisition of the 280 video
specialty stores since May 17, 1996. As a percentage of merchandise
sales, cost of goods sold increased by 4.2 percentage points from 64.6%
for the nine months ended October 31, 1996 to 68.8% for the nine months
ended October 31, 1997. This increase was primarily due to a change in
sales mix caused by the acquisition of the 280 video specialty stores and
the sale of more sell-thru titles which have a lower margin.
Amortization of Videocassette and Video Game Rental Inventory
Amortization of rental inventory increased $11.9 million, or 170.0%, from
$7.0 million for the nine months ended October 31, 1996 to $18.9 million
for the nine months ended October 31, 1997, primarily as a result of the
acquisition of the 280 video specialty stores since May 17, 1996. As a
percentage of rental revenues this amortization increased 5.3 percentage
points from 20.8% for the nine months ended October 31, 1996 to 26.1% for
the nine months ended October 31, 1997. This is primarily due to purchase
accounting for acquired stores and the change in accounting for
amortization of rental inventory as described in Note 2.
General and Administrative Expense
General and administrative expenses increased $3.5 million, or 46.1%,
from $7.6 million for the nine months ended October 31, 1996 to $11.1
million for the nine months ended October 31, 1997. The increase is
primarily related to the additional personnel and non-store operating
costs which were absorbed from the acquisition of the 280 video specialty
stores in addition to an increase in Corporate personnel hired in
anticipation of the Proposed Private Placement and related acquisitions.
As a percentage of total revenues, however, general and administrative
expenses decreased 5.2 percentage points from 18.0% for the nine months
ended October 31, 1996 to 12.8% for the nine months ended October 31,
1997 primarily reflecting the ability of the Company's administrative
staff to operate an increasing number of corporate stores and, to a
lesser extent, the change in the mix of rental revenues, merchandise
sales and franchise fees. Franchising has higher associated general and
administrative costs than rental revenues and merchandise sales.
Because of the indefinite delay in the Company's Proposed Private
Placement of debt securities and related acquisitions (Note 6), the
Company has reduced its general and administrative costs from the levels
reached in contemplation of expansion. The effects of these changes were
partially reflected in the financial results of the three months ended
October 31, 1997 and should be fully realized in future quarterly
financial results.
13
<PAGE> 14
RESULTS OF OPERATIONS (continued)
Intangible Amortization
Intangible amortization expense increased $2.9 million, or 145.0%, from
$2.0 million for the nine months ended October 31, 1996 to $4.9 million
for the nine months ended October 31, 1997. As a percentage of total
revenues, intangible amortization increased 0.9 percentage points from
4.7% for the nine months ended October 31, 1996 to 5.6% for the nine
months ended October 31, 1997. These increases are entirely related to
amortization of goodwill associated with the acquisition of 280 video
specialty stores since May 17, 1996.
Debt Offering Write-Offs
During the nine months ended October 31, 1997 the Company has written-off
$5.1 million in Debt Offering expense associated with the Proposed Private
Placement and related acquisitions due to the Company's decision to
indefinitely delay such offering.
Interest Expense and Other
Net interest expense and other increased $2.7 million or 450.0% from
$0.6 million for the nine months ended October 31, 1996 to $3.3 million
for the nine months ended October 31, 1997. Interest expense comprises
almost all of this net amount. As a percentage of total revenues,
interest expense increased 2.2 percentage points from 1.7% for the nine
months ended October 31, 1996 to 3.9% for the nine months ended October
31, 1997. The increase is attributable to additional interest expense
incurred in connection with the acquisition of the 280 video specialty
stores.
Extraordinary Item
For the nine months ended October 31, 1997 there was no extraordinary
item. For the nine months ended October 31, 1996, the Company reported an
extraordinary item of $0.2 million net of taxes. In conjunction with the
early extinguishment of a portion of the previously outstanding
subordinated debt the Company was required by terms of the note upon
completion of the Offering to pay a prepayment penalty of $400,000.
Net Income
As a result of the foregoing, net income decreased $6.8 million, from $1.6
million of net income for the nine months ended October 31, 1996 to a $5.2
million net loss for the nine months ended October 31, 1997.
Certain Factors That May Affect Future Results:
The following important factors, among others, could cause actual results
of operations to differ materially from any forward-looking statements
made in this Quarterly Report on Form 10-Q or any forward-looking
statements made elsewhere by management of the Company from time to time.
The Company's rapid growth, particularly its acquisition of 280 video
specialty stores since May of 1996 and franchising an additional 20
stores, could strain the Company's ability to manage operations, integrate
newly acquired stores into its systems, and effectively pursue its growth
strategy. The Company competes with many others, including Blockbuster
Entertainment, having significantly greater financial and marketing
resources, market share, and name recognition than the Company. Further
developments in competing technologies could have a material adverse
effect upon the video retail industry and the Company. Industry and
Company revenues are somewhat seasonal and may be affected by many
factors, including variation in the acceptance of new release titles
available for rental and sale, the extent of competition, marketing
programs, weather, the timing of any holiday weekends, special or unusual
events, and other factors that may affect retailers in general. There can
be no assurance that stores already acquired or acquired in future will
perform as expected or that the prices paid for such stores will prove to
be advantageous. The costs of integrating newly acquired stores into
14
<PAGE> 15
RESULTS OF OPERATIONS (continued)
the Company's systems may vary significantly from the amounts assumed for
purposes of the Company's pro forma financial statements. Acquisitions of
stores within the exclusive territories of existing West Coast Video(R)
franchised stores may require the Company to relocate or sell such
acquired stores, assist the franchisee to relocate, grant the franchisee
additional franchises or territorial or other rights, or include the
franchisee's stores in the Company's intended program of acquisitions. The
Company's management does not have significant experience in operating a
company as large as the Company now is. The Company's Common Stock has
traded publicly only since May 14, 1996 and no prediction can be made as
to future price levels for such stock.
15
<PAGE> 16
PRO FORMA RESULTS OF OPERATIONS (Note 3)
Three Months ended October 31, 1997 compared to Three Months ended October 31,
1996
Revenues
Pro forma revenues decreased by $0.4 million or 1.3% from $30.4 million for the
three months ended October 31, 1996 to $30.0 million for the three months ended
October 31, 1997. This decrease in revenues was mainly due to the closing of 21
stores (net of new store openings) and a reduction in franchise revenues, offset
by a 2.6% increase in same store sales.
Net Income
Pro forma net income decreased by $3.1 million, from $1.5 million of net income
for the three months ended October 31, 1996 to a $1.6 million net loss for the
three months ended October 31, 1997. This decrease in net income was primarily
attributable to a $0.4 million decrease in revenues in 1997 as compared to the
three months ended October 31, 1996, an increase in rental tape amortization of
$1.5 million caused by the change in the method of amortization as described in
Note 2 coupled with the effects of purchase accounting for the three months
ended October 31, 1996, and a change in the mix of revenues (a decrease in
franchise fees and an increase in merchandise sales) resulting in a $10.9
million increase in cost of sales.
Nine Months ended October 31, 1997 compared to Nine Months ended October 31,
1996
Revenues
Pro forma revenues decreased by $2.1 million, or 2.2%, from $95.3 million for
the nine months ended October 31, 1996 to $93.2 million for the nine months
ended October 31, 1997. This is mainly due to a same store revenues decrease of
1.6% (primarily caused by the impact of weather and the release of titles that
had not performed strongly at the box office) for the nine months ended October
31, 1997 compared to the nine months ended October 31, 1996, a reduction in
franchise fee revenues and the closing of 21 stores (net of new store openings).
Net Income
Pro forma net Income decreased by $10.2 million, from $5.4 million of net income
for the nine months ended October 31, 1996 to $4.8 million net loss for the nine
months ended October 31, 1997. This decrease was primarily due to the $5.1
million write off of costs relating to the debt offering taken during the three
months ended July 31, 1997 and the decrease in revenues of $2.1 million
mentioned above. Another factor in the decreased net income was an increase in
total costs and expenses (excluding interest and other expenses and the debt
offering costs) as a percent of revenues by 10.2 percentage points from 87.6%
for the nine months ended October 31, 1996 to 97.8% for the nine months ended
October 31, 1997. This was mainly due to an increase in store operating costs as
a result of increases in store man hours and payroll and an increase in cost of
goods sold caused by the change in sales mix (a decrease in franchise fees and
an increase in merchandise sales).
16
<PAGE> 17
LIQUIDITY AND CAPITAL RESOURCES
For the nine months ended October 31, 1997, the Company had net cash provided by
operating activities of $16.2 million, net cash used in investing activities of
$47.0 million (consisting primarily of cash used to purchase videocassette
rental inventory of $21.5 million and $22.1 million of net cash paid for the
acquisitions of new video specialty stores acquired in such period) and net cash
provided by financing activities of $32.3 million consisting of $32.2 million of
net borrowings from the Credit Facility (as described below), resulting in a net
increase in cash and cash equivalents of $1.5 million.
During the current fiscal year, the Company has financed its operations
primarily through available operating cash flow and has financed acquisitions
and other capital expenditures through a portion of such operating cash flow and
borrowings under the Credit Facility described in Note 4.
The Company's decision to indefinitely delay its Proposed Private Placement of
debt securities (Note 6) caused certain of the associated costs of such offering
to remain unpaid as of the filing date. The Company has instituted cost-cutting
measures, which included downsizing its general and administrative costs from
the levels reached in contemplation of expansion along with cost reductions at
the regional and store levels. The effects of these changes were partially
reflected in the financial results of the three months ended October 31, 1997
and should be fully realized in future quarterly financial results. The Company
is also currently seeking to find a new participant in order to increase the
amount of borrowings available under the Credit Facility by $5.0 million, in
order to improve its working capital position, bring its payables more current,
upgrade management information systems, continue the conversion of acquired
stores to West Coast Video(R) signage and fixtures, relocate existing stores and
build new stores. While there can be no assurance, the Company expects these
modifications, together with its current operating cash flow, to be sufficient
to support its current operations over the next year.
In the future, the Company may also seek additional debt refinancing or equity
capital through additional private or public offerings of securities. The
availability of debt refinancing or equity capital will depend upon prevailing
market conditions, the market price of the Company's Common Stock and other
factors over which the Company has no control, as well as the Company's
financial condition and results of operations. The number of shares of Common
Stock, if any, to be issued to sellers in connection with future acquisitions
will also be affected by such factors, since such number will be determined in
accordance with a formula based on trading prices of the Common Stock. It is not
expected that funds will be available in sufficient amounts to finance the
acquisitions or opening of video specialty stores at rates comparable to the
Company's recent rates of growth.
Capital Commitments. The remaining aggregate costs of upgrading West Coast's
management information systems and integrating stores acquired in prior
acquisitions onto such systems are expected
17
<PAGE> 18
LIQUIDITY AND CAPITAL RESOURCES (continued)
to be approximately $1.8 million over the next 12 months. Over the next 12
months the Company will make additional payments of cash and Common Stock,
currently estimated for the purpose of the Company's pro forma financial
statements at $0.4 million in the aggregate, to the sellers of six stores
purchased in prior acquisitions at formulaic purchase prices based on certain
financial measurements for such stores in future periods. The Company has
commitments or options to purchase an additional 17 stores at similar formulaic
prices (which cannot yet be estimated), payable in cash.
Subject to the availability of sufficient funds under the Credit Facility, the
Company's capital expenditure plan provides for continuing to convert the stores
acquired in various prior acquisitions to West Coast Video(R) signage and format
and installing certain West Coast layout and features at a rate of up to 100
stores per year at an estimated cost of $35,000 per store; the Company also has
immediate plans to open 5 new stores and relocate up to 3 existing stores.
Build-out costs for new stores are expected to range from $325,000 to $375,000
per store and build-out costs for relocated stores are expected to range from
$175,000 to $225,000 per store. The Company's expansion plans are subject to the
availability of sufficient funds under the Credit Agreement.
Under certain cross-purchase and area development agreements, the Company will
be entitled to acquire (and, subject to certain conditions, will be required to
acquire, if the owners elect to put) all of the assets of up to 55 stores
operated or to be operated by such owners at specified times between 1998 and
2002. In conjunction with such agreements, the Company is subject to puts during
the next 12 months; however there can be no assurance that the puts will be
consummated. The purchase prices will be equal to specified multiples of the
stores' net operating cash flow; the purchase prices of 24 such stores will be
payable in shares of Common Stock and the other purchase prices will be payable
in cash or in shares of Common Stock, at the Company's election.
Rental inventories are treated as noncurrent assets under generally accepted
accounting principles because they are not assets which are reasonably expected
to be completely realized in cash or sold in the normal business cycle. Although
the rental of this inventory generates the major portion of the Company's
revenue, the classification of these assets as noncurrent results in their
exclusion from working capital. The aggregate amount payable for this inventory,
however, is reported as a current liability until paid and, accordingly, is
included in the computation of working capital. Consequently, the Company
believes working capital is not an appropriate measure of its liquidity. Due to
the accounting treatment of rental inventory as a noncurrent asset, the Company
had a working capital deficit at October 31, 1997.
18
<PAGE> 19
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of the Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
18.0 - Letter RE: Change in Accounting Principles
27.0 - Financial Data Schedule
19
<PAGE> 20
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.
WEST COAST ENTERTAINMENT
CORPORATION
Date: December 15, 1997 By: /s/ T. Kyle Standley
--------------------
T. Kyle Standley, President and
Chief Executive Officer
(Principal Executive Officer)
Date: December 15, 1997 By: /s/ Richard G. Kelly
--------------------
Richard G. Kelly, Chief Financial Officer
(Principal Financial Officer)
Date: December 15, 1997 By: /s/ Jerry L. Misterman
----------------------
Jerry L. Misterman, Chief Accounting Officer
(Principal Accounting Officer)
20
<PAGE> 1
EXHIBIT 18.0
To the Board of Directors
of West Coast Entertainment Corporation
Dear Directors:
We have been furnished with a copy of the Corporation's Form 10-Q for the
quarter ended October 31, 1997. Note 2 therein describes a change in estimate
effected by a change in principle of amortizing the cost of videocassette rental
inventory and states that the newly adopted method is preferable in the
circumstances because the Company believes accelerating expense recognition for
new release videocassettes (copies 1-3) more closely matches the typically
higher revenue generated following a title's release during the first six months
and $6 represents a reasonable salvage value for all tapes after 36 months. It
should be understood that the preferability of one acceptable method of
videocassette rental inventory amortization method over another has not been
addressed in any authoritative accounting literature and in arriving at our
opinion expressed below, we have relied on management's business planning and
judgment. Based upon our discussions with management and the stated reasons for
the change, we believe that such change represents, in your circumstances, the
adoption of a preferable alternative method for videocassette rental inventory
amortization in conformity with Accounting Principles Board Opinion No. 20.
We have not made an audit in accordance with generally accepted auditing
standards of the financial statements of West Coast Entertainment Corporation
for the three-month or nine-month periods ended October 31, 1997 or October 31,
1996 and, accordingly, we express no opinion thereon, or on the financial
information filed as part of the Form 10-Q of which this letter is to be an
exhibit.
PRICE WATERHOUSE LLP
December 15, 1997
Boston, Massachusetts
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