FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
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: 0-21327
BLOWOUT ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 87-0498950
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification no.)
7700 NE Ambassador Place
One Airport Center, 2nd Floor, Portland, Oregon 97220
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 503-331-2729
__________________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes (X) No ( )
As of October 28, 1998, the Registrant had 2,433,330 shares of Common Stock
($.01 par value) outstanding.
<PAGE>
BLOWOUT ENTERTAINMENT, INC.
INDEX
PART I. FINANCIAL INFORMATION Page Number
Item 1. Financial Statements
Consolidated Balance Sheet
September 30, 1998 (Unaudited) and December 31, 1997 1
Consolidated Statement of Operations
Three months ended September 30, 1998 (Unaudited)
and September 30, 1997 (Unaudited) 2
Consolidated Statement of Operations
Nine months ended September 30, 1998 (Unaudited)
and September 30, 1997 (Unaudited) 3
Consolidated Statement of Cash Flows
Nine months ended September 30, 1998 (Unaudited)
and September 30, 1997 (Unaudited) 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 6 - 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings N/A
Item 2. Changes in Securities N/A
Item 3. Defaults Upon Senior Securities N/A
Item 4. Submission of Matters to a Vote of Security Holders N/A
Item 5. Other Information 14
Item 6. Exhibits and Reports on Form 8-K 14
<PAGE>
BLOWOUT ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEET
September 30, December 31,
1998 1997
------------ ------------
(Unaudited)
ASSETS
------
Current assets:
Cash and cash equivalents $ 742,855 $ 1,710,868
Receivables 263,790 219,844
Merchandise videocassette
inventory 2,686,400 2,975,630
Other current assets 179,194 93,720
------------ -----------
Total current assets 3,872,239 5,000,062
Rental videocassette inventory,net 8,674,599 9,158,819
Equipment and leasehold
improvements, net 2,835,493 3,678,593
Intangible assets, net 3,634,644 3,988,291
------------ -----------
Total assets $19,016,975 $21,825,765
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Line of credit $ 3,560,480 $ 3,020,366
Accounts payable 3,296,551 3,796,213
Accrued liabilities 1,673,662 1,488,566
Accrued payroll 602,158 582,474
Current portion of long-term debt 379,734 576,583
----------- -----------
Total current liabilities 9,512,586 9,464,202
Notes payable 4,320,085 5,678,647
Long-term debt 2,597,373 1,343,073
----------- -----------
Total liabilities 16,430,044 16,485,922
----------- -----------
Commitments and contingencies
Stockholders' equity:
Preferred stock, par value $.01
per share; 1,000,000 shares
authorized; no shares issued
and outstanding - -
Common stock, par value $.01
per share; 10,000,000 shares
authorized; 2,433,330 issued
and outstanding 24,336 24,336
Additional paid-in capital 21,947,864 21,947,864
Accumulated deficit (19,385,269) (16,632,357)
----------- -----------
Total stockholders' equity 2,586,931 5,339,843
----------- -----------
Total liabilities and
stockholders' equity $19,016,975 $21,825,765
=========== ===========
See accompanying notes to consolidated financial statements.
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BLOWOUT ENTERTAINMENT, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
Three Months Ended September 30,
1998 1997
----------- -----------
REVENUE:
Rental revenue $4,568,137 $ 5,993,482
Product sales 1,527,185 1,766,610
----------- -----------
Total revenue 6,095,322 7,760,092
----------- -----------
OPERATING COSTS AND EXPENSES:
Cost of rental and product sales 2,914,926 3,066,678
Operating expenses 4,372,933 4,493,006
Selling, general and administrative 835,139 777,155
----------- -----------
Total operating costs and expenses 8,122,998 8,336,839
----------- -----------
LOSS FROM OPERATIONS (2,027,676) (576,747)
----------- -----------
NONOPERATING (INCOME) EXPENSE:
Interest expense 233,441 234,648
Other, net (56,016) 25,008
----------- -----------
Total nonoperating expense 177,425 259,656
----------- -----------
LOSS BEFORE INCOME TAXES AND
EXTRAORDINARY ITEM (2,205,101) (836,403)
INCOME TAX PROVISION 7,666 706
----------- -----------
LOSS BEFORE EXTRAORDINARY ITEM (2,212,767) (837,109)
EXTRAORDINARY GAIN ON EXTINGUISHMENT OF DEBT 91,648 -
----------- -----------
NET LOSS $(2,121,119) $ (837,109)
=========== ===========
NET LOSS PER SHARE BEFORE EXTRAORDINARY ITEM:
Basic $ (0.91) $ (0.34)
Diluted $ (0.91) $ (0.34)
EXTRAORDINARY GAIN PER SHARE:
Basic $ 0.04 $ -
Diluted $ 0.04 $ -
NET LOSS PER SHARE:
Basic $ (0.87) $ (0.34)
Diluted $ (0.87) $ (0.34)
WEIGHTED AVERAGE COMMON SHARES 2,433,330 2,433,330
See accompanying notes to consolidated financial statements.
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BLOWOUT ENTERTAINMENT, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
Nine Months Ended September 30,
1998 1997
----------- -----------
REVENUE:
Rental revenue $14,985,146 $17,688,396
Product sales 5,456,755 5,333,637
----------- -----------
Total revenue 20,441,901 23,022,033
----------- -----------
OPERATING COSTS AND EXPENSES:
Cost of rental and product sales 8,821,522 8,790,549
Operating expenses 12,613,334 13,258,308
Selling, general and administrative 2,504,945 2,433,430
----------- -----------
Total operating costs and expenses 23,939,801 24,482,287
----------- -----------
LOSS FROM OPERATIONS (3,497,900) (1,460,254)
----------- -----------
NONOPERATING (INCOME) EXPENSE:
Interest expense 623,882 707,834
Other, net (78,984) (25,461)
----------- -----------
Total nonoperating expense 544,898 682,373
----------- -----------
LOSS BEFORE INCOME TAXES AND
EXTRAORDINARY ITEM (4,042,798) (2,142,627)
INCOME TAX PROVISION 23,609 9,413
----------- -----------
LOSS BEFORE EXTRAORDINARY ITEM (4,066,407) (2,152,040)
EXTRAORDINARY GAIN ON EXTINGUISHMENT OF DEBT 1,313,411 -
----------- -----------
NET LOSS $(2,752,996) $(2,152,040)
=========== ===========
NET LOSS PER SHARE BEFORE EXTRAORDINARY ITEM:
Basic $ (1.67) $ (0.88)
Diluted $ (1.67) $ (0.88)
EXTRAORDINARY GAIN PER SHARE:
Basic $ 0.54 $ -
Diluted $ 0.54 $ -
NET LOSS PER SHARE:
Basic $ (1.13) $ (0.88)
Diluted $ (1.13) $ (0.88)
WEIGHTED AVERAGE COMMON SHARES 2,433,330 2,433,330
See accompanying notes to consolidated financial statements.
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BLOWOUT ENTERTAINMENT, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Nine months Ended September 30,
1998 1997
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(2,752,996) $(2,152,040)
Adjustments to reconcile net loss to
net cash provided by operating
activities:
Gain on disposal of assets - (1,233)
Gain from extinguishment of debt (1,313,411) -
Amortization of videocassette
rental inventory 4,048,408 3,460,863
Depreciation 787,077 834,354
Amortization of intangible and
other assets 353,646 353,647
Changes in current assets and
liabilities:
Receivables (43,947) 163,212
Merchandise videocassette inventory 289,230 123,962
Prepaids and other assets (85,473) (27,266)
Accounts payable (499,662) (1,663,011)
Accrued liabilities 706,477 289,273
Accrued payroll 19,684 28,057
----------- -----------
Net cash provided by operating
activities 480,145 1,409,818
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of videocassette tapes, net (3,564,188) (5,069,041)
Capital expenditures, net (465,272) (142,187)
Other assets - (77,484)
----------- -----------
Net cash used in investing activities (4,029,460) (5,288,712)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Line of credit, net 540,114 1,046,137
Additional borrowings 1,500,000 3,000,697
Repayment of long-term debt (487,698) (445,338)
----------- -----------
Net cash provided by financing
activities 1,552,415 3,601,496
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (968,013) (277,398)
CASH AND CASH EQUIVALENTS, beginning of
period 1,710,868 1,379,018
----------- -----------
CASH AND CASH EQUIVALENTS, end of period $ 742,855 $ 1,101,620
=========== ===========
See accompanying notes to consolidated financial statements.
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BLOWOUT ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1: Basis of Presentation
The accompanying consolidated financial statements of BlowOut Entertainment,
Inc. and subsidiaries ("BlowOut" or the "Company") for the three month and nine
month periods ended September 30, 1998 and September 30, 1997 are unaudited and,
in the opinion of management, contain all adjustments that are of a normal and
recurring nature necessary to present fairly the financial position and results
of operations for such periods. The consolidated financial statements should be
read in conjunction with the consolidated financial statements and related notes
contained in the Company's annual report on Form 10-K for the year ended
December 31, 1997 filed with the Securities and Exchange Commission. The
results of operations for the three and nine month periods ended September 30,
1998 are not necessarily indicative of the results expected for the full year.
NOTE 2: Impact of Recent Accounting Developments
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income."
The Company has adopted the standard as of January 1, 1998. Total comprehensive
loss for the three months ended September 30, 1998 and 1997 was $2,121,119 and
$837,109, respectively and for the nine months ended September 30, 1998 and 1997
was $2,752,996 and $2,152,040, respectively.
In June 1997, the FASB issued Statement of Financial Standards No. 131,
"Disclosures About Segments of and Enterprise and Related Information" which is
effective for fiscal years beginning after December 15, 1997. The Company
believes the implementation of this statement will not have a material effect on
its results of operations or financial statement disclosures.
NOTE 3: Extinguishment of Debt
On February 22, 1998, the Company, Culture Convenience Club Co., Ltd. ("CCC")
and Rentrak Corporation ("Rentrak") signed an agreement (the "Tri-Party
Agreement") under which CCC agreed to provide the Company with $1.5 million in
debt financing to fund projected 1998 expansion plans and additional working
capital. By June 30, 1998, the entire $1.5 million funding had been received by
the Company. The new financing accrues interest at 7% per annum and the
principal plus accrued interest is payable over a 60 month term beginning in
January 2000. Up to $484,167 of the loan may be converted into shares of
BlowOut common stock at $1.00 per share, the bid price on the Nasdaq Stock
Market at the time of the signing of the Tri-Party Agreement. Under the terms
of the Tri-Party Agreement, Rentrak agreed to defer principal and interest
payments on its notes payable by the Company until December 31, 2004 during
which deferment period no interest accrues. Rentrak also agreed to the
forgiveness of all or a portion of the Rentrak notes as the Company is able to
lower Rentrak's contingent obligations under its guaranties of the Phoenix
Financial ("Phoenix") and Coast Business Credit ("CBC") lines of credit. The
Company has agreed not to draw down in excess of $4.0 million under the CBC
line, which limitation, when combined with the reduction in Rentrak's contingent
liability under the Phoenix line of credit due to principal payments made to
date by the Company, under the terms of the Tri-Party Agreement has triggered
the forgiveness of $1,313,411 in Rentrak debt through September 30, 1998. This
forgiveness of debt has no tax effect since the Company has a net operating loss
carryforward in excess of the gain.
NOTE 4: Correspondence from The Nasdaq Stock Market
The Company has received correspondence from The Nasdaq Stock Market ("Nasdaq")
that the Company's failure to maintain the net tangible asset and minimum bid
price requirements for continued listing on The Nasdaq SmallCap Market could
result in the delisting of the Company's stock. A written hearing on the issue
was held by Nasdaq on October 22, 1998 and the Company anticipates learning the
results of this hearing on or about November 5, 1998. In the event the
Company's stock is delisted from the Nasdaq SmallCap Market, the Company
anticipates that its stock would be traded on the over-the-counter market. The
Company believes that delisting is likely.
- 5 -
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Financial
Statements and Notes thereto appearing elsewhere in this report.
BlowOut Entertainment, Inc. (the "Company") operates retail "store within a
store" videocassette and video game outlets located in large mass merchant
supercenters and grocery chain stores throughout the United States. As of
September 30, 1998, the Company operated 151 retail video stores, including 124
stores located in Wal-Mart SuperCenters, ten stores located in Super Kmart
Centers, six stores in Ralphs under the name "Videos & More", seven stores
located in Food 4 Less under the name "BlowOut Video", and four stores in Fred
Meyer under the "Videos & More" name.
Background
The Company is encountering severe financial difficulties because of the decline
in revenue, limited cash resources, recent inability to obtain videocassettes
for rental on terms favorable to the Company, and high fixed costs in relation
to revenue. As a result, the Company has curtailed its expansion plans and has
implemented a program to close, in an orderly fashion, stores that do not meet
the Company's revenue criteria. The Company has sought the cooperation of its
principal business partners, including its lenders, suppliers and affected host
vendors. The continuing viability of the Company will probably depend upon the
occurrence of a number of actions and events including, without limitation,
significant immediate improvements in net rentals and sales, further curtailment
or reorganization of its business operations, debt restructuring, infusions of
additional capital, and/or other actions as may be available and appropriate,
any or all of which could impair the shareholders' position in the Company. The
Company is considering available alternatives that may be helpful in pursuing a
program to preserve the Company's business. There can be no assurance that the
Company will be able to achieve any of the actions or events or an outcome to
its financial difficulties that is favorable to its shareholders.
Between to September 30, 1998 and October 28, 1998 the Company has closed 15
Wal-Mart stores which did not meet certain performance levels. The Company is
currently reviewing the financial performance of each store in the chain and
expects to close additional stores in the fourth quarter.
The Company's revenue consists of rental revenue and product sales. Rental
revenue includes rental of prerecorded videocassettes and video games. Product
sales are derived from the sale of new and previously viewed videocassettes and
video games and, to a lesser extent, ancillary items such as blank tapes and
candy.
The Company was formed in 1992 as a subsidiary of Rentrak Corporation
("Rentrak"), and opened its first store within a store in January 1993. At
year-end 1993 and 1994, the Company operated seven stores. During these
periods, all of the Company's stores were located in grocery stores. During
1995, the Company experienced accelerated growth in retail stores and revenue,
primarily through (i) the acquisition by Rentrak on May 26, 1995, of a
controlling interest in Entertainment One, Inc. ("E-1"), a company whose primary
business was the operation of retail video outlets in Wal-Mart SuperCenters,
(ii) the acquisition by Rentrak on August 31, 1995, of certain assets and
assumption of certain liabilities which constituted SuperCenter Entertainment,
Inc.'s retail video business and consisted of retail video outlets in Wal-Marts,
Wal-Mart SuperCenters and Super Kmart Centers (the "SCE Business") and (iii) new
store openings in Wal-Mart SuperCenters and, to a lesser extent, in Super Kmart
Centers, Ralphs and Food 4 Less stores.
As a result of the acquisitions of E-1 and the SCE business, the Company
recorded approximately $5.1 million in goodwill which is being amortized over 10
to 15 years resulting in annual amortization of approximately $.5 million.
- 6 -
<PAGE>
The combination of E-1 and SCE with the Company was intended to create operating
efficiencies that began to be realized during fiscal year 1997. In addition,
the greater number of stores permitted the Company to better evaluate the
contribution of each store to gross revenue and earnings before interest, taxes,
fixed asset depreciation and amortization ("EBITDA"). Based on those
evaluations, the Company can identify under-performing stores for consideration
for closure. By eliminating under-performing stores, the Company seeks to
enhance its average per store revenues and its EBITDA, and reducing its net
operating losses. However, store closures could adversely affect gross revenue.
Prior to November 25, 1996, Rentrak owned 1,698,942 shares (approximately 70%)
of the issued and outstanding common stock, par value $.01 per share, of the
Company (the "Common Stock"). On November 25, 1996, Rentrak distributed
1,457,343 shares of Common Stock to the holders of Rentrak common stock in the
form of a special dividend (the "spin-off").
The principal executive offices of the Company are located at 7700 NE Ambassador
Place, One Airport Center, Second Floor, Portland, Oregon 97220, telephone
(503) 331-2729.
Results of Operations
Three Months Ended September 30, 1998 Compared to Three Months Ended September
30, 1997
The following table sets forth, for the periods indicated, (i) statement of
operations data expressed as a percentage of total revenue, (ii) the percentage
change from the prior period in this data and (iii) the number of stores open at
the end of each period.
Percentage
Change in dollar
Three Months Ended September 30, Amount From
1998 1997 1997 to 1998
----- ----- ------------
Rental revenue 74.9% 77.2% (23.8%)
Product sales 25.1% 22.8% (13.6%)
Total revenue 100.0% 100.0% (21.5%)
Cost of rental revenue and product
sales 47.8% 39.5% (5.0%)
Operating expenses 71.7% 57.9% (2.7%)
Selling, general and administrative 13.7% 10.0% 7.5%
Net loss (34.8%) (10.8%) (153.4%)
Number of stores open at end of period 151 188
Revenue
- -------
Revenue for the three months ended September 30, 1998 decreased $1,664,770, or
21.5%, to $6,095,322 from $7,760,092 for the comparable three months of 1997.
The number of stores in operation decreased from 188 at September 30, 1997 to
151 at September 30, 1998 as the net result of the opening of five stores and
the closing of 42 underperforming stores between September 30, 1997 and
September 30, 1998. The decrease in revenues resulted from a reduction in the
number of stores, an increase in the number of competitive store openings near
our stores as well as a decline in videocassette rentals. This decline in
rental activity occurred during a period when national competitors began
implementing revenue sharing programs with most of the major Hollywood studios
allowing these competitors to significantly increase the number of copies in
their stores. The significant increase in the number of copies available in the
overall videocassette rental market to satisfy customer demand has resulted in a
significantly shorter rental demand period for new releases which has negatively
affected the Company's rental revenues. To date the Company has been unable to
take advantage of copy depth programs being offered by the studios due to its
financial difficulties. Sales of previously viewed videocassettes also suffered
during the quarter as the Company heavily discounted its prices in an attempt to
compensate for the decline in rental activity in its stores. Sales of video
games, however, increased in the 1998 period as compared to the 1997 period.
- 7 -
<PAGE>
The following table sets forth the number of stores open for at least 12 months
as of the end of the period and average rental and product sale revenue for such
stores for the last three years and the three month periods ended September 30,
1997 and 1998.
Three Months
Fiscal Year Ended December 31, Ended September 30,
1997 1996 1995 1998 1997
-------- -------- -------- ------- -------
No. of stores open 12
months 162 130 3 145 145
Average rental revenue $127,056 $129,440 $206,387 $28,771 $33,622
Average product sales $ 41,484 $ 39,442 $ 61,648 $ 9,642 $ 9,930
Average total revenue $168,540 $168,882 $268,035 $38,413 $43,552
The decrease in average rental revenue for the three month period ended
September 30, 1998 compared to the three month period ended September 30, 1997
is the result of the factors noted above. Average product sales for the three-
month period ended September 30, 1998 decreased only slightly from the three-
month period ended September 30, 1997. The Company discounted previously viewed
videocassettes during the third quarter of 1998 in an attempt to generate
product sales to compensate for reduced rental activity. While this strategy
proved successful, as described in further detail below, gross margins on
product sales suffered in the third quarter. Video game sales continued to
increase significantly in the 1998 period compared to the 1997 period.
Operating Costs and Expenses
- ----------------------------
Cost of Rental and Product Sales
Cost of rental and product sales decreased in absolute dollars from $3,066,678
for the three months ended September 30, 1997, to $2,914,926 for the three
months ended September 30, 1998 as a direct result of a decrease in the number
of stores in operation and a reduction in the number of units purchased as a
result of cash limitations and payment terms. Cost of rental and product sales
as a percentage of revenues has increased from 39.5% to 47.8% as a result of the
discounting of sell-through product and the fixed nature of the rental product
acquisition costs. Generally, rental product is purchased based on projected
demand. When demand does not meet expectations as occurred in the second and
third quarters of fiscal 1998, the resulting amortization of the rental product
costs as a percentage of revenues increases.
Operating Expenses
Operating expenses decreased in absolute dollars from $4,493,006 (57.9% of
revenues) for the three months ended September 30, 1997, to $4,372,933
(71.7%)for the three months ended September 30, 1998 as a direct result of the
net decrease in the number of stores between these periods. These savings were
almost entirely offset by increased costs associated with the closure of stores
during the period. The increase in operating expenses as a percentage of sales
is the result of the closed store expenses incurred during the period and the
largely fixed operating expenses being spread over a comparatively smaller
revenue base in the 1998 period. The primary components of operating expenses
are store level employee compensation, occupancy, fixed asset depreciation,
supplies and communications.
Selling, General and Administrative Expenses
Selling, general and administrative ("SG&A") expenses increased in absolute
dollars from $777,155 for the three months ended September 30, 1997, to $835,139
for the three months ended September 30, 1998. The increase consisted primarily
additional expenses incurred related to closing stores. As a percentage of
revenues SG&A increased from 10.0% for the 1997 period to 13.7% for the 1998
period as a result of the largely fixed selling, general and administrative
expenses being spread over a comparatively smaller revenue base in the 1998
period.
Nonoperating Expenses, Net
- --------------------------
Nonoperating expenses, net decreased from $259,656, or 3.3% of revenue, for the
three months ended September 30, 1997, to $177,425, or 2.9% of revenue, for the
three months ended September 30, 1998. The improvement is attributable to the
decrease in interest
- 8 -
<PAGE>
expense related to the Rentrak debt as more fully described under Liquidity and
Capital Resources below. In addition, the Company realized proceeds of
approximately $53,000 during the 1998 period from an insurance claim on a
casualty loss incurred at one of the Company's stores.
Extraordinary gain on Extinguishment of Debt
- --------------------------------------------
In connection with a $1,500,000 partially convertible debt financing of BlowOut
by Culture Convenience Club Co., Ltd. ("CCC") described below, Rentrak agreed to
forgive notes payable by BlowOut as the Company reduces Rentrak's exposure on
the Company's lines of credit. In the third quarter of 1998, the Company
recorded a gain of $91,648 as a result of a decrease during the quarter in
Rentrak's exposure.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended September 30,
1997
The following table sets forth, for the periods indicated, (i) statement of
operations data expressed as a percentage of total revenue, (ii) the percentage
change from the prior period in this data and (iii) the number of stores open at
the end of each period.
Percentage
Change in dollar
Nine Months Ended September 30, Amount From
1998 1997 1997 to 1998
----- ----- ------------
Rental revenue 73.3% 76.8% (15.3%)
Product sales 26.7% 23.2% 2.3%
Total revenue 100.0% 100.0% (11.2%)
Cost of rental revenue and product
sales 43.2% 38.2% 0.4%
Operating expenses 61.7% 57.6% (4.9%)
Selling, general and administrative 12.3% 10.6% 2.9%
Net loss (13.5%) (9.3%) (27.9%)
Number of stores open at end of period 151 188
Revenue
- -------
Revenue for the nine months ended September 30, 1998 decreased $2,580,132, or
11.2%, to $20,441,901 from $23,022,033 for the comparable nine months of 1997.
As more fully described in the three month period discussion above, a decline in
rental revenue in the second and third quarters of 1998 more than offset the
gains made in the first quarter. Year to date same store sales for the nine
months ended September 30, 1998 were down 2.17% as a result of a decrease in the
second and third quarters of 9.21% while rolling twelve month same store sales
were up 1.05%.
The following table sets forth the number of stores open for at least 12 months
as of the end of the period and average rental and product sale revenue for such
stores for the last three years and the nine month periods ended September 30,
1997 and 1998.
Nine Months
Fiscal Year Ended December 31, Ended September 30,
1997 1996 1995 1998 1997
-------- -------- -------- -------- --------
No. of stores open 12
months 162 130 3 145 145
Average rental revenue $127,056 $129,440 $206,387 $ 91,781 $ 98,296
Average product sales $ 41,484 $ 39,442 $ 61,648 $ 33,432 $ 29,694
Average total revenue $168,540 $168,882 $268,035 $125,213 $127,990
Average rental revenue for the nine month period ended September 30, 1998
decreased from the nine month period ended September 30, 1997 as a result of the
decline in rental revenue in the second and third quarters of 1998 as described
throughout this report. Average product sales for the nine month period ended
September 30, 1998 increased from the nine month period ended September 30,
1997. The Company has pursued a more aggressive strategy throughout 1998 and in
the second and third quarters used price discounts and other marketing tools to
increase the sell-through revenues in most of its locations and this emphasis
has paid off in higher sales of videocassettes and video games.
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Operating Costs and Expenses
- ----------------------------
Cost of Rental and Product Sales
Cost of rental and product sales increased from $8,790,549, or 38.2% of revenue
for the nine months of 1997, to $8,821,522, or 43.2% of revenue, for the nine
months of 1998. Cost of rental and product sales as a percentage of revenues
has increased as a result of the fixed nature of the rental product acquisition
costs. Rental product is purchased based on projected demand. When demand does
not meet expectations, as occurred in the second and third quarters of fiscal
1998, the amortization of the rental product costs as a percentage of revenues
increases. Cost of rental and product sales as a percentage of revenues was
also adversely affected by the discounting of sell-through videocassettes during
the second and third quarters which resulted in higher costs as a percentage of
revenue.
Operating Expenses
Operating expenses decreased in absolute dollars from $13,258,308 for the nine
months ended September 30, 1997 to $12,613,334 for the nine months ended
September 30, 1998. The decrease in operating expenses in absolute dollars is
directly attributable to the decrease in the number of stores partially offset
by increased costs associated with the closing of stores. The primary
components of operating expenses include store level employee compensation,
occupancy, fixed asset depreciation, supplies, shipping and communications.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $2,504,945 for the
nine months ended September 30, 1998 from $2,433,430 for the nine months ended
September 30, 1997. The increase is primarily attributable to shipping charges
incurred related to closing stores as well as depreciation of closing store
assets which is charged to selling, general and administrative expenses. As a
percentage of revenues, selling, general and administrative expenses increased
from 10.6% for the nine months ended September 30, 1997 to 12.3% for the
comparable 1998 period as a result of the decrease in revenues experienced in
the 1998 period as discussed above.
Nonoperating Expenses, Net
- --------------------------
Nonoperating expenses, net decreased from $682,373, or 3.0% of revenue, for the
nine months ended September 30, 1997, to $544,898, or 2.7% of revenue, for the
nine months ended September 30, 1998. The decrease is attributable to the
decrease in interest expense related to the Rentrak debt as more fully described
under Liquidity and Capital Resources below. In addition, the Company realized
proceeds from a casualty insurance claim of approximately $53,000 during the
third quarter.
Liquidity and Capital Resources
- -------------------------------
Beginning in the second and third quarters of 1998, the Company's principal
capital needs shifted from the opening of new stores to the continuation of
operations. The Company funded its previous expansion primarily through cash
from operations, advances from Rentrak, and, as more fully described below,
borrowings from and sales of stock to Directors, trade credit from suppliers and
financing arrangements with asset based lenders.
In March and April 1996, the Company sold $1.0 million in convertible
subordinated notes to each of Mr. Bill LeVine and Culture Convenience Club Co.,
Ltd. ("CCC"), a Japanese corporation of which Mr. Muneaki Masuda is Chairman and
Mr. Yoshinori Ogida is an officer (the "Notes"). Messrs. LeVine and Ogida are
Directors of the Company while Mr. Masuda was a director of the Company until
his resignation effective September 30, 1998. On August 30, 1996, each of Mr.
LeVine and CCC converted their Notes into 121,789 shares of BlowOut Common
Stock. Also on August 30, 1996, CCC purchased from the Company for $2.98
million a total of 362,931 shares of BlowOut Common Stock at a purchase price of
approximately $8.21 per share.
- 10 -
<PAGE>
In August 1996, Phoenix Leasing, Inc. ("Phoenix") agreed to provide asset based
financing in an aggregate principal amount of $2.0 million. Amounts outstanding
under the Phoenix facility bear interest at a fixed rate per annum equal to
14.525% and are payable in monthly principal and interest installments over a
five-year term. The Phoenix facility may be used to finance the construction
and opening of (including acquisition of inventory) new Company stores in Wal-
Mart Stores and Wal-Mart SuperCenters. The Phoenix facility is secured by (i)
a continuing guaranty of Rentrak (which Phoenix, in its sole discretion, may
release once at least 36 payments of amounts outstanding under the Phoenix
Facility have been made or the Company's financial condition is, in Phoenix's
sole opinion, sufficient to justify such release), and (ii) the Company's grant
of a first continuing security interest in all assets at each location to be
financed with funds from the Phoenix facility (with the exception of inventory
which is secured by Coast Business Credit as discussed below). Under the
Phoenix facility, the Company cannot borrow more than $100,000 per store
location, with a minimum draw of $30,000 per store location. As of September 30,
1998, the Company had drawn down the entire $2.0 million facility and had
$1,455,169 outstanding under the Phoenix facility with maturity dates extending
to September 2002. At October 28, 1998 the Company is delinquent with respect
to the Phoenix principal and interest payment due on October 1, 1998 in the
amount of $46,379.
On September 12, 1996, Coast Business Credit ("CBC") entered into an agreement
with the Company to provide a revolving line of credit ("CBC Line of Credit") in
the maximum principal amount at one time outstanding of $5.0 million. Under the
CBC Line of Credit, the Company may only draw up to 85% of the Orderly
Liquidation Value (as defined by the CBC Line of Credit) of eligible new and
used videocassette inventory. As of September 30, 1998, 85% of the Orderly
Liquidation Value of the Company's inventory was approximately $4,032,689,.
Advances under the CBC Line of Credit bear interest at a floating rate per annum
equal to the prime rate plus 2.75% (11.25% as of September 30, 1998). The term
of the CBC Line of Credit is three years. Rentrak has agreed, under certain
circumstances in the event of a default under the CBC Line of Credit, to
repurchase BlowOut's videocassette inventory at specified amounts. As of
September 30, 1998, the Company had $3,560,480 outstanding under the CBC Line of
Credit and was current with respect to all payments due under the CBC Line of
Credit.
On July 22, 1996, the Company entered into an agreement with Star Video, which
was subsequently purchased by Valley Media, Inc., to provide the Company with
videocassettes for rental and sale and with video games for sale ("Star Video
Agreement"). Star Video paid off the balance of a promissory note in the amount
of $240,975 made by the Company to its previous supplier. As a result, the
Company executed a new promissory note to Star Video which has subsequently been
paid in full. In May 1998, the Company signed a two-year, non-exclusive
extension of the distribution agreement with Star Video. Recently, due to cash
flow constraints, the Company was unable to make a scheduled payment on
outstanding trade payables to Star Video. As a result, since September 1, 1998,
the Company has agreed to pay in advance for videocassettes purchased from Star
Video.
During the first quarter of 1997 the Company entered into an agreement with
Rentrak whereby payables resulting from the Company's use of the Rentrak PPT
system during the first six months of fiscal 1997 were deferred until January
1998, at which time such amounts totaling $2.1 million became due and payable in
twelve, equal, interest-free, monthly installments. The Company also has a note
payable due Rentrak in the amount of $3.01 million arising from transactions
which occurred prior to the spin-off from Rentrak. This note together with
accrued interest at 9% per annum was originally due and payable on March 31,
1999.
On February 22, 1998, the Company, CCC and Rentrak signed an agreement (the
"Tri-Party Agreement") under which CCC agreed to provide and has provided the
Company with $1.5 million to fund projected 1998 expansion plans and additional
working capital. The new financing accrues interest at 7% per annum and the
principal plus accrued interest is payable over a 60 month term beginning in
January 2000. Up to $484,167 of the loan may be converted into shares of
BlowOut common stock at $1.00 per share, the bid price on the Nasdaq Stock
Market at the time of the signing of the Tri-Party Agreement. Under the terms
of the Tri-Party Agreement, Rentrak agreed to defer principal and interest
payments on its notes until December 31, 2004 during which deferment period no
interest accrues. Rentrak also agreed to the forgiveness of all or a portion of
the Rentrak notes as the Company lowers Rentrak's contingent obligations under
their guaranties of the Phoenix and
- 11 -
<PAGE>
CBC lines of credit discussed above. The Company has agreed not to draw down
in excess of $4.0 million under the CBC line, which limitation, when combined
with the reduction in Rentrak's contingent liability under the Phoenix line of
credit due to principal payments made to date by the Company, under the terms of
the Tri-Party Agreement triggered the forgiveness of $1,313,411 in Rentrak debt
during the nine months ended September 30, 1998.
During the third quarter of 1998, the Company agreed to a change in terms under
its National Account Agreement with Rentrak. The Company now prepays Rentrak
$15 - $30 per unit for titles purchased under the Rentrak Pay-Per-Transaction
system.
During the first nine months of 1998, the Company opened four stores in Fred
Meyer and one store in Food 4 Less. The Company does not expect to open any new
stores throughout the remainder of fiscal 1998.
During the third quarter of 1998, in accordance with previously announced plans,
the Company closed 16 stores which did not meet certain performance levels
(consisting of ten stores in Wal-Mart and six stores in Kmart). Subsequent to
September 30, 1998 through October 28, 1998 the Company has closed an additional
15 Wal-Mart stores which did not meet certain performance levels. The Company
is currently reviewing the financial performance of each store in the chain and
expects to close additional stores in the fourth quarter.
The Company had cash and cash equivalents of $742,855 and borrowing capacity
under the CBC line of approximately $439,520 at September 30, 1998. The Company
expects to meet its short-term liquidity requirements through net cash provided
by operations, cash on hand, advances under the CBC Line of Credit and deferrals
of trade payables to its vendors. However, as a result of the significant
decline in rental revenue experienced in the second and third quarters as
discussed above, as well as the continuance of this adverse trend in the fourth
quarter, unless the Company is able to obtain new equity and/or debt capital, or
is able to refinance its existing debt (including trade payables) to generate
additional cash flows, Management believes that the existing sources of cash
will not be sufficient to meet its operating needs through the fourth quarter of
the current fiscal year. As discussed above, management is actively exploring
alternatives to address its capital requirements.
At September 30, 1998, the Company had a working capital deficit of $5,640,347.
Videocassette 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 a substantial
portion of the Company's revenue, the classification of these assets as
noncurrent excludes them from the computation of working capital. The
acquisition cost of videocassette rental inventories, 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
as significant a measure of financial condition for companies in the video
retail industry as it is for companies in other industries because of the
accounting treatment of videocassette rental inventory as a noncurrent asset.
The Company expects to operate with a working capital deficit.
Impact of the Year 2000 Issue
- -----------------------------
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs and business systems that have date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions or engage in similar normal business activities.
Based on a recently completed assessment, the Company has determined that it
will be required to modify or replace portions of its software so that its
computer systems will properly utilize dates beyond December 31, 1999. The
Company presently believes that with modifications to existing software and
conversions to new versions of software that are Year 2000 compliant, the
potential problems arising from the Year 2000 Issue can be
- 12 -
<PAGE>
mitigated. However, if such modifications and conversions are not made, or are
not completed timely, the Year 2000 Issue could have a material adverse effect
on the operations of the Company, including, but not limited to, the erroneous
reporting of rental transactions, revenues and inventory control data to the
Company's headquarters, the inability to accurately compute percentage rent due
to host vendors and fees due to suppliers, and possible temporary store
closures.
The Company has initiated formal communications, in the form of questionnaires
with its significant suppliers and software vendors to determine the extent to
which the Company is vulnerable to those third parties' failure to remediate the
Year 2000 Issue. At this time, the Company cannot predict the level of Year
2000 readiness of its suppliers or host vendors. The Company's total Year 2000
project cost and estimates to complete do not include the estimated costs and
time associated with the impact of any third party's Year 2000 Issue, and are
based on presently available information. However, there can be no guarantee
that the systems of other companies on which the Company's systems rely will be
timely converted, or that a failure to convert by another company, or a
conversion that is incompatible with the Company's systems, would not have a
material adverse effect on the Company. The Company has determined it has no
exposure to contingencies related to the Year 2000 Issue for the products it has
sold.
The Company will utilize both internal and external resources to reprogram or
replace and test the software for Year 2000 modifications. The Company plans to
complete its Year 2000 remediation as funds become available but not later than
June 30, 1999. The total cost of the Year 2000 project is estimated at
approximately $50,000 and will be funded through operating cash flows, as
available. The Company does not expect that it will have to accelerate the
replacement of computer hardware systems to implement its Year 2000 remediation
program. To date, the Company has incurred no significant costs related to the
assessment of, and preliminary efforts in connection with, its Year 2000 project
and the development of a remediation plan.
The costs of the project and the date on which the Company plans to complete the
Year 2000 modifications are based on management's best estimates, which were
derived utilizing numerous assumptions of future events including the continued
availability of certain resources, third party modification plans and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those plans. Specific
factors that might cause such material differences include, but are not limited
to, the availability and cost of personnel trained in this area, the ability
to locate and correct all computer code, and similar uncertainties. The Company
has not yet developed contingency plans should its Year 200 program not be
implemented to the extent necessary to assure undisrupted operation through the
turn of the century.
Statements made in this document that present information that is not historic,
including among other things, anticipated financial performance, sources and
extent of liquidity and capital, business prospects, new products and markets,
Year 2000 compliance, and anticipated store openings and closings are "forward-
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. These statements can be identified by the use of forward-
looking terminology such as "may", "will", "expect", "anticipate", "estimate"
or "continue" or the negative thereof or other variations thereon, or comparable
terminology. There are numerous risks and uncertainties that could cause actual
results to differ materially from those in such forward-looking statements.
Reference is made to the Company's Registration Statement on Form 10 and the
Company's Annual Report on Form 10-K as filed with the Securities and Exchange
Commission for a discussion of such risk factors and uncertainties.
- 13 -
<PAGE>
PART II OTHER INFORMATION
Item 5. Resignation of Board Member
---------------------------
On September 30, 1998, Mr. Muneaki Masuda tendered his resignation
from the Board of the Company for personal reasons.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
Exhibit 27 - Financial Data Schedule
- 14 -
<PAGE>
SIGNATURE
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.
BLOWOUT ENTERTAINMENT, INC.
October 29, 1998
By: /s/Thomas D. Berkompas
----------------------
Thomas D. Berkompas
Vice President, Chief Accounting and
Chief Financial Officer
Signing on behalf of the registrant
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS FOUND ON PAGES 1 AND 3 OF THE COMPANY'S FORM
10-Q FOR THE YEAR-TO-DATE AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 742,855
<SECURITIES> 0
<RECEIVABLES> 263,790
<ALLOWANCES> 0
<INVENTORY> 11,360,999
<CURRENT-ASSETS> 3,872,239
<PP&E> 5,716,969
<DEPRECIATION> 2,881,476
<TOTAL-ASSETS> 19,016,975
<CURRENT-LIABILITIES> 9,512,586
<BONDS> 6,917,458
0
0
<COMMON> 24,336
<OTHER-SE> 2,562,595
<TOTAL-LIABILITY-AND-EQUITY> 19,016,975
<SALES> 20,441,901
<TOTAL-REVENUES> 20,441,901
<CGS> 8,821,522
<TOTAL-COSTS> 23,939,801
<OTHER-EXPENSES> (78,984)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 623,882
<INCOME-PRETAX> (4,042,798)
<INCOME-TAX> 23,609
<INCOME-CONTINUING> (4,066,407)
<DISCONTINUED> 0
<EXTRAORDINARY> 1,313,411
<CHANGES> 0
<NET-INCOME> (2,752,996)
<EPS-PRIMARY> (1.67)
<EPS-DILUTED> (1.67)
</TABLE>
