UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended December 28, 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: 0-21876
FUNCO, INC.
(Exact name of registrant as specified in its charter)
Minnesota 41-1609563
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10120 West 76th Street
Eden Prairie, MN 55344
(Address of principal executive offices)
(612) 946-8883
(Registrant's telephone number, including area code)
Check whether the registrant: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
Yes __X__ No ____
On February 3, 1998, the registrant had 6,174,195 outstanding shares of common
stock, $ .01 par value.
<PAGE>
FUNCO, INC.
INDEX
PART I - FINANCIAL INFORMATION PAGE NO.
- ------------------------------ --------
ITEM 1. Consolidated Financial Statements (Unaudited)
Consolidated Statements of Income - Quarter and nine months
ended December 28, 1997 and December 29, 1996.................. 3
Consolidated Balance Sheets - December 28, 1997 and
March 30, 1997................................................. 4
Consolidated Statements of Cash Flows - Nine months ended
December 28, 1997 and December 29, 1996 ....................... 5
Notes to Consolidated Financial Statements ...................... 6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ..................................... 8
PART II - OTHER INFORMATION
- ---------------------------
ITEM 1. Legal Proceedings................................................ 11
ITEM 6. Exhibits and Reports on Form 8-K ................................ 12
SIGNATURES ................................................................ 13
- ----------
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
FUNCO, INC.
Consolidated Statements of Income
(in thousands, except share and per share data)
(Unaudited)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
----------------------------- -----------------------------
December 28, December 29, December 28, December 29,
1997 1996 1997 1996
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net sales .............................. $ 67,036 $ 46,461 $ 117,797 $ 85,738
Cost of sales .......................... 46,413 30,095 77,957 54,650
------------ ------------ ------------ ------------
Gross profit ........................ 20,623 16,366 39,840 31,088
Operating expenses ..................... 11,404 9,433 24,646 20,945
General and administrative expenses .... 2,544 2,425 6,777 6,119
------------ ------------ ------------ ------------
Operating income .................... 6,675 4,508 8,417 4,024
Interest expense ....................... (20) (18) (20) (29)
Interest income ........................ 47 22 192 104
------------ ------------ ------------ ------------
Net income before income taxes ...... 6,702 4,512 8,589 4,099
Income tax provision ................... 2,547 1,510 3,264 1,349
------------ ------------ ------------ ------------
Net income .......................... $ 4,155 $ 3,002 $ 5,325 $ 2,750
============ ============ ============ ============
Basic Earnings Per Share:
- -------------------------
Basic net income per share ............. $ 0.67 $ 0.51 $ 0.87 $ 0.47
Weighted average number of common shares 6,166,361 5,941,195 6,123,957 5,909,633
Diluted Earnings Per Share:
- -------------------------
Diluted net income per share ........... $ 0.63 $ 0.48 $ 0.81 $ 0.45
Weighted average number of common and
common equivalent shares ............... 6,635,596 6,220,172 6,576,900 6,141,792
</TABLE>
SEE ACCOMPANYING NOTES.
<PAGE>
FUNCO, INC.
Consolidated Balance Sheets
(in thousands, except share data)
December 28, March 30,
1997 1997
----------- -----------
(Unaudited) (Note)
ASSETS
- ------
Current Assets
Cash and cash equivalents .................... $ 8,222 $ 8,408
Accounts receivable .......................... 2,074 1,094
Inventories .................................. 27,716 13,831
Prepaid expenses ............................. 1,215 782
Current deferred tax asset ................... 646 532
----------- -----------
Total current assets ...................... 39,873 24,647
Net property and equipment ..................... 8,489 5,954
Long-term deferred tax asset ................... 1,154 984
Other assets ................................... 155 160
----------- -----------
Total assets ................................... $ 49,671 $ 31,745
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Accounts payable ............................. $ 9,513 $ 1,387
Accrued liabilities .......................... 8,435 5,182
Capital lease obligations .................... -- 20
Deferred revenue ............................. 1,106 747
----------- -----------
Total current liabilities ................. 19,054 7,336
Accrued rent ................................... 126 91
Shareholders' Equity
Common stock (issued: 6,170,536 and 6,056,788) 62 61
Additional paid-in capital ................... 19,545 18,698
Retained earnings ............................ 10,884 5,559
----------- -----------
Total shareholders' equity ................ 30,491 24,318
----------- -----------
Total liabilities and shareholders' equity ..... $ 49,671 $ 31,745
=========== ===========
Note: The balance sheet at March 30, 1997, has been derived from the audited
financial statements at that date but does not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
SEE ACCOMPANYING NOTES.
<PAGE>
FUNCO, INC.
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
---------------------------
December 28, December 29,
1997 1996
----------- -----------
<S> <C> <C>
Operating Activities
Net income ................................................ $ 5,325 $ 2,750
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ........................... 2,292 2,468
Deferred tax asset ...................................... (284) (398)
Net loss on disposal of property and equipment .......... 36 41
Changes in operating assets and liabilities:
Accounts receivable ................................... (980) (444)
Inventories ........................................... (13,885) (8,389)
Prepaid expenses ...................................... (433) 61
Accounts payable ...................................... 8,126 4,538
Accrued liabilities ................................... 3,288 4,806
Deferred revenue ...................................... 359 261
----------- -----------
Net cash provided by operating activities ........... 3,844 5,694
Investing Activities
Additions to property and equipment ....................... (4,778) (1,273)
Increase in other assets .................................. (80) (73)
----------- -----------
Net cash used in investing activities ................. (4,858) (1,346)
Financing Activities
Payments of obligations under capital leases .............. (20) (59)
Net proceeds from issuance of common stock ................ 848 561
----------- -----------
Net cash provided by financing activities ............. 828 502
----------- -----------
Increase (decrease) in cash and cash equivalents ............. (186) 4,850
Cash and cash equivalents at beginning of period ............. 8,408 5,783
----------- -----------
Cash and cash equivalents at end of period ................... $ 8,222 $ 10,633
=========== ===========
</TABLE>
SEE ACCOMPANYING NOTES.
<PAGE>
FUNCO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. The Company
Funco, Inc. (the Company) was incorporated in March 1988, and is engaged in the
business of providing interactive home entertainment, primarily through the
purchase and resale of new and previously played video games along with related
hardware and accessory items through its FUNCOLAND stores and mail order
operation. It also publishes a video game magazine, GAME INFORMER. The Company
operated 249 retail locations at December 28, 1997 compared to 188 retail
locations at December 29, 1996.
Note 2. Fiscal Year
The Company's fiscal year ends on a Sunday on or near March 31 which completes a
52 or 53 week reporting period. All quarters for fiscal 1998 and 1997 consist of
13 weeks with the following period ending dates:
Ending Date
-----------------------------------------
1998 1997
------------------ ------------------
First June 29, 1997 June 30, 1996
Second September 28, 1997 September 29, 1996
Third December 28, 1997 December 29, 1996
Fourth March 29, 1998 March 30, 1997
Note 3. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
solely of normal recurring accruals) considered necessary for a fair
presentation have been included.
The operating results for the quarter and nine months ended December 28, 1997,
are not necessarily indicative of the results that may be expected for the year
ending March 29, 1998 due to the seasonal nature of the Company's business.
For further information, refer to the financial statements and footnotes thereto
included in the Company's annual report on Form 10-K for the year ended March
30, 1997.
<PAGE>
Note 4. Earnings per Share
In 1997, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 128, EARNINGS PER SHARE. Statement 128 replaces the
previously reported primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic earnings
per share excludes any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is very similar to the previously
reported fully diluted earnings per share. All earnings per share amounts for
all periods have been presented, and where necessary, restated to conform to the
Statement 128 requirements.
The following table sets forth the computation of basic and diluted earnings per
share:
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
---------------------------- ----------------------------
December 28, December 28, December 28, December 28,
1997 1996 1997 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Numerator:
Net income ................................. $ 4,155,000 $ 3,002,000 $ 5,325,000 $ 2,750,000
============ ============ ============ ============
Denominator:
Denominator for basic earnings per share -
weighted average shares ................. 6,166,361 5,941,195 6,123,957 5,909,633
Dilutive securities:
Employee stock options .................. 469,235 278,977 452,943 232,159
------------ ------------ ------------ ------------
Denominator for diluted earnings per share -
adjusted weighted average shares ........ 6,635,596 6,220,172 6,576,900 6,141,792
============ ============ ============ ============
Basic earnings per share ...................... $ 0.67 $ 0.48 $ 0.87 $ 0.47
============ ============ ============ ============
Diluted earnings per share .................... $ 0.63 $ 0.48 $ 0.81 $ 0.45
============ ============ ============ ============
</TABLE>
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results of Operations
The following table sets forth certain items in the statements of income
expressed as (i) percentage of net sales for the quarter and nine months
indicated and (ii) percentage changes from the comparable period of the prior
year.
<TABLE>
<CAPTION>
Percent Percent
Quarter Ended Inc(Dec) Nine Months Ended Inc(Dec)
--------------------------- ---------- --------------------------- ----------
December 28, December 29, 1998 December 28, December 29, 1998 over
1997 1996 over 1997 1997 1996 1997
------------ ------------ ---------- ------------ ------------ ----------
<S> <C> <C> <C> <C> <C> <C>
Net sales ................. 100.0% 100.0% 44.3% 100.0% 100.0% 37.4%
Cost of sales ............. 69.2 64.8 54.2 66.2 63.7 42.6
---------- ---------- ---------- ---------- ---------- ----------
Gross profit .............. 30.8 35.2 26.0 33.8 36.3 28.2
Operating expenses ........ 17.0 20.3 20.9 20.9 24.4 17.7
General and admin. expenses 3.8 5.2 4.9 5.8 7.1 10.8
---------- ---------- ---------- ---------- ---------- ----------
Operating income .......... 10.0 9.7 48.1 7.1 4.7 109.2
Interest expense .......... -- -- 11.1 -- -- (31.0)
Interest income ........... 0.1 -- 113.6 0.2 0.1 84.6
---------- ---------- ---------- ---------- ---------- ----------
Net income before taxes ... 10.0 9.7 48.5 7.3 4.8 109.5
Income tax provision ...... 3.8 3.3 68.7 2.8 1.6 142.0
---------- ---------- ---------- ---------- ---------- ----------
Net income ................ 6.2% 6.5% 38.4% 4.5% 3.2% 93.6%
========== ========== ========== ========== ========== ==========
</TABLE>
Comparison of Third Quarter Fiscal 1998 to Third Quarter Fiscal 1997
Net sales for the quarter increased from $46,461,000 in 1997 to $67,036,000 in
1998, an increase of 44.3%. The Company opened 34 new stores during the quarter
and operated a total of 249 locations at the end of the quarter this year
compared to 188 locations at the end of the same period prior year. Comparable
store sales for the quarter increased 20%. The large sales increase is primarily
due to the strong growth of the video game industry led by Sony PlayStation and
Nintendo 64 products.
Cost of sales for the quarter increased from $30,095,000 in 1997 to $46,413,000
in 1998, an increase of 54.2%. The dollar increase in cost of sales is primarily
due to the strong growth in sales. Cost of sales as a percentage of net sales
increased from 64.8% in 1997 to 69.2% in 1998. This increase is primarily due to
sales mix for the quarter reflecting increased sales of new Sony PlayStation and
Nintendo 64 products, which are sold at lower gross margin percentages than that
of previously played product.
Operating expenses for the quarter increased from $9,433,000 in 1997 to
$11,404,000 in 1998, an increase of 20.9%. This increase is primarily due to
higher store payroll expense which occurred both as the Company operated a
greater number of stores than in the same period prior year and also to support
the 20% increase in comparable store sales. Operating expenses decreased
favorably as a percentage of net sales from 20.3% in 1997 to 17.0% in 1998, due
to leveraging as net sales increased by 44.3%.
General and administrative expenses for the quarter increased from $2,425,000 in
1997 to $2,544,000 in 1998, an increase of 4.9%. General and administrative
expenses decreased favorably as a percentage of net sales from 5.2% in 1997 to
3.8% in 1998, due to leveraging as net sales increased by 44.3%.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The Company generated operating income for the quarter of $6,675,000 compared to
$4,508,000 in the same period prior year, an increase of 48.1%.
Interest income for the quarter increased from $22,000 in 1997 to $47,000 in
1998, an increase of 113.6%, primarily as the Company maintained a higher level
of cash and cash equivalents.
The Company generated net income before income taxes for the quarter of
$6,702,000 compared to net income before income taxes of $4,512,000 in the same
period prior year, an increase of 48.5%. As a result the Company recorded an
income tax expense for the quarter of $2,547,000 compared to an income tax
expense of $1,510,000 for the same period prior year.
Due to the above factors, the Company generated net income for the quarter of
$4,155,000, or $0.63 per share, compared to net income of $3,002,000, or $0.48
per share, for the same period prior year.
Comparison of Nine Month Period Fiscal 1998 to Nine Month Period Fiscal 1997
Net sales for the nine month period increased from $85,738,000 in 1997 to
$117,797,000 in 1998, an increase of 37.4%. The Company opened 61 new stores
during the nine month period and operated a total of 249 locations at the end of
the nine month period this year compared to 188 locations at the end of the same
period prior year. Comparable store sales for the nine month period increased
21%. The large sales increase is primarily due to the strong growth of the video
game industry led by Sony PlayStation and Nintendo 64 products.
Cost of sales for the nine month period increased from $54,650,000 in 1997 to
$77,957,000 in 1998, an increase of 42.6%. The dollar increase in cost of sales
is primarily due to the strong growth in sales. Cost of sales as a percentage of
net sales increased from 63.7% in 1997 to 66.2% in 1998. This increase is
primarily due to sales mix for the nine month period reflecting increased sales
of new Sony PlayStation and Nintendo 64 products, which are sold at lower gross
margin percentages than that of previously played product.
Operating expenses for the nine month period increased from $20,945,000 in 1997
to $24,646,000 in 1998, an increase of 17.7%. This increase is primarily due to
higher store payroll expense which occurred both as the Company operated a
greater number of stores than in the same period prior year and also to support
the 21% increase in comparable store sales. Operating expenses decreased
favorably as a percentage of net sales from 24.4% in 1997 to 20.9% in 1998, due
to leveraging as net sales increased by 37.4%.
General and administrative expenses for the nine month period increased from
$6,119,000 in 1997 to $6,777,000 in 1998, an increase of 10.8%. This increase
occurred to support the store base which grew to 249 locations from 188
locations at the end of the same period in the prior year. General and
administrative expenses decreased favorably as a percentage of net sales from
7.1% in 1997 to 5.8% in 1998, due to leveraging as net sales increased by 37.4%.
The Company generated operating income for the nine month period of $8,417,000
compared to operating income of $4,024,000 in the same period prior year, an
increase of 109.2%.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Interest income for the nine month period increased from $104,000 in 1997 to
$192,000 in 1998, an increase of 84.6%, primarily as the Company maintained a
higher level of cash and cash equivalents.
The Company generated net income before income taxes for the nine month period
of $8,589,000 compared to net income before income taxes of $4,099,000 in the
same period prior year, an increase of 109.5%. As a result the Company recorded
income tax expense for the nine month period of $3,264,000 compared to income
tax expense of $1,349,000 for the same period prior year.
Due to the above factors, the Company generated net income for the nine month
period of $5,325,000, or $0.81 per share, compared to net income of $2,750,000,
or $0.45 per share, for the same period prior year.
Seasonality and Quarterly Fluctuations
The Company's business is seasonal with a majority of net sales generated in the
third and fourth fiscal quarters, which include the holiday selling season. In
addition to sales seasonality, the Company's quarterly results are also impacted
by factors including new product introductions and the number and timing of new
store openings. Growth of the store base may obscure the impact of seasonal
influences. Because of the seasonality of the Company's business and the factors
mentioned above, results for any quarter are not necessarily indicative of the
results that may be achieved for a full fiscal year. The following table sets
forth net sales by quarter and the number of stores operating at each quarter
end for the past eleven quarters:
<TABLE>
<CAPTION>
Net Sales (in thousands) Number of Stores Open at Quarter End
- ---------------------------------------------------------- -----------------------------------------------------
Fiscal Fiscal
Quarter 1998 1997 1996 Quarter 1998 1997 1996
- ---------- ----------- ----------- ----------- ---------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
First $24,001 $18,862 $12,261 First 193 173 181
Second 26,760 20,415 15,335 Second 215 176 178
Third 67,036 46,461 31,897 Third 249 188 182
Fourth -- 34,817 21,889 Fourth -- 188 173
</TABLE>
Liquidity and Capital Resources
The Company's primary ongoing financing requirements are for new store capital
expenditures and new store inventory. On an interim basis, the Company's
financing requirements are also impacted by quarterly operating results and
seasonal fluctuations in inventory levels.
During the nine months ended December 28, 1997, the Company generated $3,844,000
of cash from operating activities primarily due to an increase in net income and
accounts payable, offset by an increase in inventory, and used $4,858,000 of
cash in investing activities, primarily for new store capital expenditures. For
the nine months ended December 29, 1996, the Company generated $5,694,000 of
cash from operating activities and used $1,346,000 of cash in investing
activities.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The Company has a $3,000,000 unsecured revolving credit facility with a
commercial bank, which seasonally increases to $10,000,000. The interest rate on
outstanding borrowings under the facility (8 1/2% at December 28, 1997) is equal
to the bank's prime rate. The facility requires the Company to maintain certain
financial ratios and achieve certain operating results. The Company currently
has no borrowings under this facility.
During fiscal 1998, the Company plans to incur capital expenditures of up to
$5,500,000, of which $4,778,000 has been incurred to date, for new store
openings and other related store expenditures, corporate information systems and
general corporate expenditures. The Company incurred capital expenditures of
$1,548,000 in fiscal 1997.
The Company believes that cash from operations and funds available under its
revolving credit facility will provide sufficient funds for financing planned
store openings, working capital needs and other capital expenditures for at
least 12 months.
Forward Looking Statements
Forward looking statements contained in this document which directly or
indirectly relate to future sales prospects and expansion plans are subject to
uncertainties from factors including growth of the industry, competitive
environment, product availability, success of the Company's existing operations,
availability of new store sites and the Company's ability to finance new store
expansion. For further discussion of factors which can impact the Company's
operating results, please refer to the Company's report on Form 10-K for the
year ended March 30, 1997, and other Company filings with the Securities and
Exchange Commission
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company and its Chief Executive Officer were originally named as defendants
in a civil lawsuit filed on August 17, 1995 in the United States District Court,
District of Minnesota, entitled Christopher Cannon v. Funco, Inc. and David R.
Pomije. This was a putative class action in which the named plaintiff in the
Class Action Complaint purported to represent a class of all purchasers of the
Company's common stock during the putative class period of May 18, 1994 through
December 15, 1994. On October 18, 1996 the court dismissed the state common law
claims with prejudice and dismissed the federal securities claims without
prejudice, giving the plaintiff leave to file an Amended Complaint. The
plaintiff filed an Amended Complaint on January 6, 1997.
The Amended Complaint is a similarly styled class action suit and alleges the
Company's share price was artificially inflated, asserting various claims under
the Securities Exchange Act of 1934 as amended. Plaintiff seeks damages in an
unspecified amount plus costs and attorney's fees. The Company and its Chief
Executive Officer filed a motion to dismiss the Amended Class Action Complaint
in its entirety.
The parties have reached an agreement-in-principle to settle this lawsuit,
subject to approval by the Court and members of the class. The proposed
settlement will not have a material impact on the Company including its results
of operations, financial condition and liquidity.
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits filed with this Form 10-Q:
27 Financial Data Schedule
(b) No report on Form 8-K was filed by the registrant during the
quarter ended December 28, 1997.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Funco, Inc.
(Registrant)
Date: February 5, 1998 By: /s/ David R. Pomije
-------------------------------------
David R. Pomije
Chief Executive Officer
By: /s/ Robert M. Hiben
-------------------------------------
Robert M. Hiben
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-29-1998
<PERIOD-START> SEP-29-1997
<PERIOD-END> DEC-28-1997
<CASH> 8,222
<SECURITIES> 0
<RECEIVABLES> 2,103
<ALLOWANCES> 29
<INVENTORY> 27,716
<CURRENT-ASSETS> 39,873
<PP&E> 21,229
<DEPRECIATION> 12,740
<TOTAL-ASSETS> 49,671
<CURRENT-LIABILITIES> 19,054
<BONDS> 0
0
0
<COMMON> 62
<OTHER-SE> 30,429
<TOTAL-LIABILITY-AND-EQUITY> 49,671
<SALES> 67,036
<TOTAL-REVENUES> 67,036
<CGS> 46,413
<TOTAL-COSTS> 46,413
<OTHER-EXPENSES> 13,948
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 20
<INCOME-PRETAX> 6,702
<INCOME-TAX> 2,547
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,155
<EPS-PRIMARY> .63
<EPS-DILUTED> .63
</TABLE>
