UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] Quarterly report under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended January 31, 1997
[ ] Transition report under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from _____ to _____
Commission file number: 0-24346
VIDEO UPDATE, INC.
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(Exact Name of Small Business Issuer as Specified in its Charter)
Delaware 41-1461110
------------------------------- -------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
3100 World Trade Center
30 East 7th Street
St. Paul, Minnesota 55101
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(Address of Principal Executive Offices)
(612) 222-0006
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(Issuer's Telephone Number, Including Area Code)
Check whether the Issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 March 7, 1997, the Issuer had 18,119,341 outstanding shares of Class
A Common Stock, $.01 par value, and 2,000,000 outstanding shares of Class B
Common Stock, $.01 par value.
VIDEO UPDATE, INC.
INDEX
<TABLE>
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PART 1 - FINANCIAL INFORMATION PAGE NO.
- ------------------------------ --------
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ITEM 1. Financial Statements
Consolidated Balance Sheets - April 30, 1996, and January 31, 1997 ...... 3
Consolidated Statements of Income - Three Months and Nine Months
ended January 31, 1996 and January 31, 1997 .................... 4
Consolidated Statements of Cash Flows - Nine Months ended
January 31, 1996 and January 31, 1997........................... 5
Notes to Consolidated Financial Statements - January 31, 1997 ........... 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ............................ 11
PART II - OTHER INFORMATION
- ---------------------------
ITEM 1. Legal Information. ...................................................... 17
ITEM 4. Submission of Matters to a Vote of Security-Holders. .................... 17
ITEM 5. Other Information. ...................................................... 18
ITEM 6. Exhibits and Reports on Form 8-K ........................................ 19
SIGNATURES .......................................................................... 20
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PART 1 - FINANCIAL INFORMATION
- ------------------------------
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
VIDEO UPDATE, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
ASSETS
April 30, January 31,
1996 1997
--------- -----------
(UNAUDITED)
<S> <C> <C>
Cash and cash equivalents $ 676 $ 4,508
Accounts receivable 558 1,842
Notes receivable from related parties 1,555 1,326
Inventory 4,545 3,799
Videocassette rental inventory -- net 25,701 40,760
Property and equipment -- net 18,988 27,386
Prepaid expenses 682 1,004
Goodwill -- net 25,973 29,941
Other assets 840 1,014
--------- ---------
Total assets $ 79,518 $ 111,580
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable $ 4,859 $ 618
Accounts payable 8,692 11,324
Accrued compensation 1,334 2,527
Accrued expenses 977 1,958
Accrued rent expense 228 264
Income tax payable 593 1,297
Deferred income taxes 841 1,505
Other liabilities 494 1,586
Commitments and contingencies
Stockholders' equity:
Preferred Stock, par value $.01 per share:
Authorized shares -- 5,000,000
Issued shares -- none -- --
Class A Common Stock, par value $.01 per share:
Authorized shares -- 60,000,000
Issued and outstanding shares -- 11,017,735 at April 30,
1996 and 18,107,841 at January 31, 1997 110 181
Class B Common Stock, par value $.01 per share:
Authorized, issued and outstanding shares --
2,000,000 at April 30, 1996 and January 31, 1997 20 20
Additional paid-in capital 61,029 86,364
Retained earnings 2,186 5,498
Foreign currency translation (34) 118
--------- ---------
63,311 92,181
Notes receivable from officers for the exercise of options (1,811) (1,680)
--------- ---------
Total stockholders' equity 61,500 90,501
--------- ---------
Total liabilities and stockholders' equity $ 79,518 $ 111,580
========= =========
</TABLE>
SEE ACCOMPANYING NOTES.
Note: The balance sheet at April 30, 1996 has been derived from the audited
financial statements at that date but does not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
<TABLE>
<CAPTION>
VIDEO UPDATE, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands, except per share amounts)
Three Months Ended Nine Months Ended
January 31, January 31,
1996 1997 1996 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Rental revenue $ 15,480 $ 24,040 $ 30,061 $ 59,669
Service fees 160 136 363 419
Product sales 1,436 1,967 2,458 4,742
-------- -------- -------- --------
17,076 26,143 32,882 64,830
Costs and expenses:
Store operating expenses 12,071 18,903 23,558 49,329
Selling, general and administrative 1,725 2,058 3,726 6,080
Cost of product sales 1,006 1,206 1,660 2,842
Amortization of goodwill 329 396 674 1,139
-------- -------- -------- --------
15,131 22,563 29,618 59,390
-------- -------- -------- --------
Operating income 1,945 3,580 3,264 5,440
Interest expense (49) (31) (201) (349)
Other income 138 298 361 567
-------- -------- -------- --------
89 267 160 218
-------- -------- -------- --------
Income before income taxes 2,034 3,847 3,424 5,658
Income tax expense 857 1,568 1,464 2,346
-------- -------- -------- --------
Net income $ 1,177 $ 2,279 $ 1,960 $ 3,312
======== ======== ======== ========
Net income per share, primary $ 0.10 $ 0.12 $ 0.19 $ 0.22
======== ======== ======== ========
Net income per share, fully diluted $ 0.10 $ 0.12 $ 0.18 $ 0.22
======== ======== ======== ========
</TABLE>
SEE ACCOMPANYING NOTES.
<TABLE>
<CAPTION>
VIDEO UPDATE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
Nine Months Ended January 31,
-----------------------------
1996 1997
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<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 1,960 $ 3,312
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 7,826 18,069
Deferred rent 297 1,092
Deferred income taxes 586 664
Changes in operating assets and liabilities, net
of acquisitions of businesses:
Accounts receivable (1,155) (1,282)
Notes receivable (1) 137
Inventory (2,486) 746
Other assets (196) (686)
Accounts payable 6,076 2,632
Income taxes payable 847 704
Other liabilities (440) 1,862
-------- --------
Net cash provided by operating activities 13,314 27,250
INVESTING ACTIVITIES
Purchase of videocassette rental inventory (15,367) (26,168)
Purchase of property and equipment (8,963) (9,888)
Investment in businesses, net of cash acquired (16,569) (8,375)
Loan advance to executives (1,252) --
Payments on executive advance -- 222
-------- --------
Net cash used in investing activities (42,151) (44,209)
FINANCING ACTIVITIES
Proceeds from bank line -- 5,300
Proceeds from notes payable -- 26
Payments on bank line -- (9,400)
Payments on notes payable (3,422) (167)
Proceeds from exercise of employee options 18 --
Proceeds from exercise of Class A warrants, net 28,414 --
Proceeds from issuance of common stock, net 992 25,032
-------- --------
Net cash provided by financing activities 26,002 20,791
-------- --------
Increase/(decrease) in cash and cash equivalents (2,835) 3,832
Cash and cash equivalents at beginning of the period 5,573 676
======== ========
Cash and cash equivalents at end of the period $ 2,738 $ 4,508
======== ========
</TABLE>
SEE ACCOMPANYING NOTES.
VIDEO UPDATE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 1997
(UNAUDITED)
1. GENERAL
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-QSB and Article 10 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
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the nine months ended January 31, 1997 are
not necessarily indicative of the results that may be expected for the year
ending April 30, 1997. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's annual
report on Form 10-KSB for the year ended April 30, 1996.
RECLASSIFICATION
Certain prior year items have been reclassified to conform with the
fiscal 1997 presentation.
2. NET INCOME PER COMMON SHARE
Net income per share under the treasury stock method is computed by
dividing net income for the year by the weighted average number of shares of
common stock and common stock equivalents, if dilutive, outstanding during the
year. If the number of shares of common stock obtainable on exercise of
outstanding options and warrants in the aggregate exceeds 20% of the number of
common shares outstanding at the end of the period for which the computation is
being made, the treasury stock method shall be modified in determining the
dilutive effect of the options and warrants. The treasury stock method -
modified is presented if it is found to be diluted. The weighted average number
of shares used in the net income per share calculation was reduced by the common
shares placed in escrow in connection with the Company's initial public
offering.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JANUARY 31, JANUARY 31,
--------------------- ---------------------
1996 1997 1996 1997
-------- -------- -------- --------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
PRIMARY EARNINGS PER SHARE
Net income $ 1,177 $ 2,279 $ 1,960 $ 3,312
Adjustments to net income:
Elimination of interest upon assumed
retirement of existing debt 15 9 n/a n/a
Investment income on assumed investment of
excess proceeds from excercise of common
stock equivalents 712 788 n/a n/a
-------- -------- -------- --------
Adjusted net income available for common
shareholders $ 1,904 $ 3,076 $ 1,960 $ 3,312
======== ======== ======== ========
Weighted average shares outstanding:
Class A common shares outstanding
at quarter end 11,227 18,108 11,227 18,108
Class B common shares outstanding
at quarter end 2,000 2,000 2,000 2,000
Less: Class B common shares placed
in escrow in connection with the
initial public offering (1,300) (1,300) (1,300) (1,300)
Effect of using weighted average
common shares outstanding -- (54) (1,679) (3,905)
Effect of shares issuable under stock
options and warrants based on the
treasury stock method 10,415 11,459 -- 375
Modified treasury stock, 20% repurchase limit (2,385) (3,762) n/a n/a
-------- -------- -------- --------
19,957 26,451 10,248 15,278
======== ======== ======== ========
Net income per common and common
equivalent share, primary $ 0.10 $ 0.12 $ 0.19 $ 0.22
======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JANUARY 31, JANUARY 31,
--------------------- ---------------------
1996 1997 1996 1997
-------- -------- -------- --------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
FULLY DILUTED EARNINGS PER SHARE
Net income $ 1,177 $ 2,279 $ 1,960 $ 3,312
Adjustments to net income:
Elimination of interest upon assumed
retirement of existing debt 15 9 n/a n/a
Investment income on assumed investment of
excess proceeds from excercise of common
stock equivalents 712 780 n/a n/a
-------- -------- -------- --------
Adjusted net income available for common
shareho1ders $ 1,904 $ 3,068 $ 1,960 $ 3,312
======== ======== ======== ========
Weighted average shares outstanding:
Class A common shares outstanding
at quarter end 11,227 18,108 11,227 18,108
Class B common shares outstanding
at quarter end 2,000 2,000 2,000 2,000
Less: Class B common shares placed
in escrow in connection with the
initial public offering (1,300) (1,300) (1,300) (1,300)
Effect of using weighted average
common shares outstanding -- (54) (979) (3,905)
Effect of shares issuable under stock
options and warrants based on the
treasury stock method 10,415 11,459 -- 387
Modified treasury stock, 20% repurchase limit (2,385) (3,762) n/a n/a
-------- -------- -------- --------
19,957 26,451 10,948 15,290
======== ======== ======== ========
Net income per common and common
equivalent share, fully diluted $ 0.10 $ 0.12 $ 0.18 $ 0.22
======== ======== ======== ========
</TABLE>
n/a = not applicable
3. CHANGE IN AMORTIZATION METHOD FOR VIDEOCASSETTE RENTAL INVENTORY
Effective February 1, 1996, videocassettes that are considered base
stock (including copies one through three of new releases) are amortized over 36
months on a straight-line basis to a salvage value of $6.00 per videocassette.
New release videocassettes are amortized as follows: the fourth through ninth
copies of each title per store are amortized on a straight-line basis during
their first six months to a net book value of $6.00 and then on a straight-line
basis over 30 months with no salvage value; and the tenth and any succeeding
copies of each title per store are amortized on a straight-line basis during
their first six months to a net book value of $6.00 and then on a straight-line
basis over three months with no salvage value. The changes, which represent in
part a change in accounting principle and a change in accounting estimate, were
reflected in the Company's consolidated financial statements in total as a
change in an accounting estimate in the fourth quarter of fiscal 1996.
Prior to February 1, 1996, base stock videocassettes were amortized
over 36 months on a straight-line basis with no salvage value. Prior to May 1,
1995, new release videocassettes were amortized as follows: copies one through
three of each title per store were amortized as base stock; the fourth through
ninth copies of each title per store were amortized 40% in the first year and
30% in each of the second and third years; and the tenth and any succeeding
copies of each title per store were amortized over nine months on a
straight-line basis.
The new method of amortization was adopted because the Company believes
accelerating expense recognition for new release videocassettes (copies four and
greater) during the first six months more closely matches the typically higher
revenue generated following a title's release, and believes that $6.00
represents a reasonable salvage value for base stock videocassettes after 36
months.
The effect of the application of the new method of amortizing
videocassettes during the first nine months of fiscal 1996 (nine months ended
January 31, 1996) would have increased amortization expense by approximately
$2,156,000 and decreased net income by approximately $1,234,000 or $.11 per
share, for the period.
4. DEFICIENCY OBLIGATIONS - ACQUISITIONS
In connection with three acquisitions in which the Company has issued
an aggregate of 594,506 shares of Class A Common Stock in fiscal 1996 and 1997,
the Company may be obligated to make deficiency payments to such sellers equal
to the difference between the guaranteed price of $7.00 to $15.00 for each share
issued, and the actual market price obtained for such shares as of specified
dates between July 1996 and October 1998. The remaining deficiency payments are
estimated to be approximately $2,387,000 based on the closing stock price of
$4.25 at January 31, 1997. The Company has the option of satisfying
approximately $1,220,449 of this liability at January 31, 1997 through the
issuance of additional shares of Class A Common Stock. The Company is currently
disputing whether any deficiency payment is due with respect to 239,163 shares
held by a seller in one of the acquisitions; the seller is claiming a deficiency
payment based on proceeds from the sale of Class A Common Stock during the six
month period of March 1996 to September 1996.
During October 1996, a cash deficiency payment was made with regard to
one acquisition in the cash amount of $87,135. During November 1996, a cash
deficiency payment was made with regard to one acquisition in the amount of
$88,547. Also, during November 1996, the Company satisfied a deficiency payment
of $77,951 with regard to one acquisition with 15,106 shares of Class A Common
Stock.
5. STOCKHOLDER'S EQUITY
On October 2, 1996, the Company announced the closing of its public
offering of 6.1 million shares of Class A Common Stock. The net proceeds from
the offering were approximately $21,628,000 and were used to provide working
capital, make acquisitions, reduce outstanding debt, open additional stores and
meet other general corporate purposes.
On October 9, 1996, the Company announced the closing of the
over-allotment option of 915,000 shares of Class A Common Stock providing
approximately $3,404,000 in additional net proceeds.
In June 1996, the Board of Directors approved an additional stock
option plan (the "1996 Plan"). The 1996 Plan provides for the granting of up to
820,000 options to eligible individuals to purchase shares of Class A Common
Stock of the Company. Options under the 1996 Plan may be incentive stock options
or non-qualified options.
6. ACQUISITIONS
On January 15, 1997, the Company completed the acquisition of
substantially all of the assets of Video Warehouse, Inc. ("Video Warehouse") of
Longview, Washington, a privately owned chain of 10 video rental stores. The
purchase price under the Purchase Agreement was approximately $1,800,000 in cash
and the issuance of 25,000 shares of Class A Common Stock. The purchase method
of accounting has been used to account for the acquisition. The Company has
recorded approximately $1,100,000 in goodwill, which is being amortized over 20
years on a straight-line basis.
On January 31, 1997, the Company completed the acquisition of
substantially all of the assets of Video View Ltd. ("Video View"), a privately
owned chain of 23 video rental stores in Alberta, Canada. Video Update had been
managing the operations of Video View since December 31, 1996, under a
management agreement, pending Industry Canada approval of the transaction. As a
result, revenue and expenses incurred from December 31, 1996 and assets
purchased related to Video View are included in the Statement of Operations for
the nine months ended January 31, 1997 and the Balance Sheet at January 31,
1997, respectively. The purchase price under the Purchase Agreement was
approximately $5,800,000 in cash and the issuance of 50,000 shares of Class A
Common Stock. The purchase method of accounting has been used to account for the
acquisition. The Company has recorded approximately $3,400,000 in goodwill,
which is being amortized over 20 years on a straight-line basis.
7. ACQUISITION - FINANCIAL INFORMATION
The following unaudited pro forma summary combines the results of
operation of the Company, the Video Warehouse, Inc. acquisition and the Video
View, Ltd. acquisition for the nine months ended January 31, 1997 as if the
transactions had occurred as of the beginning of the year. The unaudited pro
forma summary reflects: (i) the combination of the acquisitions; (ii) an
adjustment to allocate the purchase price based upon the estimated fair value of
the assets acquired and the obligations assumed; (iii) adjustments for
accounting differences; and (iv) a provision for income taxes as if the combined
operations had been taxed as a C corporation for all the periods presented.
In the opinion of the Company's management, all adjustments necessary
to present fairly such pro forma summary have been made based on the terms and
structure of the transactions.
Pro Forma
Unaudited Results
Nine Months Ended
January 31, 1997
-----------------
(In thousands, except per share amount)
Total Revenue $ 71,099
============
Net income $ 3,909
============
Net income per share $ 0.24
============
This unaudited pro forma financial summary does not necessarily
indicate the actual results had the Acquisitions occurred at the beginning of
the respective periods, as the case may be, nor do they purport to indicate the
results of future operations of the Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion of the financial condition and results of
operations should be read in conjunction with the Company's unaudited
consolidated financial statements and notes thereto appearing elsewhere herein.
OVERVIEW
The Company franchised its first store in January 1983 and opened its
first Company-owned store in September 1989. By July 1994, when the Company
completed its initial public offering, the Company had grown to 15 Company-owned
stores and 30 franchised stores. Subsequently, the Company substantially
accelerated its growth and as of January 31, 1997 operated 290 Company-owned
stores in 14 states and in Canada, and has 29 franchised stores predominantly in
the United States. The majority of the Company's stores located in the United
States are superstores. Superstores are video specialty stores that carry more
than 7,500 rental units.
As a result of the acquisitions completed during fiscal 1995, 1996 and
1997, the Company anticipates that its results of operations will be reduced by
the amortization of goodwill of approximately $29,941,000, with anticipated
quarterly non-cash charges of approximately $437,000. The Company anticipates
that future acquisitions will involve the recording of additional significant
amounts of goodwill and deferred charges on its balance sheet.
The Company generates revenues primarily from the rental of
videocassettes and video games, from service fees from its franchisees, and from
the sale of products. As reflected in the chart below, rental revenues at Video
Update stores have accounted for the substantial majority of the Company's
revenues. The Company expects that this trend will continue.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JANUARY 31, JANUARY 31,
------------------------------- ------------------------------
1996 1997 1996 1997
------------ ------------ ------------ -----------
(In thousands) (In thousands)
<S> <C> <C> <C> <C>
Rental revenue $ 15,480 $ 24,040 $ 30,061 $ 59,669
Service fees 160 136 363 419
Product sales 1,436 1,967 2,458 4,742
------------ ------------ ------------ -----------
$ 17,076 $ 26,143 $ 32,882 $ 64,830
============ ============ ============ ===========
</TABLE>
Effective February 1, 1996, videocassettes that are considered base
stock (including copies one through three of new releases) are amortized over 36
months on a straight-line basis to a salvage value of $6.00 per videocassette.
New release videocassettes are amortized as follows: the fourth through ninth
copies of each title per store are amortized on a straight-line basis during
their first six months to a net book value of $6.00 and then on a straight-line
basis over 30 months with no salvage value; and the tenth and any succeeding
copies of each title per store are amortized on a straight-line basis during
their first six months to a net book value of $6.00 and then on a straight-line
basis over three months with no salvage value.
Amortization expense as a percentage of revenue for future periods may
vary based on the Company's purchase of videocassette inventory, which is
subject to change based on the Company's rate of expansion, studio release
schedules and anticipated market demand.
OPERATING RESULTS
The table below sets forth the percentage of revenues represented by
certain items included in the Company's statement of operations for the periods
indicated.
NINE MONTHS ENDED JANUARY 31,
-----------------------------
1996 1997
-------- --------
Revenues:
Rental revenue 91.4% 92.0%
Service fees 1.1 0.7
Product sales 7.5 7.3
----- -----
Total revenues 100.0 100.0
Costs and expenses:
Store operating expenses 71.6 76.1
Selling, general and administrative 11.3 9.4
Cost of product sales 5.1 4.4
Amortization of goodwill 2.1 1.7
----- -----
Total cost and expenses 90.1 91.6
----- -----
Operating income 9.9 8.4
Other income (expense):
Interest expense (0.6) (0.5)
Other income 1.1 0.8
----- -----
Total other income 0.5 0.3
----- -----
Income before income taxes 10.4 8.7
Income tax expense 4.4 3.6
----- -----
Net income 6.0% 5.1%
===== =====
NINE MONTHS ENDED JANUARY 31, 1997 COMPARED TO NINE MONTHS ENDED JANUARY 31,
1996
RENTAL REVENUE. Rental revenue was approximately $59,669,000 and
$30,061,000, or 92.0% and 91.4% of total revenues for the nine months ended
January 31, 1997 and 1996, respectively. The increase in rental revenue of
$29,608,000 was derived primarily from video stores acquired during fiscal 1996
and 1997, from the opening of 68 new Company-owned stores since the third
quarter of fiscal 1996, and from a 9.4% increase in same store revenues.
SERVICE FEES. Service fees were approximately $419,000 and $363,000, or
.7% and 1.1% of total revenues for the nine months ended January 31, 1997 and
1996, respectively. Continuing service fees and royalties from franchisees
accounted for 92.8% and 100.0% of total service fees, respectively. The decrease
in service fees as a percentage of total revenues was due to a significant
increase in the number of Company-owned stores without a corresponding increase
in the number of franchised stores.
PRODUCT SALES. Product sales were approximately $4,742,000 and
$2,458,000, or 7.3% and 7.5% of total revenues for the nine months ended January
31, 1997 and 1996, respectively. The increase in product sales of $2,284,000 was
primarily a result of product sales by the video stores acquired during fiscal
1996 and 1997, from the opening of 68 Company-owned video stores since the third
quarter of fiscal 1996 and from the increase in sales of fixed assets to
franchisees.
STORE OPERATING EXPENSES. Store operating expenses consist primarily of
compensation and related expenses, occupancy expenses, depreciation and
amortization expenses and regional management expenses. Operating expenses were
approximately $49,329,000 and $23,558,000, or 76.1% and 71.6% of total revenues
for the nine months ended January 31, 1997 and 1996, respectively. The increase
in store operating expenses of $25,771,000, was primarily the result of video
stores acquired during fiscal 1996 and 1997, the opening of 68 Company-owned
video stores since the third quarter of fiscal 1996, and an increase in
amortization expense related to videocassettes. The increase in store operating
expenses of 4.5% as a percentage of total revenues is summarized below.
Compensation and related expenses were approximately $13,863,000 and
$7,400,000, or 21.4% and 22.5% of total revenues for the nine months ended
January 31, 1997 and 1996, respectively. The increase of $6,463,000 was
primarily due to video stores acquired during fiscal 1996 and 1997 and from the
opening of 68 Company-owned video stores since the third quarter of fiscal 1996.
The decrease as a percentage of total revenues was primarily the result of
improved labor efficiencies.
Occupancy expenses were approximately $14,324,000 and $6,609,000, or
22.1% and 20.1% of total revenues for the nine months ended January 31, 1997 and
1996, respectively. The increase of approximately $7,715,000 was primarily due
to video stores acquired during fiscal 1996 and 1997 and from the opening of 68
Company-owned stores since the third quarter of fiscal 1996. The increase as a
percentage of total revenues was primarily due to higher costs associated with
the opening of new video stores prior to revenue reaching maturity during the
first year of operations.
Depreciation and amortization expenses were approximately $16,305,000
and $6,984,000, or 25.2% and 21.2% of total revenues for the nine months ended
January 31, 1997 and 1996, respectively. Depreciation and amortization expense
reflects the depreciation of store equipment and fixtures and the amortization
of videocassettes. The increase of $9,321,000 was primarily attributable to the
addition of new release videocassette inventory for new, existing, and acquired
stores. The effect of the application of the new method of amortizing
videocassettes during the first nine months of fiscal 1996 (nine months ended
January 31, 1996) would have increased amortization expense to approximately
$9,140,000 or 27.8% of total revenues. This would have resulted in a reduction
in amortization expense of 2.6% (net of the change in method of amortization of
video cassettes) during the first nine months of fiscal 1997 compared to fiscal
1996 primarily due to purchasing of video cassettes at more efficient levels.
Amortization expense as a percentage of revenues for future periods may vary
based on the Company's purchase of videocassette inventory, which is subject to
change based on the Company's rate of expansion, studio release schedules and
anticipated market demand.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses were approximately $6,080,000 and $3,726,000, or 9.4%
and 11.3% of total revenues for the nine months ended January 31, 1997 and 1996,
respectively. The increase of approximately $2,354,000 was primarily due to
adding management personnel and administrative staff to support the Company's
growth and related expenditures. The decrease as a percentage of total revenues
was due to the increase in total revenues without a proportional increase in
corporate overhead.
COST OF PRODUCT SALES. Cost of product sales was approximately
$2,842,000 and $1,660,000, or 4.4% and 5.1% of total revenues for the nine
months ended January 31, 1997 and 1996. The cost of product sales as a
percentage of total product sales revenue was approximately 59.9% and 67.5% for
fiscal 1997 and 1996, respectively. The decrease in the cost of product sales as
a percentage of total product sales was primarily the result of a different mix
of products sold.
AMORTIZATION OF GOODWILL. Amortization of goodwill was approximately
$1,139,000 and $674,000 or 1.7% and 2.1% of total revenues for the nine months
ended January 31, 1997 and 1996, respectively. The decrease as a percentage of
total sales was primarily attributable to an increase in sales from new store
openings without a proportional increase in the amortization of certain
intangible assets resulting from the video stores acquired.
INTEREST EXPENSE. Interest expense was approximately $349,000 and
$201,000, or 0.5% and 0.6% of total revenues for the nine months ended January
31, 1997 and 1996, respectively. The increase of $148,000 was primarily
attributable to interest on increased borrowings under the Company's bank line
of credit.
OTHER INCOME. Other income was approximately $567,000 and $361,000, or
0.8% and 1.1% of total revenues for the nine months ended January 31, 1997 and
1996, respectively. The increase of $206,000 was primarily due to interest
earned on notes receivable from officers.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date through cash from
operations, the proceeds of prior equity and debt offerings, borrowings under
bank facilities, trade credit and equipment leases. The Company's principal
capital requirements are for the acquisition of existing stores, the opening of
new superstores, and the purchase of videocassette rental inventory, each of
which varies based on market conditions and expansion plans.
At January 31, 1997, the Company had cash and cash equivalents of
approximately $4,508,000. The Company uses an unclassified balance sheet in its
financial statements, and as a result, does not classify its assets or
liabilities as current or noncurrent. If the Company were to use a classified
balance sheet, a portion of videocassette rental inventories would be classified
as noncurrent because they are not assets that are reasonably expected to be
completely realized in cash or sold in one year. The acquisition cost of these
inventories, however, would be reflected in current liabilities. The Company
believes that classification of videocassette rental inventories as noncurrent
assets would be misleading because it would not indicate the level of assets
expected to be converted into cash in the next year as a result of rentals or
sales of these videocassettes.
For the nine months ended January 31, 1997 net cash provided by
operating activities was approximately $27,250,000. Net cash used in investment
activities was approximately $44,209,000 consisting primarily of approximately
$9,888,000 for new and remodeled stores, $8,375,000 for acquired stores and
approximately $26,168,000 for the purchase of videocassette inventory for
existing and new stores. Net cash generated from financing activities was
approximately $20,791,000 resulting primarily from proceeds of the public
offering in October 1996.
The Company has promissory notes (the "Recourse Notes") from the
Company's Chief Executive Officer and from the President for approximately
$1,891,000 and $1,050,000, respectively, including accrued interest through
January 31, 1997. The Recourse Notes were issued by the executives upon their
exercise in August 1995 of 420,000 options granted to them under the Stock
Option Plans in May 1995 at an exercise price of $4.3125, the fair market value
of the stock on the date options were granted. The Recourse Notes represent the
total exercise price of such options plus amounts advanced by the Company to
such executives to satisfy then anticipated tax liabilities. The Recourse Notes,
which provide for full recourse against the respective officer's personal assets
and Company stockholdings, are due and payable in October 1999, and accrue
interest at 8% per annum. In the event that the obligors sell shares of the
Company's stock, the net proceeds thereof will be applied to payment, in part or
in full, of the Recourse Notes.
In addition, as of January 31, 1997, the Company has a note receivable
from the President of the Company for approximately $30,000 which accrues
interest at 8% per annum and is due November 1997. The note represents advances
from the Company to the President from January 1994 to April 1994, together with
accrued interest.
To the extent that the Company pursues any future acquisitions, the
Company expects to finance such acquisitions from the net proceeds of debt and
equity offerings, with cash from operations, and from borrowings under credit
facilities.
In connection with three acquisitions in which the Company has issued
an aggregate of 594,506 shares of Class A Common Stock in fiscal 1996 and 1997,
the Company may be obligated to make deficiency payments to such sellers equal
to the difference between the guaranteed price of $7.00 to $15.00 for each share
issued, and the actual market price obtained for such shares as of specified
dates between July 1996 and October 1998. As of January 31, 1997, the remaining
deficiency payments are estimated to be approximately $2,387,000 based on the
closing stock price of $4.25 at January 31, 1997. The Company has the option of
satisfying approximately $1,220,449 of this liability at January 31, 1997
through the issuance of additional shares of Class A Common Stock. The Company
is currently disputing whether any deficiency payment is due with respect to
239,163 shares held by a seller in one of the acquisitions; the seller is
claiming a deficiency payment based on proceeds from the sale of Class A Common
Stock during the six month period of March 1996 to September 1996.
On October 2, 1996, the Company announced the closing of its public
offering of 6.1 million shares of Class A Common Stock. The net proceeds from
the offering were approximately $21,628,000 and will be used to provide working
capital, make acquisitions, reduce outstanding debt, open additional stores and
meet other general corporate purposes.
On October 9, 1996, the Company announced the closing of the
over-allotment option of 915,000 shares of Class A Common Stock providing
approximately $3,404,000 in additional net proceeds.
On January 15, 1997, the Company completed the acquisition of
substantially all of the assets of Video Warehouse, Inc. ("Video Warehouse") of
Longview, Washington, a privately owned chain of 10 video rental stores. The
purchase price under the Purchase Agreement was approximately $1,800,000 in cash
and the issuance of 25,000 shares of Class A Common Stock. The purchase method
of accounting has been used to account for the acquisition. The Company has
recorded approximately $1,100,000 in goodwill, which is being amortized over 20
years on a straight-line basis.
On January 31, 1997, the Company completed the acquisition of
substantially all of the assets of Video View Ltd. ("Video View"), a privately
owned chain of 23 video rental stores in Alberta, Canada. Video Update had been
managing the operations of Video View since December 31, 1996, under a
management agreement, pending Industry Canada approval of the transaction. As a
result, revenue and expenses incurred from December 31, 1996 and assets
purchased related to Video View are included in the Statement of Operations for
the nine months ended January 31, 1997 and the Balance Sheet at January 31,
1997, respectively. The purchase price under the Purchase Agreement was
approximately $5,800,000 in cash and the issuance of 50,000 shares of Class A
Common Stock. The purchase method of accounting has been used to account for the
acquisition. The Company has recorded approximately $3,400,000 in goodwill,
which is being amortized over 20 years on a straight-line basis.
The Company generally does not offer lines of credit or
guarantees for the obligations of its franchisees, although on occasion, the
Company has made short term loans to current franchisees. The Company intends to
evaluate the possibility of providing loans or limited guarantees for certain
franchisee obligations, which in the aggregate are not expected to be material
to the Company's financial condition.
Substantially all Company-owned stores are in leased premises, except
for three stores that are located on premises owned by the Company. The Company
expects that most future stores will occupy leased premises.
The Company believes that the net proceeds of its recent equity
offering, together with its current cash from operations and borrowing
capabilities, will be sufficient to meet its anticipated cash requirements and
anticipated growth over the next twelve months.
INFLATION
To date, inflation has not had a material effect on the Company's
business. The Company anticipates that its business will be affected by general
economic trends. Although the Company has not operated during a period of high
inflation, it believes that it would generally be able to pass increased costs
resulting from inflation on to customers.
SEASONALITY AND QUARTERLY FLUCTUATIONS
The video rental industry generally experiences revenue declines in
April and May, due in part to the change to Daylight Savings Time and to
improved weather, and in September and October, due in part to school openings
and the introduction of new network and cable television programs.
The Company's video rental business may be affected by other factors,
including acquisitions by the Company of existing video stores, additional and
existing competition, marketing programs, weather, special or unusual events,
variations in the number of superstore openings, the quality of new release
titles available for rental and sale, and other factors that may affect
retailers in general.
SUBSEQUENT EVENTS
On February 12, 1997 a syndicate led by Bank of America Illinois
extended a $60 million revolving credit facility to the Company. This facility
replaces the $10 million credit line previously extended solely by Bank of
America Illinois.
On March 3, 1997, the Company completed the acquisition of the assets
of seven video store locations in Texas and Oklahoma from Cox Video, Inc., a
privately held company in Carrolton, Texas.
PART II - OTHER INFORMATION
- ---------------------------
ITEM 1. LEGAL PROCEEDINGS
In connection with the acquisition of the assets of Videoland,
Inc. ("Videoland") in November 1995, the Company issued
239,163 shares of its Class A Common Stock (the "Videoland
Shares") to the sellers of the assets of Videoland (the
"Videoland Sellers"). With respect to the Videoland Shares,
the Company agreed to make a deficiency payment in October
1996 to the Videoland Sellers if the gross proceeds received
by such sellers from the sale of the Videoland Shares during
the six months from March 1996 through September 1996 is not
equal to the number of shares of Videoland Shares sold
multiplied by $12.00. The Videoland Sellers were subject to
certain "lockup" or sale restrictions as a condition to any
deficiency payment. Although the Videoland Sellers have now
requested a deficiency payment of approximately $1,220,000 in
October 1996 based on a sale of all of the Videoland Shares,
the Company believes that the Videoland Sellers have violated
the contractual lockup and sale restrictions. Accordingly, the
Company has initiated an action in federal district court in
Minnesota for a declaratory judgment that the Videoland
Sellers are not entitled to any deficiency payment. Discovery
on this matter is proceeding. Although no assurances can be
given as to the outcome of such action, the Company intends to
vigorously pursue the matter.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
On Tuesday, December 17, 1996, the Company held its Annual Meeting of
Stockholders (the "Annual Meeting") to vote on the following proposals:
1. To elect six (6) members to the Board of Directors. Nominees
for Director were: (a) Daniel A. Potter; (b) John M. Bedard,
(c) Daniel C. Howard; (d) Robert E. Yager; (e) Jana Webster
Vaughn; and (f) Paul M. Kelnberger ("Proposal No. 1");
2. To approve an amendment to the Company's Restated Certificate
of Incorporation to increase the number of authorized shares
of the Company's Class A Common Stock from 50,000,000 shares
to 60,000,000 shares ("Proposal No. 2");
3. To approve and adopt the Company's 1996 Stock Option Plan,
under which 820,000 shares have been reserved for issuance
("Proposal No. 3");
4. To ratify the selection of Ernst & Young LLP as independent
auditors for the Company for the fiscal year ending April 30,
1997 ("Proposal No. 4").
Of the 20,017,735 shares of the Company's Class A and Class B Common
Stock of record as of November 5, 1996 able to be voted at the Annual Meeting
(representing an aggregate of 28,017,735 votes), a total of approximately
19,480,599 shares were voted (representing an aggregate of 27,480,599 votes) or
approximately 97% of the Company's issued and outstanding shares of Class A and
Class B Common Stock entitled to vote on these matters.
Each of the proposals was adopted, with the vote totals as follows:
<TABLE>
<CAPTION>
Proposal Votes For Votes Against Abstentions Broker Non-Votes
-------- --------- ------------- ----------- ----------------
<S> <C> <C> <C> <C>
No. 1
(a) Daniel A. Potter 26,556,589 924,010 0 0
(b) John M. Bedard 26,596,089 884,510 0 0
(c) Daniel C. Howard 26,603,139 877,460 0 0
(d) Robert E. Yager 26,600,139 880,460 0 0
(e) Jana Webster Vaughn 26,610,639 869,960 0 0
(f) Paul M. Kelnberger 26,611,139 869,460 0 0
No. 2 26,016,550 1,406,399 57,650 0
No. 3 26,320,495 1,031,852 128,252 0
No. 4 27,248,754 211,095 20,750 0
</TABLE>
ITEM 5. OTHER INFORMATION
In connection with the acquisition by Video Update, Inc. ("Video
Update") of Wilderness Video Group Ltd. ("Wilderness") in August 1995 pursuant
to a purchase agreement (the "Purchase Agreement"), Video Update issued 315,343
shares of its Class A Common Stock (the "Shares") to certain sellers of
Wilderness (the "Sellers"). Following the execution of the Purchase Agreement,
Video Update and the Sellers disputed the calculation of and timing for
deficiency payments claimed to be due by the Sellers (the "Payments"). In
February 1997, Video Update and the Sellers agreed to settle the dispute
regarding the Payments and entered into a Mutual Release and Settlement
Agreement to be effective as of January 20, 1997. Under the terms of the
Settlement Agreement, Video Update agreed to pay the Sellers the sum of $200,000
and to pay a deficiency payment to each Seller as follows: with respect to the
Shares held by such Seller, if the aggregate dollar consideration ( the "Sales
Proceeds") received by such Seller in an arms-length sale of Shares (a "Sale")
within nine months following the effective date of the Settlement Agreement (the
"Deficiency Period") does not equal or exceed an amount equal to $7.00
multiplied by the number of Shares sold in such Sale (the "Contemplated
Proceeds"), then Video Update shall pay such Seller an amount equal to the
amount by which the Contemplated Proceeds exceeds the Sales Proceeds. With
respect to any Shares not sold by a Seller during the Deficiency Period (the
"Retained Shares"), Video Update shall pay to each such Seller an additional
deficiency payment equal to the number of Retained Shares held by such Seller
multiplied by the amount, if any, by which $7.00 exceeds the Video Update Stock
Price, which means the higher of (i) the average of the closing bid and asked
prices of the Company's Class A Common Stock for the 40 days commencing at the
start of the Deficiency Period of (ii) such average for the 40 days immediately
prior to the Deficiency Period.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits. The following exhibits are filed herewith:
Exhibit No. Title
----------- -----
10a* Purchase Agreement by and among Video
Update Canada Inc., Video View Ltd., and
Gordon and Joanne Hillman, dated as of
January 1, 1997.
10b** Purchase Agreement by and among Video
Update, Inc., Video Warehouse, Inc., and
Donald and Katherine Cianci, dated as of
January 15, 1997.
27 Financial Data Schedule
------------------------------
* - Incorporated herein by reference to the Company's Current
Report on Form 8-K dated December 17, 1996.
** - Incorporated herein by reference to the Company's
Current Report on Form 8-K dated January 15, 1997.
B. Reports on Form 8-K. The Company filed a Current Report on
Form 8-K dated October 22, 1996, to report the closing of a
public offering.
The Company filed a Current Report on Form 8-K dated December
17, 1996 to report the results of the Company's Annual Meeting
of Stockholders for 1996, the execution of an asset purchase
agreement with Video View Ltd. and its stockholders, and the
issuance of securities pursuant to Regulation S promulgated
under the Securities Act of 1933, as amended.
The Company filed a Current Report on Form 8-K dated January
15, 1997 to report the execution of an asset purchase
agreement with Video Warehouse, Inc. and its stockholders.
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
VIDEO UPDATE, INC.
Date: March 10, 1997 By: /s/ Daniel A. Potter
--------------------------------------
DANIEL A. POTTER,
Chief Executive Officer and
Chairman of the Board of Directors
Date: March 10, 1997 By: /s/ Christopher J. Gondeck
--------------------------------------
CHRISTOPHER J. GONDECK,
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED JANUARY 31, 1997 AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> APR-30-1997
<PERIOD-END> JAN-31-1997
<CASH> 2,530
<SECURITIES> 1,978
<RECEIVABLES> 1,842
<ALLOWANCES> 0
<INVENTORY> 44,559
<CURRENT-ASSETS> 0<F1>
<PP&E> 32,274
<DEPRECIATION> 4,888
<TOTAL-ASSETS> 111,580
<CURRENT-LIABILITIES> 17,454<F1>
<BONDS> 534
0
0
<COMMON> 201
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 111,580
<SALES> 4,742
<TOTAL-REVENUES> 64,830
<CGS> 2,842
<TOTAL-COSTS> 59,390
<OTHER-EXPENSES> (567)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 349
<INCOME-PRETAX> 5,658
<INCOME-TAX> 2,346
<INCOME-CONTINUING> 3,312
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,312
<EPS-PRIMARY> 0.22
<EPS-DILUTED> 0.22
<FN>
<F1>THE COMPANY UTILIZES AN UNCLASSIFIED BALANCE SHEET PRESENTATION. THIS FORMAT
WAS FOLLOWED BASED ON THE PREMISE THAT THE VIDEOCASSETTE RENTAL INVENTORY
REPRESENTS ASSETS USED BY THE COMPANY TO GENERATE CURRENT OPERATING INCOME, AND
MANAGEMENT BELIEVES THAT TO CLASSIFY ALL OF THESE COSTS AS NONCURRENT WOULD BE
MISLEADING TO THE READERS OF THE FINANCIAL STATEMENTS BECAUSE IT WOULD NOT
INDICATE THE LEVEL OF ASSETS EXPECTED TO BE CONVERTED INTO CASH IN THE NEXT
YEAR AS A RESULT OF THE RENTALS OF THE VIDEOCASSETTES.
</FN>
</TABLE>
