-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GF4x+uXTwkHAt8UKVJmhR751T4UjSNWh539fZ1eTUUG/NXqPXKPSxJXaYJ1aIdav J+776Pc0GaJ/PvFLtx4oJw== 0000897101-99-000655.txt : 19990629 0000897101-99-000655.hdr.sgml : 19990629 ACCESSION NUMBER: 0000897101-99-000655 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990328 FILED AS OF DATE: 19990628 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FUNCO INC CENTRAL INDEX KEY: 0000889664 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-MISCELLANEOUS RETAIL [5900] IRS NUMBER: 411609563 STATE OF INCORPORATION: MN FISCAL YEAR END: 0405 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-21876 FILM NUMBER: 99653839 BUSINESS ADDRESS: STREET 1: 10120 WEST 76TH ST CITY: EDEN PRAIRIE STATE: MN ZIP: 55344 BUSINESS PHONE: 6129468883 MAIL ADDRESS: STREET 1: 10120 W 76TH ST CITY: EDEN PRAIRIE STATE: MN ZIP: 55344 10-K 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ----------------- [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MARCH 28, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO __________. COMMISSION FILE NUMBER: 0-21876 FUNCO, INC. (Exact name of registrant as specified in its charter) MINNESOTA 41-1609563 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 10120 WEST 76TH STREET MINNEAPOLIS, MN 55344 (Address and zip code of principal executive offices) (612) 946-8883 (Issuer's telephone number, including area code) ----------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.01 PAR VALUE (Title of Class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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___ Indicate by check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Aggregate market value of Common Stock held by nonaffiliates as of June 15, 1999: $101,671,622 (For the purpose of this calculation, only directors and executive officers are considered affiliates.) Number of shares of Common Stock outstanding as of the close of business on June 15, 1999: 5,954,181 DOCUMENTS INCORPORATED BY REFERENCE Proxy Statement for Annual Meeting of Shareholders, July 30, 1999 ("Proxy Statement") PART III ================================================================================ PART I ITEM 1. BUSINESS GENERAL Funco, Inc. (the "Company") was incorporated in March 1988 under the laws of the State of Minnesota. The Company, through its FUNCOLAND(R) stores, is a leading national specialty retailer of new and previously played interactive entertainment products. The Company's product line includes a broad selection of console-based video games, related hardware and accessories, with each store offering approximately 4,000 new and previously played items. Approximately 61% of the Company's retail sales are from new video game products, featuring competitive prices on hot new video game releases. The remaining 39% of the Company's retail sales are from previously played merchandise and are sold at an average of half the price for which these products originally sold. The FUNCOLAND store concept provides consumers an opportunity to sell video games that they no longer play and apply the proceeds toward other previously played or new video game products. The Company emphasizes personalized attention to its customers through its store-based FUNCOLAND Game Advisors and provides game sampling areas to assist the customer in the selection of new and previously played games. At March 28, 1999, the Company operated 312 retail stores in 26 major metropolitan areas. The Company's retail store strategy is complemented by Funco's mail order operation, the FUNCOLAND SUPERSTORE Web site and publication of GAME INFORMER(R), a video game magazine with over 195,000 paid subscribers. INDUSTRY OVERVIEW Video games are a preferred form of entertainment for a broad base of consumers ranging from children to adults. Video game play involves a hardware game system, or console, typically connected to a television set, together with video game software which runs on the system. Software is either contained on a game cartridge or a CD. Along with Sony, Nintendo and Sega, who currently dominate the video game hardware market, third party publishers such as Electronic Arts also develop and provide software for these game systems. Several years ago, the consumer market for video games was primarily comprised of pre-adolescent and teenage males. However, the demographics of the video game market have expanded due to the increased sophistication of games (both from a content and a technological standpoint) and the fact that individuals introduced to video games in their childhood maintain a strong interest in the sector as they grow older. Overall, the U.S. console-based video game industry has exhibited very strong growth over its relatively short history, increasing at a greater than 23% compound annual growth rate from approximately $500 million in calendar 1986 to $6.3 billion in calendar 1998. The console-based video game industry has experienced three major technological advancements that have resulted in the introduction of new hardware platforms. These introductions have come at four to five year intervals. Each subsequent generation has featured improvements in areas including graphics, processing speed and sound, and has achieved a larger installed base than that of the prior generation. As technologies advance, consumers look to the manufacturers to develop gaming systems capable of providing even richer game playing experiences. The 8-bit Nintendo system, introduced in 1985, was followed by the 16-bit Sega Genesis and Super Nintendo systems which arrived on the market in 1989 and 1991, respectively. The 32-bit Sega Saturn and Sony PlayStation were introduced in 1995 and the 64-bit Nintendo 64 was introduced in 1996. Each generation of hardware systems has generally followed bell-shaped unit sales curves over their life cycles, with product prices highest in the introduction stage, then declining over time. Software sales increase in conjunction with growth of the installed hardware base and generally peak within a year of each generation's hardware sales peak. The industry transition from 8-bit systems to the 16-bit generation occurred between 1989 and 1991, resulting in a slowdown in overall industry revenue growth. The Company was opening its first retail stores at that time and experienced growth and positive operating results during that period. Overall, this industry transition was relatively smooth and the industry continued to grow. Conversely, the 2 transition that occurred in late 1994 and 1995 led to a significant decrease in overall industry revenues, adversely impacting the Company's operations. This severe downturn occurred due to a sharp decline in the appeal of 16-bit product as consumers anticipated the introduction of 32- and 64-bit products which, in relation to expectations, were delayed in reaching the market. Following their introductions, the growing popularity of Sony PlayStation, introduced in late 1995, and Nintendo 64, introduced in 1996, has led the industry to record sales levels, with the Company also achieving record results. The Company expects continued advancements in technology and software development to drive long-term industry growth. Industry sources forecast continued sales growth for the current generation of hardware and software in calendar 1999. In addition, the U.S. introduction of the first of the next generation 128-bit hardware platforms, Sega Dreamcast, is planned for September 1999. Both Sony and Nintendo have indicated plans for next generation system introductions beginning in calendar 2000. The new Sony PlayStation is expected to be backwards compatible, meaning that current generation PlayStation software will be playable on it. The Company believes that the upcoming industry transition will be relatively smooth as the introduction of new hardware platforms occurs while sales of current generation products remain strong. Additional factors signaling a smoother transition include (1) the strength and market leadership of Sony and Nintendo, (2) expected backwards compatability of the new Sony PlayStation, (3) indications of new, dedicated production facilities for the new Sony PlayStation, (4) expanding consumer demographics, and (5) anticipated pricing below that of previous generation hardware introductions. The launch of Sega Dreamcast and competitive responses from the industry leaders, Sony and Nintendo, can be expected to significantly impact the industry for the first few years of the 21st century. Failure of the industry to periodically introduce exciting new hardware systems and compelling software acceptable to consumers could lead to future industry downturns and could affect the Company's operations. COMPANY STRATEGY The Company's primary goal is to strengthen its position as a leading provider of new and previously played interactive entertainment. During fiscal 2000, the Company's primary emphasis will be on increasing its store base and profitability. The Company's retail store expansion strategy includes adding stores in its existing markets as well as selectively evaluating and entering new markets. In future years, the Company expects to further enhance its position through increases in both the number of FUNCOLAND stores and the number of metropolitan areas in which the stores are located. The Company targets selected metropolitan areas based on market size, demographics and competitive factors. The Company believes it has achieved and will continue to achieve substantial economies in the areas of marketing and advertising, product distribution, store interior build-outs and lease terms as a result of implementing a rapid, multiple-site rollout strategy in selected metropolitan areas. This strategy positions the Company as the leading retailer of previously played video game merchandise in a given metropolitan area, enabling it to compete more effectively against generally smaller competitors. The Company's aggressive expansion strategy has also contributed to the Company's rapidly growing market share in the new product category. The Company intends to capitalize on its position as the leading specialty retailer focused on the console-based video game industry by rapidly expanding its Internet sales through the FUNCOLAND SUPERSTORE Web site. The Web site provides consumers an exciting means of direct on-line shopping for both new and previously played video game products, attracting visitors with its game tips and other gaming content. The Web site also acts as a promotional tool to drive customer traffic to the Company's retail outlets via an interactive store directory. The Company also plans to grow the GAME INFORMER subscriber base, increase advertising revenues and utilize the publication's content and industry expertise to enhance both the FUNCOLAND SUPERSTORE Web site and its retail operations. The Company believes that it can significantly increase readership by promoting the magazine to an expanding target customer demographic through a growing base of stores. GAME INFORMER also provides sought-after content that draws on-line shoppers to the FUNCOLAND SUPERSTORE Web site. 3 MERCHANDISING The Company's stores offer substantial value to the video game consumer by providing a broad selection of previously played video game merchandise at approximately half the price for which these games were originally sold; an opportunity to sell video game products that they no longer play and to apply the proceeds towards the purchase of other video game merchandise; and a broad selection of new video game products featuring hot new releases at competitive prices. The Company's net sales are generated primarily through the sale of a broad selection of Sony PlayStation, Nintendo and Sega video games, hardware and accessories. Previously played product (Funco's specialty niche) currently represents approximately 39% of sales, but generates approximately 48% of the Company's gross margin dollars. To assure customers that they will not sacrifice quality or performance, the Company provides limited warranties on its previously played products. The Company's previously played video game selection includes the newer 32- and 64-bit product categories, as well as the older 8- and 16-bit product categories. Because manufacturers generally limit the number of game cartridges or CD's produced for any given game title, after a time, many older titles offered by the Company are unavailable through retailers of exclusively new merchandise. The majority of the Company's top selling previously played games, as measured by unit sales, are no longer readily available new. The Company's inventory of individual titles is frequently modified to adapt to changing consumer preferences for particular games, game systems and categories of games. Games fall into one of several categories including sports, adventure, action, role playing and family games. The Company provides the opportunity for video game consumers to sell video game merchandise in exchange for store credit or a check from corporate headquarters. The price the Company will pay for each item of previously played merchandise is posted in the stores and is periodically adjusted, providing video game enthusiasts a reason to stop in on a regular basis. By maintaining a secondary market for video games and equipment, the Company reduces the overall cost of playing video games and encourages the purchase of new games and upgrades to more advanced systems. The Company believes that this active secondary market helps to expand consumer interest in video games and increases overall purchases of video games and equipment. PRODUCT SUPPLY The Company purchases new interactive entertainment hardware, software and accessories from the industry's leading licensees and manufacturers and generally has achieved top ten account status with these vendors, indicative of the Company's market share position and growth. The Company has established strong relationships within the industry and has successfully participated in the launch of many new products. Vendors support the FUNCOLAND previously played concept because it promotes interest in the video game industry, introduces the category to customers unable to afford higher new game prices and offers video game enthusiasts the opportunity to sell older games, providing liquidity to stimulate new game purchases. Because the Company is a significant retailer of these vendors' new games, the Company receives cooperative advertising funds and immediate access to hot new game releases, which tend to drive store traffic. The Company expects that new product quality, pricing, availability, acceptance and market penetration will affect future operating results. The Company obtains most of its previously played inventory from its customers, primarily from purchases made in its retail operations. Over the last nine years the Company has developed and utilized a model to manage its previously played inventory and to maintain the desired mix of product. The Company adjusts the price that it pays for each item of previously played merchandise (the "bid" price) regularly and currently adjusts its selling price (the "ask" price) on a monthly basis. All purchase and selling prices are determined by corporate management and are not subject to change at the store level. By adjusting these bid and ask prices, the Company strives to maintain substantial company-wide control over both its inventory levels, as well as its gross margins, on an item-by-item basis. Through its bid/ask model, the Company accumulates inventory to stock new stores as they open and to meet seasonal demands. All new stores are initially set up with inventory shipped from the Company's central distribution center. This start-up inventory includes previously played merchandise accumulated from customers at the store level as well as new products purchased directly from video game licensees and manufacturers. Once a store opens, approximately 80% of its previously played stock 4 needs are satisfied by merchandise purchased from the store's local customer trading base, with the remainder supplied by the Company's distribution center. Periodic pull-backs of inventory from the Company's stores to the distribution center provide merchandise for store-to-store stock balancing and new store openings. STORE LOCATIONS AND SITE SELECTION At March 28, 1999, the Company operated 312 FUNCOLAND stores in 26 metropolitan markets. The number of stores open in these markets at each respective year end date is summarized below:
MARCH 28, MARCH 29, MARCH 30, MARCH 31, APRIL 2, 1999 1998 1997 1996 1995 --------- --------- --------- --------- -------- Central Region: Minneapolis ....................... 15 15 14 13 13 Dallas ............................ 13 12 12 12 14 Houston ........................... 8 8 8 7 9 Chicago ........................... 32 31 30 30 34 Milwaukee ......................... 8 8 6 6 6 Detroit ........................... 28 28 24 21 21 Kansas City ....................... 5 5 5 5 5 Columbus .......................... 4 4 - - - Indianapolis ...................... 4 4 - - - Louisville ........................ 7 4 - - - St. Louis ......................... 5 5 - - - Cincinnati ........................ 6 5 - - - Cleveland ......................... 12 2 - - - Austin/San Antonio ................ 6 - - - - Memphis ........................... 4 - - - - Nashville ......................... 3 - - - - Pittsburgh ........................ 3 - - - - --- --- --- --- --- Subtotal Central Region ............ 163 131 99 94 102 East Coast Region: New York .......................... 41 39 36 37 38 Philadelphia ...................... 21 21 16 15 16 Baltimore/Washington, DC .......... 20 18 15 16 16 Boston ............................ 18 15 13 11 10 Virginia Beach/Richmond ........... 7 - - - - --- --- --- --- --- Subtotal East Coast Region ......... 107 93 80 79 80 West Coast Region: San Francisco ..................... 13 12 9 - - Sacramento ........................ 8 6 - - - Seattle ........................... 10 8 - - - Los Angeles ....................... 11 - - - - --- --- --- --- --- Subtotal West Coast Region ......... 42 26 9 - - --- --- --- --- --- Total Stores ....................... 312 250 188 173 182 === === === === ===
FUNCOLAND stores are generally located in high traffic "power strip centers" near major regional malls or in high-density retail areas. These locations provide visibility, easy access and high traffic counts. The Company targets centers that are well recognized, well maintained and have a balanced tenant mix. STORE LAYOUT AND DESIGN FUNCOLAND stores range in size from 1,000 to 3,000 square feet, with the average store containing approximately 1,650 square feet. The basic design of a FUNCOLAND store is generally consistent throughout the Company and is intended to create a bright and colorful shopping environment with 5 well-merchandised shelves emphasizing the store's broad product selection. Stores are equipped with several television monitors that display operating video games, creating an environment conducive to video game purchase. Each store is also equipped with several video game sampling areas that provide the consumer the opportunity to play games before purchase. FUNCOLAND SUPERSTORE WEB SITE The Company operates the FUNCOLAND SUPERSTORE Web site, www.funcoland.com, which provides consumers an exciting means of secure, direct on-line shopping for new and previously played video game products. The Company's site features an interactive database of approximately 5,000 items for sale including software, hardware, accessories, movies and other related products. The Company recently expanded the Superstore offerings to include new PC entertainment software titles and also began offering both new and previously played products as a charter merchant of Amazon.com Auctions. The Superstore site attracts visitors with schedules of new game arrivals, reviews of new and classic games, game tips and other compelling content. The Web site also acts as a promotional tool to drive customer traffic to the Company's retail outlets via an interactive store directory. Internet sales have grown dramatically since the launch of the Web site, increasing more than 424% to $1,572,000 in fiscal 1999 from $300,000 in fiscal 1998. The Company's Internet operations are profitable at the current level of sales. The Company expects continued strong growth in Internet sales. MAIL ORDER The Company's mail order operation is primarily engaged in selling video games and related equipment from its headquarters in Eden Prairie, Minnesota. The Company mails a bi-monthly video game catalog to approximately 60,000 customers who generally live in geographic areas not served by FUNCOLAND retail stores. In addition, the Company places direct response advertising in several leading video game magazines. Mail order transactions accounted for approximately 1% of total sales in fiscal 1999. GAME INFORMER MAGAZINE The Company publishes GAME INFORMER, a monthly video game magazine featuring reviews of new title releases, tips and secrets about existing games and news regarding current developments in interactive entertainment. For its March 1999 issue, the magazine had more than 195,000 paid subscribers. The magazine is sold via subscription and through displays in FUNCOLAND retail stores. Revenues are also generated through the sale of advertising space. GAME INFORMER is published by Sunrise Publications, Inc., a wholly-owned subsidiary of Funco, Inc. Video game enthusiasts can also access the popular content of GAME INFORMER magazine through the FUNCOLAND SUPERSTORE as well as the dedicated GAME INFORMER Web site at www.gameinformer.com. COMPETITION The console-based video game retailing business currently can be categorized into the following segments: mass merchandisers such as Target, Wal-Mart and Kmart; national retail chains that specialize in computer software such as Babbage's Etc. and Electronics Boutique; toy retailers including Toys "R" Us and KB Toys; consumer electronics superstores such as Best Buy and Circuit City; department store chains and other entertainment product retailers. Each of these segments historically has played a different role in the life cycle of video game products, with specialty retailers being the most important channel at a product's launch and mass merchants and consumer electronics retailers increasing in importance over time as a product's price decreases. A number of competitors, including Babbage's Etc. and Electronics Boutique, also feature trade-in opportunities through which consumers are able to realize value for their previously played product. These retailers then sell the previously played product in their stores. There can be no assurance that these competing retailers, many of whom have substantially greater resources than the Company, will not move more aggressively into the previously played market, thereby becoming direct competitors in both the new and previously played categories. Additionally, retailers which deeply discount new merchandise may also compete on price with Funco's previously played products. 6 Previously played video game merchandise is sold primarily through regional and local companies, although, as described above, Babbage's Etc. and Electronics Boutique also participate in the purchase and sale of previously played products. With 312 stores in 26 metropolitan areas at March 28, 1999, the Company is the nation's leading specialty retailer focusing largely on previously played product. The Company is aware of a limited number of smaller companies with stores in the United States, including It's About Games and MicroPlay, that buy and sell previously played video games through company-owned and franchised stores. In addition to competing with these specialty retail operations in its current geographic markets, the Company frequently competes with smaller businesses which buy and sell previously played video game merchandise. The Company also competes with movie/video rental outlets such as Blockbuster and Hollywood Video that rent or sell new or previously played games. For some consumers, renting a video game for multiple day rates is an alternative to buying new or previously played games. The Company believes that video game rental outlets historically have not been substantial competitors of the Company and that they have, in fact, supported the sale of video game products by maintaining consumer interest in interactive home entertainment and by providing consumers the opportunity to sample games and systems before purchase. However, there can be no assurance that the rental or sale of video games in these rental outlets will not become a significant source of competition to the Company in the future. Hollywood Video has publicly stated an intent to significantly expand their presence in the video game category. Due to the strength of the interactive entertainment industry over the past three years, the Company believes that both existing competitors and new entrants may intensify competitive efforts. The Company may be required to compete with other retailers in its existing markets, as it expands into new markets, and on the Internet. The Company believes that it competes on the basis of broad selection, price, customer service and convenience and that it measures favorably against competition with respect to these factors. To date, video games and equipment have been distributed primarily through retail stores. Other distribution channels for interactive entertainment include on-line retailing and gaming over the Internet. Although the Company believes that alternate delivery systems tend to broaden exposure and promote interactive entertainment, there can be no assurance that any such means of distributing games will not reduce sales of interactive video games and equipment through the Company's retail stores. Any such reduction could materially adversely affect the Company's operating results and financial condition. The market for interactive entertainment products is characterized by rapidly changing technology and user preferences, evolving industry standards and frequent new product introductions. Game systems introduced in the past four years include Sega Saturn, Sony PlayStation and Nintendo 64. Of these, Sony PlayStation and Nintendo 64 currently dominate the market. The first of the next generation systems, Sega Dreamcast, is scheduled for U.S. introduction in September 1999, with new offerings from Sony and Nintendo expected in calendar 2000 and 2001. Although the Company believes that its concept of creating a secondary market for previously played games and equipment applies to the systems currently on the market, there can be no assurance that future systems and technology will gain market acceptance with consumers or that the Company can successfully operate a secondary market for such future products. TRADEMARKS AND SERVICE MARKS FUNCOLAND(R), FUNCO LAND(R), FUNCO(R), GAME INFORMER(R), EXPERIENCE THE FUN AT FUNCOLAND(R), FUNCOLAND YOUR SOURCE FOR INTERACTIVE ENTERTAINMENT(R), BRING HOME THE FUN(R), FUNCOLAND FUN CLUB(R), AMERICA'S PLACE TO SHOP FOR VIDEO GAMES(R), FUNCOLAND NATIONAL VIDEO GAME CHAMPIONSHIPS(R), SUNRISE PUBLICATIONS(R), FUNCOLAND, PLUS DESIGN(R) (claim of colors) and MORE VIDEO GAMES AT HALF THE PRICE(R) have been registered as trademarks and service marks by the Company with the United States Patent and Trademark Office (the "USPTO"). The Company believes these trademarks and service marks are of considerable value to its business and important to its marketing efforts. EMPLOYEES At March 28, 1999, the Company had 867 full-time employees, including 189 corporate and administrative personnel and 678 store personnel, and 980 part-time employees. During seasonal peak periods, the Company adds temporary part-time employees. 7 ITEM 2. PROPERTIES All of the Company's retail stores are leased. Leases typically provide for an initial three-year term, with varying options for renewal. The Company operated 312 locations at March 28, 1999, which included 13 leases under negotiation. The Company's remaining retail store leases effective as of March 28, 1999 expire as follows: DURING NUMBER OF FISCAL YEAR EXPIRING LEASES ----------- --------------- 2000 63 2001 109 2002 76 2003 22 2004 23 Thereafter 6 For information regarding minimum lease payments, see Note 3 of Notes to Consolidated Financial Statements. The Company believes that the termination of any particular lease would not have a material adverse effect on its business and that similar locations on comparable terms would be available within the same or in a contiguous market area. In addition to its retail outlets, the Company leases a 50,000 square foot distribution and office facility in Eden Prairie, Minnesota, where its corporate headquarters is also located. Subsequent to fiscal year end, the Company has leased an additional 8,000 square feet for its distribution center and office facility. This lease expires June 30, 2002. The Company has a three-year renewal option for this space. ITEM 3. LEGAL PROCEEDINGS The Company and its Chief Executive Officer were named as defendants in a civil lawsuit filed on August 17, 1995 in the United States District Court, District of Minnesota, entitled Christopher Cannon v. Funco, Inc. and David R. Pomije. The plaintiff purported to represent a class of all purchasers of the Company's common stock during the putative class period May 18, 1994 through December 15, 1994. On October 18, 1996 the court dismissed the state common law claims with prejudice and dismissed the federal securities claims without prejudice, giving the plaintiff leave to file an Amended Complaint. The plaintiff filed an Amended Complaint on January 6, 1997, a similarly styled class action lawsuit, alleging the Company's share price was artificially inflated, asserting various claims under the Securities Exchange Act of 1934, as amended, seeking damages in an unspecified amount plus costs and attorney's fees. A settlement agreement was negotiated between the parties and was approved by the court on April 30, 1999. The settlement had no material impact on the Company's results of operations, financial condition or liquidity. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS No matter was submitted to a vote of security-holders during the quarter ended March 28, 1999. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock was first traded publicly on August 12, 1992. The stock is listed on the NASDAQ national market system under the symbol FNCO. The table below presents the high and low closing prices of the Company's common stock as reported by NASDAQ.
1999 Fiscal Quarter 1998 Fiscal Quarter ------------------------------------ ----------------------------------- High Low High Low ----------------- ------------------ ----------------- ----------------- First $19 1/4 $12 5/16 $19 $13 1/4 Second 17 11/16 11 5/16 23 18 1/8 Third 18 1/4 10 3/16 24 13 1/4 Fourth 18 7/8 12 18 7/8 13 1/8
At June 15, 1999, there were 5,954,181 shares of common stock outstanding, held by 182 shareholders of record. The Company has not paid any cash dividends on its common stock and does not anticipate paying cash dividends in the foreseeable future. Under the Company's current bank credit agreement, the Company is prohibited from paying dividends. 8 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (in thousands, except share and per share data and number of stores)
YEAR ENDED ----------------------------------------------------------------- MARCH 28, MARCH 29, MARCH 30, MARCH 31, APRIL 2, 1999 1998 1997 1996 1995 --------- --------- --------- --------- -------- Statements of Operations Data Net sales ................................ $ 206,673 $ 163,316 $ 120,555 $ 81,382 $ 80,365 Net income (loss) ........................ $ 9,710 $ 8,270 $ 5,350 $ 205 $ (1,275) Net income (loss) per share, basic ....... $ 1.60 $ 1.35 $ 0.90 $ 0.03 $ (0.22) Weighted average number of shares, basic ................................... 6,077,986 6,137,161 5,941,744 5,861,682 5,786,719 Net income (loss) per share, diluted ..... $ 1.53 $ 1.26 $ 0.86 $ 0.03 $ (0.22) Weighted average number of shares, diluted ................................. 6,353,311 6,572,365 6,228,630 5,965,769 5,786,719 Stores open at end of year ............... 312 250 188 173 182 Balance Sheet Data Total assets ............................. $ 55,140 $ 45,626 $ 31,745 $ 25,668 $ 23,160 Long-term obligations .................... $ 213 $ 156 $ 91 $ 115 $ 485 Shareholders' equity ..................... $ 38,836 $ 33,525 $ 24,318 $ 18,071 $ 17,800
The above selected financial data should be read in conjunction with the consolidated financial statements and related notes beginning on page 19 of this report and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing in Item 7 hereof. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Company has grown from three retail stores at the end of fiscal 1991 to 312 at the end of fiscal 1999. The Company has 163 stores in the Central Region, which includes Minneapolis, Dallas, Houston, Chicago, Milwaukee, Detroit, Kansas City, Columbus, Indianapolis, Louisville, St. Louis, Cincinnati, Cleveland, Austin/San Antonio, Memphis, Nashville and Pittsburgh; 107 stores in the East Coast Region, which includes New York, Philadelphia, Baltimore/Washington, D.C., Boston and Virginia Beach/Richmond; and 42 stores in the West Coast Region, which includes San Francisco, Sacramento, Seattle and Los Angeles. 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. 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. In addition to seasonality, key factors affecting net sales and profitability include the number of stores in operation and their relative maturities, new store openings, location of stores and customer demographics, merchandise selection, new product acceptance, competition and effectiveness of marketing techniques. Management believes that most new stores will attain mature store sales levels in their second full year of operation and thereafter may experience only modest year-to-year sales growth. No assurance can be given, however, that new stores will achieve, or that mature stores will sustain, desired operating 9 results and profitability. In addition, there can be no assurance of maintaining sales and profitability at the levels achieved during fiscal 1999. RESULTS OF OPERATIONS The following table sets forth certain items in the statements of income expressed as percentages of net sales for the years indicated and percentage changes from the prior year:
PERCENTAGE YEAR ENDED INCREASE/DECREASE ------------------------------------- ----------------------- MARCH 28, MARCH 29, MARCH 30, 1999 OVER 1998 OVER 1999 1998 1997 1998 1997 --------- --------- --------- --------- --------- Net sales .............................. 100.0% 100.0% 100.0% 26.5% 35.5% Cost of sales .......................... 67.1 65.3 63.1 30.1 40.1 ----- ----- ----- Gross profit ........................... 32.9 34.7 36.9 19.9 27.6 Operating expenses ..................... 20.2 20.7 23.4 23.8 19.4 General and administrative expenses..... 5.1 5.8 7.1 11.3 10.7 ----- ----- ----- Operating income ....................... 7.5 8.2 6.3 16.2 77.1 Interest expense ....................... - - - (40.0) (35.5) Interest income ........................ 0.2 0.2 0.2 41.4 42.5 Income tax provision ................... 3.0 3.3 2.0 15.8 125.6 ----- ----- ----- Net income ............................. 4.7% 5.1% 4.4% 17.4% 54.6% ===== ===== =====
COMPARISON OF FISCAL 1999 TO FISCAL 1998 The Company derived 98% of its fiscal 1999 net sales from retail operations, which include the Company's mail order and Web site operations. The balance of net sales was attributable to the publication of GAME INFORMER magazine. Net sales increased from $163,316,000 in fiscal 1998 to $206,673,000 in fiscal 1999, an increase of 26.5%. The Company operated 312 stores at the end of fiscal 1999 compared to 250 stores at the end of fiscal 1998. During fiscal 1999, the Company opened 64 new stores while closing 2 locations. Comparable stores sales for fiscal 1999 increased 9%. The strong sales increase is primarily due to operating a greater number of stores compared to the prior year and continued growth of Sony PlayStation, Nintendo 64 and Game Boy product categories. Cost of sales increased from $106,628,000 in fiscal 1998 to $138,693,000 in fiscal 1999, an increase of 30.1%. 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 65.3% in 1998 to 67.1% in 1999. This increase is primarily due to a shift in sales mix from previously played product to lower margin new product which accounted for 61% of sales in fiscal 1999 compared to 48% in fiscal 1998. Operating expenses increased from $33,746,000 in fiscal 1998 to $41,792,000 in fiscal 1999, an increase of 23.8%. This increase is primarily due to higher store payroll and occupancy expense related to the increased number of locations compared to prior year and also to support the 9% increase in comparable store sales. Operating expenses decreased favorably as a percentage of net sales from 20.7% in 1998 to 20.2% in 1999, the result of leveraging certain costs over a larger sales base. General and administrative expenses increased from $9,512,000 in fiscal 1998 to $10,587,000 in fiscal 1999, an increase of 11.3%. This increase is primarily due to increased payroll to support corporate functions for a growing number of stores. General and administrative expenses decreased favorably as a percentage of net sales from 5.8% in 1998 to 5.1% in 1999, the result of leveraging certain costs over a larger sales base. The Company generated operating income of $15,601,000 in fiscal 1999 compared to operating income of $13,430,000 in fiscal 1998, an increase of 16.2%. Interest expense decreased from $20,000 in fiscal 1998 to $12,000 in fiscal 1999, a decrease of 40.0%, as the Company reduced borrowings on its line of credit compared to prior year. 10 Interest income increased from $295,000 in fiscal 1998 to $417,000 in fiscal 1999, an increase of 41.4%, primarily as the Company maintained a higher level of cash and cash equivalents and short-term investments throughout most of fiscal 1999, as compared to fiscal 1998. The Company generated net income before taxes of $16,006,000 in fiscal 1999 compared to net income before income taxes of $13,705,000 in fiscal 1998, an increase of 16.8%. As a result, the Company recorded income tax expense of $6,296,000 in fiscal 1999 compared to income tax expense of $5,435,000 in fiscal 1998. Due to the above factors, the Company generated net income of $9,710,000 in fiscal 1999, or $1.53 per share, compared to net income of $8,270,000, or $1.26 per share in fiscal 1998. COMPARISON OF FISCAL 1998 TO FISCAL 1997 The Company derived approximately 97% of its fiscal 1998 net sales from retail operations, which include the Company's mail order and Web site operations. The balance of net sales was attributable to the publication of GAME INFORMER magazine. Net sales increased from $120,555,000 in fiscal 1997 to $163,316,000 during fiscal 1998, an increase of 35.5%. The Company operated 250 stores at the end of fiscal 1998 compared to 188 stores at the end of fiscal 1997. During fiscal 1998 the Company opened 65 new stores while closing 3 locations. Comparable store sales for fiscal 1998 increased 17%. The Company attributes the strong sales to continued growth of Sony PlayStation and Nintendo 64 product categories. Cost of sales increased from $76,119,000 in fiscal 1997 to $106,628,000 during fiscal 1998, an increase of 40.1%. The dollar increase in cost of sales was primarily due to the strong growth in sales. Cost of sales as a percentage of net sales increased from 63.1% in 1997 to 65.3% in 1998. This increase occurred primarily as sales mix for fiscal 1998 included proportionately higher sales of 32- and 64-bit products, which are currently sold at higher cost percentages than earlier generation product offerings. Operating expenses increased from $28,261,000 in fiscal 1997 to $33,746,000 in fiscal 1998, an increase of 19.4%. This increase was primarily due to higher store payroll and occupancy expense related to the increased number of locations compared to prior year. Operating expenses as a percentage of net sales decreased from 23.4% in fiscal 1997 to 20.7% in fiscal 1998, the result of improved sales leveraging. General and administrative expenses increased from $8,592,000 in fiscal 1997 to $9,512,000 in fiscal 1998, an increase of 10.7%. The dollar increase was primarily due to increased payroll to support corporate functions for a growing number of stores. General and administrative expenses decreased as a percentage of net sales from 7.1% in fiscal 1997 to 5.8% in fiscal 1998, the result of improved sales leveraging. The Company generated operating income of $13,430,000 in fiscal 1998 compared to $7,583,000 in fiscal 1997, an increase of 77.1%. Interest expense decreased from $31,000 in fiscal 1997 to $20,000 in fiscal 1998, a decrease of 35.5%, as the Company reduced borrowings on its line of credit compared to prior year. Interest income increased from $207,000 in fiscal 1997 to $295,000 in fiscal 1998, an increase of 42.5%, as the Company maintained higher levels of cash and cash equivalents throughout most of fiscal 1998 as compared to fiscal 1997. The Company reported an income tax provision of $5,435,000 in fiscal 1998 compared to $2,409,000 in fiscal 1997, as the Company generated net income before taxes of $13,705,000 in fiscal 1998 compared to $7,759,000 in fiscal 1997. The effective tax rate increased primarily as the Company had reversed a significant valuation allowance in fiscal 1997, which had favorably impacted the fiscal 1997 tax provision. As a result of the above factors, the Company generated net income of $8,270,000, or $1.26 per share in fiscal 1998 compared to $5,350,000, or $0.86 per share in fiscal 1997. SEASONALITY AND QUARTERLY RESULTS 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. For the 248 stores operating the full 12 months in fiscal 1999, 36% of net sales occurred in the first half of the year with 64% in the second half of the 11 year. Accordingly, annual profitability is heavily dependent on third and fourth quarter net sales. 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 factors mentioned above, results for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year. Net sales, gross profit, operating income, net income and basic and diluted income per share for the past eight fiscal quarters, together with the number of stores open at the end of each quarter, are presented in the following table:
(IN THOUSANDS, EXCEPT PER SHARE DATA AND NUMBER OF STORES) FISCAL 1999 FISCAL 1998 ---------------------------------------- ---------------------------------------- 1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- ------- ------- ------- ------- Net sales .......................... $32,894 $35,299 $82,889 $55,591 $24,001 $26,760 $67,036 $45,519 Gross profit ....................... $11,630 $12,262 $24,840 $19,248 $ 9,412 $ 9,805 $20,623 $16,848 Operating income ................... $ 714 $ 842 $ 8,843 $ 5,202 $ 946 $ 796 $ 6,675 $ 5,013 Net income ......................... $ 500 $ 560 $ 5,395 $ 3,255 $ 635 $ 535 $ 4,155 $ 2,945 Basic income per share ............. $ 0.08 $ 0.09 $ 0.90 $ 0.55 $ 0.10 $ 0.09 $ 0.67 $ 0.48 Diluted income per share ........... $ 0.08 $ 0.09 $ 0.87 $ 0.53 $ 0.10 $ 0.08 $ 0.63 $ 0.45 Stores open at quarter end ......... 252 270 310 312 193 215 249 250
Although the results presented above may not be indicative of future trends or performance, the Company anticipates that quarterly net sales and operating results will continue to be significantly impacted by seasonality patterns. LIQUIDITY AND CAPITAL RESOURCES The Company's primary ongoing financing requirements are for new store expansion and inventory. During fiscal 1999, 1998 and 1997, the Company had net cash provided by operating activities of $9,043,000, $6,904,000 and $3,451,000, respectively. During fiscal 1999, the operating items which most significantly impacted cash were net income, depreciation expense and an increase in inventory offset by an increase in accounts payable. In fiscal 1999, the Company used $5,220,000 of cash to repurchase 414,800 shares of the Company's common stock. In addition, the Company issued 124,583 shares of stock through the exercise of stock options at prices ranging from $1.33 to $15.92 per share, generating net proceeds, including tax benefits, of $821,000. The Company invested $6,838,000 in capital expenditures in fiscal 1999, primarily for new store openings and the Company's point-of-sale register conversion. During fiscal 2000, the Company plans to incur capital expenditures of approximately $7,650,000 for new store openings, other store expenditures, enhancements to store and corporate information systems and general corporate purposes. The Company has a $3,000,000 unsecured revolving credit facility with a commercial bank, seasonally increasing to $10,000,000. The interest rate on outstanding borrowings under the credit facility is based upon LIBOR plus 250 basis points (7.45% for the month ended March 28, 1999). The credit facility requires the Company to maintain certain financial ratios and achieve certain operating results. There were no borrowings outstanding under the credit facility at March 28, 1999 or March 29, 1998. YEAR 2000 READINESS PLAN The Company's year 2000 readiness plan is primarily directed towards ensuring that the Company will be able to perform its critical functions: (1) accurately process sale and purchase transactions through its retail, mail order, and web site operations, (2) order and receive merchandise from vendors, (3) make appropriate decisions as to inventory pricing and distribution and (4) assure integrity of business operations, controls and financial reporting. 12 The Company is involved in an ongoing assessment of its year 2000 readiness and is undergoing a company-wide program of adapting its computer systems and applications for the year 2000. Substantially all in-house developed software has been written to be year 2000 compliant. Recently completed upgrades of important applications, including inventory management, transfer management, merchandise information and financial systems were designed to be year 2000 compliant. Several less critical in-house applications and third party packages require year 2000 modification. All of the Company's systems and applications are included in the Company's ongoing year 2000 readiness efforts. The Company is also in the process of assessing year 2000 issues associated with its various business partners, including vendors and service providers, and is actively working with these third parties to identify and mitigate common risks. The Company is also engaged in the assessment of year 2000 issues affecting its telephone and communication systems, distribution processes, utilities, alarm systems and transportation services. RISKS The variety, nature and complexity of year 2000 issues, the dependence on technical skills and expertise of Company employees and independent contractors and issues associated with the readiness of third parties are factors which could result in the Company's efforts toward year 2000 compliance being less than fully effective. Failure to properly assess and correct year 2000 issues could result in materially adverse financial consequences through an inability to adequately process retail, mail order or web site transactions, or due to the failure of the Company's systems to provide accurate information for ordering, pricing or distributing merchandise. Accurate financial reporting is dependent upon year 2000 compliance. Failures caused by vendors not being year 2000 compliant could lead to delays in receiving product shipments, and to a resulting loss of sales. Year 2000 compliance difficulties on the part of financial institutions could interfere with cash collections, payments and funding for the Company. In addition to the above, the Company believes that other unidentified risks could be associated with failure of year 2000 compliance by the Company or third parties. READINESS PROGRESS A summary of the Company's critical systems and progress toward year 2000 readiness is as follows: Store systems include software applications and hardware that process transactions in the retail stores and enable communication of information between stores and the Company's corporate offices. These systems include a new third party software package which was installed in FUNCOLAND store locations between August 1998 and April 1999. Each store's hardware configuration includes a new server installed at the same time as the new software, and generally includes earlier installed hardware components. Although the new software and new hardware are believed to be year 2000 compliant, full testing is currently in process. Year 2000 readiness of the Company's store systems is approximately 50% complete. Financial systems primarily consist of a series of third party software modules installed between March 1998 and August 1998. These systems are used for accounting, control and financial reporting. The systems are currently being tested to recognize transactions over a wide range of critical dates. Year 2000 readiness of the Company's financial systems is approximately 80% complete. Corporate systems encompass in-house developed software applications and recently upgraded systems performing functions including inventory management, transfer management and merchandise information. These in-house developed software applications were designed for year 2000 readiness, but are undergoing comprehensive evaluation and testing. Year 2000 readiness of the Company's corporate systems is approximately 30% complete. CONTINGENCY PLANS Based on progress and efforts to date, the Company believes that its program of assessment, testing and correcting, along with selected system upgrades, will enable it to successfully meet the year 2000 challenge. The Company is in the process of completing a formal contingency plan and, in the event of failures associated with year 2000 readiness, believes that adequate resources could rapidly be directed 13 toward correcting isolated internal failures. The plan includes supplementing those systems and processes which are year 2000 ready with alternate means of data collection, storage and retrieval. It also includes alternative means of communication between the Company's corporate office, distribution center, store locations, vendors and customers. The plan's objective is to assure continuity in performing critical functions, but includes risks associated with third party service providers. COSTS As of March 28, 1999, the Company had incurred costs of less than $100,000 related to year 2000 readiness, including testing, analysis and purchase of software upgrades. Total costs associated with year 2000 readiness are expected to be less than $500,000. However, there can be no assurance that costs will not exceed this level. The Company does not expect to incur material costs associated with the use of external resources. FORWARD LOOKING STATEMENTS Statements in this document with respect to future sales prospects and expansion plans are forward looking statements and are subject to uncertainties from factors including growth of the industry, the competitive environment, success of the Company's existing operations, availability of new store sites and the Company's ability to finance new store expansion. Future financial performance greatly depends upon the Company's ability to effectively manage a base of profitable stores. The Company plans further significant expansion, including accelerated growth of approximately 90 new stores in fiscal 2000, and believes that the addition of new stores will continue to be a primary component of the Company's ongoing growth. Although the Company believes that it has effectively managed its growth in the past, there can be no assurance that the Company will successfully continue its planned expansion, that new stores will perform as anticipated or that existing stores will continue to operate at profitable levels. The Company's ability to open and operate new stores profitably will depend upon a number of factors including, but not limited to, availability of suitable locations, negotiation of acceptable lease terms, ability to attract, train and retain qualified personnel and the ability to control other operational aspects of the Company's growth. In addition to site selection and lease negotiation, lease renewals are another factor that may impact the Company's performance. The Company believes that the termination of any particular lease would not have a material adverse effect on its business because similar locations on comparable terms would be available within the same or in a contiguous market area. However, the Company's results of operations and financial condition could be adversely impacted should the Company be unable to either renew leases or relocate a material number of store locations. The ability of the Company to expand and operate stores profitably can also be dependent upon the ability of the Company to obtain requisite financing. There can be no assurance that such financing will be available to the Company at terms acceptable to the Company, or at any terms. The ability of the Company to obtain any future financing through additional issuance of stock to the public would be highly dependent upon the market price for the Company's securities. The market price for shares of the Company's Common Stock may be highly volatile depending on various factors such as the general economy, stock market conditions, announcements by the Company, its vendors or competitors, announcements of technological innovations or products that may affect the Company's business, fluctuations in the Company's operating results and performance of the Company compared to market expectations. The interactive entertainment retailing business is highly competitive and subject to rapid changes in consumer preferences, pricing and technology. As the Company offers both previously played and new product, it competes with other sellers of previously played product and with retailers of new interactive entertainment, many of which are large nationally recognized retail chains. (See Item 1. Business -- Competition.) There can be no assurance that the Company can continue to compete successfully in the sale of either new or previously played product. Increased competition, in addition to adversely impacting sales, could also negatively impact product margins, materially impacting operating profits. In addition, new distribution channels for interactive entertainment, such as on-line retailing, Internet gaming or other alternate delivery systems may adversely impact future sales of product through retail 14 stores such as the Company's. Video games also compete for the consumers' dollar with many other forms of entertainment such as sporting events, movies, music and books. Any decrease in video game popularity or shift to other such forms of entertainment would adversely impact the Company's results of operations and financial condition. Although the Company attempts to maintain product mix and inventory levels that will meet consumer demand, it may not be successful in anticipating and responding to changing consumer preferences. The ability to offer the proper merchandise assortment is important to the Company's future financial performance. Overstocked, understocked or unbalanced inventories can occur due to factors including misjudgments by the Company in assessing product demand or establishing prices, vendor allocations, logistical difficulties or potential limitations of the Company's management information systems. The interactive entertainment industry periodically undergoes technological advances and developments. Failure to appropriately respond to changing technological developments could materially adversely impact the Company's results of operations and financial condition. Introduction of new hardware systems, or the anticipated introduction of such systems, may affect consumer demand for existing games, hardware and accessories. Further, new games must continually be developed for the new hardware. Neither the development of new hardware or games nor the timing of release of new products is within the control of the Company. The continued successful release of new interactive entertainment product that is accepted by consumers is very important to the Company's business, both for increasing sales and encouraging consumers to visit the stores to buy and sell product. Changes in hardware systems may impact the Company's business both for previously played product and for new product as consumers determine whether to move to new systems or to continue purchasing games for existing systems. Also, delays in the introduction of new product may adversely affect consumer interest in the overall interactive entertainment product category. (See Item 1. Business -- Industry Overview.) The Company's business is highly seasonal with the majority of net sales and net income being generated in the third and fourth fiscal quarters which includes the holiday selling season. Accordingly, events, factors or trends which impact those quarters could materially impact full year results. General economic conditions such as high unemployment, high inflation or a falling stock market could lead consumers to reduce expenditures and impact the results of operations and financial conditions. Seasonal patterns can also intensify the impact of factors such as a shortage of qualified employees or adverse weather conditions. Although important in every quarter, failure by the Company to adequately obtain new or previously played inventory or failure by manufacturers to deliver key product either to the marketplace or to the Company would be magnified should those events occur during the fiscal third or fourth quarters. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's operations are not currently subject to market risks relating to interest rates, foreign currency exchange rates, commodity prices or other market price risks of a material nature. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Financial statements required by this item can be found beginning on page 19 of this Form 10-K and are deemed incorporated herein by reference. Supplementary data required by this item can be found on page 12 of this Form 10-K and are deemed incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 15 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item 10 is incorporated by reference from the Proxy Statement sections entitled "Election of Directors," "Other Executive Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance." ITEM 11. EXECUTIVE COMPENSATION The information required by this Item 11 is incorporated by reference from the Proxy Statement sections entitled "Election of Directors-Directors' Compensation", "Report of the Compensation Committee" and "Executive Compensation." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item 12 is incorporated by reference from the Proxy Statement section entitled "Ownership of Common Stock." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. 16 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Financial Statements The financial statements and schedule filed as part of this Annual Report on Form 10-K are described in the Index to Consolidated Financial Statements and Schedule on page 19. All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable and therefore have been omitted. (b) Reports on Form 8-K No reports on Form 8-K were filed during the last quarter of the period covered by this report. (c) Exhibits EXHIBIT NUMBER DESCRIPTION - ------- ------------------------------------------------------------------- 3.1 Articles of Incorporation, as amended and restated to date (Note 1) 3.2 Bylaws as Amended and Restated to Date 10.1a Credit Agreement effective June 20, 1995 by and between the Registrant and Marquette Capital Bank, including Revolving Credit Note and Security Agreement (Note 2) 10.1b Amendment to Credit Agreement dated June 30, 1998 (Note 3) *10.3 Stock Option Plan for Nonemployee Directors (Note 1) *10.3a Amendment to Stock Option Plan for Nonemployee Directors effective July 31, 1998 (Note 3) *10.4 Employee Incentive Stock Option Plan (Note 1) *10.4a Amendment to Employee Incentive Stock Option Plan effective July 31, 1998 (Note 3) *10.5a 1993 Stock Option Plan as Amended and Restated to Date (Note 3) *10.5b Form of agreement for nonqualified options granted under 1993 Plan (Note 4) 10.7a Lease for corporate headquarters in Eden Prairie, Minnesota (Note 5) 10.7b Amendment to lease for corporate headquarters in Eden Prairie, Minnesota 23 Consent of Independent Auditors 27 Financial Data Schedule - ------- Note 1. Filed as an exhibit to Registration Statement on Form S-18 (SEC No. 33-49102C) ("Form S-18") filed on June 30, 1992, and incorporated herein by reference. Note 2. Filed as an exhibit to Form 10-K for fiscal year 1995, filed on July 3, 1995, and incorporated herein by reference. Note 3. Filed as an exhibit to Form 10-Q for second quarter fiscal 1999, filed on October 28, 1998, and incorporated herein by reference. Note 4. Filed as an exhibit to Amendment No. 1 on Form S-1, filed June 21, 1993, and incorporated herein by reference. Note 5. Filed as an exhibit to Amendment No. 1 to Form S-18, filed on July 27, 1992, and incorporated herein by reference. * Denotes management contract or compensation plan required to be filed as an exhibit to this form. 17 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized. FUNCO, INC. by: /s/ DAVID R. POMIJE ------------------------------------ David R. Pomije Chairman of the Board of Directors and Chief Executive Officer In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant, and in the capacities indicated, on June 28, 1999. NAME TITLE - ---- ----- /s/ DAVID R. POMIJE Chairman of the Board of Directors - ------------------------------------- and Chief Executive Officer David R. Pomije /s/ ROBERT M. HIBEN Chief Financial Officer and Secretary - ------------------------------------- Robert M. Hiben /s/ STANLEY A. BODINE Director - ------------------------------------- Stanley A. Bodine /s/ GEORGE E. MILEUSNIC Director - ------------------------------------- George E. Mileusnic /s/ PATRICK J. FERRELL Director - ------------------------------------- Patrick J. Ferrell 18 FUNCO, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE PAGE ---- CONSOLIDATED FINANCIAL STATEMENTS: Report of Management ..................................................... 20 Report of Ernst & Young LLP, Independent Auditors ........................ 21 Consolidated Statements of Income for the fiscal years ended March 28, 1999, March 29, 1998 and March 30, 1997 ................................. 22 Consolidated Balance Sheets as of March 28, 1999 and March 29, 1998 ...... 23 Consolidated Statements of Cash Flows for the fiscal years ended March 28, 1999, March 29, 1998 and March 30, 1997 ....................... 24 Consolidated Statement of Shareholders' Equity for the fiscal years ended March 28, 1999, March 29, 1998 and March 30, 1997 ................. 25 Notes to Consolidated Financial Statements ............................... 26-31 SCHEDULE: Schedule II -- Valuation and Qualifying Accounts ......................... 32 19 REPORT OF MANAGEMENT The management of Funco, Inc. is responsible for the preparation, integrity and objectivity of the accompanying consolidated financial statements. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and include amounts which are based upon estimates and informed judgments of management. In fulfilling its responsibility for the integrity of financial information, management has established a system of internal controls which provides reasonable assurance that transactions are executed in accordance with management's intention and authorization, that assets are properly safeguarded and accounted for and that financial statements are prepared in accordance with generally accepted accounting principles. The concept of reasonable assurance is based on the recognition that there are inherent limitations in all systems of internal control, and that the cost of such systems should not exceed the benefits derived. These systems are periodically reviewed and modified in response to changing conditions. The management of Funco, Inc. also recognizes its responsibility for fostering a strong ethical climate so that the Company's affairs are conducted according to the highest standards of personal and business conduct. The adequacy of the Company's internal accounting controls, accounting principles employed, scope of audit work and quality of financial reporting are reviewed by the Audit Committee of the Board of Directors, consisting solely of outside directors. The independent auditors meet with the Audit Committee to discuss auditing and financial reporting issues with or without management present. 20 REPORT OF INDEPENDENT AUDITORS Board of Directors and Shareholders Funco, Inc. We have audited the accompanying consolidated balance sheets of Funco, Inc. as of March 28, 1999 and March 29, 1998, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended March 28, 1999. Our audit also included the financial statement schedule listed in Item 14(a). These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Funco, Inc. at March 28, 1999 and March 29, 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 28, 1999, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ Ernst & Young LLP Minneapolis, Minnesota May 10, 1999 21 FUNCO, INC. CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
YEAR ENDED ----------------------------------------- MARCH 28, MARCH 29, MARCH 30, 1999 1998 1997 ---------- ---------- ---------- Net sales ........................................ $ 206,673 $ 163,316 $ 120,555 Cost of sales .................................... 138,693 106,628 76,119 ---------- ---------- ---------- Gross profit ..................................... 67,980 56,688 44,436 Operating expenses ............................... 41,792 33,746 28,261 General and administrative expenses .............. 10,587 9,512 8,592 ---------- ---------- ---------- Operating income ................................. 15,601 13,430 7,583 Interest expense ................................. (12) (20) (31) Interest income .................................. 417 295 207 ---------- ---------- ---------- Net income before income taxes ................... 16,006 13,705 7,759 Income tax provision ............................. 6,296 5,435 2,409 ---------- ---------- ---------- Net income ....................................... $ 9,710 $ 8,270 $ 5,350 ========== ========== ========== Basic Net Income Per Share: - --------------------------- Basic net income per share ....................... $ 1.60 $ 1.35 $ 0.90 Weighted average number of common shares ......... 6,077,986 6,137,161 5,941,744 Diluted Net Income Per Share: - ----------------------------- Diluted net income per share ..................... $ 1.53 $ 1.26 $ 0.86 Weighted average number of common and common equivalent shares ............................... 6,353,311 6,572,365 6,228,630
See accompanying notes. 22 FUNCO, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARES)
MARCH 28, MARCH 29, 1999 1998 ---------- ---------- ASSETS ------ Current Assets Cash and cash equivalents ...................................... $ 8,550 $ 9,295 Short-term investments ......................................... - 1,460 Accounts receivable ............................................ 2,020 2,127 Inventories .................................................... 28,485 21,487 Prepaid expenses ............................................... 2,948 1,175 Current deferred tax asset ..................................... 640 603 ------- ------- Total current assets ......................................... 42,643 36,147 Net property and equipment ...................................... 11,334 8,201 Long-term deferred tax asset .................................... 1,064 1,122 Other assets .................................................... 99 156 ------- ------- Total assets .................................................... $55,140 $45,626 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Current Liabilities Accounts payable ............................................... $ 9,831 $ 4,834 Accrued liabilities ............................................ 5,266 6,219 Deferred revenue ............................................... 994 892 ------- ------- Total current liabilities .................................... 16,091 11,945 Accrued rent .................................................... 213 156 Shareholders' Equity Common stock, $0.01 par value (issued and outstanding for 1999 and 1998, respectively: 5,894,760 and 6,184,477) ......... 59 62 Additional paid-in capital ..................................... 15,238 19,634 Retained earnings .............................................. 23,539 13,829 ------- ------- Total shareholders' equity ................................... 38,836 33,525 ------- ------- Total liabilities and shareholders' equity ...................... $55,140 $45,626 ======= =======
See accompanying notes. 23 FUNCO, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED -------------------------------------- MARCH 28, MARCH 29, MARCH 30, 1999 1998 1997 ---------- ---------- ---------- Operating Activities Net income ....................................................... $ 9,710 $ 8,270 $ 5,350 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization .................................. 3,650 3,126 3,283 Deferred tax asset ............................................. 21 (209) (964) Net loss on disposal of property and equipment ................. 123 105 133 Changes in operating assets and liabilities: Accounts receivable ........................................... 107 (1,033) (473) Inventories ................................................... (6,998) (7,656) (4,056) Prepaid expenses .............................................. (1,773) (393) 334 Accounts payable .............................................. 4,997 3,447 (1,808) Accrued liabilities ........................................... (896) 1,102 1,527 Deferred revenue .............................................. 102 145 125 -------- -------- -------- Net cash provided by operating activities ................... 9,043 6,904 3,451 Investing Activities Additions of property and equipment .............................. (6,838) (5,380) (1,548) Increase in other assets ......................................... (11) (110) (98) Purchases of short-term investments .............................. (3,075) (1,460) - Sales of short-term investments .................................. 4,535 - - Proceeds from sales of property and equipment .................... - 16 3 -------- -------- -------- Net cash used in investing activities ....................... (5,389) (6,934) (1,643) Financing Activities Payments of obligations under capital leases ..................... - (20) (80) Payments for repurchase of common stock .......................... (5,220) - - Net proceeds from issuance of common stock ....................... 821 937 897 -------- -------- -------- Net cash provided by (used in) financing activities ......... (4,399) 917 817 -------- -------- -------- Increase (decrease) in cash and cash equivalents .................. (745) 887 2,625 Cash and cash equivalents at beginning of year .................... 9,295 8,408 5,783 -------- -------- -------- Cash and cash equivalents at end of year .......................... $ 8,550 $ 9,295 $ 8,408 ======== ======== ========
See accompanying notes. 24 FUNCO, INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
TOTAL COMMON STOCK ADDITIONAL SHARE- ----------------- PAID-IN RETAINED HOLDERS' SHARES AMOUNT CAPITAL EARNINGS EQUITY ------ ------ ---------- -------- -------- Balance at March 31, 1996 ................. 5,878 $59 $ 17,803 $ 209 $ 18,071 Common stock issued, net of costs ......... 179 2 799 - 801 Tax benefits of stock options ............. - - 96 - 96 Net income ................................ - - - 5,350 5,350 ------ ------ -------- ------- -------- Balance at March 30, 1997 ................. 6,057 61 18,698 5,559 24,318 Common stock issued, net of costs ......... 127 1 634 - 635 Tax benefits of stock options ............. - - 302 - 302 Net income ................................ - - - 8,270 8,270 ------ ------ -------- ------- -------- Balance at March 29, 1998 ................. 6,184 62 19,634 13,829 33,525 Common stock issued, net of costs ......... 125 1 560 - 561 Tax benefits of stock options ............. - - 260 - 260 Repurchase of common stock ................ (414) (4) (5,216) - (5,220) Net income ................................ - - - 9,710 9,710 ------ ------ -------- ------- -------- Balance at March 28, 1999 ................. 5,895 $59 $ 15,238 $23,539 $ 38,836 ====== ====== ======== ======= ========
See accompanying notes. 25 FUNCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 28, 1999 1. SIGNIFICANT ACCOUNTING POLICIES NATURE OF BUSINESS -- Funco, Inc. operates a single business segment, providing interactive home entertainment primarily through the purchase and resale of new and previously played video games, related hardware and accessory items through its FUNCOLAND stores, mail order operation and FUNCOLAND SUPERSTORE Web site. Accordingly, additional disclosures under Statement of Financial Accounting Standards No. 131 (SFAS No. 131), "Disclosures About Segments of an Enterprise and Related Information," are not required. Funco, Inc. also publishes a video game magazine, GAME INFORMER. The Company was incorporated in Minnesota in March 1988. PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All intercompany accounts and transactions have been eliminated. REVENUE RECOGNITION -- Revenue from retail sales of the Company's products is recognized at the time of sale. Deferred revenue represents amounts received for subscriptions to a specified number of future video game magazine issues. Subscription revenue is recognized on a straight-line basis as magazine issues are delivered. ADVERTISING COSTS -- Advertising costs, included in operating expenses, are expensed as incurred and were $2,769,000, $2,309,000 and $2,898,000 for the years 1999, 1998 and 1997, respectively. FISCAL YEAR -- The Company's fiscal year ends on a Sunday on or near March 31st. The fiscal years ended March 28, 1999, March 29, 1998 and March 30, 1997 consisted of 52 weeks each. Unless otherwise stated, references to years in this report relate to fiscal years rather than calendar years. CASH EQUIVALENTS -- Cash equivalents represent investments with a maturity of three months or less at the time of purchase. Cash equivalents are recorded at cost, which approximates market. SHORT-TERM INVESTMENTS -- Short-term investments represent investments with a maturity of greater than three months at the time of purchase. Realized gains and losses and declines in value judged to be other-than-temporary on short-term investments are included in interest income. Short-term investments are recorded at cost, which approximates market. INVENTORIES -- Inventories consist of new and previously played video games, hardware and accessories and are valued at the lower of cost, determined using the first-in, first-out (FIFO) method, or market. PROPERTY AND EQUIPMENT -- Property and equipment are recorded at cost. The Company uses the straight-line method of computing depreciation based on the assets' estimated useful lives, which range from three to five years. IMPAIRMENT OF LONG-LIVED ASSETS -- The Company records impairment losses of long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amounts. INTERNAL-USE SOFTWARE -- During fiscal 1999, the Company adopted Statement of Position No. 98-1 (SOP No. 98-1), "Internal Use Software." Under SOP No. 98-1, companies are required to capitalize certain development costs related to internal-use software. The Company is amortizing these costs over five years. Total capitalized costs for fiscal 1999 were $279,000. The Company historically expensed these costs. PRE-OPENING COSTS -- During fiscal 1999, the Company adopted Statement of Position No. 98-5 (SOP No. 98-5) "Reporting on the Cost of Start-Up Activities." Under SOP No. 98-5, companies are required to expense the costs of start-up activities, including store opening costs, in the period incurred. Fiscal 1999 results were not materially impacted by the adoption. 26 FUNCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) STOCK OPTIONS -- The Company has elected to recognize compensation cost for its stock-based compensation plans in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, no compensation expense is recognized for stock options with exercise prices equal to, or in excess of, the market value of the underlying shares of stock at the date of grant. The Company follows the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 (SFAS No. 123), "Accounting for Stock-Based Compensation." NET INCOME PER SHARE -- Basic net income per share is computed based on the weighted average number of common shares outstanding during each period. Diluted net income per share includes the incremental shares assumed issued on the exercise of stock options. Unless otherwise stated, all references to income per share are calculated using the diluted method. USE OF ESTIMATES -- Preparing financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reporting amounts in the financial statements and accompanying notes. Actual results could differ from these estimates. 2. FINANCING ARRANGEMENTS The Company has a $3,000,000 unsecured revolving credit facility with a commercial bank, seasonally increasing to $10,000,000. The interest rate on outstanding borrowings under the credit facility is based upon LIBOR plus 250 basis points (7.45% for the month ended March 28, 1999). The credit facility requires the Company to maintain certain financial ratios and achieve certain operating results. There were no borrowings outstanding under the credit facility at March 28, 1999 or March 29, 1998. Total interest paid approximates interest expense for the years 1999, 1998 and 1997. 3. LEASES The Company has rental commitments for office space, retail space, office equipment and vehicles under non-cancelable operating leases. Most of these leases contain provisions for renewal options and require the Company to pay other lease related costs. Future minimum lease payments under non-cancelable operating leases consist of the following: (IN THOUSANDS) -------------------------------- 2000 $ 8,167 2001 5,686 2002 3,063 2003 1,334 2004 639 Thereafter 56 -------------------------------- Total $18,945 ================================ Rent expense was $7,904,000, $6,254,000, and $5,008,000 for the years 1999, 1998 and 1997, respectively. 27 FUNCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. NET PROPERTY AND EQUIPMENT CONSIST OF THE FOLLOWING: (IN THOUSANDS) 1999 1998 ---------------------------------------------------------------- Furniture and fixtures $ 7,474 $ 5,914 Equipment 10,528 8,025 Leasehold improvements 9,497 7,341 Other 64 64 ---------------------------------------------------------------- Gross property and equipment 27,563 21,344 Less accumulated depreciation (16,229) (13,143) ---------------------------------------------------------------- Net property and equipment $ 11,334 $ 8,201 ================================================================ 5. ACCRUED LIABILITIES CONSIST OF THE FOLLOWING: (IN THOUSANDS) 1999 1998 ---------------------------------------------------------------- Purchase credit memos payable $1,848 $1,682 Employee compensation and related taxes 1,338 1,432 Sales tax payable 940 790 Income tax payable 664 1,692 Other accrued liabilities 476 623 ---------------------------------------------------------------- Total accrued liabilities $5,266 $6,219 ================================================================ 6. STOCK OPTIONS Under the terms of the Company's various stock option plans, a maximum of 1,450,000 shares of common stock has been reserved for issuance to directors, officers and employees, upon the exercise of stock options. Annually, on May 1st, the Company reserves an additional 1% of the total number of Common Stock shares outstanding at fiscal year end. Subsequent to March 28, 1999, the Company has reserved an additional 58,948 shares for use in its stock option plan. The stock options are exercisable over periods up to ten years from date of grant and include incentive stock options and non-qualified stock options. At March 28, 1999, there were 1,038,145 options outstanding. Options exercisable at the end of years 1999, 1998, and 1997 were 544,056, 442,961, and 335,120, respectively. A summary of stock option transactions is as follows: WEIGHTED AVERAGE EXERCISE PRICE SHARES PER SHARE -------------------------------------------------------------------- Outstanding March 31, 1996 666,509 $ 6.25 Granted 286,501 8.03 Exercised (94,405) 3.13 Canceled (58,972) 7.61 -------------------------------------------------------------------- Outstanding March 30, 1997 799,633 7.16 Granted 286,936 15.37 Exercised (124,771) 5.11 Canceled (22,905) 10.90 -------------------------------------------------------------------- Outstanding March 29, 1998 938,893 9.85 Granted 270,434 13.34 Exercised (124,583) 4.57 Canceled (46,599) 13.40 -------------------------------------------------------------------- Outstanding March 28, 1999 1,038,145 $ 11.24 ==================================================================== 28 FUNCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. STOCK OPTIONS (CONTINUED) The following table summarizes information concerning outstanding and exercisable options: WEIGHTED AVERAGE WEIGHTED WEIGHTED RANGE OF REMAINING AVERAGE AVERAGE EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE - -------------------------------------------------------------------------------- $ 0 - $ 4 23,692 6.55 $ 3.31 23,692 $ 3.31 $ 4 - $ 8 227,360 5.39 5.76 206,741 5.64 $ 8 - $12 205,669 5.78 9.32 154,113 9.51 $12 - $16 543,424 7.81 14.17 145,344 14.86 $16 - $20 38,000 4.18 17.31 14,166 17.95 - ------------------------------------------------------------------------------- $ 0 - $20 1,038,145 6.72 $11.24 544,056 $ 9.42 =============================================================================== In fiscal 1999, the Company's Board of Directors authorized the repurchase of up to 700,000 shares of the Company's common stock. During fiscal 1999, Company repurchased 414,800 shares of common stock at an aggregate price of $5,220,000. In addition, the Company issued 124,583 shares of stock through the exercise of stock options at prices ranging from $1.33 to $15.92 per share, generating net proceeds, including tax benefits, of $821,000. The Company follows the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 (SFAS No. 123), "Accounting for Stock-Based Compensation." The Company has elected to continue to account for stock-based compensation plans in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," making the pro forma disclosures of net earnings and earnings per share as if the fair value-based method had been applied. Accordingly, no compensation expense is recognized for stock options with exercise prices equal to, or in excess of, the market value of the underlying shares of stock at the date of grant. Had compensation expense been recognized based on the fair value at the date of grant following provisions of SFAS No. 123, the Company's pro forma net income and net income per share would have been as follows: (IN THOUSANDS EXCEPT PER SHARE DATA) 1999 1998 1997 ------------------------------------------------------------------- Net income: As reported $9,710 $8,270 $5,350 Pro forma 8,794 7,594 5,038 ------------------------------------------------------------------- Income per common share -- basic: As reported $ 1.60 $ 1.35 $ 0.90 Pro forma 1.48 1.26 0.86 ------------------------------------------------------------------- Income per common share -- diluted: As reported $ 1.53 $ 1.26 $ 0.86 Pro forma 1.42 1.17 0.82 ------------------------------------------------------------------- The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: 1999 1998 1997 ------------------------------------------------------------------- Expected volatility 80.5% 70.1% 74.4% Risk-free interest rate 5.7% 6.0% 6.0% Expected dividend yield 0.0% 0.0% 0.0% Expected life of options 3 Years 3 Years 3 Years ------------------------------------------------------------------- 29 FUNCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. STOCK OPTIONS (CONTINUED) The pro forma effect on net income and net income per share does not take into consideration pro forma compensation expense related to grants made prior to fiscal 1996. The weighted average fair value for options with an exercise price equal to market price granted during years 1999, 1998 and 1997 is $6.70, $7.65, and $4.14 per share, respectively. The weighted average fair value for options with an exercise price greater than market price granted during years 1998 and 1997 is $7.03 and $4.30, respectively. No options with an exercise price greater than market price were granted in fiscal 1999. 7. NET INCOME PER SHARE In accordance with Statement of Financial Accounting Standards No. 128 "Earnings Per Share," the following table presents a reconciliation of the numerators and denominators of basic and diluted net income per common share for the years 1999, 1998 and 1997:
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA) 1999 1998 1997 - ---------------------------------------------------------------------------------------- Numerator: Net income $ 9,710 $ 8,270 $ 5,350 ======================================================================================== Denominator: Denominator for basic net income per share -- weighted average shares 6,077,986 6,137,161 5,941,744 Dilutive securities: Employee stock options 275,325 435,204 286,886 - ---------------------------------------------------------------------------------------- Denominator for diluted net income per share -- adjusted weighted average shares 6,353,311 6,572,365 6,228,630 ======================================================================================== Basic net income per share $ 1.60 $ 1.35 $ 0.90 ======================================================================================== Diluted net income per share $ 1.53 $ 1.26 $ 0.86 ========================================================================================
8. INCOME TAXES Significant components of the provision for income taxes for the years 1999, 1998 and 1997 are as follows:
(IN THOUSANDS) 1999 1998 1997 --------------------------------------------------------------------- Current Federal $4,957 $4,346 $2,749 State 1,318 1,298 624 --------------------------------------------------------------------- Current tax expense 6,275 5,644 3,373 Deferred Federal 17 (159) (786) State 4 (50) (178) --------------------------------------------------------------------- Deferred tax expense 21 (209) (964) --------------------------------------------------------------------- Net income tax provision $6,296 $5,435 $2,409 =====================================================================
30 FUNCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. INCOME TAXES (CONTINUED) Deferred income taxes are due to temporary differences between carrying values of certain assets and liabilities for financial reporting and income tax purposes. Significant components of deferred taxes at March 28, 1999 and March 29, 1998, are as follows: (IN THOUSANDS) 1999 1998 ---------------------------------------------------------------------- Accrued rent $ 222 $ 191 Inventories 474 431 Depreciation 1,212 1,297 Other (204) (194) ---------------------------------------------------------------------- Net deferred tax asset $1,704 $1,725 ====================================================================== Income taxes of $7,017,000, $4,518,000 and $2,890,000 were paid in the years 1999, 1998 and 1997, respectively. Reconciliation of the Company's tax rate is as follows: (IN THOUSANDS) 1999 1998 1997 ---------------------------------------------------------------------- Expected tax expense $5,442 $4,701 $2,638 State income tax, net of federal benefit 870 820 294 Change in valuation allowance - - (644) Other (16) (86) 121 ---------------------------------------------------------------------- Net income tax provision $6,296 $5,435 $2,409 ====================================================================== Effective tax rate 39% 40% 31% ====================================================================== 31 FUNCO, INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
COL. A COL. B COL. C COL. D COL. E - ----------------------------------- ------------ ------------ ---------- --------- ADDITIONS DEDUCTIONS ------------ ---------- BALANCE CHARGED TO BALANCE AT BEGINNING COSTS AT END DESCRIPTION OF PERIOD AND EXPENSES DESCRIBE OF PERIOD - ----------------------------------- ------------ ------------ ---------- --------- Year ended March 28, 1999: Deducted from asset accounts Allowance for doubtful accounts $ 29 $ - $ - $ 29 Inventory reserve 354 - 4(1) 350 ------------ ------------ ---------- --------- Total $383 $ - $ 4 $379 ============ ============ ========== ========= Year ended March 29, 1998: Deducted from asset accounts Allowance for doubtful accounts $ 40 $ - $ 11(2) $ 29 Inventory reserve 624 - 270(1) 354 ------------ ------------ ---------- --------- Total $664 $ - $281 $383 ============ ============ ========== ========= Year ended March 30, 1997: Deducted from asset accounts Allowance for doubtful accounts $ 17 $ 25 $ 2(2) $ 40 Inventory reserve 402 222 - 624 ------------ ------------ ---------- --------- Total $419 $247 $ 2 $664 ============ ============ ========== =========
- ------------------ (1) Inventory previously written off was recovered. (2) Uncollectible accounts written off, net of recoveries. 32 EX-3.2 2 BYLAWS AS AMENDED AND RESTATED TO DATE Exhibit 3.2 AMENDED AND RESTATED BYLAWS OF FUNCO, INC. THROUGH FEBRUARY 18, 1999 TABLE OF CONTENTS Page ---- ARTICLE I: OFFICES; CORPORATE SEAL................................... 3 Section 1.1. Registered Office................................... 3 Section 1.2. Corporate Seal...................................... 3 ARTICLE II: MEETINGS OF SHAREHOLDERS.................................. 3 Section 2.1. Place of Meeting.................................... 3 Section 2.2. Annual Meeting...................................... 3 Section 2.3. Special Meetings.................................... 3 Section 2.4. Meetings Held upon Shareholder Demand............... 3 Section 2.5. Notice of Meetings.................................. 4 Section 2.6. Waiver of Notice.................................... 4 Section 2.7. Quorum; Adjourned Meetings.......................... 4 Section 2.8. Vote Required....................................... 5 Section 2.9. Voting Rights....................................... 5 Section 2.10. Proxies............................................. 5 Section 2.11. Action Without a Meeting............................ 5 Section 2.12. Record Date......................................... 5 Section 2.13. Advance Notice Requirements......................... 6 ARTICLE III: DIRECTORS................................................. 7 Section 3.1. General Powers...................................... 7 Section 3.2. Number, Qualifications, and Term of Office.......... 7 Section 3.3. Meetings; Place and Notice.......................... 8 Section 3.4. Electronic Communications........................... 8 Section 3.5. Waiver of Notice.................................... 8 Section 3.6. Quorum; Acts of Board............................... 8 Section 3.7. Vacancies........................................... 8 Section 3.8. Removal............................................. 8 Section 3.9. Resignation......................................... 9 Section 3.10. Committees.......................................... 9 Section 3.11. Special Litigation Committee........................ 9 Section 3.12. Absent Directors.................................... 9 Section 3.13. Presumption of Assent............................... 9 Section 3.14. Action Without a Meeting............................ 10 Section 3.15. Compensation of Directors........................... 10 Section 3.16. Limitation of Directors' Liabilities................ 10 ARTICLE IV: OFFICERS.................................................. 10 Section 4.1. Number and Designation.............................. 10 Section 4.2. Chief Executive Officer............................. 10 1 Section 4.3. Chief Financial Officer............................. 10 Section 4.4. Chairman of the Board............................... 11 Section 4.5. President........................................... 11 Section 4.6. Vice Presidents..................................... 11 Section 4.7. Secretary........................................... 11 Section 4.8. Treasurer........................................... 11 Section 4.9. Treasurer's Bond.................................... 11 Section 4.10. Vacancies........................................... 11 Section 4.11. Authority and Duties................................ 11 Section 4.12. Term; Resignation; Removal; Vacancies............... 12 Section 4.13. Salaries............................................ 12 ARTICLE V: SHARES AND THEIR TRANSFER................................. 12 Section 5.1. Certificates for Shares............................. 12 Section 5.2. Uncertificated Shares............................... 12 Section 5.3. Transfer of Shares.................................. 13 Section 5.4. Lost, Destroyed, or Stolen Certificates............. 13 Section 5.5. Transfer Agent and Registrar........................ 13 Section 5.6. Facsimile Signature................................. 13 Section 5.7. Closing of Transfer Books; Record Date.............. 13 Section 5.8. Registered Shareholders............................. 13 ARTICLE VI: INDEMNIFICATION........................................... 14 Section 6.1. Indemnification..................................... 14 Section 6.2. Insurance........................................... 14 ARTICLE VII: GENERAL CORPORATE MATTERS................................. 14 Section 7.1. Distributions....................................... 14 Section 7.2. Reserves............................................ 14 Section 7.3. Deposits............................................ 14 Section 7.4. Loans............................................... 14 Section 7.5. Advances............................................ 15 ARTICLE VIII: BOOKS OF RECORD; AUDIT; FISCAL YEAR....................... 15 Section 8.1. Share Register...................................... 15 Section 8.2. Books, Records, and Other Documents................. 15 Section 8.3. Financial Statements................................ 15 Section 8.4. Audit............................................... 16 Section 8.5. Fiscal Year......................................... 16 ARTICLE IX: AMENDMENTS................................................ 16 Section 9.1. Amendments.......................................... 16 2 AMENDED AND RESTATED BYLAWS OF FUNCO, INC. THROUGH FEBRUARY 18, 1999 ARTICLE I OFFICES; CORPORATE SEAL Section 1.1. Registered Office. The registered office of the Corporation in Minnesota shall be that set forth in the Articles of Incorporation or in the most recent amendment of the Articles of Incorporation or in a statement of the Board of Directors filed with the Secretary of State of the State of Minnesota changing the registered office in the manner prescribed by law. The Corporation may have such other offices, within or without the State of Minnesota, as the Board of Directors shall, from time to time, determine. Section 1.2. Corporate Seal. If so directed by the Board of Directors, the Corporation may use a corporate seal. The failure to use such seal, however, shall not affect the validity of any documents executed on behalf of the Corporation. The seal need only include the word "seal," but it may also include, at the discretion of the Board, such additional wording as is permitted by law. ARTICLE II MEETINGS OF SHAREHOLDERS Section 2.1. Place of Meeting. Each meeting of the shareholders shall be held at the principal executive office of the Corporation or such other place as may be designated by the Board of Directors or the chief executive officer; provided, however, that any meeting called by or at the demand of a shareholder or shareholders shall be held in the county where the principal executive office of the Corporation is located. Section 2.2. Annual Meeting. An annual meeting of the shareholders shall be held on an annual basis as determined by the Board of Directors. At each annual meeting the shareholders shall elect qualified successors for directors whose terms have expired or are due to expire within six (6) months after the date of the meeting and may transact any other business. Section 2.3. Special Meetings. A special meeting of the shareholders may be called for any purpose or purposes at any time by the chief executive officer or the chief financial officer, by the Board of Directors, or any two or more members thereof, or by one or more shareholders holding not less than ten percent (10%) of the voting power of all shares of the Corporation entitled to vote as provided in Section 2.4(b) hereof, except that a special meeting for the purpose of considering any action to directly or indirectly facilitate or effect a business combination, including any action to change or otherwise affect the composition of the board of directors for that purpose, must be called by twenty-five percent (25%) or more of the voting power of all shares entitled to vote. The chief executive officer or the Board of Directors shall be authorized to fix the time and date of any special meeting of the shareholders. Notice of any special meeting shall state the purpose for which the meeting has been called, and the business transacted at any special meeting shall be limited to the purpose stated in the notice, unless all of the shareholders are present in person or by proxy and none of them objects to the consideration of additional business. Section 2.4. Meetings Held upon Shareholder Demand. Annual or special meetings of the shareholders may be demanded by a shareholder under the following circumstances: 3 (a) If an annual meeting of shareholders has not been held during the immediately preceding fifteen (15) months, a shareholder or shareholders holding three percent (3%) or more of all voting shares may demand an annual meeting of shareholders by written notice of demand given to the chief executive officer or chief financial officer of the Corporation. If the Board fails to cause an annual meeting to be called and held as required by law, the shareholder or shareholders making the demand may call the meeting by giving notice as required by law, all at the expense of the Corporation. (b) To demand a special meeting of the shareholders, a shareholder or shareholders shall give written notice to the chief executive officer or the chief financial officer of the Corporation specifying the purposes of such meeting. Upon receipt by the chief executive officer or chief financial officer of the Corporation of a demand for a special meeting of shareholders from any shareholder or shareholders entitled to call such a meeting, the Board of Directors shall cause such meeting to be called and held in compliance with the timing requirements of Minnesota Statutes 302A.433, Subd. 2, as amended from time to time. Section 2.5. Notice of Meetings. (a) Notice of all meetings of shareholders shall be given to every shareholder entitled to vote, except where the meeting is an adjourned meeting and the date, time, and place of the meeting were announced at the time of adjournment. The notice shall be given at least ten (10) days but not more than sixty (60) days prior to the meeting; provided, however, that at least fourteen (14) days' notice must be given of a meeting at which the adoption of an agreement of merger or plan of exchange is to be considered. (b) Notice of meetings shall be given to each shareholder entitled thereto by oral communication, by mailing a copy thereof to such shareholder at the address he has designated or to the last known address of such shareholder, by handing a copy thereof to such shareholder, or by any other delivery that conforms to law. Notice by mail shall be deemed given when deposited in the United States mail with sufficient postage affixed. Section 2.6. Waiver of Notice. A shareholder may waive notice of any meeting of shareholders. A waiver of notice by a shareholder entitled to notice is effective whether given before, at, or after the meeting and whether given in writing, orally, or by attendance. Attendance by a shareholder at a meeting shall constitute waiver of notice of that meeting, except where the shareholder objects at the beginning of the meeting to the transaction of business because the meeting is not lawfully called or convened or objects before a vote on an item of business because the item may not lawfully be considered at the meeting and the shareholder does not participate in consideration of the item at the meeting. Section 2.7. Quorum; Adjourned Meetings. The presence either in person or by proxy of the holders of a majority of the voting power of the shares entitled to vote at the meeting shall constitute a quorum for the transaction of business. If, however, a quorum shall not be present in person or by proxy at any meeting of the shareholders, those present shall have the power to adjourn the meeting from time to time, without notice other than by announcement at the meeting of the date, time, and location of the reconvening of the adjourned meeting, until the requisite number of voting shares shall be represented. At any such adjourned meeting at which the required number of voting shares shall be represented, any business may be transacted which might have been transacted at the meeting as originally noticed. If a quorum is present when a duly called or held meeting is convened, the shareholders may continue to transact business until adjournment even though the withdrawal of shareholders originally present leaves less than the proportion or number otherwise required for a quorum. 4 Section 2.8. Vote Required. The shareholders shall take action by the affirmative vote of the holders of the greater of (a) a majority of the voting power of the shares present and entitled to vote on that item of business or (b) a majority of the voting power of the minimum number of the shares entitled to vote that would constitute a quorum for the transaction of business at the meeting, except where a larger proportion or number is required by statute or the Articles of Incorporation. If the Articles of Incorporation require a larger proportion or number than is required by statute for a particular action, the Articles of Incorporation shall control. Section 2.9. Voting Rights. (a) At each meeting of the shareholders, every shareholder having the right to vote shall be entitled to vote either in person or by proxy. Unless otherwise provided by the Articles of Incorporation or resolution of the Board of Directors filed with the Secretary of State, each shareholder shall have one vote for each share held. Shares owned by two or more shareholders may be voted by any one of them unless the Corporation receives written notice, addressed to the Board of Directors at the address of the registered office, from any one of them denying the authority of any other person or persons to vote those shares. Upon demand of any shareholder, the vote upon any question before the meeting shall be by ballot. (b) There shall be no cumulative voting for the election of directors. Section 2.10. Proxies. At any meeting of the shareholders, any shareholder may be represented and vote by a proxy or proxies appointed by an instrument in writing and filed with an officer of the Corporation at or before the meeting. An appointment of a proxy or proxies for shares held jointly by two or more shareholders is valid if signed by any one of them, unless and until the Corporation receives from any one of those shareholders written notice denying the authority of such other person or persons to appoint a proxy or proxies or appointing a different proxy or proxies, in which case no proxy shall be appointed unless all joint owners sign the appointment. In the event that any instrument shall designate two or more persons to act as proxies, a majority of such persons present at the meeting, or if only one shall be present then that one, shall have and may exercise all of the proxies so designated unless the instrument shall otherwise provide. If the proxies present at the meeting are equally divided on an issue, the shares represented by such proxies shall not be voted on such issue. No proxy shall be valid after the expiration of eleven (11) months from the date of its execution unless coupled with an interest or unless the person executing it specifies therein the length of time for which it is to continue in force, which in no case shall exceed three (3) years from the date of its execution. Subject to the above, any duly executed proxy shall continue in full force and effect and shall not be revoked unless written notice of its revocation or a duly executed proxy bearing a later date is filed with an officer of the Corporation. Section 2.11. Action Without a Meeting. Any action required or permitted to be taken at a meeting of the shareholders may be taken without a meeting, if authorized in writing or writings signed by all shareholders who would be entitled to vote on that action. The written action is effective when it has been signed by all such shareholders, unless a different effective date is provided in the written action. Section 2.12. Record Date. The Board of Directors may fix a date, not exceeding sixty (60) days preceding the date of any meeting of shareholders, as a record date for the determination of the shareholders entitled to notice of and to vote at such meeting, and in such case only shareholders of record on the date so fixed, or their legal representatives, shall be entitled to notice of and to vote at such meeting, notwithstanding any transfer of any shares on the books of the Corporation after any record date so fixed. The Board of Directors may close the books of the Corporation against transfer of shares during the whole or any part of such 5 period. If the Board of Directors fails to fix a record date for determination of the shareholders entitled to notice of and to vote at any meeting of shareholders, the record date shall be the twentieth (20th) day preceding the date of such meeting. Section 2.13. Advance Notice Requirements. Only persons who are nominated in accordance with the procedures set forth in this Section 2.13 shall be eligible for election as directors. Nominations of persons for election to the Board of Directors of the Corporation may be made at a meeting of shareholders (a) by or at the direction of the Board of Directors or (b) by any shareholder of the Corporation entitled to vote for the election of directors at the meeting who complies with the notice procedures set forth in this Section 2.13. Nominations by shareholders shall be made pursuant to timely notice in writing to the Secretary of the Corporation. To be timely, a shareholder's notice of nominations to be made at an annual meeting of shareholders must be delivered to the Secretary of the Corporation, or mailed and received at the principal executive offices of the Corporation, not less than 90 days before the first anniversary of the date of the preceding year's annual meeting of shareholders. If, however, the date of the annual meeting of shareholders is more than 30 days before or after such anniversary date, notice by a shareholder shall be timely only if so delivered or so mailed and received not less than 90 days before such annual meeting or, if later, within 10 days after the first public announcement of the date of such annual meeting. If a special meeting of the shareholders of the Corporation is called in accordance with Section 2.3 or 2.4 for the purpose of electing one or more directors to the Board of Directors or if a regular meeting other than an annual meeting is held, for a shareholder's notice of nominations to be timely it must be delivered to the Secretary of the Corporation, or mailed or received at the principal executive office of the Corporation, not less than 90 days before such special meeting or such regular meeting or, if later, within 10 days after the first public announcement of the date of such special meeting or such regular meeting. Except to the extent otherwise required by law, the adjournment of a regular or special meeting of shareholders shall not commence a new time period for the giving of a shareholder's notice as described above. Such shareholder's notice shall set forth (x) as to each person whom the shareholder proposes to nominate for election or re-election as a director, (i) such person's name and (ii) all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors, or is otherwise required, pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (including such person's written consent to being named in the proxy statement as a nominee and to serving as a director if elected); and (y) as to the shareholder giving the notice, (i) the name and address, as they appear on the Corporation's books, of such shareholder and (ii) the class and number of shares of the Corporation which are beneficially owned by such shareholder. At the request of the Board of Directors, any person nominated by the Board of Directors for election as a director shall furnish to the Secretary of the Corporation that information required to be set forth in a shareholder's notice of nomination which pertains to a nominee. Notwithstanding anything in these Bylaws to the contrary, no person shall be eligible for election as a director of the Corporation unless nominated in accordance with the procedures set forth in this Section 2.13. The Chairman shall, if the facts warrant, determine that a nomination was not made in accordance with the procedures prescribed in this Section 2.13 and, if the Chairman should so determine, the Chairman shall so declare to the meeting and the defective nomination shall be disregarded. At any regular or special meeting of shareholders, only such business shall be conducted as shall have been brought before the meeting (a) by or at the direction of the Board of Directors or (b) by any shareholder of the Corporation who complies with the notice procedures set forth in this Section 2.13. For business to be properly brought before any regular or special meeting by a shareholder, the shareholder must have given timely notice thereof in writing to the Secretary of the Corporation. To be timely, a shareholder's notice of any such business to be conducted at an annual meeting must be delivered to the Secretary of the Corporation, or mailed and received at 6 the principal executive office of the Corporation, not less than 90 days before the first anniversary of the date of the preceding year's annual meeting of shareholders. If, however, the date of the annual meeting of shareholders is more than 30 days before or after such anniversary date, notice by a shareholder shall be timely only if so delivered or so mailed and received not less than 90 days before such annual meeting or, if later, within 10 days after the first public announcement of the date of such annual meeting. If a special meeting of shareholders of the Corporation is called in accordance with Section 2.3 or 2.4 for any purpose other than electing directors to the Board of Directors or if a regular meeting other than an annual meeting is held, for a shareholder's notice of any such business to be timely it must be delivered to the Secretary of the Corporation, or mailed and received at the principal executive office of the Corporation, not less than 90 days before such special meeting or such regular meeting or, if later, within 10 days after the first public announcement of the date of such special meeting or such regular meeting. Except to the extent otherwise required by law, the adjournment of a regular or special meeting of shareholders shall not commence a new time period for the giving of a shareholder's notice as required above. A shareholder's notice to the Secretary shall set forth as to each matter the shareholder proposes to bring before the regular or special meeting (w) a brief description of the business desired to be brought before the meeting and the reasons for conducting such business at the meeting, (x) the name and address, as they appear on the Corporation's books, of the shareholder proposing such business, (y) the class and number of shares of the Corporation which are beneficially owned by the shareholder and (z) any material interest of the shareholder in such business. Notwithstanding anything in these Bylaws to the contrary, no business shall be conducted at any regular or special meeting except in accordance with the procedures set forth in this Section 2.13 and, as an additional limitation, the business transacted at any special meeting shall be limited to the purposes stated in the notice of the special meeting. The Chairman of the meeting shall, if the facts warrant, determine that business was not properly brought before the meeting in accordance with the provisions of this Section 2.13 and, if the Chairman should so determine, the Chairman shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted. For purposes of this Section 2.13, "public announcement" means disclosure (i) when made in a press release reported by the Dow Jones News Service, Associated Press, or comparable news service, (ii) when filed in a document publicly filed by the Corporation with the Securities and Exchange Commission pursuant to Section 13, 14, or 15(d) of the Securities Exchange Act of 1934, as amended, or (iii) when mailed as the notice of the meeting pursuant to Section 2.5 of these Bylaws. ARTICLE III DIRECTORS Section 3.1. General Powers. The property, affairs, and business of the Corporation shall be managed by the Board of Directors. The Board of Directors may exercise all powers of the Corporation and do all lawful acts not required by the Articles of Incorporation, these Bylaws, or law to be done by the shareholders. Section 3.2. Number, Qualifications, and Term of Office. The number of directors which shall constitute the whole Board shall be at least one (1), or such other number as may be determined by the Board of Directors or by the shareholders at an annual meeting or a special meeting called and held for that purpose; provided, however, that the Board of Directors may not decrease the number of directors below the number last designated by the shareholders. The creation of any new directorship by action of the Board of Directors shall require the affirmative vote of a majority of the directors serving at the time of the increase. Each of the directors shall serve until the next annual meeting of the shareholders and until his successor has been duly elected and has qualified, or until his earlier death, resignation, removal, or disqualification. Directors need not be residents of the State of Minnesota or shareholders of the Corporation. 7 Section 3.3. Meetings; Place and Notice. Meetings of the Board of Directors may be held from time to time at any place within or without the State of Minnesota that the Board of Directors may designate. In the absence of designation by the Board of Directors, Board meetings shall be held at the principal executive office of the Corporation, except as may be otherwise unanimously agreed orally or in writing or by attendance. Board meetings may be called by the chairman of the Board or chief executive officer on 24 hours notice or by any director on three (3) days notice to each director. Every such notice shall state the date, time, and place of the meeting. Notice of a meeting called by a director other than a director who is the chairman of the board or chief executive officer shall state the purpose of the meeting. Notice may be given by mail, telephone, telegram, or in person. If a meeting schedule is adopted by the Board, or if the date and time of a Board meeting has been announced at a previous meeting, no notice is required. Section 3.4. Electronic Communications. A conference among directors by any means of communication through which the directors may simultaneously hear one another during the conference constitutes a Board meeting if the notice required by Section 3.3 of these Bylaws is given of the conference and if the number of directors participating in the conference would be sufficient to constitute a quorum. Participation in a meeting by such means constitutes presence in person at the meeting. Section 3.5. Waiver of Notice. A director may waive notice of a meeting of the Board. Waiver of notice is effective, whether given before, at, or after the meeting and whether given in writing, orally, or by attendance. Attendance by a director at a meeting constitutes waiver of notice for that meeting, except where the director objects at the beginning of the meeting to the transaction of business because the meeting is not lawfully called or convened and does not participate thereafter in the meeting. Section 3.6. Quorum; Acts of Board. A majority of the directors currently holding office shall be a quorum for the transaction of business; provided, however, that if any vacancies exist by reason of death, resignation, or otherwise, a majority of the remaining directors (provided such majority consists of not less than two directors) shall constitute a quorum. In the absence of a quorum, a majority of the directors present may adjourn the meeting from time to time until a quorum is present. If a quorum is present when a duly called or held meeting is convened, the directors present may continue to transact business until adjournment, even though the withdrawal of a number of directors originally present leaves less than the proportion or number otherwise required for a quorum. Except as otherwise required by law or the Articles of Incorporation or these Bylaws, the acts of a majority of the directors present at a meeting at which a quorum is present shall be the acts of the Board of Directors. Section 3.7. Vacancies. Vacancies on the Board resulting from the death, resignation, or removal of a director may be filled by the affirmative vote of a majority of the remaining directors, even though less than a quorum. Vacancies on the Board resulting from newly created directorships may be filled by the affirmative vote of a majority of the directors serving at the time of the increase. Subject to removal as provided in Section 3.8 of these Bylaws, each director elected under this Section to fill a vacancy shall hold office until a qualified successor is elected by the shareholders at the next annual meeting or at a special meeting of the shareholders called for that purpose. Section 3.8. Removal. Except as otherwise provided by law, the entire Board of Directors or any individual director may be removed from office with or without cause by a vote of the shareholders holding a majority of the shares entitled to vote for the election of directors. The shareholders, by the same majority vote, may fill any vacancy or vacancies created by such removal. Any such vacancy not so filled may be filled by the directors as provided in Section 8 3.7 hereof. Any director named by the Board to fill a vacancy may be removed at any time, with or without cause, by the affirmative vote of the majority of the remaining directors, even if the remaining directors constitute less than a quorum, if the shareholders have not elected directors in the interval between the appointment to fill the vacancy and the time of removal. Section 3.9. Resignation. Any director may resign at any time by giving written notice to the Corporation. Such resignation shall take effect on the date of the Corporation's receipt of such notice or at any later date or time specified therein, and, unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make the resignation effective. Section 3.10. Committees. (a) A resolution approved by the affirmative vote of a majority of the Board may establish committees having the authority of the Board in the management of the business of the Corporation to the extent provided in the resolution. Except for any special litigation committee established under Section 3.11 hereof, committees shall be subject at all times to the direction and control of the Board. (b) A committee shall consist of one or more natural persons, who need not be directors, appointed by the affirmative vote of a majority of the directors present at a duly held meeting of the Board. (c) Minutes, if any, of committee meetings shall be made available upon request to members of the committee and to any director. Section 3.11. Special Litigation Committee. Pursuant to the procedure set forth in Section 3.10, the Board may establish a committee composed of one or more independent directors or other independent persons to consider legal rights or remedies of the Corporation and whether those rights or remedies should be pursued. Section 3.12. Absent Directors. A director may give written consent or opposition to a proposal to be acted on at a Board meeting by giving a written statement to the Chairman of the Board or acting Chairman of the Board setting forth a summary of the proposal to be voted on and containing a statement from the director on how he votes on such proposal. If the director is not present at the meeting, consent or opposition to a proposal does not constitute presence for purposes of determining the existence of a quorum, but consent or opposition shall be counted as a vote in favor of, or against, the proposal and shall be entered in the minutes or other record of action of the meeting if the proposal acted on at the meeting is substantially the same or has substantially the same effect as the proposal to which the director has consented or objected. Section 3.13. Presumption of Assent. A director who is present at a meeting of the Board when an action is approved by the affirmative vote of a majority of the directors present is presumed to have assented to the action approved, unless the director: (a) objects at the beginning of the meeting to the transaction of the business because the meeting is not lawfully called or convened and does not participate thereafter in the meeting, in which case the director shall not be considered to be present at the meeting for any purpose; and (b) votes against the action at the meeting; or (c) is prohibited by law from voting on the action. 9 Section 3.14. Action Without a Meeting. Any action required or permitted to be taken at a Board meeting may be taken by written consent of the number of directors that would be required to take the same action at a meeting of the Board of Directors at which all directors were present, provided that the proposed action need not be approved by the shareholders and that the Articles of Incorporation so provide. The written action is effective when signed by the necessary number of directors unless a different effective date is stated in the written action. Section 3.15. Compensation of Directors. By resolution of the Board of Directors, each director may be paid his or her expenses, if any, of attendance at each Board meeting and may be paid a stated amount as a director or a fixed sum for attendance at each Board meeting, or both. No such payment shall preclude a director from serving the Corporation in any other capacity and receiving compensation therefor. Members of special or standing committees may be allowed like compensation for attending committee meetings. Section 3.16. Limitation of Directors' Liabilities. A director shall not be liable to the Corporation or its shareholders for dividends illegally declared, distributions illegally made to shareholders, or any other action taken in good faith reliance upon financial statements of the Corporation represented to him to be correct by the chief executive officer of the Corporation or the officer having charge of its books of account or certified by an independent or certified public accountant to fairly reflect the financial condition of the Corporation; nor shall any director be liable if in good faith in determining the amount available for dividends or distribution the Board values the assets in a manner allowable under applicable law. ARTICLE IV OFFICERS Section 4.1. Number and Designation. The officers of the Corporation shall be elected or appointed by the Board of Directors. The Corporation shall have one or more natural persons exercising the functions of the offices of chief executive officer and chief financial officer. The Board of Directors may elect or appoint such other officers or agents as it deems necessary for the operation and management of the Corporation, with such powers, rights, duties, and responsibilities as may be determined by the Board, including, without limitation, a chairman of the Board (who shall be a director), a president, a secretary, and a treasurer, each of whom shall have the powers, rights, duties, and responsibilities set forth in these Bylaws, unless otherwise determined by the Board. Any of the offices or functions of those offices may be held or performed by the same person. Section 4.2. Chief Financial Officer. Unless provided otherwise by a resolution adopted by the Board of Directors, the chief executive officer (a) shall be responsible for the general active management of the business of the Corporation; (b) shall, when present, preside at all meetings of the shareholders; (c) shall be responsible for implementing all orders and resolutions of the Board; (d) shall sign and deliver in the name of the Corporation any deeds, mortgages, bonds, contracts, or other instruments pertaining to the business of the Corporation, except where authority to sign and deliver is required or permitted by law to be exercised by another person and except where such authority is expressly delegated by these Bylaws or by the Board to some other officer or agent of the Corporation; (e) may maintain records of and certify proceedings of the Board and shareholders; and (f) shall perform such other duties as may from time to time be assigned by the Board. Section 4.3. Chief Financial Officer. Unless provided otherwise by a resolution adopted by the Board of Directors, the chief financial officer (a) shall keep accurate financial records for the Corporation; (b) shall deposit all monies, drafts, and checks in the name of and to the credit of the Corporation in such banks and depositories as the Board of Directors shall designate from 10 time to time; (c) shall endorse for deposit all notes, checks, and drafts received by the Corporation as ordered by the Board, making proper vouchers therefor; (d) shall disburse the funds of the Corporation as may be ordered by the Board of Directors or the chief executive officer, making proper vouchers therefor; (e) shall render to the chief executive officer and the Board of Directors, whenever requested, an account of all of his transactions as chief financial officer and of the financial condition of the Corporation; and (f) shall perform such other duties as may be assigned by the Board of Directors or the chief executive officer from time to time. Section 4.4. Chairman of the Board. The chairman of the Board of the Corporation shall preside at all meetings of the Board of Directors and shall perform such other functions as may be determined from time to time by the Board. Section 4.5. President. Unless otherwise determined by the Board of Directors, the president shall be the chief executive officer of the Corporation. If an officer other than the president is designated chief executive officer, the president shall perform such duties as may from time to time be assigned to him by the Board, or if authorized by the Board, such duties as are assigned to him by the chief executive officer. Section 4.6. Vice Presidents. Any one or more vice presidents, if any, may be appointed by the Board of Directors. During the absence or disability of the president, it shall be the duty of the highest ranking vice president to perform the duties of the president. The determination of who is the highest ranking of two or more persons holding the same office shall, in the absence of specific designation of order or rank by the Board of Directors, be made on the basis of the earliest date of appointment or election, or, in the event of simultaneous appointment or election, on the basis of the longest continuous employment by the Corporation. Section 4.7. Secretary. The secretary, unless otherwise determined by the Board, shall attend all meetings of the shareholders and all meetings of the Board of Directors, shall record or cause to be recorded all proceedings thereof in a book to be kept for that purpose, and may certify such proceedings. Except as otherwise required or permitted by law or by these Bylaws, the secretary shall give or cause to be given notice of all meetings of the shareholders and all meetings of the Board of Directors. Section 4.8. Treasurer. Unless otherwise determined by the Board, the treasurer shall be the chief financial officer of the Corporation. If an officer other than the treasurer is designated chief financial officer, the treasurer shall perform such duties as may from time to time be assigned to him by the Board. Section 4.9. Treasurer's Bond. If required by the Board of Directors, the treasurer shall give the Corporation a bond in such sum and with such surety or sureties as shall be satisfactory to the Board of Directors for the faithful performance of the duties of his office and for the restoration to the Corporation, in case of his death, resignation, retirement, or removal from office, of all books, papers, vouchers, money, and other property of whatever kind in his possession or under his control belonging to the Corporation. Section 4.10. Vacancies. If any office becomes vacant by reason of death, resignation, retirement, disqualification, removal, or other cause, the directors then in office, although less than a quorum, may by a majority vote, choose a successor or successors who shall hold office for the unexpired term in respect of which such vacancy occurred. Section 4.11. Authority and Duties. In addition to the foregoing authority and duties, all officers of the Corporation shall respectively have such authority and perform such duties in the management of the business of the Corporation as may be designated from time to time by the Board of Directors. Unless prohibited by a resolution approved by the affirmative vote of 11 majority of the directors present, an officer elected or appointed by the Board may, without the approval of the Board, delegate some or all of the duties and powers of an office to other persons. Section 4.12. Term; Resignation; Removal; Vacancies (a) All officers of the Corporation shall hold office until their respective successors are chosen and have qualified or until their earlier death, resignation, or removal. (b) An officer may resign at any time by giving written notice to the Corporation. The resignation is effective without acceptance when the notice is given to the Corporation, unless a later effective date is specified in the notice. (c) An officer may be removed at any time, with or without cause, by a resolution approved by an affirmative vote of the majority of the directors present at a duly held Board meeting. (d) A vacancy in an office because of death, resignation, removal, disqualification, or other cause may, or in the case of a vacancy in the office of chief executive officer or chief financial officer shall, be filled by the Board. Section 4.13. Salaries. The salaries of all officers of the Corporation shall be fixed by the Board of Directors or by the chief executive officer, if authorized by the Board. ARTICLE V SHARES AND THEIR TRANSFER Section 5.1. Certificates for Shares. (a) Certificates of shares, if any, of the Corporation shall be in such form as shall be prescribed by law and adopted by the Board of Directors, certifying the number of shares of the Corporation owned by each shareholder. The certificates shall be numbered in the order in which they are issued and shall be signed, in the name of the Corporation, by the chief executive officer or the chief financial officer or secretary or by such officers as the Board of Directors may designate. Such signatures may be by facsimile if authorized by the Board of Directors or these Bylaws. Such certificates shall also have such legends as may be required by any shareholder agreement or other agreement. (b) A certificate representing shares issued by the Corporation shall, if the Corporation is authorized to issue shares of more than one class or series, set forth upon the face or back of the certificate, or shall state that the Corporation will furnish to any shareholder upon request and without charge, a full statement of the designations, preferences, limitations, and relative rights of the shares of each class or series authorized to be issued, so far as they have been determined, and the authority of the Board to determine the relative rights and preferences of subsequent classes or series. Section 5.2. Uncertificated Shares. Some or all of any or all classes and series of the shares of stock of this Corporation, upon a resolution approved by the Board of Directors, may be uncertificated shares. Within twenty (20) calendar days after the issuance or transfer of uncertificated shares, the chief executive officer shall send to the shareholder such notice as may be required by law. 12 Section 5.3. Transfer of Shares. Transfer of certificated shares on the books of the Corporation may be authorized only by the shareholder named in the certificate, or the shareholder's legal representative, or the shareholder's duly authorized attorney-in-fact, and upon surrender of the certificate or the certificates for such shares therefor properly endorsed. The Corporation may treat, as the absolute owner of shares of the Corporation, the person or persons in whose name or names the shares are registered on the books of the Corporation. The transfer of uncertificated shares, if any, shall be made by the means determined by the Board of Directors. Every certificate surrendered to the Corporation for exchange or transfer shall be canceled, and no new certificate or certificates shall be issued in exchange for any existing certificate until such existing certificate shall have been so canceled. Section 5.4. Lost, Destroyed, or Stolen Certificates. Any shareholder claiming that a certificate for shares has been lost, destroyed, or stolen shall make an affidavit of that fact in such form as the Board of Directors may require and shall, if the Board of Directors so requires, give the Corporation a sufficient indemnity bond, in form, in an amount, and with one or more sureties satisfactory to the Board of Directors, to indemnify the Corporation against any claims that may be made against it on account of the reissue of such certificate. A replacement certificate shall then be issued for the same number of shares as represented by the certificate alleged to have been lost, destroyed, or stolen. Section 5.5. Transfer Agent and Registrar. The Board of Directors may appoint one or more transfer agents or transfer clerks and one or more registrars and may require all certificates for shares to bear the signature or signatures of any of them. Section 5.6. Facsimile Signature. Where any certificate is manually signed by a transfer agent, a transfer clerk, or a registrar appointed by the Board of Directors to perform such duties, a facsimile or engraved signature of the chief executive officer or other proper officer of the Corporation authorized by the Board of Directors may be inscribed on the certificate in lieu of the actual signature of the officer. The fact that a certificate bears the facsimile signature of an officer who no longer holds office shall not affect the validity of the certificate, and such certificate, if otherwise validly issued, shall have the same effect as if the former officer held that office at the date the certificate was issued. Section 5.7. Closing of Transfer Books; Record Date. The Board of Directors may close the stock transfer books of the Corporation for a period not exceeding sixty (60) days preceding the date of any meeting of shareholders, the date for payment of any dividend or distribution or the date any change, conversion, or exchange of capital stock shall become effective. In lieu of closing the stock transfer books, the Board of Directors may fix in advance a date, not exceeding sixty (60) days preceding the date for payment of any dividend or distribution, or the date any change, conversion, or exchange of capital stock shall become effective, as a record date for the determination of the shareholders entitled to receive payment of any such dividend or distribution, or to exercise the rights in respect of any such change, conversion, or exchange of capital stock, and in such case such shareholders and only such shareholders shall be shareholders of record on the date so fixed and shall be entitled to receive payment of such dividend or distribution, or to exercise such rights, notwithstanding any transfer of any stock on the books of the Corporation after any such record date. If the Board of Directors fails to fix such a record date the record date shall be the twentieth (20th) day preceding the date of payment or the date the change, conversion, or exchange becomes effective. Section 5.8. Registered Shareholders. The Corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends and to vote as such owner, and shall be entitled to hold liable for calls and assessments a person so registered on its books as the owner of shares, and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, 13 whether or not it shall have express or other notice thereof, except as otherwise provided by applicable law. ARTICLE VI INDEMNIFICATION Section 6.1. Indemnification. The Corporation shall indemnify such persons, for such expenses and liabilities, in such manner, under such circumstances, and to such extent, as required or permitted by Minn. Stat. ss. 302A.521, as amended from time to time, or as required or permitted by other provisions of law. Section 6.2. Insurance. The Corporation may purchase and maintain insurance on behalf of any person in such person's official capacity against any liability asserted against and incurred by such person in or arising from that capacity, whether or not the Corporation would otherwise be required to indemnify the person against the liability. ARTICLE VII GENERAL CORPORATE MATTERS Section 7.1. Distributions. Subject to the Articles of Incorporation and these Bylaws, the Board of Directors may declare dividends payable in either cash, property or shares, acquire or exchange shares, or make other distributions with respect to shares of the Corporation whenever and in such amounts as, in its opinion, the condition and affairs of the Corporation shall render advisable. Section 7.2. Reserves. Before payment of any dividend, the Board of Directors may set aside out of any funds of the Corporation available for dividends such sum or sums as the Board of Directors from time to time deems proper as a reserve or reserves to meet contingencies, for equalizing dividends, for repairing or maintaining any property of the Corporation, or for such other purposes as the Board of Directors deems conducive to the interest of the Corporation, and the Board of Directors may modify or abolish any such reserve. Section 7.3. Deposits. All funds of the Corporation not otherwise employed shall be deposited from time to time to the credit of the Corporation in such banks, trust companies, or other depositories as the Board of Directors may select. Section 7.4. Loans. The Corporation shall not lend money to, guarantee the obligation of, become a surety for, or otherwise financially assist any person unless the transaction, or class of transactions to which the transaction belongs, has been approved by the affirmative vote of a majority of directors present and: (a) is in the usual and regular course of business of the Corporation; (b) is with, or for the benefit of, a related corporation, an organization in which the Corporation has a financial interest, an organization with which the Corporation has a business relationship, or an organization to which the Corporation has the power to make donations; (c) is with, or for the benefit of, an officer or other employee of the Corporation or a subsidiary, including an officer or employee who is a director of the Corporation or a subsidiary, and may reasonably be expected, in the judgment of the Board of Directors, to benefit the Corporation; or 14 (d) has been approved by the affirmative vote of the holders of two-thirds of the outstanding shares, including both voting and nonvoting shares. Section 7.5. Advances. The Corporation may, without a vote of the directors, advance money to its directors, officers, or employees to cover expenses that can reasonably be anticipated to be incurred by them in the performance of their duties and for which they would be entitled to reimbursement in the absence of an advance. ARTICLE VIII BOOKS OF RECORD; AUDIT; FISCAL YEAR Section 8.1. Share Register. The Board of Directors of the Corporation shall cause to be kept at its principal executive office, or such other place or places within the United States as determined by the Board, a share register not more than one year old, containing the names and addresses of the shareholders and the number and classes of the shares held, and the dates on which the certificates therefor were issued. Section 8.2. Books, Records, and Other Documents. The Board of Directors shall cause to be kept at its principal executive office, originals or copies of: (a) records of all proceedings of the shareholders and directors for the last three years; (b) Articles of Incorporation of the Corporation and all amendments thereto currently in effect; (c) Bylaws of the Corporation and all amendments thereto currently in effect; (d) financial statements as described in Section 8.3 hereof, if such statements have been prepared by or for the Corporation; (e) reports made to shareholders generally within the immediately preceding three years; (f) a statement of the names and usual business addresses of the directors and principal officers of the Corporation; (g) voting trust agreements; and (h) shareholder control agreements, if any. Section 8.3. Financial Statements. To the extent that they have been prepared by or for the Corporation, the financial statements required to be kept at the principal executive or registered office of the Corporation pursuant to Section 8.2(d) hereof are as follows: (a) annual financial statements, including at least a balance sheet as of the end of, and a statement of income for, each fiscal year; and 15 (b) financial statements for the most recent interim period prepared in the course of the operations of the Corporation for distribution to the shareholders or submission to a governmental agency as a matter of public record. Section 8.4. Audit. The Board of Directors may cause the records and books of account of the Corporation to be audited each fiscal year. Section 8.5. Fiscal Year. The fiscal year of the Corporation shall be determined by the Board of Directors. ARTICLE IX AMENDMENTS Section 9.1. Amendments. Except as limited by the Articles of Incorporation, these Bylaws may be altered, amended, or repealed by the affirmative vote of a majority of the members of the Board of Directors. This authority of the Board of Directors is subject to the power of the shareholders to change or repeal such Bylaws, and the Board of Directors shall not make or alter any Bylaws fixing a quorum for meetings of shareholders, prescribing procedures for removing directors or filling vacancies on the Board, or fixing the number of directors or their classifications, qualifications, or terms of office, but the Board may adopt or amend a Bylaw to increase the number of directors. The undersigned, Chief Executive Officer of Funco, Inc., a Minnesota corporation, does hereby certify that the foregoing Amended and Restated Bylaws were duly adopted as the Bylaws of the Corporation by its Board of Directors and Shareholders effective May 4, 1992. /s/ David R. Pomije ---------------------------------------- David R. Pomije Chief Executive Officer Effective February 18, 1999, the Bylaws have been amended to incorporate revisions to Section 2.13. 16 EX-10.7B 3 SIXTH AMENDMENT TO LEASE AGREEMENT Exhibit 10.7b SIXTH AMENDMENT TO LEASE AGREEMENT TO THE LEASE dated January 24, 1992 and amended July 30, 1992, July 21, 1993, October 8, 1993, July 27, 1994 and May 23, 1997, by and between MIG Kappa III Companies and then under receivership by order of the court, Eberhardt Property Management Company and now assigned to First Industrial, L.P. (a Delaware Limited Partnership) as Landlord and Funco, Inc. as Tenant. THIS AMENDMENT TO LEASE, entered into and made as of the 5th day of February 1999 by and between First Industrial, L.P. as Landlord, and Funco, Inc. as Tenant. WITNESSETH: WHEREAS, Landlord's predecessors in interest and Tenant have heretofore entered into a certain Lease dated January 24, 1992 , as amended, (the "Lease") covering that certain space at 10120 West 76th Street, Eden Prairie, MN (the "Demised Premises"), upon terms and conditions described in said Lease; and WHEREAS, effective June 1, 1999, Landlord and Tenant desire to extend and further amend said Lease as described below: 1. PREMISES: Effective June 1, 1999, Tenant shall occupy an additional 8,119 square feet of space to bring the total occupied area to 57,798 square feet as shown on Exhibit A attached hereto. 2. BASE RENT: Effective June 1, 1999, Monthly Base Rent shall be as follows: June 1, 1999 - June 30, 1999 $20,337.32 per month July 1, 1999 - June 30, 2002 $24,082.50 per month 3. OPERATING Costs: Effective June 1, 1999, Tenant's Pro Rata Share of operating expenses and real estate taxes as referenced in Paragraph 1.8 of the Lease shall be 100%. 4. TERMINATION: Section 14.19 of the Lease shall be deleted and the following shall be inserted in lieu thereof: "Tenant shall have the right, at Tenant's sole discretion, to terminate this Lease by giving Landlord eight (8) months written notice prior to July 1, 2000 or July 1, 2001. If Tenant elects to terminate this Lease effective July 1, 2000, Tenant must pay to Landlord as liquidated damages. Ten Thousand and 00/100 Dollars ($10,000.00) on or before October 31, 1999. If Tenant elects to terminate this Lease effective July 1, 2001, Tenant shall not be required to pay any liquidated damages. Tenant must vacate the Premises on or before June 30, 2000 or June 30, 2001, respectively, upon which vacating, the Lease shall terminate and neither party shall have any further obligations under the terms of the Lease." 5. TENANT IMPROVEMENT ALLOWANCE: The Premises is leased to Tenant in "as-is" condition. All tenant improvements made to the Premises and contracted by the Tenant shall be paid for in full by the Tenant. Tenant shall provide Landlord with copies of Certificates of Insurance from contractors and shall hold the Landlord harmless for claims made for such work. All work performed shall meet building code requirements and Tenant shall obtain all necessary permits and licenses with the City of Eden Prairie prior to commencing construction. In consideration for the improvements constructed by Tenant in the expanded area, the Landlord will issue a Twenty Thousand and 00/100 Dollars ($20,000.00) to the Tenant within 30 days upon receipt of construction invoices. 6. HVAC REPAIRS: Effective July 1, 1999 through June 30, 2000, the tenant shall pay an amount not to exceed $500.00 per occurrence for any related HVAC repair serving the Tenant"s expansion area (8,119 SF). Effective July 1, 2000, Tenant will be responsible for all related HVAC repairs for the entire premises. Landlord shall service and repair all existing mechanical equipment serving the expansion area to ensure proper working order upon occupancy. 7. BROKERAGE: Landlord and Tenant warrant to each other that no broker was involved in the negotiation of this Agreement. 8. OPTION TO RENEW: Section 14.18 will be deleted and the following shall be inserted in lieu thereof: Assuming the Tenant is not in default of this Lease, Landlord, hereby grants the right to the Tenant to renew this Lease for an additional three (3) year term at a Base Rent based on a four percent (4%) increase per year of the extended term, under the same terms and conditions of the existing Lease. Should Tenant elect to exercise its renewal option, notice must be received in writing no later than January 1, 2002. This option to renew is not assignable to any sub-tenant and is only valid for Funco, Inc. 9. Except as herein above set forth, all terms, provisions and covenants set forth in the Lease shall remain unchanged and in full force and effect. IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date and year first above written. LANDLORD: FIRST INDUSTRIAL, L.P. TENANT: FUNCO, INC. a Delaware Limited Partnership a Minnesota Corporation By: First Industrial Realty Trust, Inc., a Maryland Corporation, its general partner By: /s/ Duane Lund By: /s/ Stanley A. Bodine Its: Senior Regional Director Its: President EX-23 4 CONSENT OF INDEPENDENT AUDITORS Exhibit 23 Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 33-66218 and 333-60643) pertaining to the 1992 Employee Incentive Stock Option Plan, 1992 Stock Option Plan for Nonemployee Directors and 1993 Stock Option Plan of Funco, Inc. of our report dated May 10, 1999, with respect to the consolidated financial statements and schedule of Funco, Inc. included in this Annual Report (Form 10-K) for the year ended March 28, 1999. /s/ Ernst & Young LLP Minneapolis, Minnesota June 23, 1999 EX-27 5 ARTICLE 5 - FINANCIAL DATA SCHEDULE
5 1,000 YEAR MAR-28-1999 MAR-29-1998 MAR-28-1999 8,550 0 2,049 29 28,485 42,643 27,563 16,229 55,140 16,091 0 0 0 59 38,777 55,140 206,673 206,673 138,693 138,693 52,379 0 12 16,006 6,296 0 0 0 0 9,710 1.60 1.53
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