-----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, PVbNi+jxmQZF0TZJCXqctA6/Z4AZiRwdNknG6H7UMWUpsOu0Dct5OZUvF1ZvY210 tpniSdHXNVwMC58ZsbJ7ow== 0000897101-99-001007.txt : 19991028 0000897101-99-001007.hdr.sgml : 19991028 ACCESSION NUMBER: 0000897101-99-001007 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19991003 FILED AS OF DATE: 19991027 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: 0328 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-21876 FILM NUMBER: 99735172 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-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended October 3, 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 Eden Prairie, MN 55344 (Address of principal executive offices) (612) 946-8883 (Registrant's telephone number, including area code) Check whether the registrant: (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X__ No _____ On October 25, 1999, the registrant had 5,974,064 outstanding shares of common stock, $ .01 par value. FUNCO, INC. INDEX PART I - FINANCIAL INFORMATION PAGE NO. - ------------------------------ -------- ITEM 1. Consolidated Financial Statements (Unaudited) Consolidated Statements of Income - Quarter and six months ended October 3, 1999 and September 27, 1998.......................... 3 Consolidated Balance Sheets - October 3, 1999 and March 28, 1999.. 4 Consolidated Statements of Cash Flows - Six months ended October 3, 1999 and September 27, 1998.......................... 5 Notes to Consolidated Financial Statements........................ 6 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....................................... 7 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk........ 13 PART II - OTHER INFORMATION - --------------------------- ITEM 4 Submission of Matters to a Vote of Security Holders............... 13 ITEM 6. Exhibits and Reports on Form 8-K.................................. 13 SIGNATURES ................................................................. 14 - ---------- 2 of 14 PART I - FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS FUNCO, INC. Consolidated Statements of Income (in thousands, except share and per share data) (Unaudited)
Quarter Ended Six Months Ended ------------------------------ ------------------------------ October 3, September 27, October 3, September 27, 1999 1998 1999 1998 ------------- ------------- ------------- ------------- Net sales ................................... $ 52,666 $ 35,299 $ 95,171 $ 68,193 Cost of sales ............................... 36,867 23,037 65,000 44,301 ------------- ------------- ------------- ------------- Gross profit .......................... 15,799 12,262 30,171 23,892 Operating expenses .......................... 11,403 8,919 22,208 17,321 General and administrative expenses ......... 3,271 2,501 6,306 5,015 ------------- ------------- ------------- ------------- Operating income ...................... 1,125 842 1,657 1,556 Interest income ............................. 50 91 102 211 ------------- ------------- ------------- ------------- Net income before income taxes ........ 1,175 933 1,759 1,767 Income tax provision ........................ 460 373 689 707 ------------- ------------- ------------- ------------- Net income ............................... $ 715 $ 560 $ 1,070 $ 1,060 ============= ============= ============= ============= Basic Earnings Per Share: - ------------------------- Basic net income per share .................. $ 0.12 $ 0.09 $ 0.18 $ 0.17 Weighted average number of common shares ...................................... 5,962,915 6,204,179 5,945,972 6,199,815 Diluted Earnings Per Share: - --------------------------- Diluted net income per share ................ $ 0.11 $ 0.09 $ 0.17 $ 0.16 Weighted average number of common and common equivalent shares ................ 6,298,581 6,499,990 6,318,533 6,535,181
SEE ACCOMPANYING NOTES. 3 of 14 FUNCO, INC. Consolidated Balance Sheets (in thousands, except share data)
October 3, March 28, 1999 1999 ---------- ---------- (Unaudited) (Note) ASSETS - ------ Current Assets Cash and cash equivalents ................................ $ 3,509 $ 8,550 Accounts receivable ...................................... 3,226 2,020 Inventories .............................................. 45,185 28,485 Prepaid expenses ......................................... 3,107 2,948 Current deferred tax asset ............................... 640 640 ---------- ---------- Total current assets .................................. 55,667 42,643 Net property and equipment .................................. 14,655 11,334 Long-term deferred tax asset ................................ 1,064 1,064 Other assets ................................................ 102 99 ---------- ---------- Total assets ................................................ $ 71,488 $ 55,140 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY - ------------------------------------ Current Liabilities Accounts payable ......................................... $ 23,700 $ 9,831 Accrued liabilities ...................................... 6,106 5,266 Deferred revenue ......................................... 1,013 994 ---------- ---------- Total current liabilities ............................. 30,819 16,091 Accrued rent ................................................ 209 213 Shareholders' Equity Common stock (issued: 5,969,092 and 5,894,760) ........... 60 59 Additional paid-in capital ............................... 15,791 15,238 Retained earnings ........................................ 24,609 23,539 ---------- ---------- Total shareholders' equity ............................ 40,460 38,836 ---------- ---------- Total liabilities and shareholders' equity .................. $ 71,488 $ 55,140 ========== ==========
Note: The balance sheet at March 28, 1999 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. SEE ACCOMPANYING NOTES. 4 of 14 FUNCO, INC. Consolidated Statements of Cash Flows (In thousands) (Unaudited)
Six Months Ended ------------------------------- October 3, September 27, 1999 1998 ------------- ------------- Operating Activities Net income .......................................................... $ 1,070 $ 1,060 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization .................................... 2,244 1,680 Net loss on disposal of property and equipment ................... 60 30 Changes in operating assets and liabilities: Accounts receivable ........................................... (1,206) 432 Inventories ................................................... (16,700) (5,964) Prepaid expenses .............................................. (159) 64 Accounts payable .............................................. 13,869 430 Accrued liabilities ........................................... 836 (1,885) Deferred revenue .............................................. 19 (224) ------------- ------------- Net cash provided by (used in) operating activities ........ 33 (4,377) Investing Activities Additions of property and equipment ................................. (5,623) (2,403) Increase in other assets ............................................ (5) -- Purchase of short-term investments .................................. -- (1,974) Sales of short-term investments ..................................... -- 2,357 ------------- ------------- Net cash used in investing activities ......................... (5,628) (2,020) Financing Activities Payments for repurchase of common stock ............................. -- (1,291) Net proceeds from issuance of common stock .......................... 554 201 ------------- ------------- Net cash provided by (used in) financing activities ........... 554 (1,090) Increase (decrease) in cash and cash equivalents ....................... (5,041) (7,487) Cash and cash equivalents at beginning of period ....................... 8,550 9,295 ------------- ------------- Cash and cash equivalents at end of period ............................. $ 3,509 $ 1,808 ============= =============
SEE ACCOMPANYING NOTES. 5 of 14 FUNCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. The Company Funco, Inc. (the Company) was incorporated in March 1988 and is a leading national specialty retailer of interactive home entertainment, primarily through the purchase and resale of new and previously played video games along with related hardware and accessory items through its FUNCOLAND(R) stores. The store strategy is complemented by the Company's mail order operation, the FUNCOLAND SUPERSTORE Web site and publication of GAME INFORMER(R), a video game magazine. The Company operated 353 retail locations at October 3, 1999, compared to 270 retail locations at September 27, 1998. Note 2. Fiscal Year The Company's fiscal year ends on a Sunday on or near March 31st which completes a 52 or 53-week reporting period. Fiscal 2000 is a 53-week reporting period with the first quarter consisting of 14 weeks and all other quarters consisting of 13 weeks. Fiscal 1999 was a 52-week reporting period with each quarter consisting of 13 weeks. Ending Date ---------------------------------------- 2000 1999 ----------------- -------------------- First July 4, 1999 June 28, 1998 Second October 3, 1999 September 27, 1998 Third January 2, 2000 December 27, 1998 Fourth April 2, 2000 March 28, 1999 Note 3. Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting solely of normal recurring accruals) considered necessary for a fair presentation have been included. Due to the seasonal nature of the Company's business, the operating results for the quarter ended October 3, 1999 are not necessarily indicative of the results that may be expected for the fiscal year ending April 2, 2000. For further information, refer to the financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended March 28, 1999. 6 of 14 Note 4. Net Income per Share The following table sets forth the computation of basic and diluted net income per share:
Quarter Ended Six Months Ended ------------------------------ ------------------------------ October 3, September 27, October 3, September 27, 1999 1998 1999 1998 ------------- ------------- ------------- ------------- Numerator: Net income ................................... $ 715,000 $ 560,000 $ 1,070,000 $ 1,060,000 ============= ============= ============= ============= Denominator: Denominator for basic net income per share - weighted average shares ........ 5,962,915 6,204,179 5,945,972 6,199,815 Dilutive securities: Employee and nonemployee director stock options .................................... 335,666 295,811 372,561 335,366 ------------- ------------- ------------- ------------- Denominator for diluted earnings per share - adjusted weighted average shares ........... 6,298,581 6,499,990 6,318,533 6,535,181 ============= ============= ============= ============= Basic earnings per share ........................ $ 0.12 $ 0.09 $ 0.18 $ 0.17 ============= ============= ============= ============= Diluted earnings per share ...................... $ 0.11 $ 0.09 $ 0.17 $ 0.16 ============= ============= ============= =============
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations The following table sets forth certain items in the statements of income expressed as (i) percentage of net sales for the periods indicated and (ii) percentage changes from the comparable period prior year.
Percent Percent Quarter Ended Inc (Dec) Six Months Ended Inc (Dec) --------------------------- --------- --------------------------- --------- October 3, September 27, 2000 over October 3, September 27, 2000 over 1999 1998 1999 1999 1998 1999 ---------- ------------- --------- ---------- ------------- --------- Net sales....................... 100.0% 100.0% 49.2% 100.0% 100.0% 39.6% Cost of sales................... 70.0 65.3 60.0 68.3 65.0 46.7 ---------- ------------- ---------- ------------- Gross profit.................... 30.0 34.7 28.8 31.7 35.0 26.3 Operating expenses.............. 21.7 25.3 27.9 23.3 25.4 28.2 General and admin. expenses..... 6.2 7.1 30.8 6.6 7.4 25.7 ---------- ------------- ---------- ------------- Operating income................ 2.1 2.4 33.6 1.7 2.3 6.5 Interest income................. 0.1 0.3 (45.1) 0.1 0.3 (51.7) ---------- ------------- ---------- ------------- Net income before taxes......... 2.2 2.6 25.9 1.8 2.6 (0.5) Income tax provision............ 0.9 1.1 23.3 0.7 1.0 (2.5) ---------- ------------- ---------- ------------- Net income...................... 1.4 1.6 27.7 1.1 1.6 0.9 ========== ============= ========== =============
7 of 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Comparison of Second Quarter Fiscal 2000 to Second Quarter Fiscal 1999 Net sales for the quarter increased from $35,299,000 in 1999 to $52,666,000 in 2000, an increase of 49.2%. The Company opened 38 new stores during the quarter and operated a total of 353 locations at the end of the quarter this year compared to 270 locations at the end of the same period prior year. Comparable store sales for the quarter increased 32%. The strong overall sales increase is primarily due to the launch of Sega Dreamcast and to operating a greater number of stores compared to prior year. Cost of sales for the quarter increased from $23,037,000 in 1999 to $36,867,000 in 2000, an increase of 60.0%. 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 for the quarter increased from 65.3% in 1999 to 70.0% in 2000. This increase is primarily due to the shift in sales mix from previously played product to lower margin new product which accounted for 69% of sales for the second quarter, compared to 58% for the same period last year. Operating expenses for the quarter increased from $8,919,000 in 1999 to $11,403,000 in 2000, an increase of 27.9%. This increase is primarily due to higher store payroll and occupancy expense which occurred as the Company operated a greater number of stores than in the same period prior year and also to support the 32% increase in comparable store sales. Operating expenses as a percentage of net sales decreased favorably from 25.3% in 1999 to 21.7% in 2000, due to leveraging as net sales increased by 49.2%. General and administrative expenses for the quarter increased from $2,501,000 in 1999 to $3,271,000 in 2000, an increase of 30.8%. This increase occurred to support the store base which grew to 353 locations from 270 locations at the end of the same period in the prior year. General and administrative expenses decreased favorably as a percentage of net sales from 7.1% in 1999 to 6.2% in 2000, due to leveraging as net sales increased by 49.2%. The Company generated operating income for the quarter of $1,125,000 compared to operating income of $842,000 for the same period prior year, an increase of 33.6%. Interest income for the quarter decreased from $91,000 in 1999 to $50,000 in 2000, a decrease of 45.1% as the Company maintained lower average cash balances than in the prior year. The Company generated net income before income taxes for the quarter of $1,175,000 compared to net income before income taxes of $933,000 in the same period prior year, an increase of 25.9%. As a result, the Company recorded income tax expense for the quarter of $460,000 compared to income tax expense of $373,000 for the same period prior year. Due to the above factors, the Company generated net income for the quarter of $715,000, or $0.11 per share, compared to net income of $560,000, or $0.09 per share, for the same period prior year. Comparison of Six Month Period Fiscal 2000 to Six Month Period Fiscal 1999 Net sales for the six month period increased from $68,193,000 in 1999 to $95,171,000 in 2000, an increase of 39.6%. The Company opened 42 new stores and closed one store during the six month period and operated a total of 353 locations at the end of the six month period this year compared to 270 locations at the end of 8 of 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) the same period prior year. Comparable store sales for the six month period increased 16%. The strong overall sales increase is primarily due to operating a greater number of stores compared to prior year and to the launch of Sega Dreamcast. Cost of sales for the six month period increased from $44,301,000 in 1999 to $65,000,000 in 2000, an increase of 46.7%. 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 65.0% in 1999 to 68.3% in 2000. This increase is primarily due to a shift in sales mix from previously played product to lower margin new product which accounted for 64% of sales in the six month period compared to 56% one year ago. Operating expenses for the six month period increased from $17,321,000 in 1999 to $22,208,000 in 2000, an increase of 28.2%. This increase is primarily due to higher store payroll and occupancy expense which occurred both as the Company operated a greater number of stores than in the same period prior year and also to support the 16% increase in comparable store sales. Operating expenses decreased favorably as a percentage of net sales from 25.4% in 1999 to 23.3% in 2000, due to leveraging as net sales increased by 39.6%. General and administrative expenses for the six month period increased from $5,015,000 in 1999 to $6,306,000 in 2000, an increase of 25.7%. This increase occurred to support the store base which grew to 353 locations from 270 locations at the end of the same period in the prior year. General and administrative expenses decreased favorably as a percentage of net sales from 7.4% in 1999 to 6.6% in 2000, due to leveraging as net sales increased by 39.6%. The Company generated operating income for the six month period of $1,657,000 compared to operating income of $1,556,000 in the same period prior year, an increase of 6.5%. Interest income for the six month period decreased from $211,000 in 1999 to $102,000 in 2000, a decrease of 51.7%, as the Company maintained lower average levels of cash and cash equivalents and short-term investments. The Company generated net income before income taxes for the six month period of $1,759,000 compared to net income before income taxes of $1,767,000 in the same period prior year, a decrease of 0.5%. As a result, the Company recorded income tax expense for the six month period of $689,000 compared to income tax expense of $707,000 for the same period prior year. Due to the above factors, the Company generated net income for the six month period of $1,070,000, or $0.17 per share, compared to net income of $1,060,000, or $0.16 per share, for the same period prior year. 9 of 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) SEASONALITY AND QUARTERLY FLUCTUATIONS The Company's business is seasonal with a majority of net sales generated in the third and fourth fiscal quarters, which include the holiday selling season. In addition to sales seasonality, the Company's quarterly results are also impacted by factors including new product introductions and the number and timing of new store openings. Growth of the store base may obscure the impact of seasonal influences. Because of the seasonality of the Company's business and the factors mentioned above, results for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year. The following table sets forth net sales by quarter and the number of stores operating at each quarter end for the past ten quarters:
Net Sales (in thousands) Number of Stores Open at Quarter End - ---------------------------------------------------- ------------------------------------------ Fiscal Fiscal Quarter 2000 1999 1998 Quarter 2000 1999 1998 - ---------- ----------- ----------- ----------- --------- -------- -------- -------- First $42,505 $32,894 $24,001 First 315 252 193 Second 52,666 35,299 26,760 Second 353 270 215 Third 82,889 67,036 Third 310 249 Fourth 55,591 45,519 Fourth 312 250
LIQUIDITY AND CAPITAL RESOURCES The Company's primary ongoing financing requirements are for new store capital expenditures and inventory. On an interim basis, the Company's financing requirements are also impacted by quarterly operating results and seasonal fluctuations in inventory levels. During the six months ended October 3, 1999, the Company generated $33,000 of cash from operating activities primarily as net income, depreciation and the increase in accounts payable exceeded the increase in new store and seasonal inventory build. The Company used $5,628,000 of cash for investing activities, primarily for capital expenditures related to new stores, store remodels, information systems and website enhancements. For the six months ended September 27, 1998, the Company used $4,377,000 of cash for operating activities and used $2,020,000 of cash for investing activities. The Company has a $20,000,000 unsecured revolving credit facility available, representing the seasonally adjusted increase to its $5,000,000 facility with a commercial bank. During the second quarter this facility was amended by raising the seasonal line from $10,000,000 to $20,000,000 and also amended so that amounts borrowed may not exceed $10,000,000 for more than 45 days from September 15, 1999 to December 15, 1999. The Company is required to maintain certain financial ratios and achieve certain operating results. The interest rate on outstanding borrowings under the facility (7.38% for the month ended October 3, 1999) is based upon LIBOR plus 200 basis points. The Company had no borrowings under the facility at October 3, 1999. During fiscal 2000, the Company plans to incur capital expenditures of approximately $8,200,000, of which $5,623,000 has been incurred to date, for new store openings, store remodels, enhancements to store and corporate information systems and general corporate purposes. The Company incurred capital expenditures of $6,838,000 in fiscal 1999. 10 of 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company believes that cash from operations and funds available under its revolving credit facility will provide sufficient funds for financing planned store openings, working capital needs and other capital expenditures for at least 12 months. YEAR 2000 READINESS 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. The Company has been involved in an ongoing assessment of year 2000 readiness and has undergone 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 have required year 2000 modification. All of the Company's systems and applications have been included in the Company's ongoing year 2000 readiness efforts. The Company is also continuing 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 continue to identify and mitigate common risks. The Company has also been 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: 11 of 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) 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 office. 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. The new software and new hardware were designed to be year 2000 ready, with testing 95% complete. Remaining testing will be completed before the end of November 1999. 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. These systems were tested to recognize transactions over a wide range of critical dates. Testing of the year 2000 readiness of the Company's financial systems is 100% complete, with no further remediation required. 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 and programmed for year 2000 readiness. The critical components are nevertheless undergoing comprehensive evaluation and testing. Such testing is approximately 70% complete. The remainder of the testing is projected to be completed before the end of November 1999. Contingency Plan 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 also completing a formal contingency plan and, in the event of failures associated with year 2000 readiness, believes that adequate resources could rapidly be directed 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 October 3, 1999, the Company had incurred external costs of approximately $55,000 related to year 2000 readiness, including testing, analysis and purchase of hardware and software upgrades. Total costs associated with year 2000 readiness are expected to be between $75,000 and $125,000. Most of the remaining costs are expected to be related to PC replacement and will be incurred before the end of November 1999. However, there can be no assurance that costs will not exceed the projected level. FORWARD LOOKING STATEMENTS Forward looking statements contained in this document which directly or indirectly relate to future sales prospects and expansion plans are subject to uncertainties from factors including growth of the industry, competitive environment, general economic conditions, product availability, success of the Company's existing operations, availability of new store sites and the Company's ability to finance new store expansion. 12 of 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) In addition, forward looking statements contained in this document relating to Year 2000 readiness are subject to uncertainties such as third party readiness and the Company's successful completion of assessment and remediation efforts. For further discussion of forward looking statements and factors which can impact the Company's operating results, please refer to the Company's Report on Form 10-K for the year ended March 28, 1999, and other Company filings with the Securities and Exchange Commission. ITEM 3. 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. PART II - OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) The Company held its Annual Meeting of Shareholders on July 30, 1999. (b) The Shareholders voted on the election of Directors, each to serve a one year term. The vote was as follows for each of the nominees: NAME AFFIRMATIVE AUTHORITY WITHHELD ------------------- ----------- ------------------ David R. Pomije 5,612,484 4,940 Stanley A. Bodine 5,612,484 4,940 George E. Mileusnic 5,612,484 4,940 Patrick J. Ferrell 5,612,284 5,140 (c) The Shareholders also voted on the appointment of Ernst & Young LLP as the Company's independent auditors for the 2000 fiscal year. The vote was as follows: AFFIRMATIVE AUTHORITY WITHHELD ABSTENTIONS ----------- ------------------ ----------- 5,608,149 1,175 8,100 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits filed with this Form 10-Q 10.1 Amendment to Credit Agreement effective October 1, 1999, by and between the Registrant and Marquette Capital Bank, N.A., and the Amended and Restated Promissory Note 27 Financial Data Schedule (b) No report on Form 8-K was filed by the registrant during the quarter ended October 3, 1999. 13 of 14 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Funco, Inc. (Registrant) Date: October 27, 1999 By: /s/ David R. Pomije ------------------------------------- David R. Pomije Chief Executive Officer By: /s/ Robert M. Hiben ------------------------------------- Robert M. Hiben Chief Financial Officer 14 of 14 EX-10.1 2 AMENDMENT TO CREDIT AGREEMENT EXHIBIT 10.1 AMENDMENT TO CREDIT AGREEMENT THIS AMENDMENT is entered into as of October 1, 1999 by and between FUNCO, INC., a Minnesota corporation (the "Borrower"), and MARQUETTE CAPITAL BANK, N.A. (the "Bank"). In consideration of the mutual agreements set forth herein, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged by the parties, the Borrower and the Bank agree as follows: 1. The Credit Agreement dated June 20, 1995, by and between the Borrower and the Bank, as amended by an Amendment to Credit Agreement dated February 5, 1996 and by an Amendment to Credit Agreement and Security Agreement dated June 30, 1996 and by an Amendment to Credit Agreement dated June 30, 1997 and by an Amendment to Credit Agreement dated June 30, 1998 and by an Amendment to Credit Agreement dated June 30, 1999 (the "Credit Agreement"), is amended as follows: a. Section 2.01 of the Credit Agreement is amended to read as follows: Section 2.01 Advances. Subject to the provisions of this Agreement, the Bank shall make Advances to the Borrower from time to time during the period from the date hereof to July 31, 2000, or the earlier date of termination of the Line of Credit pursuant to Section 6.02, in an aggregate amount not exceeding at any time outstanding $20,000,000.00 during the period from September 15, 1999 through December 15, 1999, and in an aggregate amount not exceeding at any time outstanding $5,000,000.00 at all other times (the "Line of Credit"). Each Advance shall be in the amount of $10,000.00 or an integral multiple thereof. Within the limits of the Line of Credit, the Borrower may borrow, prepay, and reborrow under this Section 2.01. Notwithstanding the foregoing, during the period from September 15, 1999 through December 15, 1999, the Borrower shall not permit the aggregate outstanding amount of Advances to exceed $10,000,000.00 for any 45 days (whether consecutive or not). During the period from January 3, 2000 through April 2, 2000 the Borrower shall cause the aggregate outstanding amount of Advances to be zero for 45 consecutive days. b. Section 2.03 of the Credit Agreement is amended to read as follows: Section 2.03 Revolving Note. The obligation to repay the Advances and to pay interest and other charges, fees and expenses thereon is evidenced by the Borrower's $20,000,000.00 Amended and Restated Promissory Note dated October 1, 1999 in favor of the Bank (together with any amendments, extensions, renewals and replacements thereof, called the "Revolving Note"). c. All references to June 30, 2000 are changed to July 31, 2000 in Section 2.08 of the Credit Agreement. 2. Except as amended or terminated herein or herewith, all provisions of the Credit Agreement and all other agreements of the parties remain in full force and effect. No provision of this Amendment can be amended, modified, waived or terminated, except by a writing executed by the Borrower and the Bank. The Borrower shall pay to the Bank on demand all of the Bank's costs and expenses, including but not limited to reasonable attorneys' fees and legal expenses, in connection with this Amendment, the writings executed herewith, and the transactions described herein and therein. This Amendment shall bind and benefit the parties and their respective successors and assigns; provided, the Borrower shall not assign any of its rights or obligations under this Amendment without the prior written consent of the Bank, and any assignment in violation of this sentence shall be null and void. This Amendment and the Credit Agreement as amended herein shall be governed by and construed in accordance with the internal laws of the State of Minnesota (excluding conflict of law rules). Executed as of the date first above written. FUNCO, INC. By /s/ Robert M. Hiben -------------------------------------- Title CFO ----------------------------------- MARQUETTE CAPITAL BANK, N.A. By /s/ Margaret Mary Yanez -------------------------------------- Title Vice President ----------------------------------- 2 AMENDED AND RESTATED PROMISSORY NOTE Date: October 1, 1999 For valuable consideration, the receipt and sufficiency of which is hereby acknowledged by the parties, the $10,000,000.00 Amended and Restated Promissory Note of Funco, Inc. dated June 30, 1999, payable to the order of Marquette Capital Bank, N.A., is amended and restated to read as follows: $20,000,000.00 Minneapolis, Minnesota FOR VALUE RECEIVED, on July 31, 2000, the undersigned, FUNCO, INC., promises to pay to the order of MARQUETTE CAPITAL BANK, N.A. (the "Bank"), at its office in Minneapolis, Minnesota, or at such other place as any present or future holder of this Note may designate from time to time, the principal sum of (i) $20,000,000.00, or (ii) the aggregate unpaid principal amount of all advances of credit made by the Bank to the undersigned pursuant to this Note as shown in the records of any present or future holder of this Note, whichever is less, plus interest thereon from the date of each advance in whole or in part included in such amount until this Note is fully paid, computed on the basis of the actual number of days elapsed and a 360-day year, at an annual rate that shall always be 2.00% per annum in excess of the Index Rate and that shall change when and as the Index Rate shall change. Interest is due and payable on the last day of each month and at maturity. In each calendar month, "Index Rate" means the average 1-month LIBOR Rate published in The Wall Street Journal in the previous calendar month. If the Index Rate is no longer available, the Bank may select a comparable rate to be used as the Index Rate under this Note. The Bank may lend to its customers at rates that are equal to, greater than, or less than the Index Rate. Notwithstanding the foregoing, after an Event of Default this Note shall bear interest until paid at 2% per annum in excess of the rate otherwise then in effect, which rate shall continue to vary based on further changes in the Index Rate. The undersigned shall not permit the unpaid principal balance of this Note to exceed $5,000,000.00, except during the period from September 15, 1999 through December 15, 1999. All or any part of the unpaid balance of this Note may be prepaid at any time without penalty. At the option of the then holder of this Note, any payment under this Note may be applied first to the payment of other charges, fees and expenses under this Note and any other agreement or writing in connection with this Note, second to the payment of interest accrued through the date of payment, and third to the payment of principal. Also, at the option of the holder of this Note, if there is any overpayment of interest under this Note, the holder may hold the excess and apply it to future interest accruing under this Note. Amounts may be advanced and readvanced under this Note, provided the principal balance outstanding shall not exceed $20,000,000.00 during the period from September 15, 1999 through December 15, 1999, and shall not exceed $5,000,000.00 at any other time. The occurrence of an Event of Default under the Credit Agreement dated June 20, 1995 by and between the undersigned and the Bank, as it may be amended from time to time, shall constitute an Event of Default under this Note. Upon the commencement of any proceeding under any bankruptcy law by or against any maker of this Note, this Note automatically shall become immediately due and payable for the entire unpaid principal balance of this Note plus accrued interest and other charges, fees and expenses under this Note without any declaration, presentment, demand, protest, or other notice of any kind. Upon the occurrence of any other Event of Default and at any time thereafter, the then holder of this Note may, at its option, declare this Note to be immediately due and payable and thereupon this Note shall become immediately due and payable for the entire unpaid principal balance of this Note plus accrued interest and other charges on this Note without any presentment, demand, protest or other notice of any kind. The undersigned (i) waives demand, presentment, protest, notice of protest, notice of dishonor and notice of nonpayment of this Note; and (ii) agrees that when or at any time after this Note becomes due the then holder of this Note may offset or charge the full amount owing on this Note against any account then maintained by the undersigned with such holder of this Note without notice. Interest on any amount under this Note shall continue to accrue, at the option of any present or future holder of this Note, until such holder receives final payment of such amount in collected funds in form and substance acceptable to such holder. The extensions of credit under this Note are made under Section 47.59 of the Minnesota Statutes. No waiver of any right or remedy under this Note shall be valid unless in writing executed by the holder of this Note, and any such waiver shall be effective only in the specific instance and for the specific purpose given. All rights and remedies of all present and future holders of this Note shall be cumulative and may be exercised singly, concurrently or successively. This Note shall bind the undersigned and the successors and assigns of the undersigned. This Note shall be governed by and construed in accordance with the internal laws of the State of Minnesota (excluding conflict of law rules). THE UNDERSIGNED REPRESENTS, CERTIFIES, WARRANTS AND AGREES THAT THE UNDERSIGNED HAS READ ALL OF THIS NOTE AND UNDERSTANDS ALL OF THE PROVISIONS OF THIS NOTE. Executed as of October 1, 1999. FUNCO, INC. By /s/ Robert M. Hiben -------------------------------------- Title CFO ----------------------------------- Marquette Capital Bank, N.A. agrees to this Amended and Restated Promissory Note. Executed as of October 1, 1999. MARQUETTE CAPITAL BANK, N.A. By /s/ Margaret Mary Yanez -------------------------------------- Title Vice President ----------------------------------- 2 EX-27 3 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS APR-02-2000 JUL-05-1999 OCT-03-1999 3,509 0 3,255 29 45,185 55,667 32,748 18,093 71,488 30,819 0 0 0 60 40,400 71,488 52,666 52,666 36,867 36,867 14,674 0 0 1,175 460 715 0 0 0 715 .12 .11
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