UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number: 0-6664
K-TEL INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-0946588
(State or other jurisdiction of (I.RS. Employer
incorporation or organization) Identification No.)
2605 FERNBROOK LANE NORTH, MINNEAPOLIS, MINNESOTA 55447-4736
(Address of principal executive offices) (Zip Code)
(612) 559-6888
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the most recent practical date. As of December
31, 1998, there were 9,521,894 shares of the registrant's common stock, par
value $0.01 per share, outstanding.
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 1998INDEX
PART I. Financial Information: Page
Item 1. Consolidated Balance Sheets as of December 31, 1998 and
and June 30, 1998 3
Consolidated Statements of Operations and Comprehensive
Income for the Three and Six Month periods ended
December 31, 1998 and 1997 4
Consolidated Statements of Cash Flows for the Six Month
Periods Ended December 31, 1998 and 1997 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
PART II. Other Information:
Item 1. Legal Proceedings 12
Item 6. Exhibits and Reports on Form 8-K 12
2
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND JUNE 30, 1998
(IN THOUSANDS)
December 31, June 30,
1998 1998
----------- -----------
(UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents $ 5,515 $ 5,941
Accounts receivable, net 15,077 15,341
Inventories 8,240 6,430
Royalty and other advances 2,244 1,475
Prepaid expenses and other 2,819 3,043
----------- -----------
Total Current Assets 33,895 32,230
----------- -----------
Property and Equipment, net of
accumulated depreciation and amortization of
$3,037 and $2,671 2,279 2,131
Other Assets 4,465 4,674
----------- -----------
$ 40,639 $ 39,035
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of notes payable $ 8,844 $ 3,738
Note payable to affiliate 695 1,000
Accounts payable 8,548 7,390
Accrued royalties 8,907 8,465
Reserve for returns 4,917 4,758
Other current liabilities 4,431 5,736
----------- -----------
Total Current Liabilities 36,342 31,087
----------- -----------
Notes Payable 189 4,174
Shareholders' Equity:
Common stock 53 41
Additional Paid In Capital 14,847 9,609
Accumulated Deficit (9,994) (4,869)
Cumulative translation adjustment (798) (1,007)
----------- -----------
Total Shareholders' Equity 4,108 3,774
----------- -----------
$ 40,639 $ 39,035
=========== ===========
3
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED
(IN THOUSANDS - EXCEPT PER SHARE DATA)
Three Months Ended Six Months Ended
December 31, December 31,
-------------------------- --------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
NET SALES $ 21,006 $ 23,215 $ 39,798 $ 48,350
---------- ---------- ---------- ----------
COSTS AND EXPENSES:
Cost of goods sold 11,038 12,502 21,472 27,306
Advertising 4,424 4,451 8,854 8,177
Selling, general & administrative 7,118 5,684 14,207 10,896
---------- ---------- ---------- ----------
Total Costs and Expenses 22,580 22,637 44,533 46,379
---------- ---------- ---------- ----------
OPERATING INCOME (LOSS) (1,574) 578 (4,735) 1,971
---------- ---------- ---------- ----------
OTHER INCOME (EXPENSE):
Interest income 31 10 46 26
Interest expense (332) (105) (491) (175)
Foreign currency transaction gain (loss) (97) (14) 77 (44)
---------- ---------- ---------- ----------
Total Other Income (Expense) (398) (109) (368) (193)
---------- ---------- ---------- ----------
INCOME (LOSS) BEFORE (PROVISION)
BENEFIT FOR INCOME TAXES (1,972) 469 (5,103) 1,778
(PROVISION) BENEFIT FOR INCOME TAXES (76) (31) (22) (133)
---------- ---------- ---------- ----------
NET INCOME (LOSS) $ (2,048) $ 438 $ (5,125) $ 1,645
========== ========== ========== ==========
INCOME (LOSS) PER SHARE;
BASIC $ (.23) $ .06 $ (.60) $ .22
DILUTED $ (.23) $ .05 $ (.60) $ .20
SHARES USED IN THE CALCULATION OF
INCOME (LOSS) PER SHARE:
BASIC 8,889 7,632 8,604 7,620
DILUTED 8,889 8,000 8,604 8,214
OTHER COMPRESHENSIVE INCOME (LOSS):
Net income (loss) $ (2,048) $ 438 $ (5,125) $ 1,645
Foreign currency gain (loss) 19 (52) 209 (40)
---------- ---------- ---------- ----------
OTHER COMPRESHENSIVE INCOME (LOSS): $ (2,029) $ 386 $ (4,916) $ 1,605
========== ========== ========== ==========
4
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
(IN THOUSANDS)
Six Months Ended
December 31,
1998 1997
---------- ----------
Cash Flows From Operating Activities:
Net income $ (5,125) $ 1,645
Adjustments to reconcile net income to cash provided by (used for)
operating activities:
Depreciation and amortization 871 393
Changes in current operating items:
Accounts receivable 414 267
Inventories (1,699) (917)
Royalty and other advances (767) (1,395)
Prepaid expenses and other 243 (1,299)
Current liabilities 268 (771)
---------- ----------
Cash used for operating activities (5,795) (2,077)
---------- ----------
Cash flows from investing activities:
Property and equipment purchases (383) (287)
Proceeds from sale of property and equipment -- 3
Music catalog additions (115) (321)
Other (175) (33)
---------- ----------
Cash used for investing activities (673) (638)
---------- ----------
Cash flows from financing activities:
Issuance of Long Term Debt -- 4,000
Borrowings on line of credit, net 1,106 1,174
Proceeds (repayments) on note payable to affiliate, net (305) (1,500)
Proceeds from exercise of stock options 5,249 57
---------- ----------
Cash provided by financing activities 6,050 3,731
---------- ----------
Effect of exchange rates on cash (8) (27)
---------- ----------
Net increase (decrease) in cash and cash equivalents (426) 989
Cash and cash equivalents at beginning of year 5,941 3,341
---------- ----------
Cash and cash equivalents at period end $ 5,515 $ 4,330
========== ==========
5
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND DESCRIPTION
K-tel International, Inc. is an international marketer and distributor
of entertainment and consumer products and is a leader in the market
niche for pre-recorded music compilations. With more than thirty-five
years of marketing experience in the United States and Europe, the
Company has developed the resources, knowledgeable personnel,
information systems, and distribution capabilities to launch music,
video, and consumer products quickly in the North American and European
markets through traditional retail and direct-response marketing
channels. On May 1, 1998, the Company launched its Internet service,
K-tel Express (www.ktel.com), featuring a wide spectrum of music
products for purchase by the public around the globe. Open for commerce
24 hours a day, 365 days a year, K-tel Express features more than
250,000 music titles at value prices through this on-line shopping
service. Revenue generated from K-tel Express through December 31, 1998
has not been material.
The Company markets and sells pre-recorded music both from the
Company's owned music master catalog and under licenses from third
party record companies. Sales of compact discs, cassettes and albums,
are made to rack-jobbers (distributors which stock and manage inventory
within certain music and video departments for certain retail stores),
wholesalers and retailers in the U.S. and through subsidiaries and
licensees in the United Kingdom and elsewhere in Europe. Television
direct-response marketing of pre-recorded music and consumer
convenience product is a significant source of revenue for the Company,
specifically in Europe.
In 1997, the Company formed a U.S. media buying and
infomercial-marketing subsidiary, which performed media buying services
for third parties and also marketed products through infomercials
produced by third parties. As of June 30, 1998, due to accumulated
losses of $2,300,000 the Company curtailed most of these media buying
operations. In addition, in September 1998, the Company discontinued
its K-tel home video product line.
In March of 1998, the Company acquired certain media and other assets
of United Kingdom based Regal Shop International Ltd., a direct
response marketer and began operating these assets as K-tel Marketing
(UK) Limited.
2. BASIS OF PRESENTATION
The accompanying unaudited condensed 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 of normal recurring
adjustments) considered necessary for a fair presentation have been
included. Operating results for the six month period ended December 31,
1998, are not necessarily indicative of the results that may be
expected for the year as a whole. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's annual report on Form 10-K for the year ended June 30, 1998.
3. RECENTLY ISSUED ACCOUNTING STANDARDS
Statement of Financial Accounting Standards No. 131 ("SFAS 131"),
"Disclosures about Segments of an Enterprise and Related Information",
requires disclosure of business segments in the financial statements of
the Company. The Company expects to adopt SFAS No. 131 in the fourth
quarter of fiscal 1999 and anticipates a change in segment disclosure
at the time of adoption.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS No. 133). SFAS No. 133
established accounting and reporting standards requiring that every
derivative financial instrument (including certain derivative
instruments embedded in other contracts) be recorded in the balance
sheet as either an asset or liability measured at its fair value. SFAS
No. 133 requires that changes in the derivative's fair value be
recognized currently in earnings unless specific hedge accounting
criteria are met. Special accounting for qualifying hedges allows a
derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that
receive hedge accounting. The company will be required to adopt SFAS
No. 133 no later than January 1, 2000. K-tel International, Inc. had
not entered into any derivative financial instruments as of December
31, 1998. As a result, adoption of SFAS No. 133
6
would currently have no impact on the Company. In the future, if the
Company were to enter into derivative financial instruments that are
covered by SFAS No. 133, volatility in earnings and other comprehensive
income could be increased.
4. COMPUTATION OF NET INCOME (LOSS) PER SHARE
For the three and six month periods ended December 31, 1997, weighted
average shares outstanding included common stock equivalents of
approximately 368,000 and 594,000 respectively, related to stock
options. For the three and six months ended December 31, 1998, no
common stock equivalents were included because they would have been
anti-dilutive.
On April 21, 1998, the Board of Directors declared a two-for-one stock
split of the Company's Common Stock in the form of a stock dividend
payable to shareholders of record on May 1, 1998. All disclosures and
applicable per share data have been retroactively restated to reflect
this split.
5. CREDIT FACILITY
The Company has an existing $10 million credit facility with a lending
institution. The credit facility consists of a $4 million term loan due
in full on November 20, 2001 and a $6 million revolving credit
facility, limited to a percent of eligible receivables, that expires
November 20, 2001. Borrowings under the facility bear interest at a
variable rate based on a "base rate" announced by a banking affiliate
associated with the lending institution (7.75% at December 31, 1998)
and are secured by the assets of certain U.S. subsidiaries, including
accounts receivable, inventories, equipment, music library and general
intangibles. The loan agreement contains certain financial and other
covenants or restrictions, including the maintenance of a minimum
tangible net worth by the Company, limitations on capital expenditures,
restrictions on music library acquisitions, limitations on the
incurrence of indebtedness and restrictions on dividends paid by the
Company. The Company has guaranteed the obligations of its subsidiaries
under the credit facility and has pledged the stock of those
subsidiaries and its assets to secure the Company's obligations under
its guaranty. As of December 31, 1998, $4,000,000 was outstanding under
the term loan and $4,844,000 was outstanding under the line of credit
and the maximum additional available under the borrowing limitations at
that date was $922,000. At December 31,1998 the Company was in
compliance with all covenants, limitations and restrictions of the
agreement. The Company has amended certain financial covenants with the
lender for fiscal 1999 and beyond, and expects to be out of compliance
with the tangible net worth requirement that becomes effective December
31, 1999 unless the Company obtains an equity infusion or further
modifies the covenants. As a result the $4 million term loan has been
classified as a current liability. Future losses from businesses such
as K-tel Express or the inability to complete an equity placement may
result in further renegotiations of such covenants or the need to seek
replacement financing. There can be no assurances that such financing
will be available on terms satisfactory to the Company.
6. NON-RECURRING INCOME/EXPENSE
The operating loss for the three and six month periods ended December
31, 1998 include: i) a loss of $650,000, included in cost of goods,
incurred by the Company when it discontinued marketing and distribution
activities of its home video product line, ii) a loss of $800,000,
included in advertising costs, relating to the write-offs of certain
infomercials and remaining deferred media assets from its curtailed
third party media buying operation because management determined such
assets were not realizable, and iii) a loss of $250,000, included in
selling, general and administrative expenses, incurred by the Company
when it discontinued certain catalog operations in Germany. In
addition, the loss for the three months ended December 31, 1998
includes approximately $280,000 in royalty income related to a one time
settlement.
7. COMMITMENTS AND CONTINGENCIES
During the second quarter of fiscal 1998, the Company and Playboy
Enterprises, Inc. entered into an agreement to create a co-branded
online music store within Playboy.com, Playboy's free web site. The
companies also agreed that K-tel would create certain Playboy private
label compilations which K-tel would have the exclusive right to market
and sell in the United States. The term of the agreement, which is
subject to extension based upon mutual agreement by both parties, is
initially for two years, except that K-tel will have the right to sell
each Playboy private label compilation created under the agreement for
an additional 5 years following expiration of the term. In accordance
with the agreement, the Company is required to make guaranteed monthly
payments totaling $900,000 over the initial two year contract term that
are available to offset royalties to Playboy Enterprises, Inc.
7
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
K-tel International, Inc. is an international marketer and distributor of
entertainment and consumer products and is a leader in the market niche for
pre-recorded music compilations. With more than thirty-five years of marketing
experience in the United States and Europe, the Company has developed the
resources, knowledgeable personnel, information systems, and distribution
capabilities to launch music, video, and consumer products quickly in the North
American and European markets through traditional retail and direct-response
marketing channels. On May 1, 1998, the Company launched its Internet service,
K-tel Express (www.ktel.com), featuring a wide spectrum of music products for
purchase by the public around the globe. Open for commerce 24 hours a day, 365
days a year, K-tel Express features more than 250,000 music titles at value
prices through this on-line shopping service. Revenue generated from K-tel
Express through December 31, 1998 has not been material.
The Company markets and sells pre-recorded music both from the Company's owned
music master catalog and under licenses from third party record companies. Sales
of compact discs, cassettes and albums, are made to rack-jobbers (distributors
which stock and manage inventory within certain music and video departments for
certain retail stores), wholesalers and retailers in the U.S. and through
subsidiaries and licensees in the United Kingdom and elsewhere in Europe.
Television direct-response marketing of pre-recorded music and consumer
convenience product is a significant source of revenue for the Company,
specifically in Europe.
In 1997, the Company formed a U.S. media buying and infomercial-marketing
subsidiary, which performed media buying services for third parties and also
marketed products through infomercials produced by third parties. As of June 30,
1998, due to accumulated losses of $2,300,000 the Company curtailed most of
these media buying operations. In addition, in September 1998, the Company
discontinued its K-tel home video product line.
In March of 1998, the Company acquired certain media and other assets of United
Kingdom based Regal Shop International Ltd., a direct response marketer and
began operating these assets as K-tel Marketing (UK) Limited.
SALES
Net sales for the six months ended December 31, 1998 were $39,798,000 compared
to $48,350,000 or 17.7% less than the comparable period last year. Sales of
music related products and services were $25,195,000 for the six months ended
December 1998 compared to $25,030,000 in the six months ended December 31, 1997.
Sales of consumer products were $13,989,000 for the six months ended December
31,1998 compared to $12,356,000 for the comparable period in 1997 primarily due
to K-tel Marketing (UK) Ltd. which was not in existence in the prior year. Sales
of the primarily discontinued video and media buying services for the six months
ended December 31, 1998 were $615,000 compared to $10,964,000 last year.
Net sales for the three months ended December 31, 1998 were $21,006,000 compared
to $23,215,000 or 9.5% less than the comparable period last year. Sales of music
related products and services were $12,988,000 for the three months ended
December 1998 compared to $12,044,000 in the three months ended December 31,
1997. Sales of consumer products were $7,849,000 for the three months-ended
December 31,1998 compared to $6,052,000 for the comparable period in 1997
primarily due to K-tel Marketing (UK) Ltd. which was not in existence in the
prior year. Sales of the primarily discontinued video and media buying services
for the three months ended December 31, 1998 were $169,000 compared to
$5,119,000 last year.
COST OF GOODS SOLD
Cost of goods sold was $21,472,000 or 54.0% of sales for the six months ended
December 31, 1998 compared to $27,306,000 or 56.5% for the comparable period
last year. Music related cost of sales was 62.4% for the six months ended
December 31, 1998 compared to 58.1% for the comparable period last year. The
increase in music related product cost as a percentage of sales relates to the
mix of products, primarily a shift in the revenue base to increasing sales of
other music companies labels which have a higher cost of goods than K-tel owned
music products and services. These increases were offset by the consumer
products cost of goods which improved to 38.8% for the six months ended December
31, 1998 compared to 47.5% in the comparable period last year.
8
Cost of goods sold was $11,038,000 or 52.5% of sales for the three months ended
December 31, 1998 compared to $12,502,000 or 53.9% for the comparable period
last year. Music related cost of sales was 62.4% for the three months ended
December 31, 1998 compared to 58.5% for the comparable period last year. The
increase in product cost relates to the mix of products, primarily a shift in
the revenue base to increasing sales of other music companies' labels which have
a higher cost of goods than K-tel owned music products and services. These
increases were offset by the consumer products cost of goods which improved to
35.5% for the three months ended December 31, 1998 compared to 47.2% in the
comparable period last year.
ADVERTISING
Advertising which consists primarily of TV media and production costs and
co-operative advertising with customers was $8,854,000 or 22.2% in the six
months ended December 31,1998 compared to $8,177,000 or 16.9% for the comparable
period last year. The increase in 1998 expenditures compared to last year in
advertising is primarily related to the acquisition of K-tel Marketing (UK)
which had advertising expenditures of $2,007,000, other consumer products
increases of $410,000, an increase in music related advertising of $918,000
offset by a savings of $2,658,000 in advertising expenditures in discontinued
video and media buying services divisions.
Advertising was $4,424,000 or 21.1% in the three months ended December 31,1998
compared to $4,451,000 or 19.2% for the comparable period last year. The
increase in 1998 expenditures compared last year in advertising is primarily
related to the acquisition of K-tel Marketing (UK) which had advertising
expenditures of $1,048,000, other consumer products decreases of $110,000, an
increase in music related advertising of $532,000 offset by a savings of
$1,937,000 in advertising expenditures in discontinued video and media buying
services divisions.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $14,207,000 for the six months
ended December 31, 1998 compared to $10,896,000 in the comparable period last
year. The increase of $3,311,000 in selling, general and administrative expenses
primarily related to the acquisition of K-tel Marketing (UK) and K-tel express
which had selling, general and administrative expenditures of $2,494,000 and
$990,000 respectively, which did not exist in the comparable period last year.
Selling, general and administrative expenses were $7,118,000 for the three
months ended December 31, 1998 compared to $5,684,000 in the comparable period
in last year. The increase of $1,434,000 in selling, general and administrative
expenses primarily related to the acquisition of K-tel Marketing (UK) and K-tel
express which had selling, general and administrative expenditures of $1,426,000
and $571,000 respectively, which did not exist in the comparable period last
year, offset from savings in the discontinued video and media buying services
divisions.
OPERATING (LOSS) PROFIT
As a result of the item's discussed above the operating loss for the six months
ended December 31, 1998 was $4,735,000 compared to an operating profit of
$1,971,000 for the same period last year.
Operating loss for the three months ended December 31, 1998 $1,574,000 compared
to a profit of $578,000 for the same period last year.
OTHER INCOME/EXPENSE
Net interest expense for the six and three months ended December 31, 1998 was
$445,000 and $301,000 respectively compared to $149,000 and $95,000 in the
comparable periods last year. The increase relates to an increase in average
borrowings which increased $6,328000 and $4,178,000 for the six and three month
periods over last year.
9
INCOME TAXES
Income taxes which are not material to the consolidated results of operations
for the six and three months ended December 31, 1998 are a function of the
country of origin profits and net operating loss carry-forward losses available.
NET (LOSS)/INCOME
As result of the above the company experienced a net loss for the six and three
months ended December 31, 1998 of $5,125 ($0.60 per share) and $2048 ($0.23 per
share), respectively, compared to net income of $1,645 ($0.22 per share) and
$438 ($0.06 per share), respectively.
B. LIQUIDITY AND CAPITAL RESOURCES
During the six months ended December 31, 1998, the Company experienced negative
cash flow from operations of $5,795,000 and utilized another $673,000 for
investing activities. To finance the above, the Company borrowed an additional
$1,106,000 under its existing credit facilities. In September, 1998 the
Compensation Committee of the Board of Directors passed a resolution authorizing
the accelerated vesting of outstanding employee stock options if exercised by
November 30, 1998. In addition, in December, 1998 the Board of Directors granted
to the Chairman of the Board and Chief Executive Officer ("Chairman") an option
to purchase 200,000 shares which was immediately exercised to assist the Company
in meeting it's equity needs for continued listing on the Nasdaq National
Market. Cash generated from the exercise stock options was $5,249,000 during the
three months ended December 31, 1998.
The Company has an existing $10 million credit facility with a lending
institution. The credit facility consists of a $4 million term loan due in full
on November 20, 2001 and a $6 million revolving credit facility, limited to a
percent of eligible receivables that expires November 20, 2001. Borrowings under
the facility bear interest at a variable rate based on a "base rate" announced
by a banking affiliate associated with the lending institution (7.75% at
December 31, 1998) and are secured by the assets of certain U.S. subsidiaries,
including accounts receivable, inventories, equipment, music library and general
intangibles. The loan agreement contains certain financial and other covenants
or restrictions, including the maintenance of a minimum tangible net worth by
the Company, limitations on capital expenditures, restrictions on music library
acquisitions, limitations on other indebtedness and restrictions on dividends
paid by the Company. The Company has guaranteed the obligations of its
subsidiaries under the credit facility and has pledged the stock of those
subsidiaries and its assets to secure the Company's obligations under its
guaranty. As of December 31, 1998, $4,000,000 was outstanding under the term
loan and $4,844,000 was outstanding under the line of credit and the maximum
additional available under the borrowing limitations at that date was $922,000.
At December 31,1998 the Company was in compliance with all covenants,
limitations and restrictions of the agreement. The Company has amended certain
financial covenants with the lender for fiscal 1999 and beyond, and expects to
be out of compliance with the tangible net worth requirement that becomes
effective December 31, 1999 unless the Company obtains an equity infusion or
further modifies the covenants. As a result, the $4 million term loan has been
classified as a current liability. Future losses from businesses such as K-tel
Express or the inability to complete an equity placement may result in further
renegotiations of such covenants or the need to seek replacement financing.
There can be no assurances that such financing will be available on terms
satisfactory to the Company.
K-5 Leisure Products, Inc. ("K-5"), an affiliate controlled by the Company's
Chairman, has from time to time made advances to the Company. As of December 31,
1998, K-5 had advanced $695,000 to the Company and advanced an additional
$500,000 subsequent to December 31, 1998. The Company pays interest on the
unpaid principal amount of financing at the same rate as the Company pays on its
credit facility, until repayment of the loan, which is due on demand.
The Company has primarily funded its operations to date through internally
generated capital, bank financing, stock option exercises or advances made by an
affiliate of the Chairman. However, the Company anticipates that it will require
additional cash in order to further develop and promote its Internet retail
music site, K-tel Express. The Company is actively seeking and evaluating
sources of additional capital including private placement or secondary equity
offerings and a stock option grant equaling the equivalent of up to $2 million
to the Chairman, who has agreed to exercise the option if needed to meet the
liquidity needs for continued listing on the Nasdaq National Market ("Nasdaq").
Although the Company has made no material commitments for capital expenditures,
it anticipates a substantial increase in funding requirements for development
and acquisition of technology, marketing and promotion, payment of $900,000 over
two years to Playboy Enterprises, Inc. and for capital expenditures to develop
the infrastructure necessary for the anticipated growth in operations. To date,
the Company has no commitments for any additional financing and there can be no
assurance that such commitments can be obtained on favorable terms, if at all.
Historically, the Company has had available to it, funding from a company owned
by the Company's Chairman. There are no assurances that the Company will be able
to continue to borrow from this company in the future.
10
On February 8, 1999 the Company was notified of the decision by the Nasdaq
Hearing Panel that the Company's common stock will continue to be listed on the
Nasdaq as the Company evidenced compliance with all requirements for continued
listing. In the Company's form 10-Q for the quarter ended September 30, 1998 the
Company had reported that it received notification by Nasdaq that it failed to
meet certain requirements necessary for continued listing on the Nasdaq National
Market.
Year 2000 Disclosure
The Company has developed a plan to ensure its systems are compliant with the
requirements to process transactions in the Year 2000 ("Y2K"). The majority of
the Company's internal information systems have been upgraded or are in the
process of being upgraded or replaced with fully compliant new systems. The new
systems implementation related to accounting for royalties is in progress and
should be substantially completed by July 31, 1999. Other significant Company
systems in the United States are deemed to be Y2K compliant. Some of the
Company's customers utilize equipment to capture and transmit financial
transactions. The Company is in the process of making the necessary updates to
this equipment to ensure it will be effective in the Y2K. The Company is also
working with its processing banks and network providers to ensure their systems
are year 2000 compliant. All of these costs will be or have been borne by the
processors and network companies. The Company's European subsidiaries have
upgraded or are in the process of replacing or upgrading their information
systems to comply with Y2K requirements. European systems upgrades should be Y2K
compliant by September 30, 1999. The Company does not rely on any one
significant customer or vendor for it's sales or purchases. Therefore, failure
of any customer or vendor to comply with Y2K should not have a material impact
on the Company's operations. However, should the Company, its customers, its
vendors or the processing banks fail to resolve Y2K issues, the Company may lose
certain financial and operating data. The Company is in the process of
developing a contingency plan, which it expects to be completed by the end of
the fiscal year. The total cost of the software implementation to bring the
Company into Y2K compliance is estimated to be approximately $200,000.
Euro Conversion Disclosure
On January 1, 1999, eleven of the fifteen member countries of the European Union
established fixed conversion rates between their existing sovereign currencies
and the euro. The participating countries adopted the euro as their common legal
currency on that date. At this point, the Company has not yet evaluated the
impact of the euro conversion on the Company.
Important Factors Relating to Forward Looking Statements - Information in this
form 10 Q may contain forward-looking statements relating to future results of
the Company (including certain projections and business trends) that are
"forward-looking statements" as defined in the Private Securities Litigation
Reform Act of 1995. Actual results and performance may differ materially from
the forward-looking statements as a result of certain risks and uncertainties,
including but not limited to, changes in political and economic conditions,
demand for and market acceptance of new and existing products, the impact from
competition for Internet content, merchandise and recorded music, dependence on
strategic alliance partners, suppliers and distributors, market acceptance of
the Internet for commerce and as a medium for advertising, technological changes
and difficulties, and availability of financing.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On and after November 19, 1998, a number of suits styled as securities class
actions were filed against the Company as well as Philip Kives, the Company's
Chairman of the Board and Chief Executive Officer, and Lawrence Kieves, the
Company's President, in United States Federal Court for Districts of California,
Minnesota and New York. All of the cases are similar and allege, on behalf of
the named plaintiff and other persons who purchased shares of the Company's
common stock during certain periods (the longest being October 23, 1998 through
November 17,1998) damages arising from the alleged efforts of the defendants to
artificially inflate the price of the Company's stock while failing to disclose
that the Company's common stock might be delisted from the Nasdaq National
Market due to the alleged failure of the Company to satisfy the requirements for
continued listing of the Company's common stock on the Nasdaq National Market.
The Company expects that the cases will be consolidated in the United States
Federal Court for the District of Minnesota. The Company and the individual
defendants have denied any wrongdoing, believe there are meritorious defenses to
the claims and will vigorously defend the litigation.
On February 8, 1999, the Company was notified of the decision by the Nasdaq
Hearing Panel that the Company's common stock will continue to be listed on the
Nasdaq National Market and that the Company evidenced compliance with all
requirements for continued listing on the Nasdaq National Market.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBIT INDEX
10.58 Non-Qualified Stock Option Agreement - Lawrence Kieves
27. Financial Data Schedule
(b) REPORTS ON FORM 8-K
The Company did not file any reports on Form 8-K during the quarter ended
December 31, 1998.
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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.
K-TEL INTERNATIONAL, INC.
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REGISTRANT
/S/ PHILIP KIVES
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PHILIP KIVES
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
/S/ LAWRENCE KIEVES
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LAWRENCE KIEVES
PRESIDENT
/S/ STEVEN KAHN
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STEVEN KAHN
CHIEF FINANCIAL OFFICER
(principal accounting officer)
13