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, 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: 0-6664
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) 559-6800
(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 February 1,
2000, there were 9,775,405 shares of the registrant's common stock, par value
$0.01 per share, outstanding.
1
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 1999
INDEX
PART I. Financial Information: Page
Item 1. Condensed Consolidated Balance Sheets as of
December 31, 1999 and June 30, 1999 3
Condensed Consolidated Statements of Operations
for the Three and Six Month periods ended
December 31, 1999 and 1998 4
Condensed Consolidated Statements of Cash Flows
for the Six Month Periods Ended
December 31, 1999 and 1998 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 15
PART II. Other Information:
Item 2. Legal Proceedings 15
Item 6. Exhibits and Reports on Form 8-K 16
2
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND JUNE 30, 1999
(IN THOUSANDS)
December 31, June 30,
1999 1999
------------------- -----------------
(UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents $ 5,340 $ 6,782
Accounts receivable, net 14,073 12,701
Inventories 9,279 7,644
Royalty and other advances 1,500 927
Prepaid expenses and other 1,852 2,146
------------------- -----------------
Total Current Assets 32,044 30,200
------------------- -----------------
Property and Equipment, net of
accumulated depreciation and amortization of
$3,399 and $3,100 1,468 1,549
Other Assets 3,882 4,167
------------------- -----------------
$ 37,394 $ 35,916
------------------- -----------------
------------------- -----------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of notes payable $ 3,960 $ 2,633
Note payable to affiliate 1,945 1,945
Accounts payable 7,711 3,774
Accrued royalties 10,232 8,851
Reserve for returns 4,402 4,375
Other current liabilities 4,436 6,546
------------------- -----------------
Total Current Liabilities 32,686 28,124
------------------- -----------------
Long Term Debt 4,000 4,000
Shareholders' Equity:
Common stock 60 60
Additional Paid-In Capital 17,155 21,155
Accumulated Deficit (15,485) (16,416)
Cumulative translation adjustment (1,022) (1,007)
------------------- -----------------
Total Shareholders' Equity 708 3,792
------------------- -----------------
$ 37,394 $ 35,916
------------------- -----------------
------------------- -----------------
See accompanying notes to condensed consolidated financial statements.
3
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED
(IN THOUSANDS - EXCEPT PER SHARE DATA)
Three Months Ended Six Months Ended
December 31, December 31,
----------------------------------- ----------------------------------
1999 1998 1999 1998
--------------- --------------- -------------- ---------------
NET SALES $ 16,404 $ 21,006 $ 34,501 $ 39,798
--------------- --------------- -------------- ---------------
COSTS AND EXPENSES:
Cost of goods sold 7,955 11,038 17,467 21,472
Advertising 3,873 4,424 7,283 8,854
Selling, general & administrative 6,008 7,118 11,892 14,207
--------------- --------------- -------------- ---------------
Total Costs and Expenses 17,836 22,580 36,642 44,533
--------------- --------------- -------------- ---------------
OPERATING (LOSS) (1,432) (1,574) (2,141) (4,735)
--------------- --------------- -------------- ---------------
OTHER INCOME (EXPENSE):
Interest income 41 31 82 46
Interest expense (242) (332) (431) (491)
Foreign currency transaction gain (loss) (249) (97) (46) 77
Other expense (47) --- (647) ---
Gain on sale of subsidiary --- --- 4,341 ---
--------------- --------------- -------------- ---------------
Total Other Income (Expense) (497) (398) 3,299 (368)
--------------- --------------- -------------- ---------------
INCOME (LOSS) BEFORE
INCOME TAXES (1,929) (1,972) 1,158 (5,103)
INCOME TAXES 20 76 227 22
--------------- --------------- -------------- ---------------
NET INCOME (LOSS) (1,949) (2,048) $ 931 $ (5,125)
--------------- --------------- -------------- ---------------
--------------- --------------- -------------- ---------------
INCOME (LOSS) PER SHARE
BASIC $ (.20) $ (.23) $ .10 $ (.60)
DILUTED $ (.20) $ (.23) $ .10 $ (.60)
SHARES USED IN THE CALCULATION OF
INCOME (LOSS) PER SHARE
BASIC 9,775 8,889 9,775 8,604
DILUTED 9,775 8,889 9,783 8,604
COMPRESHENSIVE INCOME (LOSS)
Net income (loss) $ (1,949) $ (2,048) $ 931 $ (5,125)
Foreign currency gain (loss) (41) 19 (15) 209
--------------- --------------- -------------- ---------------
COMPRESHENSIVE INCOME (LOSS) $ (1,990) $ (2,029) $ 916 $ (4,916)
--------------- --------------- -------------- ---------------
--------------- --------------- -------------- ---------------
See accompanying notes to condensed consolidated financial statements.
4
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
(IN THOUSANDS)
Six Months Ended
December 31,
----------------------------------------
1999 1998
---------------- --------------
Cash Flows From Operating Activities:
Net income (loss) 931 $ (5,125)
Adjustments to reconcile net income (loss) to cash (used for)
operating activities:
Depreciation and amortization 831 871
Net proceeds on sale of K-tel Finland (4,341) ---
Changes in operating assets and liabilities:
Accounts receivable (1,325) 414
Inventories (1,633) (1,699)
Royalty and other advances (563) (767)
Prepaid expenses and other 259 243
Accounts payable and other 1,609 (214)
Accrued royalties 1,370 412
Reserve for returns 27 140
Income taxes, net 216 (70)
---------------- --------------
Cash (used for) operating activities (2,619) (5,795)
---------------- --------------
Investing Activities:
Net proceeds on sale of K-tel Finland 4,341 ---
Property and equipment purchases (176) (383)
Other (268) (290)
---------------- --------------
Cash provided by (used for) investing activities 3,897 (673)
---------------- --------------
Cash flows from financing activities:
Borrowings on note payable, net 1,327 1,106
Repayments on note payable to affiliate, net --- (305)
Repurchase of shares issued in private placement (4,000) ---
Proceeds from exercise of stock options --- 5,249
---------------- --------------
Cash provided by (used for) financing activities (2,673) 6,050
---------------- --------------
Effect of exchange rates on cash (47) (8)
---------------- --------------
Net decrease in cash and cash equivalents (1,442) (426)
Cash and cash equivalents at beginning of period 6,782 5,941
---------------- --------------
Cash and cash equivalents at end of period $ 5,340 $ 5,515
---------------- --------------
---------------- --------------
See accompanying notes to condensed consolidated financial statements.
5
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BUSINESS AND DESCRIPTION
K-tel International, Inc. ("the Company" or "K-tel") markets and
distributes entertainment and consumer products internationally. The
Company has more than 35 years of marketing experience in the United
States and Europe, K-tel has developed the resources, knowledgeable
personnel, information systems, and distribution capabilities to market
music and consumer products through traditional retail and
direct-response marketing channels. K-tel also markets music, video and
consumer products through two Internet e-commerce sites, K-tel.com
(www.ktel.com) in the United States and (www.ktel.de) in Europe.
2. LIQUIDITY
The Company experienced a negative cash flow of $2,619,000 from
operations for the six months ended December 31, 1999. The cash
requirements to fund this deficit were satisfied principally from the
sale of K-tel Finland which generated $4,294,000 in cash. As discussed
in note 5 below, the Company has outstanding revolving credit
agreements with Foothill Capital Corporation and K-5 Leisure Products,
Inc. The Company anticipates that it will require additional cash to
fund operations for the balance of the year and is exploring sources of
financing including equity financing and existing revolving credit
agreements. The Company has approximately $6 million of unused credit
line with K-5 Leisure Products, Inc. and the availability of the
Foothill line of credit varies with the accounts receivable asset base.
While the Company has no commitments with respect to equity financing
and has no assurance that it will have such financing when needed or
that borrowing capacity under the Company's credit facilities will be
sufficient, management believes that the Company will have adequate
resources to continue operations in the near term.
3. 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 three and six month periods ended
December 31, 1999, 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,
1999.
4. COMPUTATION OF INCOME (LOSS) PER SHARE
The diluted income per share calculation for the six months ended
December 31, 1999 included 7,954 common stock equivalents. The loss per
share calculation for the three months ended December 31, 1999 and 1998
and the six months ended December 31, 1998 do not give effect to common
stock equivalents as they would be anti-dilutive.
5. NOTES PAYABLE
K-tel has a $10,000,000 credit facility with Foothill Capital
Corporation ("Foothill"), consisting of a $4,000,000 term loan due in
full on November 20, 2001, and a $6,000,000 revolving facility, under
which borrowings are limited to a percent of eligible receivables.
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 (8.5% at December 31, 1999) and are secured by the
assets of certain Company subsidiaries in the U.S.,
6
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 shareholders' equity by K-tel, limitations
on capital expenditures, restrictions on music library acquisitions,
limitations on other indebtedness and restrictions on dividends paid
by K-tel. K-tel has guaranteed the obligations of its subsidiaries
under the credit facility and has pledged the stock of those
subsidiaries and its assets to secure K-tel's obligations under its
guaranty. As of December 31, 1999, $4,000,000 was outstanding under
the term loan, $3,960,000 was outstanding under the revolving line
of credit and the maximum additional available under the borrowing
limitations was $48,000. K-tel was in compliance with all covenants,
limitations and restrictions under the credit agreement and obtained
a waiver from the lender for the minimum shareholders' equity
covenant
On September 27, 1999, K-tel entered into a written Line of Credit
Agreement with K-5 Leisure Products, Inc. ("K-5"), an affiliate
controlled by Philip Kives, the Chairman of the Board and Chief
Executive Officer of K-tel. Subject to the terms of the agreement
(including that there be no event of default under the Foothill
Agreement), K-5 has agreed to make available up to $8,000,000 on a
revolving basis. The loan bears interest at the same rate as K-tel's
loan from Foothill and expires on November 20, 2001. The loan agreement
between K-tel and K-5 contains the same covenants as the Foothill loan
agreement, and K-5 has agreed not to declare a default prior to July 1,
2000 in the event that the Company does not comply with the
shareholders' equity covenant. The K-5 loan is subordinated to the
Foothill loan. K-tel has pledged the stock of its foreign subsidiaries
as collateral for the loan. In addition, K-5 and Foothill have agreed
that, if Foothill were to give notice of its intention to accelerate
its loan, K-5 would have the right to pay Foothill and assume the
secured creditor position of Foothill. Additionally, K-5 has indicated
to K-tel that it would assume the secured creditor's position in the
event that Foothill accelerated amounts due under the Foothill loan,
and K-5 has sufficient financial resources to do so. As of December 31,
1999, K-tel had an outstanding balance of $1,945,000 to K-5. During the
six months ended December 31, 1999 K-5 advanced an additional
$1,600,000 which was repaid in the period.
6. OTHER INCOME/EXPENSE
The Company had two significant components of other income and expense
in the six months ended December 31, 1999. The Company recognized a
gain of $4,294,000 on the sale of K-tel International (Finland) Oy and
incurred an expense of $600,000 in connection the settlement of a
private equity placement in August 1999.
Operations 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 settlement.
7. COMMITMENTS AND CONTINGENCIES
There have been no material changes in the Company's commitments and
contingencies during the six months ended December 31, 1999 except as
detailed in the following paragraph. For additional information, refer
to footnote 8 of the Company's consolidated financial statements
included in the annual report on Form 10-K for the fiscal year ended
June 30, 1999.
On January 11, 2000, the Company was named in a lawsuit entitled
CHRISTOPHER EARLY V. K-TEL INTERNATIONAL, INC., ET AL, brought in the
Circuit Court of Cook County, Illinois, against the company and certain
of its subsidiaries by Christopher Early. The suit also names as
defendants certain other manufacturers, distributors and a number of
nationwide retailers. The plaintiff seeks damages on behalf of himself
and a purported class of purchasers of cassette tapes and compact discs
produced, distributed and/or sold by the defendants. The plaintiff
claims that the defendants engaged in deceptive and misleading
packaging of cassette tapes and compact discs by failing to give proper
notice to consumers that the songs contained therein are not the
original recordings by the original artists. The complaint also alleges
consumer fraud,
7
deceptive and unfair practices, and fraud in connection with website
advertising and marketing. Similar litigation against the company
had been brought by Mr. Early in 1997, and was dismissed by a U.S.
Federal court in 1999 on jurisdictional grounds. The company denies
that it mislabeled cassette tapes and compact discs or engaged in
fraudulent or deceptive conduct and intends to vigorously defend the
purported action, which seeks an undetermined amount of compensatory
damages and punitive damages in the amount of $10.0 million, an
injunction and costs incurred in the litigation, including attorneys
fees. Based upon information available to it, the company further
believes that damages, if any, are speculative and that there are no
grounds for an award of punitive damages. While discovery has not
yet begun and no assurance can be given that the company will be
successful in defending this action, the Company believes it has
meritorious defenses to all of the plaintiff's claims.
7. SEGMENT INFORMATION
The Company markets and distributes entertainment and consumer products
internationally. K-tel's businesses are organized, managed and
internally reported as four segments: retail music sales, music
licensing, direct response consumer sales, and e-commerce. These
segments are based on differences in products, customer type and sales
and distribution methods. The Company has curtailed or discontinued the
operations of its video and third party media buying businesses and
these are collectively shown in the other column below.
The retail music segment consists primarily of the sales of
pre-recorded music both from the Company's music master catalog and
under licenses obtained from other record companies, as well as
pre-recorded music developed by other companies who desire to use K-tel
for sales and distribution of their music products. The Company sells
compact discs and cassettes directly to retailers, wholesalers and rack
service distributors which stock and manage inventory within music
departments for retail stores.
The Company licenses the rights to its master music catalog, consisting
of original recordings and re-recordings of music from the 1950's
through today to third parties world-wide, for use in albums, films,
television programs, and commercials, for either a flat fee or a
royalty based on the number of units sold.
The Company's consumer products business, which is concentrated in
Europe, consists primarily of housewares, consumer convenience items
and exercise equipment. The Company concentrates on products that have
the potential for worldwide appeal and that are innovative, readily
demonstrated and inexpensive (generally retailing for less than $100).
In Europe, the Company engages in an extensive amount of direct
response marketing. European direct response business is solicited
through television and radio advertising campaigns.
The Company's e-commerce business, K-tel.com, (www.ktel.com) enables
customers to choose from brand-name recordings as well as K-tel
compilations. K-tel On-line also gives customers the opportunity to
create their own custom CD compilations from our master music catalog.
K-tel International GmbH, the Company's German subsidiary, also
operates an internet site www.Ktel.de
Operating profits or losses of these segments include an allocation of
general corporate expenses.
8
Certain financial information on the Company's operating segments is as
follows:
SIX MONTHS ENDED DECEMBER 31, 1999
BUSINESS SEGMENT Consumer Corporate/ Total
INFORMATION Music Products Licensing Internet Other Elimination Company
- ---------------------- --------- --------- --------- -------- -------- ----------- ---------
Net Sales 1999 $ 17,323 $ 15,431 $ 1,622 $ 637 $ 17 $ (529) $ 34.501
1998 23,880 13,988 1,841 100 615 (626) 39,798
Operating 1999 $ (389) $ (1,421) $ 499 $ (695) $ (135) -- $ (2,141)
Income 1998 (1,169) (1,606) 839 (1,285) (1,514) -- (4,735)
Assets 1999 $ 21,127 $ 9,807 $ 2,269 $ 1,153 $ 337 $ 2,701 $ 37,394
1998 22,249 11,719 2,095 1,080 1,624 1,872 40,639
THREE MONTHS ENDED DECEMBER 31, 1999
BUSINESS SEGMENT Consumer Corporate/ Total
INFORMATION Music Products Licensing Internet Other Elimination Company
- ---------------------- --------- --------- --------- -------- -------- ----------- ---------
Net Sales 1999 $ 7,422 $ 8,034 $ 811 $ 396 $ --- $ (259) $ 16,404
1998 12,195 7,849 1,170 50 169 (427) 21,006
Operating 1999 $ (559) $ (931) $ 375 $ (263) $ (54) -- $ (1,432)
Income 1998 (628) (562) 560 (714) (230) -- (1,574)
9
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
K-tel markets and distributes entertainment and consumer products
internationally. With more than 35 years of marketing experience in the
United States and Europe, K-tel has developed the resources, knowledgeable
personnel, information systems, and distribution capabilities to market music
and consumer products through traditional retail and direct-response
marketing channels. K-tel also markets through two Internet e-commerce sites,
K-tel.com (www.ktel.com) in the United States and (www.ktel.de) in Europe.
Both sites feature a wide spectrum of music, video and consumer products.
A. RESULTS OF OPERATIONS
THE SIX MONTHS ENDED DECEMBER 31, 1999 VERSUS THE SIX MONTHS ENDED DECEMBER
31, 1998
Net sales for the six months ended December 31, 1999 were $34,501,000, a
decline of 13.3% from the six months ended December 31, 1998 sales of
$39,798,000. This sales decline can be primarily attributed to K-tel
International (Finland) Oy ("K-tel Finland") which was sold effective July 1,
1999. Therefore, the Company did not derive any sales from this subsidiary in
the six months ended December 31, 1999. For the six months ended December 31,
1998 K-tel Finland had sales of $4,070,000. On a comparable basis, excluding
K-tel Finland, sales for the six months ended December 31, 1999 decreased by
3.4%.
Net income for the six months ended December 31, 1999 was $931,000, or $.10
per share, compared to a loss of $5,125,000, or $0.60 per share, in the six
months ended December 31, 1998. For the six months ended December 31, 1999,
the Company incurred an operating loss of $2,141,000 compared to an operating
loss in the six months ended December 31, 1998 of $4,735,000. The Company had
two significant components of other income and expense for the six months
ended December 31, 1999: the Company recognized a gain of $4,294,000 on the
sale of K-tel Finland and incurred an expense of $600,000 in connection the
settlement of a private equity placement in August 1999. Both of these items
are discussed in further detail in the liquidity section below.
The following sections discuss the results of operations by business segment.
General corporate expenses of $734,000 in the six months ended December 31,
1999, and $1,132,000 in the six months ended December 31, 1998 have been
allocated to the segments.
BUSINESS SEGMENT RESULTS
MUSIC
Sales in the music segment were $17,323,000 in the six months ended December
31, 1999 compared to $23,880,000 in the six months ended December 31, 1998 a
decline of 27.5%. Domestic music sales decreased $1,407,000 or 8.2% and
European music sales decreased $5,150,000 of which Finland was $4,070,000.
K-tel Finland was included in this segment in 1998. Therefore, on a
comparable basis, excluding K-tel Finland, music segment sales decreased
12.6%. K-tel operates K-tel Distribution ("KTD"), which sources other record
labels for sales and distribution by K-tel. Sales of KTD increased to
$5,810,000 in the six months ended December 31, 1999 compared to $5,122,000
in the six months ended December 31, 1998.
Cost of goods sold in the music segment increased to 68.8% of sales in the
six months ended December 31, 1999 compared to 65.4% of sales in the six
months ended December 31, 1998. The KTD business represented about 34% of
sales in the six months ended December 31, 1999 compared to 26% of sales in
the six months ended December 31, 1998. KTD generally has a cost of goods
sold of about 80%, resulting in a higher cost of goods sold for the music
segment. Offsetting the high cost of goods sold in the KTD business is the
fact that the record labels pay for all of the advertising and promotion, so
K-tel does not bear these expenses. Advertising expense, within the segment,
which consists primarily of co-operative advertising payments, trade
advertising and promotions, decreased $2,048,000 and was approximately 5.9%
of sales in the six months ended December 31, 1999 compared to 12.8% for the
six months ended December 31, 1998. This spending decrease was the result of
eliminating most TV advertising, which was deemed ineffective and better
utilization of promotional spending. Additionally the increased sales from
KTD with
10
no related advertising expenses lowered the percentage of advertising expense
to sales. Selling, general and administrative expenses decreased $1,594,000
or 25.0% to $4,780,000 in the six months ended December 31, 1999 compared to
$6,374,000 in the six months ended December 31, 1998. The primary reasons for
the decrease include savings related to headcount reductions, elimination of
certain outside consulting services, general overall spending level
reductions and the elimination of G & A expenses from Finland. As a result,
the music segment incurred an operating loss of $389,000 in the six months
ended December 31, 1999 compared to an operating loss of $1,169,000 in the
six months ended December 31, 1998.
LICENSING
Licensing sales were $1,622,000 in the six months ended December 31, 1999
compared to $1,841,000 in the six months ended December 31, 1998. Included in
the segment sales in the six months ended December 31, 1999 and the six
months ended December 31, 1998 were approximately $529,000 and $626,000 of
inter-company sales, respectively, which are eliminated in the accompanying
consolidated financial statements. Operating income in the licensing segment
was $499,000 in the six months ended December 31, 1999 versus $839,000 in the
six months ended December 31, 1998. Operating income for the six months ended
December 31, 1998 includes $280,000 of income related to a settlement.
CONSUMER PRODUCTS
Sales of consumer products which are primarily sold via infomercials in
Europe were $15,431,000 in the six months ended December 31, 1999, a 10.3%
increase over the six months ended December 31, 1998 sales of $13,988,000.
Cost of goods sold, as a percentage of sales, remained constant at 34.7% in
the six months ended December 31, 1999 and 1998. Advertising expenditures
were $6,076,000 (39.4% of sales) in the six months ended December 31, 1999
compared to $4,945,000 (35.6% of sales) in the six months ended December 31,
1998. Selling, general and administrative expense was $5,426,000 in the six
months ended December 31, 1999 compared to $5,787,000 in the six months ended
December 31, 1998. Despite the sales increase, the consumer products segment
incurred an operating loss of $1,421,000 in the six months ended December 31,
1999 compared to an operating loss of $1,606,000 in the six months ended
December 31, 1998.
E-COMMERCE
K-tel operates its Internet service, K-tel.com (www.ktel.com), featuring a
wide spectrum of music and related products. K-tel also operates a European
Internet service (www.ktel.DE). This segment also includes K-tel's
promotional custom CD business. Sales for the combined e-commerce segment for
the six months ended December 31, 1999 were $637,000 compared to $100,000 for
the six months ended December 31, 1998. The cost of goods sold in the six
months ended December 31, 1999 was approximately 49.5 % of sales compared to
84.0% in 1998. In the six months ended December 31, 1999, selling general and
administrative expenses were $1,332,000 compared to $1,385,000 resulting in
operating losses of $695,000 and $1,285,000 for the six months ended December
31, 1999 and 1998, respectively.
OTHER
The other segment of the business is comprised of the third-party media
buying segment and a video business, both of which have been discontinued.
Sales from these businesses were $615,000 for the six months ended December
31,1998. Operating losses for these businesses were $135,000 and $1,514,000
for the six months ended December 31, 1999 and 1998, respectively. Expenses
in fiscal 1999 relate to ongoing litigation.
11
THE THREE MONTHS ENDED DECEMBER 31, 1999 VERSUS THE THREE MONTHS ENDED
DECEMBER 31, 1998
Net sales for the three months ended December 31, 1999 were $16,404,000, a
decline of 21.9% from the three months ended December 31, 1998 sales of
$21,006,000. This sales decline can be attributed to the music segment where
domestic sales declined $2,410,000 and K-tel Finland which was sold effective
July 1, 1999. The Company did not derive any sales from this subsidiary in
the three months ended December 31, 1999. For the three months ended December
31, 1998 K-tel Finland had sales of $2,058,000. On a comparable basis,
excluding K-tel Finland, sales for the three months ended December 31, 1999
decreased by 13.4%.
The net loss for the three months ended December 31, 1999 was $1,949,000, or
$.20 per share, compared to a loss of $2,048,000, or $0.23 per share, in the
three months ended December 31, 1998.
The following sections discuss the results of operations by business segment.
General corporate expenses of $347,000 in the three months ended December 31,
1999, and $496,000 in the three months ended December 31, 1998 has been
allocated to the segments.
BUSINESS SEGMENT RESULTS
MUSIC
Sales in the music segment were $7,422,000 in the three months ended December
31, 1999 compared to $12,195,000 in the three months ended December 31, 1998
a decline of 39.1%. Domestic music sales decreased $2,410,000 or 27% and
European music sales decreased $2,363,000 of which Finland was $2,058,000.
K-tel Finland was included in this segment in 1998. Therefore, on a
comparable basis, excluding K-tel Finland, music segment sales decreased
26.8%. K-tel operates K-tel Distribution ("KTD"), which sources other record
labels for sales and distribution by K-tel. Sales of KTD increased to
$2,601,000 in the three months ended December 31, 1999 compared to $2,533,000
in the three months ended December 31, 1998.
Cost of goods sold in the music segment increased to 68.1% of sales in the
three months ended December 31, 1999 compared to 66.1% of sales in the three
months ended December 31, 1998. The KTD business represented about 35% of
sales in the three months ended December 31, 1999 compared to 25% of sales in
the three months ended December 31, 1998, after removing the K-tel Finland
sales. This division generally has a cost of goods sold of about 80%,
resulting in a higher cost of goods sold for the music segment. Offsetting
the high cost of goods sold in the KTD business is the fact that the record
labels pay for all of the advertising and promotion, so K-tel does not bear
these expenses. Advertising expense, which consists primarily of co-operative
advertising payments, trade advertising and promotions, decreased $1,113,000
and was approximately 6.2% of sales in the three months ended December 31,
1999 compared to 12.9% for the three months ended December 31, 1998. This
spending decrease was the result of eliminating most TV advertising, which
was deemed ineffective and better utilization of promotional spending.
Additionally, the increased sales from KTD, with no related advertising
expenses, lowered the percentage of advertising expense to sales. Selling,
general and administrative expenses decreased $723,000 or 22.6% to $2,467,000
in the three months ended December 31, 1999 compared to $3,190,000 in the
three months ended December 31, 1998. The primary reasons for the decrease
include savings related to headcount reductions, elimination of certain
outside consulting services, general overall spending level reductions and
the elimination of G & A expenses from Finland. As a result, the music
segment incurred an operating loss of $559,000 in the three months ended
December 31, 1999 compared to an operating loss of $628,000 in the three
months ended December 31, 1998.
LICENSING
Licensing sales were $811,000 in the three months ended December 31, 1999
compared to $1,170,000 in the three months ended December 31, 1998. Included
in the segment sales in the three months ended December 31, 1999 and the
three months ended December 31, 1998 were approximately $259,000 and $427,000
of inter-company sales, respectively, which are eliminated in the
accompanying consolidated financial statements. Operating income in the
licensing segment was $375,000 in the three months ended December 31, 1999
versus $560,000 in the three months ended December 31, 1998. Operating income
for the three months ended December 31, 1998 includes $280,000 related to a
one-time settlement.
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CONSUMER PRODUCTS
Sales of consumer products were $8,034,000 in the three months ended December
31, 1999, a 2.4% increase over the three months ended December 31, 1998 sales
of $7,849,000. Cost of goods sold, as a percentage of sales, remained fairly
constant at 36.1% in the three months ended December 31, 1999 versus 35.5% in
the three months ended December 31,1998. Advertising expenditures were
$3,313,000 (41.2% of sales) in the three months ended December 31, 1999
compared to $2,680,000 (34.1% of sales) in the three months ended December
31, 1998. Selling, general and administrative expense was $2,755,000 in the
three months ended December 31, 1999 compared to $2,943,000 in the three
months ended December 31, 1998. The consumer products segment incurred an
operating loss of $931,000 in the three months ended December 31, 1999
compared to an operating loss of $562,000 in the three months ended December
31, 1998.
E-COMMERCE
Sales for the combined e-commerce segment for the three months ended December
31, 1999 were $396,000 compared to $50,000 for the three months ended
December 31, 1998. The cost of goods sold in the three months ended December
31, 1999 was approximately 39.8 % of sales compared to 72.0% in 1998. In the
three months ended December 31, 1999, selling general and administrative
expenses were $658,000 compared to $764,000 resulting in operating losses of
$263,000 and $714,000 for the three months ended December 31, 1999 and 1998,
respectively.
OTHER
The other segment of the business is comprised of the third-party media
buying segment and a video business, both of which have been discontinued.
Sales from these businesses were $169,000 for the three months ended December
31,1998. Operating losses for these businesses were $54,000 and $230,000 for
the three months ended December 31, 1999 and 1998, respectively. Expenses in
fiscal 1999 relate to on going litigation.
B. LIQUIDITY AND CAPITAL RESOURCES
K-tel has a $10,000,000 credit facility with Foothill Capital Corporation
("Foothill"), consisting of a $4,000,000 term loan due in full on November
20, 2001, and a $6,000,000 revolving facility, under which borrowings are
limited to a percent of eligible receivables. 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 (8.5% at December
31, 1999) and are secured by the assets of certain Company subsidiaries in
the U.S., 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 shareholders' equity by K-tel, limitations on capital expenditures,
restrictions on music library acquisitions, limitations on other indebtedness
and restrictions on dividends paid by K-tel. K-tel has guaranteed the
obligations of its subsidiaries under the credit facility and has pledged the
stock of those subsidiaries and its assets to secure K-tel's obligations
under its guaranty. As of December 31, 1999, $4,000,000 was outstanding under
the term loan, $3,960,000 was outstanding under the revolving line of credit
and the maximum additional available under the borrowing limitations was
$48,000. K-tel was in compliance with all covenants, limitations and
restrictions under the credit agreement and obtained a waiver from the lender
for the minimum shareholders' equity covenant.
On September 27, 1999, K-tel entered into a written Line of Credit Agreement
with K-5 Leisure Products, Inc. ("K-5"), an affiliate controlled by Philip
Kives, the Chairman of the Board and Chief Executive Officer of K-tel. Under
the terms of the agreement, K-5 has agreed to make available up to $8,000,000
on a revolving basis. The loan bears interest at the same rate as K-tel's
loan from Foothill and expires on November 20, 2001. The loan agreement
between K-tel and K-5 contains the same covenants as the Foothill loan
agreement, and K-5 has agreed not to declare a default prior to July 1, 2000
in the event that the Company does not comply with the shareholders' equity
covenant. The K-5 loan is subordinated to the Foothill loan. K-tel has
pledged the stock of its foreign subsidiaries as collateral for the loan. In
addition, K-5 and Foothill have agreed that, if Foothill were to give notice
of its intention to accelerate its loan, K-5 would have the right to pay
Foothill and assume the secured creditor position of Foothill. Additionally,
K-5 has indicated to K-tel that it would assume the secured creditor's
position in the event that Foothill accelerated amounts due under the
Foothill loan, and K-5 has sufficient financial resources to do so. As of
December 31, 1999, K-tel had an outstanding balance of $1,945,000 to K-5.
During the six months ended December 31, 1999 K-5 advanced an additional
$1,600,000 which was repaid in the period. K-tel pays interest on the unpaid
principal amount of financing at the same rate as K-tel pays on the Foothill
loan.
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As of December 31, 1999, K-tel had $5,340,000 in cash and cash equivalents, a
decrease of $1,442,000 from the balance at June 30, 1999. During the six
months ended December 31, 1999, K-tel experienced negative cash flow from
operating activities of $2,619,000 and provided $3,897,000 from investing
activities. The primary component of the investing activities was the sale of
K-tel Finland. In September 1999, K-tel sold all of the outstanding common
stock of its subsidiary K-tel Finland to an unrelated purchaser. Net proceeds
after $1,386,000 in transaction costs related to the sale exceeded the net
book value of K-tel Finland's net assets by approximately $4,294,000, which
was recorded as a gain and reported in other income in the consolidated
statement of operations for the six months ended December 31, 1999. K-tel
Finland was a subsidiary in the Company's music segment responsible for the
sale of music in Scandinavia. The sale of this subsidiary is not expected to
have a material effect on future operations of the Company.
Financing activities used $2,673,000 in cash in the six months ended December
31, 1999. The Company used $4,000,000 of funds related to the unwinding of a
Securities Purchase Agreement K-tel entered into with two investors in April
1999, pursuant to which K-tel would have sold in a private placement
transaction up to $18,000,000 of its common stock in two tranches. The first
tranche was to have totaled $8,000,000. Pursuant to the agreement, K-tel sold
465,794 shares of common stock for an aggregate of $4,000,000, or $8.588 per
share. K-tel was obligated to sell an additional $4,000,000 of common stock
on the effective date of a registration statement under the Securities Act of
1933, covering the common stock. In July 1999, a contractual dispute arose
between the purchasers and K-tel and the $4,000,000 balance on the first
tranche was not sold. On August 3, 1999, K-tel entered into an agreement with
the purchasers of the common stock in the private placement to void the
original agreement and for K-tel to repurchase the 465,794 shares previously
issued for $4,600,000. K-tel used $3,000,000 of internal funds and $1,600,000
of funds advanced by K-5 to repurchase the shares. As a result of this
repurchase, K-tel incurred an expense of $600,000, which was reported in
other expense in the consolidated statement of operations for the six months
ended December 31, 1999. In addition the Company increased its borrowings
under its line of credit with Foothill Capital Corporation by $1,327,000 in
the six months ended December 31, 1999.
K-tel has primarily funded its operations to date through internally
generated capital, secured lender financing, proceeds from stock option
exercises and loans from K-5 Leisure Products, Inc. While the Company has no
commitments with respect to equity financing and has no assurance that it
will have such financing when needed or that borrowing capacity under the
Company's credit facilities will be sufficient, management believes that the
Company will have adequate resources to continue operations in the near term.
YEAR 2000 DISCLOSURE
The Company utilizes management information systems, software technology and
non-information technology systems that were Year 2000 compliant, prior to
December 31, 1999. The Company continues to monitor its operations, as well
as its customers and suppliers to ensure its systems continue to meet its
internal and external requirements. The Company does not believe that it has
been or will be negatively impacted by Year 2000.
During the past two fiscal years the Company undertook a comprehensive review
of its computer systems and related software to ensure that all systems would
properly recognize Year 2000 and continue to process data. The review
encompassed information technology systems and significant third party
relationships.
Based upon this assessment, the Company upgraded portions of its information
systems related to royalties and it's website to ensure Year 2000 compliance.
The Company has not experienced any significant Year 2000 related issues
through the filing date of this report on Form 10-Q. The cost of evaluating
and replacing certain business systems did not have a significant impact on
the Company's results of operations. These costs of approximately $250,000
were funded through operating cash flows over several fiscal years and were
attributable primarily to the purchase of new software and equipment.
Through the date of this report on Form 10-Q, the Company has not experienced
any significant difficulties with third party customers, suppliers and
service providers. However, if these parties do experience future Year 2000
compliance issues, the Company's business, financial condition and results of
operations could be adversely affected.
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IMPORTANT FACTORS RELATING TO FORWARD LOOKING STATEMENTS
Information in this Form 10-Q of a non-historical nature relates to future
events and 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. The use of terminology such as
"believe," "may," "expect," "anticipate," " estimate," other variations
thereof or comparable terminology may identify such forward-looking
statements. Actual results and performance may differ materially from
expressed forward looking statements because 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, availability of
financing and other risks discussed in the Company's 10-k report for the
fiscal year ended June 30, 1999 filed with the Securities and Exchange
Commission.. The Company undertakes no obligation to publicly release the
result of any revisions to these forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the company's market risk during the
six months ended December 31, 1999. For additional information, refer to page
14 of the Company's annual report on Form 10-K for the fiscal year ended June
30, 1999.
PART II
ITEM 1. LEGAL PROCEEDINGS
There have been no material changes in the Company's commitments and
contingencies during the six months ended December 31, 1999 except as
detailed in the following paragraph. For additional information, refer to
footnote 8 of the Company's consolidated financial statements included in the
annual report on Form 10-K for the fiscal year ended June 30, 1999.
On January 11, 2000, the Company was named in a lawsuit entitled CHRISTOPHER
EARLY V. K-TEL INTERNATIONAL, INC., ET AL, brought in the Circuit Court of
Cook County, Illinois, against the company and certain of its subsidiaries by
Christopher Early. The suit also names as defendants certain other
manufacturers, distributors and a number of nationwide retailers. The
plaintiff seeks damages on behalf of himself and a purported class of
purchasers of cassette tapes and compact discs produced, distributed and/or
sold by the defendants. The plaintiff claims that the defendants engaged in
deceptive and misleading packaging of cassette tapes and compact discs by
failing to give proper notice to consumers that the songs contained therein
are not the original recordings by the original artists. The complaint also
alleges consumer fraud, deceptive and unfair practices, and fraud in
connection with website advertising and marketing. Similar litigation against
the company had been brought by Mr. Early in 1997, and was dismissed by a
U.S. Federal court in 1999 on jurisdictional grounds. The company denies that
it mislabeled cassette tapes and compact discs or engaged in fraudulent or
deceptive conduct and intends to vigorously defend the purported action,
which seeks an undetermined amount of compensatory damages and punitive
damages in the amount of $10.0 million, an injunction and costs incurred in
the litigation, including attorneys fees. Based upon information available to
it, the company further believes that damages, if any, are speculative and
that there are no grounds for an award of punitive damages. While discovery
has not yet begun and no assurance can be given that the company will be
successful in defending this action, the Company believes it has meritorious
defenses to all of the plaintiff's claims.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBIT INDEX
27. Financial Data Schedule
(b) REPORTS ON FORM 8-K
During the quarter ended December 31, 1999, two current reports on Form
8-K were filed:
October 8, 1999 - Regarding the resignation of Arthur Andersen LLP as
independent auditors.
December 16, 1999 - Regarding the appointment of Grant Thornton LLP as
independent auditors.
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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.
------------------------------------------
REGISTRANT
/S/ LAWRENCE KIEVES
------------------------------------------
LAWRENCE KIEVES
PRESIDENT
/S/ STEVEN KAHN
------------------------------------------
STEVEN KAHN
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
(principal accounting officer)
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K-tel International, Inc.
2605 Fernbrook Lane N.
Minneapolis, MN 55427
February 14, 1999
Securities and Exchange Commission
450 Fifth Street, NW
Attn: Filing Desk, Stop 1-4
Washington, D.C. 20549-1004
Gentlemen:
Enclosed is K-tel International, Inc.'s Form 10Q for the quarter ended December
31, 1999, pursuant to the applicable provisions of the Securities Exchange Act
of 1934.
Questions can be directed to the undersigned at 612-559-6863 or faxed to
612-559-6817.
Sincerely,
/S/ Steven Kahn
Vice President Finance
CFO
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