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 March 31, 2000
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:
As of May 5, 2000, there were 10,320,405 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 MARCH 31, 2000
TABLE OF CONTENTS
Page No.
PART I. Financial Information:
Item 1. Condensed Consolidated Balance Sheets as of
March 31, 2000 and June 30, 1999 1
Condensed Consolidated Statements of Operations
for the Three and Nine Month periods ended
March 31, 2000 and 1999 2
Condensed Consolidated Statements of Cash Flows
for the Nine Month Periods Ended
March 31, 2000 and 1999 3
Notes to Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk 12
PART II. Other Information:
Item 1. Legal Proceedings 13
Item 6. Exhibits and Reports on Form 8-K 13
I
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, 2000 AND JUNE 30, 1999
(IN THOUSANDS)
March 31, June 30,
2000 1999
------------------- -----------------
(UNAUDITED)
ASSETS
Current Assets:
Cash and equivalents $ 3,997 $ 6,782
Accounts receivable, net 11,524 12,701
Inventories 6,987 7,644
Royalty and other advances 1,302 927
Prepaid expenses and other 2,456 2,146
------------------- -----------------
Total Current Assets 26,266 30,200
------------------- -----------------
Property and Equipment, net of accumulated
depreciation and amortization of
$3,546 and $3,100 1,305 1,549
Other Assets 3,837 4,167
------------------- -----------------
$ 31,408 $ 35,916
=================== =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Note payable $ 1,987 $ 2,633
Note payable to affiliate 1,945 1,945
Accounts payable 6,685 3,774
Accrued royalties 9,492 8,851
Reserve for returns 4,758 4,375
Other current liabilities 4,289 6,546
------------------- -----------------
Total Current Liabilities 29,156 28,124
------------------- -----------------
Long-Term Debt 4,000 4,000
Shareholders' Equity:
Common stock 66 60
Additional Paid-In Capital 20,255 21,155
Accumulated Deficit (21,059) (16,416)
Cumulative translation adjustment (1,010) (1,007)
------------------- -----------------
Total Shareholders' Equity (1,748) 3,792
------------------- -----------------
$ 31,408 $ 35,916
=================== =================
See accompanying notes to condensed unaudited consolidated financial statements.
1
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED
(IN THOUSANDS - EXCEPT PER SHARE DATA)
Three Months Ended Nine Months Ended
March 31, March 31,
----------------------------------- ----------------------------------
2000 1999 2000 1999
--------------- --------------- -------------- ---------------
NET SALES $ 12,885 $ 18,506 $ 47,386 $ 58,304
--------------- --------------- --------------- ---------------
COSTS AND EXPENSES:
Cost of goods sold 7,957 10,397 25,424 31,869
Advertising 3,695 3,611 10,978 12,465
Selling, general & administrative 6,437 8,713 18,329 22,920
--------------- --------------- --------------- ---------------
Total Costs and Expenses 18,089 22,721 54,731 67,254
--------------- --------------- --------------- ---------------
OPERATING LOSS (5,204) (4,215) (7,345) (8,950)
--------------- --------------- --------------- ---------------
OTHER INCOME (EXPENSE):
Interest income 34 7 116 53
Interest expense (209) (185) (640) (676)
Foreign currency transaction gain (loss) (235) (364) (281) (287)
Other expense (5) -- (652) --
Gain on sale of subsidiary -- -- 4,341 --
--------------- --------------- --------------- ---------------
Total Other Income (Expense) (415) (542) 2,884 (910)
--------------- --------------- --------------- ---------------
LOSS BEFORE
INCOME TAXES (5,619) (4,757) (4,461) (9,860)
INCOME TAXES 45 16 (182) (6)
--------------- --------------- --------------- ---------------
NET LOSS $ (5,574) $ (4,741) $ (4,643) $ (9,866)
=============== =============== =============== ===============
LOSS PER SHARE
BASIC AND DILUTED $ (.56) $ (.50) $ (.47) $ (1.11)
SHARES USED IN THE CALCULATION OF
LOSS PER SHARE
BASIC AND DILUTED 9,914 9,529 9,822 8,912
COMPRESHENSIVE INCOME (LOSS)
Net loss $ (5,574) $ (4,741) $ (4,643) $ (9,866)
Foreign currency gain (loss) 12 (150) (3) 59
--------------- --------------- --------------- ---------------
COMPRESHENSIVE LOSS $ (5,562) $ (4,891) $ (4,646) $ (9,807)
=============== =============== =============== ===============
See accompanying notes to condensed unaudited consolidated financial statements.
2
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
(IN THOUSANDS)
Nine Months Ended
March 31,
------------------------------------
2000 1999
---------------- ----------------
Cash flows from operating activities:
Net loss $ (4,643) $ (9,866)
Adjustments to reconcile net loss to cash (used for)
operating activities:
Depreciation and amortization 1,275 1,311
Gain on sale of subsidiary (4,341) --
Changes in operating assets and liabilities:
Accounts receivable 1,155 1,575
Inventories 601 (2,592)
Royalty and other advances (371) (271)
Prepaid expenses and other (394) 536
Accounts payable and other 527 (1,842)
Accrued royalties 639 868
Reserve for returns 400 (28)
Income taxes, net 172 (51)
---------------- --------------
Cash used for operating activities (4,980) (10,360)
---------------- --------------
Cash flows from investing activities:
Net proceeds on sale of subsidiary 4,341 --
Property and equipment purchases (208) (461)
Other (473) (627)
---------------- --------------
Cash provided by (used for) investing activities 3,660 (1,088)
---------------- --------------
Cash flows from financing activities:
Borrowings on note payable, net (646) (675)
Repayments on note payable to affiliate, net --- 945
Repurchase of shares issued in private placement (4,000) --
Proceeds from exercise of stock options 3,106 7,381
---------------- --------------
Cash provided by (used for) financing activities (1,540) 7,651
---------------- --------------
Effect of exchange rates on cash 75 132
---------------- --------------
Net decrease in cash and equivalents (2,785) (3,665)
Cash and equivalents at beginning of period 6,782 5,941
---------------- --------------
Cash and equivalents at end of period $ 3,997 $ 2,276
================ ==============
See accompanying notes to condensed unaudited consolidated financial statements.
3
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 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 $4,980,000 from
operations for the nine months ended March 31, 2000. The cash
requirements to fund this deficit were satisfied principally from the
sale of K-tel Finland which generated $4,341,000 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 no commitments with respect to equity
financing and has no assurance that it will have such financing when
needed 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. Based on
the existing lines of credit with Foothill and K-5 Leisure Products,
Inc., management believes that the Company will have adequate resources
to continue operations in the near term.
3. BASIS OF PRESENTATION
The accompanying unaudited condensed 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 of normal
recurring adjustments) considered necessary for a fair presentation
have been included. Operating results for the three and nine month
periods ended March 31, 2000, 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 LOSS PER SHARE
The loss per share calculations for all periods do not give effect to
common stock equivalents as they would be anti-dilutive. Options to
purchase 1,855,430 and 1,502,162 shares of common stock, with weighted
average exercise prices of $7.31 and $7.75, were outstanding for the
three and nine month periods ended March 31, 2000 and were excluded
from the computation of common share equivalents for that period as
they were anti-dilutive. Options to purchase 840,575 and 1,105,952
shares of common stock, with weighted average exercise prices of $7.62
and $6.53, were outstanding for the three and nine month periods ended
March 31, 1999 and were excluded from the computation of common share
equivalents for that period as they were 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
4
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 (9% at March 31, 2000) 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 March 31, 2000,
$4,000,000 was outstanding under the term loan, $1,987,000 was
outstanding under the revolving line of credit and the maximum
additional available under the borrowing limitations was $835,000.
K-tel was in compliance with all covenants, limitations and
restrictions under the credit agreement except for the minimum
shareholders' equity covenant, for which it obtained a waiver from the
lender.
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 March 31, 2000, K-tel had an outstanding
balance of $1,945,000 to K-5. During the nine months ended March 31,
2000 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 K-tel pays on the Foothill loan.
6. OTHER INCOME/EXPENSE
The Company had two significant components of other income and expense
in the nine months ended March 31, 2000. The Company recognized a gain
of $4,341,000 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.
The operating loss for the nine month period ended March 31, 1999
includes: i) a loss of $1,057,000, incurred by the Company when it
discontinued marketing and distribution activities of its home video
product line, ii) a loss of $1,498,000, 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, 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,
iv) an approximately $280,000 in royalty income related to a one time
settlement.
The operating loss for the three month period ending March 31,1999
includes: i) an additional loss of $287,000 related to the remaining
assets of the Company's home video line for which the Company did not
expect to realize the remaining asset net book values, and ii) a loss
of $777,000 primarily related to a remaining contract from the media
buying operation which terminated in the fourth quarter of fiscal 1999.
7. COMMITMENTS AND CONTINGENCIES
There have been no material changes in the Company's commitments and
contingencies during the nine months ended March 31, 2000 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
5
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.
8. SUBSEQUENT EVENTS
K-tel was advised by the Nasdaq Stock Market ("Nasdaq") on May 4, 2000
that Nasdaq has determined that the Company no longer meets the minimum
$50,000,000 market capitalization or total assets and total revenue
requirements for continued listing on the Nasdaq National Market
("NMS") under Maintenance Standard 2 as set forth in Nasdaq's
Marketplace Rules 4450(b)(1)(A) and 4450(b)(1)(B). As a result, Nasdaq
is reviewing the Company's eligibility for continued listing on the NMS
and has requested that the Company furnish to Nasdaq a specific plan to
achieve and sustain compliance with NMS listing requirements by May 22,
2000, including the timeframe for completion of a plan.
The Company is currently reviewing various alternatives to achieve full
compliance with the continued listing requirements of the NMS. There
can be no assurance as to the timing or success of any such
alternatives. The Company intends to submit to Nasdaq a specific plan
to achieve and sustain compliance.
9. 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 amounts in
the sales elimination represents intercompany sales by the licensing
segment to the other segments.
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.
6
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.
Certain financial information on the Company's operating segments is as
follows:
NINE MONTHS ENDED MARCH 31, 2000
BUSINESS SEGMENT
INFORMATION Consumer Corporate/ Total
Music Products Licensing Internet Other Elimination Company
- --------------------------------------------------------------------------------------------------------------------
Net Sales 2000 $ 21,504 $ 22,921 $ 2,982 $ 892 $ 17 $ (930) $ 47,386
1999 31,887 23,148 3,237 432 660 (1,060) 58,304
Operating 2000 $ (4,238) $ (2,614) $ 884 $(1,079) $ (298) -- $ (7,345)
Income (Loss) 1999 (3,819) (1,896) 1,089 (1,731) (2,593) -- (8,950)
Assets 2000 $ 16,688 $ 9,665 $ 1,941 $ 894 $ 336 $ 1,884 $ 31,408
1999 19,678 11,448 2,445 977 399 723 35,670
THREE MONTHS ENDED MARCH 31, 2000
BUSINESS SEGMENT
INFORMATION Consumer Corporate/ Total
Music Products Licensing Internet Other Elimination Company
- --------------------------------------------------------------------------------------------------------------------
Net Sales 2000 $ 4,181 $ 7,490 $ 1,360 255 $ -- $ (401) $ 12,885
1999 8,007 9,160 1,396 332 45 (434) 18,506
Operating 2000 $ (3,849) $ (1,193) $ 385 $ (384) $ (163) -- $ (5,204)
Income (Loss) 1999 (2,650) (289) 250 (446) (1,080) -- (4,215)
7
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 and consumer products.
SUBSEQUENT EVENTS
K-tel was advised by The Nasdaq Stock Market ("Nasdaq") on May 4, 2000 that
Nasdaq has determined the Company no longer meets the minimum $50,000,000
market capitalization or total assets and total revenue requirements for
continued listing on the Nasdaq National Market ("NNS") under Maintenance
Standard 2 as set forth in Nasdaq's Marketplace Rules 4450(b)(1)(A) and
4450(b)(1)(B). As a result, Nasdaq is reviewing the Company's eligibility for
continued listing on the NMS and has requested that the Company furnish to
Nasdaq a specific plan to achieve and sustain compliance with NMS listing
requirements by May 22, 2000, including the timeframe for completion of a
plan.
The Company is currently reviewing various alternatives to achieve full
compliance with the continued listing requirements of the NMS. There can be
no assurance as to the timing or success of any such alternatives. The
Company intends to submit to Nasdaq a specific plan to achieve and sustain
compliance.
A. RESULTS OF OPERATIONS
THE NINE MONTHS ENDED MARCH 31, 2000 VERSUS THE NINE MONTHS ENDED MARCH 31,
1999
Net sales for the nine months ended March 31, 2000 were $47,386,000, a
decline of 18.7% from the nine months ended March 31, 1999 net sales of
$58,304,000. The net sales decline can be primarily attributed to the
following factors: a decline in the net sales of the Company's music products
of $10,383,000 of which $5,045,000 relates to K-tel International (Finland)
Oy ("K-tel Finland") which was sold effective July 1, 1999. On a comparable
basis, excluding K-tel Finland, net sales for the nine months ended March 31,
2000 decreased by 11.0%.
The net loss for the nine months ended March 31, 2000 was $4,643,000, or $.47
per share, compared to a loss of $9,866,000, or $1.11 per share, in the nine
months ended March 31, 1999. For the nine months ended March 31, 2000, the
Company incurred an operating loss of $7,345,000 compared to an operating
loss in the nine months ended March 31, 1999 of $8,950,000. The Company had
two significant components of other income and expense for the nine months
ended March 31, 2000: the Company recognized a gain of $4,341,000 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 $1,152,000 and $1,858,000 in the nine months
ended March 31, 2000 and 1999 has been allocated to the segments.
BUSINESS SEGMENT RESULTS
MUSIC
Net sales in the music segment were $21,504,000 in the nine months ended
March 31, 2000 compared to $31,887,000 in the nine months ended March 31,
1999 a decline of 32.6%. This decrease was attributed to a decline in
domestic music net sales of $3,808,000 or 16.4%. Weak consumer demand for the
Company's music compilation products caused this decline. European music net
sales decreased $6,575,000 of which Finland was $5,045,000. K-tel Finland was
included in this segment in 1999. Other European music net sales were also
hurt by weak consumer demand for
8
our products. Also reflecting the weak consumer demand were returns, which as
a percentage of gross sales increased to 30.4% for the nine months ended
March 31, 2000 compared to 22.6% for the nine months ended March 31, 1999.
Cost of goods sold in the music segment increased to 79.3% of net sales in
the nine months ended March 31, 2000 compared to 68.5% of net sales in the
nine months ended March 31, 1999. This increase in cost of goods was the
result of the lower than anticipated net sales demand, which caused the
Company to take several charges in the period to reflect inventory valuation
reductions and other inventory related charges. These charges totaled
$2,479,000 or 11.5 % of net sales in the period.
Advertising expense was $1,598,000 or 7.4% of net sales compared to
$3,653,000 or 11.5% of net sales. Advertising consists primarily of
co-operative advertising payments, trade advertising and promotions. This
spending decrease was the result of the company eliminating most TV
advertising in fiscal 2000. As a result of the weak demand, the Company is
re-evaluating TV advertising to stimulate net sales. Selling, general and
administrative expenses decreased $3,123,000 or 30.5% to $7,103,000 in the
nine months ended March 31, 2000 compared to $10,226,000 in the nine months
ended March 31, 1999. The primary reasons for the decrease include savings
related to 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
$4,238,000 in the nine months ended March 31, 2000 compared to an operating
loss of $3,819,000 in the nine months ended March 31, 1999.
LICENSING
Licensing net sales were $2,982,000 in the nine months ended March 31, 2000
compared to $3,237,000 in the nine months ended March 31, 1999. Included in
the segment net sales in the nine months ended March 31, 2000 and 1999 were
approximately $930,000 and $1,060,000 of inter-company sales, respectively,
which are eliminated in the accompanying consolidated financial statements.
Operating income in the licensing segment was $884,000 in the nine months
ended March 31, 2000 versus $1,089,000 in the nine months ended March 31,
1999. Operating income for the nine months ended March 31, 1999 includes
$280,000 of income related to a settlement.
CONSUMER PRODUCTS
Net sales of consumer products, which are primarily sold via infomercials in
Europe, were $22,921,000 in the nine months ended March 31, 2000, a 1%
decrease over the nine months ended March 31, 1999 net sales of $23,149,000.
Cost of goods sold, as a percentage of net sales, remained fairly constant at
34.9% of net sales in the nine months ended March 31, 2000 compared to 35.2%
for the nine months ended March 31, 1999. Advertising expenditures were
$9,107,000 (39.7% of net sales) in the nine months ended March 31, 2000
compared to $7,829,000 (33.8% of net sales) in the nine months ended March
31, 1999. Selling, general and administrative expense was $8,430,000 in the
nine months ended March 31, 2000 compared to $9,059,000 in the nine months
ended March 31, 1999. The consumer products segment incurred an operating
loss of $2,614,000 in the nine months ended March 31, 2000 compared to an
operating loss of $1,896,000 in the nine months ended March 31, 1999.
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. Net sales for the combined e-commerce segment
for the nine months ended March 31, 2000 were $892,000 compared to $432,000
for the nine months ended March 31, 1999. The cost of goods sold in the nine
months ended March 31, 2000 was approximately 48.2 % of net sales compared to
50.9% in 1999. In the nine months ended March 31, 2000, selling general and
administrative expenses were $1,269,000 compared to $1,553,000. As a result
operating losses were $1,079,000 and $1,731,000 for the nine months ended
March 31, 2000 and 1999.
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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.
Net sales from these businesses were $17,000 and $660,000 for the nine months
ended March 31, 2000 and 1999. Operating losses for these businesses were
$298,000 and $2,593,000 for the nine months ended March 31, 2000 and 1999.
Expenses in fiscal 2000 relate to ongoing litigation.
THE THREE MONTHS ENDED MARCH 31, 2000 VERSUS THE THREE MONTHS ENDED MARCH 31,
1999
Net sales for the three months ended March 31, 2000 were $12,885,000, a
decline of 30.4% from the three months ended March 31, 1999 net sales of
$18,506,000. This sales decline will be discussed in detail in the Business
Segment Results section below.
The net loss for the three months ended March 31, 2000 was $5,574,000, or
$.56 per share, compared to a loss of $4,741,000, or $0.50 per share, in the
three months ended March 31, 1999.
The following sections discuss the results of operations by business segment.
General corporate expenses of $418,000 and $726,000 in the three months ended
March 31, 2000 and 1999 has been allocated to the segments.
BUSINESS SEGMENT RESULTS
MUSIC
Net sales in the music segment were $4,181,000 in the three months ended
March 31, 2000 compared to $8,007,000 in the three months ended March 31,
1999 a decline of 47.8%. Domestic music net sales decreased $2,352,000 or
39.6% and European music net sales decreased $1,474,000, of which Finland was
$975,000. K-tel Finland was included in this segment in 1999. Weak consumer
demand for the Company's music compilation products caused this decline in
both the domestic and European markets. Also reflecting the weak consumer
demand were returns, which as a percentage of gross sales increased to 46.4%
for the three months ended March 31, 2000 compared to 27.7% for the three
months ended March 31, 1999.
Cost of goods sold in the music segment increased to 122.6% of net sales in
the three months ended March 31, 2000 compared to 77.6% of net sales in the
three months ended March 31, 1999. This increase in cost of goods was the
result of the lower than anticipated net sales demand, which caused the
Company to take several charges in the period to reflect inventory valuation
reductions and other inventory related charges. These charges totaled
$1,784,000 or 42.7% of net sales in the period.
Advertising expense consisting primarily of co-operative advertising
payments, trade advertising and promotions, was approximately $582,000 or
13.9% of net sales in the three months ended March 31, 2000 compared to
$589,000 or 7.4% for the three months ended March 31, 1999. Selling, general
and administrative expenses decreased $1,529,000 or 39.7% to $2,323,000 in
the three months ended March 31, 2000 compared to $3,852,000 in the three
months ended March 31, 1999. The primary reasons for the decrease include
savings related to 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 $3,849,000 in the three months ended March 31, 2000 compared to an
operating loss of $2,650,000 in the three months ended March 31, 1999.
LICENSING
Licensing net sales were $1,360,000 in the three months ended March 31, 2000
compared to $1,396,000 in the three months ended March 31, 1999. Included in
the segment net sales in the three months ended March 31, 2000 and the three
months ended March 31, 1999 were approximately $401,000 and $434,000 of
inter-company net sales, respectively, which are eliminated in the
accompanying consolidated financial statements. Operating income in the
licensing segment was $385,000 in the three months ended March 31, 2000
versus $250,000 in the three months ended March 31, 1999.
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CONSUMER PRODUCTS
Net sales of consumer products were $7,490,000 in the three months ended
March 31, 2000, an 18.2% decrease over the three months ended March 31, 1999
net sales of $9,160,000. Cost of goods sold, as a percentage of net sales,
remained fairly constant at 35.4% in the three months ended March 31, 2000
versus 36.0% in the three months ended March 31,1999. Advertising
expenditures were $3,031,000 (40.5% of net sales) in the three months ended
March 31, 2000 compared to $2,884,000 (31.5% of net sales) in the three
months ended March 31, 1999. Selling, general and administrative expense was
$3,004,000 in the three months ended March 31, 2000 compared to $3,272,000 in
the three months ended March 31, 1999. The consumer products segment incurred
an operating loss of $1,193,000 in the three months ended March 31, 2000
compared to an operating loss of $289,000 in the three months ended March 31,
1999.
E-COMMERCE
Net sales for the combined e-commerce segment for the three months ended
March 31, 2000 were $255,000 compared to $332,000 for the three months ended
March 31, 1999. The cost of goods sold in the three months ended March 31,
2000 was approximately 45.1 % of net sales compared to 41.0% in 1999. In the
three months ended March 31, 2000, selling general and administrative
expenses were $443,000 compared to $518,000 resulting in operating losses of
$384,000 and $446,000 for the three months ended March 31, 2000 and 1999.
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.
Operating losses for these businesses were $163,000 and $1,080,000 for the
three months ended March 31, 2000 and 1999. Expenses in fiscal 2000 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 (9% at March 31,
2000) 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 March 31, 2000, $4,000,000 was outstanding under
the term loan, $1,987,000 was outstanding under the revolving line of credit
and the maximum additional available under the borrowing limitations was
$835,000. K-tel was in compliance with all covenants, limitations and
restrictions under the credit agreement except for the minimum shareholders'
equity covenant, for which it obtained a waiver from the lender.
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
March 31, 2000, K-tel had an outstanding balance of $1,945,000 to K-5. During
the nine months ended March 31, 2000 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.
As of March 31, 2000, K-tel had $3,997,000 in cash and cash equivalents, a
decrease of $2,785,000 from the balance at June 30, 1999. During the nine months
ended March 31, 2000, K-tel experienced negative cash flow from
11
operating activities of $4,980,000 and provided $3,660,000 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 $4,341,000, which
was recorded as a gain and reported in other income in the consolidated
statement of operations for the nine months ended March 31, 2000. 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 $1,540,000 in cash in the nine months ended March
31, 2000. 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. 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 nine months ended March 31, 2000. In addition the
Company repaid $646,000 of its borrowings under its line of credit with
Foothill Capital Corporation in the nine months ended March 31, 2000.
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. The Company has no
commitments with respect to equity financing and has no assurance that it
will have such financing when needed 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.
Based on the existing lines of credit with Foothill and K-5 Leisure Products,
Inc., management believes that the Company will have adequate resources to
continue operations in the near term.
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
nine months ended March 31, 2000. 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.
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PART II
ITEM 1. LEGAL PROCEEDINGS
There have been no material changes in the Company's commitments and
contingencies during the nine months ended March 31, 2000, 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 the plaintiff's claims.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBIT INDEX
27. Financial Data Schedule
(b) REPORTS ON FORM 8-K
Two current reports on Form 8-K were filed:
January 21, 2000 - Regarding the Christopher Early lawsuit.
May 10, 2000 - Regarding Nasdaq listing requirements.
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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.
Date: May 15, 2000 K-TEL INTERNATIONAL, INC.
REGISTRANT
Date: May 15, 2000 /s/ KEN P. ONSTAD
------------------------------
KEN P. ONSTAD
PRESIDENT
/s/ STEVEN KAHN
------------------------------
Date: May 15, 2000 STEVEN KAHN
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
(principal accounting officer)
14