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, 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.)
5555 PIONEER CREEK DRIVE MAPLE PLAIN, MINNESOTA 55359
(Address of principal executive offices) (Zip Code)
(763) 479-8170
(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,
2001, 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 DECEMBER 31, 2000
INDEX
PART I. Financial Information: Page
Item 1. Condensed Consolidated Balance Sheets as of
December 31, 2000 and June 30, 2000 3
Condensed Consolidated Statements of Operations
for the Three and Six Month Periods Ended
December 31, 2000 and 1999 4
Condensed Consolidated Statements of Cash Flows
for the Six Month Periods Ended
December 31, 2000 and 1999 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 14
PART II. Other Information:
Item 1. Legal Proceedings 15
Item 3. Default Upon Senior Securities 16
Item 6. Exhibits and Reports on Form 8-K 16
2
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2000 AND JUNE 30, 2000
(IN THOUSANDS)
December 31, June 30,
2000 2000
---------------------- -------------------
(UNAUDITED)
ASSETS
Current Assets:
Cash and equivalents $ 66 $ 789
Accounts receivable, net 7,799 8,765
Inventories 2,386 2,717
Royalty and other advances 454 349
Prepaid expenses and other 493 270
Net assets of discontinued operations --- 3,076
---------------------- -------------------
Total Current Assets 11,198 15,966
---------------------- -------------------
Property and Equipment, net of
Accumulated depreciation and amortization of
$2,990 and $3,393 640 808
Other Assets 1,806 1,986
---------------------- -------------------
$ 13,644 $ 18,760
====================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of long term debt $ 5,170 $ 1,924
Note payable to affiliate 3,038 1,945
Accounts payable 5,508 4,709
Accrued royalties 12,334 11,625
Reserve for returns 4,535 4,623
Other current liabilities 2,191 2,531
Net liabilities of discontinued operations 544 ---
---------------------- -------------------
Total Current Liabilities 33,320 27,357
---------------------- -------------------
Long Term Debt --- 4,000
Shareholders' Equity:
Common stock 103 103
Additional Paid-In Capital 20,213 20,213
Accumulated Deficit (39,515) (32,154)
Cumulative translation adjustment (477) ( 759)
---------------------- -------------------
Total Shareholders' Equity (19,676) (12,597)
---------------------- -------------------
$ 13,644 $ 18,760
====================== ===================
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,
------------------------------------ --------------------------------
2000 1999 2000 1999
----------------- ----------------- ----------------- ---------------
NET SALES $ 5,001 $ 8,345 $ 11,300 $ 19,319
----------------- ----------------- ----------------- ---------------
COSTS AND EXPENSES:
Cost of goods sold 3,237 5,059 7,715 12,186
Advertising 93 572 287 1,241
Selling, general & administrative 3,750 3,419 6,425 6,870
----------------- ----------------- ----------------- ---------------
Total Costs and Expenses 7,080 9,050 14,427 20,297
----------------- ----------------- ----------------- ---------------
OPERATING LOSS (2,079) (705) (3,127) (978)
OTHER INCOME (EXPENSE):
Interest income --- 35 --- 71
Interest expense (180) (210) (359) (365)
Foreign currency transaction gain (loss) 262 (203) (147) (40)
Other expense --- (47) --- (647)
Gain on sale of subsidiary --- --- --- 4,341
----------------- ----------------- ----------------- ---------------
Total Other Income (Expense) 82 (425) (506) 3,360
----------------- ----------------- ----------------- ---------------
INCOME (LOSS) FROM CONTINUING
OPERATIONS BEFORE INCOME TAXES (1,997) (1,130) (3,633) 2,382
INCOME TAXES (5) (18) (11) (223)
----------------- ----------------- ----------------- ---------------
INCOME (LOSS) FROM CONTINUING
OPERATIONS (2,002) (1,148) (3,644) 2,159
LOSS FROM DISCONTINUED CONSUMER PRODUCTS GROUP (2,830) (801) (3,717) (1,228)
----------------- ----------------- ----------------- ---------------
NET INCOME (LOSS) $ (4,832) $ (1,949) $ (7,361) $ 931
================= ================= ================= ===============
INCOME (LOSS) PER SHARE
BASIC AND DILUTED
CONTINUING OPERATIONS $ (.19) $ (.12) $ (.35) $ .22
DISCONTINUED OPERATIONS (.28) (.08) (.36) (.12)
NET INCOME (LOSS) (.47) (.20) (.71) .10
SHARES USED IN THE CALCULATION OF
INCOME (LOSS) PER SHARE
BASIC 10,320 9,775 10,320 9,775
DILUTED 10,320 9,775 10,320 9,783
COMPREHENSIVE INCOME (LOSS)
Net income (loss) $ (4,832) $ (1,949) $ (7,361) $ 931
Foreign currency gain (loss) (45) (41) 282 (15)
----------------- ----------------- ----------------- ---------------
COMPREHENSIVE INCOME (LOSS) $ (4,877) $ (1,990)) $ (7,079) $ 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,
--------------------------------------
2000 1999
-------------------- ----------------
Cash Flows From Operating Activities:
Net income (loss) $ (7,361) $ 931
Adjustments to reconcile net income (loss) to cash used in
operating activities:
Depreciation and amortization 378 523
Gain on sale of subsidiary --- (4,341)
Discontinued operations 3,759 1,093
Changes in operating assets and liabilities:
Accounts receivable 951 (1,986)
Inventories 326 (1,487)
Royalty and other advances (108) (563)
Prepaid expenses and other (225) 41
Accounts payable and other 1,601 1,337
Accrued royalties 717 1,373
Reserve for returns (91) 102
Income taxes, net (20) 216
-------------------- ----------------
Cash used in operating activities (73) (2,761)
-------------------- ----------------
Investing Activities:
Gain on sale of subsidiary --- 4,341
Property and equipment purchases (10) (122)
Music catalog additions (41) (202)
Discontinued operations --- (54)
Other --- (66)
-------------------- ----------------
Cash provided by (used in) investing activities (51) 3,897
-------------------- ----------------
Cash flows from financing activities:
Borrowings on note payable, net (754) 1,327
Repurchase of shares issued in private placement --- (4,000)
-------------------- ----------------
Cash used for financing activities (754) (2,673)
-------------------- ----------------
Effect of exchange rates on cash 155 (47)
-------------------- ----------------
Net decrease in cash and cash equivalents (723) (1,584)
Cash and cash equivalents at beginning of period 789 4,164
-------------------- ----------------
Cash and cash equivalents at end of period $ 66 $ 2,580
==================== ================
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 LIQUIDITY
K-tel International, Inc. (the "Company", "K-tel", or the
"Registrant") markets and distributes entertainment products
internationally. With more than 35 years of marketing experience in
the United States and Europe, the Company has developed the
resources, knowledgeable personnel, information systems, and
distribution capabilities to market music products through
traditional retail and direct-response marketing channels. The
Company also markets through an Internet e-commerce site, K-tel.com
(www.ktel.com), which features K-tel music products. K-tel.com offers
on-line shoppers the convenience and access to an extensive number of
music items at value prices.
The Company experienced negative cash flow of $73,000 from operations
in the six months ended December 31, 2000, and had a working capital
deficit of approximately $22 million. The Company's cash requirements
were satisfied principally from borrowings under its credit
facilities. As discussed in notes 4 and 5 below, the Company has
outstanding revolving credit agreements with Foothill Capital
Corporation ("Foothill") and K-5 Leisure Products, Inc. ("K-5"). As
of December 31, 2000, the Company had $5,000 available for borrowings
under its Foothill credit facility and approximately $5,000,000 of
unused availability under its credit line with K-5. The Company's
ability to continue operations in the short and long term is
dependent on its continued ability to borrow under its credit
facilities and the sufficiency of such borrowing capacity to meet
its requirements.
2. BASIS OF PRESENTATION AND DISCONTINUED OPERATIONS
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with accounting
principles generally accepted in the United States of America ("US
GAAP") 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 US GAAP 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, 2000,
are not necessarily indicative of the results that may be expected
for the year as a whole. The unaudited condensed consolidated balance
sheet for June 30, 2000 has been derived from audited consolidated
financial statements as of that date. 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, 2000.
The Company's consumer products business, which was concentrated in
Europe, consisted primarily of housewares, consumer convenience items
and exercise equipment. The Company discontinued its consumer
products operations in Germany and in the United Kingdom in June 2000
and November 2000, respectively. Accordingly, these activities have
been presented in the accompanying financial statements as
discontinued operations. Net sales for the discontinued operations
were $3,026,000 and $7,123,000 for the three months ended December
31, 2000 and 1999 and $3,362,000 and $8,059,000 for the six months
ended December 31, 2000 and 1999.
3. COMPUTATION OF INCOME (LOSS) PER SHARE
The earnings per share calculation for the six months ended December
31, 2000 do not give effect to common stock equivalents as they would
be anti-dilutive. The earnings per share calculation for the six
months ended December 31, 1999 included 7,954 dilutive common stock
equivalents. The loss per share calculation for the three months
ended December 31, 2000 and 1999 do not give effect to common stock
equivalents as they would be anti-dilutive. Options to purchase
2,603,723 and 1,324,889 shares of common stock, with weighted average
exercise prices of $6.27 and $8.18, were outstanding for the six
month periods ended December 31, 2000 and 1999 and were excluded from
the computation of common share equivalents for the periods as they
were anti-dilutive.
6
4. LONG TERM DEBT
Long term debt consist of the following:
December 31, June 30,
2000 2000
--------------- --------------
Term Loan $ 3,405,000 $ 4,000,000
Revolving Line of Credit 1,765,000 1,924,000
--------------- --------------
5,170,000 5,924,000
Less Current Portion 5,170,000 1,924,000
--------------- --------------
Long Term Portion $ --- $ 4,000,000
=============== ==============
K-tel has a $6,400,000 credit facility with Foothill Capital
Corporation ("Foothill"), consisting of a $3,405,000 term loan due in
full on April 30, 2001, and a $2,995,000 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 (13.5% at December 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
December 31, 2000, $3,405,000 was outstanding under the term loan,
$1,765,000 was outstanding under the revolving line of credit and the
maximum additional available under the borrowing limitations was
$5,000. K-tel was in compliance with all covenants, limitations and
restrictions of the credit agreement except for the minimum
shareholders' equity covenant.
5. NOTES PAYABLE TO AFFILIATE
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
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 agreed not to declare a default prior to July 1, 2001 in the
event that the Company did 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 in its discretion 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, 2000 and as of June 30, 2000 K-tel had an
outstanding balance of $3,038,000 and $1,945,000 to K-5.
6. OTHER INCOME/EXPENSE
The Company incurred a foreign currency transaction loss from
continuing operations of $147,000 in the six months ended December
31, 2000, which was primarily the result of fluctuations in the pound
sterling in connection with the Company's United Kingdom operations.
The Company had two significant components of non-operating income
and expense in the six month period ended December 31, 1999. The
Company recognized a net gain of $4,341,000 on the sale of K-tel
International (Finland) Oy and incurred an expense of $600,000 in
connection with the settlement of a private equity placement that had
been completed in August 1999.
7
7. COMMITMENTS AND CONTINGENCIES
CLASS ACTION LAWSUIT
K-tel and certain of its current and former officers and directors
are defendants in IN RE K-TEL INTERNATIONAL, INC. SECURITIES
LITIGATION, No. 98-CV-2480. This action consolidates twenty-three
purported class actions that were initially filed in various United
States District Courts in November 1998, and were subsequently
transferred to, and consolidated in the United States District Court
for the District of Minnesota. On July 19, 1999, the plaintiffs filed
an amended consolidated class action complaint that challenges the
accuracy of certain public disclosures made by K-tel regarding its
financial condition during the period May 1998 through November 1998.
The plaintiffs assert claims under the federal securities laws and
seek damages in an unspecified amount as well as costs, including
attorneys' fees and any other relief the Court deems just and proper.
K-tel moved to move to dismiss the Complaint, and, on July 31, 2000,
the U.S. District Court granted the Company's motion to dismiss. The
Court also barred further actions by the plaintiffs and denied
plaintiffs' request to amend the complaint in order to refile the
complaint in the future. An appeal of the decision by the plaintiffs
is pending. K-tel has two insurance policies providing coverage of up
to $20,000,000, which is subject to the insurers' reservations of
legal rights under the applicable policies. Under their reservations
of rights, the insurers could contest their obligations to indemnify
the Company and its directors and officers.
EARLY V. K-TEL INTERNATIONAL, INC.
On January 11, 1999, the Company was named in a lawsuit entitled
CHRISTOPHER EARLY VS. 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 claim alleges that 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 brought against the Company by Mr. Early in 1997
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 million, an injunction and costs incurred in the
litigation, including attorneys fees.
The Company filed a motion to dismiss the complaint on June 8, 2000,
which is currently under consideration. 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.
TRANS WORLD ENTERTAINMENT CORPORATION
On November 17, 2000, K-tel brought suit against Trans World
Entertainment Corporation ("Trans World") in the United States
District Court of Minnesota. The Company alleges that Trans World
purchased music product from the Company and failed to pay for it.
The Company further alleges that Trans World made false statements to
third parties with which the Company transacts business. The Company
alleges breach of contract, breach of the duty of good faith and fair
dealing, tortious interference with contract, tortious interference
with prospective business relations, disparagement and conversion.
The Company seeks damages in excess of $1,000,000, and intends to
vigorously pursue its claims.
CREATIVE PRODUCTS, INC.
As reported in the Company's Form 10-K for the year ended June 30,
2000, K-tel and its chairman were named in a lawsuit by Creative
Products, Inc. ("CPN") brought in the Superior Court of the State of
California in 1999. The suit arose out of a distribution relationship
between the Company and CPN related to the Smart Gym-TM- product. CPN
alleged breach of contract, fraud and unfair competition. In December
8
of 2000, the suit was dismissed pursuant to a settlement agreement
between the parties. The settlements paid were within amounts
previously accrued.
RTL SHOPPING S. A.
The Company has been named in a lawsuit filed in France brought by
RTL9, a French cable TV station. Initially, RTL9 was named as a
defendant in a suit brought by a competitor of K-tel Marketing, Ltd.,
alleging that RTL9 ran a commercial for K-tel Marketing that
translated language indicating that the product was "just like" or
"as good as others" in English script to "better than" competing
products in French, contrary to French law. RTL9 then sued K-tel
Marketing pursuant to an indemnification provision the parties had
entered into. Subsequently, K-tel Marketing went into liquidation and
RTL filed a suit against K-tel International, Inc. under its
agreement to guaranty payment for the commercial time. The action
seeks an undetermined amount of in the approximate amount of 20
million French Francs, or approximately $2.8 million U. S. The
litigation is at an early stage. The company is investigating the
validity of the action and intends to vigorously contest the claims.
OTHER LITIGATION AND DISPUTES
K-tel is involved in several legal actions in the ordinary course of
its business. Although the outcomes of any such legal actions cannot
be predicted, in the opinion of management, there is no legal
proceeding pending or asserted against or involving K-tel for which
the outcome is likely to have a material adverse effect upon the
consolidated financial position or results of operations of K-tel.
ROYALTIES
The Company has received an audit claim for $9.4 million from the
Harry Fox Agency, Inc. covering the period July 1, 1994 through June
30, 1998. The Company has received similar audits in the past and,
following extensive research, generally arrives at a substantially
lower settlement. During the year ended June 30, 2000, the company
adjusted its royalty reserve to allow for an eventual settlement and
feels its reserve is adequate.
8. SEGMENT INFORMATION
The Company markets and distributes entertainment products
internationally. K-tel's businesses are organized, managed and
internally reported as three segments: retail music sales, music
licensing, and other, which consist of 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. They are included in the other column below.
Consumer product operations in the United Kingdom and Germany have
been discontinued and are presented in the accompanying financial
statements as discontinued operations. Consumer product operations
other than Europe are 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.
Operating profits or losses of these segments include an allocation
of general corporate expenses.
9
Certain financial information on the Company's continuing operating segments is
as follows:
BUSINESS SEGMENT INFORMATION
Corporate/ Total
Music Licensing Other Elimination Company
- ------------------------------------------------------------------------------------------------
(in thousands)
Six Months Ended
December 31,
Net Sales 2000 $ 9,369 $ 1,588 $ 592 $ (249) $ 11,300
1999 17,323 1,622 903 (529) 19,319
Operating 2000 $(2,333) $ 323 $ (1,117) $ --- $ (3,127)
Income 1999 (389) 499 (1,088) --- (978)
Assets 2000 $ 11,278 $ 1,445 $ 571 $ 350 $ 13,644
1999 21,127 2,269 1,878 2,701 27,975
Three Months Ended
December 31,
Net Sales 2000 $ 3,928 $ 778 $ 357 $ (62) $ 5,001
1999 7,423 812 369 (259) 8,345
Operating 2000 $(1,550) $ 226 $ (755) -- $ (2,079)
Income 1999 (559) 375 (521) -- (705)
10
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
K-tel markets and distributes entertainment 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
its music entertainment products through an Internet e-commerce site, K-tel.com
(www.ktel.com).
THE SIX MONTHS ENDED DECEMBER 31, 2000 VERSUS THE SIX MONTHS ENDED DECEMBER 31,
1999
The following sections discuss the results of continuing operations by business
segment. General corporate expenses of $1,850,000 for the six months ended
December 31, 2000, and $734,000 for the six months ended December 31, 1999 have
been allocated to the segments. 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 $4,341,000 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.
BUSINESS SEGMENT RESULTS
MUSIC
Sales in the music segment were $9,369,000 in the six months ended December 31,
2000 compared to $17,323,000 in the six months ended December 31, 1999, a
decline of 45.9%. Domestic music sales decreased $7,420,000 and European music
sales declined $534,000. The domestic music business, comprised primarily of
sales of music compilations produced by K-tel and the sales and distribution of
other record labels through K-tel Distribution ("KTD") declined as the Company
experienced a higher rate of product returns from the distributors. K-tel has
begun a more intensive profitability review of any new business, resulting in
fewer but higher margin new products being released.
Cost of goods sold in the music segment increased to 77.1% of sales in the six
months ended December 31, 2000 compared to 68.8% of sales in the six months
ended December 31, 1999. The KTD business represented about 29% of sales in the
six months ended December 31, 2000 compared to 34% of sales in the six months
ended December 31, 1999. 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
$842,000 and was approximately 1.9% of sales in the six months ended December
31, 2000, compared to 5.9% for the six months ended December 31, 1999. This
spending decrease was the result of eliminating most TV advertising, which was
deemed ineffective and better utilization of promotional spending. Selling,
general and administrative expenses decreased $480,000 or 10.0% to $4,300,000 in
the six months ended December 31, 2000 compared to $4,780,000 in the six months
ended December 31, 1999. The primary reasons for the decrease is related to
general overall spending level reductions. As a result, the music segment
incurred an operating loss of $2,333,000 in the six months ended December 31,
2000 compared to an operating loss of $389,000 in the six months ended December
31, 1999.
11
LICENSING
Licensing sales were $1,588,000 in the six months ended December 31, 2000
compared to $1,622,000 in the six months ended December 31, 1999. Included in
the segment sales for the six months ended December 31, 2000 and the six months
ended December 31, 1999 were approximately $249,000 and $529,000 of
inter-company sales, respectively, which are eliminated in the accompanying
consolidated financial statements. Operating income in the licensing segment was
$323,000 in the six months ended December 31, 2000 versus $499,000 in the six
months ended December 31, 1999.
OTHER
Consumer product sales in the United States were $256,000 in the six months
ended December 31, 2000, a 49.6% decrease over the six months ended December
31, 1999 sales of $510,000. Cost of goods sold were $149,000 in the six
months ended December 31, 2000, compared to $170,000 in the six months ended
December 31, 1999. Advertising expenditures were $3,000 in the six months
ended December 31, 2000 compared to $34,000 in the six months ended December
31, 1999. Selling, general and administrative expense was $505,000 in the six
months ended December 31, 2000 compared to $414,000 in the six months ended
December 31, 1999. Selling, general and administrative expenses in December
31, 2000 include expenses related to the Smart Gym-TM- (Creative Products)
lawsuit. The consumer product activity in the United States incurred an
operating loss of $401,000 in the six months ended December 31, 2000 compared
to an operating loss of $108,000 in the six months ended December 31, 1999.
K-tel operates its Internet service, K-tel.com (www.ktel.com), featuring K-tel's
own music and related products available for online purchase by retail
consumers. Sales for the six months ended December 31, 2000 were $336,000
compared to $376,000 for the six months ended December 31, 1999. The cost of
goods sold in the six months ended December 31, 2000 and 1999 was $227,000 and
$214,000. In the six months ended December 31, 2000, selling general and
administrative expenses were $470,000 compared to $744,000 resulting in
operating losses of $471,000 and $773,000 for the six months ended December 31,
2000 and 1999, respectively. This increase is due to the allocation of general
corporate overhead allocation.
DISCONTINUED OPERATIONS
The Company discontinued its consumer product operations in Germany and the
United Kingdom in June 2000 and November 2000 respectively. Net sales for the
discontinued operations were $3,362,000 and $8,059,000 for the six months
ended December 31, 2000 and 1999. The loss for the discontinued operations
for the six month period ending December 31, 2000 was $3,644,000 and for the
six months ending December 31, 1999 the discontinued operations recorded
income of $2,159,000. The Company believes that all foreseeable expenses for
the closing of the discontinued operations have been adequately accrued for.
THE THREE MONTHS ENDED DECEMBER 31, 2000 VERSUS THE THREE MONTHS ENDED DECEMBER
31, 1999
The following sections discuss the results of continuing operations by
business segment. General and corporate expenses of $1,495,000 and $347,000
for the three months ended December 31, 2000 and 1999 has been allocated to
the segments.
BUSINESS SEGMENT RESULTS
MUSIC
Sales in the music segment were $3,928,000 in the three months ended December
31, 2000 compared to $7,423,000 in the three months ended December 31, 1999 a
decline of 47.1%. Domestic music sales decreased $3,256,000 or 50.1% and
European music sales decreased $239,000 or 26.6%. Sales of KTD which sources
other record labels for sales and distribution by K-tel decreased to $726,000 in
the three months ended December 31, 2000 compared to $2,601,000 in the three
months ended December 31, 1999.
Cost of goods sold in the music segment increased to 74.9% of sales in the three
months ended December 31, 2000 compared to 68.1% of sales in the three months
ended December 31, 1999. The KTD business represented about 18.5% of sales in
the three months ended December 31, 2000 compared to 35% of sales in the three
months ended December 31, 1999. 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
$411,000 and was approximately 1.3% of sales in the three months ended December
31, 2000 compared to 6.2% for the three months ended December 31, 1999. This
spending decrease was the result of eliminating most TV
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advertising, which was deemed ineffective and better utilization of promotional
spending. Selling, general and administrative expenses were $2,488,000 or 63.4%
in the three months ended December 31, 2000 compared to $2,467,000 or 33.2% in
the three months ended December 31, 1999. The primary reason for the increase in
selling, general and administrative expense is the added legal expense in the
general and corporate expenses for the three months ended December 31, 2000. As
a result, the music segment incurred an operating loss of $1,550,000 in the
three months ended December 31, 2000 compared to an operating loss of $559,000
in the three months ended December 31, 1999.
LICENSING
Licensing sales were $778,000 in the three months ended December 31, 2000
compared to $812,000 in the three months ended December 31, 1999. Included in
the segment sales for the three months ended December 31, 2000 and the three
months ended December 31, 1999 were approximately $62,000 and $259,000 of
inter-company sales, respectively, which are eliminated in the accompanying
consolidated financial statements. Operating income in the licensing segment was
$226,000 in the three months ended December 31, 2000 versus $375,000 in the
three months ended December 31, 1999.
OTHER
Sales of consumer products in the United States were $124,000 in the three
months ended December 31, 2000, a 47.7% decrease over the three months ended
December 31, 1999 sales of $235,000. Selling, general and administrative
expense was $396,000 in the three months ended December 31, 2000 compared to
$213,000 in the three months ended December 31, 1999. The primary reason for
the increase in selling, general and administrative expense is the added
legal expense in the general and corporate expenses for the three months
ended December 31, 2000. Consumer product activity in the United States
incurred an operating loss of $365,000 in the three months ended December 31,
2000 compared to an operating loss of $92,000 in the three months ended
December 31, 1999.
Sales for the e-commerce segment for the three months ended December 31, were
$233,000 compared to $134,000 for the three months ended December 31, 1999. The
cost of goods sold in the three months ended December 31, 2000 was approximately
64.8 % of sales compared to 71.8% in 1999. In the three months ended December
31, 2000, selling general and administrative expenses were $242,000 compared to
$320,000 resulting in operating losses of $201,000 and $341,000 for the three
months ended December 31, 2000 and 1999, respectively.
DISCONTINUED OPERATIONS
The Company discontinued its consumer product operations in Germany and the
United Kingdom in June 2000 and November 2000, respectively. Net sales for
the discontinued operations were $3,026,000 and $7,123,000 for the three
months ended December 31, 2000 and 1999. The loss for the discontinued
operations for the three month periods ending December 31, 2000 and December
31, 1999 was $2,202,000 and $1,148,000. The Company believes that all
foreseeable expenses for the closing of the discontinued operations have been
adequately accrued for.
B. LIQUIDITY AND CAPITAL RESOURCES
K-tel has a $6,400,000 credit facility with Foothill Capital Corporation
("Foothill"), consisting of a $3,405,000 term loan due in full on April 30,
2001, and a $2,995,000 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 (13.5% at December 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 December 31,
2000, $3,405,000 was outstanding under the term loan, $1,765,000 was outstanding
under the revolving line of credit and the maximum additional available under
the borrowing limitations was $5,000. K-tel was in compliance with all
covenants, limitations and restrictions of the credit agreement except 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, 2001 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
13
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, 2000, K-tel had an outstanding
balance of $3,038,000 to K-5.
As of December 31, 2000, K-tel had $66,000 in cash and equivalents, a decrease
of $723,000 from the balance at June 30, 2000. During the six months ended
December 31, 2000, K-tel experienced negative cash flow from operating
activities of $73,000 and used $51,000 in investing activities. Financing
activities used $754,000 in cash in the six months ended December 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. 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.
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," "will," "expect," "anticipate," "estimate," "should,"
"continue," 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,
2000 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, except as required by law in the normal course of
its public disclosure practices.
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, 2000. For additional information, refer to page 13 of
the Company's annual report on Form 10-K for the fiscal year ended June 30,
2000.
14
PART II
ITEM 1. LEGAL PROCEEDINGS
CLASS ACTION LAWSUIT
K-tel and certain of its current and former officers and directors are
defendants in IN RE K-TEL INTERNATIONAL, INC. SECURITIES LITIGATION, No.
98-CV-2480. This action consolidates twenty-three purported class actions that
were initially filed in various United States District Courts in November 1998,
and were subsequently transferred to, and consolidated in the United States
District Court for the District of Minnesota. On July 19, 1999, the plaintiffs
filed an amended consolidated class action complaint that challenges the
accuracy of certain public disclosures made by K-tel regarding its financial
condition during the period May 1998 through November 1998. The plaintiffs
assert claims under the federal securities laws and seek damages in an
unspecified amount as well as costs, including attorneys' fees and any other
relief the Court deems just and proper. K-tel moved to move to dismiss the
Complaint, and, on July 31, 2000, the U.S. District Court granted the Company's
motion to dismiss. The Court also barred further actions by the plaintiffs and
denied plaintiffs' request to amend the complaint in order to refile the
complaint in the future. An appeal of the decision by the plaintiffs is pending.
K-tel has two insurance policies providing coverage of up to $20,000,000, which
is subject to the insurers' reservations of legal rights under the applicable
policies. Under their reservations of rights, the insurers could contest their
obligations to indemnify the Company and its directors and officers.
EARLY V. K-TEL INTERNATIONAL, INC.
On January 11, 1999, the Company was named in a lawsuit entitled CHRISTOPHER
EARLY VS. 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 claim alleges that 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 brought against the
Company by Mr. Early in 1997 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 million, an
injunction and costs incurred in the litigation, including attorneys fees.
The Company filed a motion to dismiss the complaint on June 8, 2000, which is
currently under consideration. 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.
TRANS WORLD ENTERTAINMENT CORPORATION
On November 17, 2000, K-tel brought suit against Trans World Entertainment
Corporation ("Trans World") in the United States District Court of Minnesota.
The Company alleges that Trans World purchased music product from the Company
and failed to pay for it. The Company further alleges that Trans World made
false statements to third parties with which the Company transacts business. The
Company alleges breach of contract, breach of the duty of good faith and fair
dealing, tortious interference with contract, tortious interference with
prospective business relations, disparagement and conversion. The Company seeks
damages in excess of $1,000,000, and intend to vigorously pursue its claims.
CREATIVE PRODUCTS, INC.
As reported in the Company's Form 10-K for the year ended June 30, 2000, K-tel
and its chairman were named in a lawsuit by Creative Products, Inc. ("CPN")
brought in the Superior Court of the State of California in 1999. The suit arose
out of a distribution relationship between the Company and CPN related to the
Smart Gym-TM- product. CPN
15
alleged breach of contract, fraud and unfair competition. In December of
2000, the suit was dismissed pursuant to a settlement agreement between the
parties. The settlement amounts paid were within the amounts previously
accrued.
RTL9 SHOPPING S A
The Company has been named in a lawsuit filed in France brought by RTL9, a
French cable TV station. Initially, RTL9 was named as a defendant in a suit
brought by a competitor of K-tel Marketing, Ltd., alleging that RTL9 ran a
commercial for K-tel Marketing that translated language indicating that the
product was "just like" or "as good as others" in English script to "better
than" competing products in French, contrary to French law RTL9 then sued
K-tel Marketing pursuant to an indemnification provision the parties had
entered into. Subsequently, K-tel Marketing went into liquidation and RTL9
filed a suit against K-tel International, Inc. under its agreement to
guaranty payment for the commercial time. The action seeks an undetermined
amount of in the approximate amount of 20 million French Francs, or
approximately $2.8 million U. S. The litigation is at an early stage. The
company is investigating the validity of the action and intends to vigorously
contest the claims.
OTHER LITIGATION AND DISPUTES
K-tel is involved in several legal actions in the ordinary course of its
business. Although the outcomes of any such legal actions cannot be predicted,
in the opinion of management, there is no legal proceeding pending or asserted
against or involving K-tel for which the outcome is likely to have a material
adverse effect upon the consolidated financial position or results of operations
of K-tel.
ROYALTIES
The Company has received an audit claim for $9.4 million from the Harry Fox
Agency, Inc. covering the period July 1, 1994 through June 30, 1998. The Company
has received similar audits in the past and, following extensive research,
generally arrives at a substantially lower settlement. During the year ended
June 30, 2000, the company adjusted its royalty reserve to allow for an eventual
settlement and feels its reserve is adequate.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company has a $6,400,000 credit facility with Foothill Capital Corporation,
consisting of a $3,405,000 term loan due in full on April 30, 2001, and a
$2,995,000 revolving facility, under which borrowings are limited to a percent
of eligible receivables, that expires on April 30, 2001. Under the terms of the
credit facility, the Company was obligated to maintain a shareholders' equity of
at least $4,000,000 as of the fiscal quarter ended December 31, 2000. As of such
date, the Company failed to meet such shareholders' equity covenant, having a
deficit shareholders' equity of approximately $19,600,000. Such default was not
cured as of the date of this 10-Q Report. The Company is not in default in the
payment of principal, interest or a sinking or purchase fund installment due
Foothill as of the date of this Report. The Company has entered into
negotiations with Foothill relating to the credit facility and its default under
the shareholders' equity covenant. There can be no assurance, however, that the
Company will be successful in negotiating terms which remove or waive the
default, or which will enable it to extend or continue its relationship with
Foothill, which has the right to declare a default and exercise its rights and
remedies under its agreements with the Company.
16
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBIT INDEX
10.17 Forbearance Agreement with Foothill Capital Dated
November 13, 2000
10.18 Amendment to Forbearance Agreement with Foothill
Capital dated January 12, 2001
(b) REPORTS ON FORM 8-K
During the quarter ended December 31, 2000, one current report
on Form 8-K was filed:
November 15, 2000 - Regarding the closing of the Company's
United Kingdom consumer products
subsidiary
17
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/ PHILIP KIVES
---------------------------------------
PHILP KIVES
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
/S/ DENNIS WARD
---------------------------------------
DENNIS WARD
CHIEF FINANCIAL OFFICER
(principal accounting officer)
18