<PAGE> 1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K/A
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED NOVEMBER 30, 1998
[ ] 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 0-27046
QUINTEL COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 22-3322277
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
ONE BLUE HILL PLAZA 10965
PEARL RIVER, NEW YORK (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (914) 620-1212
<TABLE>
<CAPTION>
TITLE OF CLASS EXCHANGE ON WHICH REGISTERED
-------------- ----------------------------
<S> <C> <C>
SECURITIES REGISTERED PURSUANT COMMON STOCK NASDAQ NATIONAL MARKET
TO SECTION 12(b) OF THE ACT: $.001 PAR VALUE
SECURITIES REGISTERED PURSUANT COMMON STOCK
TO SECTION 12(g) OF THE ACT: $.001 PAR VALUE
</TABLE>
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (sec.229.405 of this chapter) is not contained herein, and
will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
------------------------
The number of shares outstanding of the Registrant's common stock is
16,679,746 (as of 3/5/99). The aggregate market value of the voting stock held
by nonaffiliates of the Registrant was approximately $14,225,000 (as of 3/5/99,
based upon a closing price of the Company's Common Stock on the Nasdaq National
Market on such date of $1.8125).
DOCUMENTS INCORPORATED BY REFERENCE
None.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
QUINTEL COMMUNICATIONS, INC.
INDEX TO AMENDMENT NO. 1 TO ANNUAL REPORT ON FORM 10-K/A
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
FOR THE FISCAL YEAR ENDED NOVEMBER 30, 1998
-------------------------------------------
ITEMS IN FORM 10-K/A
--------------------
<TABLE>
<CAPTION>
Page
----
<S> <C> <C> <C>
Facing page
Part I
- ------
Item 1. Business ............................................................................. None
Item 2. Properties ........................................................................... None
Item 3. Legal Proceedings .................................................................... None
Item 4. Submission of Matters to Vote of Security Holders .................................... None
Part II
- -------
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters .................................................................. None
Item 6. Selected Financial Data .............................................................. 1
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................................................. None
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ........................... None
Item 8. Financial Statements and Supplementary Data .......................................... 2
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure ............................................................. None
Part III
- --------
Item 10. Directors and Executive Officers of the Registrant ................................... None
Item 11. Executive Compensation ............................................................... None
Item 12. Security Ownership of Certain Beneficial Owners and
Management ........................................................................... None
Item 13. Certain Relationships and Related Transactions ....................................... None
Part IV
- -------
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K .......................................................................... None
Signatures
</TABLE>
<PAGE> 3
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected historical financial data of the Company
for each of the years in the five year period ended November 30, 1998. The year
ended November 30, 1996 includes the results of operations of New Lauderdale,
L.C. from its acquisition date of September 10, 1996. The financial data set
forth should be read in conjunction with "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and the financial statements
of the Company.
STATEMENT OF OPERATIONS DATA:
<TABLE>
<CAPTION>
YEAR ENDED NOVEMBER 30,
-----------------------------------------------------------------------------
1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C>
Net revenue $ 94,690,251 $191,374,936 $ 86,666,768 $ 50,501,266 $ 22,771,465
Costs of sales 80,037,115 149,821,363 64,661,256 36,732,610 17,521,985
Gross profit 14,653,136 41,553,573 22,005,512 13,768,656 5,249,480
Selling, general and administrative expenses 34,049,435 18,880,769 10,159,226 3,467,008 3,012,588
------------- ------------- -------------- -------------- ---------------
(Loss) income from operations (19,396,299) 22,672,804 11,846,286 10,301,648 2,236,892
Interest expense (186,218) (80,763) (473,289) (334,318) (759,211)
Other income, net 2,212,435 1,841,356 760,413 485,250
Equity in earnings of joint venture 4,939,653 2,860,304
------------- ------------- -------------- -------------- ---------------
(Loss) income before provision for income (17,370,082) 24,433,397 17,073,063 13,312,884 1,477,681
tax
(Benefit) provision for income taxes (417,464) 10,069,616 4,898,633 220,335 54,842
------------- ------------- -------------- -------------- ---------------
Net (loss) income $(16,952,618) $ 14,363,781 $ 12,174,430 $ 13,092,549 $ 1,422,839
============= ============= ============== ============== ===============
Income before pro forma tax provision $ 13,312,884 $ 1,477,681
Pro forma income tax provision 5,633,116 835,144
-------------- ---------------
Pro forma net income $ 7,679,768 $ 642,537
============== ===============
Basic net (loss) income per share $ (1.00) $ .77 $ .76
============= ============= ==============
Diluted net (loss) income per share $ (1.00) $ .76 $ .76
============= ============= ==============
Pro forma net income per share-basic $ .64 $ .05
============== ===============
Pro forma net income per share-diluted $ .64 $ .05
============== ===============
Common shares outstanding
Basic 17,034,531 18,560,064 16,145,445 12,000,000 12,000,000
Diluted 17,034,531 18,878,790 16,124,743 12,000,000 12,000,000
</TABLE>
BALANCE SHEET DATA:
<TABLE>
<CAPTION>
YEAR ENDED NOVEMBER 30,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C>
Working capital $35,538,243 $ 43,674,688 $25,423,442 $ 3,217,627 $ 494,738
Total assets 64,413,144 115,998,775 79,029,547 16,969,956 3,976,881
Total liabilities 27,731,000 52,292,478 31,294,614 10,938,881 3,432,355
Stockholders' equity 36,682,144 63,706,297 47,734,933 6,031,075 5,445,634
</TABLE>
-1-
<PAGE> 4
The Company hereby amends Item 8, Financial Statements and
Supplementary Data, to its Annual Report on Form 10-K for the fiscal year ended
November 30, 1998 to include certain information, primarily in the footnotes, in
the financial statements included in such Form 10-K, inadvertently omitted from
such original filing.
Item 8. Financial Statements and Supplementary Data.
See Index to Financial Statements on Page F-1 of this Form 10-K/A.
-2-
<PAGE> 5
QUINTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
PAGE
Report of Independent Accountants F-1
Consolidated Balance Sheets as of November 30, 1998 and 1997 F-2
Consolidated Statements of Operations for the years ended
November 30, 1998, 1997 and 1996 F-3
Consolidated Statements of Shareholders' Equity for the years
ended November 30, 1998, 1997 and 1996 F-4
Consolidated Statements of Cash Flows for the years ended
November 30, 1998, 1997 and 1996 F-5 - F-6
Notes to Consolidated Financial Statements F-7 - F-22
Schedule II - Valuation and Qualifying Accounts and Reserves S-1
<PAGE> 6
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Quintel Communications, Inc.:
In our opinion, the consolidated financial statements listed in the index
appearing under item 14(a)(1) on page 31 present fairly, in all material
respects, the financial position of Quintel Communications, Inc. and
Subsidiaries (the "Company,") previously known as Quintel Entertainment, Inc. at
November 30, 1998 and 1997 and the consolidated results of their operations and
their cash flows for each of the years in the three year period ended November
30, 1998 in conformity with generally accepted accounting principles. In
addition, in our opinion, the financial statement schedule listed in the
accompanying index presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Melville, New York
March 10, 1999
F-1
<PAGE> 7
QUINTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
as of November 30, 1998 and 1997
<TABLE>
<CAPTION>
ASSETS: 1998 1997
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 2,123,630 $ 10,063,717
Marketable securities 15,019,233 24,730,706
Accounts receivable, trade 31,230,579 46,310,960
Deferred income taxes 11,990,442 10,021,057
Due from related parties 754,089 237,485
Prepaid expenses and other current assets 2,151,270 4,096,452
------------- -------------
Total current assets 63,269,243 95,460,377
Property and equipment, at cost, net of accumulated depreciation 1,143,901 1,041,790
Intangible assets, net 19,496,608
------------- -------------
Total assets $ 64,413,144 $ 115,998,775
============= =============
LIABILITIES:
Current liabilities:
Accounts payable $ 4,453,663 $ 4,653,862
Accrued expenses 6,897,246 7,956,308
Reserve for customer chargebacks 15,494,138 38,196,114
Due to related parties 140,756 979,405
Income taxes payable 745,197
------------- -------------
Total current liabilities 27,731,000 51,785,689
Deferred income taxes 506,789
------------- -------------
Total liabilities 27,731,000 52,292,478
------------- -------------
Commitments and contingencies (Note 7)
SHAREHOLDERS' EQUITY:
Preferred stock - $.001 par value; 1,000,000 shares authorized;
none issued and outstanding
Common stock - $.001 par value; authorized 50,000,000 shares; issued and
outstanding 16,679,746 shares and 18,649,347 shares, respectively 16,679 18,649
Additional paid-in capital 38,955,275 39,027,700
Retained earnings (deficit) (379,292) 24,663,931
Unrealized loss on marketable securities (10,488) (3,983)
Common stock held in Treasury, at cost, 773,066 shares (1,900,030)
------------- -------------
Total shareholders' equity 36,682,144 63,706,297
------------- -------------
Total liabilities and shareholders' equity $ 64,413,144 $ 115,998,775
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE> 8
QUINTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
for the years ended November 30, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Net revenue $ 94,690,251 $ 191,374,936 $ 86,666,768
Cost of sales 80,037,115 149,821,363 64,661,256
------------- ------------- -------------
Gross profit 14,653,136 41,553,573 22,005,512
Selling, general and administrative expenses 14,356,892 18,880,769 10,159,226
Special charges 19,692,543
------------- ------------- -------------
(Loss) income from operations (19,396,299) 22,672,804 11,846,286
Interest expense (186,218) (80,763) (473,289)
Other income, primarily interest 2,212,435 1,841,356 760,413
Equity in earnings of joint venture 4,939,653
------------- ------------- -------------
(Loss) income before provision for income taxes (17,370,082) 24,433,397 17,073,063
(Benefit) provision for income taxes (417,464) 10,069,616 4,898,633
------------- ------------- -------------
Net (loss) income $ (16,952,618) 14,363,781 $ 12,174,430
============= ============= =============
Basic (loss) income per share:
Net (loss) income $ (1.00) $ .77 $ .76
------------- ------------- -------------
Weighted average shares outstanding 17,034,531 18,560,064 15,918,881
============= ============= =============
Diluted (loss) income per share
Net (loss) income $ (1.00) $ .76 $ .76
------------- ------------- -------------
Weighted average shares outstanding 17,034,531 18,878,790 16,124,743
============= ============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 9
QUINTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
for the years ended November 30, 1998, 1997 and 1996
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL RETAINED
----------------------- PAID-IN EARNINGS
SHARES AMOUNT CAPITAL (DEFICIT)
---------- --------- ------------ -----------
<S> <C> <C> <C> <C>
Balance, November 30, 1995 12,000,000 $ 12,000 $ 441,258 $ 5,597,817
Collections on subscriptions receivable
Distributions to S corporation shareholders (6,897,097)
Common stock issued:
Common stock offering 3,225,000 3,225 13,398,850
Common stock issued in connection
with acquisition 3,200,000 3,200 22,796,800
Stock option exercises 27,368 27 136,812
Tax benefit from exercise of stock options 57,330
Contributed capital 575,000 (575,000)
Unrealized gains on available for sale securities
Net income for the year 12,174,430
---------- --------- ------------ -----------
Balance, November 30, 1996 18,452,368 18,452 37,406,050 10,300,150
Common stock issued:
Stock option exercises 152,797 153 837,597
Warrant exercises 44,182 44 364,458
Tax benefit from exercise of stock options 419,595
Unrealized (losses) on available for sale securities
Net income for the year 14,363,781
---------- --------- ------------ -----------
Balance, November 30, 1997 18,649,347 18,649 39,027,700 24,663,931
Unrealized (losses) on available for sale securities
Purchase of common stock, held in treasury, at cost
Retirement of stock held in treasury (1,969,601) (1,970) (72,425) (8,090,605)
Net (loss) for the year (16,952,618)
---------- --------- ------------ -----------
Balance, November 30, 1998 16,679,746 $ 16,679 $ 38,955,275 $ (379,292)
========== ========= ============ ===========
</TABLE>
<TABLE>
<CAPTION>
UNREALIZED
TREASURY STOCK GAINS (LOSSES) TOTAL
------------------------------- ON MARKETABLE SUBSCRIPTIONS SHAREHOLDERS'
SHARES AMOUNT SECURITIES RECEIVABLE EQUITY
------------ --------------- -------------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Balance, November 30, 1995 $ (20,000) $ 6,031,075
Collections on subscriptions receivable 20,000 20,000
Distributions to S corporation shareholders (6,897,097)
Common stock issued:
Common stock offering 13,402,075
Common stock issued in connection
with acquisition 22,800,000
Stock option exercises 136,839
Tax benefit from exercise of stock options 57,330
Contributed capital
Unrealized gains on available for sale securities $ 10,281 10,281
Net income for the year 12,174,430
------------ --------------- -------- ------------ ------------
Balance, November 30, 1996 10,281 - 47,734,933
Common stock issued:
Stock option exercises 837,750
Warrant exercises 364,502
Tax benefit from exercise of stock options 419,595
Unrealized (losses) on available for sale securities (14,264) (14,264)
Net income for the year 14,363,781
------------ --------------- -------- ------------ ------------
Balance, November 30, 1997 (3,983) - 63,706,297
Unrealized (losses) on available for sale securities (6,505) (6,505)
Purchase of common stock, held in treasury, at cost 2,742,667 $(10,065,030) (10,065,030)
Retirement of stock held in treasury (1,969,601) 8,165,000
Net (loss) for the year (16,952,618)
------------ --------------- -------- ------------ ------------
Balance, November 30, 1998 773,066 $ (1,900,030) $(10,488) $ - $ 36,682,144
============ =============== ======== ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 10
QUINTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended November 30, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Cash flows from operating activities:
Net (loss) income $(16,952,618) $ 14,363,781 $ 12,174,430
Adjustments to reconcile net (loss) income to net cash (used in)
provided by operating activities:
Depreciation and amortization 1,284,039 2,620,146 1,268,166
Reserve for customer chargebacks (22,701,976) 18,115,211 6,719,018
Deferred income taxes (2,471,838) (2,552,328) (6,431,212)
Other (384,250)
Special charges 19,692,543
Equity in net earnings of joint venture, net of dividends received (507,653)
Changes in assets and liabilities, net of effects from acquisition of
business:
Accounts receivable 15,080,381 (28,280,877) (1,582,937)
Due from related parties (516,604) 406,683 3,102,976
Prepaid expenses and other current assets 1,729,104 (1,331,703) (893,712)
Other assets 1,299,169
Accounts payable (200,199) 2,088,479 511,786
Income tax payable 745,197 (4,131,303) 3,894,446
Accrued expenses (1,059,062) 4,917,798 362,118
Due to related parties (838,649) (499,110) 565,806
------------ ------------ ------------
Net cash (used in) provided by operating activities (6,209,682) 5,716,777 20,098,151
------------ ------------ ------------
Cash flows from investing activities
Purchases of securities (72,275,879) (65,649,246) (37,434,414)
Proceeds from sales of securities 81,976,511 55,500,000 23,240,075
Acquisition, net of cash acquired 900,040
Capital expenditures (1,366,007) (847,053) (251,628)
------------ ------------ ------------
Net cash provided by (used in) investing activities 8,334,625 (10,996,299) (13,545,927)
------------ ------------ ------------
Cash flows from financing activities:
Loans payable, net (2,643,522)
Proceeds from public offering, less expenses 13,402,075
Proceeds from collections on common stock subscriptions 20,000
Distributions to S corporation shareholders (6,897,097)
Proceeds from stock options exercised 837,750 136,839
Proceeds from warrants exercised 364,502
Repurchase of common stock (10,065,030)
------------ ------------ ------------
Net cash (used in) provided by financing activities (10,065,030) 1,202,252 4,018,295
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents (7,940,087) (4,077,270) 10,570,519
Cash and cash equivalents, beginning of year 10,063,717 14,140,987 3,570,468
------------ ------------ ------------
Cash and cash equivalents, end of year $ 2,123,630 $ 10,063,717 $ 14,140,987
============ ============ ============
</TABLE>
CONTINUED
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 11
QUINTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
for the years ended November 30, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Supplemental disclosures:
Cash paid during the year for:
Interest $ 186,218 $ 80,763 $ 473,289
Income taxes 910,000 13,613,887 6,627,866
Details of acquisition:
Fair value of assets acquired $ 36,031,621
Liabilities assumed (11,731,621)
Stock issued (22,800,000)
--------------
Cash paid 1,500,000
Less: cash acquired (2,400,040)
--------------
Net cash received from acquisition $ (900,040)
==============
</TABLE>
During fiscal 1997 and 1996, options and warrants for shares of common stock
were exercised by certain employees, directors and an underwriter. A tax benefit
of $419,595 and $57,330 in fiscal 1997 and 1996, respectively, was recorded as
an increase in additional paid-in capital and a reduction to income taxes
currently payable.
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 12
QUINTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of Quintel Communications, Inc.
(the "Company"), previously known as Quintel Entertainment, Inc. include
the accounts of its wholly-owned subsidiaries and its majority-owned and
controlled joint ventures. On September 10, 1996, the Company acquired
the remaining interest in New Lauderdale, L.C. ("New Lauderdale") (see
Note 6). The consolidated financial statements of the Company include the
accounts of New Lauderdale subsequent to this date. New Lauderdale had
previously been accounted for by the equity method as a 50% owned joint
venture. All significant intercompany transactions and balances have been
eliminated in consolidation.
NATURE OF BUSINESS
The Company is engaged in the direct marketing and providing of various
telecommunications products and services. Additionally, the Company
utilizes its database to further provide direct marketing services under
its residential long distance customer acquisition programs. The
Company's revenues from the aforementioned are generated through the
direct sale of products and services to consumers and through revenue
sharing arrangements with its residential long distance customer
acquisition partners. The telecommunications products and services
offered by the Company in the fiscal year ended November 30, 1998
consisted primarily of (i) telephone entertainment services, such as live
conversation horoscopes and psychic consultations, and memberships in
theme-related club 900 products; (ii) a residential distributor program
agreement with a long distance telephone service provider, whereby the
Company markets their residential long distance products; and (iii)
various enhanced telephone services, including enhanced voice mail
services and call-forwarding services.
Consumers are solicited by the Company through a variety of marketing
techniques including television commercials and infomercials, print
advertising, direct mail, telemarketing, and premium gift offerings.
Customers are also obtained through solicitation by Psychic Readers
Network, Inc. and Subsidiaries ("PRN") (see Note 6). The Company has
contracts with a limited number of service bureaus for the purpose of
call processing, billing and collection. Under these contracts, the
bureaus process and accumulate call data, summarize the information, and
forward the data to the local telephone companies and/or long distance
carriers for the ultimate billing to and collection from the Company's
customers.
F-7
<PAGE> 13
NOTES TO FINANCIAL STATEMENTS, CONTINUED
The Company also contracts with numerous organizations, to provide live
operator services, computer services, telemarketing and other services
necessary to establish, fulfill and maintain the Company's programs. PRN
currently provides substantially all of the Company's live psychic
operations. Certain non-psychic services previously provided by PRN came
under the direct control of the Company in connection with the
acquisition of New Lauderdale (see Note 6).
REVENUE RECOGNITION
Revenues from all billable platforms are recorded at the time the
customer initiates a billable transaction, except for customer fees for
club and Voice Mail and EZ Page products and services ("VM"). New
customer club and VM product fees are recognized upon approved enrollment
and when the service is rendered. Continuing club and VM product fees are
recognized as customers automatically renew each month. These revenues
are recognized net of an estimated provision for customer chargebacks,
which include refunds and credits.
The Company, where applicable, estimates the reserve for customer
chargebacks monthly based on updated chargeback history, with any
resulting adjustments being charged against revenues. Chargebacks and
other provisions for new products and platforms without a history are
based on experience with similar products and platforms and adjusted as
further information becomes available. Since reserves are established
prior to the periods in which chargebacks are actually expended, the
Company's revenues may be adjusted in later periods in the event that the
Company's incurred chargebacks vary from the estimated amounts. For the
years ended November 30, 1998, 1997 and 1996, provisions for chargebacks
were $56,496,612, $103,597,803 and $46,352,638, respectively.
Revenues earned under the residential long distance customer acquisition
program (approximately $24,100,000 in 1998 and $26,500,000 in 1997) are
recorded upon the achievement of events particular to the program
offering. Subsequent to the delivery of the initial sales record to the
respective long distance carrier, the Company may be required to provide
to the customer certain fulfillment products and services, such as
prepaid cellular phones (approximately $24,100,000 in 1998 and
$26,500,000 in 1997) and complimentary airline tickets, estimated and
accrued in marketing expenses at the time the associated revenues are
recorded. This estimation is adjusted to actual amounts in subsequent
periods. There are no chargebacks from such program.
ACCOUNTS RECEIVABLE
The Company has maintained agreements with service bureaus that provide
advances against accounts receivable collections. Under the Company's
current agreement, interest is calculated at prime plus 3%. Amounts
advanced under the agreement is on a revolving basis and are primarily
limited to 50% of a defined borrowing base, net of related service fees
and costs, as applicable. Certain advances under the agreement are due on
demand and all are collateralized by the accounts receivable collected by
the service bureaus. The Company did not use any advances during fiscal
1998 and 1997. During fiscal 1996, the gross advances and weighted
average interest rate on the advances received were approximately
$9,156,355 and 13.17%.
F-8
<PAGE> 14
NOTES TO FINANCIAL STATEMENTS, CONTINUED
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentration of credit risk consist principally of cash and cash
equivalents, marketable securities and accounts receivable.
The Company invests a portion of its excess cash in debt instruments and
has established guidelines relative to diversification that maintain
safety and liquidity.
The Company's collections are received primarily through three unrelated,
unaffiliated service bureaus which process and collect all of the
Company's billings. In conjunction with servicing the accounts
receivable, the service bureaus remit amounts based on eligible accounts
receivable and withhold certain cash receipts as a reserve. As a result,
the Company's exposure to the concentration of credit risk primarily
relates to all collections on behalf of the Company by these service
bureaus.
Cash balances are held principally at three financial institution and
may, at times, exceed insurable amounts. The Company believes it
mitigates its risks by investing in or through major financial
institutions. Recoverability is dependent upon the performance of the
institutions.
TRANSACTIONS WITH MAJOR CUSTOMERS
Revenues from one long distance carrier amounted to 20% of total revenues
during fiscal 1998 and 14% during 1997 with a different carrier. It is
anticipated that in fiscal 1999 this arrangement will account for a much
greater percentage of the Company's revenues. If this occurs, the Company
would be subject to significant economic dependence on such relationship.
Accounts receivable from such carriers were approximately $8,728,000 and
$3,473,000 at November 30, 1998 and 1997, respectively.
CASH AND CASH EQUIVALENTS
All short-term investments with an original maturity of three months or
less are considered to be cash equivalents.
MARKETABLE SECURITIES
The Company accounts for its investments using Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt
and Equity Securities." The Company's marketable securities consist of
government obligations which they intend to hold only for an indefinite
period of time. At November 30, 1998 and 1997, all securities covered by
SFAS No. 115 were designated as available for sale. Accordingly, such
securities are stated at fair value, with unrealized gains and losses,
net of estimated tax effects, reported as a separate component of
shareholders' equity, until realized. The contractual maturities of all
available for sale debt securities at November 30, 1998 and 1997 are
within one year. The amortized cost of available for sale debt securities
are $15,036,713 and $24,737,345 at November 30, 1998 and 1997,
respectively.
Gross unrealized holding losses were $10,488 and $3,983, respectively,
net of deferred taxes of $6,992 and $2,656, at November 30, 1998 and
1997, respectively. Proceeds from the sale of securities classified as
available for sale for the year ended November 30, 1998 and 1997 were
approximately $81,977,000 and $55,500,000, respectively.
F-9
<PAGE> 15
NOTES TO FINANCIAL STATEMENTS, CONTINUED
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost and are depreciated
using the straight-line method over a five to seven year useful life
depending on the nature of the asset. Leasehold improvements are
amortized over the life of the improvement or the term of the lease,
whichever is shorter. Expenditures for maintenance and repairs are
expensed as incurred while renewals and betterments are capitalized.
Upon retirement or disposal, the asset cost and related accumulated
depreciation and amortization are eliminated from the respective accounts
and the resulting gain or loss, if any, is included in the results of
operations for the period.
LONG-LIVED ASSETS
If events or changes in circumstances indicate that the carrying amount
of a long-lived asset may not be recoverable, the Company estimates the
future cash flows expected to result from the use of the asset and its
eventual disposition. If the sum of the expected future cash flows
(undiscounted and without interest charges) is less than the carrying
amount of the long-lived asset, an impairment loss is recognized. (See
Note 8.)
INCOME TAXES
The Company recognizes deferred tax liabilities and assets for the
expected future tax consequences of events that have been included in the
financial statements or tax returns. Deferred tax liabilities and assets
are determined based on the difference between the financial statement
and tax bases of assets and liabilities using enacted tax rates in effect
for the year in which the differences are expected to reverse. Valuation
allowances are provided against assets which are not likely to be
realized.
ADVERTISING EXPENSES
The Company expenses advertising costs, which consist primarily of print,
media, production, telemarketing and direct mail related charges, when
the related advertising occurs. Total advertising expense for fiscal
1998, 1997, and 1996 were approximately $57,759,000, $81,576,000 and
$31,795,000, respectively. Included in prepaid expenses and other current
assets is approximately $207,000 and $488,000 relating to prepaid
advertising at November 30, 1998 and 1997, respectively.
EARNINGS PER SHARE
In December 1997, the Financial Accounting Standards Board issued
Statement No. 128 "Earnings per Share" ("SFAS No. 128"). SFAS No. 128
replaced the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Earnings per share amounts for
all periods have been restated to conform to the SFAS No. 128
requirements.
RECLASSIFICATIONS
Certain reclassifications have been made to conform prior year amounts to
the current year presentation.
F-10
<PAGE> 16
NOTES TO FINANCIAL STATEMENTS, CONTINUED
NEWLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued Statement of Accounting Standard No. 130,
"Reporting Comprehensive Income," (" SFAS No. 130"), which requires that
changes in comprehensive income be shown in a financial statement that is
displayed in the same prominence as other financial statements. SFAS No.
130 becomes effective in fiscal 1999. Management will comply with the
additional disclosure provisions of the statement.
In June 1997, the FASB issued Statement of Accounting Standard No. 131,
"Disclosures About Segments of an Enterprise and Related Information"
("SFAS 131"), which changes the way public companies report information
about segments. SFAS 131, which is based on the management approach to
segment reporting, includes requirements to report selected segment
information quarterly and entity-wide disclosures about products and
services, major customers, and the material countries in which the entity
holds and reports revenues. SFAS 131 becomes effective in fiscal 1999.
The implementation of this new statement will not affect the Company's
results of operations and financial position, but will have an impact on
future financial statement disclosure.
ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company's management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from
those estimates. The Company's most significant estimates relate to the
reserve for customer chargebacks, recoverability of long-lived assets,
the realizability of deferred tax assets and fulfillment accrual for
customer acquisition costs.
2. RELATED PARTY TRANSACTIONS:
The Company purchased various mailing lists and design, copyrighting and
artistic development services from related entities owned by certain of
the Company's officers/shareholders. The agreements require the Company
to pay fees equal to 20% of rental revenues and a management fee of 10%,
plus any fees in connection with processing and mailing lists. During
fiscal 1998, 1997 and 1996, costs of approximately $10,000, $267,000 and
$535,000, respectively, were incurred by the Company for such services.
During fiscal 1998, the related entities were sold dissolving the related
party relationship as of November 30, 1998.
The Company incurred approximately $90,800, $107,000 and $242,000,
respectively, during fiscal 1998, 1997 and 1996, in accounting fees to a
firm having a member who is also a director of the Company. In addition,
the Company incurred approximately $431,000, $372,000 and $334,000,
respectively, during fiscal 1998, 1997 and 1996, in legal fees to a firm
having a member who is also a director of the Company.
In connection with the acquisition of PRN's interest in New Lauderdale
(see Note 6), a principal shareholder of PRN was elected a director of
the Company and entered into an employment agreement with the Company
(see Note 7). The Company incurred approximately $227,000, $206,000 and
$39,000 in expense relating to this employment agreement in fiscal 1998,
1997 and
F-11
<PAGE> 17
NOTES TO FINANCIAL STATEMENTS, CONTINUED
1996, respectively. Such principle shareholder resigned from his position
of director in January 1999.
For the years ended November 30, 1998, 1997 and 1996, the Company paid
aggregate fees of approximately $7,023,000, $24,300,000 and $8,560,000,
respectively, to PRN for psychic operator services under an agreement
that extends to fiscal 2001. Since February 1996, PRN has also provided
certain non-psychic services and facilities to the Company for
approximately $14,000 per month.
During fiscal 1998 and 1997, the Company received commissions of
approximately $685,000 and $830,000, respectively, from PRN for
purchasing television media time on their behalf. In addition,
receivables existed for such commissions of approximately $578,000 and
$73,000 at November 30, 1998 and 1997, respectively.
During the fourth quarter of fiscal 1997, the Company introduced a new
club membership program offering premium telephone services to its
members for a one time payment. In conjunction with the new program, the
Company executed a contract with PRN who has assumed the responsibility
and obligation for the fulfillment of all the recurring club services
under the program. Under certain circumstances, the Company is entitled
to share in certain revenues, net of expenses generated from additional
services sold by PRN to the club members. Such amounts were not material
for fiscal 1998.
On March 13, 1998, the Company purchased from a director of the Company,
1,969,601 shares of the Company's common stock for an aggregate purchase
price of $8,165,000. At the same time, the seller's employment by the
Company was terminated and she resigned from all directorships and
offices she had held at the Company or any affiliate thereof. The shares
reacquired were subsequently retired.
3. PROPERTY AND EQUIPMENT:
Property and equipment for the years ended November 30, 1998 and 1997
consists of the following:
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Furniture and fixtures $ 314,536 $ 297,445
Computers and equipment 1,238,165 861,870
Telephone and facsimile 57,582 46,992
Leasehold improvements 51,146 51,145
---------- ----------
1,661,429 1,257,452
Less, accumulated depreciation and amortization 517,528 215,662
---------- ----------
$1,143,901 $1,041,790
========== ==========
</TABLE>
Depreciation and amortization expense for the years ended November 30,
1998, 1997 and 1996 was approximately $302,000, $150,000 and $50,000,
respectively. (See Note 8.)
F-12
<PAGE> 18
NOTES TO FINANCIAL STATEMENTS, CONTINUED
4. INCOME TAXES:
The (benefit) provision for income taxes consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED NOVEMBER 30,
---------------------------------------------
1998 1997 1996
<S> <C> <C>
Federal:
Current $ 10,201,378 $ 8,852,749
Deferred $ (2,593,444) (1,761,002) (4,723,850)
------------ ------------ -----------
(2,593,444) 8,440,376 4,128,899
------------ ------------ -----------
State:
Current 525,000 2,152,177 1,661,946
Deferred 1,650,980 (522,937) (892,212)
------------ ------------ -----------
2,175,980 1,629,240 769,734
------------ ------------ -----------
Total provision $ (417,464) $ 10,069,616 $ 4,898,633
============ ============ ===========
</TABLE>
The following is a reconciliation of the income tax expense computed
using the statutory federal income tax rate to the actual income tax
expense and its effective income tax rate:
<TABLE>
<CAPTION>
YEAR ENDED NOVEMBER 30,
----------------------------------------
1998 1997 1996
<S> <C> <C> <C>
Income tax (benefit) expense at
federal statutory rate $ (6,079,529) $ 8,551,689 $5,975,572
State income taxes, net of federal
income tax benefit 341,250 1,059,006 500,327
Deferred benefit arising from conversion to
C corporation (1,781,700)
Goodwill amortization 3,623,519 179,636
Valuation allowance 1,679,082
Other, individually less than 5% 18,214 279,285 204,434
------------ ----------- ----------
$ (417,464) $10,069,616 $4,898,633
============ =========== ==========
</TABLE>
The components of deferred tax assets are as follows:
<TABLE>
<CAPTION>
NOVEMBER 30,
---------------------------
1998 1997
<S> <C> <C>
Deferred tax assets:
Current:
Accrued expenses and reserves not currently
deductible $ 3,401,791 $10,219,454
Fixed assets and intangibles 2,006,164
Net operating loss 8,261,570
Valuation allowance (1,679,082)
------------ -----------
Total current assets 11,990,442 10,219,454
Deferred tax liabilities:
Current:
Other (198,397)
Noncurrent:
Intangibles (506,789)
------------ -----------
Net deferred tax asset $ 11,990,442 $ 9,514,268
============ ===========
</TABLE>
F-13
<PAGE> 19
NOTES TO FINANCIAL STATEMENTS, CONTINUED
A $1,679,082 valuation allowance, primarily for state tax net operating
losses which can not be carried back by statutes, has reduced the
deferred tax assets at November 30, 1998 to an amount which the Company
believes is more likely than not to be realized. The Federal deferred tax
asset expected to be realized will be through the execution of tax
planning strategies and the recapture of taxes paid on prior taxable
income.
The Company has approximately $21 million of Net Operating Losses
expiring through 2018 for Federal purposes which will be carried back in
the Company's 1998 tax return. The Company's tax year ends on December
31.
5. REGULATORY ISSUES AND OTHER RISK CONSIDERATIONS:
During September 1998, the Company was notified by the Federal Trade
Commission ("FTC") that the FTC was conducting an inquiry into the past
and present marketing practices of the Company to determine if the
Company was engaging in unfair or deceptive practices. In connection with
such inquiry, the Company was requested to submit certain materials and
information to the FTC relating to the operations of the Company from
January 1, 1994 to the present. The Company is cooperating fully with the
FTC in connection with its inquiry. To date, the Company has not been
subject to any enforcement actions by any regulatory authority and
management believes that the FTC inquiry will not result in any
enforcement actions or claims which would have a material adverse effect
on the Company. However, in the event the Company is found to have failed
to comply with applicable laws and regulations, the Company could be
subject to civil remedies, including substantial fines, penalties and
injunctions, as well as possible criminal sanctions, which would have a
material adverse effect on the Company.
The Company's primary contact with its customers is over the telephone
lines and services of numerous local telephone companies and long
distance carriers. The Company cannot predict the impact, if any, of
changes in various regulations affecting the Company, directly, or
through one of the telephone companies.
There can be no assurance that the Company will be able, for financial or
other reasons, to comply with applicable laws and regulations or that
regulatory authorities will not take action to limit or prevent the
Company from advertising, marketing or promoting its services and club
and VM products and services or otherwise require the Company to
discontinue or substantially modify the content of its services.
The Company has received requests for information from regulatory
authorities, regarding investigations of certain of its telemarketing
activities. Management believes, based on advice from counsel, that their
investigations will not result in enforcement actions or claims which
would have a material adverse effect on the financial statements.
The Company is dependent on service bureaus to process its calls,
billings and collections. In November 1998, three Local Exchange Carriers
("LECs") refused to bill customers for enhanced services provided by the
Company. This was a result of what the LECs' claim was excessive
complaints by customers for "cramming" (unauthorized charges billed to a
customer's phone bill) against the Company and its affiliates. This
billing cessation effectively prevented the Company
F-14
<PAGE> 20
NOTES TO FINANCIAL STATEMENTS, CONTINUED
from selling its enhanced services in those areas serviced by such LECs.
The remaining LECs have not altered their billing practices for the
Company's services and the Company continues to offer its enhanced
services in those areas.
As a result of such LEC imposed billing cessation, in November 1998, the
primary billing service provider for the Company's enhanced services,
terminated its arrangement with the Company for providing billing for the
Company's enhanced services. Such service bureau continues to service all
data relating to chargebacks relating to amounts billed prior to the
billing cessation. In December 1998, the Company entered into an
agreement with an alternate service bureau whereby such service bureau
provides the billing services previously provided by the Company's
primary enhanced service billing provider.
The Company is dependent on its service bureaus to provide quality
services on a timely basis on favorable terms. While the Company believes
its service bureau needs could be transferred to alternate providers, if
necessary, no contracts to cover such a contingency are currently in
effect. Accordingly, failure by any existing bureaus to provide services,
such as that experienced at the end of the fourth quarter of fiscal 1998,
would result in material interruptions in the Company's operations.
6. NEW LAUDERDALE:
In December 1994, the Company entered into an agreement with PRN, an
unrelated entity at that time, to establish a joint venture known as New
Lauderdale, L.C. New Lauderdale operated "900" entertainment services. On
September 10, 1996, the Company acquired the remaining 50% interest in
New Lauderdale for 3,200,000 common shares. PRN subsequently distributed
such shares to its shareholders. In addition to receiving its share of
New Lauderdale's earnings through the closing date, PRN received
approximately $1,500,000 in cash for the deferred tax benefit to New
Lauderdale resulting from the transaction. The common shares were valued
at the market price on the date of the letter of intent ($7.125 per
share). The acquisition was accounted for using the purchase method of
accounting and, accordingly, the purchase price was allocated to the
assets purchased based upon the fair values at the date of acquisition.
As a result, approximately $23,159,000 of the purchase price was
allocated to goodwill, customer lists and other intangibles which were
being amortized on a straight line basis over a period from 1 to 15
years. The operating results of the acquisition have been included in the
consolidated statement of operations from the date of the acquisition.
F-15
<PAGE> 21
NOTES TO FINANCIAL STATEMENTS, CONTINUED
The following pro forma information prepared assuming that this
acquisition had taken place on December 1, 1995 is not necessarily
indicative of the results of operations as they would have been had the
transaction been effected on such date. The pro forma information
includes adjustments for amortization of intangibles arising from the
transaction.
<TABLE>
<CAPTION>
NOVEMBER 30,
------------
1996
<S> <C>
Net revenues $150,284,451
Net income 12,351,385
Earnings per share .66
As of November 30, 1997, the net book value of the intangibles, primarily
goodwill, was $19,496,608, net of accumulated amortization of $3,695,704.
Amortization expense was $982,173, $2,470,476 and $1,218,576 for the
years ended November 30, 1998, 1997 and 1996. During fiscal 1998, the
Company determined that the intangibles were impaired. (See Note 8 -
Special Charges.)
</TABLE>
7. COMMITMENTS AND CONTINGENCIES:
LEASES
The Company is obligated under two noncancelable real property operating
lease agreements that expire in fiscal 2004 and 2006. Future minimum
rents consist of the following at November 30, 1998:
<TABLE>
<S> <C>
1999 $ 500,246
2000 504,912
2001 542,145
2002 548,432
2003 554,927
Thereafter 989,245
----------
$3,639,907
==========
</TABLE>
The leases contain escalation clauses with respect to real estate taxes
and related operating costs. The accompanying financial statements
reflect rent expense on a straight-line basis over the term of the lease
as required by generally accepted accounting principles. Rent expense was
$522,422, $383,867 and $210,153 for fiscal 1998, 1997 and 1996,
respectively.
EMPLOYMENT AGREEMENTS AND CONSULTING
The Company had executed employment agreements, which expired on November
30, 1998, with certain executive officers of the Company. In the event
the Company achieved pre-tax earnings of $10,000,000 or more for any such
fiscal year, the Company may grant bonuses to such persons, subject to
approval of the Compensation Committee of the Board of Directors, in an
aggregate amount not to exceed 5% of pre-tax earnings for such year. Such
bonuses amounted to approximately $1,305,000 at November 30, 1997. No
bonuses were granted during fiscal 1998. Each of the individuals have
agreed to continue to work as employees-at-will until a new agreement is
approved by the Board of Directors.
F-16
<PAGE> 22
NOTES TO FINANCIAL STATEMENTS, CONTINUED
The Company had a consulting agreement with a director/shareholder, which
expired on November 30, 1998. Under the terms of such agreement, the
director/shareholder provided services in connection with identification
and engagement of celebrities to endorse the Company's services,
engagement of independent producers to produce commercials and
infomercials and the development of new entertainment services. The
Company incurred approximately $151,000, $137,000 and $125,000 in expense
relating to this agreement in 1998, 1997 and 1996, respectively. Although
the consulting agreement has expired, the director/shareholder continues
to provide the consulting services to the Company and the Company
compensates the director/shareholder at a rate of $10,417 per month. Such
arrangements have not been formally agreed to and may be terminated by
either party at will.
In connection with the acquisition of PRN's interest in New Lauderdale
(see Note 6), a principal shareholder of PRN was elected a director of
the Company and entered into an employment agreement with the Company.
Minimum future payments under this agreement are as follows:
<TABLE>
<S> <C>
1999 $249,562
2000 274,518
2001 100,657
--------
$624,737
========
</TABLE>
OTHER
As a result of the acquisition of New Lauderdale (see Note 6), the
Company has agreements with various celebrities to promote its telephone
entertainment services. These agreements are generally for a term of one
year, which may be extended under certain circumstances, and grant
worldwide rights to use an individual's name and likeness in connection
with services promoted by advertisements. Compensation varies by
individual and generally consists of an advance payment and royalties
based on defined revenues earned by the Company. Total royalty expenses
incurred for fiscal 1998, 1997 and 1996 were $124,837, $399,395 and
$261,566, respectively.
LITIGATION
On or about May 4, 1998, a complaint entitled "Joseph Chalverus, on
behalf of himself and all others similarly situated v. Quintel
Entertainment, Inc., Jeffrey L. Schwartz and Daniel Harvey" was filed in
the United States District Court for the Southern District of New York;
subsequently, a complaint entitled "Richard M. Woodward, on behalf of
himself and all others similarly situated v. Quintel Entertainment, Inc.,
Jeffrey L. Schwartz and Daniel Harvey" was filed in that same court, as
was a complaint entitled "Dr. Michael Title, on behalf of himself and all
others similarly situated v. Jeffrey L. Schwartz, Jay Greenwald, Claudia
Newman Hirsch, Andrew Stollman, Mark Gutterman, Steven L. Feder, Michael
G. Miller, Daniel Harvey and Quintel Entertainment, Inc. (collectively,
the "Complaints"). In addition to the Company, the defendants named in
the Complaints are present and former officers and directors of the
Company (the "Individual Defendants"). The plaintiffs seek to bring the
actions on behalf of a purported class of all persons or entities who
purchased shares of the Company's Common Stock from July 15, 1997 through
October 15, 1997 and who were damaged thereby, with certain exclusions.
The Complaints allege violations of Sections 10(b) and 20 of the
Securities Exchange Act of 1934, and allege that the defendants made
misrepresentations and omissions concerning the Company's financial
results, operations and future prospects, in particular relating to the
Company's reserves for customer chargebacks and its business relationship
F-17
<PAGE> 23
NOTES TO FINANCIAL STATEMENTS, CONTINUED
with AT&T. The Complaints allege that the alleged misrepresentations and
omissions caused the Company's Common Stock to trade at inflated prices,
thereby damaging plaintiffs and the members of the purported class. The
amount of damages sought by plaintiffs and the purported class has not
been specified.
On September 18, 1998, the District Court ordered that the three actions
be consolidated, appointed a group of lead plaintiffs in the consolidated
actions, approved the lead plaintiffs' selection of counsel for the
purported class in the consolidated actions, and directed the lead
plaintiffs to file a consolidated complaint. The consolidated and amended
class action complaint ("Consolidated Complaint") which has been filed
asserts the same legal claims based on essentially the same factual
allegations as did the Complaints. On February 19, 1999, the Company and
the Individual Defendants filed a motion to dismiss the Consolidated
Complaint. Plaintiffs have served papers in opposition to the motion to
dismiss. The District Court has not yet ruled on the motion to dismiss.
The Company believes that the allegations in the Complaints are without
merit, and intends to vigorously defend the consolidated actions. The
Company is unable at this time to assess the outcome of the Consolidated
Complaint or the materiality of the risk of loss in connection therewith,
given the preliminary stage of the Consolidated Complaint and the fact
that the Consolidated Complaint does not allege damages with specificity.
An action was brought by Paramount Advertiser Services on August 13, 1998
against Access Resource Services, Inc. ("Access") and Quintel Media
Management, a subsidiary of the Company. The action alleges breach of a
contract to purchase advertising time as well as breach of a settlement
agreement resolving earlier disputes, and alleges resulting damages of
approximately $3,300,000. Access has agreed to indemnify the Company the
total sum of $2,300,000, of which, as of February 24, 1999, $1,050,000
has been placed in escrow. The Company believes the claim is without
merit and intends to vigorously defend against the action.
A counterclaim action was brought against the Company by a supplier of
cellular phones alleging damages of $1,030,000 relating to a cancelled
purchase order. The Company had previously commenced an action against
the supplier seeking to recover approximately $480,000 from such supplier
alleging breach of the contract. The Company intends to pursue its claim
against the supplier and believes the counterclaim is without merit.
Due to the early stage of the matters referred to in the preceding two
paragraphs, it is not possible to determine the amount of liability, if
any, that may result and exceed amounts recoverable under the guarantee.
8. SPECIAL CHARGES:
During 1998, the Company experienced increased chargebacks and marketing
expenditures relating to its "900" entertainment services. As a result,
this service was not providing positive operating results and cash flow
and, as such, the Company discontinued marketing such services as an
independent revenue source. Accordingly, as required by Statement of
Financial Accounting Standards No. 121, the Company reviewed its
long-lived assets, including goodwill, for impairment. The Company
determined that the "900" entertainment service could not be disposed of
nor was there a predictable estimate of any future cash flows associated
with any alternative use. The
F-18
<PAGE> 24
NOTES TO FINANCIAL STATEMENTS, CONTINUED
Company concluded that the intangibles, primarily goodwill, arising from
the acquisition of the remaining 50% interest in New Lauderdale, L.C.
were entirely impaired. As such, a non-cash charge of $18,514,435,
representing the remaining balance of the intangibles, was recorded in
the second quarter of fiscal 1998.
In addition, the Company recorded a non cash charge of approximately
$1,178,000 associated with the writedown of assets relating to the
decision to abort an Internet telephony program during the fourth quarter
of fiscal 1998 .
9. EARNINGS PER SHARE:
The following table sets forth the reconciliation of the weighted average
shares used for basic and diluted earnings per share:
<TABLE>
<CAPTION>
YEARS ENDED NOVEMBER 30,
------------------------------------
1998 1997 1996
<S> <C> <C> <C>
Denominator:
Denominator for basic earnings per share -
weighted-average shares 17,034,531 18,560,064 15,918,881
Effect of dilutive securities:
Stock options 257,984 186,033
Warrants 60,742 19,829
---------- ---------- ----------
Denominator for diluted earnings per share -
adjusted weighted-average shares 17,034,531 18,878,790 16,124,743
========== ========== ==========
</TABLE>
Options and warrants to purchase 1,579,796, 90,000 and 340,000 shares of
common stock were outstanding for the year end November 30, 1998, 1997
and 1996, respectively, but were not included in the computation of
diluted earnings per share because their effect would be anti-dilutive.
10. STOCK OPTION PLAN AND WARRANTS:
During fiscal 1995, the Company implemented the 1995 Stock Option Plan
(the "Stock Option Plan") effective as of October 1995. The Stock Option
Plan provides for the grant of options to purchase up to 750,000 shares
of the Company's common stock either as incentive stock options
("Incentive Stock Options") within the meaning of Section 422 of the
United States Internal Revenue Code or as options that are not intended
to meet the requirements of such section ("Nonstatutory Stock Options").
Options to purchase shares may be granted under the Stock Option Plan to
persons who, in the case of Incentive Stock Options, are employees
(including officers) of the Company, or, in the case of Nonstatutory
Stock Options, are employees (including officers), consultants or
nonemployee directors of the Company to the Company. The Stock Option
Plan was amended in September 1996 and in June 1997 to provide for the
granting of options to purchase an additional 500,000 and 600,000 shares,
respectively, of the Company's common stock. After these amendments,
grants are available under the Stock Option Plan to purchase a total of
1,850,000 shares of the Company's common stock.
F-19
<PAGE> 25
NOTES TO FINANCIAL STATEMENTS, CONTINUED
The exercise price of options granted under the Stock Option Plan must be
at least equal to the fair market value of such shares on the date of
grant, or, in the case of Incentive Stock Options granted to a holder of
10% or more of the Company's Common Stock, at least 110% of the fair
market value of such shares on the date of grant. The maximum exercise
period for which Incentive Stock Options may be granted is ten years from
the date of grant (five years in the case of an individual owning more
than 10% of the Company's common stock). The aggregate fair market value
(determined at the date the option is granted) of shares with respect to
which Incentive Stock Options are exercisable for the first time by the
holder of the option during any calendar year shall not exceed $100,000.
If such amount exceeds $100,000, the Board of Directors or the Committee
may, when the Options are exercised and the shares transferred to an
employee, designate those shares that will be treated as Incentive Stock
Options and those that will be treated as Nonstatutory Stock Options.
In addition, the Company's Stock Option Plan provides for certain
automatic grants of options to the Company's non-employee directors in
consideration for their services performed as directors of the Company
and for attendance at meetings. It provides for a one-time automatic
grant of an option to purchase 25,000 shares of common stock at market
value to those directors who were serving on the Board of Directors at
the inception of the Stock Option Plan and also to those persons who
become nonemployee directors of the Company in the future, upon their
appointment or election as directors of the Company. In addition, the
amended Stock Option Plan provides for quarterly grants to each
non-employee director of the Company of options to purchase 6,250 shares
of the Company's common stock at the market value on the date of each
grant. During fiscal 1998, the Company granted 143,750 options to the
non-employee directors. The Company's stock option committee approved the
granting of an additional 626,390 options to certain employees.
The stock option committee offered all option holders the right to have
their options repriced at $1.75 effective September 10, 1998. The
repricing was calculated based on the percentage of the new option price
of $1.75 over the original exercise price, applied to the number of
options elected for repricing. Total options available and elected for
repricing were 1,415,078 and 878,078, respectively. Total options
surrendered as a result of the repricing amounted to 587,949. The
repricing of the options is in compliance with the provisions of the
Stock Option Plan.
A summary of the Company's stock options is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------------------------- --------------------------- ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- --------------- -------- --------------- -------- ------------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding,
beginning of year 938,691 $ 4.75 to 15.56 653,850 $ 4.75 to 8.25 394,000 $ 5.00
Granted 1,129,374 1.75 to 6.75 470,500 7.31 to 15.56 297,250 4.75 to 8.25
Exercised (152,797) 5.00 to 6.00 (27,368) 5.00
Cancelled or lapsed* (764,087) 2.69 to 15.56 (32,862) 5.00 to 6.00 (10,032) 5.00
---------- --------------- -------- --------------- -------- ------------
Options outstanding,
end of year 1,303,978 $ 1.75 to 15.56 938,691 $ 4.75 to 15.56 653,850 $4.75 to 8.25
========== =============== ======== =============== ======== =============
Options exercisable,
end of year 666,563 645,952 653,850
========== ======== ========
Options available for
grant, end of year 373,307 731,144 568,782
========== ======== ========
Weighted-average fair
value of options
granted during the
year $ 1.17 $ 5.82 $ 3.93
========== ======== ========
</TABLE>
F-20
<PAGE> 26
NOTES TO FINANCIAL STATEMENTS, CONTINUED
*Includes 587,949 shares surrendered upon repricing.
The Company has elected to adopt the disclosure-only provisions of
Statement of Financial Accounting Standards No. 123 "Accounting for
Stock-Based Compensation." Accordingly, no compensation cost has been
recognized with regard to options granted under the Plan in the
accompanying financial statements. If stock-based compensation costs had
been recognized based on the estimated fair values at the dates of grant
for options awarded during the years ended November 30, 1998, 1997 and
1996, the Company's net income (loss) and earnings (loss) per share would
have been as follows:
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Net (loss) income as reported $(16,952,618) $14,363,781 $ 12,174,430
============ =========== ============
Net (loss) income - pro forma $(18,369,678) $13,158,826 $ 11,760,015
============ =========== ============
Basic EPS - as reported $ (1.00) $ .77 $ .76
============ =========== ============
Diluted EPS - as reported $ (1.00) $ .76 $ .76
============ =========== ============
Basic EPS-Pro forma $ (1.08) $ .71 $ .73
============ =========== ============
Diluted EPS-Pro forma $ (1.08) $ .70 $ .73
============ =========== ============
</TABLE>
The weighted average fair value of each option has been estimated on the
date of grant using the Black Scholes options pricing model with the
following weighted average assumptions used for all grants of 65.4% in
1998 and 58.5% in 1997 and 1996; risk-free interest rate ranging from
4.67% to 4.80% in 1998 and 6.17% to 6.50% in 1997 and 1996; and expected
lives of approximately 4.8 years. Weighted averages are used because of
varying assumed exercise dates.
The following table summarizes information about stock options
outstanding at November 30, 1998:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE SHARES CONTRACTUAL EXERCISABLE SHARES EXERCISABLE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
<S> <C> <C> <C> <C> <C>
$1.75 - $2.63 1,131,478 9.8 $ 1.90 510,729 $ 1.90
$2.69 - $3.81 37,500 9.7 3.06 20,834 3.36
$4.75 - $6.00 85,000 7.6 5.18 85,000 5.18
$9.38 - $11.31 37,500 8.4 10.60 37,500 10.60
$15.56 - $15.56 12,500 8.6 15.56 12,500 15.56
--------------- --------- --- ------ ------- ------
$1.75 - $15.56 1,303,978 9.6 $ 2.53 666,563 $ 3.11
=============== ========= === ====== ======= ======
</TABLE>
As of November 30, 1998 and 1997, there were 275,818 warrants outstanding
to purchase common stock at an exercise price of $8.25 per share. The
warrants are exercisable through 2000.
F-21
<PAGE> 27
NOTES TO FINANCIAL STATEMENTS, CONTINUED
11. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):
The following is a summary of the unaudited quarterly results of
operations for fiscal 1998, 1997 and 1996:
<TABLE>
<CAPTION>
QUARTER ENDED
----------------------------------------------------------
NOVEMBER 30, AUGUST 31, MAY 31, FEBRUARY 28,
<S> <C> <C> <C> <C>
1998:
Net revenues $ 20,285,085 $16,509,577 $ 21,259,988 $36,635,601
Gross profit (1,624,266) 5,070,872 1,380,175 10,499,027
(Loss) income before income taxes (5,068,084) 2,055,824 (20,505,128) 6,147,306
Net (loss) income (6,591,590) 1,460,902 (15,510,314) 3,688,384
Basic (loss) earnings per share (.41) .09 (.91) .20
Diluted (loss) earnings per share (.41) .09 (.91) .20
1997:
Net revenues $ 49,302,822 $44,688,568 $ 53,323,734 $44,059,812
Gross profit 10,072,085 4,152,170 13,786,298 13,543,020
Income before income taxes 5,420,442 307,049 9,660,751 9,045,155
Net income 2,911,615 184,229 5,832,540 5,435,397
Basic earnings per share 0.16 0.01 0.31 0.29
Diluted earnings per share 0.15 0.01 0.31 0.29
1996:
Net revenues $ 39,389,333 $17,493,179 $ 13,765,685 $16,018,571
Gross profit 11,288,981 5,737,501 1,638,439 3,340,591
Income before income taxes 7,080,889 4,918,871 1,142,807 3,930,396
Net income 4,165,501 3,111,288 595,452 4,302,189
Basic earnings per share 0.23 0.20 0.04 0.29
Diluted earnings per share 0.23 0.20 0.04 0.28
</TABLE>
During the fourth quarter of fiscal 1996, the Company recorded an accrual
of approximately $1,070,000 relating to compensation.
The fourth quarter of fiscal 1997 included an increase of approximately
$200,000 for state income taxes. This increase was attributable to
increased revenues in the states where the Company is subject to higher
tax rates.
During the fourth quarter of fiscal 1998, the Company reduced the benefit
for income taxes by approximately $2,550,000 due to a change in estimate
of the amount of permanent differences, primarily goodwill due to its
accelerated writeoff, and deferred tax asset valuation reserves.
F-22
<PAGE> 28
QUINTEL ENTERTAINMENT, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
<TABLE>
<CAPTION>
COL. A COL. B COL. C COL. D COL. E
------------------------------------ ------------ ------------------------- ------------ ---------
ADDITIONS
-------------------------
DESCRIPTION BALANCE AT CHARGED TO CHARGED TO DEDUCTIONS - BALANCE AT
BEGINNING COSTS AND OTHER DESCRIBE(3) END OF
OF PERIOD EXPENSES ACCOUNTS(1) PERIOD
<S> <C> <C> <C> <C>
YEAR ENDED NOVEMBER 30, 1998
Reserve for customer chargebacks $38,196,114 $ 56,496,612 $79,198,588 $15,494,138
============ ========== ============ =========== ============
YEAR ENDED NOVEMBER 30, 1997
Reserve for customer chargebacks $20,080,903 $103,597,803 $85,482,592 $38,196,114
============ ========== ============ =========== ============
YEAR ENDED NOVEMBER 30, 1996
Reserve for customer chargebacks $ 4,025,130 $ 55,689,393(2) $39,633,620 $20,080,903
============ ========== ============ =========== ============
</TABLE>
(1) Charged against revenues
(2) Includes assumed liability in connection with New Lauderdale acquisition of
$9,336,755 (see Note 6).
(3) Chargebacks refunded during the year.
F-23
<PAGE> 29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Dated: August 4, 1999 Quintel Communications, Inc.
By: /s/ Jeffrey L. Schwartz
----------------------------
Jeffrey L. Schwartz
Chairman and CEO
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ Jeffrey L. Schwartz Chairman and Chief August 4, 1999
- ----------------------- Executive Officer (Principal
Jeffrey L. Schwartz Executive Officer)
/s/ Jay Greenwald
President, Chief Operating August 4, 1999
- ----------------------- Officer and Director
Jay Greenwald
/s/ Daniel Harvey Chief Financial Officer August 4, 1999
- ----------------------- (Principal Financial and
Daniel Harvey Accounting Officer)
/s/ Andrew Stollman Senior Vice President August 4, 1999
- ----------------------- and Director
Andrew Stollman
/s/ Michael G. Miller Director August 4, 1999
- -----------------------
Michael G. Miller
/s/ Murray L. Skala Director August 4, 1999
- -----------------------
Murray L. Skala
/s/ Mark Gutterman Director August 4, 1999
- -----------------------
Mark Gutterman
/s/ Lawrence Burstein Director August 4, 1999
- -----------------------
Lawrence Burstein
</TABLE>
