<PAGE> 1
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 quarter ended February 28, 1999
[ ] 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)
Delaware 22-3322277
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Blue Hill Plaza
Pearl River, New York 10965
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (914) 620-1212
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 [ ]
-------------------------------------
The number of shares outstanding of the Registrant's common stock is
16,679,746 (as of 4/13/99).
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QUINTEL COMMUNICATIONS, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
QUARTER ENDED FEBRUARY 28, 1999
ITEMS IN FORM 10-Q
<TABLE>
<CAPTION>
PAGE
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<S> <C>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis
of Financial Condition and
Results of Operations 9
Item 3. Quantitative and Qualitative
Disclosures About Market Risk None
PART II OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 2. Changes in Securities
and Use of Proceeds None
Item 3. Defaults Upon Senior Securities None
Item 4. Submission of Matters to
a Vote of Security Holders None
Item 5. Other Information None
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
QUINTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
February 28, November 30,
1999 1998
(Unaudited)
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents $ 1,854,036 $ 2,123,630
Marketable securities 8,978,356 15,019,233
Accounts receivable, trade 30,435,909 31,230,579
Deferred income taxes 3,766,713 11,990,442
Recoverable Income Taxes 8,261,570
Due from related parties 786,577 754,089
Prepaid expenses and other current assets 1,856,670 2,151,270
----------- -----------
Total current assets 55,939,831 63,269,243
Property and equipment, at cost, net of accumulated
depreciation 1,069,890 1,143,901
----------- -----------
$57,009,721 $64,413,144
=========== ===========
LIABILITIES:
Current liabilities:
Accounts payable $ 3,484,151 $ 4,453,663
Accrued expenses 4,678,220 6,897,246
Reserve for customer chargebacks 11,541,454 15,494,138
Due to related parties 389,188 140,756
Income taxes payable 191,887 745,197
----------- -----------
Total current liabilities 20,284,900 27,731,000
STOCKHOLDERS' 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 16,679,748 and
16,679,748 shares, respectively 16,679 16,679
Additional paid-in capital 38,955,275 38,955,275
Retained earnings (deficit) 22,016 (379,292)
Accumulated other comprehensive (loss) (67,249) (10,488)
Common stock held in Treasury, at cost, 949,153
shares and 773,066 shares, respectively (2,201,900) (1,900,030)
----------- -----------
Total stockholders' equity 36,724,821 36,682,144
----------- -----------
$57,009,721 $64,413,144
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
3
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QUINTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------
FEBRUARY 28, FEBRUARY 28,
1999 1998
------------ -----------
<S> <C> <C>
Net revenue $ 19,805,601 $36,635,601
Cost of sales 16,753,371 26,136,574
------------ -----------
Gross profit 3,052,230 10,499,027
Selling, general and administrative
expenses 2,989,053 4,975,613
----------- ----------
63,177 5,523,414
Interest expense (303) (30,447)
Other income, net 609,241 654,339
----------- ----------
672,115 6,147,306
Provision for income taxes 270,807 2,458,922
----------- ----------
Net income $ 401,308 $ 3,688,384
=========== ==========
Basic earnings per share (Note 2):
Net income $ .03 $ .20
----------- -----------
Average shares outstanding 15,783,777 18,649,347
=========== ===========
Diluted income per common share (Note 2):
Net income $ .03 $ .20
----------- -----------
Average shares outstanding 15,849,080 18,712,302
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
4
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QUINTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Three months ended
---------------------------
February 28, February 28,
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income
Items not affecting cash: $ 401,308 $ 3,688,384
Depreciation and amortization 74,011 552,875
Reserve for customer chargebacks (3,952,684) (6,225,434)
Deferred income taxes 1,760,949
Other (5,286)
Changes in assets and liabilities:
Accounts receivable 794,670 3,518,753
Prepaid expenses and other current assets 294,600 726,791
Accounts payable (969,512) (671,354)
Income tax payable (553,310)
Due from/to related parties, net 215,944 (248,292)
Other, principally accrued expenses (2,219,026) 534,123
----------- ------------
Net cash (used in) provided by operating activities (5,913,999) 3,631,509
----------- ------------
Cash flows from investing activities:
Purchases of securities (9,657,698) (29,000,000)
Proceeds from sales of securities 15,603,973 26,974,273
Other, principally capital expenditures (219,879)
----------- ------------
Net cash provided by used in investing activities 5,946,275 (2,245,606)
----------- ------------
Cash flows from financing activities:
Repurchase of common stock (301,870)
-----------
Net cash (used in) financing activities (301,870)
----------- ------------
Net (decrease) increase in cash and cash equivalents (269,594) 1,385,903
Cash and cash equivalents, beginning of period 2,123,630 10,063,717
----------- ------------
Cash and cash equivalents, end of period $ 1,854,036 $ 11,449,620
=========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
5
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QUINTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL:
The consolidated financial statements for the three month periods ended
February 28, 1999 and February 28, 1998 are unaudited and reflect all
adjustments (consisting only of normal recurring adjustments) which are, in the
opinion of management, necessary for a fair presentation of the financial
position and operating results for the interim period. The consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto, together with management's discussion
and analysis of financial condition and results of operations, contained in the
Company's Annual Report on Form 10-K for the fiscal year ended November 30,
1998. The results of operations for the three months ended February 28, 1999
are not necessarily indicative of the results for the entire fiscal year ending
November 30, 1999.
2. 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>
February 28,
------------------------
1999 1998
<S> <C> <C>
Denominator:
Denominator for basic earnings per share-
weighted-average shares 15,783,777 18,649,347
Effect of dilutive securities:
Stock options 65,303 62,955
Dilutive potential common shares:
Denominator for diluted earnings per share - adjusted ---------- ----------
weighted-average shares and assumed conversions 15,849,080 18,712,302
========== ==========
</TABLE>
Options and warrants to purchase 872,818 and 949,944 shares of common stock
were outstanding for the quarters ended February 28, 1999 and 1998,
respectively, but were not included in the computation of diluted earnings per
share because their effect would be anti-dilutive.
6
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. ADVERTISING EXPENSES:
The Company generally expenses advertising costs, which consist primarily of
print, media, production, telemarketing and direct mail related charges, when
the related advertising occurs. For interim purposes, certain telemarketing
and production expenses are deferred and charged to operations over their
expected period of benefit. All such amounts will be expensed prior to year
end. Total advertising expense incurred for the three months ended February
28, 1999 and 1998 were approximately $13,182,000 and $11,722,000,
respectively. Included in prepaid expenses and other current assets is
approximately $317,000 and $401,000 relating to prepaid advertising at
February 28, 1999 and November 30, 1998, respectively.
4. ADOPTION OF SFAS 130, "REPORTING COMPREHENSIVE INCOME"
As of December 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130") SFAS No.
130 establishes new standards for reporting and displaying comprehensive
income and its components within the Company's financial statements; however,
the adoption of SFAS No. 130 has no impact on the Company's net income or
stockholders' equity. SFAS No. 130 requires unrealized gains and losses on
the Company's marketable securities to be reported in comprehensive income.
Prior to adoption of this statement, such gains and losses were reported
separately in stockholders' equity. Prior year financial statements have been
reclassified to conform to the requirements of SFAS No. 130.
During the first quarter of 1999 and 1998, total comprehensive income
amounted to $345,000 and $3,682,000 respectively.
5. RECENTLY ISSUED PRONOUNCEMENTS
The Financial Accounting Standards Board recently issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which
is effective for the company on November 30, 1999. This pronouncement deals
with disclosure matters and, upon adoption, will not have any effect on the
Company's financial position, results of operations or cash flows. The
Company is evaluating its reporting under this new statement and currently
believes it will be separating its information into two segments. It is
anticipated that the segments will be Residential and Long Distance Customer
Acquisition Services as one segment, and Club 900 and Enhanced services will
form the other segment.
6. LITIGATION:
On or about May 4, 1998, a complaint entitled "Joseph Chalverus, on behalf of
himself and all other 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,
7
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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 filed papers in
opposition to the motion to dismiss, and the Company and the Individual
Defendants have filed reply papers in further support of the motion. 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
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
OVERVIEW
Quintel Communications, Inc. (the "Company") is engaged in the direct
marketing and providing of various telecommunication products and services.
Principally, the Company utilizes its extensive database to provide direct
marketing services for its residential long distance customer acquisition
programs. The Company's revenues from the foregoing are generated through the
direct sale of products and services to consumers and through revenue sharing
arrangements with its residential long distance customer acquisition clients.
The following is a discussion of the financial condition and results of
operations of the Company for the three month periods ended February 28, 1999
and February 28, 1998. It should be read in conjunction with the interim
consolidated financial statements of the Company, the Notes thereto and other
financial information included elsewhere in this report.
RESULTS OF OPERATIONS
Net Revenue for the three months ended February 28, 1999 was $19,805,601, a
decrease of $16,830,000, or 46%, as compared to $36,635,601 for the three months
ended February 28, 1998. The decrease was attributable to decreases in net
revenues from the Company's "900" entertainment services of $18,332,311, or
100%, decreases in net revenues from the Company's Club 900 products of
$2,796,642, or 61%, decreases in the net revenues from enhanced voice mail
networks and other enhanced services ("enhanced services") of $3,974,112 or,
56%, and decreases in other products and services of $1,492,615, or 99%. Such
net revenue decreases were partially offset by increases in net revenues from
the Company's residential long distance customer acquisition services of
$9,765,680. See "--Residential Long Distance Customer Acquisition Services". See
"--Prior Year Special Charge" for a detailed discussion of the decrease in net
revenues from "900" entertainment services and Club 900 products. See "--Service
Bureau and Local Exchange Carriers" for a detailed discussion of the decrease in
net revenues from enhanced services. The decrease in other products and services
was principally attributable to the Company's discontinuance of its cellular
phone activities during the fourth quarter of fiscal 1998.
For the three months ended February 28, 1999, "900" entertainment services,
enhanced services, residential long distance customer acquisition services, Club
900 product memberships, and cellular phone activities and other products
approximated 0%, 16%, 75%, 9% and 0% of net revenues, respectively. For the
three months ended February 28, 1998, "900" entertainment services, enhanced
services, residential long distance customer acquisition services, Club 900
product memberships and cellular phone activities and other products
approximated 50%, 19%, 14%, 13% and 4% of net revenues, respectively.
The provisions for chargebacks, recorded as a direct reduction to
revenues, for the three months ended February 28, 1999 were $4,632,661, a
decrease of $20,257,979, or 81%, as compared to $24,890,640 for the three
months ended February 28, 1998. The decrease is primarily attributable to a
decrease in chargebacks from the Company's "900" entertainment pay per call
services of $14,901,191, or 100%, when compared to the prior comparable period.
This decrease in chargebacks resulted from the Company's reduction in the
marketing of its "900" entertainment services. See -- "Prior Year Special
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Charge". Additionally, during the three months ended February 28, 1999, the
Company's Club 900 product chargebacks decreased by $3,077,803, or 62%, when
compared to the prior comparable period. This decrease was the result of a
chargeback rate experience of 52% - the same rate as that experienced in the
prior comparable period - being applied to decreased Club 900 product gross
revenues for the quarter ended February 28, 1999 when compared with the quarter
ended February 28, 1998. Chargebacks on the Company's enhanced services
decreased by $1,690,577, or 38%, when compared to the prior comparable period.
Such decrease was the result of an increased chargeback rate applied to
decreased gross sales recorded in the three months ended February 28, 1999, as
compared to the three months ended February 28, 1998. The Company's enhanced
services' actual chargeback rate experience increased during the three months
ended February 28, 1999 (47% of related gross revenues) when compared to the
three months ended February 28, 1998 (38% of related gross revenues), as a
result of the significant increases in customer service refunds and credits
(chargebacks) being issued by the Local Exchange Carriers, See "--Service Bureau
and Local Exchange Carriers".
The impact of certain items on the operations of the Company, namely, cost
of revenues, chargebacks and marketing expenses, can be better understood in
relation to gross revenues, as opposed to net revenues. Accordingly, such
information is provided in the paragraphs that follow.
During the three months ended February 28, 1999, gross revenues from
enhanced services and Club 900 product memberships were approximately $5,834,097
and $3,680,935, respectively, as compared to approximately $11,498,786 and
$9,555,381, respectively, for the three months ended February 28, 1998. The
chargeback allowances recognized during the three months ended February 28, 1999
for the Company's enhanced services and Club 900 product memberships were
$2,728,189 (47% of related revenues) and $1,904,394 (52% of related revenues),
respectively, as compared to $4,418,766 (38% of related revenues) and $4,982,197
(52% of related revenues), respectively, for the three months ended February 28,
1998. The Company did not incur cellular phone related chargeback activity
during the three months ended February 28, 1999 due to the discontinuance of
such activities in the prior fiscal year. During the three months ended February
28, 1998, the Company's combined prepaid and conventional cellular phone
activity chargebacks approximated $588,486, representing a chargeback rate
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of 28% of the respective activities' gross revenues of approximately $2,091,140
recorded during such period. The Company's residential long distance customer
acquisition service revenues are not encumbered by chargebacks.
Cost of revenues for the three months ended February 28, 1999 was $16,753,371, a
decrease of $9,383,203, or 36%, as compared to $26,136,574 for the three months
ended February 28, 1998. The decrease is directly attributable to reductions in
service bureau fees related to the decrease in the Company's "900" entertainment
services and decreases in advertising costs expended in procuring such revenues.
The service bureau fees, including the cost of "psychic operators", related to
the "900" entertainment services were approximately $2,545,000 and $9,617,000
for the three months ended February 28, 1999 and 1998, respectively. This
decrease of approximately $7,072,000 accounts for approximately 75% of the total
decrease in cost of revenues. In addition, the "900" entertainment services
related advertising costs, principally from television broadcast media,
commercial production costs and direct mail costs, were approximately $4,932,000
and $6,967,000 for the three months ended February 28, 1999 and 1998,
respectively, a decrese of approximately $2,035,000, or 29%. Such decrease
accounted for approximately 22% of the total decrease in the cost of revenues in
the three month period ended February 28, 1999, as compared to the prior fiscal
period. Approximately $4,370,000 of the decrease in cost of revenues was
attributable to the Company's implementation, during the third quarter of the
prior fiscal year, of its strategy to reposition the marketing emphasis of the
"900" entertainment services, in response to decreasing margins, increased
marketing costs and increased chargebacks. See"--Prior Year Special Charge."
(The cost of revenues in the three months ended February 28, 1998 did not have a
comparable reduction.) The "900" entertainment services are now used in
conjunction with the marketing of the Company's other products and services (as
opposed to an independent revenue source). In accordance with this
repositioning, any amounts received by the Company in providing "900"
entertainment services, net of estimated chargebacks, are reflected as a
reduction to the cost of revenues of the Company's other products and services.
Accordingly, during the three months ended February 28, 1999, gross "900"
entertainment billing of approximately $6,670,000, net of corresponding
estimated chargebacks of $2,300,000, were
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offset to cost of revenues for the reduction of approximately $4,370,000, as
referenced above. Additional decreases in the cost of revenues were recognized
from the discontinuance of the Company's cellular phone activities
and decreases in costs associated with the marketing and billing of enhanced
services. The amount of such marketing and service bureau cost
reductions approximated $1,927,000 and $2,900,000, respectively, when compared
with the three months ended February 28, 1998. The foregoing decreases to cost
of revenues were offset by increases in marketing costs related to the
Company's increased emphasis in promoting its residential long distance
customer acquisition services. Marketing costs associated therewith approximated
$12,620,000 during the three months ended February 28, 1999, as compared to
approximately $3,710,000 during the three months ended February 28, 1998.
Cost of revenues as a percentage of gross revenues increased to
approximately 69% for the three months ended February 28, 1999 from
approximately 42% for the three months ended February 28, 1998. This increase is
specifically attributable to the Company's emphasis during the quarter ended
February 28, 1999 on the marketing of its long distance customer acquisition
services, which accounted for approximately 75% of net revenues in such quarter.
The acquisition costs incurred in acquiring a long distance customer, compared
with the commission paid to the Company for each acquired customer, resulted in
the Company realizing a small gross profit margin (and in some cases a gross
loss), for each customer acquired. This resulted in the increase in the cost of
revenues as a percentage of gross revenues for the quarter ended February 28,
1999. The Company expects the aforementioned front end customer acquisition
outcomes will be offset in future periods by revenues earned under the Company's
revenue sharing agreement with Qwest (See -- "Residential Long Distance Customer
Acquisition Services"), which calls for the Company to participate in the long
distance usage revenues for all acquired customers during their term as a long
distance customer of Qwest. This revenue sharing agreement provides for
participation in usage revenues at rates ranging from approximately 3.7% to
12.9%, net of a fixed bad debt withholding rate, currently set at 8%. The
Company expects the aforementioned future annuity based revenues (which are not
encumbered by service costs) to allow the Company to recapture its front end
customer acquisition costs and to generate profits and cash flows in future
periods that the acquired individual remains a customer of
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Qwest. See "Forward Looking Information".
The Company's total gross revenues for the three months ended February 28,
1999 were approximately $24,438,000, with marketing costs of approximately
$13,182,000, or 54% of such gross revenues. Gross revenues for the three months
ended February 28, 1998 were approximately $61,526,000, with marketing costs of
approximately $11,722,000, or 19% of such gross revenues. The increased
percentage relationship of marketing costs to gross revenues was directly
attributable to the concentration of long distance customer acquisition revenues
recorded during the three months ended February 28, 1999 when compared to the
comparable prior period. Such long distance customer acquisition net revenues
represented 75% and 14%, respectively, of the net revenues for the periods ended
February 28, 1999 and 1998. The net revenues from the long distance customer
acquisition activities yield a near breakeven gross profit at the time of
acquisition, resulting in a high cost of revenue for this service. The
aforementioned front end acquisition costs are expected to be mitigated over
time, through the realization of future revenues earned under the usage/revenue
sharing agreements attached to such programs. See "--Residential Long Distance
Customer Acquisition Services". The remaining significant component of the cost
of revenue is service bureau fees. For the three months ended February 28, 1999
and 1998, such service bureau fees were approximately $3,380,000 and
$10,911,000, respectively. This decrease of approximately $7,531,000, or 69%,
was primarily attributable to the Company's decrease in "900" entertainment
service revenues and its corresponding reduction in service bureau usage. This
decrease was also a function of decreased service bureau fees relating to the
Company's decrease in gross revenue activity from enhanced services and Club 900
memberships.
Selling, general and administrative expenses (SG&A) for the three months
ended February 28, 1999 were $2,989,053, a decrease of $1,986,560, or 40%, as
compared to $4,975,613 for the three months ended February 28, 1998. The
reduction is primarily attributable to a decrease in amortization expense of
approximately $489,000, pursuant to an impairment write-off of goodwill during
the fiscal year ended November 30, 1998. See "--Prior Year Special Charge".
Additionally, the decrease resulted from net reductions in officers'
compensation of approximately $533,000 and reductions in personnel costs of
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approximately $572,000.
Other income for the three months ended February 28, 1998 consisted
primarily of interest income. For the three months ended February 28, 1999,
other income was $609,241, a decrease of $45,098, or 7%, as compared to
$654,339 for the three months ended February 28, 1998. The decrease is
attributable to decrease interest earnings on the Company's marketable
securities, which consist primarily of direct U.S. government obligations, and
decreases in interest earned on funds held in reserve for future chargebacks by
the Company's primary "900" entertainment service bureau. See "--Liquidity and
Capital Resources".
The Company's provision for income taxes is the result of the combination
of federal statutory rates and required state statutory rates applied to
pre-tax income. This combined effective rate was 40% for the three months ended
February 28, 1999 and 1998, respectively.
LIQUIDITY AND CAPITAL RESOURCES
At February 28, 1999, the Company had cash of $1,854,036, reflecting a
reduction of approximately $270,000 during the three month period ended
February 28, 1999.
During the three months ended February 28, 1999, the Company used
$5,913,999 for operating activities, primarily to fund its working capital
requirements, the significant components being the costs of advertising and
promoting the Company's long distance customer acquisition activities and
payments on accrued chargeback liabilities.
The $5,946,275 in net cash provided by investing activities resulted from
net proceeds generated from marketable securities transactions. During the
three months ended February 28, 1999 the Company had not made any purchases of
property, plant or equipment.
The $301,870 of cash used in investing activities was expended exclusively
for the repurchase of treasury stock during the three months ended February 28,
1999.
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During the prior two fiscal years, the Company had begun to recognize
substantial increases in chargebacks experienced on its "900" entertainment
service revenues. As a result, two of the Company's service providers instituted
a cash reserve policy. Under this cash reserve policy, the service providers
withhold cash flows from carrier collections in amounts that approximate the
Company's future expected chargebacks, as they relate to each service provider.
As of February 28, 1999, the reserves withheld approximated $9,685,000 and are
included in the Company's accounts receivable. Historically, the Company has
financed its working capital requirements principally through cash flow from
operations and receivables financing. Although the Company is not currently
dependent on cash flow from receivables financing, credit lines for this purpose
are being maintained and the Company may avail itself of such financing in the
future. See "Forward Looking Information".
The Company's primary cash requirements have been to fund the cost of
advertising and promotion. Additional funds may be used in the purchasing of
equipment and services in connection with the commencement of new business lines
and further development of businesses currently being test marketed. The
Company currently has no other plans or material commitments for capital
expenditures or significant working capital demands. Under currently proposed
operating plans and assumptions (including the substantial costs associated with
the Company's advertising and marketing activities), management believes that
projected cash flows from operations, recoverable income taxes from the
carryback of the fiscal 1998 net operating loss and available cash resources,
including an available financing arrangement with a service bureau, will be
sufficient to satisfy the Company's anticipated cash requirements for at least
the next twelve months. The Company does not have any long-term obligations and
does not intend to incur any such obligations in the future. As the Company
seeks to diversify with new telecommunication products and services, the Company
may use existing cash reserves, long-term financing, or other means to finance
such diversification. See "Forward Looking Information"
15
<PAGE> 16
PRIOR YEAR SPECIAL CHARGE
During the fiscal year ended November 30, 1998, the Company experienced
decreasing margins on its "900" entertainment services, attributable to
significant increases in marketing expenditures related thereto and customer
chargebacks. As a result, these services were not providing positive operating
results and cash flow. Consequently, during the quarter ended August 31, 1998,
the Company discontinued marketing such services as an independent revenue
source and began using them in conjunction with marketing the Company's other
products and services, including its residential distributor program agreement
with Qwest. See "--Residential Long Distance Customer Acquisition Services."
Accordingly, as required by Statement of Financial Standards No. 121 ("FAS
121"), the Company reviewed long-lived assets, including goodwill, for
impairment. The Company has evaluated the recoverability of its long-lived
assets by measuring the carrying amount of the assets against projected
undiscounted future cash flows associated with them. The Company determined the
"900" entertainment services could not be disposed of and there was no
predictable estimate of any future cash flows associated with any alternative
uses. Accordingly, the Company concluded that the intangibles, primarily
goodwill, associated with the Company's 1996 acquisition of the remaining 50%
interest in New Lauderdale, were impaired. As such, a non-cash charge of
approximately $18.5 million, which represented the remaining balance of the
intangibles, primarily goodwill, was recorded at May 31, 1998. This impairment
is directly responsible for the decrease in gross revenues generated from the
Company's "900" entertainment services of approximately $26,564,000, or 80%,
when comparing gross revenues of approximately $33,234,000 recorded in the three
months ended February 28, 1998, with gross revenues for the three months ended
February 28, 1999, which are recorded as an offset to cost of revenues, of
approximately $6,670,000. The aforementioned decrease in the marketing of the
Company's "900" entertainment services is also partially responsible for the
decrease in the Company's Club 900 revenues. Such Club 900 revenues are
generated by soliciting a caller to subscribe to the Company's Club 900 product
while such potential Club member is conducting a live psychic call as offered
through the Company's "900" entertainment services. Therefore, with the
reduction in the emphasis of marketing the "900" entertainment services as an
independent
16
<PAGE> 17
revenue source, a corresponding effect was the reduction in potential callers
available for solicitation of the Company's Club 900 product.
SERVICE BUREAU AND LOCAL EXCHANGE CARRIERS
In November 1998, three of the Local Exchange Carriers ("LECs"), Ameritech
Corp., Bell Atlantic Corp. and SBC Communications, Inc., refused to bill
customers for enhanced services provided by the Company. This was the result of
what the LECs claimed 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 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 has continued 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, Billing
Information Concepts Corporation ("BIC"), terminated its arrangement with the
Company for providing billing for the Company's enhanced services. BIC continues
to service all data relating to post-billing adjustments to records billed prior
to BIC's self-imposed billing cessation. In December 1998, the Company entered
into an agreement with Federal Transtel, Inc. ("Transtel"), whereby Transtel
provides the enhanced service revenue billing services previously provided by
BIC. In effect, between the termination of the BIC billing service arrangement
and the commencement of the billing under the agreement with Transtel
(approximately two months), the Company was unable to bill for any enhanced
services provided. Subsequent to this billing cessation and re-commencement of
enhanced service billing with Transtel, the Company has substantially
discontinued marketing for new enhanced service customers, but continues to bill
and provide enhanced services to the member base that was in place at the time
of the billing cessation. This member base is subject to significant rates of
member attrition that substantially exceed the current level of new member
acquisitions. Therefore, these enhanced services cannot be expected to
contribute significant amounts to future periods' net revenues and corresponding
cash flows. "See Forward Looking Information". The Company had previously
engaged, and continues to use Transtel, for the provision of billing and
collection services in connection with the Club 900 product.
17
<PAGE> 18
RESIDENTIAL LONG DISTANCE CUSTOMER ACQUISITION SERVICES
During the fiscal year ended November 30, 1996, the Company entered into an
agreement with AT&T Communications, Inc. ("AT&T"), whereby it marketed AT&T's
long distance products. The Company terminated its strategic corporate
partnership with AT&T during the first three months ended February 28, 1998. The
termination resulted from modifications made by AT&T to its customer acquisition
strategies which significantly reduced the Company's ability to successfully
market under such strategic partnership. During the three months ended February
28, 1998, the Company recorded net revenues of approximately $4,980,000 from the
AT&T strategic partnership.
The Company concluded an agreement with the long distance carrier LCI
International Telecom Corp., d/b/a/ Qwest Communications Services ("Qwest"),
during the three months ended February 28, 1998. The Company currently provides
marketing services to Qwest primarily through outbound telemarketing and
broadcast media, directed at the acquisition of residential long distance
customers for Qwest. In addition to commissions paid to the Company for its
successful customer acquisitions on behalf of Qwest, the agreement also calls
for the Company to participate in Qwest's net revenues earned from such
customer's residential long distance usage. During the three months ended
February 28, 1999, a total of $14,913,112 of net revenues were earned under
such agreement with Qwest. Of this total, customer acquisition commissions
accounted for $12,891,234, with the balance of $2,021,878 attributable to usage
revenues earned. During the three months ended February 28, 1998, the Company
was in the test marketing phase of the Qwest arrangement and did not record net
revenues in such quarter.
THE YEAR 2000 PROBLEM
At the time computer programs were first being written, two digits were
used instead of four to define years on such programs. For example, the year
"1998" was written within such computer programs as "98". As a result, at the
onset of the new millennium, any programs that have time-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a major system failure or miscalculations. This potential
difficulty is commonly referred to as the "Y2K Problem".
18
<PAGE> 19
The Company has conducted a comprehensive review of its computer systems to
identify the systems that could be effected by the "Y2K" Problem. The Company
presently believes that its entire internal computer programs, software
packages, systems and networks are Y2K compliant. Within the past 12 months, the
Company has replaced all personal computers that were not Y2K compliant and
rewritten its entire billing system to become compliant. The Company also
recently acquired a new main database server that is compliant and that runs on
commercially available software package that is compliant. The cost of all of
the foregoing did not have a material impact on the operations of the Company.
See "Forward Looking Information".
Notwithstanding the foregoing, the Company is reliant on third parties for
the operation of the Company's day-to-day business. The Company can not provide
any assurances that the steps being taken by such third parties, if any, will be
sufficient to eliminate the Y2K problem from the computer systems used by such
third parties and relied upon by the Company. The Company has corresponded with
all its vendors, informing them that the Company will only conduct business with
those entities that are "Y2K" compliant. In addition, the Company only accepts
inbound files from outside sources that define years with four digit codes,
ensuring compliance. Lastly, the Company's customer service department operates
via the Company's computer network, which is compliant. However, in the event
modifications and conversions to computer systems are required by such third
parties and are not completed on a timely basis, the Y2K Problem may have a
material impact on the operations of the Company.
19
<PAGE> 20
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
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 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 filed papers in
opposition to the motion to dismiss and the Company and the Individual
Defendants have filed reply papers in further support of the motion. 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. No assurance can be given, however,
that the outcome of the consolidated actions will not have a materially adverse
impact upon the results of operations and financial condition of the Company.
See "Forward Looking Information."
All of the Company's entertainment services and advertisements are
reviewed by the Company's regulatory counsel, and management believes that the
Company is in substantial
20
<PAGE> 21
compliance with all material federal and state laws and regulations governing
its provision of "800" and "900" number entertainment services, all of its
billing and collection practices and the advertising of its services and has
obtained or is in the process of obtaining all licenses and permits necessary to
engage in telemarketing activities. Nevertheless, on or about September 30,
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. The Company has also received a
subpoena to produce documents related to its marketing practices from the office
of the Attorney General of the State of Kansas. To date, the Company has not
been subject to any enforcement actions by any regulatory authority and
management believes that the FTC and Kansas inquiries 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. See "Forward Looking Information."
At the request of the Federal Communications Commission, a group of the
largest Local Exchange Carriers (the "LECs") have developed a set of voluntary
Best Practices Guidelines (the "Guidelines") with regard to the problem of
"cramming" -- unauthorized, deceptive or ambiguous charges included on end-user
customers' monthly local telephone bills. The cramming problem has increasingly
been receiving a great deal of attention from federal and state legislators,
regulatory agencies and law enforcement agencies throughout the country. The FTC
has proposed regulations addressing cramming, and legislation is pending to
combat the cramming problem, as well. The Guidelines, and regulations and
legislation, if enacted, require that service providers obtain detailed and
documented authorization from end users prior to billing for miscellaneous
products or services. Advertising for products and services to be billed through
a certain type of billing mechanism known as the "4250 billing mechanism" will
need to be pre-approved by the LECs and clearing houses prior to their billing.
Moreover, each LEC is in the process of revising its individual billing and
collection agreements to implement the Guidelines and further restrict the types
of services for which it will provide billing services. Consequently, the LECs
will have broad discretionary powers to restrict services for which the Company
may bill through the customer's telephone bill and assess administrative charges
to service providers when a charge for a product or service not pre-approved by
the LEC and/or authorized by the end user, is placed on the customer's bill. As
the Company employs the 4250 billing mechanism to bill for products and
services, the Guidelines (and possible regulations and legislation) and LEC
restrictions will impact on, and need to be taken into account in, formulating
the Company's business practices.
21
<PAGE> 22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ------
<S> <C>
3.1.1 Articles of Incorporation of the Company, as amended (1)
3.1.2 Amendment to the Articles of Incorporation of the Company (2)
3.2 By-Laws of the Company (3)
27.1* Financial Data Schedule
</TABLE>
- --------------
* Filed herewith.
(1) Filed as an Exhibit to the Company's Registration Statement on Form
8-A, dated October 23, 1995, and incorporated herein by reference.
(2) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for
the fiscal quarter ended August 31, 1998, and incorporated herein by
reference.
(3) Filed as an Exhibit to the Company's Registration Statement on Form S-1
(the "S-1 Registration Statement"), dated September 6, 1995 (File No.
33-96632), and incorporated herein by reference.
(b) REPORTS ON FORM 8-K.
No reports on Form 8-K were filed during the first quarter of the
fiscal year ending November 30, 1999.
FORWARD LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains certain forward-looking
statements and information relating to the Company that are based on the beliefs
of Management, as well as assumptions made by and information currently
available to the Company. When used in this document, the words "anticipate,"
"believe," "estimate," and "expect" and similar expressions, as they relate to
the Company, are intended to identify forward-looking statements. Such
statements reflect the current views of the Company with respect to future
events and are subject to certain risks, uncertainties and assumptions,
including those described in this Quarterly Report on Form 10-Q. Should one or
more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those
described herein as anticipated, believed, estimated or expected. The Company
does not intend to update these forward-looking statements.
22
<PAGE> 23
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.
QUINTEL COMMUNICATIONS, INC.
By:/s/ Jeffrey L. Schwartz
--------------------------------
Jeffrey L. Schwartz
Date: April 14, 1999 Chairman and CEO
By:/s/ Daniel Harvey
--------------------------------
Daniel Harvey
Chief Financial Officer
Date: April 14, 1999 (Principal Financial Officer)
23
<PAGE> 24
Exhibit Index
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ------
<S> <C>
3.1.1 Articles of Incorporation of the Company, as amended (1)
3.1.2 Amendment to the Articles of Incorporation of the Company (2)
3.2 By-Laws of the Company (3)
27.1* Financial Data Schedule
</TABLE>
- --------------
* Filed herewith.
(1) Filed as an Exhibit to the Company's Registration Statement on Form
8-A, dated October 23, 1995, and incorporated herein by reference.
(2) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for
the fiscal quarter ended August 31, 1998, and incorporated herein by
reference.
(3) Filed as an Exhibit to the Company's Registration Statement on Form S-1
(the "S-1 Registration Statement"), dated September 6, 1995 (File No.
33-96632), and incorporated herein by reference.
24
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary information extracted from the Quintel
Entertainment, Inc. and Subsidiaries Consolidated Financial as presented in the
Company's Form 10Q for the quarter ended February 28, 1999 and is qualified in
its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> NOV-30-1999
<PERIOD-START> DEC-01-1998
<PERIOD-END> FEB-28-1999
<CASH> $1,854,036
<SECURITIES> 8,978,356
<RECEIVABLES> 30,435,909
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 55,939,831
<PP&E> 1,660,593
<DEPRECIATION> 590,703
<TOTAL-ASSETS> 57,009,721
<CURRENT-LIABILITIES> 20,284,900
<BONDS> 0
0
0
<COMMON> 16,679
<OTHER-SE> 36,708,142
<TOTAL-LIABILITY-AND-EQUITY> 57,009,721
<SALES> 19,805,601
<TOTAL-REVENUES> 19,805,601
<CGS> 16,753,371
<TOTAL-COSTS> 16,753,371
<OTHER-EXPENSES> 2,989,053
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 303
<INCOME-PRETAX> 672,115
<INCOME-TAX> 270,807
<INCOME-CONTINUING> 63,177
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 401,308
<EPS-PRIMARY> $0.03
<EPS-DILUTED> $0.03
</TABLE>
