UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number: 0-6664
K-TEL INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-0946588
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2605 FERNBROOK LANE NORTH, MINNEAPOLIS, MINNESOTA 55447-4736
(Address of principal executive offices) (Zip Code)
(612) 559-6888
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the most recent practical date. As of September
30, 1998, there were 8,335,668 shares of the registrant's common stock, par
value $0.01 per share, outstanding.
1
<PAGE>
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
INDEX
PART I. Financial Information: Page
Item 1. Consolidated Balance Sheets as of September 30, 1998
and June 30, 1998 3
Consolidated Statements of Operations and Comprehensive
Income for the Three Months ended September 30, 1998
and 1997 4
Consolidated Statements of Cash Flows for the Three Month
Periods Ended September 30, 1998 and 1997 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
PART II. Other Information:
Item 6. Exhibits and Reports on Form 8-K 12
2
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K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1998 AND JUNE 30, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
September 30, June 30,
1998 1998
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 3,948 $ 5,941
Accounts receivable, net 14,736 15,341
Inventories 7,253 6,430
Royalty and other advances 1,949 1,475
Prepaid expenses and other 3,399 3,043
------------ ------------
Total Current Assets 31,285 32,230
Property and Equipment, net of
accumulated depreciation and amortization of
$2,827 and $2,671 2,433 2,131
Other Assets 4,655 4,674
------------ ------------
$ 38,373 $ 39,035
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of Notes Payable $ 9,146 $ 3,738
Note payable to affiliate 3,000 1,000
Accounts payable 7,556 7,390
Accrued royalties 8,401 8,465
Reserve for returns 4,457 4,758
Other current liabilities 4,713 5,736
------------ ------------
Total Current Liabilities 37,273 31,087
Notes Payable, net of current portion 188 4,174
Shareholders' Equity:
Common stock 41 41
Additional Paid In Capital 9,634 9,609
Accumulated Deficit (7,946) (4,869)
Cumulative translation adjustment (817) (1,007)
------------ ------------
Total Shareholders' Equity 912 3,774
------------ ------------
$ 38,373 $ 39,035
============ ============
</TABLE>
3
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K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED
(IN THOUSANDS - EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three Months Ended
September 30,
------------------------------
1998 1997
------------ ------------
<S> <C> <C>
NET SALES $ 18,792 $ 25,135
------------ ------------
COSTS AND EXPENSES:
Cost of goods sold 10,434 14,804
Advertising 4,430 3,726
Selling, general & administrative 7,089 5,212
------------ ------------
Total Costs and Expenses 21,953 23,742
------------ ------------
OPERATING INCOME (LOSS) (3,161) 1,393
------------ ------------
OTHER INCOME (EXPENSE):
Interest income 15 16
Interest expense (159) (70)
Foreign currency transaction gain (loss) 174 (30)
------------ ------------
Total Other Income (Expense) 30 (84)
------------ ------------
INCOME (LOSS) BEFORE (PROVISION)
BENEFIT FOR INCOME TAXES (3,131) 1,309
(PROVISION) BENEFIT FOR INCOME TAXES 54 (102)
------------ ------------
NET INCOME (LOSS) $ (3,077) $ 1,207
============ ============
INCOME (LOSS) PER SHARE;
BASIC $ (.37) $ .16
DILUTED $ (.37) $ .15
SHARES USED IN THE CALCULATION OF
INCOME (LOSS) PER SHARE;
BASIC 8,318 7,610
DILUTED 8,318 8,013
OTHER COMPREHENSIVE INCOME;
Net income (loss) $ (3,077) $ 1,207
Foreign currency gain 190 12
------------ ------------
$ (2,887) $ 1,219
============ ============
</TABLE>
4
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K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
(IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months Ended
September 30,
1998 1997
---------- ----------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income (loss) $ (3,077) $ 1,207
Adjustments to reconcile net income to cash provided by (used for)
Operating activities:
Depreciation and amortization 402 187
Changes in current operating items:
Accounts receivable 760 (1,323)
Inventories (675) (748)
Royalty and other advances (462) (1,303)
Prepaid expenses and other (271) (329)
Current liabilities (1,558) 2,705
---------- ----------
Cash provided by (used for) operating activities (4,881) 396
---------- ----------
Cash flows from investing activities:
Property and equipment purchases (354) (106)
Music catalog additions 12 (13)
Other (156) (49)
---------- ----------
Cash used for investing activities (498) (168)
Cash flows from financing activities:
Borrowings on line of credit, Foothill Capital, net 1,407 --
Repayments on line of credit -- (787)
Proceeds on note payable to affiliate 2,000 --
Proceeds from exercise of stock options 26 46
---------- ----------
Cash provided by (used for) financing activities 3,433 (741)
---------- ----------
Effect of exchange rates on cash (47) 11
---------- ----------
Net decrease in cash and cash equivalents (1,993) (502)
Cash and cash equivalents at beginning of year 5,941 3,341
---------- ----------
Cash and cash equivalents at period end $ 3,948 $ 2,839
========== ==========
</TABLE>
5
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K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND DESCRIPTION
K-tel International, Inc. is an international marketer and distributor of
entertainment and consumer products and is a leader in the market niche
for pre-recorded music compilations. With more than thirty years of
marketing experience in the United States ("U.S."), Canada and Europe, the
Company has developed the resources, knowledgeable personnel, information
systems and distribution capabilities to launch music, video and consumer
products quickly in the North American and European markets through
traditional retail and direct-response marketing channels. On May 1, 1998,
the Company launched its new Internet service, K-tel Express
(www.ktel.com), featuring a wide spectrum of music products for purchase
by the public around the globe. Open for commerce 24 hours a day, 365 days
a year, K-tel Express features more than 250,000 music titles at value
prices through this on-line shopping service. Revenue generated from K-tel
Express through September 30, 1998 has not been material.
In 1997, the Company formed a U.S. media-buying and infomercial-marketing
subsidiary, which performed media buying services for third parties and
also marketed products through infomercials produced by third parties. As
of June 30, 1988, due to accumulated losses of $2,300,000, the Company
curtailed most of these media buying operations. In March of 1998, the
Company acquired certain media and other assets of United Kingdom based
Regal Shop International Ltd. and began operating as K-tel Marketing (UK)
Limited. In September 1998 the Company discontinued marketing and
distribution activities of its home video product line.
2. BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring adjustments)
considered necessary for a fair presentation have been included. Operating
results for the three month period ended September 30, 1998, are not
necessarily indicative of the results that may be expected for the year as
a whole. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's annual report
on Form 10-K for the year ended June 30, 1998.
3. RECENTLY ISSUED ACCOUNTING STANDARD
Statement of Financial Accounting Standards No. 131 ("SFAS 131"),
"Disclosures about Segments of an Enterprise and Related Information",
requires disclosure of business segments in the financial statements of
the Company. The Company expects to adopt SFAS No. 131 in the forth
quarter of fiscal 1999 and anticipates a change in segment disclosure at
the time of adoption.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS No. 133). SFAS No. 133
established accounting and reporting standards requiring that every
derivative financial instrument (including certain derivative instruments
embedded in other contracts) be recorded in the balance sheet as either an
asset or liability measured at its fair value. SFAS No. 133 requires that
changes in the derivative's fair value be recognized currently in earnings
unless specific hedge accounting criteria are met. Special accounting for
qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that a
company must formally document, designate, and assess the effectiveness of
transactions that receive hedge accounting. The company will be required
to adopt SFAS No. 133 no later than January 1, 2000. K-tel International,
Inc. has not entered
6
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into any derivative financial instruments as of September 30, 1998. As a
result, adoption of SFAS No. 133 would currently have no impact on the
Company. In the future, if the Company were to enter into derivative
financial instruments that are covered by SFAS No. 133, volatility in
earnings and other comprehensive income could be increased.
4. COMPUTATION OF NET INCOME (LOSS) PER SHARE
For the three-month period ended September 30, 1997, weighted average
shares outstanding included common stock equivalents of approximately
403,000 related to stock options. For the quarter ended September 30, 1998
no common stock equivalents were included because they would have been
anti-dilutive.
5. CREDIT FACILITY
The Company has an existing $10 million credit facility with a lending
institution. The credit facility consists of a $4 million term loan due in
full on November 20, 2001 and a $6 million revolving credit facility,
limited to a percent of eligible receivables and inventory, that expires
November 20, 2001. Borrowings under the facility bear interest at a
variable rate based on a "base rate" announced by a banking affiliate
associated with the lending institution (8.5% at September 30, 1998) and
are secured by the assets of certain U.S. Subsidiaries, including accounts
receivable, inventories, equipment, music library and general intangibles.
The loan agreement contains certain financial and other covenants or
restrictions, including the maintenance of a minimum tangible net worth by
the Company, limitations on capital expenditures, restrictions on music
library acquisitions, limitations on the incurrence of indebtedness and
restrictions on dividends paid by the Company. The Company has guaranteed
the obligations of its subsidiaries under the credit facility and has
pledged the stock of those subsidiaries and its assets to secure the
Company's obligations under its guaranty. As of September 30, 1998,
$4,000,000 was outstanding under the term loan and $5,146,000 was
outstanding under the line of credit and the maximum additional available
under the borrowing limitations at that date was $72,742. The Company was
either in compliance with or had obtained waivers for all covenants,
limitations and restrictions. The Company has amended certain financial
covenants with the lender for fiscal 1999 and beyond, and expects to be
out of compliance with the tangible net requirement until the Company
achieves the necessary level of profitable operations, obtains an equity
infusion or further modifies the covenants. As such, the Company has
reclassified its $4 million term loan to current as of September 30, 1998.
Future losses from businesses such as K-tel Express or the inability to
complete an equity placement may result in further renegotiations of such
covenants or the need to seek replacement financing. There can be no
assurances that such financing will be available on terms satisfactory to
the Company.
6. OPERATIONS
Operations for the three month period ended September 30, 1998 include: i)
a loss of $650,000, included in cost of goods, incurred by the Company
when it discontinued marketing and distribution activities of its home
video product line, ii) a loss of $800,000, included in advertising costs,
relating to the write-offs of certain infomercials and remaining deferred
media assets from its curtailed third party media buying operation because
management determined such assets were not realizable, and iii) a loss of
$250,000, included in selling, general and administrative expenses,
incurred by the Company when it discontinued certain catalog operations in
Germany.
7. SUBSEQUENT EVENT
Subsequent to September 30, 1998, the Company and Playboy Enterprises,
Inc. entered into an agreement to create a co-branded online music store
within Playboy.com, Playboy's free web site. The companies also agreed
that K-tel would create certain Playboy private label compilations which
K-tel would have the exclusive right to market and sell in the United
States. The term of the agreement, which is subject to extension based
upon mutual agreement by both parties, is initially for two years, except
that K-tel will have the right to sell each Playboy private label
compilation created under the agreement for an additional 5 years
following expiration of the term. In accordance with the agreement, the
Company is required to make guaranteed monthly payments totaling $900,000
over the initial two year contract term that will be used to offset
royalties to Playboy Enterprises, Inc.
7
<PAGE>
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL - K-tel International, Inc. is an international marketer and
distributor of entertainment and consumer products and is a leader in the
market niche for pre-recorded music compilations. With more than
thirty years of marketing experience in the United States ("U.S."),
Canada and Europe, the Company has developed the resources, knowledgeable
personnel, information systems, and distribution capabilities to launch
music, video, and consumer products quickly in the North American and
European markets through traditional retail and direct-response marketing
channels. On May 1, 1998, the Company launched its new Internet service,
K-tel Express (www.ktel.com), featuring a wide spectrum of music products
for purchase by the public around the globe. Open for commerce 24 hours a
day, 365 days a year, K-tel Express features more than 250,000 music
titles at value prices through this on-line shopping service. Revenue
generated from K-tel Express through September 30, 1998 has not been
material.
The Company markets and sells pre-recorded music both from the Company's
owned music master catalog and under licenses from third party record
companies. Sales of albums, cassettes and compact discs are made to
rackjobbers (distributors which stock and manage inventory within certain
music and video departments for certain retail stores), wholesalers and
retailers in the U.S. and through subsidiaries and licensees in the United
Kingdom and elsewhere in Europe. Television direct-response marketing of
pre-recorded music and consumer convenience product is a significant
source of revenue for the Company, specifically in Europe.
In 1997, the Company formed a U.S. media buying and infomercial-marketing
subsidiary, which performed media buying services for third parties and
also marketed products through infomercials produced by third parties. As
of June 30, 1998, due to accumulated losses of $2,300,000 the Company
curtailed most of these media buying operations.
In March of 1998, the Company acquired certain media and other assets of
United Kingdom based Regal Shop International Ltd. and began operating
these assets as K-tel Marketing (UK) Limited. In September 1998, the
Company discontinued its K-tel home video product line.
A. RESULTS OF OPERATIONS
Consolidated net sales for the three months ended September 30, 1998 were
$18,792,000 with an operating loss of $3,161,000 and a net loss of
$3,077,000, or $.37 per basic and diluted share. Consolidated net sales
for the same period in the prior year were $25,135,000 with operating
income of $1,393,000 and net income of $1,207,000, or $.16 per basic and
$.15 per diluted share. The following tables set forth, for the periods
indicated, results of operations by geographic region as a percentage of
net sales. All amounts are in thousands of dollars.
<TABLE>
<CAPTION>
Three Months Ended September 30, 1998
---------------------------------------------------------------------------
North Corporate
America Europe Expenses Total
-------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Net Sales $ 9,677 100% $ 9,115 100% -- $ 18,792 100%
Costs and expenses
Cost of goods sold 6,462 67 3,972 44 -- 10,434 55
Advertising 1,956 20 2,474 27 -- 4,430 24
Selling, general & administrative 3,085 32 3,368 37 636 7,089 38
-------- -------- -------- -------- -------- -------- --------
Operating income (loss) (1,826) (19) (699) (8) (636) (3,161) (17)
-------- -------- -------- -------- -------- -------- --------
Interest (expense) income, net (62) -- 12 -- (94) (144) --
Foreign translation adjustment, net 130 -- 28 -- 16 174 --
Benefit (provision) for taxes, net 76 -- (65) -- 43 54 --
-------- -------- -------- -------- -------- -------- --------
Net income (loss) $ (1,682) -- $ (724) -- $ (671) $ (3,077) --
======== ======== ======== ======== ======== ======== ========
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended September 30, 1997
---------------------------------------------------------------------------
North Corporate
America Europe Expenses Total
-------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Net Sales $ 17,818 100% $ 7,317 100% -- $ 25,135 100%
Costs and expenses
Cost of goods sold 11,472 64 3,332 46 -- 14,804 59
Advertising 2,258 13 1,468 20 -- 3,726 15
Selling, general & administrative 2,943 17 1,720 23 549 5,212 21
-------- -------- -------- -------- -------- -------- --------
Operating income (loss) 1,145 6 797 11 (549) 1,393 5
-------- -------- -------- -------- -------- -------- --------
Interest (expense) income, net (36) -- 9 -- (27) (54) --
Foreign translation adjustment, net (76) -- 45 -- 1 (30) --
Benefit (provision) for taxes, net (80) -- (59) -- 37 (102) --
-------- -------- -------- -------- -------- -------- --------
Net income (loss) $ 953 -- $ 792 -- % (538) $ 1,207 --
======== ======== ======== ======== ======== ======== ========
</TABLE>
CONSOLIDATED NET SALES for the three months ended September 30, 1998
decreased $6,343,000, or 25%, from the comparable period in 1997. North
American sales for the three months ended September 30, 1998 decreased
$8,141,000, or 46%, from the comparable period in 1997. This decrease was
mainly due to a $5,800,000 decrease in sales that resulted from the
curtailment of the Company's U.S. media buying and infomercial operations
from the comparable period in 1997, and from a $2,500,000 decrease in
music and consumer product sales from the comparable period in 1997.
European sales for the three months ended September 30, 1998 increased
$1,798,000, or 25%, from the comparable period in 1997. The increase
relates to $2,700,000 of sales generated from the Company's new marketing
operation (K-tel Marketing (UK) Limited) that began operations in April
1998 concurrent with the Company's acquisition of assets of Regal
Shop International. This increase was offset by a decrease in sales from
the comparable period in 1997 of approximately $1,500,000 from the
Company's German operations.
CONSOLIDATED COST OF GOODS SOLD AS A PERCENTAGE OF NET SALES for the nine
months ended September 30, 1998 were 55% as compared to 59% in the
comparable period in 1997. Cost of goods sold as a percentage of net
sales for North America for the three months ended September 30, 1998 were
67% as compared to 64% in the comparable period in 1997. The increase is
mainly due to a loss of $650,000 incurred by the Company when it
discontinued marketing and distribution of its home video product line.
European cost of goods sold were 44% as compared to 46% in the comparable
period in 1997 as the gross margins were slightly higher on merchandise
sold via direct response during the three months ended September 30, 1998
as compared to the merchandise sold in the comparable period in 1997.
CONSOLIDATED ADVERTISING COSTS for the three months ended September 30,
1998 increased $704,000, or 19%, from the comparable period in 1997. North
American advertising costs for the three months ended September 30, 1998,
decreased $302,000, or 13%, from the comparable period in 1997. The
majority of this decrease related to advertising costs incurred by the
Company's U.S. media buying and infomercial operations which were
$1,200,000 for the three months ended September 30, 1997. There were no
such costs in the comparable period in 1998. This decrease was offset by
an increase in advertising costs for the three month period ended
September 30, 1998 that resulted from write offs and charges of
approximately $800,000 of infomercials and deferred advertising costs
incurred by the Company on products no longer marketed. European
advertising costs for the three months ended September 30, 1998 increased
$1,006,000, or 69%, from the comparable period in 1997. This increase
specifically relates to a dvertising costs incurred by K-tel Marketing
(UK) Limited, the Company's United Kingdom marketing operation that was
not in existence for the comparable period in 1997.
CONSOLIDATED SELLING, GENERAL AND ADMINISTRATIVE EXPENSES for the three
months ended September 30, 1998, increased $1,877,000, or 36%, from the
comparable period in 1997. North American selling, general and
administrative expenses for the three months ended September 30, 1998
increased $142,000, or 5% from the comparable period in 1997. The majority
of the increase related to $600,000 of K-tel Express expenses which was
not in existence in the prior year comparable period in 1997. This
increase was partially offset by lower selling, general and
administrative expense due to discontinued operations in the Company's
media buying business. European selling, general and administrative
expenses for the three months ended September 30, 1998 increased
$1,680,000, or 96%, from the comparable period in 1997. This increase
relates primarily to $1,100,000 of
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costs incurred by K-tel Marketing (UK) Limited, the Company's United
Kingdom marketing operation that was not in existence in the comparable
period in 1997 and a $250,000 loss incurred when the Company discontinued
a catalog operation in its German subsidiary.
OPERATING INCOME for the three months ended September 30, 1998 decreased
$4,554,000 to a loss of $3,161,000 from the comparable period in 1997.
North American operating income for the three months ended September 30,
1998 decreased $2,971,000 to a loss of $1,826,000, from the comparable
period in 1997. The majority of the decrease relates to write-offs of
approximately $1,450,000 of certain non-music related assets and
curtailments of marginal business lines, a difference in earnings of
$1,100,00 that resulted from decreased music and consumer product sales,
and $600,000 from the Company's continued investment in its e-commerce
operations. European operating income for the three months ended September
30, 1998 decreased $1,496,000 to a loss of $699,000 from the comparable
period in 1997. The decrease related mostly to losses from the Company's
operation in Germany caused by a decrease in sales volume, including a
loss of $250,000 when the Company discontinued its catalog operation in
Germany.
INTEREST EXPENSE for the three months ended September 30, 1998, increased
$89,000 to $159,000, as compared to $70,000 in the same period in 1997.
The increase in interest expense corresponds with the increased borrowings
made by the Company during these periods under its existing credit
facilities. During the three months ended September 30, 1998, the Company
experienced a foreign currency transaction gain of $174,000, compared to a
loss of $30,000 experienced during the comparable period in the prior
year. Most of the Company's foreign currency transaction exposure is due
to its European subsidiaries' liabilities, which are payable to the
Company's U.S. parent or U.S. subsidiaries. In accordance with generally
accepted accounting principles the payable balances are adjusted quarterly
to the local currency equivalent of the U.S. dollar. The majority of the
translation losses for the three-month period ended September 30, 1998
were the result of these intercompany liabilities. Gains or losses
resulting from these intercompany liabilities remain unrealized until such
time as the underlying liabilities are settled.
INCOME TAXES for the three months ended September 30, 1998, were a benefit
of $54,000 compared to a provision of $102,000 in the comparable period in
1997. Variations in the Company's tax provision are a factor of the
country of origin of profits and the availability of net operating loss
carryforwards.
Operating results for the three month period is not necessarily indicative
of the results that may be expected for the full year.
B. LIQUIDITY AND CAPITAL RESOURCES
During the three months ended September 30, 1998, the Company experienced
negative cash flow from operations of $4,881,000, and utilized another
$498,000 for investing activities. To finance the above, the Company
borrowed an additional $1,407,000 under its existing credit facilities,
and borrowed $2,000,000 from an affiliate of its Chairman of the Board and
Chief Executive Officer.
The Company has an existing $10 million credit facility with a lending
institution. The credit facility consists of a $4 million term loan due in
full on November 20, 2001 and a $6 million revolving credit facility,
limited to a percent of eligible receivables and inventory, that expires
November 20, 2001. Borrowings under the facility bear interest at a
variable rate based on a "base rate" announced by a banking affiliate
associated with the lending institution (8.5% at September 30, 1998) and
are secured by the assets of certain U.S. subsidiaries, including accounts
receivable, inventories, equipment, music library and general intangibles.
The loan agreement contains certain financial and other covenants or
restrictions, including the maintenance of a minimum tangible net worth by
the Company, limitations on capital expenditures, restrictions on music
library acquisitions, limitations on the incurrence of indebtedness and
restrictions on dividends paid by the Company. The Company has guaranteed
the obligations of its subsidiaries under the credit facility and has
pledged the stock of those subsidiaries and its assets to secure the
Company's obligations under its guaranty. As of September 30, 1998,
$4,000,000 was outstanding under the term loan and $5,146,000 was
outstanding under the line of credit and the maximum additional available
under the borrowing limitations at that date was $72,742. The Company was
either in compliance with or had obtained waivers for all covenants,
limitations and restrictions. The Company has amended certain financial
covenants with the lender for fiscal 1999 and beyond, and expects to be
out of compliance with the tangible net requirement until the Company
achieves the necessary level of profitable operations, obtains an equity
placement infusion or further modifies the covenants. As such, the Company
has reclassified its $4 million term loan to current as of September 30,
1998.
10
<PAGE>
chairman has agreed to fund any capital requirements, if necessary,
through September 30, 1999. Future losses from businesses such as K-tel
Express or the inability to complete an equity placement may result in
further renegotiations of such covenants or the need to seek replacement
financing. There can be no assurances that such financing will be
available on terms satisfactory to the Company.
K-5 Leisure Products, Inc. ("K-5"), an affiliate controlled by the
Company's Chairman of the Board and Chief Executive Officer, has from time
to time made advances to the Company. As of September 30, 1998 K-5 had
advanced $3,000,000 to the Company and advanced an additional $440,000
subsequent to September 30, 1998. The Company pays interest on the unpaid
principal amount of financing at the same rate as the Company pays on its
credit facility, until repayment of the loan, which is due on demand.
The Company has primarily funded its operations to date through internally
generated capital, bank financing or advances made by an affiliate of the
Chairman of the Board and Chief Executive Officer. However, the Company
anticipates that it will require additional cash in order to further
develop and promote its Internet retail music site, K-tel Express.
Although the Company has made no material commitments for capital
expenditures, it anticipates a substantial increase in funding
requirements for development and acquisition of technology, marketing and
promotion, payment of $900,000 over two years to Playboy Enterprises, Inc.
and for capital expenditures to develop the infrastructure necessary for
the anticipated growth in operations. To date, the Company has no
commitments for any additional financing and there can be no assurance
that such commitments can be obtained on favorable terms, if at all. The
Company has available to it funding from a company owned by the Company's
Chairman of the Board and Chief Executive Officer. Although management
does not have access to the financial statements of the Chairman's other
companies, he has committed to the Company that he will fund its
operations through fiscal 1999 and the Company is in the process of
formalizing the commitment in the form a credit agreement.
During the first three months of fiscal 1999, the Company purchased
approximately $25,000 of consumer convenience product from an affiliate
controlled by the Company's Chairman of the Board and Chief Executive
Officer. The Company owed approximately $37,000 to the affiliate at
September 30, 1998. This same affiliate purchased approximately $2,000 of
consumer convenience products from the Company during the three months
ended September 30, 1998 and owed the Company $35,000 at September 30,
1998. No interest will be charged on the related outstanding balances
during fiscal 1998.
The Company has been notified by the Nasdaq Stock Market that the Company
failed to meet the minimum tangible net asset requirement necessary for
continued listing on the Nasdaq National Market. The Company has requested
a hearing to the de-listing procedures before the Nasdaq Listing
Qualifications Panel to obtain a temporary extension to these requirements
and an opportunity to raise additional capital to satisfy the
requirements. There is no assurance that the Company will be successful in
its attempt to remain listed on the Nasdaq National Market. If the Company
is de-listed from the National Market, the Company may apply to the Nasdaq
Small Cap Market.
Year 2000 Disclosure
The Company has developed a plan to ensure its systems are compliant with
the requirements to process transactions in the year 2000. The majority of
the Company's internal information systems have been upgraded or are in
the process of being upgraded or replaced with fully compliant new
systems. The Company's European subsidiaries have upgraded or are in the
process of replacing or upgrading their information systems to comply with
Year 2000 requirements. The total cost of the software and implementation
is estimated to be approximately $150,000. The new system implementation
is expected to be completed by July 31, 1999. Some of the Company's
customers utilize equipment to capture and transmit financial
transactions. The Company is in the process of making the necessary
updates to this equipment to ensure it will be effective in the year 2000.
The Company is also working with its processing banks and network
providers to ensure their systems are year 2000 compliant. All of these
costs will be or have been borne by the processors and network companies.
Should the Company, its customers, its vendors or the processing banks
fail to resolve year 2000 issues, the Company may lose certain financial
and operating data. The Company is in the process of developing a
contingency plan, which it expects to be completed by the end of the
fiscal year.
11
<PAGE>
Euro Conversion Disclosure
On January 1, 1999, eleven of the fifteen member countries of the European
Union are scheduled to establish fixed conversion rates between their
existing sovereign currencies and the euro. The participating countries
have agreed to adopt the euro as their common legal currency on that date.
At this point, the Company can not yet predict the anticipated impact of
the euro conversion on the Company.
Important Factors Relating to Forward Looking Statements - Information in
this form 10Q may contain forward-looking statements relating to future
results of the Company (including certain projections and business trends)
that are "forward-looking statements" as defined in the Private Securities
Litigation Reform Act of 1995. Actual results and performance may differ
materially from the forward-looking statements as a result of certain
risks and uncertainties, including but not limited to, changes in
political and economic conditions, demand for and market acceptance of new
and existing products, the impact from competition for Internet content,
merchandise and recorded music, dependence on strategic alliance partners,
suppliers and distributors, market acceptance of the Internet for commerce
and as a medium for advertising, technological changes and difficulties,
and availability of financing.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBIT INDEX
(b) REPORTS ON FORM 8-K
The Company did not file any reports on Form 8-K during the quarter ended
September 30, 1998.
12
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
K-TEL INTERNATIONAL, INC.
----------------------------------------
REGISTRANT
/s/ PHILIP KIVES
----------------------------------------
PHILIP KIVES
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
/s/ LAWRENCE KIEVES
----------------------------------------
LAWRENCE KIEVES
PRESIDENT
/s/ COREY FISCHER
----------------------------------------
COREY FISCHER
CHIEF FINANCIAL OFFICER
(principal accounting officer)
13
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