UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number: 0-6664
K-TEL INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-0946588
(State or other jurisdiction of (I.RS. Employer
incorporation or organization) Identification No.)
2605 FERNBROOK LANE NORTH, MINNEAPOLIS, MINNESOTA 55447-4736
(Address of principal executive offices) (Zip Code)
(612) 559-6888
(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 April 30,
1999, there were 10,246,199 shares of the registrant's common stock, par value
$0.01 per share, outstanding.
<PAGE>
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1999
INDEX
PART I. Financial Information: Page
Item 1. Consolidated Balance Sheets as of March 31, 1999 and
and June 30, 1998 3
Consolidated Statements of Operations and Comprehensive
Income for the Three and Nine Month periods ended
March 31, 1999 and 1998 4
Consolidated Statements of Cash Flows for the Nine Month
Periods Ended March 31, 1999 and 1998 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
PART II. Other Information:
Item 6. Exhibits and Reports on Form 8-K 15
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K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1999 AND JUNE 30, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
March 31, June 30,
1999 1998
---------- ----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 2,276 $ 5,941
Accounts receivable, net 13,693 15,341
Inventories 8,944 6,430
Royalty and other advances 1,728 1,475
Prepaid expenses and other 2,428 3,043
---------- ----------
Total Current Assets 29,069 32,230
---------- ----------
Property and Equipment, net of
accumulated depreciation and amortization of
$3,140 and $2,671 2,143 2,131
Other Assets 4,458 4,674
---------- ----------
$ 35,670 $ 39,035
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of notes payable $ 7,063 $ 3,738
Note payable to affiliate 1,945 1,000
Accounts payable 7,761 7,390
Accrued royalties 9,294 8,465
Reserve for returns 4,718 4,758
Other current liabilities 3,367 5,736
---------- ----------
Total Current Liabilities 34,148 31,087
---------- ----------
Long Term Debt 174 4,174
Shareholders' Equity:
Common stock 55 41
Additional Paid In Capital 16,976 9,609
Accumulated Deficit (14,735) (4,869)
Cumulative translation adjustment (948) (1,007)
---------- ----------
Total Shareholders' Equity 1,348 3,774
---------- ----------
$ 35,670 $ 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 Nine Months Ended
March 31, March 31,
--------------------- ---------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
NET SALES $ 18,506 $ 16,427 $ 58,304 $ 64,777
-------- -------- -------- --------
COSTS AND EXPENSES:
Cost of goods sold 10,397 8,635 31,869 35,941
Advertising 3,611 3,646 12,465 11,823
Selling, general & administrative 8,713 5,221 22,920 16,117
-------- -------- -------- --------
Total Costs and Expenses 22,721 17,502 67,254 63,881
-------- -------- -------- --------
OPERATING INCOME (LOSS) (4,215) (1,075) (8,950) 896
-------- -------- -------- --------
OTHER INCOME (EXPENSE):
Interest income 7 15 53 41
Interest expense (185) (130) (676) (305)
Foreign currency transaction gain (loss) (364) 17 (287) (27)
-------- -------- -------- --------
Total Other Expense (542) (98) (910) (291)
-------- -------- -------- --------
INCOME (LOSS) BEFORE (PROVISION)
BENEFIT FOR INCOME TAXES (4,757) (1,173) (9,860) 605
(PROVISION) BENEFIT FOR INCOME TAXES 16 221 (6) 88
-------- -------- -------- --------
NET INCOME (LOSS) $ (4,741) $ (952) $ (9,866) $ 693
======== ======== ======== ========
INCOME (LOSS) PER SHARE;
BASIC $ (.50) $ (12) $ (1.11) $ .09
DILUTED $ (.50) $ (.12) $ (1.11) $ .09
SHARES USED IN THE CALCULATION OF
INCOME (LOSS) PER SHARE:
BASIC 9,529 7,632 8,912 7,625
DILUTED 9,529 7,632 8,912 8,138
OTHER COMPRESHENSIVE INCOME (LOSS):
Net income (loss) $ (4,741) $ (952) $ (9,866) $ 693
Foreign currency gain (loss) (150) (61) 59 (101)
-------- -------- -------- --------
OTHER COMPRESHENSIVE INCOME (LOSS): $ (4,891) $ (1,013) $ (9,807) $ 592
======== ======== ======== ========
</TABLE>
4
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K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
(IN THOUSANDS)
<TABLE>
<CAPTION>
Nine Months Ended
March 31,
1999 1998
-------- --------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income (loss) $ (9,866) $ 693
Adjustments to reconcile net income to cash used for
operating activities:
Depreciation and amortization 1,311 621
Changes in current operating items:
Accounts receivable 1,575 3,868
Inventories (2,592) (1,303)
Royalty and other advances (271) (679)
Prepaid expenses and other 536 (3,195)
Current liabilities (1,053) (4,167)
-------- --------
Cash used for operating activities (10,360) (4,162)
-------- --------
Cash flows from investing activities:
Property and equipment purchases (461) (371)
Proceeds from sale of property and equipment -- 3
Music catalog additions (621) (559)
Other (6) 547
Acquisition of Regal Assets -- (350)
-------- --------
Cash used for investing activities (1,088) (730)
-------- --------
Cash flows from financing activities:
Issuance of Long-Term Debt -- 4,000
Borrowings on line of credit, net (675) 2,655
Repayments on line of credit -- (836)
Proceeds (repayments) on note payable to affiliate, net 945 (1,500)
Proceeds from exercise of stock options 7,381 73
-------- --------
Cash provided by financing activities 7,651 4,392
-------- --------
Effect of exchange rates on cash 132 (109)
-------- --------
Net decrease in cash and cash equivalents (3,665) (609)
Cash and cash equivalents at beginning of year 5,941 3,341
-------- --------
Cash and cash equivalents at period end $ 2,276 $ 2,732
======== ========
</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-five
years of marketing experience in the United States and Europe, the
Company has developed the resources, knowledgeable personnel,
information systems, and distribution capabilities to market music, and
consumer products through traditional retail and direct-response
marketing channels. The Company also markets through its 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 March 31, 1999
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 compact discs, cassettes and albums,
are made to rack-jobbers (distributors which stock and manage inventory
within certain music 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
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 addition, in September 1998, the Company discontinued
its K-tel home video product line.
In March of 1998, the Company acquired certain media and other assets
of United Kingdom based Regal Shop International Ltd., a direct
response marketer and began operating these assets as K-tel Marketing
(UK) Limited.
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 nine month period ended March 31,
1999, 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 STANDARDS
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 fourth
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. had
not entered into any derivative financial instruments as of March 31,
1999. As a result, adoption of SFAS No. 133 would
6
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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
On April 21, 1998, the Board of Directors declared a two-for-one stock
split of the Company's Common Stock in the form of a stock dividend
payable to shareholders of record on May 1, 1998. All disclosures and
applicable per share data have been retroactively restated to reflect
this split.
The earnings/loss per share calculation for the three month ended
periods March 31, 1999 and 1998 and the nine months ended March 31,
1999 do not give effect to common stock equivalents as they would be
anti-dilutive. In the nine month period ending March 31, 1998 the
weighted average number of shares outstanding included 513,530 common
stock equivalents.
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, 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 (7.75% at March 31, 1999) 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 March 31, 1999, $4,000,000 was outstanding under
the term loan and $3,063,000 was outstanding under the line of credit
and the maximum additional available under the borrowing limitations at
that date was $193,000. At March 31,1999 the Company was in compliance
with all covenants, limitations and restrictions of the agreement. 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 worth requirement that becomes effective December 31, 1999
unless the Company obtains an equity infusion or further modifies the
covenants. As of March 31, 1999 the Company would have required an
equity infusion of approximately $7 million in addition to covering
future operating losses to be in compliance with the $8 million
tangible net worth requirement at December 31, 1999. As a result the $4
million term loan has been classified as a current liability. Future
losses 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. NON-RECURRING INCOME/EXPENSE
The operating loss for the nine month period ended March 31, 1999
includes: i) a loss of $1,057,000, incurred by the Company when it
discontinued marketing and distribution activities of its home video
product line, ii) a loss of $1,498,000, relating to the write-offs of
certain infomercials and remaining deferred media assets from its
curtailed third party media buying operation because management
determined such assets were not realizable, iii) a loss of $250,000,
included in selling, general and administrative expenses, incurred by
the Company when it discontinued certain catalog operations in Germany
and in addition approximately $280,000 in royalty income related to a
one time settlement.
The operating loss for the three month period ending March 31,1999
includes: i) an additional loss of $287,000 related to the remaining
assets of the Company's home video line for which the Company does not
expect to realize the remaining asset net book values, and ii) a loss
of $777,000 primarily related to a remaining contract from the media
buying operation which will terminate in the fourth quarter of fiscal
1999.
7. COMMITMENTS AND CONTINGENCIES
During the second quarter of fiscal 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
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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
are available to offset royalties to Playboy Enterprises, Inc.
8. SUBSEQUENT EVENT
On April 21, 1999, K-tel International, Inc. (the "Company") entered
into a Securities Purchase Agreement (the "Agreement") with two
investors, pursuant to which the Company will sell in a private
placement transaction, up to $18.0 million of the Company's common
stock in two tranches. The Company intends to use the proceeds from the
financing for working capital purposes. The first tranche will total
$8.0 million. Pursuant to the Agreement, the Company sold 465,794
shares of common stock for an aggregate of $4,000,000, or $8.588 per
share. The Company is obligated to sell and the purchasers are
obligated to close on an additional $4.0 million of common stock, on
the effective date of a registration statement under the Securities Act
of 1933, as amended (the "Act") covering the common stock. The Company
anticipates that such additional portion of the first tranche will be
funded within 105 days, concurrent with effectiveness of a registration
statement. The per share purchase price for such remaining shares sold
pursuant to the first tranche will be $8.588. Under the terms of the
Agreement, the purchasers will be entitled to acquire additional shares
pursuant to a warrant containing a formula which takes into account the
market price of the Company's common stock at future dates, commencing
30 days after the date on which the purchasers may resell the shares
pursuant to a registration statement. The Company and the purchasers
have agreed that in the event an adjustment to the number of shares of
common stock sold should result in the issuance of an amount that would
equal or exceed 20% of the common shares outstanding on April 21, 1999,
the Company would, at its option, either seek shareholder approval for
the issuance of such additional shares or make a cash payment to the
purchasers pursuant to a formula, which would result in the issuance of
an aggregate of less than 20% of the Company's outstanding common
stock.
In addition, the Company issued warrants to the purchasers enabling
them to purchase up to 167,754 additional shares of common stock at a
purchase price of $10.73 per share, exercisable for a five-year period.
The Company will be obligated to issue additional warrants if total
investment from these investors exceeds $12.0 million.
After acquisition of the shares acquired in the first tranche and
following the effectiveness of a registration statement covering such
common stock, the Company may elect to sell and the purchasers have
agreed to purchase, additional common stock of the Company for an
aggregate purchase price of not less than $4.0 million nor more than
$10.0 million, depending upon the per share market value of the
Company's common stock. The additional shares which the Company may
elect to sell must be sold no later than 180 days after the sale of all
shares sold by the Company in the first tranche.
The Company has entered into a Registration Rights Agreement with the
purchasers requiring the Company to register shares purchased by the
purchasers pursuant to the Agreement under the Act, as well as the
shares issuable pursuant to the warrants issued to the purchasers. The
Company has agreed to pay certain expenses of the purchasers and an
advisor to the purchasers incurred in connection with the private
placement, not to exceed $50,000. No underwriting discount or
commission was paid to any broker-dealer in connection with the
transaction. The sale was effected to the purchasers in reliance upon
exemptions provided under Section 4(2) of the Act and Regulation D,
Rule 506 thereunder.
8
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The equity section of the balance sheet and calculation of loss per share on a
proforma basis, giving effect to this transaction as if it had occurred on March
31, 1999 is as follows:
As Reported Proforma
----------- --------
Shareholders' Equity:
Common stock $ 55 $ 60
Additional Paid In Capital 16,976 20,976
Accumulated Deficit (14,735) (14,735)
Cumulative translation adjustment (948) (948)
------------ ------------
Total Shareholders' Equity $ 1,348 $ 5,353
============ ============
NET LOSS $ (4,741) $ (4,741)
LOSS PER SHARE;
BASIC AND DILUTED $ (.50) $ (.50)
============ ============
SHARES USED IN THE CALCULATION OF
LOSS PER SHARE:
BASIC AND DILUTED 9,529 9,529
============ ============
9
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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-five years of marketing
experience in the United States and Europe, the Company has developed the
resources, knowledgeable personnel, information systems, and distribution
capabilities to market music, and consumer products through traditional retail
and direct-response marketing channels. The Company also markets through its
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 March 31, 1999 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 compact discs, cassettes and albums, are made to rack-jobbers (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 products is a significant source of revenue for the Company 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 addition, in September 1998, the Company
discontinued its K-tel home video product line.
In March of 1998, the Company acquired certain media and other assets of United
Kingdom based Regal Shop International Ltd., a direct response marketer and
began operating these assets as K-tel Marketing (UK).
A. RESULTS OF OPERATIONS
SALES
Net sales for the nine months ended March 31, 1999 were $58,304,000 compared to
$64,777,000 or 10.0% less than the comparable period last year. Sales of music
related products and services were $34,064,000 for the nine months ended March
31, 1999 compared to $34,412,000 for the nine months ended March 31, 1998. Sales
of consumer products were $23,410,000 for the nine months ended March 31,1999
compared to $16,050,000 for the comparable period in 1998 primarily due to K-tel
Marketing (UK) Ltd. which did not commence operations until March, 1998. Sales
of the discontinued video and curtailed media buying services for the nine
months ended March 31, 1999 were $660,000 compared to $14,314,000 for the
comparable period last year.
Net sales for the three months ended March 31, 1999 were $18,506,000 compared to
$16,427,000 an increase of 12.7% over the comparable period last year. Sales of
music related products and services were $8,969,000 for the three months ended
March 31, 1999 compared to $9,383,000 for the three months ended March 31, 1998.
Sales of consumer products were $9,421,000 for the three months-ended March
31,1999 compared to $3,694,000 for the comparable period in 1998 primarily due
to K-tel Marketing (UK) which did not commence operations until March 1998.
Sales of the discontinued video and curtailed media buying services for the
three months ended March 31, 1999 were $45,000 compared to $3,350,000 in the
comparable period last year.
COST OF GOODS SOLD
Cost of goods sold was $31,869,000 or 54.7% of sales for the nine months ended
March 31, 1999 compared to $35,941,000 or 55.5% for the comparable period last
year. Music related cost of sales was 65.2% for the nine months ended March 31,
1999 compared to 57.7% for the comparable period last year. The increase in
music related product cost as a percentage of sales relates to the mix of
products, primarily a shift in the revenue base to increasing sales of other
music companies' labels which have a higher cost of goods than K-tel-owned music
products and services, higher royalty costs and a provision for slow moving
inventory. These increases were offset by the consumer products cost of goods
which improved to 37.5% for the nine months ended March 31, 1999 compared to
46.0% in the comparable period last year.
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Cost of goods sold was $10,397,000 or 56.2% of sales for the three months ended
March 31, 1999 compared to $8,635,000 or 52.6% for the comparable period last
year. Music related cost of sales was 73.2% for the three months ended March 31,
1999 compared to 56.9% for the comparable period last year. The increase in
music related product cost as a percentage of sales, relates to the mix of
products, primarily a shift in the revenue base to increasing sales of other
music companies labels, which have a higher cost of goods than K-tel owned music
products and services, higher royalty costs and a provision for slow moving
inventory. These increases were offset by the consumer products cost of goods
which improved to 36.0% for the three months ended March 31, 1999 compared to
40.8% in the comparable period last year.
ADVERTISING
Advertising which consists primarily of TV media, production costs and
co-operative advertising with customers was $12,465,000 or 21.4% of revenues in
the nine months ended March 31,1999 compared to $11,823,000 or 18.2% of revenues
for the comparable period last year. The increase in 1999 expenditures compared
to last year in advertising is primarily related to the acquisition of K-tel
Marketing (UK) which had advertising expenditures of $3,242,000, other consumer
products increases in the German and export markets of $1,084,000, an increase
in music related advertising of $264,000 offset by a savings of $4,474,000 in
advertising expenditures in discontinued video and media buying services
divisions.
Advertising was $3,611,000 or 19.5% of revenues in the three months ended March
31,1999 compared to $3,646,000 or 22.2% of revenues for the comparable period
last year. Increases in advertising primarily related to K-tel marketing UK were
primarily offset by savings generated from not spending on the media-buying
group.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $22,920,000, 39.3% of revenues
for the nine months ended March 31, 1999 compared to $16,117,000, 24.8% of
revenues in the comparable period last year. The increase of $6,803,000 in
selling, general and administrative expenses primarily related to the
acquisition of K-tel Marketing (UK) and K-tel express which had selling, general
and administrative expenditures of $4,179,000 and $1,397,000 respectively, which
did not exist in the comparable period last year. In addition music related
expenditures increased $1,826,000 primarily related to costs associated with
K-tel Distribution, and the funding of a front line music project.
Selling, general and administrative expenses were $8,713,000, 47.1% of revenues
for the three months ended March 31, 1999 compared to $5,221,000, 32.1% of
revenues in the comparable period in last year. The increase of $3,492,000 in
selling, general and administrative expenses primarily related to the
acquisition of K-tel Marketing (UK) and K-tel express which had selling, general
and administrative expenditure increases of $1,624,000 and $407,000
respectively. In addition, music related expenditures increased $1,197,000
primarily related to costs associated with K-tel Distribution, a relatively new
division which sources and sells record labels other than those owned by K-tel,
and the funding of a front line music project.
OPERATING (LOSS) PROFIT
The Company incurred an operating loss for the nine months ended March 31, 1999
of $8,950,000, compared to an operating profit of $896,000 for the same period
last year.
The Company incurred an operating loss of $4,215,000 for the three months ended
March 31, 1999, compared to operating loss of $1,075,000 for the same period
last year.
OTHER INCOME/EXPENSE
Net interest expense for the nine and three months ended March 31, 1999 was
$623,000 and $178,000, respectively compared to $264,000 and $115,000 for the
comparable period last year. The increase relates to an increase in average
borrowings, which was required to partially fund operating losses.
INCOME TAXES
Income taxes, which are not material to the consolidated results of operations
for the nine and three months ended March 31, 1999, are a function of the
country of origin profits and net operating loss carry-forward losses available.
11
<PAGE>
NET (LOSS)/INCOME
As result of the above the Company experienced a net loss for the nine and three
months ended March 31, 1999 of $9,866,000 ($1.11 per share) and $4,741,000
($0.50 per share), respectively, compared to net income of $693,000 ($0.09 per
share) and a net loss of $952,000 ($0.12 per share), in the comparable nine and
three month periods last year.
B. LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1999 the Company had $2,276,000 in cash and cash equivalents, a
decrease of $3,665,000 from the fiscal year-end June 30, 1998 balance. During
the nine months ended March 31, 1999, the Company experienced negative cash flow
from operations of $10,360,000 and utilized $1,088,000 for investing activities
in fixed assets and music catalog additions. The negative cash flow from
operations and investing activities was primarily financed through additional
equity contributions. In September 1998 the Compensation Committee of the Board
of Directors passed a resolution authorizing the accelerated vesting of
outstanding employee stock options if exercised by November 30, 1998. In
addition, in December, 1998 the Board of Directors granted to the Chairman of
the Board and Chief Executive Officer ("Chairman") an option to purchase 200,000
shares at an exercise price of $11.19 per share, which was exercised. The
Chairman was also granted an option to purchase 836,000 shares at an exercise
price of $8.73 per share in February 1999, of which were 229,061 were exercised
in March 1999. Cash generated from the exercise stock options was $7,381,000
during the nine months ended March 31, 1999.
The Company has a $10 million credit facility with a lending institution,
consisting of a $4 million term loan due in full on November 20, 2001 and a $6
million revolving facility, limited to a percent of eligible receivables 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 (7.75% at March 31, 1999) 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 other
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 March 31, 1999, $4,000,000 was outstanding
under the term loan and $3,063,000 was outstanding under the line of credit and
the maximum additional available under the borrowing limitations at that date
was $193,000. At March 31,1999, the Company was in compliance with all
covenants, limitations and restrictions of the credit agreement. 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 worth requirement that
becomes effective December 31, 1999, unless the Company obtains an equity
infusion or further modifies the covenants. As of March 31, 1999 the Company
would have required an equity infusion of approximately $7 million in addition
to covering future operating losses to be in compliance with the $8 million
tangible net worth requirement at December 31,1999. As a result, the $4 million
term loan has been classified as a current liability. Future losses or the
inability to complete the equity transaction described in "Subsequent Events"
below, 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, has from time to time made advances to the Company. As of March 31,
1999, K-5 had advanced $1,945,000 to the Company. 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, proceeds from stock option exercises and
advances made by an affiliate of the Chairman. The Company anticipates that it
will require additional financing 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 increase in funding
requirements for development and acquisition of technology, marketing and
promotion, payment of $900,000, in monthly installments over two years
commencing November 1998 to Playboy Enterprises, Inc. for a marketing contract,
and for capital expenditures to develop the infrastructure necessary for the
anticipated growth in operations.
On February 8, 1999 the Company was notified of the decision by the NASDAQ
Hearing Panel that the Company's common stock will continue to be listed on the
NASDAQ as the Company evidenced compliance with all requirements for continued
listing. In the Company's form 10-Q for the quarter ended September 30, 1998 the
Company had reported that it received notification by NASDAQ that it failed to
meet certain requirements necessary for continued listing on the NASDAQ National
Market.
12
<PAGE>
SUBSEQUENT EVENTS
To provide working capital, the Company entered into a Securities Purchase
Agreement (the "Agreement"), on April 21, 1999 with two investors, pursuant to
which the Company will sell in a private placement transaction, up to $18.0
million of the Company's common stock in two tranches. The first tranche will
total $8.0 million. Pursuant to the Agreement, the Company sold 465,794 shares
of common stock for an aggregate of $4,000,000, or $8.588 per share. The Company
is obligated to sell and the purchasers are obligated to close on an additional
$4.0 million of common stock, on the effective date of a registration statement
under the Securities Act of 1933, as amended (the "Act") covering the common
stock. The Company anticipates that such additional portion of the first tranche
will be funded within 105 days, concurrent with effectiveness of a registration
statement. The per share purchase price for such remaining shares sold pursuant
to the first tranche is $8.588. Under the terms of the Agreement, the purchasers
will be entitled to acquire additional shares pursuant to a warrant containing a
formula which takes into account the market price of the Company's common stock
at future dates, commencing 30 days after the date on which the purchasers may
resell the shares pursuant to a registration statement. If the Company's stock
price at an adjustment date were to average for the 30 trading days prior to the
adjustment date approximately $9.66 per share, the number of additional shares
to be issued to the purchasers will not be substantial. If, however, stock price
at an adjustment date were to average for the 30 trading days prior to the
adjustment date less than $9.66 the number of additional shares issuable to the
purchasers would increase as the stock price declines. The Company and the
purchasers have agreed that in the event an adjustment to the number of shares
of common stock sold should result in the issuance of an amount that would equal
or exceed 20% of the common shares outstanding on April 21, 1999, the Company
would, at its option, either seek shareholder approval for the issuance of such
additional shares or make a cash payment to the purchasers pursuant to a
formula, which would result in the issuance of an aggregate of less than 20% of
the Company's outstanding common stock. There can be no assurance that the
shareholders of the Company would approve the transaction or that the Company
would have the cash available to pay the purchasers as described in the
preceding sentence.
In addition to the shares sold, the Company issued warrants to the purchasers
enabling them to purchase up to 167,754 additional shares of common stock at a
purchase price of $10.73 per share, exercisable for a five-year period. The
Company will be obligated to issue additional warrants if total investment from
these investors exceeds $12.0 million.
After acquisition of the shares acquired in the first tranche and following the
effectiveness of a registration statement covering such common stock, the
Company may elect to sell and the purchasers have agreed to purchase, additional
common stock of the Company for an aggregate purchase price of not less than
$4.0 million nor more than $10.0 million, depending upon the per share market
value of the Company's common stock ("Tranche Two"). The additional shares that
the Company may elect to sell must be sold no later than 180 days after the sale
of all shares sold by the Company in the first tranche. There can be no
assurances that the Company's per share market value will be at a level that
would allow for the tranche two funding.
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 ("Y2K"). 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 new
systems implementation related to accounting for royalties is in progress and
should be substantially completed by July 31, 1999. Other significant Company
systems are deemed to be Y2K compliant. 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 Y2K. 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. The
Company does not rely on any one significant customer or vendor for its sales or
purchases. The failure of any customer or vendor to comply with Y2K is not
expected to have a material impact on the Company's operations. However, should
the Company, its customers, its vendors or the processing banks fail to resolve
Y2K 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. The total cost of the software
implementation to bring the Company into Y2K compliance is estimated to be
approximately $200,000.
Euro Conversion Disclosure
On January 1, 1999, eleven of the fifteen member countries of the European Union
established fixed conversion rates between their existing sovereign currencies
and the euro. The participating countries adopted the euro as their common legal
currency on that date. At this point, the Company has not yet evaluated or
determined the impact of the euro conversion on the Company.
13
<PAGE>
Important Factors Relating to Forward Looking Statements - Information in this
report 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, success of
strategic alliance partners, relationships with suppliers and distributors,
market acceptance of the Internet for commerce and as a medium for advertising,
technological changes and difficulties, and availability of financing.
14
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBIT INDEX
27. Financial Data Schedule
(b) REPORTS ON FORM 8-K
The Company did not file any reports on Form 8-K during the quarter ended March
31, 1999.
15
<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/ STEVEN KAHN
--------------------------------------------
STEVEN KAHN
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
(principal accounting officer)
16
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