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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-6664
K-TEL INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Minnesota 41-0946588
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2605 Fernbrook Lane North,
Minneapolis, Minnesota 55447-4736
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (612) 559-6800
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01
(Title of class)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [ ]
As of September 20, 2000, the aggregate market value of voting stock
held by non-affiliates of the registrant based on the last sales price as
reported by the Nasdaq Stock Market on such date was $8,012,000.
As of September 20, 2000, the registrant had 10,320,405 shares of
Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None.
TABLE OF CONTENTS
PART I
Item 1. Business................................................................................3
Item 2. Properties..............................................................................6
Item 3. Legal Proceedings.......................................................................6
Item 4. Submission of Matters to a Vote of Security Holders.....................................7
Item 4a. Executive Officers of the Registrant....................................................7
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...................8
Item 6. Selected Financial Data.................................................................8
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...9
Item 7a. Quantitative and Qualitative Disclosures about Market Risk.............................13
Item 8. Financial Statements and Supplementary Data............................................14
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...14
PART III
Item 10. Directors and Executive Officers of the Registrant.....................................15
Item 11. Executive Compensation.................................................................16
Item 12. Security Ownership of Certain Beneficial Owners and Management.........................18
Item 13. Certain Relationships and Related Transactions.........................................19
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K........................20
SAFE HARBOR STATEMENT UNDER THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements of a non-historical nature under the captions "Business,"
"Legal Proceedings," "Market for Registrant's Common Equity and Related
Stockholder Matters," "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and elsewhere in this Form 10-K
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements may
be identified by the use of terminology such as "may," "will," "expect,"
"anticipate," "estimate," "should," or "continue" or the negative thereof or
other variations thereon or comparable terminology. Such forward-looking
statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from historical results or from those
results currently anticipated or projected. Such factors include, among other
things, the following: consumer purchasing; demand for and market acceptance
of new and existing products; the impact from competition for Internet
content, merchandise and recorded music; relationships with suppliers, market
acceptance of the Internet for commerce and as a medium for advertising;
success of marketing and promotion efforts; technological changes and
difficulties; availability of financing; foreign currency variations; general
economic, political and business conditions; and other matters set forth
under the caption "Cautionary Statements" in Exhibit 99 on page 47 filed
herewith.
2
PART I
ITEM 1: BUSINESS
K-tel International, Inc. (the "Company," "K-tel," or the "Registrant") was
incorporated in 1968. Its corporate offices are located at 2605 Fernbrook
Lane North, Minneapolis, Minnesota. K-tel markets and distributes
entertainment and consumer products internationally. With more than 35 years
of marketing experience world-wide, K-tel has developed the resources,
knowledgeable personnel, information systems, and distribution capabilities
to market music and consumer products through traditional retail and
direct-response marketing channels. K-tel also markets through an Internet
e-commerce site, K-tel.com (www.ktel.com) which features a wide spectrum of
music products. Through its association with Amazon.com, K-tel.com offers
on-line shoppers the convenience and access to a substantial number of music
titles at value prices.
DESCRIPTION OF CURRENT BUSINESSES
MUSIC SALES AND LICENSING
K-tel markets and sells pre-recorded music both from its music master catalog
and under licenses obtained from other record companies, as well as
pre-recorded music developed by other companies who desire to use K-tel for
sales and distribution of their music products. K-tel sells compact discs,
cassettes, albums and, since August 2000, DVD's direct to retailers,
wholesalers and rack service distributors. K-tel also sells such products
through subsidiaries and licensees in the United Kingdom and elsewhere in
Europe. The principal entertainment products K-tel markets and sells consist
primarily of pre-recorded thematic music packages in a compilation format
featuring various artists. These thematic music selections, which cover
nearly all music genres, are targeted to a variety of age groups. K-tel
provides marketing support for its music sales through cooperative
advertising with retailers, print media and television advertising, and
in-store promotions and displays. K-tel has two sources for its music
compilations; its proprietary music master catalog, which consists of
approximately 6,000 titles, and music licensed from third party music
companies. Its master music catalog, consisting of original recordings and
re-recordings of music from the 1950's through today, represents one of its
major assets. K-tel also has the world-wide licensing and administrative
rights to a catalog of over 30,000 music titles. In addition to utilizing
master recordings in its compilation products, K-tel also licenses the rights
to master recordings to third parties world-wide for use in albums, films,
television programs, and commercials for either a flat fee or a royalty based
on the number of units sold. K-tel continuously adds to its music master
catalog to ensure growth and product diversity. Licensing of its proprietary
music rights to third parties has historically been an important revenue
source for K-tel.
Approximately 48% of K-tel's domestic music sales, which is approximately 40%
of its consolidated revenue for fiscal 2000, were derived from five
customers: Handleman Company, Trans World Music Corp., Wherehouse
Entertainment, Best Buy Co., Inc. and The Musicland Group, Inc. None of these
accounts individually represent more than 10% of its consolidated revenue.
K-tel currently delivers music products (CD's, DVD's and cassette tapes)
through traditional wholesale and retail distribution channels. Existing
methods of distributing music could be materially altered by new technologies
which will enable users and customers of pre-recorded music to electronically
download pre-recorded music at home to various personal computer media
formats. The technology is at an early stage in which a number of competing
companies are seeking to have the industry and the public embrace their
technologies with a view to extending them to become accepted technologies
and formats. Participants in this technology competition include Microsoft
Corporation, AT&T Corp., Liquid Audio, Inc., Apple Computer, Inc., MP3.com,
Inc. and others. Digital music distribution provides both significant risks
and opportunities for K-tel. The risks include K-tel's uncertain ability to
compete with other music companies from a marketing and a technological
standpoint. Opportunities include the ability to enhance and augment current
distribution methods, as well as increasing opportunities to sell K-tel's
owned library of master recordings. In combination with its e-commerce
division, K-tel's music sales and licensing division is pursuing these
alternative distribution channels.
3
E-COMMERCE
K-tel.com, K-tel's virtual music store, enables customers to choose a large
number of music titles including the proprietary brand-name compilations that
have made the K-tel name synonymous with quality music for over 35 years.
K-tel.com also gives customers the opportunity to create their own custom CD
compilations from K-tel's master music catalog. K-tel.com features audio
sampling, user-friendly navigation and search capabilities, as well as
customer service and competitive pricing. Sales generated through K-tel.com
do not represent a significant part of K-tel's total revenue at present.
K-tel believes, however, that e-commerce presents it with a significant
opportunity to capture market share by capitalizing on its high name
recognition, extensive catalog of proprietary music and existing capabilities
and expertise in niche marketing, which K-tel believes will be critical to
success in Internet retailing. K-tel will also rely heavily on its brand
identity with consumers. A number of characteristics of on-line music
retailing, such as audio sampling, search capabilities, availability of deep
catalog content, and at home shopping convenience, all of which are provided
on K-tel's site, make the sale of pre-recorded music via the Internet
particularly attractive relative to traditional retail outlets. K-tel
commenced its e-commerce business in May 1998 and has made significant
progress in the development of this segment of the Company's business.
Further development of and penetration into this market may require
substantial additional financial resources, development and acquisition of
technology and investments in marketing. Results will also be affected by
existing competition, which K-tel anticipates will intensify, and by
additional entrants to the market who may already have necessary technology
and expertise, many of whom may have substantially greater resources than
K-tel. K-tel continually evaluates and develops effective strategies for the
optimum exploitation of the e-commerce marketplace. In August 2000, K-tel
became an Amazon.com Associate to outsource and fulfill consumer sales orders
received through K-tel.com on all music products except custom CD's and
proprietary downloads. K-tel believes that this association provides an
efficient order and delivery mechanism for the on-line shopper, and reduces
its own internal costs of maintaining and developing its e-commerce business.
In addition to developing the user-friendly technology and marketing
relationships to develop "core" on-line sales, K-tel also enables its on-line
customers to create customized CD compilations including custom packaging.
This custom CD technology not only allows on-line consumers to purchase these
custom CD's on-line, but also enables K-tel's music division to manufacture
custom CD's for corporate premiums and promotions. An individual custom CD is
"burned" for use as the "master CD." Using the "master CD" the balance of the
corporate order is filled through traditional manufacturing processes.
K-tel intends to continue to invest in marketing and enhancing K-tel.com.
Because K-tel has relatively low product gross margins in its on-line
business, achieving profitability in its on-line business will depend upon
its ability to generate and sustain substantially increased revenue from
Internet sales. Operating losses relating to its on-line business are likely
to continue for the foreseeable future and it is not possible to accurately
predict at what point such business may become profitable.
CONSUMER PRODUCTS
K-tel's consumer products consist primarily of housewares, consumer
convenience items and exercise equipment. K-tel concentrates on products that
have the potential for worldwide appeal and that are innovative, readily
demonstrated and inexpensive (generally retailing for less than $100). In
Europe, K-tel engages in an extensive amount of direct response marketing.
European direct response business is solicited through television and radio
advertising campaigns. K-tel's advertising reaches such major markets as
Germany, France, Switzerland, Austria, Belgium and Holland. K-tel's strategy
is to generate revenues and profits from both the direct response campaigns
and subsequent retail demand.
K-tel's infomercial business is concentrated in Europe. K-tel's success in
marketing through infomercials depends upon product acceptance, which K-tel
believes is achieved through the efficient airing of its infomercials, its
merchandising mix, its ability to achieve adequate response rates to its
infomercials and its ability to accurately forecast consumer demand.
Infomercials may involve substantial costs, which are committed to prior to
the airing of the infomercial. In addition, quantity and quality of airtime,
response rates and sales generated by each
4
infomercial can be affected by factors such as consumer preferences, economic
conditions, and timing of competitors' infomercials and merchandise mix.
Further, K-tel's ability to obtain inventory of consumer products on a timely
basis is critical to its marketing of a particular product and may affect
sales and customer return levels. K-tel's experience in the European consumer
products market places it in a favorable competitive position in Europe.
K-tel's infomercial business is dependent upon agreements with European
television broadcast stations or cable system operators. A significant number
of its customers are reached through the broadcasting of its infomercials
pursuant to such agreements. These agreements are subject to renegotiation
and renewal from time to time. In part, K-tel's continued success in these
areas will depend on its ability to maintain existing agreements and to
negotiate satisfactory renewals.
K-tel has endeavored to position itself in the home shopping market as the
seller of certain unique consumer products. K-tel depends upon a limited
number of product suppliers for such products. K-tel believes that there are
sufficient product suppliers to allow it to continue to offer such products
consistently.
COMPETITION
The music business is highly competitive and dominated by major companies.
K-tel faces competition for discretionary consumer purchases of its products
from other record companies and other entertainment companies, such as film
and video companies. The market for pre-recorded music is dominated by
several major record companies in the United States including Bertelsmann AG,
Sony Corp., Time Warner, Inc. and Universal Music Group. K-tel does not have
the financial resources nor does it have the depth or breadth of catalog,
distribution capabilities or current repertoire of these companies. Its
ability to compete in this market depends upon:
- the skill and creativity of its employees to expand and
utilize its music catalog, acquire licenses to enable K-tel to
create compilation packages;
- its ability to effectively and efficiently distribute its
products; and
- its ability to build upon and maintain its reputation for
producing, licensing, acquiring, marketing and distributing
high quality music.
The core of K-tel's music business involves the licensing of third party
rights and the utilization of its own catalog to create music compilations
for retail distribution. Recently, the major pre-recorded music companies,
either directly or through subsidiaries, have begun to manufacture and
distribute pre-recorded music compilations in direct competition with K-tel's
music compilation products. With this new competition, it may be more
difficult for K-tel to access pre-recorded music from these major companies
at acceptable rates.
The on-line commerce market is rapidly expanding and intensely competitive.
K-tel expects this competition to intensify. The barriers to entry are low
and both current and new competitors can launch Internet-based businesses at
relatively low cost. K-tel.com competes with a variety of music and video
marketing companies, including:
- on-line vendors of music, videos and related products such as
CDNow.com, Amazon.com and Barnes & Noble.com;
- traditional retailers of music products, including mass
merchandisers, consumer electronics stores and specialty music
retailers; and
- non-store retailers such as music clubs.
In the European consumer products/infomercial business K-tel operates in an
industry dominated by two established European competitors, Quantum and TV
SHOP Europe, both of which have substantially more television and cable
air-time than K-tel, as well as greater financial, distribution and marketing
resources. K-tel
5
also must compete with store and catalog retailers, many of whom have
substantially greater financial, distribution and marketing resources. In
addition, K-tel competes with existing and future on-line companies that may
offer similar consumer products.
EMPLOYEES
On June 30, 2000, K-tel employed 114 full time people worldwide.
FINANCIAL AND GEOGRAPHIC INFORMATION
For financial information about the Company's foreign and domestic operations
for each of the last three fiscal years ended June 30 see Note 10 to the
consolidated financial statements. For geographic information regarding
K-tel's subsidiaries see Exhibit 21.
ITEM 2: PROPERTIES
K-tel's corporate offices and U.S. operations are located in leased
facilities in suburbs of Minneapolis, Minnesota, consisting of approximately
22,000 square feet of office space and approximately 69,700 square feet of
warehouse. K-tel's online operations are located in Calabasas, California,
which consist of approximately 6,800 square feet of office space. K-tel's
foreign subsidiaries lease a total of approximately 41,400 square feet of
office and warehouse facilities. See Note 8 to the consolidated financial
statements for a summary of the lease agreements.
ITEM 3: LEGAL PROCEEDINGS
K-tel is involved in legal actions in the ordinary course of its business.
Although the outcomes of any such legal actions cannot be predicted, in the
opinion of management, there is no legal proceeding pending or asserted
against or involving K-tel for which the outcome is likely to have a material
adverse effect upon the consolidated financial position or results of
operations of K-tel.
CLASS ACTION LAWSUIT
K-tel and certain of its current and former officers and directors are
defendants in IN RE K-TEL INTERNATIONAL, INC. SECURITIES LITIGATION, No.
98-CV-2480. This action consolidates twenty three purported class actions
that were initially filed in various United States District Courts in
November, 1998, and were subsequently transferred to, and consolidated in the
United States District Court for the District of Minnesota. On July 19, 1999,
the plaintiffs filed an amended consolidated class action complaint that
challenges the accuracy of certain public disclosures made by K-tel regarding
its financial condition during the period May 1998 through November 1998. The
plaintiffs assert claims under the federal securities laws and seek damages
in an unspecified amount as well as costs, including attorneys' fees and any
other relief the Court deems just and proper. K-tel moved to dismiss the
Complaint, and, on July 31, 2000, the U.S. District Court granted the
Company's motion to dismiss. It also barred further actions by the plaintiffs
and denied plaintiffs' request to amend the complaint in order to refile the
complaint in the future. While the plaintiffs have appealed this decision,
the Company feels that the original decision will stand. K-tel has two
insurance policies providing coverage of up to $20,000,000. The insurers are
providing for the defense of the claims in the class action lawsuit subject
to their reservations of legal rights under the applicable insurance
policies. Under their reservations of rights, the insurers could contest
their obligations to indemnify the Company and its directors and officers.
6
EARLY V. K-TEL INTERNATIONAL, INC.
On January 11, 1999, The Company was named in a lawsuit entitled CHRISTOPHER
EARLY VS. K-TEL INTERNATIONAL, INC., ET AL, brought in the Circuit Court of
Cook County, Illinois, against the Company and certain of its subsidiaries by
Christopher Early. The suit also names as defendants certain other
manufacturers, distributors and a number of nationwide retailers. The
plaintiff seeks damages on behalf of himself and a purported class of
purchasers of cassette tapes and compact discs produced, distributed and/or
sold by the defendants. The plaintiff claims that the defendants engaged in
deceptive and misleading packaging of cassette tapes and compact discs by
failing to give proper notice to consumers that the songs contained therein
are not the original recordings by the original artists. The complaint also
alleges consumer fraud, deceptive and unfair practices, and fraud in
connection with website advertising and marketing. Similar litigation against
the Company had been brought by Mr. Early in 1997, and was dismissed by a
U.S. Federal Court in 1999 on jurisdictional grounds. The Company denies that
it mislabeled cassette tapes and compact discs or engaged in fraudulent or
deceptive conduct and intends to vigorously defend the purported action,
which seeks an undetermined amount of compensatory damages and punitive
damages in the amount of $10 million, an injunction and costs incurred in the
litigation, including attorneys fees. The Company has filed a motion to
dismiss the complaint. Based upon information available to it, the Company
further believes that damages, if any, are speculative and that there are no
grounds for an award of punitive damages. While discovery has not yet begun
and no assurance can be given that the Company will be successful in
defending this action, the Company believes it has meritorious defenses to
the plaintiff's claims.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of K-tel's security holders during the
fourth quarter of fiscal 2000.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to the
executive officers of K-tel at June 30, 2000.
Name of Officer Age Positions and Offices Held
- ---------------------------------- --- --------------------------------------------------------------
Philip Kives 71 Chairman of the Board, Chief Executive Officer and Director
Ken P. Onstad 49 President and Director
Jeffrey Koblick 53 Executive Vice President, Purchasing and Operations
A. Merrill Ayers 54 Vice President, Finance and Chief Financial Officer
BUSINESS EXPERIENCE
The officers of K-tel are elected annually and serve at the discretion of the
Board of Directors.
MESSRS. KIVES AND KOBLICK have held various offices and/or managerial
positions with K-tel for more than the past five years.
KEN P. ONSTAD joined K-tel March 20, 2000 as President. Prior to joining
K-tel, Mr. Onstad was with Musicland Stores Corporation for twenty six years
where he held numerous positions, most recently as the Vice President of
Strategic Planning.
A. MERRILL AYERS joined K-tel on July 24, 2000 as Vice President of Finance
and Chief Financial Officer. From 1994 to 2000 Mr. Ayers was the Senior Vice
President, Chief Financial Officer, Secretary and a Director with Sparta
Foods, Inc., a specialty food manufacturer.
7
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
On September 20, 2000 there were 1,389 record holders of K-tel's common stock
and 10,320,405 shares outstanding. Prior to September 27, 2000, K-tel's
common stock traded on the Nasdaq National Market under the symbol "KTEL",
subsequent to being delisted from the Nasdaq National Market on September 27,
2000, the Company's Common Stock has traded on the Over-the-Counter Bulletin
Board, see "Cautionary Statements - Nasdaq Delisting."
The following table shows the range of high and low closing prices per share
of K-tel's common stock as reported by The Nasdaq National Market for the
fiscal year periods indicated.
2000 1999
---------------------------- ------------------------
High Low High Low
------------- ----------- ---------- ----------
1st Quarter $ 7.44 $ 5.13 $ 14.38 $ 6.00
2nd Quarter $ 10.44 $ 4.50 $ 32.63 $ 5.19
3rd Quarter $ 7.34 $ 5.25 $ 12.63 $ 8.03
4th Quarter $ 6.38 $ 1.75 $ 9.44 $ 5.13
No cash dividends have been declared on K-tel's common stock during the past
two fiscal years and K-tel does not expect to pay cash dividends in the
foreseeable future. Management plans to use cash generated from operations
for expansion of its business. The declaration or payment by K-tel of
dividends, if any, on its common stock in the future is subject to the
discretion of the Board of Directors and will depend on K-tel's earnings,
financial condition, capital requirements and other relevant factors. The
declaration or payment by K-tel of dividends is also subject to the terms of
its credit facility.
ITEM 6: SELECTED FINANCIAL DATA
The following summary of consolidated operations and certain balance sheet
information includes the consolidated results of operations of K-tel
International, Inc. and its subsidiaries as of and for the five years ended
June 30, 2000. This summary should be read in conjunction with the
consolidated financial statements and notes thereto appearing elsewhere in
this filing. All share and per share amounts are based on the weighted
average shares issued. All amounts are in thousands of dollars, except per
share data.
2000 1999 1998 1997 1996
---------- --------- -------- --------- ---------
Net sales $ 58,604 $ 77,664 $ 85,626 $ 75,501 $ 71,987
========== ========= ========= ========= =========
Operating income (loss) $ (18,234) $ (10,152) $ (2,535) $ 3,582 $ 4
========== ========= ========= ========= =========
Net income (loss) $ (15,738) $ (11,547) $ (2,407) $ 3,204 $ (745)
========== ========= ========= ========= =========
Net income (loss) per share
Basic $ (1.58) $ (1.25) $ (.31) $ .43 $ (.10)
========== ========= ========= ========= =========
Diluted $ (1.58) $ (1.25) $ (.31) $ .41 $ (.10)
========== ========= ========= ========= =========
Total assets $ 23,199 $ 35,916 $ 39,035 $ 30,492 $ 27,795
========== ========= ========= ========= =========
Long-term debt $ 4,000 $ 4,000 $ 4,174 $ -- $ --
========== ========= ========= ========= =========
Cash dividends declared and paid $ -- $ -- $ -- $ -- $ --
========== ========= ========= ========= =========
8
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
K-tel markets and distributes entertainment and consumer products
internationally. With more than 35 years of marketing experience in the
United States and Europe, K-tel has developed the resources, knowledgeable
personnel, information systems, and distribution capabilities to market music
and consumer products through traditional retail and direct-response
marketing channels. K-tel also markets its music entertainment products
through an Internet e-commerce site, K-tel.com (www.ktel.com) in the United
States.
A. RESULTS OF OPERATIONS
The following sections discuss the results of operations by business segment.
See footnote 10 to consolidated financial statements for additional segment
information. General corporate expenses of $1,417,000 in fiscal 2000,
$2,499,000 in fiscal 1999 and $2,267,000 in fiscal 1998 have been allocated
to the segments.
FISCAL 2000 VERSUS FISCAL 1999
Net sales for fiscal 2000 were $58,604,000, a decline of 24.5% from fiscal
1999 sales of $77,664,000. This sales decline can be attributed to the
curtailment of the media buying business at the end of fiscal 1999 and the
sale of K-tel International (Finland) Oy ("K-tel Finland"), effective July 1,
1999. Sales in fiscal 1999 of K-tel Finland were $6,200,000. The net loss for
fiscal 2000 was $15,738,000, or $1.58 per share, compared to a loss of
$11,547,000, or $1.25 per share, in fiscal 1999.
BUSINESS SEGMENT RESULTS
MUSIC
Sales in the music segment were $25,739,000 in fiscal 2000 compared to
$40,329,000 in fiscal 1999. European music sales declined $8,287,000,
primarily due to the sale of K-tel Finland, and domestic music sales declined
$6,303,000. The domestic music business, composed primarily of sales of music
compilations produced by K-tel and sales and distribution of other record
labels, declined as the Company experienced a higher rate of product returns
from distributors and began a more intensive profitability review of its new
business, which resulted in fewer new products being released.
Cost of goods sold in the music segment increased to 101.1% of sales in
fiscal 2000 compared to 71.4% of sales in fiscal 1999. The substantial
increase in cost of goods sold in the music segment was due to two main
factors. The Company experienced higher royalty costs on its own compilation
products and increased its royalty reserve by approximately $2,935,000 for
additional estimated payments owed and unrecouped royalty advances.
Obsolescence reserves were increased by about $4,360,000 as a result of
attempts to reduce overstocked inventory, changes in customer product mix
purchases, and declining demand for cassette products in the industry.
Advertising expense, which consists primarily of co-operative advertising
payments, trade advertising and promotions, was approximately $2,157,000 or
8.4% of revenues in fiscal 2000 as compared to approximately $4,600,000 or
10.9% in fiscal 1999. Selling, general and administrative expenses decreased
28.9% to $8,862,000 in fiscal 2000 compared to $12,459,000 in fiscal 1999.
Both decreases represent general overall spending level reductions,
elimination of expenses from Finland and lower TV advertising and promotional
spending. As a result, the music segment incurred operating losses of
$11,308,000 in fiscal 2000 compared to operating losses of $5,301,000 in
fiscal 1999.
9
LICENSING
Licensing revenues were $3,698,000 in fiscal 2000 compared to $4,272,000 in
fiscal 1999. This decline was primarily due to stronger competition in the
music industry for this type of product. Included in the segment revenue in
fiscal 2000 and fiscal 1999 were approximately $920,000 and $1,068,000 of
inter-company revenues, respectively, which are eliminated on the
accompanying consolidated financial statements. Operating income in the
licensing segment was $819,000 in fiscal 2000 and $2,052,000 in fiscal 1999.
CONSUMER PRODUCTS
Sales of consumer products were $29,117,000 in fiscal 2000, an 11.8% decrease
over fiscal 1999 sales of $33,014,000. This decrease was the result of an
increase of $756,000 in revenues in Germany, offset by declines in the U.K.,
the U.S. domestic market and exports of $4,653,000. Cost of goods sold, as a
percentage of sales, increased to 38.1% in fiscal 2000 compared to 35.4% in
fiscal 1999 due to product mix. Advertising expenditures were $11,657,000 in
fiscal 2000 compared to $11,003,000 in fiscal 1999, primarily due to
commitments to TV advertising in Europe by the U.K. which did not result in
increased sales, while selling, general and administrative expense was
$11,753,000 in fiscal 2000 compared to $12,283,000 in fiscal 1999. As a
result, the consumer products segment incurred a loss of $5,387,000 in fiscal
2000 compared to a loss of $1,942, 000 in fiscal 1999.
E-COMMERCE
In May 1998, K-tel launched its Internet service, K-tel.com (www.ktel.com),
featuring a wide spectrum of music products for purchase by the public. In
March 1999, K-tel announced the opening of its German Internet service
(www.ktel.de). Revenues and expenses of the German e-commerce site were
insignificant in fiscal 1999, and the site became inactive in June, 2000.
Regarding K-tel.com, revenues were $955,000 in fiscal 2000 as compared to
$400,000 in fiscal 1999. The cost of goods sold in fiscal 2000 was
approximately 50.2% compared to approximately 79.5% of revenues in fiscal
1999. In fiscal 2000, advertising was $347,000 and selling, general and
administrative expenses were $1,755,000, resulting in an operating loss of
$1,626,000. In fiscal 1999, advertising was $527,000 and selling, general and
administrative expenses were $1,786,000, resulting in an operating loss of
$2,231,000.
OTHER
The other segment of the business is comprised of the third-party media
buying segment and a video business, both of which have been curtailed or
discontinued. In the fourth quarter of fiscal 1998, K-tel curtailed its
third-party media buying operation and, in the first quarter of fiscal 1999
it discontinued the operations of its video business segment. Combined
revenues from these two segments were $15,000 in fiscal 2000 compared to
$717,000 in fiscal 1999. Operating losses from these segments were $733,000
in fiscal 2000 and $2,731,000 in fiscal 1999.
FISCAL 1999 VERSUS FISCAL 1998
Net sales for fiscal 1999 were $77,664,000, a decline of 9.3% from fiscal
1998. This sales decline can be attributed to the curtailment of the media
buying business at the end of fiscal 1998. The net loss for fiscal 1999 was
$11,547,000, or $1.25 per share, compared to a loss of $2,407,000, or $0.31
per share, in fiscal 1998.
BUSINESS SEGMENT RESULTS
MUSIC
Sales in the music segment were $40,329,000 in fiscal 1999 compared to
$41,611,000 in fiscal 1998. European music sales increased $1,200,000, offset
by a decline in domestic music sales of $2,500,000. The domestic music
business, which historically has primarily consisted of sales of music
compilations produced by K-tel, was seeing a significant change in its
product mix. In fiscal 1998, K-tel began operating K-tel Distribution
("KTD"), which
10
sources other record labels for sales and distribution by K-tel. Sales of KTD
increased to $8,700,000 in fiscal 1999 compared to $1,600,000 in fiscal 1998.
Cost of goods sold in the music segment increased to 71.4% of sales in fiscal
1999 compared to 64.5% of sales in fiscal 1998. The KTD business, which
represented about 21% of sales in fiscal 1999 compared to 3% of sales in
fiscal 1998, generally has a cost of goods sold of about 80%, resulting in a
higher cost of goods sold for the segment. Offsetting the high cost of goods
sold in the KTD business is the fact that the record labels pay for all of
the advertising and promotion, so K-tel does not bear these expenses. Cost of
goods sold in the music segment has also increased due to higher royalty
costs on K-tel's own compilation products. Advertising expense, which
consists primarily of co-operative advertising payments, trade advertising
and promotions, was approximately 10.9% of revenues in both fiscal 1999 and
fiscal 1998. Selling, general and administrative expenses increased 2.2% to
$12,459,000 in fiscal 1999 compared to $11,532,000 in fiscal 1998. The
primary reasons for the increase include K-tel's unsuccessful attempt to
enter the new artist music arena at a cost of approximately $850,000 and an
increase in the provision for bad debts of approximately $160,000. As a
result, the music segment incurred operating losses of $5,301,000 in fiscal
1999 compared to operating losses of $1,315,000 in fiscal 1998.
LICENSING
Licensing revenues were $4,272,000 in fiscal 1999 compared to $3,808,000 in
fiscal 1998. Included in the segment revenue in fiscal 1999 and fiscal 1998
were approximately $1,068,000 and $933,000 of inter-company revenues,
respectively, which are eliminated on the accompanying consolidated financial
statements. Operating income in the licensing segment was $2,052,000 in
fiscal 1999 and $1,640,000 in fiscal 1998. In fiscal 1998, operating income
was adversely affected by a non-cash loss of $514,000 recognized on the
revaluation of certain securities received in connection with a previous
settlement.
CONSUMER PRODUCTS
On March 4, 1998, K-tel acquired $3,250,000 of media rights and other assets
of United Kingdom based Regal Shop International Ltd. (now K-tel Marketing
Ltd.) for purchase consideration of $350,000 cash and the assumption of
$2,900,000 of debt. K-tel accounted for the acquisition as a purchase and
accordingly, revenues and expenses of the acquired company have been included
in the results of operations since March 4, 1998. Therefore, in making
year-to-year comparisons, it is important to note that only four months of
operations of K-tel Marketing Ltd. were included in fiscal 1998.
Sales of consumer products were $33,014,000 in fiscal 1999, a 30.3% increase
over fiscal 1998 sales of $25,329,000. This increase was the result of a
$9,900,000 increase in revenues due to the UK acquisition, offset by declines
in Germany, the U.S. domestic market and exports of $2,200,000. Cost of goods
sold, as a percentage of sales, improved to 35.4% in fiscal 1999 compared to
43.6% in fiscal 1998 due to product mix. Advertising and selling, general and
administrative expense growth also increased. Advertising expenditures were
$11,003,000 in fiscal 1999 compared to $5,960,000 in fiscal 1998. Selling,
general and administrative expense was $12,283,000 in fiscal 1999 compared to
$7,488,000 in fiscal 1998. All of these increases were primarily due to the
UK acquisition. As a result, the consumer products segment incurred a loss of
$1,942,000 in fiscal 1999 compared to a income of $844, 000 in fiscal 1998.
E-COMMERCE
In May 1998, K-tel launched its Internet service, K-tel.com (www.ktel.com),
featuring a wide spectrum of music products for purchase by the public. In
March 1999, K-tel announced the opening of its German Internet service
(www.ktel.de). Revenues and expenses of the German e-commerce site were
insignificant in fiscal 1999. Regarding K-tel.com, revenues for fiscal 1999
were $400,000. The cost of goods sold in fiscal 1999 was approximately 79.5%
of revenues. In fiscal 1999, advertising was $527,000 and selling, general
and administrative expenses were $1,786,000, resulting in an operating loss
of $2,231,000. K-tel.com operated for two months in fiscal 1998 and had
revenues of $39,000 and a loss of $481,000, including start up expenses.
11
OTHER
The other segment of the business is comprised of the third-party media
buying segment and a video business, both of which have been curtailed or
discontinued. In the fourth quarter of fiscal 1998 K-tel curtailed its
third-party media buying operation and, in the first quarter of fiscal 1999
it discontinued the operations of its video business segment. Combined
revenues from these two segments were $717,000 in fiscal 1999 compared to
$15,772,000 in fiscal 1998. Operating losses from these segments were
$2,731,000 in fiscal 1999 and $3,223,000 in fiscal 1998.
B. LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2000, K-tel had $2,475,000 in cash and cash equivalents, a
decrease of $4,307,000 from the balance at June 30, 1999. During fiscal 2000,
K-tel experienced negative cash flow from operating activities of $2,257,000.
The net loss of $15,738,000 was partially offset by the decreases in accounts
receivable and inventories and increases in reserves and accrued expenses as
described in the Company's Music Segment above. The Company used $852,000 for
investing activities, primarily in fixed assets and music catalog additions.
Included in operating activities are the results of the sale of a subsidiary
of the Company. In September 1999, K-tel sold all of the outstanding common
stock of its subsidiary K-tel Finland to an unrelated purchaser. Net proceeds
after $1,386,000 in transaction costs related to the sale exceeded the net
book value of K-tel Finland's net assets by approximately $4,341,000, which
was recorded as a gain and reported in other income in the consolidated
statement of operations for the fiscal year ended June 30, 2000. K-tel
Finland was a subsidiary in the Company's music segment responsible for the
sale of music in Scandinavia. The sale of this subsidiary is not expected to
have a material effect on future operations of the Company.
Financing activities used $1,607,000 in cash in the fiscal year ended June
30, 2000. The Company used $4,000,000 of funds related to the cancellation of
a Securities Purchase Agreement K-tel entered into with two investors in
April 1999, pursuant to which K-tel would have sold in a private placement
transaction up to $18,000,000 of its common stock in two tranches. Pursuant
to the agreement, K-tel sold 465,794 shares of common stock on the effective
date of a registration statement under the Securities Act of 1933, covering
the common stock. In July 1999, a contractual dispute arose between the
purchasers and K-tel and the $4,000,000 balance on the first tranche was not
sold. On August 3, 1999, K-tel entered into an agreement with the purchasers
of the common stock in the private placement to void the original agreement
and for K-tel to repurchase the 465,794 shares previously issued for
$4,600,000. K-tel used $3,000,000 of internal funds and $1,600,000 of funds
advanced by K-5 Leisure Products, Inc. ("K-5"), an affiliate controlled by
Philip Kives, the Chairman of the Board and Chief Executive Officer of K-tel,
to repurchase the shares. As a result of this repurchase, K-tel incurred an
expense of $600,000, which was reported in other expense in the consolidated
statement of operations for the fiscal year ended June 30, 2000. In addition,
the Company decreased its borrowings under its line of credit with Foothill
Capital Corporation by $708,000 in the fiscal year ended June 30, 2000, and
generated $3,101,000 from the exercise of stock options in the fiscal year
ended June 30, 2000, partially offsetting the $4,000,000 use of funds related
to the cancellation of a Securities Purchase Agreement described above.
K-tel has a $10,000,000 credit facility with Foothill Capital Corporation
("Foothill"), consisting of a $4,000,000 term loan due in full on November
20, 2001, and a $6,000,000 revolving facility, under which borrowings are
limited to a percent of eligible receivables, that expires on 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 (9.5% at June 30, 2000) 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 shareholders' equity by K-tel, limitations on capital expenditures,
restrictions on music library acquisitions, limitations on other indebtedness
and restrictions on dividends paid by K-tel. K-tel has guaranteed the
obligations of its subsidiaries under the credit facility and has pledged the
stock of those subsidiaries and its assets to secure K-tel's obligations
under its guaranty. As of June 30, 2000, $4,000,000 was outstanding under the
term loan, $1,924,000 was outstanding
12
under the line of credit and the maximum additional available under the
borrowing limitations was $340,000. At June 30, 2000, K-tel was in compliance
with all covenants, limitations and restrictions of the credit agreement
except for the minimum shareholders' equity covenant, for which it obtained a
waiver from the lender. Although the Company has been able to obtain waivers
for covenant violations in the past, there can be no assurance such waivers
will be able to be obtained in the future.
On September 27, 1999, K-tel entered into a written Line of Credit Agreement
with K-5. Under the terms of the agreement, K-5 agreed to make available up
to $8,000,000 on a revolving basis. The loan bears interest at the same rate
as K-tel's loan from Foothill and expires on November 20, 2001. The loan
agreement between K-tel and K-5 contains the same covenants as the Foothill
loan agreement, and K-5 agreed not to declare a default prior to July 1, 2001
in the event that the Company did not comply with the shareholder equity
covenant. The K-5 loan is subordinated to the Foothill loan. K-tel has
pledged the stock of its foreign subsidiaries as collateral for the loan. In
addition, K-5 and Foothill have agreed that, if Foothill were to give notice
of its intention to accelerate its loan, K-5 would have the right to pay
Foothill and assume the secured creditor position of Foothill. Additionally,
K-5 has indicated to K-tel that it would assume the secured creditor's
position in the event that Foothill accelerated amounts due under the
Foothill loan, and K-5 has sufficient financial resources to do so. As of
June 30, 2000, K-tel had an outstanding balance of $1,945,000 to K-5. During
the twelve months ended June 30, 2000, K-5 advanced an additional $1,600,000
which was repaid in the period. Interest in the amount of $166,000 was
accrued but not paid at June 30, 2000.
K-tel has primarily funded its operations to date through internally
generated capital, secured lender financing, proceeds from stock option
exercises and loans from K-5. Management currently believes that K-tel has
sufficient cash and borrowing capacity, to ensure the Company will continue
operations in the near term. In part, this is a result of projected
improvement in operating results in fiscal 2001 as well as the existing lines
of credit with Foothill and K-5. Although K-tel's credit lines with its two
lenders are sufficient to meet its needs at this time, there can be no
assurance that they will be adequate in the future or that K-tel will be able
to obtain additional financing upon favorable terms when required.
SUBSEQUENT EVENTS
On July 6, 2000 the Company announced it had closed its German subsidiary,
Dominion Vertriebs GmbH, effective June 30, 2000. The closing of this
subsidiary is not expected to have a material effect on future operations of
the Company. Sales in fiscal 2000 and 1999 were $17,203,000 and $15,990,000,
with net losses in the same periods were $2,787,000 and $1,790,000.
On August 3, 2000 the Company received notification from Nasdaq that its
stock would be delisted at the opening of business on August 14, 2000. The
Company appealed this initial decision and also applied for listing on the
Nasdaq SmallCap Market. A hearing was conducted by a panel authorized by
Nasdaq's Board of Directors on September 21, 2000. On September 26, 2000 the
Company was notified by the Nasdaq Stock Market Inc. that its Common Stock
had been delisted from the Nasdaq National Market, effective with the open of
business September 27, 2000, and that its application for listing on the
Nasdaq SmallCap Market was denied. Delisting of the Company's Common Stock
from Nasdaq could have a material adverse effect on the market price of, and
the efficiency of the trading market for the Company's Common Stock. The
Company's Common Stock will be traded on the Over-the-Counter Bulletin Board
("the OTCBB"). The OTCBB is a controlled quotation service that offers
real-time quote, last sale prices and volume information in over-the-counter
equities.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
K-tel is exposed to various market risks, including changes in interest rates
and foreign currency exchange rates. Market risk is the potential loss
arising from adverse changes in market rates and prices, such as interest
rates and foreign currency exchange rates. K-tel does not enter into
derivatives or other financial instruments for trading or speculative
purposes.
13
K-tel's exposure to market risk for changes in interest rates relates to
K-tel's short-term borrowings and long term debt obligations. K-tel's
short-term credit facilities carry a variable interest rate that does have an
impact on future earnings and cashflows. At June 30, 2000, K-tel had fixed
rate of debt $4,000,000 and variable rate debt of $3,869,000. If the interest
rate were to change while K-tel was borrowing under the credit facilities,
interest expense would increase or decrease accordingly.
A significant portion of K-tel's revenues during the year ended June 30, 2000
was derived from operations in Europe. The results of operations and
financial position of K-tel's operations in Europe are principally measured
in their respective currencies and translated into U.S. dollars. The effect
of foreign currency fluctuations in these European countries is somewhat
mitigated by the fact that expenses are generally incurred in the same
currencies in which the revenue is generated. The reported income of these
subsidiaries will be higher or lower depending on the weakening or
strengthening of the U.S. dollar against the respective foreign currency.
Additionally, a significant portion of K-tel's assets at June 30, 2000 is
based in its foreign operations and is translated into U.S. dollars at
foreign currency exchange rate in effect as of the end of each accounting
period, with the effect of such translation reflected as a separate component
of consolidated shareholders' equity. Accordingly, K-tel's consolidated
shareholders' equity will fluctuate depending on the weakening or
strengthening of the U.S. dollar against the respective foreign currency.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and related notes and schedules
required by this Item are set forth in Part IV, Item 14, and identified in
the index on page 20.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On October 8, 1999, Arthur Andersen LLP and the Company agreed to the
resignation of Arthur Andersen LLP as independent public accountants of
Registrant.
The reports of Arthur Andersen LLP on the financial statements of the Company
for the past two years, the most recent of which is the fiscal year ended
June 30, 1999, contained no adverse opinion or disclaimer of opinion and were
not qualified or modified as to audit scope or accounting principles.
The Registrant's Board of Directors participated in and approve the decision
to change independent accountants.
In connection with its audits for the two most recent periods and through
October 8, 1999, there were no disagreements with Arthur Andersen LLP on any
matter of accounting principles or practices, financial statement disclosure,
or auditing scope or procedure, which disagreements if not resolved to the
satisfaction of Arthur Andersen LLP would have caused them to make reference
thereto in their report on the financial statements for such years.
During the two most recent fiscal years and through October 8, 1999, there
were no reportable events (as defined in Regulation S-B Item 304(a)(1)(iv)).
Arthur Andersen LLP has furnished the Company with a letter addressed to the
SEC stating that it agrees with the above statements. A copy of the letter is
included in an exhibit to the Company's Current Report on Form 8-K filed with
the SEC on October 8, 1999.
The Company engaged Grant Thornton LLP as its new independent accountants as
of December 16, 2000. During the two most recent periods and through October
8, 1999, the Company had not consulted with Grant Thornton LLP on items which
(1) were or should have been subject to SAS 50 or (2) concerned the subject
matter of a disagreement or reportable event with the former auditor (as
described in Regulation S-B Item 403(a)(2)).
14
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following describes the business, the business experience and background
of each director of K-tel.
PHILIP KIVES founded K-tel in 1968 and has served as its Chairman of the
Board since K-tel's inception. In addition, Mr. Kives was re-appointed the
Chief Executive Officer on October 16, 1995.
KEN P. ONSTAD was appointed President and a director of K-tel International,
Inc. on March 20, 2000. Prior to joining K-tel, Mr. Onstad was with Musicland
Stores Corporation for twenty six years where he held numerous positions,
most recently as the Vice President of Strategic Planning.
LAWRENCE KIEVES was President of K-tel from October 1998 through March 2000
and has served as a director since December 1998. With extensive experience
in the entertainment industry and in public service, Mr. Kieves was
previously Managing Director of EWK Associates, a private company engaged in
real-estate development. From 1995 to 1997, he served as President of Network
Event Theater, a public company operating large screen broadcast theaters on
numerous college campuses. From 1993 to 1995 Mr. Kieves served as Chief
Operating Officer of RKO Warner Video. Mr. Kieves is the first cousin, once
removed, of Philip Kives.
HERBERT DAVIS was elected a director in January 1999. Mr. Davis is an
attorney engaged in the private practice of law with the Law Offices of
Herbert Davis, which he founded in 1984. Mr. Davis specializes in business
litigation and business transactions.
JAY WILLIAM SMALLEY was elected a director in January 1999. Since 1970, Mr.
Smalley has been the Chief Executive Officer of JWS, Inc., a privately owned
real estate development and sales company specializing in hotel, motel,
industrial and residential properties.
DENNIS W. WARD was elected a director in January 1999. Since 1990, Mr. Ward
has been the Controller of K-tel International, Ltd., a Canadian corporation
owned by Philip Kives and engaged in the marketing and distribution of
consumer products. Mr. Ward is also an officer of K-tel Entertainment (CAN),
Inc., an inactive subsidiary of the registrant.
DAVID WOLINSKY was elected a director in January 1999. Mr. Wolinsky has been
a partner with the Winnipeg, Manitoba law firm of Monk Goodwin since 1991 and
specializes in entertainment, corporate and commercial law.
Information concerning executive officers of the Registrant is furnished as
Item 4A in Part I.
15
ITEM 11: EXECUTIVE COMPENSATION
The following table sets forth the aggregate cash compensation paid to or
accrued by each of K-tel's executive officers receiving in excess of $100,000
for services rendered to K-tel during the fiscal years ended June 30, 2000,
1999 and 1998. K-tel has no written employment agreements with its executive
officers.
SUMMARY COMPENSATION TABLE
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
AWARDS
---------------------------------------------------------
SECURITIES
NAME AND PRINCIPAL POSITION FISCAL YEAR SALARY BONUS UNDERLYING ALL OTHER
OPTIONS COMPENSATION (1)
- ----------------------------------------------------------------------------------------------------------------
Philip Kives 2000 $ --- $ --- 1,546,000 $ ---
Chief Executive Officer 1999 $ --- $ --- 1,036,000 $ ---
1998 $ --- $ --- 231,000 $ ---
Lawrence Kieves 2000 $ 123,145 $ --- --- $ 1,684
President (2) 1999 $ 139,231 $ --- 200,000 $ 2,237
1998 $ --- $ --- --- $ ---
Jeffrey Koblick 2000 $ 182,761 $ --- 40,000 $ 3,158
Executive Vice President 1999 $ 208,500 $ --- 27,500 $ 5,076
Purchasing & Operations 1998 $ 207,231 $ --- 56,500 $ 4,987
Steven Kahn 2000 $ 146,909 $ --- 10,000 $ 981
Vice President Finance 1999 $ 70,192 $ --- 75,000 $ 592
Chief Financial Officer (3) 1998 $ --- $ --- --- $ ---
(1) Other compensation for the 2000, 1999 and 1998 fiscal years consists of
K-tel contributions under the 401(k) plan.
(2) Lawrence Kieves left his position as President of K-tel International,
Inc. in March 2000.
(3) Steven Kahn left his position as Vice President Finance and Chief
Financial Officer on June 22, 2000.
16
The following tables summarize stock option grants and option exercises
during the fiscal year ended June 30, 2000, by each of K-tel's executive
officers receiving in excess of $100,000 for services rendered to K-tel
during the fiscal year ended June 30, 2000.
OPTION GRANTS IN LAST FISCAL YEAR
(INDIVIDUAL GRANTS)
NUMBER OF PERCENT OF POTENTIAL REALIZABLE VALUE
SECURITIES TOTAL OPTIONS AT ASSUMED ANNUAL RATES OF
UNDERLYING GRANTED TO STOCK PRICE FOR OPTION TERMS(1)
OPTIONS EMPLOYEES IN EXERCISE EXPIRATION -------------------------------
NAME GRANTED FISCAL YEAR PRICE DATE 5% 10%
- -------------------------------------------------------------------------------------------------------------------
Philip Kives 25,000 1% $ 6.4375 8/19/09 $ 101,000 $ 256,000
45,000 2% $ 5.5937 10/6/09 $ 158,000 $ 401,000
440,000 19% $ 5.7187 2/23/10 $ 1,582,000 $ 4,010,000
1,036,000 46% $ 5.5125 3/3/10 $ 3,592,000 $ 9,102,000
Lawrence Kieves --- --- --- --- --- ---
Jeffrey Koblick 40,000 2% $ 5.5125 3/3/10 $ 139,000 $ 351,000
Steven Kahn 10,000 --- $ 5.5125 3/3/10 $ 35,000 $ 88,000
- ---------------------
(1) The 5% and 10% assumed rates of appreciation are mandated by the rules
of the Commission and do not represent K-tel's estimate or projection
of the future common stock price.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION VALUES
Shares
Acquired Value Number of Securities Value of In-the Money
Name On Exercise Realized Underlying Options at FY-End Options at FY-End(1)
- ------------------------- ----------- -------- ------------------------------ -----------------------------
Exercisable Unexercisable Exercisable Unexercisable
----------- ------------- ----------- -------------
Philip Kives 530,000 $503,500 1,351,942 270,997 --- ---
Lawrence Kieves 5,000 $ 5,185 61,667 133,333 --- ---
Jeffrey Koblick --- --- 64,166 25,834 --- ---
Steven Kahn --- --- --- 10,000 --- ---
(1) Market value of underlying securities at fiscal year end minus the exercise
price.
17
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table contains certain information as of September 20, 2000,
regarding the beneficial ownership of the Common Stock by (i) each person
known to K-tel to own beneficially five percent or more of the Common Stock,
(ii) each director of K-tel, (iii) each executive officer of K-tel and (iv)
the directors and executive officers as a group. Any shares which are subject
to an option or a warrant exercisable within 60 days are reflected in the
following table and are deemed to be outstanding for the purpose of computing
the percentage of Common Stock owned by the option or warrant holder but are
not deemed to be outstanding for the purpose of computing the percentage of
Common Stock owned by any other person. Unless otherwise indicated, each
person in the table has sole voting and investment power as to the shares
shown. Unless otherwise indicated, the address for each listed shareholder is
c/o K-tel International, Inc., 2605 Fernbrook Lane North, Minneapolis,
Minnesota 55447-4736.
AMOUNT AND NATURE PERCENTAGE OF
OF BENEFICIAL OUTSTANDING
OWNERSHIP(1) STOCK
Philip Kives ............................................. 5,999,233 (2) 48.2%
220 Saulteaux Crescent
Winnipeg, Manitoba R32 3W3
Canada
Dennis Ward............................................... 105,000 (3) *
Jeffrey Koblick........................................... 91,366 (4) *
Lawrence Kieves........................................... 61,667 (5) *
Jay William Smalley....................................... 10,000 (6) *
Herbert Davis............................................. 10,000 (7) *
David Wolinsky............................................ 10,000 (8) *
Ken P. Onstad............................................. --- *
A. Merrill Ayers.......................................... --- *
All directors and officers as a group..................... 6,287,266 (9) 50.7%
(9 persons)
- ----------------------
* Indicates ownership of less than 1% of the outstanding shares of Common
Stock.
(1) The securities "beneficially owned" by a person are determined in
accordance with the definition of "beneficial ownership" set forth in the
regulations of the Securities and Exchange Commission (the "Commission")
and accordingly, may include securities owned by or for, among others, the
spouse, children or certain other relatives of such person as well as
other securities as to which the person has or shares voting or investment
power or has the right to acquire within 60 days. The same shares may be
beneficially owned by more than one person.
(2) Philip Kives holds 4,466,291 shares and 1,532,942 vested options.
(3) Dennis Ward holds 105,000 vested stock options.
(4) Jeffrey Koblick holds 27,200 shares and 64,166 vested stock options.
(5) Lawrence Kieves holds 61,667 vested stock options.
(6) Jay William Smalley holds 10,000 vested stock options.
(7) Herbert Davis holds 10,000 vested stock options.
(8) David Wolinsky holds 10,000 vested stock options.
(9) All directors and officers as a group hold 4,493,491 shares and
1,793,775 vested stock options.
18
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
K-5 Leisure Products, Inc. ("K-5"), an affiliate controlled by the Company's
Chairman of the Board and Chief Executive Officer, Philip Kives, has from
time to time made advances to the Company. As of both June 30, 2000 and 1999,
the Company had a loan balance with K-5 of $1,945,000. The Company pays
interest on the unpaid principal amount of financing at the same rate as the
Company pays on its credit facility with Foothill, until repayment of the
loan, which is due on demand. The Company incurred interest of $184,000 in
2000, $186,000 in 1999, and $95,000 in 1998 on this loan.
The advances referred to in the preceding paragraph were made under an
informal borrowing arrangement with K-5. On September 27, 1999, K-tel entered
into a written Line of Credit Agreement with K-5. Under the terms of the
agreement, K-5 has agreed to make available up to $8.0 million on a revolving
basis. The loan bears interest at a variable rate based upon the "base rate"
of a local lending institution, expires on November 20, 2001, and is
subordinated to the Foothill loan. K-tel has pledged the stock of its foreign
subsidiaries as collateral for the loan. K-5 and Foothill have agreed that,
if Foothill were to make a demand for payment as a result of a default on the
loan, K-5 has the right to pay Foothill and assume the secured creditor
position of Foothill. K-5 has separately committed to the Company that in the
event of acceleration by Foothill, K-5 would assume the secured creditor
position in addition to providing the line of credit previously discussed.
The Company purchased approximately $198,000 in fiscal 2000, $34,000 in
fiscal 1999 and $334,000 in fiscal 1998 of consumer products from K-5.
Management believes purchase prices for these products were at prices
comparable to transactions with an unrelated third party. There was a payable
amount of $150,000 at June 30, 2000, $51,000 at June 30, 1999, and $9,000 at
June 30, 1998.
The Company sold approximately $174,000 during fiscal 2000, $12,000 during
fiscal 1999, and $39,000 during fiscal 1998 of consumer convenience products
to K-5. There was a balance receivable from K-5 at June 30, 2000 of $224,000,
June 30, 1999, of $33,000, and $4,000 at June 30, 1998. Outstanding balances
are settled on a timely basis. No interest was charged on the related
outstanding balances during fiscal 2000.
K-5 retained the services of a consultant to assist it in matters relating to
its operations, as well as those of the Company. K-5 estimates the value of
the services paid to the consultant in fiscal 1999 on behalf of the Company
to be $80,000. The Company has recorded this as a contribution to additional
paid-in-capital.
19
PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) FINANCIAL STATEMENTS AND SCHEDULES
The consolidated statements and schedules listed in the accompanying
Index to Consolidated Financial Statements and Schedules on page 22
hereof are filed as part of this report.
(b) REPORTS ON 8-K
During the last quarter of the period covered by this report, no Report
on Form 8-K was filed.
(c) EXHIBITS
Reference is made to the Exhibit Index Page 41.
20
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf on September 28, 2000, by the undersigned, thereunto duly
authorized.
K-TEL INTERNATIONAL, INC.
By /s/ Philip Kives
-----------------------------------
(Philip Kives - Chairman of the Board
and Chief Executive Officer)
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated and on the dates indicated.
Signatures Title Date
- ---------- ----- ----
/s Philip Kives Chairman, Chief Executive Officer September 28, 2000
- -------------------------------- (Principal Executive Officer) and Director
Philip Kives
/s/ Ken P. Onstad President and Director September 28, 2000
- --------------------------------
Ken P. Onstad
/s/ A. Merrill Ayers Vice President-Finance Chief Financial Officer September 28, 2000
- -------------------------------- and Treasurer (Principal Accounting Officer)
A. Merrill Ayers
/s/ Herbert Davis Director September 28, 2000
- --------------------------------
Herbert Davis
/s/ Jay William Smalley Director September 28, 2000
- --------------------------------
Jay William Smalley
/s/ David Wolinsky Director September 28, 2000
- --------------------------------
David Wolinsky
/s/ Dennis Ward Director September 28, 2000
- --------------------------------
Dennis Ward
/s/ Lawrence Kieves Director September 28, 2000
- --------------------------------
Lawrence Kieves
21
(ITEM 14(A))
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants - Grant Thornton LLP.............................23
Report of Independent Public Accountants - Arthur Andersen LLP......................................24
Consolidated Balance Sheets as of June 30, 2000 and 1999............................................25
Consolidated Statements of Operations for each of the
three years in the period ended June 30, 2000.......................................................26
Consolidated Statements of Shareholders' Equity (Deficit)
for each of the three years in the period ended June 30, 2000.......................................27
Consolidated Statements of Cash Flows for each of the
three years in the period ended June 30, 2000.......................................................28
Notes to Consolidated Financial Statements..........................................................29
Supplemental Schedule to Consolidated Financial Statements:
Schedule II - Valuation and Qualifying Accounts for each of the
three years in the period ended June 30, 2000..............................................40
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission have been omitted as
not required, not applicable or the information required has been included
elsewhere in the consolidated financial statements and notes thereto.
22
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To K-tel International, Inc.:
We have audited the accompanying consolidated balance sheet of K-tel
International, Inc. (a Minnesota corporation) and subsidiaries as of June 30,
2000, and the related consolidated statements of operations, shareholders'
equity (deficit) and cash flows for the year then ended. These consolidated
financial statements and the schedule referred to below are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements and schedule based on
our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of K-tel
International, Inc. and subsidiaries as of June 30, 2000, and the
consolidated results of their operations and their consolidated cash flows
for the year then ended, in conformity with accounting principles generally
accepted in the United States of America.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index to
consolidated financial statements is presented for purposes of complying with
the Securities and Exchange Commissions rules and is not part of the basic
financial statements. The amounts in this schedule related to the year ended
June 30, 2000, have been subjected to the auditing procedures applied in our
audit of the basic financial statements and, in our opinion, fairly states in
all material respects the financial data required to be set forth therein in
relation to the basic June 30, 2000 consolidated financial statements taken as
a whole.
/S/ GRANT THORNTON LLP
Minneapolis, Minnesota,
August 23, 2000
23
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To K-tel International, Inc.:
We have audited the accompanying consolidated balance sheets of K-tel
International, Inc. (a Minnesota corporation) and subsidiaries as of June 30,
1999 and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the two years in the period ended June 30,
1999. These consolidated financial statements and the schedule referred to
below are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of K-tel International, Inc.
and subsidiaries as of June 30, 1999 and the results of their operations and
their cash flows for each of the two years in the period ended June 30, 1999,
in conformity with generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index to
consolidated financial statements is presented for purposes of complying with
the Securities and Exchange Commissions rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in our audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required
to be set forth therein in relation to the basic consolidated financial
statements taken as a whole.
/S/ ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
September 27, 1999
24
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30
(IN THOUSANDS - EXCEPT SHARE DATA)
ASSETS 2000 1999
- ---------------------------------------------------------------- ------------------ -----------------
Current Assets:
Cash and cash equivalents $ 2,475 $ 6,782
Accounts receivable, less allowances of $1,704 and $1,400 11,432 12,701
Inventories 3,221 7,644
Royalty advances 349 927
Prepaid expenses and other 1,412 2,146
------------ -------------
Total Current Assets 18,889 30,200
Property and Equipment, net of
accumulated depreciation and amortization
of $3,703 and $3,100 939 1,549
Other Assets 3,371 4,167
------------ -------------
$ 23,199 $ 35,916
============ =============
LIABILITIES AND SHAREHOLDERS'
EQUITY (DEFICIT)
- -----------------------------------------------------------
Current Liabilities:
Current portion of notes payable $ 1,924 $ 2,633
Note payable to affiliate 1,945 1,945
Accounts payable 5,944 3,774
Accrued royalties 11,649 8,851
Reserve for returns 5,069 4,375
Other current liabilities 5,265 6,546
------------ -------------
Total Current Liabilities 31,796 28,124
------------ -------------
Notes Payable, net of current portion 4,000 4,000
Commitments and Contingencies (Note 8)
Shareholders' Equity (Deficit): (Note 7)
Common stock - 50,000,000 shares authorized;
par value $.01; 10,320,405 and 10,241,199
issued and outstanding 103 102
Additional Paid-In Capital 20,213 21,113
Accumulated Deficit (32,154) (16,416)
Cumulative translation adjustment (759) (1,007)
------------ -------------
Total Shareholders' Equity (Deficit) (12,597) 3,792
------------ -------------
$ 23,199 $ 35,916
============ =============
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN
INTEGRAL PART OF THESE BALANCE SHEETS.
25
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30
(IN THOUSANDS - EXCEPT SHARE AND PER SHARE DATA)
2000 1999 1998
----------------------------------------------
NET SALES $ 58,604 $ 77,664 $ 85,626
------------ ----------- -----------
COSTS AND EXPENSES:
Cost of goods sold 37,476 42,073 47,670
Advertising 14,132 16,494 16,808
Selling, general & administrative 25,230 29,249 23,683
------------ ----------- -----------
Total costs and expenses 76,838 87,816 88,161
------------ ----------- -----------
OPERATING LOSS (18,234) (10,152) (2,535)
------------ ----------- -----------
NON-OPERATING INCOME (EXPENSE):
Interest income 141 34 48
Interest expense (833) (777) (490)
Foreign currency transaction loss (546) (587) (16)
Gain on sale of subsidiary 4,341 --- ---
Other income (expense) (600) --- 614
------------ ----------- -----------
Total non-operating income (expense) 2,503 (1,330) 156
------------ ----------- -----------
LOSS BEFORE PROVISION
FOR INCOME TAXES (15,731) (11,482) (2,379)
PROVISION FOR INCOME TAXES 7 65 28
------------ ----------- -----------
NET LOSS $ (15,738) $ (11,547) $ (2,407)
============ =========== ===========
LOSS PER SHARE - BASIC AND DILUTED $ (1.58) $ (1.25) $ (.31)
SHARES USED IN THE CALCULATION OF
LOSS PER SHARE - BASIC AND DILUTED 9,948 9,224 7,736
OTHER COMPREHENSIVE (LOSS) INCOME:
Net loss $ (15,738) $ (11,547) $ (2,407)
Foreign currency (loss) gain 248 ---- (43)
============ =========== ===========
OTHER COMPREHENSIVE (LOSS) INCOME $ (15,490) $ ( 11,547) $ (2,450)
============ =========== ===========
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN
INTEGRAL PART OF THESE STATEMENTS.
26
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30
(IN THOUSANDS)
Accumulated
Common Stock Additional Other
------------------------- Paid-In Accumulated Comprehensive
Shares Amount Capital Deficit (Loss) Total
- --------------------------------------------------------------------------------------------------------------------
Balance, July 1, 1997 7,568 $ 76 $ 7,930 $ (2,462) $ (964) $ 4,580
Net loss -- -- -- (2,407) -- (2,407)
Proceeds from exercise of
stock options 749 7 1,637 -- -- 1,644
Translation adjustment -- -- -- -- (43) (43)
-------- ------- -------- --------- ---------- ---------
Balance, June 30, 1998 8,317 83 9,567 (4,869) (1,007) 3,774
Net loss -- -- -- (11,547) -- (11,547)
Proceeds from exercise of
stock options 1,459 14 7,471 -- -- 7,485
Proceeds from private
equity placement 466 5 3,995 -- -- 4,000
Contribution of services -- -- 80 -- -- 80
-------- ------- -------- --------- ---------- ---------
Balance, June 30, 1999 10,242 102 21,113 (16,416) (1,007) 3,792
Net loss -- -- -- (15,738) -- (15,738)
Proceeds from exercise of
stock options 545 6 3,095 -- -- 3,101
Payment for cancellation of
private equity placement (466) (5) (3,995) -- -- (4,000)
Translation adjustment -- -- -- -- 248 248
-------- ------- -------- --------- ---------- ---------
Balance, June 30, 2000 10,321 $ 103 $ 20,213 $(32,154) $ (759) $ (12,597)
-------- ------- -------- --------- ---------- ---------
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN
INTEGRAL PART OF THESE STATEMENTS.
27
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30
(IN THOUSANDS)
2000 1999 1998
------------ ---------- ----------
Cash Flows From Operating Activities:
Net loss $ (15,738) $ (11,547) $ (2,407)
Adjustment to reconcile net loss to cash
used for operating activities:
Depreciation and amortization 2,179 1,520 1,060
Loss on valuation of marketable securities --- --- 514
Changes in operating assets and liabilities:
Accounts receivable 1,101 2,471 1,427
Inventories 4,366 (1,281) (1,997)
Royalty advances 572 527 75
Prepaid expenses and other 616 782 (936)
Accounts payable and other 1,109 (2,653) 3,043
Accrued royalties 2,811 408 (2,809)
Reserve for returns 727 (350) (348)
------------ ----------- -----------
Cash used for operating activities (2,257) (10,123) (2,378)
------------ ----------- -----------
Investing Activities:
Purchases of property and equipment (219) (392) (1,620)
Proceeds from sale of property and equipment 16 --- 4
Change in net assets of business to be sold --- 615 ---
Additions to music catalog (453) (877) (932)
Acquisition of Regal Shop International --- --- (350)
Other (196) 190 (348)
------------ ----------- -----------
Cash used for investing activities (852) (464) (3,246)
------------ ----------- -----------
Financing Activities:
Proceeds (payments) of long term debt --- (183) 4,178
Proceeds (payment) on line of credit, net (708) (1,105) 2,902
Proceeds (payment) on note payable to affiliate --- 945 (500)
Proceeds from exercise of stock options 3,101 7,485 1,644
Proceeds from(payments for) private equity placement (4,000) 4,000 ---
Contribution of services --- 80 ---
------------ ----------- -----------
Cash provided by (used in) financing activities (1,607) 11,222 8,224
Effect of Exchange Rate Changes on
Cash and Cash Equivalents 409 206 ---
------------ ----------- -----------
Net Increase (Decrease) in Cash and Cash Equivalents (4,307) 841 2,600
Cash and Cash Equivalents at Beginning of Year 6,782 5,941 3,341
------------ ----------- -----------
Cash and Cash Equivalents at End of year $ 2,475 $ 6,782 $ 5,941
============ =========== ===========
Supplemental Cash Flow Information
Cash Paid For -
Interest $ 799 $ 867 $ 476
============ =========== ===========
Income Taxes $ 1 $ 60 $ 60
============ =========== ===========
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN
INTEGRAL PART OF THESE STATEMENTS.
28
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000, 1999 AND 1998
1. BUSINESS AND LIQUIDITY
K-tel International, Inc. (the "Company", "K-tel", or the "Registrant")
was incorporated in 1968. Our corporate offices are located in
Minneapolis, Minnesota. K-tel markets and distributes entertainment and
consumer products internationally. With more than 35 years of marketing
experience in the United States and Europe, the Company has developed
the resources, knowledgeable personnel, information systems, and
distribution capabilities to market music and consumer products through
traditional retail and direct-response marketing channels. The Company
also markets through an Internet e-commerce site, K-tel.com
(www.ktel.com), which features a wide spectrum of music products.
K-tel.com offers on-line shoppers the convenience and access to a
substantial number of music at value prices.
The Company experienced negative cash flow of $2,257,000 from
operations in fiscal 2000 and utilized another $852,000 for investing
activities. These cash requirements were satisfied principally from
borrowings under its credit facilities and from the exercise of stock
options. As of June 30, 2000, the Company had $340,000 available for
borrowings under its Foothill Capital Corporation ("Foothill") credit
facility.
On September 27, 1999, K-tel entered into a written Line of Credit
Agreement with K-5 Leisure Products, Inc. ("K-5"), an affiliate
controlled by the Company's Chairman of the Board and Chief Executive
Officer. Under the terms of the agreement, K-5 agreed to make available
up to $8,000,000 on a revolving basis. The loan bears interest at a
variable rate based upon the "base rate" of a local lending institution
and expires on November 20, 2001. The K-5 loan is subordinated to the
Foothill loan. K-tel has pledged the stock of its foreign subsidiaries
as collateral for the loan. K-5 and Foothill have agreed that, if
Foothill were to give notice of its intention to accelerate its loan,
K-5 would have the right to pay Foothill and assume the secured
creditor position of Foothill. Additionally, K-5 has indicated to K-tel
that it would assume the secured creditor's position in the event that
Foothill accelerated amounts due under the Foothill loan, and K-5 has
sufficient financial resources to do so. Management currently believes
that K-tel has sufficient cash and borrowing capacity to ensure the
Company will continue operations in the near term.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial
statements include the accounts of K-tel International, Inc. and its
domestic and foreign subsidiaries, all of which are wholly owned. All
significant intercompany accounts and transactions have been
eliminated.
REVENUE RECOGNITION - Revenue is generally recognized upon shipment to
the customer. Most music sales are made with the right of return of
unsold units. Estimated reserves for returns are established by
management based on historical experience and product mix and are
subject to the ongoing review and adjustment by the Company. No
customer represented greater than 10% of net sales for the years ended
June 30, 2000, 1999 or 1998.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents consist
principally of cash, and short-term, highly liquid investments with
original maturities of less than ninety days.
INVENTORIES - Inventories are valued at the lower of cost, determined
on a first-in, first-out basis, or net realizable value. The cost of
finished goods includes all direct product costs.
RIGHTS TO USE MUSIC PRODUCT- Certain of the Company's compilation
products are master recordings under license from record companies and
publishers. In most instances, minimum guarantees or non-returnable
29
advances are required to obtain the licenses and are realized through
future sales of the product. The amounts paid for minimum guarantees or
non-returnable advances are capitalized and charged to expense as sales
are made. When anticipated sales appear to be insufficient to fully
recover the minimum guarantees or non-returnable advances, a provision
against current operations is made for anticipated losses. The
unrealized portion of guarantees and advances is included in royalty
advances in the accompanying consolidated balance sheets. Licenses are
subject to audit by licensors.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost.
Depreciation and amortization is provided using straight line or
declining balance methods over the estimated useful lives of the assets
which range from three to nine years.
SOFTWARE DEVELOPMENT COSTS - During the application and development
stage of the software for K-tel On-line, payroll and other direct costs
of materials and services incurred were capitalized. Such costs are
being amortized on the straight-line basis over three years.
ROYALTIES - The Company has entered into license agreements with
various record companies and publishers under which it pays royalties
on units sold. The Company accrues royalties using contractual rates
and certain estimated rates on applicable units sold. The contractual
royalty liability is computed quarterly and the accrued royalty balance
is adjusted accordingly. The royalty agreements are subject to audit by
licensors.
ADVERTISING - The Company expenses the costs of advertising when the
advertising takes place, except for direct response advertising, which
is capitalized and amortized over its expected period of future
benefits. Direct response advertising consists primarily of television
advertising whereby customers respond specifically to the advertising
and where the Company can identify the advertising that elicited the
response. At June 30, 2000 and 1999, $741,000 and $258,000,
respectively, was reported as a prepaid advertising expense in the
accompanying balance sheet. Advertising expense was $14,132,000,
$16,494,000 and $16,808,000 for each of the years ended June 30, 2000,
1999 and 1998.
FOREIGN CURRENCY - The operations of all foreign entities are measured
in local currencies. Assets and liabilities are translated into U.S.
dollars at year end exchange rates. Revenues and expenses are
translated at the average exchange rates prevailing during the year.
Adjustments resulting from translating the financial statements of
foreign entities into U.S. dollars are recorded as a separate component
of shareholders' equity.
STOCK-BASED COMPENSATION - The Company accounts for stock-based awards
to employees using the intrinsic value method and recognizes
compensation expense for certain stock based awards granted to
employees. Certain pro forma information as if the Company adopted the
fair value method of accounting for stock based compensation is
presented in Note 7.
INCOME TAXES - Deferred income taxes are provided for temporary
differences between the financial reporting basis and tax basis of the
Company's assets and liabilities at currently enacted tax rates.
NET LOSS PER SHARE - Basic and diluted loss per share have been
computed by dividing net loss by the weighted average number of shares
outstanding during the period. For all periods presented common stock
equivalents were excluded from the per share calculation as the net
effect would be antidilutive.
USE OF ESTIMATES - Preparing consolidated financial statements in
conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities, disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Principal estimates include allowances for bad debts,
inventory valuation, return reserves, royalty obligations, purchase
commitments and product replacement costs. Ultimate results could
differ from those estimates.
30
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS - 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 as amended by SFAS 137 is effective for
financial statements for fiscal years beginning after June 15, 2000.
The Company will begin implementing the reporting provisions required
under SFAS No. 133 for the fiscal year beginning July 1, 2000.
Management does not expect implementation of these reporting provisions
to have a material impact on the Company's disclosures or results of
operations.
3. SALE OF SUBSIDIARY
On September 10, 1999 the Company sold its subsidiary, K-tel
International (Finland) OY and recognized a gain of $4,341,000 on the
sale. During 1999 and 1998, the subsidiary had net sales of $6,225,000
and $5,988,000 and income from operations of $169,000 and $428,000.
4. NOTES PAYABLE
Notes payable consists of the following:
2000 1999
--------------- --------------
Term Loan $ 4,000,000 $ 4,000,000
Revolving Line of Credit 1,924,000 2,633,000
--------------- --------------
5,924,000 6,633,000
Less Current Portion 1,924,000 2,633,000
--------------- --------------
Long Term Portion $ 4,000,000 $ 4,000,000
=============== ==============
K-tel has a $10,000,000 credit facility with Foothill, consisting of a
$4,000,000 term loan due in full on November 20, 2001, and a $6,000,000
revolving facility, under which borrowings are limited to a percent of
eligible receivables, that expires on 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 (9.5% at June 30, 2000) 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 shareholders' equity by K-tel,
limitations on capital expenditures, restrictions on music library
acquisitions, limitations on other indebtedness and restrictions on
dividends paid by K-tel. K-tel has guaranteed the obligations of its
U.S. subsidiaries under the credit facility and has pledged the stock
of those subsidiaries and its assets to secure K-tel's obligations
under its guaranty. As of June 30, 2000, $4,000,000 was outstanding
under the term loan, $1,924,000 was outstanding under the line of
credit and the maximum additional available under the borrowing
limitations was $340,000. At June 30, 2000, K-tel was in compliance
with all covenants, limitations and restrictions of the credit
agreement except for the minimum shareholders' equity covenant, for
which it obtained a waiver from the lender for the period ended June
30, 2000. Effective July 1, 2000, the stated rate of interest was
amended to the lenders "base rate" plus one percent.
5. NOTE PAYABLE TO AFFILIATE
On September 27, 1999, K-tel entered into a written Line of Credit
Agreement with K-5. Under the terms of the agreement, which expires on
November 20, 2001, K-5 agreed to make available up to $8,000,000 on a
revolving basis. The loan bears interest at a variable rate based upon
the "base rate" of a local lending institution (9.5% at June 30, 2000)
on the unpaid principal amount of financing which is due on demand.
31
As of June 30, 2000 and 1999, $1,945,000 was outstanding to K-5. The
loan is subordinated to the Foothill loan and K-tel has pledged the
stock of its foreign subsidiaries as collateral for the loan.
6. INCOME TAXES
The Company operates in several countries and is subject to various tax
regulations and tax rates. The provisions for income taxes are computed
based on income reported for financial statement purposes in accordance
with the tax rules and regulations of the taxing authorities where the
income is earned.
The provision (benefit) for income taxes consists of the following for
the years ended June 30 (in thousands):
2000 1999 1998
------------ ---------- ----------
Loss before provision (benefit) for income taxes:
United States $ (9,470) $ (9,244) $ (3,702)
Foreign (6,268) (1,958) 1,323
----------- ----------- ---------
Total $ (15,738) $ (11,202) $ (2,379)
=========== =========== =========
Provision (benefit) for income taxes:
Current payable
United States $ 2 $ --- $ (119)
Foreign 5 65 147
----------- ----------- ---------
Total current payable and
total provision for income taxes $ 7 $ 65 $ 28
=========== =========== =========
A reconciliation of the U.S. Federal statutory rate to the effective
tax rate for the years ended June 30 are as follows:
2000 1999 1998
------------- ---------- ----------
Federal statutory rate 34% 34% 34%
State Taxes, net of Federal benefit 2 2 2
Change in valuation allowance (36) (36) (39)
Effect of different tax rates on foreign earnings --- (1) 2
------------- ---------- ----------
--- (1)% (1)%
------------- ---------- ----------
Deferred income taxes are provided for the temporary differences
between the financial reporting basis and the tax basis of the
Company's assets and liabilities. Temporary differences, which are all
deferred tax assets, are as follows (in thousands):
June 30, June 30,
2000 1999
------------- -----------
Net operating loss carryfowards $ 15,685 $ 17,599
Alternative minimum tax credits 432 432
Reserve for returns 1,064 1,384
Depreciation and amortization 283 317
Royalty reserves 1,900 447
Inventory reserves 1,312 464
Nondeductible accruals 1,734 1,130
32
Allowance for bad debts 485 488
Valuation allowance (22,895) (22,261)
--------------------------
$ --- $ ---
--------------------------
A valuation allowance equal to the aggregate amount of deferred tax
assets has been established until such time as realizability is more
likely than not.
For U.S. tax reporting purposes, the Company has net operating loss
carryforwards ("NOL") of approximately $43,500,000. Of this amount
approximately $8,492,000 is available only through the year 2001 while
$22,744,000 and $10,645,000 will be available through 2013 and 2019
respectively. The rest of the NOL carryforward will be available
through the year 2020. However, of the amount available through 2013
and 2020, $20,100,000 relates to deductions associated with the
exercise of stock options. The tax benefit of approximately $7,236,000
associated with this stock option deduction will be recorded as
additional paid-in capital when realized. The NOL carryforwards may be
reduced in future years, without financial statement benefit, to the
extent of intercompany dividends received from foreign subsidiaries.
Also, the NOL carryforwards are subject to review and possible
adjustment by taxing authorities. In addition, the Company has
approximately $432,000 in U.S. federal alternative minimum tax credits
which may be utilized in the future to offset any regular corporate
income tax liability. NOL's available in foreign countries approximated
$9,600,000 as of June 30, 2000.
7. CAPITAL TRANSACTIONS
SECURITIES PURCHASE AGREEMENT
On April 21, 1999, the Company entered into a Securities Purchase
Agreement with two investors, pursuant to which the Company would sell
in a private placement transaction, up to $18.0 million of the
Company's common stock in two tranches. The first tranche was to have
totaled $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 was to sell an additional $4.0 million of
common stock, on the effective date of a registration statement. Under
the terms of the Agreement, the purchasers were to be entitled to
acquire additional shares pursuant to a warrant. 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. In July 1999, a
contractual dispute arose between the purchasers and K-tel and the
$4,000,000 balance on the first tranche was not sold.
On August 3, 1999, the Company entered into an agreement with the two
purchasers of its common stock to terminate and void those agreements
and to repurchase, for $4,600,000, the purchasers' common stock
totaling 465,794 shares and warrants to acquire additional shares. The
Company has no further obligation to sell additional stock to the
purchasers, who were also relieved of obligations to purchase
additional shares. As a part of the settlement, the purchasers released
the Company from all claims and dismissed with prejudice the lawsuit
which they had commenced against the Company, resulting in an expense
of $600,000, which was reported in other expense in the consolidated
statement of operations for the fiscal year ended June 30, 2000.
The accompanying balance sheet as of June 30, 1999, includes the
465,794 shares of common stock issued for $4,000,000 on April 21, 1999,
and the computation of the 1999 loss per share considers these shares
for the time they were issued in fiscal 1999. These shares were not
outstanding as of June 30, 2000.
STOCK INCENTIVE PLAN
The Company has in place a Stock Incentive Plan for officers and other
key employees of the Company. Under the terms of this plan the Board of
Directors has the sole authority to determine the employees to whom
options and awards are granted, the type, size and terms of the awards,
timing of the grants, the
33
duration of the exercise period and any other matters arising under
the plan. The common stock incentives may take the form of incentive
stock options, nonqualified stock options, stock appreciation rights
and/or restricted stock. The Company's 1987 plan covered a maximum of
700,000 shares of common stock. No additional shares can be granted
from this plan and 2,550 shares remain exercisable, and options for
495,400 shares were granted. In February 1997, the Company's Board of
Directors approved a new stock option plan covering a maximum of
600,000 shares of common stock. In February 1999, the Company's
shareholders voted to increase the maximum shares under the 1997 plan
to 2,000,000 shares. In January 2000, the Company's shareholders voted
in to crease the maximum shares to 3,500,000. There were 3,419,117 net
shares granted under this plan as of June 30, 2000.
RESTRICTED AND NON-QUALIFIED STOCK OPTIONS
In addition to stock options granted under the terms of the Stock
Incentive Plan, the Board of Directors has the sole authority to grant
employees, officers and directors restricted and non-qualified stock
options outside the Stock Incentive Plan. The Board of Directors
determines the type, size and terms of the grants, timing of the
grants, the duration of the exercise period and any other matters
pertaining to options or awards granted outside of the Stock Incentive
Plan.
The share information for all plans is summarized below:
Weighted
Incentive Stock Non-Qualified Restricted Stock Average
Options Stock Options Options Exercise Price
-------------------- ----------------- -------------------- -----------------
Outstanding July 1, 1997 244,776 44,000 885,000 $2.01
Granted 590,000 500,000 231,000 9.47
Exercised (247,100) (47,000) (455,000) 2.01
Canceled (7,100) -- -- 3.08
-------------------- ----------------- -------------------- -----------------
Outstanding June 30, 1998 580,576 497,000 661,000 7.68
Granted 329,650 1,657,500 -- 8.28
Exercised (232,676) (580,061) (646,000) 5.13
Canceled (407,340) (521,000) (15,000) 12.31
-------------------- ----------------- -------------------- -----------------
Outstanding June 30, 1999 270,210 1,053,439 -- 8.09
Prior Year Adjustment(1) 606,939 (606,939)
Granted 2,092,000 180,000 -- 5.64
Exercised (540,000) (5,000) -- 5.69
Canceled (218,593) (124,500) -- 7.13
-------------------- ----------------- -------------------- -----------------
Outstanding June 30, 2000 2,210,556 497,000 -- $6.72
==================== ================= ==================== =================
(1) Adjustment reflects options disclosed previously as non-qualified
that should have been recorded as incentive.
The options outstanding at June 30, 2000 have exercise prices ranging
from $5.60 to $8.73, with a weighted average exercise price of $6.72.
The weighted average remaining contractual life for all outstanding
options is 9.2 years. At June 30, 2000, there were 1,883,032 options
exercisable at a weighted average exercise price of $6.56.
34
PRO FORMA OPTION INFORMATION
Had compensation costs for the Company's stock option plans been
recorded at fair value, the Company's pro forma net loss and loss per
share would have been as follows:
2000 1999 1998
------------ ----------- -----------
Net loss (in thousands):
As reported $ (15,738) $ (11,547) $ (2,407)
Pro forma $ (26,189) $ (18,788) $ (3,577)
Basic and diluted EPS:
As reported $ (1.58) $ (1.25) $ (.31)
Pro forma $ (2.85) $ (2.16) $ (.46)
The weighted average fair value of options granted in fiscal 2000 was
$4.86 , in 1999 was $5.91, and $6.10 in fiscal 1998.
The fair value of each option is estimated on the date of grant using
the Black-Scholes option pricing model. The following assumptions were
used to estimate the fair value of options:
2000 1999 1998
---- ---- ----
Risk-free interest rate 6.00% 4.25% 5.12%
Expected life 5 years 5 years 5 years
Expected volatility 120% 100% 100%
Expected dividend yield None None None
Because the fair value provisions have not been applied to options
granted prior to June 30, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
8. COMMITMENTS AND CONTINGENCIES
CLASS ACTION LAWSUIT
K-tel and certain of its current and former officers and directors are
defendants in IN RE K-TEL INTERNATIONAL, INC. SECURITIES LITIGATION,
No. 98-CV-2480. This action consolidates twenty three purported class
actions that were initially filed in various United States District
Courts in November, 1998, and were subsequently transferred to, and
consolidated in the United States District Court for the District of
Minnesota. On July 19, 1999, the plaintiffs filed an amended
consolidated class action complaint that challenges the accuracy of
certain public disclosures made by K-tel regarding its financial
condition during the period May 1998 through November 1998. The
plaintiffs assert claims under the federal securities laws and seek
damages in an unspecified amount as well as costs, including attorneys'
fees and any other relief the Court deems just and proper. K-tel moved
to move to dismiss the Complaint, and, on July 31, 2000, the U.S.
District Court granted the Company's motion to dismiss. It also barred
further actions by the plaintiffs and denied plaintiffs' request to
amend the complaint in order to refile the complaint in the future.
While the plaintiffs have appealed this decision, the Company feels
that the original decision will stand. K-tel has two insurance policies
providing coverage of up to $20,000,000. The insurers are providing for
the defense of the claims in the class action lawsuit subject to their
reservations of legal rights under the applicable insurance policies.
Under their reservations of rights, the insurers could contest their
obligations to indemnify the Company and its directors and officers.
35
EARLY V. K-TEL INTERNATIONAL, INC.
On January 11, 1999, The Company was named in a lawsuit entitled
CHRISTOPHER EARLY VS. K-TEL INTERNATIONAL, INC., ET AL, brought in the
Circuit Court of Cook County, Illinois, against the Company and certain
of its subsidiaries by Christopher Early. The suit also names as
defendants certain other manufacturers, distributors and a number of
nationwide retailers. The plaintiff seeks damages on behalf of himself
and a purported class of purchasers of cassette tapes and compact discs
produced, distributed and/or sold by the defendants. The plaintiff
claims that the defendants engaged in deceptive and misleading
packaging of cassette tapes and compact discs by failing to give proper
notice to consumers that the songs contained therein are not the
original recordings by the original artists. The complaint also alleges
consumer fraud, deceptive and unfair practices, and fraud in connection
with website advertising and marketing. Similar litigation against the
Company had been brought by Mr. Early in 1997, and was dismissed by a
U.S. Federal Court in 1999 on jurisdictional grounds. The Company
denies that it mislabeled cassette tapes and compact discs or engaged
in fraudulent or deceptive conduct and intends to vigorously defend the
purported action, which seeks an undetermined amount of compensatory
damages and punitive damages in the amount of $10 million, an
injunction and costs incurred in the litigation, including attorneys
fees. The Company has filed a motion to dismiss the complaint. Based
upon information available to it, the Company further believes that
damages, if any, are speculative and that there are no grounds for an
award of punitive damages. While discovery has not yet begun and no
assurance can be given that the Company will be successful in defending
this action, the Company believes it has meritorious defenses to the
plaintiff's claims.
OTHER LITIGATION AND DISPUTES
K-tel is involved in several legal actions in the ordinary course of
its business. Although the outcomes of any such legal actions cannot be
predicted, in the opinion of management, there is no legal proceeding
pending or asserted against or involving K-tel for which the outcome is
likely to have a material adverse effect upon the consolidated
financial position or results of operations of K-tel.
INVENTORY
Certain of the recordings in the Company's music compilations require
the advance payment of royalties, publishing rights or commitments to
purchase a minimum number of CDs or cassettes. The royalty and
publishing amounts, which are advanced based on these commitments, may
not be recoverable if the sales of the CDs and cassettes do not meet
the contractual minimum. When it is determined that a royalty advance
will not be recovered, it is charged to expense in that period. In
addition, the Company may be required to purchase additional inventory
or re-negotiate contracts related to products which had a minimum
purchase commitment that is not being met. As of June 30, 2000, the
Company had commitments to purchase approximately $1,914,000 of
inventory on guaranteed contracts. A reserve for possible future losses
on these purchase commitments of approximately $844,000 and $750,000 at
June 30, 2000 and 1999, respectively, has been recorded in other
current liabilities on the balance sheet.
36
ROYALTIES
The Company has received an audit claim for $9.4 million from the Harry
Fox Agency, Inc. covering the period July 1, 1994 through June 30,
1998. The Company has received similar audits in the past and,
following extensive research, generally arrives at a substantially
lower settlement. During the year ended June 30, 2000, the Company
adjusted its royalty reserve to allow for an eventual settlement and
feels its reserve is adequate.
LEASES
The Company has entered into several office and warehouse leases which
expire through 2003. Commitments under these leases are $808,000 in
2001, $761,000 in 2002 and $430,000 in 2003. Rental expense was
$1,007,000 in 2000, $956,000 in 1999 and $885,000 in 1998.
OTHER
The Company has made certain commitments for marketing and advertising
services relating to K-tel.com that will require payments of $20,000
per month through October 2000.
9. RELATED PARTY TRANSACTIONS
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 June 30, 2000 and 1999, the Company had a loan balance
with K-5 of $1,945,000. The Company pays interest on the unpaid
principal amount of financing at a variable rate based upon the "base
rate" of a local lending institution, until repayment of the loan,
which is due on demand. The Company incurred interest of $184,000 in
2000, $186,000 in 1999 and $95,000 in 1998.
The Company purchased approximately $198,000 in fiscal 2000, $34,000 in
fiscal 1999 and $334,000 in fiscal 1998 of consumer products from an
affiliate controlled by the Company's Chairman of the Board and Chief
Executive Officer. There was a payable amount of $150,000 at June 30,
2000, $51,000 at June 30, 1999 and $9,000 at June 30, 1998.
The Company sold approximately $174,000 during fiscal 2000, $12,000
during fiscal 1999 and $39,000 during fiscal 1998 of consumer
convenience products to an affiliate controlled by the Company's
Chairman of the Board and Chief Executive Officer. There was a balance
receivable from the affiliate of $224,000 at June 30, 2000, $33,000 at
June 30, 1999 and $4,000 at June 30, 1998. Outstanding balances are
settled on a timely basis. No interest was charged on the related
outstanding balances during fiscal 2000.
During 1999, K-5 retained the services of a consultant to assist it in
matters relating to its operations, as well as those of the Company.
Services paid to the consultant in fiscal 1999 on behalf of the Company
was $80,000 and was recorded as a contribution to additional
paid-in-capital.
10. BUSINESS SEGMENT AND GEOGRAPHIC AREA DATA
The Company markets and distributes entertainment and consumer products
internationally. K-tel's businesses are organized, managed and
internally reported as four segments: retail music sales, music
licensing, direct response consumer sales and e-commerce. These
segments are based on differences in products, customer type and sales
and distribution methods. The Company has curtailed or discontinued the
operations of its video and third party media buying businesses and
these are collectively shown in the Other column below.
37
The retail music segment consists primarily of the sales of
pre-recorded music both from the Company's music master catalog and
under licenses obtained from other record companies, as well as
pre-recorded music developed by other companies who desire to use K-tel
for sales and distribution of their music products. The Company sells
compact discs, cassettes and albums directly to retailers, wholesalers
and rack service distributors that stock and manage inventory within
music departments for retail stores. The operations of K-tel Finland
were included in this segment during 1999 and 1998.
The Company licenses its master music catalog, consisting of original
recordings and re-recordings of music from the 1950's through today.
The Company also licenses the rights to master recordings to third
parties world-wide, for use in albums, films, television programs, and
commercials, for either a flat fee or a royalty based on the number of
units sold.
The Company's consumer products business, which is concentrated in
Europe, consists primarily of housewares, consumer convenience items
and exercise equipment. The Company concentrates on products that have
the potential for worldwide appeal and that are innovative, readily
demonstrated and inexpensive (generally retailing for less than $100).
In Europe, the Company engages in an extensive amount of direct
response marketing. European direct response business is solicited
through television and radio advertising campaigns.
The Company's e-commerce business, K-tel On-line, enables customers to
choose from brand-name recordings as well as K-tel compilations. K-tel
On-line also gives customers the opportunity to create their own custom
CD compilations from our master music catalog.
Operating profits or losses of these segments include an allocation of
general corporate expenses.
BUSINESS SEGMENT
INFORMATION Consumer Corporate/ Total
Music Products Licensing Internet Other Elimination Company
- ----------------------- ----------- ---------- ----------- -------- ------- ----------- ---------
Net Sales 2000 $ 25,739 $ 29,117 $ 3,698 $ 955 $ 15 $ (920) $ 58,604
1999 40,329 33,014 4,272 400 717 (1,068) 77,664
1998 41,611 25,329 3,808 39 15,772 (933) 85,626
Operating 2000 $ (11,308) $ (5,387) $ 819 $ (1,626) $ (732) -- $ (18,234)
Income (loss) 1999 (5,301) (1,942) 2,052 (2,231) (2,730) -- (10,152)
1998 (1,315) 844 1,640 (481) (3,223) -- (2,535)
Assets 2000 $ 12,170 $ 7,785 $ 1,518 $ 588 $ 101 1,037 $ 23,199
1999 18,422 10,069 2,311 1,177 595 3,342 35,916
1998 19,311 11,699 1,786 781 3,377 2,081 39,035
GEOGRAPHIC INFORMATION
United States Europe Total
- ---------------------------- ------------------- ----------------- ----------
Net Sales 2000 $ 26,404 $ 32,200 $ 58,604
1999 34,851 42,813 77,664
1998 55,883 29,743 85,626
Assets 2000 $ 13,853 $ 9,346 $ 23,199
1999 22,694 13,222 35,916
1998 24,574 14,461 39,035
38
11. FOURTH QUARTER ADJUSTMENTS
During the fourth quarter ended June 30, 2000 the Company made a number of
adjustments which increased expenses and reduced net income by approximately
$8,700,000. The largest were $4,360,000 in increased obsolescence reserves due
to overstocked inventory, changes in customer product mix purchases, and
declining demand for cassette products in the industry; $2,935,000 increase in
the royalty reserve for additional estimated payments owed and unrecouped
royalty advances; and $1,000,000 increase in the reserve for product returns.
12. SUBSEQUENT EVENTS (UNAUDITED)
On July 6, 2000 the Company announced it had closed its German subsidiary,
Dominion Vertriebs Gmbh, effective June 30, 2000. The closing of this subsidiary
is not expected to have a material effect on future operations of the Company.
Sales in fiscal 2000 and 1999 were $17,203,000 and $15,990,000, with net losses
in the same periods were $2,787,000 and $1,790,000.
On August 3, 2000 the Company received notification from Nasdaq that its stock
would be delisted at the opening of business on August 14, 2000. The Company
appealed this initial decision and also applied for listing on the Nasdaq
SmallCap Market. A hearing was conducted by a panel authorized by Nasdaq's Board
of Directors on September 21, 2000. On September 26, 2000 the Company was
notified by the Nasdaq Stock Market Inc. that its Common Stock had been delisted
from the Nasdaq National Market, effective with the open of business September
27, 2000, and that its application for listing on the Nasdaq SmallCap Market was
denied. Delisting of the Company's Common Stock from Nasdaq could have a
material adverse effect on the market price of, and the efficiency of the
trading market for the Company's Common Stock. The Company's Common Stock will
be traded on the Over-the-Counter Bulletin Board ("the OTCBB"). The OTCBB is a
controlled quotation service that offers real-time quote, last sale prices and
volume information in over-the-counter equities.
39
SCHEDULE II
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
For the years ended June 30, 2000, 1999 and 1998
(In thousands)
Balance at Charged to Costs Charged to
Beginning of and Expenses or Other Deductions Balance at End
Period Net Sales Accounts (1) of Period
- -------------------------------------------------------------------------------------------------------------------
Allowance for
Doubtful Accounts
2000 $ 1,400 $ 296 $ (18) $ 26 (2) $ 1,704
1999 $ 661 $ 1,088 $ (3) $ (346) (2) $ 1,400
1998 $ 952 $ 986 $ (1) $ (1,276) (2) $ 661
Reserve for
Returns
2000 $ 4,375 $ 12,230 $ (28) $ (11,508) $ 5,069
1999 $ 4,758 $ 12,094 $ (27) $ (12,450) $ 4,375
1998 $ 4,930 $ 13,943 $ (9) $ (14,106) $ 4,758
(1) Exchange rate change
(2) Uncollectible accounts written off, net of recoveries
40
EXHIBIT INDEX
The Exhibits listed below, which are numbered corresponding to Item 601
of Regulation S-K, are filed as a part of this report.
Exhibit Item
- ------- ----
3 Restated Articles of Incorporation Incorporated herein by reference to the Registrant's
and Restated By-Laws Annual Report on Form 10-K for the year ended June
30, 1985
3.1 Amendment to Articles of Incorporation Incorporated herein by reference to the Registrant's
Quarterly Report on Form 10-Q for the year ended
March 31, 1998
10.1 1987 Stock Incentive Plan Incorporated herein by reference to the Registrant's
Annual Report on Form 10-K for the year ended June
30, 1987
10.2 Non-Qualified Stock Option Agreement - Philip Kives Incorporated herein by reference to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997
10.3 1997 Stock Option Plan Incorporated herein by reference to the Registrant's
Annual Report on Form 10-K for the year ended June
30, 1997
10.4 Loan and Security Agreement - Foothill Capital Incorporated herein by reference to the Registrant's
Corporation Quarterly Report on Form 10-Q for the quarter ended
December 31, 1997
10.5 Non-Qualified Stock Option Agreement - Philip Kives Incorporated herein by reference to the Registrant's
Annual Report on Form 10-K for the year ended June
30, 1998
10.6 Amendment Number One - Loan and Security Incorporated herein by reference to the Registrant's
Agreement - Foothill Capital Corporation Annual Report on Form 10-K for the year ended June
30, 1998
10.7 Amendment Number Two - Loan and Security Incorporated herein by reference to the Registrant's
Agreement - Foothill Capital Corporation Annual Report on Form 10-K for the year ended June
30, 1998
10.8 Restated Amendment Number Two - Loan and Security Incorporated herein by reference to the Registrant's
Agreement - Foothill Capital Corporation. Annual Report on Form 10-K for the year ended June
30, 1998
10.9 Sale and Purchase Agreement relating to Incorporated herein by reference to Exhibit
K-tel International (Finland) Oy by and 10.1 of the Registrant's Current Report on
between K-tel International, Inc. an Form 8-K filed on September 24, 1999
Edel Music AG, dated September 10, 1999.
10.10 Letter Agreement relating to K-tel Incorporated herein by reference to Exhibit
International (Finland) Oy by and 10.2 of the Registrant's Current Report on
between K-tel international, Inc. and Form 8-K filed on September 24, 1999
Edel Music AG, dated September 10, 1999.
10.11 Securities Purchase Agreement by and Incorporated herein by reference to the
between K-tel International, Inc. and two Registrant's Report on Form 8-K filed on
investors, dated April 21, 1999. April 27, 1999
10.12 Settlement Agreement and Mutual Release Incorporated herein by reference to the
of Securities Purchase Agreement Registrant's Report on Form 8-K filed on
Settlement by and between K-tel August 4, 1999
International, Inc. and two investors,
dated August 3, 1999.
10.13 Form of Stock Option Agreement under the Filed herewith
1997 Stock Option Plan
10.14 Form of Stock Option Agreement under the Filed herewith
1997 Stock Option Plan
10.15 Amendment Number Three - Loan and Filed herewith
Security Agreement - Foothill Capital
10.16 Amendment Number Four - Loan and Filed herewith
Security Agreement - Foothill Capital
21 Subsidiaries of the Registrant Filed herewith
23.1 Consent of Independent Certified Public Filed herewith
Accountants-Grant Thornton LLP
23.2 Consent of Independent Public Filed herewith
Accountants-Arthur Andersen LLP
27 Financial Data Schedule Filed herewith
99 Cautionary Statement Filed herewith