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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, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-6664
K-TEL INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Minnesota 41-0946588
(State or other jurisdiction of (I.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 17, 1999, 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 $56,819,500.
As of September 17, 1999, the registrant had 9,775,405 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
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.............................14
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 46 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 two Internet e-commerce sites, K-tel.com
(www.ktel.com) in the United States and (www.ktel.de) in Europe. Both sites
feature a wide spectrum of music, video and consumer products. K-tel.com
features more than 250,000 music titles and 35,000 video titles conveniently
available to on-line shoppers 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 and
albums 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 over 5,000 "Top 100" 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 49% of K-tel's domestic music sales, which is approximately 38% of
its consolidated revenue for fiscal 1999, were derived from five customers:
Handleman Company, Trans World Music Corp., Anderson Merchandisers, 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 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,
3
K-tel's music sales and licensing division is aggressively pursuing these
alternative distribution channels.
E-COMMERCE
K-tel.com, K-tel's virtual music store, enables customers to choose from more
than 250,000 music titles and 35,000 video and DVD 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, competitive pricing, and an auction
service. 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 intends to use
the same combination of resources that has made it a leader in the direct
marketing arena which K-tel pioneered. 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 their e-commerce 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 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," with the balance of the corporate order filled through
traditional manufacturing processes. In April 1999, K-tel entered into an
agreement with FairMarket, Inc. for participation in FairMarket's on-line
community auction service, which is operational on K-tel's e-commerce site.
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
Its 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 and the
Internet (its European site is www.Ktel.de). K-tels 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
4
of the infomercial. In addition, quantity and quality of air time, response
rates and sales generated by each 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.
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 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
5
television and cable air-time than K-tel, as well as greater financial,
distribution and marketing resources. K-tel 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, 1999, K-tel employed 195 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.
ITEM 2: PROPERTIES
K-tel's corporate offices and U.S. operations are located in leased facilities
in a suburb 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 consists of
approximately 3,000 square feet of office space. K-tel's foreign subsidiaries
lease a total of 43,616 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 which 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 plans to move to dismiss the
Complaint. It is not possible at this early stage of the litigation to predict
the outcome of this action with any certainty. 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 March 10, 1997, Christopher Early filed a class action Complaint against
K-tel International, Inc., Dominion Entertainment, Inc., and certain retailers
in the Circuit Court of Cook County, Illinois. The defendants removed the action
to the United States district Court for the Northern District of Illinois on
April 3, 1997. On March 30, 1998, Early obtained leave to file an Amended
Complaint adding K-tel International (USA), Inc. and one additional retailer as
defendants, and purporting to allege class actions under (1) the Illinois
Consumer Fraud and Deceptive Trade Practices Act and (2) the Racketeer
Influenced and Corrupt Organizations Act (RICO), for allegedly deceptive
packaging of certain tapes and compact discs, which packaging allegedly
defrauded consumers into believing that certain recordings thereon were original
rather than new recordings. On behalf of the class, Early purports to seek (1)
treble damages; (2) compensatory damages; (3) punitive damages; (4) an
injunction prohibiting "the further sale of mislabeled tapes and CDs;" and (5)
attorneys' fees and costs. The RICO count in the Amended Complaint has been
dismissed. The federal district court has issued an order purporting to remand
the state law count to the Circuit Court of Cook County, Illinois. Discovery has
not commenced, and the class action aspects of the complaint have not been ruled
upon. K-tel has indemnified the retailer defendants in this matter, and intends
to contest the case vigorously.
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 1999.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to the executive
officers of K-tel at June 30, 1999.
Name of Officer Age Positions and Offices Held
- --------------------- ------- ----------------------------------------------------------
Philip Kives 70 Chairman of the Board and Chief Executive Officer
Lawrence Kieves 51 President
Jeffrey Koblick 52 Executive Vice President, Purchasing and Operations
Steven Kahn 50 Vice President-Finance, Chief Financial Officer, Treasurer
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.
Lawrence Kieves - See "Directors and Executive Officers of the Registrant, Part
III, Item 10.
Steven Kahn joined K-tel in January 1999 as Vice President-Finance, Chief
Financial Officer and Treasurer. From July 1996 to December 1998, he was Vice
President and Chief Financial Officer of ACI Telecentrics, Inc., a provider of
telephone-based sales and marketing services. From August 1995 to June 1996, he
was Vice President and Chief Financial Officer of Shufflemaster Gaming, Inc., a
developer, manufacturer and marketer of automatic card shuffling equipment,
table games and video slot machine game software. From 1989 to 1995, Mr. Kahn
was a divisional Vice President and Controller with ConAgra, a diversified food
company.
7
PART II
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
On September 17, 1999, there were 1,406 record holders of K-tel's common stock
and approximately 9,775,000 shares outstanding. K-tel's common stock trades on
the Nasdaq National Market under the symbol "KTEL."
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. On April 21, 1998, the Board of Directors declared a two
for one stock split of K-tel's common stock in the form of a stock dividend paid
to shareholders of record on May 1, 1998. Prices have been adjusted to reflect
the two for one stock split.
1999 1998
----------------------------- ---------------------------------
High Low High Low
------------ ------------ ------------- -----------
1st Quarter $ 14.375 $ 6.000 $ 3.937 $ 3.062
2nd Quarter $ 32.625 $ 5.188 $ 3.750 $ 3.062
3rd Quarter $ 12.625 $ 8.031 $ 3.938 $ 3.062
4th Quarter $ 9.438 $ 5.125 $ 39.937 $ 3.250
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, 1999. 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.
1999 1998 1997 1996 1995
----------- ---------- ---------- ---------- ----------
Net Sales $ 77,664 $ 85,626 $ 75,501 $ 71,987 $ 65,917
=========== ========== ========== ========== ==========
Operating Income (loss) $ (10,152) $ (2,535) $ 3,582 $ 4 $ (2,188)
=========== ========== ========== ========== ==========
Net Income (loss) $ (11,547) $ (2,407) $ 3,204 $ (745) $ (2.483)
=========== ========== ========== ========== ==========
Net Income (Loss) Per Share
Basic $ (1.25) $ (.31) $ .43 $ (.10) $ (.33)
=========== ========== ========== ========== ==========
Diluted $ (1.25) $ (.31) $ .41 $ (.10) $ (.33)
=========== ========== ========== ========== ==========
Total Assets $ 35,916 $ 39,035 $ 30,492 $ 27,795 $ 28,637
=========== ========== ========== ========== ==========
Long-Term Debt $ 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 through two Internet e-commerce sites, K-tel.com
(www.ktel.com) in the United States and (www.ktel.de) in Europe. Both sites
feature a wide spectrum of music, video and consumer products.
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 $2,499,000 in fiscal 1999, $2,267,000
in fiscal 1998 and $1,433,000 in fiscal 1997 have been allocated to the
segments.
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, is seeing a significant change in its product mix. In fiscal
1998, K-tel began operating K-tel Distribution ("KTD"), which 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.
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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 sight are insignificant in fiscal
1999. The following information relates to 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.
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.
FISCAL 1998 VERSUS FISCAL 1997
Net sales for fiscal 1998 were $85,626,000, an increase of 13.4% from fiscal
1997 sales of $75,501,000. This sales increase can be attributed to the media
buying and the consumer products segments, which increased $7,400,000 and
$1,700,000, respectively, over the prior year. The net loss for fiscal 1998 was
$2,407,000, or $0.31 per share, compared to net income of $3,204,000, or $0.43
per share, in fiscal 1997. Contributing to the fiscal 1998 loss were
10
a $2,300,000 loss related to K-tel's curtailed U.S. third-party media buying
operation; a $1,200,000 fourth quarter loss resulting from both soft sales
and an overall decrease in gross margins on sales of K-tel's domestic
mid-line and budget priced music compilations; $400,000 in start-up costs
incurred by the launch of K-tel's online service; as well as a non-cash loss
of $514,000 recognized on the revaluation of certain securities received in
connection with a previous settlement.
MUSIC
Sales in the music segment were $41,611,000 in fiscal 1998 compared to
$39,661,000 in fiscal 1997. Domestic and European music sales increased $700,000
and $1,306,000, respectively. The domestic music business, which historically
has primarily consisted of sales of music compilations produced by K-tel, began
seeing a change in its product mix. In fiscal 1998, K-tel began operating K-tel
Distribution ("KTD"), which sources other recording labels for sales and
distribution by K-tel. Sales of KTD were $1,600,000 in fiscal 1998.
Cost of goods sold in the music segment increased to 64.5% of sales in fiscal
1998 compared to 56.9% in fiscal 1997. The cost of goods sold in the music
segment has increased due to the increased costs of sales of K-tel's domestic
mid-line and budget priced music compilations. Advertising expense, which
consists primarily of co-operative advertising payments, trade advertising,
promotions and direct TV, was $4,600,000 (10.9% of revenues) in fiscal 1998 and
$6,000,000 (15.0% of revenues) in fiscal 1997. The decrease as a percentage of
revenues was due to reduced spending on domestic TV advertising. Selling,
general and administrative expenses increased 3.5% to $11,500,000 in fiscal
1998, compared to $10,200,000 in fiscal 1997. As a result, the music segment
incurred operating losses of $1,300,000 in fiscal 1998 compared to operating
income of $900,000 in fiscal 1997.
LICENSING
Licensing revenues were $3,808,000 in fiscal 1998 compared to $4,868,000 in
fiscal 1997. Included in such revenues in fiscal 1998 and fiscal 1997 were
approximately $933,000 and $964,000 of inter-company revenues, respectively.
Operating income in the licensing segment was $1,640,000 in fiscal 1998 and
$2,162,000 in fiscal 1997. 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. In fiscal 1997,
operating income was favorably impacted by an $850,000 settlement which was a
result of the recovery of certain legal and other costs related to a dispute
with a third party over certain music licensing rights.
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 four months of operations of K-tel
Marketing Ltd. were included in fiscal 1998.
Sales of consumer products were $25,329,000 in fiscal 1998, a 7.4% increase over
fiscal 1997 sales of $23,586,000. This increase was the result of a $5,000,000
increase in revenues due to the UK acquisition, offset by declines in Germany,
the U.S. domestic market and exports of $3,300,000. Cost of goods sold, as a
percentage of sales, remained constant at 43.6% in fiscal 1998 and fiscal 1997.
Advertising and selling, general and administrative expense growth was
consistent with sales growth at approximately 7.7%. These expenses totaled
$13,448,000 in fiscal 1998 compared to $12,488,000 in fiscal 1997. As a result,
operating income was $844,000 in fiscal 1998 and $796,000 in fiscal 1997.
11
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.
K-tel.com operated for two months in fiscal 1998 and had revenues of $39,000 and
an operating loss of $481,000 including start-up expenses.
OTHER
The other segment of the business is comprised of the third-party media buying
segment and a video segment, both of which have been discontinued. In fiscal
1997, K-tel began operating a third-party media buying business which it
curtailed in the fourth quarter of fiscal 1998. The video segment did not have
revenues in fiscal 1997 or fiscal 1998. Revenue from the third-party media
buying segment was $15,772,000 in fiscal 1998 compared to $8,350,000 in fiscal
1997. Operating losses from these segments were $3,223,000 in fiscal 1998 and
$302,000 in fiscal 1997.
B. LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1999, K-tel had $6,782,000 in cash and cash equivalents, an
increase of $841,000 from the balance at June 30, 1998. During fiscal 1999,
K-tel experienced negative cash flow from operations of $10,123,000 and utilized
$464,000 for investing activities in fixed assets and music catalog additions.
The negative cash flow from operations and investing activities was primarily
financed through additional equity contributions in the form of a private equity
financing and exercise of stock options. In April 1999, K-tel issued 465,794
shares in exchange for $4,000,000 in a private placement transaction. (See
Subsequent Events below.) In addition, in September 1998, the Compensation
Committee of the Board of Directors passed a resolution authorizing the
accelerated vesting of outstanding employee stock options if exercised by
November 30, 1998. Further, in December 1998, the Board of Directors granted to
Philip Kives, the Chairman of the Board and Chief Executive Officer of K-tel, an
option to purchase 200,000 shares at an exercise price of $11.19 per share,
which was exercised. Mr. Kives was also granted an option to purchase 836,000
shares at an exercise price of $8.73 per share in February 1999, of which
229,061 were exercised in March 1999. Cash generated from the exercise stock
options was $7,485,000 during fiscal 1999.
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 (7.75%
at June 30, 1999) and are secured by the assets of certain U.S. subsidiaries,
including accounts receivable, inventories, equipment, music library and general
intangibles. The loan agreement contains certain financial and other covenants
or restrictions, including the maintenance of a minimum 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, 1999,
$4,000,000 was outstanding under the term loan, $2,633,000 was outstanding under
the line of credit and the maximum additional available under the borrowing
limitations was $139,000. At June 30, 1999, K-tel was in compliance with all
covenants, limitations and restrictions of the credit agreement.
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, has from time to
time made advances to K-tel. As of June 30, 1999, K-5 had advanced $1,945,000 to
K-tel. K-tel pays interest on the unpaid principal amount of financing at the
same rate as K-tel pays on the Foothill loan, until repayment of the loan, which
is due on demand. See the Subsequent Events paragraph below.
12
K-tel has primarily funded its operations to date through internally generated
capital, private placement equity financing, bank financing, proceeds from stock
option exercises and advances made by an affiliate of the Chairman of the Board
and Chief Executive Officer. 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 2000 and the availability of credit from its two
lenders.
SUBSEQUENT EVENTS
K-tel entered into a Securities Purchase Agreement with two investors in April
1999, pursuant to which K-tel would have sold in a private placement transaction
up to $18.0 million of its common stock in two tranches. The first tranche was
to have totaled $8,000,000. Pursuant to the agreement, K-tel sold 465,794 shares
of common stock for an aggregate of $4,000,000, or $8.588 per share. K-tel was
obligated to sell an additional $4,000,000 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 to
repurchase the shares. As a result of this repurchase, K-tel incurred
approximately $600,000 in expenses to be recorded in the quarter ending
September 30, 1999.
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 $8,000,000 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 has agreed not to declare a default prior to July 1,
2000 in the event that the Company does 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.
On September 10, 1999, K-tel sold all of the outstanding common stock of its
subsidiary K-tel International (Finland) Oy. ("K-tel Finland") to an
unrelated purchaser. In addition, the Company and the purchaser agreed to
enter into a five-year licensing agreement in two European markets. The two
transactions resulted in cash proceeds of $7,000,000. Net proceeds after
$1,350,000 in transaction costs related to the sale exceeded the net book
value of K-tel Finland's net assets of by approximately $4,400,000, which will
be recorded as a gain in the quarter ending September 30, 1999. 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. Sales in fiscal 1999,
1998 and 1997 were $6,200,000, $6,000,000 and $6,400,00, respectively, and
net earnings in the same periods were $169,000, $428,000 and $225,000,
respectively. Net assets of this subsidiary at June 30, 1999 were $611,000
and are included as assets held for resale in the prepaid expense caption of
the balance sheet.
YEAR 2000 DISCLOSURE
K-tel has developed a plan to ensure its systems are compliant with the
requirements to process transactions in the Year 2000. The majority of K-tel's
internal financial and information systems have been upgraded or are in the
process of being upgraded or replaced with fully compliant new systems. The new
systems implementation related to accounting for royalties is substantially
completed. K-tel is revamping its e-commerce site and expects the site to be
Year 2000 compliant by December 1, 1999. Some of K-tel's customers utilize
equipment to capture and transmit financial transactions. K-tel has made the
necessary updates to this equipment to ensure it will function properly in the
year 2000. K-tel is also working with its processing banks and network providers
to ensure that their systems are Year 2000 compliant. All costs associated with
the processing banks and network providers will be or have been borne by the
processing banks and network providers. K-tel does not rely on any one
significant customer or vendor for its sales or purchases. The failure of any
customer or vendor to achieve Year 2000 compliance is not expected to have a
material impact on K-tel's operations. However, should K-tel, its customers,
13
its vendors or the processing banks fail to resolve Year 2000 issues in a
timely manner, K-tel may lose certain financial and operating data. As of
June 30, 1999, K-tel had incurred less than $200,000 of costs in connection
with its Year 2000 compliance efforts. K-tel estimates that its total cost of
assessing and remedying Year 2000 issues will be less than $200,000.
EURO CONVERSION DISCLOSURE
On January 1, 1999, 11 of the 15 member countries of the European Union
established fixed conversion rates between their existing sovereign currencies
and the euro. The participating countries adopted the euro as their common legal
currency on that date. At this point, K-tel has not yet evaluated or determined
the impact of the euro conversion on K-tel.
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.
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
facility carries a variable interest rate that does have an impact on future
earnings and cashflows. At June 30, 1999, K-tel had fixed rate of debt
$4,000,000 and variable rate debt of $4,578,000. If the interest rate were to
change while K-tel was borrowing under the credit facility, interest expense
would increase or decrease accordingly.
A significant portion of K-tel's revenues during the year ended June 30, 1999
were 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, 1999 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: DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
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.
LAWRENCE KIEVES joined K-tel as President in October 1998 with extensive
experience in the entertainment industry and in public service. He has served as
a director since December 1998. Most recently he served as Managing Director of
EWK Associates, a private company engaged in real-estate development and 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 an
unnumbered item in Part I following Item 4.
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, 1999, June
30, 1998 and June 30, 1997. K-tel has no written employment agreements with its
executive officers.
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
-----------------------------------------------------
SECURITIES
UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION FISCAL YEAR SALARY BONUS OPTIONS COMPENSATION (1)
- --------------------------- ----------- ------ ----- ---------- ----------------
Philip Kives 1999 $ --- $ --- 1,036,000 $ ---
Chief Executive Officer 1998 $ --- $ --- 231,000 $ ---
1997 $ --- $ --- 400,000 $ ---
Lawrence Kieves 1999 $ 139,231 $ --- 200,000 $ 2,237
President 1998 $ --- $ --- --- $ ---
1997 $ --- $ --- --- $ ---
Jeffrey Koblick 1999 $ 208,500 $ --- 27,500 $ 5,076
Executive Vice President 1998 $ 207,231 $ --- 56,500 $ 4,987
Purchasing & Operations 1997 $ 199,312 $ 30,000 --- $ 3,894
(1) Other compensation for the 1999, 1998 and 1997 fiscal years consists of
K-tel contributions under the 401(k) plan.
16
The following table summarizes stock option grants and option exercises during
the fiscal year ended June 30, 1999, 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, 1999.
OPTION GRANTS IN LAST FISCAL YEAR
(INDIVIDUAL GRANTS)
POTENTIAL REALIZABLE VALUE
NUMBER OF PERCENT OF TOTAL AT ASSUMED ANNUAL RATES OF
SECURITIES OPTIONS EXERCISE EXPIRATION STOCK PRICE FOR OPTION
NAME UNDERLYING GRANTED TO PRICE DATE TERMS (1)
OPTIONS EMPLOYEES IN ------------------------------
GRANTED FISCAL YEAR 5% 10%
- -----------------------------------------------------------------------------------------------------------------
Philip Kives 200,000 12% $ 11.1875 12/15/08 $ 1,407,000 $ 3,566,000
836,000 49% $ 8.7313 2/25/09 $ 4,591,000 $11,633,000
Lawrence Kieves 200,000 12% $ 6.50 10/19/08 $ 818,000 $ 2,072,000
Jeffrey Koblick 27,500 2% $ 8.7313 2/25/09 $ 151,000 $ 383,000
- ----------------------------
(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 429,061 $481,100 245,439 361,500 --- ---
Lawrence Kieves --- --- --- 200,000 --- $ 93,800
Jeffrey Koblick 27,200 $453,886 7,500 42,500 $ 7,267 $ 14,535
(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 17, 1999,
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 ............................................. 4,711,730 46.5%
220 Saulteaux Crescent
Winnipeg, Manitoba R32 3W3
Canada
Lawrence Kieves........................................... ---- *
Herbert Davis............................................. 5,000 *
Jay William Smalley....................................... 5,000 *
Dennis W. Ward............................................ ---- *
David Wolinsky............................................ 5,000 *
Jeffrey Koblick........................................... 34,700 *
All directors and officers as a group
(8 persons)............................................ 4,761,430 46.8%
- --------------------
* 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.
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, has from time to time made
advances to the Company. As of June 30, 1999 and 1998, the Company had a loan
balance with K-5 of $1,945,000 and $1,000,000, respectively. The Company pays
interest on the unpaid principal amount of financing at the same rate as the
Company pays on its credit facility, until repayment of the loan, which is due
on demand. The Company incurred interest of $186,000 in 1999, $95,000 in 1998,
and $59,000 in 1997 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 the same rate as K-tel's loan from Foothill and 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 Capital Corporation have agreed that, if Foothill were to make a demand
for payment as a result of a default in the loan, K-5 would have 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 $34,000 in fiscal 1999, $334,000 in fiscal
1998, and $381,000 in fiscal 1997 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
$51,000 at June 30, 1999, $9,000 at June 30, 1998, and $255,000 at June 30,
1997.
The Company sold approximately $12,000 during fiscal 1999, $39,000 during fiscal
1998 and $229,000 in fiscal 1997 of consumer convenience product to K-5. There
was a balance receivable from K-5 at June 30, 1999, of $33,000, $4,000 at June
30, 1998, and $83,000 at June 30, 1997. Outstanding balances are settled on a
timely basis. No interest was charged on the related outstanding balances during
fiscal 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. 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 23
hereof are filed as part of this report.
(b) REPORTS ON 8-K
During the last quarter of the period covered by this report, one
Current Report on Form 8-K was filed on April 21, 1999, regarding a
private placement transaction.
(c) EXHIBITS
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 Article and Incorporated herein by reference to the
Restated By-Laws Registrant's Annual Report on Form 10-K for the
year ended June 30, 1985
3.1 Amendment to Articles Incorporated herein by reference to the
of Incorporation Registrant's Quarterly Report on Form 10-Q for the
quarter 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 Incorporated herein by reference to the
Agreement - Philip Kives 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 - Incorporated herein by reference to the
Foothill Capital Corporation Registrant's Quarterly Report on Form 10-Q for the
quarter ended December 31, 1997
10.5 Non-Qualified Stock Incorporated herein by reference to the
Option Agreement - Registrant's Annual Report on Form 10-K for the
Philip Kives year ended June 30, 1998
10.6 Amendment Number One - Incorporated herein by reference to the
Loan and Security Agreement - Registrant's Annual Report on Form 10-K for the
Foothill Capital Corporation year ended June 30, 1998
10.7 Amendment Number Two - Loan and Incorporated herein by reference to the
Security Agreement - Foothill Registrant's Annual Report on Form 10-K for the
Capital Corporation year ended June 30, 1998
10.8 Restated Amendment Number Two - Loan Incorporated herein by reference to the
and Security Agreement - Foothill Registrant's Annual Report on Form 10-K for the
Capital Corporation. year ended June 30, 1998
20
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 of 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.
21 Subsidiaries of the Registrant Filed herewith
23 Consent of Independent Public Accountants Filed herewith
27 Financial Data Schedule Filed herewith
99 Cautionary Statement Filed herewith
21
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, 1999, 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, 1999
- ----------------------- (Principal Executive Officer) and
Philip Kives Director
/s/ Lawrence Kieves President and Director September 28, 1999
- -----------------------
Lawrence Kieves
/s/ Steven Kahn Vice President-Finance September 28, 1999
- ----------------------- Chief Financial Officer and
Steven Kahn Treasurer
(Principal Accounting Officer)
/s/ Herbert Davis Director September 28, 1999
- -----------------------
Herbert Davis
/s/ Jay William Smalley Director September 28, 1999
- -----------------------
Jay William Smalley
/s/ David Wolinsky Director September 28, 1999
- -----------------------
David Wolinsky
/s/ Dennis Ward Director September 28, 1999
- -----------------------
Dennis Ward
22
(ITEM 14(A))
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants..................................................24
Consolidated Balance Sheets as of June 30, 1999 and 1998..................................25
Consolidated Statements of Operations for each of the
three years ended June 30, 1999...........................................................26
Consolidated Statements of Shareholders' Equity
for each of the three years ended June 30, 1999...........................................27
Consolidated Statements of Cash Flows for each of the
three years ended June 30, 1999...........................................................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 ended June 30, 1999..................................................41
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.
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 1998, and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the three 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 1998, and the results of their operations
and their cash flows for each of the three 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.
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 1999 1998
- ------------------------------------------------------------------ ---------- ----------
Current Assets:
Cash and cash equivalents $ 6,782 $ 5,941
Accounts receivable, less allowances of $1,400 and $661 12,701 15,341
Inventories 7,644 6,430
Royalty advances 927 1,475
Prepaid expenses and other 2,146 3,043
---------- ----------
Total Current Assets 30,200 32,230
Property and Equipment, net of
accumulated depreciation and amortization
of $3,100 and $2,671 1,549 2,131
Other Assets 4,167 4,674
---------- ----------
$ 35,916 $ 39,035
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
- --------------------------------------------
Current Liabilities:
Current portion of notes payable $ 2,633 $ 3,738
Note payable to affiliate 1,945 1,000
Accounts payable 3,774 7,390
Accrued royalties 8,851 8,465
Reserve for returns 4,375 4,758
Other current liabilities 6,546 5,736
---------- ----------
Total Current Liabilities 28,124 31,087
---------- ----------
Notes Payable, net of current portion 4,000 4,174
Commitments and Contingencies (Note 8)
Shareholders' Equity: (Note 7)
Common stock - 15,000,000 shares authorized;
par value $.01; 10,241,199 and 8,316,668
issued and outstanding 60 41
Additional Paid-In Capital 21,155 9,609
Accumulated Deficit (16,416) (4,869)
Cumulative translation adjustment (1,007) (1,007)
---------- ----------
Total Shareholders' Equity 3,792 3,774
---------- ----------
$ 35,916 $ 39,035
========== ==========
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)
1999 1998 1997
---------- ---------- ----------
NET SALES $ 77,664 $ 85,626 $ 75,501
---------- ---------- ----------
COSTS AND EXPENSES:
Cost of goods sold 42,073 47,670 41,387
Advertising 16,494 16,808 11,520
Selling, general & administrative 29,249 23,683 19,012
---------- ---------- ----------
Total Costs and Expenses 87,816 88,161 71,919
---------- ---------- ----------
OPERATING (LOSS) INCOME (10,152) (2,535) 3,582
---------- ---------- ----------
NON-OPERATING INCOME (EXPENSE):
Interest Income 34 48 124
Interest expense (777) (490) (122)
Other income -- 614 --
Foreign currency transaction loss (587) (16) (162)
---------- ---------- ----------
Total Non-operating Income (Expense) (1,330) 156 (160)
---------- ---------- ----------
(LOSS) INCOME BEFORE PROVISION
FOR INCOME TAXES (11,482) (2,379) 3,422
PROVISION FOR INCOME TAXES (Note 6) 65 28 218
---------- ---------- ----------
NET (LOSS) INCOME $(11,547) $ (2,407) $ 3,204
========== ========== ==========
NET (LOSS) INCOME PER SHARE:
BASIC $ (1.25) $ (.31) $ .43
DILUTED $ (1.25) $ (.31) $ .41
SHARES USED IN THE CALCULATION OF
(LOSS) INCOME PER SHARE:
BASIC 9,224 7,736 7,527
DILUTED 9,224 7,736 7,908
OTHER COMPREHENSIVE (LOSS) INCOME:
Net (loss) income $(11,547) $ (2,407) $ 3,204
Foreign currency (loss) gain ---- (43) (287)
---------- ---------- ----------
OTHER COMPREHENSIVE (LOSS) INCOME $(11,547) $ (2,450) $ 2,917
========== ========== ==========
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
FOR THE YEARS ENDED JUNE 30
(IN THOUSANDS)
Accumulated
Common Stock Additional Other
---------------------- Paid-In Accumulated Comprehensive
Shares Amount Capital Deficit (Loss) Total
---------- ---------- ----------- ------------- --------------- ----------
Balance, July 1, 1996 7,484 $ 37 $ 7,870 $ (5,666) $ (677) $ 1,564
Net loss -- -- -- 3,204 -- 3,204
Proceeds from exercise of
stock options 84 -- 99 -- -- 99
Translation adjustment -- -- -- -- (287) (287)
------- --------- ---------- --------- --------- ----------
Balance, June 30, 1997 7,568 37 7,969 (2,462) (964) 4,580
Net income -- -- -- (2,407) -- (2,407)
Proceeds from exercise of
stock options 749 4 1,640 -- -- 1,644
Translation adjustment -- -- -- -- (43) (43)
------- --------- ---------- --------- --------- ----------
Balance, June 30, 1998 8,317 41 9,609 (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
Translation adjustment -- -- -- -- -- --
------- --------- ---------- --------- --------- ----------
Balance, June 30, 1999 10,242 $ 60 $ 21,155 $(16,416) $ (1,007) $ 3,792
======= ========= ========== ========= ========= ==========
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)
1999 1998 1997
------------ ------------ -----------
Cash Flows From Operating Activities:
Net (loss) income $(11,547) $ (2,407) $ 3,204
Adjustment to reconcile net (loss) income to cash
provided by (used for) operating activities:
Depreciation and amortization 1,520 1,060 630
Loss on valuation of marketable securities -- 514 --
Changes in operating assets and liabilities:
Accounts receivable 2,471 1,427 (1,927)
Inventories (1,281) (1,997) 1,461
Royalty advances 527 75 (347)
Prepaid expenses and other 782 (936) (1,955)
Accounts payable and other (2,652) 2,981 1,039
Accrued royalties 408 (2,809) 412
Reserve for returns (350) (348) (1,863)
Income taxes, net (1) 62 (89)
------------ ------------ -----------
Cash provided by (used for) operating activities (10,123) (2,378) 565
------------ ------------ -----------
Investing Activities:
Purchases of property and equipment (392) (1,620) (740)
Proceeds from sale of property and equipment -- 4 141
Change in net assets of business to be sold 615 -- --
Additions to music catalog (877) (932) (200)
Acquisition of Regal Shop International (Note 3) -- (350) --
Other 190 (348) (114)
------------ ------------ -----------
Cash used for investing activities (464) (3,246) (913)
------------ ------------ -----------
Financing Activities:
Proceeds (payments) of long term debt (183) 4,178 --
Line of Credit, Foothill Capital, net (1,105) 3,738 --
Repayments on line of credit -- (836) (1,028)
Proceeds (payment) on note payable to affiliate 945 (500) 1,500
Proceeds from exercise of stock options 7,485 1,664 99
Proceeds from private equity placement 4,000 -- --
Contribution of services 80 -- --
------------ ------------ -----------
Cash provided by financing activities 11,222 8,224 571
Effect of Exchange Rate Changes on
Cash and Cash Equivalents 206 -- (137)
------------ ------------ -----------
Net Increase in Cash and Cash Equivalents 841 2,600 86
Cash and Cash Equivalents at Beginning of Year 5,941 3,341 3,255
------------ ------------ -----------
Cash and Cash Equivalents at End of year $ 6,782 $ 5,941 $ 3,341
============ ============ ===========
Supplemental Cash Flow Information
Cash Paid For -
Interest $ 867 $ 476 $ 67
============ ============ ===========
Income Taxes $ 60 $ 60 $ 268
============ ============ ===========
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, 1999, 1998 AND 1997
1. BUSINESS AND LIQUIDITY
K-tel International, Inc. (the "Company", "K-tel", or the "Registrant")
was incorporated in 1968. Its 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, we have developed the
resources, knowledgeable personnel, information systems, and
distribution capabilities to market music and consumer products through
traditional retail and direct-response marketing channels. We also
market through two Internet e-commerce sites, K-tel On-line
(www.ktel.com) in the United States and (www.ktel.de) in Europe. Both
sites feature a wide spectrum of music, video and consumer products.
K-tel On-line features more than 250,000 music titles and 35,000 video
titles conveniently available to on-line shoppers at value prices.
The Company experienced negative cash flow of $10,123,000 cash from
operations in fiscal 1999 and utilized another $464,000 investing
activities. These cash requirements were satisfied principally from
borrowings under credit facilities, advances made by an affiliate of
the Chairman of the Board and from the exercise of stock options. As of
June 30, 1999, the Company had $139,000 available for borrowings under
its 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 has 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 Capital
Corporation ("Foothill") 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, 1999, 1998 or 1997.
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.
29
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
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.
In 1993 Dominion Entertainment, Inc. and K-tel Entertainment (U.K.),
Ltd. filed a lawsuit against a United Kingdom entertainment company
regarding infringement on a number of the Company's owned music master
copyrights. During December of 1996 the Company settled the lawsuit for
$950,000. The settlement consisted of a reimbursement of legal costs
(which produced an $850,000 net income benefit) to the Company which
was recorded as a reduction of selling, general and administrative
expenses in the accompanying statement of operations for the year ended
June 30, 1997. The Company also entered into a license agreement with
the United Kingdom company which included an advance of future
royalties. As of June 30, 1998 approximately $389,000 of this amount,
had been recorded as deferred income in the accompanying balance sheet.
The remaining deferred income was recorded as revenue in 1999.
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.
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, 1999 and 1998, $258,000 and $1,337,000,
respectively, was reported as a prepaid expense in the accompanying
balance sheet. Advertising expense was $16,494,000, $16,808,000 and
$11,520,000 for each of the years ended June 30, 1999, 1998 and 1997
respectively.
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 based under Accounting
Principles Board ("APB") No. 25, Accounting for Stock Issued to
Employees, and recognizes compensation expense for certain stock based
awards granted to employees. The Company has adopted the disclosure
provisions of SFAS No. 123, Accounting for Stock Based Compensation,
which requires disclosure of certain pro forma information as if the
Company adopted the fair value method of accounting for stock based
compensation prescribed by FASB No. 123 (See Note 7).
30
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.
STOCK SPLIT - On April 21, 1998, the Board of Directors declared a
two-for-one stock split of the Company's Common Stock in the form of a
stock dividend payable to shareholders of record on May 1, 1998. All
disclosures and applicable per share data have been restated to reflect
this split.
NET (LOSS) INCOME PER SHARE - Basic earnings (loss) per share have been
computed by dividing net income (loss) by the weighted average number
of shares outstanding during the period. Diluted earnings (loss) per
share have been computed assuming the exercise of stock options and
their related income tax effect. For all periods presented common stock
equivalents that were anti-dilutive were excluded from the per share
calculation.
1999 1998 1997
----- ------ -----
Basic Earnings Per Share Computation
Weighted Average Shares Outstanding 9,224 7,736 7,527
Diluted Earnings Per Share Computation
Weighted Average Shares Outstanding 9,224 7,736 7,527
Stock Options -- -- 381
----- ------ -----
Denominator for Diluted Earnings per Share Computation 9,224 7,736 7,908
----- ------ -----
----- ------ -----
USE OF ESTIMATES - The preparation of consolidated financial statements
in conformity with generally accepted accounting principles 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 materially from those
estimates.
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 anticipates 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. ACQUISITION OF CERTAIN ASSETS OF REGAL SHOP INTERNATIONAL LTD.
On March 4, 1998, the Company acquired $3,250,000 of media rights and
other assets of United Kingdom based Regal Shop International Ltd. (now
K-tel Marketing Limited) for purchase consideration of $350,000 cash
and the assumption of $2,900,000 of debt. The Company has accounted for
the acquisition as a purchase, and the purchase price in excess of the
fair value of the net assets acquired of $500,000 has been allocated to
goodwill which is being amortized over five years. Media rights of
$2,400,000 are included in Other Assets as of June 30, 1998, and are
being amortized over a five year period. This acquisition was not
material to the Company's consolidated financial statements.
31
4. NOTES PAYABLE
1999 1998
--------------- ---------------
Term Loan $ 4,000,000 $ 4,000,000
Revolving Line of Credit 2,633,000 3,738,000
Other ---- 174,000
--------------- ---------------
Total $ 6,633,000 $ 7,912,000
Less Current Portion 2,633,000 3,738,000
--------------- ---------------
Total Long Term Debt $ 4,000,000 $ 4,174,000
--------------- ---------------
--------------- ---------------
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 (7.75% at
June 30, 1999) and are secured by the assets of certain U.S.
subsidiaries, including accounts receivable, inventories, equipment,
music library and general intangibles. The loan agreement contains
certain financial and other covenants or restrictions, including the
maintenance of a minimum 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, 1999, $4,000,000 was outstanding under the term loan, $2,633,000
was outstanding under the line of credit and the maximum additional
available under the borrowing limitations was $139,000. In September
1999, the Company and Foothill further amended the credit agreement. As
a result, the net worth covenant was changed to be defined as
shareholders' equity and must be $3 million as of June 30, 1999 and $4
million commencing June 30, 2000.
5. NOTE PAYABLE TO AFFILIATE
From time to time the Company has borrowed from K-5 Leisure Products,
Inc. The Company pays interest at prime rate (7.75% at June 30, 1999)
on the unpaid principal amount of financing which is due on demand. As
of June 30, 1999 and 1998, K-5 Leisure Products, Inc. had advanced
$1,945,000 and $1,000,000 to the Company. (See Note 11, Subsequent
Events)
6. INCOME TAXES
The Company operates in several countries and is subject to various tax
regulations and tax rates. The provisions for income taxes is 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.
32
The provision (benefit) for income taxes consists of the following for
the years ended June 30 (in thousands):
1999 1998 1997
-------- -------- ---------
Income (loss) before provision (benefit) for income taxes:
United States $ (9,244) $ (3,702) $ 1,694
Foreign (1,958) 1,323 1,728
-------- -------- ---------
Total $(11,202) $ (2,379) $ 3,422
-------- -------- ---------
-------- -------- ---------
Provision (benefit) for income taxes:
Current payable
United States $ --- $ (119) $ 111
Foreign 65 147 107
-------- -------- ---------
Total current payable and
total provision for income taxes $ 65 $ 28 $ 218
-------- -------- ---------
-------- -------- ---------
A reconciliation of the U.S. Federal statutory rate to the effective
tax rate for the years ended June 30 are as follows:
1999 1998 1997
---- ---- ----
Federal statutory rate 34% 34% 34%
State Taxes, net of Federal benefit 2 2 1
Change in valuation allowance (36) (39) (29)
Effect of different tax rates on foreign earnings (1) 2 ---
---- ---- ----
(1)% (1)% 6%
---- ---- ----
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,
1999 1998
------------ ------------
Net operating loss carryfowards $ 17,599 $ 13,522
Alternative minimum tax credits 432 432
Reserve for returns 1,384 1,477
Depreciation and amortization 317 263
Royalty reserves 447 355
Inventory reserves 464 274
Nondeductible accruals 1,130 286
Allowance for bad debts 488 198
Valuation allowance (22,261) (16,807)
------------ ------------
$ --- $ ---
------------ ------------
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.
33
For U.S. tax reporting purposes, the Company has net operating loss
carryforwards ("NOL") of approximately $48,887,000. Of this amount
approximately $8,590,000 is available only through the year 2000, an
other $8,492,000 will be available only through 2001 and $22,744,000
will be available through 2013. The rest of the NOL carryforward will
be available through the year 2019. However, of the amount available
through 2013 and 2019, $19,663,000 relates to deductions associated
with the exercise of stock options. The tax benefit of approximately
$7,079,000 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
$3,300,000 as of June 30, 1999.
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 467,794 shares and warrants to acquire additional shares. The
Company will have no further obligation to sell additional stock to the
purchasers, who are 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.
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.
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 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 9,450 shares remain
exercisable, and options for 495,400 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. There were 744,260 net shares granted
under this plan as of June 30, 1999.
34
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:
Incentive Stock Non-qualified Restricted Stock
Options Stock Options Options
--------------- ------------- ----------------
Outstanding June 30, 1996 221,000 86,250 55,000
Granted 83,000 -- 860,000
Exercised - at prices ranging from
$.75 - $3.375 per share (47,174) (36,250) --
Canceled (12,050) (6,000) (30,000)
----------- ---------- ----------
Outstanding June 30, 1997 244,776 44,000 885,000
Granted 590,000 500,000 231,000
Exercised - at prices ranging from
$.75 - $14.345 per share (247,100) (47,000) (455,000)
Canceled (7,100) -- --
----------- ---------- ----------
Outstanding June 30, 1998 580,576 497,000 661,000
Granted 329,650 1,657,500 --
Exercised - at prices ranging from
$.75 - $11.875 per share (232,676) (580,061) (646,000)
Canceled (407,340) (521,000) (15,000)
----------- ---------- ----------
Outstanding June 30, 1999 270,210 1,053,439 --
=========== ========== ==========
Exercised Prices $.75 - $14.345 $.75 - $14.345 $2.00 - $14.125
Options Exercisable 87,410 264,939 --
35
Pro forma Option Information
The Company accounts for its stock option plans under the provisions of
APB Opinion No. 25, under which no compensation costs have been
recognized. Had compensation costs for these plans been recorded at
fair value consistent with the provisions of SFAS No. 123, the
Company's pro forma net income (loss) and earnings (loss) per share
would have been as follows:
1999 1998 1997
-------------- -------------- -------------
Net income (loss) (in thousands):
As reported $ (11,547) $ (2,407) $ 3,204
Pro forma $ (11,960) $ (3,577) $ 2,757
Basic EPS:
As reported $ (1.25) $ (.31) $ .43
Pro forma $ (1.30) $ (.46) $ .37
Diluted EPS:
As reported $ (1.25) $ (.31) $ .41
Pro forma $ (1.30) $ (.46) $ .35
The weighted average fair values of options granted in fiscal 1999 was
$5.91, $6.10 in fiscal 1998 and in fiscal 1997 was $2.20.
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:
1999 1998 1997
---- ---- ----
Risk-free interest rate 4.25% 5.12% 6.3%
Expected life 5 years 5 years 5 years
Expected volatility 100% 100% 57%
Expected dividend yield None None None
Because the measurement provisions of SFAS No. 123 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
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.
36
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 which 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 plans
to move to dismiss the Complaint. It is not possible at this early
stage of the litigation to predict the outcome of this action with any
certainty. 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.
EARLY V. K-TEL INTERNATIONAL, INC.
On March 10, 1997, Christopher Early filed a class action Complaint
against K-tel International, Inc., Dominion Entertainment, Inc., and
certain retailers in the Circuit Court of Cook County, Illinois. The
defendants removed the action to the United States district Court for
the Northern District of Illinois on April 3, 1997. On March 30, 1998,
Early obtained leave to file an Amended Complaint adding K-tel
International (USA), Inc. and one additional retailer as defendants,
and purporting to allege class actions under (1) the Illinois Consumer
Fraud and Deceptive Trade Practices Act and (2) the Racketeer
Influenced and Corrupt Organizations Act (RICO), for allegedly
deceptive packaging of certain tapes and compact discs, which packaging
allegedly defrauded consumers into believing that certain recordings
thereon were original rather than new recordings. On behalf of the
class, Early purports to seek (1) treble damages; (2) compensatory
damages; (3) punitive damages; (4) an injunction prohibiting "the
further sale of mislabeled tapes and CDs;" and (5) attorneys' fees and
costs. The RICO count in the Amended Complaint has been dismissed. The
federal district court has issued an order purporting to remand the
state law count to the Circuit Court of Cook County, Illinois.
Discovery has not commenced, and the class action aspects of the
Complaint have not been ruled upon. K-tel has indemnified the retailer
defendants in this matter, and intends to contest the case vigorously.
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, 1999, the
Company had commitments to purchase approximately $2,000,000 of
inventory on guaranteed contracts. A reserve for possible future losses
on these purchase commitments of approximately $750,000 and $500,000 at
June 30, 1999 and 1998, respectively, has been recorded in other
current liabilities on the balance sheet.
LEASES
The Company has entered into several office and warehouse leases which
expire through 2003. Commitments under these leases are $852,000 in
2000, $811,000 in 2001, $373,000 in 2002, $93,000 in
37
2003 and $82,000 in 2004. Rental expense was $956,000 in 1999, $885,000
in 1998, and $988,000 in 1997.
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 Leisure Products, Inc., 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, 1999 and 1998, the
Company had a loan balance with K-5 Leisure Products, Inc. of
$1,945,000 and $1,000,000, respectively. The Company pays interest on
the unpaid principal amount of financing at the same rate as the
Company pays on its credit facility, until repayment of the loan, which
is due on demand. The Company incurred interest of $186,000 in 1999,
$95,000 in 1998, and $59,000 in 1997 on this loan. (see Subsequent
Events Footnote 11).
The Company purchased approximately $34,000 in fiscal 1999, $334,000 in
fiscal 1998, and $381,000 in fiscal 1997 of consumer products from an
affiliate controlled by the Company's Chairman of the Board and Chief
Executive Officer. Management believes purchase prices for these
products were at prices comparable to transactions with an unrelated
third party. There was a payable amount of $51,000 at June 30, 1999,
$9,000 at June 30, 1998, and $255,000 at June 30, 1997.
The Company sold approximately $12,000 during fiscal 1999, $39,000
during fiscal 1998 and $229,000 in fiscal 1997 of consumer convenience
product to an affiliate controlled by the Company's Chairman of the
Board and Chief Executive Officer. There was a balance receivable from
the affiliate at June 30, 1999, of $33,000, $4,000 at June 30, 1998,
and $83,000 at June 30, 1997. Outstanding balances are settled on a
timely basis. No interest was charged on the related outstanding
balances during fiscal 1999.
K-5 Leisure Products, Inc. retained the services of a consultant to
assist it in matters relating to its operations, as well as those of
the Company. K-5 Leisure Products, Inc. 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.
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 classified as a discontinued segment below.
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 which stock and manage inventory within
music departments for retail stores.
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
38
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 Consumer Corporate/ Total
INFORMATION Music Products Licensing Internet Other Elimination Company
- ---------------- ---- --------- ---------- --------- --------- --------- ----------- --------
Net Sales 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
1997 39,661 23,586 4,868 -- 8,350 (964) 75,501
Operating 1999 $ (5,301) $ (1,942) $ 2,052 $ (2,231) $ (2,730) -- $(10,152)
Income 1998 (1,315) 844 1,640 (481) (3,223) -- (2,535)
1997 926 796 2,162 -- (302) -- 3,582
Assets 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
1997 17,518 6,417 1,388 -- 5,080 89 30,492
Depreciation 1999 $ 2,259 $ 525 -- $ 158 $ 102 $ 56 $ 3,100
1998 2,190 383 -- 3 70 25 2,671
1997 1,807 333 -- -- 29 3 2,172
Capital 1999 $ 115 $ 229 -- $ 108 -- $ 22 $ 474
Expenditures 1998 665 111 -- 735 48 53 1,612
1997 553 49 -- -- 121 5 728
GEOGRAPHIC INFORMATION United States Europe Total
- ---------------------- ---- -------------- ----------- -----------
Net Sales 1999 $ 34,851 $ 42,813 $ 77,664
1998 55,883 29,743 85,626
1997 47,786 27,715 75,501
Assets 1999 $ 22,694 $ 13,222 $ 35,916
1998 24,574 14,461 39,035
1997 22,781 7,711 30,492
39
11. SUBSEQUENT EVENTS
K-5 LEISURE PRODUCTS, INC. LINE OF CREDIT AGREEMENT
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 $8,000,000 on a revolving basis. The loan bears interest at the same
rate as K-tel's loan from Foothill Capital Corporation ("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 has
agreed not to declare a default prior to July 1, 2000 in the event that the
Company does 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. 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.
SALE OF FINLAND AND LICENSING AGREEMENT
On September 10, 1999, K-tel sold all of the outstanding common stock of its
subsidiary K-tel International (Finland) Oy. ("K-tel Finland") to an
unrelated purchaser. In addition, the Company and the purchaser agreed to
enter into a five-year licensing agreement in two European markets. The two
transactions will result in proceeds of $7,000,000. Net proceeds after
$1,350,000 transaction costs related to the sale exceeded the net book value
of K-tel Finland's net assets of by approximately $4,400,000, which will be
recorded as a gain in the quarter ending September 30, 1999. 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. Sales in fiscal 1999,
1998 and 1997 were $6,200,000, $6,000,000 and $6,400,000, respectively, and
net earnings in the same periods were $169,000, $428,000 and $225,000,
respectively. Net assets of this subsidiary at June 30, 1999 were $611,000
and are included as assets held for resale in the prepaid expense caption of
the balance sheet.
40
SCHEDULE II
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
For the years ended June 30, 1999, 1998, and 1997
(In thousands)
Balance at Charged to Costs
Beginning of and Expenses or Net Charged to Balance at End
Period Sales Other Accounts Deductions of Period
------------- -------------------- --------------- ---------- ---------------
Allowance for
Doubtful Accounts
- -----------------
1999 $ 661 $ 1,088 $ (3)(1) $ (346)(2) $ 1,400
1998 $ 952 $ 986 $ (1)(1) $ (1,276)(2) $ 661
1997 $ 1,035 $ 533 $ (29)(1) $ (587)(2) $ 952
Reserve for
Returns
- -----------------
1999 $ 4,758 $ 12,094 $ (27)(1) $ (12,450) $ 4,375
1998 $ 4,930 $ 13,943 $ (9)(1) $ (14,106) $ 4,758
1997 $ 6,817 $ 10,096 $ (24)(1) $ (11,959) $ 4,930
(1) Exchange rate change
(2) Uncollectible accounts written off, net of recoveries
41
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 Article and Incorporated herein by reference to the
Restated By-Laws Registrant's Annual Report on Form 10-K for the
year ended June 30, 1985
3.1 Amendment to Articles Incorporated herein by reference to the
of Incorporation Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1998
10.1 1987 Stock Incentive Plan ncorporated herein by reference to the
egistrant's Annual Report on Form 10-K for the
ear ended June 30, 1987
10.2 Non-Qualified Stock Option Incorporated herein by reference to the
Agreement - Philip Kives 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 Incorporated herein by reference to the
- Foothill Capital Corporation Registrant's Quarterly Report on Form 10-Q for the
quarter ended December 31, 1997
10.5 Non-Qualified Stock Incorporated herein by reference to the
Option Agreement - Registrant's Annual Report on Form 10-K for the
Philip Kives year ended June 30, 1998
10.6 Amendment Number One - Incorporated herein by reference to the
Loan and Security Agreement Registrant's Annual Report on Form 10-K for the
- Foothill Capital Corporation year ended June 30, 1998
10.7 Amendment Number Two - Loan and Incorporated herein by reference to the
Security Agreement - Foothill Registrant's Annual Report on Form 10-K for the
Capital Corporation year ended June 30, 1998
10.8 Restated Amendment Number Two - Loan Incorporated herein by reference to the
and Security Agreement - Foothill Registrant's Annual Report on Form 10-K for the
Capital Corporation. year ended June 30, 1998
42
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 of 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.
21 Subsidiaries of the Registrant Filed herewith
23 Consent of Independent Public Accountants Filed herewith
27 Financial Data Schedule Filed herewith
99 Cautionary Statement Filed herewith
43