** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

** **

----

 

**FORM10-Q**

 

**(Mark One)**

 
| **ý** |   | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|--------|----------------------------------------------------------------------------------------------|

 

 

**For the quarterly period ended September 29, 2001**

 

**or**

 
| **o** |   | **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: 0-19902**

 

**Provell, Inc.**

(Exactname of Registrant as specified in its charter)

 
| **Minnesota**                                                                       |   | **41-1551116**                        |
|-------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State  or other jurisdiction of incorporation or organization)                     |   | (IRS  Employer Identification Number) |
|                                                                                |   |                                  |
| **301  Carlson Parkway, Suite 201****Minneapolis, Minnesota**                       |   | **55305**                             |
| (Address  of principal executive offices)                                           |   | (Zip code)                            |
|                                                                                |   |                                  |
| **952-258-2000**                                                                    |
| (Registrant’s  telephone number including area code)                           |
|                                                                                |   |                                  |
| **Not  Applicable**                                                                 |
| (Former  name, former address and former fiscal year, if changed since last report) |

 

Indicate by check mark whether theRegistrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the preceding 12 months; and (2) hasbeen subject to such filing requirements for the past 90 days.  **Yes  ****ý****     No  ****o**

 

**On November 9, 2001, there were6,924,030 shares of Class A Common Stock and no shares of Class B Common Stockoutstanding.**

 

 

**PROVELL, INC.**

 

**INDEX**

 

 
| **Part I.**  | **FINANCIAL INFORMATION** |
|--------------|---------------------------|
|         |
|         | Item 1:                   | Financial Statements |
|         |
|         |                      | Consolidated  Statements of Operations (unaudited) For the three and nine months ended  September 29, 2001 and September 30, 2000 |
|         |
|         |                      | Consolidated Balance  Sheets As of September 29, 2001 (unaudited) and December 31, 2000 |
|         |
|         |                      | Consolidated  Statements of Cash Flows (unaudited) For the three and nine months ended September  29, 2001 and September 30, 2000 |
|         |                      |   |
|         |
|         |                      | Condensed  Notes to Consolidated Financial Statements (unaudited) |
|         |
|         | Item  2:                  | Management's  Discussion and Analysis of Financial Condition and Results of Operations |
|         |                      |   |
|         |
|         | Item  3:                  | Quantitative  and Qualitative Disclosures About Market Risk |
|         |
|         |
| **Part II.** | **OTHER INFORMATION**     |
|         |
|         | Item 6:                   | Exhibits and  Reports on Form 8-K |
|         |
|         | Signature                 |

 

**PROVELL, INC.**

 

**CONSOLIDATED STATEMENTS OFOPERATIONS**

**(Unaudited)**

 
|                                                                                                             |   | **Three  months ended**                          |       | **Nine  months ended** |   |
|------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------|------------|------------------------|--------|
|                                                                                                             |   | **Sept.  29,**                                   |       | **Sept.  30,**         |   | **Sept.  29,** |   | **Sept.  30,** |   |
|                                                                                                             |   | **2001**                                         |       | **2000**               |   | **2001** |   | **2000** |   |
|                                                                                                             |   | **(Amounts in thousands except per share data)** | ** ** |
| **Net  revenues**                                                                                                |   | $                                                | 36,902     |                   | $      | 31,766 |   | $ | 104,644 |   | $ | 101,949 |   |
|                                                                                                             |   |                                             |       |                   |   |   |   |   |   |
| **Costs  and expenses:**                                                                                         |   |                                             |       |                   |   |   |   |   |   |
| Operating  and marketing expenses                                                                                |   | 38,696                                           |       | 22,389                 |   | 109,085 |   | 61,474 |   |
| General  and administrative expenses                                                                             |   | 4,645                                            |       | 4,740                  |   | 14,737 |   | 14,853 |   |
| Total  costs and expenses                                                                                        |   | 43,341                                           |       | 27,129                 |   | 123,822 |   | 76,327 |   |
|                                                                                                             |   |                                             |       |                   |   |   |   |   |   |
| **Operating  (loss) income**                                                                                     |   | (6,439                                           | )          | 4,637                  |   | (19,178 | ) | 25,622 |   |
|                                                                                                             |   |                                             |       |                   |   |   |   |   |   |
| Other  expenses, net                                                                                             |   | (1                                               | )          | (192                   | )      | -- |   | (264 | ) |
|                                                                                                             |   |                                             |       |                   |   |   |   |   |   |
| **(Loss)  income before interest, income taxes and other**                                                       |   | (6,440                                           | )          | 4,445                  |   | (19,178 | ) | 25,358 |   |
|                                                                                                             |   |                                             |       |                   |   |   |   |   |   |
| Interest  expense, net                                                                                           |   | 244                                              |       | --                     |   | 1,132 |   | -- |   |
| Amortization  of discount on Senior Convertible Notes                                                            |   | --                                               |       | --                     |   | 14,084 |   | -- |   |
| **(Loss)  income from continuing operations before income taxes and cumulative effect  of change in accounting** |   | (6,684                                           | )          | 4,445                  |   | (34,394 | ) | 25,358 |   |
|                                                                                                             |   |                                             |       |                   |   |   |   |   |   |
| Income  tax benefit (provision)                                                                                  |   | 2,421                                            |       | (1,688                 | )      | 6,844 |   | (9,439 | ) |
| **(Loss)  income from continuing operations before cumulative effect of change in  accounting**                  |   | (4,263                                           | )          | 2,757                  |   | (27,550 | ) | 15,919 |   |
| Loss  from discontinued operations, net of taxes of $3,690 and $24,153,  respectively                            |   | --                                               |       | (6,020                 | )      | -- |   | (39,960 | ) |
| Cumulative  effect of change in accounting, net of taxes of $8,703                                               |   | --                                               |       | --                     |   | -- |   | (14,201 | ) |
| **Net  loss**                                                                                                    |   | (4,263                                           | )          | (3,263                 | )      | (27,550 | ) | (38,242 | ) |
|                                                                                                             |   |                                             |       |                   |   |   |   |   |   |
| Preferred  stock dividends and amortization                                                                      |   | (922                                             | )          | (1,989                 | )      | (2,574 | ) | (1,989 | ) |
| **Net  loss available to common shareholders**                                                                   |   | $                                                | (5,185     | )                      | $      | (5,252 | ) | $ | (30,124 | ) | $ | (40,231 | ) |
|                                                                                                             |   |                                             |       |                   |   |   |   |   |   |
| Basic  and diluted loss per common share:                                                                        |   |                                             |       |                   |   |   |   |   |   |
| (Loss)  income before interest, income taxes and other                                                           |   | $                                                | (0.99      | )                      | $      | 0.77 |   | $ | (3.13 | ) | $ | 4.43 |   |
| Interest  and amortization                                                                                       |   | (0.04                                            | )          | --                     |   | (2.48 | ) | -- |   |
| Income  tax benefit (provision)                                                                                  |   | 0.37                                             |       | (0.29                  | )      | 1.12 |   | (1.65 | ) |
| Loss  from discontinued operations, net of tax                                                                   |   | --                                               |       | (1.04                  | )      | -- |   | (6.97 | ) |
| Cumulative  effect of change in accounting, net of tax                                                           |   | --                                               |       | --                     |   | -- |   | (2.48 | ) |
| Preferred  stock dividends and amortization                                                                      |   | (0.14                                            | )          | (0.35                  | )      | (0.42 | ) | (0.35 | ) |
| Net  loss available to common shareholders                                                                       |   | $                                                | (0.80      | )                      | $      | (0.91 | ) | $ | (4.91 | ) | $ | (7.02 | ) |
|                                                                                                             |   |                                             |       |                   |   |   |   |   |   |
| Weighted  average common shares outstanding                                                                      |   | 6,501                                            |       | 5,795                  |   | 6,136 |   | 5,733 |   |

 

*See accompanying condensed notes to consolidated financialstatements.*

* *

**PROVELL, INC**.

** **

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
|                                                                                                                                                                                                                                      |   | **Sept.  29,**                                     |       | **December  31,** |       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------|------------|-------------------|------------|
|                                                                                                                                                                                                                                      |   | **2001**                                           |       | **2000**          |       |
| **ASSETS**                                                                                                                                                                                                                                |   | **(Amounts in thousands   except per share data)** |       |
| Current  Assets:                                                                                                                                                                                                                          |   |                                               |       |              |       |
| Cash  and cash equivalents                                                                                                                                                                                                                |   | $                                                  | 5          |              | $          | 13,107 |   |
| Trade  accounts receivable, net                                                                                                                                                                                                           |   | 38,560                                             |       | 39,586            |       |
| Deferred  membership solicitation costs                                                                                                                                                                                                   |   | 44,982                                             |       | 41,728            |       |
| Prepaid  membership materials and marketing costs                                                                                                                                                                                         |   | 7,580                                              |       | 15,408            |       |
| Deferred  income taxes, current                                                                                                                                                                                                           |   | 26,490                                             |       | 26,490            |       |
| Other                                                                                                                                                                                                                                     |   | 1,583                                              |       | 1,731             |       |
| Total  current assets                                                                                                                                                                                                                     |   | 119,200                                            |       | 138,050           |       |
|                                                                                                                                                                                                                                      |   |                                               |       |              |       |
| Property  and equipment, net                                                                                                                                                                                                              |   | 4,324                                              |       | 3,959             |       |
| Other  assets, net                                                                                                                                                                                                                        |   | 1,139                                              |       | 50                |       |
| Deferred  income taxes, long-term                                                                                                                                                                                                         |   | 21,507                                             |       | 14,665            |       |
| Total  assets                                                                                                                                                                                                                             |   | $                                                  | 146,170    |              | $          | 156,724 |   |
|                                                                                                                                                                                                                                      |   |                                               |       |              |       |
| **LIABILITIES  AND SHAREHOLDERS’ DEFICIT**                                                                                                                                                                                           |   |                                               | ** ** |              | ** ** |
| Current  Liabilities:                                                                                                                                                                                                                     |   |                                               |       |              |       |
| Borrowings  under revolving credit facility                                                                                                                                                                                               |   | $                                                  | 10,539     |              | $          | 5,150 |   |
| Accounts  payable                                                                                                                                                                                                                         |   | 22,050                                             |       | 20,387            |       |
| Accrued  liabilities                                                                                                                                                                                                                      |   | 54,107                                             |       | 56,601            |       |
| Deferred  membership revenue                                                                                                                                                                                                              |   | 55,314                                             |       | 55,683            |       |
| Net  liabilities of discontinued operations, current                                                                                                                                                                                      |   | 11,496                                             |       | 23,830            |       |
| Total  current liabilities                                                                                                                                                                                                                |   | 153,506                                            |       | 161,651           |       |
|                                                                                                                                                                                                                                      |   |                                               |       |              |       |
| Net  liabilities of discontinued operations, long-term                                                                                                                                                                                    |   | --                                                 |       | 2,696             |       |
|                                                                                                                                                                                                                                      |   |                                               |       |              |       |
| Series  D redeemable convertible preferred stock, liquidation preference $23,650 and  $25,000, respectively, net of unamortized discount of $2,024 and $3,583, respectively                                                               |   | 16,896                                             |       | 16,417            |       |
| Series  E redeemable convertible preferred stock, liquidation preference $16,420, net  of unamortized discount of $767                                                                                                                    |   | 12,369                                             |       | --                |       |
|                                                                                                                                                                                                                                      |   |                                               |       |              |       |
| Commitments  and contingencies (Note 7)                                                                                                                                                                                                   |   |                                               |       |              |       |
|                                                                                                                                                                                                                                      |   |                                               |       |              |       |
| Shareholders’  Deficit:                                                                                                                                                                                                              |   |                                               |       |              |       |
| Class  A Common Stock, $.01 par, 77,000 and 20,000 shares authorized at September  29, 2001 and December 31, 2000, respectively; 6,501 and 5,857 shares issued  and outstanding at September 29, 2001 and December 31, 2000, respectively |   | 69                                                 |       | 58                |       |
| Class  B Common Stock, $.01 par, 2,000 shares authorized; none issued or outstanding                                                                                                                                                      |   | --                                                 |       | --                |       |
| Series  C Junior Participating Preferred Stock, $.01 par, 400 shares authorized; none  issued or outstanding                                                                                                                              |   | --                                                 |       | --                |       |
| Paid-in  capital                                                                                                                                                                                                                          |   | 73,426                                             |       | 58,594            |       |
| Common  stock warrants                                                                                                                                                                                                                    |   | 2,800                                              |       | 2,800             |       |
| Preferred  stock dividends payable                                                                                                                                                                                                        |   | 311                                                |       | 165               |       |
| Accumulated  deficit                                                                                                                                                                                                                      |   | (113,207                                           | )          | (85,657           | )          |
| Total  shareholders’ deficit                                                                                                                                                                                                         |   | (36,601                                            | )          | (24,040           | )          |
| Total  liabilities and shareholders’ deficit                                                                                                                                                                                         |   | $                                                  | 146,170    |              | $          | 156,724 |   |

 

*See accompanying condensednotes to consolidated financial statements.*

* *

**PROVELL, INC.**

 

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(Unaudited)**

 
|                                                                                         |   | **Three  months ended**     |   | **Nine  months ended** |   |
|----------------------------------------------------------------------------------------------|--------|-----------------------------|--------|------------------------|--------|
|                                                                                         |   | **Sept.  29,**              |   | **Sept.  30,**         |   | **Sept.  29,** |   | **Sept.  30,** |   |
|                                                                                         |   | **2001**                    |   | **2000**               |   | **2001** |   | **2000** |   |
| **OPERATING  ACTIVITIES:**                                                                   |   | **(Amounts in thousands )** |   |
| Net loss available to common shareholders                                                    |   | $                           | (5,185 | )                      | $      | (5,252 | ) | $ | (30,124 | ) | $ | (40,231 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used for) continuing operations: |   |                        |   |                   |   |   |   |   |   |
| Discontinued operations, net of tax                                                          |   | --                          |   | 6,020                  |   | -- |   | 39,960 |   |
| Cumulative effect of change in accounting, net  of tax                                       |   | --                          |   | --                     |   | -- |   | 14,201 |   |
| Preferred stock dividends and amortization                                                   |   | 922                         |   | 1,989                  |   | 2,574 |   | 1,989 |   |
| Depreciation and amortization                                                                |   | 708                         |   | 366                    |   | 2,213 |   | 791 |   |
| Amortization of note discount                                                                |   | --                          |   | --                     |   | 14,084 |   | -- |   |
| Interest expense on senior convertible note                                                  |   | --                          |   | --                     |   | 286 |   | -- |   |
| Deferred income taxes                                                                        |   | (2,421                      | )      | 1,688                  |   | (6,844 | ) | 9,439 |   |
| Loss on disposal of property and equipment                                                   |   | --                          |   | --                     |   | -- |   | 19 |   |
| Changes in working capital items:                                                            |   |                        |   |                   |   |   |   |   |   |
| Trade accounts receivable, net                                                               |   | (3,394                      | )      | (22,788                | )      | 1,026 |   | (13,546 | ) |
| Deferred costs and other current assets                                                      |   | 8,815                       |   | (11,740                | )      | 4,478 |   | (13,858 | ) |
| Accounts payable and accrued liabilities                                                     |   | 5,829                       |   | 17,120                 |   | (1,454 | ) | 11,394 |   |
| Deferred membership revenue                                                                  |   | 1,649                       |   | 3,647                  |   | (369 | ) | (10,519 | ) |
| Net cash provided by (used for) operating  activities                                        |   | 6,923                       |   | (8,950                 | )      | (14,130 | ) | (361 | ) |
|                                                                                         |   |                        |   |                   |   |   |   |   |   |
| **INVESTING ACTIVITIES:**                                                                    |   |                        |   |                   |   |   |   |   |   |
| Property and equipment additions, net                                                        |   | (311                        | )      | (2,008                 | )      | (1,550 | ) | (2,581 | ) |
| Other                                                                                        |   | --                          |   | --                     |   | -- |   | (8 | ) |
| Net cash used for investing activities                                                       |   | (311                        | )      | (2,008                 | )      | (1,550 | ) | (2,589 | ) |
|                                                                                         |   |                        |   |                   |   |   |   |   |   |
| **FINANCING ACTIVITIES:**                                                                    |   |                        |   |                   |   |   |   |   |   |
| Borrowings under revolving credit facility,  net                                             |   | (3,637                      | )      | 220                    |   | 5,389 |   | 11,763 |   |
| Net proceeds from issuance of Senior  Convertible Notes/Series E Preferred Stock             |   | --                          |   | 18,950                 |   | 13,133 |   | 18,950 |   |
| Payment of loan origination fees                                                             |   | --                          |   | --                     |   | (943 | ) | -- |   |
| Dividends paid                                                                               |   | --                          |   | --                     |   | (165 | ) | -- |   |
| Net proceeds from exercise of stock options                                                  |   | --                          |   | 680                    |   | 35 |   | 2,433 |   |
| Net cash (used for) provided by financing  activities                                        |   | (3,637                      | )      | 19,850                 |   | 17,449 |   | 33,146 |   |
|                                                                                         |   |                        |   |                   |   |   |   |   |   |
| Net cash used for discontinued operations                                                    |   | (3,022                      | )      | (8,727                 | )      | (14,871 | ) | (33,518 | ) |
|                                                                                         |   |                        |   |                   |   |   |   |   |   |
| Net (decrease) increase in cash and cash equivalents                                         |   | (47                         | )      | 165                    |   | (13,102 | ) | (3,322 | ) |
| Cash and cash equivalents, beginning of period                                               |   | 52                          |   | 440                    |   | 13,107 |   | 3,927 |   |
|                                                                                         |   |                        |   |                   |   |   |   |   |   |
| Cash and cash equivalents, end of period                                                     |   | $                           | 5      |                   | $      | 605 |   | $ | 5 |   | $ | 605 |   |
|                                                                                         |   |                        |   |                   |   |   |   |   |   |
| **SUPPLEMENTAL CASH FLOW INFORMATION:**                                                      |   |                        |   |                   |   |   |   |   |   |
| Interest paid during the period                                                              |   | $                           | 334    |                   | $      | 121 |   | $ | 761 |   | $ | 661 |   |
| Income taxes paid (refunded) during the period                                               |   | $                           | 2      |                   | $      | (1,040 | ) | $ | 5 |   | $ | 834 |   |

 

*See accompanying condensednotes to consolidated financial statements.*

* *

**PROVELL, INC.**

** **

**CONDENSED NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

** **

**Note 1.   Basis ofPresentation**

 

The unauditedconsolidated financial statements included herein have been prepared byProvell, Inc., formerly Damark International, Inc. (the “Company”), pursuant tothe rules and regulations of the Securities and Exchange Commission(“SEC”).  The information furnished inthese financial statements includes normal recurring adjustments and reflectsall adjustments which are, in the opinion of management, necessary for a fairpresentation of such financial statements. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted pursuant to such rules and regulations.  Although the Company believes that thedisclosures are adequate to make the information presented not misleading, itis suggested that these financial statements be read in conjunction with theconsolidated financial statements and notes thereto included in the Company’smost recent Annual and Quarterly Reports on Form 10-K and Form 10-Q as filedwith the SEC.

 

The Company's fiscalyear ends on December 31; however, each quarter ends on the last Saturday of athirteen-week period.  As a result, theoperating results included 272 days for the first three quarters of 2001 and274 days for the first three quarters of 2000. Management believes that the difference in days does not materiallyaffect the comparability of financial results for the periods presented.

 

**Note 2.   Revenue andSolicitation Costs Recognition**

 

The Company adoptedStaff Accounting Bulletin No. 101 – Revenue Recognition in Financial Statements(“SAB 101”) effective January 1, 2000 and recorded a non-cash charge of $22.9million ($14.2 million net of taxes). Under SAB 101, the Company defers all membership revenues, net ofestimated returns, and amortizes them into revenue on a straight-line basisafter the trial period has elapsed and over the remaining membership period,generally eleven months.  The allowancefor returns is based on the Company’s most recent return experience and isupdated each quarter.  The majority ofthe Company’s members can return its memberships at any time prior toexpiration of the membership term and receive either a full or pro-rated refundfor the remaining portion of the membership period.

 

In accordance with SAB101, the cost of membership kits and vouchers is expensed whendistributed.  Direct responseadvertising costs (i.e., telemarketing, direct mail, etc.), refundable fees forcommissions paid to clients and transaction processing costs, net of expectedrefunds, are capitalized as part of deferred membership solicitation costs andare amortized as expense in the same manner in which the related revenue isrecognized.  Other direct and indirectcosts incurred with enrolling and servicing members are expensed whenincurred.  Deferred membershipsolicitation costs incurred to obtain new members are generally less than theassociated membership fees charged to customers.  However, if deferred membership solicitation costs were to exceedexpected membership fees, an adjustment would be made to the extent of anyimpairment.

 

Third quarter and thefirst nine months activity in the deferred membership revenue and accruedmembership returns accounts is summarized as follows (in thousands):

** **
|                         |   | **Balance  at**   |   |          |    |           |     |                 |   |                |   |
|------------------------------|--------|-------------------|--------|---------------|---------|----------------|----------|----------------------|--------|---------------------|--------|
|                         |   | **Beginning  of** |   |          |    |           |     |                 |   | **Balance  at End** |   |
| **Quarter  ended:**          |   | **Period**        |   | **Additions** |    | **Reductions** |     | **Adjustments  (1)** |   | **of  Period**      |   |
| Deferred membership revenue: |   |              |   |          |    |           |     |                 |   |                |   |
| September  29, 2001          |   | $                 | 53,665 |          | 34,782  |           | (32,849  | )                    | (284   | )                   | $      | 55,314 |   |
| September  30, 2000          |   | $                 | 46,549 |          | 32,888  |           | (29,722  | )                    | 480    |                | $      | 50,195 |   |
| Accrued membership returns:  |   |              |   |          |    |           |     |                 |   |                |   |
| September 29, 2001           |   | $                 | 31,949 |          | 41,310  |           | (39,499  | )                    | (1,710 | )                   | $      | 32,050 |   |
| September 30, 2000           |   | $                 | 23,539 |          | 36,630  |           | (25,143  | )                    | (585   | )                   | $      | 34,441 |   |
|                         |   |              |   |          |    |           |     |                 |   |                |   |
| **Nine  months ended:**      |   |              |   |          |    |           |     |                 |   |                |   |
| Deferred membership revenue: |   |              |   |          |    |           |     |                 |   |                |   |
| September  29, 2001          |   | $                 | 55,683 |          | 94,447  |           | (95,000  | )                    | 184    |                | $      | 55,314 |   |
| September  30, 2000          |   | $                 | 24,749 |          | 76,456  |           | (92,665  | )                    | 41,655 |                | $      | 50,195 |   |
| Accrued membership returns:  |   |              |   |          |    |           |     |                 |   |                |   |
| September 29, 2001           |   | $                 | 40,339 |          | 136,500 |           | (144,090 | )                    | (699   | )                   | $      | 32,050 |   |
| September 30, 2000           |   | $                 | 16,911 |          | 91,968  |           | (77,575  | )                    | 3,137  |                | $      | 34,441 |   |

 

----

(1)   Adjustments relate primarily to the initialadoption of SAB 101 on January 1, 2000 and reclassifications between accruedreturns and deferred revenue.

 

The Company recognized$6.0 million of net revenue during the third quarter of 2000 and $33.4 millionof net revenue for the nine month period ended September 30, 2000 which wasincluded as a component of the “cumulative effect of change in accounting”adjustment.

 

**Note 3.   DiscontinuedOperations**

 

In January 2000, theCompany announced its plans to wind-down its non-member catalog marketing andrelated merchandising activities. The wind-down was substantially completed bythe end of the second quarter of 2000 and catalog mailings are now limited tomembers of the Company’s shopping clubs. The order capture, product fulfillment and customer service capabilitiesdeveloped by the Company were re-deployed into a subsidiary named ClickShipDirect, Inc. (“ClickShip”), which was formed in January 2000. The Company hadplanned to spin-off ClickShip as an independent company.  In December 2000, the Company announced thatsubstantial negative changes in capital market conditions prevented the Companyfrom obtaining sufficient capital to permit a spin-off of ClickShip to shareholderson an acceptable basis and the Company therefore adopted a plan to liquidatethe ClickShip business.  Accordingly,both the former non-member catalog business and ClickShip, as well as specificitems previously reported under the corporate segment, are reported asdiscontinued operations at September 29, 2001. The prior year consolidated financial statements have been restated toreport separately the net liabilities and operating results of the discontinuedbusinesses.  Prior to the fourth quarterof 2000, the Company had reported these businesses as the “Catalog Retail”segment.

 

Net liabilities ofdiscontinued operations include the following (in thousands):

 
| **Assets:**                                                |   | **September  29,** |   | **December  31,** |   |
|------------------------------------------------------------|--------|--------------------|--------|-------------------|--------|
|                                                       |   | **2001**           |   | **2000**          |   |
| Lease  deposit and other                                   |   | $                  | 1,939  |              | $      | 2,312 |   |
| Property  and equipment, net of estimated loss on disposal |   | --                 |   | 500               |   |
| Note  receivable from former officer                       |   | 932                |   | 871               |   |
| Other  current assets, net                                 |   | 2                  |   | 1,909             |   |
|                                                       |   |               |   |              |   |
| **Liabilities:**                                           |   |               |   |              |   |
| Accounts  payable                                          |   | (2,084             | )      | (6,529            | )      |
| Future  lease obligations                                  |   | (4,803             | )      | (6,906            | )      |
| Operating  losses through disposal date                    |   | (214               | )      | (4,000            | )      |
| Interest                                                   |   | (658               | )      | (1,300            | )      |
| Other  wind-down related expenses                          |   | (6,610             | )      | (13,383           | )      |
| Net  liabilities of discontinued operations                |   | (11,496            | )      | (26,526           | )      |
| Less:  current portion                                     |   | (11,496            | )      | (23,830           | )      |
| Net  liabilities of discontinued operations, long-term     |   | $                  | --     |              | $      | (2,696 | ) |

 

The note receivable froma former officer is due on January 2, 2003, bears interest on the unpaidprincipal balance at the Company’s borrowing rate, and is secured by futurepayments owing to the former officer.

 

The ClickShip operationwas closed in February of 2001.  TheCompany funded $14.9 million of net liabilities for all discontinued operationsduring the first nine months of 2001 and will continue to settle obligationsfor the remainder of 2001, with certain amounts continuing thereafter.  As of September 29, 2001, the Companybelieves that the balance sheet reserves established for the liquidation of itsdiscontinued operations are adequate to cover remaining obligations.

 

Summary operating resultsof the discontinued operations for the quarter and nine months ended September30, 2000 are as follows (in thousands):

 
|                        |   | **Quarter** |   | **Nine  Months** |   |
|-----------------------------|--------|-------------|--------|------------------|--------|
| Net  revenues               |   | $           | 2,131  |             | $      | 59,243 |   |
| Operating  loss             |   | (9,347      | )      | (63,187          | )      |
| Interest  expense and other |   | (363        | )      | (926             | )      |
| Loss  before taxes          |   | (9,710      | )      | (64,113          | )      |
| Tax  benefit                |   | 3,690       |   | 24,153           |   |
| Net  loss                   |   | $           | (6,020 | )                | $      | (39,960 | ) |

 

**Note 4.   Earnings (Loss) Per Common Share**

 

Basic income per shareis computed based on the weighted average shares of common stock outstanding duringthe applicable periods while diluted earnings per share assumes conversion ofpotentially dilutive securities to shares of common stock outstanding duringthe applicable periods. Potentially dilutive securities include stock optionsthat have been granted to employees and directors of the Company, convertiblepreferred stock and warrants.

 

Options to purchase 2.3million shares of the Company’s Class A Common Stock (the “Common Stock”) atSeptember 29, 2001 and 1.9 million shares of Common Stock at September 30, 2000were not included in the computation of diluted loss per share as their effectwould be anti-dilutive.  At September29, 2001, 7.4 million shares issuable upon conversion of the Series D preferredstock and exercise of the related common stock warrants and 4.4 million sharesissuable upon conversion of the Series E Preferred Stock were also excludedfrom the calculation of diluted loss per share.

 

**Note 5.   FinancingArrangements**

 

On March 27, 2001, theCompany entered into a $20.0 million revolving credit agreement.  The facility expires on September 27, 2002,and is available for working capital and general corporate needs. Availabilityunder the facility is determined monthly based upon the sufficiency of eligiblereceivables and cash collections and can be adjusted at any time within thebank’s permitted discretion.  Borrowingsoutstanding under the credit facility bear interest at the prime rate ofinterest plus 3.0% (9.0% at September 29, 2001) and are secured by all assetsof the Company.  The credit facilityincludes covenants, which require the Company to satisfy certain quarterlyfinancial tests, including minimum earnings before interest and taxes and networth. As of September 29, 2001 there was a $2.9 million reserve against borrowingavailability under the credit agreement for future expenditures associated withthe liquidation of ClickShip.  AtSeptember 29, 2001, the Company had $10.5 million outstanding under the creditfacility, $4.9 million available for additional borrowings (not includingamounts reserved for ClickShip expenditures) and was in compliance with allcovenant requirements.  Due to theCompany’s expected operating results for the fourth quarter of 2001, theCompany anticipates that it will need to amend the credit facility to maintaincompliance with its earnings before interest and taxes and minimum net worthcovenants at the end of its next covenant compliance reporting date on December31, 2001.  The Company is in the processof negotiating such an amendment under the credit facility, but there is noassurance that the Company will be successful in obtaining such amendment.  If the Company is unable to secure such anamendment or otherwise maintain compliance with financial covenants in thecredit facility at the end of any quarter, the Company’s future financialresults and liquidity could be materially adversely affected.

 

In February 2001, theCompany terminated its former $10.0 million commercial credit facility, whichwas available for working capital and general corporate needs.  Borrowings outstanding under this line ofcredit bore interest at the federal funds rate of interest plus 0.5%, bankprime or LIBOR plus 3.25% and were secured by all assets of the Company exceptreal property.

 

**Note 6.   Preferred Stock**

 

On February 27, 2001,the Company completed a private placement with five institutional investors of$14.2 million in 10% Senior Convertible Notes due February 4, 2002(“Notes”).  Following the satisfactionof certain specified conditions, the Notes plus accrued interest were convertedinto 144,856 shares of the Company's Series E Preferred Stock on June 8,2001.  In July 2001, 13,500 shares ofSeries E Preferred Stock were converted into Common Stock.  The Series E Preferred Stock has a statedvalue of $100 per share and is convertible into the Company’s Common Stock at$3.00 per share subject to certain adjustments for future dilutive events.  The Company received $10.0 million of theproceeds at closing and the balance, less transaction fees of approximately$1.1 million, was received in June 2001.

 

Because the conversionprice on the Notes was less than the stock price on the date of issuance, theCompany recorded a $14.2 million beneficial conversion feature as additionalpaid-in-capital and as a discount on the original note obligation.  Prior to the conversion to Series EPreferred Stock, the discount was being amortized ratably over the originalterm of the Notes using the effective interest method.  Prior to the conversion of the Notes, theCompany recorded a charge of $14.1 million or $2.30 per share of amortizationexpense pertaining to the note discount. This amount is not deductible for income tax purposes.

 

The unamortized notediscount of $0.1 million plus unamortized transaction fees of approximately$0.9 million reduced the basis of the Series E Preferred Stock recorded uponconversion of the Notes.  This preferredstock discount, adjusted for the conversion of preferred shares to commonshares, is being amortized ratably from the conversion date to the mandatoryredemption date of February 27, 2003 using the effective interest method.

 

The Series E PreferredStock is redeemable at 125% of the outstanding principal amount or stated valueplus interest upon the occurrence of a triggering event (such as failure tomaintain an applicable resale registration statement covering the Company'sCommon Stock issuable upon conversion of the Series E Preferred Stock orinability to maintain Nasdaq listing of the Company’s Common Stock) or a major transaction(such as a sale or merger of the Company) as defined in the Certificate ofDesignations, Preferences and Rights for the Series E Preferred Stock. Unlessconverted to Common Stock, the Series E Preferred Stock will be redeemed onFebruary 27, 2003 at the stated value of the shares in cash or, at theCompany’s option, for shares of the Company's Common Stock valued at 90% of thethen-current market price. The Series E Preferred Stock ranks pari passu withthe Series D Preferred Stock issued in September 2000.

 

On September 29, 2000,the Company completed a $20.0 million private placement of Series D PreferredStock with four institutional investors. The Company issued 200,000 shares of Series D Preferred Stock with a parvalue of $0.01 per share and a stated value of $100 per share.  The net proceeds were used to supplementworking capital needs.  Initially theSeries D Preferred Stock was convertible at any time at the option of theholder into the Company’s Common Stock at $12.94 per share, subject to certainadjustments for future events.  InFebruary 2001, the conversion price was reset to $3.00 in conjunction with thesale of the Notes.  In July 2001, 10,800shares of Series D Preferred Stock were converted into Common Stock.  The Series D Preferred Stock has a dividendrate of 6.5% per annum payable quarterly in cash or, at the Company’s option,shares of the Company’s Common Stock valued at 90% of its then-current marketprice.  Unless previously converted toCommon Stock, the Series D Preferred Stock is required to be redeemed onSeptember 29, 2002 at the stated value of the shares in cash or, at theCompany’s option, for shares of the Company’s Common Stock valued at 90% of itsthen-current market price.  The Companymay also be required to redeem the Series D Preferred Stock at the stated valueplus a 25% premium and accrued dividends for cash at any time following aconsolidation or merger with another company or the occurrence of othertriggering events as detailed in the Certificate of Designations, Preferencesand Rights of the Series D Preferred Stock.

 

In addition, the Companyissued Common Stock Purchase Warrants (“Warrants”) to the purchasers of theSeries D Preferred Stock for an aggregate of 772,798 shares of Common Stock atan exercise price of $16.17 per share, subject to adjustments similar to theSeries D Preferred Stock.  As a resultof the issuance of the Notes in February 2001, the exercise price was adjustedto $11.65 per share and the number of shares of Common Stock subject to theWarrants increased to 1,072,815 shares. The Company allocated the net proceeds of $18.9 million (cash proceedsof $20.0 million net of transaction costs of $1.1 million) from the issuance ofthe Series D Preferred Stock and Warrants between the relative fair values ofthe preferred stock and Warrants.  Thevalue allocated to the Warrants, $2.8 million, is reflected as a component ofshareholders’ deficit.  The remaining preferredstock is being accreted to its redemption value of $18.9 million over the twoyear period ending on the mandatory redemption date.

 

**Note 7.  Legal Matters**

 

On August 29, 2000, theCompany was served with a complaint styled as a class action in Minnesota StateCourt.  The complaint is similar tocomplaints previously settled by the Company with the Minnesota AttorneyGeneral on December 3, 1999, but also contends that certain business practicesviolate other Minnesota consumer protection laws.  The Company believes it has strong factual and legal defenses andis vigorously defending the allegations both on the merits and in regard toclass status.  The Company's motion forsummary judgment is currently pending. Management believes that the resolutionof this action will not have a material adverse effect on the financialcondition or operations of the Company.

 

On April 17, 2001, fourformer ClickShip employeesfileda complaint styled as a class action in Federal District Court in Minnesotaagainst the Company, alleging that the Companyhadfailed to provide appropriate notice to employees and pay annualperformance bonuses when ClickShip’s fulfillmentcenter closed.  The Company is vigorously defending theallegations and a motion to dismiss is currently pending. Management believesthat the resolution of this action will not have a material adverse effect onthe financial condition or operations of the Company.

 

The Company is party to various claims, legal actions and othercomplaints arising in the ordinary course of business and in connection withthe wind-down of ClickShip.  Managementbelieves that any losses that may occur are adequately covered by insurance or areotherwise provided for and the ultimate outcome of these matters will not havea material adverse effect on the financial position or operations of theCompany.

 

**PROVELL, INC.**

** **

**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**

**AND RESULTS OF OPERATIONS**

 

**General**

 

Provell develops, markets, and manages leading edge membership andcustomer relationship management programs. Members of the Company’s proprietary programs receive value-addedbenefits, insightful information, and exclusive savings opportunities on a widerange of related products and services in the areas of shopping, travel,hospitality, entertainment, health/fitness, finance, and affinity activitiessuch as cooking and home improvement.

 

**Resultsof Continuing Operations**

 

The Company maintained the membership acquisition pace establishedduring the third quarter of 2000, despite paring back less economicallyattractive member acquisition marketing. Acquisition levels have been consistent for the last five quarters,which is expected to help minimize quarterly fluctuations in future renewallevels.  Gross new member acquisitionsduring the third quarter of 2001 were 973,000 in comparison to 955,000 duringthe third quarter of 2000. At September 29, 2001, the Company’s membershipcount was 2.7 million members.  TheCompany’s client roster now includes several of the nation’s largest creditcard issuers, as well as a number of premier consumer marketing organizations.

 

During the third quarter of 2001, the Company continued to focuson reducing its cost per net name acquired (“CPNN”), shifting its mix ofmembership acquisitions to the more economically attractive consumer channel,increasing membership fees and multiple sale marketing occasions, and paringless attractive member acquisition marketing. During the third quarter, the consumer marketing client channelaccounted for 37% of membership acquisitions, as compared to 22% in the thirdquarter of 2000.  The increase inmarketing within the consumer client sector also led to increased inboundtelephone marketing at the Company’s clients’ call centers, a more efficientmarketing method as compared to outbound telephone marketing and direct mail solicitation.   Member enrollments obtained through inboundtelemarketing have risen steadily during the year from 5% of enrollments duringthe first quarter of 2001 to 18% of enrollments during the third quarter of 2001.  The average membership fee during the thirdquarter of 2001 was $91 as compared to $75 in the prior year comparableperiod.  The Company’s memberacquisition marketing efforts also benefited significantly from the addition ofa secondary sales effort, usually in the form of an additional club product ora coupon based savings compendium, presented at the end of a sales occasion. Asa result of these initiatives, the Company achieved a 50% reduction in CPNN incomparison to the second quarter of 2001 and a 67% reduction in CPNN incomparison to the fourth quarter of 2000.

 

Net revenues were $36.9 million for the third quarter of 2001 and$104.6 million for the first nine months of 2001, compared to net revenues of$31.8 million for the third quarter of 2000 and $101.9 million for the first ninemonths of 2000.  Gross revenues beforedeferral were $78.5 million for the third quarter of 2001 as compared to $71.1million for the third quarter of 2000, a 10.4% increase.  For the nine months ended September 29, 2001gross revenues before deferral were $235.9 million and for the prior yearcomparable period were $167.1 million, a 41.2% increase.  The significant increase in year-to-daterevenues over the prior year resulted primarily from higher average membershipfees and higher acquisition levels than the prior year comparable period.

 

The Company reported an operating loss of $6.4 million for thethird quarter of 2001 as compared to operating income of $4.6 million for theprior year comparable period.   For thenine months ended September 29, 2001, the Company reported an operating loss of$19.2 million as compared to operating income of $25.6 million for the firstnine months of 2000.  The losses forthis quarter and for the first nine months of this year are attributableprimarily to the high member acquisition costs incurred during the fourthquarter of 2000 and  the first andsecond quarters of 2001.  As previouslydiscussed, the Company has reduced its CPNN by 67% since the fourth quarter of2000; however, high marketing costs incurred in previous periods continue to beamortized into expense as required under deferral accounting.  The benefit of the lower CPNN achievedduring the third quarter of 2001 will be recognized ratably over the remainingmembership period.  The third quarter2001 reduction in CPNN is evidenced by the decrease, quarter over quarter, inthe operating loss prior to the impact of deferral accounting, which was $0.6million for third quarter 2001 as compared to losses of $7.4 million for thesecond quarter of 2001 and $14.8 million for the first quarter of 2001.   The deferred net margin on the balancesheet also reflects the benefit of reduced CPNN as well as higher levels ofprofitable member renewals as this margin has increased to $10.3 million atSeptember 29, 2001 from $4.5 million at June 30, 2001.

 

The mix of renewal and acquisition revenues also has a significantimpact on operating income, as acquisitions are less profitable thanrenewals.   While the first half of 2001was negatively impacted by low renewal levels, the third quarter of 2001benefited from a strong improvement in the number of memberships available forrenewal and renewal rates that were at their highest level since the firstquarter of 2000.  The number of membershipsavailable for renewal during the third quarter of 2001 was higher than both thesecond and first quarter of 2001 amounts. This was a direct result of significant increased acquisition levelsbeginning in the third quarter of 2000 in an effort to reduce the Company’sreliance on the Damark House file and to build up its future renewal stream.

 

Net losses were $4.3 million for the third quarter of 2001 and$3.3 million for the third quarter of 2000. Net losses were  $27.6 millionfor the first nine months of 2001 and $38.2 million for the first nine monthsof 2000.  The nine month net results for2001 were impacted by a $14.1 million non-cash charge for amortization of thenote discount related to the private placement of Senior Convertible Notes inFebruary 2001.  Third quarter 2000 earningsincluded $6.0 million of operating losses, net of taxes, from the Company’sdiscontinued operations.  Nine month2000 earnings included $40.0 million of operating losses, net of taxes, fromthe Company’s discontinued operations and a $14.2 million after tax non-cashcharge related to the cumulative effect of adopting SAB 101.

 

The Company’s effective tax rate was 36.2% for the third quarterof 2001 and 19.9% for the first nine months of 2001.  The net loss for the nine-month period of 2001 included non-deductiblecharges of $14.8 million for the amortization of discount and interestassociated with the Notes, which have been treated as permanent differences fortax purposes.  The effective tax rateexcluding these charges was 35.0% for the first nine months of 2001.

 

As of September 29, 2001, the Company has recorded on itsconsolidated balance sheet a net deferred tax asset of $48.0 million.  Despite incurring net losses in recentquarters and becoming subject to limitations on net operating loss (“NOL”)utilization, the Company has not recorded a deferred tax valuation allowancesince management believes that it is more likely than not that its operatingstrategies will allow the Company to generate sufficient taxable income incurrent and future years to realize this asset.  Should the Company’s operating strategies fail to producesufficient current and future taxable income, or if future changes incircumstances further limit NOL utilization, the Company will record avaluation allowance in the appropriate future reporting period for all or aportion of its net deferred tax asset, as required by generally acceptedaccounting principles.

 

**Impact of Terrorist Attacks**

 

The September 11, 2001 terrorist attacks on the United States havecaused significant economic disruptions. The Company’s marketing activities virtually ceased the week ofSeptember 11, resulting in the loss of approximately 100,000 trial offers.  While this will have a nominal impact onfourth quarter operating results, cash flow from operations will be negativelyimpacted initially by approximately $5.0 million due to lost billingopportunities.  At the close of thequarter, consumer response rates and renewal rates were holding at theirpre-attack levels, including sales of travel-related programs.  However, there can be no assurance thatconsumer response rates and renewal rates will continue to hold at theirpre-attack levels.

 

**Discontinued Operations**

 

The aggregate loss from discontinued operations includes lossesfrom the Company’s non-member catalog marketing and merchandising activitiesand from its ClickShip subsidiary as well as certain corporate expenses.  The net loss for the third quarter of 2000was $6.0 million, net of taxes of $3.7 million.  The net loss for the first nine months of 2000 was $40.0 million,net of taxes of $24.2 million.

 

Summary operating results of the discontinued operations for thequarter and nine months ended September 30, 2000 are as follows (in thousands):

 
|                        |   | **Quarter** |   | **Nine  Months** |   |
|-----------------------------|--------|-------------|--------|------------------|--------|
| Net  revenues               |   | $           | 2,131  |             | $      | 59,243 |   |
| Operating  loss             |   | (9,347      | )      | (63,187          | )      |
| Interest  expense and other |   | (363        | )      | (926             | )      |
| Loss  before taxes          |   | (9,710      | )      | (64,113          | )      |
| Tax  benefit                |   | 3,690       |   | 24,153           |   |
| Net  loss                   |   | $           | (6,020 | )                | $      | (39,960 | ) |

 

Net liabilities of discontinued operationsinclude the following (in thousands):

 
|                                                       |   | **September  29,** |   | **December  31,** |   |
|------------------------------------------------------------|--------|--------------------|--------|-------------------|--------|
| **Assets:**                                                |   | **2001**           |   | **2000**          |   |
| Lease  deposit and other                                   |   | $                  | 1,939  |              | $      | 2,312 |   |
| Property  and equipment, net of estimated loss on disposal |   | --                 |   | 500               |   |
| Note  receivable from former officer                       |   | 932                |   | 871               |   |
| Other  current assets, net                                 |   | 2                  |   | 1,909             |   |
|                                                       |   |               |   |              |   |
| **Liabilities:**                                           |   |               |   |              |   |
| Accounts  payable                                          |   | (2,084             | )      | (6,529            | )      |
| Future  lease obligations                                  |   | (4,803             | )      | (6,906            | )      |
| Operating  losses through disposal date                    |   | (214               | )      | (4,000            | )      |
| Interest                                                   |   | (658               | )      | (1,300            | )      |
| Other  wind-down related expenses                          |   | (6,610             | )      | (13,383           | )      |
| Net  liabilities of discontinued operations                |   | (11,496            | )      | (26,526           | )      |
| Less:  current portion                                     |   | (11,496            | )      | (23,830           | )      |
| Net  liabilities of discontinued operations, long-term     |   | $                  | --     |              | $      | (2,696 | ) |

 

The note receivable from a former officer is due on January 2,2003, bears interest on the unpaid principal balance at the Company’s borrowingrate and is secured by future payments owing to the former officer.

 

The ClickShip operation was closed in February of 2001.  The Company funded $14.9 million of netliabilities for all discontinued operations during the first nine months of2001 and will continue to settle obligations for the remainder of 2001, withcertain amounts continuing thereafter. As of September 29, 2001, the Company believes that the balance sheetreserves established for the liquidation of its discontinued operations areadequate to cover remaining obligations.

 

**Liquidity and Capital Resources**

 

**General**

 

Currently, the Company’s liquidity needs arise primarily fromfunding the growth of its continuing membership services business, liquidatingits discontinued operations, and capital expenditures. Management believes thatcash expected to be generated from continuing operations and availability underits credit facility (see below) provide adequate liquidity during the fourthquarter of 2001 to fund the operations of the Company, anticipated capitalexpenditures and the net liquidation costs for exiting the ClickShipbusiness.  However, there can be noassurance that the cash generated from these sources will be sufficient to meetthese funding needs.  The Company willpursue additional debt or equity financing to supplement its current capitalresources if needed.  The Company’sability to obtain additional financing will depend upon a number of factors,including the Company’s future performance and financial results and generaleconomic and capital market conditions. The Company cannot be sure that it will be able to raise additionalcapital on reasonable terms or at all.

 

**Cash Flow**

 

The Company used $14.1 million of cash for operations during thefirst nine months of 2001 as compared to using $0.4 million of cash fromoperations during the first nine months of 2000.   Cash usage in the first nine months of 2001 reflects aggressiveacquisition marketing, funding of returns from record acquisition quarters inthe last half of 2000, and a shift in mix between renewals and acquisitionsyear over year as the Company focuses on leveling its book of renewal businessfor future quarters.  In addition,reserves required by key business partners increased significantly compared tothe same period a year ago.  During thethird quarter, the Gramm-Leach-Bliley Act (“GLB”) regarding consumer privacyand credit card security was enacted, negatively impacting cashcollections.  Several clients migratedto direct settlement processes and away from the interchange system, therebydelaying remittances from the Company’s clients.  These delays in the collection cycle have been partiallymitigated by renegotiated vendor payment terms to more closely correspond withthe timing of cash collections.  Despitethe challenges imposed by GLB, the Company generated $6.9 million in cash fromoperations during the third quarter of 2001 due primarily to its increasedrenewal volumes and lower acquisition CPNN. The Company anticipates that significantly increased renewal volumeswill contribute to positive fourth quarter cash flows from operating activitiesconsistent with those reported for the third quarter, despite an estimated $5million initial shortfall due to the suspension of outbound marketingactivities during the week of September 11, 2001, as well as continuedtransaction settlement processing challenges resulting from GLB.

 

**Capital Expenditures**

 

During the first ninemonths of 2001, the Company incurred capital expenditures of $1.6 million ascompared to $2.6 million during the first nine months of 2000.  The investment in 2001 was primarily relatedto its management information systems. Management estimates that the Companywill invest no more than $2.5 million in capital expenditures during 2001,principally related to computer hardware and software.

 

**Financing**

 

On March 27, 2001, theCompany entered into a $20.0 million revolving credit agreement.  The facility expires on September 27, 2002,and is available for working capital and general corporate needs. Availabilityunder the facility is determined monthly based upon the sufficiency of eligiblereceivables and cash collections and can be adjusted at any time within thebank’s permitted discretion.  Borrowingsoutstanding under the credit facility bear interest at the prime rate ofinterest plus 3.0% (9.0% at September 29, 2001) and are secured by all assetsof the Company.  The credit facilityincludes covenants, which require the Company to satisfy certain quarterlyfinancial tests, including minimum earnings before interest and taxes and networth. As of September 29, 2001 there was a $2.9 million reserve againstborrowing availability under the credit agreement for future expendituresassociated with the liquidation of ClickShip. At September 29, 2001, the Company had $10.5 million outstanding underthe credit facility, $4.9 million available for additional borrowings (notincluding amounts reserved for ClickShip expenditures) and was in compliancewith all covenant requirements.   Due tothe Company’s expected operating results for the fourth quarter of 2001, theCompany anticipates that it will need to amend the credit facility to maintaincompliance with its earnings before interest and taxes and minimum net worthcovenants at the end of its next covenant compliance reporting date on December31, 2001.  The Company is in the processof negotiating such an amendment under the credit facility, but there is no assurancethat the Company will be successful in obtaining such amendment.  If the Company is unable to secure such anamendment or otherwise maintain compliance with financial covenants in thecredit facility at the end of any quarter, the Company’s future financialresults and liquidity could be materially adversely affected.

 

In February 2001, theCompany terminated its former $10.0 million commercial credit facility, whichwas available for working capital and general corporate needs.  Borrowings outstanding under this line ofcredit bore interest at the federal funds rate of interest plus 0.5%, bankprime or LIBOR plus 3.25% and were secured by all assets of the Company exceptreal property.

 

On February 27, 2001,the Company completed a private placement with five institutional investors of$14.2 million in Notes.  Following thesatisfaction of certain specified conditions, the Notes plus accrued interestwere converted into 144,856 shares of the Company's Series E Preferred Stock onJune 8, 2001.  In July 2001, 13,500shares of Series E Preferred Stock were converted into Common Stock.  The Series E Preferred Stock has a statedvalue of $100 per share and is convertible into the Company’s Common Stock at$3.00 per share subject to certain adjustments for future dilutive events.  The Company received $10.0 million of theproceeds at closing and the balance, less transaction fees of approximately$1.1 million, was received in June 2001.

 

Because the conversionprice on the Notes was less than the stock price on the date of issuance, theCompany recorded a $14.2 million beneficial conversion feature as additionalpaid-in-capital and as a discount on the original note obligation.  Prior to the conversion to Series E PreferredStock, the discount was being amortized ratably over the original term of theNotes using the effective interest method. Prior to the conversion of the Notes, the Company recorded a charge of$14.1 million or $2.30 per share of amortization expense pertaining to the notediscount.  This amount is not deductiblefor income tax purposes.

 

The unamortized notediscount of $0.1 million plus unamortized transaction fees of approximately$0.9 million reduced the basis of the Series E Preferred Stock recorded uponconversion of Notes.  This preferredstock discount, adjusted for the conversion of preferred shares to commonshares, is being amortized ratably from the conversion date to the mandatoryredemption date of February 27, 2003 using the effective interest method.

 

The Series E Preferred Stockis redeemable at 125% of the outstanding principal amount or stated value plusinterest upon the occurrence of a triggering event (such as failure to maintainan applicable resale registration statement covering the Company's Common Stockissuable upon conversion of the Series E Preferred Stock or inability tomaintain Nasdaq listing of the Company’s Common Stock) or a major transaction(such as a sale or merger of the Company) as defined in the Certificate ofDesignations, Preferences and Rights for the Series E Preferred Stock. Unlessconverted to Common Stock, the Series E Preferred Stock will be redeemed onFebruary 27, 2003 at the stated value of the shares in cash or, at theCompany’s option, for shares of the Company's Common Stock valued at 90% of thethen-current market price. The Series E Preferred Stock ranks pari passu withthe Series D Preferred Stock issued in September 2000.

 

On September 29, 2000,the Company completed a $20.0 million private placement of Series D PreferredStock with four institutional investors. The Company issued 200,000 shares of Series D Preferred Stock with a parvalue of $0.01 per share and a stated value of $100 per share.  The net proceeds were used to supplementworking capital needs.  Initially theSeries D Preferred Stock was convertible at any time at the option of theholder into the Company’s Common Stock at $12.94 per share, subject to certainadjustments for future events.  InFebruary 2001, the conversion price was reset to $3.00 in conjunction with thesale of the Notes.  In July 2001, 10,800shares of Series D Preferred Stock were converted into Common Stock.  The Series D Preferred Stock has a dividendrate of 6.5% per annum payable quarterly in cash or, at the Company’s option,shares of the Company’s Common Stock valued at 90% of its then-current marketprice.  Unless previously converted toCommon Stock, the Series D Preferred Stock is required to be redeemed onSeptember 29, 2002 at the stated value of the shares in cash or, at theCompany’s option, for shares of the Company’s Common Stock valued at 90% of itsthen-current market price.  The Companymay also be required to redeem the Series D Preferred Stock at the stated valueplus a 25% premium and accrued dividends for cash at any time following a consolidationor merger with another company or the occurrence of other triggering events asdetailed in the Certificate of Designations, Preferences and Rights of theSeries D Preferred Stock.

 

In addition, the Companyissued Common Stock Purchase Warrants (“Warrants”) to the purchasers of theSeries D Preferred Stock for an aggregate of 772,798 shares of Common Stock atan exercise price of $16.17 per share, subject to adjustments similar to theSeries D Preferred Stock.  As a resultof the issuance of the Notes in February 2001, the exercise price was adjustedto $11.65 per share and the number of shares of Common Stock subject to theWarrants increased to 1,072,815 shares. The Company allocated the net proceeds of $18.9 million (cash proceedsof $20.0 million net of transaction costs of $1.1 million) from the issuance ofthe Series D Preferred Stock and Warrants between the relative fair values ofthe preferred stock and Warrants.  Thevalue allocated to the Warrants, $2.8 million, is reflected as a component ofshareholders’ deficit.  The remainingpreferred stock is being accreted to its redemption value of $18.9 million overthe two year period ending on the mandatory redemption date.

 

**Seasonality**

 

Following the wind-downof the Catalog Retail Segment, management expects the seasonal variation inconsumer demand to have less of an impact on the operations of the Company;however, as the Company enters into more marketing arrangements with retailersand catalog companies, seasonality could have a greater impact on the Company.

## ** **

**Inflation**

 

Inflation has not had,and the Company does not expect it to have, a material impact on operatingresults. There can be no assurances, however, that the Company's business willnot be negatively affected by inflation in the future.

 

**Recently Issued Accounting Pronouncements**

 

The Company adoptedStatement of Financial Accounting Standards (“SFAS”) No. 133, "Accountingfor Derivative Investments and Hedging Activities," as of January 1,2001.  This accounting standard establishesaccounting and reporting standards for derivative instruments, includingcertain derivative instruments embedded in other contracts, and for hedgingactivities. The adoption of SFAS No. 133 had no impact on the Company'sfinancial position or results of operations.

 

**Forward-Looking Information**

 

Certain of the mattersdiscussed herein are "forward-looking statements" intended to qualifyfor the safe harbor provisions from liability provided by the PrivateSecurities Litigation Reform Act of 1995. Important factors exist that couldcause results to differ materially from those anticipated by some of thestatements herein. Forward-looking statements in this document include theadequacy of reserves for discontinued operations; the impact of the Company’slegal proceedings on the financial condition or operations of the Company; theexpected decrease in quarterly fluctuation in future renewal levels; theadequacy of current and future taxable income to utilize the Company’s creditfor net operating loss carryforwards; the impact of the September 11 terroristactivities on fourth quarter cash flows; the anticipated maintenance of fourthquarter cash flows from operating activities; the impact of seasonal variationin consumer demand and inflation;  andthe Company’s anticipated liquidity and capital expenditures.  In addition, the words “believe”, “expect”,“anticipate”, “intend”, “designed”, “goal”, “priority”, “will”, “target”, andsimilar expressions identify forward-looking statements. Investors are cautionedthat all forward-looking statements involve risks and uncertainties that couldcause actual results to differ materially from expectations, including thoseidentified below:

 

·        The economic outlook, including thecontinuing war on terrorism, and its effects on credit availability, interestrates, consumer spending patterns and the Company’s marketing operations andcash flows;

·        Deepening of the economic recession;

·        Adverse changes in relationships withvendors and business partners who provide club benefits or process credit cardtransactions;

·        Increasing reserve requirements bybusiness partners;

·        Inability to develop replacement shoppingclub or other membership programs;

·        Loss of key management and executivetalent;

·        Lower than expected membership renewal rates;

·        Higher than expected membershipcancellation rates;

·        Higher than expected fluctuations inquarterly renewal rates;

·        Lower than expected cash flows in thefourth quarter of 2001;

·        Inability to profitably expand in themembership services market;

·        Excessive new member acquisition costs;

·        Inability to retain existing clients andattract new clients in the membership services market;

·        Inability to develop new membershipprograms;

·        Effects of possible system failures andrapid changes in technology;

·        Higher than expected cash requirements tosettle known or unknown obligations of the Company’s discontinued operations;

·        Lower than expected taxable income toutilize the Company’s credit for net operating loss carryforwards;

·        Effects of possible unfavorable courtrulings related to the Company’s pending legal proceedings;

·        Higher than expected cash requirements tofund the Company’s continuing operations and capital expenditures;

·        Lower than expected borrowingavailability under the Company’s current credit facility;

·        Externally mandated changes in accountingguidelines and telemarketing practices;

·        Possible adverse effects of seasonalvariation in consumer demand and inflation;

·        Availability of capital on acceptableterms;

·        Availability of financing on acceptableterms; and

·        Inability to retain Nasdaq listing of theCompany’s Common Stock.

 

Shareholders, potentialinvestors and other readers are urged to consider these and other factors inevaluating the forward-looking statements made herein, all of which speak onlyas of the date on which they are made and as to which the Company has noobligation to update publicly.

 

**Item 3.    Quantitative and Qualitative DisclosuresAbout Market Risk**

 

**Interest Rate**

 

The Company has a $20.0million bank credit facility which bears interest at the prime rate of interestplus 3.0%. There were $10.5 million of borrowings outstanding under this bankcredit facility as of September 29, 2001. Management believes that an increasein the commercial lending rate or the Federal Funds rate would not be materialto the Company's financial position or its results of operations. If theCompany would need to replace its existing credit facility agreement, it ispossible that any replacement lending facility obtained by the Company may bemore sensitive to interest rate changes. The Company does not currently hedgeinterest rates with respect to its outstanding debt.

 

**PartII.  Other Information**

 

**Item 6.    Exhibits andReports on Form 8-K**

 

**a.             Exhibits:**

 

Exhibit10.1 – Severance and Change of Control Agreement between Provell, Inc. andGeorge S. Richards.

 

Exhibit10.2 – Severance and Change of Control Agreement between Provell, Inc. andMichael T. McGowan.

 

**b.             Reports on Form 8-K:**

 

TheCompany filed a Current Report on Form 8-K on July 20, 2001, reporting under“Item 5 Other Events” certain updated tables of the Company’s beneficialownership to demonstrate compliance with the NASDAQ public float requirements.

 

TheCompany filed a Current Report on Form 8-K on July 25, 2001, reporting under“Item 5 Other Events” that Ralph Strangis resigned from the Company’s Board ofDirectors effective July 24, 2001.

 

The Company filed aCurrent Report on Form 8-K on September 12, 2001, reporting under “Item 5 OtherEvents” that the Company issued a press release, dated September 10, 2001,announcing the resignation of Kim Mageau as Senior Vice President and ChiefFinancial Officer of the Company and filing under “Item 7 Financial Statementsand Exhibits” a copy of the press release, dated September 10, 2001.

 

**Signature**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|   |               | **PROVELL, INC.** |
|--------|--------------------|-------------------|
|   |               |              |   |
|   |               |              |   |
| Date:  | November  13, 2001 | By:               | /s/  George S. Richards |
|   |               |              | George  S. Richards |
|   |               |              | Chairman,  President and Chief Executive Officer |