K-tel International, Inc.
2605 Fernbrook Lane N.
Minneapolis, MN 55427


October 12, 1998


Securities and Exchange Commission
450 Fifth Street, NW
Attn: Filing Desk, Stop 1-4
Washington, D.C. 20549-1004


Gentlemen:

Enclosed is K-tel International, Inc.'s Form 10K for the fiscal year ended June
30, 1998, pursuant to the applicable provisions of the Securities Exchange Act
of 1934.

Questions can be directed to the undersigned at 818-225-6160 or faxed to
818-223-4200.

Sincerely,



/S/ Corey Fischer
Chief Financial Officer
K-tel International, Inc.

<PAGE>


                                  UNITED STATES
                       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, 1998

                                       OR

[ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

           For the transition period from ____________ to ____________

                          Commission file number 0-6664

                            K-TEL INTERNATIONAL, INC.
             (Exact name of registrant as specified in its charter)

            Minnesota                                    41-0946588
(State or other jurisdiction of            (I.R.S. employer 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) 559-6888

           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               The Nasdaq Stock Market
            (Title of class)              (Name of exchange on which registered)

      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
of1934 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 11, 1998 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 $34,235,000.

      As of June 30, 1998 the registrant had 8,316,668 shares of Common Stock
outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company's Notice of Meeting of Shareholders and Proxy Statement
for the Annual Shareholders Meeting, which are expected to be filed with the
Security and Exchange Commission in the next 30 days, are incorporated into Part
III of this Form by amendment.


                                       1

<PAGE>


                                     PART I


ITEM 1: BUSINESS

K-tel International, Inc. (the "Company", "K-tel" or the "Registrant") was
incorporated in 1968 with its current corporate offices located at 2605
Fernbrook Lane North, Minneapolis, Minnesota. The Company is an international
marketer and distributor of entertainment and consumer products and is a leader
in the market niche for pre-recorded music compilations. With more than thirty
years of marketing experience in the United States ("U.S."), Canada and Europe,
the Company has developed the resources, knowledgeable personnel, information
systems, and distribution capabilities to launch music, video, and consumer
products quickly in the North American and European markets through traditional
retail and direct-response marketing channels. On May 1, 1998 the Company
launched its new Internet service, K-tel Express (www.ktel.com), featuring a
wide spectrum of music products for purchase by the public around the globe.
Open for commerce 24 hours a day, 365 days a year, K-tel Express features more
than 250,000 music titles, at value prices, through this on-line shopping
service.

Development of Business

The Company's core business for many years has been the marketing and sale of
(i) pre-recorded music from both the Company's owned music master catalog and
under licenses from third party record companies, and (ii) consumer products.
Sales of music products, including albums, cassettes and compact discs are made
to rackjobbers (distributors which stock and manage inventory within certain
music and video departments for certain retail stores), wholesalers and
retailers in the U.S. and through subsidiaries and licensees in the United
Kingdom and elsewhere in Europe. The Company has also used television
direct-response marketing for many years in marketing pre-recorded music. Sales
of consumer products, including housewares, automotive accessories and exercise
equipment, are made to retailers in the U.S., Europe and directly to the
consumer in targeted direct response marketing campaigns through the use of
short and long form television advertising, print and other media.

In 1997 the Company formed a U.S. media buying and infomercial-marketing
subsidiary which performed media buying services for third parties and also
marketed products through infomercials produced by third parties. As of June 30,
1998, due to accumulated losses of $2,300,000, the Company had curtailed most of
these media buying operations. In March of 1998 the Company acquired certain
media and other assets of United Kingdom based Regal Shop International Ltd.
Acquisition of this operation now enables the Company to reach consumers in
France, Switzerland, Belgium, Austria and Luxembourg. On May 1, 1998 the Company
launched its new Internet service K-tel Express.

Description of Current Business

K-tel is currently a vertically-integrated marketer and distributor of
entertainment and consumer products and is a leader in the market niche for
pre-recorded music compilations. On May 1, 1998 the Company launched K-tel
Express, its on-line music retailing business that features a wide spectrum of
music products for purchase by the public over the Internet. Open 24 hours a
day, 365 days a year, K-tel Express is a virtual music store that enables
customers to choose from the proprietary brand-name compilations that have made
the K-tel name synonymous with quality music for over 30 years. K-tel Express
offers customers more than 250,000 other music titles at value prices and the
opportunity to create their own custom CD compilations from the Company's master
music catalog. The website features audio sampling, user-friendly navigation and
search capabilities, a high level of customer service and competitive pricing.
Revenues from K-tel Express sales are not yet a significant part of the
Company's business, but the Company believes the prospects for K-tel Express and
electronic commerce, in general, are encouraging.

The Company's music operations consist of the sale of pre-recorded music through
traditional retail distribution and over the Internet. The Company's proprietary
entertainment products consist primarily of pre-recorded thematic music packages
in a compilation format featuring various artists. These thematic music
selections cover nearly all music genres and are targeted toward all age groups.
The Company has two sources for music, its proprietary music master catalog,
which consists of 3,500 "Top 100" titles, and songs licensed from third party
record music companies. One of the Company's major assets is its music master
catalog consisting of original recordings and re-recordings of music from the
1950s through the 1980s ("Master Recordings"). The Master Recordings are
utilized in the Company's proprietary compilation products and are also licensed
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 or units
sold. The Company is constantly adding to its music master catalog to ensure
growth and product diversity. Licensing of the Company's proprietary music
rights to third parties has historically been an


                                       2

<PAGE>


important revenue source for the Company. The Company provides marketing support
for its music sales through television and print media advertising, cooperative
advertising with retailers, and in-store promotions and displays.

Music products are sold over the Internet through the Company's K-tel Express
website. The Company believes that the emergence of electronic commerce
("e-commerce") presents K-tel with a significant opportunity to capture market
share in the burgeoning e-commerce area by capitalizing on K-tel's high name
recognition, extensive catalog of proprietary music content and existing
capabilities and expertise in niche marketing, which the Company believes will
be critical to success in Internet retailing. The Company intends to use the
same combination of resources that has made it a leader in the direct marketing
arena that it pioneered and will rely heavily on its brand identity with
consumers. A number of characteristics of online music retailing such as audio
sampling, search capabilities, availability of deep catalog content, and at home
convenience shopping make the sale of pre-recorded music via the Internet
particularly attractive relative to traditional retail outlets. Although
Internet sales are not yet a significant part of K-tel's business revenues, the
Company believes the prospects of K-tel Express and e-commerce in general are
encouraging. However, the success of on-line marketing cannot be currently
determined, and further penetration in this market will require substantial
additional financial resources, development and acquisition of technology,
investments in marketing and contractual relationships with third parties.
Results will also be affected by existing competition, which the Company
anticipates will intensify, and by additional entrants to the market who may
already have the necessary technology and expertise, many of whom may have
substantially greater resources than the Company.

K-tel's marketing strategy for K-tel Express is to leverage its proprietary
music content and its worldwide television expenditures to drive traffic to the
site and gain market share. The Company's brand name recognition, along with its
international presence and direct access to consumers through alternative media
channels, all serve to create strong synergies between the existing core
operations of K-tel and its expansion into the e-commerce arena. The Company's
objective is to continue its focus on developing K-tel Express as a synergistic
asset to its music business and related marketing operations. During fiscal 1999
K-tel expects to introduce a custom compilation system that will offer on line
shoppers the ability to create compilations from any of our 3,500 "Top 100"
titles from our master music catalog. This is an example of how these synergies
create new opportunities to expand K-tel product breadth and consumer reach.
Over the coming year K-tel will continue to analyze and explore the best
strategy for the exploitation of our new e-commerce market place.

K-tel has provided additional enhancements to K-tel Express since the launch of
its online service. These actions include entering into a partnership agreement
with RealNetworks, Inc. to develop user friendly technology enabling consumers
to create customized CD compilations and artwork on-line. As an additional
enhancement the Company has licensed digital music delivery technology from
Liquid Audio which will allow K-tel Express customers to download up to 3,500
songs from K-tel's music master catalog in Liquid Track format. K-tel Express
also posts BILLBOARD MAGAZINE's industry music charts. Expanding its products
and service offerings on the site, the Company has signed an agreement to
integrate Muze Inc.'s home video content of 35,000 titles, as well as its music
and movie reviews. In order to provide a secure and convenient shopping
environment for K-tel Express customers, the Company entered into an agreement
with CyberSource to integrate its scalable payment processing infrastructure. In
addition, the Company also entered into a comprehensive Internet marketing and
services agreement with @Home Network.

The Company's consumer products consist primarily of housewares, automotive
accessories, 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 national and local
television and radio advertising and print media. The Company also utilizes
limited direct response advertising campaigns to test consumer acceptance of new
products within specific demographic or geographic markets allowing the Company
to assess a product's potential before having to make a significant capital
commitment. The Company's strategy in its direct response campaigns is to
generate revenues and profits from both the direct response campaigns and
subsequent retail demand.

With more than 30 successive years of marketing experience in the United States,
Canada and Europe, the Company has developed the resources, including
knowledgeable personnel, information systems, distribution systems and media
buying capabilities, to launch music and consumer products quickly in the North
American and European markets through the Internet, by traditional retail
(direct-to-retailers or through rackjobbers (i.e., distributors who stock and
manage inventory within music and video departments for certain retail stores))
and through direct response (direct-to-consumer). The Company, through its
subsidiaries, maintains active operations in the United States, Canada, the
United Kingdom, Germany, France, Switzerland, Belgium, Austria and Finland.


                                       3

<PAGE>


Sales of pre-recorded music products to Handleman Company represented 7%, 8%,
and 12% of the Company's consolidated net sales for the years ended June 30,
1998, 1997 and 1996. Loss of business with the Handleman Company would have a
material adverse effect on the Company's operating results.

Competition

The online commerce market, particularly over the Internet, is new, rapidly
evolving and intensely competitive, which competition the Company expects to
intensify in the future. Barriers to entry are minimal, and current and new
competitors can launch new websites at a relatively low cost. In addition, the
retail music industry is intensely competitive. Through its K-Tel Express
business, the Company currently competes with a variety of companies, including
(i) online vendors of music, music videos and other related products, (ii)
online vendors of movies, books and other related products, (iii) online service
providers which offer music products directly or cooperation with other
retailers, (iv) traditional retailers of music products, including specialty
music retailers, (v) other retailers that offer music products, including mass
merchandisers, superstores and consumer electronic stores; and (vi) non-store
retailers such as music clubs. Many of these traditional retailers also support
dedicated Web sites which compete directly with the Company. Competitive
pressures created by any one of these companies, or by the Company's competitors
collectively, could have a material adverse affect on the Company.

The Company's music and consumer products compete for the disposable income
spent by consumers on discretionary purchases. As such, K-tel's products must be
attractively priced and meet the specific interests or needs of consumers.
K-tel's products sold in retail stores compete with other entertainment products
for shelf and display space. Because most retail purchases are impulse buys by
consumers, location and size of the shelf space devoted to the Company's music
products are important factors in determining the volume of retail sales.

The market for pre-recorded music is dominated by six major recorded music
companies in the U.S. (Thorne EMI, Bertelsmann AG, Sony Corp., MCA, Inc., Time
Warner, Inc., and Polygram Holding, Inc.). K-tel primarily operates in the niche
market of music compilations. K-tel believes there are a number of competitors,
including special market divisions of the six major record companies, as well as
Simitar Entertaiment, Inc., Rhino Records (which is owned by Time Warner's
wholly-owned subsidiary, Atlantic Records) and Priority Records, an independent
record company, which are engaged in developing and marketing music
compilations. K-tel's ability to compete in this market is largely dependent on
the expansion and utilization of its catalog and the acquisition of licenses
that enable it to create compilation packages.

Employees

On June 30, 1998 the Company employed 189 full time people worldwide.

Financial Information

For financial information about the Company's foreign and domestic operations
for each of the last three fiscal years ended June 30, 1998 see Note 9 to the
consolidated financial statements.

Year 2000 Disclosure

The Company has developed a plan to ensure its systems are compliant with the
requirements to process transactions in the year 2000. The majority of the
Company's internal information systems have been upgraded or are in the process
of being upgraded or replaced with fully compliant new systems. The Company's
European subsidiaries have upgraded or are in the process of replacing or
upgrading their information systems to comply with Year 2000 requirements. The
total cost of the software and implementation is estimated to be approximately
$150,000. The new system implementation is expected to be completed by July 31,
1999. Some of the Company's customers utilize equipment to capture and transmit
financial transactions. The Company is in the process of making the necessary
updates to this equipment to ensure it will be effective in the year 2000. The
Company is also working with its processing banks and network providers to
ensure their systems are year 2000 compliant. All of these costs will be or have
been borne by the processors and network companies. Should the Company, its
customers, its vendors or the processing banks fail to resolve year 2000 issues,
the Company may lose certain financial and operating data. The Company is in the
process of developing a contingency plan, which it expects to be completed by
the end of the fiscal year.

INFORMATION CONTAINED IN THIS ITEM CONTAINS "FORWARD-LOOKING STATEMENTS" WITHIN
THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, WHICH CAN
BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "MAY," "WILL,"
"WOULD," "COULD," "INTEND," "PLAN," "EXPECT," "ANTICIPATE," "ESTIMATE," OR
"CONTINUE," OR NEGATIVE VARIATIONS THEREOF OR OTHER VARIATIONS THEREON OR
COMPARABLE TERMINOLOGY. MANY FACTORS COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THOSE


                                       4

<PAGE>


IN THE FORWARD-LOOKING STATEMENTS, INCLUDING OVERALL ECONOMIC CONDITIONS,
CONSUMER PURCHASING, CUSTOMER ACCEPTANCE OF PRODUCTS, MARKETING AND PROMOTION
EFFORTS, FOREIGN CURRENCY VARIATIONS AND CHANGES IN INTEREST RATES.


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 21,985 square
feet of office space and approximately 69,653 square feet of warehouse. In
September 1997 the Company's California operations relocated to a new leased
facility in Calabasas, California, which consists of approximately 6,758 square
feet of office space.

K-tel's foreign subsidiaries lease a total of 46,776 square feet of office and
warehouse facilities.

See Note 8 to the consolidated financial statements for a summary of lease
agreements.


ITEM 3: LEGAL PROCEEDINGS

The Company 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 the Company for which the outcome is likely to have a material
adverse effect upon the consolidated financial position or results of operations
of the Company.

K-tel International Inc. v. Platinum Entertainment Inc. In September 1997 the
Company commenced a declaratory judgment action against Platinum Entertainment,
Inc. ("Platinum") in Minnesota state court. The Company alleged that it was
entitled to $1.75 million which Platinum deposited in an earnest money escrow
account pursuant to Platinum's agreement to purchase two of the Company's
subsidiaries, K-tel International (USA), Inc. and Dominion Entertainment,
memorialized in the March 1997 Purchase and Sale Agreement. The Company further
alleged claims of breach of the March 1997 Purchase and Sale Agreement and
related confidentiality agreement, defamation, fraud, and promissory estoppel.

Platinum removed the action to federal court and asserted a counterclaim against
the Company seeking a declaration that Platinum was entitled to the earnest
money and alleging claims of breach of contract and fraudulent inducement. While
still engaged in the discovery process the parties settled the action between
themselves, agreeing to a payment to K-tel of $875,000 of the earnest money
escrow and reimbursement by Platinum of certain accounting fees paid by the
Company, along with an exchange of releases. The parties also stipulated to the
dismissal of the action with prejudice and the Court dismissed the action with
prejudice by Order dated July 7, 1998.

Early v. K-tel International Inc. On March 10, 1997 Mr. Christopher Early filed
a class action Complaint against K-tel International, Inc. ("the Company"),
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 Mr. Early obtained leave to file an Amended Complaint adding K-tel
International (USA), Inc. and one additional retailer as defendants 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 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
CD's;" and (5) attorneys' fees and costs. The defendants have moved to dismiss
the Amended Complaint and in the alternative for a partial summary judgment on
one aspect thereof. This motion has been fully briefed but not ruled upon and
discovery has not commenced. The Company has indemnified the retailer defendants
in this matter. The Company believes the case is without merit and intends to
contest the case vigorously.


                                       5

<PAGE>


ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of the Company's security holders during the
fourth quarter of fiscal 1998.



EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth certain information with respect to the executive
officers of the Company at September 28, 1998.

Name of Officer     Age     Positions and Offices Held
----------------    ---     ---------------------------------------------------

Philip Kives        69      Chairman of the Board and Chief Executive Officer

Jeffrey Koblick     51      Executive Vice President, Purchasing and Operations

Corey Fischer       41      Vice President-Finance, Chief Financial Officer, 
                            Treasurer


Business Experience

Messrs. Kives and Koblick have held various offices and/or managerial positions
with the Company for more than the past five years.

Mr. Fischer joined K-tel in July 1997 and became Chief Financial Officer in
October, 1997. Prior to joining K-tel, Mr. Fischer was the Director of Finance
at Las Vegas Entertainment Network, Inc. from 1995-1997, and at Hemsdale
Communications, Inc. from 1994-1995, both NASDAQ traded companies. Prior to
that, Mr. Fischer was a Senior Manager in the corporate entertainment group of
Deloitte & Touche.


                                       6

<PAGE>


                                     PART II


ITEM 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

On September 11, 1998 there were 1,468 record owners of the Company's common
stock and approximately 8,316,668 shares outstanding. The Company's common stock
trades on the NASDAQ National Market System under the symbol "KTEL".

The following table shows the range of high and low closing sales prices per
share, accounting for the stock split on May 1, 1998, of the Company's Common
Stock as reported by the NASDAQ Stock Market for the fiscal year periods
indicated:

                                   1998                     1997
                          ---------------------    ---------------------
                             High        Low          High        Low
                          ---------   ---------    ---------   ---------
         First Quarter     3 15/16      3 1/16      1 15/16      1 3/4
         Second Quarter     3 3/4       3 1/16      3 13/16      1 3/4
         Third Quarter        2         3 1/16       4 3/8       3 3/8
         Fourth Quarter   39 15/16      3 1/4        4 1/8       3 3/4

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 paid to shareholders
of record on May 1, 1998. Prices have been adjusted to reflect the two for one
stock split.

No cash dividends have been declared on the Company's common stock during the
past two fiscal years and the Company does not expect to pay cash dividends in
the foreseeable future. Management plans to use cash generated from operations
for expansion of its business.

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, 1998. 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.

<TABLE>
<CAPTION>
                                       1998          1997          1996          1995          1994
                                    ----------    ----------    ----------    ----------    ----------
<S>                                 <C>           <C>           <C>           <C>           <C>       
Net Sales                           $   85,626    $   75,501    $   71,987    $   65,917    $   54,270
                                    ==========    ==========    ==========    ==========    ==========
Operating Income (loss)             $   (2,535)   $    3,582    $        4    $   (2,188)   $      223
                                    ==========    ==========    ==========    ==========    ==========
Net Income (loss)                   $   (2,407)   $    3,204    $     (745)   $   (2,483)   $      376
                                    ==========    ==========    ==========    ==========    ==========
Net Income (Loss) Per Share

   Basic                            $     (.31)   $      .43    $     (.10)   $     (.33)   $      .05
                                    ==========    ==========    ==========    ==========    ==========
   Diluted                          $     (.31)   $      .41    $     (.10)   $     (.33)   $      .05
                                    ==========    ==========    ==========    ==========    ==========
Total Assets                        $   39,035    $   30,492    $   27,795    $   28,637    $   26,874
                                    ==========    ==========    ==========    ==========    ==========
Long-Term Debt                      $    4,174    $       --    $       --    $       --    $       --
                                    ==========    ==========    ==========    ==========    ==========
Cash Dividends Declared and Paid    $       --    $       --    $       --    $       --    $       --
                                    ==========    ==========    ==========    ==========    ==========
</TABLE>


                                       7

<PAGE>


ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS:

RESULTS OF OPERATIONS

The following tables set forth, for the periods indicated, results of operations
by geographic region as a percentage of net sales. All amounts are in thousands
of dollars.

<TABLE>
<CAPTION>
                                                                       Year ended June 30, 1998

                                        North                                              Corporate
                                       America                     Europe                   Expenses      Total
                                       --------                   --------                  --------     --------
<S>                                    <C>          <C>           <C>          <C>          <C>          <C>          <C> 
Net Sales                              $ 55,883          100%     $ 29,743          100%    $     --     $ 85,626          100%

Costs and expenses
  Cost of goods sold                     34,873           63        12,797           43           --       47,670           55
  Advertising                            10,161           18         6,647           22           --       16,808           20
  Selling, general & administrative      12,923           23         8,493           29        2,267       23,683           28
                                       --------     --------      --------     --------     --------     --------     --------

Operating income (loss)                  (2,074)          (4)        1,806            6       (2,267)      (2,535)          (3)
                                       --------     --------      --------     --------     --------     --------     --------

Interest (expense) income, net             (233)          --            48           --         (257)        (442)          --
Foreign translation adjustment, net          (9)          --            32           --          (39)         (16)          --
Other                                        --           --            --           --          614          614           --
Benefit (provision) for taxes, net           22           --          (147)          --           97          (28)          --
                                       --------     --------      --------     --------     --------     --------     --------
Net income (loss)                      $ (2,294)          --      $  1,739           --     $ (1,852)    $ (2,407)          --
                                       ========     ========      ========     ========     ========     ========     ========

<CAPTION>
                                                                       Year ended June 30, 1997

                                        North                                              Corporate
                                       America                     Europe                   Expenses      Total
                                       --------                   --------                  --------     --------

Net Sales                              $ 47,786          100%     $ 27,715          100%    $     --     $ 75,501          100%

Costs and expenses
  Cost of goods sold                     28,985           61        12,402           45           --       41,387           55
  Advertising                             5,820           12         5,700           21           --       11,520           15
  Selling, general & administrative      10,309           21         7,270           26        1,433       19,012           25
                                       --------     --------      --------     --------     --------     --------     --------

Operating income (loss)                   2,672            6         2,343            8       (1,433)       3,582            5
                                       --------     --------      --------     --------     --------     --------     --------

Interest (expense) income, net               29           --            11           --          (38)           2           --
Foreign translation adjustment, net         (16)          --           (63)          --          (83)        (162)          --
Benefit (provision) for taxes, net         (181)          --          (107)          --           70         (218)          --
                                       --------     --------      --------     --------     --------     --------     --------
Net income (loss)                      $  2,504           --      $  2,184           --     $ (1,484)    $  3,204           --
                                       ========     ========      ========     ========     ========     ========     ========

<CAPTION>
                                                                       Year ended June 30, 1996

                                        North                                              Corporate
                                       America                     Europe                   Expenses      Total
                                       --------                   --------                  --------     --------

Net Sales                              $ 48,605          100%     $ 23,382          100%    $     --     $ 71,987          100%

Costs and expenses
  Cost of goods sold                     27,690           57        10,975           47           --       38,665           54
  Advertising                             7,495           15         5,025           21           --       12,520           17
  Selling, general & administrative      11,423           24         7,420           32        1,955       20,798           29
                                       --------     --------      --------     --------     --------     --------     --------

Operating income (loss)                   1,997            4           (38)           0       (1,955)           4            0
                                       --------     --------      --------     --------     --------     --------     --------

Interest (expense)  income, net            (282)          --            17           --          (14)        (279)          --
Foreign translation adjustment, net           4           --          (125)          --            2         (119)          --
Benefit (provision) for taxes, net         (210)          --          (141)          --           --         (351)          --
                                       --------     --------      --------     --------     --------     --------     --------
Net income (loss)                      $  1,509           --      $   (287)          --     $ (1,967)    $   (745)          --
                                       ========     ========      ========     ========     ========     ========     ========
</TABLE>


                                       8

<PAGE>


FISCAL 1998 COMPARED WITH FISCAL 1997

      Consolidated net sales for the year ended June 30, 1998 were $85,626,000
      with an operating loss of $2,535,000 and a net loss of $2,407,000, or $.31
      per basic and diluted share. Consolidated net sales for the prior year
      were $75,501,000 with operating income of $3,582,000 and net income of
      $3,204,000 or $.43 per basic and $.41 per diluted share. Contributing to
      the 1998 loss was a $2.300,000 loss related to the Company's recently
      curtailed U.S. third-party media buying operation, $1,200,000 fourth
      quarter loss resulting from both soft sales and an overall decrease in
      gross margins on sales of the Company's domestic mid-line and budget
      priced music compilations, $400,000 in start up costs incurred by the
      launch of the Company's new online service, K-tel Express (www.ktel.com),
      as well as a non-cash loss of $514,000 recognized on the revaluation of
      certain securities received in connection with a previous settlement.

      CONSOLIDATED NET SALES for the year ended June 30, 1998 increased
      $10,125,000 or 13% from the comparable period in 1997. North American
      sales for the year ended June 30, 1998 increased $8,097,000 or 17% from
      the comparable period in 1997. This increase was mainly due to a
      $7,582,000 increase in sales derived from the Company's U.S. media buying
      and infomercial subsidiary which was not in existence for most of the
      comparable period in 1997. Revenue from the Company's Internet business,
      K-tel Express, was not significant. European sales for the year ended June
      30, 1998 increased $2,028,000 or 7% from the comparable period in 1997.
      This increase was mainly due to sales from K-tel Marketing (UK) Limited,
      the Company's new subsidiary that commenced operations in March 1998 with
      the acquisition of certain media and other assets from Regal Shop
      International Ltd.

      CONSOLIDATED COST OF GOODS SOLD AS A PERCENTAGE OF NET SALES for the year
      ended June 30, 1998 was consistent with the comparable period in 1997.
      Costs of goods sold as a percentage of net sales for North America for the
      year ended June 30, 1998 was 63% as compared to 61% in the comparable
      period in 1997. The increase is mainly due to the Company experiencing
      soft sales and overall decrease in gross margins on sales of the company's
      domestic mid-line and budget priced music compilations and a high level of
      returns of consumer products, the majority of which are no longer being
      distributed by the Company. European costs of goods sold as a percentage
      of net sales was 43% as compared to 45% in the comparable period in 1997
      as the gross margins were slightly higher on merchandise sold via direct
      response as compared to the merchandise sold in the prior period.

      CONSOLIDATED ADVERTISING COSTS for the year ended June 30, 1998 increased
      $5,288,000 or 46% from the comparable period in 1997. North American
      advertising costs for the year ended June 30, 1998 increased $4,341,000 or
      75% from the comparable period in 1997. This increase was mainly due to a
      $5,600,000 increase in the advertising and media costs incurred by the
      Company's U.S. media-buying and infomercial subsidiary that was not in
      existence for most of the comparable period of 1997. This increase was
      offset by a decrease of $1,500,000 in advertising by the Company's U.S.
      music operations that directly related to a decrease in television
      promotion for its products. European advertising costs for the year ended
      June 30, 1998 increased $947,000 or 17% from the comparable period in
      1997. This increase was mainly due to advertising costs from K-tel
      Marketing (UK) Limited, the Company's new subsidiary that commenced
      operations in March 1998.

      CONSOLIDATED SELLING, GENERAL AND ADMINISTRATIVE EXPENSES for the year
      ended June 30, 1998 increased $4,671,000 or 25% from the comparable period
      in 1997. North American selling, general and administrative expenses for
      the year ended June 30, 1998 increased $2,614,000 or 25% from the
      comparable period in 1997. The difference in part relates to a reduction
      of $850,000 in 1997 of general and administrative costs that resulted from
      the recovery of certain legal and other costs related to a dispute with a
      third party over certain music licensing rights. Excluding the settlement
      amount, general and administration expenses for the year ended June 30,
      1998 as compared to same period in 1997 increased by $1,764,000. This
      remaining increase relates to costs incurred by the Company's U.S.
      media-buying and infomercial subsidiary that was not in existence for most
      of the comparable period in 1997. European selling, general and
      administrative expenses for the year ended June 30, 1998 increased by
      $1,223,000 or 17% from the comparable period in 1997. This increase was
      mainly due to costs from K-tel Marketing (UK) Limited, the Company's new
      subsidiary that commenced operations in March 1998. Additionally,
      corporate expenses increased by $834,000 from the comparable period in
      1997. The increase mostly to related a non cash loss of $514,000 relating
      to the revaluation of certain securities received in connection with a
      previous settlement.

      OPERATING INCOME for the year ended June 30, 1998 decreased $6,117,000
      from the comparable period in 1997. North American operating income
      decreased $4,746,000 from the comparable period in 1997. The decrease in
      part relates to a reduction of $850,000 in 1997 of general and
      administrative costs that resulted from the recovery of


                                       9

<PAGE>


      certain legal and other costs related to a dispute with a third party over
      certain music licensing rights. Excluding the settlement amount operating
      income for year ended June 30, 1998, as compared to same period in 1997,
      decreased by $3,317,000. This decrease relates to $2,300,000 of losses
      incurred by the Company's U.S. third-party media buying subsidiary the
      operations of which have since been curtailed; $400,000 of startup costs
      incurred with the May 1, 1998 launch of K-tel Express, the Company's
      Internet music business; a non cash loss of $514,000 relating to the
      revaluation of certain securities received in connection with a previous
      settlement and a $700,000 difference in operations from the Company's U.S.
      music and consumer product divisions (this difference resulted mainly from
      soft sales and an overall decrease in gross margins on sales of the
      Company's domestic mid-line and budget priced music compilations and a
      high level of returns of consumer products, the majority of which are no
      longer being distributed by the Company). European operating income for
      the year ended June 30, 1998 decreased by approximately $537,000 from the
      comparable period in 1997. This decrease relates mostly to a decrease in
      operating results from the Company's United Kingdom music operation, whose
      European export business decreased due to the strength of the British
      currency against other European currencies.

      INTEREST EXPENSE for the year ended June 30, 1998, increased $368,000 to
      $490,000, as compared to $122,000 in the same period in 1997. The increase
      in interest expense corresponds with the increased borrowings made by the
      Company during these periods under its existing credit facilities.

      OTHER INCOME of $614,000 for the fiscal year ended 1998 relates to a
      settlement with Platinum Entertainment, Inc. over the disbursement of
      funds from an earnest money escrow account.

FISCAL 1997 COMPARED WITH FISCAL 1996

      Consolidated net sales for the fiscal year ended June 30, 1997 were
      $75,501,000 with operating income of $3,582,000 and net income of
      $3,204,000 or $.43 per basic and .41 per diluted share. Consolidated net
      sales for the fiscal year ended June 30, 1996 were $71,987,000 with an
      operating income of $4,000 and net loss of $745,000 or $.10 per basic and
      diluted share.

      CONSOLIDATED NET SALES increased $3,514,000 or 5% for the fiscal year
      ended June 30, 1997. North American net sales decreased 2% from the prior
      fiscal year due primarily to prior year fourth quarter divestitures of
      unprofitable businesses/divisions, lower U.S. consumer convenience product
      retail sales resulting from less new product promotions and lower U.S.
      direct response television sales resulting from fewer promotions. The
      decrease in U.S. sales more than offset the increase in sales derived from
      the Company's new U.S. media buying and infomercial company. European
      sales increased from the prior fiscal year due mainly to stronger German
      and United Kingdom sales in the current year. Foreign currency conditions
      were less favorable than in the comparable prior year period and caused
      sales to be $1,250,000 lower for the year ended June 30, 1997 than they
      would have been had exchange rates remained consistent with the prior
      year.

      CONSOLIDATED COST OF GOODS SOLD for the year ended June 30, 1997 were 55%
      of sales compared to 54% for the prior year ended. North American cost of
      goods sold, as a percentage of sales, was 61% compared to 57% for the
      prior year comparable period due primarily to the start up of a U.S. media
      buying and infomercial business which generated mainly media buying
      revenue in fiscal 1997 (media buying revenues carry small margins
      consisting only of media buying fees charged to third parties) and to
      slightly higher cost of goods sold in the U.S. retail music business.
      European cost of goods sold as a percent of net sales were 45% compared to
      47% in the prior year period due mainly to overall higher music and
      consumer product margins resulting from a stronger margin product mix in
      the current period.

      ADVERTISING COSTS as a percentage of net sales for the fiscal year ended
      June 30, 1997 was 15% compared to 17% for the previous year. North
      American advertising costs as a percent of net sales was 12% compared to
      15% for the prior year comparable period due to higher prior year levels
      of direct response television advertising in the U.S.. This decrease more
      than offset an increase in U.S. retail music current year advertising
      expenditures. Direct response sales carry higher advertising requirements
      than normal retail sales. European advertising costs as a percentage of
      net sales for the year ended June 30, 1997 were the same as the prior
      year.

      SELLING, GENERAL AND ADMINISTRATIVE expenses for the fiscal year ended
      June 30, 1997 were $19,012,000 or 25% of net sales compared to $20,798,000
      or 29% of net sales in the prior fiscal year. North American selling,
      general and administrative expenses were down $1,114,000 for the year
      ended June 30, 1997 due mainly to the second quarter settlement of a long
      outstanding legal dispute with a United Kingdom entertainment company
      regarding infringement of a number of the Company's owned music master
      recordings. The settlement resulted in a second


                                       10

<PAGE>


      quarter net benefit (recovery of legal expenses) to the Company of
      $850,000. European selling, general and administrative expenses for the
      year ended June 30, 1997 were lower as a percent of sales compared to the
      prior year due mainly to better overall European sales performance in the
      current fiscal year.

      OPERATING INCOME for the year ended June 30, 1997 increased to $3,582,000
      compared to operating income of $4,000 for the fiscal year ended June 30,
      1996. North American operating income increased from the prior year mainly
      due to the positive profit impact from the above mentioned settlement with
      a U.K. entertainment company regarding infringement of a number of the
      Company's owned music master recordings, stronger profit from third party
      licensing of the Company's owned music master catalog and lower current
      year losses from the U.S. consumer convenience product business. These
      increases more than offset decreases in operating income in the Company's
      U.S. retail music business resulting mainly from slightly higher cost of
      goods sold, higher current year advertising expenditures and increased
      selling, general and administrative expenses from the prior year in
      anticipation of future sales growth. European operating income improved
      over fiscal 1996 due mainly to strong current year profit in the Company's
      German operation versus a minor prior year profit and current profit from
      the Company's United Kingdom operation compared to prior year comparable
      period loss as a result of restructuring those operations.

      INTEREST EXPENSE was $122,000 for the fiscal year ended June 30, 1997,
      compared to $409,000 for the fiscal year ended June 30, 1996. The decrease
      in interest expense was due to less current year usage of the Company's
      asset based line of credit.

Liquidity and Capital Resources

      During the year ended June 30, 1998 the Company experienced negative cash
      flow from operations of $2,378,000, which mostly related to funding of
      losses from the Company's U.S. third-party media buying subsidiary, the
      operations of which have been curtailed as of June 30, 1998. Also during
      the year ended June 30, 1998, the Company utilized another $3,246,000 for
      investing activities. These funds were used for music catalog additions
      and for the development and acquisition of system hardware and software
      used by K-tel Express, the Company's Internet retailing site. To finance
      the above, the Company increased its borrowings under its credit
      facilities during the year by $6,500,000, and also received $1,644,000 in
      proceeds from the exercise of employee stock options.

      Until November 20, 1997 the Company had a revolving credit agreement with
      a U.S. bank that provided borrowings of up to $2,500,000 based upon a
      monthly borrowing base derived from certain of the Company's U.S.
      Subsidiaries' accounts receivable. The loan was secured by assets of the
      Company's U.S. Subsidiaries, including accounts receivable, inventories,
      equipment and owned music master recordings and was guaranteed by the
      Company.

      On November 20, 1997 certain of the Company's U.S. Subsidiaries entered
      into a new four-year $10 million credit facility with another lending
      institution. The credit facility consists of a $4 million term loan due in
      full November 20, 2001 and a $6 million revolving credit facility, limited
      to a percent of eligible receivables and inventory, that expires November
      20, 2001. Borrowings under the facility bear interest at a variable rate
      based on a "base rate" announced by a banking affiliate associated with
      the lending institution (8.5% at June 30, 1998) and are secured by the
      assets of certain U.S. Subsidiaries, including accounts receivable,
      inventories, equipment, music library and general intangibles. The loan
      agreement contains certain financial and other covenants or restrictions,
      including the maintenance of a minimum tangible net worth by the Company,
      limitations on capital expenditures, restrictions on music library
      acquisitions, limitations on the incurrence of indebtedness and
      restrictions on dividends paid by the Company. The Company has guaranteed
      the obligations of its subsidiaries under the credit facility and has
      pledged the stock of those subsidiaries and its assets to secure the
      Company's obligations under its guaranty. On November 20, 1997 a portion
      of the proceeds from the funding of the credit facility were used to repay
      in full the bank revolving credit agreement discussed in the preceding
      paragraph and such agreement was terminated. As of June 30, 1998 the
      amount outstanding under the revolving credit facility was $3,738,000 and
      the maximum additional available under the borrowing limitations at June
      30, 1998 was $148,000. The maximum amount outstanding under the line of
      credit was $4,417,000 during fiscal 1998. The Company was either in
      compliance with or had obtained waivers for all covenants, limitations and
      restrictions. The Company has amended and further amended certain
      financial covenants with the lender for fiscal 1999 and beyond, assuming
      an equity placement in the quarter ending December 31, 1999, and expects
      to be in compliance with the revised covenants. Future losses from
      businesses such as K-tel Express or the inability to complete an equity
      placement may result in further renegotiations of such covenants or the
      need to seek replacement financing. There can be no assurances that such
      financing will be available on terms satisfactory to the Company.


                                       11

<PAGE>


      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. Advances on this facility reached
      $1,500,000 as of November 20, 1997 when the debt was repaid in full from
      the borrowings under the Company's new credit facility. As of June 30,
      1998 K-5 had advanced an additional $1,000,000 to the Company and an
      additional $3,000,000 subsequent to June 30, 1998 through October 9, 1998.
      The Company pays interest on the unpaid principal amount of financing at
      the same rate as the Company pays on its credit facility, until repayment
      of the loan, which is due on demand.

      The Company has primarily funded its operations to date through internally
      generated capital, bank financing or advances made by an affiliate of the
      Chairman of the Board and Chief Executive Officer. However, the Company
      anticipates that it will require additional cash in order to further
      develop and promote its Internet retail music site, K-tel Express.
      Although the Company has made no material commitments for capital
      expenditures, it anticipates a substantial increase in funding
      requirements for development and acquisition of technology, marketing and
      promotion, and for capital expenditures to develop the infrastructure
      necessary for the anticipated growth in operations. To date the Company
      has no commitments for any additional financing and there can be no
      assurance that such commitments can be obtained on favorable terms, if at
      all. The Company has available to it funding from a company owned by the
      Company's Chairman of the Board and Chief Executive Officer. Although
      management does not have access to the financial statements of the
      Chairman's other companies, he has committed to the Company that he will
      fund its operations through fiscal 1999, and the Company is in the process
      of formalizing the commitment in the form a credit agreement.

      During the fiscal year ended June 30, 1998 the Company purchased
      approximately $334,000 of consumer convenience product from K-5. The
      Company owed approximately $9,000 to the affiliate at June 30, 1998. This
      same affiliate purchased approximately $39,000 of consumer convenience
      products from the Company during the year ended June 30, 1998, and owed
      the Company $4,000 at June 30, 1998. Outstanding balances are settled on a
      timely basis. No interest was charged on the related outstanding balances
      during fiscal 1998.

      INFORMATION CONTAINED IN THIS ITEM CONTAINS "FORWARD-LOOKING STATEMENTS"
      WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
      1995, WHICH CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY
      SUCH AS "MAY," "WILL," "WOULD," "COULD," "INTEND," "PLAN," "EXPECT,"
      "ANTICIPATE," "ESTIMATE," OR "CONTINUE," OR NEGATIVE VARIATIONS THEREOF OR
      OTHER VARIATIONS THEREON OR COMPARABLE TERMINOLOGY. MANY FACTORS COULD
      CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN THE
      FORWARD-LOOKING STATEMENTS, INCLUDING OVERALL ECONOMIC CONDITIONS,
      CONSUMER PURCHASING, CUSTOMER ACCEPTANCE OF PRODUCTS, MARKETING AND
      PROMOTION EFFORTS, FOREIGN CURRENCY VARIATIONS AND CHANGES IN INTEREST
      RATES.


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 18.

ITEM 9: DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

      None.


                                       12

<PAGE>


                                    PART III


ITEM 10:  DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT

The information concerning Directors required under this Item will be included
in the Company's Notice of Meeting of Shareholders and Proxy Statement to be
filed with the Securities and Exchange Commission and is incorporated herein by
reference. The information concerning Executive Officers of the Registrant is
furnished as an unnumbered item in Part I following Item 4.


ITEM 11: MANAGEMENT REMUNERATION

The information required under this Item will be included in the Company's
Notice of Meeting of Shareholders and Proxy Statement for the Annual Meeting of
Shareholders to be filed with the Securities and Exchange Commission and is
incorporated herein by reference.


ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required under this Item will be included in the Company's
Notice of Meeting of Shareholders and Proxy Statement to be filed with the
Securities and Exchange Commission and is incorporated herein by reference.


ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required under this Item will be included in the Company's
Notice of Meeting of Shareholders and Proxy Statement for the Annual Meeting of
Shareholders to be filed with the Securities Exchange Commission and is
incorporated herein by reference.


                                       13

<PAGE>


                                     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 25 hereof are
      filed as part of this report.

(b)   Reports on 8-K

      No reports on Form 8-K were filed during the fourth quarter ended June 30,
      1998.

(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.

<TABLE>
<CAPTION>

Exhibit    Item
-------    ----
<S>        <C>                                            <C>
3          Restated Article and Restated By-Laws          incorporated herein by reference to Exhibit 3
                                                          of the Registrant's Annual Report on Form 10-K
                                                          for the year ended June 30, 1985

3.1        Amendment to Articles of Incorporation         incorporated herein by reference to Exhibit
                                                          3.1 of the Registrant's Annual Report on Form
                                                          10-K for the year ended March 31, 1998

10.13      1987 Stock Incentive Plan                      incorporated herein by reference to Exhibit
                                                          10.13 of the Registrant's Annual Report on
                                                          Form 10-K for the year ended June 30, 1987

10.47      Non-Qualified Stock Option Agreement -         incorporated herein by reference to Exhibit
           Philip Kives                                   10.47 of the Registrant's Quarterly Report on
                                                          Form 10-Q for the quarter ended March 31, 1997

10.52      1997 Stock Option Plan                         incorporated herein by reference to Exhibit
                                                          10.52 of the Registrant's Quarterly Report on
                                                          Form 10-K for the quarter ended June 30, 1997

10.53      Loan and Security Agreement -                  incorporated herein by reference to Exhibit
           Foothill Capital Corporation                   10.53 of the Registrant's Quarterly Report on
                                                          Form 10-Q for the quarter ended December 31,
                                                          1997

10.54      Non-Qualified Stock Option Agreement -         Attached to this report as Exhibit 10.54
           Philip Kives

10.55      Amendment Number One - Loan and Security       Attached to this report as Exhibit 10.55
           Agreement- Foothill Capital Corporation

10.56      Amendment Number Two - Loan and Security       Attached to this report as Exhibit 10.56
           Agreement- Foothill Capital Corporation

10.57      Restated Amendment Number Two- Loan and        Attached to this report as Exhibit 10.57
           Security Agreement-Foothill Capital 
           Corporation

21         Subsidiaries of the Registrant                 Attached to this report as Exhibit 21

23         Consent of Independent Public Accountants      Attached to this report as Exhibit 23

27         Financial Data Schedule                        (SEC use)

</TABLE>

                                       14

<PAGE>


                                   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 18, 1998 by the undersigned, there unto 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.

<TABLE>
<CAPTION>

Signatures                    Title                                          Date
----------                    -----                                          ----
<S>                           <C>                                            <C>
/S/ Philip Kives              Chairman, Chief Executive Officer (Principal   October 12, 1998
---------------------------   Executive Officer) and Director
Philip Kives


/S/ Corey Fischer             Vice President-Finance, Director,              October 12, 1998
---------------------------   Chief Financial Officer and Treasurer
Corey Fischer                 (Principal Accounting Officer)


/S/ Jeffrey Koblick           Executive Vice President, Purchasing and       October 12, 1998
---------------------------   Operations and Director
Jeffrey Koblick


/S/ Garry Kieves              Director                                       October 12, 1998
---------------------------
Garry Kieves


/S/ Louis Scheimer            Director                                       October 12, 1998
---------------------------
Louis Scheimer

</TABLE>

                                       15

<PAGE>


(ITEM 14(A))
K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Report of Independent Public Accountants..................................    17

Consolidated Balance Sheets as of June 30, 1998 and 1997..................    18

Consolidated Statements of Operations for each of the three years ended
June 30, 1998.............................................................    19

Consolidated Statements of Shareholders' Equity for each of the three 
years ended June 30, 1998.................................................    20

Consolidated Statements of Cash Flows for each of the three years ended 
June 30, 1998.............................................................    21

Notes to Consolidated Financial Statements................................ 22-30

Supplemental Schedule to Consolidated Financial Statements:

      Schedule II - Valuation and Qualifying Accounts for each of the
      three years ended June 30, 1998.....................................    31

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.


                                       16

<PAGE>


                    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,
1998 and 1997, and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended June 30, 1998. These 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 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, 1998 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended June 30,
1998, 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 the 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 financial statements taken as a whole.


                                              ARTHUR ANDERSEN LLP


Minneapolis, Minnesota,
October 9, 1998


                                       17

<PAGE>


K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30
(IN THOUSANDS - EXCEPT SHARE DATA)

<TABLE>
<CAPTION>

ASSETS                                                        1998           1997
-------------------------------------------------------    ----------     ----------
<S>                                                        <C>            <C>       
Current Assets:
  Cash and cash equivalents                                $    5,941     $    3,341
  Accounts receivable, less allowances of $661 and $952        15,341         16,667
  Inventories                                                   6,430          4,287
  Royalty advances                                              1,475          1,552
  Prepaid expenses and other                                    3,043          2,587
                                                           ----------     ----------
    Total Current Assets                                       32,230         28,434

Property and Equipment, net of
 accumulated depreciation and amortization
   of $2,671 and $2,172                                         2,131            982
Other Assets                                                    4,674          1,076
                                                           ----------     ----------
                                                           $   39,035     $   30,492
                                                           ==========     ==========

LIABILITIES AND SHAREHOLDERS' EQUITY
-------------------------------------------------------
Current Liabilities:
  Current portion of Notes Payable                         $    3,738     $      836
  Note payable to affiliate                                     1,000          1,500
  Accounts payable                                              7,390          3,708
  Accrued royalties                                             8,465         11,296
  Reserve for returns                                           4,758          4,930
  Other current liabilities                                     5,736          3,642
                                                           ----------     ----------
    Total Current Liabilities                                  31,087         25,912
                                                           ----------     ----------

Notes Payable, net of current portion                           4,174             --

Commitments and Contingencies (Note 8)

 Shareholders' Equity:
  Common stock - 15,000,000 shares authorized;
    par value $.01; 8,316,668 and 7,567,568
    issued and outstanding                                         41             37
Additional Paid In Capital                                      9,609          7,969
Accumulated Deficit                                            (4,869)        (2,462)
Cumulative translation adjustment                              (1,007)          (964)
                                                           ----------     ----------
  Total Shareholders' Equity                                    3,774          4,580
                                                           ----------     ----------
                                                           $   39,035     $   30,492
                                                           ==========     ==========
</TABLE>

THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART
OF THESE BALANCE SHEETS.


                                       18

<PAGE>


K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30
(IN THOUSANDS - EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
                                               1998           1997           1996
                                            ----------     ----------     ----------
<S>                                         <C>            <C>            <C>       
NET SALES                                   $   85,626     $   75,501     $   71,987
                                            ----------     ----------     ----------

COSTS AND EXPENSES:
  Cost of goods sold                            47,670         41,387         38,665
  Advertising                                   16,808         11,520         12,520
  Selling, general & administrative             23,683         19,012         20,798

                                            ----------     ----------     ----------
    Total Costs and Expenses                    88,161         71,919         71,983
                                            ----------     ----------     ----------

OPERATING INCOME (LOSS)                         (2,535)         3,582              4
                                            ----------     ----------     ----------

NON-OPERATING INCOME (EXPENSE):
  Interest income                                   48            124            130
  Interest expense                                (490)          (122)          (409)
  Other income                                     614             --             --
  Foreign currency transaction loss                (16)          (162)          (119)
                                            ----------     ----------     ----------
    Total Non-operating Income (Expense)           156           (160)          (398)
                                            ----------     ----------     ----------

INCOME (LOSS) BEFORE PROVISION
  FOR INCOME TAXES                              (2,379)         3,422           (394)

PROVISION  FOR INCOME TAXES (Note 6)                28            218            351
                                            ----------     ----------     ----------

NET INCOME (LOSS)                           $   (2,407)    $    3,204     $     (745)
                                            ==========     ==========     ==========

NET INCOME (LOSS) PER SHARE;
  BASIC                                     $     (.31)    $      .43     $     (.10)
  DILUTED                                   $     (.31)    $      .41     $     (.10)
SHARES USED IN THE CALCULATION OF
INCOME (LOSS) PER SHARE;
 BASIC                                           7,736          7,527          7,460
 DILUTED                                         7,736          7,908          7,460

</TABLE>

THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART
OF THESE STATEMENTS.


                                       19

<PAGE>


K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED JUNE 30
(IN THOUSANDS)

<TABLE>
<CAPTION>
                                                  Common Stock         Additional                   Cumulative
                                           ------------------------     Paid In     Accumulated    Translation
                                             Shares        Amount       Capital       Deficit       Adjustment       Total
                                           ----------    ----------    ----------    ----------     ----------     ----------
<S>           <C>                          <C>           <C>           <C>           <C>            <C>            <C>       
Balance, July 1, 1995                      $    7,428    $       37    $    7,816    $   (4,921)    $     (479)    $    2,453

Net loss                                           --            --            --          (745)            --           (745)
Proceeds from exercise of stock options            56            --            54            --             --             54
Translation adjustment                             --            --            --            --           (198)          (198)
                                           ----------    ----------    ----------    ----------     ----------     ----------

Balance, June 30, 1996                          7,484            37         7,870        (5,666)          (677)         1,564

Net income                                         --            --            --         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 loss                                           --            --            --        (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
                                           ==========    ==========    ==========    ==========     ==========     ==========
</TABLE>

THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART
OF THESE STATEMENTS.


                                       20

<PAGE>


K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30
(IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                1998           1997           1996
                                                                             ----------     ----------     ----------
<S>                                                                          <C>            <C>            <C>        
Cash Flows From Operating Activities:
Net income (loss)                                                            $   (2,407)    $    3,204     $     (745)
Adjustments to reconcile net income (loss) to cash provided by (used for)
  operating activities:
    Depreciation and amortization                                                 1,060            630            805
    Loss  on valuation of marketable securities                                     514             --             --
Changes in current operating items:
    Restricted cash                                                                  --             --            536
    Accounts receivable                                                           1,427         (1,927)        (3,216)
    Inventories                                                                  (1,997)         1,461          1,458
    Royalty advances                                                                 75           (347)           966
    Prepaid expenses and other                                                     (936)        (1,955)         1,395
    Accounts payable                                                              2,981          1,039           (842)
    Accrued royalties                                                            (2,809)           412          1,885
    Return reserve                                                                 (348)        (1,863)            66
    Income taxes, net                                                                62            (89)           313
                                                                             ----------     ----------     ----------
      Cash provided by (used for) operating activities                           (2,378)           565          2,621
                                                                             ----------     ----------     ----------

Investing Activities:
    Property and equipment purchases                                             (1,620)          (740)          (240)
    Proceeds from sale of property and equipment                                      4            141            215
    Music catalog additions                                                        (932)          (200)          (781)
    Acquisition of Regal Shop International  (Note 3)                              (350)            --             --
    Other                                                                          (348)          (114)           (42)
                                                                             ----------     ----------     ----------
      Cash used for investing activities                                         (3,246)          (913)          (848)
                                                                             ----------     ----------     ----------

Financing Activities:
    Issuance of long term debt                                                    4,178             --             --
    Line of Credit, Foothill Capital, net                                         3,738             --             --
    Repayments on line of credit                                                   (836)        (1,028)          (652)
    Borrowings(repayment)on note payable to affiliate                              (500)         1,500             --
    Proceeds from exercise of stock options                                       1,644             99             54
                                                                             ----------     ----------     ----------
      Cash provided by (used for) financing activities                            8,224            571           (598)
    Effect of Exchange Rate Changes on Cash and Cash Equivalents                     --           (137)           (74)
                                                                             ----------     ----------     ----------
    Net Increase in Cash and Cash Equivalents                                     2,600             86          1,101
    Cash and Cash Equivalents at Beginning of Year                                3,341          3,255          2,154
                                                                             ----------     ----------     ----------
    Cash and Cash Equivalents at End of Year                                 $    5,941     $    3,341     $    3,255
                                                                             ==========     ==========     ==========

Supplemental Cash Flow Information
    Cash Paid For -
     Interest                                                                $      476     $       67     $      220
                                                                             ==========     ==========     ==========
     Income Taxes                                                            $       60     $      268     $      494
                                                                             ==========     ==========     ==========
</TABLE>

THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART
OF THESE STATEMENTS.


                                       21

<PAGE>


K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998, 1997 AND 1996


1.  BUSINESS AND LIQUIDITY

    K-tel International, Inc. (the "Company", "K-tel", the "Registrant") is an
    international marketer and distributor of entertainment and consumer
    products and is a leader in the market niche for pre-recorded music
    compilations. With more than thirty years of marketing experience in the
    United States ("U.S."), Canada and Europe, the Company has developed the
    resources, knowledgeable personnel, information systems and distribution
    capabilities to launch music, video, and consumer products quickly in the
    North American and European markets through traditional retail and
    direct-response marketing channels. On May 1, 1998, the Company launched its
    new Internet service, K-tel Express (www.ktel.com), featuring a wide
    spectrum of music products for purchase by the public around the globe. Open
    for commerce 24 hours a day, 365 days a year, K-tel Express features more
    than 250,000 music titles at value prices through this online shopping
    service.

    The Company experienced negative cash flow of $2,378,000 cash from
    operations in fiscal 1998 and utilized another $3,246,000 to fund music
    catalog additions and information systems. These cash requirements were
    satisfied principally from borrowings under new credit facilities, advances
    made by an affiliate of the Chairman of the Board and from the exercise of
    stock options. As of June 30, 1998 the Company had $148,000 available for
    borrowings under its credit facility. The Company will have to improve its
    operations to comply with its credit facility covenants, as amended and
    further amended. The covenants as of December 31, 1999 assume proceeds from
    an equity placement, which cannot be assured. Future losses from businesses
    such as K-tel Express or the inability to complete an equity placement may
    result in further renegotiations of such covenants or the need to seek
    replacement financing. The Company has obtained a commitment from its
    Chairman of the Board to fund operations as necessary through fiscal 1999,
    and is in the process of formalizing the commitment in the form of a credit
    agreement. During the period from July 1, 1998 through October 9, 1998, an
    affiliate of the Chairman of the Board has advanced an additional $3,000,000
    to the Company, which has been used to fund operations and investments in
    technology.

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. One United States customer represented 12% of
    the Company's consolidated net sales for the year ended June 30, 1996. No
    customer represented greater than 10% of net sales for the years ended June
    30, 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.

    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


                                       22

<PAGE>


    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 and 1997 approximately $389,000 and $569,000 of these amounts,
    respectively, have been recorded as deferred income in the accompanying
    balance sheets.

    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 - Payroll and other direct costs of materials and
    services incurred during the application and development stage of developing
    the software for K-tel Express, the Company's Internet retailing site, have
    been 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. On a quarterly basis the contractual royalty
    liability is computed 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,
    1998 $1,337,000 of advertising was reported as assets. Advertising expense
    was $16,808,000, $11,520,000 and $12,520,000 for each of the years ended
    June 30, 1998, 1997 and 1996 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' investment.

    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).

    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 retroactively restated to reflect
    this split.

    Net Income (Loss) Per Share - During the year ended June 30, 1998 the
    Company adopted Statement of Financial Accounting Standards No. 128,
    "Earnings Per Share." As a result, all previously reported earnings (loss)
    per share have been restated. 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.


                                       23

<PAGE>


<TABLE>
<CAPTION>
                                                                1998          1997        1996   
                                                              ---------    ---------    ---------
<S>                                                           <C>          <C>          <C>  
    Basic Earnings Per Share Computation
       Weighted Average Shares Outstanding                        7,736        7,527        7,460

    Diluted Earnings Per Share Computation
       Weighted Average Shares Outstanding                        7,736        7,527        7,460
       Stock Options                                                 --          381           --
                                                              ---------    ---------    ---------
    Denominator for Diluted Earnings per Share Computation        7,736        7,908        7,460
                                                              =========    =========    =========
</TABLE>


    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, return reserves, royalty obligations and product replacement
    costs. Ultimate results could differ materially from those estimates.

    Recently Issued Accounting Standards - The Financial Accounting Standards
    Board has released SFAS No. 130, "Reporting Comprehensive Income", effective
    for fiscal years beginning after December 15, 1997. SFAS No. 130 establishes
    standards for reporting and display in the financial statements of total net
    income and the components of all other non-owner changes in equity, referred
    to as comprehensive income. The Company will adopt SFAS 130 in Fiscal 1999
    and is currently analyzing the impact it will have on the disclosures in its
    financial statements.

    The Financial Accounting Standards Board has released Statement of Financial
    Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an
    Enterprise and Related Information" which requires a disclosure of business
    segments in the financial statements of the Company. The Company expects to
    adopt SFAS No. 131 in fiscal 1999 and anticipates a change in segment
    disclosure at the time of adoption.

    Reclassifications - Certain June 30, 1997 amounts have been reclassified to
    conform with current period presentation.

3.  ACQUSITION 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. 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 financials.

4.  NOTES PAYABLE

<TABLE>
<CAPTION>
                                                           1998             1997
                                                       ------------    ------------
<S>                                                    <C>             <C>         
    Term Loan                                          $  4,000,000    $         --
    Revolving Line of Credit                              3,738,000         836,000
        Other                                               174,000              --
                                                       ------------    ------------

    Total                                              $  7,912,000    $    836,000
    Less Current Portion                                  3,738,000         836,000
                                                       ------------    ------------
    Total Long Term Debt                               $  4,174,000    $         --
                                                       ============    ============
</TABLE>


                                       24

<PAGE>


    Until November 20, 1997 the Company had a revolving credit agreement with a
    U.S. bank that provided borrowings of up to $2,500,000 based upon a monthly
    borrowing base derived from certain of the Company's U.S. Subsidiaries'
    accounts receivable. The loan was secured by assets of the Company's U.S.
    Subsidiaries, including accounts receivable, inventories, equipment and
    owned music master recordings and was guaranteed by the Company.

    On November 20, 1997 certain of the Company's U.S. Subsidiaries entered into
    a new four-year $10 million credit facility with another lending
    institution. The credit facility consists of a $4,000,000 term loan due in
    full November 20, 2001 and a $6 million revolving credit facility, limited
    to a percent of eligible receivables and inventory, that expires November
    20, 2001. Borrowings under the facility bear interest at a variable rate
    based on a "base rate" announced by a banking affiliate associated with the
    lending institution (8.5% at June 30, 1998) and are secured by the assets of
    certain U.S. Subsidiaries, including accounts receivable, inventories,
    equipment, music library and general intangibles. The loan agreement
    contains certain financial and other covenants or restrictions, including
    the maintenance of a minimum tangible net worth by the Company, limitations
    on capital expenditures, restrictions on music library acquisitions,
    limitations on the incurrence of indebtedness and restrictions on dividends
    to the Company. The Company has guaranteed the obligations of its
    subsidiaries under the credit facility and has pledged the stock of those
    subsidiaries and its assets to secure the Company's obligations under its
    guaranty. On November 20, 1997 a portion of the proceeds from the funding of
    the credit facility were used to repay in full the bank revolving credit
    agreement discussed in the preceding paragraph and such agreement was
    terminated. As of June 30, 1998 the amount outstanding under the revolving
    credit facility was $3,738,000 and the maximum additional available under
    the borrowing limitations at June 30, 1998 was $148,000. The maximum amount
    outstanding under the line of credit was $4,417,000 during fiscal 1998. The
    Company was either in compliance with or had obtained waivers for all
    covenants, limitations and restrictions. The Company has renegotiated
    certain financial covenants with the lender for fiscal 1999. Future losses
    from businesses such as K-tel Express or the inability to complete an equity
    placement may result in further renegotiations of such covenants or the need
    to seek replacement financing.

5.  NOTE PAYABLE TO AFFILIATE

    From time to time the Company has borrowed from K-5 Leisure Products, Inc.,
    ("K-5") an affiliate controlled by the Company's Chairman of the Board and
    Chief Executive Officer. The Company pays interest at prime rate (8.5% at
    June 30, 1998) on the unpaid principal amount of financing which is due on
    demand. As of June 30, 1998 and 1997 K-5 Leisure Products, Inc. had advanced
    $1,000,000 and $1,500,000 to the Company. Subsequent to June 30, 1998 an
    additional $3,000,000 was advanced to the Company.

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.

    The provision (benefit) for income taxes consists of the following for the
    years ended June 30 (in thousands):

<TABLE>
<CAPTION>
                                                                     1998           1997          1996
                                                                  ----------     ----------    ----------
<S>                                                               <C>            <C>           <C>      
    Income (loss) before provision (benefit) for income taxes:
       United States                                              $   (3,702)    $    1,694    $      141
       Foreign                                                         1,323          1,728          (535)
                                                                  ----------     ----------    ----------
        Total                                                     $   (2,379)    $    3,422    $     (394)
                                                                  ==========     ==========    ==========

    Provision (benefit) for income taxes:
      Currently payable
       United States                                              $     (119)    $      111    $      210
       Foreign                                                           147            107           141
                                                                  ----------     ----------    ----------

        Total currently payable and
        total provision  for income taxes                         $       28     $      218    $      351
                                                                  ==========     ==========    ==========
</TABLE>


                                       25

<PAGE>


    A reconciliation of the U.S. Federal statutory rate to the effective tax
    rate for the years ended June 30 are as follows:

<TABLE>
<CAPTION>
                                                          1998         1997         1996    
                                                         -------      -------      -------
<S>                                                      <C>          <C>          <C>
    Federal statutory rate                                    34%          34%          34%
    State Taxes, net of Federal benefit                        2%           1%         (26)%
    Change in valuation allowance                            (39)%        (29)%        (99)%
    Effect of different tax rates on foreign earnings          2%          --            2%
                                                         -------      -------      -------
                                                              (1)%          6%         (89)%
                                                         =======      =======      =======
</TABLE>

    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):

<TABLE>
<CAPTION>
                                                           June 30,       June 30,
                                                             1998           1997
                                                         -----------     ----------
<S>                                                      <C>             <C>       
    Net operating loss carryforwards                     $    13,522     $    5,486
    Alternative minimum tax credits                              432            411
    Reserve for returns                                        1,477          1,419
    Depreciation and amortization                                263            136
    Royalty reserves                                             355            964
    Inventory reserves                                           274            943
    Nondeductible accruals                                       286            647
    Allowance for bad debts                                      198            284
    Valuation allowance                                      (16,807)       (10,290)
                                                         -----------     ----------
                                                         $        --     $       --
                                                         ===========     ==========
</TABLE>

    A valuation allowance equal to the aggregate amount of deferred tax assets
    has been established until such time as realizability is assured.

    For U.S. tax reporting purposes, the Company has net operating loss
    carryforward ("NOL") of approximately $36,649,000. Of this amount
    approximately $8,590,000 is available only through the year 2000 and another
    $8,492,000 will be available only through 2001. The rest of the NOL
    carryforward will be available through the year 2013. However, of the amount
    available through 2013, $14,877,000 relates to deductions associated with
    the exercise of stock options. The tax benefit of approximately $5,355,000
    associated with this stock option deduction will be recorded as additional
    paid-in capital when realized. The tax NOL carryforward 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
    of offset any regular corporate income tax liability. NOL's available in
    foreign countries approximated $1,400,000 as of June 30, 1998.

7.  CAPITAL TRANSACTIONS

    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. There were 495,400 net shares granted under
    this plan as of June 30, 1998. 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. There were 575,000 shares granted under this plan as
    of June 30, 1998.


                                       26

<PAGE>


    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:

<TABLE>
<CAPTION>
                                                  Incentive         Non-qualified        Restricted
                                                Stock Options       Stock Options      Stock Options
                                               --------------      --------------     --------------
<S>                                            <C>                  <C>               <C>    
    Outstanding July 1, 1995                          300,050              94,750            345,000

    Granted                                                --                  --                 --
    Exercised - at prices ranging from
    $.75 - $1.50 per share                           (48,800)             (4,250)                  -
    Forfeited                                        (30,250)             (4,250)          (290,000)
                                               --------------      --------------     --------------
    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)                 --
    Forfeited                                        (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)
    Forfeited                                         (7,100)                  --                 --
                                               --------------      --------------     --------------
    Outstanding June 30, 1998                         580,576             497,000            661,000
                                               ==============      ==============     ==============

    Exercise Prices                            $.75 - $14.345      $.75 - $14.345     $2.00 - $4.125

    Options Excercisable (1)                            9,476              26,000            631,000

</TABLE>

(1) Subsequent to year end the Company announced it would allow employees who
    were granted options under the existing stock option plans the opportunity
    to exercise certain unvested stock options during the months of September,
    October and November of 1998. The options not exercised during this period
    will revert back to the original vesting schedule. Under this plan 250,300
    additional Incentive Options may be exercisable during this period that are
    not included in the above table.

    Pro forma Option Information

    Effective June 30, 1997 the Company adopted SFAS No. 123. "Accounting for
    Stock-Based Compensation." As permitted by SFAS No. 123, the Company has
    elected to continue to account 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 net
    income and earnings per share would have been as follows:


                                       27

<PAGE>


                                                1998             1997
                                             ----------       ----------
    Net income (in thousands):
      As reported                            $   (2,407)      $    3,204
      Pro forma                              $   (3,577)      $    2,757

    Basic EPS:
      As reported                            $     (.31)      $      .43
      Pro forma                              $     (.46)      $      .37

    Diluted EPS:
      As reported                            $     (.31)      $      .41
      Pro forma                              $     (.46)      $      .35

    The weighted average fair values of options granted in fiscal 1998 was $6.10
    and in fiscal 1997 was $2.20. No options were granted in fiscal 1996.

    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:

                                                1998          1997
                                             ----------    ----------
           Risk-free interest rate              5.12%          6.3%
           Expected life                      5 years       5 years
           Expected volatility                   100%           57%
           Expected dividend yield               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

    The Company 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 the Company for which the outcome
    is likely to have a material adverse effect upon the consolidated financial
    position or results of operations of the Company.

    K-tel International Inc. v. Platinum Entertainment Inc. In September 1997
    the Company commenced a declaratory judgment action against Platinum
    Entertainment, Inc. ("Platinum") in Minnesota state court. The Company
    alleged that it was entitled to $1.75 million which Platinum deposited in an
    earnest money escrow account pursuant to Platinum's agreement to purchase
    two of the Company's subsidiaries, K-tel International (USA), Inc. and
    Dominion Entertainment, memorialized in the March 1997 Purchase and Sale
    Agreement. The Company further alleged claims of breach of the March 1997
    Purchase and Sale Agreement and related confidentiality agreement,
    defamation, fraud, and promissory estoppel.

    Platinum removed the action to federal court and asserted a counterclaim
    against the Company seeking a declaration that Platinum was entitled to the
    earnest money and alleging claims of breach of contract and fraudulent
    inducement. While still engaged in the discovery process the parties settled
    the action between themselves, agreeing to a payment to K-Tel International,
    Inc. of $875,000 of the earnest money escrow and reimbursement by Platinum
    of certain accounting fees paid by the Company, along with an exchange of
    releases. The parties also stipulated to the dismissal of the action with
    prejudice and the Court dismissed the action with prejudice by Order dated
    July 7, 1998.

    Early v. K-tel International Inc. On March 10, 1997 Mr. Christopher Early
    filed a class action Complaint against K-tel International, Inc. ("the
    Company"), 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


                                       28

<PAGE>


    Illinois on April 3, 1997. On March 30, 1998 Mr. Early obtained leave to
    file an Amended Complaint adding K-tel International (USA), Inc. and one
    additional retailer as defendants, 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 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 CD's;" and (5) attorneys' fees and costs. The defendants have moved to
    dismiss the Amended Complaint and in the alternative for a partial summary
    judgment on one aspect thereof. This motion has been fully briefed but not
    ruled upon and discovery has not commenced. The Company has indemnified the
    retailer defendants in this matter. The Company believes the case is without
    merit and intends to contest the case vigorously.

    Leases

    The Company has entered into several office and warehouse leases which
    expire through 2003. Commitments under these leases are $719,000 in 1999,
    $757,000 in 2000, $713,000 in 2001, $293,000 in 2002 and $11,000 in 2003.
    Rental expense was $885,000 in 1998, $988,000 in 1997 and $1,000,000 in
    1996.

    Other

    The Company has made certain commitments for marketing, advertising and
    technical services relating to K-tel Express that will be provided over the
    next fiscal year that will require payments up to $600,000 and the issuance
    of 15,000 restricted shares of the Company's common stock.

9.  OPERATIONS BY GEOGRAPHIC AREA

    The following table sets forth the Company's operations by geographic area
    as of and for the fiscal years ended June 30 (in thousands):

                                           1998          1997           1996
                                       ----------     ----------     ----------
    Net Sales:
    ---------

    North America                      $   55,883     $   47,786     $   48,605
    Europe                                 29,743         27,715         23,382
                                       ----------     ----------     ----------
    Net Sales                          $   85,626     $   75,501     $   71,987
                                       ==========     ==========     ==========

    Operating Income (Loss):
    -----------------------

    North America                      $   (2,074)    $    2,672     $    1,997
    Europe                                  1,806          2,343            (38)
    General Corporate Expenses, net        (2,267)        (1,433)        (1,955)
                                       ----------     ----------     ----------
    Operating Income (Loss)            $   (2,535)    $    3,582     $        4
                                       ==========     ==========     ==========

    Identifiable Assets:
    --------------------

    North America                      $   24,574     $   22,781     $   20,282
    Europe                                 14,461          7,711          7,513
                                       ----------     ----------     ----------
    Identifiable Assets                $   39,035     $   30,492     $   27,795
                                       ==========     ==========     ==========


                                       29

<PAGE>


10. 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. Advances on this facility reached $1,500,000
    as of November 20, 1997 when the debt was repaid in full from the borrowings
    under the Company's credit facility. As of June 30, 1998 K-5 Leisure
    Products, Inc. had advanced an additional $1,000,000 to the Company and an
    additional $3,000,000 subsequent to June 30, 1998. The Company pays interest
    on the unpaid principal amount of financing at the same rate as the Company
    pays on its credit facility, until repayment of the loan, which is due on
    demand. The Company paid interest of $95,000 in 1998, $59,000 in 1997 and no
    interest was paid or due in 1996.

    The Company purchased approximately $334,000 in fiscal 1998, $381,000 in
    fiscal 1997 and $1,050,000 in fiscal 1996 of consumer convenience product
    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 $9,000 at June 30, 1998, $255,000 at
    June 30, 1997 and there was no balance payable at June 30, 1996.

    The Company sold approximately $39,000 during fiscal 1998, $229,000 in
    fiscal 1997 and $217,000 in fiscal 1996 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, 1998 of $4,000, $83,000 at June 30, 1997 and there was no receivable
    balance owed to the Company at June 30, 1996. Outstanding balances are
    settled on a timely basis. No interest was charged on the related
    outstanding balances during fiscal 1998.


                                       30

<PAGE>


                                   SCHEDULE II

                   K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES

                        VALUATION AND QUALIFYING ACCOUNTS

                For the years ended June 30, 1998, 1997, and 1996

                                 (In thousands)

<TABLE>
<CAPTION>
                                           Charged to
                         Balance at         Costs and        Charged to                              Balance at
                        Beginning of     Expenses or Net       Other                                   End of
                           Period             Sales           Accounts          Deductions             Period
                        ------------     ---------------    -----------         -----------         -----------
<S>                     <C>               <C>               <C>                 <C>                 <C>        
Allowance for
Doubtful Accounts
--------------------

1998                    $       952       $       986       $        (1)(1)     $    (1,276)(2)     $       661
1997                    $     1,035       $       533       $       (29)(1)     $      (587)(2)     $       952
1996                    $       771       $       694       $       (15)(1)     $      (415)(2)     $     1,035

Reserve for
Returns
--------------------

1998                    $     4,930       $    13,943       $        (9)(1)     $   (14,106)        $     4,758
1997                    $     6,817       $    10,096       $       (24)(1)     $   (11,959)        $     4,930
1996                    $     6,802       $    10,485       $       (18)(1)     $   (10,452)        $     6,817

</TABLE>

(1) Exchange rate change

(2) Uncollectible accounts written off, net of recoveries


                                       31