**SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

 

**FORM 10-K**

 
| **(MARK ONE)**                               |                                                                                          |
|----------------------------------------------|-----------------------------------------------------------------------------------------------|
| **ý**                                   | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**     |
|                                         |                                                                                          |   |
| **For  the fiscal year ended June 30, 2002** |
|                                         |                                                                                          |   |
| **OR**                                       |
|                                         |                                                                                          |   |
| **o**                                        | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |

 

**For thetransition period from           to          **

** **

**Commissionfile number 0-6664**

 

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

 

| **Minnesota**                                                 |   | **41-0946588**                        |
|---------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of                              |   | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)                               |   |                                  |
|                                                          |   |                                  |
| **2655  Cheshire Lane North, Suite 100, Plymouth, Minnesota** |   | **55447**                             |
| (Address of principal  executive offices)                     |   | (Zip Code)                            |

 

Registrant’s telephone number,including area code: **(763) 559-5566**

 

Securities registeredpursuant to Section 12(b) of the Act:

**None**

 

Securities registeredpursuant to Section 12(g) of the Act:

Common Stock, par value$0.01

(Title of class)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has been subjectto such filing requirements for the past 90 days.

 

Yes  ý   No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o

 

As of September 20, 2002, the aggregate market value of voting stockheld by non-affiliates of the registrant based on the last sales price asreported by the Over-the-Counter Bulletin Board on such date was $1,365,374. 

 

As of September 20, 2002, the registrant had 13,653,738 shares ofCommon Stock outstanding.

 

DOCUMENTS INCORPORATED BYREFERENCE

 

None.

 

 

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**TABLE OF CONTENTS**

 

 
| PART I    |   |                                                                                        |   |
|-----------|--------|---------------------------------------------------------------------------------------------|--------|
|      |   |                                                                                        |   |
| Item 1.   |   | Business                                                                                    |   |
| Item 2.   |   | Properties                                                                                  |   |
| Item  3.  |   | Legal  Proceedings                                                                          |   |
| Item  4.  |   | Submission  of Matters to a Vote of Security Holders                                        |   |
| Item 4a.  |   | Executive  Officers of the Registrant                                                       |   |
|      |   |                                                                                        |   |
| PART II   |   |                                                                                        |   |
|      |   |                                                                                        |   |
| Item  5.  |   | Market  for Registrant’s Common Equity and Related Stockholder Matters                 |   |
| Item 6.   |   | Selected Financial  Data                                                                    |   |
| Item  7.  |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
| Item  7a. |   | Quantitative  and Qualitative Disclosures about Market Risk                                 |   |
| Item  8.  |   | Financial  Statements and Supplementary Data                                                |   |
| Item  9.  |   | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure       |   |
|      |   |                                                                                        |   |
| PART III  |   |                                                                                        |   |
|      |   |                                                                                        |   |
| Item  10. |   | Directors  and Executive Officers of the Registrant                                         |   |
| Item 11.  |   | Executive Compensation                                                                      |   |
| Item  12. |   | Security  Ownership of Certain Beneficial Owners and Management                             |   |
| Item  13. |   | Certain  Relationships and Related Transactions                                             |   |
|      |   |                                                                                        |   |
| PART IV   |   |                                                                                        |   |
|      |   |                                                                                        |   |
| Item  14. |   | Exhibits,  Financial Statement Schedules and Reports on Form 8-K                            |   |

 

 

 

**SAFE HARBOR STATEMENT UNDER THE**

**PRIVATE SECURITIES LITIGATION REFORMACT OF 1995**

 

Certain statements of a non-historical nature underthe captions “Business,” “Legal Proceedings,” “Market for Registrant’s CommonEquity and Related Stockholder Matters,” “Management’s Discussion and Analysisof Financial Condition and Results of Operations,” and elsewhere in this Form10-K constitute “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995. Such forward-looking statements maybe identified by the use of terminology such as “may,” “will,” “expect,”“anticipate,” “estimate,” “should,” or “continue” or the negative thereof orother variations thereon or comparable terminology. Such forward-lookingstatements are subject to certain risks and uncertainties that could causeactual results to differ materially from historical results or from thoseresults currently anticipated or projected. Such factors include, among otherthings, the following: changes in consumer purchasing; demand for and marketacceptance of new and existing products; the impact from competition formerchandise and recorded music; the outcome of securities laws claims by apurported class action lawsuit; dependence on suppliers and distributors; theoutcome of  the two subsidiaries’bankruptcy and liquidation; success of marketing and promotion efforts;technological changes and difficulties; availability of financing; foreigncurrency variations; general economic, political and business conditions; andother matters. The Company undertakes no obligation to release publicly theresult of any revisions to these forward-looking statements, except as requiredby law in the normal course of its public disclosure practices.

 

 

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**PARTI**

 

**ITEM1:  BUSINESS**

 

K-tel International, Inc.(the “Company,” “K–tel,” or the “Registrant”) was incorporated in 1968.Its corporate offices are located at 2655 Cheshire Lane North, Suite 100,Plymouth, Minnesota, and its phone number is (763) 559-5566. Through itsoperating subsidiaries, K-tel licenses its music catalog internationally andmarkets entertainment products mainly derived from its catalog through retailand direct response marketing channels in the United States and Europe.Historically, K-tel subsidiaries had also distributed consumer products throughoperations which have been discontinued, and operated an Internet e-commercesite which has been suspended due to continuing losses.

 

Description of CurrentBusinesses

 

Music Licensing and Sales

 

Currently K-tel’s primary activity is the licensing of music to otherrecord companies and to other segments of the entertainment industry. K-telowns a proprietary master music catalog of approximately 6,000 titlesconsisting of original recordings and re-recordings of music from the 1950’sthrough today. Supplementing this major asset, K-tel has a non-exclusiveworldwide license for a catalog of over 30,000 music titles. The Company alsolicenses the rights to master recordings to third parties worldwide for use inalbums, films, television programs and commercials for either a flat fee or aroyalty based on the number of units sold. K-tel continuously adds to its musicmaster catalog to ensure growth and product diversity. Licensing of itsproprietary music rights to third parties has historically been an importantrevenue source for K-tel. The Company also markets and sells pre-recordedcompact discs utilizing the master recordings in its music catalog, and DVD’sfrom its developing catalog of musical performances. Customers includeretailers, wholesalers and rack service distributors. These products are alsosold through subsidiaries and licensees in the United Kingdom and elsewhere inEurope. The principal entertainment products that K-tel markets and sellsconsist primarily of pre-recorded thematic music packages in a compilationformat featuring various artists. These thematic music selections, which covernearly all music genres, are targeted to a variety of age groups. K-telprovides marketing support for its music sales through cooperative advertisingwith retailers, print media, radio and television advertising, and in-storepromotions and displays.

 

One customer, Madacy Entertainment Group, Inc. accounted forapproximately 13% of K-tel’s revenue for the year ended June 30, 2002. The lossof, or a substantial reduction in, business from this customer would have amaterial adverse effect on the Company.

 

K-tel currently deliversmusic products (CD’s and DVD’s) through traditional wholesale and retaildistribution channels. Prior to April 2001, the Company was distributing itsproducts in the United States to most major music retailers (TransworldEntertainment, Musicland, Best Buy, Circuit City, Tower Records) and to majordistributors (Handelman, Anderson Merchandising, Valley Media). The Company nowhas a customer base that includes only a few selected retailers and distributors,and offers products that are of more interest to these individual customers.This focused approach is intended to improve product sell-through and minimizereturns of unsold inventory. These existing methods of distributing music couldbe materially altered by new technologies that will enable users and customersof pre–recorded music to electronically download pre–recorded musicat home to various personal computer media formats. The technology isdeveloping. A number of competing companies are seeking to have the industryand the public embrace their technologies. Participants in this technologycompetition include Microsoft Corporation, AT&T Corp., Liquid Audio, Inc.,Apple Computer, Inc., MP3.com, Inc. and others. Digital music distribution providesboth significant risks and opportunities for K-tel. The risks include K-tel’suncertain ability to compete with other music companies from a marketing and atechnological standpoint. The Company believes that there are opportunities toenhance its current distribution methods as well as increase opportunities tolicense its owned library of master recordings. K-tel’s music sales andlicensing subsidiaries are is pursuing these alternative distribution channels.

 

In March 2001, the Company’s music distribution subsidiary in theUnited States, K-tel International (USA), Inc. (K-tel (USA)) ceased operationsand filed for protection under Chapter 7 of the United States bankruptcy code.This event ended the Company’s traditional method of distributing music productsthrough most retailers. Through another subsidiary, K-tel Entertainment, Inc.,the Company is implementing a more-focused method of distribution that targetsthe strengths of fewer individual retailers and supplies products suited toeach retailer’s specific needs. These new products are primarily derived fromthe Company’s master music catalog. It is anticipated that this will allow theCompany to realize more competitive profit margins.

 

 

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The Company’s ability to continue its present operations and implementfuture expansion plans successfully is contingent mainly upon its ability tomaintain its line of credit arrangements with K-5 Leisure Products, Inc. (K-5)(See Note 3 to the Company’s financial statements), increase its revenues, andultimately to attain and sustain profitable operations. Without increasedrevenues and sustained profitability, the cash generated from the Company’scurrent operations may not be adequate to fund operations and service itsindebtedness on an ongoing basis. Management is concentrating its efforts onreturning to profitability by focusing on music licensing and limited musicdistribution. However, there can be no assurance that the Company’s managementwill be successful in this effort. In the event the Company is unable to fundits operations and implement its current business plan properly, it may beunable to continue as a going concern. The Company’s financial statements donot include any adjustments that might result from the outcome of thisuncertainty.

 

# E-Commerce

 

K-tel ceased operating its K-tel.com website, which marketed its ownand other suppliers’ products to retail customers, in the fourth quarter of2001 because this business segment was not cost effective. The web site hasrecently been redeveloped to support the Company’s sale of proprietarybrand-name compilations and newly developed CD and DVD products to customers inthe United States and United Kingdom.

 

Competition

 

The music business ishighly competitive and dominated by major companies. K-tel faces competitionfor discretionary consumer purchases of its products from other recordcompanies and other entertainment sources, such as film and video companies.Several major record companies in the United States including Bertelsmann AG,Sony Corp., Time Warner, Inc. and Universal Music Group dominate the market forpre–recorded music. K-tel does not have the financial resources, nor doesit have the depth or breadth of catalog, distribution capabilities or currentrepertoire of these companies. Its ability to compete in this market dependsupon:

 

•                  the skill and creativity of its employees to expand and utilize itsmusic catalog to create compilation packages;

 

•                  its ability to distribute its products effectively and efficiently; and

 

•                  its ability to build upon and maintain its reputation for producing,licensing, marketing and distributing high quality music.

 

The core of K-tel’s musicbusiness involves the licensing of third party rights and the utilization ofits own catalog to create music compilations for retail distribution. The majorpre–recorded music companies, either directly or through subsidiaries,now manufacture or distribute pre–recorded music compilations in directcompetition with K-tel’s music compilation products. With this new competition,it is far more difficult for K-tel to access pre–recorded music fromthese major companies at acceptable rates. Therefore, the Company reliesheavily on its own Dominion catalog and has accelerated the rate at which itproduces new master recordings.

 

Another form ofcompetition for the Company is the developing ability for users and customersof pre-recorded music to download pre-recorded music electronically at home tovarious personal computer media formats. The technology is at an early stageand K-tel is uncertain how this new technology will impact its currentoperations.

 

Employees

 

On June 30, 2002, K-telemployed 27 full time people worldwide.

 

# Financialand Geographic Information 

 

For financial information about the Company’s businesssegment and geographic area operations for each of the three fiscal years endedJune 30, 2002 see Note 8 to the consolidated financial statements.

 

**ITEM2:  PROPERTIES**

 

K-tel’s corporateoffices and U.S. operations are located in leased facilities in Plymouth, asuburb of Minneapolis, Minnesota, consisting of approximately 4,000 square feetof office space and approximately 6,000 square feet of 

 

 

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warehouse. K-tel’sforeign subsidiaries lease a total of approximately 9,500 square feet of officeand warehouse facilities. See Note 6 to the consolidated financial statementsfor a summary of the lease agreements. The Company believes that thesefacilities are adequate for its current needs.

 

**ITEM3:  LEGAL PROCEEDINGS**

 

Class ActionLawsuit

 

K-tel and certainof its current and former officers and directors are defendants in *In re K-tel International, Inc. Securities Litigation*,No. 98-CV-2480.  This actionconsolidates twenty-three purported class actions that were initially filed invarious United States District Courts in November 1998, and were subsequentlytransferred to, and consolidated in, the United States District Court for theDistrict of Minnesota. On July 19, 1999, the plaintiffs filed an amendedconsolidated class action complaint that challenges the accuracy of certainpublic disclosures made by K-tel regarding its financial condition during theperiod from May 1998 through November 1998. The plaintiffs assert claims underthe federal securities laws and seek damages in an unspecified amount as wellas costs, including attorneys’ fees and any other relief the Court deems justand proper. K-tel moved to dismiss the complaint, and on July 31, 2000, theUnited States District Court granted the Company’s motion to dismiss. The Courtalso barred further actions by the plaintiffs and denied plaintiffs’ request toamend the complaint in order to refile the complaint in the future. Theplaintiffs appealed to the United States Court of Appeals for the EighthCircuit, and the Court of Appeals heard the matter in October 2001. On August7, 2002 the Court of Appeals, in a two to one decision, denied the plaintiff’sappeal. On August 20, 2002 the plaintiff applied for a rehearing by the fullCourt of Appeals. K-tel filed a response on September 15, 2002 to theplaintiff’s petition for rehearing at the request of the Court. K-tel isawaiting a ruling on this appeal. K-tel has two insurance policies providingcoverage of up to $20 million, which is subject to the insurers’ reservationsof legal rights under the applicable policies. Under their reservations ofrights, the insurers could contest their obligations to indemnify the Companyand its directors and officers. K-tel may have an obligation to indemnify theofficers and directors named in this lawsuit.

 

Early v. K-telInternational, Inc.

 

On January 11,1999, the Company was named in a lawsuit entitled *Christopher Early vs. K-telInternational, Inc. et al* brought in the Circuit Court of CookCounty, Illinois, against the Company and certain of its subsidiaries byChristopher Early. The suit also named as defendants certain othermanufacturers, distributors and a number of nationwide retailers. The plaintiffsought damages on behalf of himself and a purported class of purchasers ofcassette tapes and compact discs produced, distributed and/or sold by thedefendants. The claim alleged that defendants engaged in deceptive andmisleading packaging of cassette tapes and compact discs by failing to giveproper notice to consumers that the songs contained therein were not theoriginal recordings by the original artists. The complaint also allegedconsumer fraud, deceptive and unfair practices, and fraud in connection withwebsite advertising and marketing. Similar litigation was brought against theCompany by Mr. Early in 1997 and was dismissed by a United States Federal Courtin 1999 on jurisdictional grounds. The Company denies that it mislabeledcassette tapes and compact discs or engaged in fraudulent or deceptive conductand defended vigorously the purported action, which sought an undeterminedamount of compensatory damages and punitive damages in the amount of $10million, an injunction and costs incurred in the litigation, includingattorneys fees. The Company filed a motion to dismiss the complaint on June 8,2000. On February 16, 2001, the court dismissed the complaint against the othermanufacturers, distributors and nationwide retailers, but allowed the case tocontinue against the Company. On May 28, 2002, the Court approved an agreementbetween the Company and Mr. Early on terms favorable to the Company within theamount previously reserved for in the Company’s financial statements.

 

RTL Shopping S.A.

 

The Company hasbeen named in a lawsuit filed in France brought by RTL9, a French cable TVstation. Initially, RTL9 was named as a defendant in a suit brought by acompetitor of K-tel Marketing Ltd. alleging that RTL9 ran a commercial forK-tel Marketing which presented a product under brand names alleged to infringeon the competitor’s own trademarks and also translated an English languagescript indicating that the product was “just like” or “as good as” others into“better than” in French, contrary to French law. The suit alleged trademarkinfringement, unfair competition, illicit comparative advertising and passingoff. RTL9 then sued K-tel Marketing on October 4, 2000, pursuant to anindemnification provision the parties had entered into. Subsequently, K-telMarketing went into liquidation and RTL9 filed a suit in December 2000 againstK-tel International, Inc. under its agreement to guarantee payment for thecommercial time. On May 28, 2001, RTL9 presented documents in court identifyingK-tel International (USA), Inc. as a target of its claim. On September 3, 2001the Company filed documents disputing the claim and advising the court of K-tel(USA)’s Chapter 7 bankruptcy filing. At a procedural hearing on December 3,2001, RTL9 filed its brief in response to the Company’s filing. In response, 

 

 

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the Company fileda further brief. At a further hearing on May 6, 2002, several companiesinvolved in the initial suit against RTL9 filed additional briefs or indicatedthat additional briefs would be filed. The Court directed that all additionalbriefs were to be filed by June 24, 2002. Several parties filed additionalbriefs on September 11, 2002. The Company filed a brief in response. At ahearing on September 16, 2002, the Court received new submissions from three ofthe other parties and set a hearing date of October 28, 2002, at which time itwill declare an end to the written submissions. The Court has scheduled oralarguments for November 12, 2002. The action seeks the approximate amount of 20million French Francs, or approximately $2.8 million. The Company believes thatRTL9 has no basis for a complaint against the Company.

 

Hollins & Fields, LLP v K-tel International, Inc.

 

Hollins &Fields, LLP (H&F) sublet a portion of the Company’s former executiveoffices in Los Angeles. On September 21, 2001, H&F sued K-tel in Californiafor breach of contract and conversion, seeking damages in excess of $150,000.On November 26, 2001, the Court dismissed the punitive damage claim in theamount of $100,000. The Company filed a defense and counterclaim. As a resultof information exchanged during discovery, the parties settled the matter onApril 30, 2002 on terms favorable to the Company.

 

K-telInternational, Inc. vs. Tristar Products, Inc.

 

K-tel and itssubsidiary in Germany have commenced an action for breach of express andimplied warranties against Defendant Tristar Products, Inc. This action isvenued in the United States District Court for the District of Minnesota. Thisaction arises out of Tristar’s sale to Plaintiffs of a defective home exerciseproduct called the “BunBlaster” for resale in Germany, Austria and Switzerland.By written contract, Tristar has agreed to indemnify Plantiffs for injuries anddamages arising out of the resale of those goods. Plaintiffs are seekingapproximately $2 million in consequential damages. Tristar is vigorouslydefending this claim and the action is currently in discovery.

 

Tristar has alsoasserted a patent and trademark/ trade-dress action against K-tel for passingoff a product called the “K-tel Hook and Hang” while allegedly a distributor ofthe original patented Tristar Hook and Hang product. The Company denies theallegation because it never was a distributor of this or any similar product andintends to defend this action vigorously. Tristar has not identified the amountof damages it seeks with respect to this counterclaim. Discovery proceedingshave commenced.

 

#### Litigation andDisputes

 

K-tel and itssubsidiaries are also involved in other legal actions in the ordinary course ofits business. With all litigation matters, management considers theirlikelihood of loss based on the facts and circumstances. If managementdetermines that a loss is probable and the amount of loss can be reasonablyestimated, such amount is recorded as a liability. Although the outcome of anysuch legal actions cannot be predicted, in the opinion of management there iscurrently no legal proceeding pending or asserted against or involving K-telfor which the outcome is likely to have a material adverse effect upon theconsolidated financial position or results of operations of K-tel.

 

Subsidiaries’Bankruptcy and Liquidation

 

In March 2001, theCompany’s music distribution subsidiary in the United States, K-tel International(USA), Inc., ceased operations and filed for protection under Chapter 7 of theUnited States Bankruptcy Code. Although the bankruptcy court has not yetconfirmed the formal plan of liquidation, the Company has not been informed bythe trustee or its counsel of any plan by the court to attempt to hold it orany of its subsidiaries liable for any of the commitments of K-tel (USA).Management believes the Company will have no ongoing material liability relatedto K-tel (USA) as a result of the filing and the outcome of the bankruptcyproceeding.

 

In November 2000,the Company’s consumer products subsidiary in the United Kingdom, K-telMarketing Ltd., ceased operations and began voluntary liquidation proceedings.At the initial meeting of the creditors on November 24, 2000, the creditorsvoted for the liquidation to become a creditors’ liquidation under English law.The Company has not been informed by the liquidators or their counsel of anyplan to attempt to hold it or any of its subsidiaries liable for any of thecommitments of K-tel Marketing Ltd. Management believes the Company will haveno ongoing material liability related to K-tel Marketing Ltd. as a result ofthe liquidation proceeding. 

** **

 

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**ITEM4:  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

No matters were submittedto a vote of K-tel’s security holders during the fourth quarter of fiscal 2002.

 

**ITEM4A.  EXECUTIVE OFFICERS OF THEREGISTRANT**

 

The following table setsforth certain information with respect to the executive officers of K-tel atJune 30, 2002.

 
| **Name of Office** |   | **Age** |   | **Positions and Offices Held**                                          |
|--------------------|--------|---------|--------|-------------------------------------------------------------------------|
|               |   |    |   |                                                                    |
| Philip Kives       |   | 73      |   | Chairman of the Board,  Chief Executive Officer, President and Director |
|               |   |    |   |                                                                    |
| Dennis Ward        |   | 56      |   | Chief Financial  Officer, Secretary and Director                        |

 

The officers of K-tel areelected annually and serve at the discretion of the Board of Directors.

 

**PhilipKives** has heldvarious offices and/or managerial positions with K-tel for more than the pastfive years. Mr. Kives is currently the Company’s Chairman, Chief ExecutiveOfficer and President.

 

**Dennis W. Ward** was appointed Chief Financial Officer and Secretaryof K-tel on December 29, 2000and has served as Controller of K-5 Leisure Products, Inc. (K-tel’s largestshareholder) for more than twelve years.

 

 

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**PARTII**

 

**ITEM5:  MARKET FOR REGISTRANT’S COMMON STOCKAND RELATED STOCKHOLDER MATTERS**

 

On September 20, 2002there were 1,393 record holders of K-tel’s common stock and 13,653,738 sharesoutstanding. Prior to September 27, 2000, K-tel’s common stock traded on theNasdaq National Market under the symbol “KTEL”. On September 27, 2000, theCompany’s common stock was delisted from the Nasdaq National Market and istraded on the Over-the-Counter Bulletin Board.

 

The following table showsthe range of high and low closing prices per share of K-tel’s common stock forthe fiscal year periods indicated. 

 

|        |   | **2002** |   | **2001** |   |
|-------------|--------|----------|--------|----------|--------|
|        |   | **High** |   | **Low**  |   | **High** |   | **Low** |   |
| 1st Quarter |   | $        | .14    |     | $      | .10 |   | $ | 2.44 |   | $ | .63 |   |
| 2nd Quarter |   | $        | .39    |     | $      | .12 |   | $ | .92 |   | $ | .16 |   |
| 3rd Quarter |   | $        | .40    |     | $      | .13 |   | $ | .19 |   | $ | .10 |   |
| 4th Quarter |   | $        | .15    |     | $      | .09 |   | $ | .15 |   | $ | .10 |   |

 

No cash dividendshave been declared on K-tel’s common stock during the past two fiscal years andK-tel does not expect to pay cash dividends in the foreseeable future.Management plans to use cash generated from operations for expansion of itsbusiness. The declaration or payment by K-tel of dividends, if any, on itscommon stock in the future is subject to the discretion of the Board ofDirectors and will depend on K-tel’s earnings, financial condition, capitalrequirements and other relevant factors. The declaration or payment by K-tel ofdividends is also subject to the terms of its credit facility.

 

**EquityCompensation Plan Information**

The following table provides information as of June30, 2002 with respect to compensation plans under which the Company’s equitysecurities are authorized for issuance.

 
|                                                            |   | **Number of  securities to be issued upon exercise of outstanding options, warrants and  rights (a)** |   | **Weighted-average  exercise price of outstanding options, warrants and rights (b)** |   | **Number of  securities remaining available for future issuance under equity compensation  plans (excluding securities reflected in column (a)) (c)** |    |
|-----------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------|---------|
| Equity  compensation plans approved by security holders         |   | 2,273,839                                                                                             |   | $                                                                                    | 5.87   |                                                                                                                                                  | 854,350 | (1) |
| Equity  compensation plans not approved by security holders (2) |   | 5,000                                                                                                 |   | $                                                                                    | 8.73   |                                                                                                                                                  | NA      |   |
| Total                                                           |   | 2,278,839                                                                                             |   | $                                                                                    | 5.90   |                                                                                                                                                  | 854,350 |   |

 

(1)          Represents shares of common stock remaining availablefor future issuance under the Company’s 1997 Stock Option Plan, as amended.

 

 

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(2)          Represents a stock option granted to a non-employeedirector of the Company on February 26, 1999.

 

**ITEM 6:  SELECTEDFINANCIAL DATA**

 

The followingsummary of consolidated operations and certain balance sheet informationincludes the consolidated results of operations of K–tel and itssubsidiaries as of and for the five years ended June 30, 2002. This summaryshould be read in conjunction with the consolidated financial statements andnotes thereto appearing elsewhere in this filing. All share and per shareamounts are based on the weighted average shares issued. All amounts are inthousands of dollars, except per share data.

 
|                                        |   | **2002** |   | **2001** |   | **2000** |   | **1999** |    | **1998** |   |
|---------------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|---------|----------|--------|
|                                        |   |     |   |     |   |     |   |     |    |     |   |
| Net sales                                   |   | $        | 6,875  |     | $      | 17,514   |   | $        | 29,092  |     | $      | 44,650 |   | $ | 60,260 |   |
| Operating loss  from continuing operations  |   | $        | (332   | )        | $      | (9,480   | )      | $        | (12,980 | )        | $      | (8,356 | ) | $ | (3,674 | ) |
| Income (loss)  from discontinued operations |   | $        | (180   | )        | $      | (4,315   | )      | $        | (5,541  | )        | $      | (2,260 | ) | $ | 1,171 |   |
| Extraordinary  item:                        |   |     |   |     |   |     |   |     |    |     |   |
| Gain on  bankruptcies                       |   | $        | 894    |     | $      | 16,185   |   | $        | —  |     | $      | — |   | $ | — |   |
| Net income  (loss)                          |   | $        | 14     |     | $      | 1,369    |   | $        | (15,738 | )        | $      | (11,547 | ) | $ | (2,407 | ) |
| Net loss per  share:                        |   |     |   |     |   |     |   |     |    |     |   |
| Continuing  operations                      |   | $        | (.05   | )        | $      | (.77     | )      | $        | (1.02   | )        | $      | (1.01 | ) | $ | (.47 | ) |
| Total assets                                |   | $        | 4,250  |     | $      | 3,832    |   | $        | 17,941  |     | $      | 32,249 |   | $ | 33,274 |   |
| Long-term debt                              |   | $        | — |     | $      | —   |   | $        | 4,000   |     | $      | 4,000 |   | $ | 4,174 |   |

 

 

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**ITEM7:  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**General**

 

Through itsoperating subsidiaries, K-tel International, Inc. licenses its music cataloginternationally and markets entertainment products mainly derived from itscatalog in the United States and Europe through retail and direct responsemarketing channels.

 

For this analysis,the following changes in the Company’s business should be considered: K-telclosed the operations of its German subsidiary, Dominion Vertriebs GmbH, inJune 2000, one of its subsidiaries in the United Kingdom, K-tel Marketing Ltd.,in November 2000 and a U.S. subsidiary, K-tel Consumer Products, Inc. inFebruary 2001. These three closings represent the discontinuation of theCompany’s consumer products division and accordingly have been presented in theaccompanying financial statements as discontinued operations. In addition, inMarch 2001, the Company’s music distribution subsidiary in the United States,K-tel International (USA), Inc. ceased operations and filed for protectionunder Chapter 7 of the U.S. bankruptcy code.

 

Through anothersubsidiary, K-tel Entertainment, Inc., K-tel is implementing a more focusedmethod of distribution that targets the strengths of fewer individual retailersand supplies products suited to each retailer’s specific needs. These newproducts are derived mainly from the Company’s master recordings music catalogand it is anticipated that this will allow the Company to realize morecompetitive profit margins.

 

**A. RESULTS OF OPERATIONS**

 

The followingsections discuss the results of operations by business segment. See Note 8 tothe consolidated financial statements for additional segment information.General corporate expenses of $1,049,000 in fiscal 2002, $2,689,000 in fiscal 2001, $1,417,000 infiscal 2000 and $2,499,000 in fiscal 1999 have been allocated to the segments.The decrease in corporate expenses in fiscal 2002 was primarily a result ofdecreased legal expenses and senior management salaries.

 

**FISCAL 2002 VERSUS FISCAL 2001**

 

Net sales for the year endedJune 30, 2002 were $6,875,000, a decline of 61% from fiscal 2001 sales of$17,514,000. This sales decline can be attributed the cessation of operationsof the Company’s domestic music distribution subsidiary, K-tel (USA), which hadsales of $11,948,000 during fiscal 2001. For the fiscal year ended June 30,2002, approximately 43% of the Company’s net sales were derived in Europe. Netincome for fiscal 2002 was $14,000, or $.00 per share (after an extraordinarygain of $894,000 related to the K-tel Marketing liquidation), compared to a netincome of $1,369,000, or $.10 per share (after an extraordinary gain of$16,185,000 related to the K-tel (USA) bankruptcy filing) in fiscal 2001.

 

The following sectionsdiscuss the results of continuing operations by business segment.

 

**BUSINESS SEGMENT RESULTS**

 

**Music**

 

Sales in the music segmentwere $3,757,000 for the year ended June 30, 2002 compared to $14,202,000 forthe year ended June 30, 2001, a decline of 74%. European sales decreased$674,000 and domestic music sales decreased $9,965,000. The domestic businesshad been comprised primarily of sales of music compilations produced by K-teland the sales and distribution of other record labels. Sales declined as K-tel(USA) ceased operations and filed for bankruptcy in March 2001. Sales duringthe year ended June 30, 2002 are in another domestic subsidiary that marketsproducts derived from the Company’s proprietary master music catalog.

 

Cost of goods sold in themusic segment decreased to 55% of sales for the year ended June 30, 2002compared to 106.9% of sales for the year ended June 30, 2001. The cost of goodsin excess of net sales for the year ended June 30, 2001 reflects the disposalof slow-moving and obsolete inventory at prices less than cost during theperiod. Advertising expenses within the segment, which consists primarily ofco-operative advertising payments, trade advertising and promotions, decreasedto $183,000 for the year ended June 30, 2002 compared to $513,000 for the yearended June 30, 2001. The decrease in advertising spending was primarily theresult of reduced levels of advertising during fiscal 2002.

 

 

10

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Selling, general andadministrative expenses for the segment decreased $3,070,000, or 49%, to$3,269,000 for the year ended June 30, 2002 compared to $6,261,000 for the yearended June 30, 2001. The primary reasons for the decrease were related to generaloverall spending level reductions and nine months of operations of the domesticmusic distribution subsidiary in the year ended June 30, 2001. As a result, themusic segment incurred an operating loss of $1,725,000 for the year ended June30, 2002 compared to an operating loss of $7,749,000 for the year ended June30, 2001.

 

In connection with the K-telMarketing Ltd. creditors’ liquidation in the year ended June 30, 2002, theassets and liabilities of the subsidiary have been removed from the books ofthe Company and the remaining net liability has been shown as a gain onliquidation. During the fiscal year ended June 30, 2002, this subsidiary wasnot operating. During the fiscal year ended June 30, 2001, this subsidiary hadnet sales of $3,179,000 and sustained operating losses of $3,220,000.Management believes the Company will have no ongoing liability related to thissubsidiary as a result of the filing and the outcome of the liquidationproceeding.

 

In connection with the K-telInternational (USA), Inc. bankruptcy filing in the year ended June 30, 2001,the assets and liabilities of the subsidiary were removed from the books of theCompany and the remaining net liability has been shown as a gain onliquidation. During the fiscal year ended June 30, 2002, this subsidiary wasnot operating. During the fiscal year ended June 30, 2001, this subsidiary hadnet sales of $11,948,000 and sustained operating losses $5,229,000. Managementbelieves the Company will have no ongoing liability related to this subsidiaryas a result of the filing and the outcome of the bankruptcy proceeding.

 

**Licensing**

 

Licensing revenueswere $3,118,000 for fiscal 2002 compared to $3,710,000 for fiscal 2001, adecrease of 15.9%. Included in the segment revenue in fiscal 2001 was approximately$763,000 of inter–company revenue which was eliminated on theaccompanying consolidated financial statements. Operating income in thelicensing segment was $1,393,000 for fiscal 2002 and $425,000 for fiscal 2001,an increase of 228%, which is a result of operational productivityimprovements.

 

**Other**

 

The “Other”segment of the business is comprised of the e-commerce business, which wasclosed in the fourth quarter of fiscal 2001. The Company had neither revenuenor losses from this segment in fiscal 2002. Revenue from this segment was$365,000 in fiscal 2001. Operating losses from this segment were $2,156,000 infiscal 2001.

 

**FISCAL 2001 VERSUS FISCAL 2000**

 

Net sales for theyear ended June 30, 2001 were $17,514,000, a decline of 39.8% from fiscal 2000sales of $29,092,000. This sales decline can be attributed to the higher rateof product returns from distributors in the domestic music business and thecessation of operations of the Company’s domestic music distributionsubsidiary. Net income for fiscal 2001 was $1,369,000, or $0.10 per share(after an extraordinary gain of $16,185,000 related to the K-tel (USA)bankruptcy filing), compared to a loss of $15,738,000, or $1.58 per share, infiscal 2000.

 

**BUSINESS SEGMENT RESULTS**

 

**Music**

 

Sales in the musicsegment were $14,202,000 for the year ended June 30, 2001 compared to$25,739,000 for the year ended June 30, 2000, a decline of 44.8%. Domesticmusic sales decreased $11,217,000 and European music sales decreased $320,000.Sales from the domestic music business, comprised primarily of sales of musiccompilations produced by K-tel and the sales and distribution of other recordlabels through K-tel Distribution (“KTD”) declined as the Company experienced ahigher rate of product returns from distributors, the Company-produced newreleases were down in the current year and K-tel ceased the operations of itsdomestic music distribution subsidiary in March 2001.

 

Cost of the goodssold in the music segment increased to 106.9% of sales for the year ended June30, 2001 compared to 101.1% of sales for the year ended June 30, 2000. The costof goods sold in excess of net sales reflects the disposal of slow moving andobsolete inventory at prices less than cost during the third quarter of fiscal2001.  In the prior year, the high costof goods sold was the result of higher royalty costs incurred on K-tel’s owncompilation products and increased obsolescence reserves related to overstockedinventory. Advertising expenses within the segment, which consisted primarily 

 

 

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of co-operativeadvertising payments, trade advertising and promotions, decreased $1,644,000 to$513,000 during the year. This spending decrease was the result of eliminatingmost TV advertising, which was deemed ineffective, and better utilization ofpromotional spending.

 

Selling, generaland administrative expenses for the segment decreased $2,601,000, or 29.4%, to$6,261,000 for the year ended June 30, 2001 compared to $8,862,000 for the yearended June 30, 2000. The primary reasons for the decrease was related togeneral overall spending level reductions and only nine months of operations ofthe domestic music distribution subsidiary. As a result, the music segmentincurred an operating loss of $7,749,000 for the year ended June 30, 2001compared to an operating loss of $11,308,000 for the year ended June 30, 2000.

 

In connection withthe K-tel (USA) bankruptcy filing, the assets and liabilities of the subsidiarywere removed from the books of the Company and the remaining net liability hasbeen shown as a gain on liquidation. During the fiscal years ended June 30,2001 and 2000, this subsidiary had net sales of $11,948,000 and $23,426,000 andsustained operating losses of $5,229,000 and $9,857,000, respectively. Management believes the Companywill have no ongoing liability related to this subsidiary as a result of thebankruptcy filing and the outcome of the bankruptcy proceeding.

 

**Licensing**

 

Licensing revenueswere $3,710,000 for fiscal 2001 compared to $3,698,000 for fiscal 2000, anincrease of 0.3%. Included in the segment revenue in fiscal 2001 and fiscal2000 were approximately $763,000 and $920,000 of inter–company revenues,respectively, which are eliminated on the accompanying consolidated financialstatements. Operating income in the licensing segment was $425,000 for fiscal2001 and $819,000 for fiscal 2000, a drop of 48.1%, which is a result of alarger corporate expense allocation in fiscal 2001.

 

**Other**

 

Revenue from thee-commerce business was $365,000 in fiscal 2001 compared to $575,000 in fiscal2000. Operating losses from this segment were $2,156,000 in fiscal 2001 and$2,491,000 in fiscal 2000.

 

**Recent Accounting Pronouncements**

 

 The Company adopted Financial AccountingStandard Boards (FASB) Statement of Financial Accounting Standards (SFAS) 141, *“Business Combinations,”* and SFAS 142, *“Goodwill and Intangible Assets”* on June30, 2002. These pronouncements, among other things, eliminate thepooling-of-interest method of accounting for business combinations and requireintangible assets acquired in business combinations to be recorded separatelyfrom goodwill. The pro­nouncements also eliminate the amortization of goodwilland other intangible assets with indefinite lives and require negative goodwillbe recognized as an extraordinary gain. There­after, goodwill and otherintangible assets with indefinite lives will be tested for impairment annuallyor whenever an impairment indicator arises. The Company expects that theadoption of the provisions of SFAS No. 141 and SFAS No. 142 does not have amaterial impact on the Company’s financial statements because the Company doesnot use the pooling-of-interest method of accounting for business combinationsand has no goodwill and other intangible assets.

 

 In August 2001, the FASB issued SFAS 144, *“Accounting for the Impairment or Disposal ofLong-Lived Assets.”* SFAS 144 retains the requirement from SFAS 121to test a long-lived asset or asset group for impairment using a two-stepimpairment test whenever a triggering event occurs. SFAS 144 provides anadditional triggering event, a current expectation that, more likely than not,a long-lived asset or asset group will be sold or disposed of significantlybefore the end of its previously estimated useful life would indicate the needto test that asset or asset group for impairment. SFAS 144 is effective forfiscal years beginning after Decem­ber 15, 2001, and is generally to beapplied prospectively. SFAS 144 does not apply to good­will and otherintangible assets with indefinite lives, long-term customer relationships offinancial institutions, financial instruments, deferred policy acquisitioncosts, deferred tax assets, and other long-lived assets for which theaccounting is prescribed in certain other FASB Statements.

 

The FASB alsoissued SFAS 143, *“Accounting for AssetRetirement Obligations.”* SFAS 143 applies to all entities that have legal obligations associatedwith the retirement of a tangible long-lived asset that result from acquisition,construction, or devel­opment and (or) normal operations of the long-livedasset.  For purposes of SFAS 143, aliability for an asset retirement obligation should be recognized if theobligation meets the definition of a liability in FASB Concepts Statement 6, *“Elements of Financial Statements,”* and ifthe amount of the liability can be reasonably estimated.  Consequently, an entity should recognize aliability for an asset retirement obligation if (a) the entity has a duty orresponsibility to settle an 

 

 

12

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asset retirementobligation, (b) the entity has little or no discretion to avoid the futuretransfer or use of assets, and (c) the transaction or other event obligatingthe entity has occurred.

 

 The SFAS 144 and 143 should not have a materialeffect on the Company’s financial statements because the Company has no assetretirement obligations.

 

## **B. LIQUIDITY AND CAPITAL RESOURCES**

 

K-tel has a Line of Credit Agreement with K-5 Leisure Products, Inc., anaffiliate of the Company controlled by Philip Kives, the Chairman of the Board,President and Chief Executive Officer of K-tel. Under the terms of theagreement (the “K-5 Facility”), K-5 has agreed to make available up to$8,000,000 to K-tel on a revolving basis. The loan bears interest at a variablerate based upon the “base rate” of a nationally recognized lending institution(4.75% at June 30, 2002), expires July 20, 2005, and is subordinated to theFoothill loan (see below). The K-5 Facility contains the same covenants as theFoothill loan agreement. K-tel has pledged the stock of its foreignsubsidiaries as collateral for the loan, and the loan carries a subordinatedposition to the Foothill loan on all other assets of the Company. K-tel hadoutstanding balances of $6,026,000 and $4,807,000, as of June 30, 2002 and 2001respectively under the K-5 Facility.

 

In addition, K-tel has a second loan agreement with K-5, under whichK-5 assumed rights and obligations under a former loan with an outside party pursuantto an Assignment and Acceptance Agreement dated February 27, 2001. ThisFoothill loan, which has been extended through July 20, 2005, provides for a$10,000,000 credit facility consisting of a $4,000,000 term loan due uponexpiration, and a $6,000,000 revolving facility under which borrowings arelimited to a percent of eligible receivables. Borrowings under the facilitybear interest at a variable rate based on a “base rate” of a nationallyrecognized lending institution plus 1% (5.75% at June 30, 2002) and arecollateralized by the assets of certain Company subsidiaries in the UnitedStates, including accounts receivable, inventories, equipment, music libraryand general intangibles. The loan agreement contains certain financial andother covenants or restrictions, including the maintenance of a minimumshareholders’ equity by K-tel, limitations on capital expenditures,restrictions on music library acquisitions, limitations on other indebtednessand restrictions on dividends paid by K-tel. As of June 30, 2002 and 2001,$4,000,000 was outstanding under the term loan and there were no borrowingsunder the revolving facility. At June 30, 2002, K-tel obtained a waiver fromK-5 for its default under the covenants, limitations and restrictions of the creditagreement.

 

K-tel has an overdraft privilege borrowing facilitywith The Royal Bank of Scotland in the United Kingdom. This facility is securedby a standby letter of credit for $260,000 provided by K-tel InternationalLtd., a Canadian company controlled by Philip Kives and is payable on demand inaccordance with normal banking practices. Borrowings bear interest of 2% perannum over the base rate (6.0% at June 30, 2002) and are subject to a minimumof 6% per annum. K-tel has an outstanding balance of $227,000 as of June 30,2002.

 

K-tel hasprimarily funded its operations to date through internally generated capital,proceeds from stock option exercises and secured loans from K-5. Managementcurrently believes that K-tel has sufficient cash and borrowing capacity toensure the Company will continue operations in the near term. In part, this isa result of improvement in operating results in fiscal 2002 as well as the twoexisting lines of credit with K-5. Although K-5 continues to advance fundssufficient to meet the Company’s needs at this time, there can be no assurancethat this will be adequate or continue in the future or that K-tel will be ableto obtain additional financing upon favorable terms when required.

 

TheCompany’s ability to continue its present operations and implement futureexpansion plans successfully is contingent mainly upon its ability to maintainits line of credit arrangements with K-5, increase its revenues, and ultimatelyto attain and sustain profitable operations. Without increased revenues andsustained profitability, the cash generated from the Company’s currentoperations may not be adequate to fund operations and service its indebtednesson an ongoing basis. Management is concentrating its efforts on returning theCompany to profitability by focusing on music licensing and limited musicdistribution. However, there can be no assurance that the Company’s managementwill be successful in this effort. In the event the Company is unable to fundits operations and implement its current business plan properly, it may beunable to continue as a going concern. The Company’s financial statements donot include any adjustments that might result from the outcome of thisuncertainty.

 

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**ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

K-tel is exposed tovarious market risks, including changes in interest rates and foreign currencyexchange rates. Market risk is the potential loss arising from adverse changesin market rates and prices, such as interest rates and foreign currencyexchange rates. K-tel does not enter into derivatives or other financialinstruments for trading or speculative purposes.

 

K-tel’s exposureto market risk for changes in interest rates relates to K-tel’s short-termborrowings. K-tel’s short-term credit facilities carry a variable interest ratethat does have an impact on future earnings and cash flows. At June 30, 2002,K-tel had variable rate debt of $10,026,000. If the interest rate were to change100 basis points or 1% while K-tel was borrowing under the credit facilities,interest expense would increase by $100,000.

 

Approximately 42%of K-tel’s revenues during the year ended June 30, 2002 was derived fromoperations in Europe. The results of operations and financial position ofK-tel’s operations in Europe were principally measured in their respectivecurrencies and translated into U.S. dollars. The effect of foreign currencyfluctuations in these European countries is somewhat mitigated by the fact thatexpenses are generally incurred in the same currencies in which the revenue isgenerated. The reported income of these subsidiaries will be higher or lowerdepending on the weakening or strengthening of the U.S. dollar against therespective foreign currency. Additionally, approximately 38% of K-tel’s assetsat June 30, 2002 were based in its foreign operations and were translated intoU.S. dollars at foreign currency exchange rate in effect as of the end of eachaccounting period, with the effect of such translation reflected as a separatecomponent of consolidated shareholders’ equity (deficit). Accordingly, K-tel’sconsolidated shareholders’ equity (deficit) will fluctuate depending on theweakening or strengthening of the U.S. dollar against the respective foreigncurrency.

 

**ITEM8:  FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

The consolidatedfinancial statements and related notes and schedules required by this Item areset forth in Part IV, Item 14, and identified in the index on page 21.

 

**ITEM 9:  CHANGES INAND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

There were no changes or disagreements with accountants during the yearended June 30, 2002.

 

 

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**PART III**

 

**ITEM 10:  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

The followingdescribes the business, the business experience and background of each directorof K-tel.

 

**Philip Kives** founded K-tel in 1968 and has served asits Chairman of the Board since K-tel’s inception. In addition, Mr. Kives wasre–appointed the Chief Executive Officer on October 16, 1995.

 

**Jay William Smalley** was elected a director in January 1999.Since 1970, Mr. Smalley has been the Chief Executive Officer of JWS, Inc., aprivately owned real estate development and sales company specializing inhotel, motel, industrial and residential properties.

 

**Dennis W. Ward** was elected a director in January 1999and the Company’s Secretary and Chief Financial Officer in December 2000. Since1990, Mr. Ward has been the Controller of K–tel International, Ltd., aCanadian corporation owned by Philip Kives and engaged in the marketing anddistribution of consumer products, and of K-5 Leisure Products, Inc. (K-tel’slargest shareholder).

 

Information concerningexecutive officers of the Registrant is furnished as Item 4A in Part I.

 

**Section16(a) Beneficial Ownership Reporting Compliance**

 

Section 16(a) of the Securities Exchange Act of 1934,as amended, requires K-tel’s officers, directors and persons who own more than10% of a registered class of K-tel’s equity securities to file reports ofownership on Form 3 and changes in ownership on Form 4 or 5 with the Securitiesand Exchange Commission.  Such officers,directors and 10% shareholders also are required by Securities and ExchangeCommission’s rules to furnish K-tel with copies of all Section 16(a) reportsthey file.  Based solely on its reviewof the copies of such forms received by it, or written representations fromcertain reporting persons, the Company believes that during the last fiscalyear, its officers and directors filed all reports on a timely basis, except aSecurities ownership report on Form 4 for a transaction by Philip Kives, anofficer and director of the Company, has not been filed.

 

**ITEM 11: EXECUTIVE COMPENSATION**

 

The followingtable sets forth the aggregate cash compensation paid to or accrued by each ofK-tel’s executive officers receiving in excess of $100,000 for servicesrendered to K-tel during the fiscal years ended June 30, 2002, 2001 and 2000.K-tel has no written employment agreements with its executive officers.

 

**SummaryCompensation Table**
|                                  |   |                     |       |                                    |                   |      |    |                               |   |                        |   |
|---------------------------------------|--------|--------------------------|------------|-----------------------------------------|------------------------|-----------|---------|------------------------------------|--------|-----------------------------|--------|
| ** **                            |   | **Annual  Compensation** | ** ** | **Long-Term  Compensation**

**Awards** |                   |      |    |
| **Name and  Principal Position**      |   | **Fiscal  Year**         |       | **Salary**                              |                   | **Bonus** |    | **Securities  Underlying Options** |   | **All Other  Compensation** |   |
|                                  |   |                     |       |                                    |                   |      |    |                               |   |                        |   |
| Philip Kives  Chief Executive Officer |   | 2002

2001

2000         |       | $  $  $                                 | —

—

— |      | $  $  $ | —

—

—             |   | —

80,000

1,546,000   |   | $  $  $ | —

—

— |   |
|                                  |   |                     |       |                                    |                   |      |    |                               |   |                        |   |
| Dennis Ward  Chief Financial Officer  |   | 2002

2001

2000         |       | $  $  $                                 | —

—

— |      | $  $  $ | —

—

—             |   | —

190,000

—     |   | $  $  $ | —

—

— |   |

 

No options were granted during the fiscal year endedJune 30, 2002, to any of K-tel’s Named Executive Officers.

 

 

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Thefollowing table sets forth information concerning the unexercised options heldby the named Executive Officers as of the end of the last fiscal year. Nooptions were exercised by the named Executive Officers during the last fiscalyear.

 

**Aggregated Option Exercises in Last Fiscal Year**

**and Fiscal Year End Option Values**
|         |   |                                                    |   |                                             |   |            |   |              |   |
|--------------|--------|---------------------------------------------------------|--------|--------------------------------------------------|--------|-----------------|--------|-------------------|--------|
|         |   | **Number of  Securities  Underlying Options at FY-End** |   | **Value of  In-the Money  Options at FY-End(1)** |   |
| **Name**     |   | **Exercisable**                                         |   | **Unexercisable**                                |   | **Exercisable** |   | **Unexercisable** |   |
| Philip Kives |   | 1,567,441                                               |   | 135,498                                          |   | —          |   | —            |   |
|         |   |                                                    |   |                                             |   |            |   |              |   |
| Dennis Ward  |   | 255,000                                                 |   | —                                           |   | —          |   | —            |   |

 

(1)                                  Market value of underlying securities atfiscal year end minus the exercise price.

 

**ITEM 12:  SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

The followingtable contains certain information as of September 20, 2002, regarding thebeneficial ownership of the Common Stock by (i) each person known to K-tel toown beneficially five percent or more of the Common Stock, (ii) each directorof K-tel, (iii) each executive officer of K-tel and (iv) the directors and executiveofficers as a group. The percentage of beneficial ownership is based on13,653,738 shares outstanding as of September 20,2002. Any shares which aresubject to an option or a warrant exercisable within 60 days are reflected inthe following table and are deemed to be outstanding for the purpose ofcomputing the percentage of Common Stock owned by the option or warrant holderbut are not deemed to be outstanding for the purpose of computing thepercentage of Common Stock owned by any other person. Unless otherwiseindicated, each person in the table has sole voting and investment power as tothe shares shown. Unless otherwise indicated, the address for each listedshareholder is c/o K-tel International, Inc., 2655 Cheshire Lane North,  Suite 100, Plymouth, Minnesota 55447.

 
|                                                                           |   | **Amount and  Nature of Beneficial Ownership****(1)** |        | **Percentage  of Outstanding Stock** |   |
|--------------------------------------------------------------------------------|--------|-------------------------------------------------------|--------|--------------------------------------|--------|
| Philip Kives  220 Saulteaux Crescent  Winnipeg, Manitoba  R32 3W3  Canada |   | 9,367,055                                             | (2)    | 61.5                                 | %      |
|                                                                           |   |                                                  |   |                                 |   |
| Dennis Ward                                                                    |   | 255,000                                               | (3)    | 1.8                                  | %      |
|                                                                           |   |                                                  |   |                                 |   |
| Jay William  Smalley                                                           |   | 10,000                                                | (3)    | *                                    |   |
|                                                                           |   |                                                  |   |                                 |   |
| All directors  and officers as a group (3 persons)                             |   | 9,632,065                                             | (4)    | 62.2                                 | %      |

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*                       Indicates ownership of less than 1% ofthe outstanding shares of Common Stock.

(1)                The securities “beneficially owned” by a person aredetermined in accordance with the definition of “beneficial ownership” setforth in the regulations of the Securities and Exchange Commission (the“Commission”) and accordingly, may include securities owned by or for, amongothers, the spouse, children or certain other relatives of such person as wellas other securities as to which the person has or shares voting or investmentpower or has the right to acquire within 60 days. More than one person maybeneficially own the same shares.

(2)                Consists of 7,474,278 shares held directly by K-5Leisure Products Inc. (an affiliate of the Company controlled by Mr. Kives),325,336 shares held by a wholly-owned subsidiary of K-5 and 1,567,441 sharespurchasable upon the exercise of options.

(3)                Represents shares purchasable upon the exercise ofoptions.

(4)                Includes 1,842,441 shares purchasable upon theexercise of options.

 

 

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**ITEM13:  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

K-tel has a Line of Credit Agreement with K-5 Leisure Products, Inc.,an affiliate of the Company controlled by Philip Kives, the Chairman of theBoard, President and Chief Executive Officer of K-tel. Under the terms of theagreement (the “K-5 Facility”), K-5 has agreed to make available up to$8,000,000 to K-tel on a revolving basis. The loan bears interest at a variablerate based upon the “base rate” of a nationally recognized lending institution(4.75% at June 30, 2002), expires July 20, 2005, and is subordinated to theFoothill loan (see below). The K-5 Facility contains the same covenants as theFoothill loan agreement. K-tel has pledged the stock of its foreignsubsidiaries as collateral for the loan, and the loan carries a subordinatedposition to the Foothill loan on all other assets of the Company. K-tel hadoutstanding balances of $6,026,000 and $4,807,000, as of June 30, 2002 and 2001respectively under the K-5 Facility. The Company incurred interest of $451,000in 2002 and $483,000 in 2001 on this loan.

 

In addition, K-tel has a second loan agreement with K-5, under whichK-5 assumed rights and obligations under a former loan with an outside partypursuant to an Assignment and Acceptance Agreement dated February 27, 2001. ThisFoothill loan, which has been extended through July 20, 2005, provides for a$10,000,000 credit facility consisting of a $4,000,000 term loan due uponexpiration, and a $6,000,000 revolving facility under which borrowings arelimited to a percent of eligible receivables. Borrowings under the facilitybear interest at a variable rate based on a “base rate” of a nationallyrecognized lending institution plus 1% (5.75% at June 30, 2002) and arecollateralized by the assets of certain Company subsidiaries in the UnitedStates, including accounts receivable, inventories, equipment, music libraryand general intangibles. The loan agreement contains certain financial andother covenants or restrictions, including the maintenance of a minimumshareholders’ equity by K-tel, limitations on capital expenditures,restrictions on music library acquisitions, limitations on other indebtednessand restrictions on dividends paid by K-tel. As of June 30, 2002 and 2001,$4,000,000 was outstanding under the term loan and there were no borrowingsunder the revolving facility. At June 30, 2002, K-tel obtained a waiver fromK-5 for its default under the covenants, limitations and restrictions of thecredit agreement.

 

K-tel has an overdraft privilege borrowing facilitywith The Royal Bank of Scotland in the United Kingdom. This facility is securedby a standby letter of credit for $260,000 provided by K-tel InternationalLtd., a Canadian company controlled by Philip Kives and is payable on demand inaccordance with normal banking practices. Borrowings bear interest of 2% perannum over the base rate (6.0% at June 30, 2002) and are subject to a minimumof 6% per annum. K-tel has an outstanding balance of $227,000 as of June 30,2002.

 

The Companypurchased approximately $366,000 in fiscal 2002, $574,000 in fiscal 2001 and$198,000 in fiscal 2000 of consumer convenience products from K-5. There weretrade payables to K-5 of $291,000 at June 30, 2002, $ 285,000 at June 30, 2001and $150,000 at June 30, 2000.

 

The Company had nosales of consumer convenience products to K-5 during fiscal 2002, sales of$13,000 during fiscal 2001 and $174,000 during fiscal 2000. There was a balancereceivable from K-5 at June 30, 2002 of $129,000, June 30, 2001 of $109,000 andJune 30, 2000 of $224,000. No interest was charged on the related outstandingbalances during fiscal 2002 and 2001 and 2000.

 

 

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**PART IV**

 

**ITEM14:  EXHIBITS, FINANCIAL STATEMENTSCHEDULES AND REPORTS ON FORM 8-K**

 

(a)                                  Financial Statements and Schedules

 

The consolidatedstatements and schedules listed in the accompanying Index to ConsolidatedFinancial Statements and Schedules on page 21 hereof are filed as part of thisreport.

 

(b)                                 Reports on 8-K

 

There were noreports filed under Form 8-K by the Company for the three-month period endedJune 30, 2002.

 

(c)                                  Exhibits

 

Reference is madeto the Exhibit Index on Page 21.

 

 

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SIGNATURES

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theCompany has duly caused this report to be signed on its behalf on September 28,2002, by the undersigned, thereunto duly authorized.

 
|   |   | K-TEL INTERNATIONAL,  INC.                   |
|--------|--------|----------------------------------------------|
|   |   |                                         |   |
|   |   | By                                           | /s/ Philip Kives |
|   |   | (Philip Kives –  Chairman of the Board, |
|   |   | Chief Executive Officer  and President)      |
|   |   |                                         |   |

 

Pursuant to therequirements of the Securities and Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities indicated and on the dates indicated.

 
| **Signatures**          |   | **Title**                           |   | **Date**            |
|-------------------------|--------|-------------------------------------|--------|---------------------|
|                    |   |                                |   |                |
| /s/ Philip Kives        |   | Chairman, Chief  Executive Officer, |   | September 28,  2002 |
| Philip Kives            |   | (Principal Executive  Officer),     |   |                |
|                    |   | President and Director              |   |                |
|                    |   |                                |   |                |
| /s/ Dennis Ward         |   | Chief Financial Officer             |   | September 28,  2002 |
| Dennis Ward             |   | (Principal Financial  Officer)      |   |                |
|                    |   | Director                            |   |                |
|                    |   |                                |   |                |
| /s/ Jay William Smalley |   | Director                            |   | September 28,  2002 |
| Jay William Smalley     |   |                                |   |                |

 

 

19

----

 

**CERTIFICATIONS**

## ** **

## ** **

## **Chief ExecutiveOfficer**

I, Philip Kives, certifythat:

 

1.                                       I have reviewed this annual report onForm 10-K of K-tel International, Inc.;

 

2.                                       Based on my knowledge, this annual reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report; and

 

3.                                       Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperation and cash flows of the registrant as of, and for, the periodspresented in this annual report.

 
|   |   | Dated:  September 28, 2002 |   |   |   | By     | /s/  Philip Kives                                        |
|--------|--------|----------------------------|--------|--------|--------|--------|----------------------------------------------------------|
|   |   |                       |   |   |   |   | Philip  Kives                                            |
|   |   |                       |   |   |   |   | *Chairman, Chief Executive Officer*                      |
|   |   |                       |   |   |   |   | *(principal  executive officer), President and Director* |

## ** **

 

 

## **Chief FinancialOfficer**

I, Dennis Ward, certifythat:

 

1.                                       I have reviewed this annual report onForm 10-K of K-tel International, Inc.;

2.                                       Based on my knowledge, this annual reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report; and

3.                                       Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperation and cash flows of the registrant as of, and for, the periodspresented in this annual report.
|   |   | Dated:  September 28, 2002 |   |   |   | By  | /s/  Dennis  Ward                                   |
|--------|--------|----------------------------|--------|--------|--------|----------|----------------------------------------------------------|
|   |   |                       |   |   |   |     | Dennis  Ward                                             |
|   |   |                       |   |   |   |     | *Chief Financial Officer (principal financial  officer)* |
|   |   |                       |   |   |   |     | *Director*                                               |

 

 

20

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**(ITEM 14(A))**

## **K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES**

**INDEX TO CONSOLIDATED FINANCIALSTATEMENTS**

 
| Report  of Independent Certified Public Accountants                                                                            |   |
|--------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                           |   |
| Consolidated  Balance Sheets as of June 30, 2002 and 2001                                                                      |   |
|                                                                                                                           |   |
| Consolidated  Statements of Operations for each of the three years in the period ended June  30, 2002                          |   |
|                                                                                                                           |   |
| Consolidated  Statements of Shareholders’ Equity (Deficit) for each of the three years in  the period ended June 30, 2002 |   |
|                                                                                                                           |   |
| Consolidated  Statements of Cash Flows for each of the three years in the period ended June  30, 2002                          |   |
|                                                                                                                           |   |
| Notes to  Consolidated Financial Statements                                                                                    |   |
|                                                                                                                           |   |
| Supplemental Schedule  to Consolidated Financial Statements:                                                                   |   |
|                                                                                                                           |   |
| Schedule  II - Valuation and Qualifying Accounts for each of the three years in the  period ended June 30, 2002                |   |

 

All otherschedules for which provision is made in the applicable accounting regulationsof the Securities and Exchange Commission have been omitted as not required,not applicable or the information required has been included elsewhere in theconsolidated financial statements and notes thereto.

 

 

21

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**REPORTOF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS**

 

 

To the Board ofDirectors and Shareholders of K-tel International, Inc.

 

We have auditedthe accompanying consolidated balance sheets of K-tel International, Inc. (aMinnesota corporation) and subsidiaries as of June 30, 2002 and 2001 and therelated consolidated statements of operations, shareholders’ equity (deficit),and cash flows for each of the three years in the period ended June 30, 2002.These financial statements are the responsibility of the Company’s management.Our responsibility is to express an opinion on these financial statements basedon our audits.

 

We conducted ouraudits in accordance with auditing standards generally accepted in the UnitedStates of America. Those standards require that we plan and perform the auditto obtain reasonable assurance about whether the financial statements are freeof material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion,the consolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of K-tel International, Inc. andsubsidiaries as of June 30, 2002 and 2001 and the results of their operationsand their cash flows for the each of the three years in the period ended June30, 2002 in conformity with accounting principles generally accepted in theUnited States of America.

 

Theaccompanying financial statements have been prepared assuming that the Companywill continue as a going concern. As discussed in Note 1 to the financialstatements, the Company has suffered significant recurring losses fromoperations and has a net working capital deficit that raises substantial doubtabout the Company’s ability to continue as a going concern. Management’s plansin regard to these matters are also described in Note 1. The financial state­mentsdo not include any adjustments that might result from the outcome of thisuncertainty.

 

We have alsoaudited Schedule II for each of the three years in the period ended June 30,2002. In our opinion, this schedule, when considered in relation to the basicfinancial statements taken as a whole, presents fairly, in all materialrespects, the information therein.

 

 

 
|                    |   |   | /S/ GRANT THORNTON LLP |
|-------------------------|--------|--------|------------------------|
|                    |   |   |                   |
| Minneapolis, Minnesota, |   |   |                   |
| August 20, 2002         |   |   |                   |

 

 

22

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**K-TEL INTERNATIONAL, INC. ANDSUBSIDIARIES**

## **CONSOLIDATEDBALANCE SHEETS**

**JUNE 30,**

*(in thousands - except share data)*

 
|                                                                                                  |   | **2002** |   | **2001** |   |
|-------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| ASSETS                                                                                                |   |     |   |     |   |
| Current Assets:                                                                                       |   |     |   |     |   |
| Cash and cash  equivalents                                                                            |   | $        | 75     |     | $      | 173 |   |
| Accounts  receivable, net                                                                             |   | 1,656    |   | 915      |   |
| Inventories                                                                                           |   | 637      |   | 418      |   |
| Royalty advances                                                                                      |   | 282      |   | 182      |   |
| Prepaid expenses  and other                                                                           |   | 378      |   | 480      |   |
| Total Current  Assets                                                                                 |   | 3,028    |   | 2,168    |   |
|                                                                                                  |   |     |   |     |   |
| Property and  equipment, net of accumulated depreciation and amortization of $1,418 and  $1,136       |   | 162      |   | 231      |   |
|                                                                                                  |   |     |   |     |   |
| Owned catalog  masters, net of accumulated amortization of $2,829 and $2,687                          |   | 1,060    |   | 1,424    |   |
| Other assets                                                                                          |   | —   |   | 9        |   |
|                                                                                                  |   |     |   |     |   |
|                                                                                                  |   | $        | 4,250  |     | $      | 3,832 |   |
|                                                                                                  |   |     |   |     |   |
| LIABILITIES AND  SHAREHOLDERS’ DEFICIT                                                           |   |     |   |     |   |
| Current  Liabilities:                                                                                 |   |     |   |     |   |
| Notes payable to  affiliate and other                                                                 |   | $        | 10,253 |     | $      | 8,807 |   |
| Accounts payable                                                                                      |   | 1,264    |   | 1,284    |   |
| Accrued  royalties                                                                                    |   | 2,245    |   | 2,080    |   |
| Reserve for  returns                                                                                  |   | 40       |   | 50       |   |
| Other current  liabilities                                                                            |   | —   |   | 760      |   |
| Net liabilities  of discontinued operations                                                           |   | 92       |   | 1,103    |   |
| Total Current  Liabilities                                                                            |   | 13,894   |   | 14,084   |   |
|                                                                                                  |   |     |   |     |   |
| Shareholders’  Deficit:                                                                          |   |     |   |     |   |
| Common Stock —  50,000,000 shares authorized; par value $.01; 13,653,738 issued and  outstanding |   | 136      |   | 136      |   |
| Additional  paid-in capital                                                                           |   | 21,292   |   | 20,680   |   |
| Accumulated  deficit                                                                                  |   | (30,771  | )      | (30,785  | )      |
| Cumulative  translation adjustment                                                                    |   | (301     | )      | (283     | )      |
| Total  Shareholders’ Deficit                                                                     |   | (9,644   | )      | (10,252  | )      |
|                                                                                                  |   |     |   |     |   |
|                                                                                                  |   | $        | 4,250  |     | $      | 3,832 |   |
|                                                                                                  |   |     |   |     |   |

***The accompanying notes are anintegral part of these financial statements***

 

23

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**K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

## **YEARSENDED JUNE 30,**

*(in thousands – except pershare data)*

 
|                                                                       |   | **2002** |   | **2001** |   | **2000** |   |
|----------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Net Sales                                                                  |   | $        | 6,875  |     | $      | 17,514   |   | $ | 29,092 |   |
| Costs and  Expenses:                                                       |   |     |   |     |   |     |   |
| Cost of goods  sold                                                        |   | 2,485    |   | 15,658   |   | 26,244   |   |
| Advertising                                                                |   | 172      |   | 618      |   | 2,484    |   |
| Selling, general  & administrative                                     |   | 4,550    |   | 10,718   |   | 13,344   |   |
| Total Costs and  Expenses                                                  |   | 7,207    |   | 26,994   |   | 42,072   |   |
| Operating Loss                                                             |   | (332     | )      | (9,480   | )      | (12,980  | )      |
| Other Income  (Expense):                                                   |   |     |   |     |   |     |   |
| Interest income                                                            |   | —   |   | 155      |   | 10       |   |
| Interest expense                                                           |   | (472     | )      | (912     | )      | (549     | )      |
| Foreign currency  transaction loss                                         |   | —   |   | (360     | )      | (412     | )      |
| Other expense                                                              |   | (37      | )      | —   |   | (600     | )      |
| Gain on sale of  subsidiary                                                |   | —   |   | —   |   | 4,341    |   |
| Total Other  Income (Expense)                                              |   | (509     | )      | (1,117   | )      | 2,790    |   |
| Loss from  Continuing Operations                                           |   |     |   |     |   |     |   |
| Before Income  Taxes                                                       |   | (841     | )      | (10,597  | )      | (10,190  | )      |
| Benefit  (Provision) for Income Taxes                                      |   | 141      |   | 96       |   | (7       | )      |
| Loss from  Continuing Operations                                           |   | (700     | )      | (10,501  | )      | (10,197  | )      |
| Discontinued  Operations:                                                  |   |     |   |     |   |     |   |
| Loss from  Discontinued Operations                                         |   | (180     | )      | (4,315   | )      | (5,541   | )      |
| Loss before  Extraordinary Item                                            |   | (880     | )      | (14,816  | )      | (15,738  | )      |
| Extraordinary  Item:                                                       |   |     |   |     |   |     |   |
| Gain on  Subsidiary Liquidations                                           |   | 894      |   | 16,185   |   | —   |   |
| Net Income  (Loss)                                                         |   | $        | 14     |     | $      | 1,369    |   | $ | (15,738 | ) |
|                                                                       |   |     |   |     |   |     |   |
| Income (Loss)  per Share — Basic and Diluted:                         |   |     |   |     |   |     |   |
| Continuing  Operations                                                     |   | $        | (.05   | )        | $      | (.77     | )      | $ | (1.02 | ) |
| Discontinued  Operations                                                   |   | (.01     | )      | (.32     | )      | (.56     | )      |
| Extraordinary  Item                                                        |   | .06      |   | 1.19     |   | —   |   |
| Net Income  (Loss)                                                         |   | $        | .00    |     | $      | .10      |   | $ | (1.58 | ) |
|                                                                       |   |     |   |     |   |     |   |
| Shares used in  the calculation of loss per share— Basic and Diluted: |   | 13,654   |   | 13,654   |   | 9,848    |   |
|                                                                       |   |     |   |     |   |     |   |
| Comprehensive  Income (Loss)                                               |   |     |   |     |   |     |   |
| Net income  (loss)                                                         |   | $        | 14     |     | $      | 1,369    |   | $ | (15,738 | ) |
| Foreign currency  gain (loss)                                              |   | (18      | )      | 476      |   | 248      |   |
| Comprehensive  Income (Loss)                                               |   | $        | (4     | )        | $      | 1,845    |   | $ | (15,490 | ) |
|                                                                       |   |     |   |     |   |     |   |

 

*The accompanying notes are anintegral part of these financial statements.*

* *

 

24

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**K-TEL INTERNATIONAL, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)**

**YEARS ENDED JUNE 30, 2002, 2001 AND 2000**

*(in thousands)*

 

 

 

 
|                                                 |   | **Common  Stock** |   |       |   |           |   |            |   |              |    |
|------------------------------------------------------|--------|-------------------|--------|------------|--------|----------------|--------|-----------------|--------|-------------------|---------|
|                                                 |   |              |   |       |   | **Additional** |   |            |   | **Accumulated**   |    |   |   |
|                                                 |   |              |   |       |   | **Paid-In**    |   | **Accumulated** |   | **Comprehensive** |    | **Other** |   |
|                                                 |   | **Shares**        |   | **Amount** |   | **Capital**    |   | **Deficit**     |   | **(Loss)**        |    | **Total** |   |
|                                                 |   |              |   |       |   |           |   |            |   |              |    |   |   |
| Balance at June 30, 1999                             |   | 10,242            |   | $          | 102    |           | $      | 21,113          |   | $                 | (16,416 | ) | $ | (1,007 | ) | $ | 3,792 |   |
|                                                 |   |              |   |       |   |           |   |            |   |              |    |   |   |
| Net loss                                             |   | —            |   | —     |   | —         |   | (15,738         | )      | —            |    | (15,738 | ) |
| Proceeds from exercise of stock options              |   | 545               |   | 6          |   | 3,095          |   | —          |   | —            |    | 3,101 |   |
| Payment for cancellation of private equity placement |   | (466              | )      | (5         | )      | (3,995         | )      | —          |   | —            |    | (4,000 | ) |
| Translation adjustment                               |   | —            |   | —     |   | —         |   | —          |   | 248               |    | 248 |   |
|                                                 |   |              |   |       |   |           |   |            |   |              |    |   |   |
| Balance at June 30, 2000                             |   | 10,321            |   | 103        |   | 20,213         |   | (32,154         | )      | (759              | )       | (12,597 | ) |
|                                                 |   |              |   |       |   |           |   |            |   |              |    |   |   |
| Net income                                           |   | —            |   | —     |   | —         |   | 1,369           |   | —            |    | 1,369 |   |
| Conversion of debt to equity                         |   | 3,333             |   | 33         |   | 467            |   | —          |   | —            |    | 500 |   |
| Translation adjustment                               |   | —            |   | —     |   | —         |   | —          |   | 476               |    | 476 |   |
|                                                 |   |              |   |       |   |           |   |            |   |              |    |   |   |
| Balance at June 30, 2001                             |   | 13,654            |   | 136        |   | 20,680         |   | (30,785         | )      | (283              | )       | (10,252 | ) |
|                                                 |   |              |   |       |   |           |   |            |   |              |    |   |   |
| Net income                                           |   | —            |   | —     |   | —         |   | 14              |   | —            |    | 14 |   |
| Reduction of notes payable to affiliate              |   | —            |   | —     |   | 612            |   | —          |   | —            |    | 612 |   |
| Translation adjustment                               |   | —            |   | —     |   | —         |   | —          |   | (18               | )       | (18 | ) |
|                                                 |   |              |   |       |   |           |   |            |   |              |    |   |   |
| Balance at June 30, 2002                             |   | 13,654            |   | $          | 136    |           | $      | 21,292          |   | $                 | (30,771 | ) | $ | (301 | ) | $ | (9,644 | ) |

 

*The accompanying notes are anintegral part of these financial statements.*

* *

 

25

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**K-TEL INTERNATIONAL, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YEARS ENDED JUNE 30,**

*(in thousands)*

 

 
|                                                                                                   |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Operating  Activities:                                                                                 |   |     |   |     |   |     |   |
| Net income  (loss)                                                                                     |   | $        | 14     |     | $      | 1,369    |   | $ | (15,738 | ) |
| Adjustment to  reconcile net income (loss) to cash used in operating activities:                       |   |     |   |     |   |     |   |
| Depreciation and  amortization                                                                         |   | 380      |   | 408      |   | 1,594    |   |
| Loss on disposal  of property and equipment                                                            |   | 3        |   | 349      |   | —   |   |
| Write down of  long lived asset                                                                        |   | —   |   | 417      |   | —   |   |
| Gain on sale of  subsidiary                                                                            |   | —   |   | —   |   | (4,341   | )      |
| Gain on  liquidation                                                                                   |   | (894     | )      | (16,185  | )      | —   |   |
| Discontinued  operations                                                                               |   | (109     | )      | 3,630    |   | 3,943    |   |
| Changes in  operating assets and liabilities:                                                          |   |     |   |     |   |     |   |
| Accounts  receivable                                                                                   |   | (689     | )      | 3,217    |   | 1,132    |   |
| Inventories                                                                                            |   | (199     | )      | 2,378    |   | 3,530    |   |
| Royalty and  other advances                                                                            |   | (84      | )      | (82      | )      | 572      |   |
| Prepaid expenses  and other assets                                                                     |   | 295      |   | (225     | )      | 383      |   |
| Accounts payable  and other liabilities                                                                |   | (699     | )      | 2,421    |   | (1,755   | )      |
| Accrued  royalties                                                                                     |   | 157      |   | 230      |   | 2,429    |   |
| Income Taxes                                                                                           |   | (130     | )      | —   |   | —   |   |
| Reserve for  returns                                                                                   |   | (12      | )      | (370     | )      | 744      |   |
| Cash used in  operating activities                                                                     |   | (1,967   | )      | (2,443   | )      | (7,507   | )      |
|                                                                                                   |   |     |   |     |   |     |   |
| Investing  Activities:                                                                                 |   |     |   |     |   |     |   |
| Proceeds from  sale of subsidiary                                                                      |   | —   |   | —   |   | 6,350    |   |
| Purchases of  property and equipment                                                                   |   | (124     | )      | (62      | )      | (184     | )      |
| Music catalog  additions                                                                               |   | —   |   | (63      | )      | (649     | )      |
| Discontinued  operations                                                                               |   | —   |   | —   |   | (68      | )      |
| Other                                                                                                  |   | 27       |   | 27       |   | 16       |   |
| Cash provided by  (used in) investing activities                                                       |   | (97      | )      | (98      | )      | 5,465    |   |
|                                                                                                   |   |     |   |     |   |     |   |
| Financing  Activities:                                                                                 |   |     |   |     |   |     |   |
| Borrowings on  notes payable                                                                           |   | 3,676    |   | 13,946   |   | 25,985   |   |
| Payments on  notes payable                                                                             |   | (1,629   | )      | (12,508  | )      | (26,693  | )      |
| Repurchase of  shares issued in private placement                                                      |   | —   |   | —   |   | (4,000   | )      |
| Proceeds from  exercise of stock options                                                               |   | —   |   | —   |   | 3,101    |   |
| Cash provided by  (used in) financing activities                                                       |   | 2,047    |   | 1,438    |   | (1,607   | )      |
|                                                                                                   |   |     |   |     |   |     |   |
| Effect of  exchange rates on cash                                                                      |   | (81      | )      | 478      |   | 308      |   |
|                                                                                                   |   |     |   |     |   |     |   |
| Net decrease in  cash equivalents                                                                      |   | (98      | )      | (625     | )      | (3,341   | )      |
|                                                                                                   |   |     |   |     |   |     |   |
| Cash and  equivalents at beginning of period                                                           |   | 173      |   | 798      |   | 4,139    |   |
|                                                                                                   |   |     |   |     |   |     |   |
| Cash and  equivalents at end of period                                                                 |   | $        | 75     |     | $      | 173      |   | $ | 798 |   |
|                                                                                                   |   |     |   |     |   |     |   |
| Supplemental  Cash Flow Information                                                                    |   |     |   |     |   |     |   |
| Cash Paid For -                                                                                        |   |     |   |     |   |     |   |
| Interest                                                                                               |   | $        | 598    |     | $      | 483      |   | $ | 799 |   |
| Income Taxes                                                                                           |   | $        | — |     | $      | 4        |   | $ | 1 |   |
| Non-cash  Information                                                                                  |   |     |   |     |   |     |   |
| Reduction of  notes payable to affiliate through debt forgiveness, recorded as a capital  contribution |   | $        | 612    |     | $      | —   |   | $ | — |   |
| Music Catalogs  reclassified to prepaid assets                                                         |   | $        | 173    |     | $      | —   |   | $ | — |   |

* *

*The accompanying notes are anintegral part of these financial statements*

* *

 

26

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**K-TEL INTERNATIONAL, INC. ANDSUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**JUNE 30, 2002, 2001 AND 2000**

 

**1.****                                     ****BUSINESS AND LIQUIDITY**

 

K-telInternational, Inc. (the “Company” or “K-tel”) was incorporated in 1968 andcurrently has its corporate offices located in Plymouth, Minnesota. Through itsoperating subsidiaries, K-tel licenses its music catalog internationally andmarkets entertainment products mainly derived from its catalog through retailand direct marketing channels in the United States and Europe.

 

Subsidiaries’ Bankruptcyand Liquidation

 

In March 2001, the Company’s music distributionsubsidiary in the United States, K-tel International (USA), Inc. ceasedoperations and filed for protection under Chapter 7 of the U. S. bankruptcycode. In connection with this filing, the assets and liabilities of thissubsidiary were removed from the books of the Company as control of thesubsidiary was transferred to the bankruptcy trustee. The net liability at thetime of this filing was shown as a gain on the Chapter 7 liquidation.Management believes the Company will have no ongoing liability related to thissubsidiary as a result of the filing and the outcome of the bankruptcyproceeding. During the fiscal years ended June 30, 2001 and 2000, thissubsidiary had net sales of $11,948,000 and $23,426,000 and operating lossesof  $5,299,000 and $9,857,000, respectively.

 

In November 2000,the Company’s consumer products subsidiary in the United Kingdom, K-telMarketing Ltd., ceased operations and began voluntary liquidation proceedings.At the initial meeting of the creditors on November 24, 2000, the creditorsvoted for the liquidation to become a creditors’ liquidation under English law.The Company has not been informed by the liquidators or their counsel of anyplan to attempt to hold it or any of its subsidiaries liable for any of thecommitments of K-tel Marketing Ltd. Management believes the Company will haveno ongoing material liability related to K-tel Marketing Ltd. as a result ofthe liquidation proceeding. K-tel Marketing Ltd. had no operations during thefiscal year ended June 30, 2002. During fiscal 2001, this subsidiary had netsales of $3,179,000 and operating losses of $3,220,000.

 

DiscontinuedOperations

 

The Company’sconsumer products business, which was concentrated in Europe, consisted primarilyof housewares, consumer convenience items and exercise equipment. The Companydiscontinued its consumer products operations in Germany, the United Kingdomand the United States in June 2000, November 2000 and January 2001,respectively. Accordingly, these activities have been presented in theaccompanying financial statements as discontinued operations. No consumerproduct sales occurred in the fiscal year ended June 30, 2002. Net sales forthe years ended June 30, 2001 and 2000 were $3,818,000, and $29,512,000,respectively. The accompanying consolidated financial statements have beenprepared (and restated, in the case of the 2000 financial statements) toreflect the consumer products division as a discontinued operation. The netliabilities of discontinued operations at June 30, 2002 consist of assets of$14,000 and liabilities of $106,000.

 

Going Concern 

During the yearsended June 30, 2002, 2001 and 2000, the Company incurred net losses fromcontinuing operations of $841,000, $10,597,000 and $10,190,000, respectively,and used $1,967,000, $2,443,000, and $7,507,000 of cash in operatingactivities. Additionally, the Company had a working capital deficit of$10,866,000 at June 30, 2002.

 

The Company’sability to continue its present operations and implement future expansion planssuccessfully are contingent mainly upon its ability to maintain its line ofcredit arrangements with K-5 Leisure Products, Inc. (K-5) (See Note 3),increase its revenues and ultimately to attain and sustain profitable operations.Without increased revenues and sustained profitability, the cash generated fromthe Company’s current operations may not be adequate to fund operations andservice its indebtedness on an ongoing basis. Management is concentrating itsefforts on returning the Company to profitability by focusing on musiclicensing and limited music distribution. However, there can be no assurancethat the Company’s management will be successful in this effort. In the eventthe Company is unable to fund its operations and implement its business planproperly, it

 

 

27

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may be unable tocontinue as a going concern. The financial statements do not include anyadjustments that might result from the outcome of this uncertainty.

 

**2.****                                     ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

Principles ofConsolidation -The accompanying consolidated financial statements include the accounts ofK-tel International, Inc. and its domestic and foreign subsidiaries, all ofwhich are wholly owned. All significant intercompany accounts and transactionshave been eliminated.

 

Revenue Recognition — The Company derives its revenue fromseveral different sources: the sale of music compilations (predominatelycompact discs) produced by the Company, and license revenue from the licensingof Company-owned masters. Revenue from music sales is recognized at the time ofshipment to the customer, while license revenue is recognized when payment isreceived from customers or when known amounts are receivable, as prior to thatdate collection is not considered probable. Most music sales are made with aright of return of unsold goods. Estimated reserves for returns are establishedby management based upon historical experience and product mix and are subjectto ongoing review and adjustment by the Company. These reserves are recorded atthe time of sale and are reflected as a reduction in revenues.

 

Cost of Goods Sold — The Company expenses all productmanufacturing, distribution and royalty costs associated with music sales ascost of goods sold. The Company also expenses royalties, commissions andamortization of its owned master recordings associated with its license revenueas cost of goods sold.

 

Shipping and HandlingCosts — TheCompany expenses within cost of goods sold all shipping and handling costsincurred in the shipment of goods.

 

Cash andEquivalents -Cash and equivalents consist principally of cash, and short–term, highlyliquid investments with original maturities of less than ninety days.

 

Inventories — Inventories, which consists offinished goods that include all direct product costs, are valued at the lowerof cost, determined on a first-in, first-out basis, or net realizable value.

 

Owned Catalog Masters — The Company capitalizes the costs topurchase owned master recordings at the time of acquisition. These costs areamortized over the estimated useful life of these master recordings, which isgenerally seven years and represents management’s best estimate of the averageperiod of value.

 

Rights to Use MusicProduct- Certainof the Company’s compilation products are master recordings under license fromrecord companies and publishers. In most instances, minimum guarantees ornon-refundable advances are required to obtain the licenses and are realizedthrough future sales of the product. The amounts paid for minimum guarantees ornon–refundable advances are capitalized and charged to expense as salesare made. When anticipated sales appear to be insufficient to fully recover theminimum guarantees or non–refundable advances, a provision againstcurrent operations is made for anticipated losses. The unrealized portion ofguarantees and advances is included in royalty advances in the accompanyingconsolidated balance sheets. Licenses are subject to audit by licensors.

 

Property andEquipment -Property and equipment are stated at cost. Depreciation and amortization isprovided using straight line or declining balance methods over the estimateduseful lives of the assets, which range from three to nine years.

 

Long Lived-Assets — The Company evaluates its long-livedassets quarterly, or earlier if a triggering event occurs, to determinepotential impairment by comparing the carrying value of those assets to therelated undiscounted future cash flows of the assets. If an asset is determinedto be impaired, it is written down to its estimated fair value. During thequarter ended March 31, 2001, the Company suspended its online business torelocate these operations to the Company’s offices in Minnesota and update thewebsite to reflect the Company’s continuing operations. The Company wrote downthe assets of that business to its estimated fair value, resulting in a chargeduring the quarter ended March 31, 2001 of approximately $240,000. In addition,during the quarter ended June 30, 2001, the Company wrote down approximately$177,000 of trademarks related to its European operations, which weredetermined to have no remaining value as the Company is no longer marketing theproducts benefited by those trademarks. These charges were included withingeneral and 

 

 

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administrative expense.

 

Royalties - The Company has entered into licenseagreements with various record companies and publishers under which it paysroyalties on units sold. The Company accrues royalties using contractual ratesand certain estimated rates on applicable units sold. The contractual royaltyliability is computed quarterly and the accrued royalty balance is adjustedaccordingly. The royalty agreements are subject to audit by licensors.

 

Advertising - The Company expenses the costs ofadvertising when the advertising takes place, except for direct responseadvertising, which is capitalized and amortized over its expected period offuture benefits (usually the period remaining under a related contract, whichis generally less than one year). Direct response advertising consistsprimarily of television advertising whereby customers respond specifically tothe advertising and where the Company can identify the advertising thatelicited the response. Advertising expense was $172,000, $618,000 and$2,484,000 for each of the years ended June 30, 2002, 2001 and 2000,respectively.

 

Foreign Currency - The operations of all foreign entitiesare measured in local currencies. Assets and liabilities are translated intoU.S. dollars at period-end exchange rates. Revenues and expenses are translatedat the average exchange rates prevailing during the year. Adjustments resultingfrom translating the financial statements of foreign entities into U.S. dollarsare recorded as a separate component of shareholders’ equity.

 

Stock–basedCompensation -The Company accounts for stock-based awards to employees using the intrinsicvalue method and recognizes compensation expense for certain stock-based awardsgranted to employees. Certain pro forma information as if the Company adoptedthe fair value method of accounting for stock-based compensation is presentedin Note 5.

 

Income Taxes - Deferred income taxes are provided fortemporary differences between the financial reporting basis and tax basis ofthe Company’s assets and liabilities at currently-enacted tax rates.

 

Net Income ( Loss)Per Share - Basicand diluted net income (loss) per share have been computed by dividing netincome (loss) by the weighted average number of shares outstanding during theperiod. For all periods presented, common stock equivalents were excluded fromthe per share calculation as the net effect would be antidilutive. Options topurchase 2,273,839, 2,580,992 and 1,822,582 shares of common stock, withweighted average exercise prices of $5.89, $6.05 and $7.34 were excluded fromthe computation of common share equivalents for the respective periods as theywere antidilutive.

 

Use of Estimates - Preparing consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America (“US GAAP”) requires management to make estimates andassumptions that affect the reported amounts of assets, liabilities, disclosureof contingent assets and liabilities at the date of the financial statementsand the reported amounts of revenues and expenses during the reporting period.Principal estimates include allowances for bad debts, inventory valuation,return reserves, royalty obligations, purchase commitments and productreplacement costs. Actual results could differ from those estimates used bymanagement.

 

**3.**                                      **LOANS PAYABLE TO AFFILIATE**

 

K-tel has a Line of Credit Agreement with K-5 LeisureProducts, Inc., the Company’s largest shareholder controlled by Philip Kives,the Chairman of the Board, President and Chief Executive Officer of K-tel.Under the terms of the agreement (the “K-5 Facility”), K-5 has agreed to makeavailable up to $8,000,000 to K-tel on a revolving basis. The loan bearsinterest at a variable rate based upon the “base rate” of a nationallyrecognized lending institution (4.75% at June 30, 2002), expires July 20, 2005,and is subordinated to the Foothill loan (see below). The K-5 Facility containsthe same covenants as the Foothill loan agreement. K-tel has pledged the stockof its foreign subsidiaries as collateral for the loan, and the loan carries asubordinated position to the Foothill loan on all other assets of the Company.K-tel had outstanding balances of $6,026,000 and $4,807,000 as of June 30, 2002and 2001 respectively under the K-5 Facility.

 

In addition, K-tel has a second loan agreement withK-5, under which K-5 assumed rights and obligations under a former loan with anoutside party pursuant to an Assignment and Acceptance Agreement dated February27, 2001. This Foothill loan, which has been extended through July 20, 2005,provides for a $10,000,000 credit facility consisting of a $4,000,000 term loandue upon expiration, and a $6,000,000 revolving facility under 

 

 

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which borrowings are limited to a percent of eligiblereceivables. Borrowings under the facility bear interest at a variable ratebased on a “base rate” of a nationally recognized lending institution plus 1%(5.75% at June 30, 2002) and are collateralized by the assets of certainCompany subsidiaries in the United States, including accounts receivable,inventories, equipment, music library and general intangibles. The loan agreementcontains certain financial and other covenants or restrictions, including themaintenance of a minimum shareholders’ equity by K-tel, limitations on capitalexpenditures, restrictions on music library acquisitions, limitations on otherindebtedness and restrictions on dividends paid by K-tel. As of June 30, 2002and 2001, $4,000,000 was outstanding under the term loan and there were noborrowings under the revolving facility. At June 30, 2002, K-tel obtained awaiver from K-5 for its default under the covenants, limitations andrestrictions of the credit agreement.

 

K-tel has an overdraftprivilege borrowing facility with The Royal Bank of Scotland in the UnitedKingdom. This facility is secured by a standby letter of credit for $260,000provided by K-tel International Ltd., a Canadian company controlled by PhilipKives and is payable on demand in accordance with normal banking practices.Borrowings bear interest of 2% per annum over the base rate (6.0% at June 30,2002) and are subject to a minimum of 6% per annum. K-tel has an outstandingbalance of $227,000 as of June 30, 2002.

 

**4.****                                     ****INCOME TAXES**

 

The Companyoperates in several countries and is subject to various tax regulations and taxrates. The provisions for income taxes are computed based on income reportedfor financial statement purposes in accordance with the tax rules andregulations of the taxing authorities where the income is earned.

 

The provision(benefit) for income taxes consists of the following for the years ended June30 (in thousands):

 

 
|                                                        |   | **2002** |   | **2001** |   | **2000** |   |
|-------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Income (loss)  before provision (benefit) for income taxes: |   |     |   |     |   |     |   |
| United States                                               |   | $        | (295   | )        | $      | 2,871    |   | $ | (9,468 | ) |
| Foreign                                                     |   | 168      |   | (1,598   | )      | (6,263   | )      |
| Total                                                       |   | $        | (127   | )        | $      | 1,273    |   | $ | (15,731 | ) |
|                                                        |   |     |   |     |   |     |   |
| Provision  (benefit) for income taxes:                      |   |     |   |     |   |     |   |
| Current                                                     |   |     |   |     |   |     |   |
| United States                                               |   | $        | (141   | )        | $      | (100     | )      | $ | 2 |   |
| Foreign                                                     |   | —   |   | 4        |   | 5        |   |
|                                                        |   |     |   |     |   |     |   |
| Total provision  for income taxes                           |   | $        | (141   | )        | $      | (96      | )      | $ | 7 |   |

 

 

A reconciliationof the U.S. Federal statutory rate to the effective tax rate for the yearsended June 30 is as follows:

 
|                                 |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                 |   |     |   |     |   |     |   |
| Federal  statutory rate              |   | 34       | %      | 34       | %      | 34       | %      |
| State Taxes, net  of Federal benefit |   | 2        |   | 2        |   | 2        |   |
| Valuation  allowance                 |   | (36      | )      | (36      | )      | (36      | )      |
|                                 |   | —   |   | —   |   | —   |   |

 

 

30

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Deferred incometaxes are provided for the temporary differences between the financialreporting basis and the tax basis of the Company’s assets and liabilities.Temporary differences, which are all deferred tax assets, are as follows (inthousands):

 

 
|                             |   | **June 30,  2002** |   | **June 30,  2001** |   |
|----------------------------------|--------|--------------------|--------|--------------------|--------|
|                             |   |               |   |               |   |
| Net operating  loss carryfowards |   | $                  | 17,661 |               | $      | 12,628 |   |
| Alternative  minimum tax credits |   | 432                |   | 432                |   |
| Foreign tax  credit              |   | 325                |   | 325                |   |
| Reserve for  returns             |   | 761                |   | 315                |   |
| Depreciation and  amortization   |   | 238                |   | 325                |   |
| Royalty reserves                 |   | 105                |   | 1,920              |   |
| Inventory  reserves              |   | 40                 |   | 515                |   |
| Nondeductible  accruals          |   | 310                |   | 1,952              |   |
| Allowance for  bad debts         |   | 29                 |   | 62                 |   |
| Valuation  allowance             |   | (19,901            | )      | (18,474            | )      |
|                             |   | $                  | — |               | $      | — |   |

 

A valuationallowance equal to the aggregate amount of deferred tax assets has beenestablished until such time as realizability is more likely than not.

 

For U.S. taxreporting purposes, the Company has net operating loss carryforwards (“NOL”) ofapproximately $49,000,000. However, of the amount available through 2013 and2020, $20,100,000 relates to deductions associated with the exercise of stockoptions. The tax benefit of approximately $7,236,000 associated with this stockoption deduction will be recorded as additional paid–in capital whenrealized. The NOL carryforwards may be reduced in future years, withoutfinancial statement benefit, to the extent of intercompany dividends receivedfrom foreign subsidiaries. Also, the NOL carryforwards are subject to reviewand possible adjustment by taxing authorities. In addition, the Company hasapproximately $432,000 in U.S. federal alternative minimum tax credits and$325,000 in foreign tax credits which may be utilized in the future to offsetany regular corporate income tax liability.

 

**5.****                                     ****CAPITAL TRANSACTIONS**

 

SecuritiesPurchase Agreement

 

On April 21, 1999,the Company entered into a Securities Purchase Agreement with two investors,pursuant to which the Company would sell in a private placement transaction, upto $18.0 million of the Company’s common stock in two tranches. The firsttranche was to have totaled $8.0 million. Pursuant to the Agreement, the Company sold 465,794 shares of commonstock for an aggregate of $4,000,000, or $8.588 per share. The Company was tosell an additional $4.0 million of common stock, on the effective date of aregistration statement. Under the terms of the Agreement, the purchasers wereto be entitled to acquire additional shares pursuant to a warrant. In addition,the Company issued warrants to the purchasers enabling them to purchase up to167,754 additional shares of common stock at a purchase price of $10.73 pershare, exercisable for a five–year period. In July 1999, a contractualdispute arose between the purchasers and K-tel and the $4,000,000 balance onthe first tranche was not sold.

 

On August 3, 1999,the Company entered into an agreement with the two purchasers of its commonstock to terminate and void those agreements and to repurchase, for $4,600,000,the purchasers’ common stock totaling 465,794 shares and warrants to acquireadditional shares. The Company has no further obligation to sell additionalstock to the purchasers, who were also relieved of obligations to purchaseadditional shares. As a part of the settlement, the purchasers released theCompany from all claims and dismissed with prejudice the lawsuit which they hadcommenced against the Company, resulting in an expense of $600,000, which wasreported in Other expense in the consolidated statement of operations for thefiscal year ended June 30, 2000. Payment of $600,000 was made for the releasefrom this agreement.

 

 

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Stock Option Plan

 

The Company has aStock Option Plan for officers, directors, and employees of the Company. Underthe terms of this plan the Board of Directors has the sole authority todetermine the employees to whom options and awards are granted, the type, sizeand terms of the awards, the timing of the grants, the duration of the exerciseperiod and any other matters arising under the plan. The common stockincentives may take the form of incentive stock options and nonqualified stockoptions.  The Company’s 1987 plan, whichhas expired, covered a maximum of 700,000 shares of common stock, of which2,000 shares remain outstanding and exercisable. In February 1997, theCompany’s Board of Directors approved a new stock option plan covering amaximum of 600,000 shares of common stock, which was subsequently amended to5,000,000 through shareholder amendments in February 1999, January 2000 andNovember 2000. There were options on 4,145,650 net shares granted under thisplan as of June 30, 2002. Of these options granted, 1,814,744 have beenterminated or have expired.

 

Restricted and Non–QualifiedStock Options

 

In addition tostock options granted under the terms of the Stock Option Plan, the Board ofDirectors has the sole authority to grant employees, officers and directorsincentive stock options and non–qualified stock options outside the StockOption Plan. The Board of Directors determines the type, size and terms of thegrants, timing of the grants, the duration of the exercise period and any othermatters pertaining to options or awards granted outside of the Stock OptionPlan. For all periods presented, there are no restricted stock optionsoutstanding.

 

The shareinformation for all plans is summarized below:

 
|                       |   |                |   |               |   | **Weighted**        |   |
|----------------------------|--------|---------------------|--------|--------------------|--------|---------------------|--------|
|                       |   | **Incentive Stock** |   | **Non-Qualified**  |   | **Average**         |   |
|                       |   | **Options**         |   | **Stock  Options** |   | **Exercise  Price** |   |
| Outstanding July  1, 1999  |   | 270,210             |   | 1,053,439          |   | $                   | 8.09   |   |
|                       |   |                |   |               |   |                |   |
| Adjustment (1)             |   | 606,939             |   | (606,939           | )      |                |   |
|                       |   |                |   |               |   |                |   |
| Granted                    |   | 2,092,000           |   | 180,000            |   | 5.64                |   |
| Exercised                  |   | (540,000            | )      | (5,000             | )      | 5.69                |   |
| Canceled                   |   | (218,593            | )      | (124,500           | )      | 7.13                |   |
| Outstanding June  30, 2000 |   | 2,210,556           |   | 497,000            |   | $                   | 6.72   |   |
|                       |   |                |   |               |   |                |   |
| Granted                    |   | 310,000             |   | 75,000             |   | 1.06                |   |
| Canceled                   |   | (228,167            | )      | (527,500           | )      | 6.49                |   |
| Outstanding June  30, 2001 |   | 2,292,389           |   | 44,500             |   | $                   | 5.77   |   |
|                       |   |                |   |               |   |                |   |
| Adjustment (2)             |   | (2,105,045          | )      | 2,105,045          |   |                |   |
|                       |   |                |   |               |   |                |   |
| Granted                    |   | —              |   | —             |   | —              |   |
| Canceled                   |   | (36,050             | )      | (27,000            | )      | 5.86                |   |
| Outstanding June  30, 2002 |   | 151,294             |   | 2,122,545          |   | $                   | 5.89   |   |

 

(1)          Adjustment reflects options disclosed previously asnon-qualified that should have been recorded as incentive.

(2)          Adjustment reflects options disclosed previously asincentive that should have been recorded as non-qualified.

 

 

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The followingtables summarize information concerning currently outstanding and exercisablestock options at June 30, 2002:

 
| **Options  Outstanding** |   |
|--------------------------|--------|
| **Exercise Prices**      |   |   |   | **Weighted Average** |   |
|                     |   | **Weighted** |   | **Number** |   | **Remaining** |   |
| **Range**                |   | **Average** |   | **of Shares** |   | **Contractual  Life** |   |
| $0.15-$1.75              |   | $ | 0.47 |   | 231,000 |   | 8.4 years |   |
| 1.84-3.38                |   | 1.87 |   | 81,400 |   | 8.0 years |   |
| 5.51-6.50                |   | 5.56 |   | 1,256,500 |   | 7.6 years |   |
| 8.73                     |   | 8.73 |   | 704,939 |   | 6.7 years |   |
|                     |   |   |   | 2,273,839 |   |   |   |
|                     |   |   |   |   |   |   |   |
| **Options Exercisable**  |   |   |
| **Exercise Prices**      |   |   |   |   |
|                     |   | **Weighted** |   | **Number** |   |   |
| **Range**                |   | **Average** |   | **of Shares** |   |   |
| $0.15-$1.75              |   | $ | 0.47 |   | 231,000 |   |   |
| 1.84-3.38                |   | 1.87 |   | 81,400 |   |   |
| 5.51-6.50                |   | 5.55 |   | 1,234,500 |   |   |
| 8.73                     |   | 8.73 |   | 704,939 |   |   |
|                     |   |   |   | 2,251,839 |   |   |

 

Pro Forma Option Information

 

Had compensationcosts for the Company’s stock option plans been recorded at fair value, theCompany’s pro forma net loss and loss per share would have been as follows:

 

 
|                               |   | **2002** |   | **2001** |   | **2000** |   |
|------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Net income  (loss) (in thousands): |   |     |   |     |   |     |   |
| As reported                        |   | $        | 14     |     | $      | 1,369    |   | $ | (15,738 | ) |
| Pro forma                          |   | $        | (458   | )        | $      | (496     | )      | $ | (26,189 | ) |
|                               |   |     |   |     |   |     |   |
| Basic and  diluted EPS:            |   |     |   |     |   |     |   |
| As reported                        |   | $        | .00    |     | $      | .10      |   | $ | (1.58 | ) |
| Pro forma                          |   | $        | (.04   | )        | $      | (.04     | )      | $ | (2.85 | ) |

 

 

The weightedaverage fair value of options granted in fiscal 2001 was $0.98, and 2000 was$4.86. No options were granted in fiscal 2002. Because the fair valueprovisions have not been applied to options granted prior to June 30, 1995, theresulting pro forma compensation cost may not be representative of that to beexpected in future years.

 

The fair value ofeach option is estimated on the date of grant using the Black-Scholes optionpricing model. The following assumptions were used to estimate the fair valueof options:

 

 
|                     |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------------|--------|----------|--------|----------|--------|----------|--------|
|                     |   |     |   |     |   |     |   |
| Risk-free  interest rate |   | 5.00     | %      | 5.00     | %      | 6.00     | %      |
| Expected life            |   | 5 years  |   | 5 years  |   | 5 years  |   |
| Expected  volatility     |   | 150      | %      | 150      | %      | 120      | %      |
| Expected  dividend yield |   | None     |   | None     |   | None     |   |

 

 

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**6.****                                     ****COMMITMENTS AND CONTINGENCIES**

 

Class ActionLawsuit

 

K-tel and certain of its current and former officersand directors are defendants in *In re K-telInternational, Inc. Securities Litigation*, No. 98-CV-2480.  This action consolidates twenty-threepurported class actions that were initially filed in various United StatesDistrict Courts in November 1998, and were subsequently transferred to, andconsolidated in, the United States District Court for the District ofMinnesota. On July 19, 1999, the plaintiffs filed an amended consolidated classaction complaint that challenges the accuracy of certain public disclosuresmade by K-tel regarding its financial condition during the period from May 1998through November 1998. The plaintiffs assert claims under the federalsecurities laws and seek damages in an unspecified amount as well as costs,including attorneys’ fees and any other relief the Court deems just and proper.K-tel moved to dismiss the complaint, and on July 31, 2000, the United StatesDistrict Court granted the Company’s motion to dismiss. The Court also barredfurther actions by the plaintiffs and denied plaintiffs’ request to amend thecomplaint in order to refile the complaint in the future. The plaintiffsappealed to the United States Court of Appeals for the Eighth Circuit, and theCourt of Appeals heard the matter in October 2001. On August 7, 2002 the Courtof Appeals, in a two to one decision, denied the plaintiffs appeal. On August20, 2002 the plaintiffs applied for a rehearing by the full Court of Appeals.K-tel filed a response on September 15, 2002 to the plaintiff’s petition forrehearing at the request of the Court. K-tel is awaiting a ruling on thisappeal. K-tel has two insurance policies providing coverage of up to $20million, which is subject to the insurers’ reservations of legal rights underthe applicable policies. Under their reservations of rights, the insurers couldcontest their obligations to indemnify the Company and its directors andofficers. K-tel may have an obligation to indemnify the officers and directorsnamed in this lawsuit.

 

Early v. K-telInternational, Inc.

 

On January 11,1999, the Company was named in a lawsuit entitled *Christopher Early vs. K-telInternational, Inc., et al* brought in the Circuit Court of CookCounty, Illinois, against the Company and certain of its subsidiaries byChristopher Early. The suit also named as defendants certain othermanufacturers, distributors and a number of nationwide retailers. The plaintiffsought damages on behalf of himself and a purported class of purchasers ofcassette tapes and compact discs produced, distributed and/or sold by thedefendants. The claim alleged that defendants engaged in deceptive andmisleading packaging of cassette tapes and compact discs by failing to giveproper notice to consumers that the songs contained therein were not theoriginal recordings by the original artists. The complaint also allegedconsumer fraud, deceptive and unfair practices, and fraud in connection withwebsite advertising and marketing. Similar litigation was brought against theCompany by Mr. Early in 1997 and was dismissed by a United States Federal Courtin 1999 on jurisdictional grounds. The Company denies that it mislabeledcassette tapes and compact discs or engaged in fraudulent or deceptive conductand defended vigorously the purported action, which sought an undeterminedamount of compensatory damages and punitive damages in the amount of $10million, an injunction and costs incurred in the litigation, includingattorneys fees. The Company filed a motion to dismiss the complaint on June 8,2000. On February 16, 2001, the court dismissed the complaint against the othermanufacturers, distributors and nationwide retailers, but allowed the case tocontinue against the Company. On May 28, 2002, the Court approved an agreementbetween the Company and Mr. Early on terms favorable to the Company within theamount previously reserved for in the Company’s financial statements.

 

RTL Shopping S.A.

 

The Company hasbeen named in a lawsuit filed in France brought by RTL9, a French cable TVstation. Initially, RTL9 was named as a defendant in a suit brought by acompetitor of K-tel Marketing Ltd. alleging that RTL9 ran a commercial forK-tel Marketing which presented a product under brand names alleged to infringeon the competitor’s own trademarks and also translated an English languagescript indicating that the product was “just like” or “as good as” others into“better than” in French, contrary to French law. The suit alleged trademarkinfringement, unfair competition, illicit comparative advertising and passingoff. RTL9 then sued K-tel Marketing on October 4, 2000, pursuant to anindemnification provision the parties had entered into. Subsequently, K-telMarketing went into liquidation and RTL9 filed a suit in December 2000 againstK-tel International, Inc. under its agreement to guarantee payment for thecommercial time. On May 28, 2001, RTL9 presented documents in court identifyingK-tel International (USA), Inc. as a target of its claim. On September 3, 2001the Company filed documents disputing the claim and advising the court of K-tel(USA)’s Chapter 7 

 

 

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bankruptcy filing.At a procedural hearing on December 3, 2001, RTL9 filed its brief in responseto the Company’s filing. In response, the Company filed a further brief. At afurther hearing on May 6, 2002, several companies involved in the initial suitagainst RTL9 filed additional briefs or indicated that additional briefs wouldbe filed. The Court directed that all additional briefs were to be filed byJune 24, 2002. Several parties filed additional briefs on September 11, 2002.The Company filed a brief in response. At a hearing on September 16, 2002, theCourt received new submissions from three of the other parties and set ahearing date of October 28, 2002, at which time it will declare an end to thewritten submissions. The Court has scheduled oral arguments for November 12,2002. The action seeks the approximate amount of 20 million French Francs, orapproximately $2.8 million. The Company believes that RTL9 has no basis for acomplaint against the Company. 

 

Hollins & Fields, LLPv K-tel International, Inc.

 

Hollins &Fields, LLP (H&F) sublet a portion of the Company’s former executiveoffices in Los Angeles. On September 21, 2001, H&F sued in California forbreach of contract and conversion, seeking damages in excess of $150,000. OnNovember 26, 2001, the Court dismissed the punitive damage claim in the amountof $100,000. The Company filed a defense and counterclaim. As a result ofinformation exchanged during discovery, the parties settled the matter on April30, 2002 on terms favorable to the Company.

 

K-telInternational, Inc. vs. Tristar Products, Inc.

 

K-tel and itssubsidiary in Germany have commenced an action for breach of express andimplied warranties against Defendant Tristar Products, Inc. This action isvenued in the United States District Court for the District of Minnesota. Thisaction arises out of Tristar’s sale to Plaintiffs of a defective home exerciseproduct called the “BunBlaster” for resale in Germany, Austria and Switzerland.By written contract, Tristar has agreed to indemnify Plantiffs for injuries anddamages arising out of the resale of those goods. Plaintiffs are seeking approximately$2 million in consequential damages. Tristar is vigorously defending this claimand the action is currently in discovery.

 

Tristar has alsoasserted a patent and trademark/ trade-dress action against K-tel for passingoff a product called the “K-tel Hook and Hang” while allegedly a distributor ofthe original patented Tristar Hook and Hang product. The Company denies theallegation because it never was a distributor of this or any similar productand intends to defend this action vigorously. Tristar has not identified theamount of damages it seeks with respect to this counterclaim. Discoveryproceedings have commenced.

 

#### Litigation and Disputes

 

K-tel and its subsidiaries are also involved in other legal actions inthe ordinary course of its business. With all litigation matters, managementconsiders their likelihood of loss based on the facts and circumstances. Ifmanagement determines that a loss is probable and the amount of loss can bereasonably estimated, such amount is recorded as a liability. Although theoutcome of any such legal actions cannot be predicted, in the opinion ofmanagement there is currently no legal proceeding pending or asserted againstor involving K-tel for which the outcome is likely to have a material adverseeffect upon the consolidated financial position or results of operations ofK-tel.

 

Subsidiaries’ Bankruptcy and Liquidation

In March 2001, the Company’s music distributionsubsidiary in the United States, K-tel International (USA), Inc. ceasedoperations and filed for protection under Chapter 7 of the United StatesBankruptcy Code. Although the bankruptcy court has not yet confirmed the formalplan of liquidation, the Company has not been informed by the trustee or itscounsel of any plan by the court to attempt to hold it or any of itssubsidiaries liable for any of the commitments of K-tel (USA). Managementbelieves the Company will have no ongoing material liability related to K-tel(USA) as a result of the filing and the outcome of the bankruptcy proceeding.

In November 2000, the Company’s consumer productssubsidiary in the United Kingdom, K-tel Marketing Ltd., ceased operations andbegan voluntary liquidation proceedings. At the initial meeting of thecreditors on November 24, 2000, the creditors voted for the liquidation tobecome a creditors’ liquidation under English law. The Company has not beeninformed by the liquidators or their counsel of any plan to attempt to hold itor any 

 

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of itssubsidiaries liable for any of the commitments of K-tel Marketing Ltd.Management believes the Company will have no ongoing material liability relatedto K-tel Marketing Ltd. as a result of the liquidation proceeding.

Royalties

 

During the yearended June 30, 2000, the Company received an audit claim for $9.4 million fromthe Harry Fox Agency, Inc. covering the period July 1, 1994 through June 30,1998 related to the operations of K-tel International (USA), Inc. The Companyhas received similar audits in the past and, following extensive research,generally arrives at a substantially lower settlement. During the year endedJune 30, 2000, the Company adjusted its royalty reserve to allow for aneventual settlement and believes its reserve is adequate. This liability was surrenderedto the bankruptcy trustee when K-tel (USA) filed for Chapter 7 bankruptcyprotection.

 

Leases

 

The Company hasentered into several office and warehouse leases which expire through 2005.Commitments under these leases are $235,464 in 2003, $202,464 in 2004, and$43,110 in 2005. Rental expense was $216,327 in 2002, $654,000 in 2001, and$1,007,000 in 2000.

 

**7.****                                     ****SIGNIFICANT CUSTOMERS AND RELATED PARTY TRANSACTIONS**

 

One customer,Madacy Entertainment Group, Inc. accounted for approximately 13% of K-tel’srevenue for the year ended June 30, 2002. The loss of, or a substantialreduction in, business from this customer would have a material adverse effecton the Company.

 

See Note 4 forinformation regarding debt transactions with related parties.

 

The Companypurchased approximately $366,000 in fiscal 2002, $574,000 in fiscal 2001 and$198,000 in fiscal 2000 of consumer convenience products from K-5. There weretrade payables to K-5 of $291,000 at June 30, 2002, $ 285,000 at June 30, 2001and $150,000 at June 30, 2000.

 

The Company had nosales of consumer convenience products to K-5 during fiscal 2002, sales of$13,000 during fiscal 2001 and $174,000 during fiscal 2000. There was a balancereceivable from K-5 at June 30, 2002 of $129,000, June 30, 2001 of $109,000 andJune 30, 2000 of $224,000. No interest was charged on the related outstandingbalances during fiscal 2002 and 2001 and 2000.

 

**8.****                                     ****BUSINESS SEGMENT AND GEOGRAPHIC AREA DATA**

 

The Company markets and distributes entertainmentproducts internationally through its operating subsidiaries. K–tel’sbusinesses are organized, managed and internally reported as three segments:retail music sales, music licensing, and other, which consist primarily of e–commerce(which was closed in the fourth quarter of fiscal 2002). These segments arebased on differences in products, customer type and sales and distributionmethods. The Company’s consumer product operations have been discontinued andare presented in the accompanying financial statements as discontinued operationsand are therefore not included in the segment information.

 

The retail musicsegment consists primarily of the sales of pre–recorded music both fromthe Company’s music master catalog and under licenses obtained from otherrecord companies. The Company sells compact discs and DVD’s directly toretailers, wholesalers and rack service distributors which stock and manageinventory within music departments for retail stores.

 

In the licensingsegment, the Company licenses the rights to its master music catalog,consisting of original recordings and re–recordings of music from the1950’s through today, to third parties world–wide for use in albums,films, television programs, and commercials, for either a flat fee or a royaltybased on the number of units sold.

 

Operating profitsor losses of these segments include an allocation of general corporateexpenses.  Depreciation and amortizationand capital additions are not significant and have therefore been excluded frompresentation.

 

 

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Certain financialinformation on the Company’s continuing operating segments is as follows:

 

 
| **BUSINESS SEGMENT INFORMATION** |   | **Music**        |   | **Licensing** |                    | **Other** |   | **Corporate/  Elimination** |   | **Total  Company** |                   |
|----------------------------------|--------|------------------|--------|---------------|-------------------------|-----------|--------|-----------------------------|--------|--------------------|------------------------|
| **(in thousands)**               |   |
|                             |   |             |   |          |                    |      |   |                        |   |               |                   |   |   |
| Net Sales                        |   | 2002

2001

2000 |   | $             | 3,757

14,202

25,739   |      | $      | 3,118

3,710

3,698         |   | $                  | —

365

575       |   | $ | —

(763

(920 | )  ) | $  $ | 6,875

17,514

29,092 |   |
|                             |   |             |   |          |                    |      |   |                        |   |               |                   |   |   |
| Operating Income  (loss)         |   | 2002

2001

2000 |   | $             | (1,725

(7,749

(11,308 | )  )  )   | $      | 1,393

425

819             |   | $                  | —

(2,156

(2,491 | )  ) | $ | —

—

— |   | $ | (332

(9,480

(12,980 | )  )  ) |
|                             |   |             |   |          |                    |      |   |                        |   |               |                   |   |   |
| Assets                           |   | 2002

2001

2000 |   | $             | 2,319

1,501

11,856    |      | $      | 1,668

1,650

1,832         |   | $                  | 121

443

689          |   | $ | 142

238

1,037 |   | $  $ | 4,250

3,832

15,414 |   |

 

 

 
| **GEOGRAPHIC  INFORMATION** |   |             |   | **United  States** |                  | **Europe** |   | **Total**           |   |
|-----------------------------|--------|------------------|--------|--------------------|-----------------------|------------|--------|---------------------|--------|
|                        |   |             |   |               |                  |       |   |                |   |
| Net Sales                   |   | 2002

2001

2000 |   | $                  | 3,949

13,914

25,277 |       | $      | 2,926

3,600

3,815 |   | $ | 6,875

17,514

29,092 |   |
|                        |   |             |   |               |                  |       |   |                |   |
| Assets                      |   | 2002

2001

2000 |   | $                  | 2,792

2,042

13,583  |       | $      | 1,458

1,790

1,831 |   | $ | 4,250

3,832

15,414 |   |

 

 

**9.****                                     ****RECENT ACCOUNTING PRONOUNCEMENTS**

 

 The Company adopted Financial AccountingStandard Boards (FASB) Statement of Financial Accounting Standards (SFAS) 141, *“Business Combinations,”* and SFAS 142, *“Goodwill and Intangible Assets”* on June30, 2002. These pronouncements, among other things, eliminate thepooling-of-interest method of accounting for business combinations and requireintangible assets acquired in business combinations to be recorded separatelyfrom goodwill. The pro­nouncements also eliminate the amortization of goodwilland other intangible assets with indefinite lives and require negative goodwillbe recognized as an extraordinary gain. There­after, goodwill and otherintangible assets with indefinite lives will be tested for impairment annuallyor whenever an impairment indicator arises. The Company expects that theadoption of the provisions of SFAS No. 141 and SFAS No. 142 does not have amaterial impact on the Company’s financial statements because the Company doesnot use the pooling-of-interest method of accounting for business combinationsand has no goodwill and other intangible assets.

 

 In August 2001, the FASB issued SFAS 144, *“Accounting for the Impairment or Disposal ofLong-Lived Assets.”* SFAS 144 retains the requirement from SFAS 121to test a long-lived asset or asset group for impairment using a two-stepimpairment test whenever a triggering event occurs. SFAS 144 provides anadditional triggering event, a current expectation that, more likely than not,a long-lived asset or asset group will be sold or disposed of significantlybefore the end of its previously estimated useful life would indicate the needto test that asset or asset group for impairment. SFAS 144 is effective forfiscal years beginning after Decem­ber 15, 2001, and is generally to beapplied prospectively. SFAS 144 does not apply to good­will and otherintangible assets with indefinite lives, long-term customer relationships offinancial institutions, financial instruments, deferred policy acquisitioncosts, deferred tax assets, and other long-lived assets for which theaccounting is prescribed in certain other FASB Statements.

 

 

37

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The FASB alsoissued SFAS 143, *“Accounting for AssetRetirement Obligations.”* SFAS 143 applies to all entities that have legal obligations associatedwith the retirement of a tangible long-lived asset that result fromacquisition, construction, or devel­opment and (or) normal operations of thelong-lived asset.  For purposes of SFAS143, a liability for an asset retirement obligation should be recognized if theobligation meets the definition of a liability in FASB Concepts Statement 6, *“Elements of Financial Statements,”* and ifthe amount of the liability can be reasonably estimated.  Consequently, an entity should recognize a liabilityfor an asset retirement obligation if (a) the entity has a duty orresponsibility to settle an asset retirement obligation, (b) the entity haslittle or no discretion to avoid the future transfer or use of assets, and (c)the transaction or other event obligating the entity has occurred.

 

 The SFAS 144 and 143 should not have a materialeffect on the Company’s financial statements because the Company has no assetretirement obligations.

 

 

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**SCHEDULEII**

 

**K-TELINTERNATIONAL, INC. AND SUBSIDIARIES**

 

**VALUATIONAND QUALIFYING ACCOUNTS**

 

Years ended June 30,

(In thousands)

 

 
|                                   |   | **Balance at Beginning of Period** |       | **Charged to Costs and Expenses or Net Sales** |       | **Charged to Other Accounts (1)** |       | **Deductions** |   | **Balance at End  of Period** |       |
|----------------------------------------|--------|------------------------------------|------------|------------------------------------------------|------------|-----------------------------------|------------|----------------|--------|-------------------------------|------------|
| **Allowance  for   Doubtful Accounts** |   |                               |       |                                           |       |                              |       |           |   |                          |       |
| 2002                                   |   | $                                  | 33         |                                           | $          | 50                                |       | $              | 5      |                          | $          | (20 | )(2) | $ | 68 |   |
| 2001                                   |   | $                                  | 1,416      |                                           | $          | (41                               | )          | $              | (4     | )                             | $          | (1,338 | )(2) | $ | 33 |   |
| 2000                                   |   | $                                  | 1,349      |                                           | $          | 59                                |       | $              | (5     | )                             | $          | 13 | (2) | $ | 1,416 |   |
|                                   |   |                               |       |                                           |       |                              |       |           |   |                          |       |
| **Reserve for**                        |   |                               | ** ** |                                           | ** ** |                              | ** ** |           |   |                          | ** ** |
| **Returns**                            |   |                               | ** ** |                                           | ** ** |                              | ** ** |           |   |                          | ** ** |
|                                   |   |                               |       |                                           |       |                              |       |           |   |                          |       |
| 2002                                   |   | $                                  | 50         |                                           | $          | 49                                |       | $              | 6      |                          | $          | 65 |   | $ | 40 |   |
| 2001                                   |   | $                                  | 4,623      |                                           | $          | 45                                |       | $              | (3     | )                             | $          | (4,615 | ) | $ | 50 |   |
| 2000                                   |   | $                                  | 3,884      |                                           | $          | 5,140                             |       | $              | (1     | )                             | $          | (4,400 | ) | $ | 4,623 |   |

----

(1) Exchange ratechange

 

(2) Uncollectibleaccounts written off, net of recoveries

 

 

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EXHIBIT INDEX

 

The Exhibitslisted below, which are numbered corresponding to Item 601 of Regulation S-K,are filed as a part of this report.

 
| Exhibit |   | Item                                                                                                                                                            |   |                                                                                                                               |
|---------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                            |   |                                                                                                                               |
| 3       |   | Restated Articles of  Incorporation and Restated By-Laws                                                                                                        |   | Incorporated herein by  reference to 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 the Registrant’s Quarterly Report on Form 10-Q for the year  ended March 31, 1998        |
|    |   |                                                                                                                                                            |   |                                                                                                                               |
| 10.1    |   | 1987 Stock Incentive  Plan                                                                                                                                      |   | Incorporated herein by  reference to the Registrant’s Annual Report on Form 10-K for the year ended  June 30, 1987            |
|    |   |                                                                                                                                                            |   |                                                                                                                               |
| 10.2    |   | Non-Qualified Stock Option  Agreement — Philip Kives                                                                                                       |   | Incorporated herein by  reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter  ended March 31, 1997     |
|    |   |                                                                                                                                                            |   |                                                                                                                               |
| 10.3    |   | 1997 Stock Option Plan                                                                                                                                          |   | Incorporated herein by  reference to the Registrant’s Annual Report on Form 10-K for the year ended  June 30, 1997            |
|    |   |                                                                                                                                                            |   |                                                                                                                               |
| 10.4    |   | Loan and Security  Agreement — Foothill Capital Corporation                                                                                                |   | Incorporated herein by  reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter  ended December 31, 1997  |
|    |   |                                                                                                                                                            |   |                                                                                                                               |
| 10.5    |   | Non-Qualified Stock  Option Agreement — Philip Kives                                                                                                       |   | Incorporated herein by  reference to the Registrant’s Annual Report on Form 10-K for the year ended  June 30, 1998            |
|    |   |                                                                                                                                                            |   |                                                                                                                               |
| 10.6    |   | Amendment Number One —  Loan and Security Agreement — Foothill Capital Corporation                                                                    |   | Incorporated herein by  reference to the Registrant’s Annual Report on Form 10-K for the year ended  June 30, 1998            |
|    |   |                                                                                                                                                            |   |                                                                                                                               |
| 10.7    |   | Amendment Number Two —  Loan and Security Agreement — Foothill Capital Corporation                                                                    |   | Incorporated herein by  reference to the Registrant’s Annual Report on Form 10-K for the year ended  June 30, 1998            |
|    |   |                                                                                                                                                            |   |                                                                                                                               |
| 10.8    |   | Restated Amendment  Number Two — Loan and Security Agreement — Foothill Capital Corporation.                                                          |   | Incorporated herein by  reference to the Registrant’s Annual Report on Form 10-K for the year ended  June 30, 1998            |
|    |   |                                                                                                                                                            |   |                                                                                                                               |
| 10.9    |   | Sale and Purchase  Agreement relating to K-tel International (Finland) Oy by and between K-tel  International, Inc. an Edel Music AG, dated September 10, 1999. |   | Incorporated herein by  reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K  filed on September 24, 1999 |
|    |   |                                                                                                                                                            |   |                                                                                                                               |
| 10.10   |   | Letter Agreement  relating to K-tel International (Finland) Oy by and between K-tel  international, Inc. and Edel Music AG, dated September 10, 1999.           |   | Incorporated herein by  reference to Exhibit 10.2 of the Registrant’s Current Report on Form 8-K  filed on September 24, 1999 |

 

 

40

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|   |   |                                                                                                                                                                    |   |                                                                                                                              |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------|
| 10.11  |   | Securities Purchase  Agreement by and between K-tel International, Inc. and two investors, dated  April 21, 1999.                                                       |   | Incorporated herein by  reference to the Registrant’s Report on Form 8-K filed on April 27, 1999                             |
|   |   |                                                                                                                                                                    |   |                                                                                                                              |
| 10.12  |   | Settlement Agreement  and Mutual Release of Securities Purchase Agreement Settlement by and between  K-tel International, Inc. and two investors, dated August 3, 1999. |   | Incorporated herein by  reference to the Registrant’s Report on Form 8-K filed on August 4, 1999                             |
|   |   |                                                                                                                                                                    |   |                                                                                                                              |
| 10.13  |   | Form of Stock Option  Agreement under the 1997 Stock Option Plan                                                                                                        |   | Incorporated herein by  reference to the Registrant’s Annual report on Form 10-K for the year ended  June 30, 2000           |
|   |   |                                                                                                                                                                    |   |                                                                                                                              |
| 10.14  |   | Form of Stock Option  Agreement under the 1997 Stock Option Plan                                                                                                        |   | Incorporated herein by  reference to the Registrant’s Annual report on Form 10-K for the year ended  June 30, 2000           |
|   |   |                                                                                                                                                                    |   |                                                                                                                              |
| 10.15  |   | Amendment Number Three  — Loan and Security Agreement — Foothill Capital                                                                                      |   | Incorporated herein by  reference to the Registrant’s Annual report on Form 10-K for the year ended  June 30, 2000           |
|   |   |                                                                                                                                                                    |   |                                                                                                                              |
| 10.16  |   | Amendment Number Four —  Loan and Security Agreement — Foothill Capital                                                                                       |   | Incorporated herein by  reference to the Registrant’s Annual report on Form 10-K for the year ended  June 30, 2000           |
|   |   |                                                                                                                                                                    |   |                                                                                                                              |
| 10.17  |   | Amendment to Credit  Agreement and Note                                                                                                                                 |   | Incorporated herein by  reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter  ended December 31, 2001 |
|   |   |                                                                                                                                                                    |   |                                                                                                                              |
| 10.18  |   | Amendment to Loan  Agreement and Security Agreement                                                                                                                     |   | Incorporated herein by  reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter  ended December 31, 2001 |
|   |   |                                                                                                                                                                    |   |                                                                                                                              |
| 21     |   | Subsidiaries of the  Registrant                                                                                                                                         |   | Filed herewith                                                                                                                    |
|   |   |                                                                                                                                                                    |   |                                                                                                                              |
| 23.1   |   | Consent of Grant  Thornton LLP                                                                                                                                          |   | Filed herewith                                                                                                                    |
|   |   |                                                                                                                                                                    |   |                                                                                                                              |
| 99.1   |   | Certification pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                |   | Filed herewith                                                                                                                    |
|   |   |                                                                                                                                                                    |   |                                                                                                                              |
| 99.2   |   | Certification pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                |   | Filed herewith                                                                                                                    |

 

 

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