##### **UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

##### **FORM 10-Q**

 

**(Mark One)**

 

**ý****                                   QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period endedDecember 31, 2001**

 

**or**

 

**o**                                   **TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

                                                **For the transitionperiod from __________ to __________**

** **

**Commission File Number:  0-6664**

** **

**K-TEL INTERNATIONAL, INC.**

(Exactname of registrant as specified in its charter)

 
| **Minnesota**                                                   |   | **41****-0946588**   |
|-----------------------------------------------------------------|--------|----------------------|
| (State  or other jurisdiction of                                |   | (I.RS.  Employer     |
| incorporation  or organization)                                 |   | Identification  No.) |
|                                                            |   |                 |
| **5555  Pioneer Creek Drive,  Maple Plain Minnesota** |   | **55359**            |
| (Address of principal  executive offices)                       |   | (Zip Code)           |

 

**(763) 479-8170**

(Registrant’stelephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

Yesý    No o

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of themost recent practical date.  As ofFebruary 13, 2002, there were 13,653,738 shares of the registrant’s commonstock, par value $0.01 per share, outstanding.

 

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

** FORM 10-Q**

 

**FOR THETHREE AND SIX MONTH PERIODS**

**ENDEDDECEMBER 31, 2001**

 

INDEX

 
| PART I.        | Financial Information  (Unaudited): |
|----------------|-------------------------------------|
|           |                                |   |
|           | Item 1.                             | Condensed  Consolidated Balance Sheets as of December 31, 2001 and June 30, 2001 |
|           |                                |   |
|           |                                | Condensed  Consolidated Statements of Operations for the Three and Six Month Periods  Ended December 31, 2001 and 2000 |
|           |                                |   |
|           |                                | Condensed  Consolidated Statements of Cash Flows for the Six Month Periods Ended  December 31, 2001 and 2000 |
|           |                                |   |
|           |                                | Notes  to Consolidated Financial Statements |
|           |                                |   |
|           | Item  2.                            | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|           |                                |   |
|           | Item  3.                            | Quantitative  and Qualitative Disclosures About Market Risk |
|           |                                |   |
|           |                                |   |
| PART II.  | Other Information:                  |
|           |                                |   |
|           |                                |   |
|           | Item 1.                             | Legal  Proceedings |
|           |                                |   |
|           | Item 6.                             | Exhibits and Reports  on Form 8-K |

 

2

----

 

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

**CONDENSED CONSOLIDATED BALANCE SHEETS****- UNAUDITED**

*(in thousands*)

 
|                                                                                                 |   | **December  31,** |   | **June 30,** |   |
|------------------------------------------------------------------------------------------------------|--------|-------------------|--------|--------------|--------|
|                                                                                                 |   | **2001**          |   | **2001**     |   |
|                                                                                                 |   |              |   |         |   |
| ASSETS                                                                                               |   |              |   |         |   |
|                                                                                                 |   |              |   |         |   |
| Current Assets:                                                                                      |   |              |   |         |   |
| Cash and equivalents                                                                                 |   | $                 | 144    |         | $      | 173 |   |
| Accounts receivable, net                                                                             |   | 1,828             |   | 915          |   |
| Inventories                                                                                          |   | 362               |   | 418          |   |
| Royalty and other advances                                                                           |   | 80                |   | 182          |   |
| Prepaid expenses and other                                                                           |   | 285               |   | 480          |   |
| Total Current Assets                                                                                 |   | 2,699             |   | 2,168        |   |
|                                                                                                 |   |              |   |         |   |
| Property and equipment, net of accumulated depreciation and  amortization of  $1,167 and $1,136 |   | 182               |   | 231          |   |
|                                                                                                 |   |              |   |         |   |
| Owned catalog masters, net of accumulated amortization of $2,879 and  $2,687                         |   | 1,343             |   | 1,424        |   |
| Other assets                                                                                         |   | 5                 |   | 9            |   |
|                                                                                                 |   |              |   |         |   |
|                                                                                                 |   | $                 | 4,229  |         | $      | 3,832 |   |
|                                                                                                 |   |              |   |         |   |
| LIABILITIES AND SHAREHOLDERS’ DEFICIT                                                           |   |              |   |         |   |
|                                                                                                 |   |              |   |         |   |
| Current Liabilities:                                                                                 |   |              |   |         |   |
| Loans payable to affiliate                                                                           |   | $                 | 5,490  |         | $      | 8,807 |   |
| Accounts payable                                                                                     |   | 1,815             |   | 1,284        |   |
| Accrued royalties                                                                                    |   | 2,450             |   | 2,080        |   |
| Reserve for returns                                                                                  |   | 52                |   | 50           |   |
| Other current liabilities                                                                            |   | 134               |   | 760          |   |
| Net liabilities of discontinued operations                                                           |   | 1,196             |   | 1,103        |   |
| Total Current Liabilities                                                                            |   | 11,137            |   | 14,084       |   |
|                                                                                                 |   |              |   |         |   |
| Long Term Debt                                                                                       |   |              |   |         |   |
| Loan payable to affiliate                                                                            |   | 4,000             |   | —       |   |
|                                                                                                 |   |              |   |         |   |
| Shareholders’ Deficit:                                                                          |   |              |   |         |   |
| Common stock                                                                                         |   | 136               |   | 136          |   |
| Additional paid-in capital                                                                           |   | 20,680            |   | 20,680       |   |
| Accumulated deficit                                                                                  |   | (31,396           | )      | (30,785      | )      |
| Cumulative translation adjustment                                                                    |   | (328              | )      | (283         | )      |
| Total Shareholders’ Deficit                                                                     |   | (10,908           | )      | (10,252      | )      |
|                                                                                                 |   |              |   |         |   |
|                                                                                                 |   | $                 | 4,229  |         | $      | 3,832 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

3

----

 

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

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS****- UNAUDITED**

*(in thousands - except per sharedata)*

 
|                                                          |   | **Three  Months Ended** |   | **Six Months  Ended** |   |
|---------------------------------------------------------------|--------|-------------------------|--------|-----------------------|--------|
|                                                          |   | **December  31,**       |   | **December  31,**     |   |
|                                                          |   | **2001**                |   | **2000**              |   | **2001** |   | **2000** |   |
|                                                          |   |                    |   |                  |   |   |   |   |   |
| Net Sales                                                     |   | $                       | 2,104  |                  | $      | 4,880 |   | $ | 3,485 |   | $ | 11,051 |   |
|                                                          |   |                    |   |                  |   |   |   |   |   |
| Costs and Expenses:                                           |   |                    |   |                  |   |   |   |   |   |
| Cost of goods sold                                            |   | 894                     |   | 3,148                 |   | 1,416 |   | 7,568 |   |
| Advertising                                                   |   | 28                      |   | 92                    |   | 51 |   | 284 |   |
| Selling, general & administrative                         |   | 1,035                   |   | 3,068                 |   | 2,268 |   | 5,680 |   |
| Total Costs and Expenses                                      |   | 1,956                   |   | 6,308                 |   | 3,735 |   | 13,532 |   |
| Operating Income (Loss)                                       |   | 148                     |   | (1,428                | )      | (250 | ) | (2,481 | ) |
|                                                          |   |                    |   |                  |   |   |   |   |   |
| Other Income (Expense):                                       |   |                    |   |                  |   |   |   |   |   |
| Interest income                                               |   | —                  |   | 46                    |   | — |   | — |   |
| Interest expense                                              |   | (88                     | )      | (226                  | )      | (169 | ) | (358 | ) |
| Foreign currency transaction gain (loss)                      |   | —                  |   | 236                   |   | — |   | (102 | ) |
| Other                                                         |   | (50                     | )      | —                |   | (50 | ) | — |   |
| Total Other Income (Expense)                                  |   | (138                    | )      | 56                    |   | (219 | ) | (460 | ) |
|                                                          |   |                    |   |                  |   |   |   |   |   |
| Income (Loss) from Continuing Operations Before Income Taxes  |   | 10                      |   | (1,372                | )      | (469 | ) | (2,941 | ) |
|                                                          |   |                    |   |                  |   |   |   |   |   |
| Income Taxes                                                  |   | —                  |   | (5                    | )      | — |   | (11 | ) |
|                                                          |   |                    |   |                  |   |   |   |   |   |
| Income (Loss) from Continuing Operations                      |   | 10                      |   | (1,377                | )      | (469 | ) | (2,952 | ) |
|                                                          |   |                    |   |                  |   |   |   |   |   |
| Discontinued Operations:                                      |   |                    |   |                  |   |   |   |   |   |
| Loss from Discontinued Operations                             |   | (117                    | )      | (3,455                | )      | (142 | ) | (4,409 | ) |
|                                                          |   |                    |   |                  |   |   |   |   |   |
| Net Loss                                                      |   | $                       | (107   | )                     | $      | (4,832 | ) | $ | (611 | ) | $ | (7,361 | ) |
|                                                          |   |                    |   |                  |   |   |   |   |   |
| Loss per Share — Basic and Diluted:                      |   |                    |   |                  |   |   |   |   |   |
| Continuing Operations                                         |   | $                       | .00    |                  | $      | (.13 | ) | $ | (.03 | ) | $ | (.28 | ) |
| Discontinued Operations                                       |   | (.01                    | )      | (.34                  | )      | (.01 | ) | (.43 | ) |
| Net Loss                                                      |   | $                       | (.01   | )                     | $      | (.47 | ) | $ | (.04 | ) | $ | (.71 | ) |
|                                                          |   |                    |   |                  |   |   |   |   |   |
| Weighted Average Shares Outstanding — Basic and Diluted: |   | 13,654                  |   | 10,320                |   | 13,654 |   | 10,320 |   |
|                                                          |   |                    |   |                  |   |   |   |   |   |
| Comprehensive Income (Loss):                                  |   |                    |   |                  |   |   |   |   |   |
| Net loss                                                      |   | $                       | (107   | )                     | $      | (4,832 | ) | $ | (611 | ) | $ | (7,361 | ) |
| Foreign currency gain (loss)                                  |   | 47                      |   | (45                   | )      | (45 | ) | 282 |   |
| Comprehensive Loss                                            |   | $                       | (60    | )                     | $      | (4,877 | ) | $ | (656 | ) | $ | (7,079 | ) |

 

See accompanying notes to condensed consolidatedfinancial statements.

 

4

----

 

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

##### **CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS** - UNAUDITED

* (in thousands)*

 
|                                                                     |   | **Six Months  Ended** |   |
|--------------------------------------------------------------------------|--------|-----------------------|--------|
|                                                                     |   | **December  31,**     |   |
|                                                                     |   | **2001**              |   | **2000** |   |
| Cash flows from Operating Activities:                                    |   |                  |   |   |   |
| Net loss                                                                 |   | $                     | (611   | ) | $ | (7,361 | ) |
| Adjustments to reconcile  net loss to cash used in operating activities: |
| Depreciation and amortization                                            |   | 230                   |   | 378 |   |
| Loss on disposal of property and equipment                               |   | 4                     |   | — |   |
| Discontinued operations                                                  |   | 93                    |   | 3,946 |   |
| Changes in operating assets and liabilities:                             |   |                  |   |   |   |
| Accounts receivable                                                      |   | (901                  | )      | 895 |   |
| Inventories                                                              |   | 62                    |   | 272 |   |
| Royalty and other advances                                               |   | 105                   |   | (105 | ) |
| Prepaid expenses and other                                               |   | 203                   |   | (224 | ) |
| Accounts payable and other                                               |   | (114                  | )      | 1,697 |   |
| Accrued royalties                                                        |   | 370                   |   | 559 |   |
| Reserve for returns                                                      |   | 1                     |   | (88 | ) |
| Income taxes, net                                                        |   | 4                     |   | (19 | ) |
| Cash used in operating activities                                        |   | (554                  | )      | (50 | ) |
|                                                                     |   |                  |   |   |   |
| Cash flows from Investing Activities:                                    |   |                  |   |   |   |
| Proceeds from sale of property and equipment                             |   | 27                    |   | 49 |   |
| Purchases of property and equipment                                      |   | —                |   | (10 | ) |
| Music catalog additions                                                  |   | (114                  | )      | (90 | ) |
| Cash used in investing activities                                        |   | (87                   | )      | (51 | ) |
|                                                                     |   |                  |   |   |   |
| Cash flows from Financing Activities:                                    |   |                  |   |   |   |
| Borrowings on loans payable                                              |   | 1,312                 |   | 7,100 |   |
| Payments on loans payable                                                |   | (629                  | )      | (7,854 | ) |
| Cash provided by (used in) financing activities                          |   | 683                   |   | (754 | ) |
|                                                                     |   |                  |   |   |   |
| Effect of exchange rates on cash                                         |   | (71                   | )      | 123 |   |
|                                                                     |   |                  |   |   |   |
| Net decrease in cash and equivalents                                     |   | (29                   | )      | (723 | ) |
|                                                                     |   |                  |   |   |   |
| Cash and equivalents at beginning of period                              |   | 173                   |   | 798 |   |
|                                                                     |   |                  |   |   |   |
| Cash and equivalents at end of period                                    |   | $                     | 144    |   | $ | 66 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

5

----

 

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

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**1.             BUSINESSAND LIQUIDITY**

 

K-tel International, Inc. (the “Company”,“K-tel”, or the “Registrant”) was incorporated in 1968 and currently has itscorporate offices located in Maple Plain, Minnesota. Through its operatingsubsidiaries, K-tel licenses its music catalog internationally and marketsentertainment products mainly derived from its catalog through retail anddirect response marketing channels in the United States and Europe.

 

During the three months ended December 31, 2001, the Company had incomefrom continuing operations of $10,000. Additionally, the Company had a working capital deficit of $8,438,000 atDecember 31, 2001.

 

The Company’s ability tocontinue its present operations and successfully implement future expansionplans are contingent upon its ability to maintain its line of creditarrangements with K-5 Leisure Products, Inc. (See Note 3.), increase itsrevenues, and ultimately attain and sustain profitable operations. Withoutincreased revenues and sustained profitability, the cash generated from theCompany’s current operations may not be adequate to fund operations and serviceits indebtedness during fiscal 2002.  Managementis concentrating its efforts on returning the Company to profitability byfocusing on its music licensing business and limited music distribution.  However, there can be no assurance that theCompany’s business plan will be successful in this effort.  In the event the Company is unable to fundits operations and its business plan, it may be unable to continue as a goingconcern.  The financial statements donot include any adjustments that might result from the outcome of thisuncertainty.

 

SubsidiaryBankruptcy

 

In March 2001, the Company’s musicdistribution subsidiary in the United States, K-tel International (USA), Inc.,(“K-tel (USA)”) ceased operations and filed for protection under Chapter 7 ofthe United States Bankruptcy Code.  Inconnection with this filing, the assets and liabilities of K-tel (USA) havebeen removed from the books of the Company as control of the subsidiary wastransferred to the bankruptcy trustee. Management believes the Company willhave no ongoing liability related to this subsidiary as a result of the filingand the outcome of the bankruptcy proceeding. Sales of this subsidiary for the three and six month periods endedDecember 31, 2000, were $3,179,000 and $8,276,000, respectively.

 

Discontinued Operations

 

The Company’s consumer products business, which was concentrated inEurope, consisted primarily of housewares, consumer convenience items andexercise 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, theseactivities have been presented in the accompanying financial statements asdiscontinued operations. Net sales of these discontinued operations for thethree and six month periods ended December 31, 2000 were $457,000 and$3,611,000, respectively.  Theaccompanying consolidated financial statements have been prepared (andrestated, in the case of the 

 

6

----

 

2000 financial statements) to reflect the consumer products division asa discontinued operation.  The netliabilities of discontinued operations consist of assets of $1,027,000 andliabilities of $2,223,000.  The increasefrom the prior period is a result of additional claims related to thoseoperations.

 

**2.             BASIS OFPRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

Basis of Presentation - The accompanying condensed consolidated unauditedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America (“US GAAP”) forinterim financial information and with the instructions to Form 10-Q and Rule10-01 of Regulation S-X.  Accordingly,they do not include all of the information and footnotes required by US GAAPfor complete financial statements.  Inthe opinion of management, all adjustments (consisting of normal recurringadjustments) considered necessary for a fair presentation have beenincluded.  Operating results for thethree and six month periods ended December 31, 2001, are not necessarilyindicative of the results that may be expected for the year as a whole.  The unaudited condensed consolidated balancesheet for June 30, 2001 has been derived from audited consolidated financialstatements as of that date.  For furtherinformation, refer to the consolidated financial statements and footnotesthereto included in the Company’s annual report on Form 10-K for the year endedJune 30, 2001.

 

Principles of Consolidation — Theaccompanying condensed consolidated unaudited financial statements include theaccounts of K-tel International, Inc. and its domestic and foreignsubsidiaries, all of which are wholly owned. All significant intercompany accounts and transactions have beeneliminated.

 

Revenue Recognition — The Companyderives its revenue from several different sources: the sale of musiccompilations (predominately compact discs) produced by the Company and licenserevenue from the licensing of Company-owned masters.  Revenue from the music sales is recognized at the time of thesale to the customer, while license revenue is recognized when payment isreceived from customers, because prior to that date collection is notconsidered probable.  Most music salesare made with a right of return of unsold goods.  Estimated reserves for returns are established by managementbased upon historical experience and product mix and are subject to ongoingreview and adjustment by the Company. These reserves are recorded at the time of the sales and are reflectedas a reduction in revenue.

 

Cost of Goods Sold — The Companyexpenses all product manufacturing, distribution and royalty costs associatedwith the music sales as cost of goods sold. The Company also expenses royalties, commissions and amortization of itsowned masters associated with its license revenue as cost of goods sold.

 

Shipping and Handling Costs — The Companyexpenses all shipping and handling costs incurred in the shipment of goodswithin cost of goods sold.

 

Cash and Equivalents — Cash andequivalents consist principally of cash, and short-term, highly liquidinvestments with original maturities of less than ninety days.

 

Inventories — Inventories,which consist of finished goods that include all direct product costs, arevalued at the lower of cost, determined on a first-in, first-out basis, or netrealizable value.  

 

7

----

 

Owned Catalog Masters — The Companycapitalizes the costs to purchase owned masters at the time ofacquisition.  These costs are amortizedover the estimated useful life of these masters, which is generally seven yearsand represents managements’ best estimate of the average period of value.

 

Rights to Use Music Product - Certain of the Company’scompilation products are master recordings under license from record companiesand publishers.  In most instances,minimum guarantees or non-returnable advances are required to obtain thelicenses and are realized through future sales of the product.  The amounts paid for minimum guarantees ornon–returnable advances are capitalized and charged to expense as salesare made.  When anticipated sales appearto be insufficient to fully recover the minimum guarantees or non–returnableadvances, a provision against current operations is made for anticipatedlosses.  The unrealized portion ofguarantees and advances is included in royalty advances in the accompanyingconsolidated balance sheets.  Licensesare subject to audit by licensors.

 

Property and Equipment - Property and equipmentare stated at cost.  Depreciation andamortization is provided using straight line or declining balance methods overthe estimated useful lives of the assets, which range from three to nine years.

 

Long-Lived Assets — The Companyevaluates its long-lived assets quarterly, or earlier if a triggering event occurs,to determine potential impairment by comparing the carrying value of thoseassets to the related undiscounted future cash flows of the assets.  If an asset is determined to be impaired, itis written down to its estimated net realizable value.

 

Royalties - The Company has entered into license agreementswith various publishers under which it pays royalties on units sold.  The Company accrues royalties usingcontractual or statutory rates and certain estimated rates on applicable unitssold.  The contractual royalty liabilityis computed quarterly, the statutory royalty is computed monthly and theaccrued royalty balance is adjusted accordingly.  The royalty agreements are subject to audit by licensors.

 

Advertising - The Companyexpenses the costs of advertising when the advertising takes place, except fordirect response advertising, which is capitalized and amortized over itsexpected period of future benefits (usually the period remaining under arelated contract, which is 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.

 

Foreign Currency - The operations of all foreign entities aremeasured in local currencies.  Assetsand liabilities are translated into U.S. dollars at period end exchangerates.  Revenues and expenses aretranslated at the average exchange rates prevailing during the period.  Adjustments resulting from translating thefinancial statements of foreign entities into U.S. dollars are recorded as aseparate component of shareholders’ equity.

 

Stock–based Compensation - The Company accounts forstock-based awards to employees using the intrinsic value method and recognizescompensation expense for certain stock based awards granted to employees.

 

Income Taxes - Deferred income taxes are provided for temporarydifferences between the financial reporting basis and tax basis of theCompany’s assets and liabilities at currently enacted tax rates.

 

8

----

 

NetLoss Per Share - Basic and diluted net loss per share have beencomputed by dividing net loss by the weighted average number of sharesoutstanding during the period. For all periods presented, common stockequivalents were excluded from the per share calculation as the effect would beantidilutive.  Options to purchase2,331,445 and 2,776,688 shares of common stock, with weighted average exerciseprices of $5.88 and $6.27 for the six month periods and options to purchase2,331,673 and 2,741,688 with weighted average exercise prices of $5.88 and$6.25 for the three month periods ended December 31, 2001 and 2000 wereexcluded from the computation of common share equivalents for the respectiveperiods as they were antidilutive.

 

Use of Estimates - Preparing consolidated financialstatements in conformity with 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 reportingperiod.  Actual results could differfrom those estimates used by management.

 

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

 

K-tel has a written Line of Credit Agreementwith K-5 Leisure Products, Inc. (“K-5”), an affiliate controlled by PhilipKives, the Chairman of the Board and Chief Executive Officer of K-tel. Underthe terms of the agreement (the “K-5 facility”), K-5 agreed to make availableup to $8,000,000 on a revolving basis. The loan bears interest at a variable rate based upon the “base rate” ofa lending institution (4.75% at December 31, 2001), expires July 20, 2005, andis subordinated to the Foothill Loan (see below).  The loan agreement between K-tel and K-5 contains the samecovenants as the Foothill loan agreement. K-tel has pledged the stock of its foreign subsidiaries as collateralfor the loan, and the loan carries a subordinated position to the formerFoothill Loan on all other assets of the Company.  K-tel had outstanding balances of $4,807,000 and $5,490,000, asof June 30 and December 31, 2001 under the K-5 facility.

 

In addition, K-tel has a second loanagreement with K-5, under which K-5 assumed all of the debtor’s rights underthe former Foothill Loan pursuant to the Assignment and Acceptance Agreementdated February 27, 2001.  This loan,which has been extended through July 20, 2005, provides for a $10,000,000credit facility consisting of a $4,000,000 term loan due upon expiration, and a$6,000,000 revolving facility under which borrowings are limited to a percentof eligible receivables.  Borrowingsunder the facility bear interest at a variable rate based on a “base rate” of alending institution plus 1% (5.75% at December 31, 2001) and are collateralizedby the assets of certain Company subsidiaries in the United States, includingaccounts receivable, inventories, equipment, music library and generalintangibles.  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 andDecember 31, 2001, $4,000,000 was outstanding under the term loan and therewere no borrowings under the revolving facility.  At December 31, 2001, K-tel has obtained a waiver from K-5 for itsdefault under the covenants, limitations and restrictions of the creditagreement.

 

9

----

 

**4.             COMMITMENTSAND CONTINGENCIES**

 

Class Action Suit

 

K-tel and certain of its current and former officers and directors aredefendants in *In re K-tel International,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, theplaintiffs filed an amended consolidated class action complaint that challengesthe accuracy of certain public disclosures made by K-tel regarding itsfinancial condition during the period from May 1998 through November 1998.  The plaintiffs assert claims under thefederal securities laws and seek damages in an unspecified amount as well ascosts, including attorneys’ fees and any other relief the Court deems just andproper.  K-tel moved to dismiss thecomplaint, and on July 31, 2000, the United States District Court granted theCompany’s motion to dismiss. The Court also barred further actions by theplaintiffs and denied plaintiffs’ request to amend the complaint in order torefile the complaint in the future.  Theplaintiff appealed, and the court of appeals heard the matter in October 2001.The Company is waiting for a court ruling regarding this appeal. K-tel has twoinsurance policies providing coverage of up to $20,000,000, which is subject tothe insurers’ reservations of legal rights under the applicable policies. Undertheir reservations of rights, the insurers could contest their obligations toindemnify the Company and its directors and officers.  K-tel may have an obligation to indemnify the officers anddirectors named in this lawsuit.

 

Early v. K-tel International, Inc.

 

On January 11, 1999, the Company was named in a lawsuit entitled *ChristopherEarly vs. K-tel International, Inc., et al*, brought in the CircuitCourt of Cook County, Illinois, against the Company and certain of itssubsidiaries, by Christopher Early.  Thesuit also names as defendants certain other manufacturers, distributors and a numberof nationwide retailers.  The plaintiffseeks 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 alleges thatdefendants engaged in deceptive and misleading packaging of cassette tapes andcompact discs by failing to give proper notice to consumers that the songscontained therein are not the original recordings by the original artists.  The complaint also alleges consumer fraud,deceptive and unfair practices, and fraud in connection with websiteadvertising and marketing.  Similarlitigation against the Company, brought against the Company by Mr. Early in1997, was dismissed by a United States Federal Court in 1999 on jurisdictionalgrounds.  The Company denies that itmislabeled cassette tapes and compact discs or engaged in fraudulent ordeceptive conduct and intends to defend vigorously the purported action, whichseeks an undetermined amount of compensatory damages and punitive damages inthe amount of $10 million, an injunction and costs incurred in the litigation,including attorneys fees.  The Companyfiled a motion to dismiss the complaint on June 8, 2000. On February 16, 2001,the court dismissed the complaint against the other manufacturers, distributorsand nationwide retailers, but allowed the case to continue against theCompany.  While discovery has not yetbegun and no assurance can be given that the Company will be successful indefending this action, the Company believes it has meritorious defenses to theplaintiff’s claims.

 

10

----

 

RTL Shopping S. A.

 

The Company has been named in a lawsuit filed in France brought byRTL9, a French cable TV station. Initially, RTL9 was named as a defendant in asuit brought by a competitor of K-tel Marketing Ltd., alleging that RTL9 ran acommercial for K-tel Marketing which presented a device under brand namesalleged to infringe on the competitor’s own trademarks and translated anEnglish language script indicating that the product was “just like” or “as goodas” others into “better than” in French, contrary to French law. The suitalleged trademark infringement, unfair competition, illicit comparativeadvertising and passing off. RTL9 then sued K-tel Marketing on October 4, 2000,pursuant to an indemnification provision the parties had entered into.Subsequently, K-tel Marketing went into liquidation and RTL9 filed a suit inDecember 2000 against K-tel International, Inc. under its agreement to guarantypayment for the commercial time. On May 28, 2001, RTL9 presented documents incourt identifying K-tel International (USA), Inc. as a target of its claim. OnSeptember 3, 2001 the Company filed documents disputing the claim and advisingthe court of K-tel (USA)’s Chapter 7 bankruptcy filing. At a procedural hearingon December 3, 2001, RTL9 filed its brief in response to the Company’sfiling.  In response, the Company fileda further brief, which has yet to be heard. 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, LLP vK-tel International, Inc.

 

Hollins & Fields, LLP (H&F) sublet a portion of the Company’sformer executive offices in Los Angeles. On September 21, 2001, H&F sued for breach of contract andconversion, seeking damages in excess of $150,000.  On November 26, 2001, the Court dismissed the punitive damageclaim in the amount of $100,000.  TheCompany has filed a defense and counterclaim. Discovery is ongoing and no assurances can be given that the Companywill be successful in defending this action. The Company believes it has meritorious defenses to the plaintiff’sclaims.

 

Other Litigation and Disputes

 

K-tel is alsoinvolved in other legal actions in the ordinary course of its business.  With all litigation matters, managementconsiders their likelihood of loss based on the facts and circumstances.  When management determines that a loss isprobable and the amount of loss can be reasonably estimated, such amount isrecorded as a liability.  Although theoutcome of any such legal actions cannot be predicted, in the opinion ofmanagement there is no legal proceeding pending or asserted against orinvolving K-tel for which the outcome is likely to have a material adverseeffect upon the consolidated financial position or results of operations ofK-tel.

 

Subsidiary Bankruptcy

In March 2001, the Company’smusic distribution subsidiary in the United States, K-tel (USA), ceasedoperations and filed for protection under Chapter 7 of the United StatesBankruptcy Code.  Although thebankruptcy court has not yet confirmed the formal plan of liquidation, theCompany has not been informed by the trustee or its counsel of any plan by thecourt to attempt to hold it or any of its subsidiaries liable for any of thecommitments of K-tel (USA).  Managementbelieves the Company will have no ongoing material liability related to thissubsidiary as a result of the filing and the outcome of the bankruptcyproceeding.

 

11

----

 

**5.             SEGMENTINFORMATION**

 

The Company markets and distributesentertainment products internationally. K-tel’s businesses are organized, managed and internally reported as twosegments: retail music sales and music licensing.  These segments are based on differences in products, customertype and sales and distribution methods.

 

The retail music segment consists primarilyof the sales of pre–recorded music both from the Company’s music mastercatalog and under licenses obtained from other record companies. The Companysells compact discs and DVD’s directly to retailers, wholesalers and rackservice distributors which stock and manage inventory within music departmentsfor retail stores.

 

In the licensing segment, the Companylicenses the rights to its master music catalog, consisting of originalrecordings and re–recordings of music from the 1950’s through today, tothird parties world–wide for use in albums, films, television programs,and commercials, for either a flat fee or a royalty based on the number ofunits sold.

 

Operating profits or losses of these segmentsinclude an allocation of general corporate expenses.  Certain financial information on the Company’s continuingoperating segments is as follows:

 
| **Six Months Ended December  31,** |   | **Music** |   | **Licensing** |   | **Corporate Elimination** |   | **Total Company** |   |
|------------------------------------|--------|-----------|--------|---------------|--------|---------------------------|--------|-------------------|--------|
| ***(in thousands)***               |   |      |   |          |   |                      |   |              |   |
|                               |   |      |   |          |   |                      |   |              |   |
| Net Sales                          | 2001   |      | $      | 2,303         |   | $                         | 1,548  |              | $      | (366 | ) | $ | 3,485 |   |
|                               | 2000   |      | 9,705  |          | 1,588  |                      | (242   | )                 | 11,051 |   |
|                               |   |      |   |          |   |                      |   |              |   |
| Operating Income (Loss)            | 2001   |      | $      | (630          | )      | $                         | 380    |              | — |   | $ | (250 | ) |
|                               | 2000   |      | (2,804 | )             | 323    |                      | — |              | (2,481 | ) |
|                               |   |      |   |          |   |                      |   |              |   |
|                                    |        |           |        |               |        |                           |        |                   |        |  |  |  |  |  |

 
| **Three  Months Ended December 31,** |   |   |   |   |   |   |   |   |   |
|--------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
|                                 |   |   |   |   |   |   |   |   |   |
| Net Sales                            | 2001   |   | $      | 1,547  |   | $      | 764    |   | $      | (207 | ) | $ | 2,104 |   |
|                                 | 2000   |   | 4,157  |   | 778    |   | (55    | )      | 4,880  |   |
|                                 |   |   |   |   |   |   |   |   |   |
| Operating Income (Loss)              | 2001   |   | $      | (57    | )      | $      | 205    |   | — |   | $ | 148 |   |
|                                 | 2000   |   | (1,654 | )      | 226    |   | — |   | (1,428 | ) |
|                                      |        |        |        |        |        |        |        |        |        |  |  |  |  |  |

 

 

12

----

 

**ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**General**

 

Through its operatingsubsidiaries, K-tel licenses its music catalog internationally and marketsentertainment products mainly derived from its catalog in the United States andEurope through retail and direct response marketing channels.

 

For this analysis, thefollowing changes in the Company’s business should be considered:  K-tel closed the operations of its Germansubsidiary, Dominion Vertriebs GmbH, in June 2000; one of its subsidiaries inthe United Kingdom, K-tel Marketing Ltd., in November 2000; and a U.S.subsidiary, K-tel Consumer Products, Inc., in February 2001. These threeclosings represent the discontinuation of the Company’s consumer productsdivision and accordingly have been presented in the accompanying financialstatements as discontinued operations. In addition, in March 2001, the Company’s music distribution subsidiaryin the United States, K-tel (USA) ceased operations and filed for protectionunder Chapter 7 of the United States Bankruptcy Code.

 

Through another subsidiary, K-tel is implementing amore-focused method of distribution that targets the strengths of fewerindividual retailers and supplies products suited to each retailer’s specificneeds. These new products are derived from the Company’s master music catalog,it is anticipated that this will allow the Company to realize more competitiveprofit margins.

 

#### **THREE MONTHS ENDED DECEMBER 31, 2001 VERSUSDECEMBER 31, 2000**

 

Net sales for the threemonths ended December 31, 2001 were $2,104,000, a decline of 56.9% from salesof $4,880,000 for the quarter ended December 31, 2000. This sales decline canbe attributed to the cessation of operations of the Company’s domestic musicdistribution subsidiary, K-tel (USA), which had sales of $3,179,000 during theprior period.  The loss for the threemonths ended December 31, 2001 was $107,000, or $.01 per share, compared to aloss of $4,832,000, or $.47 per share, for the three months ended December 31,2000.

 

General corporate expensesof $113,000 and $613,000 for the three months ended December 31, 2001 and 2000have been allocated to the business segments.

 

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

 

#### **BUSINESSSEGMENT RESULTS**

 

#### **Music**

 

Sales in the music segmentwere $1,547,000 for the three months ended December 31, 2001 compared to$4,157,000 for the three months ended December 31, 2000, a decrease of$2,610,000, or 62.8%.

 

While European salesincreased $250,000, domestic music sales decreased $2,860,000.  The domestic business had been comprisedprimarily of sales of music compilations produced by K-tel and the sales anddistribution of other record labels. Sales declined as K-tel (USA) ceased operations and filed for bankruptcyin March 2001.  Sales during the threemonths ended 

 

13

----

 

December 31, 2001 are inanother domestic subsidiary that markets products derived from the Company’sproprietary master music catalog.

 

Cost of goods sold in themusic segment decreased to 41.6% of sales for the three months ended December31, 2001 compared to 74.9% of sales for the three months ended December 31,2000.  This reflects the Company’scontinuing efforts to reduce product costs and eliminate products that do notgenerate an acceptable gross profit. Advertising expenses within the segment, which consist primarily ofco-operative advertising payments, trade advertising and promotions, decreasedto $28,000 and were approximately 1.8% of sales for the three months endedDecember 31, 2001 compared to $50,000, or 1.3% of sales for the three monthsended December 31, 2000.  This decreaseis related to the reduced levels of advertising done during the current period.  Selling, general and administrative expenseswere $934,000, or 60.4% of sales for the three months ended December 31, 2001compared to $2,487,000, or 63.3% of sales for the three months ended December31, 2000.  The reduction of $1,534,000is mainly because of the closure of the former domestic music distributionsubsidiary.  The costs in excess ofsales during the three months ended December 31, 2001 reflect the start upcosts of implementing the Company’s new music distribution strategy.  As a result, the music segment incurred anoperating loss of $57,000 for the three months ended December 31, 2001 comparedto an operating loss of $1,654,000 for the three months ended December 31,2000.

 

**Licensing**

 

Licensing revenue was$764,000 in the three months ended December 31, 2001 compared to $778,000 inthe three months ended December 31, 2000, a decrease of 1.8%.  Revenue in Europe decreased $166,000 as theCompany began to evaluate its licensing activities with the goal of increasingprofitability.  Included in the segmentrevenue in the three months ended December 31, 2001 and 2000 were approximately$207,000 and $55,000 of intercompany revenues, respectively, which areeliminated on the accompanying financial statements.  Operating income in the licensing segment was $205,000 for thethree months ended December 31, 2001 and $226,000 for the three months endedDecember 31, 2000, a decrease of 9.3%.

 

 

#### **SIX MONTHS ENDED DECEMBER 31, 2001 VERSUSDECEMBER 31, 2000**

 

Net sales for the six monthsended December 31, 2001 were $3,485,000, a decline of 68.5% from sales of$11,051,000 for the six months ended December 31, 2000.  The sales decline can be attributed to thecessation of operations of the Company’s domestic music distributionsubsidiary, K-tel (USA), which had sales of $8,276,000 during that period.  The loss for the six months ended December31, 2001 was $611,000, or $.04 per share, compared to a loss of $7,361,000, or$.71 per share, for the six months ended December 31, 2000.

 

General corporate expensesof $477,000 and $1,110,000 for the six months ended December 31, 2001 and 2000have been allocated to the business segments.

 

The following sections discuss the results ofcontinuing operations by business segment.

 

14

----

 

#### **BUSINESSSEGMENT RESULTS**

 

#### **Music**

 

Sales in the music segmentwere $2,303,000 for the six months ended December 31, 2001 compared to$9,705,000 for the six months ended December 31, 2000, a decrease of$7,402,000, or 76.3%.

 

While European salesincreased $371,000, domestic music sales decreased $7,773,000.  The domestic business had been comprisedprimarily of sales of music compilations produced by K-tel and the sales anddistribution of other record labels. Sales declined as K-tel (USA) ceased operations and filed for bankruptcyin March 2001.  Sales during the sixmonths ended December 31, 2001 were attributed to another domestic subsidiarythat markets products derived from the Company’s proprietary master musiccatalog.

 

Cost of goods sold in themusic segment decreased to 49.7% of sales for the six months ended December 31,2001 compared to 77.2% of sales for the six months ended December 31,2000.  This decrease reflects theCompany’s continuing efforts to reduce product costs and eliminate productsthat do not generate an acceptable gross profit.  Advertising expenses within the segment, which consist primarilyof co-operative advertising payments, trade advertising and promotions,decreased to $51,000 and was approximately 2.2% of sales for the six monthsended December 31, 2001 compared to $173,000, or 1.9% of sales for the sixmonths ended December 31, 2000.  Thisdecrease was related to the reduced levels of advertising done during theperiod.  Selling, general andadministrative expenses were $1,737,000, or 75.4% of sales for the six monthsended December 31, 2001 compared to $4,300,000, or 44.3% of sales for the sixmonths ended December 31, 2000.  Thereduction of $2,563,000, or 59.6%, is mainly due to the closure of the formerdomestic music distribution subsidiary. The costs in excess of sales during the six months ended December 31,2001 reflect the start up costs of implementing the Company’s new musicdistribution strategy.  As a result, themusic segment incurred an operating loss of $630,000 for the six months endedDecember 31, 2001 compared to an operating loss of $2,804,000 for the sixmonths ended December 31, 2000.

 

**Licensing**

 

Licensing revenue was$1,548,000 in the six months ended December 31, 2001 compared to $1,588,000 inthe six months ended December 31, 2000, a decrease of 2.5%.  Revenue in Europe decreased $230,000 as theCompany began to evaluate its licensing activities with the goal of increasingprofitability.  Included in the segmentrevenue in the six months ended December 31, 2001 and 2000 were approximately$366,000 and $242,000 of intercompany revenues, respectively, which areeliminated on the accompanying financial statements.  Operating income in the licensing segment was $380,000 for thesix months ended December 31, 2001 and $323,000 for the six months ended December31, 2000, an increase of 17.6%.

 

**B. LIQUIDITY AND CAPITAL RESOURCES**

 

K-tel has primarily funded its operations to datesecured loans from K-5 (See Note 3 to the Condensed Consolidated FinancialStatements).  The Company used $554,000and $50,000 of cash in operating activities during the six month periods endedDecember 31, 2001 and December 31, 2000, respectively.

 

15

----

 

The Company’s ability to continue its presentoperations and successfully implement future expansion plans is contingent uponits ability to maintain its line of credit arrangements with K-5, increase itsrevenues, and ultimately attain and sustain profitable operations. Withoutincreased revenues and sustained profitability, the cash generated from theCompany’s current operations may not be adequate to fund operations and serviceits indebtedness during fiscal 2002. Management is concentrating its efforts on returning the Company toprofitability by focusing on its music licensing business and limited musicdistribution.  However, there can be noassurance that the Company’s business plan will be successful in thiseffort.  In the event the Company isunable to fund its operations and its business plan, it may be unable tocontinue as a going concern.  Thefinancial statements do not include any adjustments that might result from theoutcome of this uncertainty.

**Important Factors Relating toForward Looking Statements**

 

Information in this Form 10-Q of anon-historical nature relates to future events and results of the Company(including certain projections and business trends) that are “forward-lookingstatements” as defined in the Private Securities Litigation Reform Act of 1995.The use of terminology such as “believe,” “may,” “will,” “expect,”“anticipate,” “estimate,” “should,” “continue,” and other variations thereof orcomparable terminology may identify such forward-looking statements.  Actual results and performance may differmaterially from expressed forward looking statements because of certain risksand uncertainties, including but not limited to, changes in political andeconomic conditions; demand for and market acceptance of new and existingproducts; dependence on strategic alliance partners, suppliers anddistributors; the outcome of K-tel (USA)’s bankruptcy; technological changesand difficulties; availability of financing and other risks discussed in theCompany’s 10-K report for the fiscal year ended June 30, 2001 filed with theSecurities and Exchange Commission. The Company undertakes no obligation topublicly release the result of any revisions to these forward-lookingstatements, except as required by law in the normal course of its publicdisclosure practices.

 

**ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

There have been no materialchanges in the Company’s market risk during the six months ended December 31,2001.  For additional information, referto page 12 of the Company’s annual report on Form 10-K for the fiscal yearended June 30, 2001.

 

 

#### **PART II**

 

 

#### **ITEM 1. LEGAL PROCEEDINGS**

 

Class Action Lawsuit

 

K-tel and certain of its current and former officers and directors aredefendants in *In re K-tel International,Inc. Securities Litigation*, No. 98-CV-2480.  This action consolidates twenty three purportedclass actions that were initially filed in various United States DistrictCourts in November 1998, and were subsequently transferred to, and consolidatedin, the United States District Court for the District of Minnesota.  On July 19, 1999, the plaintiffs filed anamended consolidated class action complaint that challenges the accuracy ofcertain public disclosures made by K-tel regarding its financial conditionduring the period May 1998 through November 1998.  The plaintiffs assert claims under the federal securities lawsand seek damages in an unspecified amount as well as costs, includingattorneys’ 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 States District Court granted the Company’s motionto dismiss. The Court also barred further actions by the plaintiffs and deniedplaintiffs’ request to amend the complaint in order to refile the complaint inthe future.  The plaintiff appealed, andthe court of appeals heard the matter in October 2001. The Company is waitingfor a court ruling regarding this appeal. K-tel has two insurance policies providing coverage of up to$20,000,000, which is subject to the insurers’ reservations of legal rightsunder the applicable policies. Under their reservations of rights, the insurerscould contest their obligations to indemnify the Company and its directors andofficers.  K-tel may have an obligationto indemnify the officers and directors named in this lawsuit.

 

Early v. K-tel International, Inc.

 

On January 11, 1999, The Company was named in a lawsuit entitled *ChristopherEarly vs. K-tel International, Inc., et al*, brought in the CircuitCourt of Cook County, Illinois, against the Company and certain of itssubsidiaries by Christopher Early.  Thesuit also names as defendants certain other manufacturers, distributors and anumber of nationwide retailers.  Theplaintiff seeks damages on behalf of himself and a purported class ofpurchasers of cassette tapes and compact discs produced, distributed and/orsold by the defendants.  The claimalleges that defendants engaged in deceptive and misleading packaging ofcassette tapes and compact discs by failing to give proper notice to consumers thatthe songs contained therein are not the original recordings by the originalartists.  The complaint also allegesconsumer fraud, deceptive and unfair practices, and fraud in connection withwebsite advertising and marketing. Similar litigation against the Company, brought against the Company byMr. Early in 1997, was dismissed by a United States Federal Court in 1999 onjurisdictional grounds.  The Companydenies that it mislabeled cassette tapes and compact discs or engaged infraudulent or deceptive conduct and intends to defend vigorously the purportedaction, which seeks an undetermined amount of compensatory damages and punitivedamages in the amount of $10 million, an injunction and costs incurred in thelitigation, including attorneys fees. The Company filed a motion to dismiss the complaint on June 8, 2000. OnFebruary 16, 2001, the court dismissed the complaint against the othermanufacturers, distributors and nationwide retailers, but allowed the case tocontinue against the Company. While discovery has not yet begun and no assurancecan be given that the Company will be successful in defending this action, theCompany believes it has meritorious defenses to the plaintiff’s claims.

* *

16

----

 

RTL Shopping  S. A.

 

The Company has been named in a lawsuit filed in France brought byRTL9, a French cable TV station. Initially, RTL9 was named as a defendant in asuit brought by a competitor of K-tel Marketing Ltd., alleging that RTL9 ran acommercial for K-tel Marketing which presented a device under brand namesalleged to infringe on the competitor’s own trademarks and translated anEnglish language script indicating that the product was “just like” or “as goodas” others into “better than” in French, contrary to French law. The suitalleged trademark infringement, unfair competition, illicit comparativeadvertising and passing off. RTL9 then sued K-tel Marketing on October 4, 2000,pursuant to an indemnification provision the parties had entered into.Subsequently, K-tel Marketing went into liquidation and RTL9 filed a suit inDecember 2000 against K-tel International, Inc. under its agreement to guarantypayment for the commercial time. On May 28, 2001, RTL9 presented documents incourt identifying K-tel International (USA), Inc. as a target of its claim. OnSeptember 3, 2001 the Company filed documents disputing the claim and advisingthe court of K-tel (USA)’s Chapter 7 bankruptcy filing. At a procedural hearingon December 3, 2001, RTL9 filed its brief in response to the Company’s filing.  In response, the Company filed a furtherbrief, which has yet to be heard.  Theaction 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, LLP vK-tel International, Inc.

 

Hollins & Fields, LLP (H&F) sublet a portion of the Company’sformer executive offices in Los Angeles. On September 21, 2001, H&F sued for breach of contract andconversion, seeking damages in excess of $150,000.  On November 26, 2001, the Court dismissed the punitive damageclaim in the amount of $100,000.  TheCompany has filed a defense and counterclaim. Discovery is ongoing and no assurances can be given that the Companywill be successful in defending this action. The Company believes it has meritorious defenses to the plaintiff’sclaims.

 

#### **Other Litigation and Disputes**

 

K-tel is alsoinvolved in other legal actions in the ordinary course of its business.  With all litigation matters, managementconsiders their likelihood of loss based on the facts and circumstances.  When management determines that a loss isprobable and the amount of loss can be reasonably estimated, such amount isrecorded as a liability.  Although theoutcomes of any such legal actions cannot be predicted, in the opinion ofmanagement there is no legal proceeding pending or asserted against orinvolving K-tel for which the outcome is likely to have a material adverseeffect upon the consolidated financial position or results of operations ofK-tel.

 

 

17

----

 

## **ITEM6.  EXHIBITSAND REPORTS ON FORM 8-K**

 

 

(a)                                  EXHIBIT INDEX

 

10.1                           Amendment toCredit Agreement and Note

 

10.2                           Amendment toLoan Agreement and Security Agreement

 

(b)                                 REPORTS ON FORM8-K

 

There were no reports filedunder Form 8-K by the Company during the three month period ended December 31,2001.

 

 

 

18

----

 

SIGNATURES

 

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
|                     |   |   |   |   |                                  |   |
|--------------------------|--------|--------|--------|--------|---------------------------------------|--------|
|                     |   |   |   |   | K-TEL  INTERNATIONAL, INC.            |   |
|                     |   |   |   |   | REGISTRANT                            |   |
|                     |   |   |   |   |                                  |   |
|                     |   |   |   |   |                                  |   |
|                     |   |   |   |   |                                  |   |
|                     |   |   |   |   |                                  |   |
|                     |   |   |   |   |                                  |   |
|                     |   |   |   |   |                                  |   |
| Dated: February 13, 2002 |   |   |   |   | /S/ PHILIP KIVES                      |   |
|                     |   |   |   |   | PHILP KIVES                           |   |
|                     |   |   |   |   | CHAIRMAN AND CHIEF  EXECUTIVE OFFICER |   |
|                     |   |   |   |   |                                  |   |
|                     |   |   |   |   |                                  |   |
|                     |   |   |   |   |                                  |   |
|                     |   |   |   |   |                                  |   |
| Dated: February 13, 2002 |   |   |   |   | /S/ DENNIS WARD                       |   |
|                     |   |   |   |   | DENNIS  WARD                          |   |
|                     |   |   |   |   | CHIEF FINANCIAL OFFICER               |   |
|                     |   |   |   |   | (principal accounting  officer)       |   |

 

 

19

----