##### ** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

**FORM 10-Q**

**(MarkOne)**

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

**Forthe quarterly period ended December 31, 2006**

**OR**

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

**Forthe transition period from                to                **

**CommissionFile Number:  1-07115**

**K-TEL INTERNATIONAL, INC.**

(Exact name of registrant as specified in its charter)

| **Minnesota**                                    |   | **41-0946588**                        |
|--------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of                 |   | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)                  |   |                                  |
|                                             |   |                                  |
| **2491  Xenium Lane North, Plymouth, Minnesota** |   | **55441**                             |
| (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 beensubject to such filing requirements for the past 90 days.

Yes  x    No  o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large AcceleratedFiler  o                            AcceleratedFiler  o                            Non-AcceleratedFiler  x

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

Yes  o    No  x

As of February 13, 2007,the registrant had 13,653,738 shares of Common Stock outstanding.

 

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

**FORM 10-Q**

**FOR THE THREE AND SIX MONTH PERIODS**

**ENDED DECEMBER 31, 2006**

INDEX
| PART I.                     | Financial Information (Unaudited): |                                                                                                            |
|-----------------------------|------------------------------------|-----------------------------------------------------------------------------------------------------------------|
|                        |                               |                                                                                                            |
|                        | Item 1.                            | Financial Statements                                                                                            |   |
|                        |                               |                                                                                                            |   |
|                        |                               | Condensed Consolidated Balance Sheets as of  December 31, 2006 and June 30, 2006                                |   |
|                        |                               |                                                                                                            |
|                        |                               |                                                                                                            |   |
|                        |                               | Condensed Consolidated Statements of Operations  for the Three and Six Months Ended  December 31, 2006 and 2005 |   |
|                        |                               |                                                                                                            |
|                        |                               |                                                                                                            |
|                        |                               |                                                                                                            |   |
|                        |                               | Condensed Consolidated Statements of Cash Flows  for the Six Months Ended December 31, 2006 and 2005            |   |
|                        |                               |                                                                                                            |
|                        |                               |                                                                                                            |   |
|                        |                               | Notes to Condensed 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                                                     |   |
|                        |                               |                                                                                                            |   |
|                        | Item  4.                           | Controls  and Procedures                                                                                        |   |
|                        |                               |                                                                                                            |   |
| PART II. Other Information: |
|                        |
|                        | Item 1.                            | Legal Proceedings                                                                                               |   |
|                        |                               |                                                                                                            |   |
|                        | Item 6.                            | Exhibits                                                                                                        |   |
|                        |                               |                                                                                                            |   |
| Signatures                  |                               |
|                        |                               |                                                                                                            |   |
| Index to Exhibits           |                               |

 

**SAFE HARBOR STATEMENT UNDER THE**

**PRIVATESECURITIES LITIGATION REFORM ACT OF 1995**

Certainstatements of a non-historical nature under the caption “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andelsewhere in this Form 10-Q constitute “forward-looking statements” within themeaning of the Private Securities Litigation Reform Act of 1995. Suchforward-looking statements may be identified by the use of terminology such as “may,”“will,” “expect,” “anticipate,” “estimate,” “should,” or “continue” or thenegative thereof or other variations thereon or comparable terminology. Suchforward-looking statements are subject to certain risks and uncertainties thatcould cause actual results to differ materially from historical results or fromthose results currently anticipated or projected. Such factors include, amongother things, the following: changes in consumer purchasing; demand for andmarket acceptance of new and existing products; the impact from competition forrecorded music; the outcome of legal proceedings; dependence on suppliers and distributors;success of marketing and promotion efforts; technological changes anddifficulties; availability of financing; foreign currency variations; generaleconomic, political and business conditions; and other matters. We undertake noobligation to release publicly the result of any revisions to theseforward-looking statements, except as required by law.

2

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

**CONDENSED CONSOLIDATED BALANCESHEETS - UNAUDITED**

*(in thousands — except share data*)
| ** **                                                                                                                       | ** ** | **December 31,  2006** | ** ** | **June 30,  2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
|                                                                                                                             |       |                        |       |                    |       |
| ASSETS                                                                                                                           |       |                        |       |                    |       |
|                                                                                                                             |       |                        |       |                    |       |
|  Current assets:                                                                                                            |       |                        |       |                    |       |
| Cash and cash  equivalents                                                                                                       |       | $                           | 1,690      |                    | $          | 1,689 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $2 at December 31 and  June 30                                   |       | 604                         |       | 601                     |       |
| Inventories                                                                                                                      |       | 377                         |       | 390                     |       |
| Royalty advances                                                                                                                 |       | 7                           |       | 7                       |       |
| Prepaid expenses  and other                                                                                                      |       | 225                         |       | 194                     |       |
| Total current  assets                                                                                                            |       | 2,903                       |       | 2,881                   |       |
|                                                                                                                             |       |                        |       |                    |       |
| Property and equipment,  net of accumulated depreciation and amortization of $330 at December 31 and  $306 at June 30            |       | 52                          |       | 55                      |       |
|                                                                                                                             |       |                        |       |                    |       |
| Owned catalog masters,  net of accumulated amortization of  $3,356 at December 31 and $3,277 at June 30                     |       | 261                         |       | 336                     |       |
|                                                                                                                             |       | $                           | 3,216      |                    | $          | 3,272 |   |
|                                                                                                                             |       |                        |       |                    |       |
| LIABILITIES AND  SHAREHOLDERS’ DEFICIT                                                                                      |       |                        |       |                    |       |
| Current  liabilities:                                                                                                            |       |                        |       |                    |       |
| Notes payable to  affiliate and other                                                                                            |       | $                           | 12,812     |                    | $          | 12,098 |   |
| Accounts payable                                                                                                                 |       | 863                         |       | 1,206                   |       |
| Accrued  royalties                                                                                                               |       | 2,083                       |       | 1,793                   |       |
| Reserve for  returns                                                                                                             |       | 55                          |       | 126                     |       |
| Net liabilities  of discontinued operations                                                                                      |       | 23                          |       | 31                      |       |
| Total current  liabilities                                                                                                       |       | 15,836                      |       | 15,254                  |       |
|                                                                                                                             |       |                        |       |                    |       |
| Shareholders’ deficit:                                                                                                      |       |                        |       |                    |       |
| Common stock —  50,000,000 shares authorized; par value $.01; 13,653,738 issued and  outstanding at December 31 and June 30 |       | 136                         |       | 136                     |       |
| Additional  paid-in capital                                                                                                      |       | 21,292                      |       | 21,292                  |       |
| Accumulated  deficit                                                                                                             |       | (33,853                     | )          | (33,134                 | )          |
| Accumulated  other comprehensive loss                                                                                            |       | (195                        | )          | (276                    | )          |
| Total  shareholders’ deficit                                                                                                |       | (12,620                     | )          | (11,982                 | )          |
|                                                                                                                             |       | $                           | 3,216      |                    | $          | 3,272 |   |

 

The accompanyingnotes are an integral part of these financial statements.

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

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS - UNAUDITED**

*(in thousands - except per sharedata)*

 
| ** **                                                                       | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                             |       |                                                |       |                                              |       |   |   |   |   |
|  Net sales                                                                  |       | $                                                   | 1,009      |                                              | $          | 1,302 |   | $ | 1,897 |   | $ | 2,498 |   |
|                                                                             |       |                                                |       |                                              |       |   |   |   |   |
| Costs and  expenses:                                                             |       |                                                |       |                                              |       |   |   |   |   |
| Cost of goods sold                                                               |       | 412                                                 |       | 580                                               |       | 699 |   | 1,085 |   |
| Advertising                                                                      |       | 56                                                  |       | 68                                                |       | 119 |   | 88 |   |
| Selling, general and administrative                                              |       | 661                                                 |       | 588                                               |       | 1,311 |   | 1,331 |   |
| Total costs and expenses                                                         |       | 1,129                                               |       | 1,236                                             |       | 2,129 |   | 2,504 |   |
| Operating income  (loss)                                                         |       | (120                                                | )          | 66                                                |       | (232 | ) | (6 | ) |
|                                                                             |       |                                                |       |                                              |       |   |   |   |   |
| Other expense:                                                                   |       |                                                |       |                                              |       |   |   |   |   |
| Interest expense                                                                 |       | (244                                                | )          | (212                                              | )          | (483 | ) | (399 | ) |
| Other expense, net                                                               |       | —                                              |       | (19                                               | )          | (4 | ) | (21 | ) |
| Total other expense                                                              |       | (244                                                | )          | (231                                              | )          | (487 | ) | (420 | ) |
|                                                                             |       |                                                |       |                                              |       |   |   |   |   |
| Loss from  continuing operations                                                 |       | (364                                                | )          | (165                                              | )          | (719 | ) | (426 | ) |
|                                                                             |       |                                                |       |                                              |       |   |   |   |   |
| Discontinued  operations:                                                        |       |                                                |       |                                              |       |   |   |   |   |
| Loss from discontinued operations, net of taxes                                  |       | —                                              |       | —                                            |       | — |   | (3 | ) |
|                                                                             |       |                                                |       |                                              |       |   |   |   |   |
| Net loss                                                                         |       | $                                                   | (364       | )                                                 | $          | (165 | ) | $ | (719 | ) | $ | (429 | ) |
|                                                                             |       |                                                |       |                                              |       |   |   |   |   |
| Loss per share –  basic and diluted:                                        |       |                                                |       |                                              |       |   |   |   |   |
| Continuing operations                                                            |       | $                                                   | (.03       | )                                                 | $          | (.01 | ) | $ | (.05 | ) | $ | (.03 | ) |
| Discontinued operations                                                          |       | —                                              |       | —                                            |       | — |   | — |   |
| Net loss                                                                         |       | $                                                   | (.01       | )                                                 | $          | (.01 | ) | $ | (.05 | ) | $ | (.03 | ) |
|                                                                             |       |                                                |       |                                              |       |   |   |   |   |
|  Shares used in the calculation of loss per  share – basic and diluted |       | 13,654                                              |       | 13,654                                            |       | 13,654 |   | 13,654 |   |
|                                                                             |       |                                                |       |                                              |       |   |   |   |   |
| Comprehensive  loss:                                                             |       |                                                |       |                                              |       |   |   |   |   |
|  Net loss                                                                   |       | $                                                   | (364       | )                                                 | $          | (165 | ) | $ | (719 | ) | $ | (429 | ) |
|  Translation  adjustment                                                    |       | 52                                                  |       | (36                                               | )          | 81 |   | (56 | ) |
|                                                                             |       |                                                |       |                                              |       |   |   |   |   |
| Comprehensive loss                                                               |       | $                                                   | (312       | )                                                 | $          | (201 | ) | $ | (638 | ) | $ | (485 | ) |

 

The accompanyingnotes are an integral part of these financial statements.

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** **

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

##### **CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS - UNAUDITED**

*(in thousands)*

* *
| ** **                                                               | ** ** | **Six Months Ended  December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                               | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                   |       |                                              |       |   |   |
| Net loss                                                                 |       | $                                                 | (719       | ) | $ | (429 | ) |
| Adjustments to  reconcile net loss to cash used in operating activities: |       |                                              |       |   |   |
| Depreciation and amortization                                            |       | 88                                                |       | 102 |   |
| Discontinued operations                                                  |       | (11                                               | )          | — |   |
| Changes in  operating assets and liabilities:                            |       |                                              |       |   |   |
| Accounts receivable, net                                                 |       | 43                                                |       | 411 |   |
| Inventories                                                              |       | 33                                                |       | 88 |   |
| Royalty advances                                                         |       | 2                                                 |       | 33 |   |
| Prepaid expenses                                                         |       | (28                                               | )          | (25 | ) |
| Accounts payable                                                         |       | (390                                              | )          | (481 | ) |
| Accrued royalties                                                        |       | 251                                               |       | 161 |   |
| Reserve for returns                                                      |       | (71                                               | )          | 34 |   |
| Cash used in operating activities                                        |       | (802                                              | )          | (106 | ) |
|                                                                     |       |                                              |       |   |   |
| Cash flows from  investing activities:                                   |       |                                              |       |   |   |
| Purchases of property and equipment                                      |       | (7                                                | )          | — |   |
| Cash used in investing activities                                        |       | (7                                                | )          | — |   |
|                                                                     |       |                                              |       |   |   |
| Cash flows from  financing activities:                                   |       |                                              |       |   |   |
| Borrowings on notes payable                                              |       | 1,860                                             |       | 1,978 |   |
| Payments on notes payable                                                |       | (1,145                                            | )          | (1,806 | ) |
| Cash provided by financing activities                                    |       | 715                                               |       | 172 |   |
|                                                                     |       |                                              |       |   |   |
| Effect of  exchange rates on cash                                        |       | 95                                                |       | (40 | ) |
|                                                                     |       |                                              |       |   |   |
| Net increase in  cash and cash equivalents                               |       | 1                                                 |       | 26 |   |
|                                                                     |       |                                              |       |   |   |
| Cash and cash  equivalents at beginning of period                        |       | 1,689                                             |       | 1,272 |   |
|                                                                     |       |                                              |       |   |   |
| Cash and cash  equivalents at end of period                              |       | $                                                 | 1,690      |   | $ | 1,298 |   |

 

The accompanyingnotes are an integral part of these financial statements.

5

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

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

**1.             BUSINESS AND LIQUIDITY**

K-telInternational, Inc. (the “Company”, “K-tel” or the “registrant”) wasincorporated in 1968 and currently has its corporate offices located inPlymouth, Minnesota. Through its operating subsidiaries, K-tel licenses therights to its master music catalog, consisting of original recordings and re-recordingsof music from the 1950’s through today, to third parties world-wide foruse in albums, films, television programs, commercials and electronic downloadsto various media formats, for either a flat fee or a royalty based on thenumber of units sold.  K-tel also marketsentertainment products mainly derived from its catalog through retail anddirect response marketing channels in the United States and Europe. Theseproducts are derived mainly from the Company’s master recordings music catalogwith the objective of realizing more competitive profit margins. K-tel seeks tolicense its name and trademarks to other companies.  Licenses are granted for a royalty or fee,with no cost to the Company.

DiscontinuedOperations

The Company’sconsumer products business, which was concentrated in Europe, consistedprimarily of housewares, consumer convenience items and exercise equipment. TheCompany discontinued its consumer products operations in Germany, the UnitedKingdom and 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. The accompanyingcondensed consolidated financial statements have been prepared to reflect theconsumer products division as a discontinued operation. The net liabilities ofdiscontinued operations at December 31, 2006 and June 30, 2006, and losses fromdiscontinued operations for the six months ended December 31, 2005 relateprimarily to legal matters and completion of statutory reporting requirementsfor the former operations in Germany.

Liquidity

During the sixmonths ended December 31, 2006 and 2005, the Company incurred net losses fromcontinuing operations of $719,000 and $426,000, respectively. Operatingactivities used $802,000 and $106,000 of cash during the six months endedDecember 31, 2006 and 2005, respectively. Additionally, the Company had aworking capital deficit of $12,933,000 at December 31, 2006.

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 Leisure Products, Inc. (See Note 3),increase its revenues and profit margins, and ultimately attain and sustainprofitable operations. Without increased revenues and sustained profitability,the Company’s current operations will likely not generate cash sufficient tofund operations and service its indebtedness on an ongoing basis. Management isfocusing its efforts on music licensing, music downloads and limited music distribution.However, there can be no assurance that the Company will achieve profitableoperations through these efforts. The financial statements do not include anyadjustments that might result from the outcome of these uncertainties.

GoingPrivate Transaction

On January 9,2007, the Company announced that on January 8, 2007, it filed with theSecurities and Exchange Commission (“SEC”) a Schedule 13E-3 in connection witha reverse split of the Company’s common stock intended to take the Companyprivate.   See “Note 7” of “Notes toCondensed Consolidated Financial Statements” for further discussion.

**2.             BASIS OF PRESENTATION AND SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

Basis ofPresentation —The accompanying condensed consolidated unaudited financial statements havebeen prepared in accordance with accounting principles generally accepted inthe United States of America (“US GAAP”) for interim financial information andwith the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby US GAAP for complete financial

6

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statements. In theopinion of management, all adjustments (consisting of normal recurringadjustments) considered necessary for a fair presentation have been included.Operating results for the six month period ended December 31, 2006 are notnecessarily indicative of the results that may be expected for the year as awhole. The unaudited condensed consolidated balance sheet for June 30, 2006 hasbeen derived from audited consolidated financial statements as of that date.For further information, refer to the consolidated financial statements andfootnotes thereto included in the Company’s annual report on Form 10-K for theyear ended June 30, 2006.

Principles of Consolidation- The accompanying condensed consolidated financial statements include theaccounts of K-tel International, Inc. and its domestic and foreignsubsidiaries, all of which are wholly owned. All significant intercompanyaccounts and transactions have been eliminated.

RevenueRecognition — The Company derives its revenue mainly from twosources: license revenue from the licensing of Company-owned masters and thesale of music compilations (predominately compact discs) produced by theCompany.  License revenue is recognizedwhen payment is received from customers or when known amounts are receivable,as prior to that date collection is not considered probable.  Revenue from music sales is recognized at thetime of shipment to the customer and most music sales are made with a right ofreturn of unsold goods. Estimated reserves for returns are established bymanagement based upon historical experience and product mix and are subject toongoing review and adjustment by the Company. These reserves are recorded atthe time of sale and are reflected as a reduction in revenue. The Company’sreserve for returns was $55,000 at December 31, 2006 and $126,000 at June 30,2006.

Cost of Goods Sold— The Company expenses all product manufacturing, distribution and royaltycosts associated with music sales as cost of goods sold. The Company alsoexpenses royalties, commissions and amortization of its owned master recordingsassociated with its license revenue as cost of goods sold.

Shipping andHandling Costs — The Company expenses within cost of goodssold all shipping and handling costs incurred in the shipment of goods.

Cash and CashEquivalents — Cash and cash equivalents consist principallyof cash and short-term, highly liquid investments with original maturities ofless than ninety days.

AccountsReceivable - Accounts receivable balances are presented netof allowances. The Company determines its allowances by considering a number offactors, including the length of time trade receivables are past due, theCompany’s previous history, and the customer’s current ability to payobligations to the Company. The Company writes off accounts receivables whenthey become uncollectible.

Inventories— Inventories, which consists of finished goods that include all direct productcosts, are valued at the lower of cost, determined on a first-in, first-outbasis, or net realizable value.

Owned CatalogMasters — The Company capitalizes the costs to purchase ownedmaster recordings at the time of acquisition. These costs are amortized overthe estimated useful life of these master recordings, which is generally sevenyears, and represents management’s best estimate of the average period ofvalue.

Property andEquipment - Property and equipment are stated at cost.Depreciation and amortization is provided using straight line or decliningbalance methods over the estimated useful lives of the assets, which range fromthree to nine years.

Long Lived-Assets— The Company evaluates its long-lived assets quarterly, or earlier if atriggering event occurs, to determine potential impairment by comparing thecarrying value of those assets to the related undiscounted future cash flows ofthe assets. If an asset is determined to be impaired, it is written down to itsestimated fair value.

Royalties- The Company has entered into license agreements with various record companiesand publishers under which it pays royalties on units sold. The Company accruesroyalties using contractual rates and certain estimated rates on applicableunits sold. The contractual royalty liability is computed quarterly and theaccrued royalty balance is adjusted accordingly. The royalty agreements aresubject to audit by licensors.

Advertising- The Company expenses the costs of advertising when the advertising takes place,except for direct response advertising, which is capitalized and amortized overits expected period of future benefits (usually the period remaining under arelated contract, which is generally less than one year). Direct responseadvertising

7

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consists primarilyof television advertising whereby customers respond specifically to theadvertising and where the Company can identify the advertising that elicitedthe response. Advertising expenses were $119,000 and $88,000 for the six monthperiods ended December 31, 2006 and 2005, respectively.

Foreign Currency- The operations of foreign subsidiaries are measured in local currencies.Assets and liabilities are translated into U.S. dollars at period-end exchangerates. Revenue and expenses are translated at the average exchange ratesprevailing during the period. Adjustments resulting from translating thefinancial statements of foreign entities into U.S. dollars are recorded as acomponent of accumulated other comprehensive income or loss.

Stock-basedCompensation — The Company accounts for stock-based awards toemployees using the intrinsic value method prescribed in APB No. 25, “Accountingfor Stock Issued to Employees,” whereby the options are granted at marketprice, and therefore no compensation costs are recognized. The Company haselected to retain its current method of accounting as described above and hasadopted the SFAS Nos. 123 and 148 disclosure requirements. If compensationexpense for the Company’s various stock option plans had been determined basedupon the projected fair values at the grant dates for awards under those plansin accordance with SFAS No. 123, the Company’s pro-forma net earnings, andbasic and diluted earnings per common share would have been unchanged from asreported.

Income Taxes- Deferred income taxes are provided for temporary differences between thefinancial reporting basis and tax basis of the Company’s assets and liabilitiesat currently enacted tax rates. A valuation allowance equal to the aggregateamount of deferred tax assets is established when realization is not likely.

Net Loss Per Share - Basic anddiluted net loss per share have been computed by dividing net loss by theweighted average number of shares outstanding during the period. For allperiods presented, common stock equivalents were excluded from the per sharecalculation as the net effect would be antidilutive. For the three and sixmonth periods ended December 31, 2006 and 2005, weighted average options topurchase 2,228,939 shares of common stock, with weighted average exercise priceof $.19 were excluded from the computation of common share equivalents for therespective periods as they were antidilutive.

Use of Estimates- Preparing consolidated financial statements in conformity with US GAAPrequires management to make estimates and assumptions that affect the reportedamounts of assets, liabilities, and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenue and expenses during the reporting period. Principal estimates includeallowances for bad debt, inventory valuation, return reserves, royaltyobligations, purchase commitments and product replacement costs. Actual resultscould differ from those estimates used by management.

**3.             LOANS PAYABLE TO AFFILIATE**

K-tel has a Line of Credit Agreement with K-5 Leisure Products, Inc. (“K-5”),the Company’s largest shareholder and an entity controlled by Philip Kives, theChairman of the Board, President and Chief Executive Officer of K-tel. Underthe 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 (8.25% at December 31, 2006), expires July 20,2008, and is subordinated to the Foothill loan (see below). The K-5 Facilitycontains the same covenants as the Foothill loan agreement. K-tel has pledgedthe stock of its foreign subsidiaries as collateral for the loan, and the loancarries a subordinated position to the Foothill loan on all other assets of theCompany. K-tel had outstanding balances of $8,812,000 and $8,098,000 as ofDecember 31, 2006 and June 30, 2006, respectively, under the K-5 Facility. AtDecember 31, 2006, K-tel obtained a waiver from K-5 for its non-complianceunder the covenants, limitations and restrictions of the credit agreement.

In addition, K-telhas a second loan agreement with K-5, under which K-5 assumed rights andobligations under a loan from the Company’s former banker (Foothill CapitalCorporation) pursuant to an Assignment and Acceptance Agreement dated February27, 2001. This Foothill loan, which has been extended through July 20, 2008,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 which borrowingsare limited 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% (9.25% at December 31, 2006) 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 December 31, 2006 and June30,

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2006, K-tel had$4,000,000 outstanding under the term loan and there were no borrowings underthe revolving facility. At December 31, 2006, K-tel obtained a waiver from K-5for its non-compliance under the covenants, limitations and restrictions of thecredit agreement.

**4.**      **    COMMITMENTS AND CONTINGENCIES**

K-tel and itssubsidiaries are also involved in other legal proceedings in the ordinary courseof their business. With all litigation matters, management considers thelikelihood 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 proceedings cannot be predicted, in the opinion of management thereis currently 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.

**5.             BUSINESSSEGMENT AND GEOGRAPHIC AREA DATA**

K-tel’sbusinesses are organized, managed and internally reported as two segments:music licensing and retail music sales. These segments are based on differencesin products, customer type and sales and distribution methods.

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,commercials and electronic downloads to various media formats, for either aflat fee or a royalty based on the number of units sold.

The retail musicsegment of the Company markets and distributes entertainment productsinternationally and through its operating subsidiaries. The retail musicsegment consists primarily of the sales of pre-recorded music from theCompany’s master music catalog. The Company sells compact discs directly toretailers, wholesalers and rack service distributors which stock and manageinventory within music departments for retail stores.

The Company’sconsumer product and e-commerce operations have been discontinued and arepresented in the accompanying financial statements as discontinued operationsand are therefore not included in the segment information.

Operating profitsor losses of these segments include an allocation of general corporateexpenses. Depreciation and amortization and capital additions are notsignificant and have therefore been excluded from the presentation.

Certainfinancial information on the Company’s continuing operating segments is asfollows:

BUSINESS SEGMENTINFORMATION *(in thousands)*
| **Six Months Ended  December 31,** | ** **   | ** **   | ** **   | **Licensing** | ** **   | **Music**    | ** **   | **Other**    | ** **   | **Total  Company** | ** **   |
|---------------------------------------------------|--------------|--------------|--------------|---------------|--------------|--------------|--------------|--------------|--------------|--------------------|--------------|
| *** ***                                      | *** *** | *** *** | *** *** | *** ***  | *** *** | *** *** | *** *** | *** *** | *** *** | *** ***       | *** *** |
| Net sales                                         |         | 2006         |         | $             | 1,008        |         | $            | 889          |         | $                  | —       |   | $ | 1,897 |   |
|                                              |         | 2005         |         | 1,332         |         | 1,166        |         | —       |         | 2,498              |         |
|                                              |         |         |         |          |         |         |         |         |         |               |         |
| Operating income  (loss)                          |         | 2006         |         | $             | 281          |         | $            | (513         | )            | $                  | —       |   | $ | (232 | ) |
|                                              |         | 2005         |         | 589           |         | (595         | )            | —       |         | (6                 | )            |
|  Assets                                      |         | 2006         |         | $             | 300          |         | $            | 2,830        |         | $                  | 86           |   | $ | 3,216 |   |
|                                              |         | 2005         |         | 434           |         | 3,543        |         | 73           |         | 4,050              |         |
|                                              |         |         |         |          |         |         |         |         |         |               |         |

 
| **Three Months Ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
|                                |       |       |       |       |       |       |       |       |       |       |       |
| Net sales                           |       | 2006       |       | $          | 539        |       | $          | 470        |       | $          | —     |   | $ | 1,009 |   |
|                                |       | 2005       |       | 817        |       | 485        |       | —     |       | 1,302      |       |
|                                |       |       |       |       |       |       |       |       |       |       |       |
| Operating income  (loss)            |       | 2006       |       | $          | 180        |       | $          | (300       | )          | $          | —     |   | $ | (120 | ) |
|                                |       | 2005       |       | 425        |       | (359       | )          | —     |       | 66         |       |

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GEOGRAPHICINFORMATION *(in thousands)*
| **Six Months Ended  December 31,** | ** ** | ** ** | ** ** | **United States** | ** ** | **Europe** | ** ** | **Total** | ** ** |
|---------------------------------------------------|------------|------------|------------|------------------------|------------|------------|------------|-----------|------------|
| * *                                          | * *   | * *   | * *   | * *               | * *   | * *   | * *   | * *  | * *   |
| Net sales                                         |       | 2006       |       | $                      | 997        |       | $          | 900       |       | $ | 1,897 |   |
|                                              |       | 2005       |       | 1,408                  |       | 1,090      |       | 2,498     |       |
|                                              |       |       |       |                   |       |       |       |      |       |
| Assets                                            |       | 2006       |       | $                      | 641        |       | $          | 2,575     |       | $ | 3,216 |   |
|                                              |       | 2005       |       | 1,709                  |       | 2,341      |       | 4,050     |       |
|                                              |       |       |       |                   |       |       |       |      |       |

 
| **Three Months Ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
|                                |       |       |       |       |       |       |       |       |       |
| Net sales                           |       | 2006       |       | $          | 468        |       | $          | 541        |       | $ | 1,009 |   |
|                                |       | 2005       |       | 636        |       | 666        |       | 1,302      |       |
|                                     |            |            |            |            |            |            |            |            |            |  |  |  |

 

**6.           RECENT ACCOUNTING PRONOUNCEMENTS**

In June 2006, the Financial Accounting Standards Board (“FASB”)issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” — aninterpretation of FASB Statement No. 109, “Accounting for Income Taxes” (“FIN48”), which clarifies the accounting for uncertainty in income taxes. FIN 48prescribes a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. The interpretation requires that the Company recognizein the financial statements the impact of a tax position.  Recognition is allowed if the tax position ismore likely than not to be sustained on audit, based on the technical merits ofthe position. FIN 48 also provides guidance on derecognition, classification,interest and penalties, accounting in interim periods and disclosure. Theprovisions of FIN 48 are effective for fiscal years beginning after December15, 2006 with the cumulative effect of the change in accounting principlerecorded as an adjustment to opening retained earnings. The adoption of thisstatement is not expected to have a material impact on the Company’sconsolidated financial position or results of operations.

In September 2006, the SEC staff issued Staff AccountingBulletin No. 108, “Considering the Effects of Prior Year Misstatements whenQuantifying Misstatements in Current Year Financial Statements.”  SAB 108was issued to provide consistency between how registrants quantify financialstatement misstatements and is effective for fiscal years ending after November15, 2006. SAB 108 established an approach that requires quantification offinancial statement misstatements based on the effects of the misstatement oneach of the company’s financial statements and the related financial statementdisclosures.  This approach is commonly referred to as the “dual approach”because it requires quantification of errors under both the roll-over and ironcurtain methods.    The initialapplication of SAB 108 is not expected to have a material impact on the Company’sconsolidated financial position or results of operations.

**7.          GOING PRIVATE TRANSACTION**

OnJanuary 9, 2007, the Company announced that on January 8, 2007, it filed withthe Securities and Exchange Commission (“SEC”) a Schedule 13E-3 in connectionwith a reverse split of the Company’s common stock intended to take the Companyprivate.  Under the terms of the reversesplit, each 5,000 shares of the Company’s common stock will be converted intoone share of common stock and holders of fewer than 5,000 shares of commonstock on the record date will receive cash of $.0625 per pre-split share.  Immediately following the reverse split, theCompany will effect a 5,000-for-1 forward split so that the number of sharesheld by each holder of at least one share of common stock following the reversesplit will ultimately be unchanged. The Company refers to the reverse split,forward split, and the related payments to shareholders holding fewer than5,000 pre-split shares as the “Reverse/Forward Split.”  The anticipated result of the Reverse/ForwardSplit will be to reduce the number of shareholders of record to fewer than 300. The Company intends to cease filing periodic reports with the SEC assoon as practicable following the Reverse/Forward Split.

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TheCompany’s Board of Directors has approved the Reverse/Forward Split based onits determination that the Company achieves few of the benefits of publicownership because of a lack of an active trading market for its common stock,while remaining burdened with the significant costs of being a publicly heldcompany.  Under Minnesota Law, the Boardof Directors of the Company may amend the Company’s Articles of Incorporationto conduct the Reverse/Forward Split without the approval of its shareholders.  Therefore, the Company is not seekingshareholder approval for the Reverse/Forward Split.  The Reverse/Forward Split will not beeffective until the SEC completes its review of the Schedule 13E-3, the Companydistributes required material, including the definitive disclosure document toits shareholders, and files amendments to its Articles of Incorporation withthe State of Minnesota.  The Companyestimates that the aggregate cash payment to shareholders holding fewer than5,000 shares of Common Stock will be approximately $135,000.  The funds for the Reverse/Forward Split willcome from the Company’s working capital and, potentially, from K-tel’s workingcapital line of credit provided by K-5 Leisure Products, Inc., the Company’slargest shareholder and an entity controlled by Philip Kives, K-tel’s Presidentand Chief Executive Officer.

**ITEM 2: MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

**General**

Throughits operating subsidiary, Dominion Entertainment, Inc. (“Dominion”), K-tellicenses its master music catalog internationally and has entered intolicensing agreements with several companies that offer electronic downloads viatheir internet sites of many of Dominion’s owned masters.  K-tel and Dominion have also entered intoagreements with BCI Eclipse Company, LLC (“BCI”) to market and sellentertainment products derived from Dominion’s master music catalog under theK-tel logo in the United States and Canada.

Through anothersubsidiary, K-tel Entertainment, Inc., K-tel has a focused method ofdistribution that targets the strengths of selected individual retailers andsupplies products suited to each retailer’s specific needs. These products areprimarily derived from the Company’s master recordings music catalog with theobjective of realizing more competitive profit margins. The Company also seeksto license its name and marks to other businesses for a royalty or fee.

**GoingPrivate Transaction**

OnJanuary 9, 2007, the Company announced that on January 8, 2007, it filed withthe Securities and Exchange Commission (“SEC”) a Schedule 13E-3 in connectionwith a reverse split of the Company’s common stock intended to take the Companyprivate.   See “Liquidity and CapitalResources” for further discussion of the Company’s going private transaction.

**A.            RESULTS OF OPERATIONS**

#### THREE MONTHS ENDED DECEMBER 31, 2006 VERSUSDECEMBER 31, 2005

Netsales for the three month period ended December 31, 2006 were $1,009,000 adecrease of 22.5% from net sales of $1,302,000 for the three month period endedDecember 31, 2005. This net decrease primarily resulted from decreased musicand licensing sales during the quarter ended December 31, 2006 in the Company’sdomestic subsidiaries. The net loss for the three month period ended December 31,2006 was $364,000, or $.03 per share, compared to net loss of $165,000, or $.01per share, for the three month period ended December 31, 2005.

Generalcorporate expenses of $151,000 and $108,000 for the three month periods endedDecember 31, 2006 and 2005, respectively, have been allocated to the segments.

Thefollowing sections discuss the results of continuing operations by businesssegment.

#### BUSINESS SEGMENT RESULTS

**Licensing**

Licensingrevenue was $539,000 for the three month period ended December 31, 2006,compared to $817,000 for the three month period ended December 31, 2005, adecrease of $278,000. The decrease in licensing revenue was

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primarilydue to the decrease in domestic licensing revenue related to the Company’slicensing agreements with BCI. The licensing segment had operating income of$180,000 for the three month period ended December 31, 2005 compared to$425,000 for the three month period ended December 31, 2005, a decrease of$245,000.

#### **Music**

Sales in the musicsegment were $470,000 for the three month period ended December 31, 2006compared to $485,000 for the three month period ended December 31, 2005, adecrease of $15,000, or 3.1%. The decrease was due to the decrease in domesticmusic sales related to the Company’s transition from a primarily retail musicdistribution business to a licensing business.

Costof goods sold in the music segment decreased to $341,000, or 72.6% of sales forthe three month period ended December 31, 2006 compared to $458,000, or 94.4%of sales for the three month period ended December 31, 2005, reflective of thereduced music sales during the three month period ended December 31, 2006.  The segment’s advertising expenses, whichconsist primarily of co-operative advertising payments, trade advertising andpromotions, decreased to $56,000 for the three month period ended December 31,2006 compared to $68,000 for the three month period ended December 31, 2005.

Selling,general and administrative expenses were $373,000, or 79.4% of sales for thethree month period ended December 31, 2006 compared to $318,000, or 65.6% ofsales for the three month period ended December 31, 2005. The increase was dueprimarily to the increase in the general corporate legal and consultingexpenses allocated to the segments.

Themusic segment incurred an operating loss of $300,000 for the three month periodended December 31, 2006 compared to an operating loss of $359,000 for the threemonth period ended December 31, 2005.

#### **SIX MONTHS ENDED DECEMBER 31, 2006 VERSUSDECEMBER 31, 2005**

Netsales for the six month period ended December 31, 2006 were $1,897,000 comparedto $2,498,000 for the six month period ended December 31, 2005. This netdecrease primarily resulted from a decrease in both licensing and music salesin the Company’s domestic subsidiaries. The net loss for the six month periodended December 31, 2006 was $719,000, or $.05 per share, compared to net lossof $429,000, or $.03 per share, for the six month period ended December 31,2005.

Generalcorporate expenses of $249,000 and $213,000 for the six month periods endedDecember 31, 2006 and 2005, respectively, have been allocated to the segments.

Thefollowing sections discuss the results of continuing operations by businesssegment.

#### **BUSINESS SEGMENT RESULTS**

**Licensing**

Licensingrevenue was $1,008,000 for the six month period ended December 31, 2006compared to $1,332,000 for the six month period ended December 31, 2005, adecrease of $324,000.  This decreasereflected the decrease in the domestic licensing activity related to the Company’sagreements with BCI.  The Companycontinues its efforts on building licensing arrangements in several othersegments of the entertainment industry and continues to license its mastermusic catalog to several companies that offer electronic downloads via theirinternet sites.

Royaltyexpense within the segment decreased to $158,000 for the six month period endedDecember 31, 2006 compared to $230,000 for the six month period ended December31, 2005, due to the decrease in licensing revenue.

Selling,general and administrative expenses increased to $569,000 for the six monthperiod ended December 31, 2006 compared to $514,000 for the six month periodended December 31, 2005, an increase of 10.8%.  The primary reason for the increase in general and administrativeexpenses was the increased general corporate legal and consulting overheadexpenses allocated to the segment.

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Operatingincome in the licensing segment was $281,000 for the six month period endedDecember 31, 2006 compared to an operating income of $589,000 for the six monthperiod ended December 31, 2005, a decrease of $308,000.

#### **Music**

Sales in the musicsegment were $889,000 for the six month period ended December 31, 2006 comparedto $1,166,000 for the six month period ended December 31, 2005, a decrease of$277,000, or 23.8%.  The decrease was dueto a decrease in domestic music sales related to the Company’s transition froma primarily retail music distribution business to a licensing business.

Costof goods sold in the music segment were $541,000, or 60.9% of sales for the sixmonth period ended December 31, 2006 compared to $855,000, or 73.3% of salesfor the six month period ended December 31, 2005, a decrease of $314,000reflective of the decreased music sales in the six month period ended December31, 2005.­­­ The segment’s advertising expenses, which consist primarily ofco-operative advertising payments, trade advertising and promotions, increasedto $119,000 for the six month period ended December 31, 2006 compared to$88,000 for the six month period ended December 31, 2005.

Selling,general and administrative expenses were $742,000, or 83.5% of sales for thesix month period ended December 31, 2006 compared to $818,000, or 70.2% ofsales for the six month period ended December 31, 2005, a decrease of $76,000relating to the staff and cost reductions at the Company’s office in the UnitedStates.

Themusic segment incurred an operating loss of $513,000 for the six month periodended December 31, 2006 compared to an operating loss of $595,000 for the sixmonth period ended December 31, 2005.

**B.            LIQUIDITYAND CAPITAL RESOURCES**

K-tel has a Line of Credit Agreement with K-5 Leisure Products, Inc. (“K-5”),the Company’s largest shareholder  and anentity controlled by Philip Kives, the Chairman of the Board, President andChief Executive Officer of K-tel. Under the terms of the agreement (the “K-5Facility”), K-5 has agreed to make available up to $8,000,000 to K-tel on arevolving basis. The loan bears interest at a variable rate based upon the “baserate” of a nationally recognized lending institution (8.25% at December 31,2006), expires July 20, 2008, and is subordinated to the Foothill loan (seebelow). The K-5 Facility contains the same covenants as the Foothill loanagreement. K-tel has pledged the stock of its foreign subsidiaries ascollateral for the loan, and the loan carries a subordinated position to theFoothill loan on all other assets of the Company. K-tel had outstandingbalances of $8,812,000 and $8,098,000 as of December 31, 2006 and June 30,2006, respectively, under the K-5 Facility. At December 31, 2006, K-telobtained a waiver from K-5 for its non-compliance under the covenants,limitations and restrictions of the credit agreement.

In addition, K-telhas a second loan agreement with K-5, under which K-5 assumed rights andobligations under a loan from the Company’s former banker (Foothill CapitalCorporation) pursuant to an Assignment and Acceptance Agreement dated February27, 2001. This Foothill loan, which has been extended through July 20, 2008,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 which borrowingsare limited 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% (9.25% at December 31, 2006) 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 December 31, 2006 and June30, 2006, K-tel had $4,000,000 outstanding under the term loan and there wereno borrowings under the revolving facility. At December 31, 2006, K-telobtained a waiver from K-5 for its non-compliance under the covenants,limitations and restrictions of the credit agreement.

K-tel has beenfunding its operations in recent years through internally generated capital andsecured loans from K-5. Assuming K-5 continues to advance funds sufficient tomeet the Company’s needs, management currently believes that K-tel hassufficient cash and borrowing capacity to ensure the Company will continueoperations for the foreseeable future. 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.

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The Company’sability to continue its present operations is contingent mainly upon itsability to maintain its line of credit arrangements with K-5, increase itsrevenues and profit margins, and ultimately attain and sustain profitableoperations. Without increased revenues and sustained profitability, the Company’scurrent operations will likely not generate cash sufficient to fund operationsand service its indebtedness on an ongoing basis. Management is focusing itsefforts on music licensing and limited music distribution. However, there canbe no assurance that the Company will achieve profitable operations throughthese efforts. In the event the Company is unable to fund its operations andimplement its current business plan properly, it may be unable to continueoperations. The financial statements do not include any adjustments that mightresult from the outcome of these uncertainties.

OnJanuary 9, 2007, the Company announced that on January 8, 2007 it filed withthe Securities and Exchange Commission (“SEC”) a Schedule 13E-3 in connectionwith a reverse split of the Company’s common stock intended to take the Companyprivate.  Under the terms of the reversesplit, each 5,000 shares of the Company’s common stock will be converted intoone share of common stock and holders of fewer than 5,000 shares of commonstock on the record date will receive cash of $.0625 per pre-split share.  Immediately following the reverse split, theCompany will effect a 5,000-for-1 forward split so that the number of sharesheld by each holder of at least one share of common stock following the reversesplit will ultimately be unchanged. The Company refers to the reverse split,forward split, and the related payments to shareholders holding fewer than5,000 pre-split shares as the “Reverse/Forward Split.”  The anticipated result of the Reverse/ForwardSplit will be to reduce the number of shareholders of record to fewer than 300. The Company intends to cease filing periodic reports with the SEC assoon as practicable following the Reverse/Forward Split.

TheCompany’s Board of Directors has approved the Reverse/Forward Split based onits determination that the Company achieves few of the benefits of publicownership because of a lack of an active trading market for its common stock,while remaining burdened with the significant costs of being a publicly heldcompany.  Under Minnesota Law, the Boardof Directors of the Company may amend the Company’s Articles of Incorporationto conduct the Reverse/Forward Split without the approval of itsshareholders.  Therefore, the Company isnot seeking shareholder approval for the Reverse/Forward Split.  The Reverse/Forward Split will not beeffective until the SEC completes its review of the Schedule 13E-3, the Companydistributes required material, including the definitive disclosure document toits shareholders, and files amendments to its Articles of Incorporation withthe State of Minnesota. The Company estimates that the aggregate cash paymentto shareholders holding fewer than 5,000 shares of Common Stock will beapproximately $135,000.  The funds forthe Reverse/Forward Split will come from the Company’s working capital and,potentially, from K-tel’s working capital line of credit provided by K-5Leisure Products, Inc., the Company’s largest shareholder and an entitycontrolled by Philip Kives, K-tel’s President and Chief Executive Officer.

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

Therehave been no material changes in the Company’s market risk during the six monthperiod ended December 31, 2006. For additional information, refer to theCompany’s annual report on Form 10-K for the fiscal year ended June 30, 2006.

**ITEM4.  CONTROLS AND PROCEDURES**

Under thesupervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and Principal Financial Officer, theCompany evaluated the effectiveness of the design and operation of itsdisclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e)under the Exchange Act). Based on that evaluation, the Chief Executive Officerand Principal Financial Officer concluded that, as of the end of the periodcovered by this report, the Company’s disclosure controls and procedures wereeffective.  Previous untimely filings hadresulted in part from the follow up necessary to address the materialweaknesses in internal control over financial reporting that had been reportedin fiscal year 2004 and have since been remediated.

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**PART II**

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

#### K-tel and its subsidiaries are also involved in other legal proceedingsin the ordinary course of their business. With all litigation matters,management considers the likelihood of loss based on the facts and circumstances.If management 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 proceedings 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.

#### **ITEM 6. EXHIBITS**

See “Index toExhibits.”

 

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                     | K-TEL INTERNATIONAL, INC.            |
|--------------------------|--------------------------------------|
|                     | REGISTRANT                           |
|                     |                                 |
|                     |                                 |
| Dated: February 14, 2007 | /S/ PHILIP KIVES                     |
|                     | PHILIP KIVES                         |
|                     | CHAIRMAN AND CHIEF EXECUTIVE OFFICER |
|                     |                                 |
|                     |                                 |
| Dated: February 14, 2007 | /s/ KIMMY LOCKWOOD                   |
|                     | KIMMY LOCKWOOD                       |
|                     | PRINCIPAL FINANCIAL OFFICER          |

 

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**INDEX TOEXHIBITS**
| Exhibit No. | ** ** | **Description of Exhibit**                                                                                                                              |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **  | ** ** | ** **                                                                                                                                              |
| 31.1        |       | Certification by Chief Executive Officer pursuant to  Rule 13a-14(a).                                                                                   |
| 31.2        |       | Certification by Principal Financial Officer  pursuant to Rule 13a-14(a).                                                                               |
| 32.1        |       | Certification by Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sabanes-Oxley Act of 2002.     |
| 32.2        |       | Certification by Principal Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sabanes-Oxley Act of 2002. |

 

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