##### **UNITEDSTATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

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

**(MarkOne)**

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

**For thequarterly period ended December 31, 2004**

**OR**

**o****                                ****TRANSITION REPORT PURSUANT TO SECTION13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**Forthe transition period from                    to                    **

**Commission File Number:  1-07115**

**K-TELINTERNATIONAL, INC.**

(Exact name of registrant as specified in its charter)
| **Minnesota**                                                 | ** ** | **41-0946588**                       |
|---------------------------------------------------------------|------------|--------------------------------------|
| (State or other  jurisdiction of                              |       | (I.RS. Employer  Identification No.) |
| incorporation or  organization)                               |       |                                 |
|                                                          |       |                                 |
| **2655  Cheshire Lane North, Suite 100, Plymouth, Minnesota** | ** ** | **55447**                            |
| (Address of  principal executive offices)                     |       | (Zip Code)                           |

 

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

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

**None**

Securitiesregistered pursuant 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 o   No x

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 Accelerated Filer o |   | Accelerated Filer o |   | Non-Accelerated Filer 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 September 15, 2006, the registrant had 13,653,738 shares ofcommon stock outstanding.

 

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

**FORM 10-Q**

**FOR THE THREE AND SIX MONTH PERIODS**

**ENDED DECEMBER 31, 2004**

INDEX
| PART I.                      | Financial Information (Unaudited): |                                                                                                            |
|------------------------------|------------------------------------|-----------------------------------------------------------------------------------------------------------------|
|                         |                               |                                                                                                            |   |
|                         | Item 1.                            | Financial Statements                                                                                            |   |
|                         |                               |                                                                                                            |   |
|                         |                               | Condensed  Consolidated Balance Sheets as of December 31, 2004 and June 30, 2004                                |   |
|                         |                               |                                                                                                            |   |
|                         |                               | Condensed  Consolidated Statements of Operations for the Three and Six Months Ended  December 31, 2004 and 2003 |   |
|                         |                               |                                                                                                            |   |
|                         |                               | Condensed  Consolidated Statements of Cash Flows for the Three and Six Months Ended  December 31, 2004 and 2003 |   |
|                         |                               |                                                                                                            |   |
|                         |                               | 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  and Reports on Form 8-K                                                                               |   |
|                         |                               |                                                                                                            |   |
| 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 anddistributors; success of marketing and promotion efforts; technological changesand difficulties; availability of financing; foreign currency variations;general economic, political and business conditions; and other matters. Weundertake no obligation to release publicly the result of any revisions tothese forward-looking statements, except as required by law.

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

**CONDENSEDCONSOLIDATED BALANCE SHEETS - UNAUDITED**

*(inthousands – except share data*)
| ** **                                                                                            | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                            | ** ** | **2004**              | ** ** | **2004**          | ** ** |
|                                                                                                  |       |                  |       |              |       |
| ASSETS                                                                                                |       |                  |       |              |       |
|                                                                                                  |       |                  |       |              |       |
| Current Assets:                                                                                       |       |                  |       |              |       |
| Cash and cash  equivalents                                                                            |       | $                     | 126        |              | $          | 147 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $4 and $4                             |       | 3,715                 |       | 2,691             |       |
| Inventories                                                                                           |       | 526                   |       | 561               |       |
| Royalty advances                                                                                      |       | 38                    |       | 50                |       |
| Prepaid expenses  and other                                                                           |       | 269                   |       | 308               |       |
| Total Current  Assets                                                                                 |       | 4,674                 |       | 3,757             |       |
|                                                                                                  |       |                  |       |              |       |
| Property and equipment,  net of accumulated depreciation and amortization of $1,125 and $1,506        |       | 106                   |       | 83                |       |
|                                                                                                  |       |                  |       |              |       |
| Owned catalog masters,  net of accumulated amortization of $3,030 and $2,942                          |       | 583                   |       | 656               |       |
|                                                                                                  |       |                  |       |              |       |
|                                                                                                  |       | $                     | 5,363      |              | $          | 4,496 |   |
|                                                                                                  |       |                  |       |              |       |
| LIABILITIES AND  SHAREHOLDERS’ DEFICIT                                                           |       |                  |       |              |       |
|                                                                                                  |       |                  |       |              |       |
| Current Liabilities:                                                                                  |       |                  |       |              |       |
| Notes payable to  affiliate and other                                                                 |       | $                     | 11,527     |              | $          | 11,165 |   |
| Accounts payable                                                                                      |       | 1,576                 |       | 1,432             |       |
| Accrued  royalties                                                                                    |       | 2,099                 |       | 1,907             |       |
| Reserve for  returns                                                                                  |       | 151                   |       | 133               |       |
| Net liabilities  of discontinued operations                                                           |       | 34                    |       | 30                |       |
| Total Current  Liabilities                                                                            |       | 15,387                |       | 14,667            |       |
|                                                                                                  |       |                  |       |              |       |
| Shareholders’ Deficit:                                                                           |       |                  |       |              |       |
| Common stock –  50,000,000 shares authorized; par value $.01; 13,653,738 issued and  outstanding |       | 136                   |       | 136               |       |
| Additional  paid-in capital                                                                           |       | 21,292                |       | 21,292            |       |
| Accumulated  deficit                                                                                  |       | (31,429               | )          | (31,466           | )          |
| Accumulated  other comprehensive loss                                                                 |       | (23                   | )          | (133              | )          |
| Total  Shareholders’ Deficit                                                                     |       | (10,024               | )          | (10,171           | )          |
|                                                                                                  |       |                  |       |              |       |
|                                                                                                  |       | $                     | 5,363      |              | $          | 4,496 |   |

 

The accompanyingnotes are an integral part of these financial statements.

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

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED**

*(inthousands - except per share data)*
| ** **                                                            | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                            | ** ** | **December 31,**            | ** ** | **December 31,**          | ** ** |
| ** **                                                            | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net Sales                                                             |       | $                                | 1,695      |                           | $          | 1,759 |   | $ | 3,531 |   | $ | 3,381 |   |
|                                                                  |       |                             |       |                           |       |   |   |   |   |
| Costs and Expenses:                                                   |       |                             |       |                           |       |   |   |   |   |
| Cost of goods  sold                                                   |       | 772                              |       | 857                            |       | 1,693 |   | 1,513 |   |
| Advertising                                                           |       | 40                               |       | 32                             |       | 67 |   | 75 |   |
| Selling, general  and administrative                                  |       | 873                              |       | 910                            |       | 1,790 |   | 1,748 |   |
| Total Costs and  Expenses                                             |       | 1,685                            |       | 1,799                          |       | 3,550 |   | 3,336 |   |
| Operating Income (Loss)                                               |       | 10                               |       | (40                            | )          | (19 | ) | 45 |   |
|                                                                  |       |                             |       |                           |       |   |   |   |   |
| Other Expense:                                                        |       |                             |       |                           |       |   |   |   |   |
| Interest expense                                                      |       | (157                             | )          | (120                           | )          | (302 | ) | (237 | ) |
| Other                                                                 |       | 125                              |       | —                         |       | 147 |   | (11 | ) |
| Total Other  Expense                                                  |       | (32                              | )          | (120                           | )          | (155 | ) | (248 | ) |
|                                                                  |       |                             |       |                           |       |   |   |   |   |
| Loss from Continuing  Operations                                      |       | (22                              | )          | (160                           | )          | (174 | ) | (203 | ) |
|                                                                  |       |                             |       |                           |       |   |   |   |   |
| Income (loss) from  Discontinued Operations, net of taxes             |       | 212                              |       | (20                            | )          | 211 |   | (61 | ) |
|                                                                  |       |                             |       |                           |       |   |   |   |   |
| Net Income (Loss)                                                     |       | $                                | 190        |                           | $          | (180 | ) | $ | 37 |   | $ | (264 | ) |
|                                                                  |       |                             |       |                           |       |   |   |   |   |
| Income (Loss) per Share  – Basic and Diluted:                    |       |                             |       |                           |       |   |   |   |   |
| Continuing  Operations                                                |       | $                                | —     |                           | $          | (.01 | ) | $ | (.01 | ) | $ | (.02 | ) |
| Discontinued  Operations                                              |       | .02                              |       | —                         |       | .02 |   | — |   |
| Net Income  (Loss)                                                    |       | $                                | .02        |                           | $          | (.01 | ) | $ | .01 |   | $ | (.02 | ) |
|                                                                  |       |                             |       |                           |       |   |   |   |   |
| Shares used in the  calculation of loss per share - Basic and Diluted |       | 13,654                           |       | 13,654                         |       | 13,654 |   | 13,654 |   |
|                                                                  |       |                             |       |                           |       |   |   |   |   |
| Comprehensive Income  (Loss):                                         |       |                             |       |                           |       |   |   |   |   |
| Net income  (loss)                                                    |       | $                                | 190        |                           | $          | (180 | ) | $ | 37 |   | $ | (264 | ) |
| Translation  adjustment                                               |       | 65                               |       | 76                             |       | 110 |   | 76 |   |
|                                                                  |       |                             |       |                           |       |   |   |   |   |
| Comprehensive Income (Loss)                                           |       | $                                | 255        |                           | $          | (104 | ) | $ | 147 |   | $ | (188 | ) |

 

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**

*(inthousands)*
| ** **                                                               | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                               | ** ** | **December 31,**          | ** ** |
| ** **                                                               | ** ** | **2004**                       | ** ** | **2003** | ** ** |
| Cash flows from  Operating Activities:                                   |       |                           |       |   |   |
| Net income (loss)                                                        |       | $                              | 37         |   | $ | (264 | ) |
| Adjustments to reconcile  net loss to cash used in operating activities: |       |                           |       |   |   |
| Depreciation and  amortization                                           |       | 123                            |       | 132 |   |
| Loss on disposal  of property and equipment                              |       | (11                            | )          | — |   |
| Discontinued  operations                                                 |       | 4                              |       | (6 | ) |
| Changes in operating  assets and liabilities:                            |       |                           |       |   |   |
| Accounts  receivable, net                                                |       | (908                           | )          | (30 | ) |
| Inventories                                                              |       | 47                             |       | (54 | ) |
| Royalty advances                                                         |       | 13                             |       | 8 |   |
| Prepaid expenses                                                         |       | 43                             |       | (197 | ) |
| Accounts payable                                                         |       | 99                             |       | (525 | ) |
| Accrued  royalties                                                       |       | 164                            |       | 138 |   |
| Reserve for  returns                                                     |       | 18                             |       | (8 | ) |
| Cash used in  operating activities                                       |       | (371                           | )          | (806 | ) |
|                                                                     |       |                           |       |   |   |
| Cash flows from  Investing Activities:                                   |       |                           |       |   |   |
| Purchases of  property and equipment                                     |       | (55                            | )          | (41 | ) |
| Other                                                                    |       | (13                            | )          | (6 | ) |
| Cash used in  investing activities                                       |       | (68                            | )          | (47 | ) |
|                                                                     |       |                           |       |   |   |
| Cash flows from  Financing Activities:                                   |       |                           |       |   |   |
| Borrowings on  notes payable                                             |       | 2,320                          |       | 1,483 |   |
| Payments on  notes payable                                               |       | (1,958                         | )          | (1,819 | ) |
| Cash provided by  (used in) financing activities                         |       | 362                            |       | (336 | ) |
|                                                                     |       |                           |       |   |   |
| Effect of exchange  rates on cash                                        |       | 56                             |       | 19 |   |
|                                                                     |       |                           |       |   |   |
| Net decrease in cash  and cash equivalents                               |       | (21                            | )          | (1,170 | ) |
|                                                                     |       |                           |       |   |   |
| Cash and cash  equivalents at beginning of period                        |       | 147                            |       | 1,219 |   |
|                                                                     |       |                           |       |   |   |
| Cash and cash equivalents at end of period                               |       | $                              | 126        |   | $ | 49 |   |

 

The accompanyingnotes are an integral part of these financial statements.

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**K-TELINTERNATIONAL, 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 itsmusic catalog internationally and markets entertainment products mainly derivedfrom its catalog through retail and direct response marketing channels in theUnited States and Europe. The Company has a focused method of distribution thattargets the strengths of selected individual retailers and supplies productssuited to each retailer’s needs. These products are derived mainly from theCompany’s master recordings music catalog with the objective of realizing morecompetitive profit margins. K-tel seeks to license its trademarks to othercompanies in businesses unrelated to K-tel’s current operations. Licenses aregranted 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, 2004 and June 30, 2004, and resultsfrom discontinued operations for the three and six months ended December 2004and 2003, relate primarily to legal matters and completion of statutoryreporting requirements for the former operations in Germany.

Liquidity

During the sixmonths ended December 31, 2004 and 2003, the Company incurred net losses fromcontinuing operations of $304,000 and $203,000, respectively. Operatingactivities used $371,000 and $806,000 of cash during the six months endedDecember 31, 2004 and 2003 respectively. Additionally, the Company had aworking capital deficit of $10,713,000 at December 31, 2004.

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 cash generated from the Company’s current operations will likely beinadequate to fund operations and service its indebtedness on an ongoing basis.Management is focusing its efforts on music licensing, music downloads andlimited music distribution. However, there can be no assurance that the Companywill achieve profitable operations through these efforts. The financialstatements do not include any adjustments that might result from the outcome ofthese uncertainties.

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

Basis ofPresentation – The accompanying condensed consolidatedunaudited financial 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 theinformation and footnotes required by US GAAP for complete financialstatements. In the opinion of management, all adjustments (consisting of normalrecurring adjustments) considered necessary for a fair presentation have beenincluded. Operating results for the six month periods ended December 31, 2004are not necessarily indicative of the results that may be expected for the yearas a whole. The unaudited condensed consolidated balance sheet for June 30,2004 has been derived from audited consolidated financial statements as of thatdate. For further information, refer to the consolidated financial statementsand footnotes thereto included in the Company’s annual report on Form 10-K/Afor the year ended June 30, 2004.

6

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Principles ofConsolidation - The accompanying condensed consolidatedfinancial statements include the accounts of K-tel International, Inc. and itsdomestic and foreign subsidiaries, all of which are wholly owned. Allsignificant intercompany accounts and transactions have been eliminated.

During the quarterended March 31, 2004, the Company began to consolidate the financial statementsof Lancaster Trading Limited (Lancaster), a variable interest entity of whichthe Company determined it was the primary beneficiary.  Sales and purchases between Lancaster and theCompany have been eliminated in consolidation, and the additional effects ofLancaster on the Company’s operations were not material.

RevenueRecognition – The Company derives its revenue mainly from twosources: the sale of music compilations (predominately compact discs) producedby the Company, and license revenue from the licensing of Company-ownedmasters. Revenue from music sales is recognized at the time of shipment to thecustomer, while license revenue is recognized when payment is received fromcustomers or when known amounts are receivable, as prior to that datecollection is not considered probable. Most music sales are made with a rightof return 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 $151,000 at December 31, 2004 and $133,000 at June 30,2004.

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 costs 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.

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.

Rights to UseMusic Product - Certain of the Company’s compilation productsare master recordings under license from record companies and publishers. Inmost instances, minimum guarantees or non-refundable advances are required toobtain the licenses and are realized through future sales of the product. Theamounts paid for minimum guarantees or non-refundable advances arecapitalized and charged to expense as sales are made. The unrealized portion ofguarantees and advances is included in royalty advances in the accompanyingconsolidated balance sheets. Licenses are subject to audit by licensors. Whenanticipated sales appear to be insufficient to fully recover the minimumguarantees or non-refundable advances, a provision against currentoperations is made for anticipated losses.

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.

7

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Advertising- The Company expenses the costs of advertising when the advertising takesplace, except for direct response advertising, which is capitalized andamortized over its expected period of future benefits (usually the periodremaining under a related contract, which is generally less than one year).Direct response advertising consists primarily of television advertisingwhereby customers respond specifically to the advertising and where the Companycan identify the advertising that elicited the response. Advertising expenseswere $67,000 and $75,000 for the six month periods ended December 31, 2004 and2003, 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, basicand diluted earnings per common share would have been as follows:
| ** **                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                      | ** ** | **December 31,**            | ** ** | **December 31,**          | ** ** |
| ** **                      | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                            |       |                             |       |                           |       |   |   |   |   |
| Net Gain (Loss) (in  thousands) |       |                             |       |                           |       |   |   |   |   |
| As reported                     |       | $                                | 190        |                           | $          | (180 | ) | $ | 37 |   | $ | (264 | ) |
| Pro forma                       |       | $                                | 190        |                           | $          | (180 | ) | $ | 37 |   | $ | (264 | ) |
|                            |       |                             |       |                           |       |   |   |   |   |
| Basic and Diluted EPS           |       |                             |       |                           |       |   |   |   |   |
| As reported                     |       | $                                | .02        |                           | $          | (.01 | ) | $ | .01 |   | $ | (.02 | ) |
| Pro forma                       |       | $                                | .02        |                           | $          | (.01 | ) | $ | .01 |   | $ | (.02 | ) |

 

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 Income (Loss) Per Share - Basicand diluted net income (loss) per share have been computed by dividing netincome (loss) by the weighted average number of shares outstanding during theperiod. For all periods presented, common stock equivalents were excluded fromthe per share calculation as the net effect would be antidilutive. For the sixmonth periods ended December 31, 2004 and 2003, weighted average options topurchase 2,564,839 and 953,630 shares of common stock, with weighted averageexercise prices of $.36 and $.95, respectively, were excluded from thecomputation of common share equivalents for the respective periods as they wereantidilutive.   For the three monthperiods ended December 31, 2004 and 2003, weighted average options to purchase2,564,839 and 1,464,360 shares of common stock, with weighted average exerciseprices of $.36 and $.64, respectively, were excluded from the computation ofcommon share equivalents for the respective periods as they were antidilutive.

Use of Estimates- Preparing consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America (US GAAP)requires 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.

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**3.             LOANS PAYABLE TO AFFILIATE**

K-telhas a Line of Credit Agreement with K-5 Leisure Products, Inc. (“K-5”), theCompany’s largest shareholder which is controlled by Philip Kives, the Chairmanof the Board, President and Chief Executive Officer of K-tel. Under the termsof the agreement (the “K-5 Facility”), K-5 has agreed to make available up to$8,000,000 to K-tel on a revolving basis. The loan bears interest at a variablerate based upon the “base rate” of a nationally recognized lending institution(5.25% at December 31, 2004), expires July 20, 2008, and is subordinated to theFoothill loan (see below). The K-5 Facility contains the same covenants as theFoothill loan agreement. K-tel has pledged the stock of its foreignsubsidiaries as collateral for the loan, and the loan carries a subordinatedposition to the Foothill loan on all other assets of the Company. K-tel hadoutstanding balances of $7,527,000 and $7,165,000 as of December 31, 2004 andJune 30, 2004, respectively, under the K-5 Facility. At December 31, 2004,K-tel obtained a waiver from K-5 for its non-compliance under the covenants,limitations and restrictions of the credit agreement.

Inaddition, K-tel has a second loan agreement with K-5, under which K-5 assumedrights and obligations under a loan from the Company’s former banker (FoothillCapital Corporation) pursuant to an Assignment and Acceptance Agreement datedFebruary 27, 2001. This Foothill loan, which has been extended through July 20,2008, provides for a $10,000,000 credit facility consisting of a $4,000,000term loan due upon expiration, and a $6,000,000 revolving facility under whichborrowings are limited to a percent of eligible receivables. Borrowings underthe facility bear interest at a variable rate based on a “base rate” of anationally recognized lending institution plus 1% (6.25% at December 31, 2004)and are collateralized by the assets of certain Company subsidiaries in theUnited States, including accounts receivable, inventories, equipment, musiclibrary and general intangibles. The loan agreement contains certain financialand other 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, 2004 and June30, 2004, $4,000,000 was outstanding under the term loan and there were noborrowings under the revolving facility. At December 31, 2004, K-tel obtained awaiver from K-5 for its non-compliance under the covenants, limitations andrestrictions of the credit agreement.

K-telhad an overdraft privilege borrowing facility with The Royal Bank of Scotlandin the United Kingdom. This facility was secured by a standby letter of creditfor $55,000 provided by K-tel International Ltd., a Canadian company controlledby Philip Kives and was payable on demand in accordance with normal bankingpractices.   K-tel had no outstanding balanceas of December 31, 2004 and June 30, 2004. This overdraft privilege borrowing facility was canceled at the end ofcalendar year 2004.

**4.**             **COMMITMENTSAND CONTINGENCIES**

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

On March 14, 2000,K-tel and its subsidiary in Germany commenced an action for breach of expressand implied warranties against Tristar Products, Inc. This action arose out ofTristar’s sale to K-tel of a defective home exercise product called the “BunBlaster”for resale in Germany, Austria and Switzerland. By written contract, Tristarhagreed to indemnify K-tel for injuries and damages arising out of the resaleof those goods. 

On April 30, 2001,Tristar also asserted a patent and trademark/ trade-dress counterclaim againstK-tel for allegedly passing off a product called the “K-tel Hook and Hang”while allegedly a distributor of the original patented Tristar Hook and Hangproduct. The Company denies the allegation because it never was a distributorof this or any similar product. 

On December 30, 2004, aMutual General Release and Settlement Agreement was signed by K-tel andTristar,  whereby both companies agreedto mutual releases and Tristar agreed to pay K-tel $350,000.  The payment of $350,000 was received February18, 2005.

#### Other Litigation and Disputes

K-tel and itssubsidiaries are also involved in other legal proceedings in the ordinarycourse of 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

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outcome is likelyto have a material adverse effect upon the consolidated financial position orresults of operations of K-tel.

Subsidiary’sLiquidation

TheCompany discontinued its United States subsidiary, K-tel Consumer Products,Inc., in February 2001. This closing represents the discontinuation of theCompany’s consumer products division and accordingly has been presented in theaccompanying financial statements as discontinued operations. In addition, inMarch 2001, the Company’s music distribution subsidiary in the United States,K-tel (USA) ceased operations and filed for protection under Chapter 7 of theUnited States Bankruptcy Code.

In fiscal 2004, $214,000 was received from the liquidation of K-telMarketing LTD. The Company also received approximately $333,000 in fiscal 2004from the sale of assets and account receivable collections related to the March2001 bankruptcy of K-tel International, (USA), Inc.

**5.             BUSINESS SEGMENT AND GEOGRAPHICAREA DATA**

The Companymarkets and distributes entertainment products internationally and through itsoperating subsidiaries. K-tel’s businesses are organized, managed andinternally reported as two segments: retail music sales and music licensing.These segments are based on differences in products, customer type and salesand distribution methods. The Company’s consumer product and e-commerceoperations have been discontinued and are presented in the accompanyingfinancial statements as discontinued operations and are therefore not includedin the segment information.

The retail musicsegment consists primarily of the sales of pre-recorded music from theCompany’s music master catalog.  TheCompany sells compact discs and DVDs directly to retailers, wholesalers andrack service distributors which stock and manage inventory within musicdepartments for retail stores.

In the licensingsegment, the Company licenses the rights to its master music catalog,consisting of original recordings and re-recordings of music from the 1950’sthrough today, to third parties world-wide for use in albums, films,television programs, commercials, and for electronic down loads to variousmedia formats, for either a flat fee or a royalty based on the number of unitssold.

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,** | ** ** | **Music** | ** ** | **Licensing** | ** ** | **Other** | ** ** | **Corporate  Elimination** | ** ** | **Total  Company** | ** ** |
|---------------------------------------------------|------------|-----------|------------|---------------|------------|-----------|------------|----------------------------|------------|--------------------|------------|
| * *                                          | * *   | * *  | * *   | * *      | * *   | * *  | * *   | * *                   | * *   | * *           | * *   |
| Net Sales                                         | 2004       |      | $          | 2,881         |       | $         | 650        |                       | $          | —             |       | $ | — |   | $ | 3,531 |   |
|                                              | 2003       |      | 2,501      |          | 880        |      | —     |                       | —     |               | 3,381      |   |
|                                              |       |      |       |          |       |      |       |                       |       |               |       |   |
| Operating Income  (Loss)                          | 2004       |      | $          | (12           | )          | $         | (7         | )                          | $          | —             |       | — |   | $ | (19 | ) |
|                                              | 2003       |      | (54        | )             | 99         |      | —     |                       | —     |               | 45         |   |
|                                              |       |      |       |          |       |      |       |                       |       |               |       |   |
| Assets                                            | 2004       |      | $          | 4,213         |       | $         | 587        |                       | $          | 563                |       | $ | — |   | $ | 5,363 |   |
|                                              | 2003       |      | 3,771      |          | 783        |      | 197        |                       | —     |               | 4,751      |   |

 
| **Three Months  Ended  December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| * *                              | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   |
| Net Sales                             | 2004       |       | $          | 1,350      |       | $          | 345        |       | $          | —     |       | $ | — |   | $ | 1,695 |   |
|                                  | 2003       |       | 1,398      |       | 361        |       | —     |       | —     |       | 1,759      |   |
|                                  |       |       |       |       |       |       |       |       |       |       |       |   |
| Operating Income  (Loss)              | 2004       |       | $          | (67        | )          | $          | 77         |       | $          | —     |       | $ | — |   | $ | 10 |   |
|                                  | 2003       |       | (7         | )          | (47        | )          | —     |       | —     |       | (40        | ) |

 

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GEOGRAPHICINFORMATION *(in thousands)*
| Six Months Ended  December 31, | ** ** | **United States** | ** ** | **Europe** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|------------|------------|-----------|------------|
| * *                                      | * *   | * *               | * *   | * *   | * *   | * *  | * *   |
| Net Sales                                     | 2004       |                   | $          | 1,909      |       | $         | 1,622      |   | $ | 3,531 |   |
|                                          | 2003       |                   | 2,022      |       | 1,359      |      | 3,381      |   |
|                                          |       |                   |       |       |       |      |       |   |
| Assets                                        | 2004       |                   | $          | 2,503      |       | $         | 2,860      |   | $ | 5,363 |   |
|                                          | 2003       |                   | 2,660      |       | 2,091      |      | 4,751      |   |

 
| **Three Months Ended  December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|------------|------------|------------|------------|
|                                 |       |       |       |       |       |       |       |
| Net Sales                            | 2004       |       | $          | 893        |       | $          | 802        |   | $ | 1,695 |   |
|                                 | 2003       |       | 1,057      |       | 702        |       | 1,759      |   |
|                                      |            |            |            |            |            |            |            |  |  |  |  |

 

**6.             SUBSEQUENTEVENT**

Effective October10, 2005, K-tel, through a wholly owned subsidiary, entered into a trademark licenseagreement with BCI Eclipse Company, LLC (“BCI”) and effective October 16, 2005,entered into a phonograph record license agreement with BCI.

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

**General**

Throughits operating subsidiaries, K-tel licenses its music catalog internationallyand markets entertainment products mainly derived from its catalog in theUnited States and Europe through retail and direct response marketing channels.

Througha subsidiary, 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. As well, the Companyseeks to license its name and marks to other businesses for a royalty or fee.

#### **A. RESULTS OF OPERATIONS**

#### **THREE MONTHS ENDED DECEMBER 31, 2004 VERSUSDECEMBER 31, 2003**

Netsales for the three month period ended December 31, 2004 were $1,695,000 adecrease of 3.6% from net sales of $1,759,000 for the three month period endedDecember 31, 2003. This decrease was attributed to decreased  music sales during the quarter ended December31, 2004. The net income for the three month period ended December 31, 2004 was$190,000, or $.02 per share, compared to a net loss of $180,000, or $.01 pershare, for the three month period ended December 31, 2003.

Generalcorporate expenses of $170,000 and $237,000 for the three month periods endedDecember 31, 2004 and 2003, respectively, have been allocated to the segments.

Thefollowing sections discuss the results of continuing operations by businesssegment.

#### **BUSINESS SEGMENT RESULTS**

#### **Music**

Sales in the musicsegment were $1,350,000 for the three month period ended December 31, 2004compared to $1,398,000 for the three month period ended December 31, 2003, adecrease of $48,000, or 3.4%. The decrease was primarily due to a decrease inmusic DVD sales.

Costof goods sold in the music segment increased to 57.4% of sales for the threemonth period ended December 31, 2004 compared to 55.6% of sales for the threemonth period ended December 31, 2003. Advertising expenses within the segment, which consist primarily ofco-operative advertising payments, trade advertising and promotions, increasedto $40,000 for the three month period ended December 31, 2004 compared to$37,000 for the three month period ended December 31, 2003.

Selling,general and administrative expenses were $597,000, or 44.3% of sales for thethree month period ended December 31, 2004 compared to $582,000, or 41.6% ofsales for the three month period ended December 31, 2003. The primary reasonfor the increase was general and administrative expenses related to the Germanbranch of K-tel Entertainment (UK) Ltd.

Themusic segment incurred an operating loss of $67,000 for the three month periodended December 31, 2004 compared to operating income of $7,000 for the threemonth period ended December 31, 2003.

**Licensing**

Licensingrevenue was $345,000 for the three month period ended December 31, 2004compared to $361,000 for the three month period ended December 31, 2003, adecrease of 4.4% reflecting reduced licensing activity.  The licensing segment had operating income of$77,000 for the three month period ended December 31, 2004 compared tooperating an loss of $47,000 for the three month period ended December 31,2003, an increase of $124,000.

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TheCompany is concentrating its efforts on building licensing arrangements inseveral other segments of the entertainment industry.  In September 2004, the Company beganlicensing its master music catalog to several companies that offer electronicdownloads via their internet sites.

#### **SIX MONTHS ENDED DECEMBER 31, 2004 VERSUSDECEMBER 31, 2003**

Netsales for the six month period ended December 31, 2004 were $3,531,000 comparedto $3,381,000 for the six month period ended December 31, 2003. This increasewas attributed to increased music sales offset by a decrease in licensingrevenue. The net gain for the six month period ended December 31, 2004 was$37,000, or $.01 per share, compared to a net loss of $264,000, or $.02 pershare, for the six month period ended December 31, 2003.

Generalcorporate expenses of $343,000 and $449,000 for the six month periods endedDecember 31, 2004 and 2003, respectively, have been allocated to the segments.

Thefollowing sections discuss the results of continuing operations by businesssegment.

#### **BUSINESS SEGMENT RESULTS**

#### **Music**

Sales in the musicsegment were $2,881,000 for the six month period ended December 31, 2004compared to $2,501,000 for the six month period ended December 31, 2003, anincrease of $380,000, or 15.2%.  Thedecrease in domestic sales was offset by an increase in music sales in theUnited Kingdom.  The increase wasprimarily due to increased sales of an expanded product offering during the sixmonths ended December 31, 2004.

Costof goods sold in the music segment increased to 55.5% of sales for the sixmonth period ended December 31, 2004 compared to 54.1% of sales for the sixmonth period ended December 31, 2003. Advertising expenses within the segment,which consists primarily of co-operative advertising payments, trade advertisingand promotions, were $67,000 for the six month period ended December 31, 2004compared to $75,000 for the six month period ended December 31, 2003.

Selling,general and administrative expenses were $1,213,000, or 42.2% of sales for thesix month period ended December 31, 2004 compared to $1,126,000, or 45.0% ofsales for the six month period ended December 31, 2003.  The primary reason for the increase inexpenses was general and administrative expenses related to the German branchof K-tel Entertainment (UK) Ltd.

Themusic segment incurred an operating loss of $12,000 for the six month periodended December 31, 2004 compared to an operating loss of $54,000 for the sixmonth period ended December 31, 2003.

**Licensing**

Licensingrevenue was $650,000 for the six month period ended December 31, 2004 comparedto $880,000 for the six month period ended December 31, 2003, a decrease of26.1% reflecting reduced licensing activity in the United States and the UnitedKingdom.  The Company is concentratingits efforts on building licensing arrangements in several other segments of theentertainment industry.  In September2004, the Company began licensing its master music catalog to several companiesthat offer electronic downloads via their internet sites.

Royaltycosts within the segment decreased to $81,000 for the six month period endedDecember 31, 2004 compared to $160,000 for the six month period ended December31, 2003 due primarily to the decrease in licensing revenue.

Selling,general and administrative expenses decreased to $576,000 for the six monthperiod ended December 31, 2004 compared to $622,000 for the six month periodended December 31, 2003, a decrease of 7.4%.  The primary reason for the decrease was the Company-wide effort toreduce overhead expenses.

Therewas an operating loss in the licensing segment of $7,000 for the six monthperiod ended December 31, 2004 compared to operating income of $99,000 for thesix month period ended December 31, 2003, a decrease of $106,000.

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**B.            LIQUIDITYAND CAPITAL RESOURCES**

K-telhas a Line of Credit Agreement with K-5 Leisure Products, Inc. (“K-5”), theCompany’s largest shareholder which is controlled by Philip Kives, the Chairmanof the Board, President and Chief Executive Officer of K-tel. Under the termsof the agreement (the “K-5 Facility”), K-5 has agreed to make available up to$8,000,000 to K-tel on a revolving basis. The loan bears interest at a variablerate based upon the “base rate” of a nationally recognized lending institution(5.25% at December 31, 2004), expires July 20, 2008, and is subordinated to theFoothill loan (see below). The K-5 Facility contains the same covenants as theFoothill loan agreement. K-tel has pledged the stock of its foreignsubsidiaries as collateral for the loan, and the loan carries a subordinatedposition to the Foothill loan on all other assets of the Company. K-tel hadoutstanding balances of $7,527,000 and $7,165,000 as of December 31, 2004 andJune 30, 2004, respectively, under the K-5 Facility. At December 31, 2004, K-telobtained a waiver from K-5 for its non-compliance under the covenants,limitations and restrictions of the credit agreement.

Inaddition, K-tel has a second loan agreement with K-5, under which K-5 assumedrights and obligations under a loan from the Company’s former banker (FoothillCapital Corporation) pursuant to an Assignment and Acceptance Agreement datedFebruary 27, 2001. This Foothill loan, which has been extended through July 20,2008, provides for a $10,000,000 credit facility consisting of a $4,000,000term loan due upon expiration, and a $6,000,000 revolving facility under whichborrowings are limited to a percent of eligible receivables. Borrowings underthe facility bear interest at a variable rate based on a “base rate” of anationally recognized lending institution plus 1% (6.25% at December 31, 2004)and are collateralized by the assets of certain Company subsidiaries in theUnited States, including accounts receivable, inventories, equipment, musiclibrary and general intangibles. The loan agreement contains certain financialand other 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, 2004 and June30, 2004, $4,000,000 was outstanding under the term loan and there were noborrowings under the revolving facility. At December 31, 2004, K-tel obtained awaiver from K-5 for its non-compliance under the covenants, limitations andrestrictions of the credit agreement.

K-telhad an overdraft privilege borrowing facility with The Royal Bank of Scotlandin the United Kingdom. This facility was secured by a standby letter of credit for$55,000 provided by K-tel International Ltd., a Canadian company controlled byPhilip Kives and was payable on demand in accordance with normal bankingpractices.   K-tel had no outstandingbalance as of December 31, 2004 and June 30, 2004.  This overdraft privilege borrowing facilitywas canceled at the end of calendar year 2004.

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.

TheCompany’s ability to continue its present operations is contingent mainly uponits ability 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 cashgenerated from the Company’s current operations will likely be inadequate tofund operations and service its indebtedness on an ongoing basis. Management isfocusing its efforts on music licensing and limited music distribution.However, there can be no assurance that the Company will achieve profitableoperations through these efforts. In the event the Company is unable to fundits operations and implement its current business plan properly, it may beunable to continue operations. The financial statements do not include anyadjustments that might result from the outcome of these uncertainties.

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

Therehave been no material changes in the Company’s market risk during the six monthperiod ended December 31, 2004. For additional information, refer to theCompany’s annual report on Form 10-K/A for the fiscal year ended June 30, 2004.

**ITEM4.  CONTROLS AND PROCEDURES**

Under the supervision andwith the participation of the Company’s management, including the Company’sChief Executive Officer and Chief Financial Officer, the Company evaluated theeffectiveness of the design and operation of its disclosure controls andprocedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act).Based on that evaluation, the Chief Executive Officer and Chief FinancialOfficer concluded that, as of the end of the period covered by this report, theCompany’s disclosure controls and procedures were not effective because of thefollowing material weakness in internal control over financial reporting.

The Company didnot maintain effective controls over cash disbursements and payrolltransactions at its UK subsidiary. In September 2004, the Company discoveredthat the former Chief Financial Officer of its UK subsidiary misappropriatedfunds from the subsidiary and one of its customers. Adjustments related to thereversal of overstated expenses and recovery of amounts misappropriated wereincluded in the restatement of the Company’s consolidated financial statementsfor the years ended June 30, 2004 and 2003.

*Inresponse to the material weakness above, the Company terminated the employee,undertook a full-scale investigation of the matter, retained a forensicauditing firm and dismissed the accounting firm in the UK that audited the UKsubsidiary’s financial books and records. In addition the Company hired a newFinancial Controller and stringent internal control procedures were created andimplemented for the Company’s purchasing, accounts payable, check signing, payroll,petty cash and financial reporting policies. Management believes that theseprocedures, implemented upon the discovery of the misappropriation of funds,will allow the Company to reestablish internal control over financialreporting.*

During the Company’sfiscal quarter ended December 31, 2004, there had been no change in the Company’sinternal control over financial reporting (as defined in Rule 13a-15(f) or15d-15(f) under the Exchange Act) that has materially affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

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**PART II**

#### **ITEM1. LEGAL PROCEEDINGS**

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

On March 14, 2000,K-tel and its subsidiary in Germany commenced an action for breach of expressand implied warranties against Tristar Products, Inc. This action arose out ofTristar’s sale to K-tel of a defective home exercise product called the “BunBlaster”for resale in Germany, Austria and Switzerland. By written contract,Tristar  agreed to indemnify K-tel forinjuries and damages arising out of the resale of those goods.

On April 30, 2001,Tristar also asserted a patent and trademark/ trade-dress counterclaim againstK-tel for allegedly passing off a product called the “K-tel Hook and Hang”while allegedly a distributor of the original patented Tristar Hook and Hangproduct. The Company denies the allegation because it never was a distributorof this or any similar product.

On December 30, 2004, aMutual General Release and Settlement Agreement was signed by K-tel andTristar,  whereby both companies agreedto mutual releases and Tristar agreed to pay K-tel $350,000.  The payment of $350,000 was received February18, 2005.

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

K-tel and itssubsidiaries are also involved in other legal proceedings in the ordinarycourse of 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.

Subsidiary’sLiquidation

In November 2000,the Company’s consumer products subsidiary in the United Kingdom, K-telMarketing Ltd., ceased operations and began voluntary liquidation proceedings.At the initial meeting of the creditors on November 24, 2000, the creditorsvoted for the liquidation to become a creditors’ liquidation under English law.The Company has not been informed by the liquidators or their counsel of anyplan to attempt to hold it or any of its subsidiaries liable for any of thecommitments of K-tel Marketing Ltd. Management believes the Company will haveno ongoing material liability related to K-tel Marketing Ltd. as a result ofthe liquidation proceeding. As the only secured creditor, the Company receiveddistributions of approximately $138,000 on March 1, 2004 and $76,000 on May 14,2004.

*Inaddition to the $214,000 from the liquidation of K-tel Marketing LTD., theCompany also received approximately $333,000 in fiscal 2004 from the sale ofassets and account receivable collections related to the March 2001 bankruptcyof K-tel International, (USA), Inc.*

***ITEM 6.  EXHIBITS***

See “Index to Exhibits.”

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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: September  18, 2006 |   | /S/ PHILIP KIVES                      |
|                       |   | PHILIP KIVES                          |
|                       |   | CHAIRMAN AND  CHIEF EXECUTIVE OFFICER |
|                       |   |                                  |
|                       |   |                                  |
| Dated: September  18, 2006 |   | /s/ LARRY DUNMALL                     |
|                       |   | LARRY DUNMALL                         |
|                       |   | CHIEF FINANCIAL  OFFICER              |

 

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**INDEX TO EXHIBITS**
| Exhibit No. | ** ** | **Description of Exhibit**                                                                                                                          |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                |
| 31.1        |       | Certification by Chief Executive Officer pursuant to  Rule 13a-14(a).                                                                               |
|        |       |                                                                                                                                                |
| 31.2        |       | Certification by Chief 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 Chief 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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