**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

| **(Mark One)**                            |
|-------------------------------------------|
|                                      |
| **ý**                                | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|                                      |   |
|                                      | **For the quarterly period ended September 30, 2003 or** |
|                                      |   |
| **o**                                     | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|                                      |   |
|                                      | **For the transition period from                     to                   ** |
|                                      |   |
| **Commission File Number:  1-07115** |

 

**K-TEL INTERNATIONAL, INC.**

(Exact name of registrant as specified in its charter)

 

| **Minnesota**                                                    |   | **41-0946588**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or  other jurisdiction of  incorporation or organization) |   | (I.RS.  Employer  Identification No.) |
|                                                             |   |                                  |
| **2655 Cheshire Lane North, Suite 100, Plymouth, Minnesota**     |   | **55447**                             |
| (Address of  principal executive offices)                        |   | (Zip Code)                            |
|                                                             |
| **(763) 559-5566**                                               |
| (Registrant’s telephone number, including area code)        |

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.

Yes ý       Noo

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined by Rule 12b-2 of theExchange Act).

Yes o       Noý

 

As of November 14, 2003, therewere 13,653,738 shares of the registrant’s common stock, par value $0.01 pershare, outstanding.

 

 

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

**FORM10-Q**

 

**FOR THETHREE MONTH PERIOD**

**ENDEDSEPTEMBER 30, 2003**

 

INDEX

 
| PART I.            | Financial  Information (Unaudited): |                                                                                                            |
|--------------------|-------------------------------------|-----------------------------------------------------------------------------------------------------------------|
|               |                                |
|               | Item 1.                             | Financial  Statements                                                                                           |   |
|               |                                |                                                                                                            |   |
|               |                                | Condensed  Consolidated Balance Sheets as of  September 30, 2003 and June 30, 2003                              |   |
|               |                                |                                                                                                            |   |
|               |                                | Condensed Consolidated Statements of Operations  for the Three Month Periods Ended  September 30, 2003 and 2002 |   |
|               |                                |                                                                                                            |   |
|               |                                | Condensed Consolidated Statements of Cash Flows  for the Three Month Periods Ended  September 30, 2003 and 2002 |   |
|               |                                |                                                                                                            |   |
|               |                                | 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 |                                |
|                    |                                     |                                                                                                                 |  |  |

 

**Important FactorsRelating to Forward Looking Statements**

 

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” orthe negative thereof or other variations thereon or comparable terminology.Such forward-looking statements are subject to certain risks and uncertaintiesthat could cause actual results to differ materially from historical results orfrom those results currently anticipated or projected. Such factors include,among other things, the following: changes in consumer purchasing; demand forand market acceptance of new and existing products; the impact from competitionfor recorded music; the outcome of legal proceedings; dependence on suppliersand distributors; the outcome of our subsidiaries’ bankruptcy and liquidation;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.

 

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

**CONDENSEDCONSOLIDATED BALANCE SHEETS - UNAUDITED**

*(in thousands –except share data*)

 
|                                                                                                 |   | **September  30,  2003** |   | **June 30,  2003** |   |
|------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|--------------------|--------|
|                                                                                                 |   |                     |   |               |   |
| ASSETS                                                                                               |   |                     |   |               |   |
|                                                                                                 |   |                     |   |               |   |
| Current Assets:                                                                                      |   |                     |   |               |   |
| Cash and cash equivalents                                                                            |   | $                        | 200    |               | $      | 1,219 |   |
| Accounts receivable, net of allowance for  doubtful accounts of $20 and $25                          |   | 1,538                    |   | 1,559              |   |
| Inventories                                                                                          |   | 467                      |   | 520                |   |
| Royalty advances                                                                                     |   | 219                      |   | 235                |   |
| Prepaid expenses and other                                                                           |   | 216                      |   | 304                |   |
| Total Current Assets                                                                                 |   | 2,640                    |   | 3,837              |   |
|                                                                                                 |   |                     |   |               |   |
| Property and equipment, net of accumulated  depreciation and amortization of $1,451 and $1,506       |   | 95                       |   | 101                |   |
|                                                                                                 |   |                     |   |               |   |
| Owned catalog masters, net of accumulated  amortization of $2,798 and $2,755                         |   | 768                      |   | 819                |   |
|                                                                                                 |   |                     |   |               |   |
|                                                                                                 |   | $                        | 3,503  |               | $      | 4,757 |   |
|                                                                                                 |   |                     |   |               |   |
| LIABILITIES AND SHAREHOLDERS’ DEFICIT                                                           |   |                     |   |               |   |
|                                                                                                 |   |                     |   |               |   |
| Current Liabilities:                                                                                 |   |                     |   |               |   |
| Notes payable to affiliate and other                                                                 |   | $                        | 10,470 |               | $      | 11,515 |   |
| Accounts payable                                                                                     |   | 1,080                    |   | 1,162              |   |
| Accrued royalties                                                                                    |   | 2,330                    |   | 2,333              |   |
| Reserve for returns                                                                                  |   | 200                      |   | 213                |   |
| Net liabilities of discontinued operations                                                           |   | 134                      |   | 116                |   |
| Total Current Liabilities                                                                            |   | 14,214                   |   | 15,339             |   |
|                                                                                                 |   |                     |   |               |   |
| 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                                                                                  |   | (31,888                  | )      | (31,759            | )      |
| Accumulated other comprehensive loss                                                                 |   | (251                     | )      | (251               | )      |
| Total Shareholders’ Deficit                                                                     |   | (10,711                  | )      | (10,582            | )      |
|                                                                                                 |   |                     |   |               |   |
|                                                                                                 |   | $                        | 3,503  |               | $      | 4,757 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

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

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS -UNAUDITED**

*(in thousands -except per share data)*

 
|                                                                   |   | **Three  Months Ended  September 30,** |   |
|------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                   |   | **2003**                               |   | **2002** |   |
|                                                                   |   |                                   |   |   |   |
| Net Sales                                                              |   | $                                      | 1,618  |   | $ | 1,498 |   |
|                                                                   |   |                                   |   |   |   |
| Costs and  Expenses:                                                   |   |                                   |   |   |   |
| Cost of goods sold                                                     |   | 669                                    |   | 599 |   |
| Advertising                                                            |   | 43                                     |   | 46 |   |
| Selling, general and administrative                                    |   | 866                                    |   | 951 |   |
| Total Costs and Expenses                                               |   | 1,578                                  |   | 1,596 |   |
| Operating Income (Loss)                                                |   | 40                                     |   | (98 | ) |
| Other Expense:                                                         |   |                                   |   |   |   |
| Interest expense                                                       |   | (117                                   | )      | (136 | ) |
| Other                                                                  |   | (11                                    | )      | (64 | ) |
| Total Other Expense                                                    |   | (128                                   | )      | (200 | ) |
|                                                                   |   |                                   |   |   |   |
| Loss from Continuing Operations                                        |   | (88                                    | )      | (298 | ) |
|                                                                   |   |                                   |   |   |   |
| Loss from Discontinued Operations                                      |   | (41                                    | )      | (210 | ) |
|                                                                   |   |                                   |   |   |   |
| Net Loss                                                               |   | $                                      | (129   | ) | $ | (508 | ) |
|                                                                   |   |                                   |   |   |   |
| Loss per Share - Basic and Diluted:                                    |   |                                   |   |   |   |
| Continuing Operations                                                  |   | $                                      | (.01   | ) | $ | (.02 | ) |
| Discontinued Operations                                                |   | —                                 |   | (.02 | ) |
| Net Loss                                                               |   | $                                      | (.01   | ) | $ | (.04 | ) |
|                                                                   |   |                                   |   |   |   |
| Shares used in the calculation of loss per  share - Basic and Diluted: |   | 13,654                                 |   | 13,654 |   |
|                                                                   |   |                                   |   |   |   |
| Comprehensive Loss:                                                    |   |                                   |   |   |   |
| Net loss                                                               |   | $                                      | (129   | ) | $ | (508 | ) |
| Translation adjustment                                                 |   | —                                 |   | (61 | ) |
| Comprehensive Loss                                                     |   | $                                      | (129   | ) | $ | (569 | ) |

 

The accompanying notes are an integral part of these financialstatements.

 

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

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS -UNAUDITED**

*(in thousands)*

 
|                                                                                   |   | **Three  Months Ended  September 30,** |   |
|----------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                                   |   | **2003**                               |   | **2002** |   |
| Cash flows from Operating Activities:                                                  |   |                                   |   |   |   |
| Net loss                                                                               |   | $                                      | (129   | ) | $ | (508 | ) |
| Adjustments to reconcile net loss to cash  provided by (used in) operating activities: |   |                                   |   |   |   |
| Depreciation and amortization                                                          |   | 65                                     |   | 103 |   |
| Loss on disposal of property and equipment                                             |   | 1                                      |   | — |   |
| Discontinued operations                                                                |   | 14                                     |   | 201 |   |
| Changes in operating assets and  liabilities:                                          |   |                                   |   |   |   |
| Accounts receivable, net                                                               |   | 25                                     |   | (110 | ) |
| Inventories                                                                            |   | 52                                     |   | (119 | ) |
| Royalty advances                                                                       |   | 17                                     |   | (19 | ) |
| Prepaid expenses                                                                       |   | 87                                     |   | 81 |   |
| Accounts payable                                                                       |   | (106                                   | )      | 137 |   |
| Accrued royalties                                                                      |   | (4                                     | )      | 27 |   |
| Reserve for returns                                                                    |   | (13                                    | )      | 50 |   |
| Cash provided by (used in) operating  activities                                       |   | 9                                      |   | (157 | ) |
|                                                                                   |   |                                   |   |   |   |
| Cash flows from Investing Activities:                                                  |   |                                   |   |   |   |
| Proceeds from sale of property and  equipment                                          |   | 12                                     |   | — |   |
| Purchases of property and equipment                                                    |   | (6                                     | )      | (4 | ) |
| Cash provided by (used in) investing  activities                                       |   | 6                                      |   | (4 | ) |
|                                                                                   |   |                                   |   |   |   |
| Cash flows from Financing Activities:                                                  |   |                                   |   |   |   |
| Borrowings on notes payable                                                            |   | 431                                    |   | 651 |   |
| Payments on notes payable                                                              |   | (1,476                                 | )      | (400 | ) |
| Cash provided by (used in) financing  activities                                       |   | (1,045                                 | )      | 251 |   |
|                                                                                   |   |                                   |   |   |   |
| Effect of exchange rates on cash                                                       |   | 11                                     |   | (80 | ) |
|                                                                                   |   |                                   |   |   |   |
| Net increase (decrease) in cash and  equivalents                                       |   | (1,019                                 | )      | 10 |   |
|                                                                                   |   |                                   |   |   |   |
| Cash and equivalents at beginning of period                                            |   | 1,219                                  |   | 75 |   |
|                                                                                   |   |                                   |   |   |   |
| Cash and equivalents at end of period                                                  |   | $                                      | 200    |   | $ | 85 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

5

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

 

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**1.****                                      BUSINESSAND LIQUIDITY**

 

K-tel International, Inc. (the“Company” or “K-tel”) was incorporated in 1968 and currently has its corporateoffices located in Plymouth, Minnesota. Through its operating subsidiaries, K-tel licenses its music catalog internationallyand markets entertainment products mainly derived from its catalog throughretail and direct response marketing channels in the United States and Europe.The Company has a focused method of distribution that targets the strengths ofselected individual retailers and supplies products suited to each retailer’sneeds. These new products are derived mainly from the Company’s masterrecordings music catalog with the objective of realizing more competitiveprofit margins. K-tel seeks to license its trademarks to other companies inbusinesses unrelated to K-tel’s current operations. Licenses are granted for aroyalty or fee, with no cost to the Company. The Company has licensed certainmarks to K-tel Drug Mart Ltd., a Canadian direct marketer of prescription drugsbeneficially owned by Philip Kives, the Chairman of the Board, President andChief Executive Officer of K-tel. K-tel Drug Mart, which recently beganoperations, offers prescription drugs from its pharmacy in Canada to persons inthe United States. K-tel is merely a licensor of its mark to K-tel Drug Mart.To date, K-tel Drug Mart’s operations have not generated any significantlicensing revenues for the Company.

 

Discontinued Operations

 

The Company’s consumer products business,which was concentrated in Europe, consisted primarily of housewares, consumerconvenience items and exercise equipment. The Company discontinued its consumerproducts operations in Germany, the United Kingdom and the United States inJune 2000, November 2000 and January 2001 respectively. Accordingly, theseactivities have been presented in the accompanying financial statements asdiscontinued operations. The accompanying condensed consolidated financialstatements have been prepared to reflect the consumer products division as adiscontinued operation. The net liabilities of discontinued operations atSeptember 30, 2003 and 2002 consist of assets of $7,000 and $7,000 andliabilities of $141,000 and $299,000.

 

Going Concern

 

During the three months ended September 30,2003 and 2002, the Company incurred net losses from continuing operations of$88,000 and $298,000 respectively. Operating activities provided $9,000 of cashduring the three months ended September 30, 2003 and used $157,000 of cash inthe three months ended September 30, 2002. Additionally, the Company had aworking capital deficit of $11,574,000 at September 30, 2003.

 

The Company’sability to continue its present operations and implement future expansion planssuccessfully is contingent mainly upon its ability to maintain its line ofcredit arrangements with K-5 Leisure Products, Inc. (See Note 3), 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. The financial statements do not include anyadjustments that might result from the outcome of these uncertainties.

 

**2.****                                      BASISOF PRESENTATION AND SUMMARY OF 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 three month period ended September 30, 2003are not necessarily indicative of the results that may be expected for the yearas a whole. The unaudited condensed consolidated balance sheet for June 30,2003 has been derived from audited consolidated financial

 

6

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statements as of that date. Forfurther 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, 2003.

 

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 mainlyfrom two sources: the sale of music compilations (predominately compact discs)produced by the Company, and license revenue from the licensing ofCompany-owned masters. Revenue from music sales is recognized at the time ofshipment to the customer, while license revenue is recognized when payment isreceived from customers or when known amounts are receivable, as prior to thatdate collection is not considered probable. Most music sales are made with aright of return of unsold goods. Estimated reserves for returns are establishedby management based upon historical experience and product mix and are subjectto ongoing review and adjustment by the Company. These reserves are recorded atthe time of sale and are reflected as a reduction in revenues. The Company’sreserve for returns was $200,000 at September 30, 2003 and $89,000 at September30, 2002.

 

Cost of GoodsSold – The Company expenses all product manufacturing,distribution and royalty costs associated with music sales as cost of goodssold. The Company also expenses royalties, commissions and amortization of itsowned master recordings associated with its license revenue as costs of goodssold.

 

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

 

Cash and CashEquivalents – Cash and cash equivalents consistprincipally of cash and short-term, highly liquid investments with originalmaturities of less 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 topurchase owned master recordings at the time of acquisition. These costs areamortized over the estimated useful life of these master recordings, which isgenerally seven years and represents management’s best estimate of the averageperiod of value.

 

Rights to UseMusic Product - Certain of the Company’s compilationproducts are master recordings under license from record companies andpublishers. In most instances, minimum guarantees or non-refundable advancesare required to obtain the licenses and are realized through future sales ofthe product. The amounts paid for minimum guarantees or non-refundable advancesare capitalized and charged to expense as sales are made. The unrealizedportion of guarantees and advances is included in royalty advances in theaccompanying consolidated balance sheets. Licenses are subject to audit bylicensors. When anticipated sales appear to be insufficient to fully recoverthe minimum guarantees or non-refundable advances, a provision against currentoperations is made for anticipated losses.

 

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

 

LongLived-Assets – The Company evaluates its long-livedassets quarterly, or earlier if a triggering event occurs, to determinepotential impairment by comparing the carrying value of those assets to therelated undiscounted future cash flows of the assets. If an asset is determinedto be impaired, it is written down to its estimated fair value.

 

Royalties - TheCompany has entered into license agreements with various record companies andpublishers 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 - TheCompany 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

 

7

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period remaining under a related contract,which is generally less than one year). Direct response advertising consistsprimarily of television advertising whereby customers respond specifically tothe advertising and where the Company can identify the advertising thatelicited the response. Advertising expenses were $43,000 and $46,000 for thethree month periods ended September 30, 2003 and 2002 respectively.

 

Foreign Currency -The operations of foreign subsidiaries are measured in local currencies. Assetsand liabilities are translated into U.S. dollars at period-end exchange rates.Revenues and expenses are translated at the average exchange rates prevailingduring the period. Adjustments resulting from translating the financialstatements of foreign entities into U.S. dollars are recorded as a component ofaccumulated other comprehensive income or loss.

 

Stock-based Compensation– The Company accounts for stock-based awards to employees using the intrinsicvalue method prescribed in APB No. 25, “Accounting for Stock Issued toEmployees,” whereby the options are granted at market price, and therefore nocompensation costs are recognized. The Company has elected to retain itscurrent method of accounting as described above and has adopted the SFAS Nos.123 and 148 disclosure requirements. If compensation expense for the Company’svarious stock option plans had been determined based upon the projected fairvalues at the grant dates for awards under those plans in accordance with SFASNo. 123, the Company’s pro-forma net earnings, basic and diluted earnings percommon share would have been as follows:

 
|                      |   | **Three  Months Ended  September 30,** |   |
|---------------------------|--------|----------------------------------------|--------|
|                      |   | **2003**                               |   | **2002** |   |
| Net loss (in  thousands): |   |                                   |   |   |   |
| As reported               |   | $                                      | (129   | ) | $ | (508 | ) |
| Pro forma                 |   | $                                      | (129   | ) | $ | (508 | ) |
|                      |   |                                   |   |   |   |
| Basic and Diluted EPS:    |   |                                   |   |   |   |
| As reported               |   | $                                      | (.01   | ) | $ | (.04 | ) |
| Pro forma                 |   | $                                      | (.01   | ) | $ | (.04 | ) |

 

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 - Basic anddiluted net income (loss) per share have been computed by dividing net income(loss) by the weighted average number of shares outstanding during the period.For all periods presented, common stock equivalents were excluded from the pershare calculation as the net effect would be antidilutive. For the three monthperiods ended September 30, 2003 and 2002, weighted average options to purchase442,900 and 2,273,839 shares of common stock, with weighted average exerciseprices of $1.95 and $5.88 were excluded from the computation of common shareequivalents for the respective periods as they were antidilutive.

 

Use ofEstimates - Preparing consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America (US GAAP) requires management to make estimates andassumptions that affect the reported amounts of assets, liabilities, anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Principal estimates include allowances for bad debt,inventory valuation, return reserves, royalty obligations, purchase commitmentsand product replacement costs. Actual results could differ from those estimatesused by management.

 

**3.****                                      LOANSPAYABLE TO AFFILIATE**

 

K-tel has a Line of CreditAgreement with K-5 Leisure Products, Inc. (“K-5”), the Company’s largestshareholder controlled by Philip Kives, the Chairman of the Board, Presidentand Chief Executive Officer of K-tel. Under the terms of the agreement (the“K-5 Facility”), K-5 has agreed to make available up to $8,000,000 to K-tel ona revolving basis. The loan bears interest at a variable rate based upon the“base rate” of a nationally recognized lending institution (4.0% at September30, 2003), expires July 20, 2005, 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 $6,237,000 and $6,276,000 as of September 30,

 

8

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2003 and 2002 respectivelyunder the K-5 Facility. At September 30, 2003, K-tel obtained a waiver from K-5for its non-compliance under the covenants, limitations and restrictions of thecredit agreement.

 

In addition, K-tel has a secondloan agreement with K-5, under which K-5 assumed rights and obligations under aloan from the Company’s former banker (Foothill Capital Corporation) pursuantto an Assignment and Acceptance Agreement dated February 27, 2001. ThisFoothill loan, which has been extended through July 20, 2005, provides for a$10,000,000 credit facility consisting of a $4,000,000 term loan due uponexpiration, and a $6,000,000 revolving facility under which borrowings arelimited to a percent of eligible receivables. Borrowings under the facilitybear interest at a variable rate based on a “base rate” of a nationallyrecognized lending institution plus 1% (5.0% at September 30, 2003) 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 September 30, 2003 and June30, 2003, $4,000,000 was outstanding under the term loan and there were noborrowings under the revolving facility. At September 30, 2003, K-tel obtaineda waiver from K-5 for its non-compliance under the covenants, limitations andrestrictions of the credit agreement.

 

K-tel has anoverdraft privilege borrowing facility with The Royal Bank of Scotland in theUnited Kingdom. This facility is secured by a standby letter of credit for$260,000 provided by K-tel International Ltd., a Canadian company controlled byPhilip Kives and is payable on demand in accordance with normal bankingpractices. Borrowings bear interest of 2.0% per annum over the base rate (atotal of 6.0% at September 30, 2003) but are subject to a minimum of 6.0% perannum. K-tel had outstanding balances of $234,000 and $233,000 as of September30, 2003 and June 30, 2003 respectively.

 

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

 

RTL Shopping S. A.

 

The Company has been named in a lawsuit filedin France brought by RTL9, a French cable TV station. The action seeks damagesin the approximate amount of 20 million French Francs, or approximately $2.8million. Initially, RTL9 was named as a defendant in a suit brought by acompetitor of K-tel Marketing Ltd. alleging that RTL9 ran a commercial forK-tel Marketing which presented a product under brand names alleged to infringeon the competitor’s own trademarks and also translated an English languagescript indicating that the product was “just like” or “as good as” others into“better than” in French, contrary to French law. The suit alleged trademarkinfringement, unfair competition, illicit comparative advertising and passingoff. RTL9 then sued K-tel Marketing on October 4, 2000, pursuant to anindemnification provision the parties had entered into. Subsequently, K-telMarketing went into liquidation and RTL9 filed a suit in December 2000 againstK-tel International, Inc. under its agreement to guarantee payment for thecommercial time. On May 28, 2001, RTL9 presented documents in court identifyingK-tel International (USA), Inc. as a target of its claim. On September 3, 2001,the Company filed documents disputing the claim and advising the court of K-tel(USA)’s Chapter 7 bankruptcy filing.

 

After the Company advised the Court that RTL9had no basis for a complaint against the Company, RTL9 proposed to drop theirlawsuit. On September 23, 2003, RTL9 and the Company signed an agreementterminating the suit. The final disposition of the lawsuit will be confirmed bythe Court at a future hearing.

 

K-tel International, Inc. vs. TristarProducts, Inc.

 

On March 14, 2000, K-tel and its subsidiaryin Germany commenced an action for breach of express and implied warranties againstDefendant Tristar Products, Inc. This action is venued in the United StatesDistrict Court for the District of Minnesota. This action arises out ofTristar’s sale to K-tel of a defective home exercise product called the“BunBlaster” for resale in Germany, Austria and Switzerland. By writtencontract, Tristar has agreed to indemnify K-tel for injuries and damagesarising out of the resale of those goods. K-tel is seeking approximately $2million in consequential damages. Tristar is vigorously defending this claim.Discovery has been completed. Tristar has filed a Motion for Summary Judgment,to which the Company filed a Memorandum in Opposition. This motion was heard inU.S. District Court in Minneapolis on August 25, 2003. The Court has yet torule on this motion.

 

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On April 30, 2001, Tristar alsoasserted a patent and trademark/ trade-dress counterclaim against K-tel forallegedly passing off a product called the “K-tel Hook and Hang” whileallegedly a distributor of the original patented Tristar Hook and Hang product.The Company denies the allegation because it never was a distributor of this orany similar product and intends to defend this action vigorously. Tristar hasnot identified the amount of damages it seeks with respect to thiscounterclaim. The United States District Court for the District of Minnesotaissued an order on August 14, 2001 severing this action from the Company’saction. This action is at an early stage and no discovery or other actions haveoccurred.

 

OtherLitigation and Disputes

 

K-tel and its subsidiaries arealso involved in other legal actions in the ordinary course of their business.With all litigation matters, management considers the likelihood of loss basedon the facts and circumstances. If management determines that a loss isprobable and the amount of loss can be reasonably estimated, such amount isrecorded as a liability. Although the outcome of any such legal actions cannotbe predicted, in the opinion of management there is currently no legalproceeding pending or asserted against or involving K-tel for which the outcomeis likely to have a material adverse effect upon the consolidated financialposition or results of operations of K-tel.

 

Subsidiaries’Bankruptcy and Liquidation

 

In March 2001, the Company’smusic distribution subsidiary in the United States, K-tel International (USA),Inc. ceased operations and filed for protection under Chapter 7 of the UnitedStates Bankruptcy Code. Pursuant to an agreement between the bankruptcy trusteeand K-5 Leisure Products, Inc. (K-tel’s secured creditor and controllingshareholder) entered into on March 3, 2003, the trustee released K-5 LeisureProducts, Inc., K-tel and its subsidiaries and affiliates from any claims and actionswith respect to the bankruptcy filing. The trustee filed a Limited Notice ofAbandonment relative to K-5’s security interest in K-tel’s assets. TheBankruptcy Court approved the abandonment as of June 13, 2003.

 

In November 2000, the Company’sconsumer products subsidiary in the United Kingdom, K-tel Marketing Ltd.,ceased operations and began voluntary liquidation proceedings. At the initialmeeting of the creditors on November 24, 2000, the creditors voted for theliquidation to become a creditors’ liquidation under English law. The Companyhas not been informed by the liquidators or their counsel of any plan toattempt to hold it or any of its subsidiaries liable for any of the commitmentsof K-tel Marketing Ltd. Management believes the Company will have no ongoingmaterial liability related to K-tel Marketing Ltd. as a result of theliquidation proceeding.

 

**5.****                                      BUSINESSSEGMENT AND GEOGRAPHIC AREA DATA**

 

The Company markets anddistributes entertainment products internationally and through its operatingsubsidiaries. K-tel’s businesses are organized, managed and internally reportedas two segments: retail music sales and music licensing.  These segments are based on differences inproducts, customer type and sales and distribution methods. 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.

 

The retail music segment consists primarilyof the sales of pre-recorded music both from the Company’s music master catalogand under licenses obtained from other record companies. The Company sellscompact discs and DVD’s directly to retailers, wholesalers and rack servicedistributors which stock and manage inventory within music departments forretail stores.

 

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

 

Operating profits or losses of these segmentsinclude an allocation of general corporate expenses. Depreciation andamortization and capital additions are not significant and have therefore beenexcluded from the presentation.

 

Certain financial information on the Company’s continuing operatingsegments is as follows:

 

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BUSINESS SEGMENT INFORMATION

 
| **Three Months Ended  September 30,** |   | **Music** |   | **Licensing** |   | **Other** |   | **Corporate  Eliminations** |   | **Total  Company** |   |
|---------------------------------------|--------|-----------|--------|---------------|--------|-----------|--------|-----------------------------|--------|--------------------|--------|
| **(in thousands)**                    |   |      |   |          |   |      |   |                        |   |               |   |
|                                  |   |      |   |          |   |      |   |                        |   |               |   |
| Net Sales                             | 2003   |      | $      | 1,099         |   | $         | 519    |                        | $      | —             |   | — |   | $ | 1,618 |   |
|                                  | 2002   |      | 943    |          | 555    |      | — |                        | — |               | 1,498  |   |
|                                  |   |      |   |          |   |      |   |                        |   |               |   |
| Operating Income (Loss)               | 2003   |      | $      | (107          | )      | $         | 147    |                        | $      | —             |   | — |   | $ | 40 |   |
|                                  | 2002   |      | (166   | )             | 68     |      | — |                        | — |               | (98    | ) |
|                                  |   |      |   |          |   |      |   |                        |   |               |   |
| Assets                                | 2003   |      | $      | 2,611         |   | $         | 818    |                        | $      | 126                |   | (52 | ) | $ | 3,503 |   |
|                                  | 2002   |      | 2,905  |          | 1,309  |      | 87     |                        | 74     |               | 4,375  |   |

 

GEOGRAPHIC INFORMATION

 
| **Three  Months Ended****September 30,** |   | **United States** |   | **Europe** |   | **Total** |   |
|------------------------------------------|--------|-------------------|--------|------------|--------|-----------|--------|
| **(in thousands)**                       |   |              |   |       |   |      |   |
|                                     |   |              |   |       |   |      |   |
| Net Sales                                | 2003   |              | $      | 964        |   | $         | 654    |   | $ | 1,618 |   |
|                                     | 2002   |              | 981    |       | 517    |      | 1,498  |   |
|                                     |   |              |   |       |   |      |   |   |
| Assets                                   | 2003   |              | $      | 2,309      |   | $         | 1,194  |   | $ | 3,503 |   |
|                                     | 2002   |              | 2,956  |       | 1,419  |      | 4,375  |   |

 

**6.****                                      RECENTACCOUNTING PRONOUNCEMENTS**

 

In January 2003, the FinancialAccounting Standards Board (FASB) issued FASB Interpretation (FIN 46), *Consolidation of Variable Interest Entities.*FIN 46 is an interpretation of Accounting Research Bulletin No. 51, *Consolidated Financial Statements,* andaddresses consolidation by business enterprises of variable interest entities.FIN 46 applies immediately to variable interest entities created or obtainedafter January 31, 2003 and it applies in the first fiscal year or interimperiod beginning after June 15, 2003, to variable interest entities in which anenterprise holds a variable interest that is acquired before February 1, 2003.This pronouncement is not anticipated to have a material effect on theCompany’s consolidated financial position or results of operations.

 

In May 2003, the FASB issued Statement of Financial AccountingStandards Statement 150 (SFAS 150), *Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity*. Statement 150 changes the classifications in the statementof financial position of certain common financial instruments from eitherequity or mezzanine presentation to liabilities and requires an issuer of thosefinancial statements to recognize changes in fair value or redemption amount,as applicable, in earnings. SFAS 150 is effective for financial instrumentsentered into or modified after May 31, 2003, and otherwise is effective at thebeginning of the first interim period beginning after June 15, 2003. Adoptionof Statement 150 is not anticipated to have an impact on the Company’sconsolidated financial position or results of operations.

 

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**ITEM2****: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

**General**

 

Through itsoperating subsidiaries, K-tel licenses its music catalog internationally andmarkets entertainment products mainly derived from its catalog in the UnitedStates and Europe through retail and direct response marketing channels.

 

For thisanalysis, the following changes in the Company’s business should be considered:K-tel closed the operations of its German subsidiary, Dominion Vertriebs GmbH,in June 2000; one of its subsidiaries in the United Kingdom, K-tel MarketingLtd., in November 2000; and a United States subsidiary, K-tel ConsumerProducts, Inc., in February 2001. These three closings represent thediscontinuation of the Company’s consumer products division and accordinglyhave been presented in the accompanying financial statements as discontinuedoperations. In addition, in March 2001, the Company’s music distributionsubsidiary in the United States, K-tel (USA) ceased operations and filed forprotection under Chapter 7 of the United States Bankruptcy Code.

 

Through another subsidiary,K-tel Entertainment, Inc., K-tel has a focused method of distribution thattargets the strengths of fewer individual retailers and supplies productssuited to each retailer’s specific needs. These new products are derived fromthe Company’s master recordings music catalog with the objective of realizingmore competitive profit margins. As well, the Company seeks to license its nameand marks to other businesses for a royalty or fee.

 

**A.****                                    RESULTSOF OPERATIONS**

 

Net sales forthe three months ended September 30, 2003 were $1,618,000 an increase of 8.0%from sales of $1,498,000 for the three month period ended September 30, 2002.This increase was attributed to increased domestic music sales partially offsetby a decrease in licensing revenue. The loss for the three month period endedSeptember 30, 2003 was $129,000, or $.01 per share, compared to a loss of$508,000, or $.04 per share, for the three month period ended September 30,2002.

 

Generalcorporate expenses of $212,000 and $114,000 for the three months periods endedSeptember 30, 2003 and 2002 respectively have been allocated to the segments.

 

The followingsections discuss the results of continuing operations by business segment.

 

**BUSINESSSEGMENT RESULTS**

 

**Music**

 

Sales in the music segment were$1,099,000 for the three month period ended September 30, 2003 compared to$943,000 for the three month period ended September 30, 2002, an increase of$156,000, or 16.5%. The overall increase was primarily due to an increased number of products available forsale during the most recently completed reporting period.

 

Cost of goodssold in the music segment increased to 53.8% of sales for the three monthperiod ended September 30, 2003 compared to 48.6% of sales for the three monthperiod ended September 30, 2002 reflecting higher domestic product returns.Advertising expenses within the segment, which consists primarily ofco-operative advertising payments, trade advertising and promotions, decreasedto $23,000 for the three month period ended September 30, 2003 compared to$46,000 for the three month period ended September 30, 2002.

 

Selling,general and administrative expenses were $572,000, or 52.1% of sales for thethree month period ended September 30, 2003 compared to $536,000, or 56.8% ofsales for the three month period ended September 30, 2002. The primary reasonfor the decrease was the efforts to reduce overhead costs in the Company’soffice in England. As a result, the music segment incurred an operating loss of$107,000 for the three month period ended September 30, 2003 compared to anoperating loss of $166,000 for the three month period ended September 30, 2002.

 

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**Licensing**

 

Licensingrevenue was $519,000 for the three month period ended September 30, 2003compared to $555,000 for the three month period ended September 30, 2002, adecrease of 6.5% reflecting a general reduction in licensing activity in themusic industry. Operating income in the licensing segment was $147,000 for thethree month period ended September 30, 2003 compared to $68,000 for the threemonth period ended September 30, 2002, an increase of 116.2%.

 

**RecentAccounting Pronouncements**

 

In January 2003, the FinancialAccounting Standards Board (FASB) issued FASB Interpretation (FIN 46), *Consolidation of Variable Interest Entities.*FIN 46 is an interpretation of Accounting Research Bulletin No. 51, *Consolidated Financial Statements,* andaddresses consolidation by business enterprises of variable interest entities.FIN 46 applies immediately to variable interest entities created or obtainedafter January 31, 2003 and it applies in the first fiscal year or interimperiod beginning after June 15, 2003, to variable interest entities in which anenterprise holds a variable interest that is acquired before February 1, 2003.This pronouncement is not anticipated to have a material effect on theCompany’s consolidated financial position or results of operations.

 

In May 2003, the FASB issued Statement of Financial AccountingStandards Statement 150 (SFAS 150), *Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity*. Statement 150 changes the classifications in the statementof financial position of certain common financial instruments from eitherequity or mezzanine presentation to liabilities and requires an issuer of thosefinancial statements to recognize changes in fair value or redemption amount,as applicable, in earnings. SFAS 150 is effective for financial instrumentsentered into or modified after May 31, 2003, and otherwise is effective at thebeginning of the first interim period beginning after June 15, 2003. Adoptionof Statement 150 is not anticipated to have an impact on the Company’s consolidatedfinancial position or results of operations.

 

**B.****                                    LIQUIDITYAND CAPITAL RESOURCES**

 

K-tel has a Line of CreditAgreement with K-5 Leisure Products, Inc. (“K-5”), the Company’s largestshareholder controlled by Philip Kives, the Chairman of the Board, Presidentand Chief Executive Officer of K-tel. Under the terms of the agreement (the“K-5 Facility”), K-5 has agreed to make available up to $8,000,000 to K-tel ona revolving basis. The loan bears interest at a variable rate based upon the“base rate” of a nationally recognized lending institution (4.0% at September30, 2003), expires July 20, 2005, 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 $6,237,000 and $7,282,000 as of September 30, 2003 and June 30, 2003respectively under the K-5 Facility. At September 30, 2003, K-tel obtained awaiver from K-5 for its non-compliance under the covenants, limitations andrestrictions of the credit agreement.

 

In addition, K-tel has a secondloan agreement with K-5, under which K-5 assumed rights and obligations under aloan from the Company’s former banker (Foothill Capital Corporation) pursuantto an Assignment and Acceptance Agreement dated February 27, 2001. ThisFoothill loan, which has been extended through July 20, 2005, provides for a$10,000,000 credit facility consisting of a $4,000,000 term loan due uponexpiration, and a $6,000,000 revolving facility under which borrowings arelimited to a percent of eligible receivables. Borrowings under the facilitybear interest at a variable rate based on a “base rate” of a nationallyrecognized lending institution plus 1% (5.0% at September 30, 2003) 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, restrictionson music library acquisitions, limitations on other indebtedness andrestrictions on dividends paid by K-tel. As of September 30, 2003 and June 30,2003, $4,000,000 was outstanding under the term loan and there were noborrowings under the revolving facility. At September 30, 2003, K-tel obtaineda waiver from K-5 for its non-compliance under the covenants, limitations andrestrictions of the credit agreement.

 

K-tel has anoverdraft privilege borrowing facility with The Royal Bank of Scotland in the UnitedKingdom. This facility is secured by a standby letter of credit for $260,000provided by K-tel International Ltd., a Canadian

 

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companycontrolled by Philip Kives and is payable on demand in accordance with normalbanking practices. Borrowings bear interest of 2.0% per annum over the baserate (a total of 6.0% at September 30, 2003) but are subject to a minimum of6.0% per annum. K-tel had outstanding balances of $234,000 and $233,000 as ofSeptember 30, 3002 and June 30, 2003 respectively.

 

K-tel has primarily funded itsoperations to date through internally generated capital, proceeds from stockoption exercises and secured loans from K-5. Management currently believes thatK-tel has sufficient cash and borrowing capacity to ensure the Company willcontinue operations in the near term. In part, this is a result of improvementin operating results in fiscal 2003 as well as the two existing lines of creditwith K-5. Although K-5 continues to advance funds sufficient to meet theCompany’s needs at this time, there can be no assurance that this will beadequate or continue in the future or that K-tel will be able to obtainadditional financing upon favorable terms when required.

 

The Company’sability to continue its present operations and implement future expansion planssuccessfully is contingent mainly upon its ability to maintain its line ofcredit arrangements with K-5, increase its revenues and profit margins, andultimately attain and sustain profitable operations. Without increased revenuesand sustained profitability, the cash generated from the Company’s currentoperations will likely be inadequate to fund operations and service itsindebtedness on an ongoing basis. Management is focusing its efforts on musiclicensing and limited music distribution. However, there can be no assurancethat the Company will achieve profitable operations through these efforts. Inthe event the Company is unable to fund its operations and implement itscurrent business plan properly, it may be unable to continue operations. Thefinancial statements do not include any adjustments that might result from theoutcome of these uncertainties.

 

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**ITEM3****.  QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

There havebeen no material changes in the Company’s market risk during the three monthperiod ended September 30, 2003. For additional information, refer to page 15of the Company’s annual report on Form 10-K for the fiscal year ended June 30,2003.

 

**ITEM4****.  CONTROLS ANDPROCEDURES**

 

Under the supervision and withthe participation of the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, the Company evaluated the effectivenessof the design and operation of its disclosure controls and procedures (asdefined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act). Based uponthat evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that, as of the end of the period covered by this report, theCompany’s disclosure controls and procedures are adequately designed to ensurethat information required to be disclosed by the Company in the reports itfiles or submits under the Exchange Act is recorded, processed, summarized andreported, within the time periods specified in applicable rules and forms.

 

During the Company’s mostrecent fiscal quarter, there has been no change in the Company’s internalcontrol over financial reporting (as defined in Rule 13a-15(f) or 15d-15(f)under the Exchange Act) that has materially affected, or is reasonably likelyto materially affect, the Company’s internal control over financial reporting.

 

**PART II**

 

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

 

RTL Shopping S.A.

 

The Company has been named in a lawsuit filedin France brought by RTL9, a French cable TV station. The action seeks damagesin the approximate amount of 20 million French Francs, or approximately $2.8million. Initially, RTL9 was named as a defendant in a suit brought by a competitorof K-tel Marketing Ltd. alleging that RTL9 ran a commercial for K-tel Marketingwhich presented a product under brand names alleged to infringe on thecompetitor’s own trademarks and also translated an English language scriptindicating that the product was “just like” or “as good as” others into “betterthan” in French, contrary to French law. The suit alleged trademarkinfringement, unfair competition, illicit comparative advertising and passingoff. RTL9 then sued K-tel Marketing on October 4, 2000, pursuant to anindemnification provision the parties had entered into. Subsequently, K-telMarketing went into liquidation and RTL9 filed a suit in December 2000 againstK-tel International, Inc. under its agreement to guarantee payment for the commercialtime. On May 28, 2001, RTL9 presented documents in court identifying K-telInternational (USA), Inc. as a target of its claim. On September 3, 2001, theCompany filed documents disputing the claim and advising the court of K-tel(USA)’s Chapter 7 bankruptcy filing.

 

After the Company advised the Court that RTL9had no basis for a complaint against the Company, RTL9 proposed to drop theirlawsuit. On September 23, 2003, RTL9 and the Company signed an agreementterminating the suit. The final disposition of the lawsuit will be confirmed bythe Court at a future hearing.

 

K-tel International, Inc. vs. TristarProducts, Inc.

 

On March 14, 2000, K-tel andits subsidiary in Germany commenced an action for breach of express and impliedwarranties against Defendant Tristar Products, Inc. This action is venued inthe United States District Court for the District of Minnesota. This actionarises out of Tristar’s sale to K-tel of a defective home exercise productcalled the “BunBlaster” for resale in Germany, Austria and Switzerland. Bywritten contract, Tristar has agreed to indemnify K-tel for injuries anddamages arising out of the resale of those goods. K-tel is seekingapproximately $2 million in consequential damages. Tristar is vigorouslydefending this claim. Discovery has been completed. Tristar has filed a Motionfor Summary Judgment, to which the Company filed a Memorandum in Opposition.This motion was heard in U.S. District Court in Minneapolis on August 25, 2003.The Court has yet to rule on this motion.

 

On April 30, 2001, Tristar alsoasserted a patent and trademark/ trade-dress counterclaim against K-tel forallegedly passing off a product called the “K-tel Hook and Hang” whileallegedly a distributor of the original patented Tristar

 

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Hook and Hang product. TheCompany denies the allegation because it never was a distributor of this or anysimilar product and intends to defend this action vigorously. Tristar has notidentified the amount of damages it seeks with respect to this counterclaim.The United States District Court for the District of Minnesota issued an orderon August 14, 2001 severing this action from the Company’s action. This actionis at an early stage and no discovery or other actions have occurred.

 

OtherLitigation and Disputes

 

K-tel and its subsidiaries are also involvedin other legal actions in the ordinary course of their business. With alllitigation matters, management considers the likelihood of loss based on thefacts and circumstances. If management determines that a loss is probable andthe amount of loss can be reasonably estimated, such amount is recorded as aliability. Although the outcome of any such legal actions cannot be predicted,in the opinion of management there is currently no legal proceeding pending orasserted against or involving K-tel for which the outcome is likely to have amaterial adverse effect upon the consolidated financial position or results ofoperations of K-tel.

 

Subsidiaries’Bankruptcy and Liquidation

 

In March 2001, the Company’smusic distribution subsidiary in the United States, K-tel International (USA),Inc. ceased operations and filed for protection under Chapter 7 of the UnitedStates Bankruptcy Code. Pursuant to an agreement between the bankruptcy trusteeand K-5 Leisure Products, Inc. (K-tel’s secured creditor and controllingshareholder) entered into on March 3, 2003, the trustee released K-5 LeisureProducts, Inc., K-tel and its subsidiaries and affiliates from any claims andactions with respect to the bankruptcy filing. The trustee filed a LimitedNotice of Abandonment relative to K-5’s security interest in K-tel’s assets.The Bankruptcy Court approved the abandonment as of June 13, 2003.

 

In November 2000, the Company’sconsumer products subsidiary in the United Kingdom, K-tel Marketing Ltd.,ceased operations and began voluntary liquidation proceedings. At the initialmeeting of the creditors on November 24, 2000, the creditors voted for theliquidation to become a creditors’ liquidation under English law. The Companyhas not been informed by the liquidators or their counsel of any plan toattempt to hold it or any of its subsidiaries liable for any of the commitmentsof K-tel Marketing Ltd. Management believes the Company will have no ongoingmaterial liability related to K-tel Marketing Ltd. as a result of theliquidation proceeding.

 

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**ITEM 6.****  EXHIBITS ANDREPORTS ON FORM 8-K**

 

(a)                                  EXHIBIT INDEX

 

See “Index toExhibits.”

 

(b)                                 REPORTS ON FORM 8-K

 

There were noreports filed under Form 8-K by the Company during the three month period endedSeptember 30, 2003.

 

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**SIGNATURES**

 

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 

 
|                      | K-TEL  INTERNATIONAL, INC.                               |   |
|---------------------------|----------------------------------------------------------|--------|
|                      | REGISTRANT                                               |
|                      |                                                     |
|                      |                                                     |
| Dated:  November 14, 2003 | /S/ PHILIP  KIVES                                        |   |
|                      | PHILIP KIVES                                             |
|                      | CHAIRMAN AND  CHIEF EXECUTIVE OFFICER                    |
|                      |                                                     |
|                      |                                                     |
| Dated:  November 14, 2003 | /S/ DENNIS  WARD                                         |   |
|                      | DENNIS WARD                                              |
|                      | CHIEF  FINANCIAL OFFICER  (principal accounting officer) |

 

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**INDEXTO EXHIBITS**

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

 

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