##### **UNITEDSTATESSECURITIES 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 September 30, 2005**

**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)                  |   |                                 |
|                                             |   |                                 |
| **2491  Xenium Lane North, Plymouth, Minnesota** |   | **55441**                            |
| (Address of  principal executive offices)        |   | (Zip Code)                           |

 

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

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

**None**

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

**Common Stock, par value $0.01**

(Title of class)

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

 

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 ExchangeAct.
| 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 | Nox |
|--|-------|-----|

 

As of November 13, 2006,the registrant had 13,653,738 shares of Common Stock outstanding.

 

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**K-TELINTERNATIONAL, INC. AND SUBSIDIARIESFORM 10-Q**

**FOR THE THREE MONTH PERIODENDED SEPTEMBER 30, 2005**

INDEX
| PART I.            | Financial Information (Unaudited): | 3                                                           |
|--------------------|------------------------------------|-------------------------------------------------------------|
|               |                               |                                                        |
|               | Item 1.                            | Financial Statements                                        | 3 |
|               |                               |                                                        |   |
|               |                               | Condensed  Consolidated Balance Sheets as of                |   |
|               |                               | September 30,  2005 and June 30, 2005                       | 3 |
|               |                               |                                                        |   |
|               |                               | Condensed Consolidated  Statements of Operations            |   |
|               |                               | for the Three  Months Ended September 30, 2005 and 2004     | 4 |
|               |                               |                                                        |   |
|               |                               | Condensed  Consolidated Statements of Cash Flows            |   |
|               |                               | for the Three  Months Ended September 30, 2005 and 2004     | 5 |
|               |                               |                                                        |   |
|               |                               | Notes to  Condensed Consolidated Financial Statements       | 6 |
|               |                               |                                                        |   |
|               | Item 2.                            | Management’s  Discussion and Analysis of Financial     |   |
|               |                               | Condition and  Results of Operations                        | 10 |
|               |                               |                                                        |   |
|               | Item 3.                            | Quantitative  and Qualitative Disclosures About Market Risk | 12 |
|               |                               |                                                        |   |
|               | Item 4.                            | Controls and  Procedures                                    | 12 |
|               |                               |                                                        |   |
| PART II.           | Other  Information:                | 13                                                          |
|               |                               |                                                        |
|               | Item 1.                            | Legal Proceedings                                           | 13 |
|               |                               |                                                        |   |
|               | Item 6.                            | Exhibits                                                    | 13 |
|               |                               |                                                        |   |
| Signatures         | 14                                 |
|               |                               |
| Index  to Exhibits | 15                                 |

 

**SAFE HARBORSTATEMENT UNDER THEPRIVATE SECURITIES LITIGATION REFORM ACT OF 1995**

Certain statements 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. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS - UNAUDITED**

*(inthousands - except share data*)
| ** **                                                                                                                        | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                                                                                                        | ** ** | **2005**               | ** ** | **2005**          | ** ** |
|                                                                                                                              |       |                   |       |              |       |
| ASSETS                                                                                                                            |       |                   |       |              |       |
|                                                                                                                              |       |                   |       |              |       |
| Current assets:                                                                                                                   |       |                   |       |              |       |
| Cash and cash  equivalents                                                                                                        |       | $                      | 1,259      |              | $          | 1,272 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $4 at September 30 and  June 30                                   |       | 1,550                  |       | 2,045             |       |
| Inventories                                                                                                                       |       | 530                    |       | 563               |       |
| Royalty advances                                                                                                                  |       | 6                      |       | 6                 |       |
| Prepaid expenses  and other                                                                                                       |       | 207                    |       | 227               |       |
| Total current  assets                                                                                                             |       | 3,552                  |       | 4,113             |       |
|                                                                                                                              |       |                   |       |              |       |
| Property and equipment,  net of accumulated depreciation and amortization of $1,140 at September 30  and $1,138 at June 30        |       | 73                     |       | 84                |       |
|                                                                                                                              |       |                   |       |              |       |
| Owned catalog masters,  net of accumulated amortization of  $3,156 at September 30 and $3,115 at June 30                     |       | 456                    |       | 498               |       |
|                                                                                                                              |       |                   |       |              |       |
|                                                                                                                              |       | $                      | 4,081      |              | $          | 4,695 |   |
|                                                                                                                              |       |                   |       |              |       |
| LIABILITIES AND  SHAREHOLDERS’ DEFICIT                                                                                       |       |                   |       |              |       |
|                                                                                                                              |       |                   |       |              |       |
| Current liabilities:                                                                                                              |       |                   |       |              |       |
| Notes payable to  affiliate and other                                                                                             |       | $                      | 11,767     |              | $          | 11,518 |   |
| Accounts payable                                                                                                                  |       | 1,025                  |       | 1,727             |       |
| Accrued  royalties                                                                                                                |       | 1,880                  |       | 1,760             |       |
| Reserve for  returns                                                                                                              |       | 224                    |       | 221               |       |
| Net liabilities  of discontinued operations                                                                                       |       | 30                     |       | 30                |       |
| Total current  liabilities                                                                                                        |       | 14,926                 |       | 15,256            |       |
|                                                                                                                              |       |                   |       |              |       |
| Shareholders’ deficit:                                                                                                       |       |                   |       |              |       |
| Common stock –  50,000,000 shares authorized; par value $.01; 13,653,738 issued and  outstanding at September 30 and June 30 |       | 136                    |       | 136               |       |
| Additional  paid-in capital                                                                                                       |       | 21,292                 |       | 21,292            |       |
| Accumulated  deficit                                                                                                              |       | (32,187                | )          | (31,923           | )          |
| Accumulated  other comprehensive loss                                                                                             |       | (86                    | )          | (66               | )          |
| Total  shareholders’ deficit                                                                                                 |       | (10,845                | )          | (10,561           | )          |
|                                                                                                                              |       |                   |       |              |       |
|                                                                                                                              |       | $                      | 4,081      |              | $          | 4,695 |   |

 

The accompanying notesare 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** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **September 30,**           | ** ** |
| ** **                                        | ** ** | **2005**                         | ** ** | **2004** | ** ** |
|                                              |       |                             |       |   |   |
| Net sales                                         |       | $                                | 1,196      |   | $ | 1,836 |   |
|                                              |       |                             |       |   |   |
| Costs and  expenses:                              |       |                             |       |   |   |
| Cost of goods sold                                |       | 505                              |       | 921 |   |
| Advertising                                       |       | 20                               |       | 27 |   |
| Selling, general and administrative               |       | 743                              |       | 917 |   |
| Total costs and expenses                          |       | 1,268                            |       | 1,865 |   |
| Operating loss                                    |       | (72                              | )          | (29 | ) |
|                                              |       |                             |       |   |   |
| Other expense:                                    |       |                             |       |   |   |
| Interest expense                                  |       | (187                             | )          | (145 | ) |
| Other                                             |       | (2                               | )          | 22 |   |
| Total other expense                               |       | (189                             | )          | (123 | ) |
|                                              |       |                             |       |   |   |
| Loss from  continuing operations                  |       | (261                             | )          | (152 | ) |
|                                              |       |                             |       |   |   |
| Loss from  discontinued operations                |       | (3                               | )          | (1 | ) |
|                                              |       |                             |       |   |   |
| Net loss                                          |       | $                                | (264       | ) | $ | (153 | ) |
|                                              |       |                             |       |   |   |
| Loss per share -  basic and diluted:              |       |                             |       |   |   |
| Continuing operations                             |       | $                                | (.02       | ) | $ | (.01 | ) |
| Discontinued operations                           |       | —                           |       | — |   |
| Net loss                                          |       | $                                | (.02       | ) | $ | (.01 | ) |
|                                              |       |                             |       |   |   |
| Shares used in  the calculation of loss per share |       |                             |       |   |   |
| - Basic and  Diluted:                             |       | 13,654                           |       | 13,654 |   |
|                                              |       |                             |       |   |   |
| Comprehensive  loss:                              |       |                             |       |   |   |
| Net loss                                          |       | $                                | (264       | ) | $ | (153 | ) |
| Translation adjustment                            |       | (20                              | )          | 45 |   |
| Comprehensive loss                                |       | $                                | (284       | ) | $ | (108 | ) |

 

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)*
| ** **                                                               | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                               | ** ** | **September 30,**           | ** ** |
| ** **                                                               | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                   |       |                             |       |   |   |
| Net loss                                                                 |       | $                                | (264       | ) | $ | (153 | ) |
| Adjustments to  reconcile net loss to cash used in operating activities: |       |                             |       |   |   |
| Depreciation and amortization                                            |       | 53                               |       | 63 |   |
| Loss on disposal of property and equipment                               |       | —                           |       | (11 | ) |
| Discontinued operations                                                  |       | —                           |       | 1 |   |
| Changes in  operating assets and liabilities:                            |       |                             |       |   |   |
| Accounts receivable, net                                                 |       | 495                              |       | (655 | ) |
| Inventories                                                              |       | 30                               |       | 88 |   |
| Royalty advances                                                         |       | —                           |       | 18 |   |
| Prepaid expenses                                                         |       | 13                               |       | 18 |   |
| Accounts payable                                                         |       | (718                             | )          | 186 |   |
| Accrued royalties                                                        |       | 127                              |       | 119 |   |
| Reserve for returns                                                      |       | 3                                |       | 14 |   |
| Cash used in operating activities                                        |       | (261                             | )          | (312 | ) |
|                                                                     |       |                             |       |   |   |
| Investing  activities:                                                   |       |                             |       |   |   |
| Purchases of property and equipment                                      |       | —                           |       | (62 | ) |
| Cash used in investing activities                                        |       | —                           |       | (62 | ) |
|                                                                     |       |                             |       |   |   |
| Financing  activities:                                                   |       |                             |       |   |   |
| Borrowings on notes payable                                              |       | 1,031                            |       | 1,033 |   |
| Payments on notes payable                                                |       | (782                             | )          | (827 | ) |
| Cash provided by financing activities                                    |       | 249                              |       | 206 |   |
|                                                                     |       |                             |       |   |   |
| Effect of  exchange rates on cash                                        |       | (1                               | )          | 48 |   |
|                                                                     |       |                             |       |   |   |
| Net decrease in  cash and cash equivalents                               |       | (13                              | )          | (120 | ) |
|                                                                     |       |                             |       |   |   |
| Cash and cash  equivalents at beginning of period                        |       | 1,272                            |       | 147 |   |
|                                                                     |       |                             |       |   |   |
| Cash and cash  equivalents at end of period                              |       | $                                | 1,259      |   | $ | 27 |   |

 

The accompanyingnotes are an integral part of these financial statements.

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

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS(UNAUDITED)**

## **1.****                                      BUSINESSAND 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 name and trademarks toother companies. Licenses are granted for a royalty or fee, with no cost to theCompany.

On October 10,2005, the Company, through a wholly owned subsidiary, entered into a trademarklicense agreement with BCI Eclipse Company, LLC (“BCI”) and, effective October16, 2005, entered into a phonograph record license agreement with BCI.

DiscontinuedOperations

The Company’s consumerproducts business, which was concentrated in Europe, consisted primarily ofhouse wares, consumer convenience items and exercise equipment. The Companydiscontinued its consumer products operations in Germany, the United Kingdomand the United States in June 2000, November 2000 and January 2001,respectively. Accordingly, these activities have been presented in theaccompanying financial statements as discontinued operations. The accompanyingcondensed consolidated financial statements have been prepared to reflect theconsumer products division as a discontinued operation. The net liabilities ofdiscontinued operations at September 30, 2005 and June 30, 2005, and resultsfrom discontinued operations for the three months ended September 30, 2005 and2004, relate primarily to legal matters and completion of statutory reportingrequirements for the former operations in Germany.

Liquidity

During the threemonths ended September 30, 2005 and 2004, the Company incurred net losses fromcontinuing operations of $261,000 and $152,000, respectively. Operatingactivities used $261,000 and $312,000 of cash during the three months endedSeptember 30, 2005 and 2004, respectively. Additionally, the Company had aworking capital deficit of $11,374,000 at September 30, 2005.

TheCompany’s ability to continue its present operations and implement futureexpansion plans successfully is contingent mainly upon its ability to maintainits line of credit arrangements with K-5 Leisure Products, Inc. (See Note 3),increase its revenues and profit margins, and ultimately attain and sustainprofitable operations. Without increased revenues and sustained profitability,the Company’s current operations will likely not generate cash sufficient tofund operations and service its indebtedness on an ongoing basis. Management isfocusing its efforts on music licensing 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.             BASIS OF PRESENTATION AND SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

Basis ofPresentation –The accompanying condensed consolidated unaudited financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America (“US GAAP”) for interim financial information and withthe instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,they do not include all of the information and footnotes required by US GAAPfor complete financial statements. In the opinion of management, alladjustments (consisting of normal recurring adjustments) considered necessaryfor a fair presentation have been included. Operating results for the threemonth period ended September 30, 2005 are not necessarily indicative of theresults that may be expected for the year as a whole. The unaudited condensedconsolidated balance sheet for June 30, 2005 has been derived from audited consolidatedfinancial

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statements as ofthat date. For further information, refer to the consolidated financialstatements and footnotes thereto included in the Company’s annual report onForm 10-K for the year ended June 30, 2005.

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.

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 at thetime of sale and are reflected as a reduction in revenue. The Company’s reservefor returns was $224,000 at September 30, 2005 and $221,000 at June 30, 2005.

Cost of Goods Sold– The Company expenses all product manufacturing, distribution and royalty costsassociated with music sales as cost of goods sold. The Company also expensesroyalties, commissions and amortization of its owned master recordingsassociated with its license revenue as cost of goods sold.

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

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

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

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

Owned CatalogMasters – The Company capitalizes the costs to purchase ownedmaster recordings at the time of acquisition. These costs are amortized over theestimated 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. Depreciationand amortization is provided using straight line or declining balance methodsover the estimated useful lives of the assets, which range from three to nineyears.

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 applicable unitssold. The contractual royalty liability is computed quarterly and the accruedroyalty balance is adjusted accordingly. The royalty agreements are subject toaudit by licensors.

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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 $20,000 and $27,000 for the three month periods ended September 30, 2005and 2004, respectively.

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

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

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

Net Loss Per Share - Basic anddiluted net loss per share have been computed by dividing net loss by theweighted average number of shares outstanding during the period. For all periodspresented, common stock equivalents were excluded from the per sharecalculation as the net effect would be antidilutive. For the three monthperiods ended September 30, 2005 and 2004, weighted average options to purchase2,228,939 and 2,564,839 shares of common stock, with weighted average exerciseprices of $.19 and $.36, 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.

**3.             LOANS PAYABLE TO AFFILIATE**

K-tel has a Line of Credit Agreement with K-5 Leisure Products, Inc. (“K-5”),the Company’s largest shareholder and an entity controlled by Philip Kives, theChairman of the Board, President and Chief Executive Officer of K-tel. Underthe terms of the agreement (the “K-5 Facility”), K-5 has agreed to makeavailable up to $8,000,000 to K-tel on a revolving basis. The loan bearsinterest at a variable rate based upon the “base rate” of a nationallyrecognized lending institution (6.0% at September 30, 2005), expires July 20,2008, and is subordinated to the Foothill loan (see below). The K-5 Facilitycontains the same covenants as the Foothill loan agreement. K-tel has pledgedthe stock of its foreign subsidiaries as collateral for the loan, and the loancarries a subordinated position to the Foothill loan on all other assets of theCompany. K-tel had outstanding balances of $7,767,000 and $7,518,000 as ofSeptember 30, 2005 and June 30, 2005, respectively, under the K-5 Facility. AtSeptember 30, 2005, K-tel obtained a waiver from K-5 for its non-complianceunder the covenants, limitations and restrictions of the credit agreement.

In addition, K-telhas a second loan agreement with K-5, under which K-5 assumed rights andobligations under a loan from the Company’s former banker (Foothill CapitalCorporation) pursuant to an Assignment and Acceptance Agreement dated February27, 2001. This Foothill loan, which has been extended through July 20, 2008,provides for a $10,000,000 credit facility consisting of a $4,000,000 term loandue upon expiration, and a $6,000,000 revolving facility under which borrowingsare limited to a percent of eligible receivables. Borrowings under the facilitybear interest at a variable rate based on a “base rate” of a nationallyrecognized lending institution plus 1% (7.0% at September 30, 2005) and arecollateralized by the assets of certain Company subsidiaries in the UnitedStates, including accounts receivable, inventories, equipment, music libraryand general intangibles. The loan

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agreement containscertain financial and other covenants or restrictions, including themaintenance of a minimum shareholders’ equity by K-tel, limitations on capitalexpenditures, restrictions on music library acquisitions, limitations on otherindebtedness and restrictions on dividends paid by K-tel. As of September 30,2005 and June 30, 2005, K-tel had $4,000,000 outstanding under the term loanand there were no borrowings under the revolving facility. At September 30,2005, K-tel obtained a waiver from K-5 for its non-compliance under thecovenants, limitations and restrictions of the credit agreement.

**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 Defendant Tristar Products, Inc. This action aroseout of Tristar’s sale to K-tel of a defective home exercise product called the “BunBlaster”for resale in Germany, Austria and Switzerland. By written contract, Tristarhad agreed to indemnify K-tel for injuries and damages arising out of theresale of those goods.

On April 30, 2001,Tristar asserted a patent and trademark/ trade-dress counterclaim against K-telfor allegedly 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 denied the allegation because it never was a distributor of this orany similar product.

On December 30, 2004, aMutual General Release and Settlement Agreement was signed by K-tel andTristar, whereby both Companies agreed to mutual releases and Tristar agreed topay K-tel $350,000.  The payment of$350,000 was received February 18, 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 the consolidatedfinancial position or results of operations of K-tel.

Subsidiary’sLiquidation

TheCompany discontinued its United States subsidiary, K-tel Consumer Products,Inc., in February 2001. This closing represented the discontinuation of theCompany’s consumer products division and has been presented in the accompanyingfinancial statements as discontinued operations. In addition, in March 2001,the Company’s music distribution subsidiary in the United States, K-telInternational (USA), Inc. ceased operations and filed for protection underChapter 7 of the United States Bankruptcy Code.

**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. The Company sells compact discs and DVDsdirectly to retailers, wholesalers and rack service distributors which stockand manage inventory within music departments for retail stores.

In the licensingsegment, the Company licenses the rights to its master music catalog,consisting of original recordings and re-recordings of music from the1950’s through today, to third parties world-wide for use in albums,

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films, televisionprograms, commercials and for electronic down loads to various media formats,for either a flat fee or a royalty based on the number of units sold.

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)*
| Three Months Ended  September 30, | ** ** | **Music** | ** ** | **Licensing** | ** ** | **Other** | ** ** | **Total  Company** | ** ** |
|--------------------------------------------------|------------|-----------|------------|---------------|------------|-----------|------------|--------------------|------------|
|                                             |       |      |       |          |       |      |       |               |       |
| Net sales                                        | 2005       |      | $          | 681           |       | $         | 515        |               | $          | — |   | $ | 1,196 |   |
|                                             | 2004       |      | 1,531      |          | 305        |      | —     |               | 1,836      |   |
|                                             |       |      |       |          |       |      |       |               |       |   |
| Operating income  (loss)                         | 2005       |      | $          | (236          | )          | $         | 164        |               | $          | — |   | $ | (72 | ) |
|                                             | 2004       |      | 55         |          | (84        | )         | —     |               | (29        | ) |
|                                             |       |      |       |          |       |      |       |               |       |   |
| Assets                                           | 2005       |      | $          | 3,468         |       | $         | 482        |               | $          | 131 |   | $ | 4,081 |   |
|                                             | 2004       |      | 4,034      |          | 651        |      | 226        |               | 4,911      |   |

 

GEOGRAPHIC INFORMATION *(in thousands)*
| Three Months Ended  September 30, | ** ** | **United States** | ** ** | **Europe** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|------------|------------|-----------|------------|
| Net sales                                        | 2005       |                   | $          | 772        |       | $         | 424        |   | $ | 1,196 |   |
|                                             | 2004       |                   | 1,016      |       | 820        |      | 1,836      |   |
|                                             |       |                   |       |       |       |      |       |   |
| Assets                                           | 2005       |                   | $          | 2,051      |       | $         | 2,030      |   | $ | 4,081 |   |
|                                             | 2004       |                   | 2,271      |       | 2,640      |      | 4,911      |   |

 

**ITEM 2: MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL 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**

Netsales for the three months ended September 30, 2005 were $1,196,000 a decreaseof 34.9% from sales of $1,836,000 for the three month period ended September30, 2004. This net decrease resulted from decreased music sales that werepartially offset by an increase in licensing sales. The net loss for the threemonth period ended September 30, 2005 was $264,000, or $.02 per share, comparedto a loss of $153,000, or $.01 per share, for the three month period endedSeptember 30, 2004.

Generalcorporate expenses of $105,000 and $173,000 for the three months periods endedSeptember 30, 2005 and 2004, respectively, have been allocated to the segments.

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Thefollowing sections discuss the results of continuing operations by businesssegment.

#### **BUSINESS SEGMENT RESULTS**

#### **Music**

Sales in the musicsegment were $681,000 for the three month period ended September 30, 2005compared to $1,531,000 for the three month period ended September 30, 2004, adecrease of $850,000, or 55.5%. The overall decrease was primarily due to anindustry wide decrease in retail music sales.

Costof goods sold in the music segment increased to 58.3% of sales for the threemonth period ended September 30, 2005 compared to 53.9% of sales for the threemonth period ended September 30, 2004 reflecting increased production costs inthe United Kingdom.  The segment’sadvertising expenses, which consist primarily of co-operative advertisingpayments, trade advertising and promotions, decreased to $20,000 for the threemonth period ended September 30, 2005 compared to $27,000 for the three monthperiod ended September 30, 2004.

Selling,general and administrative expenses were $500,000, or 73.5% of sales for thethree month period ended September 30, 2005 compared to $616,000, or 40.2% ofsales for the three month period ended September 30, 2004. The primary reasonfor the decrease in general and administrative expenses was the efforts toreduce overhead costs at the Company’s offices in the United Kingdom and theUnited States.

Themusic segment incurred an operating loss of $236,000 for the three month periodended September 30, 2005 compared to operating income of $55,000 for the threemonth period ended September 30, 2004.

**Licensing**

Licensingrevenue was $515,000 for the three month period ended September 30, 2005compared to $305,000 for the three month period ended September 30, 2004, an increaseof 69.0%.  This increase reflected anincrease in activity related to licensing the Company’s master music catalog tocompanies that offer electronic downloads via their internet sites.  The Company continues to concentrate itsefforts on building additional licensing arrangements in several other segmentsof the entertainment industry.

Royaltycosts within the segment increased to $108,000 for the three month period endedSeptember 30, 2005 compared to $88,000 for the three month period ended September30, 2004 due to the increased licensing sales. Selling, general and administrative expenses for the segment decreased$58,000 for the three month period ended September 30, 2005 to $243,000compared to $301,000 for the three month period ended September 30, 2004.  The primary reason for the decrease ingeneral and administrative expenses was the effort to reduce overhead costs atthe Company’s offices in the United Kingdom and the United States.

Therewas operating income in the licensing segment of $164,000 for the three monthperiod ended September 30, 2005 compared to an operating loss of $84,000 forthe three month period ended September 30, 2004, an increase of $248,000.

**B.            LIQUIDITYAND CAPITAL RESOURCES**

K-tel has a Line of Credit Agreement with K-5 Leisure Products, Inc. (“K-5”),the Company’s largest shareholder and an entity controlled by Philip Kives, theChairman of the Board, President and Chief Executive Officer of K-tel. Underthe terms of the agreement (the “K-5 Facility”), K-5 has agreed to makeavailable up to $8,000,000 to K-tel on a revolving basis. The loan bearsinterest at a variable rate based upon the “base rate” of a nationallyrecognized lending institution (6.0% at September 30, 2005), expires July 20,2008, and is subordinated to the Foothill loan (see below). The K-5 Facilitycontains the same covenants as the Foothill loan agreement. K-tel has pledgedthe stock of its foreign subsidiaries as collateral for the loan, and the loancarries a subordinated position to the Foothill loan on all other assets of theCompany. K-tel had outstanding balances of $7,767,000 and $7,518,000 as ofSeptember 30, 2005 and June 30, 2005, respectively, under the K-5 Facility. AtSeptember 30, 2005, K-tel obtained a waiver from K-5 for its non-complianceunder the covenants, limitations and restrictions of the credit agreement.

In addition, K-telhas a second loan agreement with K-5, under which K-5 assumed rights andobligations under a loan from the Company’s former banker (Foothill CapitalCorporation) pursuant to an Assignment and Acceptance Agreement dated February27, 2001. This Foothill loan, which has been extended through July 20, 2008,provides for a $10,000,000 credit facility consisting of a $4,000,000 term loandue upon expiration, and a $6,000,000

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revolving facilityunder which borrowings are limited to a percent of eligible receivables.Borrowings under the facility bear interest at a variable rate based on a “baserate” of a nationally recognized lending institution plus 1% (7.0% at September 30, 2005) andare collateralized 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 and othercovenants or restrictions, including the maintenance of a minimum shareholders’equity by K-tel, limitations on capital expenditures, restrictions on musiclibrary acquisitions, limitations on other indebtedness and restrictions ondividends paid by K-tel. As of September 30, 2005 and June 30, 2005, K-tel had$4,000,000 outstanding under the term loan and there were no borrowings underthe revolving facility. At September 30, 2005, K-tel obtained a waiver from K-5for its non-compliance under the covenants, limitations and restrictions of thecredit agreement.

K-tel has beenfunding its operations in recent years through internally generated capital andsecured loans from K-5. Assuming K-5 continues to advance funds sufficient tomeet the Company’s needs, management currently believes that K-tel hassufficient cash and borrowing capacity to ensure the Company will continueoperations for the foreseeable future. Although K-5 continues to advance fundssufficient to meet the Company’s needs at this time, there can be no assurancethat this will be adequate or continue in the future or that K-tel will be ableto obtain additional financing upon favorable terms when required.

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 Company’scurrent operations will likely not generate cash sufficient to fund operationsand service its indebtedness on an ongoing basis. Management is focusing itsefforts on music licensing and limited music distribution. However, there canbe no assurance that the Company will achieve profitable operations throughthese efforts. In the event the Company is unable to fund its operations andimplement its current business plan properly, it may be unable to continueoperations. The financial statements do not include any adjustments that mightresult from the outcome of these uncertainties.

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

Therehas been no material changes in the Company’s market risk during the threemonth period ended September 30, 2005. For additional information, refer to theCompany’s annual report on Form 10-K for the fiscal year ended June 30, 2005.

**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 weaknesses 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 periods prior to June 30, 2004 and for the years ended June 30, 2005 and2004.

*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 thatthese procedures, implemented upon the discovery of the misappropriation offunds, have allowed the Company to reestablish effective internal control overfinancial reporting.*

*Infiscal 2005 and 2004, it was determined that the segregation of duties in theU.S. office was limited due to the small number of employees. This segregationof duties became further limited by vacancies that occurred in the Company’sfinance department.   In particular,customer orders were recorded by the same person who initiated*

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*shipments,checks were deposited by the accounts receivable clerk, and employee payrolland changes were entered by the Operations Manager, who also distributed the payrollchecks.*

*Inresponse to the material weakness in the U.S. office, the former Controller wasrehired and duties and responsibilities were revised to allow for improvedsegregation of duties and to increase the level of approvals and reviews.*

# Other than as set forth above, during the fiscalquarter ended September 30, 2005, there was 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.

**PARTII**

#### **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 Defendant Tristar Products, Inc. This actionarose out of Tristar’s sale to K-tel of a defective home exercise productcalled the “BunBlaster” for resale in Germany, Austria and Switzerland. By writtencontract, Tristar had agreed to indemnify K-tel for injuries and damagesarising out of the resale of those goods.

On April 30, 2001,Tristar asserted a patent and trademark/ trade-dress counterclaim against K-telfor allegedly 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 denied the allegation because it never was a distributor of this orany similar product.

On December 30, 2004, aMutual General Release and Settlement Agreement was signed by K-tel andTristar, whereby both Companies agreed to mutual releases and Tristar agreed topay K-tel $350,000.  The payment of$350,000 was received February 18, 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.

***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: November  22, 2006 | /S/ PHILIP KIVES                      |   |
|                      | PHILIP KIVES                          |
|                      | CHAIRMAN AND  CHIEF EXECUTIVE OFFICER |
|                      |                                  |
|                      |                                  |
| Dated: November  22, 2006 | /s/ KIMMY LOCKWOOD                    |   |
|                      | KIMMY LOCKWOOD                        |
|                      | PRINCIPAL  FINANCIAL OFFICER          |
|                           |                                       |        |  |

 

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**INDEX TO EXHIBITS**
| Exhibit No. | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                        |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                                                                              |
| 10.1        |       | Amendment Number Two to Loan Agreement and Security  Agreement between the Company and K-5 Leisure Products, Inc., as assignee of  Foothill Capital Corporation dated July 20, 2005 (incorporated by reference  to our Annual report on Form 10-K/A for the fiscal year ended June 30, 2004  (File No. 1-07115)). |
|        |       |                                                                                                                                                                                                                                                                                                              |
| 10.2        |       | Amendment Number Two to Credit Agreement and Note  between the Company and K-5 Leisure Products, Inc. dated July 20, 2005  (incorporated by reference to our Annual Report on Form 10-K/A for the fiscal  year ended June 30, 2004 (File No. 1-07115)).                                                           |
|        |       |                                                                                                                                                                                                                                                                                                              |
| 31.1        |       | Certification by Chief Executive Officer pursuant to  Rule 13a-14(a).                                                                                                                                                                                                                                             |
|        |       |                                                                                                                                                                                                                                                                                                              |
| 31.2        |       | Certification by Principal Financial Officer  pursuant to Rule 13a-14(a).                                                                                                                                                                                                                                         |
|        |       |                                                                                                                                                                                                                                                                                                              |
| 32.1        |       | Certification by Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sabanes-Oxley Act of 2002.                                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                                                                              |
| 32.2        |       | Certification by Principal Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sabanes-Oxley Act of 2002.                                                                                                                                                           |

 

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