##### **UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

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

 

**(MarkOne)**

 
| **ý** |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|------------|--------|------------------------------------------------------------------------------------------------|
|       |   |                                                                                           |
|       |   | **For  the quarterly period ended September 30, 2001**                                         |
|       |   |                                                                                           |
| **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:  0-6664**

 

**K-TEL INTERNATIONAL, INC.**

(Exact name of registrantas specified in its charter)

|                                                            |   |                |
|-----------------------------------------------------------------|--------|---------------------|
| **Minnesota**                                                   |   | 4**1-0946588**      |
| (State or other  jurisdiction of                                |   | (I.RS. Employer     |
| incorporation or  organization)                                 |   | Identification No.) |
|                                                            |   |                |
| **5555  Pioneer Creek Drive,  Maple Plain Minnesota** |   | **55359**           |
| (Address of principal  executive offices)                       |   | (Zip Code)          |

 

**(763) 479-8170**

(Registrant’s telephonenumber, including area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.                                                                                             Yesý    No o

 

APPLICABLEONLY TO CORPORATE ISSUERS:

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the most recent practical date. As of November 9, 2001, there were 13,653,738  shares of the registrant’s common stock, par value $0.01 pershare, outstanding.

 

 

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

** FORM 10-Q**

 

**FOR THEQUARTER ENDED SEPTEMBER 30, 2001**

 

INDEX

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

 

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

** CONDENSED CONSOLIDATEDBALANCE SHEETS - UNAUDITED**

**September 30, 2001 and June 30, 2001**

*(in thousands*)

 
|                                                                                                 |   | **September 30,** |          | **June 30,** |          |
|------------------------------------------------------------------------------------------------------|--------|-------------------|---------------|--------------|---------------|
|                                                                                                 |   | **2001**          |          | **2001**     |          |
|                                                                                                 |   |              |          |         |          |
| ASSETS                                                                                               |   |              |          |         |          |
| Current Assets:                                                                                      |   |              |          |         |          |
| Cash and  equivalents                                                                                |   | $                 | 186           |         | $             | 173 |   |
| Accounts  receivable, net                                                                            |   | 1,270             |          | 915          |          |
| Inventories                                                                                          |   | 400               |          | 418          |          |
| Royalty and  other advances                                                                          |   | 156               |          | 182          |          |
| Prepaid expenses  and other                                                                          |   | 398               |          | 480          |          |
| Total Current  Assets                                                                                |   | 2,410             |          | 2,168        |          |
|                                                                                                 |   |              |          |         |          |
| Property and  equipment, net of accumulated depreciation and amortization of  $1,157 and $1,136 |   | 199               |     | 231          |     |
|                                                                                                 |   |              |          |         |          |
| Owned catalog  masters, net of accumulated amortization of $2,746 and $2,687                         |   | 1,488             |          | 1,424        |          |
| Other assets                                                                                         |   | 8                 |          | 9            |          |
|                                                                                                 |   |              |          |         |          |   |   |
|                                                                                                 |   | $                 | 4,105         |         | $             | 3,832 |   |
|                                                                                                 |   |              |          |         |          |
|                                                                                                 |   |              |          |         |          |
| LIABILITIES AND SHAREHOLDERS’ DEFICIT                                                           |   |              |          |         |          |
| Current  Liabilities:                                                                                |   |              |          |         |          |
| Loans payable to  affiliate                                                                          |   | $                 | 9,405         |         | $             | 8,807 |   |
| Accounts payable                                                                                     |   | 2,079             |          | 1,284        |          |
| Accrued  royalties                                                                                   |   | 2,145             |          | 2,080        |          |
| Reserve for  returns                                                                                 |   | 61                |          | 50           |          |
| Other current  liabilities                                                                           |   | 131               |          | 760          |          |
| Net liabilities  of discontinued operations                                                          |   | 1,132             |          | 1,103        |          |
| Total Current  Liabilities                                                                           |   | 14,953            |          | 14,084       |          |
|                                                                                                 |   |              |          |         |          |
|                                                                                                 |   |              |          |         |          |
| Shareholders’  Deficit:                                                                         |   |              |          |         |          |
| Common stock                                                                                         |   | 136               |          | 136          |          |
| Additional  paid-in capital                                                                          |   | 20,680            |          | 20,680       |          |
| Accumulated  deficit                                                                                 |   | (31,289           | )             | (30,785      | )             |
| Cumulative  translation adjustment                                                                   |   | (375              | )             | (283         | )             |
| Total  Shareholders’ Deficit                                                                    |   | (10,848           | )             | (10,252      | )             |
|                                                                                                 |   |              |          |         |          |
|                                                                                                 |   | $                 | 4,105         |         | $             | 3,832 |   |
|                                                                                                 |   |              |          |         |          |

 

See accompanying notes to condensed consolidated financial statements.

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

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED**

*(in thousands - except per share data)*

 
|                                                           |   | **Three Months Ended** |   |
|----------------------------------------------------------------|--------|------------------------|--------|
|                                                           |   | **September  30,**     |   |
|                                                           |   | **2001**               |   | **2000** |   |
|                                                           |   |                   |   |   |   |
| Net Sales                                                      |   | $                      | 1,381  |   | $ | 6,171 |   |
|                                                           |   |                   |   |   |   |
| Costs and  Expenses:                                           |   |                   |   |   |   |
| Cost of goods  sold                                            |   | 522                    |   | 4,420 |   |
| Advertising                                                    |   | 23                     |   | 192 |   |
| Selling, general  & administrative                         |   | 1,233                  |   | 2,612 |   |
| Total Costs and  Expenses                                      |   | 1,779                  |   | 7,224 |   |
| Operating Loss                                                 |   | (398                   | )      | (1,053 | ) |
|                                                           |   |                   |   |   |   |
| Other Income  (Expense):                                       |   |                   |   |   |   |
| Interest income                                                |   | ---                    |   | 46 |   |
| Interest expense                                               |   | (81                    | )      | (225 | ) |
| Foreign currency  transaction gain (loss)                      |   | ---                    |   | (338 | ) |
| Total Other  Income (Expense)                                  |   | (81                    | )      | (517 | ) |
|                                                           |   |                   |   |   |   |
| Loss from  Continuing Operations                               |   |                   |   |   |   |
| Before Taxes                                                   |   | (479                   | )      | (1,570 | ) |
|                                                           |   |                   |   |   |   |
| Income Taxes                                                   |   | ---                    |   | (6 | ) |
|                                                           |   |                   |   |   |   |
| Loss from  Continuing Operations                               |   | (479                   | )      | (1,576 | ) |
|                                                           |   |                   |   |   |   |
| Discontinued  Operations:                                      |   |                   |   |   |   |
| Loss from  Discontinued Operations                             |   | (25                    | )      | (954 | ) |
|                                                           |   |                   |   |   |   |
| Net Loss                                                       |   | $                      | (504   | ) | $ | (2,530 | ) |
|                                                           |   |                   |   |   |   |
| Loss per Share -  Basic and Diluted:                           |   |                   |   |   |   |
| Continuing  Operations                                         |   | $                      | (.04   | ) | $ | (.15 | ) |
| Discontinued  Operations                                       |   | --                     |   | (.10 | ) |
| Net Loss                                                       |   | $                      | (.04   | ) | $ | (.25 | ) |
|                                                           |   |                   |   |   |   |
|                                                           |   |                   |   |   |   |
| Weighted Average  Shares Outstanding – Basic and Diluted: |   | 13,654                 |   | 10,320 |   |
|                                                           |   |                   |   |   |   |
| Comprehensive  Income (loss):                                  |   |                   |   |   |   |
| Net loss                                                       |   | $                      | (504   | ) | $ | (2,530 | ) |
| Foreign currency  gain (loss)                                  |   | (92                    | )      | 327 |   |
| Comprehensive  Loss                                            |   | $                      | (596   | ) | $ | (2,203 | ) |

 

See accompanying notes to condensed consolidated financial statements.

 

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

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

* (in thousands)*

 
|                                                                     |   | **Three Months Ended** |          |
|--------------------------------------------------------------------------|--------|------------------------|---------------|
|                                                                     |   | **September  30,**     |          |
|                                                                     |   | **2001**               |          | **2000** |   |
| Cash flows from  Operating Activities:                                   |   |                   |          |   |   |
| Net loss                                                                 |   | $                      | (504          | ) | $ | (2,530 | ) |
| Adjustments to  reconcile net loss to cash used in operating activities: |   |                   |     |   |     |
| Depreciation and  amortization                                           |   | 69                     |          | 166 |   |
| Loss on Fixed  Asset Disposal                                            |   | 4                      |          | --- |   |
| Discontinued  operations                                                 |   | 29                     |          | 954 |   |
| Changes in  operating assets and liabilities:                            |   |                   |          |   |   |
| Accounts  receivable                                                     |   | (314                   | )             | (295 | ) |
| Inventories                                                              |   | 28                     |          | (199 | ) |
| Royalty and  other advances                                              |   | 30                     |          | (227 | ) |
| Prepaid expenses  and other                                              |   | 94                     |          | 39 |   |
| Accounts payable  and other                                              |   | 140                    |          | 137 |   |
| Accrued  royalties                                                       |   | 61                     |          | 385 |   |
| Reserve for  returns                                                     |   | 9                      |          | 131 |   |
| Cash used in  operating activities                                       |   | (354                   | )             | (1,439 | ) |
|                                                                     |   |                   |          |   |   |
| Cash flows from  Investing Activities:                                   |   |                   |          |   |   |
| Proceeds from  sale of property and equipment                            |   | 27                     |          | 49 |   |
| Purchases of  property and equipment                                     |   | ---                    |          | (8 | ) |
| Music catalog  additions                                                 |   | (114                   | )             | (43 | ) |
| Cash used in  investing activities                                       |   | (87                    | )             | (2 | ) |
|                                                                     |   |                   |          |   |   |
| Cash flows from  Financing Activities:                                   |   |                   |          |   |   |
| Borrowings on  loans payable                                             |   | 789                    |          | 7,100 |   |
| Payments on  loans payable                                               |   | (191                   | )             | (6,614 | ) |
| Cash provided by  financing activities                                   |   | 598                    |          | 486 |   |
|                                                                     |   |                   |          |   |   |
| Effect of  exchange rates on cash                                        |   | (144                   | )             | 500 |   |
|                                                                     |   |                   |          |   |   |
| Net increase  (decrease) in cash and equivalents                         |   | 13                     |          | (455 | ) |
|                                                                     |   |                   |          |   |   |
| Cash and  equivalents at beginning of period                             |   | 173                    |          | 799 |   |
|                                                                     |   |                   |          |   |   |
| Cash and  equivalents at end of period                                   |   | $                      | 186           |   | $ | 344 |   |

 

See accompanying notes tocondensed consolidated financial statements.**K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**1.             BUSINESSAND LIQUIDITY**

 

K-tel International, Inc. (the "Company","K-tel", or the "Registrant") was incorporated in 1968 withcorporate offices located in Maple Plain, Minnesota. Through its operatingsubsidiaries, K-tel licenses its music catalog internationally and marketsentertainment products mainly derived from its catalog in the United States andEurope through retail and direct response marketing channels.

 

During the threemonths ended September 30, 2001, the Company continued to sustain losses fromcontinuing operations, losing $479,000 during the period.  Additionally, the Company had a workingcapital deficit of $12,543,000 at September 30, 2001.

 

The Company's ability tocontinue its present operations and successfully implement future expansionplans is contingent upon its ability to maintain its line of creditarrangements with K-5, increase its revenues, and ultimately attain and sustainprofitable operations. Without increased revenues and sustained profitability,the cash generated from the Company's current operations may not be adequate tofund operations and service its indebtedness during fiscal 2002. Management is concentrating its efforts on returning the Company toprofitability by focusing on its music licensing business and limited musicdistribution.  However, there can be no assurance that the Company’sbusiness plan will be successful in this effort.  In the event the Company is unable to fund its operations and itsbusiness plan, it may be unable to continue as a going concern.  The financial statements do not include anyadjustments that might result from the outcome of this uncertainty

 

                SubsidiaryBankruptcy

 

In March 2001, the Company’s music distributionsubsidiary in the United States, K-tel International (USA), Inc., (“K-tel(USA)”) ceased operations and filed for protection under Chapter 7 of the U. S.bankruptcy code.  In connection withthis filing, the assets and liabilities of this subsidiary have been removedfrom the books of the Company as control of the subsidiary was transferred tothe bankruptcy trustee. Management believes the Company will have no ongoingliability related to this subsidiary as a result of the filing and the outcomeof the bankruptcy proceeding.  Sales ofthis subsidiary included in the three months ended September 30, 2000 were$5,097,000.

 

DiscontinuedOperations

 

The Company’sconsumer products business, which was concentrated in Europe, consistedprimarily of housewares, consumer convenience items and exerciseequipment.  The Company discontinued itsconsumer products operations in Germany, the United Kingdom and the UnitedStates in June 2000, November 2000 and January 2001, respectively.  Accordingly, these activities have beenpresented in the accompanying financial statements as discontinued operations.Net sales for the three months ended September 30, 2000 were $3,154,000.  The accompanying consolidated financialstatements have been prepared (and restated, in the case of the 2000 financialstatements) to reflect the consumer products division as a discontinuedoperation.

 

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

 

Basis of Presentation - The accompanying condensedconsolidated unaudited financial statements have been prepared in accordancewith accounting principles generally accepted in the United States of America(“US GAAP”) for interim financial information and with the instructions to Form10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by US GAAP for 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 three month period ended September 30, 2001,are not necessarily indicative of the results that may be expected for the yearas a whole.  The unaudited condensedconsolidated balance sheet for June 30, 2001 has been derived from auditedconsolidated financial statements as of that date.  For further information, refer to the consolidated financialstatements and footnotes thereto included in the Company’s annual report on Form10-K for the year ended June 30, 2001.

 

Principles ofConsolidation – The accompanying condensed consolidatedunaudited financial statements include the accounts of K-tel International,Inc. and its domestic and foreign subsidiaries, all of which are whollyowned.  All significant intercompanyaccounts and transactions have been eliminated.           

 

Revenue Recognition– The Company derives its revenue from several different sources: the sale ofmusic compilations (predominately compact discs) produced by the Company andlicense revenue from the licensing of Company-owned masters.  Revenue from the music sales is recognizedat the time of the sale to the customer, while license revenue is recognizedwhen payment is received from customers, because prior to that date collectionis not considered probable.  Most musicsales are made with a right of return of unsold goods.  Estimated reserves for returns areestablished by management based upon historical experience and product mix andare subject to ongoing review and adjustment by the Company.  These reserves are recorded at the time ofthe sales and are reflected as a reduction in revenue.

 

Cost of Goods Sold– The Company expenses all product manufacturing, distribution and royaltycosts associated with the music sales as cost of goods sold.  The Company also expenses royalties,commissions and amortization of its owned masters associated with its licenserevenue as cost of goods sold.

 

Shipping and HandlingCosts – The Company expenses all shipping and handling costsincurred in the shipment of goods within cost of goods sold.

 

Cash and Equivalents– Cash and equivalents consist principally of cash, and short-term, highlyliquid investments with original maturities of less than ninety days.

 

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

 

Rights to UseMusic Product- Certain of the Company's compilation productsare master recordings under license from record companies and publishers.  In most instances, minimum guarantees ornon-returnable advances are required to obtain the licenses and are realizedthrough future sales of the product. The amounts paid for minimum guarantees or non–returnable advancesare capitalized and charged to expense as sales are made.  When anticipated sales appear to beinsufficient to fully recover the minimum guarantees or non–returnableadvances, a provision against current operations is made for anticipatedlosses.  The unrealized portion ofguarantees and advances is included in royalty advances in the accompanyingconsolidated balance sheets.  Licensesare subject to audit by licensors.

 

Property andEquipment - Property and equipment are stated at cost.  Depreciation and amortization is providedusing straight line or declining balance methods over the estimated usefullives of the assets which range from three to nine years.

 

Long Lived-Assets– The Company evaluates its long-lived assets quarterly, or earlier if atriggering event occurs, to determine potential impairment by comparing thecarrying value of those assets to the related undiscounted future cash flowsassets.  If an asset is determined to beimpaired, it is written down to its estimated net realizable value.

 

Royalties- The Company has entered into license agreements with various publishers underwhich it pays royalties on units sold. The Company accrues royalties using contractual or statutory rates andcertain estimated rates on applicable units sold.  The contractual royalty liability is computed quarterly, thestatutory royalty is computed monthly and the accrued royalty balance is adjustedaccordingly.  The royalty agreements aresubject to audit by licensors.

 

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 oneyear).  Direct response advertisingconsists primarily of television advertising whereby customers respondspecifically to the advertising and where the Company can identify theadvertising that elicited the response.

 

Foreign Currency- The operations of all foreign entities are measured in local currencies.  Assets and liabilities are translated intoU.S. dollars at period end exchange rates. Revenues and expenses are translated at the average exchange ratesprevailing during the period. Adjustments resulting from translating the financial statements offoreign entities into U.S. dollars are recorded as a separate component of shareholders'equity.

 

Stock–basedCompensation - The Company accounts for stock-based awards toemployees using the intrinsic value method and recognizes compensation expensefor certain stock based awards granted to employees.

 

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.

 

Net Loss Per Share- Basic and diluted net loss per share have been computed by dividing net lossby the weighted average number of shares outstanding during the period. For allperiods presented, common stock equivalents were excluded from the per sharecalculation as the effect would be antidilutive.  Options to purchase 2,336,434 and 2,804,488,shares of commonstock, with weighted average exercise prices of $5.88 and $6.36 were excludedfrom the computation of common share equivalents for the respective periods asthey were antidilutive.

 

Use of Estimates- Preparing consolidated financial statements in conformity with US GAAP requiresmanagement to make estimates and assumptions that affect the reported amountsof assets, liabilities, disclosure of contingent assets and liabilities at thedate of the financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from those estimates used by management.

 

**3.             LOANS PAYABLE TO AFFILIATE**

 

On September 27, 1999,K-tel entered into a written Line of Credit Agreement with K-5 LeisureProducts, Inc. ("K-5"), an affiliate controlled by Philip Kives, theChairman of the Board and Chief Executive Officer of K-tel.  Under the terms of the agreement (the K-5facility), K-5 agreed to make available up to $8,000,000 on a revolving basis.  The loan bears interest at a variable ratebased upon the “base rate” of a lending institution (6.00% at September 30,2001), expires on November 20, 2001, and is subordinated to the Foothill loan(see below).  The loan agreement betweenK-tel and K-5 contains the same covenants as the Foothill loan agreement.  K-tel has pledged the stock of its foreignsubsidiaries as collateral for the loan. As of June 30, 2001, K-tel had an outstanding balance of $4,807,000 andas of September 30, 2001, K-tel had an outstanding balance of $5,405,000 underthe K-5 facility.

 

On February 27, 2001,K-tel International, Inc. entered into an Assignment and Acceptance Agreementpursuant to which Foothill Capital Corporation (“Foothill”) assigned to K-5 allof Foothill’s rights and obligations as the creditor under a Loan and SecurityAgreement dated November 19, 1997, between Foothill, K-tel  (USA), Dominion Entertainment, Inc., K-telConsumer Products, Inc., K-tel TV, Inc. and K-tel Video, Inc. (the “FoothillLoan”).  K-tel International, Inc. is aguarantor of the Foothill Loan.  K-5paid Foothill  $3,480,000 inconsideration for assignment of the Foothill Loan and other ancillaryagreements, representing the principal amount of all outstanding obligations toFoothill together with accrued interest and fees.  Pursuant to the Assignment and Acceptance Agreement, K-telInternational, Inc. and K-5 released and discharged Foothill from anyobligations as the lender under the Foothill Loan.  K-tel International, Inc. will continue to guarantee payments tobe made to K-5 pursuant to the Foothill Loan.

 

The assigned FoothillLoan provides for a $10,000,000 credit facility consisting of a $4,000,000 termloan due in full on November 20, 2001, and a $6,000,000 revolving facilityunder which borrowings are limited to a percent of eligible receivables.  Borrowings under the facility bear interestat a variable rate based on a “base rate” announced by a banking affiliateassociated with Foothill plus 1% (7.00% at September 30, 2001) and are collateralizedby the assets of certain Company subsidiaries in the United States, includingaccounts receivable, inventories, equipment, music library and generalintangibles.  The loan agreementcontains certain financial and other covenants or restrictions, including themaintenance of a minimum shareholders’ equity by K-tel, limitations on capitalexpenditures, restrictions on music library acquisitions, limitations on otherindebtedness and restrictions on dividends paid by K-tel.  K-tel has guaranteed the obligations of itssubsidiaries under the credit facility and has pledged the stock of thosesubsidiaries and its assets to secure K-tel’s obligations under itsguaranty.  As of September 30 and June30, 2001, $4,000,000 was outstanding under the term loan and there were noavailable borrowings available under the revolving facility due to borrowingbase limitations.  K-tel was in defaultunder the covenants, limitations and restrictions of the credit agreement, butK-5 has permitted the default situation to continue.

 

In a separate transactionpursuant to a voluntary Surrender Agreement entered into on March 12, 2001,between K-tel (USA) and K-5 and amended on March 17, 2001, K-tel (USA)voluntarily surrendered assets to K-5 which served as collateral pursuant to aLoan and Security Agreement in connection with the Foothill Loan.  In consideration of the surrender of suchassets, K-5 agreed to apply funds realized from their disposition in accordancewith the Uniform Commercial Code and to reduce the amount of indebtedness owedby K-tel (USA) to K-5 on a dollar for dollar basis as proceeds arecollected.  The Foothill loan balance atSeptember 30, 2001 has been reduced to reflect collections received throughthat date.  Management does not expectfuture collections to be significant.

 

Both of the Company’sexisting debt agreements expire in November 2001.  Management anticipates that it will be able to enter into newagreements with comparable rates and terms.

 

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

 

Class ActionLawsuit

 

K-tel and certainof its current and former officers and directors are defendants in In reK-tel International, Inc. Securities Litigation, No. 98-CV-2480.  This action consolidates twenty threepurported class actions that were initially filed in various United StatesDistrict Courts in November 1998, and were subsequently transferred to, andconsolidated in the United States District Court for the District ofMinnesota.  On July 19, 1999, theplaintiffs filed an amended consolidated class action complaint that challengesthe accuracy of certain public disclosures made by K-tel regarding itsfinancial condition during the period May 1998 through November 1998.  The plaintiffs assert claims under thefederal securities laws and seek damages in an unspecified amount as well as costs,including attorneys' fees and any other relief the Court deems just andproper.  K-tel moved to dismiss theComplaint, and, on July 31, 2000, the U.S. District Court granted the Company'smotion to dismiss. The Court also barred further actions by the plaintiffs anddenied plaintiffs' request to amend the complaint in order to refile thecomplaint in the future.  The plaintiffappealed, and the court of appeals heard the matter in October 2001. TheCompany is waiting a court ruling. K-tel has two insurance policies providingcoverage of up to $20,000,000, which is subject to the insurers’ reservationsof legal rights under the applicable policies. Under their reservations ofrights, the insurers could contest their obligations to indemnify the Company andits directors and officers.  K-tel mayhave an obligation to indemnify the officers and directors named in thislawsuit.

 

                Early v. K-tel International,Inc.

 

On January 11,1999, The Company was named in a lawsuit entitled *Christopher Early vs. K-tel International,Inc., et al*, brought in the Circuit Court of Cook County, Illinois,against the Company and certain of its subsidiaries by Christopher Early.  The suit also names as defendants certainother manufacturers, distributors and a number of nationwide retailers.  The plaintiff seeks damages on behalf ofhimself and a purported class of purchasers of cassette tapes and compact discsproduced, distributed and/or sold by the defendants.  The claim alleges that defendants engaged in deceptive and misleadingpackaging of cassette tapes and compact discs by failing to give proper noticeto consumers that the songs contained therein are not the original recordingsby the original artists.  The complaintalso alleges consumer fraud, deceptive and unfair practices, and fraud inconnection with website advertising and marketing.  Similar litigation against the Company, brought against theCompany by Mr. Early in 1997, was dismissed by a U.S. Federal Court in 1999 onjurisdictional grounds.  The Companydenies that it mislabeled cassette tapes and compact discs or engaged infraudulent or deceptive conduct and intends to vigorously defend the purportedaction, which seeks an undetermined amount of compensatory damages and punitivedamages in the amount of $10 million, an injunction and costs incurred in thelitigation, including attorneys fees. The Company filed a motion to dismiss the complaint on June 8, 2000. OnFebruary 16, 2001, the court dismissed the complaint against the othermanufacturers, distributors and nationwide retailers, but allowed the case tocontinue against the Company.   Whilediscovery has not yet begun and no assurance can be given that the Company willbe successful in defending this action, the Company believes it has meritoriousdefenses to the plaintiff’s claims.

                

                Mix Connection Mutimedia,Inc. v. K-tel International (USA), Inc.

 

On January 25,2001, K-tel International (USA), Inc. was named in a lawsuit in HennepinCounty, Minnesota district court which was brought by Mix ConnectionMultimedia, Inc. (“Mix Connection”). Mix Connection alleges that it soldproduct to K-tel (USA) and that K-tel (USA) failed to pay for the product. MixConnection asserts claims of breach of contract and replevin and seeks damagesin the amount of approximately $566,000. The action has been stayed as a resultof K-tel (USA)’s Chapter 7 bankruptcy filing.

 

                RTL Shopping  S. A.

 

The Company hasbeen named in a lawsuit filed in France brought by RTL9, a French cable TVstation. 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 that translated language indicating that the product was “justlike” or “as good as others” in English script to “better than” competingproducts in French, contrary to French law. RTL9 then sued K-tel Marketing onOctober 4, 2000, pursuant to an indemnification provision the parties hadentered into. Subsequently, K-tel Marketing went into liquidation and RTL fileda suit in December 2000, against K-tel International, Inc. under its agreementto guaranty payment for the commercial time. On May 28, 2001, RTL9 presenteddocuments in court identifying K-tel International (USA), Inc. as a target ofits claim. On September 3, 2001 the Company filed documents disputing the claimand advising the court of K-tel (USA)’s Chapter 7 bankruptcy filing.  A procedural hearing has been scheduled forDecember 3, 2001 at which time RTL9 will file its brief in response to theCompany's filing. The action seeks the approximate amount of 20 million FrenchFrancs, or approximately $2.8 million. The Company believes that RTL9 has nobasis for a complaint against the Company.

 

CarnegieEntertainment v K-tel (USA)

 

CarnegieEntertainment  (“Carnegie”) and K-tel(USA), entered into a distribution agreement. Carnegie sued for breach of contract, tortuous interference withcontractual relations and interference with prospective business relations.  Carnegie seeks damages in excess of$500,000.  The case was stayed byK-tel  (USA)’s bankruptcy petition.  

 

Hollins &Fields, LLP v K-tel International, Inc.

 

Hollins &Fields, LLP (H&F) sublet a portion of the Company's former executiveoffices in Los Angeles.  On September21, 2001, H&F sued for breach of contract and conversion, seeking damagesin excess of $150,000.  While discoveryhas not yet begun and no assurances can be given that the Company will besuccessful in defending this action, the Company believes it has meritoriousdefenses to the plaintiff's claims.

 

Other Litigation andDisputes

 

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

 

Subsidiary Bankruptcy

In March 2001, the Company'smusic distribution subsidiary in the United States, K-tel  (USA), ceased operations and filed forprotection under Chapter 7 of the U.S. bankruptcy code.  Although thebankruptcy court has not yet confirmed the formal plan of liquidation, theCompany has not been informed by the trustee or its counsel of any plan by thecourt to attempt to hold it or any of its subsidiaries liable for any of thecommitments of K-tel (USA).  Management believes the Company will have noongoing material liability related to this subsidiary as a result of the filingand the outcome of the bankruptcy proceeding.

 

**5.             SEGMENT INFORMATION**

 

The Companymarkets and distributes entertainment products internationally.  K–tel's businesses are organized,managed and internally reported as two segments: retail music sales and musiclicensing.  These segments are based ondifferences in products, customer type and sales and distribution methods.

 

     Theretail music segment consists primarily of the sales of pre–recordedmusic both from the Company’s music master catalog and under licenses obtainedfrom other record companies. The Company sells compact discs and DVD’s directlyto retailers, wholesalers and rack service distributors which stock and manageinventory within music departments for retail stores.

 

                Inthe licensing segment, the Company licenses the rights to its master musiccatalog, consisting of original recordings and re–recordings of musicfrom the 1950's through today, to third parties world–wide for use inalbums, films, television programs, and commercials, for either a flat fee or aroyalty based on the number of units sold.

 

          Operating profits or losses of thesesegments include an allocation of general corporate expenses.

 

Certain financial information on the Company’scontinuing operating segments is as follows

 

BASIC SEGMENT INFORMATION
|                                 |       |      |   |           |       |       |   | **Corporate Elimination** |   | **TotalCompany** |   |
|--------------------------------------|------------|-----------|--------|----------------|------------|------------|--------|---------------------------|--------|------------------|--------|
| **Three Months Ended September 30,** | ** ** | **Music** |   | **Licensing**  | ** ** | ** ** |   |
|                                 |       |      |   | (in thousands) |       |
| Net  Sales                           |       | 2001      |   | $              | 756        |       | $      | 784                       |   | $                | (159   | ) | $ | 1,381 |   |
|                                 |       | 2000      |   | 5,548          |       | 810        |   | (187                      | )      | 6,171            |   |
|                                 |       |      |   |           |       |       |   |                      |   |             |   |
| Operating                            |       | 2001      |   | $              | (573       | )          | $      | 175                       |   | --               |   | $ | (398 | ) |
| Income (Loss)                        |       | 2000      |   | (1,150         | )          | 97         |   | --                        |   | (1,053           | )      |
|                                      |            |           |        |                |            |            |        |                           |        |                  |        |  |  |  |  |

 

 

**ITEM2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS****THE THREE MONTHS ENDED SEPTEMBER 30, 2001 VERSUS THETHREE MONTHS ENDED SEPTEMBER 30, 2000**

 

**General**

Through its operating subsidiaries, K-tel licenses itsmusic catalog internationally and markets entertainment products mainly derivedfrom its catalog in the United States and Europe through retail and directresponse marketing channels.

 

For this analysis, the following changes in theCompany’s business should be considered: K-tel closed the operations of its German subsidiary, Dominion VertriebsGmbH, in June 2000, one of its subsidiaries in the United Kingdom, K-telMarketing Ltd., in November 2000 and a U.S. 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 distribution subsidiary in the United States, K-tel (USA)ceased operations and filed for protection under Chapter 7 of the U.S.bankruptcy code.

 

Net sales for the three months ended September 30,2001 were $1,381,000, a decline of 77.6% from sales of $6,171,000 for thequarter ended September 30, 2000. This sales decline can be attributed to thecessation of operations of the Company’s domestic music distributionsubsidiary, K-tel (USA).  The loss forthe three months ended September 30, 2001 was $504,000, or $.04 per share,compared to a loss of $2,530,000, or $.25 per share, for the three months endedSeptember 30, 2000.

 

General corporate expenses of $364,000 and $355,000for the three months ended September 30, 2001 and 2000 have been allocated tothe segments.

 

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

 

#### **BUSINESSSEGMENT RESULTS**

 

#### **Music**

 

Sales in the music segment were $756,000 for the threemonths ended September 30, 2001 compared to $5,548,000 for the three monthsended September 30, 2000, a decrease of $4,792,000, or 86.4%. While Europeansales increased $121,000, domestic music sales decreased $4,913,000.  The domestic business had been comprisedprimarily of sales of music compilations produced by K-tel and the sales anddistribution of other record labels. Sales declined as K-tel (USA) ceased operations and filed for bankruptcyin March 2001.  Sales during the threemonths ended September 30, 2001 are in another domestic subsidiary that marketsproducts derived from the Company’s proprietary master music catalog.

 

Cost of goods sold in the music segment decreased to66.4% of sales for the three months ended September 30, 2001 compared to 78.9%of sales for the three months ended September 30, 2000.  This reflects the Company’s continuingefforts to reduce product costs and eliminate products that do not generate andacceptable gross profit.  Advertisingexpenses within the segment, which consists primarily of co-operativeadvertising payments, trade advertising and promotions, decreased to $23,000and was approximately 3.1% of sales for the three months ended September 30,2001 compared to $123,000, or 2.6% of sales for the three months endedSeptember 30, 2000.  This decrease isrelated to the reduced sales levels. Selling, general and administrative expenses were $803,000, or 106.2% ofsales for the three months ended September 30, 2001 compared to $2,180,000, or45.5% of sales for the three months ended September 30, 2000.  The reduction of $1,377,000 is mainlybecause of the closure of the former domestic music distributionsubsidiary.  The costs in excess ofsales during the three months ended September 30, 2001 reflect the start upcosts of implementing the Company’s new music distribution strategy.  As a result, the music segment incurred anoperating loss of $573,000 for the three months ended September 30, 2001compared to an operating loss of $1,150,000 for the three months endedSeptember 30, 2000.

 

**Licensing**

 

Licensing revenue was $784,000 in the three monthsended September 30, 2001 compared to $810,000 for the three months endedSeptember 30, 2000, a decrease of 3.2%. Revenue in Europe decreased $64,000 as the Company began to evaluate itslicensing activities with the goal of increasing profitability.  Included in the segment revenue in the threemonths ended September 30, 2001 and 2000 were approximately $159,000 and$187,000 of intercompany revenues, respectively, which are eliminated on theaccompanying financial statements. Operating income in the licensing segment was $175,000 for the threemonths ended September 30, 2001 and $97,000 for the three months endedSeptember 30, 2000, an increase of 80.4%.

 

**B.LIQUIDITY AND CAPITAL RESOURCES**

 

On September 27, 1999, K-tel entered into a writtenLine of Credit Agreement with K-5 Leisure Products, Inc. ("K-5"), anaffiliate controlled by Philip Kives, the Chairman of the Board and ChiefExecutive Officer of K-tel.  Under theterms of the agreement (the K-5 facility), K-5 agreed to make available up to$8,000,000 on a revolving basis.  Theloan bears interest at a variable rate based upon the “base rate” of a locallending institution (6.00% at September 30, 2001), expires on November 20,2001, and is subordinated to the Foothill loan (see below).  The loan agreement between K-tel and K-5contains the same covenants as the Foothill loan agreement.   K-tel has pledged the stock of its foreignsubsidiaries as collateral for the loan. As of September 30 and June 30, 2001, K-tel had an outstanding balanceof $5,405,000 and $4,807,000 under the K-5 facility.

 

On February 27, 2001, K-tel International, Inc. enteredinto an Assignment and Acceptance Agreement pursuant to which Foothill Assignedto K-5 all of Foothill’s rights and obligations as the creditor under a Loanand Security Agreement dated November 19, 1997, between Foothill, K-tel (USA),Dominion Entertainment Inc., K-tel Consumer Products, Inc., K-tel TV, Inc. andK-tel Video, Inc. (the “Foothill Loan”). K-tel International, Inc. is aguarantor of the Foothill Loan. K-5 paid to Foothill an aggregate of $3,480,000in consideration for assignment of the Foothill Loan and other ancillaryagreements, representing the principal amount of all outstanding obligations toFoothill under the Foothill Loan together with an accrued interest, fees andother payments owed to Foothill. Pursuant to the Assignment and AcceptanceAgreement, K-tel International, Inc. and K-5 released and discharged Foothillfrom any obligations as the lender under the Foothill Loan. K-telInternational, Inc. will continue to guarantee payments to be made to K-5pursuant to the Foothill Loan.

 

The assigned Foothill Loan provides for a $10,000,000credit facility consisting of a $4,000,000 term loan and a $6,000,000 revolvingfacility under which borrowings are limited to a percent of eligiblereceivables. Borrowings under the facility bear interest at a variable ratebased on a “base rate” announced by a banking affiliate associated withFoothill plus 1% (7.00% at September 30, 2001) and are collateralized by theassets of certain Company subsidiaries in the United States, including accountsreceivable, inventories, equipment, music library and general intangibles. Theloan agreement contains certain financial and other covenants or restrictions,including the maintenance of a minimum shareholders’ equity by K-tel,limitations on capital expenditures, restrictions on music libraryacquisitions, limitations on other indebtedness and restrictions on dividendspaid by K-tel. K-tel has guaranteed the obligations of its subsidiaries underthe credit facility and has pledged the stock of those subsidiaries and itsassets to secure K-tel’s obligations under its guaranty. As of September 30 andJune 30, 2001, $4,000,000 was outstanding under the term loan and there were noavailable borrowings available under the revolving facility due to borrowingbase limitations. K-tel was in default under the covenants, limitations andrestrictions of the credit agreement, but K-5 has permitted the defaultsituation to continue.

 

In a separate transaction pursuant to a voluntarySurrender Agreement entered into on March 12, 2001, between K-tel (USA) and K-5and amended on March 17, 2001, K-tel (USA) voluntarily surrendered assets toK-5 which served as collateral pursuant to a Loan and Security Agreement inconnection with the Foothill Loan. In consideration of the voluntary surrenderof such assets, K-5 agreed to apply funds realized from the disposition ofassets in accordance with the Uniform Commercial Code and to reduce the amountof indebtedness owed by K-tel (USA) to K-5 on a dollar for dollar basis asproceeds are collected.  The Foothillloan balance at September 30, 2001 has been reduced to reflect collectionsreceived through that date.  Managementdoes not expect future collections to be significant.

 

K-tel has primarily funded its operations to datethrough internally generated capital, proceeds from stock option exercises andsecured loans from K-5. Management currently believes that K-tel has sufficientcash and borrowing capacity to ensure the Company will continue operations inthe near term. In part, this is a result of projected improvement in operatingresults in fiscal 2002 as well as the two existing lines of credit with K-5.Although K-tel’s lender 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's ability to continue its presentoperations and successfully implement future expansion plans is contingent uponits ability to maintain its line of credit arrangements with K-5, increase itsrevenues, and ultimately attain and sustain profitable operations. Withoutincreased revenues and sustained profitability, the cash generated from the Company'scurrent operations may not be adequate to fund operations and service itsindebtedness during fiscal 2002.  Management is concentrating its effortson returning the Company to profitability by focusing on its music licensingbusiness and limited music distribution.  However, there can be noassurance that the Company’s business plan will be successful in thiseffort.  In the event the Company isunable to fund its operations and its business plan, it may be unable tocontinue as a going concern.  The financialstatements do not include any adjustments that might result from the outcome ofthis uncertainty.

Both of the Company’sexisting debt agreements expire in November 2001.  Management anticipates that it will be able to enter into newagreements with comparable rates and terms.

 

**Important Factors Relating to Forward Looking Statements**

 

Information in this Form 10-Q of a non-historical nature relates tofuture events and results of the Company (including certain projections andbusiness trends) that are “forward-looking statements” as defined in thePrivate Securities Litigation Reform Act of 1995. The use of terminology suchas "believe," "may," "will," "expect,""anticipate," "estimate," "should,""continue," other variations thereof or comparable terminology mayidentify such forward-looking statements. Actual results and performance may differ materially from expressedforward looking statements because of certain risks and uncertainties,including but not limited to, changes in political and economic conditions;demand for and market acceptance of new and existing products; the impact fromcompetition for Internet content, merchandise and recorded music; dependence onstrategic alliance partners, suppliers and distributors; market acceptance of theInternet for commerce and as a medium for advertising; technological changesand difficulties; availability of financing and other risks discussed in theCompany’s 10-K report for the fiscal year ended June 30, 2001 filed with theSecurities and Exchange Commission. The Company undertakes no obligation topublicly release the result of any revisions to these forward-lookingstatements, except as required by law in the normal course of its publicdisclosure practices.

 

**ITEM3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

There have been no material changes in the company'smarket risk during the three months ended September 30, 2001.  For additional information, refer to page 12of the Company's annual report on Form 10-K for the fiscal year ended June 30,2001.

 

**PART II**

 

 

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

 

Class ActionLawsuit

 

K-tel and certainof its current and former officers and directors are defendants in In reK-tel International, Inc. Securities Litigation, No. 98-CV-2480.  This action consolidates twenty threepurported class actions that were initially filed in various United StatesDistrict Courts in November 1998, and were subsequently transferred to, andconsolidated in the United States District Court for the District of Minnesota.  On July 19, 1999, the plaintiffs filed anamended consolidated class action complaint that challenges the accuracy ofcertain public disclosures made by K-tel regarding its financial conditionduring the period May 1998 through November 1998.  The plaintiffs assert claims under the federal securities lawsand seek damages in an unspecified amount as well as costs, includingattorneys' fees and any other relief the Court deems just and proper.  K-tel moved to dismiss the Complaint, and,on July 31, 2000, the U.S. District Court granted the Company's motion todismiss. The Court also barred further actions by the plaintiffs and deniedplaintiffs' request to amend the complaint in order to refile the complaint inthe future.  The plaintiff appealed, andthe court of appeals heard the matter in October 2001. The Company is waiting acourt ruling. K-tel has two insurance policies providing coverage of up to$20,000,000, which is subject to the insurers’ reservations of legal rightsunder the applicable policies. Under their reservations of rights, the insurerscould contest their obligations to indemnify the Company and its directors andofficers.  K-tel may have an obligationto indemnify the officers and directors named in this lawsuit.

 

Early v. K-telInternational, Inc.

 

On January 11,1999, The Company was named in a lawsuit entitled *Christopher Early vs. K-telInternational, Inc., et al*, brought in the Circuit Court of CookCounty, Illinois, against the Company and certain of its subsidiaries byChristopher Early.  The suit also namesas defendants certain other manufacturers, distributors and a number ofnationwide retailers.  The plaintiffseeks damages on behalf of himself and a purported class of purchasers ofcassette tapes and compact discs produced, distributed and/or sold by thedefendants.  The claim alleges thatdefendants engaged in deceptive and misleading packaging of cassette tapes andcompact discs by failing to give proper notice to consumers that the songs containedtherein are not the original recordings by the original artists.  The complaint also alleges consumer fraud,deceptive and unfair practices, and fraud in connection with websiteadvertising and marketing.  Similarlitigation against the Company, brought against the Company by Mr. Early in1997, was dismissed by a U.S. Federal Court in 1999 on jurisdictionalgrounds.  The Company denies that itmislabeled cassette tapes and compact discs or engaged in fraudulent ordeceptive conduct and intends to vigorously defend the purported action, whichseeks an undetermined amount of compensatory damages and punitive damages inthe amount of $10 million, an injunction and costs incurred in the litigation,including attorneys fees.  The Companyfiled a motion to dismiss the complaint on June 8, 2000. On February 16, 2001,the court dismissed the complaint against the other manufacturers, distributorsand nationwide retailers, but allowed the case to continue against theCompany.   While discovery has not yetbegun and no assurance can be given that the Company will be successful indefending this action, the Company believes it has meritorious defenses to theplaintiff’s claims.

 

Mix Connection Mutimedia,Inc. v. K-tel International (USA), Inc.

 

On January 25, 2001,K-tel International (USA), Inc. was named in a lawsuit in Hennepin County,Minnesota district court which was brought by Mix Connection Multimedia, Inc.(“Mix Connection”). Mix Connection alleges that it sold product to K-tel (USA)and that K-tel (USA) failed to pay for the product. Mix Connection assertsclaims of breach of contract and replevin and seeks damages in the amount ofapproximately $566,000. The action has been stayed as a result of K-tel (USA)’sChapter 7 bankruptcy filing.

 

RTL Shopping  S. A.

 

The Company hasbeen named in a lawsuit filed in France brought by RTL9, a French cable TVstation. 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 that translated language indicating that the product was “justlike” or “as good as others” in English script to “better than” competingproducts in French, contrary to French law. RTL9 then sued K-tel Marketing onOctober 4, 2000, pursuant to an indemnification provision the parties hadentered into. Subsequently, K-tel Marketing went into liquidation and RTL fileda suit in December 2000, against K-tel International, Inc. under its agreementto guaranty payment for the commercial time. On May 28, 2001, RTL9 presenteddocuments in court identifying K-tel International (USA), Inc. as a target ofits claim. On September 3, 2001 the Company filed documents disputing the claimand advising the court of K-tel (USA)’s Chapter 7 bankruptcy filing. Aprocedural hearing has been scheduled for December 3, 2001 at which time RTL9will file its brief in response to the Company's filing. The action seeks theapproximate amount of 20 million French Francs, or approximately $2.8 million.The Company believes that RTL9 has no basis for a complaint against theCompany.

 

CarnegieEntertainment v K-tel (USA)

 

CarnegieEntertainment  (“Carnegie”) and K-tel(USA), entered into a distribution agreement. Carnegie sued for breach of contract, tortuous interference withcontractual relations and interference with prospective businessrelations.  Carnegie seeks damages inexcess of $500,000.  The case was stayedby K-tel  (USA)’s bankruptcy petition.

 

Hollins &Fields, LLP v K-tel International, Inc.

 

Hollins &Fields, LLP (H&F) sublet a portion of the Company's former executiveoffices in Los Angeles.  On September21, 2001, H&F sued for breach of contract and conversion, seeking damagesin excess of $150,000.  While discoveryhas not yet begun and no assurances can be given that the Company will besuccessful in defending this action, the Company believes it has meritoriousdefenses to the plaintiff's claims.

 

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

 

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

 

## **ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K**

 

 

(a)           EXHIBIT INDEX

 

No exhibits

 

(b)           REPORTS ON FORM 8-K

 

There were no reports filed under Form 8-K by theCompany during the three month period ended September 30, 2001.

 

 

SIGNATURES

 

 

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

 

 
|                            |   |   | K-TEL INTERNATIONAL,  INC.           |
|---------------------------------|--------|--------|--------------------------------------|
|                            |   |   | REGISTRANT                           |
|                            |   |   |                                 |
|                            |   |   |                                 |
|                            |   |   |                                 |
|                            |   |   |                                 |
|                            |   |   |                                 |
|                            |   |   |                                 |
| Dated:   November 14, 2001 |   |   | /S/ PHILIP KIVES                     |
|                            |   |   | PHILP KIVES                          |
|                            |   |   | CHAIRMAN AND CHIEF EXECUTIVE OFFICER |
|                            |   |   |                                 |
|                            |   |   |                                 |
|                            |   |   |                                 |
|                            |   |   |                                 |
| Dated:   November 14, 2001 |   |   | /S/ DENNIS WARD                      |
|                            |   |   | DENNIS WARD                          |
|                            |   |   | CHIEF FINANCIAL OFFICER              |
|                            |   |   | (principal accounting officer)       |