##### **UNITEDSTATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

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

**(MarkOne)**

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

**For thequarterly period ended March 31, 2007**

**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.R.S. Employer  Identification No.) |
| incorporation or  organization)                  |                                  |
|                                             |                                  |
| **2491  Xenium Lane North, Plymouth, Minnesota** | **55441**                             |
| (Address of  principal executive offices)        | (Zip Code)                            |

 

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

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

**None**

Securitiesregistered pursuant to Section 12(g) of the Act:

**Common Stock, par value $0.01**

(Title of class)

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

Yes x     No o

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

 

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

Yes o     No x

As of May 10, 2007, theregistrant had 13,653,738 shares of Common Stock outstanding.

 

----

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

**FORM 10-Q**

**FOR THE THREE AND NINE MONTH PERIODS**

**ENDED MARCH 31, 2007**

INDEX
|                                            | ** ** | ** **                                                                                                   | **Page** |
|--------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|----------|
| PART I. Financial Information (Unaudited): |       |
|                                       |       |
|                                       | Item 1.    | Financial Statements                                                                                         |     |
|                                       |       |                                                                                                         |     |
|                                       |       | Condensed Consolidated Balance Sheets as of March 31,  2007 and June 30, 2006                                |     |
|                                       |       |                                                                                                         |     |
|                                       |       | Condensed Consolidated Statements of Operations for  the Three and Nine Months Ended March 31, 2007 and 2006 |     |
|                                       |       |                                                                                                         |     |
|                                       |       | Condensed Consolidated Statements of Cash Flows for  the Nine Months Ended March 31, 2007 and 2006           |     |
|                                       |       |                                                                                                         |     |
|                                       |       | Notes to Condensed Consolidated Financial Statements                                                         |     |
|                                       |       |                                                                                                         |     |
|                                       | Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                  |     |
|                                       |       |                                                                                                         |     |
|                                       | Item 3.    | Quantitative  and Qualitative Disclosures About Market Risk                                                  |     |
|                                       |       |                                                                                                         |     |
|                                       | Item 4.    | Controls and  Procedures                                                                                     |     |
|                                       |       |                                                                                                         |     |
| PART II. Other Information:                |       |
|                                       |       |                                                                                                         |     |
|                                       | Item 1.    | Legal Proceedings                                                                                            |     |
|                                       |       |                                                                                                         |     |
|                                       | Item  6.   | Exhibits                                                                                                     |     |
|                                       |       |                                                                                                         |     |
| Signatures                                 |       |
|                                       |       |                                                                                                         |     |
| Index to Exhibits                          |       |

 

**SAFE HARBOR STATEMENT UNDER THE**

**PRIVATESECURITIES LITIGATION REFORM ACT OF 1995**

Certainstatements of a non-historical nature under the caption “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andelsewhere in this Form 10-Q constitute “forward-looking statements” within themeaning of the Private Securities Litigation Reform Act of 1995. Suchforward-looking statements may be identified by the use of terminology such as “may,”“will,” “expect,” “anticipate,” “estimate,” “should,” or “continue” or thenegative thereof or other variations thereon or comparable terminology. Suchforward-looking statements are subject to certain risks and uncertainties thatcould cause actual results to differ materially from historical results or fromthose results currently anticipated or projected. Such factors include, amongother things, the following: changes in consumer purchasing; demand for andmarket acceptance of new and existing products; the impact from competition forrecorded music; dependence on suppliers and distributors; success of marketingand promotion efforts; technological changes and difficulties; availability offinancing; foreign currency variations; general economic, political andbusiness conditions; and other matters. We undertake no obligation to releasepublicly the result of any revisions to these forward-looking statements,except as required by law.

2

----

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

**CONDENSEDCONSOLIDATED BALANCE SHEETS - UNAUDITED**

*(inthousands — except share data*)
| ** **                                                                                                                    | ** ** | **March 31,** | ** ** | **June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-------------------|------------|
| ** **                                                                                                                    | ** ** | **2007**           | ** ** | **2006**          | ** ** |
|                                                                                                                          |       |               |       |              |       |
| ASSETS                                                                                                                        |       |               |       |              |       |
|                                                                                                                          |       |               |       |              |       |
| Current assets:                                                                                                               |       |               |       |              |       |
| Cash and cash  equivalents                                                                                                    |       | $                  | 1,682      |              | $          | 1,689 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $2 at March 31 and June  30                                   |       | 588                |       | 601               |       |
| Inventories                                                                                                                   |       | 203                |       | 390               |       |
| Royalty advances                                                                                                              |       | 7                  |       | 7                 |       |
| Prepaid expenses  and other                                                                                                   |       | 275                |       | 194               |       |
| Total current  assets                                                                                                         |       | 2,755              |       | 2,881             |       |
|                                                                                                                          |       |               |       |              |       |
| Property and equipment,  net of accumulated depreciation and amortization of $337 at March 31 and $306  at June 30            |       | 54                 |       | 55                |       |
|                                                                                                                          |       |               |       |              |       |
| Owned catalog masters,  net of accumulated amortization of $3,393 at March 31 and $3,277 at June 30                           |       | 223                |       | 336               |       |
|                                                                                                                          |       |               |       |              |       |
|                                                                                                                          |       | $                  | 3,032      |              | $          | 3,272 |   |
|                                                                                                                          |       |               |       |              |       |
| LIABILITIES AND  SHAREHOLDERS’ DEFICIT                                                                                   |       |               |       |              |       |
|                                                                                                                          |       |               |       |              |       |
| Current liabilities:                                                                                                          |       |               |       |              |       |
| Notes payable to  affiliate and other                                                                                         |       | $                  | 13,058     |              | $          | 12,098 |   |
| Accounts payable                                                                                                              |       | 854                |       | 1,206             |       |
| Accrued  royalties                                                                                                            |       | 2,198              |       | 1,793             |       |
| Reserve for  returns                                                                                                          |       | 40                 |       | 126               |       |
| Net liabilities  of discontinued operations                                                                                   |       | 23                 |       | 31                |       |
| Total current  liabilities                                                                                                    |       | 16,173             |       | 15,254            |       |
|                                                                                                                          |       |               |       |              |       |
| Shareholders’ deficit:                                                                                                   |       |               |       |              |       |
| Common stock –  50,000,000 shares authorized; par value $.01; 13,653,738 issued and  outstanding at March 31 and June 30 |       | 136                |       | 136               |       |
| Additional  paid-in capital                                                                                                   |       | 21,292             |       | 21,292            |       |
| Accumulated  deficit                                                                                                          |       | (34,384            | )          | (33,134           | )          |
| Accumulated  other comprehensive loss                                                                                         |       | (185               | )          | (276              | )          |
| Total  shareholders’ deficit                                                                                             |       | (13,141            | )          | (11,982           | )          |
|                                                                                                                          |       |               |       |              |       |
|                                                                                                                          |       | $                  | 3,032      |              | $          | 3,272 |   |

 

The accompanyingnotes are an integral part of these financial statements.

3

----

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

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED**

*(inthousands - except per share data)*
| ** **                                                            | ** ** | **Three Months Ended  March 31,** | ** ** | **Nine Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                            | ** ** | **2007**                                         | ** ** | **2006**                                        | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                  |       |                                             |       |                                            |       |   |   |   |   |
| Net sales                                                             |       | $                                                | 986        |                                            | $          | 1,144 |   | $ | 2,883 |   | $ | 3,642 |   |
|                                                                  |       |                                             |       |                                            |       |   |   |   |   |
| Costs and expenses:                                                   |       |                                             |       |                                            |       |   |   |   |   |
| Cost of goods  sold                                                   |       | 504                                              |       | 432                                             |       | 1,203 |   | 1,517 |   |
| Advertising                                                           |       | 89                                               |       | 25                                              |       | 208 |   | 113 |   |
| Selling, general  and administrative                                  |       | 667                                              |       | 728                                             |       | 1,978 |   | 2,059 |   |
| Total costs and  expenses                                             |       | 1,260                                            |       | 1,185                                           |       | 3,389 |   | 3,689 |   |
| Operating loss                                                        |       | (274                                             | )          | (41                                             | )          | (506 | ) | (47 | ) |
|                                                                  |       |                                             |       |                                            |       |   |   |   |   |
| Other expense:                                                        |       |                                             |       |                                            |       |   |   |   |   |
| Interest expense                                                      |       | (261                                             | )          | (232                                            | )          | (744 | ) | (631 | ) |
| Other income  (expense), net                                          |       | 4                                                |       | 5                                               |       | — |   | (16 | ) |
| Total other  expense                                                  |       | (257                                             | )          | (227                                            | )          | (744 | ) | (647 | ) |
|                                                                  |       |                                             |       |                                            |       |   |   |   |   |
| Loss from continuing  operations                                      |       | (531                                             | )          | (268                                            | )          | (1,250 | ) | (694 | ) |
|                                                                  |       |                                             |       |                                            |       |   |   |   |   |
| Discontinued  operations:                                             |       |                                             |       |                                            |       |   |   |   |   |
| Loss from discontinued  operations, net of taxes                      |       | —                                           |       | (8                                              | )          | — |   | (11 | ) |
|                                                                  |       |                                             |       |                                            |       |   |   |   |   |
| Net loss                                                              |       | $                                                | (531       | )                                               | $          | (276 | ) | $ | (1,250 | ) | $ | (705 | ) |
|                                                                  |       |                                             |       |                                            |       |   |   |   |   |
| Loss per share – basic  and diluted:                             |       |                                             |       |                                            |       |   |   |   |   |
| Continuing  operations                                                |       | $                                                | (.04       | )                                               | $          | (.02 | ) | $ | (.09 | ) | $ | (.05 | ) |
| Discontinued  operations                                              |       | —                                           |       | —                                          |       | — |   | — |   |
| Net loss                                                              |       | $                                                | (.04       | )                                               | $          | (.02 | ) | $ | (.09 | ) | $ | (.05 | ) |
|                                                                  |       |                                             |       |                                            |       |   |   |   |   |
| Shares used in the  calculation of loss per share - basic and diluted |       | 13,654                                           |       | 13,654                                          |       | 13,654 |   | 13,654 |   |
|                                                                  |       |                                             |       |                                            |       |   |   |   |   |
| Comprehensive loss:                                                   |       |                                             |       |                                            |       |   |   |   |   |
| Net loss                                                              |       | $                                                | (531       | )                                               | $          | (276 | ) | $ | (1,250 | ) | $ | (705 | ) |
| Translation  adjustment                                               |       | 10                                               |       | 13                                              |       | 91 |   | (43 | ) |
|                                                                  |       |                                             |       |                                            |       |   |   |   |   |
| Comprehensive loss                                                    |       | $                                                | (521       | )                                               | $          | (263 | ) | $ | (1,159 | ) | $ | (748 | ) |

 

The accompanyingnotes are an integral part of these financial statements.

4

----

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

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

*(inthousands)*
| ** **                                                                             | ** ** | **Nine Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| Cash flows from  operating activities:                                                 |       |                                            |       |   |   |
| Net loss                                                                               |       | $                                               | (1,250     | ) | $ | (705 | ) |
| Adjustments to  reconcile net loss to cash (used in) provided by operating activities: |       |                                            |       |   |   |
| Depreciation and  amortization                                                         |       | 133                                             |       | 151 |   |
| Changes in operating  assets and liabilities:                                          |       |                                            |       |   |   |
| Accounts  receivable, net                                                              |       | 40                                              |       | 842 |   |
| Inventories                                                                            |       | 206                                             |       | 180 |   |
| Royalty advances                                                                       |       | 7                                               |       | 4 |   |
| Prepaid expenses                                                                       |       | (81                                             | )          | (13 | ) |
| Accounts payable                                                                       |       | (404                                            | )          | (604 | ) |
| Accrued  royalties                                                                     |       | 367                                             |       | 150 |   |
| Reserve for  returns                                                                   |       | (86                                             | )          | 33 |   |
| Cash (used in)  provided by operating activities                                       |       | (1,068                                          | )          | 38 |   |
|                                                                                   |       |                                            |       |   |   |
| Cash flows from  investing activities:                                                 |       |                                            |       |   |   |
| Purchases of  property and equipment                                                   |       | (16                                             | )          | (8 | ) |
| Cash used in  investing activities                                                     |       | (16                                             | )          | (8 | ) |
|                                                                                   |       |                                            |       |   |   |
| Cash flows from  financing activities:                                                 |       |                                            |       |   |   |
| Borrowings on  notes payable                                                           |       | 2,652                                           |       | 2,831 |   |
| Payments on  notes payable                                                             |       | (1,691                                          | )          | (2,731 | ) |
| Cash provided by  financing activities                                                 |       | 961                                             |       | 100 |   |
|                                                                                   |       |                                            |       |   |   |
| Effect of exchange  rates on cash                                                      |       | 116                                             |       | (28 | ) |
|                                                                                   |       |                                            |       |   |   |
| Net (decrease) increase  in cash and cash equivalents                                  |       | (7                                              | )          | 102 |   |
|                                                                                   |       |                                            |       |   |   |
| Cash and cash  equivalents at beginning of period                                      |       | 1,689                                           |       | 1,272 |   |
|                                                                                   |       |                                            |       |   |   |
| Cash and cash equivalents at end of period                                             |       | $                                               | 1,682      |   | $ | 1,374 |   |

 

The accompanyingnotes are an integral part of these financial statements.

5

----

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

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(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 therights to its master music catalog, consisting of original recordings and re-recordingsof music from the 1950’s through today, to third parties world-wide foruse in albums, films, television programs, commercials and electronic downloadsto various media formats, for either a flat fee or a royalty based on thenumber of units sold.  K-tel also marketsentertainment products mainly derived from its catalog through retail anddirect response marketing channels in the United States and Europe. Theseproducts are derived mainly from the Company’s master recordings music catalogwith the objective of realizing more competitive profit margins. The Company iscurrently conducting a direct response test program in Europe on certain newproduct lines. Further, K-tel seeks to license its name and trademarks to othercompanies.  Licenses are granted for aroyalty or fee, with no cost to the Company.

DiscontinuedOperations

The Company’sconsumer products business, which was concentrated in Europe, consistedprimarily of housewares, consumer convenience items and exercise equipment. TheCompany discontinued its consumer products operations in Germany, the UnitedKingdom and the United States in June 2000, November 2000 and January 2001,respectively. Accordingly, these activities have been presented in theaccompanying financial statements as discontinued operations. The accompanyingcondensed consolidated financial statements have been prepared to reflect theconsumer products division as a discontinued operation. The net liabilities ofdiscontinued operations at March 31, 2007 and June 30, 2006, and losses fromdiscontinued operations for the three and nine months ended March 31, 2006relate primarily to legal matters and completion of statutory reportingrequirements for the former operations in Germany.

Liquidity

During the ninemonths ended March 31, 2007 and 2006, the Company incurred net losses fromcontinuing operations of $1,250,000 and $694,000, respectively. Operatingactivities used $1,068,000 during the nine months ended March 31, 2007, andprovided $38,000 of cash during the nine months ended March 31, 2006.Additionally, the Company had a working capital deficit of $13,418,000 at March31, 2007.

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 not generate cash sufficient to fundoperations and service its indebtedness on an ongoing basis. Management isfocusing its efforts on music licensing, music downloads and limited musicdistribution. However, there can be no assurance that the Company will achieveprofitable operations through these efforts. The financial statements do notinclude any adjustments that might result from the outcome of theseuncertainties.

GoingPrivate Transaction

On January 8,2007, the Company filed with the Securities and Exchange Commission (“SEC”) aSchedule 13E-3 in connection with a reverse split of the Company’s common stockintended to take the Company private. On April 24, 2007, the Company filedAmendment No. 1 (“Amendment No. 1”) to its Schedule 13E-3. Amendment No. 1states that, under the terms of the reverse split, each 5,000 shares of theCompany’s common stock will be converted into one share of common stock andholders of fewer than 5,000 shares of common stock on the record date willreceive cash of $.095 per pre-split share. This amount represents an increase of $.0325 per share over the pershare valuation of $.0625 previously established by the Special Committee ofthe Board of Directors of the Company. (See Note 7 “Notes to CondensedConsolidated Financial Statements” for further discussion.)

6

----

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

Basis ofPresentation –The accompanying condensed consolidated unaudited financial statements havebeen prepared in accordance with accounting principles generally accepted inthe United States of America (“US GAAP”) for interim financial information andwith the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby US GAAP for complete financial statements. In the opinion of management, alladjustments (consisting of normal recurring adjustments) considered necessaryfor a fair presentation have been included. Operating results for the ninemonth period ended March 31, 2007 are not necessarily indicative of the resultsthat may be expected for the year as a whole. The unaudited condensedconsolidated balance sheet for June 30, 2006 has been derived from auditedconsolidated financial statements as of that date. For further information,refer to the consolidated financial statements and footnotes thereto includedin the Company’s annual report on Form 10-K for the year ended June 30, 2006.

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: license revenue from the licensing of Company-owned masters and thesale of music compilations (predominately compact discs) produced by theCompany.  License revenue is recognizedwhen payment is received from customers or when known amounts are receivable, asprior to that date collection is not considered probable.  Revenue from music sales is recognized at thetime of shipment to the customer and most music sales are made with a right ofreturn of unsold goods. Estimated reserves for returns are established bymanagement based upon historical experience and product mix and are subject toongoing review and adjustment by the Company. These reserves are recorded atthe time of sale and are reflected as a reduction in revenue. The Company’sreserve for returns was $40,000 at March 31, 2007 and $126,000 at June 30,2006.

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

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

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

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

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

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

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

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

Royalties- The Company has entered into license agreements with various record companiesand publishers under which it pays royalties on units sold. The Company accruesroyalties using contractual rates and certain estimated

7

----

rates onapplicable units sold. The contractual royalty liability is computed quarterlyand the accrued royalty balance is adjusted accordingly. The royalty agreementsare subject 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 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 $208,000 and $113,000 for the nine month periods ended March 31, 2007 and2006, 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 the financialstatements of foreign entities into U.S. dollars are recorded as a component ofaccumulated other comprehensive income or loss.

Stock-basedCompensation – Prior to adoption of Statement of FinancialAccounting Standards Board No. 123 (R),*Share-Based Payment,* effective with the beginning of fiscal 2006,the Company had accounted for stock based awards to employees using theintrinsic method prescribed in Accounting Principles Board No.25,*Accounting for Stock Issued to Employees*,whereby the options were granted at market price, and no compensation costswere recognized.  The Company had adopted the disclosures requirements ofSFAS No. 123,*Accounting for Stock-BasedCompensation*.  The Company has recognized no stock-basedcompensation because all options had vested prior to the adoption of SFAS No.123(R) and no new stock awards have been granted.

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

Net Loss Per Share - Basic anddiluted net loss per share have been computed by dividing net loss by theweighted average number of shares outstanding during the period. For allperiods presented, common stock equivalents were excluded from the per sharecalculation as the net effect would be antidilutive. For the three and ninemonth periods ended March 31, 2007 and 2006, weighted average options topurchase 2,228,939 shares of common stock, with weighted average exercise priceof $.19 were excluded from the computation of common share equivalents for therespective periods as they were antidilutive.

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

**3.             LOANS PAYABLE TO AFFILIATE**

K-tel has a Line of Credit Agreement with K-5 Leisure Products, Inc. (“K-5”),the Company’s largest shareholder and an entity controlled by Philip Kives, theChairman of the Board, President and Chief Executive Officer of K-tel. Underthe terms of the agreement (the “K-5 Facility”), K-5 has agreed to makeavailable up to $8,000,000 to K-tel on a revolving basis. The loan bearsinterest at a variable rate based upon the “base rate” of a nationallyrecognized lending institution (8.25% at March 31, 2007), 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 $9,058,000 and $8,098,000 as ofMarch 31, 2007 and June 30, 2006, respectively, under the K-5 Facility. AtMarch 31, 2007, K-tel obtained a waiver from K-5 for its non-compliance underthe 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%

8

----

(9.25% at March31, 2007) and are collateralized by the assets of certain Company subsidiariesin the United States, including accounts receivable, inventories, equipment,music library and general intangibles. The loan agreement contains certainfinancial and other covenants or restrictions, including the maintenance of aminimum shareholders’ equity by K-tel, limitations on capital expenditures,restrictions on music library acquisitions, limitations on other indebtednessand restrictions on dividends paid by K-tel. As of March 31, 2007 and June 30,2006, K-tel had $4,000,000 outstanding under the term loan and there were noborrowings under the revolving facility. At March 31, 2007, K-tel obtained awaiver from K-5 for its non-compliance under the covenants, limitations andrestrictions of the credit agreement.

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

K-tel and itssubsidiaries are involved in legal proceedings in the ordinary course of theirbusiness. With all litigation matters, management considers the likelihood ofloss based on the facts and circumstances. If management determines that a lossis probable and the amount of loss can be reasonably estimated, such amount isrecorded as a liability. Although the outcome of any such legal proceedingscannot be predicted, in the opinion of management there is currently no legalproceeding pending or asserted against or involving K-tel for which the outcomeis likely to have a material adverse effect upon the consolidated financialposition or results of operations of K-tel.

**5.             BUSINESS SEGMENT AND GEOGRAPHIC AREA DATA**

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

The Companylicenses the rights to its master music catalog, consisting of original recordingsand re-recordings of music from the 1950’s through today, to thirdparties world-wide for use in albums, films, television programs,commercials and electronic downloads to various media formats, for either aflat fee or a royalty based on the number of units sold.

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

The Company’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.

Operating profitsor losses of these segments include an allocation of general corporate expenses.Depreciation and amortization and capital additions are not significant andhave therefore been excluded from the presentation.

Certain financialinformation on the Company’s continuing operating segments is as follows:

BUSINESS SEGMENT INFORMATION *(inthousands)*
|                               | ** ** | **Licensing** | ** ** | **Music** | ** ** | **Other** | ** ** | **Total  Company** | ** ** |
|-------------------------------|------------|---------------|------------|-----------|------------|-----------|------------|--------------------|------------|
| * *                      | * *   | * *      | * *   | * *  | * *   | * *  | * *   | * *           | * *   |
| Nine Months  Ended March 31,  |       |          |       |      |       |      |       |               |       |
|                          |       |          |       |      |       |      |       |               |       |
| Net sales                     | 2007       |          | $          | 1,583     |       | $         | 1,300      |               | $          | — |   | $ | 2,883 |   |
|                          | 2006       |          | 1,981      |      | 1,661      |      | —     |               | 3,642      |   |
|                          |       |          |       |      |       |      |       |               |       |   |
| Operating income  (loss)      | 2007       |          | $          | 493       |       | $         | (999       | )                  | $          | — |   | $ | (506 | ) |
|                          | 2006       |          | 858        |      | (905       | )         | —     |               | (47        | ) |
|                          |       |          |       |      |       |      |       |               |       |   |
| Assets                        | 2007       |          | $          | 257       |       | $         | 2,634      |               | $          | 141 |   | $ | 3,032 |   |
|                          | 2006       |          | 424        |      | 3,090      |      | 80         |               | 3,594      |   |
|                          |       |          |       |      |       |      |       |               |       |   |
| Three Months  Ended March 31, |       |          |       |      |       |      |       |               |       |
|                          |       |          |       |      |       |      |       |               |       |   |
| Net sales                     | 2007       |          | $          | 575       |       | $         | 411        |               | $          | — |   | $ | 986 |   |
|                          | 2006       |          | 649        |      | 495        |      | —     |               | 1,144      |   |
|                          |       |          |       |      |       |      |       |               |       |   |
| Operating income  (loss)      | 2007       |          | $          | 212       |       | $         | (486       | )                  | $          | — |   | $ | (274 | ) |
|                          | 2006       |          | 269        |      | (310       | )         | —     |               | (41        | ) |

 

9

----

GEOGRAPHICINFORMATION *(in thousands)*

|                               | ** ** | **United States** | ** ** | **Europe** | ** ** | **Total** | ** ** |
|-------------------------------|------------|------------------------|------------|------------|------------|-----------|------------|
| * *                      | * *   | * *               | * *   | * *   | * *   | * *  | * *   |
| Nine Months  Ended March 31,  | * *   | * *               | * *   | * *   | * *   | * *  | * *   |
|                          | * *   | * *               | * *   | * *   | * *   | * *  | * *   |
| Net sales                     | 2007       |                   | $          | 1,461      |       | $         | 1,422      |   | $ | 2,883 |   |
|                          | 2006       |                   | 2,018      |       | 1,624      |      | 3,642      |   |
|                          |       |                   |       |       |       |      |       |   |
| Assets                        | 2007       |                   | $          | 265        |       | $         | 2,767      |   | $ | 3,032 |   |
|                          | 2006       |                   | 1,322      |       | 2,272      |      | 3,594      |   |
|                          |       |                   |       |       |       |      |       |   |
| Three Months  Ended March 31, |       |                   |       |       |       |      |       |
|                          |       |                   |       |       |       |      |       |   |
| Net sales                     | 2007       |                   | $          | 464        |       | $         | 522        |   | $ | 986 |   |
|                          | 2006       |                   | 610        |       | 534        |      | 1,144      |   |

 

**6.             RECENT ACCOUNTING PRONOUNCEMENTS**

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

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

**7.             GOING PRIVATE TRANSACTION**

On January 8,2007, the Company filed with the Securities and Exchange Commission (“SEC”) aSchedule 13E-3 in connection with a reverse split of the Company’s common stockintended to take the Company private.  OnApril 24, 2007 the Company filed Amendment No. 1 (“Amendment No. 1”) to itsSchedule 13E-3.  Amendment No. 1 statesthat, under the terms of the reverse split, each 5,000 shares of the Company’scommon stock will be converted into one share of common stock and holders offewer than 5,000 shares of common stock on the record date will receive cash of$.095 per pre-split share.  This amountrepresents an increase of $.0325 per share over the per share valuation of$.0625 previously established by the Special Committee of the Board ofDirectors of the Company.  Immediatelyfollowing the reverse split, the Company will effect a 5,000-for-1 forwardsplit so that the number of

10

----

shares held byeach holder of at least one share of common stock following the reverse splitwill ultimately be unchanged. The Company refers to the reverse split, forwardsplit, and the related payments to shareholders holding fewer than 5,000pre-split shares as the “Reverse/Forward Split.”  The anticipated result of the Reverse/ForwardSplit will be to reduce the number of shareholders of record to fewer than 300. The Company intends to cease filing periodic reports with the SEC assoon as practicable following the Reverse/Forward Split.

The Company’s Board of Directors has approved theReverse/Forward Split based on its determination that the Company achieves fewof the benefits of public ownership because of a lack of an active tradingmarket for its common stock, while remaining burdened with the significantcosts of being a publicly held company. Under Minnesota Law, the Board of Directors of the Company may amend theCompany’s Articles of Incorporation to conduct the Reverse/Forward Splitwithout the approval of its shareholders. Therefore, the Company is not seeking shareholder approval for theReverse/Forward Split.  TheReverse/Forward Split will not be effective until the SEC completes its reviewof the Schedule 13E-3, the Company distributes required material, including thedefinitive disclosure document to its shareholders, and files amendments to itsArticles of Incorporation with the State of Minnesota.  The Company estimates that the aggregate cashpayment to shareholders holding fewer than 5,000 shares of Common Stock will beapproximately $205,200.  The funds forthe Reverse/Forward Split will come from the Company’s working capital line ofcredit provided by K-5 Leisure Products, Inc., the Company’s largestshareholder and an entity controlled by Philip Kives, K-tel’s Chairman,President and Chief Executive Officer.

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

**General**

Through itsoperating subsidiary, Dominion Entertainment, Inc. (“Dominion”), K-tel licensesits master music catalog internationally and has entered into licensingagreements with several companies that offer electronic downloads via their internetsites of many of Dominion’s owned masters. K-tel and Dominion have also entered into agreements with BCI EclipseCompany, LLC (“BCI”) to market and sell entertainment products derived fromDominion’s master music catalog under the K-tel logo in the United States andCanada.

Through anothersubsidiary, K-tel Entertainment, Inc., K-tel has a focused method ofdistribution that targets the strengths of selected individual retailers andsupplies products suited to each retailer’s specific needs. These products areprimarily derived from the Company’s master recordings music catalog with theobjective of realizing more competitive profit margins. The Company iscurrently conducting a direct response test program in Europe on certain newproduct lines.  The Company also seeks tolicense its name and marks to other businesses for a royalty or fee.

**GoingPrivate Transaction**

On January 8,2007, the K-tel filed with the Securities and Exchange Commission (“SEC”) aSchedule 13E-3 in connection with a reverse split of the Company’s common stockintended to take the Company private. On April 24, 2007, the Company filedAmendment No. 1 (“Amendment No. 1”) to its Schedule 13E-3.  Amendment No. 1 states that, under the termsof the reverse split, each 5,000 shares of the Company’s common stock will beconverted into one share of common stock and holders of fewer than 5,000 sharesof common stock on the record date will receive cash of $.095 per pre-splitshare.  This amount represents an increaseof $.0325 per share over the per share valuation of $.0625 previouslyestablished by the Special Committee of the Board of Directors of the Company.(See “Liquidity and Capital Resources” for further discussion of the goingprivate transaction.)

**A.            RESULTS OF OPERATIONS**

#### **THREE MONTHS ENDED MARCH 31, 2007 VERSUSMARCH 31, 2006**

Net sales for thethree month period ended March 31, 2007 were $986,000 a decrease of 13.8% fromnet sales of $1,144,000 for the three month period ended March 31, 2006. Thisnet decrease primarily resulted from decreased music and licensing sales duringthe quarter ended March 31, 2007 in the Company’s domestic subsidiaries. Thenet loss for the three month period ended March 31, 2007 was $531,000, or $.04per share, compared to net loss of $276,000, or $.02 per share, for the threemonth period ended March 31, 2006.

General corporateexpenses of $173,000 and $85,000 for the three month periods ended March 31,2007 and 2006, respectively, have been allocated to the segments.

11

----

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

#### **BUSINESSSEGMENT RESULTS**

**Licensing**

Licensing revenuewas $575,000 for the three month period ended March 31, 2007, compared to$649,000 for the three month period ended March 31, 2006, a decrease of $74,000.The decrease in licensing revenue was primarily due to the decrease in domesticlicensing revenue related to the Company’s licensing agreements with BCI. Thelicensing segment had operating income of $212,000 for the three month periodended March 31, 2007 compared to $269,000 for the three month period endedMarch 31, 2006, a decrease of $57,000.

#### **Music**

Net sales in the musicsegment were $411,000 for the three month period ended March 31, 2007 comparedto $495,000 for the three month period ended March 31, 2006, a decrease of$84,000, or 16.9%. The decrease was due to the decrease in domestic music salesrelated to the Company’s transition from a primarily retail music distributionbusiness to a licensing business.

Cost of goods soldin the music segment increased to $444,000, or 107.9% of net sales for thethree month period ended March 31, 2007 compared to $311,000, or 62.7% of netsales for the three month period ended March 31, 2006, reflective of thereduced music sales and an adjustment of inventory to net realizable valuesduring the three month period ended March 31, 2007.  The segment’s advertising expenses, whichconsist primarily of co-operative advertising payments, trade advertising andpromotions, increased to $89,000 for the three month period ended March 31,2007 compared to $25,000 for the three month period ended March 31, 2006.  The increase in advertising expense was dueprimarily to increased direct response advertising in Europe.

Selling, generaland administrative expenses were $364,000, or 88.6% of net sales for the threemonth period ended March 31, 2007 compared to $469,000, or 94.7% of net salesfor the three month period ended March 31, 2006. The decrease was due primarilyto the decrease in the general corporate legal and consulting expensesallocated to the music segment.

The music segmentincurred an operating loss of $486,000 for the three month period ended March31, 2007 compared to an operating loss of $310,000 for the three month periodended March 31, 2006.

#### **NINE MONTHS ENDED MARCH 31, 2007 VERSUS MARCH31, 2006**

Net sales for thenine month period ended March 31, 2007 were $2,883,000 compared to $3,642,000for the nine month period ended March 31, 2006. This decrease primarilyresulted from a decrease in both licensing and music sales in the Company’sdomestic subsidiaries. The net loss for the nine month period ended March 31,2007 was $1,250,000, or $.09 per share, compared to net loss of $705,000, or$.05 per share, for the nine month period ended March 31, 2006.

General corporateexpenses of $422,000 and $296,000 for the nine month periods ended March 31,2007 and 2006, respectively, have been allocated to the segments.

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

#### **BUSINESSSEGMENT RESULTS**

**Licensing**

Licensing revenuewas $1,583,000 for the nine month period ended March 31, 2007 compared to$1,981,000 for the nine month period ended March 31, 2006, a decrease of$398,000.  This decrease reflected thedecrease in the domestic licensing activity related to the Company’s agreementswith BCI.  The Company continues itsefforts to enter into licensing arrangements in several other segments of theentertainment industry and continues to license its master music catalog toseveral companies that offer electronic downloads via their internet sites.

12

----

Royalty expensewithin the segment decreased to $218,000 for the nine month period ended March31, 2007 compared to $351,000 for the nine month period ended March 31, 2006,due to the decrease in licensing revenue.

Selling, generaland administrative expenses increased to $872,000 for the nine month periodended March 31, 2007 compared to $772,000 for the nine month period ended March31, 2006, an increase of 13.0%.   Theprimary reason for the increase in general and administrative expenses was theincreased general corporate legal and consulting overhead expenses allocated tothe licensing segment.

Operating incomein the licensing segment was $493,000 for the nine month period ended March 31,2007 compared to an operating income of $858,000 for the nine month periodended March 31, 2006, a decrease of $365,000.

#### **Music**

Sales in the musicsegment were $1,300,000 for the nine month period ended March 31, 2007 comparedto $1,661,000 for the nine month period ended March 31, 2006, a decrease of$361,000, or 21.7%.  The decrease was dueto a decrease in domestic music sales related to the Company’s transition froma primarily retail music distribution business to a licensing business.

Cost of goods soldin the music segment were $985,000, or 75.7% of sales for the nine month periodended March 31, 2007 compared to $1,166,000, or 70.2% of sales for the ninemonth period ended March 31, 2006, a decrease of $181,000 reflective of thedecreased music sales and an adjustment of inventory to net realizable valuesin the nine month period ended March 31, 2007. The segment’s advertising expenses, which consist primarily ofco-operative advertising payments, trade advertising and promotions, increasedto $208,000 for the nine month period ended March 31, 2007 compared to $113,000for the nine month period ended March 31, 2006. The increase in advertising expense was due primarily to increaseddirect response advertising in Europe.

Selling, generaland administrative expenses were $1,106,000, or 85.1% of sales for the ninemonth period ended March 31, 2007 compared to $1,287,000, or 77.5% of sales forthe nine month period ended March 31, 2006, a decrease of $181,000. Thedecrease was due primarily to the decrease in the general corporate legal andconsulting expenses allocated to the music segment.

The music segmentincurred an operating loss of $999,000 for the nine month period ended March31, 2007 compared to an operating loss of $905,000 for the nine month periodended March 31, 2006.

**B.            LIQUIDITYAND CAPITAL RESOURCES**

K-telhas a Line of Credit Agreement with K-5 Leisure Products, Inc. (“K-5”), theCompany’s largest shareholder  and anentity controlled by Philip Kives, the Chairman of the Board, President andChief Executive Officer of K-tel. Under the terms of the agreement (the “K-5Facility”), K-5 has agreed to make available up to $8,000,000 to K-tel on arevolving basis. The loan bears interest at a variable rate based upon the “baserate” of a nationally recognized lending institution (8.25% at March 31, 2007),expires July 20, 2008, and is subordinated to the Foothill loan (see below).The K-5 Facility contains the same covenants as the Foothill loan agreement.K-tel has pledged the stock of its foreign subsidiaries as collateral for theloan, and the loan carries a subordinated position to the Foothill loan on allother assets of the Company. K-tel had outstanding balances of $9,058,000 and$8,098,000 as of March 31, 2007 and June 30, 2006, respectively, under the K-5Facility. At March 31, 2007, K-tel obtained a waiver from K-5 for itsnon-compliance under the covenants, limitations and restrictions of the creditagreement.

In addition, K-tel has asecond loan agreement with K-5, under which K-5 assumed rights and obligationsunder a loan from the Company’s former banker (Foothill Capital Corporation)pursuant to an Assignment and Acceptance Agreement dated February 27, 2001.This Foothill loan, which has been extended through July 20, 2008, provides fora $10,000,000 credit facility consisting of a $4,000,000 term loan due uponexpiration, and a $6,000,000 revolving facility under which borrowings arelimited to a percent of eligible receivables. Borrowings under the facilitybear interest at a variable rate based on a “base rate” of a nationallyrecognized lending institution plus 1% (9.25% at March 31, 2007) and arecollateralized by the assets of certain Company subsidiaries in the UnitedStates, including accounts receivable, inventories, equipment, music libraryand general intangibles. The loan agreement contains certain financial andother covenants or restrictions, including the maintenance of a minimumshareholders’ equity by K-tel, limitations on capital expenditures,restrictions on music library acquisitions, limitations on other indebtednessand restrictions on dividends paid by K-tel. As of March 31, 2007 and June 30,2006, K-tel had $4,000,000 outstanding under the term loan and there were noborrowings under the revolving facility. At March 31,

13

----

2007, K-tel obtained awaiver from K-5 for its non-compliance under the covenants, limitations andrestrictions of the credit agreement.

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

The Company’sability to continue its present operations is contingent mainly upon itsability to maintain its line of credit arrangements with K-5, increase itsrevenues and profit margins, and ultimately attain and sustain profitableoperations. Without increased revenues and sustained profitability, the Company’scurrent operations will not generate cash sufficient to fund operations andservice 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.

On January 8,2007, the Company filed with the Securities and Exchange Commission (“SEC”) aSchedule 13E-3 in connection with a reverse split of the Company’s common stockintended to take the Company private.  OnApril 24, 2007 the Company filed Amendment No. 1 (“Amendment No. 1”) to itsSchedule 13E-3.  Amendment No. 1 statesthat, under the terms of the reverse split, each 5,000 shares of the Company’scommon stock will be converted into one share of common stock and holders offewer than 5,000 shares of common stock on the record date will receive cash of$.095 per pre-split share.  This amountrepresents an increase of $.0325 per share over the per share valuation of$.0625 previously established by the Special Committee of the Board ofDirectors of the Company.  Immediatelyfollowing the reverse split, the Company will effect a 5,000-for-1 forwardsplit so that the number of shares held by each holder of at least one share ofcommon stock following the reverse split will ultimately be unchanged. TheCompany refers to the reverse split, forward split, and the related payments toshareholders holding fewer than 5,000 pre-split shares as the “Reverse/ForwardSplit.”  The anticipated result of theReverse/Forward Split will be to reduce the number of shareholders of record tofewer than 300.  The Company intends to cease filing periodicreports with the SEC as soon as practicable following the Reverse/ForwardSplit.

The Company’s Board of Directors has approved theReverse/Forward Split based on its determination that the Company achieves fewof the benefits of public ownership because of a lack of an active tradingmarket for its common stock, while remaining burdened with the significantcosts of being a publicly held company. Under Minnesota Law, the Board of Directors of the Company may amend theCompany’s Articles of Incorporation to conduct the Reverse/Forward Splitwithout the approval of its shareholders. Therefore, the Company is not seeking shareholder approval for theReverse/Forward Split.  TheReverse/Forward Split will not be effective until the SEC completes its reviewof the Schedule 13E-3, the Company distributes required material, including thedefinitive disclosure document to its shareholders, and files amendments to itsArticles of Incorporation with the State of Minnesota.  The Company estimates that the aggregate cashpayment to shareholders holding fewer than 5,000 shares of Common Stock will beapproximately $205,200.  The funds forthe Reverse/Forward Split will come from the Company’s working capital and,potentially, from K-tel’s working capital line of credit provided by K-5Leisure Products, Inc., the Company’s largest shareholder and an entitycontrolled by Philip Kives, K-tel’s Chairman, President and Chief ExecutiveOfficer.

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

There have been nomaterial changes in the Company’s market risk during the nine month periodended March 31, 2007. For additional information, refer to the Company’s annualreport on Form 10-K for the fiscal year ended June 30, 2006.

**ITEM4.  CONTROLS AND PROCEDURES**

Under thesupervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and Principal Financial Officer, theCompany evaluated the effectiveness of the design and operation of itsdisclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e)under the Exchange Act). Based on that evaluation, the Chief Executive Officerand Principal Financial Officer concluded that, as of the end of the periodcovered by this report, the Company’s disclosure controls and procedures wereeffective.

14

----

During the fiscalquarter ended March 31, 2007, 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.

**PART II**

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

#### K-tel and its subsidiaries are involved in legal proceedings in theordinary course of their business. With all litigation matters, managementconsiders the likelihood of loss based on the facts and circumstances. Ifmanagement determines that a loss is probable and the amount of loss can bereasonably estimated, such amount is recorded as a liability. Although theoutcome of any such legal proceedings cannot be predicted, in the opinion ofmanagement there is currently no legal proceeding pending or asserted againstor involving K-tel for which the outcome is likely to have a material adverseeffect upon the consolidated financial position or results of operations ofK-tel.

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

See “Index toExhibits.”

15

----

**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: May 14,  2007 |   |   | /S/ PHILIP KIVES                     |
|                 |   |   | PHILIP KIVES                         |
|                 |   |   | CHAIRMAN AND CHIEF EXECUTIVE OFFICER |
|                 |   |   |                                 |
|                 |   |   |                                 |
| Dated: May 14,  2007 |   |   | /s/ KIMMY LOCKWOOD                   |
|                 |   |   | KIMMY LOCKWOOD                       |
|                 |   |   | PRINCIPAL FINANCIAL OFFICER          |

 

16

----

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

 

17

----