**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

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

 

| **(Mark One)** |
|----------------|
|           |   |
| **ý**     | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|           |   |
|           | **For the quarterly period ended March 31, 2002** |

 

**or**

 

| o      | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                                                                                                                                                                                           |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                      |
|   | **For the transition period  from                       to                       ** |

 

**CommissionFile Number:  0-6664**

 

**K-TEL INTERNATIONAL, INC.**

(Exact name of registrant as specified in its charter)

 

| **Minnesota**                                                  |   | **41****-0946588**                  |
|----------------------------------------------------------------|--------|-------------------------------------|
| (State or other jurisdiction of incorporation or organization) |   | (I.RS. Employer Identification No.) |
|                                                           |   |                                |
| **2655 Cheshire Lane North, Suite 100, Plymouth Minnesota**    |   | **55447**                           |
| (Address of principal  executive offices)                      |   | (Zip Code)                          |
|                                                           |   |                                |
| **(763) 559-5566**                                             |
| (Registrant’s telephone number, including area code)      |
|                                                           |   |                                |
| **5555 Pioneer Creek Drive, Maple Plain  Minnesota**           |   | **55359**                           |
| (Former address of principal executive offices)                |   | (Zip Code)                          |

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

Yes ý                 No o

 

APPLICABLE ONLY 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 May 13, 2002, there were 13,653,738 shares of the registrant’scommon stock, par value $0.01 per share, outstanding.

 

 

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

**FORM10-Q**

 

**FOR THETHREE AND NINE MONTH PERIODS**

**ENDEDMARCH 31, 2002**

 

INDEX

 
| PART  I. | Financial  Information (Unaudited): |
|----------|-------------------------------------|
|     |                                |   |
|     | Item 1.                             | Condensed  Consolidated Balance Sheets as of March 31, 2002 and June 30, 2001 |
|     |                                |   |
|     |                                | Condensed  Consolidated Statements of Operations for the Three and Nine Month Periods  Ended March 31, 2002 and 2001 |
|     |                                |   |
|     |                                | Condensed  Consolidated Statements of Cash Flows for the Nine Month Periods Ended March  31, 2002 and 2001 |
|     |                                |   |
|     |                                | 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 |

 

2

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

**CONDENSED CONSOLIDATED BALANCE SHEETS - UNAUDITED**

*(in thousands*)

 
|                                                                                           |   | **March 31,2002** |   | **June 30,2001** |   |
|------------------------------------------------------------------------------------------------|--------|-------------------|--------|------------------|--------|
|                                                                                           |   |              |   |             |   |
| ASSETS                                                                                         |   |              |   |             |   |
|                                                                                           |   |              |   |             |   |
| Current Assets:                                                                                |   |              |   |             |   |
| Cash and equivalents                                                                           |   | $                 | 147    |             | $      | 173 |   |
| Accounts receivable, net                                                                       |   | 1,483             |   | 915              |   |
| Inventories                                                                                    |   | 447               |   | 418              |   |
| Royalty and other advances                                                                     |   | 270               |   | 182              |   |
| Prepaid expenses and other                                                                     |   | 375               |   | 480              |   |
| Total Current Assets                                                                           |   | 2,722             |   | 2,168            |   |
|                                                                                           |   |              |   |             |   |
| Property and equipment, net of accumulated  depreciation and amortization of $1,184 and $1,136 |   | 170               |   | 231              |   |
|                                                                                           |   |              |   |             |   |
| Owned catalog master recordings, net of  accumulated amortization of $2,773 and $2,687         |   | 1,109             |   | 1,424            |   |
| Other assets                                                                                   |   | 3                 |   | 9                |   |
|                                                                                           |   |              |   |             |   |
|                                                                                           |   | $                 | 4,004  |             | $      | 3,832 |   |
|                                                                                           |   |              |   |             |   |
| LIABILITIES AND SHAREHOLDERS’ DEFICIT                                                     |   |              |   |             |   |
|                                                                                           |   |              |   |             |   |
| Current Liabilities:                                                                           |   |              |   |             |   |
| Bank indebtedness                                                                              |   | $                 | 185    |             | $      | — |   |
| Loans payable to affiliate                                                                     |   | 5,954             |   | 8,807            |   |
| Accounts payable                                                                               |   | 1,662             |   | 1,284            |   |
| Accrued royalties                                                                              |   | 2,267             |   | 2,080            |   |
| Reserve for returns                                                                            |   | 48                |   | 50               |   |
| Other current liabilities                                                                      |   | 137               |   | 760              |   |
| Net liabilities of discontinued operations                                                     |   | 923               |   | 1,103            |   |
| Total Current Liabilities                                                                      |   | 11,176            |   | 14,084           |   |
|                                                                                           |   |              |   |             |   |
| Long Term Debt                                                                                 |   |              |   |             |   |
| Loan payable to affiliate                                                                      |   | 4,000             |   | —           |   |
|                                                                                           |   |              |   |             |   |
| Shareholders’ Deficit:                                                                    |   |              |   |             |   |
| Common stock                                                                                   |   | 136               |   | 136              |   |
| Additional paid-in capital                                                                     |   | 20,680            |   | 20,680           |   |
| Accumulated deficit                                                                            |   | (31,703           | )      | (30,785          | )      |
| Cumulative translation adjustment                                                              |   | (285              | )      | (283             | )      |
| Total Shareholders’ Deficit                                                               |   | (11,172           | )      | (10,252          | )      |
|                                                                                           |   |              |   |             |   |
|                                                                                           |   | $                 | 4,004  |             | $      | 3,832 |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

3

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

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED**

*(in thousands -except per share data)*

 
|                                                      |   | **Three Months Ended  March 31,** |   | **Nine Months Ended  March 31,** |   |
|-----------------------------------------------------------|--------|-----------------------------------|--------|----------------------------------|--------|
|                                                      |   | **2002**                          |   | **2001**                         |   | **2002** |   | **2001** |   |
|                                                      |   |                              |   |                             |   |   |   |   |   |
| Net Sales                                                 |   | $                                 | 1,766  |                             | $      | 5,174 |   | $ | 5,251 |   | $ | 16,225 |   |
|                                                      |   |                              |   |                             |   |   |   |   |   |
| Costs and Expenses:                                       |   |                              |   |                             |   |   |   |   |   |
| Cost of goods sold                                        |   | 719                               |   | 7,657                            |   | 2,135 |   | 15,225 |   |
| Advertising                                               |   | 18                                |   | 246                              |   | 69 |   | 530 |   |
| Selling, general & administrative                     |   | 1,157                             |   | 2,674                            |   | 3,425 |   | 8,815 |   |
| Total Costs and Expenses                                  |   | 1,894                             |   | 10,577                           |   | 5,629 |   | 24,570 |   |
| Operating Loss                                            |   | (128                              | )      | (5,403                           | )      | (378 | ) | (8,345 | ) |
|                                                      |   |                              |   |                             |   |   |   |   |   |
| Other Income (Expense):                                   |   |                              |   |                             |   |   |   |   |   |
| Interest expense                                          |   | (177                              | )      | (214                             | )      | (346 | ) | (574 | ) |
| Foreign currency transaction gain (loss)                  |   | —                            |   | 54                               |   | — |   | (48 | ) |
| Other                                                     |   | 2                                 |   | —                           |   | (48 | ) | — |   |
| Total Other Expense                                       |   | (175                              | )      | (160                             | )      | (394 | ) | (622 | ) |
|                                                      |   |                              |   |                             |   |   |   |   |   |
| Loss from Continuing Operations Before  Income Taxes      |   | (303                              | )      | (5,563                           | )      | (772 | ) | (8,967 | ) |
|                                                      |   |                              |   |                             |   |   |   |   |   |
| Income Taxes                                              |   | —                            |   | 1                                |   | — |   | (10 | ) |
|                                                      |   |                              |   |                             |   |   |   |   |   |
| Loss from Continuing Operations                           |   | (303                              | )      | (5,562                           | )      | (772 | ) | (8,977 | ) |
|                                                      |   |                              |   |                             |   |   |   |   |   |
| Discontinued Operations:                                  |   |                              |   |                             |   |   |   |   |   |
| Loss from Discontinued Operations                         |   | (4                                | )      | (131                             | )      | (146 | ) | (4,077 | ) |
|                                                      |   |                              |   |                             |   |   |   |   |   |
| Loss before Extraordinary Item                            |   | (307                              | )      | (5,693                           | )      | (918 | ) | (13,054 | ) |
|                                                      |   |                              |   |                             |   |   |   |   |   |
| Extraordinary Item:                                       |   |                              |   |                             |   |   |   |   |   |
| Gain on Chapter 7 Liquidation                             |   | —                            |   | 15,860                           |   | — |   | 15,860 |   |
|                                                      |   |                              |   |                             |   |   |   |   |   |
| Net Income (Loss)                                         |   | $                                 | (307   | )                                | $      | 10,167 |   | $ | (918 | ) | $ | 2,806 |   |
|                                                      |   |                              |   |                             |   |   |   |   |   |
| Loss per Share - Basic and Diluted:                       |   |                              |   |                             |   |   |   |   |   |
| Continuing Operations                                     |   | $                                 | (.02   | )                                | $      | (.41 | ) | $ | (.06 | ) | $ | (.66 | ) |
| Discontinued Operations                                   |   | —                            |   | (.01                             | )      | (.01 | ) | (.30 | ) |
| Extraordinary Item                                        |   | —                            |   | 1.16                             |   | — |   | 1.16 |   |
| Net Income (Loss)                                         |   | $                                 | (.02   | )                                | $      | .74 |   | $ | (.07 | ) | $ | .20 |   |
|                                                      |   |                              |   |                             |   |   |   |   |   |
| Weighted Average Shares Outstanding - Basic  and Diluted: |   | 13,654                            |   | 13,654                           |   | 13,654 |   | 13,654 |   |
|                                                      |   |                              |   |                             |   |   |   |   |   |
| Comprehensive Income (Loss):                              |   |                              |   |                             |   |   |   |   |   |
| Net income (loss)                                         |   | $                                 | (307   | )                                | $      | 10,167 |   | $ | (918 | ) | $ | 2,806 |   |
| Foreign currency gain (loss)                              |   | 43                                |   | 46                               |   | (2 | ) | 328 |   |
| Comprehensive Income (Loss)                               |   | $                                 | (264   | )                                | $      | 10,213 |   | $ | (920 | ) | $ | 3,134 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

4

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

##### **CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS -UNAUDITED**

*(in thousands)*

 
|                                                                              |   | **Nine Months Ended  March 31,** |   |
|-----------------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                              |   | **2002**                         |   | **2001** |   |
| Cash flows from Operating Activities:                                             |   |                             |   |   |   |
| Net income (loss)                                                                 |   | $                                | (918   | ) | $ | 2,806 |   |
| Adjustments to reconcile net income (loss)  to cash used in operating activities: |   |                             |   |   |   |
| Depreciation and amortization                                                     |   | 296                              |   | 464 |   |
| Write down of long lived asset                                                    |   | —                           |   | 240 |   |
| Loss on disposal of property and equipment                                        |   | 4                                |   | — |   |
| Gain on Chapter 7 liquidation                                                     |   | —                           |   | (15,860 | ) |
| Discontinued operations                                                           |   | (180                             | )      | 4,006 |   |
| Changes in operating assets and  liabilities:                                     |   |                             |   |   |   |
| Accounts receivable                                                               |   | (566                             | )      | 2,951 |   |
| Inventories                                                                       |   | (28                              | )      | 2,200 |   |
| Royalty and other advances                                                        |   | (90                              | )      | (117 | ) |
| Prepaid expenses and other                                                        |   | 234                              |   | (231 | ) |
| Accounts payable and other                                                        |   | (259                             | )      | (228 | ) |
| Accrued royalties                                                                 |   | 189                              |   | 520 |   |
| Reserve for returns                                                               |   | (2                               | )      | 1,776 |   |
| Income taxes, net                                                                 |   | 7                                |   | (14 | ) |
| Cash used in operating activities                                                 |   | (1,313                           | )      | (1,487 | ) |
|                                                                              |   |                             |   |   |   |
| Cash flows from Investing Activities:                                             |   |                             |   |   |   |
| Proceeds from sale of property and  equipment                                     |   | 27                               |   | — |   |
| Purchases of property and equipment                                               |   | —                           |   | (10 | ) |
| Music catalog additions                                                           |   | (114                             | )      | (41 | ) |
| Cash used in investing activities                                                 |   | (87                              | )      | (51 | ) |
|                                                                              |   |                             |   |   |   |
| Cash flows from Financing Activities:                                             |   |                             |   |   |   |
| Borrowings on loans payable                                                       |   | 2,039                            |   | 513 |   |
| Payments on loans payable                                                         |   | (702                             | )      | — |   |
| Cash provided by financing activities                                             |   | 1,337                            |   | 513 |   |
|                                                                              |   |                             |   |   |   |
| Effect of exchange rates on cash                                                  |   | 37                               |   | 264 |   |
|                                                                              |   |                             |   |   |   |
| Net decrease in cash and equivalents                                              |   | (26                              | )      | (761 | ) |
|                                                                              |   |                             |   |   |   |
| Cash and equivalents at beginning of period                                       |   | 173                              |   | 798 |   |
|                                                                              |   |                             |   |   |   |
| Cash and equivalents at end of period                                             |   | $                                | 147    |   | $ | 37 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

5

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

 

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**1.             BUSINESS AND LIQUIDITY**

 

K-tel International, Inc. (the“Company”, “K-tel”, or the “Registrant”) was incorporated in 1968 and currentlyhas its corporate offices located in Plymouth, Minnesota. Through its operatingsubsidiaries, K-tel licenses its music catalog internationally and marketsentertainment products, mainly derived from its catalog, through retail anddirect response marketing channels in the United States and Europe.

 

During the three months ended March 31, 2002, the Company had a lossfrom continuing operations of $303,000. Additionally, the Company had a working capital deficit of $8,454,000 atMarch 31, 2002.

 

The Company’sability to continue its present operations and successfully implement futureexpansion plans are contingent mainly upon its ability to maintain its line ofcredit arrangements with K-5 Leisure Products, Inc. (See Note 3.), increase itsrevenues, and ultimately attain and sustain profitable operations. Withoutincreased revenues and sustained profitability, the cash generated from theCompany’s current operations may not be adequate to fund operations and serviceits indebtedness on an ongoing basis. 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’s businessplan and management will be successful in this effort. In the event the Companyis unable to fund its operations and properly implement its business plan, itmay be unable to continue as a going concern. The financial statements do notinclude any adjustments that might result from the outcome of this uncertainty.

 

Subsidiary Bankruptcy

 

In March 2001, the Company’smusic distribution subsidiary in the United States, K-tel International (USA),Inc., (“K-tel (USA)”) ceased operations and filed for protection under Chapter7 of the United States Bankruptcy Code. In connection with this filing, the assets and liabilities of K-tel(USA) were removed from the books of the Company as control of the subsidiarywas transferred to the bankruptcy trustee. The net liability at the time of this filing was shown as a gain on theChapter 7 liquidation.  Managementbelieves the Company will have no ongoing liability related to this subsidiaryas a result of the bankruptcy filing and the outcome of the bankruptcyproceeding.  Sales of this subsidiaryfor the three and nine month periods ended March 31, 2001, were $3,672,000 and$11,948,000, respectively.

 

Discontinued Operations

 

The Company’s consumer products business, which was concentrated inEurope, consisted primarily of housewares, consumer convenience items andexercise equipment.  The Companydiscontinued its consumer products operations in Germany, the United Kingdomand the United States in June 2000, November 2000 and January 2001,respectively.  Accordingly, theseactivities have been presented in the accompanying financial statements asdiscontinued operations. Net sales of these discontinued operations for thethree and nine month periods ended

 

6

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March 31, 2001 were $19,000 and $3,630,000, respectively.  The accompanying consolidated financialstatements have been prepared to reflect the consumer products division as adiscontinued operation.  The netliabilities of discontinued operations consist of assets of $976,000 and liabilitiesof $1,899,000.  The decrease in the netliabilities from the prior period is a result of payments made in the periodagainst certain liabilities.

 

**2.            BASIS OF PRESENTATION AND SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

Basis of Presentation - Theaccompanying condensed consolidated unaudited financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America (“US GAAP”) for interim financial information and withthe instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by US GAAP for complete financialstatements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring adjustments)considered necessary for a fair presentation have been included.  Operating results for the three and ninemonth periods ended March 31, 2002, are not necessarily indicative of theresults that may be expected for the year as a whole.  The unaudited condensed consolidated balance sheet for June 30,2001 has been derived from audited consolidated financial statements as of thatdate.  For further information, refer tothe consolidated financial statements and footnotes thereto included in theCompany’s annual report on Form 10-K for the year ended June 30, 2001.

 

Principles ofConsolidation — The accompanying condensedconsolidated unaudited financial statements include the accounts of K-telInternational, Inc. and its domestic and foreign subsidiaries, all of which arewholly owned.  All significantintercompany accounts and transactions have been eliminated.

 

RevenueRecognition — The Company derives its revenue fromseveral different sources: the sale of music compilations (predominatelycompact discs) produced by the Company and license revenue from the licensingof Company-owned master recordings. Revenue from the music sales is recognized at the time of the sale tothe customer, while license revenue is recognized when payment is received fromcustomers because prior to the receipt collection is not consideredprobable.  Most music sales are madewith a right of return of unsold goods. Estimated reserves for returns are established by management based uponhistorical experience and product mix and are subject to ongoing review andadjustment by the Company.  Thesereserves are recorded at the time of the sales and are reflected as a reductionin revenue.

 

Cost of GoodsSold — The Company expenses all product manufacturing,distribution and royalty costs associated with the music sales as cost of goodssold.  The Company also expensesroyalties, commissions and amortization of its owned master recordingsassociated with its license revenue as cost of goods sold.

 

Shipping andHandling Costs — The Company expenses all shipping andhandling costs incurred in the shipment of goods within cost of goods sold.

 

Cash andEquivalents — Cash and equivalents consist principallyof cash, and short-term, highly liquid investments with original maturities ofless 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.

 

7

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Owned CatalogMaster Recordings — The Company capitalizes the coststo purchase owned master recordings at the time of acquisition.  These costs are amortized over the estimateduseful life of these master recordings, which is generally seven years andrepresents managements’ best estimate of the average period of value.

 

Rights to Use Music Product-Certain of the Company’s compilation products are master recordings underlicense from record companies and publishers. In most instances, minimum guarantees or non-returnable advances arerequired to obtain the licenses and are realized through future sales of theproduct.  The amounts paid for minimumguarantees or non–returnable advances are capitalized and charged toexpense as sales are made.  Whenanticipated sales appear to be insufficient to fully recover the minimumguarantees or non–returnable advances, a provision against currentoperations is made for anticipated losses. The unrealized portion of guarantees and advances is included in royaltyadvances in the accompanying consolidated balance sheets.  Licenses are subject to audit by licensors.

 

Property and Equipment- Property and equipment are stated at cost. Depreciation and amortization is provided using straight line ordeclining balance methods over the estimated useful lives of the assets, whichrange from three to nine years.

 

Long-LivedAssets — The Company evaluates its long-lived assetsquarterly, or earlier if a triggering event occurs, to determine potentialimpairment by comparing the carrying value of those assets to the relatedundiscounted future cash flows of the assets. If an asset is determined to be impaired, it is written down to itsestimated net realizable value.

 

Royalties - TheCompany has entered into license agreements with various publishers under whichit pays royalties on units sold.  TheCompany accrues royalties using contractual rates, statutory rates or certainestimated rates on applicable units sold. The contractual royalty liability is computed quarterly, the statutoryroyalty 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 the Company can identify the advertisingthat 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 ofshareholders’ equity.

 

Stock–based Compensation- The Company accounts for stock-based awards to employees using the intrinsicvalue method and recognizes compensation expense for certain stock based awardsgranted to employees.

 

8

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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 netloss per share have been computed by dividing net loss by the weighted averagenumber of shares outstanding during the period. For all periods presented,common stock equivalents were excluded from the per share calculation as theeffect would be antidilutive.  Optionsto purchase 2,330,906 and 2,661,091 shares of common stock, with weightedaverage exercise prices of $5.88 and $6.13 for the nine month periods ended March31, 2002 and 2001 and options to purchase 2,330,906 and 2,429,898 with weightedaverage exercise prices of $5.88 and $5.81 for the three month periods endedMarch 31, 2002 and 2001 were excluded from the computation of common shareequivalents for the respective periods as they 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**

 

K-tel has a Line of CreditAgreement with K-5 Leisure Products, Inc. (“K-5”), an affiliate controlled byPhilip Kives, the Chairman of the Board and Chief Executive Officer of K-tel.Under the terms of the agreement (the “K-5 Facility”), K-5 agreed to makeavailable up to $8,000,000 on a revolving basis.  The loan bears interest at a variable rate based upon the “baserate” of a lending institution (4.75% at March 31, 2002), expires July 20,2005, and is subordinated to the Foothill Loan (see below).  The K-5 Facility contains the same covenantsas the Foothill loan agreement.  K-telhas pledged the stock of its foreign subsidiaries as collateral for the loan,and the loan carries a subordinated position to the former Foothill Loan on allother assets of the Company.  K-tel hadoutstanding balances of $4,807,000 and $5,954,000, as of June 30, 2001 andMarch 31, 2002, respectively, under the K-5 Facility.

 

In addition, K-tel has a secondloan agreement with K-5, under which K-5 assumed all of the Company’s rightsunder the former Foothill Loan pursuant to the Assignment and AcceptanceAgreement dated February 27, 2001.  Thisloan, which has been extended through July 20, 2005, provides for a $10,000,000credit facility consisting of a $4,000,000 term loan due upon expiration, and a$6,000,000 revolving facility under which borrowings are limited to a percentof eligible receivables.  Borrowingsunder the facility bear interest at a variable rate based on a “base rate” of alending institution plus 1% (5.75% at March 31, 2002) and are collateralized bythe 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. As of both June 30and March 31, 2002, $4,000,000 was outstanding under the term loan and therewere no borrowings under the revolving facility.  At March 31, 2002, K-tel has obtained a waiver from K-5 for itsdefault under the covenants, limitations and restrictions of the creditagreement.

 

9

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K-tel has anoverdraft privilege borrowing facility with its banker in the UnitedKingdom.  This facility is secured by aletter of credit for $260,000 provided by K-tel International Ltd., a Canadian companycontrolled by Philip Kives.  K-tel hasan outstanding balance of $185,000 as of March 31, 2002.

 

**4.            COMMITMENTS AND CONTINGENCIES**

 

Class Action Suit

 

K-tel and certain of its current and formerofficers and directors are defendants in *Inre K-tel International, Inc. Securities Litigation*, No.98-CV-2480.  This action consolidatestwenty three purported class actions that were initially filed in variousUnited States District Courts in November 1998, and were subsequentlytransferred to, and consolidated in, the United States District Court for theDistrict of Minnesota.  On July 19,1999, the plaintiffs filed an amended consolidated class action complaint thatchallenges the accuracy of certain public disclosures made by K-tel regardingits financial condition during the period from May 1998 through November1998.  The plaintiffs assert claimsunder the federal securities laws and seek damages in an unspecified amount aswell as costs, including attorneys’ fees and any other relief the Court deemsjust and proper.  K-tel moved to dismissthe complaint, and on July 31, 2000, the United States District Court grantedthe Company’s motion to dismiss. The Court also barred further actions by theplaintiffs and denied plaintiffs’ request to amend the complaint in order torefile the complaint in the future.  Theplaintiff appealed, and the court of appeals heard the matter in October 2001.The Company is waiting for a court ruling regarding this appeal. K-tel has twoinsurance policies providing coverage of up to $20,000,000, which is subject tothe insurers’ reservations of legal rights under the applicable policies. Undertheir reservations of rights, the insurers could contest their obligations toindemnify the Company and its directors and officers.  K-tel may have an obligation to indemnify the officers anddirectors named in this lawsuit.

 

Early v. K-tel International, Inc.

 

On January 11, 1999, the Company was named ina lawsuit entitled *Christopher Early vs. K-tel International, Inc., etal*, brought in the Circuit Court of Cook County, Illinois, againstthe 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 was brought against the Company by Mr. Earlyin 1997 and was dismissed by a United States 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 defend vigorously 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.

 

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RTL Shopping S. A.

 

The Company has been named in a lawsuit filedin France brought by RTL9, a French cable TV station. Initially, RTL9 was namedas a defendant in a suit brought by a competitor of K-tel Marketing Ltd.,alleging that RTL9 ran a commercial for K-tel Marketing which presented adevice under brand names alleged to infringe on the competitor’s own trademarksand translated an English language script indicating that the product was “justlike” or “as good as” others into “better than” in French, contrary to Frenchlaw. The suit alleged trademark infringement, unfair competition, illicitcomparative advertising and passing off. 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 RTL9filed a suit in December 2000 against K-tel International, Inc. under itsagreement to 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. At aprocedural hearing on December 3, 2001, RTL9 filed its brief in response to theCompany’s filing.  In response, theCompany filed a further brief.  At afurther hearing on May 6, 2002, several companies involved in the initial suitagainst RTL9 filed additional briefs or indicated that additional briefs wouldbe filed.  The Court directed that alladditional briefs are to be filed by June 24, 2002, after which time anotherhearing will be scheduled for the Company to respond.  The Court has scheduled oral arguments for November 12,2002.  The action seeks the approximateamount of 20 million French Francs, or approximately $2.8 million. The Companybelieves that RTL9 has no basis for a complaint against the Company.

 

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

 

Hollins & Fields, LLP (H&F) sublet aportion of the Company’s former executive offices in Los Angeles.  On September 21, 2001, H&F sued inCalifornia for breach of contract and conversion, seeking damages in excess of$150,000.  On November 26, 2001, theCourt dismissed the punitive damage claim in the amount of $100,000.  The Company filed a defense andcounterclaim.  As a result ofinformation exchanged during discovery, the parties settled the matter on April30, 2002 on terms favorable to the Company.

 

Other Litigation and Disputes

 

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.  If management determines that a loss isprobable and the amount of loss can be reasonably estimated, such amount isrecorded as a liability.  Although theoutcome of any such legal actions 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.

 

SubsidiaryBankruptcy

 

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 United StatesBankruptcy Code.  Although thebankruptcy court has not yet confirmed the formal plan of liquidation, theCompany

 

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has not beeninformed by the trustee or its counsel of any plan by the court to attempt tohold it or any of its subsidiaries liable for any of the commitments of K-tel(USA).  Management believes the Companywill have no ongoing material liability related to K-tel (USA) as a result ofthe filing and the outcome of the bankruptcy proceeding.

** **

**5.            SEGMENT INFORMATION**

 

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

 

The retailmusic segment consists primarily of the sales of pre–recorded music bothfrom the Company’s music master recordings 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.

 

In thelicensing segment, the Company licenses the rights to its master recordingsmusic catalog, consisting of original recordings and re–recordings ofmusic from the 1950’s through today, to third parties world–wide for usein albums, films, television programs, and commercials, for either a flat feeor a royalty based on the number of units sold.

 

Operatingprofits or losses of these segments include an allocation of general corporateexpenses.  Certain financial informationon the Company’s continuing operating segments is as follows:

 
| **Nine Months Ended March 31,**   |   | **Music** |   | **Licensing** |   | **Corporate  Elimination** |   | **Total  Company** |   |
|-----------------------------------|--------|-----------|--------|---------------|--------|----------------------------|--------|--------------------|--------|
| *(in thousands**)*                |   |      |   |          |   |                       |   |               |   |   |   |
|                              |   |      |   |          |   |                       |   |               |   |   |   |
| Net Sales                         |   | 2002      |   | $             | 3,264  |                       | $      | 1,987              |   | $ | — |   | $ | 5,251 |   |
|                              |   | 2001      |   | 13,993        |   | 2,561                      |   | (329               | )      | 16,225 |   |
|                              |   |      |   |          |   |                       |   |               |   |   |   |
| Operating Income (Loss)           |   | 2002      |   | $             | (1,167 | )                          | $      | 789                |   | — |   | $ | (378 | ) |
|                              |   | 2001      |   | (9,011        | )      | 666                        |   | —             |   | (8,345 | ) |
|                              |   |      |   |          |   |                       |   |               |   |   |   |
| **Three  Months Ended March 31,** |   |      |   |          |   |                       |   |               |   |
|                              |   |      |   |          |   |                       |   |               |   |   |   |
| Net Sales                         |   | 2002      |   | $             | 962    |                       | $      | 804                |   | — |   | $ | 1,766 |   |
|                              |   | 2001      |   | 4,281         |   | 973                        |   | (80                | )      | 5,174 |   |
|                              |   |      |   |          |   |                       |   |               |   |   |   |
| Operating Income (Loss)           |   | 2002      |   | $             | (537   | )                          | $      | 409                |   | — |   | $ | (128 | ) |
|                              |   | 2001      |   | (5,745        | )      | 342                        |   | —             |   | (5,403 | ) |
|                                   |        |           |        |               |        |                            |        |                    |        |  |  |  |  |  |  |

 

**6.            RECENTLY ISSUED ACCOUNTING STANDARDS**

 

In June 2001, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards (“SFAS”) 141, *BusinessCombinations,*and SFAS 142, *Goodwilland Other Intangible Assets.* These pronouncements, among other things, eliminate the pooling-of-interestmethod of accounting for business combinations and require intangible assetsacquired in business combinations be recorded separately from goodwill.  The pronouncements also eliminate theamortization of goodwill and other intangible assets with indefinitelives.  SFAS 141 and the nonamortizationprovisions of SFAS 142 were effective for purchase business combinationscompleted after June 30, 2001.  Theremaining provisions of SFAS 142 are effective for the Company beginning July1, 2002.  Adoption of thesepronouncements are not expected to have a

 

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material effect on the Company,as the Company does not have any goodwill or other intangible assets withindefinite lives.

 

In September 2001, the FASBissued SFAS 144, *Accounting for theImpairment or Disposal of Long-Lived Assets.* SFAS 144 supercedes SFAS 121 and furtherclarifies the accounting for disposals of long-lived assets.  The Company will adopt this pronouncement onJuly 1, 2002.  Adoption of thispronouncement is not expected to have a material effect on the Company.

 

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**ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

 

**General**

 

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

 

For thisanalysis, the following changes in the Company’s business should beconsidered:  K-tel closed the operationsof its German subsidiary, Dominion Vertriebs GmbH, in June 2000; one of itssubsidiaries in the United Kingdom, K-tel Marketing Ltd., in November 2000; anda United States subsidiary, K-tel Consumer Products, Inc., in February 2001.These three closings represent the discontinuation of the Company’s consumerproducts division and accordingly have been presented in the accompanyingfinancial statements as discontinued operations.  In addition, in March 2001, the Company’s music distributionsubsidiary in the United States, K-tel (USA) ceased operations and filed forprotection under Chapter 7 of the United States Bankruptcy Code.

 

Through another subsidiary, K-tel is implementing amore-focused method of distribution that targets the strengths of fewerindividual retailers and supplies products suited to each retailer’s specificneeds. These new products are derived from the Company’s master recordingsmusic catalog and it is anticipated that this will allow the Company to realizemore competitive profit margins.

 

A description of the Company’s critical accountingpolicies and accounting estimates can be found in the notes to the Company’scondensed consolidated financial statements.

 

#### **THREE MONTHS ENDED MARCH31, 2002 VERSUS MARCH 31, 2001**

 

Net sales forthe three months ended March 31, 2002 were $1,766,000, a decline of 65.9% fromsales of $5,174,000 for the quarter ended March 31, 2001. This sales declinecan be attributed to the cessation of operations of the Company’s domesticmusic distribution subsidiary, K-tel (USA), which had sales of $3,672,000during the prior period.  The loss forthe three months ended March 31, 2002 was $307,000, or $.02 per share, comparedto an income of $10,167,000, or $.74 per share, for the three months endedMarch 31, 2001.  In March 2001, theCompany’s music distribution subsidiary in the United States, K-telInternational (USA), Inc., (“K-tel (USA)”) ceased operations and filed for protectionunder Chapter 7 of the United States Bankruptcy Code.  In connection with this filing, the assets and liabilities ofK-tel (USA) were removed from the books of the Company as control of thesubsidiary was transferred to the bankruptcy trustee.  The remaining liability was shown as a gain on Chapter 7liquidation.

 

Generalcorporate expenses of $404,000 and $385,000 for the three months ended March31, 2002 and March 31, 2001 have been allocated to the business segments.

 

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

 

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#### **BUSINESS SEGMENT RESULTS**

 

#### **Music**

 

Sales in themusic segment were $962,000 for the three months ended March 31, 2002 comparedto $4,281,000 for the three months ended March 31, 2001, a decrease of$3,319,000, or 77.5%.

 

While Europeansales increased $26,000, domestic music sales decreased $3,345,000.  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 March 31, 2002 are in another domestic subsidiary that marketsproducts derived from the Company’s proprietary master music catalog.

 

Cost of goodssold in the music segment decreased to 70.0% of sales for the three monthsended March 31, 2002 compared to 172.8% of sales for the three months endedMarch 31, 2001.  The cost of goods soldin excess of net sales in the three months ended March 31, 2001 reflects thedisposal of slow-moving and obsolete stock at prices less than cost during thequarter.  Cost of goods sold in thethree months ended March 31, 2002 are higher than normal because of significantincreased sales to a large distributor in the United Kingdom at lower thanaverage margins.  Advertising expenseswithin the segment, which consist primarily of co-operative advertising payments,trade advertising and promotions, decreased to $29,000 and were approximately3.0% of sales for the three months ended March 31, 2002 compared to $246,000,or 5.8% of sales for the three months ended March 31, 2001.  This decrease is related to the reducedlevels of advertising done during the current period.  Selling, general and administrative expenses were $834,000, or86.7% of sales for the three months ended March 31, 2002 compared to$1,403,000, or 33.0% of sales for the three months ended March 31, 2001.  The reduction of $569,000 is mainly becauseof the closure of the former domestic music distribution subsidiary.  The high level of costs related to salesduring the three months ended March 31, 2002 reflect the start-up costs ofimplementing the Company’s new music distribution strategy.

 

As a result,the music segment incurred an operating loss of $537,000 for the three monthsended March 31, 2002 compared to an operating loss of $5,745,000 for the threemonths ended March 31, 2001.

 

**Licensing**

 

Licensingrevenue was $804,000 for the three months ended March 31, 2002 compared to$973,000 in the three months ended March 31, 2001, a decrease of 17.4%.  Revenue in Europe decreased $386,000 as theCompany continued to evaluate its licensing activities with the goal ofincreasing profitability.  Included inthe segment revenue in the three months ended March 31, 2001 was approximately$80,000 of intercompany revenues, which is eliminated on the accompanyingfinancial statements.  There were nointercompany revenues included in the segment revenue in the three months endedMarch 31, 2002.  Operating income in thelicensing segment was $409,000 for the three months ended March 31, 2002 and$342,000 for the three months ended March 31, 2001, an increase of 19.6%.

 

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#### **NINE MONTHS ENDED MARCH31, 2002 VERSUS MARCH 31, 2001**

 

Net sales forthe nine months ended March 31, 2002 were $5,251,000, a decline of 67.6% fromsales of $16,225,000 for the nine months ended March 31, 2001.  The sales decline can be attributed to thecessation of operations of the Company’s domestic music distributionsubsidiary, K-tel (USA), which had sales of $11,948,000 during thatperiod.  The loss for the nine monthsended March 31, 2002 was $918,000, or $.07 per share, compared to an income of$2,806,000, or $.20 per share, for the nine months ended March 31, 2001.

 

Generalcorporate expenses of $881,000 and $1,850,000 for the nine months ended March31, 2002 and 2001 have been allocated to the business segments.

 

The following sections discuss the results of continuing operations bybusiness segment.

#### ** **

#### **BUSINESS SEGMENT RESULTS**

 

#### **Music**

 

Sales in themusic segment were $3,264,000 for the nine months ended March 31, 2002 comparedto $13,993,000 for the nine months ended March 31, 2001, a decrease of$10,729,000, or 76.7%.

 

While Europeansales increased $397,000, domestic music sales decreased $11,126,000.  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 ninemonths ended March 31, 2002 were attributed to another domestic subsidiary thatmarkets products derived from the Company’s proprietary master recordings musiccatalog.

 

Cost of goodssold in the music segment decreased to 55.7% of sales for the nine months endedMarch 31, 2002 compared to 107.0% of sales for the nine months ended March 31,2001.  The cost of goods sold in excessof net sales in the nine months ended March 31, 2001 reflects the disposal ofslow-moving and obsolete stock at prices less than cost during the thirdquarter of the 2001 fiscal year. Advertising expenses within the segment, which consist primarily ofco-operative advertising payments, trade advertising and promotions, decreasedto $80,000 and was approximately 2.5% of sales for the nine months ended March31, 2002 compared to $420,000, or 3.1% of sales for the nine months ended March31, 2001.  This decrease was related tothe reduced levels of advertising done during the period.  Selling, general and administrative expenseswere $2,560,000, or 78.4% of sales for the nine months ended March 31, 2002compared to $5,703,000, or 40.6% of sales for the nine months ended March 31,2001.  The reduction of $3,143,000, or55.1%, is mainly due to the closure of the former domestic music distributionsubsidiary, K-tel (USA).  The costs inexcess of sales during the nine months ended March 31, 2002 reflect the startup costs of implementing the Company’s new music distribution strategy.

 

As a result,the music segment incurred an operating loss of $1,167,000 for the nine monthsended March 31, 2002 compared to an operating loss of $9,011,000 for the ninemonths ended March 31, 2001.

 

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**Licensing**

 

Licensingrevenue was $1,987,000 for the nine months ended March 31, 2002 compared to$2,561,000 for the nine months ended March 31, 2001, a decrease of 22.4%.  Revenue in Europe decreased $616,000 as theCompany continued to evaluate its licensing activities with the goal ofincreasing profitability.  Included inthe segment revenue in the nine months ended March 31, 2001 was approximately$329,000 of intercompany revenues, which is eliminated on the accompanyingfinancial statements.  There were nointercompany revenues included in the segment revenue in the nine months endedMarch 31, 2002.  Operating income in thelicensing segment was $789,000 for the nine months ended March 31, 2002 and$666,000 for the nine months ended March 31, 2001, an increase of 18.5%.

 

**B. LIQUIDITY AND CAPITAL RESOURCES**

 

K-tel has primarily funded its operations over thepast several years with secured loans from K-5 (See Note 3 to the CondensedConsolidated Financial Statements).  TheCompany used $1,313,000 and $1,487,000 of cash in operating activities duringthe nine month periods ended March 31, 2002 and March 31, 2001, respectively.

 

The Company’s ability tocontinue its present operations and successfully implement its future businessplans is contingent mainly 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 on an ongoing basis.  Management is concentrating its efforts onreturning the Company to profitability by focusing on its music licensingbusiness and limited music distribution. However, there can be no assurance that the Company’s business plan andmanagement 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.

 

**Important FactorsRelating to Forward Looking Statements**

 

Information in this Form 10-Qof a non-historical nature relates to future events and results of the Company(including certain projections and business trends) that are “forward-lookingstatements” as defined in the Private Securities Litigation Reform Act of 1995.The use of terminology such as “believe,” “may,” “will,” “expect,”“anticipate,” “estimate,” “should,” “continue,” and other variations thereof orcomparable terminology may identify such forward-looking statements.  Actual results and performance may differmaterially from expressed forward looking statements because of certain risksand uncertainties, including but not limited to, changes in political andeconomic conditions; demand for and market acceptance of new and existingproducts; dependence on strategic alliance partners, suppliers anddistributors; the outcome of K-tel (USA)’s bankruptcy; 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.

 

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

 

There havebeen no material changes in the Company’s market risk during the nine monthsended March 31, 2002.  For additionalinformation, refer to page 12 of the Company’s annual report on Form 10-K forthe fiscal year ended June 30, 2001.

 

#### **PART II**

 

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

 

Class Action Lawsuit

 

K-tel and certain of its current and formerofficers and directors are defendants in *Inre K-tel International, Inc. Securities Litigation*, No.98-CV-2480.  This action consolidatestwenty three purported class actions that were initially filed in variousUnited States District Courts in November 1998, and were subsequentlytransferred to, and consolidated in, the United States District Court for theDistrict of Minnesota.  On July 19,1999, the plaintiffs filed an amended consolidated class action complaint thatchallenges the accuracy of certain public disclosures made by K-tel regardingits financial 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 ascosts, including attorneys’ fees and any other relief the Court deems just andproper.  K-tel moved to dismiss theComplaint, and, on July 31, 2000, the United States District Court granted theCompany’s motion to dismiss. The Court also barred further actions by theplaintiffs and denied plaintiffs’ request to amend the complaint in order torefile the complaint in the future.  Theplaintiff appealed, and the court of appeals heard the matter in October 2001.The Company is waiting for a court ruling regarding this appeal.  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 Companyand its directors and officers.  K-telmay have 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 ina lawsuit entitled *Christopher Early vs. K-tel International, Inc., etal*, brought in the Circuit Court of Cook County, Illinois, againstthe 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 andmisleading packaging of cassette tapes and compact discs by failing to giveproper notice to consumers that the songs contained therein are not theoriginal recordings by the original artists. The complaint also alleges consumer fraud, deceptive and unfairpractices, and fraud in connection with website advertising and marketing.  Similar litigation was brought against theCompany by Mr. Early in 1997 and was dismissed by a United States Federal Courtin 1999 on jurisdictional grounds.  TheCompany denies that it mislabeled cassette tapes and compact discs or engagedin fraudulent or deceptive conduct and intends to defend vigorously thepurported action, which seeks an undetermined amount of compensatory damagesand punitive

 

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damages in the amount of $10 million, aninjunction and costs incurred in the litigation, including attorneys fees.  The Company filed a motion to dismiss thecomplaint on June 8, 2000. On February 16, 2001, the court dismissed thecomplaint against the other manufacturers, distributors and nationwideretailers, but allowed the case to continue 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.

 

RTL Shopping S. A.

 

The Company has been named in a lawsuit filed in France brought byRTL9, a French cable TV station. Initially, RTL9 was named as a defendant in asuit brought by a competitor of K-tel Marketing Ltd., alleging that RTL9 ran acommercial for K-tel Marketing which presented a device under brand namesalleged to infringe on the competitor’s own trademarks and translated anEnglish language script indicating that the product was “just like” or “as goodas” others into “better than” in French, contrary to French law. The suitalleged trademark infringement, unfair competition, illicit comparativeadvertising and passing off. RTL9 then sued K-tel Marketing on October 4, 2000,pursuant to an indemnification provision the parties had entered into.Subsequently, K-tel Marketing went into liquidation and RTL9 filed a suit inDecember 2000 against K-tel International, Inc. under its agreement to guarantypayment for the commercial time. On May 28, 2001, RTL9 presented documents incourt identifying K-tel International (USA), Inc. as a target of its claim. OnSeptember 3, 2001 the Company filed documents disputing the claim and advisingthe court of K-tel (USA)’s Chapter 7 bankruptcy filing. At a procedural hearingon December 3, 2001, RTL9 filed its brief in response to the Company’sfiling.  In response, the Company fileda further brief.  At a further hearingon May 6, 2002, several companies involved in the initial suit against RTL9filed additional briefs or indicated that additional briefs would befiled.  The Court directed that alladditional briefs are to be filed by June 24, 2002, after which time anotherhearing will be scheduled for the Company to respond.  The Court has scheduled oral arguments for November 12,2002.  The action seeks the approximateamount of 20 million French Francs, or approximately $2.8 million. The Companybelieves that RTL9 has no basis for a complaint against the Company.

 

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

 

Hollins & Fields, LLP (H&F) sublet a portion of the Company’sformer executive offices in Los Angeles. On September 21, 2001, H&F sued in California for breach of contractand conversion, seeking damages in excess of $150,000.  On November 26, 2001, the Court dismissedthe punitive damage claim in the amount of $100,000.  The Company filed a defense and counterclaim.  As a result of information exchanged duringdiscovery, the parties settled the matter on April 30, 2002 on terms favorableto the Company.

 

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

 

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.  If 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 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.

 

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## **ITEM6.  EXHIBITS AND REPORTS ON FORM 8-K**

 

(a)           EXHIBIT INDEX

 

None.

 

(b)           REPORTS ON FORM 8-K

 

There were no reports filed under Form 8-K by the Company during thethree month period ended March 31, 2002.

 

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SIGNATURES

 

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

 
|                 |   |   |   |   | K-TEL INTERNATIONAL, INC.             |
|----------------------|--------|--------|--------|--------|---------------------------------------|
|                 |   |   |   |   | REGISTRANT                            |   |
|                 |   |   |   |   |                                  |   |
|                 |   |   |   |   |                                  |   |
| Dated: May  13, 2002 |   |   |   |   | /S/ PHILIP  KIVES                     |
|                 |   |   |   |   | PHILIP KIVES                          |   |
|                 |   |   |   |   | CHAIRMAN AND  CHIEF EXECUTIVE OFFICER |
|                 |   |   |   |   |                                  |   |
|                 |   |   |   |   |                                  |   |
| Dated: May  13, 2002 |   |   |   |   | /S/ DENNIS  WARD                      |
|                 |   |   |   |   | DENNIS WARD                           |   |
|                 |   |   |   |   | CHIEF  FINANCIAL OFFICER              |
|                 |   |   |   |   | (principal  accounting officer)       |   |

 

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