Edgar Filing: K TEL INTERNATIONAL INC

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended December 31, 2004

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 1-07115

K-TEL INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

Minnesota		41-0946588
(State or other jurisdiction of		(I.RS. Employer Identification No.)
incorporation or organization)

2655 Cheshire Lane North, Suite 100, Plymouth, Minnesota		55447
(Address of principal executive offices)		(Zip Code)

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

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered 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) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes o No x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-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 mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

As of September 15, 2006, the registrant had 13,653,738 shares of common stock outstanding.

K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES

FORM 10-Q

FOR THE THREE AND SIX MONTH PERIODS

ENDED DECEMBER 31, 2004

INDEX

PART I.	Financial Information (Unaudited):

	Item 1.	Financial Statements

		Condensed Consolidated Balance Sheets as of December 31, 2004 and June 30, 2004

		Condensed Consolidated Statements of Operations for the Three and Six Months Ended December 31, 2004 and 2003

		Condensed Consolidated Statements of Cash Flows for the Three and Six Months Ended December 31, 2004 and 2003

		Notes to Condensed Consolidated Financial Statements

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk

	Item 4.	Controls and Procedures

PART II. Other Information:

	Item 1.	Legal Proceedings

	Item 6.	Exhibits and Reports on Form 8-K

Signatures

Index to Exhibits

SAFE HARBOR STATEMENT UNDER THE

PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Certain statements of a non-historical nature under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Form 10-Q constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may be identified by the use of terminology such as “may,” “will,” “expect,” “anticipate,” “estimate,” “should,” or “continue” or the negative thereof or other variations thereon or comparable terminology. Such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or from those results currently anticipated or projected. Such factors include, among other things, the following: changes in consumer purchasing; demand for and market acceptance of new and existing products; the impact from competition for recorded music; the outcome of legal proceedings; dependence on suppliers and distributors; success of marketing and promotion efforts; technological changes and difficulties; availability of financing; foreign currency variations; general economic, political and business conditions; and other matters. We undertake no obligation to release publicly the result of any revisions to these forward-looking statements, except as required by law.

K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS - UNAUDITED

(in thousands – except share data)

	December 31,			June 30,
	2004			2004

ASSETS

Current Assets:
Cash and cash equivalents	$	126		$	147
Accounts receivable, net of allowance for doubtful accounts of $4 and $4	3,715			2,691
Inventories	526			561
Royalty advances	38			50
Prepaid expenses and other	269			308
Total Current Assets	4,674			3,757

Property and equipment, net of accumulated depreciation and amortization of $1,125 and $1,506	106			83

Owned catalog masters, net of accumulated amortization of $3,030 and $2,942	583			656

	$	5,363		$	4,496

LIABILITIES AND SHAREHOLDERS’ DEFICIT

Current Liabilities:
Notes payable to affiliate and other	$	11,527		$	11,165
Accounts payable	1,576			1,432
Accrued royalties	2,099			1,907
Reserve for returns	151			133
Net liabilities of discontinued operations	34			30
Total Current Liabilities	15,387			14,667

Shareholders’ Deficit:
Common stock – 50,000,000 shares authorized; par value $.01; 13,653,738 issued and outstanding	136			136
Additional paid-in capital	21,292			21,292
Accumulated deficit	(31,429		)	(31,466		)
Accumulated other comprehensive loss	(23		)	(133		)
Total Shareholders’ Deficit	(10,024		)	(10,171		)

	$	5,363		$	4,496

The accompanying notes are an integral part of these financial statements.

K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED

(in thousands - except per share data)

	Three Months Ended						Six Months Ended
	December 31,						December 31,
	2004			2003			2004			2003
Net Sales	$	1,695		$	1,759		$	3,531		$	3,381

Costs and Expenses:
Cost of goods sold	772			857			1,693			1,513
Advertising	40			32			67			75
Selling, general and administrative	873			910			1,790			1,748
Total Costs and Expenses	1,685			1,799			3,550			3,336
Operating Income (Loss)	10			(40		)	(19		)	45

Other Expense:
Interest expense	(157		)	(120		)	(302		)	(237		)
Other	125			—			147			(11		)
Total Other Expense	(32		)	(120		)	(155		)	(248		)

Loss from Continuing Operations	(22		)	(160		)	(174		)	(203		)

Income (loss) from Discontinued Operations, net of taxes	212			(20		)	211			(61		)

Net Income (Loss)	$	190		$	(180	)	$	37		$	(264	)

Income (Loss) per Share – Basic and Diluted:
Continuing Operations	$	—		$	(.01	)	$	(.01	)	$	(.02	)
Discontinued Operations	.02			—			.02			—
Net Income (Loss)	$	.02		$	(.01	)	$	.01		$	(.02	)

Shares used in the calculation of loss per share - Basic and Diluted	13,654			13,654			13,654			13,654

Comprehensive Income (Loss):
Net income (loss)	$	190		$	(180	)	$	37		$	(264	)
Translation adjustment	65			76			110			76

Comprehensive Income (Loss)	$	255		$	(104	)	$	147		$	(188	)

The accompanying notes are an integral part of these financial statements.

K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED

(in thousands)

	Six Months Ended
	December 31,
	2004			2003
Cash flows from Operating Activities:
Net income (loss)	$	37		$	(264	)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization	123			132
Loss on disposal of property and equipment	(11		)	—
Discontinued operations	4			(6		)
Changes in operating assets and liabilities:
Accounts receivable, net	(908		)	(30		)
Inventories	47			(54		)
Royalty advances	13			8
Prepaid expenses	43			(197		)
Accounts payable	99			(525		)
Accrued royalties	164			138
Reserve for returns	18			(8		)
Cash used in operating activities	(371		)	(806		)

Cash flows from Investing Activities:
Purchases of property and equipment	(55		)	(41		)
Other	(13		)	(6		)
Cash used in investing activities	(68		)	(47		)

Cash flows from Financing Activities:
Borrowings on notes payable	2,320			1,483
Payments on notes payable	(1,958		)	(1,819		)
Cash provided by (used in) financing activities	362			(336		)

Effect of exchange rates on cash	56			19

Net decrease in cash and cash equivalents	(21		)	(1,170		)

Cash and cash equivalents at beginning of period	147			1,219

Cash and cash equivalents at end of period	$	126		$	49

The accompanying notes are an integral part of these financial statements.

K-TEL INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. BUSINESS AND LIQUIDITY

K-tel International, Inc. (the “Company”, “K-tel” or the “registrant”) was incorporated in 1968 and currently has its corporate offices located in Plymouth, Minnesota. Through its operating subsidiaries, K-tel licenses its music catalog internationally and markets entertainment products mainly derived from its catalog through retail and direct response marketing channels in the United States and Europe. The Company has a focused method of distribution that targets the strengths of selected individual retailers and supplies products suited to each retailer’s needs. These products are derived mainly from the Company’s master recordings music catalog with the objective of realizing more competitive profit margins. K-tel seeks to license its trademarks to other companies in businesses unrelated to K-tel’s current operations. Licenses are granted for a royalty or fee, with no cost to the Company.

Discontinued Operations

The Company’s consumer products business, which was concentrated in Europe, consisted primarily of housewares, consumer convenience items and exercise equipment. The Company discontinued its consumer products operations in Germany, the United Kingdom and the United States in June 2000, November 2000 and January 2001, respectively. Accordingly, these activities have been presented in the accompanying financial statements as discontinued operations. The accompanying condensed consolidated financial statements have been prepared to reflect the consumer products division as a discontinued operation. The net liabilities of discontinued operations at December 31, 2004 and June 30, 2004, and results from discontinued operations for the three and six months ended December 2004 and 2003, relate primarily to legal matters and completion of statutory reporting requirements for the former operations in Germany.

Liquidity

During the six months ended December 31, 2004 and 2003, the Company incurred net losses from continuing operations of $304,000 and $203,000, respectively. Operating activities used $371,000 and $806,000 of cash during the six months ended December 31, 2004 and 2003 respectively. Additionally, the Company had a working capital deficit of $10,713,000 at December 31, 2004.

The Company’s ability to continue its present operations and implement future expansion plans successfully is contingent mainly upon its ability to maintain its line of credit arrangements with K-5 Leisure Products, Inc. (See Note 3), increase its revenues and profit margins, and ultimately attain and sustain profitable operations. Without increased revenues and sustained profitability, the cash generated from the Company’s current operations will likely be inadequate to fund operations and service its indebtedness on an ongoing basis. Management is focusing its efforts on music licensing, music downloads and limited music distribution. However, there can be no assurance that the Company will achieve profitable operations through these efforts. The financial statements do not include any adjustments that might result from the outcome of these uncertainties.

2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation – The accompanying condensed consolidated unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) for interim financial information and with 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 required by US GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the six month periods ended December 31, 2004 are not necessarily indicative of the results that may be expected for the year as a whole. The unaudited condensed consolidated balance sheet for June 30, 2004 has been derived from audited consolidated financial statements as of that date. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K/A for the year ended June 30, 2004.

Principles of Consolidation - The accompanying condensed consolidated financial statements include the accounts of K-tel International, Inc. and its domestic and foreign subsidiaries, all of which are wholly owned. All significant intercompany accounts and transactions have been eliminated.

During the quarter ended March 31, 2004, the Company began to consolidate the financial statements of Lancaster Trading Limited (Lancaster), a variable interest entity of which the Company determined it was the primary beneficiary. Sales and purchases between Lancaster and the Company have been eliminated in consolidation, and the additional effects of Lancaster on the Company’s operations were not material.

Revenue Recognition – The Company derives its revenue mainly from two sources: the sale of music compilations (predominately compact discs) produced by the Company, and license revenue from the licensing of Company-owned masters. Revenue from music sales is recognized at the time of shipment to the customer, while license revenue is recognized when payment is received from customers or when known amounts are receivable, as prior to that date collection is not considered probable. Most music sales are made with a right of return of unsold goods. Estimated reserves for returns are established by management based upon historical experience and product mix and are subject to ongoing review and adjustment by the Company. These reserves are recorded at the time of sale and are reflected as a reduction in revenue. The Company’s reserve for returns was $151,000 at December 31, 2004 and $133,000 at June 30, 2004.

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

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

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

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

Owned Catalog Masters – The Company capitalizes the costs to purchase owned master recordings at the time of acquisition. These costs are amortized over the estimated useful life of these master recordings, which is generally seven years, and represents management’s best estimate of the average period of value.

Rights to Use Music Product - Certain of the Company’s compilation products are master recordings under license from record companies and publishers. In most instances, minimum guarantees or non-refundable advances are required to obtain the licenses and are realized through future sales of the product. The amounts paid for minimum guarantees or non-refundable advances are capitalized and charged to expense as sales are made. The unrealized portion of guarantees and advances is included in royalty advances in the accompanying consolidated balance sheets. Licenses are subject to audit by licensors. When anticipated sales appear to be insufficient to fully recover the minimum guarantees or non-refundable advances, a provision against current operations is made for anticipated losses.

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

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

Royalties - The Company has entered into license agreements with various record companies and publishers under which it pays royalties on units sold. The Company accrues royalties using contractual rates and certain estimated rates on applicable units sold. The contractual royalty liability is computed quarterly and the accrued royalty balance is adjusted accordingly. The royalty agreements are subject to audit by licensors.

Advertising - The Company expenses the costs of advertising when the advertising takes place, except for direct response advertising, which is capitalized and amortized over its expected period of future benefits (usually the period remaining under a related contract, which is generally less than one year). Direct response advertising consists primarily of television advertising whereby customers respond specifically to the advertising and where the Company can identify the advertising that elicited the response. Advertising expenses were $67,000 and $75,000 for the six month periods ended December 31, 2004 and 2003, 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 exchange rates. Revenue and expenses are translated at the average exchange rates prevailing during the period. Adjustments resulting from translating the financial statements of foreign entities into U.S. dollars are recorded as a component of accumulated other comprehensive income or loss.

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

	Three Months Ended					Six Months Ended
	December 31,					December 31,
	2004		2003			2004		2003

Net Gain (Loss) (in thousands)
As reported	$	190	$	(180	)	$	37	$	(264	)
Pro forma	$	190	$	(180	)	$	37	$	(264	)

Basic and Diluted EPS
As reported	$	.02	$	(.01	)	$	.01	$	(.02	)
Pro forma	$	.02	$	(.01	)	$	.01	$	(.02	)

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

Net Income (Loss) Per Share - Basic and diluted net income (loss) per share have been computed by dividing net income (loss) by the weighted average number of shares outstanding during the period. For all periods presented, common stock equivalents were excluded from the per share calculation as the net effect would be antidilutive. For the six month periods ended December 31, 2004 and 2003, weighted average options to purchase 2,564,839 and 953,630 shares of common stock, with weighted average exercise prices of $.36 and $.95, respectively, were excluded from the computation of common share equivalents for the respective periods as they were antidilutive. For the three month periods ended December 31, 2004 and 2003, weighted average options to purchase 2,564,839 and 1,464,360 shares of common stock, with weighted average exercise prices of $.36 and $.64, respectively, were excluded from the computation of common share equivalents for the respective periods as they were antidilutive.

Use of Estimates - Preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (US GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Principal estimates include allowances for bad debt, inventory valuation, return reserves, royalty obligations, purchase commitments and product replacement costs. Actual results could 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 which is controlled by Philip Kives, the Chairman of the Board, President and Chief Executive Officer of K-tel. Under the terms of the agreement (the “K-5 Facility”), K-5 has agreed to make available up to $8,000,000 to K-tel on a revolving basis. The loan bears interest at a variable rate based upon the “base rate” of a nationally recognized lending institution (5.25% at December 31, 2004), 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 the loan, and the loan carries a subordinated position to the Foothill loan on all other assets of the Company. K-tel had outstanding balances of $7,527,000 and $7,165,000 as of December 31, 2004 and June 30, 2004, respectively, under the K-5 Facility. At December 31, 2004, K-tel obtained a waiver from K-5 for its non-compliance under the covenants, limitations and restrictions of the credit agreement.

In addition, K-tel has a second loan agreement with K-5, under which K-5 assumed rights and obligations under 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 for a $10,000,000 credit 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 percent of eligible receivables. Borrowings under the facility bear interest at a variable rate based on a “base rate” of a nationally recognized lending institution plus 1% (6.25% at December 31, 2004) and are collateralized by the assets of certain Company subsidiaries in the United States, including accounts receivable, inventories, equipment, music library and general intangibles. The loan agreement contains certain financial and other covenants or restrictions, including the maintenance of a minimum shareholders’ equity by K-tel, limitations on capital expenditures, restrictions on music library acquisitions, limitations on other indebtedness and restrictions on dividends paid by K-tel. As of December 31, 2004 and June 30, 2004, $4,000,000 was outstanding under the term loan and there were no borrowings under the revolving facility. At December 31, 2004, K-tel obtained a waiver from K-5 for its non-compliance under the covenants, limitations and restrictions of the credit agreement.

K-tel had an overdraft privilege borrowing facility with The Royal Bank of Scotland in the United Kingdom. This facility was secured by a standby letter of credit for $55,000 provided by K-tel International Ltd., a Canadian company controlled by Philip Kives and was payable on demand in accordance with normal banking practices. K-tel had no outstanding balance as of December 31, 2004 and June 30, 2004. This overdraft privilege borrowing facility was canceled at the end of calendar year 2004.

4. COMMITMENTS AND CONTINGENCIES

K-tel International, Inc. vs. Tristar Products, Inc.

On March 14, 2000, K-tel and its subsidiary in Germany commenced an action for breach of express and implied warranties against Tristar Products, Inc. This action arose out of Tristar’s sale to K-tel of a defective home exercise product called the “BunBlaster” for resale in Germany, Austria and Switzerland. By written contract, Tristar hagreed to indemnify K-tel for injuries and damages arising out of the resale of those goods.

On April 30, 2001, Tristar also asserted a patent and trademark/ trade-dress counterclaim against K-tel for allegedly passing off a product called the “K-tel Hook and Hang” while allegedly a distributor of the original patented Tristar Hook and Hang product. The Company denies the allegation because it never was a distributor of this or any similar product.

On December 30, 2004, a Mutual General Release and Settlement Agreement was signed by K-tel and Tristar, whereby both companies agreed to mutual releases and Tristar agreed to pay K-tel $350,000. The payment of $350,000 was received February 18, 2005.

Other Litigation and Disputes

K-tel and its subsidiaries are also involved in other legal proceedings in the ordinary course of their business. With all litigation matters, management considers the likelihood of loss based on the facts and circumstances. If management determines that a loss is probable and the amount of loss can be reasonably estimated, such amount is recorded as a liability. Although the outcome of any such legal proceedings cannot be predicted, in the opinion of management there is currently no legal proceeding pending or asserted against or involving K-tel for which the

outcome is likely to have a material adverse effect upon the consolidated financial position or results of operations of K-tel.

Subsidiary’s Liquidation

The Company discontinued its United States subsidiary, K-tel Consumer Products, Inc., in February 2001. This closing represents the discontinuation of the Company’s consumer products division and accordingly has been presented in the accompanying financial statements as discontinued operations. In addition, in March 2001, the Company’s music distribution subsidiary in the United States, K-tel (USA) ceased operations and filed for protection under Chapter 7 of the United States Bankruptcy Code.

In fiscal 2004, $214,000 was received from the liquidation of K-tel Marketing LTD. The Company also received approximately $333,000 in fiscal 2004 from the sale of assets and account receivable collections related to the March 2001 bankruptcy of K-tel International, (USA), Inc.

5. BUSINESS SEGMENT AND GEOGRAPHIC AREA DATA

The Company markets and distributes entertainment products internationally and through its operating subsidiaries. K-tel’s businesses are organized, managed and internally reported as two segments: retail music sales and music licensing. These segments are based on differences in products, customer type and sales and distribution methods. The Company’s consumer product and e-commerce operations have been discontinued and are presented in the accompanying financial statements as discontinued operations and are therefore not included in the segment information.

The retail music segment consists primarily of the sales of pre-recorded music from the Company’s music master catalog. The Company sells compact discs and DVDs directly to retailers, wholesalers and rack service distributors which stock and manage inventory within music departments for retail stores.

In the licensing segment, the Company licenses the rights to its master music catalog, consisting of original recordings and re-recordings of music from the 1950’s through today, to third parties world-wide for use in albums, films, television programs, commercials, and for electronic down loads to various media formats, for either a flat fee or a royalty based on the number of units sold.

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

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

BUSINESS SEGMENT INFORMATION (in thousands)

Six Months Ended December 31,		Music			Licensing			Other		Corporate Elimination		Total Company

Net Sales	2004	$	2,881		$	650		$	—	$	—	$	3,531
	2003	2,501			880			—		—		3,381

Operating Income (Loss)	2004	$	(12	)	$	(7	)	$	—	—		$	(19	)
	2003	(54		)	99			—		—		45

Assets	2004	$	4,213		$	587		$	563	$	—	$	5,363
	2003	3,771			783			197		—		4,751

Three Months Ended December 31,

Net Sales	2004	$	1,350		$	345		$	—	$	—	$	1,695
	2003	1,398			361			—		—		1,759

Operating Income (Loss)	2004	$	(67	)	$	77		$	—	$	—	$	10
	2003	(7		)	(47		)	—		—		(40		)

GEOGRAPHIC INFORMATION (in thousands)

Six Months Ended December 31,		United States		Europe		Total

Net Sales	2004	$	1,909	$	1,622	$	3,531
	2003	2,022		1,359		3,381

Assets	2004	$	2,503	$	2,860	$	5,363
	2003	2,660		2,091		4,751

Three Months Ended December 31,

Net Sales	2004	$	893	$	802	$	1,695
	2003	1,057		702		1,759

6. SUBSEQUENT EVENT

Effective October 10, 2005, K-tel, through a wholly owned subsidiary, entered into a trademark license agreement with BCI Eclipse Company, LLC (“BCI”) and effective October 16, 2005, entered into a phonograph record license agreement with BCI.

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

General

Through its operating subsidiaries, K-tel licenses its music catalog internationally and markets entertainment products mainly derived from its catalog in the United States and Europe through retail and direct response marketing channels.

Through a subsidiary, K-tel Entertainment, Inc., K-tel has a focused method of distribution that targets the strengths of selected individual retailers and supplies products suited to each retailer’s specific needs. These products are primarily derived from the Company’s master recordings music catalog with the objective of realizing more competitive profit margins. As well, the Company seeks to license its name and marks to other businesses for a royalty or fee.

A. RESULTS OF OPERATIONS

THREE MONTHS ENDED DECEMBER 31, 2004 VERSUS DECEMBER 31, 2003

Net sales for the three month period ended December 31, 2004 were $1,695,000 a decrease of 3.6% from net sales of $1,759,000 for the three month period ended December 31, 2003. This decrease was attributed to decreased music sales during the quarter ended December 31, 2004. The net income for the three month period ended December 31, 2004 was $190,000, or $.02 per share, compared to a net loss of $180,000, or $.01 per share, for the three month period ended December 31, 2003.

General corporate expenses of $170,000 and $237,000 for the three month periods ended December 31, 2004 and 2003, respectively, have been allocated to the segments.

The following sections discuss the results of continuing operations by business segment.

BUSINESS SEGMENT RESULTS

Music

Sales in the music segment were $1,350,000 for the three month period ended December 31, 2004 compared to $1,398,000 for the three month period ended December 31, 2003, a decrease of $48,000, or 3.4%. The decrease was primarily due to a decrease in music DVD sales.

Cost of goods sold in the music segment increased to 57.4% of sales for the three month period ended December 31, 2004 compared to 55.6% of sales for the three month period ended December 31, 2003. Advertising expenses within the segment, which consist primarily of co-operative advertising payments, trade advertising and promotions, increased to $40,000 for the three month period ended December 31, 2004 compared to $37,000 for the three month period ended December 31, 2003.

Selling, general and administrative expenses were $597,000, or 44.3% of sales for the three month period ended December 31, 2004 compared to $582,000, or 41.6% of sales for the three month period ended December 31, 2003. The primary reason for the increase was general and administrative expenses related to the German branch of K-tel Entertainment (UK) Ltd.

The music segment incurred an operating loss of $67,000 for the three month period ended December 31, 2004 compared to operating income of $7,000 for the three month period ended December 31, 2003.

Licensing

Licensing revenue was $345,000 for the three month period ended December 31, 2004 compared to $361,000 for the three month period ended December 31, 2003, a decrease of 4.4% reflecting reduced licensing activity. The licensing segment had operating income of $77,000 for the three month period ended December 31, 2004 compared to operating an loss of $47,000 for the three month period ended December 31, 2003, an increase of $124,000.

The Company is concentrating its efforts on building licensing arrangements in several other segments of the entertainment industry. In September 2004, the Company began licensing its master music catalog to several companies that offer electronic downloads via their internet sites.

SIX MONTHS ENDED DECEMBER 31, 2004 VERSUS DECEMBER 31, 2003

Net sales for the six month period ended December 31, 2004 were $3,531,000 compared to $3,381,000 for the six month period ended December 31, 2003. This increase was attributed to increased music sales offset by a decrease in licensing revenue. The net gain for the six month period ended December 31, 2004 was $37,000, or $.01 per share, compared to a net loss of $264,000, or $.02 per share, for the six month period ended December 31, 2003.

General corporate expenses of $343,000 and $449,000 for the six month periods ended December 31, 2004 and 2003, respectively, have been allocated to the segments.

The following sections discuss the results of continuing operations by business segment.

BUSINESS SEGMENT RESULTS

Music

Sales in the music segment were $2,881,000 for the six month period ended December 31, 2004 compared to $2,501,000 for the six month period ended December 31, 2003, an increase of $380,000, or 15.2%. The decrease in domestic sales was offset by an increase in music sales in the United Kingdom. The increase was primarily due to increased sales of an expanded product offering during the six months ended December 31, 2004.

Cost of goods sold in the music segment increased to 55.5% of sales for the six month period ended December 31, 2004 compared to 54.1% of sales for the six month period ended December 31, 2003. Advertising expenses within the segment, which consists primarily of co-operative advertising payments, trade advertising and promotions, were $67,000 for the six month period ended December 31, 2004 compared to $75,000 for the six month period ended December 31, 2003.

Selling, general and administrative expenses were $1,213,000, or 42.2% of sales for the six month period ended December 31, 2004 compared to $1,126,000, or 45.0% of sales for the six month period ended December 31, 2003. The primary reason for the increase in expenses was general and administrative expenses related to the German branch of K-tel Entertainment (UK) Ltd.

The music segment incurred an operating loss of $12,000 for the six month period ended December 31, 2004 compared to an operating loss of $54,000 for the six month period ended December 31, 2003.

Licensing

Licensing revenue was $650,000 for the six month period ended December 31, 2004 compared to $880,000 for the six month period ended December 31, 2003, a decrease of 26.1% reflecting reduced licensing activity in the United States and the United Kingdom. The Company is concentrating its efforts on building licensing arrangements in several other segments of the entertainment industry. In September 2004, the Company began licensing its master music catalog to several companies that offer electronic downloads via their internet sites.

Royalty costs within the segment decreased to $81,000 for the six month period ended December 31, 2004 compared to $160,000 for the six month period ended December 31, 2003 due primarily to the decrease in licensing revenue.

Selling, general and administrative expenses decreased to $576,000 for the six month period ended December 31, 2004 compared to $622,000 for the six month period ended December 31, 2003, a decrease of 7.4%. The primary reason for the decrease was the Company-wide effort to reduce overhead expenses.

There was an operating loss in the licensing segment of $7,000 for the six month period ended December 31, 2004 compared to operating income of $99,000 for the six month period ended December 31, 2003, a decrease of $106,000.

B. LIQUIDITY AND CAPITAL RESOURCES

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

The Company’s ability to continue its present operations is contingent mainly upon its ability to maintain its line of credit arrangements with K-5, increase its revenues and profit margins, and ultimately attain and sustain profitable operations. Without increased revenues and sustained profitability, the cash generated from the Company’s current operations will likely be inadequate to fund operations and service its indebtedness on an ongoing basis. Management is focusing its efforts on music licensing and limited music distribution. However, there can be no assurance that the Company will achieve profitable operations through these efforts. In the event the Company is unable to fund its operations and implement its current business plan properly, it may be unable to continue operations. The financial statements do not include any adjustments that might result from the outcome of these uncertainties.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in the Company’s market risk during the six month period ended December 31, 2004. For additional information, refer to the Company’s annual report on Form 10-K/A for the fiscal year ended June 30, 2004.

ITEM 4. CONTROLS AND PROCEDURES

Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company evaluated the effectiveness of the design and operation of its disclosure 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 Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were not effective because of the following material weakness in internal control over financial reporting.

The Company did not maintain effective controls over cash disbursements and payroll transactions at its UK subsidiary. In September 2004, the Company discovered that the former Chief Financial Officer of its UK subsidiary misappropriated funds from the subsidiary and one of its customers. Adjustments related to the reversal of overstated expenses and recovery of amounts misappropriated were included in the restatement of the Company’s consolidated financial statements for the years ended June 30, 2004 and 2003.

In response to the material weakness above, the Company terminated the employee, undertook a full-scale investigation of the matter, retained a forensic auditing firm and dismissed the accounting firm in the UK that audited the UK subsidiary’s financial books and records. In addition the Company hired a new Financial Controller and stringent internal control procedures were created and implemented for the Company’s purchasing, accounts payable, check signing, payroll, petty cash and financial reporting policies. Management believes that these procedures, implemented upon the discovery of the misappropriation of funds, will allow the Company to reestablish internal control over financial reporting.

During the Company’s fiscal quarter ended December 31, 2004, there had been no change in the Company’s internal control 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 likely to materially affect, the Company’s internal control over financial reporting.

PART II

ITEM 1. LEGAL PROCEEDINGS

K-tel International, Inc. vs. Tristar Products, Inc.

On March 14, 2000, K-tel and its subsidiary in Germany commenced an action for breach of express and implied warranties against Tristar Products, Inc. This action arose out of Tristar’s sale to K-tel of a defective home exercise product called the “BunBlaster” for resale in Germany, Austria and Switzerland. By written contract, Tristar agreed to indemnify K-tel for injuries and damages arising out of the resale of those goods.

Other Litigation and Disputes

Subsidiary’s Liquidation

In November 2000, the Company’s consumer products subsidiary in the United Kingdom, K-tel Marketing Ltd., ceased operations and began voluntary liquidation proceedings. At the initial meeting of the creditors on November 24, 2000, the creditors voted for the liquidation to become a creditors’ liquidation under English law. The Company has not been informed by the liquidators or their counsel of any plan to attempt to hold it or any of its subsidiaries liable for any of the commitments of K-tel Marketing Ltd. Management believes the Company will have no ongoing material liability related to K-tel Marketing Ltd. as a result of the liquidation proceeding. As the only secured creditor, the Company received distributions of approximately $138,000 on March 1, 2004 and $76,000 on May 14, 2004.

In addition to the $214,000 from the liquidation of K-tel Marketing LTD., the Company also received approximately $333,000 in fiscal 2004 from the sale of assets and account receivable collections related to the March 2001 bankruptcy of K-tel International, (USA), Inc.

ITEM 6. EXHIBITS

See “Index to Exhibits.”

SIGNATURES

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

		K-TEL INTERNATIONAL, INC.
		REGISTRANT


Dated: September 18, 2006		/S/ PHILIP KIVES
		PHILIP KIVES
		CHAIRMAN AND CHIEF EXECUTIVE OFFICER


Dated: September 18, 2006		/s/ LARRY DUNMALL
		LARRY DUNMALL
		CHIEF FINANCIAL OFFICER

INDEX TO EXHIBITS

Exhibit No.		Description of Exhibit

31.1		Certification by Chief Executive Officer pursuant to Rule 13a-14(a).

31.2		Certification by Chief 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 Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sabanes-Oxley Act of 2002.