U.S. SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-KSB

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

For the fiscal year ended July 31, 1998           Commission file number 0-28158

                             KIDEO PRODUCTIONS, INC.
                 (Name of small business issuer in its charter)

             DELAWARE                                       13-3729350
             --------                                       ----------
  (State or other jurisdiction of                        (I.R.S. Employer
  incorporation or organization)                        Identification No.)

     611 BROADWAY, SUITE 523
        NEW YORK, NEW YORK                                   10012
     -----------------------                                 -----
(Address of principal executive offices)                  (Zip Code)

                     Issuer's telephone number 212-505-6605
       Securities registered under Section 12(b) of the Exchange Act: NONE
         Securities registered under Section 12(g) of the Exchange Act:

                                                      Name of each exchange
       Title of each class                            on which registered
       -------------------                            -------------------

COMMON STOCK, par value $0.0001 per share                     None
REDEEMABLE WARRANTS, exercisable at $4.00
per share of Common Stock for 4 years 
commencing June 24, 1997                                      None

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 |X| No |_|

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. |_|

The issuer's revenues for its fiscal year ended July 31, 1998 were $2.0 million.
As of October 9, 1998, 3,775,886 shares of Common Stock were outstanding (of
which 1,147,052 shares were held, either directly or indirectly, by affiliates
of the Company) and 1,610,000 Redeemable Warrants were outstanding. Based upon
the average closing bid and asked prices of the Common Stock on Nasdaq on
October 9, 1998, the aggregate market value of the shares of Common Stock held
by non-affiliates was approximately $2.8 million. In making this computation,
all shares known to be owned by directors and executive officers of the issuer
and all shares known to be owned by other persons holding in excess of 5% of the
issuer's Common Stock have been deemed held by "affiliates" of the issuer.
Nothing herein shall prejudice the right of the issuer or any such person to
deny that any such director, executive officer or stockholder is an "affiliate."

Transitional Small Business Disclosure Format (check one):  Yes |_|; No |X| .


                                       1
<PAGE>

                                     Part 1

Item 1. Business

General

      In its nearly five year history, Kideo Productions, Inc. has succeeded in
developing proprietary technologies and production processes which have made it
a low-cost manufacturer of a new category of home entertainment products:
digitally photo-personalized home videos ("Kideos") and photo-personalized
books. Since commercially launching its first photo-personalized video products
nationally in the spring of 1994, the Company had focused primarily on producing
and marketing Kideo products for children aged two to seven featuring
proprietary content and characters developed and owned by Kideo. In 1997,
however, the Company obtained licenses (the "Barney Licenses") to manufacture
and sell photo-personalized home videos and books featuring Barney, the dinosaur
character from the highly-rated children's television series "Barney and
Friends"; and in that same year the Company also obtained a license (the "Disney
License") from The Disney Publishing Group providing for the release of four
English language photo-personalized books featuring certain characters owned by
the Walt Disney Co. With its existing photo-personalized product lines targeting
the children's market, the Company has created a unique product niche in the
children's home entertainment market.

      In the Company's photo-personalized products, a child's face and name are
digitally placed by a PC-based production system into a story template that has
been digitally stored. The digital content is then output to either analog video
or a printed format, allowing the child to become the star in a personalized VHS
videocassette or book.

      The Company currently markets nine proprietary personalized video titles
for children, including one photo-personalized Barney home video, one
photo-personalized Barney book. The Barney Licenses provide for the of two
additional photo-personalized Barney books.. The Company has the right to market
its Barney video title for the five-year period ending June 30, 2002 and its
Barney books for the five-year period ending September 30, 2002. The Disney
Licence provides for the release by the Company of four English language
photo-personalized books featuring Disney's standard characters (i.e., Mickey
Mouse, Minnie Mouse, Donald Duck, Daisy Duck, Pluto and Goofy) and characters to
be designated by Disney from the popular animated motion pictures "The Lion
King" and "Toy Story". Two of the Disney Books are required to be early learning
books and two are to be original story books. The Company has the rights to
distribute the four Disney Books until April 30, 2000 in Canada and the United
States and its territories and possessions.

      For its fiscal years ended July 31, 1997 and July 31, 1998, the Company
had net losses of approximately $3,819,000 and $2,730,000, respectively, and it
had an accumulated deficit of approximately $11,899,000 as of July 31, 1998. The
report of independent accountants on the Company's consolidated financial
statements for the fiscal year ended July 31, 1998 contains an explanatory
paragraph stating that the Company's consolidated financial statements have been
prepared assuming that the Company will continue as a going concern, while
noting that the Company's recurring losses from operations and net working
capital deficiency raise substantial doubt about its ability to continue as a
going concern. The consolidated financial statements do not include any
adjustments that might result should the Company be unable to continue as a
going concern.

      The Company claims proprietary rights in its technologies and production
process. In April 1997, the Company was issued a U.S. patent relating to its
digital personalization production process (Patent No. 5,623,587). The Company
believes that this patent could potentially have substantial value, since the
Company expects that businesses owning characters that are popular in the
children's home video and television markets will ultimately seek to exploit
those characters in digitally personalized audiovisual products.

      Prior to 1997, the Company had marketed six Kideo titles (the "Original
Kideos"), which were created utilizing the first generation of the Company's
proprietary computerized production process. That production process resulted,
in general, in a videocassette product that might be likened to a "video
picturebook" - the child's personalized character appearing in an Original Kideo
is capable of only a very limited range of partial-motion animation.

      In January 1997, the Company began marketing the first two titles in its
new series of Gregory and Me Kideos. The Company created these titles utilizing
a newly implemented proprietary production system. As a result of the improved
computerized production technologies employed by this system, in a Gregory and
Me title the child's photo-personalized character can exhibit two-dimensional
full-motion animation and can be made to interact with both two-dimensional
animated versions and three-dimensional puppet versions of the Gregory and Me
cast of proprietary


                                       2
<PAGE>

characters -- who in each title are led by Gregory Gopher. It is this recently
patented production process -- a sophisticated technological system for the low
cost, mass production of digitally photo-personalized videos and books -- which
the Company believes will provide it with a meaningful near-term competitive
advantage over new entrants into the emerging market for digitally
photo-personalized home entertainment products.

      Each of the Original Kideos and Gregory and Me Kideos utilizes a
digitally-stored video story template that features content and characters which
are proprietary to the Company. The eight existing Kideo titles each has a
playing time of approximately 20 minutes and a suggested retail list price of
$29.95 to 34.95. The Company believes, however, that more than half of all
Kideos sold by its vendor-based customers have been offered at an actual retail
price of $34.95 or higher. To date, substantially all Kideos sold have been
purchased by U.S. consumers. The Company historically has relied primarily on
national catalogue retailers (such as Hammacher Schlemmer) to market and sell
its products. However, the Company has increasingly been targeting its marketing
strategies towards direct-to-consumer advertising and most recently with
electronic retailers ( such as Home Shopping Network ("HSN") and QVC, Inc.).

Operating Strategy

      During 1997, the Company determined to focus its near-term development
efforts for new digitally photo-personalized products increasingly upon the
creation of titles featuring licensed characters (instead of proprietary ones)
that have proven popularity in the children's home video market. In furtherance
of that objective, the Company in 1997 obtained the Barney Licenses (which allow
for the use of the Barney character in one photo-personalized home video and
three photo-personalized books) and the Disney License (which allows for the use
of certain Disney characters in four English language photo-personalized books).
In order to advance that objective, the Company also is currently seeking out
licensing, marketing and other arrangements with companies that control similar
types of characters and/or that have the demonstrated financial and operational
capabilities to promote and distribute children's home video products through a
broad range of domestic distribution channels, including retail outlets of
various kinds. The Company, however, is not currently seeking, or engaged in
negotiations concerning, any arrangements that relate to any merger,
consolidation, purchase or sale transaction involving the Company, any of its
assets or any other business.

      The Company's long-term business strategy is to become a premier market
leader, both domestically and internationally, in the development, manufacturing
and marketing -- to children and other consumers -- of a wide variety of
digitally photo-personalized home video titles, other photo-personalized
audiovisual products, photo-personalized books, and related articles of
merchandise (both personalized and non-personalized). Included among the
Company's product development goals are:

      -     to develop additional photo-personalized home video and book titles
            for children employing both proprietary and licensed characters; and

      -     to develop other digitally personalized audiovisual and printed
            products likely to appeal to a demographic base spanning both
            children and adults, such as personalized screen savers and other
            personalized software products for personal computers.

      In addition, the Company will in general continue to seek to expand its
product line by exploiting more sophisticated digital personalization
technologies, as they become available, in order to offer to consumers
progressively more sophisticated and entertaining personalized media products.

Technology Overview

      The production of Kideos was made possible by relatively recent
advancements in the capabilities of affordable desktop personal computers
("PCs") to process, manipulate and edit digital video information. A
photo-personalized Kideo product is created by the following process: overlaying
a digitized photographic image of a child's face onto the body of an illustrated
character embodied in a pre-existing, digitally-stored template; and then
outputting the resulting series of digital images to either an analog VHS
videocassette or a printed format. That process, in the production of a
photo-personalized VHS videocassette, is synchronized with accompanying musical
and narrative soundtracks. The narrative track is also personalized in
appropriate places by inserting the spoken name of the child. In the book
format, the printed images of the photo-personalized child's character are
accompanied by text into which that child's name also has been digitally
inserted. In the future, the Company's current production technologies will
enable it to manufacture its photo-personalized products in digital versatile
disk ("DVD") and other digital formats.


                                       3
<PAGE>

      The three older titles of those comprising the Original Kideos -- Mr.
Tibbs & the Great Pet Search; My Alphabet; and 1,2,3, Come Count With Me -- were
conceived and produced by the Company prior to the Company's development of its
recently patented digital personalization production process, using a less
advanced production system (referred to herein as the "TVL system"). These three
Kideo titles consist of 130 to 150 two-dimensional full-screen illustrated
images (or "frames") in which the child appears as the main character together
with other illustrated characters who comprise the standard content of the
particular title. In the three Kideo titles produced with the TVL System, the
illustrated body of the child's personalized character can be moved around
within a frame, but only in a limited number of frames, and each frame appears
on screen for almost six seconds before fading to the next frame. As a result,
the finished Kideo product has an appearance that might be likened to a "video
picturebook," as distinguished from the full-motion animation a consumer
experiences when viewing, for example, a videocassette of Disney's The Lion
King. During the second half of 1996, the Company ceased producing the three
older Original Kideos on the TVL system and began manufacturing them using the
digital personalization production process currently used by the Company.

      The fourth of the Original Kideo titles is My Christmas Wish. First
introduced to the market in the latter half of 1995, this title was the first
Kideo to be produced by the Company utilizing a newly-implemented system for the
production of digitally personalized videos. Because the Company utilized some
of the new and more advanced production technologies available to it with such
system, the two-dimensional illustrated body of the child's personalized
character in this title exhibits a significantly greater range of animated
motion -- although still not full-motion animation. In My Christmas Wish, not
only can the illustrated character be moved around the screen, but there is also
movement within the illustrated body itself (i.e., arms can be raised, the head
turned, etc.).

      In January 1997, the Company introduced to the market the first two titles
of the Gregory and Me series of Kideos - See What I Can Do! and My Amazing
Animal Adventure. In creating these two titles, the Company utilized some of the
more advanced production capabilities afforded by its new digital
personalization production process. As a result, in the first two Gregory and Me
Kideos, the illustrated body of the child's personalized character exhibits
two-dimensional full-motion animation (instead of merely partial-motion
animation) and is able to interact with both two-dimensional animated versions
and three-dimensional puppet versions of the Gregory and Me cast of proprietary
characters.

      The Company most recently employed these same advanced production
capabilities in creating its first photo-personalized Barney home video title --
"My Party with Barney" -- which the Company debuted through direct- response
promotions on the HSN and QVC television channels and is currently selling
through all marketing channels.

      The Company's ultimate objective for the evolution of its digital
personalization production process, however, is to create a manufacturing system
capable of producing, at low cost, photo-personalized videos -- as well as other
digitally personalized consumer media products -- in which the customer's
personalized character can exhibit two dimensional or three dimensional
full-motion animation in both its illustrated body and in the features of its
personalized facial image (e.g., moving eyes and eyebrows and lips that move in
synchronization with sound). There can be no assurance, however, that the
Company will ever succeed in developing a production system capable of producing
products with such features at a cost acceptable to the Company. For instance,
while the Company believes that, at the present time, there are existing
technologies that could be used to produce products with such features, the
Company believes that costs currently associated with such production would make
those products far too expensive for the broad-based consumer market.

Production of Kideo Products

      The Company's current digital personalization production process was
developed in order to further the Company's ultimate objective of creating
digitally personalized products featuring two-dimensional and three-dimensional
full-motion animation. The new production system (which is based upon the use of
affordable, networked IBM-compatible PCs) produces Kideos by employing PC
hardware, proprietary computer software and proprietary production technologies
and components in combination with various commercially available multimedia
production software applications.

      The Company claims proprietary rights in its production technologies and
processes. In April 1997, the Company was issued a U.S. patent relating to its
digital personalization production process (Patent No. 5,623,587). The Company
believes that this patent could potentially have substantial value, since the
Company expects that 


                                       4
<PAGE>

businesses owning characters that are popular in the children's entertainment
markets will ultimately seek to exploit those characters in digitally
personalized audiovisual products.

The Company first used its current digital personalization production process in
the development of My Christmas Wish. As a result, this title became the first
Kideo title in which the illustrated body of the child's personalized character
is able to exhibit actual two-dimensional partial-motion animation. The new
Kideo production system is already capable, however, of producing an even wider
range of motion than that exhibited by the personalized character in My
Christmas Wish. The more advanced technologies utilized in the new system make
it possible to produce a personalized video in which (i) the illustrated body of
the child's personalized character can exhibit two-dimensional full-motion
animation and (ii) the personalized facial image of the child's character can
exhibit at least some limited motion, such as eyes that blink and lips that move
up and down (although not necessarily in synchronization with the soundtrack).
The Company expects that these improvements in the features of its Kideos will
enable it to produce new titles that will be more entertaining and engaging for
the child for whom a Kideo is purchased. To date, however, the Company has not
made use in any Kideo titles of the capability to achieve partial animation of
the personalized facial id's character. It is anticipated that this feature
improvement will first be implemented at some time during 1999 in connection
with a future title featuring popular children's characters licensed from others
(the development of which cannot be assured).

Product Fulfillment

      The Company designs, develops and produces its Kideo personalized video
products as finished goods at its New York City facility, without employing any
subcontractors in the production process. Pre-paid Kideo order kits are shipped
to the Company's customers from third-party fulfillment centers. The components
used in the production of the Company's photo-personalized videos (e.g., P.C.s,
commercially available multimedia production software applications, and VHS
videocassettes and related labels and packaging) are readily available to the
Company from a large number of competitively priced suppliers. Once ordered, a
personalized Kideo is produced and shipped to the customer generally within two
to four weeks after the order is received. There is consequently no meaningful
backlog.

      The Company believes that it currently has the production capacity,
personnel and other resources required in order to produce and deliver its
existing Kideo products on a timely basis and in accordance with the Company's
estimated demand for its products. This belief is derived in large part from the
nature of the Company's new production system, which is comprised of modular
production stations. In the event of increased demand for its Kideos, the
Company's experience has been that one or more production stations can be added
and the related production personnel trained in about one week. In addition,
because the Company sells a Kideo by first selling the order kit for the desired
title, the Company at any point in time can accurately forecast the short-term
demand for its products based upon the number of Kideo order kits in
circulation. As a result, the Company believes that it can anticipate a need to
add new Kideo production stations reasonably in advance of having actually to
meet any increased future demand for its products.

The Existing Kideo Titles

      The six Original Kideo titles (Mr. Tibbs & the Great Pet Search; My
Alphabet; 1,2,3, Come Count With Me; My Christmas Wish; Mystery of the Missing
King; and Space Ace ) and the first two Gregory and Me titles (See What I Can
Do! and My Amazing Animal Adventure) all feature characters developed by the
Company - respectively, Mr. Tibbs, Alexander G. Bear, Counting Cat, the
Company's own version of Santa Claus and, in each Gregory and Me title, a cast
of animal characters consisting of Gregory Gopher (the "host" of each title),
Cyrus, Shelly, Ziggy and Zag. Each personalized video title is approximately 20
minutes in length.

      Each of the nine personalized video titles now being marketed has been
designed to take advantage of the power of video personalization to stimulate
the imagination of children by literally placing them in exciting and
educational situations where they can see themselves learning and having fun.
They ride on the back of a hippo while counting four turtles in a boat; they
learn about the letter "L" by leapfrogging over Alexander G. Bear; and they dive
beneath the sea to meet a tortoise. Mr. Tibbs even asks, "Sarah, would you like
a zebra for a pet?" In My Amazing Animal Adventure, the child at one point sees
her personalized character riding in a canoe with a three-dimensional puppet
version of Gregory Gopher, who calls her attention - addressing her by name - to
various animals they are passing on the river.

      In addition to the child's face appearing throughout his or her
personalized Kideo, the child's name is spoken in various appropriate places on
the Kideo soundtrack. The Company maintains an extensive digital archive of the
audio


                                       5
<PAGE>

recordings of the spoken first names of all of its child-customers. The archive
is updated on a regular basis as new Kideo orders are received which require the
recording and insertion of a name not then in the Company's database. In its
Kideo order kits and other marketing materials, the Company makes a commitment
to its potential customers to produce a Kideo in which any specified name of a
child will be spoken on the Kideo to that child's personalized character. The
child's name is also printed on the outside cover of each tape (which is
packaged in a white vinyl album cover), as well as on the label of the tape
itself. The tape shells come in assorted bright colors.

      Each of the existing Kideo titles currently has a suggested retail list
price of $29.95 to $34.95. The Company believes, however, that more than half of
all Kideos sold to date by its vendor-based customers have been offered at an
actual retail price of $34.95 or higher, and the Company is considering raising
its suggested retail list price to $34.95 in the near future.

Photo-Personalized Products Featuring Barney the Dinosaur and Disney Characters

      In March 1998, the Company began selling on HSN and QVC its first
photo-personalized Barney home video title -- "My Party with Barney." In this
17-minute home video, the photo-personalized child character interacts with
Barney, one of the most popular children's market characters in America and the
star of the highly-rated children's television series "Barney and Friends." "My
Party with Barney" takes advantage of all of the sophisticated production
technologies and features that the Company has used in the production of the
Gregory and Me series of Kideos. This title is packaged similarly to the Gregory
titles in a personalized vinyl videocassette cover. The suggested retail list
price for "My Party with Barney" is $34.95. Under the Barney Licenses, the
Company has the right to market "My Party with Barney" for the five-year period
ending June 30, 2002.

      The Company believes that the proven broad appeal of Barney products in
the Company's targeted demographic market will contribute to making this video
title its most successful ever. In the consumer marketplace, Barney has become
one of the most popular children's characters of all time. The Barney television
series is currently the number one ranked series among children from two to five
years old. Barney also is currently the number one ranked character in the
children's home video market, in which sales of Barney titles account for
approximately 17% of all children's non-theatrical home video titles.

      In the spring of 1998, the Company introduced on the shopping network
stations (HSN and QVC) the Kideo title "My Party With Barney". A 15 minute
promotional spot was broadcast by HSN six times during a 48 hour period. In
response, over 9,000 orders were received for this title. In comparison, for the
fiscal year ended July 31, 1997 the Company had total sales of approximately
$1,346,000. Through July 31, 1998, orders for prepaid Kideo order kits by HSN
and QVC were approximately $1,637,000 (most of which represented orders for "My
Party With Barney"). This recent experience has reaffirmed the Company's belief
that it may be able to exploit significant sales opportunities through the
creation of Kideos that, like "My Party with Barney," feature licensed
characters that have proven popularity in the children's home video market.

      The Barney Licenses also permit the Company to market three
photo-personalized Barney books over the five-year period ending September 30,
2002. The first of these books, "Barney's Alphabet Adventure With Me," was
released in late spring 1998. It is a 24-page, laminated hardcover book in which
the child's image is digitally printed throughout, accompanied by the insertion
of the child's printed name in the text of the story. Through July 31, 1998, the
Company had sold over 12,000 copies and had orders for an additional 2,000
copies.

      The Company believes that the proven broad appeal of Barney products in
the Company's targeted demographic market will contribute to making this book a
successful new product. Since 1993, over 34 million Barney books have been sold.
The latest "All-Time Bestselling Hardcover Children's Book Lists" according to
Publisher's Weekly includes 27 Barney book titles.

      Under the Barney Licenses, the Company has the right to market its Barney
video title for the five-year period ending June 30, 2002 and its Barney books
for the five year period ending September 30, 2002. In each case, the Company's
distribution rights extend to Canada and the United States and its territories
and possessions. With respect to Barney video titles, the Company's
manufacturing rights are limited to the production of videos in the NTSC format
only. Within 60 days after the one-year anniversary of the first release of "My
Party with Barney", Kideo and Lyons Partnership, L.P. ("Lyons"), the licensor of
the Barney characters, are to negotiate in good faith regarding the potential
grant of a license by Lyons to the Company for the manufacture and distribution
of additional videos featuring Barney characters. On sales of videos and books
pursuant to the Barney Licenses, the Company is obligated to pay to Lyons, on a
quarterly basis, certain specified royalties (at rates believed by the Company
to be


                                       6
<PAGE>

customary in the home video and book publishing industries for licensing
transactions of similar nature). Lyons' royalty rates for video and book sales
are subject to a specified dollars-and-cents minimum royalty per unit sold. In
the case of video sales, Lyons' royalty rates will increase as certain specified
unit sales levels are exceeded.

      The Company's newly licensed Disney book entitled, Simba and Me in "A
Friend to Count On", featuring Disney characters from the feature film The Lion
King, debuted on QVC October 17, 1998.

      The Disney License provides for the release by the Company of four English
language photo-personalized books featuring Disney's standard characters (i.e.,
Mickey Mouse, Minnie Mouse, Donald Duck, Daisy Duck, Pluto and Goofy) and
characters to be designated by Disney from the popular animated motion pictures
"Disney's The Lion King" and "Toy Story". Two of the Disney Books are required
to be early learning books and two are to be original stroy books. The Company
has the rights to distribute the four Disney Books until April 30, 2000 in
Canada and the United States and its territories and possessions. The Company's
rights under the Disney License are nonexclusive; accordingly, Disney could
license any of its characters to third parties for the creation of different
photo-personalized books (the Company's rights being exclusive during the
contract's term with respect to the publication and sale of the Disney Books
created by it under the Disney License). The Disney Books are required to be
hardcover books and are to be of a type and quality designed to sell at a
suggested retail price of $19.95; the Company, however, has the absolute
discretion to price each book as it deems appropriate. As partial consideration
for the rights granted by Disney under the Disney License, the Company paid
Disney $30,000, along with a stand by letter of credit in the amount of $75,000
as an advance against the royalties payable to Disney thereunder. On sales of
the Disney Books pursuant to the Disney License, the Company is obligated to pay
to Disney, on a monthly basis, certain specified royalties (at rates believed by
the Company to be customary in the book publishing industry for licensing
transactions of similar nature), subject to (i) a specified dollars-and-cents
minimum royalty per unit sold and (ii) guaranteed aggregate minimum royalties
paid to Disney during the contract's term of $100,000.

Potential Future Products

      There can be no assurance that the Company will ever be successful in
developing any of the potential new products described below (or their
associated production methodologies), that it will have the financial and other
capabilities required to commercialize such new products, or that any of such
products, if commercialized, will be successfully marketed by the Company or
contribute materially to the Company's future revenues or profits (if any).

Near-Term Product Development Goals

      From among the many conceivable new product opportunities envisioned by
the Company, it currently intends, in the short- to near-term, to continue to
direct its product development efforts towards the market segment that it
believes it has largely created and accordingly knows best -- the home-consumer
market for digitally personalized products that are essentially videos, books
and other digitally photo-personalized printed products (as opposed to, for
example, computer games or other computer software titles, such as personalized
computer screen savers). Examples of the types of new products currently being
investigated by the Company include photo-personalized puzzles, calendars and
posters. The Company does not expect, however, to be able to commercialize any
of those products for introduction to the markets until late in the 1998
calendar year at the earliest.

Kideo Related Merchandise. By using proprietary content and characters to expand
its line of Kideos, the Company believes that it may be able to leverage the
investment it makes in the creation of such characters into an additional
revenue stream, i.e., by selling related merchandise featuring those same
characters. Mr. Tibbs, Alexander G. Bear and Counting Cat, for instance, could
all be produced as plush stuffed-animal toys or could be featured in children's
coloring books and work books. The Company currently is marketing a plush toy
version of Gregory Gopher as well as an audio cassette containing the songs that
are sung by Gregory Gopher, Cyrus, Shelly, Ziggy and Zag in See What I Can Do
and My Amazing Animal Adventure.

Photo-Personalized Videos Featuring Popular Licensed Characters. Although the
Company historically has focused on the development and exploitation of its
proprietary content, it has not ignored potential opportunities to expand its
line of Kideos to include titles featuring licensed characters that are popular
in the children's market. Since the Company's successful implementation of its
new production process in the manufacturing of the "My Party with Barney"
photo-personalized home video titles, the Company has increasingly devoted
management resources to the development in the near-term of Kideo titles
featuring licensed characters. In furtherance of that development objective, the
Company is currently seeking out licensing, marketing and other arrangements
with companies that control those types of characters and/or that have the
demonstrated financial and operational capabilities to promote


                                       7
<PAGE>

and distribute children's home video products through a broad range of domestic
distribution channels, including retail outlets of various kinds. In a Kideo
title featuring licensed characters, the child's personalized character could
conceivably appear alongside and interact with animated characters (e.g., Rug
Rats, Blues Clues and Bugs Bunny) or live-action characters (e.g. Big Bird).

      To date, however, the Company has not entered into any definitive
agreements with respect to the licensing of any such characters, and there can
be no assurance either that any such licenses will be made available to the
Company or that, if made available, they will be offered on terms and conditions
that are acceptable to the Company.

      In pursuing these product development goals, the Company is not currently
seeking, or engaged in negotiations concerning, any arrangements that relate to
any merger, consolidation, purchase or sale transaction involving the Company,
any of its assets or any other business.

Longer-Term Product Development Goals

      The Company believes that, over the course of the next decade or so, the
digital/electronic audiovisual media industries will experience significant
growth and that this growth could present businesses employing technologies like
those the Company has developed with numerous opportunities to apply digital
personalization to virtually any popular media content. While no assurance can
be given to this effect, such opportunities could someday in the future result
in consumer products that might conceivably include personalized computer screen
savers, personalized interactive video games or even personalized interactive
television programming. In order to capitalize on such opportunities, it is part
of the Company's long-term strategy for the development of future products to
create digitally personalized audiovisual products that are likely to appeal to
a broad demographic base, spanning both children and adults. The Company also
intends to continually seek to expand its product line by exploiting more
sophisticated digital personalization technologies, as they become available, in
order to offer progressively more sophisticated and entertaining personalized
media products.

Research and Development Expenditures

      In the fiscal years ended July 31, 1998 and 1997, the Company's
expenditures on research and development activities totaled approximately
$215,000 and $374,000, respectively.

Marketing

      General

      The Company believes that it has developed important sales and
distribution relationships with some of the country's most respected catalog
retailers, electronic retailers (TV shopping networks) and retail stores. Kideo
order kits have been available for purchase at various times through HSN, QVC
and such national mail order catalogs as Hammacher Schlemmer, Spiegel, Personal
Creations, Fingerhut, Celebration Fantastic, One Step Ahead, Johnson Smith, Just
Between Us, Critics Choice Video and Troll Learn & Play. Since the Company first
began marketing its products, sales through catalog retailers have historically
been the primary distribution outlet for Kideos. More recently, however,
electronic sales and direct- to-consumer sales have increased substantially, as
the Company has explored and tested various types of direct marketing campaigns
(including television, radio and direct mail). With the objective of reducing
overall selling expenses while sustaining steady growth, in 1998 the Company's
direct marketing efforts consisted largely of a combination of low cost
direct-to-consumer sales achieved through marketing and promotional partnerships
with third parties, and direct marketing programs that have historically yielded
profitable returns.

      Electronic Sales (TV Shopping Networks)

      In March of the fiscal year ended July 31, 1998, the Company's products
debuted on HSN and subsequently on QVC and the Canadian Home Shopping Station
with great success. A 15 minute promotional spot was broadcast by HSN six times
during a 48 hour period. In response, over 9,000 orders were received for "My
Party with Barney". Electronic sales accounted for approximately 51% of the
Company's revenue for the fiscal year ended July 31, 1998. Through July 31,
1998, orders for prepaid Kideo order kits through HSN and QVC were approximately
$1,637,000 (most of which represented orders for "My Party With Barney").


                                       8
<PAGE>

      Catalog Sales

      During the fiscal year ended July 31, 1998, catalog sales accounted for
approximately 14% of the Company's revenues. The Company believes that the
initial placement of Kideo information in mail order catalogs resulted largely
from the Company's engagement of an independent national catalog representative
who represents over forty catalogs nationwide. This representative (who is still
being utilized by the Company) receives commissions based on the net sales
proceeds generated by its product placements.

      Because of the success generally experienced through Hammacher Schlemmer
and other catalog retailers who were among the first to offer Kideos in their
catalogs, the Company currently is finding it increasingly easy to convince
other catalog retailers to feature Kideos in their publications. Since the start
of the 1996 Fiscal Year (August 1, 1995), the number of nationally distributed
catalogs in which Kideos were marketed increased from 14 at the start of such
year to approximately 27 currently. For the foreseeable future, the Company will
continue to target major catalogs as potential new marketing outlets for Kideos.
The Company's launch of its new products featuring the well-known licensed
character, Barney, has generated interest on the part of current and new catalog
accounts in the Company's product lines.

      In October 1997, the Company mailed the first edition of The Kideo
Catalog, a sixteen page four-color consumer catalog featuring the Company's full
line of personalized and non-personalized products. In the fiscal year ended
July 31, 1999, the Company plans to mail two editions of The Kideo Catalog to
both the Company's past customers, and various outside lists of consumers that
closely match the Company's typical customer profile. The next edition of The
Kideo Catalog to be mailed is expected to be the holiday edition in fall 1998,
and it will prominently feature Barney and Disney products both inside the
catalog and on the cover.

      Direct Sales

      Direct sales to consumers accounted for approximately 34% of the Company's
revenues for the fiscal year ended July 31, 1998 (as compared to approximately
56% of revenues for the prior fiscal year). During the fiscal year ended July
31, 1998, the Company experienced an 8% decrease (to $694,000) in
direct-to-consumer sales as compared to the corresponding period in the prior
fiscal year. The Company believes that this decrease reflects the overall
cost-effective savings cut back in response to unprofitable promotions spending
of the Company's direct marketing activities (including television and radio
advertising, direct mail campaigns, and publicity efforts).

      The Company believes that its direct-to-consumer sales in Fiscal 1999 will
benefit also from a higher level of consumer awareness resulting from television
(direct TV advertising and electronic sales) and print exposure of the Company
and its products. The Company has benefited from significant media attention due
to both the popularity of the Barney character and the release of the first
Barney feature film, Barney's Great Adventure, with which the Company had timed
the launch of its Barney products to coincide. The Company believes this
exposure will contribute positively to its direct-to-consumer sales. In the fall
of 1998, the Barney film was released on video and included a trailer at the
beginning of the movie of a Kideo spot along with an insert of a Kideo order
form.

      Beginning with the launch of the Company's line of personalized Barney
products in April 1998, the Company's plan is to rely largely on low-cost
cooperative direct marketing efforts that the Company is currently developing
with various marketing and promotional partners. For the Barney product launch
the Company has partnered with various entertainment and consumer product
companies to make the Company's products available through in-store promotions,
package inserts, and assorted other programs. Promotional partners include
Lyrick Studios (Kideo order forms in Barney home video; Kideo trailers on Barney
home videos; mailings to 800,000 member Barney fan club), Kodak (Kideo offers at
Kodak Qualex photo-finishing locations), and Polygram Filmed Entertainment
(promotional trailer and inserts in 4.5 millions "Barney's Great Adventure" home
videos). The Company intends to use the personalized Barney product marketing
plan as a model for future direct-to-consumer marketing efforts.

      Retail Distribution

      To date, sales of Kideos through retail toy stores and other retailers
have not been a significant source of revenues. For the 1998 Fiscal Year, sales
of Kideos through retail outlets accounted for less then 1% of the Company's
revenues. In March 1994, the FAO Schwarz flagship store on Fifth Avenue in New
York City became the first retail store to market


                                       9
<PAGE>

the Company's products. The store used an in-store display that provided order
kits for Kideos. Most retailers typically sell a Kideo order kit for $34.95 to
$39.95.

Customer Satisfaction and Service

      A Kideo customer's satisfaction is guaranteed by the Company in that, if
unhappy with the product, the customer may return it until the Company has
produced and delivered a satisfactory replacement Kideo. Even with this policy,
refunds have historically been negligible.

      The Company provides its customers with the opportunity to track the
status of their Kideo orders by utilizing the Company's automated, toll-free
telephone response system (the "Customer Response System"). A customer who
orders a Kideo receives his or her order number for it from the Kideo order kit
that was purchased. When the Company receives that order kit, it creates a
digital, computerized version of the order (including the corresponding order
number) together with a physical bar-coded version (which also embodies the
order number information). At each stage of the Company's manufacturing process
of that particular Kideo, the bar-coded physical order is manually "swiped"
through an optical scanner, resulting in the computerized version of the order
being updated as to what stage that customer's Kideo is at in the production
process (e.g., the child's voice has been recorded and/or inserted into the
title; the child's face has been digitized; etc.). Because the Company's
production system is fully computerized and networked, when that customer calls
the toll-free number and inputs his order number, the Company's customer service
operator can respond almost immediately with the status of the order in question
after checking the appropriate computer database.

Competition and Industry Background

      The Company believes that the market for digitally personalized video
media -- although only in its development stages -- will likely evolve into a
highly competitive market. The technologies which have enabled the production of
digitally personalized video products utilizing relatively low cost PC hardware
and software (as opposed to more expensive computer workstations and larger
computer systems) have only been available since approximately 1993. As a
result, there is relatively limited information available concerning the
potential market and demand for personalized video media products or concerning
the performance and prospects of companies seeking to do business in this new
and largely untested market.

      To the Company's knowledge, at present there is only one other company
marketing personalized video media of any kind: U.R. The Star ("URTS"). URTS, a
Florida-based company, has been in the personalized video business since 1993.
The Company believes that URTS currently offers six stories, each having a
suggested retail list price of $19.95. Although the URTS product features a
combination of two-dimensional and three-dimensional partial motion animation,
the Company does not believe that these products compete effectively with Kideos
on the basis of quality. While each URTS tape is approximately 12 to 15 minutes
long, for example, the child's face will appear on-screen only for a total of
approximately 60 seconds. Several minutes can pass without the child's face
appearing at all. The Company does not believe that URTS engages in substantial
marketing of its stories through major national catalog retailers, direct
mail-order solicitations or television advertising.

      There are numerous other companies involved in video media production who
could possibly enter the personalized market segment in which the Company is
doing business. Many of such companies have substantially greater financial,
technical, research, development, production, marketing and other resources than
those of the Company. Although the Company believes -- based upon the technical
expertise it has developed in its market and the quality, price and features of
its products -- that it will be able to compete favorably with its existing and
future competitors, there can be no assurances in this regard. In light of the
fact that the personalized video media business is in the earliest stages of its
development, there also can be no assurance that existing or future competitors
of the Company will not develop technologies and products that are significantly
superior to those of the Company, or that their products will not gain
substantially greater market acceptance, or that developments will not
ultimately render the Company's technologies obsolete or its products
unmarketable.

      Despite risks of this nature, the Company believes that its recently
patented digital personalization production process will provide it with a
meaningful short-term to near-term competitive advantage over new entrants into
the emerging market for digitally personalized video products. The Company does
not believe that even well-financed potential competitors will be able, in a
relatively short period of time, to successfully research, develop, test and
implement production systems capable of low-cost mass production of digitally
personalized videos.


                                       10
<PAGE>

Intellectual Property Rights

      The Company believes that its prospects for success depend more upon the
dedication, knowledge, ability, experience and technological expertise of its
employees than upon any legal protection that may be afforded to the Company's
proprietary rights.

      The Company claims proprietary rights in various technologies (including
hardware and software), videos, cartoon characters, music, text, graphic images,
techniques, methods and trademarks which relate to the Company's products and
operations. Like many computer-related technology companies, the Company seeks
to protect such proprietary rights by relying upon a combination of patent,
trade secret, copyright, trademark and unfair competition laws and various
contractual restrictions, including confidentiality and non-disclosure
agreements.

      Although the Company intends to protect its rights vigorously, there can
be no assurance as to the degree of legal protection that may be afforded to the
proprietary rights claimed by the Company. It is possible, for example, that
trade secrets may not be established, that secrecy obligations will not be
honored or enforceable, or that other parties will independently develop
technologies or processes that are similar or superior to those of the Company.
It is also possible that a consultant or other third party engaged by the
Company might independently develop certain technological information which such
party then applies to one of the Company's own technological processes. In such
an event, a dispute could arise as to the ownership of the proprietary rights to
the information developed by such party. It is possible that such a dispute
might not be resolved in the Company's favor, despite steps the Company may have
taken in a contract with the party at issue seeking to claim ownership in
information developed by that party while engaged by the Company.

      In April 1997, the Company was issued a U.S. patent relating to its
digital personalization production process (Patent No. 5,623,587). None of the
Company's intellectual property rights, however, are currently the subject of
any issued patents in any foreign jurisdiction. The Company believes that this
patent could potentially have substantial value, since the Company expects that
businesses owning characters that are popular in the children's home video and
television markets will ultimately seek to exploit those characters in digitally
personalized audiovisual products.

      Patents and patent applications, like the ones issued to and filed by the
Company, involve complex legal and factual questions, and the scope and breadth
of patent claims that may have issued, or that may be allowed in the future, is
inherently uncertain. As a result, even when a patent is issued to a company,
there can be no assurance as to the degree or adequacy of protection that such
patent may afford.

      Three federal trademark applications are currently pending in the United
States with respect to the name "Kideo," and corresponding trademark
applications have been filed in Australia, France, Germany, Japan, Spain and the
United Kingdom. However, since one or more other parties may have rights to this
trademark (in this country and/or overseas), there can be no assurance that the
Company will ultimately obtain a registered trademark for the word "Kideo" for
use with respect to its products and services. A federal trademark application
also is currently pending in the United States with respect to the name "Gregory
and Me."

      The Company also claims proprietary rights in its personalized sticker
books. In April 1997, the Company filed a U.S. patent application covering the
sticker books themselves and the process for making the personalized sticker
books.

Employees

      As of October 7, 1998, the Company employed 90 full-time and seasonal
employees and four part-time employees, including four in administration and
finance, one in marketing and sales, five in new product creation, forty seven
in production, ten in shipping, twenty four who are secretarial/clerical,
database or customer service employees and three in information services. During
the Christmas holiday season (roughly the months of October through December),
the Company employs additional part-time (seasonal) employees, which are
included above, to perform production and database tasks. The Company's
employees are not represented by any labor organizations. Management believes
that its relationship with its employees is good.


                                       11
<PAGE>

Item 2. Property

The Company's principal executive office consists of approximately 11,000 square
feet of leased space in New York City, of which approximately 2,400 square feet
are used for offices and 7,600 are used for the manufacturing of Kideos. In
addition to customary office furnishings and equipment, the Company's tangible
property is comprised primarily of the PC hardware, digital image scanning
equipment, VHS video cassette recorders and related hardware that constitute its
system for the production of digitally personalized videos.

Item 3. Legal Proceedings

      The Company has adopted and used the word "Kideo" as its principal
trademark for its products and services. The Company has applied for
registration of this trademark in the United States, Australia, France, Germany,
Japan, Spain and the United Kingdom. Another party had previously registered two
allegedly similar trademarks but had ceased using them and had filed for
bankruptcy under Chapter 11. On July 6, 1994, the Company commenced proceedings,
before the Trademark Trial and Appeals Board of the United States Patent and
Trademark Office, against such party's successor (the "Successor"), seeking to
obtain the cancellation of these trademarks on the basis of abandonment. The
Company has prevailed in the proceeding. Pursuant to a stipulation agreed upon
by the Company and the Successor, the Successor has agreed to withdraw its
registration and a pending application to register the mark "Kideo" and to cease
using this mark in the United States. The settlement agreement has been
prepared, and executed by both parties.

      Another third party also has been using the trademark "Kideo" locally in
the State of Illinois and has obtained an Illinois state registration of this
mark. This may prevent the Company from using the "Kideo" mark in the state of
Illinois.

      In the event that the Company does not prevail in obtaining the
unquestioned right to use the mark "Kideo," it does not believe that its
business or prospects will be materially adversely affected. While the Company
thinks that the name "Kideo" is particularly well-suited to the type of product
that it sells, the Company does not believe that its market penetration to date
has been extensive enough that the inability to market products under the Kideo
name will adversely affect its ability to find new customer accounts or damage
its relationships with existing accounts.

Item 4. Submission of Matters to a Vote of Security Holders

      There were no matters submitted to a vote of security holders during
fiscal 1998.


                                       12
<PAGE>

                                     Part II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

      Market For Common Stock

      On September 26, 1997 The Company was advised by the Nasdaq Stock Market
that Nasdaq had deleted the Company's stock from listing in the Nasdaq SmallCap
Market. The Nasdaq decision was based in part upon the Company's having not met,
as reflected in its Form 10-QSB for the quarterly period ended April 30, 1997,
the "total assets" and "capital and surplus" requirements for continued listing
on the Nasdaq SmallCap Market. Despite the Company's submission of a plan for
achieving compliance with those requirements, the Nasdaq decision indicated that
the compliance panel lacked adequate confidence in the Company's ability to
sustain long term compliance.

      The Common Stock and Warrants are traded in the Over the Counter Market
under the respective symbols KIDO and KIDOW. The following table sets forth the
range of the high and low bid information (as provided by Nasdaq and Standard &
Poors Comstock) of these securities since June 24, 1996 (the effective date of
the Underwritten Offering). Such quotations reflect inter-dealer prices, without
retail mark-up, mark-down or commission, and may not represent actual
transactions.

                                  Common Stock                  Warrants
                                  ------------                  --------
                               Low Bid     High Bid       Low Bid       High Bid
                              --------------------------------------------------
FISCAL 1997:
1st Quarter .................  2-3/4        4-1/8           1/2           1-1/8
2nd Quarter .................  2            3-1/2           3/8             7/8
3rd Quarter .................  2-3/4        4-1/8           3/8           1
4th Quarter .................  2-1/2        4-1/8          14/32           15/16
FISCAL 1998:
1st Quarter .................   15/16       2-3/4           1/8             7/8
2nd Quarter .................  1-5/16       2-1/16          1/8             1/2
3rd Quarter .................  1-3/8        2-5/16          1/4             3/8
4th Quarter .................  1-3/8        2-1/16          1/8             5/16

      Holders of Record

      As of July 31, 1998, there were approximately 800 holders of record of
Common Stock, and 9 holders of record of Warrants.

      Dividends

      The Company has never paid any cash dividends on its Common Stock, and the
Board does not intend to declare or pay any dividends on its Common Stock in the
foreseeable future. The Board currently intends to retain all available earnings
(if any) generated by the Company's operations for the development and growth of
its business. The declaration in the future of any cash or stock dividends on
the Common Stock will be at the discretion of the Board and will depend upon a
variety of factors, including the earnings, capital requirements and financial
position of the Company and general economic conditions at the time in question.
In the case of cash dividends payable on the Common Stock (if ever declared by
the Board), the Company's ability to pay them at any time after the date hereof
may depend upon whether, at that time, it has satisfied in full its obligations
to pay all dividends then accrued but unpaid on any then-outstanding shares of
its Series A Preferred Stock, currently aggregating $10,000 (the dividends on
which may be paid by the Company, at its option, wholly or partly in cash and/or
shares of Common Stock). In addition, the payment of cash dividends on the
Common Stock in the future could be limited or prohibited by the terms of
financing agreements


                                       13
<PAGE>

that may be entered into by the Company (e.g., a bank line of credit or an
agreement relating to the issuance of other debt securities of the Company) or
by the terms of any additional series of Preferred Stock that may be issued.

Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

General

      The Company was organized in August 1993 (and began operations in November
1993) to develop, manufacture and market digitally personalized videos for
children. The process of mass-producing personalized videos was developed
internally and supplemented with additional technology purchased in 1995 (see
"1995 Technology Acquisition" below). The Company claims proprietary rights in
its technologies and production process. In April 1997, the Company was issued a
U.S. patent relating to its digital personalization production process (Patent
No. 5,623,587).

The Company has incurred substantial operating losses since its inception,
resulting in an accumulated deficit of approximately $11,899,000 as of July 31,
1998. For its fiscal year ended July 31, 1997, the Company had revenues of
approximately $1,346,000 and a net loss of approximately $3,819,000, and, for
the fiscal year ended July 31, 1998, the Company had revenues of approximately
$2,033,000 and a net loss of approximately $2,730,000. The Company believes that
it will continue to operate at loss until such time when its operations generate
sufficient revenues to cover its costs. The report of independent public
accountants on the Company's consolidated financial statements for the fiscal
year ended July 31, 1998 contains an explanatory paragraph stating that the
Company's consolidated financial statements have been prepared assuming that the
Company will continue as a going concern, while noting that the Company's
recurring losses from operations and net working capital deficiency raise
substantial doubt about its ability to continue as a going concern. The
consolidated financial statements do not include any adjustments that might
result should the Company be unable to continue as a going concern.

      On September 26, 1997, the Company was advised by Nasdaq that the
Company's Common Stock and Warrants had been deleted from listing on the Nasdaq
SmallCap Market. The Nasdaq decision was based upon the Company's failure to
meet the "total assets" and "capital and surplus" requirements for continued
listing on the Nasdaq SmallCap Market.

The information set forth below includes "forward-looking statements" within the
meaning of Section 21E of the Exchange Act and is subject to the safe harbor
created by that section. Readers are cautioned not to place undue reliance on
these forward-looking statements, as they speak only as of the date hereof.

Revenue Recognition

The Company's products are marketed directly to consumers and also through
mail-order catalogs, retail and television shopping networks sales. All customer
orders, regardless of their source, are processed at the Company's manufacturing
plant in New York City.

      The Company generally records an account receivable and a corresponding
liability for unearned revenue for personalized product order kits shipped to
television shopping networks, mail order houses, catalogs and other retail
vendors. Revenue is recognized on the accrual basis when the personalized
product is shipped to the ultimate consumer.

Results of Operations

The following discussion and analysis should be read in conjunction with the
Company's consolidated financial statements and related notes included elsewhere
in this report.

      Fiscal year ended July 31, 1998 (the "1998 Fiscal Year") Compared to the
      Fiscal year ended July 31, 1997 (the "1997 Fiscal Year")

      Sales. Sales increased to $2,033,000 or 51% in the 1998 Fiscal Year from
$1,346,000 in the 1997 Fiscal Year. During the fourth quarter of the 1998 fiscal
year, the Company released it's newly licensed Barney tape, My Party With
Barney, which premiered on the shopping networks (electronic sales) and recorded
sales of approximately $1,211,000 for the period. Additional new products
premiered in the fourth quarter were personalized books and stickers. The
Company introduced two book titles: Gregory and Me! And The Amazing Alphabet
Machine, featuring Gregory Gopher a proprietary character and Barney's Alphabet
Adventure, featuring the newly licensed


                                       14
<PAGE>

Barney character. Personalized stickers and books represented 10% or
approximately $207,000 in sales for the 1998 Fiscal Year.

      The Company sells a plush version of Gregory Gopher, a propriety
character, and a non-personalized audio cassette featuring the sound track from
the Gregory Gopher videos. Revenues of these ancillary products accounted for
$31,000 in sales or 2% in fiscal year 1998 as compared to $10,000 or 1% in
fiscal year 1997 and have not been significant to date.

      The increase of the television shopping networks revenue was offset by a
decline in catalog and retail sales of $296,000 or 50% in fiscal year 1998 from
$592,000 in fiscal year 1997 and a decline in direct sales of $60,000 or 8% to
$694,000 in fiscal year ended 1998 from $754,000 in fiscal year 1997. These
decreases in the fiscal year 1998 are attributed to the fact that the Company
put all its efforts into its newly licensed Barney tape and personalized books
and stickers which premiered on the Shopping networks in the fourth quarter as
compared to fiscal year 1997 when the Company had introduced an advertising
campaign direct to the public.

Cost of Sales: The Company had a gross profit of 19% or $394,000 for fiscal year
1998 as compared to 2% in fiscal year 1997 or $21,000. Continued inventory
controls, improved manufacturing process and increases in volume have reduced
the cost of raw materials and direct labor. Depreciation expense declined
$103,000 in fiscal year 1998 due to the retirement of manufacturing equipment in
the prior period. This savings was offset by an increase in amortization expense
of $325,000 due to the write off of capitalized content costs in fiscal year
1998 and an increase in royalties of $50,000 directly related to the increased
sales generated by the newly licensed Barney products.

Production Equipment Write-Off: A write-off of production equipment in the
amount of $226,000 existed in fiscal year 1997. The Company provided for the
disposal of certain production equipment during the second quarter of its prior
fiscal year. This equipment was written off after the successful completion of
tests which established that older Kideo titles could be produced using the
Company's new, more efficient production equipment.

Selling expenses: Selling expenses decreased $530,000 or 27% in fiscal year 1998
to $1,429,000 from $1,959,000 in fiscal year 1997. Promotional and media
expenses decreased by $416,000 in the Current Period as a result of spending cut
backs by the Company. Additional decreases reflect reductions in sales related
payroll and benefits of $231,000 and outside services of $30,000. These savings
were offset by an increase in commissions (net of related vendor expenses) of
$65,000 mostly related to sales of the new Barney tape on direct TV shopping
networks and shipping related expenses of $94,000 due to increased sales volume.
The Company's present marketing programs include direct to consumer Barney
promotions, a "Kideo Catalog" and a Kideo products promotion on the TV shopping
networks.

General and administrative expenses: The Company's general and administrative
expenses decreased $569,000 or 30% to $1,332,000 in fiscal year 1998 from
$1,901,000 in fiscal year 1997. The primary causes for this decrease were
savings in payroll and related payroll expense of $179,000, professional fees of
$110,000 and new product development costs of $165,000 as compared to fiscal
year 1997. Other cost-effective savings by the Company during fiscal year 1998
were in expenses associated with being a public company of $38,000, insurance of
$26,000 and all over infrastructure costs.

Loss from operations: The loss from operations decreased $1,472,000 or 38% to
$2,367,000 in fiscal year 1998 from $3,839,000 in fiscal year 1997. In response
to unprofitable promotions spending in fiscal year 1998, the Company has
implemented cost-saving measures that include across-the-board salary
reductions, reductions in shipping costs, headcount, benefits, and discretionary
spending. The Company continues this management policy as evidenced by the
decreases in selling, general and administrative expenses in the 1998 Fiscal
Year as compared to the Fiscal Year 1997.

      Management continues to seek strategic marketing alliances with the intent
to reduce its financial risk in direct-to-consumer promotions and to develop a
broader based distribution for the Company's products as accomplished with the
direct TV marketing networks. There can be no assurances that these objectives
will continue to be achieved.

Other (expense) income: The fiscal year 1998 reflects amortization of discount
and deferred debt expense of the January 1998 Financing (as detailed below) of
$303,000, along with debt and lease interest expenses net of interest income in
that period. Fiscal year 1997 reflects an excess of interest income from
investments (Treasury bills, money market funds and corporate commercial paper)
over lease interest expenses.


                                       15
<PAGE>

Net Loss: The net loss in the 1998 Fiscal Year was $2,730,000 or $0.76 loss per
share on 3,605,647 average shares of common stock outstanding, as compared to
the fiscal year 1997 net loss of $3,819,000, or $1.37 loss per share on
2,939,014 average shares of common stock outstanding.

Liquidity and Capital Resources

Net cash used by operations of $332,000 for fiscal year 1998 improved 86%, or
$2,124,000, from 1997 fiscal use of $2,457,000. The Company invested $442,000 in
fiscal year 1998, of which $419,000 was in capital content of the newly-licensed
Barney home video title, as compared to $1,009,000 invested in fiscal year 1997.
Additional funds were generated in fiscal year 1998 through (i) the issuance of
Common Stock for gross proceeds of $300,000, as described below under
"--September 1997 Financing," and (ii) the January 1998, Financing, which raised
gross proceeds of $500,000.

The Company's capital requirements in connection with its development of new
product, infrastructure and marketing activities have been and will continue to
be significant. The Company anticipates, based on its currently proposed plans
and assumptions relating to its operations (including assumptions regarding the
progress and timing of its new licensed-character development efforts, like
those involving the Barney and Disney characters), that anticipated revenues
from operations and its current cash and cash equivalent balances will be
sufficient to fund the Company's operations and capital requirements for the
foreseeable future. In the event the Company's plans change or its assumptions
change or prove to be inaccurate, however, the Company could be required to seek
additional financing sooner than currently anticipated. The Company has no
current arrangements with respect to, or potential sources of any additional
financing, and it is not anticipated that existing stockholders will provide any
portion of the Company's future financing requirements. Consequently, there can
be no assurance that any additional financing will be available to the Company
when needed, on commercially reasonable terms, or at all.

Balance sheet conditions which may be indicators of the Company's liquidity
would include the unrestricted cash balance along with the accounts receivable
(approximately [$99,000] at July 31, 1998, as compared to a cash balance of
approximately [$195,000] at July 31, 1997); working capital (which was a
deficiency of approximately $2,013,000 at July 31, 1998, as compared to a
deficiency of approximately $666,000 at July 31, 1997); and the stockholders'
equity position (deficiency of approximately $1,348,000 at July 31, 1998, as
compared to equity of approximately $422,000 at July 31, 1997). The shrinking
cash balances indicate the Company's need for additional capital during the
periods concerned. Although there can be no assurances, the Company believes
that its new vendor relationships with HSN and QVC as well as its licensing
agreements with Disney and Barney will generate revenues sufficient to fund its
operations. The unearned income of approximately $1,028,000 listed as a current
liability at July 31, 1998 represents sales revenue on future orders.

In the spring of 1998, the Company introduced on the shopping network stations
(HSN and QVC) the Kideo title "My Party With Barney". A 15 minute promotional
spot was broadcast by HSN six times during a 48 hour period. In response, over
9,000 orders were received for this title. Through July 31, 1998, orders for
prepaid Kideo order kits through HSN and QVC were approximately $1,637,000 (most
of which represented orders for "My Party With Barney"). Of that amount, the
Company had collected approximately $1,597,000 through July 31, 1998. Although
historically the Company has been dependent on equity financings to fund
operations, the Company expects that the continued marketing of the Kideo
products on the shopping networks and the related funds generated and other
vendor based and direct sales will continue to generate revenue and serve to
fund its operations and reduce its working capital deficit.

Additionally, improvement in these indicators has, in the past, been dependent
on external sources of financing in the forms described below rather than
through operations. Those operating factors which would afford an evaluation of
the Company's ability to internally generate liquidity in both the short term
and long term would include the revenue growth rate (51% over the prior fiscal
year), the gross margin generated from operating activities and the rate of
selling, general and administrative expense spending relative to the revenue
generated. Operating cash flow as evidenced by earnings adjusted for the
non-cash expenses of depreciation, amortization of content costs and non-cash
write-offs (resulting in negative operating cash flow of [$332,000] for the 1998
Fiscal Year ) would provide an indication of the financing needed to fund future
operating activities; however, these must be evaluated along with management's
actions to increase its revenue stream, increase the efficiency of its marketing
efforts, and control the costs of its infrastructure as discussed above.


                                       16
<PAGE>

The Company's material commitments or plans for capital expenditures at the
present time are driven by order volume. Currently, the Company's sales volume
can be met with existing production equipment, and increases in volume can be
met by adding additional shifts with existing equipment. Capital expansion for
additional production equipment will be driven by increases in sales volume and
will be funded by such revenues and any available equipment lease agreements.

Because the Company has operated at a loss since its inception and has not
generated sufficient revenue from its operations to fund its activities, it has,
to date, been substantially dependent on loans from its stockholders and private
and public offerings of its securities to fund its operations.

      January 1998 Financing

On January 30, 1998, the Company entered into a Note and Warrant Purchase
Agreement (the "January 1998 Purchase Agreement") with Benjamin and Michael
Bollag (the "Bollags") pursuant to which, among other things, the Company: (a)
sold for $500,000 (i) an aggregate of $500,000 principal amount of 10%
convertible promissory notes (the "January 1998 Notes") and (ii) warrants to
purchase 500,000 shares of Common Stock (the "January 1998 Warrants"); (b)
entered into a security agreement, dated January 30, 1998 (the "Security
Agreement") with the Bollags, pursuant to which the Company granted the Bollags
a security interest in all of the assets of the Company as security for
performance by the Company under the January 1998 Notes; (c) agreed to register
all of the shares of Common Stock into which the January 1998 Notes may be
converted and for which the January 1998 Warrants may be exercised; and (d)
agreed that if the Company determined to sell securities prior to the repayment
in full of the January 1998 Notes, it would first offer the Bollags the
opportunity to purchase such securities. The transactions consummated pursuant
to the January 1998 Purchase Agreement are referred to herein as the "January
1998 Financing."

      The January 1998 Notes of which $453,334 remain outstanding, may be
converted, under certain circumstances in whole or in part, into shares of
Common Stock. The number of shares of the Common Stock to be received upon
conversion shall be determined by dividing the principal amount of that portion
of the January 1998 Notes being converted by $.90, subject to certain
adjustments (the"Conversion Price").

      The January 1998 Warrants were issued on January 30, 1998 and entitle the
holders thereof to purchase through January 30, 2003 an aggregate of 500,000
shares of Common Stock at a price of $.90 per share as follows: one-third of the
January 1998 Warrants became exercisable following May 1, 1998 and were
excercised after such date; an additional one-third became exercisable on July,
15, 1998; and the balance became exercisable on October 15, 1998. The exercise
price is subject to adjustment in certain circumstances (including in the event
of a stock split or dividend, recapitalization, reorganization, merger,
consolidation or sale of assets of the Company or the issuance by the Company of
shares of Common Stock (or securities convertible into or exercisable for shares
of Common Stock) at a price less than the exercise price of the January 1998
Warrants.

      The Company delivered to KSH Investment Group, Inc. ("KSH") 12,500 shares
of Common Stock (the "KSH Shares") in consideration of KSH arranging the January
1998 Financing and agreed to register the KSH Shares. The KSH Shares are
included in the Shares that have been registered in connection with, and that
are being offered pursuant to, this Offering.

      The Company's Board of Directors determined that the services of KSH in
arranging the January 1998 Financing had a value to the Company of approximately
$22,000, and accordingly issued the 12,500 KSH Shares based upon an approximate
fair market value of $1.75 per share of Common Stock.


                                       17
<PAGE>

      Concurrently with the Company's efforts to secure from the Bollags the
financing that they ultimately provided pursuant to the January 1998 Purchase
Agreement, the Company was negotiating with Charles C. Johnston, a director and
principal stockholder of the Company, concerning an offer by him to loan the
Company $500,000 on a short-term basis (the "January 1998 Johnston Financing
Proposal"). The Company asked for and received Mr. Johnston's agreement to allow
the Company to use his offer as a benchmark in its discussions with the Bollags,
for the purpose of securing from the Bollags more favorable terms relating to
their investment offer. When the Company reached its final agreement with the
Bollags and rejected the January 1998 Johnston Financing Proposal, the Company's
Board of Directors (excluding Mr. Johnston) determined that the Company had
derived meaningful advantages in its negotiations with the Bollags from being
able to use Mr. Johnston's offer and, accordingly, on January 29, 1998 agreed to
Mr. Johnston's request that the Company should (i) grant to Mr. Johnston
warrants to purchase 20,000 shares of Common Stock (the "1998 Johnston
Warrants") for $1.00 per share and (ii) agree to register the shares of Common
Stock for which the 1998 Johnston Warrants may be exercised. The Company
additionally agreed to reimburse Mr. Johnston for up to $5,000 in legal fees
incurred by him in negotiating the January 1998 Johnston Financing Proposal. The
1998 Johnston Warrants are exercisable at any time after January 31, 1999
through March 8, 2003 and contain other terms identical to the January 1998
Warrants. See "Management--Directors and Executive Officers,""Principal
Stockholders" and "Certain Transactions--Transactions with Director Charles C.
Johnston."

      Prior to the closing of the January 1998 Financing, Solovay Edlin &
Eiseman, P.C. ("SEE"), the Company's outside legal counsel (of which Michael B.
Solovay, a director of the Company, is a shareholder) agreed to allow the
Company to continue to defer payment of legal fees and expenses owing as of
December 31, 1997 in the amount of $160,000. In consideration of such agreement,
the Company agreed to pay SEE $40,000 by March 15, 1998 and, on January 30,
1998, issued: (i) to SEE, a note (the "SEE Note") in the amount of $120,000 and
containing other terms identical to the January 1998 Notes; and (ii) to certain
shareholders and employees of SEE, warrants to purchase an aggregate of 120,000
shares of Common Stock (the "SEE Warrants") for $.90 per share. The Company also
agreed to register the shares of Common Stock for which the SEE Warrants may be
exercised. The shares underlying the SEE Warrants are included in the Shares
that have been registered in connection with, and that are being offered
pursuant to, this Offering. The SEE Warrants are exercisable at any time after
January 31, 1999 through February 2, 2003 and contain other terms identical to
the January 1998 Warrants.

On July 15, 1998 the Bollags exercised a cashless exchange of 166,666 warrants
for 81,258 shares of $.0001 par value, Common Stock.

On October 15, 1998 the Company made $166,666 prepayment on the first tranche of
the convertible debt, along with accrued interest to date.

On October 15, 1998 SEE issued a wavier giving the Company an extension to
October 31, 1998 to prepay the first tranche of $40,000 on the convertible debt.

      September 1997 Financing

The Company issued 200,000 shares of Common Stock on September 16, 1997 to an
affiliate of Charles C. Johnston, a director and principal stockholder of the
Company, for an aggregate purchase price of $300,000 (the "September 1997
Financing"), which the Company's Board of Directors (excluding Johnston)
determined to be the fair market value of those 200,000 shares at the time of
issuance. The Company used the proceeds from this financing as working capital
for general corporate purposes. See "Certain Relationships and Related
Transactions--Transactions with Director Charles C. Johnston."

      May 1997 Financing

On May 9, 1997, the Company's Board of Directors, acting pursuant to the
authority granted under its Certificate of Incorporation, authorized the
creation of a series of the Company's Preferred Stock, par value $.0001 per
share (the "Preferred Stock"). The series so authorized is designated as the
Series A 6% Convertible Participating Preferred Stock (the "Series A Preferred
Stock") and consists of 4,000 shares, each share having a liquidation value of
$1,000. On May 13, 1997, the Company consummated a private placement sale,
arranged by a placement agent, to Sellet Marketing Corp. ("Sellet") of 750
shares of Series A Preferred Stock (the "May 1997 Financing"). The shares were
sold at their liquidation value, for a total purchase price of $750,000. The
Company used the approximately $705,000 in net proceeds from the May 1997
Financing as working capital for general corporate purposes (the $45,000 balance
representing issuance costs). Pursuant to a Registration Rights Agreement
between the Company and Sellet, the Company, in August 1996, registered under
the Securities Act the shares of Common Stock into which Sellet could convert
its 750 shares of Series A Preferred Stock. Those 750 shares became convertible
into Common Stock at Sellet's option on and after July 12, 1997, and Sellet
thereafter converted all of those shares into Common Stock, receiving an
aggregate of 543,114 shares of Common Stock.

That conversion feature afforded a discount to fair market value at the time of
conversion of the Series A Preferred Stock into Common Stock. The intrinsic
value of this feature related to the 750 shares issued to Sellet in May 1997 was
$187,500, and that amount was recognized in the Company's consolidated financial
statements for the fiscal year 1997. In accounting for this intrinsic value, the
Company reduced retained earnings by the appropriate portion of the discount,
which is analogous to a dividend, and increased additional paid-in capital, as
if that dividend were directly reinvested. In the consolidated balance sheet for
the fiscal year 1997, total assets, total liabilities and total equity balances
remained unchanged after this adjustment, although the equity section of that
balance sheet did reflect the reclassification from earned capital to
contributed capital in the amount of the discount recognized. In the
consolidated statement of operations for the fiscal year 1997, the Company's
loss per share calculation reflected the increase to loss per share of Common
Stock which resulted from the reduction to retained earnings in recognition of
the discount described above (i.e., as if it were a dividend to the holders of
the Series A Preferred Stock).

Year 2000 Compliance

      The Company's database and present accounting system are year 2000
compliant. The Company does not anticipate any material additional costs with
regard to its year 2000 compliance. The year 2000 issue is not expected to
effect the systems of various entities with which the Company interacts.
However, there can be no assurance that the systems of the other companies on
which the Company relies will be timely converted, or that by failure by another
company's systems to be year 2000 compliant would not have a material adverse
effect on the Company.


                                       18
<PAGE>

Item 7. Financial Statements

Index to Consolidated Financial Statements                                  Page
                                                                            ----

Report of Independent Accountants........................................   F-1
Consolidated Balance Sheets..............................................   F-2
Consolidated Statements of Operations....................................   F-3
Consolidated Statements of Shareholders' Equity..........................   F-4
Consolidated Statements of Cash Flows....................................   F-5
Supplemental Cash Flow Information.......................................   F-6
Notes to Consolidated Financial Statements...............................   F-7


                                       19
<PAGE>

Item 8. Changes in and Disagreements with Accountants on Accounting and
        Financial Disclosure.

        None.

                                    Part III

Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
        with Section 16 (a) of the Exchange Act.

(a) Directors and Executive Officers

      The following are the directors and executive officers of the Company.
Allofficers serve at the discretion of the Board of Directors. The Company
currently has authorized five directors. There are no vacancies on the Board.

      Name                         Age            Position

      Richard L. Bulman             34            Chairman of the Board and
                                                  President

      Marvin H. Goldstein           52            Vice President-Controller

      Bradley Dahl                  38            Vice President-Development

      Richard D. Bulman             63            Secretary, Director and
                                                  Acting Chief Financial Officer

      Charles C. Johnston           63            Director

      Thomas Griffin                60            Director

      Michael B. Solovay            39            Assistant Secretary and
                                                  Director

      Richard L. Bulman is the founder of the Company and has served as its
President and Chairman of the Board since its inception in August 1993. Prior
thereto, from April 1991 to June 1993, Mr. Bulman was Director of Applications
Development at Targa Systems Corp. ("Targa"), where he was responsible for
developing customized multimedia applications for such clients as International
Business Machines ("IBM"), John Hancock Mutual Life and Keystone Foods
(McDonalds). From February 1990 to April 1991, Mr. Bulman managed his own
marketing consulting firm, Richard Bulman Consulting, in Milan, Italy, where he
had responsibility for developing international marketing and advertising
campaigns for a broad range of clients including multinational corporations such
as Montedison and Instrumentation Laboratories. From December 1988 to February
1990, Mr. Bulman was Advertising Manager for 7 Days Magazine in New York.
Richard L. Bulman is the son of Richard D. Bulman, a director of the Company.

      Marvin H. Goldstein was the Chief Financial Officer of the Company from
June 1994 until December 1995, when he became Vice President-Controller. Mr.
Goldstein also has been a partner of Golden Pearl Associates, a real estate
management firm that owns, manages and operates various business interests since
1980. In addition, from August 1979 to December 1993, Mr. Goldstein owned and
operated Hermans Haberdashery Co. Inc., a retail clothing firm, and prior to
that time he was with the accounting firm of Grant Thornton for approximately
four years and was a partner at William Greene & Co., CPAs for approximately
five years. Mr. Goldstein has been licensed as a certified public accountant in
the State of New York since 1972.


                                       20
<PAGE>

      Bradley Dahl has served as the Company's Vice President of Development
since July 1995. Prior to being employed by the Company, Mr. Dahl served as the
Creative Director of Interactive Videosystems, Inc. from January 1993 to April
1995, where he market tested and developed certain technologies (lathe Company)
relating to the mass production of digitally personalized video products. Prior
to his employment at Interactive Videosystems, Mr. Dahl was, from May 1992 to
January 1993, a product developer for Serius Imaging and, from May 1990 to May
1992, an Account Representative at Impex Controls Ltd., a company that develops
computer-based network control systems for institutions such as hospitals and
prisons. From January 1984 to May 1990, Mr. Dahl was the President of Alphatel
Videotex Directories Ltd., which developed, marketed and operated digital video
multimedia local area networked systems for large corporations and government
agencies.

      Richard D. Bulman has served as Secretary and a director of the Company
since August 1993 and became acting Chief Financial Officer in November 1997.
Mr. Bulman has served as the Chairman of the Board of Directors of Targa since
March 1992. Prior to joining that company, Mr. Bulman was Vice President and
General Manager for the International Market Network (IMNET), a joint venture
between IBM and Merrill Lynch & Co., from March 1988 to January 1991. For the
preceding 30 years, Mr. Bulman held various positions at IBM, including Group
Director and Chief Financial Officer of the U.S. Product Group, Group Director
of the U.S. Marketing and Services Group, and Vice President, Chief Financial
Officer and Treasurer of the IBM Service Bureau Corporation. Mr. Bulman has also
served as President of Bedford Associates, a subsidiary of British Airways,
Chairman and Chief Executive Officer of Information Systems, Inc., a technology
outsourcing company, and a consultant to various venture capital firms. Richard
D. Bulman is the father of Richard L. Bulman, the President and Chairman of the
Board of the Company.

      Charles C. Johnston has served as a director of the Company since June
1994. Mr. Johnston has served as the Chairman of the Board of the Computer
Systems and Services Business Unit of Teleglobe, Inc. of Montreal, Canada since
November 1989. He was previously founder, Chief Executive Officer and Chairman
of the Board of ISI Systems, Inc., a provider of specialty data processing
services and software which was acquired by Teleglobe, Inc. in 1989. Mr.
Johnston has also served as Chairman and Chief Executive Officer of Ventex
Technologies, a company involved in the design and sale of electronic
transformers for the neon lighting industry. Mr. Johnston serves on the Board of
Directors of I.D. Matrix of Clearwater, Florida, Wordenglass & Electric, Inc.
and Spectrum Signal Processing of Vancouver, Canada, and is a trustee of
Worcester Polytechnic Institute.

      Thomas Griffin has served as a director of the Company since February
1996. Mr. Griffin has been the Co-Chairman of Griffin Bacal, Inc., an
advertising agency that he founded, since 1978. Griffin Bacal focuses on the
advertising and marketing of entertainment products and services for children
and adults. Mr. Griffin is also the founder, and since 1978 has been
Co-Chairman, of Sunbow Entertainment, Inc., a company that produces and
distributes animated and live action dramatic television programming for
children. Mr. Griffin also has been serving as a director of both DDB Needham
Worldwide since July 1994 and the Eastern Region of the American Association of
Advertising Agencies from 1994 to 1996.


                                       21
<PAGE>

      Michael B. Solovay has served as a director of the Company since July 1996
and as an Assistant Secretary since February 1996. Since January 1992, Mr.
Solovay has been a partner in the law firm of Solovay, Edlin and Eisenman, PC
(which has acted as legal counsel to the Company since October 1995). For
approximately five years prior to that time, Mr. Solovay had been an associate
attorney in the law firm of Skadden Arps Slate Meagher & Flom.

      All directors will hold office until the annual meeting of stockholders to
be held during 1999 (the "1999 Annual Meeting") and until their successors are
duly elected and qualified. The Certificate of Incorporation provides that, at
the 1999 Annual Meeting, the terms of office of the directors will be divided
into three classes, designated Class I, Class II and Class III. At the 1998
Annual Meeting, Class I directors (consisting initially of Thomas Griffin and
Michael B. Solovay) will be elected for a term expiring at the annual meeting of
stockholders to be held in 2000, Class II directors (consisting initially of
Charles C. Johnston) will be elected for a term expiring at the annual meeting
of stockholders to be held in 2001, and Class III directors (consisting
initially of Richard L. Bulman and Richard D. Bulman) will be elected for a term
expiring at the annual meeting of stockholders to be held in 2002. At each
annual meeting of stockholders beginning with the 2000 annual meeting, the
successors to directors whose terms will then expire will be elected to serve
from the time of election and qualification until the third annual meeting
following election (and in each case until their successors have been duly
elected and qualified). Any additional directorships resulting from an increase
in the number of directors will be distributed among the three classes so that,
as nearly as possible, each class will consist of an equal number of directors.

      The Company has agreed that, until June 24, 2001, if so requested by the
Underwriter of the IPO, the Company will nominate and use its best efforts to
elect a designee of the Underwriter to the Company's Board of Directors or, at
the Underwriter's option, as a nonvoting advisor to the Board. The Underwriter
has not yet exercised its right to designate such person, and has informed the
Company that it does not currently anticipate that it will exercise such right
in the foreseeable future.

      The Company has obtained key man life insurance on the life of Richard L.
Bulman in the amount of $2,000,000.

      The Company reimburses the directors for reasonable travel expenses
incurred in connection with their activities on behalf of the Company but does
not pay its directors any fees for Board participation (although it may do so in
the future).

(b) Section 16(a) Beneficial Ownership Reporting Compliance.

      During the 1998 Fiscal Year, all reports required by Section 16(a) of the
Securities Exchange Act of 1934 to be filed, were filed within the compliance
deadlines.

Item 10. Executive Compensation

      For the 1998 Fiscal Year,no one executive officer received aggregate cash
compensation in excess of $100,000. Based upon the foregoing, Mr. Bulman is the
only executive officer of the Company who qualifies as a "Named Executive
Officer" for purposes of the disclosure set forth below.


                                       22
<PAGE>

      The following table summarizes the cash and other compensation paid by the
Company to the Named Executive Officer in each of the Company's last three
completed fiscal years.

Summary Compensation Table

                               Annual Compensation

                                                                     Long Term 
                                                                    Compensation
                                                                      Award(s)
                             Fiscal                                 Securities
Name and                   Year Ended                               Underlying
Principal Position          July 31,         Salary        Bonus      Options
--------------------------------------------------------------------------------

Richard L. Bulman,
  Chairman and President      1996          $118,000         0       125,000

                              1997          $123,000         0             0

                              1998          $ 83,000         0             0

----------

Fiscal Year-End Option Values

      The following table sets forth information concerning unexercised options,
including the aggregate dollar value of in-the-money options, held by the Named
Executive Officer at the end of fiscal year 1998. The closing price of the
Common Stock underlying the options on July 31, 1998 (the last trading day of
the fiscal year) was $1.56. No options were exercised by the Named Executive
Officer in fiscal year 1998.

                   Number of Securities              Value of Unexercised
                   Underlying Unexercised            In-the-Money
                   Options at FY-End (#)             Options at FY-End ($)
                   ---------------------             ---------------------

    Name          Exercisable   Unexercisable       Exercisable   Unexercisable
    ----          -----------   -------------       -----------   -------------

Richard Bulman      125,000           --                --             --

Repricing of Options

      As of February 20, 1998, Richard Bulman surrendered options covering
125,000 shares of Common Stock which were granted in 1996 pursuant to the Option
Plan. New options covering 125,000 shares of Common Stock were granted to Mr.
Bulman, as of February 20, 1998, with exercise prices equal to $2.50 per share
(the fair market value per share on the date of the grant), pursuant to the
Option Plan. Concurrently with the repricing of Mr. Bulman's options, all other
holders of options had their respective options repriced in the same manner. The
old options held by Mr. Bulman and the other optionholders were designed to
further compensate and provide for an incentive for them, and the Board of
Directors determined that the significant decline in the market price of the
Common Stock since the date of grant of the old options frustrated these
purposes. The Board beieved that by awarding Mr. Bulman (and the other
optionholders) new options with exercise prices at $2,50 per share (the fair
market value per share on the date of the grant) they will be fairly compensated
for their efforts and further motivated to achieve the Company's success. The
Board also believes that exchanging "out-of-the-money" options is a
cost-effective method of retaining key employees and preserving the important
motivating effect that stock options have.

Employment Agreement With Named Executive Officer

      Effective January 1, 1996, the Company entered into athree-year employment
agreement with Mr. Bulman, the Chairman of the Board and President of the
Company. Pursuant to this agreement, Mr. Bulman was entitled to receive a base
salary of $125,000 for 1996, which is subject to annual increases determined at
the Board's discretion (but not less than the annual increase in the cost of
living). Mr. Bulman was also eligible to receive a discretionary annual bonus in
respect of each of the fiscal years ended July 31, 1996, 1997 and 1998. No
discretionary annual bonus was awarded to Mr. Bulman in respect of either of
those fiscal years.

      Under the agreement, Mr. Bulman is entitled to a $1 million term life
insurance policy and to long-term disability insurance, and his employment is
subject to confidentiality restrictions and a two-year non-competition covenant.
Pursuant to the employment agreement, Mr. Bulman was granted ten-year options
under the Option Plan to purchase an aggregate of 125,000 shares of Common
Stock, which options vested in increments as follows: (i) as to 41,667 shares,
on March 13, 1996; (ii) as to 41,667 shares, on January 1, 1997; and (iii) as to
41,666 shares, on January 1, 1998. The options were originally granted to Mr.
Bulman at an exercise price of $5.00 per share of Common Stock. All of the
options, however, were repriced to $2.50 per share in February 1998.

      All of Mr. Bulman's options will vest immediately in the event of the
termination without cause of Mr. Bulman's employment prior to December 31, 1998.
In the event of his termination for cause, however, such termination will result
in the simultaneous termination of all of Mr. Bulman's then-unexercised options.
Mr. Bulman's employment agreement also provides that, in the event of the
termination without cause of his employment before December 31, 1998, he will be
entitled to receive severance pay in an amount equal to his annual base salary
for the then-current year of the term of the agreement. In the event Mr.


                                       23
<PAGE>

Bulman's employment is terminated for cause, however, he will not be entitled to
receive any severance pay. Mr. Bulman's employment agreement defines "cause" as
including (in summary terms) his commission of a fraud on the Company,
misappropriation of Company funds or assets, possession of an illegal substance,
a material violation of any covenant in his Employment Agreement, or knowingly
influencing the Company's financial reporting in a manner inconsistent with
generally accepted accounting principles.

Item 11. Security Ownership of Certain Beneficial Owners and Management 

      The following table sets forth certain information (based on information
obtained from the persons named below), as of October 9, 1998 (the "Computation
Date"), relating to the beneficial ownership of shares of Common Stock by (i)
each person or entity who is known by the Company to own beneficially five
percent or more of the outstanding Common Stock, (ii) each of the Company's
directors and (iii) all directors and executive officers of the Company as a
group. The Common Stock is the only class of the Company's equity securities
constituting voting securities. With respect to beneficial ownership of
Warrants, see note 7 below. The Company is not a party to any arrangements, or
aware of any arrangements among any of its stockholders or involving any of them
and third parties, which may result in a change of control of the Company.

                                               Amount and Nature
Name and Address                                 of Beneficial      Percent of
of Beneficial Owners(1)                           Ownership(2)       Shares(2)
-----------------------                           ------------       ---------

Charles C. Johnston .......................       518,136(4)          13.30%

Richard L. Bulman .........................       501,471(3)          12.86%

Michael Bollag    .........................       222,129(9)           5.63%

Benjamin Bollag   .........................       207,129(10)          5.25%

Richard D. Bulman .........................        46,000(5)           1.20%

Michael B. Solovay ........................         3,800(8)              *

Thomas Griffin ............................        23,000(6)              *

All directors and executive officers
as a group (7 persons) ....................     1,144,052(7)          27.80%

----------

(1)   Unless otherwise indicated in the notes below, the address for each named
      individual or group is in care of Kideo Productions, Inc., 611 Broadway,
      Suite 523, New York, New York 10012.

(2)   Unless otherwise indicated, the Company believes that all persons named in
      the table have sole voting and investment power with respect to all shares
      of Common Stock beneficially owned by them. A person is deemed to be the
      beneficial owner of securities that can be acquired by such person within
      60 days after the Computation Date upon the exercise of options, warrants
      or convertible securities. Each beneficial owner's percentage ownership is
      determined by assuming that options, warrants 


                                       24
<PAGE>

      or convertible securities that are held by such person (but not those held
      by any other person) and which are exercisable within 60 days after the
      Computation Date have been exercised and converted. Before any
      consideration is given to outstanding options, warrants or convertible
      securities, the percentages herein are based upon there being 3,775,886
      shares of Common Stock outstanding as of the Computation Date. An asterisk
      (*) indicates less than 1%.

(3)   Includes 125,000 shares of Common Stock issuable upon exercise of
      currently exercisable options granted under the Option Plan.

(4)   Includes (i) 15,000 shares of Common Stock issuable upon exercise of
      currently exercisable options granted under the Option Plan, (ii) 83,975
      shares of Common Stock issuable upon exercise of the Johnston Warrants,
      which are currently exercisable, (iii) 200,000 shares of Common Stock
      issued to an affiliate of Mr. Johnston's in the September 1997 Financing
      described above under "Management's Discussion and Analysis of Financial
      Condition and Results of Operations--Liquidity and Capital Resources" and
      (iv) 20,000 shares of Common Stock issuable upon exercise of warrants
      issued in connection with the January 1998 Financing described above under
      "Management's Discussion and Analysis of Financial Condition and Results
      of Operations--Liquidity and Capital Resources."

(5)   Includes (i) 45,000 shares of Common Stock issuable upon exercise of
      currently exercisable options granted under the Option Plan and (ii) 1,000
      shares of Common Stock issuable upon exercise of currently exercisable
      Warrants.

(6)   Includes (i) 15,000 shares of Common Stock issuable upon exercise of
      currently exercisable options granted under the Option Plan and (ii) 8,000
      shares of Common Stock issuable upon exercise of currently exercisable
      Warrants.

(7)   Includes (i) an aggregate of 227,000 shares of Common Stock issuable upon
      exercise of currently exercisable options granted under the Option Plan,
      (ii) 83,975 shares of Common Stock issuable upon exercise of the Johnston
      Warrants and (iii) 32,000 shares of Common Stock issuable upon exercise of
      currently exercisable Warrants. The seven persons constituting the group
      of directors and executive officers are Richard L. Bulman, Charles C.
      Johnston, Richard D. Bulman, Thomas Griffin, Michael B. Solovay, Marvin H.
      Goldstein and Bradley Dahl. Except as stated in the next sentence, as of
      the Computation Date, no director or executive officer of the Company was
      the beneficial owner of any Warrants, and no record holder of Warrants was
      the beneficial owner of five percent or more of the outstanding Warrants.
      As of the Computation Date, the following directors and executive officers
      were the beneficial owners of the indicated Warrants, representing in each
      case less than one percent of the outstanding Warrants: Richard D. Bulman,
      1,000 Warrants and Thomas Griffin, 8,000 Warrants.

(8)   Includes (i) 3,800 shares of Common Stock.

(9)   Includes (i) 55,629 shares of Common Stock and (ii) 166,500 shares of
      Common Stock issuable upon exercise of currently exercisable Warrants. The
      address of this stockholder is Hollister Ranch, Lot 89, Gaviota,
      California 93117.

(10)  Includes (i) 40,629 shares of Common Stock and (ii) 166,500 shares of
      Common Stock issuable upon exercise of currently exercisable Warrants. The
      address of this stockholder is Hollister Ranch, Lot 89, Gaviota,
      California 93117.


                                       25
<PAGE>

Item 12. Certain Relationships and Related Transactions

      Future transactions (if any) between the directors, officers and/or 5%
stockholders will continue to be on terms no less favorable to the Company than
could be obtained from independent third parties and will be approved by a
majority of the independent, disinterested directors of the Company.

Transactions with Director Charles C. Johnston

      Charles C. Johnston, a principal stockholder of the Company, has been a
director of the Company since June 1994, at which time he first purchased shares
of Common Stock. In the September 1997 Financing, the Company on September 16,
1997 issued 200,000 shares of Common Stock to an affiliate of Mr. Johnston for
an aggregate purchase price of $300,000, which the Company's Board of Directors
(excluding Johnston) determined to be the fair market value of those 200,000
shares at the time of issuance. As a consequence of the January 1998 Johnston
Financing Proposal, on March 9, 1998 the Company issued to Mr. Johnston the 1998
Johnston Warrants described above. These warrants entitle him to purchase 20,000
shares of Common Stock for $.90 per share. The Company has registered the 20,000
shares of Common Stock underlying the 1998 Johnston Warrants.

Transactions with Solovay Edlin & Eiseman, P.C.

      Prior to the closing of the January 1998 Financing, Solovay, Edlin &
Eisenman, P.C. ("SEE"), the Company's outside legal counsel (of which Michael B.
Solovay, a director of the Company, is a shareholder) agreed to the continuing
deferral of payment by the Company of certain unpaid legal fees and expenses.
The Company in exchange issued to SEE the SEE Note and the SEE Warrants
described above. The SEE Warrants entitle certain shareholders and employees of
SEE to purchase an aggregate of 120,000 shares of Common Stock for $.90 per
share. The Company has registered the 120,000 shares of Common Stock underlying
the SEE Warrants.

Item 13. Exhibits, List and Reports on Form 8-K.

(a) Exhibits.

      27. Financial Data Schedule.

(b) Reports on Form 8-K.

      No reports on Form 8-K were filed during the last quarter of the 1998
fiscal year.


                                       26
<PAGE>

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Shareholders of Kideo Productions, Inc.:

      We have audited the accompanying consolidated balance sheets of Kideo 
Productions, Inc. (a Delaware Corporation) and subsidiary as of July 31, 1998
and 1997, and the related consolidated statements of operations, shareholders'
equity and cash flows for the years then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.

      We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Kideo
Productions, Inc. and subsidiary as of July 31, 1998 and 1997, and the results
of their operations and their cash flows for the years then ended in conformity
with generally accepted accounting principles.

      The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the consolidated financial statements, the Company suffered recurring
losses from operations and has a net capital deficiency that raises substantial
doubt about its ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 1. The consolidated financial
statements do not include any adjustments relating to the recoverability and
classification of asset carrying amounts or the amount and classification of
liabilities that might result should the Company be unable to continue as a
going concern.


/s/ Arthur Andersen, LLP

New York, New York
October 16, 1998


                                       F-1
<PAGE>

                             KIDEO PRODUCTIONS, INC.
                           CONSOLIDATED BALANCE SHEETS
                 (Dollars in thousands except per share amounts)

<TABLE>
<CAPTION>
                                                                       at July 3l,    at July 3l,
                                                                           1998           1997
                                                                       -----------    -----------
<S>                                                                    <C>            <C>        
ASSETS
Current Assets:
   Cash and cash equivalents (including restricted cash of $75,000 
      in 1998; -0- in 1997) ........................................   $        82    $       164
   Accounts receivable, net ........................................            92             31
   Inventory .......................................................            53            103
   Prepaid expenses ................................................           169             28
                                                                       -----------    -----------
      Total current assets .........................................           396            326
Property and equipment, net ........................................           220            507
Capitalized content costs, net .....................................           387            518
Other assets .......................................................            68            137
                                                                       -----------    -----------
      Total assets .................................................   $     1,071    $     1,488
                                                                       ===========    ===========

LIABILITIES AND SHAREHOLDERS' (DEFICIENCY) EQUITY 
Current Liabilities:
   Accounts payable ................................................   $       736    $       475
   Accrued expenses ................................................           348            210
   Capital lease obligations, current portion ......................            49             74
   Unearned revenue ................................................         1,028            233
   Convertible notes payable ($620,000 net of $372,000 of discount 
      in 1998; -0- in 1997) ........................................           248             --
                                                                       -----------    -----------
      Total current liabilities ....................................         2,409            992
Capital lease obligations, long term portion .......................            10             74
                                                                       -----------    -----------
      Total liabilities ............................................         2,419          1 066
                                                                       -----------    -----------

Commitments and Contingencies (Notes 5 and 6)

Shareholders' (Deficiency) Equity
   Preferred Stock, $.0001 par value; issuable in series: authorized
      5,000,000 shares, issued and outstanding 0 shares at, July 31,
      1998 and 750 shares at July 31, 1997 .........................            --             --

   Common Stock, $.0001 par value; authorized 15,000,000 shares,
      issued and outstanding 3,775,999 end 2,939,014 shares at
      July 31, 1998 and 1997 .......................................            --             --
   Additional paid-in capital ......................................        10,551          9,591
   Accumulated deficit .............................................       (11,899)        (9,169)
                                                                       -----------    -----------
      Shareholders' (Deficiency) Equity ............................        (1,348)           422
                                                                       -----------    -----------
Total liabilities and shareholders' (deficiency) equity ............   $     1,071    $     1,488
                                                                       ===========    ===========
</TABLE>

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


                                      F-2
<PAGE>

                             KIDEO PRODUCTIONS, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                 (Dollars in thousands except per share amounts)

                                                     Year ended     Year ended
                                                      July 31,       July 31,
                                                        1998           1997
                                                    -----------    -----------
Sales ...........................................   $     2,033    $     1,346
Cost of sales ...................................         1,639          1,099
Write off of production equipment ...............            --            226
                                                    -----------    -----------
Gross profit ....................................           394             21

Selling expenses ................................         1,429          1,959
General and administrative expenses .............         1,332          1,901
                                                    -----------    -----------
Loss from operations ............................        (2,367)        (3,839)
                                                    -----------    -----------
Other (expense) income, net .....................          (363)            20

                                                    -----------    -----------
Net loss ........................................   $    (2,730)   $    (3,819)
                                                    ===========    ===========
Net loss per share ..............................   $     (0.76)         (1.37)
                                                    ===========    ===========
Weighted average number of shares outstanding ...     3,605,647      2,939,014
                                                    ===========    ===========

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


                                      F-3
<PAGE>

                             KIDEO PRODUCTIONS, INC.
          CONSOLIDATED STATEMENTS OF SHAREHOLDERS' (DEFICIENCY) EQUITY
                 (Dollars in thousands except per share amounts)

<TABLE>
<CAPTION>
                                                                                             Additional                Shareholders'
                                                       Preferred Stock      Common Stock      Paid-in    Accumulated   (Deficiency)
                                                       Shares   Amount    Shares     Amount   Capital      Deficit        Equity
                                                      -----------------------------------------------------------------------------
<S>                                                    <C>        <C>    <C>           <C>    <C>         <C>            <C>     
Balance at July 31, 1996 ............................    (0)      --     2,939,014     --      8,737      $ (5,152)      $ 3,585
                                                      -----------------------------------------------------------------------------
Issuanace of preferred stock in connection                                                               
   with "Sellet" financing ..........................   750       --                             666                         666
Discount to fair market value of the preferred                                                           
   stock on the conversion to common stock ..........                                            188          (188)           --
Dividends on preferred stock ........................                                                          (10)          (10)
Net loss ............................................                                                       (3,819)       (3,819)
                                                      -----------------------------------------------------------------------------
Balance at July 31, 1997 ............................   750       --     2,939,014     --      9,591      $ (9,169)      $   422
                                                      -----------------------------------------------------------------------------
Conversion of preferred stock to common .............  (750)      --       543,114     --        (25)           --           (25)
Issuance of common stock in connection                                                                   
   with the September 1997 Johnston Financing .......                      200,000     --        300            --           300 
Discount to fair market value of the January 1998,                                                       
   convertible notes payable on the conversion                                                           
   common stock .....................................                                            465                         465 
Issuance of warrants in connection                                                                       
   with the January 1998, Financing .................                                            198                         198 
Issuance of common stock in lieu of commission in                                                        
   connection with the January 1998, Financing ......                       12,500                22                          22 
Conversion of warrants to common stock ..............                       81,258                                               
Net loss ............................................                                                       (2,730)       (2,730)
                                                      -----------------------------------------------------------------------------
Balance at July 31, 1998 ............................   (--)      --     3,775,886     --     10,551      $(11,899)      $(1,348)
                                                      =============================================================================
</TABLE>

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


                                      F-4
<PAGE>

                             KIDEO PRODUCTIONS, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                 (Dollars in thousands except per share amounts)

<TABLE>
<CAPTION>
                                                                                 Year ended       Year ended
                                                                                July 3l, 1998    July 3l, 1997
                                                                                -------------    -------------
<S>                                                                             <C>              <C>           
Cash flows from operating activities:
   Net loss .................................................................   $      (2,730)   $      (3,819)
   Adjustments to reconcile net loss to net cash used
      in operating activities:
      Depreciation and amortization of operating assets .....................             815              696
      Amortization of loan discount and deferred debt costs .................             258               --
      Write-off of capitalized content costs ................................             130               --
      Write-off of production equipment .....................................              --              226
      Effect of changes in operating assets and liabilities:
         Accounts receivable ................................................             (61)              64
         Inventory ..........................................................              50              (86)
         Prepaid expenses ...................................................            (141)              94
         Other assets .......................................................              --               15
         Accounts payable ...................................................             261              416
         Accrued expenses ...................................................             291              (71)
         Unearned revenue ...................................................             795                8
                                                                                -------------    -------------
   Net cash used in operating activities ....................................            (332)          (2,457)
                                                                                -------------    -------------

Cash flows from investing activities:
   Purchase of property and equipment .......................................             (23)            (561)
   Increase in capitalized content and program costs ........................            (419)            (448)
                                                                                -------------    -------------
   Net cash used in investing activities ....................................            (442)          (1,009)
                                                                                -------------    -------------

Cash flows from financing activities:
   Net proceeds from issuances of capital stock .............................             275              666
   Proceeds from convertible debt ...........................................             500               --
   Proceeds from lease financing ............................................              --              208
   Principal payments on capital leases .....................................             (83)            (101)
                                                                                -------------    -------------
   Net cash provided by financing activities ................................             692              773
                                                                                -------------    -------------
Net decrease in cash ........................................................             (82)          (2,693)
Cash and cash equivalents at the beginning of the period ....................             164            2,857
                                                                                -------------    -------------
Cash and cash equivalents at the end of the period ..........................   $          82    $         164
                                                                                =============    =============
</TABLE>

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


                                      F-5
<PAGE>

                             KIDEO PRODUCTIONS, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                            SUPPLEMENTAL INFORMATION
                 (Dollars in thousands except per share amounts)

<TABLE>
<CAPTION>
                                                                          Year ended      Year ended
                                                                         July 31, 1998   July 31, 1997
                                                                         -------------   -------------
<S>                                                                      <C>             <C>          
Cash payments for interest ...........................................   $          20   $          26
Cash payments for income taxes .......................................              16              12

Supplemental schedule of noncash investing and financing activities:
   Capital lease obligations for equipment purchases .................   $          --   $         207
   Dividends accrued on preferred stock ..............................              --              10
   Proceeds of security deposits applied to capital leases ...........              --             186
   Discount to fair market value of the preferred stock
      upon conversion to common stock ................................              --             188
   Discount to fair market value of the January 1998,
      convertible notes payable on the conversion to common stock ....             465              -- 
   Issuance of warrants in connection with the
      January 1998, Financing ........................................             198              --
   Issuance of common stock in lieu of commission in connection
      with the January 1998, Financing ...............................              22              --
</TABLE>

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


                                      F-6
<PAGE>

                             KIDEO PRODUCTIONS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CORPORATE STRUCTURE AND PRINCIPAL
BUSINESS ACTIVITY:

Business and Organization

      Kideo Productions, Inc. ("Kideo-Delaware"), a Delaware corporation, was
incorporated on June 24, 1994. The accompanying consolidated financial
statements include the accounts of Kideo-Delaware and its wholly owned
subsidiary Kideo Productions (Canada), Inc. (collectively the "Company"). Kideo
Productions (Canada), Inc. commenced operations in July 1995. All significant
intercompany transactions and balances have been eliminated. The Company is
devoted to the development of multimedia products using emerging technologies
with an emphasis on personalized products for children.

      The Company develops, produces and markets personalized children's
educational video tapes featuring licensed and proprietary characters currently
being sold through television shopping networks, mail-order houses, various
catalogs and direct sales. During the current fiscal year the Company introduced
a new line of personalized books and stickers.

      The accompanying consolidated financial statements have been prepared
assuming the Company will continue as a going concern. As shown in the
consolidated financial statements, the Company has incurred net losses of
$2,730,000 and $3,819,000 for the years ended July 31, 1998 and July 31, 1997,
respectively. In addition, the Company has a net working capital deficiency of
$2,013,000 at July 31, 1998. These factors indicate that there is substantial
doubt about the Company's ability to continue. The Company's strategy is to
continue to obtain licenses for popular media characters and apply its
technology to the characters under license. The Company plans to sell these
products to its existing customers as well as to new customers obtained through
television shopping networks, direct mail and catalogs. The Company anticipates
that a portion of the cost of the distribution, including advertising, will be
funded by the licensing partner. Although there can be no assurances, the
Company anticipates, based on its currently proposed plans and assumptions
relating to its operations (including assumptions regarding the progress and
timing of its new development efforts), together with anticipated revenues from
operations and its current cash and cash equivalents balance, that these
proceeds will be sufficient to fund the Company's operations and capital
requirements through July 31, 1999.

      The Nasdaq Stock Market has deleted the Company's stock from listing in
the Nasdaq Small Cap Market. The Nasdaq decision was based in part upon the
Company's having not met the "total assets" and "capital and surplus"
requirements for continued listing on the Nasdaq Small Cap Market.


                                      F-7
<PAGE>

                             KIDEO PRODUCTIONS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Revenue Recognition

      The Company generally records an account receivable and a corresponding
liability for unearned revenue for personalized product order kits shipped to
television shopping networks, mail order houses, catalogs and other retail
vendors. Revenue is recognized on the accrual basis when the personalized
product is shipped to the ultimate consumer.

Capitalized Content Costs, net

      Capitalized content costs are capitalized as film costs and are amortized
using the individual-film-forecast-computation method in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 53 "Financial Reporting
by Producers and Distributors of Motion Picture Films." Utilizing this method,
film costs are amortized in the same ratio that current gross revenues bear to
anticipated gross revenues. Due to uncertainties in the estimating process,
anticipated total gross revenues may vary from actual gross revenues. The
anticipated gross revenues are continuously updated by management to reflect the
most current data available.

Long Lived Assets

      In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Acquired Assets and for Long Lived Assets to
be Disposed of", management periodically assesses whether there has been an
impairment in the carrying value of the excess of cost of such assets by
comparing the current and expected annual undiscounted cash flows with the
carrying amount. In the event there is an impairment of the asset, management
would reduce the carrying value to an amount equal to the projected discounted
cash flow of the underlying assets.

Advertising Costs

      Advertising costs are charged to operations when the advertising takes
place. Advertising expenses for the years ended July 31, 1998 and 1997 were
$351,000 and $743,000, respectively.

Depreciation

      Depreciation of property and equipment is provided for principally by the
straight-line method over the estimated useful lives of the respective assets.

Income Taxes

      The Company follows the provisions of Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes", which requires that the tax
effect of temporary differences between the recorded carrying values and the
adjusted tax basis of assets and liabilities be reflected in the financial
statements at the tax rate at which the differences are expected to reverse. At
July 31, 1998 and 1997, there were no material temporary differences between the
book basis and tax basis of the Company's assets and liabilities.


                                      F-8
<PAGE>

                             KIDEO PRODUCTIONS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

      As of July 31, 1998, the Company had a net operating loss carryforward for
both financial reporting and income tax purposes of approximately $11,467,000
available to offset future income, expiring during 2009 to 2013. This resulted
in a deferred income tax asset of approximately $5,160,000 for which the Company
recorded a full valuation allowance due to the uncertainty of future realization
of such losses. Based on the ownership changes arising from the initial public
offering, utilization of the net operating loss carry-forward will be limited.

Net Loss Per Share

      In accordance with SFAS No. 128, net loss per common share amounts ("Basic
EPS") were computed by dividing net earnings after adjustments for preferred
stock dividend requirements, by the weighted average number of common shares
outstanding and excluded any potential dilution. Net loss per common share
amounts assuming dilution ("Diluted EPS") were computed by reflecting potential
dilution from the exercise of stock options, to the extent they are dilutive.

Warranty Costs

      To date, the Company has not had any significant warranty costs for repair
or replacement of its product. Based on current sales and historical experience,
warranty costs, if any are charged to operations when incurred.

Royalty Costs

      Included in prepaid expenses is an accrual of minimum deferred royalty
expenses that will be charged to operations based on revenue earned from sales
of the related products in proportion to the revenues generated from the license
products sold in fiscal 1999.

Use of Estimates

      The Company's sales have traditionally been seasonal in nature based, in
part, on purchases made during the months of October through December.

      During the fourth quarter of Fiscal 1998 the Company recorded 60% of total
sales due to the introduction of its newly licensed Barney products.

      The preparation of financial statements in conformity with generally
accepted accounting principles requires the use of estimates by management
affecting the reported amounts of assets, liabilities, revenue and expenses and
the disclosed amounts of contingent assets and liabilities. Actual results could
differ from those estimates.

Cash and Cash Equivalents

      The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. Cash equivalents
include investments in money market funds and are stated at cost, which
approximates market value. At July 31, 1998, the Company has $75,000 of
restricted cash, which represents amounts held in a deposit account in
accordance with a third party license contract. The Company believes this amount
will be freed during fiscal 1999.


                                      F-9
<PAGE>

                             KIDEO PRODUCTIONS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. PROPERTY AND EQUIPMENT, NET

      Property and equipment, at cost, consists of the following:

                                           July 31,       July 31,    Estimated
                                             1998           1997     Useful Life
                                          ---------      --------    -----------
Video production equipment
and related software ................     $ 627,000      $605,000      3 years
Furniture and fixtures ..............        10,000        10,000      7 years
Office equipment ....................       124,000       124,000      5 years
Leasehold improvements ..............       164,000       164,000      3 years
                                          ---------      --------
                                            925,000       903,000
Less accumulated depreciation              (705,000)     (396,000)
                                          ---------      --------
                                          $ 220,000      $507,000
                                          =========      ========

      Included in property and equipment at July 31, 1998 and 1997 are
approximately $207,000 of assets acquired under capital leases. Accumulated
depreciation on these assets as of July 31, 1998 and 1997 amounted to
approximately $68,000 and $53,000, respectively. The property held under these
leases is collateral for the related capital lease obligations as described in
Note 6.

      Certain technology rights, intellectual property and software related to
the production of video products, amounting to approximately $192,000, were
acquired on July 17, 1995 and are being amortized over a three-year period which
commenced August 1, 1995 using the straight-line method. Depreciation and
amortization charged to operations amounted to $62,000 and $64,000, respectively
for the years ended July 31, 1998 and 1997.

      The Company provided for the disposal of certain production equipment in
the amount of $226,000 during the year ended July 31, 1997. This equipment was
written off after the successful completion of tests allowing for the production
of older Kideo titles on new, more efficient equipment.

3. CAPITALIZED CONTENT COSTS, net

      Capitalized content costs include the development, scripts, characters,
props, filming and postproduction of new Kideo titles introduced.

                                                      July 31,         July 31,
                                                        1998             1997
                                                      --------         --------
Capitalized content costs ..................          $419,000         $777,000
Less accumulated amortization ..............           (32,000)        (259,000)
                                                      --------         --------
 Net book value ............................          $387,000         $518,000
                                                      ========         ========


                                      F-10
<PAGE>

                             KIDEO PRODUCTIONS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. OTHER ASSETS:

      Other assets consist of the following:

                                                          July 31,      July 31,
                                                            1998          1997
                                                          --------      --------
Deposits on capital lease obligations ..............      $ 34,000      $ 34,000
Technology rights and intellectual property ........            --        17,000
Security deposits ..................................        18,000        18,000
Deferred expenses ..................................        16,000        68,000
                                                          --------      --------
                                                          $ 68,000      $137,000
                                                          ========      ========

5. COMMITMENTS AND CONTINGENCIES:

      The Company leases 11,000 square feet of space under several noncancelable
operating leases for office, manufacturing and warehouse space. These leases are
subject to escalation for the Company's proportionate share of increases in real
estate taxes and certain other operating expenses. In addition the Company rents
additional office and warehouse space on a month to month basis at a monthly
rent of approximately $1,800. Total rent expense for the years ended July 31,
1998 and 1997 amounted to $124,000 and $121,000, respectively. Future
approximate minimum rental payments required are listed below and are subject to
a 25% discount when the monthly payment is made prior to the 11th day of the
month in which it is due.

Year ending July 31,
      1999 ...............................................     $314,000
      2000 ...............................................      356,000
      2001 ...............................................      149,000
      2002 ...............................................       11,000
                                                               --------
                                                               $830,000
                                                               ========

      The Company has entered into employment contracts with two employees
expiring a various times through December 1998. The aggregate minimum commitment
for future salaries, excluding bonus is $89,000 through the fiscal year ended
July 31, 1999.


                                      F-11
<PAGE>

                             KIDEO PRODUCTIONS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6. CAPITAL LEASE OBLIGATIONS:

      Included in property and equipment is $207,000 in production and office
equipment held under capital leases at July 31, 1998 and 1997. The future
minimum lease payments under capital leases, all with interest rates ranging
from 13% to 16.5%, at July 31, 1998 are as follows:

Year ending July 31,
      1999 .................................................            $ 63,000
      2000 .................................................               6,000
      2001 .................................................               3,000
      2002 .................................................               2,000
                                                                        --------
                                                                          74,000
Less amounts representing interest .........................              15,000
                                                                        --------
                                                                        $ 59,000
                                                                        ========

7. SHAREHOLDERS' (DEFICIENCY) EQUITY:

January 1998, Financing

      The Company issued convertible notes ("Notes") in the aggregate amount
of $620,000, bearing interest at the rate of 10% per annum, due April 15, 1999.
The Notes convert at a price of $1.00 per share. In addition the Company issued
Warrants at the then fair market value. The warrants provide for the purchase of
a total of 640,000 shares of the Company's Common Stock, par value $.0001 per
share, to certain investors and advisors.

      The conversion feature affords a discount to fair market value at the time
of conversion of the Notes into shares of Common Stock. The beneficial
conversion feature of the Notes of $465,000, and the fair value of the warrants
of $155,000, have been treated as additional discount on the issuance of the
Notes, and accordingly have been netted against the principle amount
outstanding. The conversion feature is being amortized from the date the
security was issued until the date it first became convertible and the warrants
are being amortized over the life of the debt.

      On July 10, 1998 certain investors exercised a cashless conversion of
166,666 warrants into 81,258 shares of the Company's Common Stock.

September 1997 Financing

      The Company issued 200,000 shares of Common Stock on September 16, 1997 to
an affiliate of Charles C. Johnston, a director and principal stockholder of the
Company, for an aggregate purchase price of $300,000 (the "September 1997
Financing"), which the Company's Board of Directors (excluding Johnston)
determined to be the fair market value of those 200,000 shares at the time of
issuance. The Company used the proceeds from this financing as working capital
for general corporate purposes.


                                      F-12
<PAGE>

                             KIDEO PRODUCTIONS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

May 13, 1997 Financing

      On May 13, 1997, the Company closed the private placement of 750 shares of
a newly authorized series of Preferred stock, designated as the Series A 6%
Convertible Participating Preferred Stock (the "Series A Preferred Stock",
"Preferred Stock"). The shares were sold at their liquidation value of $1,000
per share, for a total purchase price of $750,000 in a transaction arranged
through Gerard Klauer Mattison & Co., Inc. as placement agent.

      The Preferred Stock became convertible at the holder's option after July
12, 1997 into common shares based on the ratio of (a) the total liquidation
value (at $1,000 per preferred share) of the preferred shares being converted,
to (b) the then-effective conversion price. The conversion price at any point in
time is 80% of the prior three days average of the closing bid price per share
of the Company's common stock.

      The Company has the option to sell up to 1,250 additional shares of
Preferred Stock for $1,250,000, commencing thirty days following the
effectiveness of a registration statement on the underlying shares. The
Company's registration statement was declared effective on September 2, 1997.
The Company did not exercise its option to sell the remaining additional shares
of Preferred Stock.

      The conversion feature affords a discount to fair market value at the time
of conversion of the Preferred Stock into common. The intrinsic value of this
feature is $500,000 for the entire subscription of 2,000 Preferred Shares and
will be recognized in the financial statements in the proportion that the shares
issued bear to the total subscription. The amount recognized in the consolidated
financial statements at the fiscal year end of July 31, 1997 was $187,500, which
is the ratable portion of the discount related to the 750 Preferred Shares
issued on May 31, 1997. In accounting for this intrinsic value, the Company
reduced retained earnings by the appropriate portion of the discount, which is
analogous to a dividend, and increased additional paid-in capital, as if that
dividend were directly reinvested. Those 750 shares became convertible into
Common Stock at Sellet's option on and after July 12, 1997, and Sellet
thereafter converted all of those shares into Common Stock, receiving an
aggregate of 543,114 shares of Common Stock.

8. OTHER (EXPENSE) INCOME, net

      The Consolidated Statements of Operations for the year ended July 31, 1998
includes $334,000 of expenses related to the amortization of debt discount,
amortization of debt issuance costs and interest related to the January 1998,
Financing.


                                      F-13
<PAGE>

                             KIDEO PRODUCTIONS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. STOCK OPTION PLAN

      In February 1996, the Board of Directors approved a stock option plan (the
"Plan"), under which 350,000 shares of common stock were reserved for future
issuance. The Plan provides for the sale of shares of common stock to employees
of the Company, including officers and directors ( whether or not employees) as
well as to consultants to the Company. For stock options granted before the
closing of the Company's initial public offering, the per share exercise price
of such options was $5.00 and for stock options granted after the closing of the
Company's initial public offering, the per share exercise price of such options
cannot be less than the fair market value of the shares of common stock on the
date of grant. The term of each option and the manner of exercise is determined
by the Plan's administrators, but options granted under the Plan will become
exercisable after the vesting period or periods specified in each option
agreement. However, options are not exercisable after the expiration of 10 years
from the date of grant.

      On February 20, 1998, 273,000 options previously issued to employees and
directors with a weighted average exercise price of $4.95 were repriced at
$2.50. This revaluation did not alter or amend any other provision of the
optionee's original option agreement, including vesting period and option term.
There was no effect on the Statement of Operations for the repricing.

      The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123 ("SFAS No. 123"), entitled "Accounting
For Stock-Based Compensation. SFAS No. 123 calls for measuring compensation
cost at the date of grant, based on an estimate of fair value of the option over
its expected life.

      The Company accounts for the cost of stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion Number
25, "Accounting for Stock Issued to Employees," and related Interpretations of
that rule. Accordingly, compensation cost for stock options is measured as the
excess of market value over the exercise price of the related option, measured
as of the date that the option is exercised. There were no options exercised
during the fiscal years ended July 31, 1998 and 1997. Accordingly, there was no
compensation expense recorded in these years.

      Had the accounting provisions of SFAS No. 123 been adopted by the Company,
reported net income and earnings per share would have changed as follows:

                                               Fiscal 1998         Fiscal 1997
                                               -----------         -----------
Net (loss), as reported                        $(2,730,000)        $(3,819,000)
Net (loss), pro forma for SFAS No. 123         $(2,635,000)        $(3,994,000)

Loss per share, as reported                    $     (0.76)        $     (1.37)
Loss per share, pro forma for SFAS No. 123     $     (0.73)        $     (1.41)

      The SFAS No. 123 pro forma effects are calculated using the grant date as
the measurement date; the Black-Scholes option-pricing model as the determinant
of fair value, further adjusted for lack of transferability of the underlying
shares at grant date; and an estimated option life of 5 years over which the
fair value is to be amortized. Additional variables used in applying
Black-Scholes included a volatility assumption of 60%; risk-free interest rate
of 5.58% and no common stock dividends during the option period.


                                      F-14
<PAGE>

                             KIDEO PRODUCTIONS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

      The following table summarizes activity in the stock option plan:

Weighted Average

                            Stock Options     Price per share    Price per share
                            ----------------------------------------------------
Balance at July 31, 1996      334,000               $5.00            $5.00
                            ----------------------------------------------------
Grants during Fiscal 1997      13,000           $3.19 - $3.63        $3.29
Forfeitures                   (39,000)          $3.19 - $5.00        $4.77
Options exercised                  --
                            ----------------------------------------------------
Balance at July 31, 1997      308,000           $3.19 - $5.00        $4.96
Grants during Fiscal 1998          --
Forfeitures                   (50,000)              $5.00            $5.00
Options exercised                  --
                            ----------------------------------------------------
Balance at July 31, 1998      258,000               $2.50*           $2.50
                            ====================================================

*Repriced February 20, 1998 by a unanimous vote by the Board of Directors' of
the Company, to $2.50.

10. SIGNIFICANT CUSTOMERS and CONCENTRATION OF CREDIT RISK

      For the year ended July 31, 1998 approximately 62% of the Company's sales
were one customer.

      At July 31, 1998, one of the Company's vendors represented approximately
39% of the Company's accounts payable balance.

11. RELATED PARTY TRANSACTIONS

      Notes in the amount of $120,000 issued in connection with the January 1998
Financing, were issued to the Company's legal advisor, who is also a director of
the Company. Professional fees paid to the legal advisor for the year ended July
31, 1998 and 1997, totalled approximately $60,000 and $36,000, respectively.


                                      F-15
<PAGE>

                                   SIGNATURES

      In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

Dated: October 29, 1998

                                              KIDEO PRODUCTIONS, INC.

                                              By /s/ Richard L. Bulman
                                                 -------------------------------
                                                 Richard L. Bulman
                                                 President

      In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.

Signature                        Title                         Date
---------                        -----                         ----


/s/ Richard L. Bulman            President and Chairman        October 29, 1998
------------------------         of the Board (Principal
Richard L. Bulman                Executive Officer)


/s/ Richard D. Bulman            Director                      October 29, 1998
------------------------         Secretary and Chief
Richard D. Bulman                Financial Officer


/s/ Marvin H. Goldstein          Vice President, Controller    October 29, 1998
------------------------         (Principal Accounting and
Marvin H. Goldstein              Financial Officer)

/s/ Charles C. Johnston          Director                      October 29, 1998
------------------------
Charles C. Johnston


/s/ Thomas Griffin               Director                      October 29, 1998
------------------------
Thomas Griffin


/s/ Michael B. Solovay           Director                      October 29, 1998
------------------------
Michael B. Solovay


                                       27