-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Hzyl4iB9o9p36uv/oIU9v0fjdjlqv2vScSgI7vQyCiYgvl5bJwDPxKIqSjmOOqn1 18t8zlSne4qczfxK1ngW1Q== 0001005477-98-000895.txt : 19980327 0001005477-98-000895.hdr.sgml : 19980327 ACCESSION NUMBER: 0001005477-98-000895 CONFORMED SUBMISSION TYPE: SB-2 PUBLIC DOCUMENT COUNT: 8 FILED AS OF DATE: 19980326 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: KIDEO PRODUCTIONS INC CENTRAL INDEX KEY: 0000946073 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MOTION PICTURE & VIDEO TAPE PRODUCTION [7812] IRS NUMBER: 133729350 STATE OF INCORPORATION: DE FISCAL YEAR END: 0731 FILING VALUES: FORM TYPE: SB-2 SEC ACT: SEC FILE NUMBER: 333-48657 FILM NUMBER: 98573461 BUSINESS ADDRESS: STREET 1: 611 BROADWAY STE 523 CITY: NEW YORK STATE: NY ZIP: 10022 MAIL ADDRESS: STREET 1: 611 BROADWAY STREET 2: STE 523 CITY: NEW YORK STATE: NY ZIP: 10012 SB-2 1 FORM SB-2 As filed with the Securities and Exchange Commission on March __, 1998 Registration No. 333- ================================================================================ - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------ FORM SB-2 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------ KIDEO PRODUCTIONS, INC. (Exact Name of Registrant as Specified in its Charter) Delaware 7812 13-3729350 (State or other (Primary Standard (I.R.S. employer jurisdiction Industrial Number) identification number) of incorporation) 611 Broadway, Suite 523 New York, New York 10012 (212) 505-6605 (Address, including zip code, and telephone number, including area code, of Registrant's principal executive offices) ------------------ Richard L. Bulman, President Kideo Productions, Inc. 611 Broadway, Suite 523 New York, New York 10012 (212) 505-6605 (Address, including zip code, and telephone number, including area code, of agent for service) ------------------ Copies to: Michael B. Solovay, Esq. Solovay Marshall & Edlin, P.C. 845 Third Avenue New York, New York 10022 Telephone: (212) 752-1000 Facsimile: (212) 355-4608 ------------------ Approximate date of commencement of proposed sale to public: As soon as practicable after the Registration Statement becomes effective. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1993 check the following box: |X| If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: |_| __________ If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier registration statement for the same offering: |_| ____________ If the delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box: |_| - -------------------------------------------------------------------------------- ================================================================================ CALCULATION OF REGISTRATION FEE ================================================================================ Proposed Last Maximum Reported Aggregate Amount of Title of Each Class of Amount to Sale Offering Registration Securities to be Registered be Registered Price(1) Price Fee - -------------------------------------------------------------------------------- Common Stock, par value $.0001 per share(2)......... 1,152,500 $ 2.00 $2,305,000 $ 794.83 - -------------------------------------------------------------------------------- Total Registration Fee............................................. $ 794.83 ================================================================================ (1) Last reported sale price as provided by Standard & Poor's Comstock for March 20, 1998. (2) Represents shares owned by the Selling Stockholders of the Company, which are being registered for offer on a delayed basis pursuant to Rule 415. The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. PRELIMINARY PROSPECTUS--SUBJECT TO COMPLETION PROSPECTUS KIDEO PRODUCTIONS, INC. 1,152,500 Shares of Common Stock This Prospectus relates to the public offering by certain selling stockholders (the "Selling Stockholders") of up to 1,152,500 shares (the "Shares") of the Common Stock, par value $.0001 per share (the "Common Stock"), of Kideo Productions, Inc., a Delaware corporation (the "Company"). The Company will not receive any proceeds from the sale of the Shares offered hereby. The Company is bearing the costs of this Offering. See "Plan of Distribution." The Common Stock is traded on the over-the-counter market under the symbol KIDO. The Common Stock is not listed or admitted for trading on any stock market and in September 1997 was delisted from trading on the Nasdaq SmallCap Market. As a result of that delisting and the market prices for the Common Stock, the Common Stock is currently a "penny stock" for purposes of regulations promulgated by the Securities and Exchange Commission. Prior to the consummation in June 1996 of the Underwritten Offering referenced herein, there had been no public market for the Common Stock. There can be no assurance that an active market for the Common Stock will exist or be sustained at any time after the date hereof. See "Risk Factors--September 1997 Delisting of Securities from Nasdaq," "--Additional Risks Relating to Delisted and Penny Stocks" and "Price Range of Securities and Dividend Policy." The report of independent accountants on the Company's consolidated financial statements for the fiscal year ended July 31, 1997 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. See "Risk Factors--Going Concern Qualification in Auditor's Report; History of Significant Losses; Limited Revenues; Accumulated Deficit; Anticipated Future Losses." The Company has informed the Selling Stockholders that the anti-manipulative rules under the Securities and Exchange Act of 1934, as amended (the "Exchange Act"), including Rule 10b-3 and Regulation M, may apply to their sales in the market and has furnished the Selling Stockholders with a copy of these Rules. The Company also has informed the Selling Stockholders of the need for delivery of copies of this Prospectus. PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE RISKS ASSOCIATED WITH AN INVESTMENT IN THE SHARES, CERTAIN OF WHICH ARE DESCRIBED UNDER THE CAPTION "RISK FACTORS" AT PAGES 10 TO 19 OF THIS PROSPECTUS. ------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ------------------ THE COMPANY HAS NOT REGISTERED OR QUALIFIED THE SHARES UNDER THE SECURITIES LAWS OF ANY STATE AND, UNLESS THE SALE OF ANY SHARES TO A PARTICULAR PURCHASER IS EXEMPT FROM REGISTRATION OR QUALIFICATION UNDER APPLICABLE STATE SECURITIES LAWS, THAT SALE MAY NOT BE EFFECTED UNTIL THOSE SHARES HAVE BEEN SO REGISTERED OR QUALIFIED. ------------------ IN CONNECTION WITH ITS JUNE 1996 INITIAL PUBLIC OFFERING, THE COMPANY CONSENTED TO THE DENIAL OF SECONDARY TRADING IN ITS SECURITIES IN THE STATE OF NEW JERSEY. AS A RESULT OF THIS ACTION, STOCKHOLDERS OF THE COMPANY CANNOT SELL ITS SECURITIES THROUGH A BROKER-DEALER WHOSE OFFICE IS LOCATED IN NEW JERSEY OR TO ANY NEW JERSEY RESIDENT, WHETHER THROUGH A BROKER-DEALER OR NOT, UNLESS SUCH DENIAL IS REMOVED, OF WHICH THERE CAN BE NO ASSURANCE. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, THE SHARES IN ANY STATE TO ANY PERSON TO WHOM IT IS UNLAWFUL FOR THE SELLING STOCKHOLDERS TO MAKE SUCH OFFER OR SOLICITATION. The Shares have been registered on behalf of the Selling Stockholders. The Shares may be offered by them pursuant to this Prospectus until _______ __, 199_, provided that this Prospectus is kept current in accordance with applicable provisions of the Securities Act of 1933, as amended (the "Securities Act"), and the rules and regulations of the Securities and Exchange Commission (the "Commission") promulgated thereunder. The Company intends to maintain a current prospectus covering the Shares until at least the three-year anniversary of the date of this Prospectus. See "Description of Securities--Registration Rights--Registration Rights Granted in Connection with the January 1998 Financing." The Shares may be offered and sold by the Selling Stockholders from time to time as market conditions permit in the over-the-counter market, or otherwise, at prices and terms then prevailing or at prices relating to the then-current market price, or in negotiated transactions. The Shares may be sold by the Selling Stockholders by one or more of the following methods, without limitation: (i) a block trade in which a broker or dealer so engaged will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction; (ii) purchases by a broker or dealer as principal and resale by such broker or dealer for its account pursuant to this Prospectus; (iii) ordinary brokerage transactions and transactions in which the broker solicits purchases; and (iv) face-to-face transactions between sellers and purchasers without a broker/dealer. In effecting sales, brokers or dealers engaged by the Selling Stockholders may arrange for other brokers or dealers to participate. Such brokers or dealers may receive commissions or discounts from Selling Stockholders in amounts to be negotiated. The Selling Stockholders and any brokers, dealers agents or underwriters who act in connection with the sale of the Shares hereunder may be deemed to be "underwriters," within the meaning of the Securities Act, in connection with such sale; accordingly, any commissions received by them and any profit on any resale of the Shares effected as a principal might be deemed to be underwriting discounts and commissions under the Securities Act. A person who is deemed to be an underwriter could become subject to potential liability under Section 11 of the Securities Act, from a lawsuit brought by a purchaser of the Shares, in the event that the Registration Statement of which this Prospectus is a part contains an untrue statement of a material fact or omits to state a material fact that is required to be stated in the Registration Statement or that is necessary to make the statements in the Registration Statement not misleading. In addition, under applicable rules and regulations under the Exchange Act, any person engaged in a distribution of the Shares may not simultaneously engage in market-making activities with respect to the Company's Common Stock for a period of nine business days prior to the commencement of such distribution, except under certain limited circumstances. The aggregate proceeds to the Selling Stockholders from the Shares will be the purchase price of the Shares sold less the aggregate agents' or brokerage commission and underwriters' discount, if any. The date of this Prospectus is April __, 1998. TABLE OF CONTENTS Page ---- Available Information................................................... 1 Certain Trademarks...................................................... 1 Prospectus Summary...................................................... 2 Recent Developments..................................................... 5 Risk Factors............................................................ 8 Price Range of Securities and Dividend Policy........................... 18 Capitalization.......................................................... 19 Selected Financial Data................................................. 20 Management's Discussion and Analysis of Financial Condition and results of Operations................................... 21 Business................................................................ 30 Management.............................................................. 42 Principal Stockholders.................................................. 50 Selling Stockholders.................................................... 52 Plan of Distribution.................................................... 53 Certain Transactions.................................................... 54 Description of Securities............................................... 56 Shares Eligible for Future Sale......................................... 62 Legal Matters........................................................... 63 Experts................................................................. 63 Financial Statements.................................................... F-1 AVAILABLE INFORMATION The Company has filed with the Commission a Registration Statement on Form SB-2 (the "Registration Statement") under the Securities Act with respect to the Shares offered hereby. This Prospectus, which constitutes a part of the Registration Statement, does not contain all of the information set forth in the Registration Statement, certain items of which are contained in the exhibits thereto as permitted by the rules and regulations of the Commission. Statements made in this Prospectus as to the contents of any contract, agreement or other document referred to herein are not necessarily complete. With respect to each such contract, agreement or other document filed as an exhibit to the Registration Statement, reference is made to the exhibit for a more complete description of the matter involved, and each such statement shall be deemed qualified in its entirety by such reference. The Company files periodic reports and other information with the Commission pursuant to the Exchange Act. The Registration Statement and the exhibits thereto, as well as such periodic reports and other information filed with the Commission, may be inspected without charge at the principal office of the Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, and copies of such material may be obtained by mail at prescribed rates from the Public Reference Section of the Commission at that same address. Such materials should also be available for inspection and copying at the regional offices of the Commission: 500 West Madison Street, Suite 1400, Chicago, Illinois 60661; and Seven World Trade Center, New York, New York 10048. The Commission maintains a Web site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants, such as the Company, that file electronically with the Commission. The Company furnishes its stockholders with annual reports containing financial statements which are examined and reported on, with an opinion expressed, by an independent public accounting firm, as well as quarterly reports containing unaudited financial information for the first three quarters of each fiscal year. Requests for copies of such documents may be directed to the Vice President-Finance, Kideo Productions, Inc., 611 Broadway, Suite 523, New York, New York 10012. No dealer, salesman or other person has been authorized in connection with this Offering to give any information or to make any representation other than those contained in this Prospectus, and, if given or made, such information or representation must not be relied upon as having been authorized by the Company or any broker, dealer, agent or underwriter. Except where otherwise indicated, this Prospectus speaks as of the effective date of the Registration Statement. Neither the delivery of this Prospectus nor any sale hereunder shall under any circumstances create any implication that there have been no changes in the affairs of the Company since the date hereof. CERTAIN TRADEMARKS 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. A federal trademark application also is currently pending in the United States with respect to the name "Gregory and Me." Third-party trademarks appearing in this Prospectus are the property of their respective holders. 1 PROSPECTUS SUMMARY The following summary is qualified in its entirety by reference to the more detailed information and financial statements, including the notes thereto, appearing elsewhere in this Prospectus. Each prospective investor is urged to read this Prospectus in its entirety. Except as otherwise noted, all information contained in this Prospectus, including per share data and information relating to the number of shares outstanding, (i) gives effect, retroactive to the Company's inception, to an 8.6545-for-1 split of the Common Stock effected on January 5, 1996, (ii) assumes no exercise of the Underwriter's Warrants (as defined below under "Recent Developments--The 1996 Underwritten Offering"), (iii) assumes no exercise of options (the "Employee Options") outstanding under the Company's 1996 Stock Option Plan (the "Option Plan"), and (iv) assumes no conversion of the January 1998 Notes into and no exercise of the January 1998 Warrants, the 1998 Johnston Warrants or the SME Warrants (as those terms are defined below under "Recent Developments--The January 1998 Financing") for any shares of Common Stock. The Company 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 revolutionary new type of home entertainment product: digitally photo-personalized home videos ("Kideos") and photo-personalized books. Since commercially launching its first Kideos nationally in the spring of 1994, the Company has focused primarily on producing proprietary Kideo titles for children aged two to seven. 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." With its existing photo-personalized product lines targeting the children's market, the Company has created -- and believes it dominates -- a unique product niche in the home video 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 eight proprietary personalized video titles for children. The Barney Licenses provide for the release by the Company of one photo-personalized Barney home video and three 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. For its fiscal years ended July 31, 1996 and 1997, the Company had net losses of approximately $3,059,000 and $3,819,000, respectively, and it had an accumulated deficit of approximately $10,398,000 as of January 31, 1998. The report of independent accountants on the Company's consolidated financial statements for the fiscal year ended July 31, 1997 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. See "Risk Factors--Going Concern Qualification in Auditor's Report; History of Significant Losses; Limited Revenues; Accumulated Deficit; Anticipated Future Losses" at page 10 below. 2 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 photo-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 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. The Company believes, however, that more than half of all Kideos sold by its 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 and Spiegel) to market and sell its products. Since the Underwritten Offering, however, the Company has increasingly been targeting its marketing strategies towards direct-to-consumer advertising and the development of relationships with established national distributors of children's home video products. During 1997, the Company determined to focus its near-term development efforts for new Kideos 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 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 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. In March 1998, the Company's photo-personalized Barney home video title -- "My Party with Barney" -- was first marketed for sale on The Home Shopping Network ("HSN"), which broadcasts to over 70 million U.S. households. A 15 minute promotional spot was broadcast by HSN six times during a 48 hour period. In 3 response, HSN received telephone orders for approximately 9,000 units of "My Party with Barney." In comparison, from the spring of 1994 (when the Company first began selling its Kideo products) through January 31, 1998, the Company had sold approximately 121,000 Kideos. HSN has agreed to continue marketing "My Party with Barney," along with the Company's Gregory and Me Kideos, throughout the spring and summer of 1998. 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 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: o to develop additional photo-personalized home video and book titles for children employing both proprietary and licensed characters; and o 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. The Company, a Delaware corporation, was originally incorporated in August 1993 under the laws of the State of New York. The stockholders of the Company's New York predecessor, which was also known as Kideo Productions, Inc. (referred to herein as "Kideo-NY"), exchanged all of their outstanding shares of common stock of Kideo-NY for the capital stock of the Company in January 1995. Effective upon such exchange, Kideo-NY became a wholly-owned subsidiary of the Company until it was merged into the Company in March 1996. Unless the context otherwise requires, the terms "Company" and "Kideo Productions, Inc." as used herein refer to Kideo Productions Inc., a Delaware corporation; its predecessor, Kideo-NY; and its wholly-owned subsidiary, Kideo Productions (Canada), Inc. ("Kideo-Canada"). The Company's principal executive offices are located at 611 Broadway, Suite 523, New York, New York 10012, and its telephone number is (212) 505-6605. 4 The Offering This Prospectus relates to the public offering by the Selling Stockholders of up to 1,152,500 shares of Common Stock (this "Offering"). None of the Shares covered by this Prospectus have been sold prior to the date hereof. The Company will not receive any proceeds from the sale of the Shares. The Company is bearing substantially all of the costs of this Offering. The Shares may be offered by the Selling Stockholders pursuant to this Prospectus until _____ __, 199_, provided that this Prospectus is kept current in accordance with applicable provisions of the Securities Act and the rules and regulations of the Commission promulgated thereunder. The Company intends to maintain a current prospectus covering the Shares through that date and, thereafter, until at least the three-year anniversary of the date of this Prospectus. The Shares may be sold by the Selling Stockholders in transactions in the over-the-counter market, in negotiated transactions, or a combination of such methods of sale. See "Selling Stockholders," "Plan of Distribution" and "Certain Transactions--Registration Rights of the 1998 Investors." The Common Stock is traded on the over-the-counter market under the symbol KIDO. The Common Stock is not listed or admitted for trading on any stock market and in September 1997 was delisted from trading on the Nasdaq SmallCap Market. See "Risk Factors--September 1997 Delisting of Securities from Nasdaq," "--Additional Risks Relating to Delisted and Penny Stocks" and "Price Range of Securities and Dividend Policy." An investment in the Shares involves a high degree of risk. Prospective investors should understand that they may sustain a total loss of their investment and should carefully consider the factors described herein under "Risk Factors." 5 RECENT DEVELOPMENTS The 1996 Underwritten Offering On June 24, 1996, the Company completed an underwritten initial public offering of 1,400,000 shares of Common Stock and redeemable warrants to purchase 1,610,000 shares of Common Stock (the "Warrants"), all of which were sold by the Company (the "Underwritten Offering"). The initial public offering price was $5.00 per share of Common Stock and $.10 per Warrant. Each Warrant entitles the registered holder thereof to purchase, at any time from June 24, 1997 through June 24, 2001, one share of Common Stock at a price of $4.00 per share, subject to adjustment in certain circumstances (including in the event of a stock split or dividend, recapitalization, reorganization, merger or consolidation of the Company). See "Description of Securities--Common Stock" and "--Public Warrants." The Company sold 140,000 warrants to Whale Securities Co., L.P., as underwriter of the Underwritten Offering (the "Underwriter") and its designees (the "Underwriter's Warrants"). Each Underwriter's Warrant entitles the registered holder thereof to purchase one share of Common Stock at an exercise price of $8.25 per share (165% of the initial public offering price per share) and/or one warrant (each exercisable to purchase one share of Common Stock at a price of $5.20 per share) at an exercise price of $.165 per warrant (165% of the initial public offering price per Warrant). The Underwriter's Warrants contain a cashless exercise provision. In the event that all of the Underwriter's Warrants (and the warrants to purchase Common Stock which underlie the Underwriter's Warrants) were to be exercised, the holders of the Underwriter's Warrants would become the owners of an aggregate of 280,000 shares of Common Stock. Pursuant to an agreement between the Company and the Underwriter, those 280,000 shares were registered under the Securities Act and included by the Company in a registration statement that was declared effective in September 1997. The Underwriter's Warrants are exercisable during the four-year period ending June 24, 2001 (the "Warrant Exercise Term"). In general, before that date, the Underwriter's Warrants may not be sold, transferred, assigned or hypothecated except to the officers and partners of the Underwriter and members of the selling group formed by it to effectuate the Underwritten Offering. During the Warrant Exercise Term, the holders of the Underwriter's Warrants are given, at nominal cost, the opportunity to profit from a rise in the market price of the Common Stock. To the extent that the Underwriter's Warrants are exercised, dilution to the percentage ownership in the Company held by the Company's current stockholders will occur. Further, the terms upon which the Company will be able to obtain additional equity capital may be adversely affected, since the holders of the Underwriter's Warrants can be expected to exercise them at a time when the Company would, in all likelihood, be able to obtain any needed capital on terms more favorable to the Company than those provided in the Underwriter's Warrants. Any profit realized by the Underwriter on the sale of the Underwriter's Warrants, the underlying shares of Common Stock or the underlying warrants, or the shares of Common Stock issuable upon exercise of such underlying warrants, may be deemed additional underwriting compensation. The Company has also granted certain demand registration rights to the holders of the Underwriter's Warrants during the four-year Warrant Exercise Period, and has granted certain piggyback registration rights to such holders during the seven year period ending June 24, 2003. In connection with the qualification for sale under certain state securities laws of the Common Stock and the Warrants at the time of the Underwritten Offering, the Company consented to the denial of secondary trading in its securities in the State of New Jersey. As a result of this action, stockholders of the Company cannot sell shares of Common Stock or Warrants through a broker-dealer whose office is located in New Jersey or to any New Jersey resident, whether through a broker-dealer or not, unless such denial is removed, of which there can be no assurance. 6 The 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." Pursuant to the January 1998 Purchase Agreement, the Company has registered under the Securities Act and included in the Registration Statement 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. The following is a summary of certain terms of the January 1998 Notes and the January 1998 Warrants and of certain other transactions that were undertaken by the Company in anticipation of, or in connection with, the January 1998 Financing. January 1998 Notes The January 1998 Notes were issued on January 30, 1998, bear interest at the rate of 10% per annum, payable quarterly commencing April 30, 1998, and are due on demand of the holder thereof at any time on or after April 15, 1999. An "Event of Default" will occur under the January 1998 Notes if the Company, among other things, fails to pay interest or principal when due or fails to perform any material agreement, or materially breaches any representation or warranty under, the January 1998 Purchase Agreement or the Security Agreement. Upon an Event of Default, the entire indebtedness and accrued interest may become immediately due and payable. Any amount outstanding under the January 1998 Notes may be prepaid subject to the following limitations: (a) All interest accrued through the date of prepayment must be paid; (b) The amount of such prepayment may not exceed net operating income (excluding any non-cash expenses) generated by the Company from January 30, 1998 through the date of prepayment; (c) If, while the January 1998 Notes are outstanding, the Company sells shares of Common Stock or securities convertible into or exercisable for Common Stock, subject to certain exceptions, only twenty (20%) percent of the January 1998 Notes may be prepaid; and (d) The Company shall forfeit the right to prepay one-third of the principal amount of the January 1998 Notes if such amount is not prepaid on or before October 15, 1998 and one-third of the principal amount of the January 1998 Notes if such amount is not prepaid on or before January 15, 1999. That portion of the principal amount that is not prepaid on or before October 15, 1998, if any, is referred to as the "October Tranche" and that portion of the principal amount 7 that is not prepaid on or before January 15, 1999, if any, is referred to as the "January Tranche." That portion of the remaining principal amount that is not paid on or before the date April 15, 1999, if any, is referred to as the "Final Tranche." If all or any part of the January 1998 Notes are outstanding on or after April 15, 1999, then the Company may, upon 30 days prior written notice, pay such amount, subject to the right of the holders thereof to convert their January 1998 Notes into Common Stock during the period following their receipt of notice and prior to repayment. The January 1998 Notes may be converted, in whole or in part, into shares of Common Stock after the following dates: (a) October 15, 1998, with respect to the October Tranche, if any; (b) January 15, 1999, with respect to the January Tranche, if any; and (c) April 16, 1999 with respect to the Final Tranche, if any. The number of shares of the Common Stock to be received upon conversion shall be determined as by dividing the principal amount of that portion of the January 1998 Notes being converted by $1.00, subject to certain adjustments (the "Conversion Price"). That conversion feature affords a discount to fair market value at the time of conversion of the January 1998 Notes into Common Stock. The intrinsic value of this feature related to the Notes issued in January 1998 was $465,000, and that amount was recorded in the Company's financial statements for the fiscal period ended January 31, 1998, as a deferred financing cost, which will be amortized from the date the security was issued until the date it first becomes convertible. January 1998 Warrants 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 $1.00 per share as follows: one-third of the January 1998 Warrants become exercisable following May 1, 1998; an additional one-third become exercisable on July, 15, 1998; and the balance become 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. Agreement with KSH Investment Group, Inc. 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. January 1998 Johnston Financing Proposal 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 so 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 and disbursements 8 incurred by him in negotiating the January 1998 Johnston Financing Proposal. The shares underlying the 1998 Johnston Warrants are included in the Shares that have been registered in connection with, and that are being offered pursuant to, this Offering. 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." Agreement with Solovay Marshall & Edlin, P.C. Prior to the closing of the January 1998 Financing, Solovay Marshall & Edlin. P.C. ("SME"), 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 SME $40,000 by March 15, 1998 and, on February 2, 1998, issued: (i) to SME, a note (the "SME 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 SME, warrants to purchase an aggregate of 120,000 shares of Common Stock (the "SME Warrants") for $1.00 per share. The Company also agreed to register the shares of Common Stock for which the SME Warrants may be exercised. The shares underlying the SME Warrants are included in the Shares that have been registered in connection with, and that are being offered pursuant to, this Offering. The SME Warrants are exercisable at any time after January 31, 1999 through February 2, 2003 and contain other terms identical to the January 1998 Warrants. Repricing of Employee Stock Options The Company's Board of Directors in February 1998 recommended to the Administrators of the Option Plan that 273,000 previously granted options to purchase shares of Common Stock should be repriced to have an exercise price of $2.50 per share. The options had previously been granted by the Administrators to employees and directors of the Company at purchase prices ranging from $3.1875 to $5.00 per share, and the weighted average purchase price of the 273,000 options was approximately $4.95 per share. The Administrators approved the Board's recommendation on that same day. The resulting revaluation did not otherwise alter in any respect any of the terms and conditions originally made applicable under any optionee's stock option agreement, including provisions relating to vesting, term of exercise and events of forfeiture. See "Management--1996 Stock Option Plan." 9 RISK FACTORS The securities being offered hereby are highly speculative and involve a high degree of risk, including but not limited to, those risk factors set forth below, and therefore should not be purchased by anyone who cannot afford a loss of his entire investment. Prior to making an investment in the Company, each prospective investor should carefully consider the following risk factors inherent in and affecting the business of the Company and this offering. Limited Operating History. Although the Company was organized in August 1993, it did not launch its initial line of Kideo products until the spring of 1994. In the approximately four years since then, the Company has sold only a total of approximately 121,000 Kideos. The Company thus has a limited operating history upon which an evaluation of its business and prospects can be based. Such prospects must be considered in light of the numerous risks, expenses, difficulties and delays frequently encountered in connection with the formation and early phase of operation of a new business, the development and commercialization of new products based on innovative technology (such as Kideos, which are an emerging business concept in a new and largely untested market) and the rapid technological changes and evolving industry standards associated with the industry in which the Company operates. See "Business." Going Concern Qualification in Independent Auditor's Report; History of Significant Losses; Limited Revenues; Accumulated Deficit; Anticipated Future Losses. The report of independent accountants on the Company's consolidated financial statements for the fiscal year ended July 31, 1997 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 has incurred substantial operating losses since its inception, resulting in an accumulated deficit of approximately $10,398,000 as of January 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 six months ended January 31, 1998, the Company had revenues of approximately $593,000 and a net loss of approximately $1,225,000. The Company believes that its net loss for the fiscal year ending July 31, 1998 could exceed the net loss for the prior fiscal year, and that the Company will continue to operate at a loss until such time, if ever, when its operations generate sufficient revenues to cover its costs. There can be no assurance that revenues will increase significantly in the future, or even be sustained, or that the Company will ever achieve profitability. See "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and Consolidated Financial Statements. September 1997 Delisting of Securities from Nasdaq. Based upon its actual balance sheet at April 30, 1997, the Company failed to meet Nasdaq's maintenance requirements for continued listing on the Nasdaq SmallCap Market. The Company fell short of the required level of $2 million in total assets (reporting total assets at April 30, 1997 of approximately $1.6 million) and fell short of the required level of $1 million of capital and surplus (i.e., total stockholders' equity) (reporting total stockholders' equity at April 30, 1997 of approximately $240,000). Nasdaq subsequently notified the Company that -- unless the Company could present to Nasdaq an acceptable financing and/or other plan which would remedy such shortcomings and would make likely the Company's long-term compliance with the listing requirements for the Nasdaq SmallCap Market -- the Company's Common Stock and Warrants would be deleted from trading on Nasdaq. Following the Company's submission of such a plan and hearings and other administrative proceedings conducted by Nasdaq concerning the plan and the Company's likelihood of long-term compliance with applicable listing requirements, on September 26, 10 1997 Nasdaq notified the Company that the Common Stock and Warrants had been deleted as of that date from listing on the SmallCap Market. As a consequence of this delisting, the Common Stock and Warrants since September 1997 have been traded on the over-the-counter market and, as described immediately below, have been subject to Commission regulations applicable to so-called "penny stocks". As a further consequence of this delisting and the trading of the Common Stock and Warrants on the over-the-counter market, purchasers of the Shares offered hereby may find that the liquidity of the Company's securities has been significantly impaired -- not only in the number of securities that can be bought and sold, but also through delays in the timing of transactions, reduction in security analysts' and the news media's coverage of the Company, and lower prices for the Company's securities than might otherwise be attained. Additional Risks Relating to Delisted and Penny Stocks. Since the Company's securities were delisted from Nasdaq, they have become subject to Rule 15g-9 of the Exchange Act, which imposes additional sales practice requirements on broker-dealers which sell such securities to persons other than established customers and "accredited investors" (generally, an institution with assets in excess of $5,000,000 or an individual with net worth in excess of $1,000,000 or annual income exceeding $200,000, or $300,000 together with a spouse). For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser's written consent to the transaction prior to sale. Consequently, such rule may adversely affect the ability of broker-dealers to sell the Company's securities and may adversely affect the ability of purchasers of the Shares offered hereby to re-sell any of such Shares in the secondary market. As a result of the September 1997 delisting of the Company's securities from Nasdaq, the Common Stock (including the Shares offered hereby) and the Warrants constitute "penny stocks" for purposes of Commission regulations. Those regulations define a "penny stock" to be any non-Nasdaq equity security that has a market price (as therein defined) of less than $5.00 per share or with an exercise price of less than $5.00 per share (subject to certain exceptions). For any transaction by broker-dealers involving a penny stock, unless exempt, the rules require delivery, prior to any transaction in a penny stock, of a disclosure schedule prepared by the Commission relating to the penny stock market. Disclosure is also required to be made regarding commissions payable to both the broker-dealer and the registered representative and current quotations for the securities. Finally, monthly statements are required to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. The status of the Company's securities as penny stocks additionally render the Company subject to Section 15(b)(6) of the Exchange Act, which gives the Commission the authority to prohibit any person that is engaged in unlawful conduct while participating in a distribution of a penny stock from associating with a broker-dealer or participating in a distribution of a penny stock, if the Commission finds that such a restriction would be in the public interest. Significant Capital Requirements; Working Capital Deficit; Need for Additional Financing. The Company's capital requirements in connection with its development and marketing activities have been and will continue to be significant. Because the Company has operated at a loss since its inception and is not generating sufficient revenues from its operations to fund its activities (as of January 31, 1998, the Company had a working capital deficit of $962,000), it has to date been substantially dependent on loans from its stockholders and private and public market sales of its securities to fund its operations. Most recently, the Company undertook the January 1998 Financing so as to obtain the working capital that it required in order to continue its creative development activities and fund its marketing plans, as well as its other working capital requirements. Although the Company anticipates, based on its currently proposed 11 plans and assumptions relating to its operations (including assumptions regarding the progress and timing of its new product development efforts), 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 until approximately April 30, 1998, there can be no assurance that such funds will not be expended prior thereto due to unanticipated changes in economic conditions or other unforeseen circumstances. In the event the Company's plans change or its assumptions change or prove to be inaccurate, 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. Any inability to obtain additional financing when needed would have a material adverse effect on the Company, requiring it to curtail and possibly cease its operations. In addition, any additional equity financing may involve substantial dilution to the interest's then existing stockholders. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." Developing Market; New Entrants; Uncertain Growth of Market. The market for digitally personalized media products has only recently begun to develop, is rapidly evolving and currently has few proven products. As it evolves, the Company believes it likely that this market will become characterized by rapid technological changes and an increasing number of market entrants. Because the market for the Company's products is new and evolving, it is difficult to predict the future growth rate (if any) and size of this market or which methods of product distribution will ultimately prove successful. The Company, for instance, has experienced difficulties in attempting to market its products through mass market retailers. It believes that such difficulties may stem inherently from the fact that a customer at a retail store cannot make an impulse purchase of a Kideo (but instead must take home, fill out and send in a Kideo order form and then wait two to four weeks to receive the product). There can be no assurance that the market for the Company's products will develop to a point that will enable the Company's business to grow significantly (if at all) or become profitable. If the market fails to develop, develops more slowly than expected or becomes saturated with competitors, or, if the Company's products do not achieve market acceptance, the Company's business, operating results and financial condition will be materially adversely affected. See "Business--Competition and Industry Background." Unproven Market Acceptance of the Company's Products. As is typical in the case of a new and rapidly evolving industry, demand and market acceptance for recently introduced products are subject to a high level of uncertainty, and there can be no assurance that products like those of the Company will meet with widespread consumer acceptance. The Company believes that in order for Kideos to meet with widespread consumer acceptance, they may ultimately need to be produced so that (unlike the present time) the personalized child characters appearing in them can exhibit substantially the same features as the animated and live-action characters now appearing in popular children's films and television shows -- such features as three-dimensional full-motion animation and lips that move in synchronization with the child character's voice. There can be no assurance that the Company will ever succeed in developing a production system capable of producing Kideos with those types of features at a cost acceptable to the Company or consumers Limited Marketing Capabilities. The Company historically has had, and continues to be disadvantaged by, limited marketing experience and limited financial, personnel and other resources to undertake extensive marketing and advertising activities. Only after receiving the net proceeds of the Underwritten Offering did the Company enjoy any meaningful capabilities to engage in any 12 significant marketing and advertising activities. In the approximately one year period following the June 1996 consummation of the Underwritten Offering, the Company devoted approximately $1.2 million of the net proceeds therefrom to various types of marketing tests and campaigns (primarily in connection with the development and support of various forms of direct-to-consumer marketing, including direct-response television and radio advertising). While revenues for the fiscal year ended July 31, 1997 (approximately $1,346,000) were 77% higher than revenues for the corresponding period of the prior fiscal year (approximately $761,000), the Company's marketing activities did not generate revenues sufficient to attain profitability. Developing increased market acceptance for the Company's existing and proposed Kideo products will require substantial marketing efforts and the expenditure of a significant amount of funds. If current revenue levels are sustained for the near term, the Company does not believe that it will have the capability to devote to those marketing efforts funds of its own in amounts that will be sufficient to create broad consumer awareness of the Company's products. The Company is therefore seeking out marketing and other arrangements with companies that have the demonstrated financial and operational capabilities to promote and distribute children's home video products through a broad range of distribution channels. No assurance can be given, however, that any of those arrangements (if concluded on terms favorable to the Company, of which there can be no assurance) will materially improve the Company's abilities to penetrate on a widescale basis the existing children's video market or to position its products to appeal to mainstream consumer markets. There in fact can be no assurance given that any marketing efforts undertaken by the Company (or its future marketing partners, if any) will result in any increased demand for the Company's products, or that any such efforts will result in any significant increase in revenues. See "Business--Marketing." Dependence on Key Personnel. The success of the Company is largely dependent on the abilities and continued personal efforts of its executive officers, including especially those of Richard L. Bulman, the Company's President and Chairman of the Board. All of the Company's current employment agreements with its officers expire by December 1998. Any incapacity or inability of Mr. Bulman or other of the Company's officers to perform their services would have a material adverse effect on the Company. Moreover, other than key man life insurance on the life of Mr. Bulman in the amount of $2,000,000, the Company does not have (and does not intend to have) key man life insurance on the lives of its officers or employees. The success of the Company is also dependent on its ability to continue to retain and attract qualified personnel. There is considerable and often intense competition for the services of such personnel, both on a national level and within the rapidly growing community of young computer-related businesses that have recently chosen to locate in New York City, the site of the Company's offices. There can be no assurance that the Company will be able either to retain its existing personnel or to acquire additional qualified personnel as and when needed. The loss of any of its key employees' services could have a material adverse effect on the Company's operations. See "Business--Employees" and "Management." Potential Obsolescence due to Rapid Technological Changes. The technologies underlying the Company's products (such as personal computer hardware and software), as well as the market for those products, are subject to rapid changes and evolving industry standards often resulting in product obsolescence or short product lifecycles. While the Company will continue to devote its efforts and funds to further developing and enhancing its existing products, technologies and production facilities, there can be no assurance that it will succeed in those efforts. The Company will likely depend to a considerable extent upon its ability to develop and implement improved technologies for the production of digitally personalized media products that embody features (e.g., improved animation) superior to those displayed by the Company's existing Kideos. The development and implementation of such new technologies is a complex and uncertain process requiring high levels of skill and innovation, as well as accurate anticipation 13 of technological and market trends, and there can be no assurance that the Company's efforts in this direction will succeed. The Company's digitally personalized media products are designed for a relatively new and largely untested market. Such a new market is particularly susceptible to rapidly changing and evolving technologies and industry standards. The introduction by the Company's existing or future competitors of digitally personalized media products embodying superior technologies or the emergence of new industry standards could exert adverse price pressures on the Company's existing or future products or could render the Company's technologies obsolete or its products unmarketable, any of which occurrences would have a material adverse effect on the Company. See "Business--Technology Overview," "--Potential Future Products" and "--Competition and Industry Background." Competition. 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 Company is aware of only one other company in this country that is currently producing and marketing personalized video media products. However, 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, production, marketing and other resources than those of the Company. In the case of an entity with such resources, the Company does not believe that there currently are, or are likely to be in the foreseeable future, prohibitive barriers to entry into the business of developing and marketing digitally personalized media products. Accordingly, the ability of the Company to compete will depend on its ability to complete development of, and introduce into the marketplace in a timely manner, its proposed products and technology, and to continually enhance and improve such products and technology. There can be no assurance that the Company will be able to compete successfully, that its existing or future competitors will not develop technologies or products that render the Company's products and technology obsolete or less marketable (or otherwise have a material adverse effect upon the Company's operations), or that the Company will be able to enhance successfully its proposed products or technology or to adapt them satisfactorily. See "Business--Competition and Industry Background." Seasonality; Significant Fluctuations in Quarterly Financial Results. Based upon the Company's limited operating history, it expects that a substantial portion of its revenues in any fiscal year may result from sales during the months of October through December. The Company believes that a reason for this sales pattern is that a significant percentage of its products have been given as gifts and, as such, sell at larger volumes during the holiday season. For that and other reasons, the Company's results of operations are likely to vary significantly from quarter to quarter, and financial results for any given fiscal quarter will not necessarily be indicative of the results to be anticipated for a full fiscal year. Other such reasons could include significant fluctuations in demand for the Company's products, a change in the mix of distribution channels through which products are sold, the introduction of new products by the Company or its competitors, and changes in general economic conditions. Moreover, as a result of its limited operating history, the Company does not have historical financial data for a significant number of periods on which to base planned operating expenses. Accordingly, the Company's expense levels are based in part on its expectations as to future revenues and to a large extent are fixed. However, the Company typically operates with no backlog. As a result, quarterly sales and operating results generally depend on the volume and timing of and ability to fulfill orders received within the quarter, which are difficult to forecast. The Company may be unable to adjust spending in a timely manner to compensate for any unexpected shortfall in revenue. Accordingly, any significant shortfall of demand for the Company's products and services in relation to the Company's expectations would have an immediate adverse impact on the Company's business, operating results and financial condition. Due to all of the foregoing factors, it is likely that the Company's operating results in some future quarter 14 will be below the expectations of public market analysts (if any are then following the Common Stock) and investors. In such an event, the market price of the securities offered hereby would likely be materially adversely affected. At the present time, to the Company's knowledge, no public market securities analysts are following the Common Stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Limited Assurances as to Protection of Proprietary Technology. The Company claims proprietary rights in its digital personalization 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). None of the Company's production technologies, however, are currently the subject of any issued patents in any foreign jurisdiction, and there can be no assurance that any foreign patents will be issued to the Company. Patents and patent applications, like the ones issued to and filed involve complex legal and factual questions, 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. There can be no assurance, for instance, (i) that the U.S. patent issued to the Company will be sufficiently broad to protect the Company's proprietary technology or the processes to which such patent relates, or (ii) that this patent will not be challenged, invalidated, designed around by others or otherwise circumvented. There additionally can be no assurance that - --independently of any protection afforded by any patents now or hereafter issued -- the steps taken by the Company to protect its proprietary rights will be adequate to prevent the misappropriation of its technology or the independent development by others of hardware and software products with features based upon, or otherwise similar to, those of the Company's products. In addition, if the Company were to become involved in litigation to enforce any of its patent rights, the attendant costs could be substantial or even prohibitive. The Company accordingly may not enjoy any effective patent protection with respect to its proprietary technology and processes. Although the Company believes that its existing technologies and implementations of such technologies do not infringe upon the rights of others, it is possible that third parties may currently have, or may be granted in the future, patents claiming products or processes that are necessary for or useful to the development of the Company's technology, and that legal actions could be brought against the Company asserting infringement. In addition, there can be no assurance that products developed by the Company in the future will not infringe the current or future patent rights of others, giving rise to infringement claims against the Company. In the case of such infringement, the Company could, under certain circumstances, be required to modify its products or to obtain a third-party license in order to render the Company's technology or processes non-infringing. Such thirty-party license might not be granted, or may not be available to the Company on reasonable terms, either of which results could materially adversely affect the Company's business and prospects. See "Business--Intellectual Property Rights." Possible Inability to Use or Register the Word "Kideo" as a Trademark. 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. There can be no assurance that the Company will be granted a registered trademark of the word "Kideo" in any jurisdiction. In the United States, another party had previously registered two allegedly similar trademarks but had ceased using them and had filed for bankruptcy under Chapter 11. In July 1994, the Company commenced proceedings against the successor to the original owner of these two trademarks (the "Successor") in order to obtain the cancellation of these trademarks on the basis of abandonment. The Company prevailed in one proceeding but the other proceeding is still pending. This latter proceeding is currently suspended, pursuant to a stipulation agreed upon by the Company and the Successor while they complete the formalities of a settlement. In this settlement, the Successor has agreed to withdraw its registration and a pending 15 application to register the mark "Kideo" and to cease using this mark in the United States. The settlement agreement has been prepared, agreed to by both parties, and is in the process of being executed. If for any reason the settlement agreement is not executed and delivered by the Successor (which the Company currently considers unlikely), then the Company would recommence the pending proceeding. In Company expects (based upon statements made to it by the Successor) that the Successor will allege that, even if the previously registered trademarks were abandoned by the original owner, the Successor nonetheless made the first use thereafter of the trademark "Kideo" in the United States. A proceeding of this nature is a lengthy and potentially expensive process, and there can be no assurance that the Company will ultimately obtain a registered trademark for the word "Kideo" and obtain the right to use this mark in connection with its products and services. 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 this mark in the state of Illinois. To date, however, the Company has received no communication from any party objecting to or otherwise challenging its right to conduct its business and offer its products for sale in Illinois under the name "Kideo." See "Business--Legal Proceedings." Market for the Company's Securities; Possible Price Volatility. There can be no assurance that an active trading market for the Company's securities will exist or be sustained at any time after the date hereof, especially in view of the September 1997 delisting of the Common Stock and Warrants from Nasdaq. No person or entity is required to make a market in the Common Stock. As a result, a purchaser of the Shares may experience difficulty in selling his Shares. In addition, the market prices of the Company's securities may from time to time be highly volatile, as has been the case with the securities of other companies in emerging growth businesses. Factors such as the Company's financial results, the introduction of new products by the Company or its competitors, and factors affecting the video industry generally may have a significant impact on the market price of the Company's securities. In recent years, the stock market itself has experienced a high level of price and volume volatility, and market prices for the stock of many companies (particularly of small and emerging growth companies, like the Company, whose common stock is traded only in the over-the-counter-market) have experienced wide price fluctuations which have not necessarily been related to the operating performance of such companies. See "Price Range of Securities and Dividend Policy." No Dividends. The Company has never paid any cash or other dividends on its Common Stock. Payment of dividends on the Common Stock is within the discretion of the Board of Directors and will depend upon the Company's earnings, its capital requirements and financial condition, and other relevant factors. For the foreseeable future, the Board intends to retain future earnings (if any) to finance its business operations and does not anticipate paying any cash dividends with respect to the Common Stock. In addition, the payment of cash dividends in the future will potentially be limited by the terms of financing agreements that may hereafter be entered into by the Company or by the terms of any series of dividend-bearing Preferred Stock that may be issued by the Company. See "Price Range of Securities and Dividend Policy" and "Description of Securities--Series A Preferred Stock." Significant Management Holdings. As of the date of this Prospectus, the Company's directors and officers as a group own an aggregate of approximately 22% of the outstanding shares of Common Stock (28% when beneficial ownership is considered) and will thus be able to exert significant influence over all matters requiring stockholder approval, including the election of directors and the approval of significant corporate transactions (such as acquisitions of the Company or its assets). If they were to act together as a group, the Company's officers and directors could delay or prevent a change of control of the Company. See "Principal Stockholders" and "Description of Securities." 16 Delaware Anti-Takeover Statute; Possible Adverse Effects Associated with the Issuance of "Blank Check" Preferred Stock. The Company is a Delaware corporation and is subject to imposed by Section 203 of the Delaware General Corporation Law ("DGCL"), which is generally viewed as an anti-takeover statute. In general, this statute prohibits a public company incorporate in Delaware from entering into certain business combinations without the approval of its Board of Directors and, as such, could prohibit or delay mergers or other attempted takeovers or changes in control with respect to the Company. Such provisions may discourage attempts to acquire the Company. In addition, the Company's Certificate of Incorporation authorizes the Company's Board of Directors to issue up to 5,000,000 shares of "blank check" preferred stock, from time to time, in one or more series, solely on the authorization of its Board of Directors -- as was done in the case of the creation in May 1997 of the Series A 6% Convertible Participating Preferred Stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources--May 1997 Financing." The Board of Directors is thus authorized, without further approval of the stockholders, to fix the dividend rights and terms, conversion rights, voting rights, redemption rights and terms, liquidation preferences, and any other rights, preferences, privileges and restrictions applicable to each new series of preferred stock. The issuance of such stock could, among other results, adversely affect the voting power of the holders of Common Stock and, under certain circumstances, make it more difficult for a third party to gain control of the Company, discourage bids for the Common Stock at a premium, or otherwise adversely affect the market price of the Common Stock and Warrants. See "Description of Securities--Preferred Stock" and "--Anti-Takeover Provisions of Delaware Law." Certain Charter Provisions Having Anti-Takeover Effects. The Company's Certificate of Incorporation includes provisions that may, under certain circumstances, make it more difficult for a third party to gain control of the Company (e.g., by means of a tender offer), prevent or substantially delay such a change of control, discourage bids for the Company's securities at a premium, or otherwise adversely affect the market price of the Company's securities. At the next annual meeting of stockholders, for example, the Company's Board of Directors will be classified into three classes of directors, with each class serving a staggered three-year term. The Certificate of Incorporation also provides that stockholder action may only be effected at a duly called meeting of stockholders and not by a written consent in lieu of a meeting. These provisions could make it more difficult for stockholders to effect certain corporate actions that might facilitate a proposed acquisition of the Company (e.g., the replacement of directors of the Company) and might have the effect of delaying or preventing a change of control of the Company. See "Management--Directors and Executive Officers." Limitations on Liability of Directors and Officers. The Company's Certificate of Incorporation includes provisions to eliminate, to the full extent permitted by the DGCL as in effect from time to time, the personal liability of directors of the Company for monetary damages arising from a breach of their fiduciary duties as directors. The Certificate of Incorporation also includes provisions to the effect that (subject to certain exceptions) the Company shall, to the maximum extent permitted from time to time under the law of the State of Delaware, indemnify, and upon request shall advance expenses to, any director or officer to the extent that such indemnification and advancement of expenses is permitted under such law, as it may from time to time be in effect. In addition, the Company's By-Laws (the "By-Laws") require the Company to indemnify, to the full extent permitted by law, any director, officer, employee or agent of the Company for acts which such person reasonably believes are not in violation of the Company's corporate purposes as set forth in the Certificate of Incorporation. As a result of such provisions in the Certificate of Incorporation and the By-Laws, stockholders may be unable to recover damages against the directors and officers of actions taken by them which constitute negligence, gross negligence or a violation of their fiduciary duties, which may reduce the 17 likelihood of stockholders instituting derivative litigation against directors and officers and may discourage or deter stockholders from suing directors, officers, employees and agents of the Company for breaches of their duty of care, even though such an action, if successful, might otherwise benefit the Company and its stockholders. See "Management--Limitations of Liability and Indemnification." State Registration Required for Sale of Shares. An investor may purchase Shares only if those Shares are qualified for sale, or are exempt from registration or qualification, under the applicable state securities laws of the State in which the prospective purchaser resides. The Company has not registered or qualified the Shares under any state securities laws and, unless the sale of Shares to a particular investor is exempt from registration or qualification under applicable state securities laws, that sale may not be effected until those Shares have been so registered or qualified. Shares Eligible for Future Sale; Registration Rights. As of the date of this Prospectus, the Company has 3,694,628 shares of Common Stock outstanding. Of the outstanding shares, an aggregate of 2,233,114 shares have previously been registered for sale under the Securities Act and, accordingly, are freely tradeable without restriction or further registration thereunder. The Company effectuated those prior registrations in June 1996 (as part of the Underwritten Offering) and in August 1997 (in connection with the May 1997 Financing described below under "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources--May 1997 Financing"). Of the outstanding shares of Common Stock registered in June 1996, (i) 1,400,000 registered shares of Common Stock were sold in the public market pursuant to the Underwritten Offering, and (ii) 290,000 shares of Common Stock were registered on behalf of certain selling stockholders of the Company. All of the 543,114 outstanding shares of Common Stock registered in August 1997 were registered on behalf of a selling stockholder of the Company. All of the 1,461,514 remaining shares of Common Stock currently outstanding (the "Restricted Common Stock") are "restricted securities" (as that term is defined in Rule 144 under the Securities Act), and as such they may be sold only pursuant to a registration statement under the Securities Act, in compliance with the exemption provisions of Rule 144 or pursuant to another exemption under the Securities Act. Since June 24, 1997, however, substantially all of these restricted securities have either been (i) eligible for sale in the public market pursuant to Rule 144 or (ii) subject to the exercise of certain demand and/or piggyback registration rights which the Company from time to time has granted to various of its securityholders. A total of 1,235,234 shares of the Restricted Common Stock are held by stockholders to whom the Company has granted registration rights. No prediction can be made as to the effect, if any, that sales of such securities, or the availability of such securities for sale, will have on the market prices prevailing from time to time for the Common Stock and Warrants. However, even the possibility that a substantial number of the Company's securities may, in the near future, be sold in the public market may adversely affect prevailing market prices for the Common Stock and could impair the Company's ability to raise capital through the sale of its equity securities. In addition, any future exercise of the registration rights held by existing securityholders of the Company could cause it to incur substantial expenses and could have a further negative impact upon the Company's ability to raise capital through the sale of its equity securities. See "Description of Securities--Registration Rights," "Shares Eligible for Future Sale" and "Plan of Distribution." Effect of Outstanding Convertible Securities. As of the date of this Prospectus, there are outstanding: (i) currently exercisable Warrants to purchase an aggregate of 1,610,000 shares of Common Stock at a price of $4.00 per share; 18 (ii) fully vested Employee Options to purchase 261,003 shares of Common Stock at $2.50 per share; (iii) currently exercisable Underwriter's Warrants to purchase an aggregate of 140,000 shares of Common Stock at a price of $8.25 per share; (iv) currently exercisable Common Stock purchase warrants (which underlie the Underwriter's Warrants) to purchase an aggregate of 140,000 shares of Common Stock at a price of $5.20 per share; (v) certain currently exercisable warrants (issued in October 1996 to an independent contractor to the Company) to purchase an aggregate of 20,000 shares of Common Stock at a price of $5.00 per share; and (vi) certain currently exercisable warrants (which are beneficially held by Charles C. Johnston, a director and principal stockholder of the Company) to purchase an aggregate of 83,975 shares of Common Stock at a price of $3.60 per share. If any of these convertible securities are exercised for or converted into their underlying Common Stock equivalents, then the percentage ownership of persons then holding shares of Common Stock (such as the purchasers of the Shares offered hereby) will be diluted (and could be substantially diluted), and subsequent sales in the public market of such underlying Common Stock could adversely affect the prevailing market prices for the Common Stock (including the Shares offered hereby). See "Recent Developments--Repricing of Employee Stock Options," "Management--1996 Stock Option Plan" and "Description of Securities." Tax Loss Carryforward. The Company's net operating loss carryforwards ("NOLs") expire in the year 2010. Under Section 382 of the Internal Revenue Code of 1986, as amended, utilization of prior NOLs is limited after an ownership change, as defined in Section 382, to an annual amount equal to the value of the loss corporation's outstanding stock immediately before the date of the ownership change multiplied by the federal long-term exempt tax rate. The equity financing obtained by the Company in connection with the Underwritten Offering and certain private financings completed prior thereto resulted in an ownership change and, thus, in limitations on the Company's use of its prior NOLs. In the event the Company achieves profitable operations, any significant limitation on the utilization of its NOLs would have the effect of increasing the Company's tax liability and reducing net income and available cash resources. See Consolidated Financial Statements. 19 PRICE RANGE OF SECURITIES AND DIVIDEND POLICY 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 Standard & Poors Comstock) of these securities for the period from June 24, 1996 (the effective date of the Underwritten Offering) through March 13, 1998. Such information may reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not reflect actual transactions. Common Stock Warrants -------------- ---------- Low Bid High Bid Low Bid High Bid ------- -------- ------- -------- FISCAL 1996: 4th Quarter (from 7/31/96) 2-1/8 5-3/4 3/8 1-1/2 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 4-3/8 14/32 15/16 FISCAL 1998: 1st Quarter 15/16 2-3/4 1/8 7/8 2nd Quarter 1-15/16 2-1/16 1/8 1/2 3rd Quarter (to 3/16/98) 1-3/8 2-3/16 1/8 1/2 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 hereafter may depend upon whether, at the time in question, it has satisfied in full its obligations (if any) to pay all dividends then accrued but unpaid on any then-outstanding shares of a series of dividend-bearing Preferred Stock of the Company (if any such series is then authorized and outstanding). 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 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). See "Description of Securities--Preferred Stock". As of March 16, 1998, there were approximately 800 record holders of Common Stock, and 9 record holders of Warrants. 20 CAPITALIZATION The following table sets forth the short-term debt and capitalization of the Company as of January 31, 1998: (i) on an actual basis; and (ii) on a pro forma basis, giving effect as of such date to the conversion of all of the January 1998 Notes into 620,000 shares of Common Stock. All amounts are in thousands of dollars. January 31, 1998 ------------------- Actual Pro Forma(1) ------ --------- Short-term portion of capitalized leases obligations $ 78 $ 78 ======== ======= Long-term portion of capitalized lease obligations $ 28 $ 28 Convertible notes payable-long term 620 -- Stockholders' Equity: Preferred Stock, $.0001 par value, issuable in series: 5,000,000 shares authorized; 4,000 shares authorized as Series A 6% Convertible Participating Preferred Stock; no shares issued and outstanding -- -- Common Stock, $.0001 par value: 15,000,000 shares, issued and outstanding 3,694,628 shares at January 31, 1998 (actual); issued and outstanding 4,314,628 shares (pro forma)(1) -- -- Additional paid-in capital 10,551 11,171 Accumulated deficit (10,442) (10,907) -------- ------- Total Stockholder's Equity 109 264 -------- ------- Total Capitalization $ 757 $ 292 ======== ======= xxxx - --------- (1) Gives pro forma effect to the conversion pursuant to the January 1998 Financing, of $620,000 of convertible notes payable (i.e., the January 1998 Notes and the SME Note) into 620,000 shares of Common Stock. Includes the recognition of the discount in the amount of $465,000 that resulted from the allocation of proceeds to the beneficial conversion feature relating to such notes. 21 SELECTED FINANCIAL DATA The following selected financial data for the years and periods presented below is derived from the Company's consolidated financial statements. The financial data for the two fiscal years ended July 31, 1997 is derived from the Company's audited consolidated financial statements and related notes included elsewhere in this Prospectus. The data as of January 31, 1997 and 1998 and for the six-month periods then ended is derived from the Company's unaudited financial statements included elsewhere in this Prospectus, which, in the opinion of management, include all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation of the information set forth therein. The results of operations for the six months ended January 31, 1998 are not necessarily indicative of the results that may be expected for the full fiscal year. The following data should be read in conjunction with the Company's consolidated financial statements and related notes included elsewhere in this Prospectus and "Management's Discussion and Analysis of Financial Condition and Results of Operations." All amounts are in thousands of dollars, except per share amounts and number of shares. Statement of Operations Data: Six months Six months ended ended Year Ended Year Ended January 31, January 31, July 31, 1996 July 31, 1997 1997 1998 ------------------------------------------------------- (unaudited) (unaudited) Sales $ 761 $ 1,346 $ 761 $ 593 Gross profit 124 21 (76) 80 Net loss (3,059) (3,819) (2,336) (1,269) Net loss per share(3) $ (2.27) $ (1.37) $ (0.79) $ (0.37) Weighted average shs.(1) {1,304,876} {2,939,014} {2,939,014} {3,481,829} Balance Sheet Data: July 31, 1997 January 31, 1998 January 31, 1998 ---------------------------------------------------- (unaudited) (pro forma)(2) Cash and cash equivalents $ 164 $ 7 $ 7 Working capital (deficit) (666) (962) (962) Total assets 1,488 2,269 1,804 Long-term obligations 74 648 28 Total liabilities 1,066 2,160 1,540 Stockholders' equity $ 422 $ 109 $ 264 - ---------- (1) Weighted average shares outstanding assumes all pre-IPO issuances of Common Stock and all conversions into Common Stock of a previously authorized series of Preferred Stock and of certain convertible debt were made as of the beginning of the periods presented. (2) Gives pro forma effect to the conversion pursuant to the January 1998 Financing, of $620,000 of convertible notes payable (i.e., the January 1998 Notes and the SME Note) into 620,000 shares of Common Stock. Includes the recognition of the discount in the amount of $465,000 that resulted from the allocation of proceeds to the beneficial conversion feature relating to such notes. (3) Restated in accordance with SFAS No. 128 and SAB No. 98 refer to "Managements' Discussion and Analysis of Financial Condition and Results of Operations." 22 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 $10,398,000 as of January 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 six months ended January 31, 1998, the Company had revenues of approximately $593,000 and a net loss of approximately $1,225,000. The Company believes that its net loss for the fiscal year ended July 31, 1997 could exceed the net loss for the prior fiscal year, and that the Company will continue to operate at a loss until such time, if ever, when its operations generate sufficient revenues to cover its costs. The report of independent accountants on the Company's consolidated financial statements for the fiscal year ended July 31, 1997 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 in part upon the Company's failure to meet, as reflected in its Form 10-QSB for the fiscal quarter ended April 31, 1997, the "total assets" and "capital and surplus" requirements for continued listing on the Nasdaq SmallCap Market. See "Risk Factors--September 1997 Delisting of Securities from Nasdaq," "--Additional Risks Relating to Delisted and Penny Stocks" and "Price Range of Securities and Dividend Policy." In June 1996 the Company consummated the Underwritten Offering (see "Initial Public Offering" below), raising net proceeds of approximately $5,560,000 through the issuance of 1,400,000 shares of Common Stock and 1,610,000 Warrants. In connection with the Underwritten Offering (sometimes called the "IPO"), all outstanding shares of a previously-authorized series of Preferred Stock (the "Retired Preferred Stock") were automatically converted into an aggregate of 293,533 shares of Common Stock, and $1,000,000 in principal amount of the Company's 10% Convertible Subordinated Debentures due 1998 (the "Debentures") was converted into 279,889 shares of Common Stock. 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. 23 Revenue Recognition The Company's products are marketed directly to consumers and also through mail-order catalogs and retail stores. All customer orders, regardless of their source, are processed at the Company's manufacturing plant in New York City. Revenue is recognized when the completed personalized video is shipped to the customer. Results of Operations The following discussion should be read in conjunction with the Company's consolidated financial statements and related notes included elsewhere in this Prospectus. Six months ended January 31, 1998 (the "Current Period") Compared to the Six Months Ended January 31, 1997 (the "Prior Period") Sales. Sales declined 22% to $593,000 in the Current Period from $761,000 in the Prior Period. The direct-to-consumer sales declined 1% to $405,000 in the Current Period from $409,000 in the Prior Period. The catalogue and retail sales declined $163,000 or approximately 46% to $189,000 for the Current Period. This is attributed to the fact that in the Current Period there were no new product releases as compared to the Prior Period when the Company had launched new proprietary products and titles. Due to the decline in vendor-based orders, the ratio of direct tape sales increased to 52% for the Current Period as compared to 45% in the Prior Period, improving the average sales price per tape to $27.73 for the Current Period as compared to $24.28 in the Prior Period. The Company sells a plush version of Gregory Gopher, a proprietary character, and a non-personalized audiocassette featuring the sound track from the Gregory Gopher videos. Sales of these ancillary products have not been significant to date. Cost of Sales. The Company had a gross profit of 13% or $80,000 for the Current Period as compared to a loss in the Prior Period of ($76,000). Continued inventory controls and improved manufacturing process, combined with a decrease in volume, have reduced the cost of raw materials and direct labor, generating savings of $28,000 and $73,000 respectively. Depreciation expense declined $103,000 in the Current Period due to the retirement of manufacturing equipment in the Prior Period; however, this reduction was offset by an increase of $147,000 in amortization of content costs in the Current Period. Royalties and other fixed costs of sales showed savings of $19,000 and $34,000 for the Current Period. Selling Expenses. Selling expenses decreased $611,000 or 49% in the Current Period to $643,000 from $1,254,000 in the Prior Period. Promotional and media expenses decreased by $238,000 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 $196,000, catalog and retail-sourced expenses of $31,000, outside services of $33,000 and a decrease in shipping expenses of $71,000. The Company's present marketing programs include a "Kideo Catalog" and a Kideo products promotion on the Home Shopping Network, introduced late in the Current Period. General and Administrative Expenses. The Company's general and administrative expenses decreased $382,000 or 37% to $654,000 in the Current Period from $1,036,000 in the Prior Period. The primary causes for this decrease were in non-recurring development expenses of $192,000 and payroll and related payroll expenses of $82,000 in the Current Period. Other cost-effective savings by the Company during the Current Period were in insurance of $17,000, expenses 24 associated with being a public company of $15,000 and infrastructure costs of $57,000. These savings were offset by higher depreciation charges of $21,000. Loss from Operations. The loss from operations decreased $1,149,000 or 49% to $1,217,000 in the Current Period from $2,366,000 in the Prior Period. In response to unprofitable promotions spending in the prior periods, 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 Current Period as compared to the Prior Period. Other Income (Expense). The Current Period reflects $44,000 of expenses related to the January 1998 financing and $12,000 of lease interest expenses net of $4,000 of interest income in that period. The Prior Period reflects an excess of interest income from investments (Treasury bills, money market funds and corporate commercial paper) over lease interest expenses. Net Loss. The net loss in the Current Period was $1,269,000 or $0.37 loss per share on 3,481,829 average shares of Common Stock outstanding, as compared to the Prior Period net loss of $2,336,000, or $0.79 loss per share on 2,939,014 average shares of Common Stock outstanding. 25 Fiscal year ended July 31, 1997 (the "1997 Fiscal Year") Compared to the Fiscal Year Ended July 31, 1996 (the "1996 Fiscal Year") Sales. During the 1997 Fiscal Year, the Company sold 45,600 personalized videos, an increase of 42% over the 32,100 units produced and sold during the 1996 Fiscal Year. During the 1997 Fiscal Year, the Company released four new personalized video titles. Mystery of the Missing King and Space Ace are animated titles that were released in the first quarter of the 1997 Fiscal Year (ended October 31, 1996) with direct mail and telemarketing programs. In January 1997, the Company released its first personalized videos combining live-action and animation sequences: Gregory & Me: See What I Can Do! and Gregory & Me: My Amazing Animal Adventure. Both titles feature Gregory Gopher and his friends, proprietary characters developed by Company. In the 1997 Fiscal Year, these four titles doubled the Company's video product offerings to eight proprietary titles. The Company in the 1997 Fiscal Year also released a plush version of Gregory Gopher and a non-personalized audio cassette featuring the sound track from the videos. Sales of these ancillary products were not significant in the period. The newly released videos accounted for 35% of the total sales volume in the 1997 Fiscal Year. Sales increased 77% to $1,346,000, and include a 265% increase (to $745,000) in direct-to-consumer sales. This increase reflects the cumulative results of the Company's direct marketing activities during the 1997 Fiscal Year, which were undertaken utilizing proceeds from the Underwritten Offering. These direct marketing activities included direct mail, telemarketing, radio, print and television advertising. The Company believes that its direct-to-consumer sales benefitted also from a higher level of consumer awareness resulting from television and print exposure of the Company and its products, including television exposure on the Oprah Winfrey Show, EXTRA, Managing with Lou Dobbs, and articles on the Company published by The New York Times, Gannett Newspapers, Newsweek, and Equity Magazine. Catalog and retail-sourced sales increased 6% to $591,000. There was an over all volume decline in the retail channel which primarily reflects 1996 Fiscal Year marketing programs that were not rolled out in the 1997 Fiscal Year. The number of catalogs offering the Company's products increased from 16 in the 1996 Fiscal Year to 36 in the 1997 Fiscal Year. Revenues from this source, however, remained level with the 1996 Fiscal Year due to several factors. The timing of the release of the new Gregory & Me titles did not permit their inclusion in Christmas catalogs. Additionally, one of the Company's first and largest customers had been given an exclusive right to sell the Gregory & Me titles in the catalog channel, which limited their exposure. That exclusive right expired at the end of 1996. Since the balance of the Company's catalog trade was limited to the first four titles of the Original Kideos, there was some price erosion in this channel. Production Equipment Write-Off. A write-off of production equipment accounted for $226,000 in the 1997 Fiscal Year. The Company provided for the disposal of certain production equipment during the second quarter of its current 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. Gross Margin. The Company's gross margin fell to 2% of sales in the 1997 Fiscal Year from 16% in the 1996 Fiscal Year. Unit selling prices improved by approximately 5% due to the shift in sales mix from catalog-sourced sales (wholesale pricing) to direct-to-consumer sales (retail pricing). Unit sales in the 1997 Fiscal Year were 50% higher than in the 1996 Fiscal Year. However, these positive results were offset by increases in fixed costs of $396,000 related primarily to an expansion of production capacity (depreciation of $26,000, rent of $31,000, supervision of $11,000, utilities of $9,000) and amortization of Gregory & Me content development costs of $259,000. The one-time write-off of 26 production equipment described above in the amount of $226,000 was recognized in this period. Selling Expenses. The Company's selling expenses increased 166% in the 1997 Fiscal Year, to $1,959,000, from $737,000 in the 1996 Fiscal Year, reflecting principally the costs of marketing the new Gregory & Me titles through television, radio, print, direct mail, and telemarketing campaigns of $1,100,000. In addition there were increased salaries of $291,000 mostly related to data input and increased shipping expenses of $58,000 due to higher sales volume. Retail marketing programs pursued during the 1996 Fiscal Year in the amount of $133,000 were not recurring in the 1997 Fiscal Year. General and Administrative Expenses. The Company's general and administrative increased 67% in the 1997 Fiscal Year, to $1,901,000, from $1,137,000 in the 1996 Fiscal Year. Research and development expenses increased $161,000 during the 1997 Fiscal Year, to $374,000, from $213,000 in the 1996 Fiscal Year. The remainder of inter-period change relates primarily to (i) the higher expenses associated with being a public company (legal, stockholder reporting and insurance account for $326,000), (ii) higher infrastructure costs (payroll, benefits, depreciation on leasehold improvements and online services account for $235,000) and (iii) an allowance for doubtful accounts (for $28,000). Loss from Operations. Loss from operations increased 25% in the 1997 Fiscal Year, to $3,819,000, from $3,059,000 in the 1996 Fiscal Year, reflecting the above changes. Most notably, the cost of launching the new Gregory & Me titles on radio and television exceeded the revenues derived. One of the benefits of the launch, however, was that the Company built a substantial database of leads derived from people calling an 800 number for free Kideo order kits. Management is pursuing strategic marketing alliances with third parties, with the intention of reducing the Company's financial risk in direct-to-consumer advertising programs. There can be no assurances that these objectives will be achieved. The loss from operations includes operating investments in infrastructure, including space expansion, operating systems, research and development, and management. Other Income (Expense). Other income net of expense reflects an excess of interest income from investments (Treasury bills, money market funds and corporate commercial paper) over interest expenses Nonrecurring Items. Nonrecurring items relate to interest charges, amortization of original issue discount related to certain of the Company's pre-IPO private financings, and amortization of the issuance costs of certain debt securities that either were repaid out of proceeds from the Underwritten Offering or were converted into Common Stock upon the closing of that offering. Net Loss. The net loss for the 1997 Fiscal Year was $3,819,000, or $1.37 per share on 2,939,000 average shares of Common Stock outstanding, as compared to a net loss for the 1996 Fiscal Year of $3,059,000, or $2.27 per share on 1,304,876 average shares of Common Stock outstanding. 27 Fiscal year ended July 31, 1996 Compared to the Fiscal Year Ended July 31, 1995 Sales. For the fiscal year ended July 31, 1996 (the "1996 Fiscal Year"), approximately 32,100 Kideos were produced and sold, representing an increase of 51% over the approximately 21,300 Kideos sold during the fiscal year ended July 31, 1995 (the "1995 Fiscal Year"). Sales increased by 46% (or $239,700), from $521,200 for the 1995 Fiscal Year to $760,900 in the 1996 Fiscal Year. Catalogue-sourced sales accounted for $139,200 of the increase. Orders from consumers grew 27%, accounting for an increase of $44,000 to $204,100 for the 1996 Fiscal Year. Retail-sourced sales increased 128%, to $100,500 for the 1996 Fiscal Year from $44,000 in the 1995 Fiscal Year. The increase in sales for the 1996 Fiscal Year is attributable to the Company's representation in several nationally and regionally recognized catalogs, including, most notably, Hammacher Schlemmer, which accounted for 26% of the Company's total sales for the year, as compared to 42% for the 1995 Fiscal Year. Several direct marketing initiatives in print and well as a higher level of consumer awareness of the Company's products, drove the growth in direct sales. The Company's sales are highly seasonal, with 49% of orders placed during the October-December period in the 1995 Fiscal Year and 58% in the 1996 Fiscal Year. Cost of Sales. Cost of sales decreased 3% or $21,000 from 658,000 in the 1995 Fiscal Year to 636,700 in the 1996 Fiscal Year. Volume related increases in materials and royalties accounted for $35,000 and depreciation accounted for an additional increase of $186,000. These increases were more than offset by reductions in consulting fees ($73,000), lower content amortization costs ($66,000) and lower direct payroll costs ($110,000). Selling Expenses. Selling expenses increased 10%, or $69,500, from $667,700 in the 1995 Fiscal Year to $737,200 for the 1996 Fiscal Year. Volume-related increases in catalog commissions of $43,000 and packaging materials of $122,000 were offset by lower advertising expenses of $87,000 in the 1996 Fiscal Year. General and Administrative Expenses. General and administrative expenses increased $480,700, from $656,100 in the 1995 Fiscal Year to $1,136,800 in the 1996 Fiscal Year. The primary causes of this increase were in development expenses related to enhancing the technology used to personalize videos of $200,000, costs incurred in connection with the Company's customer and production databases of $69,000, and additional staffing to accommodate increased business of $168,000. The development and database expenses are expected to be ongoing as the Company expands its title offerings and production volume. Interest and Nonrecurring Items. Nonrecurring items for the 1996 Fiscal Year were $1,221,000. The nonrecurring items are for interest and Debenture amortization of $307,000 upon the conversion of the Debentures, interest and amortization of original issue discount of $826,000 related to certain of the Company's private financings undertaken before the Underwritten Offering, and the redemption of Warrants (exercisable to purchase an aggregate of 34,989 shares of Common Stock at $2.86 per share) and certain Class B Warrants (exercisable to purchase an aggregate of 17,496 shares of Common Stock at $5.72 per share), for an aggregate redemption price of approximately $88,000. These items were paid at or prior to the consummation of the Underwritten Offering. A decrease in interest expense of $30,000, from $118,000 for the 1995 Fiscal Year to $88,000 in the 1996 Fiscal Year, was due to reclassification of Debenture interest to nonrecurring expenses for the 1996 Fiscal Year. 28 Liquidity and Capital Resources Net cash used by operations of $607,000 for the six months ended January 31, 1998 improved 64%, or $1,092,000, from the Prior Period use of $1,699,000. The Company invested $294,000 in that six-month period, of which $291,000 was in capital content of the newly-licensed Barney home video title, as compared to $899,000 invested in the six months ended January 31, 1997. Additional funds were generated in the six months ended January 31, 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 development efforts), 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 until approximately April 30, 1998. 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 cash balance along with the financing receivable which was received in February 1998 (approximately [$317,000] at January 31, 1998, after the infusion on January 30, 1998 of $500,000 in proceeds from the January 1998 Financing, as compared to a cash balance of approximately [$164,000] at January 31, 1997); working capital (which was a deficiency of approximately $962,000 at January 31, 1998, as compared to a deficiency of approximately $346,000 at January 31, 1997); and the stockholders' equity position (approximately $109,000 at January 31, 1998, as compared to approximately $422,000 at January 31, 1997). 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 (77% over the prior fiscal year), the gross margin generated from operating activities (the fiscal year ended July 31, 1997 includes a significant equipment write-off) 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 [$2,457,000] for the 1997 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. 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. These financings that have occurred since August 1, 1995 (being the commencement of the Company's fiscal year ended July 31, 1996) are described below. 29 1995 Pre-Bridge Financing During September and October 1995, the Company effectuated a private placement of $300,000 of its securities to six existing stockholders, including an affiliate of Charles C. Johnston, a director of the Company (the "1995 Pre-Bridge Financing"). In connection with such financing, the Company issued to the investors an aggregate of $300,000 in principal amount of 9% promissory notes (the "1995 Pre-Bridge Notes") and 90,000 shares of Common Stock (the "1995 Pre-Bridge Shares"). The 1995 Pre-Bridge Notes bore interest at the rate of 9% per annum and were to be repaid on the earlier of (i) one year from the date of issuance and (ii) the consummation of an initial public offering of the Company's securities. The net proceeds of the 1995 Pre-Bridge Financing were used for working capital purposes. The Company used approximately $320,000 of the IPO proceeds to repay all of the 1995 Pre-Bridge Notes. In addition, the 90,000 1995 Pre-Bridge Shares were registered by the Company with a per share value of $1.81, concurrently with the IPO, for resale by their holders. See "Management--Directors and Executive Officers," "Principal Stockholders" and "Certain Transactions--Transactions with Director Charles C. Johnston." 1996 Pre-Bridge Financing In January 1996, the Company obtained an aggregate of $125,000 in financing (the "1996 Pre-Bridge Financing") from two of its executive officers (Robert J. Riscica, who was then the Company's Chief Financial Officer, and Marvin H. Goldstein, the Company's Vice President-Controller). In connection with this 1996 Pre-Bridge Financing, Messrs. Riscica and Goldstein purchased two and one-half units of the Company's securities, which units were identical to the Bridge Units subsequently issued in connection with the 1996 Bridge Financing, as such terms are defined immediately below (except that, unlike the shares of Common Stock included in the Bridge Units, the shares included in these units (the "1996 Pre-Bridge Shares") were not registered concurrently with the IPO). As a result of the 1996 Pre- Bridge Financing, the Company issued to Messrs. Riscica and Goldstein unsecured 9% promissory notes of the Company in the aggregate principal amount of $125,000 (the "1996 Pre-Bridge Notes") and an aggregate of 25,000 1996 Pre-Bridge Shares with a per share value of $2.32. The Company used approximately $129,000 of the IPO proceeds to repay all of the 1996 Pre-Bridge Notes. 1996 Bridge Financing In February 1996, the Company completed the sale of 15 units (the "Bridge Units") to 11 private investors (the "1996 Bridge Financing"), each Bridge Unit consisting of (i) an unsecured 9% promissory note of the Company in the principal amount of $50,000, due and payable on the earlier of the consummation of the IPO and February 23, 1997 (subject to extension, under certain circumstances, to February 23, 1998) (each, a "Bridge Note") and (ii) 10,000 shares of Common Stock (the "Bridge Shares"), at a price of $50,000 per Bridge Unit. The Company received gross proceeds of $750,000 from the sale of the Bridge Units. After the payment of $75,000 in placement fees to the Underwriter of the IPO, who acted as placement agent for the Company with respect to the sale of the Bridge Units, and other offering expenses of approximately $85,000, the Company received net proceeds of approximately $590,000 in connection with the 1996 Bridge Financing. The Company's sale of the 15 Bridge Units resulted in the Company's issuance of a total of $750,000 in principal amount of Bridge Notes and 150,000 Bridge Shares. The Company used approximately $767,000 of the IPO proceeds to repay all of the Bridge Notes. The 150,000 Bridge Shares were registered by the Company with a per share value of $1.82, concurrently with the IPO, for resale by their holders. 30 June 1996 Financing In June 1996, the Company completed the sale of two units (the "June Bridge Units") to two private investors (the "June 1996 Financing"), each June 1996 Unit consisting of (i) an unsecured 9% promissory note of the Company in the principal amount of $100,000, due and payable on the earlier of the consummation of the IPO and February 23, 1997 (subject to extension, under certain circumstances, to February 23, 1998) (each, a "June 1996 Note") and (ii) 25,000 shares of Common Stock (the "June 1996 Shares"), at a price of $100,000 per June 1996 Unit. The Company received gross proceeds of $200,000 from the sale of the June 1996 Units. After the payment of $20,000 in placement fees to the Underwriter, who acted as placement agent for the Company with respect to the sale of the June 1996 Units, the Company received net proceeds of $180,000 in connection with the June 1996 Financing. The Company's sale of the two June 1996 Units resulted in the Company's issuance of a total of $200,000 in principal amount of June 1996 Notes and 50,000 June 1996 Shares. Upon the consummation of the IPO, the Company used $201,200 of the proceeds to repay all of the June 1996 Notes, including interest. The 50,000 June 1996 Shares were registered by the Company with a per share value of $1.80, concurrently with the IPO, for resale by their holders. Initial Public Offering In January 1996, the Company's Board of Directors authorized an increase in the number of shares of preferred stock from 100,000 to 5,000,000. In addition, the Company's Board of Directors authorized an increase in the number of shares of Common Stock from 400,000 shares, par value $.01 per share, to 15,000,000 shares, par value $.0001 per share, and declared a stock split p stockholders received 8.6545 shares of Common Stock for each share of Common Stock previously owned. In June 1996, the Company consummated the Underwritten Offering of 1,400,000 shares of Common Stock at an offering price of $5.00 per share and 1,610,000 Warrants at an offering price of $.10 per Warrant. The net proceeds to the Company were approximately $5,560,000 after deducting issuance costs of $1,601,000, which were charged to equity. Upon the closing of the IPO, the Company repaid $1,375,000 principal amount of bridge note financings and converted the outstanding Debentures into 279,889 shares of Common Stock. In addition, all outstanding shares of the Retired Preferred Stock were converted into 293,533 shares of Common Stock. A more detailed summary of the Underwritten Offering begins on page ii of this Prospectus. 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 the 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 31 of those shares into Common Stock, receiving an aggregate of 543,114 shares of Common Stock. The Certificate of Designations relating to the Series A Preferred Stock provides that the Series A Preferred Stock is initially convertible (subject to customary anti-dilution adjustments) into shares of Common Stock based upon 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 will be 80% of the prior three trading days' average of the reported closing bid price per share of Common Stock. That conversion feature affords 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 financial statements for the fiscal year ended July 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. In the consolidated balance sheet for the fiscal year ended July 31, 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 ended July 31, 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). 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 the 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 "Management--Directors and Executive Officers," "Principal Stockholders" and "Certain Transactions--Transactions with Director Charles C. Johnston." January 1998 Financing A summary of this transaction begins on page 7 of this Prospectus under "Recent Developments--The January 1998 Financing." As of March 16, 1998, the Company had used all of the proceeds from this financing as working capital for general corporate purposes. 32 Impact of Recent Accounting Pronouncements During the six month period ended January 31, 1998, the Company adopted SFAS No. 128, "Earnings Per Share." This statement establishes standards for computing and presenting earnings per share ("EPS"), replacing the presentation of currently required primary EPS with a presentation of basic EPS. EPS amounts for the Company's prior accounting periods have been restated to conform with SFAS No. 128. Staff Accounting Bulletin 98 ("SAB 98"), was issued on February 3, 1998. SAB 98 revises various existing SAB's to be consistent with the requirements of SFAS No. 128. The most significant revision relates to the calculation of earnings per share when there have been issuances of stock or options at prices below the IPO price in periods preceding an initial public offering. SAB 98 requires all registrants who accounted for transactions under SAB 83 to restate these results in conformity with SFAS 128. Accordingly, the Company has restated the net loss per share data, and weighted average numbers of shares outstanding at July 31, 1996, as required. 33 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 revolutionary new type of home entertainment product: digitally photo-personalized home videos ("Kideos") and photo-personalized books. Since commercially launching its first Kideos nationally in the spring of 1994, the Company has focused primarily on producing proprietary Kideo titles for children aged two to seven. 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". With its existing photo-personalized product lines targeting the children's market, the Company has created -- and believes it dominates -- a unique product niche in the home video 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 eight proprietary personalized video titles for children. The Barney Licenses provide for the release by the Company of one photo-personalized Barney home video and three 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. For its fiscal years ended July 31, 1996 and 1997, the Company had net losses of approximately $3,059,000 and $3,819,000, respectively, and it had an accumulated deficit of approximately $10,398,000 as of January 31, 1998. The report of independent accountants on the Company's consolidated financial statements for the fiscal year ended July 31, 1997 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 34 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 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. The Company believes, however, that more than half of all Kideos sold by its 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 and Spiegel) to market and sell its products. Since the Underwritten Offering, however, the Company has increasingly been targeting its marketing strategies towards direct-to-consumer advertising and the development of relationships with established national distributors of children's home video products. Operating Strategy During 1997, the Company determined to focus its near-term development efforts for new Kideos 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 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 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: o to develop additional photo-personalized home video and book titles for children employing both proprietary and licensed characters; and o 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. 35 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. 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 merely 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 a somewhat static 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 in use currently 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 -- 36 "My Party with Barney" -- which the Company expects will be widely released for sale through various distribution channels in April 1998. 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, Kideos -- 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). The Company believes that such features may be required in order for digitally personalized media products to achieve broad consumer acceptance. 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 (such as those that enabled Pixar Animation Studios to produce the feature film Toy Story) that could be used to produce products with such features, the costs 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 Company developed this new system using, in large part, certain computer software assets and production technologies that it acquired through an asset purchase transaction consummated with a Canadian company in July 1995. See "Certain Transactions--1995 Technology Acquisition." 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 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. 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 1998 in connection with a new title in the Gregory and Me series or in a future title featuring popular 37 children's characters licensed from others (the development of which cannot be assured). The Company believes that -- in addition to improving the quality and features of the Company's products -- its new Kideo production system will afford it a variety of other competitive advantages, including these: o Reduced Production Time. When using the new production system, the time required to manually silhouette (or "cut") the customer's face and then for the PC to automatically size and place that face's digital image throughout a digital video template has been reduced by approximately 50% when compared with the time required for these procedures using the defunct TVL system. o Greater Production Yields. A single production station employing the Company's new production system is capable of producing approximately 160 personalized Kideos during an eight-hour shift, as compared to the less than 80 such Kideos that a single TVL-system production station was capable of producing during the same shift. Product Fulfillment The Company designs, develops and produces its Kideo 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 Kideos (e.g., Pcs, 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 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 on 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 video story lasts for approximately 20 minutes. Each of the eight Kideo 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 38 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 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. The Company believes, however, that more than half of all Kideos sold to date by its 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 The Company expects that in April 1998 it will widely release for sale through various distribution channels its first photo-personalized Barney home video title -- "My Party with Barney." In this 17-minute home video, the photo-personalized child character will interact 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 will be packaged similarly to the Gregory titles in a personalized vinyl videocassette cover. The suggested retail list price for "My Party with Barney" will be $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 March 1998, the Company's photo-personalized Barney home video title - -- "My Party with Barney" -- was first marketed for sale on The Home Shopping Network ("HSN"), which broadcasts to over 70 million U.S. households. A 15 minute promotional spot was broadcast by HSN six times during a 48 hour period. In response, HSN received telephone orders for approximately 9,000 units of "My Party with Barney." In comparison, from the spring of 1994 (when the Company first began selling its Kideo products) through January 31, 1998, the Company had sold approximately 121,000 Kideos. HSN has agreed to continue marketing "My Party with Barney," along with the Company's Gregory and Me Kideos, throughout the spring and summer of 1998. This recent experience has reaffirmed the Company's 39 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," is expected to be released in April 1998. It will be 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. 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" includes 27 Barney book titles. 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 in nature (as opposed to, for example, computer games or other computer software titles). For the near future, the Company also intends to focus its efforts primarily on the continued expansion of the Kideo concept and product line. The Gregory and Me any believes that, in the short term, it will continue to derive the substantial majority of its revenue from the sale of Kideos embodying its own proprietary content. The Company accordingly will continue to seek to develop and produce new titles for release as part of the Gregory and Me series, and it will seek to exploit Gregory Gopher and the rest of the series cast in merchandise and other entertainment media. The two titles that now comprise the Gregory and Me series are being produced utilizing the Company's recently-patented digital personalization production process, and the cast of proprietary characters appearing throughout this new series appear at different times as two-dimensional animated characters and three-dimensional live action puppet-based characters. The child's personalized character interacts with these other characters in various entertaining environments. The illustrated body of the child's personalized character exhibits two-dimensional full-motion animation. In addition, in the two Gregory and Me Kideos the child's personalized character appears throughout each title on a nearly continuous basis (whereas in the four Original Kideos the personalized character appears far less frequently). 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 other, 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 40 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. Kideos 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 Gregory and Me titles and the U.S. Patent Examiner's grant of the patent claims relating to aspects of that production process, 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 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., Bugs Bunny and Johnny Quest) or live-action characters (e.g., Barney and 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 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 expects 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. Marketing General Over the approximately two years that Kideos have been marketed, the Company believes that it has developed important sales and distribution relationships with some of the country's most respected catalogue retailers and retail stores. During the 1996 Fiscal Year, Kideo order kits were available for 41 purchase at various times through such national mail order catalogues as Hammacher Schlemmer, Spiegel, the Boston Museum of Fine Arts, Personal Creations, Fingerhut, Celebration Fantastic, One Step Ahead, Johnson Smith, Just Between Us, Skymall, Critics Choice Video and Troll Learn & Play. Since the Company first began marketing its products, sales through catalogue retailers have historically been the primary distribution outlet for Kideos. More recently, however, 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). The Company currently is seeking to expand its sales and marketing efforts by increasing its distribution channels, including by pursuing strategic marketing alliances with third parties. Catalogue Sales During the 1996 Fiscal Year, catalogue sales accounted for approximately 60% of the Company's revenues. Sales through the Hammacher Schlemmer catalogue, in particular, accounted for approximately 26% of the Company's revenues. The Company believes that the initial placement of Kideo information in mail order catalogues resulted largely from the Company's engagement of an independent national catalogue representative who represents over forty catalogues nationwide. This representative (who is still being utilized by the Company) receives 15% of the net sales proceeds generated by its product placements. Because of the success generally experienced by Hammacher Schlemmer and other catalogue retailers who were among the first to offer Kideos in their catalogues, the Company currently is finding it increasingly easy to convince other catalogue retailers to feature Kideos in their publications. In the 1996 Christmas holiday season, for example, Kideos appeared for the first time in the Sears 1996 Wish Book. Since the start of the 1996 Fiscal Year (August 1, 1995), the number of nationally distributed catalogues in which Kideos were marketed increased from 14 at the start of such year to approximately 36 currently. For the foreseeable future, the Company will continue to target major catalogues as potential new marketing outlets for Kideo. Retail Distribution To date, sales of Kideos through retail toy stores and other retailers have not been a significant source of revenues. For the 1996 Fiscal Year, sales of Kideos through retail outlets accounted for approximately 13% 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 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. There can be no assurance that any of the Company's current or future efforts to expand the marketing of Kideos through mass market retail locations will prove successful or meaningful to the Company's operations -- including any of its recent efforts to obtain licensing, marketing and other arrangements with companies that control popular children's market characters and/or that have the ability to distribute children's home video products through a broad range of retail and other domestic distribution channels. See "Risk Factors--Limited Marketing Capabilities." Direct Sales Direct sales to consumers accounted for approximately 27% of the Company's revenues for the 1996 Fiscal Year (as compared to approximately 31% of revenues for the prior fiscal year). During the six months ended January 31, 1998, the Company experienced a 304% increase (to $643,000) in direct-to-consumer sales as compared to the corresponding period in the prior fiscal year. The Company believes that this increase reflects the cumulative results of the Company's direct marketing activities (including television and radio advertising and direct mail campaigns) undertaken by utilizing proceeds from its June 1996 IPO. Before the consummation of the IPO, the high costs of developing a broad-based 42 direct marketing capability had prevented the Company from engaging in meaningful direct marketing activities. The Company believes that its direct-to-consumer sales benefitted also from a higher level of consumer awareness resulting from television and print exposure of the Company and its products, including television exposure on the Oprah Winfrey Show, EXTRA, Managing with Lou Dobbs, and articles on the Company published by The New York Times, Gannett Newspapers, Newsweek, and Equity Magazine. The Company strongly believes that, over the long term, if sufficient funds are available for this purpose, direct sales efforts could ultimately become the Company's largest distribution channel. While the Company cannot predict which types of direct marketing activities may ultimately prove successful in producing increased sales of Kideos, it anticipates that the development and implementation of various types of direct marketing capabilities will continue to consume a substantial portion of the Company's marketing expenditures in the short to near term. If current revenue levels are sustained for the near term, however, the Company does not believe that it will have the capability to devote to its marketing efforts funds of its own in amounts that will be sufficient to create broad consumer awareness of the Company's products. The Company accordingly is pursuing strategic marketing alliances with third parties, with the intention of reducing its financial risk in direct-to-consumer advertising programs. There can be no assurances that these objectives will be achieved. See "Risk Factors--Limited Marketing Capabilities." 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 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 order number for it from the Kideo order kit that he 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 process of manufacturing 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 where that customer's Kideo is 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 instantly 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 43 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 ill 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. 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. 44 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 March 16, 1997, the Company employed 17 full-time employees and four part-time employees, including three in administration and finance, one in marketing and sales, five in new product creation, six in production, one in shipping, and five who are secretarial/clerical, database or customer service employees. During the Christmas holiday season (roughly the months of October through December), the Company generally employs approximately 30 additional part-time employees 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. Facilities The Company's principal executive office consists of approximately 6,000 square feet of leased space in New York City, of which approximately 2,400 square feet are used for offices and 3,600 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. 45 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 one proceeding, but the other proceeding is still pending. This latter proceeding is currently suspended, pursuant to a stipulation agreed upon by the Company and the Successor, while they complete the formalities of a settlement. In this settlement, 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, agreed to by both parties, and is in the process of being executed. The Company does not anticipate any reason why the settlement agreement would not be executed and delivered by the Successor. 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. 46 MANAGEMENT Directors and Executive Officers The following are the directors and executive officers of the Company. All officers serve at the discretion of the Board of Directors. The Company currently has authorized five directors (pursuant to a resolution adopted by the Board in accordance with the Certificate of Incorporation). There are no vacancies on the Board. Name Age Position Richard L. Bulman 33 Chairman of the Board and President Marvin H. Goldstein 51 Vice President-Controller Bradley Dahl 37 Vice President-Development Richard D. Bulman 63 Secretary, Director and Acting Chief Financial Officer Charles C. Johnston 63 Director Thomas Griffin 59 Director Michael B. Solovay 39 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. 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 47 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. 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 in 1978, for more than five years prior to the date hereof. 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. 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 Marshall & Edlin (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 1998 (the "1998 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 1999, 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 2000, and Class III directors (consisting initially of Richard L. Bulman and Richard D. Bulman) will be elected for a term expiring 48 at the annual meeting of stockholders to be held in 2001. At each annual meeting of stockholders beginning with the 1999 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, it 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. Director Compensation 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). Executive Compensation For the 1997 Fiscal Year, the executive officers in the aggregate were paid approximately $364,000, and only one executive officer (Richard L. Bulman) received aggregate cash compensation in excess of $100,000. Richard L. Bulman, the Chairman of the Board and President, received cash compensation during the 1997 Fiscal Year totaling approximately $123,000 and cash compensation totaling approximately $118,000 and $88,000 for the fiscal years respectively ended July 31, 1996 and 1995 (all of which represented salary in each case). 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 under this discussion entitled "Executive Compensation." The following table summarizes the cash and other compensation paid by the Company to Richard L. Bulman in respect of the 1996 Fiscal Year and the 1997 Fiscal Year. 49 Summary Compensation Table Annual Compensation Long Term Compensation Award ----- ----------------------------------- Securities Name and Year Ended Underlying Principal Position July 31, Salary Bonus Options - ------------------ -------- ------ ----- ------- Richard L. Bulman, Chairman and President 1995 $ 88,000 0 45,003(1) 1996 $118,000 0 125,000(2) 1997 $123,000 0 0 - ---------- (1) Represents non-plan options granted in connection with a private placement financing undertaken by the Company in May 1995. By their terms, these options expired as of July 31, 1996 by reason of the Company failing to achieve the level of pre-tax earnings required in order for the options to become exercisable. (2) Represents options granted under the Option Plan described further below. The following table sets forth all grants of options to purchase Common Stock which had been awarded to Richard L. Bulman before the end of the 1997 Fiscal Year. Individual Option Grants During Prior Fiscal Years Number of Securities Percent of Total Exercise Underlying Options Granted or Base Options to Employees in Price Expiration Granted Fiscal Year ($/share) Date ------- ----------- --------- ---- Richard L. Bulman: 1995 Fiscal Year 45,003(1) 100% $3.57 Expired 1996 Fiscal Year 125,000(1) 36.7% $2.50(2) 3/13/06 1997 Fiscal Year 0 - ---------- (1) See the notes to the immediately preceding table. (2) These options, originally granted at an exercise price of $5.00 per share of Common Stock, were repriced in February 1998 as described above under "Recent Developments--Repricing of Employee Stock Options." 50 The following table sets forth information concerning outstanding options to purchase Common Stock held by Richard L. Bulman as of the end of the 1997 Fiscal Year. Mr. Bulman did not exercise any options during the 1997 Fiscal Year. Option Exercises During 1996 Fiscal Year and Option Values Number of Value of Unexercised Unexercised In- Options at the-Money Shares 7/31/96: Options at Acquired on Value Exercisable/ 7/31/96: Exercise Realized Unexercisable Exercisable/ -------- -------- ------------- ------------- Richard L. Bulman 0 0 83,334 No exercisable exercisable; or unexercisable 41,666 options were in- unexercisable the-money at 7/31/97 Employment Agreement With Named Executive Officer Richard L. Bulman. Effective January 1, 1996, the Company entered into a three-year employment agreement with Mr. Bulman, the Chairman of the Board and President of the Company. Pursuant to this agreement, Mr. Bulman is 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 and 1997. 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 vest 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 as described above under "Recent Developments--The January 1998 Financing--Repricing of Employee Stock Options." 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, the Option Plan 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. 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. 51 1996 Stock Option Plan The 1996 Stock Option Plan was approved by the Board of Directors and the requisite number of stockholders in March 1996. The Option Plan is designed to serve as an incentive for retaining qualified and competent employees, directors and consultants. A total of 350,000 shares of Common Stock have been reserved for issuance under the Option Plan. So long as the Company is subject to the reporting requirements under the Exchange Act, the Option Plan must be administered by members of the Board of Directors who are "disinterested persons" within the meaning of that term under Rule 16b-3(c)(2)(i) promulgated by the Commission under the Exchange Act (such persons are herein called the "Plan Administrators"). In February 1996, the Board appointed Richard D. Bulman and Thomas Griffin to serve as the Plan Administrators. Under the terms of the Option Plan, any Plan Administrator, upon his initial appointment as such, is automatically granted nonstatutory stock options exercisable for 15,000 shares of Common Stock. The Plan Administrators are not permitted under the Option Plan to grant any options to themselves. Under the Option Plan, the Plan Administrators are authorized, in their discretion, to grant options thereunder to all eligible employees of the Company, including officers and directors (whether or not employees) of the Company as well as to consultants to the Company. The Option Plan provides for the granting of both (a) "incentive stock options" (as defined in Section 422 of the Internal Revenue Code) to employees (including officers and employee directors) and (b) nonstatutory stock options to employees (including officers and employee directors) and consultants. Options can be granted under the Option Plan on such terms and at such prices as determined by the Plan Administrators, except that: (i) in the case of incentive stock options granted prior to the consummation of the Underwritten Offering, the per share exercise price of such options must be $5.00 or more; and (ii) in the case of incentive stock options granted after the consummation of that offering, the per share exercise price of such options cannot be less than the fair market value of the Common Stock on the date of grant. In the case of an incentive stock option granted to a 10% stockholder (a "10% Stockholder"), the per share exercise price cannot be less than 110% of such fair market value. To the extent that the grant of an option results in the aggregate fair market value of the shares with respect to which options are exercisable by a grantee for the first time in any calendar year to exceed $100,000, such option will be treated under the Option Plan as a nonstatutory option. Options granted under the Option Plan will become exercisable after the periods specified in each option agreement. Options are not exercisable, however, after the expiration of ten years from the date of grant (or five years from such date in the case of an incentive stock option granted to a 10% Stockholder) and are not transferable other than by will or by the laws of descent and distribution. In addition, except in the case of an employee's death, options held by any employee are not exercisable following the third month after the date on which the employee's employment by the Company has terminated. As of the date of this Prospectus, out of the 350,000 shares of Common Stock reserved for issuance under the Option Plan, there are outstanding options covering 273,000 shares of Common Stock held by 16 directors, officers and employees of the Company, including options to purchase 125,000, 15,000, 20,000, 45,000, 15,000 and 10,000 shares granted respectively to Richard L. Bulman, Charles C. Johnston, Marvin H. Goldstein, Richard D. Bulman, Thomas Griffin and Bradley Dahl. All of those 273,000 outstanding options were repriced to $2.50 per share in February 1998 as described above under "Recent Developments--Repricing of Employee Stock Options." 52 Limitations of Liability and Indemnification Section 145 of the DGCL contains provisions entitling the Company's directors and officers to indemnification from judgments, fines, amounts paid in settlement and reasonable expenses (including attorneys' fees) as the result of an action or proceeding in which they may be involved by reason of having been a director or officer of the Company. In its Certificate of Incorporation, the Company has included a provision that limits, to the fullest extent now or hereafter permitted by the DGCL, the personal liability of its directors to the Company or its stockholders for monetary damages arising from a breach of their fiduciary duties as directors. Under the DGCL as currently in effect, this provision limits a director's liability except where such director (i) breaches his duty of loyalty to the Company or its stockholders, (ii) fails to act in good faith or engages in intentional misconduct or a knowing violation of law, (iii) authorizes payment of an unlawful dividend or stock purchase or redemption as provided in Section 174 of the DGCL, or (iv) obtains an improper personal benefit. This provision does not prevent the Company or its stockholders from seeking equitable remedies, such as injunctive relief or rescission. If equitable remedies are found not to be available to stockholders in any particular case, stockholders may not have any effective remedy against actions taken by directors that constitute negligence or gross negligence. The Certificate of Incorporation also includes provisions to the effect that (subject to certain exceptions) the Company shall, to the maximum extent permitted from time to time under the law of the State of Delaware, indemnify, and upon request shall advance expenses to, any director or officer to the extent that such indemnification and advancement of expenses is permitted under such law, as it may from time to time be in effect. In addition, the By-Laws require the Company to indemnify, to the fullest extent permitted by law, any director, officer, employee or agent of the Company for acts which such person reasonably believes are not in violation of the Company's corporate purposes as set forth in the Certificate. At present, the DGCL provides that, in order to be entitled to indemnification, an individual must have acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the Company's best interests. Director and Officer Indemnification Agreements Pursuant to a Board resolution adopted before the consummation of the IPO, the Company in November 1996 entered into indemnification agreements (the "Indemnification Agreements") with each of the following persons (being all of the Company's current directors and executive officers): Richard L. Bulman, Charles C. Johnston, Thomas Griffin, Richard D. Bulman, Michael B. Solovay, Marvin H. Goldstein, and Bradley Dahl. Under an Indemnification Agreement, the Company (among other things) is obligated to (i) indemnify and hold harmless the director or officer in question to the full extent permitted or authorized by the DGCL and (ii) under circumstances, advance monies to that person in order to cover expenses incurred in connection with a pending or threatened indemnifiable claim. The Indemnification Agreements are given effect retroactive to June 24, 1996, the date on which the Commission declared the registration statement relating to the Underwritten Offering to be effective. The Board of Directors authorized and directed the Company to enter into these agreements based in part upon the Board's determination that these agreements would enhance the Company's ability to continue to attract and retain individuals of the highest quality to serve as its directors and officers. The Company is not aware of any pending or threatened claim against any of the Company's directors or executive officers for which indemnification may be sought. 53 PRINCIPAL STOCKHOLDERS The following table sets forth certain information (based on information obtained from the persons named below), as of March 16, 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. As no executive officer, other than Richard L. Bulman, received cash compensation during the 1997 Fiscal Year exceeding $100,000, Mr. Bulman is the only executive officer qualifying as a "Named Executive Officer" for purposes of this table. With respect to beneficial ownership of Warrants, see note 9 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) - ----------------------- ------------ --------- Richard L. Bulman ......................... 501,471(3) 13.13% Charles C. Johnston ....................... 498,136(4) 13.13% Richard D. Bulman ......................... 46,000(5) 1.26% Michael B. Solovay ........................ 3,800 * Thomas Griffin ............................ 23,000(6) * All directors and executive officers as a group (7 persons) .................... 1,133,052(7) 28.22% - ---------- (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 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 3,694,628 shares of Common Stock outstanding as of the Computation Date. An asterisk (*) indicates less than 1%. (3) Includes 125,000 shares of Common Stock subject to currently exercisable options granted under the Option Plan. (4) Includes (i) 15,000 shares of Common Stock subject to 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, and (iii) the 200,000 shares of Common Stock issued to an affiliate of Mr. Johnston's in the September 1997 Financing 54 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 subject to currently exercisable options granted under the Option Plan and (ii) 1,000 shares of Common Stock subject to currently exercisable Warrants. (6) Includes (i) 15,000 shares of Common Stock subject to currently exercisable options granted under the Option Plan and (ii) 8,000 shares of Common Stock subject to currently exercisable Warrants. (7) Includes (i) an aggregate of 227,000 shares of Common Stock subject to currently exercisable options granted under the Option Plan, (ii) 83,975 shares of Common Stock issuable upon exercise of the Johnston Warrants and (iii) 9,000 shares of Common Stock subject to 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. 55 SELLING STOCKHOLDERS The following table provides certain information with respect to the Common Stock held by each Selling Stockholder as of the Computation Date. Except as otherwise disclosed in the footnotes to the table below, none of the Selling Stockholders has had any position, office or material relationship with the Company or any of its affiliates within the past three years (other than as a result of his or its ownership of securities of the Company). The Selling Stockholders are under no obligation to sell all or any of the Shares offered hereby, nor are they obligated to sell any Shares immediately under this Prospectus. The Company will not receive any proceeds from any sales of any Shares by the Selling Stockholders. Shares Beneficially Owned Shares ------------------ Registered Shares in Offered Connection Pursuant with to this this Selling Shareholder Number Percentage Prospectus Prospectus - ------------------- ------ ---------- ---------- ---------- Benjamin Bollag(1) 0 * 500,000 500,000 Michael Bollag(1) 15,000 * 500,000 500,000 KSH Investment Group, Inc.(2) 77,449 2.10% 12,500 12,500 Charles C. Johnston(3) 498,136 13.13% 20,000 20,000 Michael B. Solovay(4) 3,800 * 18,000 18,000 Richard A. Edlin(4) 3,800 * 18,000 18,000 Jonathan Eiseman(4) 3,800 * 18,000 18,000 Wayne Lehrhaupt(4) 3,800 * 18,000 18,000 Norman Solovay(4) 3,800 * 18,000 18,000 Eric R. Levine(4) 0 * 14,000 14,000 Peter Kakoyiannis(4) 0 * 14,000 14,000 Stephen L. Weinstein(4) 0 * 2,000 2,000 --------- --------- --------- --------- TOTAL 609,585 16.07% 1,152,500 1,152,500 - ---------- An asterisk (*) indicates less than 1%. (1) The address of this Selling Stockholder is Hollister Ranch, Lot 89, Gaviota, California 93117. (2) The address of this Selling Stockholder is 245 Great Neck Road, Great Neck, New York 11021. Represents (i) the 12,500 KSH Shares issued in connection with the January 1998 Financing to KSH Investment Group and (ii) 49,572 and 17,377 shares beneficially owned by, respectively, Harvey Kohn and Cary Sucoff, who are owners and executive officers of that company. (3) The address of this Selling Stockholder is 184 High Street, Boston, Massachusetts 02110. Mr. Johnston is a director and principal stockholder of the Company. See Note (4) to the Principal Stockholders table appearing above in this Prospectus, "Management--Directors and Executive Officers," "Principal Stockholders" and "Certain Transactions--Transactions with Director Charles C. Johnston." (4) The address of this Selling Stockholder is c/o Solovay Marshall & Edlin, P.C., 845 Third Avenue, New York, New York 10022. This Selling Stockholder is a member or employee of the law firm Solovay Marshall & Edlin, P.C., the Company's outside legal counsel. The shares of Common Stock registered 56 on his behalf in connection with this Prospectus represent his allocated shares underlying the SME Warrants described above under "Recent Developments--The January 1998 Financing--Agreement with Solovay Marshall & Edlin, P.C." PLAN OF DISTRIBUTION The Shares offered pursuant to this Prospectus are being offered on behalf of the Selling Stockholders, and the Company will not receive any proceeds from this Offering. The Shares may be offered by the Selling Stockholders pursuant to this Prospectus until _____ __, 199_, provided that this Prospectus is kept current in accordance with applicable provisions of the Securities Act, and the rules and regulations of the Commission promulgated thereunder. The Company intends to maintain a current prospectus covering the Shares offered hereby until at least the three-year anniversary of the date of this Prospectus. See "Certain Transactions--Registration Rights In Connection with the January 1998 Financing." The sale of the Shares by the Selling Stockholders may be effected in transactions in the over-the-counter market, in negotiated transactions, or a combination of such methods of sale. The Shares may be sold at market prices prevailing at the time of sale, at prices related to such prevailing market prices or at negotiated prices. The Selling Stockholders may effect such transactions by selling the Shares directly to purchasers or through underwriters or broker-dealers who may act as agents or principals. Such underwriters and broker-dealers may receive compensation in the f, concessions or commissions from the Selling Stockholders or the purchasers of the Shares for whom such underwriters or broker-dealers may act as agent or to whom they sell as principal, or both (which compensation as to a particular underwriter or broker-dealer may be in excess of customary compensation). Introducing brokers may act as broker-dealer on behalf of one or more of the Selling Stockholders in connection with the offering of certain of the Shares by Selling Stockholders. A Selling Stockholder and any underwriter or broker-dealer who acts in connection with the sale of the Shares hereunder may be deemed to be "underwriters" within the meaning of the Securities Act, and any commissions received by them and any profit on any resale of the Shares as principal might be deemed to be underwriting discounts and commissions under the Securities Act. Under applicable rules and regulations under the Exchange Act, any person engaged in a distribution of the Shares may not simultaneously engage in market-making activities with respect to such Shares for a period of nine business days prior to the commencement of such distribution, except under certain limited circumstances. In addition to, and without limiting the foregoing, the Selling Stockholders and any other person participating in such distribution will be subject to applicable provisions of the Exchange Act and rules and regulations thereunder (including Rule 10b-3 and Regulation M), which provisions may limit the timing of purchases and sales of any of the Shares by the Selling Stockholders and any other such stockholders. The Company has agreed to pay substantially all of the expenses incident to the registration, offering and sale of the Shares to the public, excluding the commissions or discounts of underwriters, broker-dealers or agents. 57 CERTAIN TRANSACTIONS Future transactions (if any) between the of its 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. Described below are transactions that have occurred since March 16, 1996 or that are proposed to be effectuated by the Company as of the date of this Prospectus. 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 the 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 under "Recent Developments--The January 1998 Financing--January 1998 Johnston Financing Proposal." These warrants entitle him to purchase 20,000 shares of Common Stock for $1.00 per share. The Company also agreed to register under the Securities Act the 20,000 shares of Common Stock underlying the 1998 Johnston Warrants. Those shares are included in the Shares that have been registered in connection with, and that are being offered pursuant to, this Offering. Transactions with Solovay Marshall & Edlin, P.C. Prior to the closing of the January 1998 Financing, Solovay Marshall & Edlin. P.C. ("SME"), 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 SME the SME Note and the SME Warrants described above under "Recent Developments--The January 1998 Financing--Agreement with Solovay Marshall & Edlin, P.C." The SME Warrants entitle certain shareholders and employees of SME to purchase an aggregate of 120,000 shares of Common Stock for $1.00 per share. The Company also agreed to register under the Securities Act the 120,000 shares of Common Stock underlying the SME Warrants. Those shares are included in the Shares that have been registered in connection with, and that are being offered pursuant to, this Offering. On March 26, 1996, SME agreed to accept from the Company, in lieu of cash and as partial payment for legal services rendered before that date, 24,000 shares of Common Stock (valued by the Company at that time as having a fair market value of $3.50 per share). The Company issued such 24,000 shares to members and an employee of SME on March 27, 1996. 58 DESCRIPTION OF SECURITIES General The Company is authorized to issue 15,000,000 shares of Common Stock, par value $.0001 per share, and 5,000,000 shares of Preferred Stock, par value $.01 per share. As of the date of this Prospectus, there are 3,694,628 shares of Common Stock outstanding and no shares of any Preferred Stock outstanding. Common Stock The holders of the Common Stock are entitled to one vote for each shad in the election of directors of the Company and in all other matters to be voted on by the stockholders. There is no cumulative voting with respect to the election of directors, with the result that the holders of more than 50% of the shares voting for the election of directors can elect all of the directors. Holders of Common Stock are entitled (i) to receive such dividends as may be declared from time to time by the Board out of funds legally available therefor, and (ii) in the event of liquidation, dissolution or winding up of the Company, to share ratably in all assets remaining after payment of liabilities and after provision has been made for each class of stock (if any) having preference over the Common Stock. As a result of the creation of the Series A Preferred Stock pursuant to the May 1997 Financing, and in accordance with the terms of the Certificate of Designations relating to that series of stock and the Certificate of Incorporation, in the event that the Company hereafter were to issue any of the 3,250 authorized shares of that series which remain available for issuance, the holders of Common Stock would rank junior to the future holders of Series A Preferred Stock in the event of any voluntary or involuntary liquidation, distribution or sale of assets, dissolution or winding up of the Company. Holders of Common Stock have no conversion rights or preemptive rights and are not subject to further capital calls or assessments. There are no redemption or sinking fund provisions applicable to the Common Stock. The rights of the holders of the Common Stock are subject to any rights that may be fixed for holders of Preferred Stock, when and if any Preferred Stock is issued. All of the outstanding shares of Common Stock are fully paid and non-assessable. The Company's By-Laws provide that the holders of at least 10% of its voting stock will be able to call special meetings of stockholders. Preferred Stock The Company is authorized to issue 5,000,000 shares of Preferred Stock from time to time in one or more series, in all cases ranking senior to the Common Stock with respect to payment of dividends and in the event of the liquidation, dissolution or winding up of the Company. There is no Preferred Stock currently authorized for issuance by the Company other than the Series A Preferred Stock. The Board has the power, without stockholder approval, to issue shares of one or more series of Preferred Stock, at any time, for such consideration and with such relative rights, privileges, preferences and other terms as the Board may determine (including, but not limited to, terms relating to dividend rates, redemption rates, liquidation preferences and voting, sinking fund and conversion or other rights). The rights and terms relating to any new series of Preferred Stock could adversely affect the voting power or other rights of the holders of the Common Stock or could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of the Company. 59 Series A Preferred Stock 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 Preferred Stock designated as the Series A 6% Convertible Participating Preferred Stock (the "Series A Preferred Stock"). The Series A Preferred Stock consists of 4,000 shares, each share having a liquidation value of $1,000. In connection with the May 1997 Financing, 750 shares of Series A Preferred Stock were issued to Sellet Marketing Corp. Pursuant to the Certificate of Designations, on July 12, 1997 the Series A Preferred Stock became convertible at a holder's option into shares of Common Stock. All of such shares were subsequently converted into shares of Common Stock. As a consequence, 3,250 shares of Series A Preferred Stock remain available for future issuance. Except as may be required by law, the holders of the Series A Preferred Stock are not entitled under the Certificate of Designations to vote in the election of directors of the Company or in any other matters to be voted on by holders of the Common Stock. Holders of the Series A Preferred Stock have no preemptive rights and are not subject to further capital calls or assessments. There are no redemption or sinking fund provisions applicable to the Series A Preferred Stock. The rights of the holders of the Series A Preferred Stock are subject, without requiring any series or class vote, to any rights that may be fixed for holders of any other series of Preferred Stock (when and if issued) which ranks on a parity with the Series A Preferred Stock as to dividends or distributions made upon dissolution, liquidation and winding up of the Company. However, without the consent of the registered holders of at least fifty percent of the then-outstanding shares of Series A Preferred Stock, no class or series of equity securities of the Company may be authorized or issued which would rank senior to the Series A Preferred Stock as to the payment of dividends or distributions of any kind. The Certificate of Designations provides that the Series A Preferred Stock will initially be convertible (subject to customary anti-dilution adjustments) into shares of Common Stock based upon 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 will be 80% of the prior three trading days' average of the reported closing bid price per share of Common Stock. The Certificate of Designations provides that dividends on the Series A Preferred Stock are payable semi-annually on each July 31st and January 31st, commencing with July 31, 1998. The Company has the option to pay any or all of the dividends through the issuance of additional shares of Common Stock (utilizing the same conversion ratio as described above). Dividends on each outstanding share of Series A Preferred Stock accrue, cumulatively on a daily basis, at the rate of 6% per annum of the liquidation value per share as in effect at the commencement of the fiscal year of the Company in question. (As of the date hereof, that liquidation value is $1,000 per share.) Those dividends accrue whether or not dividends have been declared by the Board of Directors and whether or not there are profits, surplus or other funds of the Company legally available for the payment of the dividends. In addition to the cumulative dividend described above, on and after July 31, 1998 the holders of outstanding shares (if any) of Series A Preferred Stock will also have the right, on a fiscal-year basis, to participate in any cash dividend payments made to the holders of the Common Stock. This participating dividend will be payable, on July 31 of each year, in a sum equal to the amount by which (i) the aggregate cash dividends paid on one share of Common Stock during the fiscal year then ended exceeds (ii) the amount of the cumulative dividend accrued (whether or not paid) in respect of on one share of Series A 60 Preferred Stock. Johnston Warrants There are currently outstanding certain Class A Warrants and Class B Warrants (which together constitute the Johnston Warrants) to purchase an aggregate of 83,975 shares of Common Stock. All of these warrants are beneficially owned by Charles C. Johnston, a director and principal stockholder of the Company. Each Johnston Warrant is exercisable for the purchase of one share of Common Stock at an initial exercise price of $3.60 per share. The exercise price is subject to adjustment in certain circumstances (including in the event of a stock split or dividend, recapitalization, reorganization, merge or consolidation of the Company). All of the Johnston Warrants will expire during the year 2000. In addition, the Johns callable by the Company under certain circumstances. The Company has also granted the holders of the Johnston Warrants certain piggyback registration rights for the Common Stock issuable upon exercise thereof. See "--Registration Rights" further below. Public Warrants Each Warrant offered pursuant to the Underwritten Offering entitles the registered holder thereof to purchase one share of Common Stock, at a price of $4.00, subject to adjustment in certain circumstances, at any time during the four year period following June 24, 1997. The Warrants are redeemable by the Company, upon the consent of the Underwriter, at any time following June 24, 1997, upon notice of not less than 30 days, at a price of $.10 per Warrant, provided that the closing bid quotation of the Common Stock, for a period of 20 consecutive trading days ending on the third day prior to the day on which the Company gives notice, has been at least 150% (currently $6.00, subject to adjustment) of the then effective exercise price of the Warrants. The holders of the Warrants will have the right to exercise their Warrants until the close of business on the date fixed for redemption. The Warrants were issued in registered form under a Warrant Agreement by and among the Company, American Stock Transfer & Trust Company, as Warrant Agent, and the Underwriter. Reference is made to the Warrant Agreement (which has been filed as an exhibit to the Registration Statement) for a complete description of the terms and conditions therein. Other Warrants In October 1996, the Company issued a warrant to purchase Common Stock to an executive and owner of the company that acted as an independent contractor to the Company in connection with the development, scripting and filming of the animation and live-action sequences for the first two Gregory & Me titles. This warrant, which is currently exercisable, entitles the holder to purchase an aggregate of 20,000 shares of Common Stock, at an initial exercise price of $5.00 per share, until October 30, 2001. The exercise price is subject to adjustment in certain circumstances (including in the event of a stock split or dividend, recapitalization, reorganization, merger or consolidation of the Company). A summary description of the Underwriter's Warrants is set forth on page 6 of this Prospectus under the "Recent Developments--The Underwritten Offering." In connection with the January 1998 Financing, the Company issued the January 1998 Warrants, the 1998 Johnston Warrants and the SME Warrants described above under "Recent Developments--The January 1998 Financing." 61 Registration Rights 1995 Registration Rights Agreement The Company has granted certain piggyback registration rights relating to the shares of Common Stock held by the persons who invested in the May 1995 Units Financing and the shares of Common Stock issuable upon exercise of the Johnston Warrants, which together represent an aggregate of 663,830 shares of Common Stock (collectively, the "1995 Registrable Shares"), pursuant to an agreement between the holders of such securities and the Company, dated May 12, 1995 (the "1995 Registration Rights Agreement"). In the event a registration is a primary registration on behalf of the Company, the Company will use its best efforts to include in such registration, subject to the agreement of the managing underwriter or underwriters of the offering relating thereto (if any): (i) first, the securities that the Company proposes to sell; (ii) second, those (a) 1995 Registrable Shares, (b) securities which are registrable pursuant to the terms of an agreement, dated June 17, 1994 (the "Investor Rights Agreement"), between the Company and certain stockholders (the "June Investor Shares"), and (c) Bulman Shares (as hereinafter defined) which are requested by the holders thereof to be included in such registration (pro rata among the holders thereof); and (iii) third, other securities requested to be included in such registration. In secondary, non-issuer registrations, the Company will use its best efforts to include in such registration, subject to the agreement of the managing underwriter or underwriters of the offering relating thereto (if any): (X) first, those 1995 Registrable Shares, June Investor Shares and Bulman Shares which are requested by the holders thereof to be included in such registration (pro rata among the holders thereof); and (Y) second, other securities requested to be included in such registration. In connection with any underwritten piggyback registration, the holders of the 1995 Registrable Shares have agreed to execute and deliver a "lock-up agreement" with respect to any of their registrable securities included therein for up to 90 days (or longer as the Company's underwriters may request but not to exceed 180 days) after the effective date of the registration statement relating to such underwritten offering. Investor Rights Agreement Under the Investor Rights Agreement, the Company agreed to register the June Investor Shares (representing 136,342 shares of Common Stock) upon the demand of holders owning at least 20% of the June Investor Shares then outstanding; provided that (among other conditions): (i) no such demand registration is required to become effective prior to the earlier of June 1, 1999 or within 90 days (or longer as the Company's underwriters may request but not to exceed 180 days) after the effective date of any registration statement initiated by the Company; and (ii) no more than two such demand registrations are required to be effected. The Company also agreed to cause a Form S-3 registration of the June Investor Shares upon demand, but not more frequently than once every year, and to include the June Investor Shares in certain piggyback registrations as provided in the Investor Rights Agreement, which are subject to the priorities discussed above concerning the 1995 Registration Rights Agreement. See "Shares Eligible for Future Sale." Bulman Registration Rights Agreement Pursuant to an agreement between the Company and Richard L. Bulman, dated January 1, 1995, the Company has agreed to cause a registration statement to be filed with respect to the shares of Common Stock held by Mr. Bulman (the "Bulman Shares") upon Mr. Bulman's demand made not more than once per year during an eight year period ending January 1, 2003. In addition, Mr. Bulman was granted piggyback registration rights relating to such shares, which are subject to the 62 priorities discussed above concerning the 1995 Registration Rights Agreement. Mr. Bulman is currently the owner of 376,471 outstanding shares of Common Stock. See "Shares Eligible for Future Sale." Registration Rights of Gary Bilezikian Pursuant to an agreement, dated October 26, 1993, between the Company and Gary Bilezikian, a stockholder of the Company, the Company has granted Mr. Bilezikian certain piggyback registration rights relating to his shares of Common Stock if it proposes to file a registration statement under the Securities Act. The Company is not obligated, however, to include any shares of Common Stock held by Mr. Bilezikian either (i) in any registration statement relating solely to the sale of securities to participants in a Company stock plan or (ii) in any registration statement whose form does not include substantially the same information as would be required to be included in a registration statement covering the sale of shares of Common Stock owned by Mr. Bilezikian. Mr. Bilezikian is currently the owner of 38,945 outstanding shares of Common Stock. See "Shares Eligible for Future Sale." V-Seion Registration Rights Agreement Pursuant to a Registration Rights Agreement, dated as of July 14, 1995, between the Company and V-Seion Multimedia Systems, Inc. ("V-Seion", which was the seller of the assets acquired by the Company in the Technology Acquisition), the Company granted V-Seion piggyback registration rights relating to its shares of Common Stock (other than in connection with a registration effected solely to implement an employee benefit plan or a transaction to which Rule 145(a) promulgated under the Securities Act is applicable). If the registration proposed by the Company is to be an underwritten offering of securities for the account of either the Company or the holders of such securities, then the amount of shares which V-Seion will be allowed to register can be limited, in the underwriter's discretion, by certain relevant marketing factors. In the event that any shares of Common Stock held by V-Seion are permitted by the underwriter to be included in such a registration, V-Seion is prohibited from selling any of such shares to the public for a period of 90 days (or such longer period, not to exceed 180 days, as the underwriter may request) from the effective date of such registration. V-Seion is currently the owner of 19,645 outstanding shares of Common Stock. See "Shares Eligible for Future Sale." Registration Rights Related to Underwriter's Warrants Subject to certain limitations and exclusions, the Company has agreed that, upon the request of the holders of a majority of the Underwriter's Warrants, the Company will (at its own expense), on one occasion during the Warrant Exercise term, register the Underwriter's Warrants and the securities underlying the Underwriter's Warrants under the Securities Act and that it will include the Underwriter's Warrants and all such underlying securities in any appropriate registration statement which is filed by the Company under the Securities Act during the seven years following the date of this Prospectus. Pursuant to the request of the holders of a Underwriter's Warrants, the Company in August 1997 registered the 280,000 shares of Common Stock underlying the Underwriter's Warrants (and the warrants underlying the same). Registration Rights Granted in Connection with the January 1998 Financing As described above under "Recent Developments--The January 1998 Financing," the Company in connection with that financing agreed to register under the Securities Act the shares of Common Stock underlying the January 1998 Warrants, the 1998 Johnston Warrants and the SME Warrants. Those shares have been registered under the Registration Statement of which this Prospectus is a part and constitute the Shares being offered hereby. The Company additionally agreed 63 to maintain a current prospectus covering the Shares until at least the three-year anniversary of the date of this Prospectus. Anti-Takeover Provisions of Delaware Law The Company is a Delaware corporation and thus subject to Section 203 of the DGCL ("Section 203"), which is generally viewed as an anti-takeover statute. In general, Section 203 prohibits a publicly traded Delaware corporation from engaging in any "business combination" (as defined) with any "interested stockholder" (as defined) for a period of three years following the date that such stockholder became an interested stockholder, unless: (i) prior to such date, the board of directors of the corporation approved either the business combination or the h resulted in the stockholder becoming an interested stockholder; (ii) upon consummation of the transaction which resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purpose of determining the number of shares outstanding those shares owned (a) by persons who are directors and also officers and (b) by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or (iii) on or subsequent to such date, the business combination is approved by the board of directors and authorized at an annual or special meetings of the stockholders, and not by written consent, by the affirmative vote of at least 66-2/3% of the outstanding voting stock which is not owned by the interested stockholder. In general, Section 203 defines a "business combination" to include: (i) any merger or consolidation involving the corporation and the interested stockholder; (ii) any sale, transfer, pledge or other disposition involving the interested stockholder of 10% or more of the assets of the corporation; (iii) (subject to certain exceptions) any transaction which results in the issuance or transfer by the corporation of any stock of the corporation to the interested stockholder; (iv) any transaction involving the corporation which has the effect of increasing the proportionate share of the stock of any class or series of the corporation beneficially owned by the interested stockholder; or (v) the receipt by the interested stockholder of the benefit of any loans, advances, guarantees, pledges or other financial benefits provided by or through corporation. In general, Section 203 defines an "interested stockholder" as (a) any entity or person beneficially owning 15% or more of the outstanding voting stock of the corporation or (b) any entity or person affiliated with or controlling or controlled by such entity or person. The existence of Section 203 would be expected to have the effect of discouraging takeover attempts involving the Company, including attempts that might result in a premium over the market price of the Common Stock (if it is then publicly traded). Transfer Agent, Warrant Agent and Registrar The transfer agent, warrant agent and registrar for the Common Stock is American Stock Transfer & Trust Company. 64 SHARES ELIGIBLE FOR FUTURE SALE As of the date of this Prospectus, the Company has 3,694,628 shares of Common Stock outstanding. Of the outstanding shares, an aggregate of 2,233,114 shares have previously been registered for sale under the Securities Act and, accordingly, are freely tradeable without restriction or further registration thereunder. The Company effectuated those prior registrations in June 1996 (as part of the Underwritten Offering) and in August 1997 (in connection with the May 1997 Financing described below under "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources--May 1997 Financing"). Of the outstanding shares of Common Stock registered in June 1996, (i) 1,400,000 registered shares of Common Stock were sold in the public market pursuant to the Underwritten Offering, and (ii) 290,000 shares of Common Stock were registered on behalf of certain selling stockholders of the Company. All of the 543,114 outstanding shares of Common Stock registered in August 1997 were registered on behalf of a selling stockholder of the Company. All of the 1,461,514 remaining shares of Common Stock currently outstanding (the "Restricted Common Stock") are "restricted securities" (as that term is defined in Rule 144 under the Securities Act), and as such they may be sold only pursuant to a registration statement under the Securities Act, in compliance with the exemption provisions of Rule 144 or pursuant to another exemption under the Securities Act. Since June 24, 1997, however, substantially all of these restricted securities have either been (i) eligible for sale in the public market pursuant to Rule 144 or (ii) subject to the exercise of certain demand and/or piggyback registration rights which the Company from time to time has granted to various of its securityholders. A total of 1,235,234 shares of the Restricted Common Stock are held by stockholders to whom the Company has granted registration rights. In general, under Rule 144 as currently in effect, any person (or persons whose shares are aggregated), including persons who may be deemed to be "affiliates" of the Company (as that term is defined under the Securities Act), is entitled to sell, within any three-month period, a number of restricted shares that have been beneficially owned for a least one year which does not exceed the greater of (i) 1% of the then outstanding shares of Common Stock or (ii) an amount equal to the average weekly trading volume in the Common Stock during the four calendar weeks preceding such sale. Sales under Rule 144 are also subject to certain requirements as to the manner of sale, notice and the availability of current public information about the Company. However, a person who is not deemed an affiliate and has beneficially owned restricted shares for at least two years is entitled to sell such shares without regard to the volume or other resale requirements. No predictions can be made of the effect, if any, that sales of shares of Common Stock, or the availability of such shares for sale, will have on the market price of such securities prevailing from time to time. Nevertheless, sales of substantial amounts of Common Stock in the public market could adversely affect prevailing market prices for the Common Stock and could impair the Company's ability to raise capital through the sale of its equity securities. 65 LEGAL MATTERS The validity of the securities offered hereby will be passed upon for the Company by Solovay Marshall & Edlin, P.C. ("SME"), New York, New York. See "Certain Transactions--Transactions with Solovay Marshall & Edlin, P.C." EXPERTS The audited consolidated financial statements for the years ended July 31, 1996 and July 31, 1997, included in this Prospectus and elsewhere in the Registration Statement have been audited by Arthur Andersen LLP, independent public accountants, as indicated in its report with respect thereto, and are included herein in reliance upon the authority of said firm as experts in giving said report. Reference is made to said report, which includes an explanatory paragraph relating to the Company's ability to continue as a going concern, as described in Note 1 of the notes to the financial statements. 66 Kideo Productions Inc. Index to Consolidated Financial Statements Report of Independent Accountants.......................................... F-2 Financial Statements: Balance Sheet, July 31, 1996 and 1997......................................... F-3 Statement of Operations, Years Ended July 31, 1996 and 1997............................. F-4 Statement of Shareholders' (Deficiency) Equity, Years Ended July 31, 1996 and 1997............................. F-5 Statement of Cash Flows, Years Ended July 31, 1996 and 1997............................. F-6 Statement of Cash Flows, Supplemental Information Years Ended July 31, 1996 and 1997............................. F-7 Notes to Financial Statements.............................................. F-8 Financial Statements (unaudited) Balance Sheet, January 31, 1998............................................... F-17 Statement of Operations, Six Months Ended January 31, 1998 and 1997..................... F-18 Statement of Shareholders' (Deficiency) Equity, Six Months Ended January 31, 1998 and 1997..................... F-19 Statement of Cash Flows, Six Months Ended January 31, 1998 and 1997..................... F-20 Notes to Financial Statements.............................................. F-21 F-1 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, 1996 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, 1996 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 working 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 31, 1997 F-2 KIDEO PRODUCTIONS, INC. CONSOLIDATED BALANCE SHEETS (Dollars in thousands)
at July 31, at July 31, 1996 1997 ------- ------- ASSETS Current Assets: Cash and cash equivalents .................................................... $ 2,857 $ 164 Accounts receivable, net ..................................................... 95 31 Inventory .................................................................... 17 103 Prepaid expenses ............................................................. 123 28 ------- ------- Total current assets ...................................................... 3,092 326 Property and equipment, net ...................................................... 558 507 Capitalized content costs, net ................................................... 432 518 Other assets ..................................................................... 286 137 ------- ------- Total assets .............................................................. $ 4,368 $ 1,488 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable ............................................................. $ 59 $ 475 Accrued expenses ............................................................. 271 210 Capital leases, current portion .............................................. 147 74 Unearned revenue ............................................................. 225 233 ------- ------- Total current liabilities ................................................. 702 992 Capital leases, long term portion ................................................ 81 74 ------- ------- Total liabilities ......................................................... 783 1,066 ------- ------- Commitments and Contingencies (Notes 5, 6 & 11) Shareholders' Equity Preferred Stock, $.0001 par value; issuable in series: authorized 5,000,000 shares, issued and outstanding -0- shares at July 31, 1996 and 750 shares at July 31, 1997 .............................................................. -- -- Common Stock, $.0001 par value; authorized 15,000,000 shares, issued and outstanding 2,939,014 shares at July 31, 1996 and 1997 ..................................................... -- -- Additional paid-in capital ................................................... 8,737 9,591 Accumulated deficit .......................................................... (5,152) (9,169) ------- ------- Shareholders' Equity........................................................ 3,585 422 ------- ------- Total liabilities and shareholders' equity ....................................... $ 4,368 $ 1,488 ======= =======
The accompanying notes are an integral part of these consolidated financial statements. F-3 KIDEO PRODUCTIONS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands except per share amounts)
Year ended Year ended July 31, July 31, 1996 1997 ----------- ----------- Sales ........................................ $ 761 $ 1,346 Cost of sales ................................ 637 1,099 Write off of production equipment ............ -- 226 ----------- ----------- Gross profit (loss) .......................... 124 21 Selling expenses ............................. 737 1,959 General and administrative expenses .......... 1,137 1,901 ----------- ----------- Loss from operations ......................... (1,750) (3,839) ----------- ----------- Other income (expense), net .................. (88) 20 Nonrecurring expenses related to debt extinguished in connection with the Initial Public Offering (1,221) -- ----------- ----------- Net loss ..................................... $ (3,059) $ (3,819) =========== =========== Net loss per share* .......................... $ (2.27) $ (1.37) =========== =========== Weighted average number of shares outstanding* 1,304,876 2,939,014 =========== ===========
- ---------- * Restated see note 1 to the accompanying financial statements. The accompanying notes are an integral part of these consolidated financial statements. F-4 KIDEO PRODUCTIONS, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Dollars in thousands except per share amounts)
Additional Preferred Stock Common Stock Paid-in Accumulated Shareholders' Shares Amount Shares Amount Capital Deficit Equity ---------------------------------------------------------------------------------- Balance at July 31, 1995 ..................... 956,000 $ -- 616,891 $ -- $1,385 $(1,999) $ (614) ---------------------------------------------------------------------------------- Issuance of preferred stock in connection with the May 1995 Units Financing ....... 43,750 -- -- -- 44 44 Issuance of common stock in satisfaction of expenses in connection with the May 1995 Units Financing ................ -- -- 3,239 -- 7 7 Issuance of common stock in connection with October 1995 private placement ..... -- -- 90,000 -- 163 163 Issuance of common stock in connection with January 1996 private placement ..... -- -- 25,000 -- 58 58 Issuance of common stock in partial payment of interest on debt issued in the May 1995 Units Financing ......... -- -- 6,462 -- 23 23 Issuance of preferred stock in satisfaction of dividends on preferred stock issued in the May 1995 Units Financing ......... 48,672 -- -- -- 49 49 Issuance of common stock in connection with the February 1996 private placement -- -- 150,000 -- 274 274 Issuance of common stock for legal costs in connection with the Company's initial public offering ................. -- -- 24,000 -- 84 84 Issuance of common stock in connection with the June 1996 private placement .... -- -- 50,000 -- 90 90 Issuance of common stock in connection with the initial public offering ........ -- -- 1,400,000 -- 5,399 5,399 Issuance of warrants in connection with the initial public offering ................. -- -- -- -- 161 161 Conversion of preferred stock to common ...... (1,048,672) -- 293,533 -- -- -- Conversion of debentures to common ........... -- -- 279,889 -- 1,000 1,000 Dividends on preferred stock ................. -- -- -- -- -- (94) (94) Net loss ..................................... -- -- -- -- -- (3,059) (3,059) ---------------------------------------------------------------------------------- Balance at July 31, 1996 ..................... (0) $ -- 2,939,014 $ -- $8,737 $(5,152) $ 3,585 ---------------------------------------------------------------------------------- Issuance of preferred stock in connection with May 13, 1997 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 ==================================================================================
The accompanying notes are an integral part of these consolidated financial statements. F-5 KIDEO PRODUCTIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
Year ended Year ended July 31, 1996 July 31, 1997 ------------- ------------- Cash flows from operating activities: Net loss ................................................ $(3,059) $(3,819) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization of operating assets .... 333 696 Amortization of loan discount ........................ 585 -- Amortization of deferred debt costs .................. 396 -- Write off of production equipment .................... -- 226 Effect of changes in operating assets and liabilities: Accounts receivable ............................... (35) 64 Prepaid expenses and other current assets ......... (32) 8 Other assets ...................................... (489) 15 Accounts payable .................................. (369) 416 Accrued expenses .................................. 181 (71) Unearned revenue .................................. 183 8 ------- ------- Net cash used in operating activities ................... (2,306) (2,457) ------- ------- Cash flows from investing activities: Purchase of property and equipment ...................... (108) (561) Increase in capitalized content and program costs ....... -- (448) ------- ------- Net cash used in investing activities ................... (108) (1,009) ------- ------- Cash flows from financing activities: Proceeds from bridge notes .............................. 1,375 -- Net proceeds from issuances of common and preferred stock 5,592 666 Proceeds from long term debt ............................ 32 -- Proceeds from lease financing ........................... -- 208 Repayment of loans payable - related parties ............ (61) -- Repayment of bridge notes ............................... (1,375) -- Principal payments on capital leases .................... (112) (101) Debt issuance costs incurred ............................ (180) -- Dividends paid on preferred stock ....................... (61) -- ------- ------- Net cash provided by financing activities ............... 5,210 773 ------- ------- Net increase in cash ........................................ 2,796 (2,693) Cash and cash equivalents at the beginning of the period .... 61 2,857 ------- ------- Cash and cash equivalents at the end of the period .......... $ 2,857 $ 164 ======= =======
The accompanying notes are an integral part of these consolidated financial statements. F-6 KIDEO PRODUCTIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL INFORMATION (Dollars in thousands)
Year ended Year ended July 31, July 31, 1996 1997 ---------- ---------- Cash payments for interest ................................... $ 89 $ 26 Cash payments for income taxes ............................... 4 12 Supplemental schedule of noncash investing and financing activities: Capital lease obligations for equipment purchases ........ -- 207 Dividends accrued on preferred stock ..................... 33 10 Security deposits applied to capital lease obligations ... -- 186 Discount to fair market value of the preferred stock upon conversion to common stock ................. -- 188 Issuance of capital stock in satisfaction of expenses .... 84 -- Conversion of accrued expenses into long term debt ....... 12 -- Conversion of accrued expenses into capital stock ........ 41 -- Conversion of dividends payable into preferred stock ..... 49 -- Original issue discounts associated with bridge financings 546 -- Conversion of long term debt into common stock ........... 1,000 -- Conversion of preferred stock into common stock .......... 1,049 --
The accompanying notes are an integral part of these consolidated financial statements. F-7 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 develops, produces and markets personalized children's educational video tapes sold through direct sales, mail-order houses, children's toy stores and various catalogs. The principal shareholder developed the initial product line prior to the Company's commencement of operations. The Company is devoted to the development of multimedia products using emerging technologies with an emphasis on personalized products for children. The Company's sales are seasonal in nature based, in part, on purchases made during the months of October through December. 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 $3,059,000 and $3,819,000 for the years ended July 31, 1996 and July 31, 1997, respectively. In addition, the Company has a net working capital deficiency of $666,000 at July 31, 1997. 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 direct mail to customers and sales to retail outlets. 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), that the proceeds remaining from the May 13, 1997 financing, and the September 16, 1997 financing (described below), together with anticipated revenues from operations and its current cash and cash equivalent balances, will be sufficient to fund the Company's operations and capital requirements through July 31, 1998. Revenue Recognition The Company generally records an account receivable and a corresponding liability for unearned revenue for video tape order kits shipped to mail order houses and retail stores. Revenue is recognized on the accrual basis when the video tape is shipped to the ultimate consumer. At July 31, 1997 the Company adjusted its unearned revenue account to recognize the excess of the liability over the amount related to kits that are reasonably expected to be redeemed from these sources. Capitalized Content Costs Capitalized costs consist of deferred production costs related to the production and development of the storylines of the Company's video tapes. The Company's policy is to amortize production costs over the anticipated revenue stream of the title, which it currently estimates to be two years. Management continually evaluates its policy as sales of each title are made. 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 $64,000 per year for the years ended July 31, 1996 and 1997. F-8 KIDEO PRODUCTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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, 1996 and 1997 were $97,000 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, 1996 and 1997, there were no material temporary differences between the book basis and tax basis of the Company's assets and liabilities. As of July 31, 1997, the Company had a net operating loss carryforward for both financial reporting and income tax purposes of approximately $8,844,000 available to offset future income, expiring during 2009 to 2012. This resulted in a deferred income tax asset of approximately $3,980,000 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. Staff Accounting Bulletin 98 ("SAB 98") revises various existing SAB's to be consistent with the requirements of SFAS No. 128. The most significant revision relates to the calculation of earnings per share when there have been issuances of stock options at prices below the IPO price in periods preceding an initial public offering. SAB 98 requires all registrants who accounted for transactions under SAB 83 to restate those results in conformity with SFAS 128. Accordingly, the Company has restated earnings per share, and weighted average number of shares outstanding data for all periods presented in accordance with SFAS No. 128 and SAB 98. F-9 KIDEO PRODUCTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. Estimates 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. Reclassifications For comparability, certain Fiscal 1996 amounts have been reclassified where appropriate to conform to the financial statement presentation used in Fiscal 1997. 2. PROPERTY AND EQUIPMENT Property and equipment, at cost, consists of the following: July 31, July 31, Estimated 1996 1997 Useful Life --------- ----------- ----------- Video production equipment and related software ........ $ 931,000 $ 605,000 3 years Furniture and fixtures ...... 5,000 10,000 7 years Office equipment ............ 63,000 124,000 5 years Leasehold improvements ...... 21,000 164,000 3 years --------- ----------- 1,020,000 903,000 Less accumulated depreciation (462,000) (396,000) --------- ----------- $ 558,000 $ 507,000 ========= =========== Included in property and equipment at July 31, 1996 and at July 31, 1997 are approximately $431,000 and $207,000, respectively, of assets acquired under capital leases. Accumulated depreciation on these assets as of July 31, 1996 and July 31, 1997 amounted to approximately $216,000 and $53,000 respectively. The property held under these leases is collateral for the related capital lease obligations as described in Note 6. The Company provided for the disposal of certain production equipment during the second quarter of the fiscal year. This equipment was written off after the successful completion of tests allowing F-10 KIDEO PRODUCTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for the production of older Kideo titles on new, more efficient equipment. The write-off of production equipment accounted for a $226,000 expense for the year ended July 31, 1997. 3. CAPITALIZED CONTENT COSTS Capitalized content costs include the development, scripts, characters, props, filming and post production of new Kideo titles introduced for the year ended July 31, 1997. July 31, July 31, 1996 1997 -------- -------- Capitalized content costs .................. $432,000 $777,000 Less accumulated amortization .............. -- 259,000 -------- -------- Net book value ............................ $432,000 $518,000 ======== ======== 4. OTHER ASSETS: Other assets consist of the following: July 31, July 31, 1996 1997 -------- -------- Deposits on capital lease obligations .............. 195,000 34,000 Technology rights and intellectual property ........ 34,000 17,000 Security deposits .................................. 17,000 18,000 Deferred expenses .................................. 40,000 68,000 -------- -------- $286,000 $137,000 ======== ======== 5. COMMITMENTS: The Company leases 7,000 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 space on a month to month basis at a monthly rent of approximately $950. Total rent expense for the years ended July 31, 1996 and 1997 amounted to $76,000 and $121,000, respectively. Future approximate minimum rental payments required are as follows: Year ending July 31, 1998 ............................................... $108,000 1999 ............................................... 18,000 -------- $126,000 ======== 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 as follows: Year ending July 31, 1998................................................ $211,000 1999................................................ 56,000 -------- $267,000 ======== F-11 KIDEO PRODUCTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. CAPITAL LEASE OBLIGATIONS: Included in property and equipment are $431,000 and $207,000 in production and office equipment held under capital leases at July 31, 1996 and 1997, respectively. The future minimum lease payments under capital leases, all with interest rates ranging from 13% to 16.5%, at July 31, 1997 are as follows: Year ending July 31, 1998 ................................................. $105,000 1999 ................................................. 63,000 2000 ................................................. 6,000 2001 ................................................. 3,000 2002 ................................................. 2,000 -------- 179,000 Less amounts representing interest ......................... 31,000 -------- $148,000 ======== 7. SHAREHOLDERS' EQUITY: 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 liquidition 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. As of November 4, 1997 the Company had not exercised 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 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. F-12 KIDEO PRODUCTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Certificate of Designations provides that dividends on the Series A Preferred Stock are payable semi-annually on each July 31st and January 31st, commencing with July 31, 1998. The Company has the option to pay any or all of the dividends through the issuance of additional shares of Common Stock (utilizing the same conversion ratio as described above). Initial Public Offering In January 1996, the Company's Board of Directors authorized an increase in the number of shares of preferred stock from 100,000 to 5,000,000. In addition, the Company's Board of Directors authorized an increase in the number of shares of common stock from 400,000, $.01 par value, to 15,000,000, $.0001 par value, and declared a stock split for which shareholders received 8.6545 shares of common stock for each share of common stock previously owned. On June 25, 1996, the Company consummated an initial public offering of 1,400,000 common shares at an offering price of $5.00 per share and 1,610,000 warrants at an offering price of $.10 per warrant. The net proceeds to the Company were $5,560,000 after deducting issuance costs of $1,601,000, which were charged to equity. Each warrant entitles the holder to purchase one share of common stock at an exercise price of $4.00 per share. The warrants will be exercisable for a period of four years commencing June 24, 1997. Upon the closing of the offering, the Company repaid $1,375,000 principal amount of bridge note financings. Included in the bridge note financings were payments to two officers for $125,000 and $300,000 to a director of the Company. In addition the Company converted the outstanding principal amount of $1,000,000 subordinated debentures into 279,889 shares of common stock and the 1,048,672 shares of outstanding preferred stock were converted into 293,533 shares of common stock. Additional loans of $61,000 in the aggregate were repaid to a shareholder and a former director out of the proceeds of the offering. The Company has granted to a director/shareholder and another shareholder certain preemptive rights to purchase additional shares of common stock to avoid dilution of their ownership in the event of certain sales of securities. The Company has the right to acquire all or a part of one of these shareholders' outstanding shares (up to 38,945 shares) for a price of up to $150,000 plus the fair value of outstanding options, warrants or other rights to purchase securities of the Company. In March 1996, the Company issued 24,000 shares of common stock, valued by the Company at $84,000 ($3.50 per share) at the time of the issuance, for legal services rendered in connection with the IPO. 8. NON RECURRING CHARGES RELATED TO THE SECURITIES RETIRED UPON THE IPO The Statement of Operations for the year ended July 31, 1996 reflects $1,221,000 of expenses related to financings that were either retired or converted into common shares in connection with the IPO. This consists of the following: Amortization of debt issuance costs outstanding from July 31, 1995 ........................................... $ 207,000 Amortization of debt issuance costs incurred in connection with bridge financings that closed during the year ended July 31, 1996 .......................... 190,000 Amortization of original issue discount arising from the allocation of a portion of bridge financing proceeds to shareholders' equity, where shares of common stock were issued in addition to bridge notes issued at par value ............................. 585,000 F-13 KIDEO PRODUCTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Interest on debt retired .......................................... 151,000 Redemption of certain warrants .................................... 88,000 ---------- $1,221,000 ========== 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 proposed initial public offering, the per share exercise price of such options is $5.00 and for stock options granted after the closing of the Company's proposed 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 The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 ("FAS 123"), entitled "Accounting For Stock-Based Compensation." FAS 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 actually exercised. There were no options exercised during the fiscal years ended July 31, 1996 or 1997. Accordingly, there was no compensation expense related to stock options in those years. Had the accounting provisions of FAS 123 been adopted by the Company, reported net income and earnings per share would have changed as follows: Fiscal 1996 Fiscal 1997 ----------- ----------- Net Earnings, as reported $(3,059,000) $(3,819,000) Net Earnings, pro forma for FAS 123 $(3,117,000) $(3,994,000) Earnings per share, as reported $(2.27)* $(1.37) Earnings per share, pro forma for FAS 123 $(1.74) $(1.41) The FAS 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 6% and no common stock dividends during the option period. - --------- * Restated F-14 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 -------------------------------------------------------------------- August 1, 1995 balance -- Grants during Fiscal 1996 341,000 $5.00 $5.00 Forfeitures (7,000) $5.00 $5.00 Options exercised -- -------------------------------------------------------------------- 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 ====================================================================
10. SIGNIFICANT CUSTOMER: During the years ended July 31, 1996 and 1997, $201,000 and $95,000, respectively, of the Company's sales were to one customer. 11. LITIGATION: The Company has applied for a registered trademark for the name "Kideo," however, this trademark has been previously registered by another party. On July 6, 1994, the Company began litigation against the successor to the original owner of the trademark before the Trademark Trial and Appeals Board of the United States Patent and Trademark Office. That proceeding is currently suspended pursuant to a stipulation agreed upon by the Company and such successor while they discuss possible settlement. There can be no assurance that a settlement satisfactory to the Company can be reached. If a satisfactory settlement is not obtained the Company will pursue the original proceeding, and in the event that the Company does not prevail in the proceeding it does not believe that its business will be adversely affected. 12. SUBSEQUENT EVENTS: September 16, 1997 Financing On September 16, 1997, the Company issued 200,000 common shares to an affiliate of Charles C. Johnston, a director of the Company in exchange for an equity infusion of $300,000, which approximates fair market value. Conversion of Preferred Stock At various times during August and September, 1997 the holder of the Company's Preferred Stock converted the 750 Preferred shares into 543,114 shares of common stock at an average price of $1.38 per share. Nasdaq Delisting 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 Small Cap Market. The Nasdaq decision was based F-15 KIDEO PRODUCTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 Small Cap 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. F-16 KIDEO PRODUCTIONS, INC. CONSOLIDATED BALANCE SHEET (unaudited) (Dollars in thousands except per share amounts) at January 31, 1998 -------------- ASSETS Current Assets: Cash and cash equivalents ................................... $ 7 Financing receivable escrow ................................. 310 Accounts receivable trade ................................... 48 Inventory ................................................... 124 Prepaid expenses ............................................ 61 -------- Total current assets ..................................... 550 Property and equipment, net .................................... 355 Capitalized content costs, net ................................. 615 Deferred debt expense .......................................... 646 Other assets ................................................... 103 -------- Total assets ............................................. $ 2,269 ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable ............................................ $ 789 Accrued expenses ............................................ 300 Capital leases, current portion ............................. 78 Unearned revenue ............................................ 345 -------- Total current liabilities ................................ 1,512 Convertible notes payable-long term ............................ 620 Capital leases, long term portion .............................. 28 -------- Total liabilities ........................................ $ 2,160 -------- Shareholders' Equity Preferred Stock: $.0001 par value; issuable in series: authorized 5,000,000 shares, -0- shares issued and outstanding at January 31, 1998 .................. -- Common Stock, $.0001 par value; authorized 15,000,000 shares, issued and outstanding 3,694,628 shares at January 31, 1998 ........................ -- Additional paid-in capital .................................. 10,551 Accumulated deficit ......................................... (10,442) -------- Shareholders' (Deficiency) Equity .......................... 109 -------- Total liabilities and shareholders' equity ............... $ 2,269 ======== See accompanying notes. F-17 KIDEO PRODUCTIONS, INC. CONSOLIDATED STATEMENT OF OPERATIONS (unaudited) (Dollars in thousands except for per share amounts) Six months ended January 31, January 31, 1998 1997 ------------------------------ Sales ...................................... $ 593 $ 761 Cost of sales .............................. 513 611 Write off of production equipment .......... -- 226 ----------- ----------- Gross profit (loss) ........................ 80 (76) Selling expenses ........................... 643 1,254 General and administrative expenses ........ 654 1,036 ----------- ----------- Loss from operations ....................... (1,217) (2,366) Other (expense) income, net ................ (52) 30 ----------- ----------- Net loss ................................... $ (1,269) $ (2,336) =========== =========== Net loss per share - Basic ................. $ (0.37) $ (0.79) =========== =========== Net loss per share - Diluted ............... $ (0.36) $ (0.79) =========== =========== Weighted average number of shares outstanding ............................. 3,481,829 2,939,014 =========== =========== See accompanying notes. F-18 KIDEO PRODUCTIONS, INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (unaudited) (Dollars in thousands except per share amounts)
Additional Preferred Stock Common Stock Paid-in Accumulated Shareholders' Shares Amount Shares Amount Capital Deficit Equity -------------------------------------------------------------------------------- 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 Dividends on preferred stock ...................... (4) (4) Discount to fair market value of the January 1998, convertible notes payable on the conversion to 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 Net loss .......................................... (1,269) (1,269) -------------------------------------------------------------------------------- Balance at January 31, 1998 ....................... (0) $ -- 3,694,628 $ -- $ 10,551 $ (10,442) $ 109 ================================================================================
See accompanying notes. F-19 KIDEO PRODUCTIONS, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (unaudited) (Dollars in thousands except per share amounts)
Six months ended January 31, January 31, 1998 1997 -------------------------- Cash flows from operating activities: Net loss ........................................... $(1,269) $(2,335) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization of operating assets .. 383 317 Write off of equipment ............................. -- 226 Financing charges .................................. 44 -- Changes in operating assets and liabilities: Accounts receivable ................................ (327) 8 Inventory .......................................... (21) (103) Prepaid expenses and other current assets .......... (33) 2 Other assets ....................................... -- (89) Accounts payable ................................... 434 186 Accrued expenses ................................... 70 (111) Unearned revenue ................................... 112 200 --------------------- Net cash used in operating activities ........... (607) (1,699) --------------------- Cash flows from investing activities: Purchase of property and equipment ................. (3) (553) Increase in capitalized content costs .............. (291) (346) --------------------- Net cash used in investing activities ........... (294) (899) --------------------- Cash flows from financing activities: Net proceeds from issuances of capital stock ....... 275 -- Proceeds from long term debt ....................... 500 -- Proceeds from lease financing ...................... -- 207 Principal payments on capital leases ............... (31) (66) --------------------- Net cash provided by financing activities ....... 744 141 --------------------- Net increase (decrease) in cash .......................... (157) (2,457) Cash and cash equivalents at the beginning of the period . 164 2,857 --------------------- Cash and cash equivalents at the end of the period ....... $ 7 $ 400 =====================
See accompanying notes. F-20 KIDEO PRODUCTIONS, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1 Basis of Presentation The interim financial data is unaudited; however, in the opinion of management, the interim data includes all adjustments, consisting of all normal recurring adjustments, necessary for a fair statement of results for the interim periods. The financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures included herein are adequate to make the information presented not misleading. Operating results for the six months ended January 31, 1998 are not necessarily indicative of the results that may be expected for the fiscal year ending July 31, 1998. The organization and the business of the Company, accounting policies followed by the Company and other information are contained in the notes to the Company's consolidated financial statements filed as part of the Company's annual report for the fiscal year ended July 31, 1997 on Form 10-KSB. This quarterly report should be read in conjunction with such annual report. For comparability, certain January 31, 1997 amounts have been reclassified where appropriate to conform to the financial statement presentation used at January 31, 1998. 2 Earnings Per Share For the periods ended January 31, 1998, the Company adopted Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." In accordance with the requirements of SFAS No. 128, Basic EPS was computed by dividing net loss after adjustment for preferred dividend requirements, by the weighted average number of shares outstanding. Diluted EPS was computed by dividing net loss after adjustments for preferred dividend requirements, by the weighted average number of shares outstanding. This excludes the antidilutive effect of outstanding equity instruments. SFAS No. 128 requires presentation of both Basic EPS and Diluted EPS on the face of the statement of operations. Earnings per share amounts for the same prior-year period are restated to conform with the provisions of SFAS No. 128. Staff Accounting Bulletin 98 ("SAB 98") was issued in February 3, 1998. SAB 98 revises various existing SAB's to be consistent with the requirements of SFAS No. 128. The most significant revision relates to the calculation of earnings per share when there have been issuances of stock or options at prices below the IPO price in periods preceding an initial public offering. SAB 98 requires all registrants who accounted for transactions under SAB 83 to restate these results in conformity with SFAS 128. Accordingly, the Company has restated the net loss per share data, and weighted average number of shares outstanding for prior periods as required. F-21 A reconciliation of the Basic EPS and Diluted EPS computations for net earnings (loss) follows: Six Months Ended January 31, 1998 ----------------- Basic Earnings Per Share Net loss as reported $(1,268,696) Less: Dividends on preferred Stock (4,769) ----------- Net loss attributable to common stock $(1,273,445) =========== Weighted average number of shares 3,481,829 ----------- Net loss per share $ (0.37) =========== Diluted Earnings Per Share Net loss attributable to common stock $(1,268,676) =========== Weighted average number of shares 3,481,82 Convertible debt -- Stock options -- Stock warrants -- ----------- Diluted weighted average number of shares 3,481,829 ----------- Diluted net loss per share $ (0.36) =========== F-22 Six Months Ended January 31, 1997 ---------------- Basic Earnings Per Share Net loss as reported $(2,335,110) Less: Dividends on preferred Stock -- ----------- Net loss attributable to common stock $(2,335,110) =========== Weighted average number of shares 2,939,014 ----------- Net loss per share $ (0.79) =========== Diluted Earnings Per Share Net loss as reported $(2,335,110) Less: Dividends on preferred Stock -- ----------- Net loss attributable to common stock $(2,335,110) =========== Weighted average number of shares 2,939,014 Convertible debt -- Stock options -- Stock warrants -- ----------- Diluted weighted average number of shares 2,939,014 ----------- Diluted net loss per share $ (0.79) =========== Six Months Ended Per share amounts January 31, 1997 ----------------- ---------------- Primary EPS as reported $ (0.79) Effect of SFAS No. 128 -- ----------- Basic EPS as restated $ (0.79) =========== Fully diluted EPS as reported $ (0.79) Effect of SFAS No. 128 -- ----------- Diluted EPS as restated $ (0.79) =========== 3 January 1998, Financing The Company issued convertible notes and warrant purchase agreements in the aggregate amount of $620,000, bearing interest at the rate of 10% per annum, due April 15, 1999 and warrants to purchase a total of 640,000 shares of its Common Stock, par value $.0001 per share, to certain investors and advisors. The notes convert at a price of $1.00 per share. The Company has included on its balance sheet deferred debt expense of $646,000, in connection with this transaction, of which $465,000 is attributed to a beneficial conversion feature recorded with the issuance of the convertible debt. The deferred debt expense will be amortized over the life of the notes as required. 4 Subsequent Event 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. F-23 PART II. INFORMATION NOT REQUIRED IN PROSPECTUS Item 24. Indemnification of Directors and Officers Section 145 of the Delaware General Corporations Law (the "DGCL") contains provisions entitling the Company's directors and officers to indemnification from judgments, fines, amounts paid in settlement, and reasonable expenses (including attorneys' fees) as the result of an action or proceeding in which they may be involved by reason of having been a director or officer of the Company. In its Certificate of Incorporation, the Company has included a provision that limits, to the fullest extent now or hereafter permitted by the DGCL, the personal liability of its directors to the Company or its stockholders for monetary damages arising from a breach of their fiduciary duties as directors. Under the DGCL as currently in effect, this provision limits a director's liability except where such director (i) breaches his duty of loyalty to the Company or its stockholders, (ii) fails to act in good faith or engages in intentional misconduct or a knowing violation of law, (iii) authorizes payment of an unlawful dividend or stock purchase or redemption as provided in Section 174 of the DGCL, or (iv) obtains an improper personal benefit. This provision does not prevent the Company or its stockholders from seeking equitable remedies, such as injunctive relief or rescission. If equitable remedies are found not to be available to stockholders in any particular case, stockholders may not have any effective remedy against actions taken by directors that constitute negligence or gross negligence. The Certificate of Incorporation also includes provisions to the effect that (subject to certain exceptions) the Company shall, to the maximum extent permitted from time to time under the law of the State of Delaware, indemnify, and upon request shall advance expenses to, any director or officer to the extent that such indemnification and advancement of expenses is permitted under such law, as it may from time to time be in effect. In addition, the By-Laws require the Company to indemnify, to the full extent permitted by law, any director, office, employee or agent of the Company for acts which such person reasonably believes are not in violation of the Company's corporate purposes as set forth in the Certificate of Incorporation. At present, the DGCL provides that, in order to be entitled to indemnification, an individual must have acted in good faith and in a manner her or she reasonably believed to be in or not opposed to the Company's best interests. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Company pursuant to any charter, provision, by-law, contract, arrangement, statute or otherwise, the Registrant has been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. See Item 28. II-1 Item 25. Other Expenses of Issuance and Distribution. The estimated expenses payable by the Registrant (also herein called the "Company") in connection with the issuance and distribution of the securities being registered hereby (other than underwriting discounts and commissions) are set forth in the table below. None of such expenses will be borne by the Selling Stockholders. SEC registration fee........................................ $ 794.83 Printing expenses........................................... 1,000.00 Legal fees and expenses..................................... 20,000.00 Accounting fees and expenses................................ 15,000.00 TOTAL..................................... $36,794.83 Item 26. Recent Sales of Unregistered Securities Within the past three years, the Registrant has issued securities without registration under the Securities Act of 1933, as amended (the "Act"), as follows: On June 2, 1994, the Registrant issued to a private investor known to the Company 5,965 shares of Common Stock for a total consideration of $25,000. On June 17, 1994, the Registrant issued 53,681 shares of Common Stock to a private investor for a total consideration of $200,000. In connection with such issuance this investor became a director of the Registrant. In June and October 1994, and in connection with the above-mentioned March and June transactions, the Registrant issued to two existing stockholders of the Registrant an aggregate of 8,922 shares of Common Stock in lieu of aggregate cash payments in the amount of $14,518 payable for investments advisory services. In November 1994, the Registrant issued 9,356 shares of Common Stock to a private investor known to the Registrant for a total consideration of $26,000. In March 1995, the Registrant issued an aggregate of 19,271 shares of Common Stock to four existing stockholders of the Registrant for a total consideration of $47,450. During the period from May through October 1995, the Registrant issued to 79 accredited investors, including a director/principal stockholder of the Registrant, through a private placement (the "May 1995 Units Financing"), an aggregate of 1,000 shares of Series A Preferred Stock and an aggregate of $1,000,000 principal amount of Debentures. The Registrant received total compensation of $2,000,000, consisting of cash in the amount of $1,025,000 and the conversion of certain notes outstanding in the aggregate principal amount of $975,000, including $200,000 in principal amount of notes owing to the director/principal stockholder of the Registrant. In connection with the May 1995 Units Financing, the Registrant paid a placement fee to one of the investors in the May 1995 Units Financing and a company controlled by such investor in the aggregate amount of $90,000 in cash, 35,477 shares of Common Stock, 11,625 shares of Series A Preferred Stock and a Debenture in the principal amount of $11,625. II-2 In July 1995, the Registrant issued to V-Seion Multimedia, Inc., a company controlled by Bradley Dahl, 19,645 shares of Common Stock as a $70,000 partial payment for the acquisition of certain hardware and software assets. In connection with such transaction, Mr. Dahl became an executive officer of the Registrant. In September and October 1995, the Registrant effectuated a private placement to six accredited investors known to the Registrant, including a director/principal stockholder of the Registrant whereby the Registrant issued $300,000 in principal amount of notes and 90,000 shares of Common Stock. The Registrant received total cash consideration of $300,000 (including $100,000 from the director/principal stockholder in exchange for a $100,000 principal amount promissory note and 30,000 shares of Common Stock). In January 1996, the Registrant issued to two executive officers of the Registrant $125,000 in aggregate principal amount of promissory notes and an aggregate of 25,000 shares of Common Stock. The Registrant received a total cash consideration of $125,000. In February 1996, the Registrant issued to eleven accredited investors $750,000 in aggregate principal amount of promissory notes and an aggregate of 150,000 shares of Common Stock pursuant to a private placement (the "1996 Bridge Financing"). The Registrant received total cash consideration in the gross amount of $750,000. In connection with the 1996 Bridge Financing, Whale Securities Co., L.P. ("Whale") acted as placement whereby Whale received an aggregate commission of $75,000 in cash. On March 26, 1996, SME agreed to accept from the Registrant, in lieu of cash and as partial payment for legal services rendered prior to that date, 24,000 shares of Common Stock (valued by the Company at that time as having a fair market value of $3.50 per share). The Registrant issued such 24,000 shares to members and an employee of SME on March 27, 1996. On May 24, 1996, options to purchase an aggregate of 4,000 shares of Common Stock at a purchase price of $5.00 per share were granted under the 1996 Stock Option Plan to a consultant of the Registrant. Subject to various vesting conditions, all of such options (once vested) will be exercisable until May 24, 2006. The Registrant received no consideration for these options, and such options were issued without registration because no sale occurred in connection with the issuance of the options. On June 3, 1996, the Registrant issued to two accredited investors $200,000 in aggregate principal amount of promissory notes and an aggregate of 50,000 shares of Common Stock pursuant to a private placement (the "June 1996 Financing"). The Registrant received total cash consideration in the gross amount of $200,000. In connection with this financing, Whale (the Underwriter of the Underwritten Offering) received an aggregate commission of $20,000 in cash. On October 30, 1996, the Registrant issued a warrant to purchase 20,000 shares of Common Stock at a price of $5.00 per share to an executive and owner of a company that had acted as an independent contractor to the Registrant. See the discussion in the Prospectus under "Description of Securities-Other Warrants." The Registrant received no separate consideration for this warrant (apart from the services rendered by such independent contractor), and such warrant was issued without registration because no sale occurred in connection with its issuance. In March, May and September of 1996 and in April of 1997, the Registrant granted options to purchase shares of its Common Stock to participants in its 1996 Stock Option Plan. See the discussion in the Prospectus under "Management-1996 Stock Option Plan." The Registrant received no consideration for these options, and such options were issued without registration because no sale occurred in connection with the issuance of the options. II-3 On May 13, 1997, the Registrant issued 750 shares of its Series A Preferred Stock to Sellet Marketing Corp. as described in the Prospectus included in this Registration Statement under "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources--May 1997 Financing." On September 16, 1997, the Registrant issued 200,000 shares of Common Stock 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 the be the fair market value of those 200,000 shares at the time of issuance. On January 30, 1998, the Registrant issued the January 1998 Notes, the January 1998 Warrants, the 1998 Johnston Warrants, the KSH Shares and the SME Warrants as described in the Prospectus included in this Registration Statement under "Recent Developments." Unless stated otherwise, at the times the above-mentioned securities were issued, the foregoing persons represented to the Registrant that they were acquiring the securities for purposes of investment and not with a view to distribution, and appropriate legends were placed on the certificates representing the securities so issued. In addition, the foregoing persons had adequate access, through employment, business relationships, or otherwise to information about the Registrant. Exemption from registration of such securities is claimed under Section 4(2) of the Act since no public offering was involved and the securities had been taken for investment purposes and not with a view to distribution. Item 27. Exhibits Except for Exhibits 4.5, 5.1, 10.32 through 10.35, and 23.1 hereto, and except for Exhibits marked (as indicated in the next paragraph) as being filed as part of this Registration Statement, all Exhibits to this Registration Statement referenced below (i) were previously filed as Exhibits to the Company's Registration Statement on Form SB-2 (reg. no. 333-2294), declared effective by the Commission in June 1996 (the "1996 Registration Statement"), or as Exhibits to its Registration Statement on Form SB-2 (reg. no. 333-31035), declared effective by the Commission in August 1997 (the "1997 Registration Statement"), and (ii) are accordingly incorporated herein by reference. The Company's Commission file number is 0-28158. Any Exhibit marked below with an asterisk (*) indicates a contract or compensatory plan or arrangement relating to the Company's management. Any Exhibit marked below with a double asterisk (**) indicates an Exhibit to be filed by amendment. Any Exhibit marked below with a number symbol (#) indicates an Exhibit filed herewith. Any Exhibit marked below with a double number symbol (##) indicates an Exhibit previously filed herewith. No. Description - --- ----------- 3.1 Certificate of Incorporation. Previously filed as Exhibit 3.1 to the 1996 Registration Statement. 3.2 By-laws, as amended and restated as of May 24, 1996. Previously filed as Exhibit 3.3 to the 1996 Registration Statement. 3.3 Certificate of Amendment to the Company's Certificate of Incorporation, as filed with the Delaware Secretary of State on May 24, 1996. Previously filed as Exhibit 3.4 to the 1996 Registration Statement. 3.4 Certificate of Designations of Series A 6% Convertible Participating Preferred Stock. Previously filed as Exhibit 3.1 to the Company's Report on Form 8-K, dated May 27, 1997, and incorporated herein by reference. 4.1 Form of Common Stock certificate. Previously filed as Exhibit 4.1 to the 1996 Registration Statement. II-4 4.2 Form of Warrant Agreement between the Company and Whale Securities Co., L.P., including Form of Warrant Certificate. Previously filed as Exhibit 4.2 to the 1996 Registration Statement. 4.3 Form of Public Warrant Agreement among the Company, Whale Securities Co., L.P. and American Stock Transfer & Trust Company as Warrant Agent. Previously filed as Exhibit 4.3 to the 1996 Registration Statement. 4.4 Form of Redeemable Warrant. Previously filed as Exhibit 4.4 to the 1996 Registration Statement. 4.5 Form of certificate representing shares of Series A 6% Convertible Participating Preferred Stock. Previously filed as Exhibit 4.1 to the Company's Report on Form 8-K, dated May 27, 1997, and incorporated herein by reference. 4.6 Warrant issued on October 30, 1996. Previously filed as Exhibit 4.6 to the 1997 Registration Statement. 4.7# Form of January 1998 Warrant issued as of January 30, 1998 to each of Benjamin Bollag and Michael Bollag. 4.8# Form of SME Warrant issued as of January 30, 1998 to various members and employees of Solovay Marshall & Edlin, P.C. 4.9# Form of 1998 Johnston Warrant issued as of January 30, 1998 to Charles C. Johnston. 5.1** Opinion of Solovay Marshall & Edlin, P.C. 10.1 Investor Rights Agreement, dated June 17, 1994, between the Company and the investors named therein. Previously filed as Exhibit 10.1 to the 1996 Registration Statement. 10.2 Form of Stock Purchase Agreement, dated March 7, 1994, between the Company and the investors named therein, relating to a private placement of shares of Common Stock. Previously filed as Exhibit 10.2 to the 1996 Registration Statement. 10.3 Form of Stock Purchase Agreement, dated March 31, 1994, between the Company and the investors named therein, relating to a private placement of shares of Common Stock. Previously filed as Exhibit 10.3 to the 1996 Registration Statement. 10.4 Stock Purchase Agreement between the Company and Richard Carney, dated May 10, 1994. Previously filed as Exhibit 10.4 to the 1996 Registration Statement. 10.5 Stock Purchase Agreement between the Company and Henry Fredericks, dated June 2, 1994. Previously filed as Exhibit 10.5 to the 1996 Registration Statement. 10.6 Stock Purchase Agreement between the Company and Charles Johnston, dated June 17, 1994. Previously filed as Exhibit 10.6 to the 1996 Registration Statement. 10.7 Marketing Agreement between the Company and Consumer Programs, Inc. dated November 3, 1994. Previously filed as Exhibit 10.7 to the 1996 Registration Statement. 10.8 Equipment Lease Agreements between the Company and National Marketing Network, Inc., dated November 9, 1994, November 27, 1994 and December 8, 1994. Previously filed as Exhibit 10.8 to the 1996 Registration Statement. II-5 10.9 Equipment Lease Agreements between the Company and Technilease, dated August 22, 1994 and October 3, 1994. Previously filed as Exhibit 10.9 to the 1996 Registration Statement. 10.10 Equipment Lease Agreement between the Company and Television Laboratories, Inc., dated November 1994. Previously filed as Exhibit 10.10 to the 1996 Registration Statement. 10.11 Promissory Note to Charles Johnston, dated March 2, 1995. Previously filed as Exhibit 10.11 to the 1996 Registration Statement. 10.12 Registration Rights Agreement between the Company and Richard L. Bulman, dated January 1, 1995. Previously filed as Exhibit 10.12 to the 1996 Registration Statement. 10.13 Stock Option Agreement between the Company and Richard L. Bulman, dated March 15, 1995. Previously filed as Exhibit 10.13 to the 1996 Registration Statement. 10.14 Stock Escrow Agreement between V-Seion and 477250 B.C. Ltd. (the predecessor corporation which subsequently changed its name to become Kideo-Canada), dated July 14, 1995. Previously filed as Exhibit 10.14 to the 1996 Registration Statement. 10.15 Stock Transfer Restriction and Repurchase Agreement between 477250 B.C. Ltd. and V-Seion, dated July 14, 1995. Previously filed as Exhibit 10.15 to the 1996 Registration Statement. 10.16 Registration Rights Agreement between the Company and V-Seion, dated July 14, 1995. Previously filed as Exhibit 10.16 to the 1996 Registration Statement. 10.17 Asset Purchase Agreement between V-Seion Multimedia and 477250 B.C. Ltd., dated July 17, 1995. Previously filed as Exhibit 10.17 to the 1996 Registration Statement. 10.18 Office Lease between the Company and Cable Building Associates, dated September 28, 1995. Previously filed as Exhibit 10.18 to the 1996 Registration Statement. 10.19* Employment and Stock Issuance Agreement between the Company and Gary Bilezikian, dated October 26, 1993. Previously filed as Exhibit 10.19 to the 1996 Registration Statement. 10.20* Employment Agreement between 477250 B.C. and Bradley Dahl, dated July 14, 1995. Previously filed as Exhibit 10.20 to the 1996 Registration Statement. 10.21* Amended and Restated Employment Agreement between the Company and Marvin Goldstein, dated as of January 1, 1996. Previously filed as Exhibit 10.21 to the 1996 Registration Statement. 10.22* Amended and Restated Employment Agreement between the Company and Robert J. Riscica, dated as of January 1, 1996. Previously filed as Exhibit 10.22 to the 1996 Registration Statement. 10.23* Amended and Restated Employment Agreement between the Company and Richard L. Bulman, dated as of January 1, 1996. Previously filed as Exhibit 10.23 to the 1996 Registration Statement. 10.24* Amended and Restated Employment Agreement between the Company and Joanne Denk, dated as of January 2, 1996. Previously filed as Exhibit 10.24 to the 1996 Registration Statement. 10.25* Form of Class A Warrant (Charles Johnston, a director of the Company, is currently the only holder of any Class A Warrants). II-6 10.26* Form of Class B Warrant (Charles Johnston, a director of the Company, is currently the only holder of any Class B Warrants). 10.27* 1996 Stock Option Plan. Previously filed as Exhibit 10.28 to the 1996 Registration Statement. 10.28* Form of Stock Option Agreement. Previously filed as Exhibit 10.29 to the 1996 Registration Statement. 10.29 Form of Consulting Agreement between the Company and Whale Securities Co., L.P. Previously filed as Exhibit 10.30 to the 1996 Registration Statement. 10.30 Patent Application filed by Bradley Dahl, dated July 7, 1994. Previously filed as Exhibit 10.31 to the 1996 Registration Statement pursuant to a granted request for confidential treatment. 10.31 Patent Application filed by the Company dated June 9, 1995. Previously filed as Exhibit 10.32 to the 1996 Registration Statement pursuant to a granted request for confidential treatment. 10.32 Form of Stock Purchase Agreement, dated as of May 13, 1997, between the Company and Sellet Marketing Corp. ("Sellet"). Previously filed as Exhibit 10.1 to the Company's Report on Form 8-K, dated May 27, 1997, and incorporated herein by reference. 10.33 Form of Registration Rights Agreement, dated as of May 13, 1997, between the Company and Sellet. Previously filed as Exhibit 10.2 to the Company's Report on Form 8-K, dated May 27, 1997, and incorporated herein by reference. 10.34 Form of Joint Escrow Instructions, dated as of May 13, 1997, between the Company and Krieger & Prager, as Escrow Agent. Previously filed as Exhibit 10.3 to the Company's Report on Form 8-K, dated May 27, 1997, and incorporated herein by reference. 10.35 Form of Indemnification Agreement, dated as of November 12, 1996 and made retroactively effective as of June 24, 1996, between the Company and each of the following persons (being all of its current directors and executive officers): Richard L. Bulman, Charles C. Johnston, Thomas Griffin, Richard D. Bulman, Michael B. Solovay, Robert J. Riscica, Marvin H. Goldstein, and Bradley Dahl. Previously filed as Exhibit 10.1 to the Company's Report on Form 10-QSB relating to the quarter ended July 31, 1997 (dated March 14, 1997) and incorporated herein by reference. 10.36# Form of Note and Warrant Purchase Agreement (the "January 1998 Purchase Agreement"), dated as of January 30, 1998, among the Company, Michael Bollag and Benjamin Bollag. 10.37# Form of Security Agreement, dated as of January 29, 1998, made by the Company in favor of Michael Bollag and Benjamin Bollag. 10.38# Form of $250,000 principal amount Convertible Promissory Note (the "January 1998 Notes"), dated January 30, 1998, made by the Company in favor of each of Michael Bollag and Benjamin Bollag. 21.1 List of the Company's subsidiaries. Previously filed as Exhibit 21.1 to the 1996 Registration Statement. 23.1# Consent of Arthur Andersen LLP, Independent Certified Public Accountants. Filed herewith. 24.1 No person has signed this Registration Statement under a power of attorney. A power of attorney relating to the signing of amendments hereto is incorporated in the signature pages hereof. II-7 Item 28. Undertakings (1) The undersigned Registrant hereby undertakes that it will: (a) File, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement to: (i) include any prospectus required by Section 10(a)(3) of the Act; (ii) reflect in the prospectus any facts or events which, individually or together, represent a fundamental change in the information in the Registration Statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the law or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price present no more than a 20% change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement, and (iii) include any additional or changed material information on the plan of distribution. (b) For determining any liability under the Act, each post-effective amendment shall be deemed to be a new Registration Statement of the securities offered, and the offering of securities at that time shall be deemed to be the initial bona fide offering thereof. (c) Remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of this offering. (2) The undersigned Registrant hereby undertakes to provide to the Underwriter at the closing specified in the Underwriting Agreement certificates in such denominations and registered in such names as required by the Underwriter to permit prompt delivery to each purchaser. (3) Insofar as indemnification for liabilities arising under the Act may be permitted to directors, officers and controlling persons of the Company, pursuant to the foregoing provisions, or otherwise, the Company has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Company of expenses incurred or paid by a director, officer or controlling person of the Company in the successful defense of any action suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Company will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. (4) The undersigned Registrant hereby undertakes that it will: (a) For determining any liability under the Securities Act, treat the information omitted from the form of prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4), or 497(h) under the Securities Act as part of this registration statement as of the time it was declared effective. II-8 (b) For determining any liability under the Securities Act, treat each post-effective amendment that contains a form of prospectus as a new registration statement for the securities offered in the registration statement, and the offering of such securities at that time as the initial bona fide offering of those securities. II-9 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form SB-2 and has duly caused this Registration Statement or amendment thereto to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of New York, New York. Dated: March __, 1998 KIDEO PRODUCTIONS, INC. By /s/ Richard L. Bulman ------------------------ Richard L. Bulman President KNOW ALL MEN BY THESE PRESENTS, that each director and officer whose signature appears below constitutes and appoints Richard L. Bulman, Robert J. Riscica and Lawrence J. Studnicky III, or any of them, his true and lawful attorney-in-fact and agent, with full power and substitution and re-substitution, to sign in any and all capacities any and all amendments or post-effective amendments to this Registration Statement on Form SB-2 and to file the same with all exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, granting to such attorneys-in-fact and agents, and each of them, full power and authority to do all such other acts and execute all such other documents as they, or any of them, may deem necessary or desirable in connection with the foregoing, as fully as the undersigned might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents, or any of them, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, this Registration Statement or amendment has been signed by the following persons in the capacities and on the dates indicated: Signature Title Date - --------- ----- ---- /s/ Richard L. Bulman President and Chairman March __, 1998 - ------------------------ of the Board Richard L. Bulman /s/ Marvin H. Goldstein Vice President-Controller March __, 1998 - ------------------------ (the Registrant's principal Marvin H. Goldstein accounting officer) /s/ Richard D. Bulman Secretary and Director March __, 1998 - ------------------------ Richard D. Bulman /s/ Charles C. Johnston Director March __, 1998 - ------------------------ Charles C. Johnston /s/ Michael B. Solovay Director March __, 1998 - ------------------------ Michael B. Solovay /s/ Thomas Griffin Director March __, 1998 - ------------------------ Thomas Griffin II-10 EX-4.7 2 WARRANT CERTIFICATE EXHIBIT 4.7 THIS WARRANT CERTIFICATE, AND THE SHARES TO BE ISSUED UPON ITS EXERCISE, HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), AND MAY NOT BE OFFERED FOR SALE, SOLD OR TRANSFERRED UNLESS REGISTERED UNDER THE ACT, OR UNLESS AN EXEMPTION FROM SUCH REGISTRATION IS AVAILABLE. WARRANT CERTIFICATE Dated: January 30, 1998 Warrant to Purchase up to 250,000 shares of Common Stock, par value $.0001 per share, of KIDEO PRODUCTIONS, INC. VOID AFTER MIDNIGHT, NEW YORK, NEW YORK LOCAL TIME ON JANUARY 30, 2003 KIDEO PRODUCTIONS, INC., a Delaware corporation (the "Company"), hereby certifies that BENJAMIN BOLLAG, his successors and assigns (the "Holder"), is entitled to purchase from the Company at any time after the dates set forth in Section 1 hereof and before Midnight, New York, New York local time on January 30, 2003, up to 250,000 shares of common stock, par value $.0001 per share, of the Company (the "Common Stock"), at the price of $1.00 per share (the "Exercise Price", subject to adjustment as provided herein). 1. Exercise of Warrants. In order to exercise the rights to purchase Common Stock evidenced by this Warrant Certificate, the Holder must, subject to Section 7 below, present and surrender this Warrant Certificate with the attached Purchase Form duly executed at the principal office of the Company. This Warrant Certificate may be exercised with respect to all of the Common Stock subject hereto or any portion thereof; provided, however, notwithstanding anything to the contrary contained herein, the Holder may only exercise this Warrant for the following number of shares of the Common Stock on or after the following dates: Number of Shares Exercise Date ---------------- ------------- 83,333 May 1, 1998 166,666 July 15, 1998 250,000 October 15, 1998 2. Exchange and Transfer. This Warrant Certificate at any time prior to the exercise hereof, upon presentation and surrender to the Company, may be exchanged, alone or with other Warrant Certificates, if any, of like tenor registered in the name of the same Holder, for another Warrant Certificate of like tenor in the name of such Holder exercisable for the same aggregate number of shares of Common Stock as the Warrant Certificate(s) surrendered. 3. Rights and Obligations of the Holder of the Warrant Certificate. The Holder shall not, by virtue hereof, be entitled to any rights of a stockholder in the Company, either at law or in equity; provided, however, upon exercise of this Warrant, such Holder shall, for all purposes, be deemed to have become the holder of record of such Common Stock on the date on which this Warrant, together with a duly executed Purchase Form, was surrendered and payment of the Exercise Price was made, irrespective of the date of delivery of the share certificate. The rights of the Holder of this Warrant are limited to those expressed herein and the Holder, by acceptance hereof, consents to and agrees to be bound by and comply with all the provisions of this Warrant and the agreement, dated the date hereof, between the Holder and the Company, providing for, among other things, the issuance of this Warrant (the "Purchase Agreement"). In addition, the Holder agrees that the Company may deem and treat the person in whose name this Warrant is registered as the absolute, true and lawful owner for all purposes whatsoever, unless and until such time as the Company has received written notice to the contrary. 4. Common Stock. (a) The Company covenants and agrees that this Warrant is duly and validly authorized and issued, and free from all stamp-taxes, liens, and charges with respect to the delivery or purchase thereof. In addition, the Company agrees at all times to reserve and keep available an authorized number of shares of Common Stock sufficient to permit the exercise in full of this Warrant. (b) The Company covenants and agrees that all shares of Common Stock delivered upon exercise of this Warrant, will, upon delivery, be duly and validly authorized and issued, fully-paid and non-assessable, and free from all stamp-taxes, liens, and charges with respect to the purchase thereof. 5. Disposition of the Warrant and Common Stock. The Holder hereby agrees and represents that (a) this Warrant and the Common Stock issuable upon exercise are being acquired for the Holder's account, and not with a view to or in connection with any offering or distribution; and (b) no public distribution of this Warrant of the Common Stock will be made in violation of the provisions of the Securities Act of 1933, as amended (the "Act"), or in violation of the provisions of applicable state laws. The Company shall use its 2 best efforts to cause its counsel, at the Company's expense, to render any opinion required in connection with any transfer of this Warrant or the shares of Common Stock underlying this Warrant. The Holder is responsible for any transfer taxes due as a result of any transfer of this Warrant. 6. Registration Rights. The Holder shall have those registration rights with respect to the Common Stock issued or issuable upon exercise of this Warrant set forth in the Purchase Agreement. 7. Exercise of This Warrant. Subject to Section 1 of this Warrant, at any time on or prior to Midnight, New York, New York local time, on January 30, 2003, the Holder shall have the right to acquire up to 250,000 shares of Common Stock on the following terms and conditions: (a) Exercise Price: Fractional Shares. The Exercise Price shall be a price per share of Common Stock equal to One Dollar ($1.00), subject to reduction as set forth in Section 4.1 of the Purchase Agreement and subject to adjustment as set forth below and in the Purchase Agreement. All calculations of shares of Common Stock to be issued in connection with any exercise hereunder shall be rounded to the nearest one-hundredth of a whole share. (b) Exercise Procedure. (1) Payment for Shares. (x) On a date determined by the Company, but which shall in no event be later than five (5) days after the Company's receipt of the surrendered Warrant and Purchase Form, the Holder shall deliver to the Company, at the Company's principal executive office, a certified or bank cashier's check payable to the Company in the amount of the Exercise Price then in effect times the number of shares of Common Stock being purchased (the "Aggregate Stock Purchase Price"). (y) In lieu of paying the Aggregate Stock Purchase Price upon exercise of this Warrant, for so long as the Common Stock is publicly traded, the Holder may elect a "cashless exercise" in which event the Holder will receive upon exercise of this Warrant a reduced number of shares of Common Stock equal to (i) the number of shares of Common Stock that would be issuable pursuant to this Warrant upon payment of the Aggregate Stock Purchase Price minus (ii) the number of shares of Common Stock that have an aggregate fair market value equal to the Aggregate Stock Purchase Price. For purposes of the preceding sentence, the fair market value of a share of Common Stock shall mean the average of the last reported sale prices of the Common Stock on the ten trading days preceding the date of exercise. (2) Effective Date of Exercise. Each exercise will be deemed to have been effected as of the close of business on the later of (i) the date that the Purchase Form is received by the Company, or (ii) the date on which this original Warrant is returned 3 to the Company for cancellation, and, if applicable, reissuance at the principal office of the Company at 611 Broadway, Suite 515, New York, New York 10012. At such time as such exercise has been effected, the person (or entity) or persons (or entities) in whose name or names any certificate(s) for shares of Common Stock are to be issued upon such exercise will be deemed to have become the holder or holders of record of the shares of Common Stock represented thereby. (c) Delivery of Certificates. As soon as practicable after an exercise has been effected (but in any event within three (3) business days), the Company will deliver to the Holder: (1) a certificate or certificates representing the number of shares of Common Stock issuable by reason of such exercise in such name(s) and such denomination(s) as the Holder has specified; (2) a new Warrant Certificate entitling the Holder to purchase the number of shares of Common Stock as to which the original Warrant Certificate was not exercised and reflecting any changes to the Exercise Price which have theretofore been effectuated and which Warrant Certificate shall otherwise be in form and substance identical to that delivered by the Holder to the Company for said exercise. (d) Closure of Issuer Books. The Company will not close its books against the transfer of Warrants or of Common Stock issued or issuable upon exercise of Warrants in any manner which interferes with the timely exercise of Warrants. (e) Payment of Taxes. The Company will pay all taxes and other governmental charges (other than taxes measured by the revenue or income of the Holder) that may be imposed in respect of the issue or delivery of shares of Common Stock upon exercise of this Warrant; provided, however, that the Holder shall pay any such tax which is due because shares of Common Stock are issued in a name other than such Holder's. (f) Notices of Record Date. In the event of (i) any taking by the Company of a record of the holders of any class or series of securities for the purpose of determining the holders thereof who are entitled to receive any dividend or other distribution or (ii) any reclassification or recapitalization of the capital stock of the Company, any merger or consolidation of the Company, or any transfer of all or substantially all the assets of the Company to any other corporation, entity or person, or any voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Company, the Company shall mail to the Holder at least twenty (20) days prior to the record date specified therein (the "Notice Period"), a notice specifying (A) the date on which any such record is to be taken for the purpose of such dividend or distribution and a description of such dividend or distribution, (B) the date on which any such reorganization, reclassification, transfer, consolidation, merger, dissolution, liquidation or winding up is expected to become effective, and (C) the time, if any is to be fixed, as to when the holders of record of Common Stock 4 (or other securities) shall be entitled to exchange their shares of Common Stock (or other securities) for securities or other property deliverable upon such reorganization, reclassification, transfer, consolidation, merger, dissolution, liquidation or winding up. During the Notice Period, the Holder shall have the exercise rights provided elsewhere in this Warrant. 8. Adjustment of Exercise Price and Number of Shares. The Exercise Price and the number of shares purchasable upon the exercise of this Warrant shall be subject to adjustment from time to time as set forth below; however, no adjustment in the Exercise Price need be made unless the adjustment would require an increase or decrease of at least 1% in the Exercise Price. Any adjustments that are not made shall be carried forward and taken into account in any subsequent adjustment. Upon each adjustment of the Exercise Price, the holder of this Warrant shall thereafter be entitled to purchase, at the Exercise Price resulting from such adjustment, the number of shares obtained by multiplying the Exercise Price in effect immediately prior to such adjustment by the number of shares purchasable pursuant hereto immediately prior to such adjustment, and dividing the product thereof by the Exercise Price resulting from such adjustment. (a) Adjustment for Common Stock Splits and Combinations. If the Company shall at any time or from time to time after the date hereof effect a subdivision of the outstanding Common Stock, the Exercise Price then in effect immediately before that subdivision shall be proportionately decreased; conversely, if the Company shall at any time or from time to time after the date hereof reduce the outstanding shares of Common Stock by combination or otherwise, the Exercise Price then in effect immediately before the combination shall be proportionately increased. Any adjustment under this Section 8(a) shall become effective at the close of business on the date the subdivision or combination becomes effective. (b) Adjustment for Certain Dividends and Distributions of Common Stock. In the event the Company at any time or from time to time after the date hereof shall make or issue, or fix a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in additional shares of Common Stock, then and in each such event the Exercise Price then in effect shall be decreased as of the time of such issuance or, in the event such a record date shall have been fixed, as of the close of business on such record date, by multiplying the Exercise Price then in effect by a fraction: (1) the numerator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date, and (2) the denominator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date, plus the number of shares of Common Stock 6 issuable in payment of such dividend or distribution; provided, however, if such record date shall have been fixed and such dividend is not fully paid or if such distribution is not fully made on the date fixed therefor, the Exercise Price shall be recomputed accordingly as of the close of business on such record date and thereafter the Exercise Price shall be adjusted pursuant to this Section 8(b) as of the time of actual payment of such dividends or distributions. (c) Adjustment for Other Dividends and Distributions. In the event the Company at any time or from time to time after the date hereof shall make or issue, or fix a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in securities of the Company other than shares of Common Stock, then and in each such event provision shall be made so that Holder shall receive upon exercise of this Warrant in addition to the number of shares of Common Stock receivable thereupon, the amount of securities of the Company that it would have received had this Warrant been exercised on the date of such event and had thereafter, during the period from the date of such event to and including the exercise date, retained such securities receivable by it as aforesaid during such period giving application to all adjustments called for during such period under this Warrant with respect to the rights of the Holder. (d) Adjustment for Reclassification, Exchange or Substitution. If the Common Stock issuable upon the exercise of this Warrant shall be changed into the same or a different number of shares of any class or classes of stock, whether by reclassification, exchange, substitution or other change (other than a reorganization, merger, consolidation or sale of assets provided for in Section 8(e) below), then and in each such event, the Holder shall have the right thereafter to exercise this Warrant into the kind and amounts of shares of stock and other securities and property receivable upon such reclassification, exchange, substitution or other change, by holders of the number of shares of Common Stock into which this Warrant might have been exercised immediately prior to such reclassification, exchange, substitution, or other change, all subject to further adjustment as provided herein. (e) Reorganization, Mergers, Consolidations or Sales of Assets. If at any time or from time to time there shall be a reorganization of the Common Stock (other than a reclassification, exchange or substitution of shares provided for in Section 8(d) above) or a merger or consolidation of the Company with or into another corporation, or the sale of all or substantially all the Company's properties and assets to any other person, then, as a part of such reorganization, merger, consolidation or sale, provision shall be made so that the Holder shall thereafter be entitled to receive upon exercise of this Warrant, the number of shares of stock or other securities or property of the Company or of the successor corporation resulting from such reorganization, merger, consolidation or sale, to which a holder of that number of shares of Common Stock deliverable upon exercise of this Warrant would have been entitled on such reorganization, merger, consolidation or sale. In any such case, appropriate adjustment shall be made in the application of the provisions of this 7 Warrant with respect to the rights of the Holder after the reorganization, merger, consolidation or sale to the end that the provisions of this Warrant (including adjustment of the number of shares issuable upon exercise of this Warrant) shall be applicable after that event as nearly equivalent as may be practicable. (f) Sales of Shares Below Exercise Price. (1) Adjustment of Exercise Price. Subject to Subsection 8(f)(5) below, if at any time or from time to time after the date hereof, the Company shall issue or sell Additional Shares of Common Stock (as hereinafter defined), other than as a dividend as provided in Section 8(b) above, and other than upon a subdivision or combination of shares of Common Stock as provided in Section 8(a) above, for a consideration per share less than the then effective Exercise Price, then and in each case the Exercise Price shall be reduced, as of the opening of business on the date of such issuance or sale, to a price equal to the price at which such Additional Shares of Common Stock are sold. In no event shall any adjustment under this Subsection 8(f)(1) result in an increase in the Exercise Price. (2) Determination of Consideration. For the purpose of making any adjustment in the Exercise Price or number of shares of Common Stock purchasable on exercise of this Warrant as provided above, the consideration received by the Company for any issue or sale of securities shall, i. to the extent it consists of cash, be computed at the gross amount of cash received by the Company in connection with such issue or sale, ii. to the extent it consists of services or property other than cash, be computed at the fair value of such services or property as determined in good faith by the Company's Board of Directors (the "Board"), and iii. if Additional Shares of Common Stock, Convertible Securities (as hereinafter defined), or rights or options to purchase either Additional Shares of Common Stock or Convertible Securities are issued or sold together with other stock or securities or other assets of the Company for a consideration that covers both, be computed as the portion of the consideration so received that may be reasonably determined in good faith by the Board to be allocable to such Additional Shares of Common Stock, Convertible Securities or rights or options. (3) Convertible Securities. For the purpose of the adjustment provided in Subsection 8(f)(1) hereof, if at any time or from time to time after the date hereof the Company shall issue any rights or options for the purchase of, or stock or other securities convertible into, Additional Shares of Common Stock (such convertible stock or securities being hereinafter referred to as "Convertible Securities"), then, in each case, if the Effective Price (as hereinafter defined) of such rights, options or Convertible Securities shall 8 be less than the then existing Exercise Price, the Company shall be deemed to have issued at the time of the issuance of such rights or options or Convertible Securities the maximum number of Additional Shares of Common Stock issuable upon exercise or conversion thereof and to have received as consideration for the issuance of such shares an amount equal to the total amount of the consideration, if any, received by the Company for the issuance of such rights or options or Convertible Securities, plus, in the case of such options or rights, the minimum amounts of consideration, if any, payable to the Company upon exercise or conversion of such options or rights. For purposes of the foregoing, "Effective Price" shall mean the quotient determined by dividing the total of all such consideration by such maximum number of Additional Shares of Common Stock. No further adjustment of the Exercise Price adjusted upon the issuance of such rights, options or Convertible Securities shall be made as a result of the actual issuance of Additional Shares of Common Stock on the exercise of any such rights or options or the conversion of any such Convertible Securities. If all such rights or options or the conversion privilege represented by any such Convertible Securities shall expire without having been exercised, the Exercise Price adjusted upon the issuance of such rights, options or Convertible Securities shall be readjusted to the Exercise Price that would be in effect had no adjustment been made with respect to such rights or options or rights of conversion of such Convertible Securities. (4) Rights or Options for Convertible Securities. For the purpose of the adjustment provided for in Subsection 8(f)(1) hereof, if at any time or from time to time after the date hereof, the Company shall issue any rights or options for the purchase of Convertible Securities, then, in each such case, if the Effective Price thereof is less than the current Exercise Price, the Company shall be deemed to have issued at the time of the issuance of such rights or options the maximum number of Additional Shares of Common Stock issuable upon conversion of the total amount of Convertible Securities covered by such rights or options and to have received as consideration for the issuance of such Additional Shares of Common Stock an amount equal to the amount of consideration, if any, received by the Company for the issuance of such rights or options, plus the minimum amounts of consideration, if any, payable to the Company upon the conversion of such Convertible Securities. For purposes of the foregoing, "Effective Price" shall mean the quotient determined by dividing the total amount of such consideration by such maximum number of Additional Shares of Common Stock. No further adjustment of such Exercise Price adjusted upon the issuance of such rights or options shall be made as a result of the actual issuance of the Convertible Securities upon the exercise of such rights or options or upon the actual issuance of Additional Shares of Common Stock upon the conversion of such Convertible Securities. The provisions of Subsection 8(f)(3) above for the readjustment of such Exercise Price upon the expiration of rights or options or the rights of conversion of Convertible Securities shall apply mutatis mutandis to the rights, options and Convertible Securities referred to in this Subsection 8(f)(4). (5) Certain Exceptions. Notwithstanding the provisions of Subsection 8(f)(1) above, no adjustment shall be made to the Exercise Price with respect to the issuance or sale of Additional Shares of Common Stock for a consideration per share 9 equal to or greater than the then current Exercise Price nor shall any adjustment be made related to the issuance of 12,500 shares of Common Stock as a fee for arranging the transactions in which this Warrant was issued. For the purposes of this Section 8(f), the issuance of not more than 500,000 shares of Common Stock to employees or consultants or the Company pursuant to stock option or stock purchase plans approved by the Board (including the reissuance of shares purchased by the Company from employee or consultants of the Company) shall not be considered the issuance or sale of Additional Shares of Common Stock; provided, that any such employee or consultant options may not be exercised by the recipient thereof for a period of at least one year from the date of issuance. (6) Definition. The term "Additional Shares of Common Stock" as used herein shall mean all shares of Common Stock issued or deemed issued by the Company after the date hereof, whether or not subsequently reacquired or retired by the Company. Notwithstanding anything to the contrary contained herein, Common Stock issuable upon conversion of any Preferred Stock of the Company outstanding on the date hereof or the convertible notes issued by the Company to any party concurrently with this Warrant and other warrant certificates pursuant to the terms of the Purchase Agreement shall not be deemed to be Additional Shares of Common Stock or Convertible Securities for purposes of causing an adjustment to the Exercise Price. (g) Certificate of Adjustment. In each case of an adjustment or readjustment of the Exercise Price, the Company, at its expense, shall prepare a certificate showing such adjustment or readjustment signed by the duly elected Treasurer or Chief Financial Officer of the Company (the "Adjustment Certificate) and shall mail the Adjustment Certificate, by first class mail, postage prepaid, to the Holder at the Holder's address as shown in the Company's books. The Adjustment Certificate shall set forth such adjustment or readjustment, showing in detail the facts upon which such adjustment or readjustment is based including a statement of the Exercise Price and the number of shares of Common Stock or other securities issuable upon exercise of this Warrant immediately before and after giving effect to the applicable adjustment or readjustment. If the holders of a majority of the shares of Common Stock represented by all outstanding Warrants being issued concurrently herewith do not in good faith believe that such adjustment or readjustment was calculated in accordance with the terms of this Warrant, such holders shall have the right to challenge such adjustment or readjustment, or method of calculating the same, by delivering written notice to the Company at 611 Broadway, Suite 515, New York, New York 10012, Attention: Richard L. Bulman, within thirty (30) days after the Holder's receipt of the Adjustment Certificate. In the event such holders deliver such written notice to the Company, the Company, at its expense, shall cause independent certified public accountants of recognized standing selected by the Company (who may be the independent certified public accountants then auditing the books of the Company) to recompute such adjustment or readjustment in accordance herewith and prepare a certificate signed by such accountants (the "Accountant's Adjustment Certificate") showing such adjustment or readjustment. The Company shall then mail the Accountant's Adjustment Certificate, by first class mail, postage prepaid, to the Holder at the Holder's address as shown in the 10 Company's books. In the event of any conflict between the Adjustment Certificate and the Accountant's Adjustment Certificate, the Accountant's Adjustment Certificate shall control. 9. Survival. The various rights and obligations of the Holder hereof and of this Company as set forth in Sections 5, 6, and 7 hereof, as may be applicable, shall survive the exercise of this Warrant or the surrender of this Warrant, and upon the surrender of this Warrant and the exercise of all the rights represented hereby, each party shall, if requested, deliver to the other hereof its written acknowledgement of its continuing obligations under said Sections. 10. Mutilated or Missing Warrants. In case this Warrant Certificate shall be mutilated, lost, stolen or destroyed, the Company will, upon request, issue and deliver in exchange and substitution for and upon cancellation of the mutilated Warrant Certificate, or in lieu of and substitution of the Warrant Certificate lost, stolen or destroyed, a new Warrant Certificate of like tenor and representing an equivalent right or interest, but only upon receipt of evidence satisfactory to the Company of such loss, theft, or destruction of such Warrant Certificate and, in the case of a lost, stolen or destroyed Warrant Certificate, indemnity, if requested, also satisfactory to the Company. Applicants for such substitute Warrant Certificate shall also comply with such other reasonable regulations and pay such reasonable charges as the Company may prescribe. 11. Notices. All notices, requests, consents and other communications hereunder shall be in writing and shall be deemed to have been made when delivered or mailed first class registered or certified mail, postage prepaid, return receipt requested, as follows: if the Holders, at the address of the Holder as shown on the Company's registry books, and, if to the Company, at 611 Broadway, Suite 515, New York, New York, 10012, Attention: Richard L. Bulman. 12. Governing Law. This Warrant shall be governed by and construed in accordance with the laws of the State of New York, without reference to principles of conflicts of law. 13. Binding Effect. This Warrant shall be binding upon and inure to the benefit of the Company and the Holder. Nothing in this Warrant is intended or shall be construed to confer upon any other person any right, remedy or claim, in equity or at law, or to impose upon any other person any duty, liability or obligation. IN WITNESS WHEREOF, the Company has caused this Warrant to be duly executed as of the date first above written. KIDEO PRODUCTIONS, INC. By: ----------------------------- Richard L. Bulman, President 11 PURCHASE FORM ------------, ----- KIDEO PRODUCTIONS, INC. 611 Broadway Suite 515 New York, NY 10012 The undersigned hereby irrevocably elects to exercise the attached Warrant Certificate to the extent of __________ shares of common stock of Kideo Productions, Inc., $.0001 par value per share, and hereby makes payment of $__________ in payment of the purchase price thereof. Alternatively, the undersigned hereby elects a "cashless" exercise to the extent of __________ shares represented by the attached Warrant Certificate. INSTRUCTIONS FOR REGISTRATION OF SECURITIES Name: ____________________________________________________________________ (Please typewrite or print in block letters) DELIVER SECURITIES TO: Address: __________________________ __________________________ __________________________ Holder: __________________________________________________ [Signature of Holder of Warrant Certificate, if an individual] Holder: __________________________________________________ By: ______________________________________________ Its: _______________________________________ [Signature of Holder of Warrant Certificate, if a corporation, partnership or other entity] EX-4.8 3 WARRANT CERTIFICATE EXHIBIT 4.8 THIS WARRANT CERTIFICATE, AND THE SHARES TO BE ISSUED UPON ITS EXERCISE, HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), AND MAY NOT BE OFFERED FOR SALE, SOLD OR TRANSFERRED UNLESS REGISTERED UNDER THE ACT, OR UNLESS AN EXEMPTION FROM SUCH REGISTRATION IS AVAILABLE. WARRANT CERTIFICATE Dated: February 2, 1998 Warrant to Purchase up to 18,000 shares of Common Stock, par value $.0001 per share, of KIDEO PRODUCTIONS, INC. VOID AFTER MIDNIGHT, NEW YORK, NEW YORK LOCAL TIME ON FEBRUARY 2, 2003 KIDEO PRODUCTIONS, INC., a Delaware corporation (the "Company"), hereby certifies that MICHAEL B. SOLOVAY, his successors and assigns (the "Holder"), is entitled to purchase from the Company at any time after January 31, 1999 and before Midnight, New York, New York local time on February 2, 2003, up to 18,000 shares of common stock, par value $.0001 per share, of the Company (the "Common Stock"), at the price of $1.00 per share (the "Exercise Price", subject to adjustment as provided herein). 1. Exercise of Warrants. In order to exercise the rights to purchase Common Stock evidenced by this Warrant Certificate, the Holder must, subject to Section 7 below, present and surrender this Warrant Certificate with the attached Purchase Form duly executed at the principal office of the Company. This Warrant Certificate may be exercised with respect to all of the Common Stock subject hereto or any portion thereof. 2. Exchange and Transfer. This Warrant Certificate at any time prior to the exercise hereof, upon presentation and surrender to the Company, may be exchanged, alone or with other Warrant Certificates, if any, of like tenor registered in the name of the same Holder, for another Warrant Certificate of like tenor in the name of such Holder exercisable for the same aggregate number of shares of Common Stock as the Warrant Certificate(s) surrendered. 3. Rights and Obligations of the Holder of the Warrant Certificate. The Holder shall not, by virtue hereof, be entitled to any rights of a stockholder in the Company, either at law or in equity; provided, however, upon exercise of this Warrant, such Holder shall, for all purposes, be deemed to have become the holder of record of such Common Stock on the date on which this Warrant, together with a duly executed Purchase Form, was surrendered and payment of the Exercise Price was made, irrespective of the date of delivery of the share certificate. The rights of the Holder of this Warrant are limited to those expressed herein and the Holder, by acceptance hereof, consents to and agrees to be bound by and comply with all the provisions of this Warrant. In addition, the Holder agrees that the Company may deem and treat the person in whose name this Warrant is registered as the absolute, true and lawful owner for all purposes whatsoever, unless and until such time as the Company has received written notice to the contrary. 4. Common Stock. (a) The Company covenants and agrees that this Warrant is duly and validly authorized and issued, and free from all stamp-taxes, liens, and charges with respect to the delivery or purchase thereof. In addition, the Company agrees at all times to reserve and keep available an authorized number of shares of Common Stock sufficient to permit the exercise in full of this Warrant. (b) The Company covenants and agrees that all shares of Common Stock delivered upon exercise of this Warrant, will, upon delivery, be duly and validly authorized and issued, fully-paid and non-assessable, and free from all stamp-taxes, liens, and charges with respect to the purchase thereof. 5. Disposition of the Warrant and Common Stock. The Holder hereby agrees and represents that (a) this Warrant and the Common Stock issuable upon exercise are being acquired for the Holder's account, and not with a view to or in connection with any offering or distribution; and (b) no public distribution of this Warrant of the Common Stock will be made in violation of the provisions of the Securities Act of 1933, as amended (the "Act"), or in violation of the provisions of applicable state laws. The Company shall use its best efforts to cause its counsel, at the Company's expense, to render any opinion required in connection with any transfer of this Warrant or the shares of Common Stock underlying this Warrant. The Holder is responsible for any transfer taxes due as a result of any transfer of this Warrant. 6. Registration Rights. The Holder shall have those registration rights with respect to the Common Stock issued or issuable upon exercise of this Warrant set forth in 2 the Note and Warrant Purchase Agreement, dated January 30, 1998, between the Company and Benjamin and Michael Bollag (the "Purchase Agreement"). 7. Exercise of This Warrant. Subject to Section 1 of this Warrant, at any time on or prior to Midnight, New York, New York local time, on February 2, 2003, the Holder shall have the right to acquire up to 18,000 shares of Common Stock on the following terms and conditions: (a) Exercise Price: Fractional Shares. The Exercise Price shall be a price per share of Common Stock equal to One Dollar ($1.00), subject to reduction as set forth in Section 4.1 of the Purchase Agreement and subject to adjustment as set forth below and in the Purchase Agreement. All calculations of shares of Common Stock to be issued in connection with any exercise hereunder shall be rounded to the nearest one-hundredth of a whole share. (b) Exercise Procedure. (1) Payment for Shares. (x) On a date determined by the Company, but which shall in no event be later than five (5) days after the Company's receipt of the surrendered Warrant and Purchase Form, the Holder shall deliver to the Company, at the Company's principal executive office, a certified or bank cashier's check payable to the Company in the amount of the Exercise Price then in effect times the number of shares of Common Stock being purchased (the "Aggregate Stock Purchase Price"). (y) In lieu of paying the Aggregate Stock Purchase Price upon exercise of this Warrant, for so long as the Common Stock is publicly traded, the Holder may elect a "cashless exercise" in which event the Holder will receive upon exercise of this Warrant a reduced number of shares of Common Stock equal to (i) the number of shares of Common Stock that would be issuable pursuant to this Warrant upon payment of the Aggregate Stock Purchase Price minus (ii) the number of shares of Common Stock that have an aggregate fair market value equal to the Aggregate Stock Purchase Price. For purposes of the preceding sentence, the fair market value of a share of Common Stock shall mean the average of the last reported sale prices of the Common Stock on the ten trading days preceding the date of exercise. (2) Effective Date of Exercise. Each exercise will be deemed to have been effected as of the close of business on the later of (i) the date that the Purchase Form is received by the Company, or (ii) the date on which this original Warrant is returned to the Company for cancellation, and, if applicable, reissuance at the principal office of the Company at 611 Broadway, Suite 515, New York, New York 10012. At such time as such exercise has been effected, the person (or entity) or persons (or entities) in whose name or names any certificate(s) for shares of Common Stock are to be issued upon such exercise will be deemed to have become the holder or holders of record of the shares of Common Stock represented thereby. 3 (c) Delivery of Certificates. As soon as practicable after an exercise has been effected (but in any event within three (3) business days), the Company will deliver to the Holder: (1) a certificate or certificates representing the number of shares of Common Stock issuable by reason of such exercise in such name(s) and such denomination(s) as the Holder has specified; (2) a new Warrant Certificate entitling the Holder to purchase the number of shares of Common Stock as to which the original Warrant Certificate was not exercised and reflecting any changes to the Exercise Price which have theretofore been effectuated and which Warrant Certificate shall otherwise be in form and substance identical to that delivered by the Holder to the Company for said exercise. (d) Closure of Issuer Books. The Company will not close its books against the transfer of Warrants or of Common Stock issued or issuable upon exercise of Warrants in any manner which interferes with the timely exercise of Warrants. (e) Payment of Taxes. The Company will pay all taxes and other governmental charges (other than taxes measured by the revenue or income of the Holder) that may be imposed in respect of the issue or delivery of shares of Common Stock upon exercise of this Warrant; provided, however, that the Holder shall pay any such tax which is due because shares of Common Stock are issued in a name other than such Holder's. (f) Notices of Record Date. In the event of (i) any taking by the Company of a record of the holders of any class or series of securities for the purpose of determining the holders thereof who are entitled to receive any dividend or other distribution or (ii) any reclassification or recapitalization of the capital stock of the Company, any merger or consolidation of the Company, or any transfer of all or substantially all the assets of the Company to any other corporation, entity or person, or any voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Company, the Company shall mail to the Holder at least twenty (20) days prior to the record date specified therein (the "Notice Period"), a notice specifying (A) the date on which any such record is to be taken for the purpose of such dividend or distribution and a description of such dividend or distribution, (B) the date on which any such reorganization, reclassification, transfer, consolidation, merger, dissolution, liquidation or winding up is expected to become effective, and (C) the time, if any is to be fixed, as to when the holders of record of Common Stock (or other securities) shall be entitled to exchange their shares of Common Stock (or other securities) for securities or other property deliverable upon such reorganization, reclassification, transfer, consolidation, merger, dissolution, liquidation or winding up. During the Notice Period, the Holder shall have the exercise rights provided elsewhere in this Warrant. 4 8. Adjustment of Exercise Price and Number of Shares. The Exercise Price and the number of shares purchasable upon the exercise of this Warrant shall be subject to adjustment from time to time as set forth below; however, no adjustment in the Exercise Price need be made unless the adjustment would require an increase or decrease of at least 1% in the Exercise Price. Any adjustments that are not made shall be carried forward and taken into account in any subsequent adjustment. Upon each adjustment of the Exercise Price, the holder of this Warrant shall thereafter be entitled to purchase, at the Exercise Price resulting from such adjustment, the number of shares obtained by multiplying the Exercise Price in effect immediately prior to such adjustment by the number of shares purchasable pursuant hereto immediately prior to such adjustment, and dividing the product thereof by the Exercise Price resulting from such adjustment. (a) Adjustment for Common Stock Splits and Combinations. If the Company shall at any time or from time to time after the date hereof effect a subdivision of the outstanding Common Stock, the Exercise Price then in effect immediately before that subdivision shall be proportionately decreased; conversely, if the Company shall at any time or from time to time after the date hereof reduce the outstanding shares of Common Stock by combination or otherwise, the Exercise Price then in effect immediately before the combination shall be proportionately increased. Any adjustment under this Section 8(a) shall become effective at the close of business on the date the subdivision or combination becomes effective. (b) Adjustment for Certain Dividends and Distributions of Common Stock. In the event the Company at any time or from time to time after the date hereof shall make or issue, or fix a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in additional shares of Common Stock, then and in each such event the Exercise Price then in effect shall be decreased as of the time of such issuance or, in the event such a record date shall have been fixed, as of the close of business on such record date, by multiplying the Exercise Price then in effect by a fraction: (1) the numerator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date, and (2) the denominator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date, plus the number of shares of Common Stock issuable in payment of such dividend or distribution; provided, however, if such record date shall have been fixed and such dividend is not fully paid or if such distribution is not fully made on the date fixed therefor, the Exercise Price shall be recomputed accordingly as of the close of business on such record date and thereafter the Exercise Price shall be adjusted pursuant to this Section 8(b) as of the time of actual payment of such dividends or distributions. 5 (c) Adjustment for Other Dividends and Distributions. In the event the Company at any time or from time to time after the date hereof shall make or issue, or fix a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in securities of the Company other than shares of Common Stock, then and in each such event provision shall be made so that Holder shall receive upon exercise of this Warrant in addition to the number of shares of Common Stock receivable thereupon, the amount of securities of the Company that it would have received had this Warrant been exercised on the date of such event and had thereafter, during the period from the date of such event to and including the exercise date, retained such securities receivable by it as aforesaid during such period giving application to all adjustments called for during such period under this Warrant with respect to the rights of the Holder. (d) Adjustment for Reclassification, Exchange or Substitution. If the Common Stock issuable upon the exercise of this Warrant shall be changed into the same or a different number of shares of any class or classes of stock, whether by reclassification, exchange, substitution or other change (other than a reorganization, merger, consolidation or sale of assets provided for in Section 8(e) below), then and in each such event, the Holder shall have the right thereafter to exercise this Warrant into the kind and amounts of shares of stock and other securities and property receivable upon such reclassification, exchange, substitution or other change, by holders of the number of shares of Common Stock into which this Warrant might have been exercised immediately prior to such reclassification, exchange, substitution, or other change, all subject to further adjustment as provided herein. (e) Reorganization, Mergers, Consolidations or Sales of Assets. If at any time or from time to time there shall be a reorganization of the Common Stock (other than a reclassification, exchange or substitution of shares provided for in Section 8(d) above) or a merger or consolidation of the Company with or into another corporation, or the sale of all or substantially all the Company's properties and assets to any other person, then, as a part of such reorganization, merger, consolidation or sale, provision shall be made so that the Holder shall thereafter be entitled to receive upon exercise of this Warrant, the number of shares of stock or other securities or property of the Company or of the successor corporation resulting from such reorganization, merger, consolidation or sale, to which a holder of that number of shares of Common Stock deliverable upon exercise of this Warrant would have been entitled on such reorganization, merger, consolidation or sale. In any such case, appropriate adjustment shall be made in the application of the provisions of this Warrant with respect to the rights of the Holder after the reorganization, merger, consolidation or sale to the end that the provisions of this Warrant (including adjustment of the number of shares issuable upon exercise of this Warrant) shall be applicable after that event as nearly equivalent as may be practicable. (f) Sales of Shares Below Exercise Price. 6 (1) Adjustment of Exercise Price. Subject to Subsection 8(f)(5) below, if at any time or from time to time after the date hereof, the Company shall issue or sell Additional Shares of Common Stock (as hereinafter defined), other than as a dividend as provided in Section 8(b) above, and other than upon a subdivision or combination of shares of Common Stock as provided in Section 8(a) above, for a consideration per share less than the then effective Exercise Price, then and in each case the Exercise Price shall be reduced, as of the opening of business on the date of such issuance or sale, to a price equal to the price at which such Additional Shares of Common Stock are sold. In no event shall any adjustment under this Subsection 8(f)(1) result in an increase in the Exercise Price. (2) Determination of Consideration. For the purpose of making any adjustment in the Exercise Price or number of shares of Common Stock purchasable on exercise of this Warrant as provided above, the consideration received by the Company for any issue or sale of securities shall, i. to the extent it consists of cash, be computed at the gross amount of cash received by the Company in connection with such issue or sale, ii. to the extent it consists of services or property other than cash, be computed at the fair value of such services or property as determined in good faith by the Company's Board of Directors (the "Board"), and iii. if Additional Shares of Common Stock, Convertible Securities (as hereinafter defined), or rights or options to purchase either Additional Shares of Common Stock or Convertible Securities are issued or sold together with other stock or securities or other assets of the Company for a consideration that covers both, be computed as the portion of the consideration so received that may be reasonably determined in good faith by the Board to be allocable to such Additional Shares of Common Stock, Convertible Securities or rights or options. (3) Convertible Securities. For the purpose of the adjustment provided in Subsection 8(f)(1) hereof, if at any time or from time to time after the date hereof the Company shall issue any rights or options for the purchase of, or stock or other securities convertible into, Additional Shares of Common Stock (such convertible stock or securities being hereinafter referred to as "Convertible Securities"), then, in each case, if the Effective Price (as hereinafter defined) of such rights, options or Convertible Securities shall be less than the then existing Exercise Price, the Company shall be deemed to have issued at the time of the issuance of such rights or options or Convertible Securities the maximum number of Additional Shares of Common Stock issuable upon exercise or conversion thereof and to have received as consideration for the issuance of such shares an amount equal to the total amount of the consideration, if any, received by the Company for the issuance of such rights or options or Convertible Securities, plus, in the case of such options or rights, the minimum amounts of consideration, if any, payable to the Company upon 7 exercise or conversion of such options or rights. For purposes of the foregoing, "Effective Price" shall mean the quotient determined by dividing the total of all such consideration by such maximum number of Additional Shares of Common Stock. No further adjustment of the Exercise Price adjusted upon the issuance of such rights, options or Convertible Securities shall be made as a result of the actual issuance of Additional Shares of Common Stock on the exercise of any such rights or options or the conversion of any such Convertible Securities. If all such rights or options or the conversion privilege represented by any such Convertible Securities shall expire without having been exercised, the Exercise Price adjusted upon the issuance of such rights, options or Convertible Securities shall be readjusted to the Exercise Price that would be in effect had no adjustment been made with respect to such rights or options or rights of conversion of such Convertible Securities. (4) Rights or Options for Convertible Securities. For the purpose of the adjustment provided for in Subsection 8(f)(1) hereof, if at any time or from time to time after the date hereof, the Company shall issue any rights or options for the purchase of Convertible Securities, then, in each such case, if the Effective Price thereof is less than the current Exercise Price, the Company shall be deemed to have issued at the time of the issuance of such rights or options the maximum number of Additional Shares of Common Stock issuable upon conversion of the total amount of Convertible Securities covered by such rights or options and to have received as consideration for the issuance of such Additional Shares of Common Stock an amount equal to the amount of consideration, if any, received by the Company for the issuance of such rights or options, plus the minimum amounts of consideration, if any, payable to the Company upon the conversion of such Convertible Securities. For purposes of the foregoing, "Effective Price" shall mean the quotient determined by dividing the total amount of such consideration by such maximum number of Additional Shares of Common Stock. No further adjustment of such Exercise Price adjusted upon the issuance of such rights or options shall be made as a result of the actual issuance of the Convertible Securities upon the exercise of such rights or options or upon the actual issuance of Additional Shares of Common Stock upon the conversion of such Convertible Securities. The provisions of Subsection 8(f)(3) above for the readjustment of such Exercise Price upon the expiration of rights or options or the rights of conversion of Convertible Securities shall apply mutatis mutandis to the rights, options and Convertible Securities referred to in this Subsection 8(f)(4). (5) Certain Exceptions. Notwithstanding the provisions of Subsection 8(f)(1) above, no adjustment shall be made to the Exercise Price with respect to the issuance or sale of Additional Shares of Common Stock for a consideration per share equal to or greater than the then current Exercise Price nor shall any adjustment be made related to the issuance of 12,500 shares of Common Stock as a fee for arranging the transactions in which this Warrant was issued. For the purposes of this Section 8(f), the issuance of not more than 500,000 shares of Common Stock to employees or consultants or the Company pursuant to stock option or stock purchase plans approved by the Board (including the reissuance of shares purchased by the Company from employee or consultants of the Company) shall not be considered the issuance or sale of Additional Shares of 8 Common Stock; provided, that any such employee or consultant options may not be exercised by the recipient thereof for a period of at least one year from the date of issuance. (6) Definition. The term "Additional Shares of Common Stock" as used herein shall mean all shares of Common Stock issued or deemed issued by the Company after the date hereof, whether or not subsequently reacquired or retired by the Company. Notwithstanding anything to the contrary contained herein, Common Stock issuable upon conversion of any Preferred Stock of the Company outstanding on the date hereof or the convertible notes issued by the Company to any party concurrently with this Warrant and other warrant certificates pursuant to the terms of the Purchase Agreement shall not be deemed to be Additional Shares of Common Stock or Convertible Securities for purposes of causing an adjustment to the Exercise Price. (g) Certificate of Adjustment. In each case of an adjustment or readjustment of the Exercise Price, the Company, at its expense, shall prepare a certificate showing such adjustment or readjustment signed by the duly elected Treasurer or Chief Financial Officer of the Company (the "Adjustment Certificate) and shall mail the Adjustment Certificate, by first class mail, postage prepaid, to the Holder at the Holder's address as shown in the Company's books. The Adjustment Certificate shall set forth such adjustment or readjustment, showing in detail the facts upon which such adjustment or readjustment is based including a statement of the Exercise Price and the number of shares of Common Stock or other securities issuable upon exercise of this Warrant immediately before and after giving effect to the applicable adjustment or readjustment. If the holders of a majority of the shares of Common Stock represented by all outstanding Warrants being issued concurrently herewith do not in good faith believe that such adjustment or readjustment was calculated in accordance with the terms of this Warrant, such holders shall have the right to challenge such adjustment or readjustment, or method of calculating the same, by delivering written notice to the Company at 611 Broadway, Suite 515, New York, New York 10012, Attention: Richard L. Bulman, within thirty (30) days after the Holder's receipt of the Adjustment Certificate. In the event such holders deliver such written notice to the Company, the Company, at its expense, shall cause independent certified public accountants of recognized standing selected by the Company (who may be the independent certified public accountants then auditing the books of the Company) to recompute such adjustment or readjustment in accordance herewith and prepare a certificate signed by such accountants (the "Accountant's Adjustment Certificate") showing such adjustment or readjustment. The Company shall then mail the Accountant's Adjustment Certificate, by first class mail, postage prepaid, to the Holder at the Holder's address as shown in the Company's books. In the event of any conflict between the Adjustment Certificate and the Accountant's Adjustment Certificate, the Accountant's Adjustment Certificate shall control. 9. Survival. The various rights and obligations of the Holder hereof and of this Company as set forth in Sections 5, 6, and 7 hereof, as may be applicable, shall survive the exercise of this Warrant or the surrender of this Warrant, and upon the surrender of this Warrant and the exercise of all the rights represented hereby, each party shall, if requested, 9 deliver to the other hereof its written acknowledgement of its continuing obligations under said Sections. 10. Mutilated or Missing Warrants. In case this Warrant Certificate shall be mutilated, lost, stolen or destroyed, the Company will, upon request, issue and deliver in exchange and substitution for and upon cancellation of the mutilated Warrant Certificate, or in lieu of and substitution of the Warrant Certificate lost, stolen or destroyed, a new Warrant Certificate of like tenor and representing an equivalent right or interest, but only upon receipt of evidence satisfactory to the Company of such loss, theft, or destruction of such Warrant Certificate and, in the case of a lost, stolen or destroyed Warrant Certificate, indemnity, if requested, also satisfactory to the Company. Applicants for such substitute Warrant Certificate shall also comply with such other reasonable regulations and pay such reasonable charges as the Company may prescribe. 11. Notices. All notices, requests, consents and other communications hereunder shall be in writing and shall be deemed to have been made when delivered or mailed first class registered or certified mail, postage prepaid, return receipt requested, as follows: if the Holders, at the address of the Holder as shown on the Company's registry books, and, if to the Company, at 611 Broadway, Suite 515, New York, New York, 10012, Attention: Richard L. Bulman. 12. Governing Law. This Warrant shall be governed by and construed in accordance with the laws of the State of New York, without reference to principles of conflicts of law. 13. Binding Effect. This Warrant shall be binding upon and inure to the benefit of the Company and the Holder. Nothing in this Warrant is intended or shall be construed to confer upon any other person any right, remedy or claim, in equity or at law, or to impose upon any other person any duty, liability or obligation. IN WITNESS WHEREOF, the Company has caused this Warrant to be duly executed as of the date first above written. KIDEO PRODUCTIONS, INC. By: ----------------------------------- Richard L. Bulman, President 10 PURCHASE FORM ------------, ----- KIDEO PRODUCTIONS, INC. 611 Broadway Suite 515 New York, NY 10012 The undersigned hereby irrevocably elects to exercise the attached Warrant Certificate to the extent of __________ shares of common stock of Kideo Productions, Inc., $.0001 par value per share, and hereby makes payment of $__________ in payment of the purchase price thereof. Alternatively, the undersigned hereby elects a "cashless" exercise to the extent of __________ shares represented by the attached Warrant Certificate. INSTRUCTIONS FOR REGISTRATION OF SECURITIES Name: ____________________________________________________________________ (Please typewrite or print in block letters) DELIVER SECURITIES TO: Address: __________________________ __________________________ __________________________ Holder: __________________________________________________ [Signature of Holder of Warrant Certificate, if an individual] Holder: __________________________________________________ By: ______________________________________________ Its: _______________________________________ [Signature of Holder of Warrant Certificate, if a corporation, partnership or other entity] EX-4.9 4 WARRANT CERTIFICATE EXHIBIT 4.9 THIS WARRANT CERTIFICATE, AND THE SHARES TO BE ISSUED UPON ITS EXERCISE, HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), AND MAY NOT BE OFFERED FOR SALE, SOLD OR TRANSFERRED UNLESS REGISTERED UNDER THE ACT, OR UNLESS AN EXEMPTION FROM SUCH REGISTRATION IS AVAILABLE. WARRANT CERTIFICATE Dated: March 9, 1998 Warrant to Purchase up to 20,000 shares of Common Stock, par value $.0001 per share, of KIDEO PRODUCTIONS, INC. VOID AFTER MIDNIGHT, NEW YORK, NEW YORK LOCAL TIME ON MARCH 8, 2003 KIDEO PRODUCTIONS, INC., a Delaware corporation (the "Company"), hereby certifies that CHARLES C. JOHNSTON, his successors and assigns (the "Holder"), is entitled to purchase from the Company at any time after January 31, 1999 and before Midnight, New York, New York local time on March 8, 2003, up to 20,000 shares of common stock, par value $.0001 per share, of the Company (the "Common Stock"), at the price of $1.00 per share (the "Exercise Price", subject to adjustment as provided herein). 1. Exercise of Warrants. In order to exercise the rights to purchase Common Stock evidenced by this Warrant Certificate, the Holder must, subject to Section 7 below, present and surrender this Warrant Certificate with the attached Purchase Form duly executed at the principal office of the Company. This Warrant Certificate may be exercised with respect to all of the Common Stock subject hereto or any portion thereof. 2. Exchange and Transfer. This Warrant Certificate at any time prior to the exercise hereof, upon presentation and surrender to the Company, may be exchanged, alone or with other Warrant Certificates, if any, of like tenor registered in the name of the same Holder, for another Warrant Certificate of like tenor in the name of such Holder exercisable for the same aggregate number of shares of Common Stock as the Warrant Certificate(s) surrendered. 3. Rights and Obligations of the Holder of the Warrant Certificate. The Holder shall not, by virtue hereof, be entitled to any rights of a stockholder in the Company, either at law or in equity; provided, however, upon exercise of this Warrant, such Holder shall, for all purposes, be deemed to have become the holder of record of such Common Stock on the date on which this Warrant, together with a duly executed Purchase Form, was surrendered and payment of the Exercise Price was made, irrespective of the date of delivery of the share certificate. The rights of the Holder of this Warrant are limited to those expressed herein and the Holder, by acceptance hereof, consents to and agrees to be bound by and comply with all the provisions of this Warrant. In addition, the Holder agrees that the Company may deem and treat the person in whose name this Warrant is registered as the absolute, true and lawful owner for all purposes whatsoever, unless and until such time as the Company has received written notice to the contrary. 4. Common Stock. (a) The Company covenants and agrees that this Warrant is duly and validly authorized and issued, and free from all stamp-taxes, liens, and charges with respect to the delivery or purchase thereof. In addition, the Company agrees at all times to reserve and keep available an authorized number of shares of Common Stock sufficient to permit the exercise in full of this Warrant. (b) The Company covenants and agrees that all shares of Common Stock delivered upon exercise of this Warrant, will, upon delivery, be duly and validly authorized and issued, fully-paid and non-assessable, and free from all stamp-taxes, liens, and charges with respect to the purchase thereof. 5. Disposition of the Warrant and Common Stock. The Holder hereby agrees and represents that (a) this Warrant and the Common Stock issuable upon exercise are being acquired for the Holder's account, and not with a view to or in connection with any offering or distribution; and (b) no public distribution of this Warrant of the Common Stock will be made in violation of the provisions of the Securities Act of 1933, as amended (the "Act"), or in violation of the provisions of applicable state laws. The Company shall use its best efforts to cause its counsel, at the Company's expense, to render any opinion required in connection with any transfer of this Warrant or the shares of Common Stock underlying this Warrant. The Holder is responsible for any transfer taxes due as a result of any transfer of this Warrant. 6. Registration Rights. The Holder shall have those registration rights with respect to the Common Stock issued or issuable upon exercise of this Warrant set forth in the Note and Warrant Purchase Agreement, dated January 30, 1998, between the Company and Benjamin and Michael Bollag (the "Purchase Agreement"). 2 7. Exercise of This Warrant. Subject to Section 1 of this Warrant, at any time on or prior to Midnight, New York, New York local time, on March 8, 2003, the Holder shall have the right to acquire up to 20,000 shares of Common Stock on the following terms and conditions: (a) Exercise Price: Fractional Shares. The Exercise Price shall be a price per share of Common Stock equal to One Dollar ($1.00), subject to reduction as set forth in Section 4.1 of the Purchase Agreement and subject to adjustment as set forth below and in the Purchase Agreement. All calculations of shares of Common Stock to be issued in connection with any exercise hereunder shall be rounded to the nearest one-hundredth of a whole share. (b) Exercise Procedure. (1) Payment for Shares. (x) On a date determined by the Company, but which shall in no event be later than five (5) days after the Company's receipt of the surrendered Warrant and Purchase Form, the Holder shall deliver to the Company, at the Company's principal executive office, a certified or bank cashier's check payable to the Company in the amount of the Exercise Price then in effect times the number of shares of Common Stock being purchased (the "Aggregate Stock Purchase Price"). (y) In lieu of paying the Aggregate Stock Purchase Price upon exercise of this Warrant, for so long as the Common Stock is publicly traded, the Holder may elect a "cashless exercise" in which event the Holder will receive upon exercise of this Warrant a reduced number of shares of Common Stock equal to (i) the number of shares of Common Stock that would be issuable pursuant to this Warrant upon payment of the Aggregate Stock Purchase Price minus (ii) the number of shares of Common Stock that have an aggregate fair market value equal to the Aggregate Stock Purchase Price. For purposes of the preceding sentence, the fair market value of a share of Common Stock shall mean the average of the last reported sale prices of the Common Stock on the ten trading days preceding the date of exercise. (2) Effective Date of Exercise. Each exercise will be deemed to have been effected as of the close of business on the later of (i) the date that the Purchase Form is received by the Company, or (ii) the date on which this original Warrant is returned to the Company for cancellation, and, if applicable, reissuance at the principal office of the Company at 611 Broadway, Suite 515, New York, New York 10012. At such time as such exercise has been effected, the person (or entity) or persons (or entities) in whose name or names any certificate(s) for shares of Common Stock are to be issued upon such exercise will be deemed to have become the holder or holders of record of the shares of Common Stock represented thereby. 3 (c) Delivery of Certificates. As soon as practicable after an exercise has been effected (but in any event within three (3) business days), the Company will deliver to the Holder: (1) a certificate or certificates representing the number of shares of Common Stock issuable by reason of such exercise in such name(s) and such denomination(s) as the Holder has specified; (2) a new Warrant Certificate entitling the Holder to purchase the number of shares of Common Stock as to which the original Warrant Certificate was not exercised and reflecting any changes to the Exercise Price which have theretofore been effectuated and which Warrant Certificate shall otherwise be in form and substance identical to that delivered by the Holder to the Company for said exercise. (d) Closure of Issuer Books. The Company will not close its books against the transfer of Warrants or of Common Stock issued or issuable upon exercise of Warrants in any manner which interferes with the timely exercise of Warrants. (e) Payment of Taxes. The Company will pay all taxes and other governmental charges (other than taxes measured by the revenue or income of the Holder) that may be imposed in respect of the issue or delivery of shares of Common Stock upon exercise of this Warrant; provided, however, that the Holder shall pay any such tax which is due because shares of Common Stock are issued in a name other than such Holder's. (f) Notices of Record Date. In the event of (i) any taking by the Company of a record of the holders of any class or series of securities for the purpose of determining the holders thereof who are entitled to receive any dividend or other distribution or (ii) any reclassification or recapitalization of the capital stock of the Company, any merger or consolidation of the Company, or any transfer of all or substantially all the assets of the Company to any other corporation, entity or person, or any voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Company, the Company shall mail to the Holder at least twenty (20) days prior to the record date specified therein (the "Notice Period"), a notice specifying (A) the date on which any such record is to be taken for the purpose of such dividend or distribution and a description of such dividend or distribution, (B) the date on which any such reorganization, reclassification, transfer, consolidation, merger, dissolution, liquidation or winding up is expected to become effective, and (C) the time, if any is to be fixed, as to when the holders of record of Common Stock (or other securities) shall be entitled to exchange their shares of Common Stock (or other securities) for securities or other property deliverable upon such reorganization, reclassification, transfer, consolidation, merger, dissolution, liquidation or winding up. During the Notice Period, the Holder shall have the exercise rights provided elsewhere in this Warrant. 4 8. Adjustment of Exercise Price and Number of Shares. The Exercise Price and the number of shares purchasable upon the exercise of this Warrant shall be subject to adjustment from time to time as set forth below; however, no adjustment in the Exercise Price need be made unless the adjustment would require an increase or decrease of at least 1% in the Exercise Price. Any adjustments that are not made shall be carried forward and taken into account in any subsequent adjustment. Upon each adjustment of the Exercise Price, the holder of this Warrant shall thereafter be entitled to purchase, at the Exercise Price resulting from such adjustment, the number of shares obtained by multiplying the Exercise Price in effect immediately prior to such adjustment by the number of shares purchasable pursuant hereto immediately prior to such adjustment, and dividing the product thereof by the Exercise Price resulting from such adjustment. (a) Adjustment for Common Stock Splits and Combinations. If the Company shall at any time or from time to time after the date hereof effect a subdivision of the outstanding Common Stock, the Exercise Price then in effect immediately before that subdivision shall be proportionately decreased; conversely, if the Company shall at any time or from time to time after the date hereof reduce the outstanding shares of Common Stock by combination or otherwise, the Exercise Price then in effect immediately before the combination shall be proportionately increased. Any adjustment under this Section 8(a) shall become effective at the close of business on the date the subdivision or combination becomes effective. (b) Adjustment for Certain Dividends and Distributions of Common Stock. In the event the Company at any time or from time to time after the date hereof shall make or issue, or fix a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in additional shares of Common Stock, then and in each such event the Exercise Price then in effect shall be decreased as of the time of such issuance or, in the event such a record date shall have been fixed, as of the close of business on such record date, by multiplying the Exercise Price then in effect by a fraction: (1) the numerator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date, and (2) the denominator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date, plus the number of shares of Common Stock issuable in payment of such dividend or distribution; provided, however, if such record date shall have been fixed and such dividend is not fully paid or if such distribution is not fully made on the date fixed therefor, the Exercise Price shall be recomputed accordingly as of the close of business on such record date and thereafter the Exercise Price shall be adjusted pursuant to this Section 8(b) as of the time of actual payment of such dividends or distributions. 5 (c) Adjustment for Other Dividends and Distributions. In the event the Company at any time or from time to time after the date hereof shall make or issue, or fix a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in securities of the Company other than shares of Common Stock, then and in each such event provision shall be made so that Holder shall receive upon exercise of this Warrant in addition to the number of shares of Common Stock receivable thereupon, the amount of securities of the Company that it would have received had this Warrant been exercised on the date of such event and had thereafter, during the period from the date of such event to and including the exercise date, retained such securities receivable by it as aforesaid during such period giving application to all adjustments called for during such period under this Warrant with respect to the rights of the Holder. (d) Adjustment for Reclassification, Exchange or Substitution. If the Common Stock issuable upon the exercise of this Warrant shall be changed into the same or a different number of shares of any class or classes of stock, whether by reclassification, exchange, substitution or other change (other than a reorganization, merger, consolidation or sale of assets provided for in Section 8(e) below), then and in each such event, the Holder shall have the right thereafter to exercise this Warrant into the kind and amounts of shares of stock and other securities and property receivable upon such reclassification, exchange, substitution or other change, by holders of the number of shares of Common Stock into which this Warrant might have been exercised immediately prior to such reclassification, exchange, substitution, or other change, all subject to further adjustment as provided herein. (e) Reorganization, Mergers, Consolidations or Sales of Assets. If at any time or from time to time there shall be a reorganization of the Common Stock (other than a reclassification, exchange or substitution of shares provided for in Section 8(d) above) or a merger or consolidation of the Company with or into another corporation, or the sale of all or substantially all the Company's properties and assets to any other person, then, as a part of such reorganization, merger, consolidation or sale, provision shall be made so that the Holder shall thereafter be entitled to receive upon exercise of this Warrant, the number of shares of stock or other securities or property of the Company or of the successor corporation resulting from such reorganization, merger, consolidation or sale, to which a holder of that number of shares of Common Stock deliverable upon exercise of this Warrant would have been entitled on such reorganization, merger, consolidation or sale. In any such case, appropriate adjustment shall be made in the application of the provisions of this Warrant with respect to the rights of the Holder after the reorganization, merger, consolidation or sale to the end that the provisions of this Warrant (including adjustment of the number of shares issuable upon exercise of this Warrant) shall be applicable after that event as nearly equivalent as may be practicable. (f) Sales of Shares Below Exercise Price. 6 (1) Adjustment of Exercise Price. Subject to Subsection 8(f)(5) below, if at any time or from time to time after the date hereof, the Company shall issue or sell Additional Shares of Common Stock (as hereinafter defined), other than as a dividend as provided in Section 8(b) above, and other than upon a subdivision or combination of shares of Common Stock as provided in Section 8(a) above, for a consideration per share less than the then effective Exercise Price, then and in each case the Exercise Price shall be reduced, as of the opening of business on the date of such issuance or sale, to a price equal to the price at which such Additional Shares of Common Stock are sold. In no event shall any adjustment under this Subsection 8(f)(1) result in an increase in the Exercise Price. (2) Determination of Consideration. For the purpose of making any adjustment in the Exercise Price or number of shares of Common Stock purchasable on exercise of this Warrant as provided above, the consideration received by the Company for any issue or sale of securities shall, i. to the extent it consists of cash, be computed at the gross amount of cash received by the Company in connection with such issue or sale, ii. to the extent it consists of services or property other than cash, be computed at the fair value of such services or property as determined in good faith by the Company's Board of Directors (the "Board"), and iii. if Additional Shares of Common Stock, Convertible Securities (as hereinafter defined), or rights or options to purchase either Additional Shares of Common Stock or Convertible Securities are issued or sold together with other stock or securities or other assets of the Company for a consideration that covers both, be computed as the portion of the consideration so received that may be reasonably determined in good faith by the Board to be allocable to such Additional Shares of Common Stock, Convertible Securities or rights or options. (3) Convertible Securities. For the purpose of the adjustment provided in Subsection 8(f)(1) hereof, if at any time or from time to time after the date hereof the Company shall issue any rights or options for the purchase of, or stock or other securities convertible into, Additional Shares of Common Stock (such convertible stock or securities being hereinafter referred to as "Convertible Securities"), then, in each case, if the Effective Price (as hereinafter defined) of such rights, options or Convertible Securities shall be less than the then existing Exercise Price, the Company shall be deemed to have issued at the time of the issuance of such rights or options or Convertible Securities the maximum number of Additional Shares of Common Stock issuable upon exercise or conversion thereof and to have received as consideration for the issuance of such shares an amount equal to the total amount of the consideration, if any, received by the Company for the issuance of such rights or options or Convertible Securities, plus, in the case of such options or rights, the minimum amounts of consideration, if any, payable to the Company upon 7 exercise or conversion of such options or rights. For purposes of the foregoing, "Effective Price" shall mean the quotient determined by dividing the total of all such consideration by such maximum number of Additional Shares of Common Stock. No further adjustment of the Exercise Price adjusted upon the issuance of such rights, options or Convertible Securities shall be made as a result of the actual issuance of Additional Shares of Common Stock on the exercise of any such rights or options or the conversion of any such Convertible Securities. If all such rights or options or the conversion privilege represented by any such Convertible Securities shall expire without having been exercised, the Exercise Price adjusted upon the issuance of such rights, options or Convertible Securities shall be readjusted to the Exercise Price that would be in effect had no adjustment been made with respect to such rights or options or rights of conversion of such Convertible Securities. (4) Rights or Options for Convertible Securities. For the purpose of the adjustment provided for in Subsection 8(f)(1) hereof, if at any time or from time to time after the date hereof, the Company shall issue any rights or options for the purchase of Convertible Securities, then, in each such case, if the Effective Price thereof is less than the current Exercise Price, the Company shall be deemed to have issued at the time of the issuance of such rights or options the maximum number of Additional Shares of Common Stock issuable upon conversion of the total amount of Convertible Securities covered by such rights or options and to have received as consideration for the issuance of such Additional Shares of Common Stock an amount equal to the amount of consideration, if any, received by the Company for the issuance of such rights or options, plus the minimum amounts of consideration, if any, payable to the Company upon the conversion of such Convertible Securities. For purposes of the foregoing, "Effective Price" shall mean the quotient determined by dividing the total amount of such consideration by such maximum number of Additional Shares of Common Stock. No further adjustment of such Exercise Price adjusted upon the issuance of such rights or options shall be made as a result of the actual issuance of the Convertible Securities upon the exercise of such rights or options or upon the actual issuance of Additional Shares of Common Stock upon the conversion of such Convertible Securities. The provisions of Subsection 8(f)(3) above for the readjustment of such Exercise Price upon the expiration of rights or options or the rights of conversion of Convertible Securities shall apply mutatis mutandis to the rights, options and Convertible Securities referred to in this Subsection 8(f)(4). (5) Certain Exceptions. Notwithstanding the provisions of Subsection 8(f)(1) above, no adjustment shall be made to the Exercise Price with respect to the issuance or sale of Additional Shares of Common Stock for a consideration per share equal to or greater than the then current Exercise Price nor shall any adjustment be made related to the issuance of 12,500 shares of Common Stock as a fee for arranging the transactions in which this Warrant was issued. For the purposes of this Section 8(f), the issuance of not more than 500,000 shares of Common Stock to employees or consultants or the Company pursuant to stock option or stock purchase plans approved by the Board (including the reissuance of shares purchased by the Company from employee or consultants of the Company) shall not be considered the issuance or sale of Additional Shares of 8 Common Stock; provided, that any such employee or consultant options may not be exercised by the recipient thereof for a period of at least one year from the date of issuance. (6) Definition. The term "Additional Shares of Common Stock" as used herein shall mean all shares of Common Stock issued or deemed issued by the Company after the date hereof, whether or not subsequently reacquired or retired by the Company. Notwithstanding anything to the contrary contained herein, Common Stock issuable upon conversion of any Preferred Stock of the Company outstanding on the date hereof or the convertible notes issued by the Company to any party concurrently with this Warrant and other warrant certificates pursuant to the terms of the Purchase Agreement shall not be deemed to be Additional Shares of Common Stock or Convertible Securities for purposes of causing an adjustment to the Exercise Price. (g) Certificate of Adjustment. In each case of an adjustment or readjustment of the Exercise Price, the Company, at its expense, shall prepare a certificate showing such adjustment or readjustment signed by the duly elected Treasurer or Chief Financial Officer of the Company (the "Adjustment Certificate) and shall mail the Adjustment Certificate, by first class mail, postage prepaid, to the Holder at the Holder's address as shown in the Company's books. The Adjustment Certificate shall set forth such adjustment or readjustment, showing in detail the facts upon which such adjustment or readjustment is based including a statement of the Exercise Price and the number of shares of Common Stock or other securities issuable upon exercise of this Warrant immediately before and after giving effect to the applicable adjustment or readjustment. If the holders of a majority of the shares of Common Stock represented by all outstanding Warrants being issued concurrently herewith do not in good faith believe that such adjustment or readjustment was calculated in accordance with the terms of this Warrant, such holders shall have the right to challenge such adjustment or readjustment, or method of calculating the same, by delivering written notice to the Company at 611 Broadway, Suite 515, New York, New York 10012, Attention: Richard L. Bulman, within thirty (30) days after the Holder's receipt of the Adjustment Certificate. In the event such holders deliver such written notice to the Company, the Company, at its expense, shall cause independent certified public accountants of recognized standing selected by the Company (who may be the independent certified public accountants then auditing the books of the Company) to recompute such adjustment or readjustment in accordance herewith and prepare a certificate signed by such accountants (the "Accountant's Adjustment Certificate") showing such adjustment or readjustment. The Company shall then mail the Accountant's Adjustment Certificate, by first class mail, postage prepaid, to the Holder at the Holder's address as shown in the Company's books. In the event of any conflict between the Adjustment Certificate and the Accountant's Adjustment Certificate, the Accountant's Adjustment Certificate shall control. 9. Survival. The various rights and obligations of the Holder hereof and of this Company as set forth in Sections 5, 6, and 7 hereof, as may be applicable, shall survive the exercise of this Warrant or the surrender of this Warrant, and upon the surrender of this Warrant and the exercise of all the rights represented hereby, each party shall, if requested, 9 deliver to the other hereof its written acknowledgement of its continuing obligations under said Sections. 10. Mutilated or Missing Warrants. In case this Warrant Certificate shall be mutilated, lost, stolen or destroyed, the Company will, upon request, issue and deliver in exchange and substitution for and upon cancellation of the mutilated Warrant Certificate, or in lieu of and substitution of the Warrant Certificate lost, stolen or destroyed, a new Warrant Certificate of like tenor and representing an equivalent right or interest, but only upon receipt of evidence satisfactory to the Company of such loss, theft, or destruction of such Warrant Certificate and, in the case of a lost, stolen or destroyed Warrant Certificate, indemnity, if requested, also satisfactory to the Company. Applicants for such substitute Warrant Certificate shall also comply with such other reasonable regulations and pay such reasonable charges as the Company may prescribe. 11. Notices. All notices, requests, consents and other communications hereunder shall be in writing and shall be deemed to have been made when delivered or mailed first class registered or certified mail, postage prepaid, return receipt requested, as follows: if the Holders, at the address of the Holder as shown on the Company's registry books, and, if to the Company, at 611 Broadway, Suite 515, New York, New York, 10012, Attention: Richard L. Bulman. 12. Governing Law. This Warrant shall be governed by and construed in accordance with the laws of the State of New York, without reference to principles of conflicts of law. 13. Binding Effect. This Warrant shall be binding upon and inure to the benefit of the Company and the Holder. Nothing in this Warrant is intended or shall be construed to confer upon any other person any right, remedy or claim, in equity or at law, or to impose upon any other person any duty, liability or obligation. IN WITNESS WHEREOF, the Company has caused this Warrant to be duly executed as of the date first above written. KIDEO PRODUCTIONS, INC. By: ----------------------------------- Richard L. Bulman, President 10 PURCHASE FORM ------------, ----- KIDEO PRODUCTIONS, INC. 611 Broadway Suite 515 New York, NY 10012 The undersigned hereby irrevocably elects to exercise the attached Warrant Certificate to the extent of __________ shares of common stock of Kideo Productions, Inc., $.0001 par value per share, and hereby makes payment of $__________ in payment of the purchase price thereof. Alternatively, the undersigned hereby elects a "cashless" exercise to the extent of __________ shares represented by the attached Warrant Certificate. INSTRUCTIONS FOR REGISTRATION OF SECURITIES Name: ____________________________________________________________________ (Please typewrite or print in block letters) DELIVER SECURITIES TO: Address: __________________________ __________________________ __________________________ Holder: __________________________________________________ [Signature of Holder of Warrant Certificate, if an individual] Holder: __________________________________________________ By: ______________________________________________ Its: _______________________________________ [Signature of Holder of Warrant Certificate, if a corporation, partnership or other entity] EX-10.36 5 NOTE AND WARRANT PURCHASE AGREEMENT EXHIBIT 10.36 NOTE AND WARRANT PURCHASE AGREEMENT NOTE AND WARRANT PURCHASE AGREEMENT, dated as of January 30, 1998 (the "Agreement"), between Kideo Productions, Inc., a Delaware corporation (the "Company"), and Benjamin Bollag and Michael Bollag (each a "Buyer" and together the "Buyers"). WHEREAS, each of the Buyers wishes to acquire from the Company (a) a note in the aggregate principal amount of $250,000 bearing interest at the rate of 10% per annum, due April 15, 1999, in the form attached hereto as Exhibit A (each a "Note" and together the "Notes"), and (b) warrants to purchase 250,000 shares of its common stock, par value $.0001 per share (the "Common Stock"), to be in the form of warrants attached hereto as Exhibit B (each a "Warrant" and together the "Warrants"); and WHEREAS, the Company is willing to sell to each Buyer a Note and a Warrant in consideration of the payment to the Company by the Buyers of $250,000 each (an aggregate of $500,000). NOW, THEREFORE, in consideration of the foregoing premises and the respective representations warranties, covenants, agreements and conditions hereinafter set forth, and intending to be legally bound hereby, the parties hereto agree as follows: I. THE CLOSING. A. Time and Place of Closing. The consummation of the transactions contemplated by this Agreement (the "Closing") will take place by exchange of all documents and instruments required hereby concurrently with the execution of this Agreement at such place and time as the parties may agree. B. Purchase and Sale of the Notes and the Warrants. At the Closing, the Company will, and hereby does, issue and sell to the Buyers the Notes and the Warrants and the Buyers will, and hereby do purchase, acquire, accept and pay for, as hereinafter provided, the Notes and the Warrants. C. Consideration for the Notes and the Warrants. The aggregate consideration for the Note and the Warrants shall consist of immediately available funds in the amount of $500,000 (the "Consideration"). D. Deliveries by the Company. At the Closing, the Company shall deliver the following to the Buyers: 1. A duly executed copy of this Agreement. 2. Two duly executed Notes, one to each of the Buyers. 3. Two duly executed certificates representing a Warrant, one to each of the Buyers. 4. A duly executed copy of a security agreement in the form of Exhibit C hereto (the "Security Agreement"). 5. Any other documents and instruments incident to the transactions contemplated hereby as the Buyers may reasonably request. E. Deliveries by the Buyers. At the Closing, the Buyers shall deliver the following to the Company: 1. A duly executed copy of this Agreement. 2. Cash in immediately available funds in the aggregate amount of $500,000 by wire transfer to an account or accounts designated by the Company prior to the Closing. 3. Any other documents and instruments incident to the transactions contemplated hereby as the Company may reasonably request. II. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company represents and warrants to the Buyers as follows: A. Organization. The Company is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware and has all requisite corporate power and authority to own and operate its properties, to carry on its business as now conducted and as proposed to be conducted, to enter into this Agreement, to issue and sell the Notes and the Warrants and to carry out the terms of this Agreement, the Notes, the Warrants and the Security Agreement (collectively, the "Operative Agreements"). B. Authority Relative to this Agreement. The Company has full corporate power and authority to execute and deliver the Operative Agreements and to consummate the transactions contemplated thereby. The execution and delivery of the Operative Agreements and the consummation of the transactions contemplated thereby have been duly and validly authorized by the Board of Directors of the Company and no other corporate proceedings on the part of the Company are necessary to authorize the Operative Agreements or to consummate the transactions contemplated thereby. The Operative Agreements have been duly and validly executed and delivered by the Company and 2 constitute valid and binding agreements or obligations of the Company, enforceable against the Company in accordance with their respective terms. C. Compliance with Other Instruments. The Company is not in violation of any term of its certificate or articles of incorporation or by-laws, nor is the Company in violation of any term of any agreement or instrument to which it is a party or by which it is bound or any term of any applicable law, ordinance, rule or regulation of any governmental authority or any term of any applicable order, judgment or decree of any court, arbitrator or governmental authority, the consequences of which violation would have a materially adverse effect on the business, operations, affairs, condition (financial or otherwise), properties or assets of the Company; the execution, delivery and performance of the Operative Agreements will not result in any violation of or be in conflict with or constitute a default under any such term or result in the creation of (or impose any obligation on the Company to create) any lien upon any of the properties or assets of the Company pursuant to any such term (other than in accordance with the Security Agreement), the consequences of which violation would have a materially adverse effect on the business, operations, affairs, condition (financial or otherwise), properties or assets of the Company. D. Capitalization. As of the date hereof and prior to the consummation of the transactions contemplated hereby, the authorized capital stock of the Company consists of 15,000,000 shares of the Common Stock, of which 3,682,128 shares are issued and outstanding, and 5,000,000 shares of preferred stock, par value $.0001 per share, none of which are issued and outstanding. As of the date hereof and prior to the consummation of the transactions contemplated hereby, 2,126,898 shares of the Common Stock are reserved for issuance upon the exercise of outstanding options and warrants. All of the outstanding shares of the Common Stock are, and all shares of the Common Stock which may be issued pursuant to the exercise of options and warrants or otherwise (including the Warrants) or upon conversion of convertible securities (including the Note) will be, when issued in accordance with the respective terms thereof, duly authorized, validly issued, fully paid and nonassessable and free of any preemptive rights in respect thereto. Other than with respect to the transactions contemplated hereby, as of the date hereof there are no outstanding obligations to sell or convey any shares of capital stock of the Company or any securities exercisable for or convertible into shares of capital stock of the Company. E. Reports. The Company has filed all forms, reports, statements and other documents required to be filed with (i) the Securities and Exchange Commission (the "SEC") including, without limitation, (A) all Annual Reports on Form 10-KSB, (B) all Quarterly Reports on Form 10-QSB, (C) all Reports on Form 8-K, (D) all other reports or registration statements and (E) all amendments and supplements to all such reports and registration statements (collectively referred to as the "SEC Reports") and (ii) any other applicable state securities authorities (all such forms, reports, statements and other documents in (i) and (ii) of this Section 2.5 being referred to herein, collectively, as the "Reports"). The Reports (i) were prepared in all material respects in accordance with the requirements of applicable law (including, with respect to the SEC Reports, the Securities 3 Act of 1933 (the "Securities Act") and the Securities Exchange Act of 1934 (the "Exchange Act"), as the case may be, and the rules and regulations of the SEC thereunder applicable to such SEC Reports) and (ii) did not at the time they were filed contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. F. Security Interest. Upon the recording of UCC-1s and such other filings as may be necessary or requested by the Buyers under the Security Agreement, including an assignment of patent to be filed in the United States Patent and Trademark Office, each of which the Company agrees to prepare and file promptly after the Closing (and in no event more than three business days following the Closing), the Security Agreement will create a perfected first priority lien in and to the Collateral (as defined in the Security Agreement). III. REPRESENTATIONS AND WARRANTIES OF THE BUYER. Each of the Buyers represents and warrants to the Company as follows: A. The Buyer is sufficiently experienced in financial and business matters to be capable of evaluating the merits and risks of this investment and to make an informed decision relating thereto. The Buyer has the financial capability for making the investment, can afford a complete loss of the investment, and the investment is a suitable one for the Buyer. B. Prior to the execution of this Agreement, the Buyer has had the opportunity to ask questions of and receive answers from representatives of the Company concerning the finances, operations, business and prospects of the Company. C. The Buyer understands that the Company shall not be deemed to have made to the Buyer any representation or warranty other than as expressly made in this Agreement. D. The Buyer understands that the Notes and Warrants (and the Common Stock into which they may be converted and exercised for) are not registered under the Securities Act, and are not registered under any state "blue sky" laws, and the Notes and Warrants (and such Common Stock) may not be transferred except in compliance with such laws. E. The Buyer understands that the Notes and Warrants (and such Common Stock) are "restricted securities" as that term is defined in Rule 144 under the Securities Act and that the Notes and Warrants (and such Common Stock) must be held indefinitely unless they are subsequently registered under the Securities Act or an exemption from such registration is available. The Buyer understands that in the case of sales in which Rule 144 4 is not available, compliance with Regulation A under the Securities Act or some other exemption under the Securities Act will be required. F. The Buyer represents that the Buyer is purchasing the Notes and Warrants for the Buyer's own account for investment and not with a view to the distribution thereof or with any present intention of distributing or selling any of the Notes and Warrants. The Buyer further represents that the Buyer is an accredited investor within the meaning of Rule 501 under the Securities Act. IV. CERTAIN AGREEMENTS. A. Registration and Limitations on Sale. 1. The Company agrees to include the 500,000 (as appropriately adjusted for any stock splits, stock dividends or similar events) shares of Common Stock for which the Warrants may be exercised and the 500,000 (as appropriately adjusted for any stock splits, stock dividends or similar events) shares of Common Stock into which the Notes may be converted (the "Registrable Securities") in a registration statement (the "Registration Statement") which shall be filed no later than sixty (60) days following the Closing. The Company will use its reasonable best efforts to have the Registration Statement declared effective as promptly as practicable thereafter and shall keep the Registration Statement effective in order to permit a public offering and sale of the Registrable Securities thereunder. The Company shall also use its best efforts to register or qualify all of the Registrable Securities under such other securities or blue sky laws of such States of the United States of America where an exemption is not available and as the Buyers shall reasonably request. In the event the Registration Statement is not effective on or before May 1, 1998, the per share exercise price of the Warrants and the per share conversion price of the Notes shall each be reduced $.10 and shall be reduced an additional $.10 per share on the first day of each month thereafter through and including the month in which the Registration Statement is declared effective. The $.10 referred to above shall be appropriately adjusted for any stock splits, stock dividends or similar events occurring after the date hereof. 2. The Company will pay all Registration Expenses (as defined below) in connection with the Registration Statement. "Registration Expenses" means all costs, fees and expenses incident to the Company's performance of or compliance with its obligation to register the Registrable Securities, including, without limitation, all registration, filing and NASD fees, all fees and expenses of complying with securities or blue sky laws, all printing expenses, and delivery expenses, the fees and disbursements of counsel for the Company and of its independent public accountants, and any fees and disbursements customarily paid by issuers or sellers of securities (excluding any underwriting discounts or commissions or transfer taxes with respect to the Registrable Securities and the fees and disbursements of more than one counsel for the Buyers). 5 3. The Company may require, and the Buyers hereby agree, to furnish the Company such information regarding the Buyers and the distribution of the Registrable Securities as the Company may from time to time reasonably request in writing. 4. The Company will use its reasonable best efforts to keep the Registration Statement effective in order to permit a public offering and sale of any Registrable Securities registered thereunder until the earlier of (i) the date that all of the Registrable Securities have been sold pursuant to the Registration Statement, (ii) the date the Buyer may sell such securities under the provisions of Rule 144(k) and (iii) the third anniversary of the effective date of the Registration Statement. 5. At any time during which the Registration Statement is effective, if any Buyer desires to sell shares of Registrable Securities, such Buyer hereby agrees to give the Company written notice (the "Notice") on the third business day prior to the date of such proposed sale (the "Sale Date") and the Company agrees that such Buyer may sell Registrable Securities for a period of 90 days commencing on the Sale Date; provided, however, no such sale shall be made if after the receipt of the Notice and prior to the Sale Date the Company shall inform such Buyer in writing that in the good faith judgement of the Company's counsel, the sale or transfer of shares of Registrable Securities by such Buyer would, at such time, require the disclosure of material information that the Company has a bona fide business purpose for preserving as confidential or the Company would be required to provide information required by the SEC or the Securities Act (or the rules and regulations promulgated thereunder), such as pro forma financial information, that at such time the Company would be unable to provide; provided further, that in no event shall the Company prohibit any sales pursuant to the foregoing proviso for more than 60 consecutive days or more than 90 days in any 12 month period. 6. The Company shall (a) promptly notify the Buyers upon discovery that, or upon the happening of any event as a result of which, the prospectus included in the Registration Statement, as then in effect, includes an untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading, in the light of the circumstances under which they were made, and (b) at the request of the Buyers, promptly prepare and furnish to the Buyers a reasonable number of copies of a supplement to or an amendment of such prospectus as may be necessary so that, as thereafter delivered to the purchasers of such securities, such prospectus shall not include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances under which they were made. The Buyers agree that, upon receipt of any notice from the Company of the happening of any event of the kind described in this Section 4.1.7, the Buyers will forthwith discontinue disposition of Registrable Securities pursuant to the Registration Statement until the receipt by the Buyers of the copies of the supplemented or amended prospectus and, if so directed by the Company, will promptly deliver to the Company (at the Company's expense) all copies, 6 other than permanent file copies, then in the Buyers' possession of the prospectus relating to such Registrable Securities current at the time of receipt of such notice. B. Expenses. Except as provided in Section 4.1.2, all costs and expenses incurred in connection with this Agreement and the transactions contemplated hereby will be paid by the party incurring such costs and expenses; provided, however, the Company will pay directly the fees and expenses of counsel to the Buyers in an amount equal to $10,000. C. Best Efforts. Subject to the terms and conditions of this Agreement, each of the parties hereto will use its best efforts to take, or cause to be taken, all action, and to do, or cause to be done, all things necessary, proper or advisable under applicable laws and regulations to consummate and make effective the transactions contemplated by this Agreement. D. Restrictions on Transfer of Notes and Warrants. The Notes and the Warrants issued under this Agreement, including any Notes or Warrants issued upon the transfer of the Notes or the Warrants, shall be stamped or otherwise imprinted with a legend in substantially the following form: "This [security] has not been registered under the Securities Act of 1933, as amended, or applicable State securities laws, if any, and may not be transferred in the absence of such registration or receipt by the Company of an opinion of counsel reasonably satisfactory to the Company that the transfer may be properly made under an exemption from registration under such Act and such laws." E. Information. From and after the date hereof and through April 15, 1999, the Company shall provide the Buyers with such information related to the Company as may be reasonably requested by the Buyers. F. Indemnification in Connection with the Registration Statement. 1. Indemnification by the Company. The Company will, and hereby does, indemnify and hold harmless, the Buyers against any losses, claims, damages or liabilities to which the Buyers may become subject under the Securities Act or otherwise, including, without limitation, the fees and expenses of legal counsel, insofar as such losses, claims, damages or liabilities (or actions or proceedings, whether commenced or threatened, in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement, any preliminary prospectus, final prospectus or summary prospectus contained therein, or any amendment or supplement thereto, or any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein in light of the circumstances in which they were made not misleading, or any violation by the Company 7 of the Securities Act or any rule or regulation thereunder applicable to the Company and the Company will promptly reimburse the Buyers for any legal or any other expenses reasonably incurred by the Buyers in connection with investigating or defending any such loss, claim, liability, action or proceeding; provided, that the Company shall not be liable in any such case to the extent that any such loss, claim, damage, liability (or action or proceeding in respect thereof) or expense arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in the Registration Statement, any such preliminary prospectus, final prospectus, summary prospectus, amendment or supplement in reliance upon and in conformity with written information furnished to the Company through an instrument duly executed by or on behalf of the Buyer specifically stating that it is for use in the preparation thereof. Such indemnity shall remain in full force and effect regardless of any investigation made by or on behalf of the Buyers and shall survive the transfer of the Registrable Securities by the Buyers. 2. Indemnification by the Buyers. The Buyers hereby agree to indemnify and hold harmless (in the same manner and to the same extent as set forth in Section 4.6.1) the Company, and each director, officer and employee of the Company and each other person, if any, who participates as an underwriter in the offering or sale of securities pursuant to the Registration Statement, with respect to any untrue statement or alleged untrue statement of a material fact contained in or any omission or alleged omission to state therein a material fact in the Registration Statement, any preliminary prospectus, final prospectus or summary prospectus contained therein, or any amendment or supplement thereto, if such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to the Company through an instrument duly executed by or on behalf of the Buyers specifically stating that it is for use in the preparation of the Registration Statement, preliminary prospectus, final prospectus, summary prospectus, amendment or supplement; provided, however, that the liability of the Buyers under this Section 4.6.2 shall be limited to the amount of proceeds received by the Buyers in the offering giving rise to such liability. Such indemnity shall remain in full force and effect, regardless of any investigation made by or on behalf of the Company or any such director, officer or employee and shall survive the transfer of such securities by such seller. 3. Notices of Claims. Promptly after receipt by an indemnified party of notice of the commencement of any action or proceeding involving a claim referred to in this Section 4.6, such indemnified party will, if a claim in respect thereof is to be made against an indemnifying party, give written notice to the latter of the commencement of such action; provided, however, that the failure of any indemnified party to give notice as provided herein shall not relieve the indemnifying party of its obligations under this Section 4.6, except to the extent that the indemnifying party is actually prejudiced by such failure to give notice. In case any such action is brought against an indemnified party, the indemnifying party shall be entitled to participate in and to assume the defense thereof, jointly with any other indemnifying party similarly notified to the extent that it may wish, with counsel reasonably satisfactory to such indemnified party, and after notice from the 8 indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party shall not be liable to such indemnified party for any legal or other expenses subsequently incurred by the latter in connection with the defense thereof other than reasonable costs of investigation; provided, however, that if the indemnified party reasonably believes it is advisable for it to be represented by separate counsel because there exists a conflict of interest between its interests and those of the indemnifying party with respect to such claim, or there exist defenses available to such indemnified party which may not be available to the indemnifying party, or if the indemnifying party shall fail to assume responsibility for such defense, the indemnified party may retain counsel satisfactory to it and the indemnifying party shall pay all fees and expenses of such counsel. No indemnifying party shall be liable for any settlement of any action or proceeding effected without its written consent, which consent shall not be unreasonably withheld or delayed. No indemnifying party shall, without the consent of the indemnified party, consent to entry or any judgment or enter into any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to such indemnified party of a release from all liability in respect to such claim or litigation or which requires action other than the payment of money by the indemnifying party. Each indemnified party shall furnish such information regarding itself or the claim in question as an indemnifying party may reasonably request in writing and as shall be reasonably requested in connection with the defense of such claim and litigation resulting therefrom. 4. Contribution. If the indemnification provided for in this Section 4.6 shall for any reason be held by a court of competent jurisdiction to be unavailable to an indemnified party in respect of any loss, claim, damage or liability, or any action in respect thereof, then, in lieu of the amount paid or payable under Section 4.6.1 or 4.6.2 hereof, the indemnified party and the indemnifying party shall contribute to the aggregate losses, claims, damages and liabilities (including legal or other expenses reasonably incurred in connection with investigating the same), (a) in such proportion as is appropriate to reflect the relative fault of the Company and the Buyers in connection with the statement or omissions which resulted in such loss, claim, damage or liability, or action in respect thereof, as well as any other relevant equitable consideration (the relative fault of the Company and such prospective sellers to be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company or the Buyers and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission) or (b) if the allocation provided by clause (a) above is not permitted by applicable law, in such proportion as shall be appropriate to reflect the relative benefits received by the Company and the Buyers from the offering of the securities covered by the Registration Statement. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. In addition, no person shall be obligated to contribute hereunder any amounts in payment of any settlement of any action or claim effected without such person's consent, which consent shall not be unreasonably withheld or delayed. 9 5. Other Indemnification. Indemnification and contribution similar to that specified in the preceding sections of this Section 4.6 (with appropriate modifications) shall be given by the Company and the Buyers with respect to any required registration or other qualification of securities under any federal or state law, rule or regulation of any governmental authority other than the Securities Act. 6. Indemnification Payments. The indemnification and contribution required by this Section 4.6 shall be made by prompt periodic payments of the amount thereof during the course of the investigation or defense, as and when bills are received or expense, loss, damage or liability is incurred. G. Other Company Registrations. While the Note is outstanding, the Company will not file any other registration statement pursuant to which any shares of the Common Stock would be saleable prior to February 1, 1999. Notwithstanding the foregoing, the Company may include in the Registration Statement 140,000 shares of the Common Stock issuable upon exercise of outstanding warrants provided that the holders thereof may not sell any shares received upon exercise of such warrants until January 31, 1999. H. Right of First Offer for Additional Offerings. 1. If at any time prior to the repayment or conversion in full of the Notes, and other than in connection with a merger, consolidation, sale of assets, disposition or acquisition of a business, product or license by the Company, strategic alliance, bank loan or other credit facility agreement, public offering, exercise of options or warrants or exchange of capital stock for assets, stock or other joint venture interests, the Company determines to offer to sell securities of the Company, the Company shall first offer the Buyers the opportunity to purchase the securities being offered by delivering to the Buyers written notice (the "Notice of Offer") which shall specify (i) the type and number or amount of securities the Company wishes to sell (the "Offered Securities"); (ii) the proposed sale price for the Offered Securities (the "Offer Price"); and (iii) all other terms and conditions of the offer. The Notice of Offer shall constitute an irrevocable offer by the Company to sell to the Buyer the Offered Securities at the Offer Price. 2. Within 10 business days following their receipt of the Notice of Offer, the Buyers shall notify the Company whether they elect to purchase all or a portion of the Offered Securities (such notification shall be referred to as the "Acceptance"). The Acceptance shall be deemed to be an irrevocable commitment to purchase from the Company the number or amount of the Offered Securities specified in the Acceptance. If the Buyers do not deliver an Acceptance within 10 business days following their receipt of the Notice of Offer, the Buyers shall be deemed to have declined to purchase the Offered Securities. If the Buyers deliver an Acceptance for a portion of the Offered Securities, the Buyers shall be deemed to have declined to purchase the balance of the Offered Securities. 10 3. If the Buyers do not elect to purchase all of the Offered Securities available for purchase, the Company may, within a period of six months from the date of the Notice of Offer, sell the remaining Offered Securities to one or more third parties (each a "Third Party Transferee"), for not less than the Offer Price and on such other terms and conditions as are no more favorable to the proposed Third Party Transferee than those specified in the Notice of Offer. If the Company does not complete a sale within such six-month period, the provisions of this Section 4.8 shall again apply to the Offered Securities, and no sale of such Offered Securities shall be made otherwise than in accordance with the terms of this Agreement. 4. Any closing of a purchase of Offered Securities by the Buyer pursuant to this Section 4.8 shall take place on the 30th day after the delivery of the Acceptance at 11:00 A.M. at the principal office of the Company, or at such other date, time or place as the parties to the sale may agree. At such closing, the Company shall sell, convey, transfer and deliver to the Buyers full right, title and interest in and to the Offered Securities so purchased by the Buyers, free and clear of all liens, security interests or adverse claims of any kind or nature, shall make representations and warranties and, unless the Notice of Offer specifically provides otherwise and shall carry over to the terms offered to a third party as provided above, enter into an agreement providing rights substantially similar to those contained herein (including registration rights) and shall deliver to the Buyers a certificate or certificates representing the Offered Securities sold to such party, in each case duly endorsed for transfer or accompanied by appropriate stock transfer powers duly endorsed. The Buyers shall deliver to the Company, in full payment of the purchase price of the Offered Securities purchased, a certified or bank check payable to the order of the Company in an amount equal to the Offer Price and, if there is consideration other than cash included in the Offer Price, such other consideration. 5. For purposes of this Section 4.8, the Buyers shall apportion the Offered Securities they desire to purchase among themselves in their sole discretion. V. MISCELLANEOUS PROVISIONS. A. Survival of Representations. All representations and warranties made by either party pursuant to this Agreement shall survive the Closing. B. Indemnification. In addition to the indemnification provided for in Section 4.6, each of the parties hereto (the "Indemnifying Party") shall, to the fullest extent permitted under applicable law, indemnify and hold the other (the "Indemnified Party") harmless against any losses, claims, damages, liabilities, actions, judgments, causes of action, costs or expenses including without limitation, interest, penalties and attorneys' fees and expenses (the "Liabilities") asserted against, resulting from, imposed upon or incurred or suffered by an Indemnified Party as a result of, arising out of or relating to any breach of a representation, warranty, covenant or agreement contained in the Operative Agreements. 11 All procedural and operating terms of such indemnification shall be as set forth in Section 4.6. C. Amendment and Modification. This Agreement may be amended, modified or supplemented only by written agreement of the Company and the Buyer. D. Waiver of Compliance; Consents. Except as otherwise provided in this Agreement, any failure of any of the parties to comply with any obligation, covenant, agreement or condition herein may be waived by the party or parties entitled to the benefits thereof only by a written instrument signed by the party granting such waiver, but such waiver or failure to insist upon strict compliance with such obligation, covenant, agreement or condition shall not operate as a waiver of, or estoppel with respect to, any subsequent or other failure. Whenever this Agreement requires or permits consent by or on behalf of any party hereto, such consent shall be given in writing in a manner consistent with the requirements for a waiver of compliance as set forth in this Section 5.3. E. Investigations. The respective representations and warranties of the Company and the Buyer contained herein shall not be deemed waived or otherwise affected by any investigation made by any party hereto. F. Notices. All notices and other communications hereunder shall be in writing and shall be deemed given if delivered faxed to the numbers set forth below with a record of receipt, personally or mailed by registered or certified mail (return receipt requested), postage prepaid, to the parties at the following addresses (or at such other address for a party as shall be specified by like notice, provided that notices of a change of address shall be effective only upon receipt thereof): (a) if to the Company, to Kideo Productions, Inc. 611 Broadway Suite 523 New York, New York 10012 Attention: President Fax: 212-505-6605 with a copy to Solovay Marshall & Edlin, P.C. 845 Third Avenue New York, New York 10022 Attention: Michael B. Solovay, Esq. Fax: 212-355-4608 12 (b) if to the Buyers, to Benjamin Bollag Hollister Ranch Lot 89 Gaviota, California 93117 Fax: 805-567-1599 with a copy to Squadron Ellenoff Plesent & Sheinfeld, LLP 551 Fifth Avenue New York, New York 10176 Attention: Kenneth R. Koch, Esq. Fax: 212-697-6686 G. Assignment. This Agreement and all of the provisions hereof shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns, but neither this Agreement nor any of the rights, interests or obligations hereunder shall be assigned by any of the parties hereto without the prior written consent of the other parties, nor is this Agreement intended to confer upon any other person except the parties hereto any rights or remedies hereunder. H. Governing Law. This Agreement shall be governed by the laws of the State of New York (regardless of the laws that might otherwise govern under applicable Delaware principles of conflicts of law) as to all matters, including but not limited to matters of validity, construction, effect, performance and remedies. I. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. J. Interpretation. The article and section headings contained in this Agreement are solely for the purpose of reference, are not part of the agreement of the parties and shall not in any way affect the meaning or interpretation of this Agreement. K. Entire Agreement. This Agreement, including the exhibits hereto and the documents and instruments referred to herein, embodies the entire agreement and understanding of the parties hereto in respect of the transactions contemplated by this Agreement. There are no restrictions, promises, representations, warranties, covenants or undertakings, other than those expressly set forth or referred to herein. This Agreement supersedes all prior agreements and understandings between the parties with respect to such transactions. 13 L. Survival of Certain Agreements. All agreements contained in this Agreement which by their terms shall survive the Closing hereunder, including, without limitation, the agreements contained in Sections 4.1 through 4.8 and 5.2 hereof and this Section 5.12, shall survive the Closing for an indefinite period of time. IN WITNESS WHEREOF, the Company and the Buyer have caused this Agreement to be signed by their respective duly authorized officers as of the date first above written. KIDEO PRODUCTIONS, INC. By: ___________________________ Richard Bulman, President ------------------------------- BENJAMIN BOLLAG ------------------------------- MICHAEL BOLLAG 14 EX-10.37 6 SECURITY AGREEMENT EXHIBIT 10.37 SECURITY AGREEMENT SECURITY AGREEMENT, dated as of January 29, 1998, made by KIDEO PRODUCTIONS, INC., a Delaware corporation ("Debtor"), in favor of Benjamin and Michael Bollag (the "Secured Parties"). W I T N E S E T H : WHEREAS, pursuant to that certain Note and Warrant Purchase Agreement, dated the date hereof, between Debtor and the Secured Parties (as the same may from time to time be amended, modified or supplemented, the "Purchase Agreement"), the Secured Parties have agreed to lend $500,000 (the "Loan") to Grantor; WHEREAS, the Secured Parties are willing to make the Loan but only upon the condition, among others, that Grantor shall have executed and delivered to the Secured Parties this Security Agreement. WHEREAS, the Debtor is delivering to the Secured Parties its promissory notes in the aggregate principal amount of $500,000 (the "Notes"); and WHEREAS, as a condition to their acceptance of the Notes, the Secured Parties are requiring that the performance and payment of all obligations, liabilities and indebtedness of the Debtor to the Secured Parties under the Notes be secured by the Debtor's grant of a security interest pursuant to the terms and condition of this Security Agreement. NOW, THEREFORE, in consideration of the foregoing premises and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto, intending to be legally bound, hereby agree as follows: 1. Grant of Security Interest. As collateral security for the prompt and complete payment and performance when due of all indebtedness, liabilities and obligations of the Debtor to the Secured Parties under the Notes, including interest (collectively, the "Obligations"), the Debtor hereby assigns, conveys, mortgages, pledges, hypothecates and transfers to the Secured Parties, and hereby grants to the Secured Parties, a continuing security interest in the Debtor's right, title and interest in, to and under all of the following (all of which are hereinafter collectively referred to as "Collateral"): (i) any and all present and future "accounts" (as defined in the Code referred to below), accounts receivable, contract rights, general intangibles, instruments and chattel paper and including without limitation any and all purchase orders, instruments and other documents, evidencing obligations for and representing payment for goods sold or leased and/or services rendered by Debtor, proceeds of and the goods represented by any of the foregoing and all books and records pertaining to same (the "Accounts Receivable"); (ii) any and all "equipment" (as defined in the Code) now or hereafter owned or leased by Debtor, including, without limitation, all leasehold improvements, machinery, furniture, tools, attachments, and other equipment of any kind and nature, whether affixed to real property or not, that is now owned or hereafter owned by the Debtor, wherever located, and any additions and accessions thereto, substitutions therefor, replacements thereof, and the Proceeds of any of the foregoing and all of the Debtor's books and records pertaining to all of the foregoing (the "Equipment"); (iii) any and all "inventory" (as defined in the Code) of every nature and description belonging to the Debtor, wherever located, whether now owned or in existence or hereafter acquired and including without limitation, all raw materials, work in process, all finished goods, now owned or hereafter acquired by the Debtor and wherever located and in all returns and refunds (applicable thereto), all parts and accessories thereof and additions thereto, the Proceeds of any of the foregoing and the right to collect the same and all books and records pertaining to same (the "Inventory"); (iv) any and all "general intangibles" (as such term is defined in the Code) now or hereafter owned by Debtor and including but not limited to all marks, trademarks, trademark applications, trademark registrations, patents, patent registrations, patent applications, copyrights, goodwill of the Debtor's business symbolized by any of the foregoing, license rights, license agreements, permits, franchises and patents; and (v) all "proceeds" (as defined in the Code) including, without limitation, (x) any and all proceeds of any insurance, indemnity, warranty or guaranty payable to the Debtor from time to time with respect to any of the Collateral, (y) any and all payments (in any form whatsoever) made or due and payable to the Debtor from time to time in connection with any requisition, confiscation, condemnation, seizure or forfeiture of all or any part of the Collateral by any governmental body, authority, bureau or agency (or any other person whether or not acting under color or governmental authority), and (z) any and all other amounts from time to time paid or payable under or in connection with any of the Collateral. Notwithstanding anything to the contrary in this Security Agreement, nothing herein shall be construed so as to require the Secured Parties to provide any future credit to the Debtor. 2. Representations, Warranties and Covenants. 2 The Debtor hereby represents, warrants and covenants as follows: (a) The Debtor's chief executive office and the place where its records concerning the Collateral are kept is located at 611 Broadway, Suite 515, New York, New York 10012. (b) The Debtor is the sole owner of the Collateral, free and clear of any liens, mortgages, security interests, pledges, charges or encumbrances of any kind or nature whatsoever (collectively, the "Liens") except as may be granted to the Secured Parties herein. (c) No effective financing statement or other instrument similar in effect covering all or any part of the Collateral is on file in any recording office. (d) The Debtor shall give the Secured Parties at least thirty (30) days' prior written notice of any change in the Debtor's name, trade style or the location of its chief executive office. (e) The Debtor shall, at its own expense, keep the Collateral free of all Liens except the security interest of the Secured Parties. (f) The Debtor shall not, directly or indirectly, sell, transfer or otherwise dispose of the Collateral or any interest therein, except in the ordinary course of its business. (g) The Debtor shall not remove any of the Equipment from 611 Broadway, Suite 515, New York, New York 10012. (h) The Debtor shall at all times keep the Equipment in good operating condition and repair. (i) The Debtor will furnish to the Secured Parties from time to time statements and schedules further identifying and describing the Collateral and such other reports in connection with the Collateral as the Secured Parties may reasonably request, all in reasonable detail. (j) Following the closing under the Purchase Agreement, the Debtor will from time to time pay or cause to be paid all Liens, taxes, assessments and governmental charges levied, assessed or imposed upon any of the Collateral, unless and to the extent only that the same shall be contested in good faith and by appropriate proceedings by the Debtor. 3. Secured Parties Appointed as Attorney-in-Fact. 3 (a) The Debtor hereby irrevocably constitutes and appoints the Secured Parties, and each of them and their agents, with full power of substitution, as its true and lawful attorneys-in-fact with full irrevocable power and authority in the place and stead of the Debtor and in the name of the Debtor or in their own name, from time to time in their discretion, but only upon the occurrence of an Event of Default under this Security Agreement or any Obligation, for the purpose of carrying out the terms of this Security Agreement, to take any and all appropriate action and to execute any and all documents and instruments which may be necessary or desirable to accomplish the purposes of this Security Agreement. The Debtor hereby ratifies all that said attorneys shall lawfully do or cause to be done by virtue hereof. This power of attorney is a power coupled with an interest and shall be irrevocable. (b) The powers conferred on the Secured Parties and the other attorneys appointed hereunder are solely to protect the interests of the Secured Parties in the Collateral and shall not impose any duty upon them to exercise any such powers. The Secured Parties and the other attorneys appointed hereunder shall be accountable only for amounts that they actually receive as a result of the exercise of such powers and neither they, nor any of their agents, shall be responsible to the Debtor for any act or failure to act, except for their gross negligence or willful misconduct. (c) The Debtor also authorizes the Secured Parties, as agent for the Debtor, at any time after the occurrence of an Event of Default, and from time to time, to communicate in their own names with any party to any contract, agreement or instrument included in the Collateral with regard to the assignment thereof hereunder and other matters relating thereto. 4. Performance by Secured Parties of Debtor's Obligations. If the Debtor fails to perform or comply with any of its agreements contained herein, or in the observance or performance of any other agreement or obligation to the Debtor, as provided for by the terms of this Security Agreement, in the event the Secured Parties shall perform or comply, or otherwise cause performance or compliance, with such agreement, the expenses of the Secured Parties incurred in connection with such performance or compliance, together with interest thereon at the rate of ten percent (10%) per annum, shall be payable by the Debtor to the Secured Parties on demand and, until such payment, shall constitute Obligations secured hereby. 5. Events of Default. The occurrence of any of the following shall be an "Event of Default" hereunder: (a) an Event of Default (as defined in the Purchase Agreement or the Notes) shall have occurred; or 4 (b) any representation or warranty made by the Debtor in connection with this Security Agreement or the Purchase Agreement shall prove to have been untrue or misleading in any material respect when made; or (c) default by the Debtor in the observance or performance of any other covenant or agreement contained in this Security Agreement, and the continuance of the same for thirty (30) days after the occurrence thereof. If any such event specified above shall occur, the Secured Parties may declare, by notice to the Debtor, the Obligations to be due and payable, whereupon the Obligations shall become immediately due and payable without presentment, demand, protest or other notice of any kind, all of which are hereby expressly waived, anything contained herein or in the Obligations to the contrary notwithstanding. 6. Remedies, Rights Upon Default. (a) If an Event of Default shall occur and be continuing, the Secured Parties may exercise in addition to all other rights and remedies granted to the Secured Parties in this Security Agreement, all rights and remedies of secured parties under the Uniform Commercial Code as the same may be in effect from time to time in New York (referred to in this Security Agreement as the "Code") and any other Uniform Commercial Code in any relevant jurisdiction. Without limiting the generality of the foregoing, the Debtor agrees that in any such event, the Secured Parties may forthwith collect, receive, appropriate and realize upon the Collateral, or any part thereof, and may forthwith sell, lease, assign, give option or options to purchase or otherwise dispose of and deliver the Collateral (or contract to do so), or any part thereof, in one or more parcels at public or private sale or sales, at the office of a Secured Party or elsewhere at such prices as they may deem best, for cash or on credit or for future delivery without assumption of any credit risk. The Debtor further agrees, at the request of the Secured Parties, to assemble the Collateral and make it available to the Secured Parties at places which any of the Secured Parties shall reasonably select, whether at the Debtor's premises or elsewhere. To the extent permitted by applicable law, the Debtor waives all claims, damages and demands against the Secured Parties arising out of the repossession, retention or sale of the Collateral. The Debtor shall remain liable for any deficiency if the proceeds of any sale or disposition of the Collateral are insufficient to pay all amounts to which the Secured Parties are entitled, the Debtor also being liable for the reasonable fees of any attorneys employed by the Agent to collect such deficiency. The Debtor also agrees to pay all costs of the Secured Parties, including reasonable attorney's fees, incurred with respect to the collection of any of the Obligations and the enforcement of any of its rights hereunder. The Debtor hereby waives presentment, demand, protest or any notice (to the extent permitted by applicable law and except as stated herein) of any kind in connection with this Security Agreement or any Collateral. 7. Limitation on Duty of the Secured Parties in Respect of Collateral. Beyond the use of reasonable and prudent care in the custody and preservation thereof, the 5 Secured Parties shall not have any duty as to any Collateral in their possession or control or in the possession or control of their agents or nominees or any income thereon or as to the preservation of rights against prior parties or any other rights pertaining thereto. 8. Notices. All notices, requests, demands and other communications required or permitted to be given hereunder shall be in writing, and shall be deemed to have been duly given or made on the date when the same is delivered by hand or sent by telecopier or, if mailed, seventy-two (72) hours after the same is deposited with the United States mail, by registered or certified mail, postage prepaid, return receipt requested, and addressed at the address set forth in the Purchase Agreement or at such other address which any party shall designate by written notice to the others in accordance with the provisions of this Section 8. 9. Severability. Any provision of this Security Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. 10. Financing Statements; Further Assurances. The Debtor authorizes the Secured Parties to sign and file financing statements at any time and from time to time with respect to the Collateral without the Debtor's signature. The Debtor agrees that at any time and from time to time upon the written request of the Secured Parties, the Debtor will promptly execute and deliver any and all such further instruments and documents and do such further acts as the Secured Parties may request in order to carry out the purposes of this Security Agreement and obtain for the Secured Parties the full benefits of the security interest granted to the Secured Parties hereby. 11. Definitions. Capitalized terms used and not otherwise defined herein shall have the respective meanings ascribed to such terms in the Purchase Agreement. 12. Waivers; Amendments; Cumulative Remedies. The Secured Parties shall not by any act, delay, omission or otherwise be deemed to have waived any rights or remedies hereunder and no waiver shall be valid unless in writing, signed by the Secured Parties, and then only to the extent therein set forth. A waiver by the Secured Parties of any right or remedy hereunder on any one occasion shall not be construed as a bar to any right or remedy which the Secured Parties would otherwise have had on any future occasion. No failure to exercise, nor any delay in exercising, on the part of the Secured Parties of any right, power or privilege hereunder, shall operate as a waiver thereof, nor shall any single or partial exercise of any right, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The rights and remedies hereunder provided are cumulative and may be exercised singly or concurrently, and are not exclusive of any rights and remedies provided by law. None of the terms and 6 provisions of this Security Agreement may be waived, altered, modified or amended except by an instrument in writing, duly executed by the parties hereto. 13. Successors and Assigns; Governing Law. This Security Agreement and all obligations of the Debtor hereunder shall be binding upon the successors and assigns of the Debtor, and shall inure to the benefit of each of the Secured Parties and their successors and assigns. This Security Agreement shall be governed by, and be construed and interpreted in accordance with, the laws of the State of New York, without regard to principles of conflicts of laws. 14. Further Indemnification. The Debtor agrees to pay, and to save the Secured Parties harmless from, any and all liabilities with respect to, or resulting from any delay in paying, any and all excise, sales or other taxes which may be payable or determined to be payable with respect to any of the Collateral or in connection with any of the transactions contemplated by this Security Agreement. 7 IN WITNESS WHEREOF, the Debtor and the Secured Parties have each caused this Security Agreement to be executed on the date first set forth above. KIDEO PRODUCTIONS, INC. By: ------------------------------- Richard Bulman, President ----------------------------------- BENJAMIN BOLLAG ----------------------------------- MICHAEL BOLLAG 8 EX-10.38 7 CONVERTIBLE PROMISSORY NOTE EXHIBIT 10.38 This Note has not been registered under the Securities Act of 1933, as amended, or applicable State securities laws, if any, and may not be transferred in the absence of such registration or receipt by the Company of an opinion of counsel reasonably satisfactory to the Company that the transfer may be properly made under an exemption from registration under such Act and such laws. CONVERTIBLE PROMISSORY NOTE $250,000 January 30, 1998 For value received, the undersigned, KIDEO PRODUCTIONS, INC., a Delaware corporation ("Maker"), promises to pay to MICHAEL BOLLAG ("Holder"), on demand of Holder at any time on or after April 15, 1999, at the office of Maker at 611 Broadway, Suite 515, New York, New York 10012, or at such other place as Holder may designate, the sum of TWO HUNDRED FIFTY THOUSAND DOLLARS ($250,000), together with interest on the unpaid balance of this Note, beginning as of the date hereof, before or after maturity or judgment, at the rate of ten percent (10%) per annum, which rate shall be computed monthly on the basis of a Three Hundred Sixty (360) day year and actual days elapsed. Interest on the principal amount outstanding under this Note shall be due and payable, in arrears, at the rate set forth herein, commencing on April 30, 1998 and continuing on the last day of each and every July, October, January and April thereafter until this Note is paid in full. Events of Default. The occurrence at any time of any one or more of the following events shall constitute an "Event of Default" under this Note: (a) Maker's failure to pay any interest when due under this Note which failure continues for more than three (3) days following receipt by Maker of written notice from Holder requesting such payment; (b) Maker's failure to pay principal or other amount (other than interest) when due under this Note; (c) failure of Maker to perform in any material respect its agreements and obligations, or a material breach of any of Maker's representations and warranties, under the Note and Warrant Purchase Agreement, dated January 30, 1998, between Maker and, among others, Holder (the "Purchase Agreement") or the Security Agreement, dated January 30, 1998, between Maker and, among others, Holder (the "Security Agreement"); (d) the dissolution, liquidation or termination of legal existence of Maker; (e) the appointment of a receiver, trustee or similar judicial officer or agent to take charge of or liquidate any property of assets of Maker, or action by any court to take jurisdiction of all or substantially all of the property or assets of Maker; (f) the sale of all or substantially all of Maker's property or assets; (g) the commencement of any proceeding under any provision of the Bankruptcy Code of the United States, as now in existence or hereafter amended, or of any other proceeding under any federal or state law, now existing or hereafter in effect, relating to bankruptcy, reorganization, insolvency, liquidation or otherwise, for the relief of debtors or readjustment of indebtedness, by or against Maker. Effect of Default. Maker agrees that upon the occurrence of an Event of Default, the entire indebtedness with accrued interest thereon due under this Note shall, at the option of the Holder, be immediately due and payable without notice. Failure to exercise such option shall not constitute a waiver of the right to exercise the same in the event of any subsequent Event of Default. Prepayment. Any amount, outstanding under this Note may be prepaid, in whole or in part, by Maker at any time subject to the following limitations and the limitations contained in the second paragraph of the Section titled "Conversion" below: Prepayment of principal may be made only if (a) all interest accrued through the date of prepayment is paid at the time of prepayment and (b) the amount of such prepayment does net exceed net operating income (excluding any non-cash expenses) generated by the Maker from the date of this Note up to the date that any such prepayment may be made. In addition, Maker shall forfeit the right to prepay prior to April 15, 1999 that portion of the following principal amounts that is not prepaid on or before the following dates: Amount Date by which must be Prepaid ----------------------------------------------------- $83,333 October 15, 1998 $83,333 January 15, 1999 That portion of the $83,333 principal amount that is not prepaid on or before October 15, 1998 is referred to herein as the "October Tranche" and that portion of the $83,333 of principal amount that is not prepaid on or before January 15, 1999 is referred to herein as the "January Tranche." That portion of the remaining $83,334 principal amount that is not paid on or before the date due shall be referred to herein as the "Final Tranche." If all or any part of this Note is outstanding on or after April 15, 1999, Maker may, at any time on or after such date, repay all or a portion of such amount unless Holder has exercised its right of conversion described below. Nothing contained herein shall be deemed to relieve Maker of its obligations to pay this Note when due. If all or any part of this Note is outstanding on or after April 15, 1999, Maker may, at any time on or after such date, give Holder written notice (the "Repayment Notice") of Maker's intention pay such amount on a date specified in the Repayment Notice, which date shall be no less than 30 days after the date of the Repayment Notice. During the period between the date of the Repayment Notice and the date set forth therein for repayment, Holder may exercise its right of conversion described below. Conversion. All or any part of the principal amount due and owing under this Note may be converted by Holder into shares of the common stock, par value $.0001 per 2 share, of Maker (the "Common Stock") at any time and from time to time after the following dates: (a) October 15, 1998 with respect to the October Tranche, (b) January 15, 1999 with respect to the January Tranche and (c) April 15, 1999 with respect to the Final Tranche. The number of shares of the Common Stock to be received upon conversion shall be determined by dividing (i) the principal amount of the portion of this Note which is being converted by (ii) $1.00 (the "Conversion Price"), subject to the adjustments described below under "Adjustments" and in Section 4.1.1 of the Purchase Agreement . Notwithstanding anything to the contrary contained in this Note, at any time that this Note is outstanding, if Maker sells any shares of the Common Stock or securities convertible into or exercisable for Common Stock (which shall not include the issuance of shares of the Common Stock upon the exercise of warrants or options outstanding on the date hereof or options issued to employees in connection with an employee option plan), all but $50,000 of the entire principal amount outstanding under this Note shall become immediately convertible in accordance with the terms hereof and shall not be prepayable. The remaining $50,000 shall be deemed included in the Final Tranche. At any time that any portion of this Note becomes convertible by Holder, Maker shall promptly send notice to Holder advising Holder of such fact and the principal amount of this Note which may be converted. To exercise the right of conversion, Holder must give written notice to Maker. Such notice shall specify the principal amount of this Note Holder desires to convert. Holder hereby agrees to take all steps reasonably requested by Maker to assist Maker in complying with any such conversion request, including, without limitation, delivering this Note to Maker so that a replacement Note reflecting a reduced principal amount may be issued to Holder following any conversion. At all times during which Holder has the right to convert this Note or any portion hereof, the Company agrees to reserve and keep available an authorized number of shares of the Common Stock sufficient to permit the conversion in full of this Note and the Company represents and warrants that all of the shares of Common Stock issued upon conversion of this Note shall be duly and validly issued, fully paid and nonassessable.. Adjustments. The number of shares of Common Stock into which this Note may be converted and the effective conversion price shall be adjusted for the same events and in the same manner as the number of shares of Common Stock underlying, and the exercise price of, the Warrant issued to Holder concurrently herewith. Security Agreement. This Note is one of the Notes referred to in, and is entitled to the benefits of, the Security Agreement, dated January 30, 1998, between the Company and the holders of such notes. 3 Notice. Any notice required to be given under this Note shall be given in the same manner and subject to the same terms and conditions as set forth in Section 5.6 of the Purchase Agreement. Failure by the Holder to insist upon the strict performance by Maker of any terms and provisions herein shall not be deemed to be a waiver of any terms and provisions herein, and the Holder shall retain the right thereafter to insist upon strict performance by the Maker of any and all terms and provisions of this Note or any document securing the repayment of this Note. Maker waives diligence, demand, presentment for payment, notice of nonpayment, protest and notice of protest, and notice of any renewals or extensions of this Note. This Note shall be governed by and construed in accordance with the laws of the State of New York (but not its conflicts of law provisions). Maker hereby consents to the exclusive jurisdiction of any State or Federal court located in New York County. KIDEO PRODUCTIONS, INC. By: -------------------------------- RICHARD BULMAN, President 4 EX-23.1 8 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the use of our report (and to all references to our Firm) included in or made a part of this Registration Statement of Kideo Productions, Inc. filed on Form SB-2. /s/ Arthur Andersen LLP ARTHUR ANDERSEN LLP New York, New York March 23, 1998 -----END PRIVACY-ENHANCED MESSAGE-----