KUSHNER LOCKE CO, 10-K/A, 1999-02-22

KUSHNER LOCKE CO
10-K/A, 1999-02-22
MOTION PICTURE & VIDEO TAPE PRODUCTION

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K/A
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998 COMMISSION FILE NO. 0-17295

THE KUSHNER-LOCKE COMPANY
(Exact name of registrant as specified in its charter)

CALIFORNIA 95-4079057
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

11601 Wilshire Blvd., 21st Floor, Los Angeles, California 90025
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(310) 481-2000
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Not Applicable

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, without par value
10% Convertible Subordinated Debentures, Series A due 2000
13 3/4% Convertible Subordinated Debentures, Series B due 2000
Common Stock Purchase Warrants, Class C

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

The aggregate market value based on the closing price of the Registrant's Common
Stock held by nonaffiliates of the Registrant was approximately $64,023,000 as
of December 24, 1998.

There were 10,573,042 shares of outstanding Common Stock of the Registrant as of
December 24, 1998.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive Proxy Statement for its 1999 Annual
Meeting of Stockholders to be filed pursuant to Regulation 14A not later than
120 days after the end of the Registrant's fiscal year (September 30, 1998) are
incorporated by reference in Part III Items 10, 11, 12 and 13 of this Form 10-K.

Total number of pages 102. Exhibit Index begins on page 85.

================================================================================

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The undersigned registrant (the "Registrant") hereby amends its Annual Report on
Form-K for the fiscal year ended September 30, 1998 (the "Report") as follows:

PART I

1. BUSINESS

GENERAL

The Kushner-Locke Company (the "Company") is a leading independent entertainment
company which principally develops, produces, and distributes original feature
films and television programming. The Company's feature films are developed and
produced for the theatrical, made-for-video and pay cable motion picture
markets. The Company's television programming has included television series,
mini-series, movies-for-television, animation, reality and game show programming
for the major networks, cable television, first-run syndication and
international markets.

The Company established its feature film production operations in 1993. In 1994,
the Company established an international theatrical film subsidiary to expand
into foreign theatrical distribution. In 1995, the Company formed KLC/New City
Tele-Ventures ("KLC/New City"), a joint venture 82.5% owned by the Company, to
acquire films for distribution through emerging new delivery systems, including
pay cable, pay-per-view, basic cable, video-on-demand and satellite systems. In
late 1997, the Company acquired control of 800-U.S. Search, a leading provider
of fee-based people search and other customized individual reference services.
In February 1998 the Company established KL/Phoenix, an 80% owned entity, which
distributes film and television product in Latin America.

The Company's feature film activities can be grouped into three areas:
production and distribution of a limited number of higher-budget films intended
for wide-screen domestic theatrical release, production and distribution of
low-to-moderate budget films released direct-to-video or on pay cable
television, and distribution licensing of acquired film rights. In certain
cases, the Company's low-to-moderate budget films may have a limited theatrical
release or a pay cable premiere before being released in home video. The
Company's feature slate for fiscal 1998 generated $ 26,200,000 of revenues.

Ringmaster starring Jerry Springer, Mambo Cafe starring Thalia and Danny Aiello,
Confessions of a Trick Baby: Freeway II starring Natasha Leone, Vincent Gallo,
and But I'm A Cheerleader were released or delivered, or are scheduled for
release or delivery by the Company in fiscal 1999. In addition, the Company has
recently completed production on Beowulf starring Christopher Lambert, which is
licensed for domestic distribution to Dimension Films, a division of Miramax
Film Corp., Susan's Plan written and directed by John Landis and starring
Natassja Kinski, Billy Zane, Michael Biehn, Rob Schneider, Lara Flynn Boyle and
Dan Aykroyd, Black and White starring Gina Gershon, Swing starring Lisa
Stansfield and Hugo Speer, and Basil starring Christian Slater and Claire
Forlani. Also in various stages of production for the Company's current
distribution slate under the Magic Adventure banner are seven family films for
direct-to-video release.

In addition, the Company continues to acquire domestic cable rights for films
for distribution through KLC/New City, including over 125 low budget feature
films which are distributed to the pay-per-view, pay cable, basic cable and
other ancilliary markets. The Company also continues to acquire the
international distribution rights to films for distribution through Kushner
Locke International, Inc. The Company has acquired international distribution
rights to two feature films which recently completed production, One Man's Hero
starring Tom Berenger being distributed domestically by MGM, and Minion starring
Dolph Lundgren. In fiscal 1998, the Company recognized $12,900,000 of revenues
from licenses of its existing library and from domestic distribution of films
acquired through KLC/New City.

In 1998, the Company financed the production of Ringmaster starring Jerry
Springer. The Company licensed domestic distribution rights to Artisan
Entertainment which released the picture theatrically in November 1998. The
Company continues to license the foreign distribution rights to the film and
retains the right of ownership of such film.

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In 1997 the Company entered into an agreement in principle with Universal
Studios, Inc. ("Universal"), whereby the Company has the right to distribute in
international territories up to nine moderate to high-budget motion pictures
over a three-year period. Universal would contribute 45% of production costs and
own the North American distribution rights and the Company would contribute 55%
of production costs and own foreign distribution rights for such pictures. The
Company has the right to select the motion pictures, if any, to be distributed
among titles made available by Universal. No pictures have yet been selected
under such agreement. In the event Universal and the Company agree upon one or
more films under the arrangement, management currently expects to finance its
acquisition of the distribution rights via credit facilities not presently in
place.

Since its inception in 1983, the Company has produced or distributed over 1,000
hours of original television programming, including various television series,
movies-for-television and mini-series. The Company's recent movies-of-the-week
which have aired include Princess in Love for CBS, starring Julie Cox, Every
Woman's Dream for CBS starring Jeff Fahey, A Husband, A Wife and a Lover for CBS
starring Judith Light, Echo for ABC starring Jack Wagner, Jack Reed for NBC,
starring Brian Dennehy and Unlikely Angel for CBS, starring Dolly Parton. For
fiscal 1998, the Company's television slate generated $18,500,000 of revenue,
principally from network and international licensing of the former one hour ABC
prime time network series Cracker starring Robert Pastorelli (through a joint
venture with Granada Television under a 16 episode order), 26 one hour episodes
of the syndicated television series Hammer starring Stacy Keach, a half-hour HBO
series which the Company is distributing to international and other domestic
markets, and 26 half-hour episodes of Mowgli: The New Adventures of The Jungle
Book, including 13 episodes for the Fox Kids Network. As of September 30, 1998,
the Company had 7 movies-for-television and one television series in different
stages of development for potential production. In various stages of production
for the Company's current television slate are Killer App, a one-hour pilot for
the Fox network written by Gary Trudeau and directed by Robert Altman and
Criminal Minds, a one-hour pilot for CBS.

TV First, a partnership 50% owned by the Company, purchases media time for
Christian music infomercials and commenced retail marketing of compact discs and
audio and video cassettes in fiscal 1999. Fiscal 1998 sales by the joint venture
exceeded $4,000,000.

The Company's operating revenues were $75,800,000 for the fiscal year ended
September 30, 1998, an increase of 33% from the $56,935,000 recognized for the
fiscal year ended September 30, 1997. This increase reflects revenues from the
acquired 800-US Search and increased availabilities of feature films.

The Company had 68 full-time employees as of December 15, 1998. The Company's
executive offices are located at 11601 Wilshire Boulevard, Suite 2100, Los
Angeles, California 90025, and its telephone number is (310) 481-2000.

800-U.S. SEARCH

GENERAL. 800-U.S. Search ("Search"), an 80% owned subsidiary of the Company, is
a leading provider of fee-based people search and other customized individual
reference services. Search uses a wide variety of public records and other
publicly available information on individuals. In August 1997, Peter Locke
obtained an option to acquire 45% of the common stock of Search, in exchange for
indemnification of the optionor against certain potential liabilities. In
November 1997, Mr. Locke exercised his option and immediately transferred the
Search common stock to an entity controlled by the Company in exchange for
indemnification against any liability of Mr. Locke to the optionor arising from
Mr. Locke's exercise of his option. Such entity subsequently acquired an
additional 35% of the common stock of Search from the remaining shareholder in
exchange for indemnification of the shareholder against certain potential
liabilities, bringing such entity's ownership to an aggregate of 80% of the
outstanding common stock of Search, and issued to the Company an option at a
nominal exercise price to acquire such 80% interest in exchange for the
assumption of certain liabilities. In January 1998, the Company exercised its
option.

Search's services are marketed through its 1800ussearch.com Internet world wide
web ("Web") site and through its direct response 1-800USSEARCH telephone number.
Search operates a 24 hour, seven days a week sales and service center, where its
employees research, aggregate and cross-check data from a wide variety of
sources. Research results are placed in a pre-formatted template and then
delivered to Search's customers via e-mail, fax or U.S. mail.

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In November 1998, Search's Web site averaged 49,000 unique visitors or users per
day. According to Media Metrix, a leading Internet usage measuring company,
Search's Web site was the seventh most visited directory on the Internet in
September 1998 and one of the top 150 most visited of all Web sites on the
Internet for September of 1998. Search's monthly revenues have grown from
$213,000 in November 1997 to $835,000 in October 1998. Internet sales have
increased from 4% of Search's monthly revenue in November 1997 to 40% in October
1998. With the introduction in December 1998 of new pricing strategies and
search services which provide limited instantaneous on-line results, Search has
improved its sales conversion rate to 1 out of approximately 110 unique Web site
visitors from 1 out of approximately 240 during the nine months ending September
30, 1998.

800-U.S. SEARCH'S INDIVIDUAL REFERENCE SERVICES. Search's current individual
reference search services consist of person locator services, individual
background checks, identification verification and adoption reunion services and
are available 24 hours a day, 7 days a week. Search supports these services with
trained customer service personnel available via telephone or online.

Person Locator. This service is targeted at people interested in finding
long-lost friends, family and other missing persons. With as little as a
person's name, date of birth, social security number or last known address,
Search searches various databases and public records to find the missing person.
Search currently charges from $39.95 up to $79.95 for a person locator search
and the customer receives the most current information found on the missing
person. Person locator searches represented 95% of all company searches in
November 1998.

Identification Verification. This service allows customers to search for
evidence of anyone using their social security number or assuming their identity
for fraudulent purposes. One of the major causes of credit card fraud is the
unlawful use of a person's social security number to surreptitiously gain
credit. The person whose identity that was used typically suffers expense of
time and money correcting the derogatory information which may later appear on
such person's credit reports. This service allows for early detection of such
activity, avoiding time consuming and costly resolution. Search's fee for this
service currently is $39.95 to $79.95 and the customer is provided with
discovered current and past addresses associated with their social security
number for the past 7-10 years, the telephone number, date of birth, any known
aliases, and name variations of the social security number, and the state and
year the social security number was issued.

Adoption Reunion. Over the past four years Search has received thousands of
calls from people wishing to find their biological family members. In response
to this growing demand, in July 1998, Search began marketing adoption search
services. The adoption search service is targeted at clients who have been
separated by adoption and would like to find biological family members. Search's
adoption search often requires much less information than the customer believes
is necessary. Search's fee for this service currently is $125.00. Beginning in
September 1998, Search began focusing a portion of its television and Internet
advertising toward this market.

INFORMATION DATABASE SOURCES. Search has instant access to an extensive list of
public record databases and other data. To run its searches, Search obtains
information on a purchase order basis from information service providers which
gives it access to Experian (formerly TRW Information Services), TransUnion,
Choice Point (formerly Equifax), Ameridex, On Line Searches, Metronet, CBD
Infotek, Vericheck and Information America. These service providers supply
Search with quick access to critical information such as aliases, drivers
license information, vehicle ownership, bankruptcies, property ownership, past
and current addresses, address profiles, current and previous telephone numbers,
judgments, deed transfer information, corporate affiliation information, UCC
filings, pilots licenses, and aircraft and water vessel ownership. Search
maintains open accounts with its service providers and pays fixed fees per
inquiry. Search is not dependent on any single third party source for any
particular public record information.

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USING SEARCH'S SERVICES.

Internet Transactions. Internet customers arrive at Search's Web site by either
linking to the site through a people search results page from one of Search's
Internet directory partners or by entering Search's Web site address into their
Internet browser in response to a television or print advertisement. Online
users are prompted to choose from different types of searches they would like to
perform, and then are guided through the ordering process.

Direct Response Transactions. Direct response customers call a toll-free
telephone number (1-800-US SEARCH) which plays a 50-second recorded message.
This message gives a brief description of the range of services provided by
Search and provides Search's telephone number for services. To continue, a
caller would then call directly into Search's pool of live search specialists
using another toll-free telephone number (1-800-987-7327). Search has
approximately 100 search specialists, and the response center receives customer
calls 24 hours a day, seven days a week. The search specialist then enters the
search information and payment information into Search's Internet server. The
Search fee is billed to a credit card or telephone number which appears on the
customer's telephone bill as a 900 number charge.

Search commenced its direct marketing operations in November 1994. Since its
inception, Search has received over 6,000,000 telephone inquiries regarding its
search services.

MARKETING. Search's marketing strategy is to promote, advertise and increase
Search's visibility and to acquire new customers through (i) the development of
distribution and marketing alliances with major Internet search engines and
directories, (ii) advertising on leading Web sites, (iii) the expansion of
Search's affiliates network and linking programs, (iv) an increase in national
television advertisements, and (v) the creation of a sales force for
business-to-business applications. Search believes that the use of multiple
marketing channels reduces reliance on any one source of customers, lowers
customer acquisition costs and maximizes brand awareness.

Strategic Alliances. Search has formed strategic alliances with several leading
Internet directories including InfoSpace.com, Infoseek.com, Switchboard.com, and
whowhere.lycos.com. Search believes that these directories reach the majority of
Internet users who access free people search services on the Search,
constituting a natural source of customers for paid individual references
services.

Television Advertisements. Search currently advertises on several leading
television programs including two times per week on Wheel of Fortune (the
highest rated syndicated show), four times per week on Leeza, and five times per
week on The Ricki Lake Show. In addition, Search recently added television
advertising on Judge Judy, Newlywed Game, Dating Game, Jeopardy (the second
highest rated syndicated show), Hollywood Squares, Judge Joe Brown, CNN,
Headline News and MSNBC. Search also has a relationship with PIC-TV, one of the
largest brokers of promotional fee spot advertising on television.

Search's executive offices are located at 9107 Wilshire Blvd., Suite 700,
Beverly Hills, California 90210, and its telephone number is (310) 553-7000.
Search had 83 full time employees and 14 part time employees as of December 24,
1998.

GRAN CANAL LATINO

In November 1998, the Company launched Gran Canal Latino ("GCL"), its first
satellite channel through a newly-formed 80%-owned subsidiary. GCL broadcasts 24
hours a day, with a selection of Spanish language films mostly from Spain. GCL's
satellite transmission reaches the United States and all of Latin America
including Mexico. Under a distribution arrangement with Enrique Cerezo, the
Company is broadcasting selections from 1,500 Spanish language movie titles.

FORWARD LOOKING STATEMENTS

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Except for the historical information contained herein, certain of the matters
discussed in this annual report are "forward-looking statements" as defined in
the Private Securities Litigation Reform Act of 1995 which involve certain risks
and uncertainties which could cause actual results to differ materially from
those discussed herein. Such risks and uncertainties include, but are not
limited to, liquidity and financing requirements, variability of quarterly
results and prior losses, increased interest expense, dependence on a limited
number of projects, certain accounting policies including amortization of film
costs, dependence on key personnel, production deficits, the risk involved in
the Internet, television and theatrical film industries, competition, government
regulation, labor relations, limited operating history and continued operating
losses of Search and GCL, reliance of Search on strategic relationships in
Internet market, uncertain acceptance and maintenance of the 1-800-USSearch
brand, risks associated with offering new services, risks associated with growth
and expansion, liability for online content, rapidly changing technology,
standards and consumer demands, online commerce security risks, including credit
card fraud, system disruptions and capacity constraints for Search, risks
associated with domain names, year 2000 compliance, shares available for future
sale, and the volatility of public markets. See the relevant discussions
elsewhere herein, and in the Company's registration statement on Form S-3
(Registration No. 333-40391), as filed on November 17, 1997 and the Company's
periodic reports and other documents filed with the Securities and Exchange
Commission for further discussions of these and other risks and uncertainties
pertaining to the Company and its business.

MOTION PICTURE INDUSTRY OVERVIEW

The business of the motion picture industry may be broadly divided into two
major segments: production, involving the development, financing and making of
motion pictures, and distribution, involving the promotion and exploitation of
completed motion pictures in a variety of media.

Historically, the largest companies, the so-called "Majors" and "mini-Majors,"
have dominated the motion picture industry by both producing and distributing a
majority of the motion pictures which generate significant box office receipts.
Over the past decade, however, "Independents" or smaller film production and
distribution companies, such as the Company, have played an increasing role in
the production and distribution of motion pictures to fill the increasing
worldwide demand for filmed entertainment product.

The Majors (and mini-Majors) include Universal Pictures, Warner Bros. Pictures,
Metro-Goldwyn-Mayer Inc., Twentieth Century Fox Film Corporation, Paramount
Pictures Corporation, Sony Pictures Entertainment (including Columbia Pictures,
TriStar Pictures and Triumph Releasing) and The Walt Disney Company (Buena Vista
Pictures, Touchstone Pictures and Hollywood Pictures). Generally, the Majors own
their own production studios (including lots, sound stages and post-production
facilities), have nationwide or worldwide distribution organizations, release
pictures with direct production costs generally ranging from $25,000,000 to
$75,000,000, and provide a continual source of pictures to film exhibitors. In
addition, some of the Majors have divisions which are promoted as "independent"
distributors of motion pictures. These "independent" divisions of Majors include
Miramax Films (a division of The Walt Disney Company), Sony Classics (a division
of Sony Pictures), The Samuel Goldwyn Company (a division of
Metro-Goldwyn-Mayer), October Films (a division of Universal), New Line (a
division of Time Warner) and its Fine Line distribution label, and Republic
Pictures (a division of Viacom).

In addition to the Majors, the Independents engaged primarily in the
distribution of motion pictures produced by companies other than the Majors
include, among others, Trimark Holdings and Artisan Entertainment. The
Independents typically do not own production studios or employ as large a
development or production staff as the Majors.

MOTION PICTURE PRODUCTION AND FINANCING

The production of a motion picture usually involves four steps: development,
pre-production, production and post-production. The development stage includes
developing a concept internally, or obtaining an original screenplay or a
screenplay based on a pre-existing literary work, or acquiring and rewriting a
screenplay. Creative personnel may be contacted to determine availability and
for planning the timing of the project, or in some cases actually hired. In
pre-production, a budget is prepared, the remaining creative personnel,
including a director, actors and various technical

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personnel are hired, shooting schedules and locations are planned and other
steps necessary to prepare for principal photography are completed. Production
is the principal photography of the project and generally continues for a period
of not more than three months. In post-production, the film is edited and
synchronized with music and dialogue and, in certain cases, special effects are
added. The final edited synchronized product, the negative, is used to
manufacture release prints suitable for public exhibition.

The production of a motion picture requires the financing of the direct and
indirect overhead costs of production. Direct production costs include film
studio rental, cinematography, post-production costs and the compensation of
creative and other production personnel. Distribution costs (including costs of
advertising and release prints) are not included in direct production costs.

The Majors generally have sufficient cash flow from their motion picture and
related activities, or in some cases, from unrelated businesses (e.g., theme
parks, publishing, electronics, and merchandising) to pay or otherwise provide
for their production costs. Overhead costs are, in substantial part, the
salaries and related costs of the production staff and physical facilities which
the Majors maintain on a full-time basis. The Majors often enter into contracts
with writers, producers and other creative personnel for multiple projects or
for fixed periods of time.

Independents generally avoid incurring substantial overhead costs by hiring
creative and other production personnel and retaining the other elements
required for pre-production principal photography and post-production activities
only on a project-by-project basis. Unlike the Majors, Independents also
typically finance their production activities from various sources, including
bank loans, "pre-sales," equity offerings and joint ventures. Independents
generally attempt to complete their financing of a motion picture production
prior to commencement of principal photography, at which point substantial
production costs begin to be incurred and require payment.

"Pre-sales" are often used by Independents to finance all or a portion of the
direct production costs of a motion picture. Pre-sales consist of fees or
advances paid or guaranteed to the producer by third parties in return for the
right to exhibit the completed motion picture in theaters or to distribute it in
home video, television, international or other ancillary markets. Independents
with distribution capabilities may retain the right to distribute the completed
motion picture either domestically or in one or more international markets.
Other independents may separately license theatrical, home video, television,
international and other distribution rights among several licensees. Payment
commitments in a pre-sale are typically subject to delivery and to the approval
of a number of prenegotiated factors, including script, production budget, cast
and director.

Both Majors and Independents often acquire motion pictures for distribution
through an arrangement known as a "negative pickup" under which the Major or
Independent agrees to acquire from another production company some or all rights
to a film upon its completion. The Independent often finances production of the
motion picture pursuant to financing arrangements with banks or other lenders
wherein the lender obtains a security interest in the film and in the
Independent's rights under its distribution arrangement. When the Major or
Independent "picks up" the completed motion picture, it may assume some or all
of the production financing indebtedness incurred by the production company in
connection with the film. In addition, the Independent is often paid a
production fee and is granted a participation in the profits from distribution
of the motion picture.

Both Majors and Independents often grant third-party participations in
connection with the distribution and production of a motion picture.
Participations are contractual rights of actors, directors, screenwriters,
producers, owners of rights and other creative and financial contributors
entitling them to share in revenues or profits (as defined in the respective
agreements) from a particular motion picture. Except for the most sought-after
talent, participations are generally payable only after all distribution and
marketing fees and costs, direct production costs (including overhead) and
financing costs are recouped by the producer in full.

MOTION PICTURE DISTRIBUTION

Distribution of a motion picture involves the domestic and international
licensing of the picture for (i) theatrical

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exhibition, (ii) home video, (iii) presentation on television, including
pay-per-view, video-on-demand, satellites, pay cable, network, basic cable and
syndication, (iv) non-theatrical exhibition, which includes airlines, hotels,
armed forces facilities and schools and (v) marketing of the other rights in the
picture, which may include books, CD-ROMs, merchandising and soundtrack
recordings.

Theatrical Distribution and Exhibition. Motion pictures are often exhibited
first in theaters open to the public where an admission fee is charged.
Theatrical distribution involves the manufacture of release prints; licensing of
motion pictures to theatrical exhibitors; and promotion of the motion picture
through advertising and promotional campaigns. The size and success of the
promotional and advertising campaign may materially affect the revenues realized
from its theatrical release, generally referred to as "box office gross." Box
office gross represents the total amounts paid by patrons at motion picture
theaters for a particular film, as determined from reports furnished by
exhibitors. The ability to exhibit films during summer and holiday periods,
which are generally considered peak exhibition seasons, may affect the
theatrical success of a film. Competition among distributors to obtain
exhibition dates in theaters during these seasons is significant. In addition,
the costs incurred in connection with the distribution of a motion picture can
vary significantly depending on the number of screens on which the motion
picture is to be exhibited and the ability to exhibit motion pictures during
peak exhibition seasons. Similarly, the ability to exhibit motion pictures in
the most popular theaters in each area can affect theatrical revenues.
Exhibition arrangements with theater operators for the first run of a film
generally provide for the exhibitor to pay the greater of 90% of ticket sales in
excess of fixed amounts relating to the theater's costs of operation and
overhead, or a minimum percentage of ticket sales which varies from 40% to 70%
for the first week of an engagement at a particular theater, decreasing each
subsequent week to 25% to 30% for the final weeks of the engagement. The length
of an engagement depends principally on the audience response to the film.

Films with theatrical releases (which generally may continue for several months
domestically) typically are made available for release in other media as
follows:

<TABLE>
<CAPTION>
MONTHS AFTER
THEATRICAL APPROXIMATE RELEASE
MARKET RELEASE PERIOD
------ ------------- -------------------
<S> <C> <C>
Domestic home video.................. 4 - 6 months 6 months
Domestic pay-per-view................ 6 - 9 months 3 months
Domestic pay cable................... 10 - 18 months 12 - 21 months
Domestic network or basic cable...... 30 - 36 months 18 - 36 months
Domestic syndication................. 30 - 36 months 3 - 15 years
International theatrical............. -- 4 - 6 months
International home video............. 6 - 12 months 6 months
International television............. 18 - 24 months 18 months - 10 years
</TABLE>

Home Video. The home video distribution business involves the promotion and sale
of videocassettes and videodiscs to video retailers (including video specialty
stores, convenience stores, record stores and other outlets), which then rent or
sell the videocassettes and videodiscs to consumers for private viewing. The
home video marketplace now generates total revenues greater than the domestic
theatrical exhibition market.

Major feature films are usually scheduled for release in the home video market
four to six months after theatrical release to capitalize on the recent
theatrical advertising and publicity for the film. Promotion of new home video
releases is generally undertaken during the nine to twelve weeks before the home
video release date. Videocassettes of feature films are generally sold to
domestic wholesalers on a unit basis. Unit-based sales typically involve the
sales of individual videocassettes to wholesalers or distributors at $50.00 to
$60.00 per unit and generally are rented by consumers for fees ranging from
$1.00 to $5.00 per day (with all rental fees retained by the retailer).
Wholesalers who meet certain sales and performance objectives may earn rebates,
return credits and cooperative advertising allowances. Selected titles including
certain made-for-video programs, are priced significantly lower to encourage
direct purchase by consumers. The market for direct sale to consumers is
referred to as the "priced-for-sale" or "sell-through" market.

<PAGE> 9

Technological developments, including videoserver and compression technologies
which regional telephone companies and others are developing, and expanding
markets for DVD and laser discs, could make competing delivery systems
economically viable and could significantly impact the home video market
generally and, as a consequence, the Company's home video revenues.

Pay-per-view. Pay-per-view television allows cable television subscribers to
purchase individual programs, primarily recently released theatrical motion
pictures, sporting events and music concerts, on a "per use" basis. The fee a
subscriber is charged is typically split among the program distributor, the pay-
per-view operator and the cable operator.

Pay Cable. The domestic pay cable industry (as it pertains to motion pictures)
currently consists primarily of HBO/Cinemax, Showtime/The Movie Channel,
Encore/Starz and a number of regional pay services. Pay cable services are sold
to cable system operators for a monthly license fee based on the number of
subscribers receiving the service. These pay programming services are in turn
offered by cable system operators to subscribers for a monthly subscription fee.
The pay television networks generally acquire their film programming by
purchasing the distribution rights from motion picture distributors.

Non-Theatrical Markets. In addition to the distribution media described above, a
number of sources of revenue exist for motion picture distribution through the
exploitation of other rights, including the right to distribute films to
airlines, schools, libraries, hotels, armed forces facilities and hospitals.

International Markets. The worldwide demand for motion pictures has expanded
significantly as evidenced by the development of new international markets and
media. This growth is primarily driven by the overseas privatization of
television stations, introduction of direct broadcast satellite services, growth
of home video and increased cable penetration. In September 1994 the Company
established foreign theatrical distribution operations for its own and third
party product.

MOTION PICTURE ACQUISITION

In addition to its own production activities, the Company continually seeks to
acquire rights to films and other programming from Independent film producers,
distribution companies and others in order to maximize the number of films it
can distribute in the emerging new delivery systems. To be successful, the
Company must locate and track the development and production of numerous
independent feature films.

Types of Motion Pictures Acquired. The Company generally seeks to produce or
acquire motion pictures across a broad range of genres, including drama,
thriller, comedy, science fiction, family, action and fantasy/adventure, which
will individually appeal to a targeted audience. The Company has been very
selective in acquiring higher budget (over $10,000,000) films because of the
interest that the Majors have shown in acquiring such films, and the associated
competition and higher production advances, minimum guarantees and other costs.
The Company acquires projects when it believes it can limit its financial risk
on such projects through, for example, significant presales, and when it
believes that a project has significant marketability. In most cases, the
Company attempts to acquire rights to motion pictures with a recognizable
marquis "name" personality with public recognition, thereby enhancing promotion
of the motion pictures in the home video or international markets. The Company
believes that this approach increases the likelihood of producing a product
capable of generating positive cash flow, ancillary rights income and the
possibility of a theatrical release.

Methods of Acquisition. The Company typically acquires films on either a
"pick-up" basis or a "pre-buy" basis. The "pick-up" basis refers to those films
in which the Company acquires distribution rights following completion of most
or all of the production and post-production process. These films are generally
acquired after management of the Company has viewed the film to evaluate its
commercial viability.

The "pre-buy" basis refers to films in which the Company acquires distribution
rights prior to completion of a substantial portion of production and
post-production. Management's willingness to acquire films on a pre-buy basis is
based upon

<PAGE> 10

factors generally including the track record and reputation of the picture's
producer, the quality and commercial value of the screenplay, the "package"
elements of the picture, including the director and principal cast members, the
budget of the picture and the genre of the picture. Before making an offer to
acquire rights in a film on a pre-buy basis, the Company may work with the
producer to modify certain of these elements. Once the modifications are
considered acceptable, the Company's obligation to accept delivery and make
payment is conditioned upon receipt of a finished film conforming to the script
reviewed by the Company and other specifications considered important by the
Company.

Sources of Distribution Rights. Typically, projects are submitted directly to
the Company for consideration. To promote the submission of projects, the
Company relies primarily on its reputation as an Independent having significant
access to the international markets. The Company also relies upon the personal
contacts of its senior officers which have been generated through their prior
business and personal dealings with Majors, other Independents, legal and
accounting firms, business management firms, talent agencies, production lenders
and personal managers who are actively involved in the production community.

Acquisition Process. If the Company locates a motion picture project which it
believes satisfies its criteria, the Company may pay an advance or a guaranteed
minimum payment conditioned upon delivery of a completed film ("minimum
guarantee") against a share or participation in the revenue actually received by
the Company from the exploitation of a film in each licensed media. The minimum
guarantee is generally paid prior to the film's release. Typically, the Company
will recoup the minimum guarantee and certain other amounts from the
distribution revenues realized by the Company prior to paying any additional
revenue participation to the production company.

Film Library. The Company's distribution rights, which may include either
worldwide, foreign, or domestic rights, generally range from an initial
licensing cycle of seven to 21 years to perpetuity.

COMPANY FEATURE FILM PRODUCTION

The Company's feature film division was established in 1993 to develop and
produce low and medium budget films. The Company's low to medium budget films to
date have had production budgets ranging from less than $1 million to $10
million, although the Company from time to time may release films having higher
budgets. The Company's low-budget films are primarily targeted for direct
distribution to the television market and its medium-budget films may be
targeted for theatrical release. The Company generally retains distribution
rights for licensing to third parties internationally. The Company's films
generally are distributed by third parties domestically or are limited to
international distribution. In unique circumstances, the Company undertakes
limited domestic distribution or co-distribution activities.

The Company's feature film strategy generally is to develop and produce feature
films when the production budgets for the films are expected to be substantially
covered through a combination of pre-sales, output arrangements, equity
arrangements and production loans with "gap" financing. To further limit the
Company's financing risk or to obtain production loans, the Company often
purchases completion bonds to guarantee the completion of production.

The following films were released or delivered by the Company or its joint
ventures in fiscal 1998:

Denial Pay Cable or December 1997 Jason Alexander
Video

Minion Pay Cable or March 1998 Dolph Lundgren
Video

Possums Theatrical December 1997 Mac Davis

Susan's Plan Theatrical September 1998 Natassja Kinski, Billy
Zane, Michael Biehn, Rob
Schneider, Lara Flynn Boyle
and Dan Aykroyd

Black and White HBO Premiere September 1998 Gina Gershon

Girl Theatrical June 1998 Dominique Swain

One Man's Hero MGM Theatrical June 1998 Tom Berenger

Taxman Pay Cable or June 1998 Joe Pantoliano
Video

Legion Pay Cable or December 1997 Parker Stevenson
Video
</TABLE>

<PAGE> 11

<TABLE>
<CAPTION>
Picture Initial Media Delivery/Release Date Principal Talent
- ------- ------------- --------------------- ---------------------------
<S> <C> <C> <C>
Swing Theatrical September 1998 Lisa Stansfield and Hugo
Speer
Jungle Book: The Pay Cable and December 1997
Search for the Video
Elephant Eye Diamond

Nine family pictures Video/Cable Various

Noose Theatrical December 1997
</TABLE>

<PAGE> 12

The following films were released or delivered or are currently scheduled for
release or delivery by the Company in fiscal 1999:

<TABLE>
<CAPTION>
Expected
Picture Initial Media
- --------------------- ----------------
<S> <C>
Mambo Cafe Theatrical

Confessions of a Theatrical
Trickbaby

Seven family pictures Video/Cable

Ringmaster Theatrical

But I'm A Cheerleader Theatrical
</TABLE>

There is no assurance that any motion picture which has not yet been released
will be released, that a change in the scheduled release dates of any such films
will not occur or, if such motion picture is released, it will be successful.
The Company has various additional potential feature films under development.
There is no assurance that any project under development will be produced.

International Distribution

From April 1997 through September 1998 Pascal Borno handled the Company's
international distribution activities as President of Kushner-Locke
International pursuant to an employment agreement ( the "Borno Agreement")
entered into in April 1997. As an integral part of the Borno Agreement, the
Company agreed to hire three employees of Mr. Borno's company, Conquistador
Entertainment, as additional sales and marketing personnel and further agreed to
distribute certain theatrical motion pictures which had been licensed by
Conquistador. Conquistador would conduct no new business during the term of Mr.
Borno's employment with the Company, and Conquistador did not retain any
separate staff. The Company's retention of Mr. Borno and related arrangements
relating to Conquistador were all reflected in the Borno Agreement and were
negotiated at arm's length before the company had any business relationship with
Mr. Borno, Conquistador, or its other employees. Following Mr. Borno's departure
in September 1998, Chris Perry-Melish assumed responsibility for handling the
Company's international distribution activities.

TELEVISION INDUSTRY OVERVIEW

The domestic television market remains the largest in the world, consisting of
the principal broadcast networks and their affiliates, independent television
stations and cable television networks. Expanding international television
broadcast, cable and satellite delivery systems offer further opportunities for
the exploitation of television programming.

Domestic Market. The domestic market for television programming primarily is
composed of four submarkets: the broadcast television networks (ABC, CBS, NBC
and Fox and emerging networks UPN and WBN), pay cable services (such as
HBO/Cinemax, Encore/Starz and Showtime/The Movie Channel), basic cable services
(such as USA Network, the Arts & Entertainment Network, Lifetime, The Family
Channel, The Disney Channel, and Turner Broadcasting Network) and syndicators of
first-run programming (such as MCA, King World Productions and Multimedia,
Inc.).

The domestic broadcast television market currently is dominated by the four
major networks, each of which has approximately 200 affiliated stations. The
affiliates broadcast network-supplied programming and national commercials in
return for payments by the major networks. This relationship results in the
networks being able to reach virtually all of the significant domestic
television markets. There are also a significant number of independent
commercial television stations in the United States. These stations offer an
alternative to network distribution through syndication. The network schedule
provides affiliates with only a portion of their daily program schedule, and the
balance of the time is filled with programs acquired through television
syndication companies or produced locally by the station.

Cable services generally are classified as being in one of four categories:
telephone delivery, superstations, pay cable services (e.g., HBO/Cinemax) and
basic cable networks (advertiser-supported, e.g., The Family Channel). The most
successful cable networks reach more than 60% of the U.S. television households.
Recently developed digital

<PAGE> 13

compression technology combined with fiber optics or small-sized satellite
dishes may permit cable companies, telephone companies or direct broadcast
satellite systems to expand the domestic television market up to 500 or more
channels.

Television Programming. Each of the three major television networks currently
broadcasts approximately 22 hours of prime-time programming and approximately 30
hours of daytime programming each week. Prime-time programming generally
consists of half-hour series (often situation comedies), reality shows,
hour-length series, movies-for-television (films of two hours or less) and
mini-series (dramatic epics of three hours or more). The increased channel
capacity and large base of cable subscribers that have developed during the
1980s and 1990s have made possible the development of a number of pay cable and
basic cable networks which have become important purchasers of both original and
rerun television programming, including movies-for-television, mini-series and
series. Suppliers of television programming include the production division or
affiliated companies of the major networks, major film studios (Majors), station
owners and independent producers (Independents) such as the Company.

International Markets. The number of international outlets for television
programming has been increasing with the worldwide proliferation of broadcast,
cable and satellite delivery systems. Over the last ten years, European
governments have privatized television systems in several countries, including
Germany, Italy, France and Spain. The Company believes privatized systems are
more likely to broadcast American programming than government-owned networks. In
addition, both the number of pay and satellite television systems in Europe and
the number of subscribers to these systems have increased. Pay television and
satellite distribution systems also are developing in other geographic areas,
including many Asian countries. In international markets, suppliers of
programming may be subject to local content and quota requirements which
prohibit or limit the amount of American programming in particular markets. See
"Business-Government Regulations."

COMPANY TELEVISION STRATEGY

The Company was founded in 1983 to develop and produce, on a cost-effective
basis, quality television programming with broad appeal. The Company's
television business has evolved from the production of programs owned by third
parties and typically airing on local television stations in the first-run
syndication market, such as the long-running daytime series Divorce Court, to
the development, production and ownership of series, movies-for-television and
mini-series for major domestic and international television networks and the
expanding pay and basic cable markets. In 1991, the Company established an
international distribution licensing operation for its own and acquired
television programming. The Company believes that through the control of the
distribution of its own programming this operation has increased the Company's
ability to recover the cost of new programs and to retain the fees and profit
potential previously realized by third parties.

The Company seeks to increase the amount of programming it provides to the major
U.S. networks, primarily one-hour series, movies-of-the-week and mini-series, in
part because the Company believes network exhibition enhances a television
program's potential value both in international markets and potential rerun
syndication. To increase the likelihood of developing programs that will be
licensed by the networks, the Company has expanded its roster of
network-approved writers, producers and actors and literary materials and rights
acquisition budgets. As of September 30, 1998, the Company had 7
movies-for-television and one television series in active development for
potential production, many of which are being funded at least in part by the
networks or other third parties.

To position itself for the perceived growth in this market, the Company is
actively acquiring various forms of domestic cable, video-on-demand and
satellite rights from third party producers for license periods ranging from
fifteen years to perpetuity through its KLC/New City joint venture. The
customary release cycle includes a period of approximately six months of
pay-per-view followed by 18 to 24 months of pay cable, finally 24 to 48 months
of basic cable, and free television thereafter.

The Company utilizes licensing and co-production arrangements to fund the costs
of production, and generally retains additional licensing rights including, in
the case of series, rerun syndication rights which offer future upside profit

<PAGE> 14

potential. The Company generally does not commence principal photography of its
television programming without first obtaining license or other revenue
commitments or production financing which equal all or a substantial portion of
the budgeted production costs. By obtaining license fees and other pre-committed
revenues through the efforts of its international television distribution
division to cover a substantial portion or all of its budgeted production costs,
the Company believes that it reduces many of the financial risks associated with
an individual production.

TELEVISION PROGRAM FINANCING

Development Costs. The Company generally finances project development costs
without third-party involvement until the script commitment stage. Because of
the likelihood that the significant costs in producing scripts and pilots will
not be recovered, the Company attempts to limit its financial investment by
obtaining financial commitments from networks or other third parties to cover
all or a substantial portion of these costs. See "Business-Television Projects
in Development."

Program Licensing. Generally, the Company licenses to a network the right to
broadcast a program for a period ending the earlier of the second broadcast of
the program or four years from delivery in exchange for a license fee which
represents a portion of the program's budgeted production cost. The remaining
amount is referred to as the "production deficit". The Company generally retains
all other rights to the program and will usually license certain rights to
international broadcasters, enabling the Company to recoup all, or a portion, of
the production deficit. In addition, the Company will typically license
additional domestic releases in other media to cover the remainder, if any, of
the production deficit. A production order sets forth the principal terms for a
license of the Company's product to a network and specifies the license fee to
be paid and the conditions to be met for payment. Production orders typically
are contingent on the producer's obtaining certain approvals from the network,
including the script, principal cast and director, prior to commencement of
principal photography. The Company usually receives its license fee in
installments, with one-third due on or prior to commencement of principal
photography, one-third due upon completion of principal photography and
one-third due upon delivery of the completed program. International distribution
typically involves licensing the rights to exhibit programming in international
territories to broadcasters within those territories for a fixed license fee
usually payable after the program has been completed. Due to timing differences
between the Company's receipt of license fees and its payment of production
costs, the Company generally is required to fund at least a portion of its
production costs from working capital or secured borrowings, even if the
original license fees equal or exceed budgeted production costs.

For first-run syndication programs, license agreements with the first-run
syndicator generally provide the Company a fixed license fee and a percentage of
revenues from distribution after the syndicator recoups the fixed license fee
and its distribution fees and costs.

An alternate first-run syndication revenue source is called "barter" sales. A
television station, in lieu of or in combination with paying licensing fees, may
grant to the Company's distributor the right to sell advertising spots during
the exhibition of the Company's television program. For a program to be
barterable, exhibition of the program on stations reaching at least 70% of the
U.S. television households and in most of the top ten major metropolitan areas
typically is required. The amount of the fee paid by the advertiser is
conditioned upon the program achieving certain agreed upon ratings. If the
specified rating is not achieved, the distributor is required to "make good" by
giving the advertiser additional advertising time or cash payment, and the
Company's share of barter revenues decreases. The Company has licensed its
television series Hammer and Could It Be a Miracle on this basis.

The Company seeks to cover most or all of its production costs with license fees
and other pre-committed revenues, however it may finance some of the production
costs on its own and may rely on subsequent licensing in international or other
ancillary markets to recoup the remaining production costs. Additional profits
from a television program initially shown on a network or cable service are
realized from subsequent reruns of the program on local television stations,
international delivery systems and cable services after exhibition on a major
network or cable service. In any event, any production is subject to the risk of
cost overruns, and there is no assurance that the Company will be able to
recover any investment it undertakes in a deficit-financed project.

<PAGE> 15

International Co-Productions. An international co-production is a joint venture
or partnership between entities in two or more countries which in certain cases
take advantage of alternative sources of financing for its productions, to
utilize international tax benefits, to pass foreign quota restrictions and to
benefit from lower pre-production costs in certain foreign countries. In a
typical co-production arrangement, the Company transfers all or part of its
copyright ownership in the project to third parties (the co-production
entities), which generally provide a portion of the production financing and
other services. Typically, the co-production partners grant distribution rights
to the Company. Receipts from its distribution of the project recoup production
funding, production fees, talent participations, distribution fees and expenses.
Excess receipts, if any, are distributed to the various parties in accordance
with their agreed-upon profit participation. The Adventures of Pinocchio is an
example of a co-production with German, French and English participation.

Producer-for-Hire. In addition to developing and producing its own programs, the
Company may be hired as a producer-for-hire for a creative concept or literary
property owned by another person. There are at least two types of
producer-for-hire arrangements. Under the first type, the Company receives a set
fee and agrees to deliver the completed program for that fee. The Company's
profit is the excess of its fee over its production costs. If production costs
exceed the package fee, the Company bears the deficit. Under the second type,
the Company furnishes personnel as a producer, receives a fixed fee per episode
and the production costs of the program are reimbursed directly by the
distributor. The Company's production of 860 episodes of Divorce Court from 1984
to 1988 was on a producer-for-hire basis.

Rerun Syndication. Domestic rerun syndication typically involves the exhibition
of programming on local television stations and cable services after exhibition
on a major network. Since production costs for network series may exceed network
license fees and other pre-committed revenues, some television production
companies depend on successful syndication of their programming for profitable
operations. Generally, to be successful in rerun syndication, a television
series must have at least 66 episodes (the equivalent of three full television
seasons).

TELEVISION PRODUCTION ACTIVITIES

As a producer, the Company first develops literary properties internally or
acquires them from third parties. The Company may refine the concept of an
acquired property. It then attempts to interest one of the networks or another
buyer in the project. If the buyer is interested in a concept presented to it,
the buyer will usually order a script from the Company. Once the script is
delivered, the buyer may order production of a single pilot episode or a limited
number of episodes in the case of a series, or the entire production in the case
of a movie-for-television or mini-series.

Once production is ordered, the Company and the buyer negotiate a financing
arrangement. The Company then undertakes pre-production activities in which a
budget is prepared, the screenplay is polished or rewritten, director, actors, a
line producer and technical personnel are engaged, filming is scheduled,
locations are arranged and other steps are taken to prepare the project for
principal photography. By this point, the Company generally has negotiated
license fees and obtained other commitments to cover a substantial portion of
the budgeted production costs. Principal photography is then undertaken,
followed by post-production, in which the film is edited, synchronized with
music and dialogue and, in certain cases, special effects are added. In the case
of a series, if episodes are ordered and the ratings are sufficiently strong,
additional episodes may be ordered for the entire season and then for additional
seasons.

The Company hires writers, directors, cast and crew members on a
project-by-project basis. The terms of employment and compensation are
negotiated in light of an individual's previous experience, the prevailing
market conditions and, where applicable, collective bargaining agreements. The
Company also obtains locations, sets and post-production personnel and
facilities on an as-needed basis. The Company believes that production and
post-production personnel and facilities are in ample supply at competitive
rates.

The production of animated programming is a labor-intensive process that
commences with artistic sketches of the various characters and the story line.
Storyboards, models, songs and voice elements are then sent to various
production companies, typically in Asia, where drawings of the animation frames
are prepared. The frames are painted and then subsequently photographed to
create film. The film is then usually sent back to the United States, where
final editing of

<PAGE> 16

footage and mixing of sound effects, dialogue and music is completed, although
on occasion final editing and mixing may be completed in Asia.

The following table summarizes the Company's television programming for fiscal
1998, the type of program and the network or other medium where such programming
initially exhibited or will exhibit:

<TABLE>
<CAPTION>
First Fiscal 1998
Title Type of program Exhibition Deliveries
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Mowgli: The New Adventures
of The Jungle Book (26 1/2 hour Series Fox Kids 7
total episodes) Worldwide

Erotic Confessions (52 total 1/2 hour Series HBO 33
episodes)

Cracker (16 total episodes) One hour Series ABC 11

Hammer (26 total episodes) One hour Series Syndication 19

Killer App One hour Series Fox 0
(Pilot)

Criminal Minds One hour Series CBS 0
(Pilot)

Denial HBO premiere HBO 1

Bone Daddy HBO premiere HBO 1

Black and White HBO premiere HBO 1
</TABLE>

There is no assurance that any television program which has not yet aired will
be aired, that a change in the scheduled airing date of such programming will
not occur or, if such television program is aired, that it will be successful.

TELEVISION PROJECTS IN DEVELOPMENT

The Company requires adequate access to program concepts, ideas and scripts.
Such access is dependent upon numerous factors, including the reputation and
credibility of the Company in the creative community, the relationships the
Company has in the entertainment industry and the Company's financial and other
resources. The Company occasionally enters into agreements with producers and
writers to develop or acquire new programming. While the Company may finance the
early development of such projects, the Company typically does not proceed with
the preparation of a script or the production of a pilot, which involves a more
significant financial commitment, unless a network or other buyer has agreed to
fund all or a substantial portion of the costs associated therewith.

The following table sets forth potential television movies in various stages of
development and the potential network or other medium to which each may be
delivered, if known:

<TABLE>
<CAPTION>
Working Title Type of Program
- -----------------------------------------------------------
<S> <C>
Aliens Ate My Homework Movie-of-the-week (Showtime)
Jack Reed VI Movie-of-the-week (NBC)
The Life She Left Behind Movie-of-the-week (CBS)
Coast Guard One Hour Drama (ABC)
Murder of Tut Movie-of-the-Week (Fox)
After the Storm Movie-of-the-Week (USA)
Death Cloud Movie-of-the-week (TBS)
Unlikely Angel II Movie-of-the-week (CBS)
</TABLE>

While the Company has many projects in development, as is typical in the
industry, only a relatively small number of such projects are ultimately
produced (with the likelihood of production being more remote in the case of
television series). It is rare for any projects in development to have
production commitments until late in the development process. There is no
assurance that the Company's efforts in developing or acquiring potential new
programs, including any of the projects described above, will lead to production
commitments or that any programs that are ultimately produced will be
successful.

TELEVISION DISTRIBUTION ACTIVITIES

Domestic Distribution. The Company's original programming generally is initially
licensed to a network or cable broadcaster for a period expiring on the earlier
of two broadcasts or a period of up to four years from delivery. Following

<PAGE> 17

the expiration of the license, the rights typically revert to the Company's
library and become available for additional licensing. Further revenues are
generally obtained from subsequent licensing in the domestic market in other
media, including syndication, cable and home video.

International Distribution. In 1991, the Company commenced the distribution of
its own television programming and, to a lesser extent, acquired television
programs for distribution in international markets. Previously the Company had
utilized third parties to arrange for the distribution of its television
programming in international markets. Programming is distributed primarily to
local international broadcasters and, where available, the home video market,
pay television and cable services. The Company's international television
distribution operation has increased the Company's ability to recover the costs
of new programs and to retain the fees and profit potential previously realized
by outside distributors through the control of the distribution of its own
television programming, including the ability to package such product for
distribution in different media. The Company also believes its international
television distribution operation enables it to increase its distribution of
programs produced by others. In December 1994, the Company expanded its
activities in international distribution by establishing an international
distribution subsidiary. The Company's combined film and television distribution
division gives the Company increased control over the marketing of its product
line, greater bargaining strength, and improved cost efficiencies.

The Company's strategy has been to reduce its business risks in international
markets by securing business relationships with strong local distributors and
broadcasters. The Company has entered into output arrangements in certain
foreign territories with broadcasters and distributors who have agreed to
license distribution rights in such markets for all of the Company's product
produced during the specified term of the agreement (generally between three and
five years) at designated prices for various types of film or television
product.

LIBRARY

Since its inception in 1983, the Company has produced or acquired more than
1,000 hours of television programming. In addition, as a producer for hire, the
Company produced 860 episodes of Divorce Court, 65 episodes of the Night Games
game show, 34 episodes of the children's game show The Krypton Factor, the
animated feature film Pound Puppies: The Legend of Big Paw and the Family Dog
episode of Steven Spielberg's Amazing Stories.

The Company's current library includes a variety of feature films,
movies-for-television, television series, game shows and talk shows produced or
acquired by the Company since its inception. The following table sets forth, as
of September 30, 1998, certain completed feature films and television
programming in which the Company has ownership rights, distribution rights or
the right to share in future profit participation:

Feature Films

<TABLE>
<CAPTION>
Title First Exhibition
- -----------------------------------------------------------------------
<S> <C>
Animalympics NBC
The Brave Little Toaster Disney Channel
Andre Theatrical
Babysitters Home Video
Basil Cable
Beowulf Theatrical
Black and White Cable
Brave Little Toaster Goes to School Home Video
Brave Little Toaster Goes to Mars Home Video
Cafe Society Pay Cable
Closer, The Theatrical
Forbidden Passion Home Video
Deadly Exposure Home Video
Denial Cable
Double Tap Cable
Dragon World: The Legend Continues Home Video
Dream Master Home Video
</TABLE>

<PAGE> 18

<TABLE>
<CAPTION>
Title First Exhibition
- -----------------------------------------------------------------------
<S> <C>
Eggs From 70 Million B.C. Home Video
Flesh Suitcase Pay Cable
Freeway Pay Cable
The Incredible Genie Home Video
Girl Theatrical
The Grave Pay Cable
The Human Pets Home Video
Indecent Behavior Home Video
Johnny Mysto: Boy Wizard Home Video
Journey to the Magic Cavern Home Video
The Midas Touch Home Video
Lady-in-Waiting Home Video
Last Gasp Home Video
Last Battle for the Universe Home Video
The Last Time I Committed Suicide Theatrical
Legion Cable
Little Ghost Home Video
Lost World of the Giants Home Video
Medium Rare Home Video
Mesmer Home Video
Minion Cable
Naked Souls Home Video
Noose Theatrical
Oblivion HBO
One Man's Hero Theatrical
The Adventures of Pinocchio Theatrical
Planet of the Dino-Knights Home Video
Red Hot Home Video
Red Ribbon Blues Cable/Home Video
Sensation HBO
Serpent's Lair Pay Cable
Shrunken Heads Home Video
Susan's Plan Cable
Swing Theatrical
Taxman Cable
Test Tube Teens Home Video
Trapped in Toyworld Home Video
Wes Craven Presents: Mindripper Home Video
The Whole Wide World Theatrical
Alien Abduction Cable/Home Video
Angel of Passion Cable/Home Video
Banished Behind Bars Cable/Home Video
Bare Exposure Cable/Home Video
Bikini Drive In Cable/Home Video
Blonde Heaven Cable/Home Video
Caged Hearts Cable/Home Video
Call Girl Cable/Home Video
Cave Girl Island Cable/Home Video
Cellblock Sisters Cable/Home Video
Centerfold Cable/Home Video
Donor, The Cable/Home Video
Electra Cable/Home Video
Elke's Erotic Nights Cable/Home Video
Forbidden Games Cable/Home Video
Hard Bounty Cable/Home Video
Illicit Dreams II Cable/Home Video
Improper Conduct Cable/Home Video
Innocence Betrayed Cable/Home Video
International Beach Cable/Home Video
Irresistible Impulse Cable/Home Video
Jacko Cable/Home Video
Jungle Law Cable/Home Video
Lap Dancer Cable/Home Video
Love Me Twice Cable/Home Video
</TABLE>

<PAGE> 19

<TABLE>
<CAPTION>
Title First Exhibition
- -----------------------------------------------------------------------
<S> <C>
Lover's Concerto Cable/Home Video
Lurid Tales Cable/Home Video
Masseuse, The Cable/Home Video
Miami Models Cable/Home Video
Midnight Confessions Cable/Home Video
Midnight Tease II Cable/Home Video
Midnight Temptations Cable/Home Video
Petticoat Planet Cable/Home Video
Pleasure in Paradise Cable/Home Video
Powder Burn Cable/Home Video
Prelude to Love Cable/Home Video
Private Obsession Cable/Home Video
Professional Affair Cable/Home Video
Raven's Kiss Cable/Home Video
Second Sight Cable/Home Video
Seduction of Innocence Cable/Home Video
Sensuous Summer Cable/Home Video
Shadow Dancer Cable/Home Video
Siren's Kiss Cable/Home Video
Softbodies, The Movie Cable/Home Video
Spirit of the Night Cable/Home Video
Stolen Heart Cable/Home Video
Target of Seduction Cable/Home Video
Totally Exposed Cable/Home Video
Tropical Tease Cable/Home Video
Under Lock and Key Cable/Home Video
Under The Gun Cable/Home Video
Uninhibited Cable/Home Video
Virtual Desire Cable/Home Video
Wager of Love Cable/Home Video
</TABLE>

Television Movies and Mini-Series

<TABLE>
<CAPTION>
Title First Exhibition
- -----------------------------------------------------------------------
<S> <C>
Aladdin International
Glory Years (4 hours) HBO
Family Pictures ABC
JFK: Reckless Youth (3 hours) ABC
Carolina Skeletons NBC
Confessions: Two Faces of Evil NBC
Father and Son: Dangerous Relations NBC
Fire in the Dark CBS
Getting Gotti: The Diane Giacalone Story CBS
Good Cops, Bad Cops NBC
Jack Reed III: A Search For Justice NBC
Jack Reed IV: A Killer Amongst Us NBC
Jack Reed V: Death and Vengeance NBC
Dangerous Intentions CBS
Lady Killer CBS
Murder C.O.D. NBC
Kiss Shot CBS
Liberace: Behind the Music CBS
Overruled NBC
Sins of the Mother CBS
Sweet Bird of Youth NBC
Then There Were Giants NBC
To Save the Children CBS
Your Mother Wears Combat Boots NBC
Candles in the Dark Family Channel
City Boy PBS
Every Woman's Dream CBS
A Husband, A Wife and A Lover CBS
Innocent Victims NBC
</TABLE>

<PAGE> 20

<TABLE>
<CAPTION>
Title First Exhibition
- -----------------------------------------------------------------------
<S> <C>
Princess in Love CBS
Echo ABC
Unlikely Angel CBS
</TABLE>

Television Series/Game Shows

<TABLE>
<CAPTION>
Episodes
Title Produced First Exhibition
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Sweating Bullets 66 CBS
Pigasso's Place 13 Syndication
Teen Wolf 21 CBS
Mapletown 39 Syndication
Cinematractions 26 Syndication
1st and Ten 80 HBO
Harts of the West 15 CBS
Trial Watch 118 NBC
The Barbara De Angelis Show 70 CBS
Heroes: Made in the USA 38 Syndication
Profiles-Unauthorized Biographies 4 A&E
Relatively Speaking 90 Syndication
Erotic Confessions 39 HBO
Could It Be a Miracle 24 Syndication
Gun 6 ABC
Cracker 16 ABC
Mike Hammer 26 Syndication
Mowgli: The New Adventures of The Jungle Book 26 Fox Kids Worldwide
</TABLE>

A significant portion of the Company's library is under license in many of the
major domestic and international markets. Following the expiration of the
licenses, rights generally revert to the Company for relicensing.

JOINT VENTURES AND ANCILLARY ACTIVITIES

The Company has expanded into areas which exploit the characters and story ideas
in its feature films and television programs through joint ventures and
partnerships. The Company markets the music used in its productions through an
arrangement with Cherry Lane Music, Inc., a music publisher. Using its expertise
as a television producer, the Company produced two infomercials for its 50%
owned partnership TVFirst. TVFirst markets recorded Christian music sung by
contemporary Christian artists. From October 1995 through September 1998 music
revenues have exceeded $13,700,000.

Responding to the increased demand for product by the pay-per-view, telephone
delivery, pay cable and basic cable services, the Company formed an entity
called KLC/New City Tele-Ventures to acquire product from third parties for
distribution in the cable, pay service and satellite markets, as well as other
emerging markets. The joint venture has acquired over 100 films for this
purpose. The Company owns 82.5% of this entity.

The Company also holds 50% ownership interests in BLT Ventures, which produced
the two sequels to the animated feature Brave Little Toaster, Cracker Company
LLC, which produced the network television series Cracker, Swing Ventures, which
produced the feature Swing, and a 25% interest in Grendel Productions LLC, which
produced the feature Beowulf.

The Company holds 80% ownership interests in 800-US Search and Gran Canal
Latino, as described above.

GOVERNMENT REGULATIONS

The Federal Communications Commission ("FCC") repealed its financial interest
and syndication rules effective in September 1995. Those FCC rules, which were
adopted in 1970 to limit television network control over television programming
and thereby foster the development of diverse programming sources, restricted
the ability of the three established, major U.S. television networks (i.e., ABC,
CBS and NBC), to own and syndicate television programming.

<PAGE> 21

The ultimate impact of the repeal of the FCC's financial interest and
syndication rules on the Company's operations cannot be predicted at the present
time, although there has been an increase in in-house productions of programming
for the networks' own use since the effective date of the repeal of the FCC's
financial interest and syndication rules, and this has placed additional
competitive pressures on program suppliers, such as the Company.

Under the Telecommunications Act of 1996 (the "1996 Act"), manufacturers of
television set equipment are required to equip all new television receivers with
a so-called "V-Chip" which would allow for parental blocking of violent,
sexually-explicit or indecent programming based on a rating for any given
program that would be broadcast along with the program. The FCC is directed by
the 1996 Act to develop a ratings system based upon the recommendations of an
advisory committee selected by the FCC unless the television industry
establishes its own voluntary ratings system by February 1997. The television
networks did establish and have implemented such a system. Other provisions of
the 1996 Act revise the broadcast multiple ownership rules, allow local exchange
telephone companies to offer multichannel video programming service, subject to
certain regulatory requirements, and allow for cable companies to offer local
exchange telephone service, subject to certain regulatory requirements.

The impact on the Company of the changes brought about by the 1996 Act,
including the new ratings guidelines and by accompanying changes in FCC rules
cannot be predicted at the present time. However, it is possible that recent
alliances of certain program producers and television station group owners,
coupled with the recent FCC rule revisions allowing a single television station
licensee to own television stations reaching up to 35% of the nation's
television households, may place additional competitive pressures on program
suppliers, such as the Company, to the extent they are unaligned with the major
networks or any television station group owners.

In international markets, the Company's programming is occasionally subject to
local content and quota requirements, and/or other limitations, which prohibit
or limit the amount of programming produced outside of the local market.
Although the Company believes these requirements have not affected the Company's
licensing of its programs in international markets to date, such restrictions,
or new or different restrictions, could have an adverse impact on the Company's
operations in the future should opportunities to obtain foreign content not be
available.

In connection with certain services provided or intended to be provided by
Search, particularly individual background checks used for certain purposes,
Search may be considered a "consumer reporting agency" as such term is used in
the Fair Credit Reporting Act, as amended ("FCRA"), and, therefore, may be
required to comply with the various consumer credit disclosure requirements of
the FCRA. While Search intends to comply with the FCRA as a "consumer reporting
agency" in connection with providing individual background checks for employment
purposes in the future, the procedures which are implemented by the Company may
be deemed to be insufficient. In addition, Search's limited procedures to date
to avoid being regulated as a consumer reporting agency by attempting to
restrict its individual background check service to permissible purposes (which
do not permit use for employment purposes), may not be sufficient. Willful or
negligent noncompliance with the FCRA, including with respect to Search's prior
operations, could result in civil liability to the subjects of reports. Also,
the Americans with Disabilities Act of 1990 ("ADA") contains pre-employment
inquiry and confidentiality restrictions designed to prevent discrimination
against individuals with disabilities in the hiring process. The use by Search's
customers of certain information sold to them is also regulated, both in respect
to the type of information and the timing of its use by the ADA. Similarly,
there are a number of states which have laws similar to the FCRA, and some
states which have laws more restrictive than the ADA. Further, many state laws
limit the type of information which can be made available to the public. In
addition, certain state laws may require Search to be licensed in order to
conduct its background check business within those states. Customers in such
states can access Search's Web site, which may subject Search to the laws of
such states. There is no assurance that Search will not be subject to the laws
of states in which Search has no contacts other than through residents of such
state ordering services through Search's Web site and Search mailing, faxing or
e-mailing reports to the resident within such state. In the event Search is
determined to have violated any of the federal or state laws referred to herein,
Search could be subject to substantial civil and/or criminal liability which
could have a material adverse effect on the Company's business, financial
condition, results of operations and prospects.

<PAGE> 22

2. PROPERTIES

The Company leases approximately 23,000 square feet of office space on the 20th
and 21st floors at 11601 Wilshire Boulevard, Los Angeles, California under a
lease agreement through March 2000. The annual rent under the lease is
approximately $528,000. The Company's 80%-owned subsidiary, 800-US Search,
leases approximately 8,000 square feet of office space in Beverly Hills,
California under a lease agreement through February 2001. The annual rent under
the lease is approximately $174,000.

The Company rents studio facilities as needed for production, except that
certain post-production off-line editing is performed at the Company's executive
offices.

3. LEGAL PROCEEDINGS

In January 1998, the Company settled certain disputes with WarnerVision which
were the subject matter of a complaint filed against WarnerVision in June 1997,
and WarnerVision settled certain disputes with the Company which were the
subject matter of a complaint filed against the Company in October 1997. The
settlement clarified the Company's and WarnerVision's rights regarding the
exploitation of certain films, and WarnerVision reduced the Company's
contractual payment obligation to WarnerVision, which had been accrued but not
paid due to the disputes. Pursuant to the settlement, the Company paid
$1,543,000 to WarnerVision during fiscal 1998.

The Company is party to certain legal proceedings and claims arising out of the
normal course of business. The Company believes that the ultimate resolution of
all of these matters will not have a material adverse effect upon the Company's
financial position, results of operations or liquidity.

4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

PART II

5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's Common Stock is quoted on the NASDAQ National Market ("NNM") under
the symbol "KLOC." Additionally, the stock is listed on the Pacific Stock
Exchange under the symbol "KLO." The following table sets forth the range of
high and low sale prices for the Common Stock, as reported on the NNM, for the
periods indicated, as retroactively adjusted for a one-for-six reverse stock
split in September 1997:

<TABLE>
<CAPTION>
COMMON STOCK HIGH LOW
------------ ------------
<S> <C> <C>
FISCAL 1996
First Quarter (ended December 31, 1995)...................... $4.50 $2.82
Second Quarter (ended March 31, 1996)........................ 6.36 3.48
Third Quarter (ended June 30, 1996).......................... 9.00 5.46
Fourth Quarter (ended September 30, 1996).................... 8.64 3.36

FISCAL 1997
First Quarter (ended December 31, 1996)...................... 4.32 2.28
Second Quarter (ended March 31, 1997)........................ 3.36 1.86
</TABLE>

<PAGE> 23

<TABLE>
<CAPTION>
COMMON STOCK HIGH LOW
------------ ------------
<S> <C> <C>
Third Quarter (ended June 30, 1997).......................... 3.00 1.32
Fourth Quarter (ended September 30, 1997).................... 3.90 1.68

FISCAL 1998
First Quarter (ended December 31, 1997)...................... 5.25 2.44
Second Quarter (ended March 31, 1998)........................ 3.19 1.75
Third Quarter (ended June 30, 1998).......................... 3.78 1.75
Fourth Quarter (ended September 30, 1998).................... 5.13 2.44

FISCAL 1999
First Quarter (through December 24, 1998).................... 8.38 1.63
</TABLE>

On December 24, 1998, the last sale price for the Common Stock as reported on
the NNM was $6.6875. On November 30, 1998, there were approximately 745 record
holders

RECENT SALES OF UNREGISTERED SECURITIES; USES OF PROCEEDS

In December 1998, the Company issued to certain accredited investors 1,200,000
shares of Common Stock in a private placement with Allen & Company, Incorporated
as placement agent. The net proceeds to the Company of the private placement
were $5,673,000 after deducting a 5% placement agency fee and certain
reimbursable expenses of Allen & Company. The Common Stock issued in the private
placement was issued pursuant to exemptions from registration requirements under
Section 4(2) of the Securities Act of 1933, as amended (the "Act") and
Regulation D promulgated thereunder, and accordingly the Common Stock was not
registered under the Act and may not be offered or sold in the United States
absent registration or an applicable exemption from registration requirements.
The Company has agreed to file a registration statement covering the Common
Stock within 60 days of the closing of the private placement. The Company
expects to use the net proceeds for working capital and general corporate
purposes, including providing additional funding to Search for its operations.

DIVIDENDS

The Company has never paid any cash dividends and has no present intention to
declare or to pay cash dividends. The payment of dividends also is restricted by
covenants in the Company's credit agreement and the indentures and fiscal agency
agreements under which the Company's Convertible Subordinated Debentures were
issued. It is the present policy of the Company to retain any earnings to
finance the growth and development of the Company's business.

6. SELECTED FINANCIAL DATA

The following table summarizes selected consolidated financial data for the
Company and should be read in conjunction with the detailed consolidated
financial statements included elsewhere in this Annual Report. The selected
consolidated financial data for the fiscal years are derived from the
consolidated financial statements audited by PricewaterhouseCoopers LLP,
independent public accountants, whose report with respect to the consolidated
balance sheet of the Company as of September 30, 1998, and the related
consolidated statements of operations, cash flows and stockholders' equity for
the year ended September 30, 1998, and by KPMG Peat Marwick LLP, independent
public accountants, whose report with respect to the consolidated balance sheet
of the Company as of September 30, 1997, and the related consolidated statements
of operations, cash flows and stockholders' equity for each of the years in the
two year period ended September 30, 1997 each appears elsewhere in this Annual
Report. On October 20, 1998, the Company changed its independent public
accountants. See Part II, item 9 of this report on Form 10-K.

<PAGE> 24

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS DATA:

<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1998 1997 1996 1995 1994
------------ ------------- ------------ ---------- ----------
<S> <C> <C> <C> <C> <C>
Operating revenues............................ $75,800 $56,935 $80,157 $20,407 $50,736
Costs relating to operating revenues.......... (61,627) (52,084) (70,648) (17,404) (54,952)
Selling, general and administrative expenses.. (12,028) (4,023) (3,096) (3,388) (3,008)
Provision for bad debts....................... (2,118) (1,310) (499) (450) (200)
----------- ------------ ----------- --------- ----------
Earnings (loss) from operations............... 27 (482) 5,914 (835) (7,424)
Interest income............................... 79 163 198 300 197
Interest expense.............................. (6,261) (4,027) (4,027) (3,409) (2,209)
Interest expense related to bridge
note financing -- -- (943) -- --
----------- ------------ ----------- ---------- ----------
Earnings (loss) before income taxes and
cumulative effect of a change in accounting
principle and extraordinary item............ (6,155) (4,346) 1,142 (3,944) (9,436)
Income taxes.................................. (181) (23) (47) (31) 2,277
----------- ------------ ----------- ---------- ----------
Earnings (loss) before cumulative effect of a
change in accounting principle and
extraordinary item.......................... (6,336) (4,369) 1,095 (3,975) (7,159)
Cumulative effect of a change in
accounting for income taxes................. -- -- -- -- 394
----------- ------------ ------------ ---------- ----------
(6,336) (4,369) 1,095 (3,975) (6,765)
Extraordinary item: costs associated with
repayment of credit facility................ -- -- (365) -- --
----------- ------------ ------------ ---------- ----------
Net earnings (loss)........................... ($6,336) $(4,369) $730 $(3,975) $(6,765)
=========== ============ ============ ========== ==========
Basic and diluted earnings (loss)
per share(2):
Before cumulative effect of a change in
accounting and extraordinary items. $(.69) $(.49) $.16 $(.75) $(1.46)
Cumulative effect of a change in
accounting for income taxes........ -- -- -- -- .08
Extraordinary item..................... -- -- (.05) -- --
----------- ----------- ----------- ----------
Net earnings (loss).................... $(.69) $(.49) $.11 $(.75) $(1.38)
=========== =========== =========== ========== ========
Weighted average common shares outstanding(2) 9,181 8,959 6,668 5,286 4,896
=========== =========== =========== ========== ========
</TABLE>

CONDENSED CONSOLIDATED BALANCE SHEET DATA:
<TABLE>
<CAPTION>
SEPTEMBER 30,
-----------------------------------------------------
(IN THOUSANDS)

1998 1997 1996 1995 1994
----------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents(1)............................ $3,309 $16,791 $11,636 $4,301 $15,681
Accounts receivable, net................................ 40,418 27,696 22,885 7,864 6,177
Film and television property costs, net ............... 73,773 68,507 58,463 73,716 30,688
Total assets............................................ 137,105 124,368 100,152 88,952 54,254
Notes payable........................................... 73,151 62,647 41,481 28,398 9,600
Convertible subordinated debentures, net................ 11,526 11,631 12,039 17,745 22,056
Total liabilities....................................... 111,639 93,232 65,902 69,745 35,713
Stockholders' equity.................................... 25,466 31,136 34,250 19,207 18,541
========== ======== ======== ======== ========
</TABLE>

<PAGE> 25

- -----------

(1) $1,988 of cash and cash equivalents are restricted deposits that are
collateral for a sale/leaseback transaction and for certain production loans
for 1998 ($1,609 for 1997, $419 for 1996 and $1,162 for 1995) and $66 ($105
for 1997, $4,126 for 1996 and none for 1995) is cash collected by the
Company and reserved for use by Chase Manhattan Bank to pay down outstanding
borrowings under the Company's credit facility.

(2) In September 1997 the Company effected a 1-for-6 reverse stock split.
Amounts for all periods presented herein give retroactive effect to the
reverse split.

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

GENERAL

The Company's revenues are derived primarily from the production or the
acquisition of distribution rights of films licensed for release domestically by
studios, pay cable, basic cable and videocassette companies; and from the
development, production and distribution of television programming for the major
domestic television networks, basic and pay cable television and first-run
syndicators; as well as from the licensing of rights to films and television
programs in international markets. Major domestic television networks are
reducing the volume of independently produced television programming. The
Company generally finances all or a substantial portion of the budgeted
production costs of its programming through advances obtained from distributors
and borrowings secured by domestic and international licenses. The Company
typically retains rights in its programming to be exploited in future periods or
in additional markets or media. In 1993, the Company established a feature film
operation which produces low and medium budget films for theatrical and/or home
video or cable release. The Company produces a limited number of higher-budget
theatrical films to the extent the Company is able to obtain an acceptable
domestic studio to release the film theatrically in the U.S. In 1994, the
Company established an international theatrical film subsidiary to expand into
foreign theatrical distribution. In 1995, the Company formed KLC/New City
Tele-Ventures ("KLC/New City"), a joint venture 82.5% owned by the Company, to
acquire films for distribution through emerging new delivery systems, including
pay cable, pay-per-view, basic cable, video-on-demand and satellite systems. In
late 1997, the Company acquired control of 800-U.S. Search, a leading provider
of fee-based people search and other customized individual reference services.
In February 1998 the Company established KL/Phoenix, an 80% owned entity, which
distributes film and television product in Latin America.

The Company's revenues and results of operations are significantly affected by
accounting policies required for the industry and management's estimates of the
ultimate realizable value of its films and programs (See Note 1 of Notes to
Consolidated Financial Statements). Revenues from distributor production
advances or license fees received prior to delivery or completion of a program
are deferred. Production advances and deferred license fees are generally
recognized as revenue on the date the film or program is delivered or available
for delivery. Activities conducted through joint ventures, wherein the Company
reports its equity in earnings (losses) as revenues, can significantly affect
comparability of revenues. See "Results of Operations" below.

The Company generally capitalizes the costs it has incurred to produce a film or
television program. These costs include direct production expenditures, certain
exploitation costs, production overhead, and interest relating to financing the
project. Capitalized exploitation or distribution costs include those costs that
clearly benefit future periods such as film prints and prerelease and early
release advertising that is expected to benefit the film or program in future
markets. These costs, as well as third party participations and talent
residuals, are amortized each period on an individual film or television program
basis in the ratio that the current period's gross revenues from all sources for
the program bear to management's estimate of anticipated total gross revenues
for such film or program from all sources. In the event management reduces its
estimates of the future gross revenues associated with a particular product,
which had been expected to yield greater future proceeds, a significant
write-down and a corresponding decrease in the Company's earnings for the
quarter and fiscal year end in which such write-down is taken could result. See
"Results of Operations-

<PAGE> 26

Comparison of Fiscal Years Ended September 30, 1998 and 1997" and "Results of
Operations-Comparison of Fiscal Years Ended September 30, 1997 and 1996."

Gross profits for any period are a function, in part, of the number of programs
delivered in that period and the recognition of costs in that period. Because
initial licensing revenues and related costs generally are recognized either
when the program has been delivered or is available for delivery, significant
fluctuations in revenues and net earnings may occur from period to period. Thus,
a change in the amount of entertainment product available for delivery from
period to period can materially affect a given period's revenues and results of
operations and year-to-year results may not be comparable. The continuing shift
of the Company's product mix during the fiscal year may further affect the
Company's quarter-to-quarter or year-to-year results of operations as new
products may be amortized differently as determined by length of product life
cycle and the number of related revenue sources. Film costs, net of accumulated
amortization, increased to $73,773,000 at September 30, 1998 from $68,507,000 at
September 30, 1997. Film costs in process or development at September 30, 1998
increased slightly to $10,570,000 from $10,497,000 at September 30, 1997. See
"Results of Operations Comparison of Fiscal Years Ended September 30, 1998 and
1997" below.

800-US SEARCH. In November 1997, the Company acquired 80% control of 800-U.S.
Search, a leading provider of fee-based people search and other customized
individual reference services. Since its acquisition, Search's financial
position and results of operations have been consolidated in the Company's
financial statements. The consolidation of Search has resulted in a substantial
change in the presentation of the Company's results of operations due to the
inclusion of this new line of business. Since such acquisition, the Company has
consolidated $7,900,000 of revenues and over $2,800,000 of net losses
attributable to Search. Management's strategy is to build Search's long-term
value through continued investment in enhancing Search's brand awareness and
market position through increased advertising and distribution and marketing
alliances. As an expected result of increases in revenues trailing such
increases in expenditures, the Company believes that Search will continue to
adversely affect the Company's results of operations for the foreseeable future.
See Note 10 of Notes to Consolidated Financial Statements.

GRAN CANAL LATINO. In November 1998, the Company launched Gran Canal Latino
("GCL"), its first satellite channel. GCL broadcasts 24 hours a day, with a
selection of films mostly from Spain. GCL's satellite transmission reaches the
United States and all of Latin America including Mexico. Through November 30,
1998, GCL's cable distributors had a base of 700,000 subscribers. The Company is
planning to launch a second channel by the end of 1999. Under a distribution
agreement with Enrique Cerezo, the Company is broadcasting selections from
approximately 1,500 Spanish language movie titles. The Company expects that its
new satellite operations will adversely affect the Company's results of
operations during the start-up phase of such satellite operations continuing
into fiscal 1999.

RESULTS OF OPERATIONS

COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 1998 AND 1997

The Company's operating revenues for the fiscal year ended September 30, 1998
were $75,800,000, an increase of $18,865,000 (33%) from $56,935,000 for the
prior fiscal year. This increase was due primarily to the timing of delivery
and/or availability of films and television programs, to the increase during
1998 in revenues related to certain films previously marketed by Conquistador
and to the inclusion in 1998 of the revenues of newly acquired 800-U.S. Search.

The Company recognized $26,200,000 (35%) of revenues during the fiscal year
ended September 30, 1998 from the delivery and/or availability of 25 feature
films, including Susan's Plan written and directed by John Landis and starring
Natassja Kinski, Billy Zane, Michael Biehn, Rob Schneider, Lara Flynn Boyle and
Dan Aykroyd, Black and White starring Gina Gershon, Girl starring Dominique
Swain, One Man's Hero starring Tom Berenger, Taxman starring Joe Pantoliano,
Minion starring Dolph Lundgren, Noose directed by Ted Demme, and Legion starring
Parker Stevenson. Also included were the Company's equity in net earnings of
joint ventures which delivered Beowulf starring Christopher

<PAGE> 27

Lambert, Swing starring Lisa Stansfield and Hugo Speer, and Denial starring
Jason Alexander and directed by Adam Rifkin. In addition, the Company recognized
$18,500,000 (24%) of revenues from its television slate during the fiscal year
ended September 30, 1998, including revenues from the delivery and/or
availability of the remaining episodes of the first-run syndication series
Hammer and Mowgli: The New Adventures of The Jungle Boy, and the net earnings
from the delivery by a joint venture of the remaining episodes of the ABC
network series Cracker. Revenues of $4,300,000 (6%) came from deliveries of nine
films in the Company's family division of direct-to-video product. In addition,
the Company recognized $12,900,000 (17%) of revenues from continuing licenses of
product from the Company's library to domestic cable channel operators through
its majority-owned subsidiary KLC/New City, and through international
sub-distributors. Revenues of $7,900,000 (10%) were recognized from delivery of
people search services by the recently acquired 800-U.S. Search business.
Remaining revenues of approximately $6,000,000 (8%) came from the sales of
contemporary Christian music on behalf of a joint venture and from other
sources.

During the fiscal year ended September 30, 1997, the Company's feature films
generated over $19,800,000 (35%) of revenues principally from the international
exploitation of Basil, starring Christian Slater, Claire Forlani and Jared Leto
and Double Tap, starring Heather Locklear and Stephen Rea, delivery of a film
produced for Twentieth Century Fox Film Corporation, equity in the earnings of
the joint venture which produced two sequels to the animated feature Brave
Little Toaster, and seven children's fantasy adventure films. In addition, the
Company's television slate generated $22,800,000 (40%) of revenues during fiscal
1997 principally from the Company's six one hour prime time episodes of a
mid-season replacement series for ABC entitled Gun which aired in the spring of
1997, equity in the earnings of the joint venture which produced five episodes
of the ABC prime time network series Cracker starring Robert Pastorelli, under a
22 episode order, (which was cancelled by ABC after 16 episodes) seven episodes
of the syndicated television series Hammer starring Stacy Keach, and 6 episodes
of Mowgli: The New Adventures of The Jungle Book, out of a total of 13 half-hour
episodes for the Fox Kids Network and 26 episodes for an international
distributor. In addition, the Company recognized $4,400,000 (8%) of revenues
from distribution to domestic cable and pay-per-view media for films acquired
through KLC/New City. The Company also recognized $7,300,000 (13%) of revenues
from continuing licenses of completed product from the Company's library to
foreign distributors, domestic cable channel operators and international
sub-distributors. Operating revenues include $2,189,000 relating to the
Company's equity in earnings from Cracker Company LLC, TV First and the joint
venture producing and distributing the Brave Little Toaster sequels. Gross
revenues for the three joint ventures were $24,681,000 for fiscal 1997.

In various stages of production for the Company's fiscal 1999 distribution slate
are Ringmaster starring Jerry Springer, Mambo Cafe starring Thalia and Danny
Aiello; and Confessions of a Trick Baby: Freeway II starring Natasha Leone and
Vincent Gallo. In addition, the Company has recently completed production on
Beowulf starring Christopher Lambert licensed for domestic distribution to
Dimension Films, a division of Miramax Film Corp., Susan's Plan written and
directed by John Landis and starring Natassja Kinski, Billy Zane, Michael Biehn,
Rob Schneider, Lara Flynn Boyle and Dan Aykroyd, Black and White starring Gina
Gershon, Swing starring Lisa Stansfield and Hugo Speer, and Basil starring
Christian Slater and Claire Forlani. The Company is also producing two pilots
for television networks, Killer App, a one-hour pilot for the Fox network
written by Gary Trudeau and directed by Robert Altman and Criminal Minds, a
one-hour pilot for CBS. In addition, the Company continues to acquire domestic
cable rights for films for distribution through KLC/New City and the
international distribution rights to films for distribution through Kushner
Locke International, Inc.

Costs relating to operating revenues for the fiscal year ended September 30,
1998 were $61,627,000, a $9,543,000 (18%) increase as compared to $52,084,000
during the fiscal year ended September 30, 1997. As a percentage of operating
revenues, costs relating to operating revenues were 81% for the fiscal year
ended September 30, 1998 compared to 91% for the fiscal year ended September 30,
1997. The decreased percentage in fiscal 1998 principally reflects a change in
the product mix. This principally includes the effects in fiscal 1998 of
consolidating $3,156,000 of Search costs which were substantially less than the
related consolidation of $7,869,000 of Search revenues. The increase in gross
profit margins was partially offset by the inclusion in fiscal 1998 of
$15,265,000 of amortization expense pertaining to film titles produced by others
which were previously marketed by Conquistador Entertainment that are expected
to be less profitable than Company titles included in fiscal 1997 costs where
the Company assumed greater risks.

<PAGE> 28

Selling, general and administrative expenses for the fiscal year ended September
30, 1998 were $12,028,000, a $8,005,000 (199%) increase as compared to
$4,023,000 during the fiscal year ended September 30, 1997. The increase in such
expenses is due to inclusion of $7,431,000 of advertising and administrative
expenses of 800 U.S. Search (primarily $4,747,000 of advertising expenses),
which was acquired in the current year. The Company expects the trend of
increased selling, general and administrative expenses relating to Search to
continue in fiscal year 1999. The Company recently adopted an administrative
down-sizing program for film and television operations which management expects
will reduce costs by more than $500,000 per year. However, Search advertising
and administrative costs are expected to increase.

A $808,000 (62%) increase in the provision for doubtful accounts and notes in
fiscal 1998 compared to fiscal 1997 resulted principally from a deterioration in
net expected international collections.

Interest expense for the fiscal year ended September 30, 1998 was $6,261,000, a
$2,234,000 (55%) increase as compared to $4,027,000 for the fiscal year ended
September 30, 1997. The increase was principally attributable to the increased
average levels of borrowing in the current fiscal year, which was not offset by
increased production-related interest capitalized in the current period. Total
indebtedness for borrowed money increased 13% to $84,296,000 at September 30,
1998 from $74,278,000 at September 30, 1997. Management expects the level of
borrowings to increase in fiscal 1999.

The Company's effective income tax rate was (3%) for the fiscal year ended
September 30, 1998 compared to an effective income tax rate of (1%) for the
fiscal year ended September 30, 1997. Income tax expense for the fiscal year
ended September 30, 1998 consisted of minimum state income and federal
alternative minimum taxes despite its net loss and loss carry forwards. As of
September 30, 1998 the Company had a $ 35,000,000 federal income tax net
operating loss carryforwards which expire through fiscal 2013. The Company
expects to incur increased Federal alternative minimum taxes over the next few
years despite the availability of Federal net operating losses.

The Company reported a net loss of $(6,336,000) ($0.69 per share) for the fiscal
year ended September 30, 1998 as compared to a net loss of $(4,369,000) ($0.49
per share) for the fiscal year ended September 30, 1997. Weighted number of
common shares for the compared fiscal years were 9,181,000 in 1998 and 8,959,000
in 1997. The weighted number of common shares at September 30, 1998 does not
reflect the subsequent issuance of 1,200,000 shares in a private placement after
period end. The 1998 net loss resulted primarily from consolidating Search
operations into the Company's financial statements resulting in a net loss of
$(2,810,000). In addition, the Company's film and television business
experienced a change in product mix in fiscal 1998, including the release of low
profit margin titles formerly distributed by Conquistador which generated
$15,689,000 of revenues but only $424,000 of gross profit.

The Company continues to use the intrinsic value-based method under Accounting
Principles Board Opinion No. 25, as allowed under SFAS 123, to account for all
of its employee stock-based compensation plans. Therefore, in the consolidated
financial statements, the Company has made the required pro forma disclosures in
a footnote to the financial statements.

COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 1997 AND 1996

The Company's operating revenues for the fiscal year ended September 30, 1997
were $56,935,000, a decrease of $(23,222,000) (29%) from $80,157,000 for the
prior fiscal year. The decrease was due primarily to 1997 deliveries of joint
venture projects whose $24,681,000 of gross revenues (compared to $3,393,000 in
fiscal 1996) are not consolidated in the accompanying financial statements, and
no repetition of the 1996 delivery of the higher-budget feature The Adventures
of Pinocchio, from which the Company generated $26,300,000 of revenues in fiscal
1996. If revenues generated by The Adventures of Pinocchio were excluded from
both fiscal 1996 and 1997 periods, fiscal 1997 revenues would have increased 2%.
The Company's production and deliveries during fiscal 1997 shifted somewhat
toward increased episodic television programming with related start-up costs.

<PAGE> 29

For fiscal 1997, the Company did not release a higher budget film, but earned
revenues of more than $1,800,000 (3% of total revenues) for the continued
international exploitation of The Adventures of Pinocchio, which was originally
released in fiscal 1996. The Company's feature slate for fiscal 1997 generated
over $19,800,000 (35%) of revenues principally from the international
exploitation of Basil, starring Christian Slater, Claire Forlani and Jared Leto
and Double Tap, starring Heather Locklear and Stephen Rea, delivery of a film
produced for Twentieth Century Fox Film Corporation, equity in the earnings of
the joint venture which produced two sequels to the animated feature Brave
Little Toaster, and seven children's fantasy adventure films. In addition, the
Company's television slate generated $22,800,000 (40%) of revenues during fiscal
1997 principally from the Company's six one hour prime time episodes of a
mid-season replacement series for ABC entitled Gun which aired in the spring of
1997, equity in the earnings of the joint venture which produced five episodes
of the ABC prime time network series Cracker starring Robert Pastorelli, seven
episodes of the syndicated television series Hammer starring Stacy Keach, a
half-hour HBO series which the Company also distributes to international and
other domestic markets, and 6 episodes of Mowgli: The New Adventures of The
Jungle Book, out of a total of 13 half-hour episodes for the Fox Kids Network
and 26 episodes for an international distributor. In addition, the Company
recognized $4,400,000 (8%) of revenues from distribution to domestic cable and
pay-per-view media for films acquired through KLC/New City. The Company also
recognized $7,300,000 (13%) of revenues from continuing licenses of completed
product from the Company's library to foreign distributors, domestic cable
channel operators and international sub-distributors. Operating revenues
included $2,189,000 (an 868% increase from $226,000 in fiscal 1996) relating to
the Company's equity in earnings from the following joint ventures: Cracker
Company LLC, which produced and distributes the Cracker series, TV First, and
the joint venture which produced and distributes the Brave Little Toaster
sequels.

The Company recognized approximately $44,100,000 (55%) of operating revenues for
fiscal 1996, primarily attributable to the delivery and/or availability of 16
feature films, including $26,300,000 (33%) from the initial release of the
feature film The Adventures of Pinocchio and $9,000,000 (11%) from the films
Serpent's Lair, The Grave, Freeway, The Whole Wide World, and The Last Time I
Committed Suicide. In addition, the Company recognized $22,800,000 (28%) of
revenues during fiscal 1996 from the delivery and/or availability of 4 network
movies, Princess in Love, Every Woman's Dream, A Husband, A Wife and a Lover and
Echo, the network mini-series Innocent Victims and the network pilot for the
Company's mid-season series Gun. Twelve other film and video projects generated
$8,800,000 (11%) of revenues during fiscal 1996. In addition, the Company
recognized approximately $4,100,000 (5%) of revenues from distribution to
domestic cable for films acquired through KLC/New City. The Company also
recognized additional revenues from continuing licenses of completed product
from the Company's library to foreign distributors, domestic cable channel
operators and international sub-distributors and from the national rollout of an
infomercial marketing contemporary Christian music on compact discs.

Costs relating to operating revenues were $52,084,000 during fiscal 1997 as
compared to $70,648,000 during fiscal 1996. As a percentage of operating
revenues, costs relating to operating revenues were 91% for fiscal 1997 compared
to 88% for fiscal 1996. In comparison to the third quarter's percentage of
operating revenues, wherein margins were relatively high due to the delivery of
two animated video sequels to Brave Little Toaster, in the fourth quarter the
Company's joint venture with Granada Television delivered five episodes of
Cracker, to ABC and the Company delivered seven episodes of Hammer. As is
usually the case with newly-introduced episodic television series, the joint
venture realized a relatively low operating margin on Cracker, and the Company
realized relatively low operating margins on Hammer and certain additional new
product. Also during the fourth quarter of fiscal 1997, the Company reduced
prior estimates of future revenues of certain film and television productions.
Principal among the productions so adjusted was Gun, which was not picked up by
the ABC television network for its Fall 1997 or Spring 1998 broadcast seasons.
These factors combined to decrease the carrying value of film and television
inventory by $1,325,000 in the fourth quarter.

Selling, general and administrative expenses increased to $4,023,000 in fiscal
1997 compared to $3,096,000 in fiscal 1996. This 30% increase resulted
principally from increased salary and benefits expenses. An $811,000 (163%)
increase in the provision for doubtful accounts and notes in fiscal 1997
compared to fiscal 1996 resulted principally from a deterioration in net
expected international collections.

<PAGE> 30

Interest expense for the year ended September 30, 1997 was $4,027,000 as
compared to $4,970,000 for the year ended September 30, 1996. The 19% decrease
in fiscal 1997 was primarily due to the absence of the $943,000 charge to
interest expense in 1996 related to the issuance of shares of common stock as
part of a refinancing by the Company. Other factors, including lower effective
interest rates on the line of credit in 1997, increased 1997 credit facility
borrowings, and the capitalization of $306,000 less interest to film and
television property costs in fiscal 1997 were largely offsetting. Total
indebtedness for borrowed money increased 39% to $74,278,000 at September 30,
1997 from $53,520,000 at September 30, 1996 due to increased production
borrowings to finance a larger production slate.

The Company's effective income tax rate was (1%) for the year ended September
30, 1997 compared to an effective income tax rate of 4% for the year ended
September 30, 1996. The Company recognized minimum state income tax expense
incurred despite its net loss and loss carryforwards.

The Company reported a net loss of $(4,369,000), or $(.49) per share, for the
fiscal year ended September 30, 1997, and net earnings of $730,000, or $.11 per
share, for the fiscal year ended September 30, 1996. The loss in 1997 resulted
primarily from the Company's fourth quarter reduction of prior estimates of
future revenues of certain film and television product, and fourth quarter
increased allowance for doubtful receivables which aggregated $2,600,000, and
also from start-up costs in connection with the Company's new distribution
personnel and products activities

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents decreased 80% to $3,309,000 (including $1,988,000 of
restricted cash being used as collateral for a film sale/leaseback transaction
and for certain production loans, and $66,000 of reserved cash to be applied
against the Company's outstanding borrowings under its credit facility) at
September 30, 1998 from $16,791,000 (including $1,609,000 of restricted cash and
$105,000 of reserved cash) at September 30, 1997 primarily from utilizing cash
flow to fund extended trade receivables and certain joint ventures. The above
amounts are prior to the Company's receipt of net proceeds of $5,673,000 in a
private placement of common stock completed in December 1998.

The Company's production and distribution operations, and its investment in the
start-up operations of Search and GCL are capital intensive. Newly-acquired or
established entities are less capital-intensive but will require additional
working capital to support planned growth. The Company has funded its working
capital requirements through receipt of third party domestic and international
licensing payments as well as other operating revenues, and proceeds from debt
and equity financing, and has relied upon its line of credit and transactional
production loans to provide bridge production financing prior to receipt of
license fees. The Company funds production and acquisition costs out of its
working capital, including the line of credit, and through certain pre-sale of
rights in international markets. In addition, the expansion of the Company's
international distribution business significantly increased the Company's
working capital requirements and use of related production LOANS. In addition,
the expansion of the Company's international distribution business, the
establishment of its feature film division and its Internet and direct marketing
subsidiary U.S. Search have significantly increased the Company's working
capital requirements and use of related production loans. The amount available
under the credit facility as of December 29, 1998 was $310,000. The Company
increased the maximum amount of its secured line of credit in December 1998, as
described below.

The Company experienced net negative cash flows of $(19,601,000) from operating
activities primarily resulting from the Company's operating expenditures
exceeding operating receipts at the Company and its newly-acquired subsidiary
800-US Search, and from extended trade receivables during the twelve months
ended September 30, 1998. This was partially offset by net cash of $10,228,000
provided by financing activities from production loans, and greater usage of the
Company's revolving line of credit. As a result primarily of an excess of
production and operating expense payments over cash collections plus borrowings,
net unrestricted cash decreased by $(13,822,000) to $1,255,000 on September 30,
1998. On December 29, 1998 the Company held more than $7,500,000 in net
unrestricted cash. As the Company

<PAGE> 31

expands production and distribution activities and increases its debt service
burdens, it will continue to experience net negative cash flows from operating
activities, pending receipt of licensing revenues, other revenues and sales from
its library.

CREDIT FACILITY

In June 1996, the Company obtained a $40,000,000 syndicated revolving credit
facility with a group of banks led by The Chase Manhattan Bank N.A. ("Chase").
In September 1997 that agreement was amended to increase the maximum amount of
revolving credit to $60,000,000, and in December 1998 the agreement was further
amended to increase the maximum amount of revolving credit to $75,000,000, as
discussed more fully below. The agreement provides for borrowing by the Company
on specified percentages of domestic and international accounts and contracts
receivable and a specified amount based upon the Company's appraised library
value for unsold or unlicensed rights. In addition, the Company may from time to
time allocate a production tranche in its line of credit for the Company's
productions. Such tranche will allow the Company to borrow production funding
after accounting for specified percentages of pre-sales, licensing fees and
similar revenues from third parties and a required Company equity participation.
All loans made pursuant to such agreement are secured by substantially all of
the Company's otherwise unencumbered assets and bear interest, at the Company's
option, either (i) at LIBOR (5.25% as of December 24,1998) plus 3% (for that
portion of the borrowing base supported by accounts or contracts receivable) or
4% (for that portion of the borrowing base supported by unamortized library film
costs or for loans made under the production tranche) or (ii) at the Alternate
Base Rate (which is the greater of (a) Chase's Prime Rate (7.75% as of December
24, 1998), (b) Chase's Base CD Rate (5.61% as of December 24, 1998) plus 1% or
(c) the Federal Funds Effective Rate (4.72% as of December 24, 1998) plus 1/2%)
plus 2% (for that portion of the borrowing base supported by accounts or
contracts receivable) or 3% (for that portion of the borrowing base supported by
unamortized library film costs or loans made under the production tranche). The
Company is required to pay a commitment fee of .5% per annum of the unused
portion of the credit line. As of December 29, 1998, the Company had drawn down
$62,690,000 under the credit facility out of a total net borrowing base
availability of $63,000,000. Also on that date, the Company held over $7,500,000
of unrestricted cash and over $1,900,000 of restricted cash.

The credit agreement contains various restrictive covenants to which the Company
must adhere. These covenants, among other things, include limitations on
additional indebtedness, liens, investments, disposition of assets, guarantees,
deficit financing, capital expenditures, affiliate transactions and the use of
proceeds and prohibit payment of cash dividends and prepayment of subordinated
debt. In addition, the credit agreement requires the Company to maintain a
minimum liquidity level, limits overhead expense and requires the Company to
meet certain ratios. The credit agreement also contains a provision permitting
the bank to declare an event of default if either of Messrs. Locke or Kushner
fails to be the Chief Executive Officer of the Company or if any person or group
acquires ownership or control of capital stock of the Company having voting
power greater than the voting power at the time controlled by Messrs. Kushner
and Locke combined (other than any institutional investor able to report its
holdings on Schedule 13G which holds no more than 15% of such voting power). In
December 1998 the credit agreement was further amended to change the leverage
covenant effective as of September 30, 1998.

As of December 1998 the banks increased the maximum amount of the Company's
collateralized line of credit from $60,000,000 to $75,000,000. Existing
participants in the syndicate approved the increase and are committed to lend up
to $63,000,000. Additional availability is subject to adding new banks to the
syndicate. The Company expects that availability under the line of credit will
increase to at least $68,000,000 in the next 60 days based on discussions with
potential new syndicate members. As of December 29, 1998, the principal amount
outstanding under this credit line was $62,690,000 and $310,000 remained
available for borrowing.

SECURITIES OFFERINGS

As of September 30, 1998, $4,700,000 principal amount of 8% Convertible
Subordinated Debentures and $4,100,000 principal amount of 9% Convertible
Subordinated Debentures were outstanding. Through December 17, 1998, an
additional $100,000 principal amount of the 8% Debentures were converted into
17,094 shares of Common Stock and no

<PAGE> 32

additional shares of 9% Debentures were converted. As of September 30, 1998,
approximately $77,000 principal amount of Series A Debentures (convertible into
common stock at an adjusted rate of approximately $7.61 per share) and
$3,205,500 of Series B Debentures (convertible into common stock at an adjusted
rate of approximately $9.27 per share) were outstanding. The Company has the
right to redeem the Series A Debentures and the Series B Debentures at par.

In September 1994, the Company filed a registration statement covering an
aggregate of 21,388,064 shares (now equivalent to 3,564,678 shares giving effect
to the 1-for-6 reverse stock split) of common stock comprising the shares of
common stock issuable upon conversion of the 8% Convertible Subordinated
Debentures and the 9% Convertible Subordinated Debentures and certain warrants
issued to underwriters.

In May 1996, the Company issued $1,500,000 of short-term bridge notes in a
private placement which were repaid in July 1996 in connection with the
secondary public offering referred to below.

In July 1996, the Company closed a secondary public offering of an aggregate of
4,750,000 units (a "Unit"), each Unit consisting of two shares of Common Stock
(now equivalent to 1,583,334 shares in the aggregate giving effect to the
1-for-6 reverse stock split) and one five year Class C Redeemable Common Stock
Purchase Warrant to purchase Common Stock at an adjusted exercise price of
$6.8625 per share. The Company received net proceeds in the amount of
$9,203,000. In connection with such offering, the Company issued warrants to
purchase up to an aggregate of 475,000 Units (prior to the reverse split) at an
adjusted rate of $18.00 per Unit to the underwriter thereof and a consultant.

In December 1998, the Company issued 1,200,000 shares of Common Stock in a
private placement. The Company received net proceeds of $5,673,000.

OTHER LOANS

The Company's other borrowings, totaling $14,171,000 as of September 30, 1998,
consisted of production loans from Banque Paribas (Los Angeles Agency)
("Paribas"), Equicap Financial Corporation ("Equicap") and Comerica Bank -
California ("Comerica") to consolidated production entities, and loans to the
Company's 80%-owned subsidiary, 800-US Search. The Kushner-Locke Company
provided limited corporate guarantees for portions of the production loans which
are callable in the event that the respective borrower does not repay the loans
by the respective maturity date. Deposits paid by the distributing licensees
prior to the delivery of the financed pictures are held as restricted cash
collateral by the Lenders

The table below shows other loans as of September 30, 1998:

<TABLE>
<CAPTION>
KUSHNER-
LOCKE
ORIGINAL AMOUNT WEIGHTED CORPORATE PRESENT
FILM OR COMPANY LENDER LOAN AMOUNT OUTSTANDING INTEREST GUARANTY MATURITY
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Basil Paribas $ 6,300,000 $ 2,159,000 10% $2,159,000 6/15/99
Black & White Comerica 1,850,000 1,804,000 Prime +2% -- 1/31/99
Magic Adventures 3 Equicap 3,500,000 2,995,000 Cdn. Prime +2% -- 4/1/99
Ringmaster Comerica 2,900,000 2,359,000 Prime + 1% 800,000 4/30/99
Susan's Plan Comerica 4,625,000 4,115,000 Prime + 1% 600,000 3/31/99
800-US Search Comerica and
trade
creditors 739,000 10.5% 345,000 Various
----------- ----------- ----------
$19,175,000 $14,171,000 $3,904,000
=========== =========== ==========
</TABLE>

<PAGE> 33

rights, title and assets related to the film which is being delivered to
sub-distributors. In May 1997 a third party invested $2,000,000 in the film
project in exchange for certain rights and profit participations. In December
1998 Paribas extended the maturity of the production loan guaranteed by the
Company to June 1999.

In November 1997, an $8,200,000 production loan was obtained from Comerica by an
unconsolidated company 25%-owned by the Company to cover a portion of the
production budget of Beowulf. The loan bears interest at Prime (7.75% as of
December 24, 1998) plus 1% or at LIBOR (5.25 % as of December 24, 1998) plus 2%.
The Company provided a corporate guaranty in the amount of $1,250,000 in
connection with this loan. The loan matures on January 31, 1999. The loan is
collateralized by the rights, title and assets related to the film.

In February 1998, 800-U.S. Search obtained a collateralized line of credit from
Comerica. Advances under the line bear interest at Prime (7.75% December 24,
1998) plus 2.50% payable monthly. In August 1998 the bank and the Company agreed
that the loan would be capped at the $345,000 amount outstanding as of that
date. In November 1998, Search did not repay the loan then due. In December 1998
Comerica extended the loan's maturity date to March 1999. Through September 30,
1998 the Company had also loaned 800-U.S. Search $1,152,000 and the Company
continues to provide funding to Search.

In April 1998, a $4,625,000 production loan was obtained by a consolidated
subsidiary from Comerica to cover the production budget of Susan's Plan. The
loan bears interest at Prime (7.75% as of December 24, 1998) plus 1% or at LIBOR
(5.25% as of December 24, 1998) plus 2%. The loan is collateralized by the
rights, title and assets related to the film. The Company provided a corporate
guaranty in the amount of $600,000 in connection with this loan.

In April 1998, a $1,850,000 production loan was obtained by a consolidated
subsidiary from Comerica to cover the production budget of Black & White. The
loan bears interest at Prime (7.75% as of December 24, 1998) plus 2% or at LIBOR
(5.25% as of December 24, 1998) plus 2.25%. The loan is collateralized by the
rights, title and assets related to the film.

In May 1998, a Canadian dollar 5,100,000 production loan was obtained from a
Canadian financial institution, by a consolidated subsidiary to cover a portion
of the production budgets of six direct-to-video feature films. The loan bears
interest at the Canadian Prime Rate (6.75% as of December 24, 1998) plus 2%. The
loan is collateralized by the rights, title and assets related to the films. The
Company agreed to pay $550,000 to the subsidiary borrower upon delivery of each
of the films for the acquisition of distribution rights.

In August 1998, a $2,900,000 production loan was obtained by a consolidated
subsidiary from Comerica to cover the production budget of Ringmaster. The loan
bears interest at Prime (7.75% as of December 24, 1998) plus 1% or at LIBOR
(5.25% as of December 24, 1998) plus 2%. The loan is collateralized by the
rights, title and assets related to the film. The Company provided a corporate
guaranty in the amount of $800,000 in connection with this loan.

The Company entered into an agreement in principle with Universal Studios, Inc.
whereby the Company has the right to distribute in international territories up
to nine moderate to high-budget motion pictures over a three year period. The
Company has the right to select the motion pictures, if any, to be distributed
among titles made available by Universal Studios, Inc. In the event the Company
and Universal Studios, Inc. agree upon one or more films under the arrangement,
management currently expects to finance its acquisition of the distribution
rights via credit facilities not presently in place. There can be no assurance
that definitive agreements for this distribution arrangement will be agreed to,
that financing will be obtained, or that such activities will ultimately be
profitable if undertaken.

Management expects to finance future production, broadcast and distribution
arrangements through a combination of production loans and credit facility
borrowings. No assurance can be given that such financing will be available when
and if needed. Management believes the Company will comply with the restrictive
covenants of the Chase agreement and accordingly the credit facility will be
available through June 2000, the maturity date. Search is contemplating raising
additional capital through an issuance or issuances of common stock either in a
private placement or in an initial public offering ("IPO") in 1999. Such
offerings would be made only by means of a private placement memorandum to
qualified investors or by means of a prospectus. In the event of any issuance of
common stock in a private placement, such common stock will not be registered
under the Securities Act of 1933, a amended, and accordingly may not be offered
or sold in the United States absent registration or an applicable exemption from
registration

<PAGE> 34

requirements. If any such offering were completed, the Company's
equity interest and ultimately its control of Search will be diluted. The
valuation of Search in any new financing is extremely speculative since Search
is a company with net losses. There is significant uncertainty whether Search
would be able to complete any financing and, if so, at a significant valuation.
At the same time, the Company expects Search to increase its Internet and
television advertising of Search's services. As a result, Search's net losses
may continue to increase.

After September 30, 1998, certain wholly-owned subsidiaries of the Company
entered into production loan arrangements with Far East National Bank for loans
aggregating up to $3,900,000. As of December 24, 1998, approximately $3,370,000
was outstanding under such loans.

The Company expects international operations to increase as a portion of total
operations. Therefore the Company may be exposed to increased risks of currency
translation losses, cash collection and repatriation risks and risks of adverse
political, regulatory and economic changes.

SUMMARY

Management believes that existing resources and cash generated from operating
activities, together with amounts expected to be available under the syndicated
revolving credit agreement with Chase will be sufficient to meet the Company's
working capital requirements for at least the next twelve months. The Company
may be required to seek other sources of financing to meet its working capital
requirements, including a further increase under its syndicated revolving credit
agreement, a separate equity financing for Search or other possible sources of
financing. The Company from time to time will seek additional financing through
the issuance of new debt or equity securities, additional bank financings, or
other means available to the Company to increase its working capital. The
Company may not obtain additional financing on terms satisfactory to the Company
or at all.

In addition to expanding production and its distribution business, whether
internally or by acquisition, the Company also considers acquisition
possibilities from time to time, including film libraries and companies
ancillary to the Company's business, subject to the availability of financing as
necessary.

The Company's business and operations have not been materially affected by
inflation.

SEASONALITY

Management believes that the Company's sales volumes are not subject to
significant fluctuations based upon seasonality.

YEAR 2000 ("Y2K") ISSUES

The "Year 2000 Issue" is typically the result of certain firmware limitations
and of limitations of certain software written using two digits rather than four
to define the applicable year. If software and firmware with date-sensitive
functions are not Year 2000 compliant, they may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including, among other
things, interruptions in customer service operations, a temporary inability to
process transactions, conduct searches, or engage in similar normal business
activities.

The Company utilizes off-the-shelf and custom software developed internally and
by third parties. The Company believes that most of its off-the-shelf software
is Year 2000 compliant. However, there is no assurance that the Company will not
be required to modify or replace significant portions of its software so that
its systems will function properly with respect to dates in the year 2000 and
thereafter. The Company is engaged in a two-phase process to evaluate its
internal status with respect to the Year 2000 issue. The Company is currently
conducting a Year 2000 evaluation ("Phase One") including Information Technology
("IT") systems, non-IT systems, and critical third-party

<PAGE> 35

entities with which the Company transacts business. If required modifications to
existing software and firmware or conversions to new software or firmware are
not made, or are not completed timely, or if there is a malfunction in software
or firmware used on computer systems utilized by those upon whom the Company
depends for provision of its services, there is no assurance that potential
systems interruptions or the cost necessary to update such software or firmware
or any outages or delays in services will not have a material adverse effect on
the Company's business, financial condition, results of operations and
prospects. Further, the failure of the Company to successfully resolve such
issues could result in a shut-down of some or a substantial portion of the
Company's operations (including those of Search), which could have a material
adverse effect on the business, financial condition, results of operations and
prospects of the Company.

Search depends on information contained primarily in electronic format in
databases and computer systems maintained by third parties. The disruption of
such third-party systems and the supply of information provided through such
systems could have a material adverse effect on Search's, and therefore the
Company's, business, financial condition, results of operations and prospects.
In addition, Search relies on the integration of various systems in aggregating
the content from multiple sources. The failure of any of those systems as a
result of Year 2000 compliance issues could prevent Search from delivering its
products and services, which could have a material adverse effect on the
Company's business, financial condition, results of operations and prospects.
Search does not currently have any information concerning the Year 2000
compliance status of its customers and their Internet service providers. In the
event that substantial numbers of Internet users do not successfully and timely
achieve Year 2000 compliance, Search's, and therefore the Company's, business,
financial condition, results of operations and prospects could be adversely
affected.

The Company has not yet fully developed a comprehensive contingency plan to
address situations that may result if the Company is unable to achieve Year 2000
readiness of its critical operations, and in particular those related to Search.
Contingency plans are expected to be developed in detail and expanded during
1999. There is no assurance that the Company will be able to develop a
contingency plan that will adequately address all Year 2000 issues. The failure
of the Company to develop and implement, if necessary, an appropriate
contingency plan could have a material impact on the Company's business,
financial condition, results of operations and prospects. Finally, the Company
is also vulnerable to external forces that might generally affect industry and
commerce, such as utility or transportation company or Internet Year 2000
compliance failures and related service interruptions. Any significant
interruption of general access to, or the customary function and operations of,
the Internet could have a material adverse effect on the Company's business,
financial condition, results of operations and prospects. Some commentators have
predicted significant litigation regarding Year 2000 compliance issues. Because
of the unprecedented nature of such litigation, it is uncertain whether or to
what extent the Company may be affected by it. Although the Company currently
believes that this issue will not pose significant operational problems, delays
in the modification or conversion of its or Search's systems, or those of
vendors and suppliers of services to the Company and Search, or the failure to
fully identify all Year 2000 dependencies in the systems could have a material
adverse effect on the Company's business, financial condition, results of
operations and prospects.

Until the completion of phase one, the Company cannot quantify the impact of the
Year 2000 issue; however, failure of critical internal IT systems, non-IT
systems, third-party vendors and financial institutions may limit or prevent the
Company from performing services for its customers, and could have a material
adverse effect on the Company's business, financial condition, and results of
operations. Through September 30, 1998 the Company incurred no material year
2000 remediation costs, and presently anticipates incurring no material
remediation costs in the future

RECENT ACCOUNTING PRONOUNCEMENTS

In February 1997, the Financial Accounting Standards Board issued SFAS No, 128,
"Earnings Per Share." SFAS No. 128 specifies new standards designed to improve
the earnings per share (EPS) information provided in financial statements by
simplifying the existing computational guidelines, revising the disclosure
requirements and increasing the comparability of EPS data on an international
basis. Some of the changes made to simplify the EPS computations include: (a)
eliminating the presentation of primary EPS and replacing it with basic EPS, for
which common stock

<PAGE> 36

equivalents are not considered, (b) eliminating the modified treasury stock
method and the three percent materiality provision and (c) revising the
contingent share provision and the supplemental EPS data requirements. SFAS No.
128 also makes a number of changes to existing disclosure statements issued for
periods ending after December 15, 1997, including interim periods. The Company's
basic earnings per share as calculated under SFAS 128 are $(0.69), $(0.49)and
$0.11 for the years ended September 30, 1998, 1997 and 1996 respectively.

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard ("SFAS") No. 130, "Reporting Comprehensive
Income." This statement establishes standards for the reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements. Comprehensive income generally represents all changes in
stockholders' equity during the period except those resulting from investments
by, or distributions to, stockholders. SFAS No. 130 is effective for fiscal
years beginning after December 15, 1997, and requires restatement of earlier
periods presented.

In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS No.
131 establishes standards for the reporting of operating segment information in
annual financial statements and in interim financial reports issued to
shareholders. SFAS No. 131 is effective for financial statements issued for
periods beginning after December 15, 1997. Management believes that the impact
of SFAS No. 131 will not be material to the Company's financial statements.

8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements and supplementary data required by Item 8 are set forth
in the pages indicated in Item 14.

9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE

On October 20, 1998, the Company changed its independent public accountants.
This change (and the response of the Company's former independent public
accountants) is described in the Company's Current Report on Form 8-K filed on
October 27, 1998, which is incorporated by reference herein. This Annual Report
contains an independent auditor's report issued by the Company's former
independent public accountants.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT

Executive Officers and Directors

Directors of the Company are elected annually by the shareholders to serve for a
term of one year or until their successors are duly elected and qualified. Set
forth below is certain information concerning each person who was an executive
officer or director of the Company as of September 30, 1998.

<TABLE>
<CAPTION>
DIRECTOR
NAME AGE SINCE POSITION
---- --- -------- --------
<S> <C> <C> <C>
Peter Locke 55 1983 Co-Chairman and Co-Chief Executive
Officer; Director
</TABLE>

<PAGE> 37

DIRECTOR
NAME AGE SINCE POSITION
---- --- -------- --------
<S> <C> <C> <C>
Donald Kushner 53 1983 Co-Chairman, Co-Chief Executive Officer
and Secretary; Director
Irwin Friedman+ 64 1998 Director

Stuart Hersch+ 48 1989 Director

John Lannan+ 52 1998 Director

Bruce St. J. Lilliston 47 -- Chief Operating Officer and President

Robert Swan 51 -- Senior Vice President and Chief
Financial Officer
</TABLE>

- ----------------------

+ Member of Audit Committee and Compensation Committee

Background of Executive Officers and Directors

The business experience, principal occupations and employment of each of the
directors and executive officers of the Company, for at least the past five
years, are as follows:

Peter Locke co-founded the Company with Donald Kushner in 1983 and currently
serves as Co-Chairman and Co-Chief Executive Officer of the Company. Mr. Locke
has served as executive producer on substantially all of the Company's
programming since its inception. Prior to 1983, Mr. Locke produced several
prime-time television programs, including two years of the Stockard Channing
Show and the NBC television mini-series The Star Maker, starring Rock Hudson.
Mr. Locke also produced two made-for-television movies telecast on CBS and the
films The Hills Have Eyes Parts I and II. Mr. Locke is President and Co-Chairman
of the board of directors of 800-U.S. Search ("Search"), an 80%-owned subsidiary
of the Company.

Donald Kushner co-founded the Company with Peter Locke in 1983 and currently
serves as Co-Chairman, Co-Chief Executive Officer and Secretary. Mr. Kushner has
served as executive producer on substantially all of the Company's programming
since its inception. Mr. Kushner was the producer of Tron, a 1982 Walt Disney
theatrical film starring Jeff Bridges, which was nominated for two Academy
Awards. Mr. Kushner is Co-Chairman of the board of directors of Search.

Irwin Friedman has served as a director of the Company since 1998. Mr. Friedman
is President of I. Friedman Equities, Inc., a corporate financial services firm,
which he founded more than twenty years ago. Since 1991 Mr. Friedman has
rendered financial consulting services to the Company through I. Friedman
Equities, Inc. Mr. Friedman was responsible for introducing the Company to
various investment banking firms and has advised and assisted the Company with
six financing transactions. Mr. Friedman is a director of Recoton Corporation, a
consumer electronics company.

Stuart Hersch has served as a director of the Company since August 1989. Since
February 1996, Mr. Hersch has been a consultant to several entertainment
companies. In April 1996, Mr. Hersch became a consultant to the Company. Mr.
Hersch assists the Company in analyzing potential strategic acquisitions and
provides the Company consulting services in connection with the Company's
infomercial operations. From August 1990 to January 1996, Mr. Hersch was
President of the WarnerVision Entertainment division of Atlantic Records, a
subsidiary of Time-Warner, Inc. From 1988 to August 1989, Mr. Hersch was
Chairman of Hersch Diener & Company, an independent consulting firm. From 1983
to 1987, Mr. Hersch was the Chief Operating and Chief Financial Officer of King
World Productions, Inc.

John Lannan has served as a director of the Company since 1998. Mr. Lannan is
the President of Brentwood Partners,

<PAGE> 38

Inc., a mortgage banking company. From May 1995 to May 1998 Mr. Lannan was Vice
President of Westco Real Estate Finance Corp., a mortgage banking company.
Previously he was Vice-Chairman of Hollingsworth & Lord, a mortgage banking
company. Mr. Lannan is a director of Centennial Bank and of Orange County
Bancorp, treasurer of the Lannan Foundation, a not-for-profit organization, and
is a member of the California Bar.

Bruce St. J. Lilliston became President and Chief Operating Officer of the
Company in October 1996. Prior to joining the Company, Mr. Lilliston practiced
entertainment law for 19 years. He represented the Company in various
transactions for the two years preceding his appointment as Company President
and Chief Operating Officer. Mr. Lilliston served as an arbitrator for the
American Film Marketing Association, and also served a special master for the
Los Angeles Superior Court. He graduated from the University of Chicago Law
School in 1977, where he was an associate editor of the University of Chicago
Law Review. He received his bachelor of arts degree with honors from Brown
University in 1974. Mr. Lilliston was a partner in the law firm of Paul,
Hastings, Janofsky & Walker from 1989 to 1991, where he was managing partner of
that firm's entertainment finance and transactions practice.

Robert Swan joined the Company as Controller on October 28, 1996. On May 1, 1997
Mr. Swan was appointed Chief Financial Officer and on May 1, 1998 became enior
Vice President and Chief Financial Officer. Prior to assuming the Chief
Financial Officer role for the Company, Mr. Swan had been Chief Financial
Officer of AVI Entertainment Group, Inc., a music publishing and distribution
company since 1994. From 1991 to 1994 Mr. Swan was Chief Financial Officer of
Global Releasing Corporation and several affiliated companies which produced and
distributed feature films. One affiliated company, Cannon Television, Inc., was
placed in voluntary bankruptcy several months after Mr. Swan left its employ.
From 1986 to 1991 Mr. Swan was an audit partner at KPMG Peat Marwick. Mr. Swan
is a Certified Public Accountant.

Directors who are also executive officers of the Company do not receive any
additional compensation for serving as members of the Board of Directors or any
committee thereof. Peter Locke and Donald Kushner receive no compensation for
serving as a member of the Board of Directors. Irwin Friedman and Stuart Hersch
receive $25,000 annually each, and John Lannan receives $15,000 annually, for
serving on the Board of Directors and any committees thereof. Each of Messrs.
Friedman and Lannan were granted options to purchase 16,667 shares at an
exercise price of $2.84 in June 1998, and Mr. Hersch was granted options to
purchase 16,667 shares at an exercise price of $1.875 in August 1997.

During the 1998 fiscal year, there were six meetings of the Board of Directors,
five meetings of the Compensation Committee and two meetings of the Audit
Committee of the Board of Directors. Each director attended all of the meetings
of the Board of Directors, the Compensation Committee and the Audit Committee
held during the period for which he was a director or for which he had served as
a committee member.

OTHER SIGNIFICANT EMPLOYEES

The business experience, principal occupations and employment for at least the
past five years of certain other significant employees who have made or are
expected to make significant contributions to the business of the Company are as
follows:

D'Arcy Conrique, age 34, was appointed Senior Vice President, Operations of
Kushner-Locke International, Inc., the international theatrical distribution
subsidiary of the Company, in April 1997. Mr. Conrique joined Kushner-Locke
International, Inc. as Vice President in January 1995. Prior to joining
Kushner-Locke International, Inc., Mr. Conrique was Manager, Contracts
Administration at August Entertainment, Inc., a producer and distributor of
feature films, from 1994 to 1995. From 1986 through 1994 Mr. Conrique was
Managing Director at Koritain Entertainment, a producer and distributor of
feature films.

Chris Perry-Melish, age 31, was appointed President, Film and Television Salesof
Kushner-Locke International, Inc., the international theatrical distribution
subsidiary of the Company, in October 1998. In May 1998 Mr. Perry-Melish

<PAGE> 39

was appointed Vice President, International Sales of Kushner-Locke
International. Mr. Perry-Melish joined Kushner-Locke International, Inc. as
Director, International Distribution in April 1997. From 1996 to April 1997 Mr.
Perry-Melish was Director, International Distribution for Conquistador
Entertainment, Inc., a distributor of feature films. From 1992 through 1996 Mr.
Perry-Melish was Manager of International Distribution for Prism Entertainment,
a producer and distributor of feature films and television programs.

Richard Marks, age 50, was appointed Executive Vice President and General
Counsel of the Company in April 1997. Prior to that, he served as the Company's
Senior Vice President in charge of Legal and Business Affairs since joining the
Company in October 1993. From 1991 to October 1993, Mr. Marks served as Senior
Vice President in charge of Business and Legal Affairs for Media Home
Entertainment, an independent film producer and video distributor. From 1983 to
1991 Mr. Marks held similar legal and business affairs positions with Walt
Disney Pictures, Paramount Pictures and Weintraub Entertainment Group.

Frank Hildebrand, age 48, joined the Company in January 1998 as Executive Vice
President Production. From 1992 through 1997 Mr. Hildebrand was an independent
producer and produced numerous films, among them two films for the Company,
Freeway and the special effects film Beowulf. From 1988 to 1991 he was Executive
Vice President at NOVA Entertainment, where he was responsible for the
production of all features and television, including the Disney film Firebirds
and Triumph of the Spirit, among others. From 1985 to 1987, Mr. Hildebrand was a
producer and executive with The Samuel Goldwyn Co., where he produced the
successful comedy Once Bitten.

Phillip Mittleman, age 28, joined the Company in 1993 as Director of
Development, Feature Films. In March 1994 Mr. Mittleman was appointed Vice
President, Feature Films. In 1995 Mr. Mittleman was appointed Executive Vice
President, Feature Films. Prior to 1993 Mr. Mittleman served as production
coordinator, script coordinator and writer's assistant on various Company
projects.

Andrew Steinberg, age 34, joined the Company as Executive Vice
President-Television in April 1997. Before joining the Company, Mr. Steinberg
was a Senior Packaging Agent at International Creative Management ("ICM")
beginning in April 1990, where he represented many producers, writers and
authors. Mr. Steinberg also worked with ICM's chairman, Jeff Berg, on building a
corporate consulting business. While at ICM, Mr. Steinberg worked closely with
the Company and packaged four television projects for the Company, including the
CBS made-for-television movie "Unlikely Angel" starring Dolly Parton.

Nicholas Matzorkis, age 36, is the Chief of Technology and a director of the
Company's subsidiary, 800-U.S. Search. Mr. Matzorkis co-founded 800-U.S Search
in 1994 and served as its President from inception to September 1998. From 1992
to 1994, Mr. Matzorkis was founder and President of U.S. Bell Long Distance, an
aggregator and reseller of telecommunications services. In addition, from 1992
through 1997 Mr. Matzorkis consulted with companies in the entertainment
industry on Web site development, and promoted a variety of music and
entertainment ventures.

Alan Mazursky, age 40, is serving as Chief Financial Officer of 800-U.S. Search
as part of his duties as a consultant to the Company. From 1996 to 1998 Mr.
Mazursky was an independent financial consultant. From 1988 to 1996 Mr. Mazursky
was Chief Financial Officer of Hard Rock Cafe America, the owner, operator and
franchisor of Hard Rock Cafe restaurants in the western United States and
certain international territories.

Robert Zakari, age 28, has served as Vice President-Legal and Business Affairs
of 800-U.S. Search since August 1996. Previously Mr. Zakari attended New York
Law School where he received a Juris Doctorate degree in 1996. Mr. Zakari is a
member of the California state bar.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Exchange Act requires executive officers and directors, and
persons who beneficially own more than 10% of any class of the Company's equity
securities to file initial reports of ownership and reports of changes in

<PAGE> 40

ownership with the Securities and Exchange Commission ("SEC"). Executive
officers, directors and beneficial owners of more than 10% of any class of the
Company's equity securities are required by SEC regulations to furnish the
Company with copies of all Section 16(a) forms they file.

Based solely on a review of the copies of such forms furnished to the Company
during or with respect to fiscal 1997, and certain written representations from
executive officers and directors, the Company believes that each such person has
complied with all Section 16(a) filing requirements applicable to such executive
officers, directors and greater than 10% beneficial owners, except that Irwin
Friedman inadvertently failed to file one report on a timely basis, covering one
small sale of securities in December 1998, and Bruce Lilliston inadvertently
failed to file one report on a timely basis, covering one transaction reflecting
the receipt by Mr. Lilliston of stock options granted pursuant to the 1988 Stock
Incentive Plan.

ITEM 11. EXECUTIVE COMPENSATION

Cash Compensation

The following table sets forth the cash compensation paid or accrued by the
Company during the fiscal year ended September 30, 1998 to the Chief Executive
Officer and each executive officer of the Company whose salary and bonus
exceeded $100,000 (the "Named Executive Officers").

<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
------------
ANNUAL SECURITIES
COMPENSATION(1) UNDERLYING ALL OTHER
----------------- OPTIONS COMPENSATION
FISCAL SALARY BONUS SARs (1,3)
NAME AND PRINCIPAL POSITION YEAR ($) ($) (#) ($)
- --------------------------- ------ ------- ------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Peter Locke(2) 1998 425,000 -- -- 30,856
Co-Chairman, Co-Chief Executive 1997 425,000 -- 166,666/0 36,293
Officer 1996 425,000 -- -- 34,313

Donald Kushner 1998 425,000 -- -- 27,989
Co-Chairman, Co-Chief Executive 1997 425,000 -- 166,666/0 33,878
Officer and Secretary 1996 425,000 -- -- 30,415

Bruce Lilliston(4) 1998 400,000 74,132 8,333/0 --
President and Chief Operating 1997 400,000 -- 41,667/0 --
Officer

Robert Swan(4) 1998 172,558 -- -- --
Senior Vice President and Chief 1997 124,154 -- 25,000/0 --
Financial Officer
</TABLE>

- ----------------------

(1) Does not include perquisites including automobile allowances and $25,000
annual non-accountable expense allowances in the case of Messrs. Locke,
Kushner and Lilliston.

(2) Does not include payments by the Company's subsidiary, 800-U.S. Search,
prior to January 30, 1998, when the Company acquired such subsidiary.

<PAGE> 41

(3) Does not include options to purchase shares of the common stock of 800-U.S.
Search which were approved by the Company and Search, but subsequently were
terminated prior to full documentation pursuant to a waiver of any rights to
receive such options executed by Messrs. Kushner and Locke.

(4) Includes term life insurance premiums paid by the Company on behalf of the
Named Executive Officers in respect of a $3,500,000 policy and disability
insurance premiums paid by the Company on behalf of the Named Executive
Officers.

(5) Commenced employment in fiscal 1997.

EMPLOYMENT AGREEMENTS

Messrs. Kushner and Locke. In March 1994, Messrs. Kushner and Locke each agreed
to an amendment to his respective employment agreement with the Company to (i)
extend the term of the agreement to September 1998 and (ii) reduce the maximum
annual performance bonus that each may receive to 4% of pre-tax earnings for the
applicable period up to a maximum of $200,000 in fiscal 1994, $220,000 in fiscal
1995, $250,000 in fiscal 1996, $270,000 in fiscal 1997 and $290,000 in fiscal
1998. Under the then revised employment agreements, Messrs. Kushner and Locke
each were entitled to a base salary of $425,000 in fiscal 1996 through fiscal
1998, subject to potential increase upon review by the Company's Board of
Directors after fiscal 1995.

In order to induce Messrs. Kushner and Locke to enter into the March 1994
amended employment agreements, the Company granted to each, as of March 7, 1994,
options to purchase 150,000 adjusted shares of Common Stock at an adjusted
exercise price per share equal to $5.04 (the last reported sale price of the
Common Stock on the date of the initial closing of the 8% Debentures). The
options vest over a five year period, with 20% vesting respectively on each of
the five annual anniversary dates following the date of the grant (subject to
possible acceleration following a "change-in-control" as defined in the
Company's 1988 Stock Incentive Plan (the "Plan")). Options to purchase up to
120,000 shares of Common Stock have vested as to each officer as of January 27,
1999.

As of October 1, 1997, Messrs. Kushner and Locke each agreed to a further
amendment to his respective employment agreement with the Company to extend the
term of the agreement to October 2002. Under the revised employment agreements,
Messrs. Kushner and Locke each continue to be entitled to an annual base
compensation of $425,000 in fiscal 1997, and are entitled to $25,000 annual
increases beginning with the second employment year (commencing October 1998)
under the amended agreement up to a maximum of $525,000. In the event the
Company achieves earnings before income taxes prior to the profit bonuses in
excess of $2,000,000, each of Messrs. Kushner and Locke are entitled to certain
profit bonuses at graduated rates ranging from 5% of such annual earnings before
income taxes (from the first dollar of earnings before income taxes) up to
$4,000,000 to increasing percentages up to 7.5% of annual earnings before income
taxes in excess of $8,000,000, but not to exceed two times annual base
compensation.

In addition, the Company granted to each of Messrs. Kushner and Locke, as of
August 1, 1997, options to purchase 83,333 (post reverse split) shares of Common
Stock at an exercise price per share equal to $1.875 (the last reported sale
price of the Common Stock on the date prior to the award date, as adjusted).
These options (time vesting options) vest over a five year period, with 20%
vesting respectively on each of the five annual anniversary dates following the
date of the grant (subject to acceleration in the event of termination of
optionee's employment agreement by such optionee for "cause" (as defined
therein) or wrongfully by the Company or upon certain "Events" (as defined under
the Plan), including termination following a "change-in-control" as defined in
the Plan). The Company also granted to each of Messrs. Kushner and Locke options
to purchase an additional 83,333 (post reverse split) shares of Common Stock at
an exercise price per share equal to $1.875, vesting at the rate of 20% per
year, but exercisable only upon (i) the achievement of at least 85% of certain
annual earnings before income tax targets to be set by the board of directors or
(ii) the Company's Common Stock reaching certain public trading prices ranging
from $3.00 to $6.00 per share. Such performance options are also subject to
accelerated vesting and exercisability under the circumstances described above
for the time-vesting option tranche.

<PAGE> 42

The Company also provides Messrs. Kushner and Locke with certain fringe
benefits, including $3,500,000 of term life insurance with a split dollar
ownership structure and disability insurance for each person. If the employment
agreement is terminated by employee for "cause" or wrongfully by the Company,
the Company is required to pay the present value of all unpaid premiums on the
split dollar policy for the ten (10) year period ending February 2007. The
Company also agreed to assign any key-man life insurance policy to the employee
after certain terminations of the employment agreement. The agreements permit
Messrs. Kushner and Locke to collect outside compensation to which they may be
entitled and to provide incidental and limited services outside of their
employment with the Company and to receive compensation therefor, so long as
such activities do not materially interfere with the performance of their duties
under the agreements. Each of Messrs. Kushner and Locke also may require the
Company to change its name to remove his name within one year after the
expiration or termination of his employment agreement, except that the Company
may continue to use such name for a period of one year after such notice, or for
such longer period of time as is reasonably necessary to cause the Company not
to default under any indebtedness for borrowed money or other material
agreement. In the event Messrs. Kushner's or Locke's employment agreement is
terminated following a change of control, as such term is defined therein, such
executive would be entitled to a lump sum payment equal to all compensation and
benefits provided for in the agreement for the remainder of the term, discounted
at the rate of 10% per annum.

Mr. Lilliston. On September 14, 1996, the Company entered into an employment
agreement with Bruce St. J. Lilliston pursuant to which the Company employed Mr.
Lilliston as the President and Chief Operating Officer of the Company effective
October 1, 1996 for a three year term. As part of the agreement, Mr. Lilliston
will be paid a base salary of $400,000 per year. In addition, the Company loaned
him $100,000 on September 3, 1996 and $200,000 in October 1996. The loan was
made to assist Mr. Lilliston in the transition from his private law practice to
his duties as Chief Operating Officer of the Company. The loan accrues simple
interest at the rate of 8% per annum and will be repaid over a five year period
at certain specified dates ending October 1, 2001. Mr. Lilliston has the right
to receive bonuses equal to the amount of the payments, including interest, due
for such loan if Mr. Lilliston is still employed by the Company (including the
renewal of his employment agreement if applicable) on certain dates (the
"Employment Bonus"). Beginning October 1, 1997, so long as Mr. Lilliston is then
employed by the Company (including the renewal of his employment agreement if
applicable), he shall be entitled to receive a bonus of $100,000 the first time
the adjusted "Average Closing Price" (the average closing price of the common
stock over a thirty calendar day period) is $6.00 or more greater than the
"First Day Price" (the average closing price of the Common Stock, as adjusted,
over the thirty calendar day period immediately prior to October 1, 1996).
Thereafter, if Mr. Lilliston is still employed by the Company (including the
renewal of his employment agreement if applicable), he shall be entitled to
receive an additional $100,000 bonus the first time the Average Closing Price
exceeds the First Day Price by $12.00 or more, as adjusted, and each whole
six-dollar amount through and including $60.00, as adjusted, (each such bonus, a
"Stock Bonus"). The aggregate of such bonuses shall not exceed $1,000,000. The
Stock Bonuses shall be reduced by an amount equal to the Employment Bonus up to
$150,000 plus interest payable thereon from September 3, 1996. As of September
30, 1998 Mr. Lilliston had received an Employment Bonus of $80,049 but no Stock
Bonus.

If the Company realizes pre-tax operating profits or earnings per share for any
fiscal year during Mr. Lilliston's employment greater than 100% of the Company's
largest pre-tax operating profit or earnings per share amount for any of the
preceding years of Mr. Lilliston's employment under his employment agreement or
in any of the five fiscal years immediately preceding the commencement of such
agreement, and if Mr. Lilliston is still employed by the Company at the end of
the applicable fiscal year, then Mr. Lilliston shall be entitled to receive a
bonus of $50,000 for each such event. No bonus was earned or paid for fiscal
1998.

As part of the agreement, the Company agreed to grant Mr. Lilliston options to
purchase up to 41,667 adjusted shares of Common Stock, with 20,834 of such
options having been granted and vested upon the authorization by the
shareholders of the Company of additional shares of common stock in November
1996. Options to purchase an additional 8,333 shares of common stock and 12,500
shares of common stock were granted and vested on October 1, 1997 and October 1,
1998, respectively, as Mr. Lilliston reached the performance criteria
established by the Board of Directors or a committee thereof. If Mr. Lilliston's
employment is extended for a second term pursuant to such

<PAGE> 43

agreement (the "Second Term"), the Company has agreed to grant Mr. Lilliston
options to purchase up to an additional 83,334 shares of Common Stock, 41,667,
16,667, and 25,000 of such options to be granted upon commencement and one, and
two years, respectively, after the commencement of the Second Term with one-half
of each such grant to vest immediately upon grant and the remainder thereof to
vest upon Mr. Lilliston reaching certain performance criteria to be established
by the Board of Directors or a committee thereof. If Mr. Lilliston's employment
is extended beyond a Second Term, the Company has agreed to grant Mr. Lilliston
options to purchase up to an additional 41,667 shares of Common Stock as
adjusted, with such options granted in full upon such employment extension with
one-half of such grant to vest immediately upon grant and the remainder thereof
to vest upon Mr. Lilliston reaching certain performance criteria to be
established by the Board of Directors or a committee thereof. In the event the
performance goals are not met, such options vest at a fixed date in the future,
contingent solely on future employment. The exercise price for such options
shall be equal to the closing price of the Common Stock on the applicable date
of grant. Finally, as part of Mr. Lilliston's agreement, he is allowed to
maintain not more than two independent outside legal consultancy client
relationships, subject to approval by the Co-Chief Executive Officers, with
earnings from such consultancies limited to $150,000 per year.

Mr. Swan. Effective May 1, 1997 ("the Effective Date") the Company entered into
an employment agreement with Robert Swan pursuant to which the Company employed
Mr. Swan as the Chief Financial Officer of the Company for a three year term.
Mr. Swan was paid a base annual salary of $160,000 for the first year, $175,000
for the current year and $200,000, for the subsequent year. Mr. Swan has the
right to receive a bonus equal to 10% of his base annual salary to the extent
that net earnings for each fiscal year are greater than that of the immediately
preceding fiscal year. The Company agreed to grant Mr. Swan options to purchase
up to 25,000 shares of Common Stock, with options exercisable for 8,334 shares
immediately vesting and for 8,333 shares vesting on each of the first and second
anniversaries of the agreement. The agreement is subject to early termination by
the Company in its discretion on the second anniversary date of the Effective
Date.

1998 STOCK INCENTIVE PLAN

The 1998 Stock Incentive Plan adopted by the Board of Directors in October 1988
(the "Plan") authorizes the granting of stock incentive awards ("Awards") to
qualified officers, employees, directors, key employees and third parties
providing valuable services to the Company, e.g., independent contractors,
consultants and advisors to the Company. In November 1996, the shareholders of
the Company voted to increase the adjusted authorized number of shares available
under the Plan from 750,000 to 1,250,000. The Plan may be administered by a
committee appointed by the Board and consisting of two or more members, each of
whom must be Non-Employee Directors. A Non-Employee Director is defined as a
director who is not employed by the Company or its subsidiaries, does not
receive compensation from the Company or its subsidiaries other than as a
director, except for compensation in an amountless than $60,000, and is
generally disinterested. The Plan is currently administered by the entire board
of directors, who determine the number of shares to be covered by an Award, the
term and exercise price, if any, of the Award and other terms and provisions of
Awards.

The Plan is designed to help the Company attract and retain qualified persons
for positions of substantial responsibility and to provide certain key employees
and consultants with an additional incentive to contribute to the success of the
Company. As of January 27, 1999, options to purchase 944,692 shares of the
Company's Common Stock were outstanding under the Plan. Under the Plan options
to purchase 296,556 shares had been exercised, options to purchase 411,279
shares had expired or been canceled and options to purchase 8,752 shares
remained available for grant under the Plan.

Awards can be Stock Options ("Options"), Stock Appreciation Rights ("SARs"),
Performance Share Awards ("PSAs") and Restricted Stock Awards ("RSAs"). The
number and kind of shares available under the Plan are subject to adjustment in
certain events. Shares relating to Options or SARs which are not exercised,
shares relating to RSAs which do not vest and shares relating to PSAs which are
not issued will again be available for issuance under the Plan.

<PAGE> 44

An Option may be an incentive stock option ("ISO") or a nonqualified Option. The
exercise price for Options is to be determined by the Committee, but in the case
of an ISO is not to be less than fair market value on the date the Option is
granted (110% of fair market value in the case of an ISO granted to any person
who owns more than 10% of the Common Stock). The purchase price is payable in
any combination of cash, shares of Common Stock already owned by the participant
for at least six months or, if authorized by the Committee, a promissory note
secured by the Common Stock issuable upon exercise. In addition, the award
agreement may provide for "cashless" exercise and payment. Subject to early
termination or acceleration provisions, an Option is exercisable, in whole or in
part, from the date specified in the related award agreement (which may be six
months after the date of grant) until the expiration date determined by the
Committee (not to exceed 10 years from the date of grant).

An SAR is the right to receive payment based on the appreciation in the fair
market value of Common Stock from the date of grant to the date of exercise. In
its discretion, the Committee may grant an SAR concurrently with the grant of an
Option. An SAR is only exercisable at such time, and to the extent, that the
related Option is exercisable. Upon exercise of an SAR, the holder receives for
each share with respect to which the SAR is exercised an amount equal to the
difference between the exercise price under the related Option and the fair
market value of a share of Common Stock on the date of exercise of the SAR. The
Committee in its discretion may pay the amount in cash, shares of Common Stock,
or a combination thereof.

An RSA is an award of a fixed number of shares of Common Stock subject to
restrictions. The Committee specifies the prices, if any, the recipient must pay
for such shares. Shares included in an RSA may not be sold, assigned,
transferred, pledged or otherwise disposed of or encumbered until they have
vested. The recipient is entitled to dividend and voting rights pertaining to
such RSA shares even though they have not vested, so long as such shares have
not been forfeited.

A PSA is an award of a fixed number of shares of Common Stock, the issuance of
which is contingent upon the attainment of such performance objectives, and the
payment of such consideration, if any, as is specified by the Committee.

The Plan also provides for certain tax-offset bonuses and tax withholding using
shares of Common Stock instead of cash.

Upon the date a participant is no longer employed by the Company for any reason,
shares subject to the participant's RSAs which have not become vested by that
date or shares subject to the participant's PSAs which have not been issued
shall be forfeited in accordance with the terms of the related Award agreements.
Options which have become exercisable by the date of termination of employment
or of service on the Committee must be exercised within certain specified
periods of time from the date of termination, the period of time to depend on
the reason for termination. Options which have not yet become exercisable on the
date the participant terminates employment or service on the Committee for a
reason other than retirement, death or total disability shall terminate on that
date.

The Board of Directors may, at any time, terminate, amend or suspend the Plan.
In addition, the Committee may, with certain exceptions, amend any provision of
the Plan.

All employees, officers and directors of, and consultants to, the Company are
eligible to participate in the Plan. The Committee determines which persons
shall be granted options, the extent of such grants and, consistent with the
Plan, the terms and conditions thereof. As of December 31, 1998, approximately
60 employees of the Company, and three directors of the Company who are not also
employees of the Company, are eligible to receive option grants under the Plan.
Options granted under the Plan may be either ISOs or options which are not
intended to qualify as ISOs, except that ISOs may only be granted to employees
of the Company.

The aggregate fair market value (determined on the date of grant) of the shares
of Common Stock for which ISOs may be granted to any participant under the Plan
and any other plan by the Company or its affiliates which are exercisable for
the first time by such participant during any calendar year may not exceed
$100,000.

<PAGE> 45

The options granted under the Plan become exercisable on such dates as the Board
determines in the terms of each individual option. Options are subject to
termination in the event of a disposition of all or substantially all of the
assets or capital stock of the Company by means of a sale, merger,
consolidation, reorganization, liquidation or otherwise; unless the Committee
arranges for a continuation of the Plan or for the optionee to receive payment
or new options covering shares of the corporation purchasing or acquiring the
assets or stock of the Company, in substitution of the options granted under the
Plan. The Committee in any event may, on such terms and conditions as it deems
appropriate, accelerate the exercisability of options granted under the Plan. An
ISO to a holder of more than 10% of the total combined voting power of all
classes of stock of the Company must expire no later than five years from the
date of grant. A nonqualified stock option must expire no later than ten years
from the date of the grant.

The options granted under the Plan are not transferable other than by will or
the laws of descent and distribution. Unexercised options generally lapse 3
months after termination of employment other than by reason of retirement,
disability or death (except in the case of ISOs) in which case it terminates one
year thereafter.

The Plan provides for anti-dilution adjustments which are applicable in the
event of a reorganization, merger, combination, recapitalization,
reclassification, stock dividend, stock split or reverse stock split; however,
no such adjustment need be made if it is determined that the adjustment may
result in the receipt of federally taxable income to optionees or the holders of
Common Stock or other classes of the Company's securities. Upon the dissolution
or liquidation of the Company, or upon a reorganization, merger or consolidation
of the Company as a result of which the Company is not the surviving entity, the
Plan shall terminate, and any outstanding awards shall terminate and be
forfeited unless assumed by the successor corporation.

The Plan currently provides that the Board may amend the Plan at any time
without obtaining shareholder approval to the fullest extent permitted by
applicable law or regulation, and, in the event the Board determines that
shareholder approval is required by applicable law or regulation, than such
amendments would be effective once approved by the Board and the holders of a
majority of the shares of Common Stock.

OPTION/SAR GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
---------------------------------------------
PERCENT OF
NUMBER OF TOTAL POTENTIAL REALIZABLE
SECURITIES OPTIONS VALUE AT ASSUMED
UNDERLYING SARS ANNUAL RATES OF STOCK
OPTIONS GRANTED TO EXERCISE PRICE APPRECIATION
/SARS EMPLOYEES OR BASE FOR OPTION TERM
GRANTED IN FISCAL PRICE EXPIRATION ----------------------
NAME (#) YEAR ($/SH) DATE 5%($) 10%($)
- ---- ---------- ---------- -------- ---------- --------- -------
(a) (b) (c) (d) (e) (f) (g)
<S> <C> <C> <C> <C> <C> <C>
Peter Locke -- --% -- -- -- --

Donald Kushner -- --% -- -- -- --

Bruce Lilliston 8,333 7.41% $3.875 10/1/07 $20,307 $51,463

Robert Swan -- --% -- -- -- --
</TABLE>

<PAGE> 46

AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES

<TABLE>
<CAPTION>
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS/SARS OPTIONS/
SHARES VALUE AT FY-END SARS AT FY-END($)
ACQUIRED REALIZED EXERCISABLE/ EXERCISABLE
NAME ON EXERCISE(#) ($) UNEXERCISABLE UNEXERCISABLE
- ---- -------------- -------- ---------------- -----------------
<S> <C> <C> <C>
Peter Locke -0- N/A 183,334/133,332 $44,794/$179,177

Donald Kushner -0- N/A 183,334/133,332 $44,794/$179,177

Bruce Lilliston -0- N/A 41,667/0 $18,882/$0

Robert Swan -0- N/A 16,667/8,333 $22,397/$11,198
</TABLE>

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

From October 1, 1997 through June 18, 1998 the Compensation Committee consisted
of Messrs. Hersch, Braun and Coppersmith. On June 18, 1998, at the Company's
annual shareholders meeting, Messrs. Braun and Coppersmith did not stand for
reelection and Messrs. Friedman and Lannan were elected to the Board of
Directors. In a subsequent Board meeting on June 18, 1998, Messrs. Friedman and
Lannan were appointed to the Compensation Committee. The Compensation Committee
participated in deliberations and decisions regarding executive compensation.
However, the full Board of Directors of the Company participated in
deliberations and decisions regarding grants of new options to certain directors
and certain employees in connection with new employment agreements and
amendments and extensions of employment agreements with the Company. Other than
Messrs. Kushner and Locke, no member of the Board of Directors was, during the
fiscal year or formerly, an officer or employee of the Company or any of its
subsidiaries, however Stuart Hersch, a director, is paid $7,500 per month
pursuant to a consulting contract. During fiscal year 1998, Mr. Locke served as
Co-Chairman of the Board, and Co-Chief Executive Officer of the Company, and Mr.
Kushner served as Co-Chairman of the Board, Co-Chief Executive Officer, and
Secretary of the Company.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

BENEFICIAL OWNERSHIP OF CERTAIN STOCKHOLDERS

The following table sets forth certain information as of January 27, 1999
concerning the beneficial ownership of Common Stock, by (i) each person who is
known to the Company to be a beneficial owner of more than 5% of the outstanding
Common Stock; (ii) each of the current Directors of the Company; (iii) each of
the Named Executive Officers; and (iv) all current Directors and Executive
Officers of the Company as a group.

<PAGE> 47
<TABLE>
<CAPTION>
PERCENT
COMMON STOCK OF
BENEFICIAL OWNER BENEFICIALLY OWNED CLASS(7)
- ---------------- ------------------ --------
<S> <C> <C>
Peter Locke ................................... 681,013(1)(2) 6.31%
11601 Wilshire Blvd., 21st Floor
Los Angeles, CA 90025
(310) 481-2000

Donald Kushner ................................ 681,158 (3) 6.31%
11601 Wilshire Blvd., 21st Floor
Los Angeles, CA 90025
(310) 481-2000

Irwin Friedman ................................ 91,389 (3) *
375 Park Avenue, Suite 2608
New York, NY 10152
(212) 813-1611

Stuart Hersch ................................. 82,295 (4) *
11601 Wilshire Blvd., 21st Floor
Los Angeles, CA 90025
(310) 481-2000

John Lannan ................................... 18,888 (5) *
11601 Wilshire Blvd., 21st Floor
Los Angeles, CA 90025
(310) 481-2000

Bruce St. J. Lilliston ........................ 41,667 (6) *
11601 Wilshire Blvd., 21st Floor
Los Angeles, CA 90025
(310) 481-2000

Robert Swan ................................... 6,667 (6) *
11601 Wilshire Blvd., 21st Floor
Los Angeles, CA 90025
(310) 481-2000

Gruber & McBaine Capital Management, LLC ...... 1,009,000 (7) 9.51
50 Osgood Place
San Francisco, CA 94133

All directors and executive officers as a group
(seven individuals) ........................... 1,603,077 14.31%
(1)(2)(3)(4)(5)(6)
</TABLE>

* Less than 1%

(1) Includes 183,334 shares subject to options which are currently exercisable
or exercisable within 60 days of the date hereof, and excludes 133,332
options which are not currently exercisable or exercisable within 60 days of
the date hereof.

(2) Includes 33,333 shares owned by a corporation controlled by Mr. Kushner.

(3) Includes 88,890 shares subject to options and warrants currently
exerciseable, and excludes 27,777 shares

47
<PAGE> 48
subject to options and warrants which are not currently exercisable or
exercisable within 60 days.

(4) Includes 82,295 shares subject to options currently exercisable, and
excludes 5,555 shares subject to options which are not currently exercisable
or exercisable within 60 days.

(5) Includes 5,556 shares subject to options currently exercisable, and excludes
11,111 shares subject to options which are not currently exercisable or
exercisable within 60 days.

(6) Represents shares subject to options currently exercisable.

(7) Based upon Form 3 and Form 13D filings by the investment advisor dated
December 30, 1998, as updated by the investment advisor to the Company so as
to represent holdings on January 27, 1999.

(8) As a percentage of the 10,608,141 shares outstanding on January 27, 1999
plus certain shares issuable upon conversion of convertible securities or
subject to options held by such person or persons.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

In fiscal 1993, the Company entered into a domestic home video distribution
agreement with WarnerVision for the feature film Deadly Exposure. Stuart Hersch,
a Director of the Company, was President of WarnerVision at that time. The
distribution agreement provides for payment by WarnerVision to the Company of an
advance in exchange for certain domestic home video rights, subject to certain
back-end participation rights of the Company, and payments by the Company to
WarnerVision of 30% of the Company's net revenues derived from Canadian home
video and broadcast television exploitation of Deadly Exposure. Through
September 30, 1998, no payments had been made by the Company to WarnerVision
pursuant to such agreement.

In fiscal 1994, the Company entered into certain joint ventures with
WarnerVision whereby WarnerVision and the Company share production costs and
expenses and any resulting revenues with respect to certain motion pictures. The
Company has also entered into domestic home video distribution agreements with
WarnerVision for the feature films Lady-in-Waiting and Last Gasp. These
agreements provide for the payment by WarnerVision to the Company of $510,000
and $530,000 in exchange for WarnerVision receiving participation rights with
the Company in the revenues derived from the exploitation of Lady-in-Waiting and
Last Gasp, respectively. The Company also agreed to license to WarnerVision
domestic distribution rights to Wes Craven Presents: Mind Ripper for a
recoupable minimum guaranty payment against revenues.

In fiscal 1994, the Company entered into a five picture joint venture with
WarnerVision similar to the Lady-in-Waiting and Last Gasp joint ventures.
Through September 30, 1998, the Company had received approximately $924,000 from
WarnerVision towards the production costs and expenses of these films pursuant
to such joint ventures. The Company believes that the terms of the forgoing
transactions are no less favorable to the Company than those that could have
been obtained in transactions with unaffiliated third parties.

On September 14, 1996, the Company entered into an employment agreement with
Bruce St. J. Lilliston pursuant to which the Company agreed to hire Mr.
Lilliston as the President and Chief Operating Officer of the Company effective
October 1, 1996. As part of such agreement, Mr. Lilliston is allowed to maintain
not more than two independent outside legal consultancy client relationships,
subject to approval by the Chief Executive Officers. Prior to his employment,
Mr. Lilliston provided various legal services to the Company through the Law
Offices of Bruce St. J. Lilliston. During fiscal 1996, the Company paid Mr.
Lilliston $180,000 for such legal services. In addition, Mr. Lilliston had
provided various legal services to certain of Kushner-Locke International's
distributing licensees as well as August Entertainment. See Item II, Executive
Compensation - Employment Agreement - Mr. Lilliston for a further description of
Mr. Lilliston's employment arrangement with the Company.

<PAGE> 49

During fiscal 1998 the Company paid to WarnerVision $1,543,000, a previously
accrued payment obligation, and settled certain disputes with WarnerVision.

In April 1996, the Company entered into a month-to-month consulting agreement
with Stuart Hersch which provides for a monthly fee of $7,500 to be paid to Mr.
Hersch. Mr. Hersch assists the Company in analyzing potential strategic
acquisitions and provides the Company consulting services in connection with the
Company's infomercial operations.

In February 1998 the Company paid I. Friedman Equities, Inc. $24,000 pursuant to
Mr. Friedman's consulting agreement.

In August 1997, Mr. Locke acquired an option to purchase 45% of the outstanding
shares of common stock of 800-U.S.Search ("Search") from Robert L. Rich pursuant
to an option agreement (the "Rich Option"). In November 1997, Mr. Locke
exercised the Rich Option in exchange for Mr. Locke's entering into an
indemnification agreement whereby he agreed to personally indemnify Mr. Rich
against certain liabilities to which Mr. Rich may have been subject in
connection with Search (the "Indemnified Liabilities"). Mr. Locke subsequently
transferred the shares to Dayton Way V, Inc., a California corporation and
affiliate of the Company ("Dayton Way"), in exchange for indemnification by
Dayton Way from the Indemnified Liabilities. In October 1997, the Company
purchased 35% of the outstanding shares of common stock of Search from Nicholas
Matzorkis in exchange for the Company's agreement to indemnify Mr. Matzorkis
against certain liabilities to which Mr. Matzorkis may have been subject in
connection with the Indemnified Liabilities. The indemnification obligation
included substantially the same liabilities as the Indemnified Liabilities under
the Rich Option. Subsequently, the Company assigned its rights under this
agreement to Dayton Way, and Dayton Way acquired the shares, bringing its total
ownership to 80% of the outstanding common stock of Search. In connection with
these transactions, Dayton Way granted to the Company an option to purchase the
80% interest for $100 and the Company's agreement to indemnify Dayton Way
against the Indemnified Liabilities. The Company exercised this option in
January 1998.

From May 1997 to October 1997, Mr. Locke personally loaned Search $187,000,
bearing interest at 10% per annum, payable upon demand. This loan was
subsequently repaid in full. In addition, Search paid $35,000 in consulting fees
to Mr. Locke for services rendered from May 1997 through December 1997.

The Company believes that the terms of the foregoing transactions are no less
favorable to the Company than those that could have been obtained in
transactions with unaffiliated third parties.

Each of Messrs. Friedman and Lannan were granted options to purchase 16,667
shares of common stock of the Company at an exercise price of $2.84 in June
1998.

In July 1998, Messrs. Braun and Coppersmith, each of whom was director of the
Company until June 1998, each entered into a one year consulting agreement with
the Company providing for payments totalling $20,000. In addition, the board of
directors fully vested the options previously granted to Messrs.
Braun and Coppersmith.

<PAGE> 50

14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
(a) (1) Financial Statements:
Report of Independent Accountants...................................................... 51
Independent Auditors' Report........................................................... 52
Consolidated Balance Sheets at September 30, 1998 and 1997............................. 53
Consolidated Statements of Operations for the years ended September 30, 1998, 1997,
and 1996............................................................................... 54
Consolidated Statements of Cash Flows for the years ended September 30, 1998, 1997,
and 1996............................................................................... 55
Consolidated Statements of Stockholders' Equity for the years ended September 30,
1998, 1997, and 1996.............................................................. 57
Notes to Consolidated Financial Statements............................................. 58
(2) Financial Statement Schedule
Schedule II for the years ended September 30, 1998, 1997, and 1996..................... 82
All other schedules are inapplicable and, therefore, have been omitted.
(3) Exhibits
Exhibits filed as part of this report are listed in the Exhibit Index, which follows
the Signatures

(b) Report on Form 8-K:
Current Report of the Company on Form 8-K, as filed on October 27, 1998
</TABLE>

50
<PAGE> 51

REPORT OF INDEPENDENT ACCOUNTANTS

The Board of Directors and Stockholders of The Kushner-Locke Company:

In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of cash flows and of stockholders' equity
present fairly, in all material respects, the financial position of The
Kushner-Locke Company (the "Company") and its subsidiaries at September 30,
1998, and the results of their operations and their cash flows for the year
ended September 30, 1998, in conformity with generally accepted accounting
principles. 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 audit. We conducted our audit of these statements in
accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for the opinion expressed
above.

PricewaterhouseCoopers LLP

Los Angeles, California
December 24, 1998

51
<PAGE> 52

INDEPENDENT AUDITORS' REPORT

The Board of Directors
The Kushner-Locke Company:

We have audited the accompanying consolidated balance sheet of The Kushner-Locke
Company and subsidiaries as of September 30, 1997, and the related consolidated
statements of operations, cash flows and stockholders' equity for each of the
years in the two-year period ended September 30, 1997. In connection with our
audits of the consolidated financial statements, we have also audited the
accompanying financial statement schedule for each of the years in the two-year
period ended September 30, 1997. These consolidated financial statements and the
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and the financial statement schedule 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 The Kushner-Locke
Company and subsidiaries as of September 30, 1997, and the results of their
operations and their cash flows for each of the years in the two-year period
ended September 30, 1997, in conformity with generally accepted accounting
principles. Also in our opinion, the related financial statement schedule for
each of the years in the two-year period ended September 30, 1997, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.

KPMG LLP

Los Angeles, California
December 26, 1997

<PAGE> 53
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, SEPTEMBER 30,
1998 1997
------------- -------------
<S> <C> <C>
ASSETS
Cash and cash equivalents ................................................ $ 1,255,000 $ 15,077,000
Reserved cash ............................................................ 66,000 105,000
Restricted cash .......................................................... 1,988,000 1,609,000
Accounts receivable, net of allowance for doubtful accounts of $2,509,000
in 1998 and $891,000 in 1997 ........................................... 40,418,000 27,696,000
Due from affiliates ...................................................... 2,488,000 588,000
Note receivable from related party ....................................... 231,000 423,000
Film and television property costs, net of accumulated amortization ...... 73,773,000 68,507,000
Investments in unconsolidated entities, at equity ........................ 10,798,000 7,135,000
Other assets ............................................................. 6,088,000 3,228,000
------------- -------------

Total assets ............................................................. $ 137,105,000 $ 124,368,000
============= =============

LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued liabilities ................................. $ 6,031,000 $ 2,935,000
Notes payable ............................................................ 73,151,000 62,647,000
Deferred film license fees ............................................... 4,111,000 3,362,000
Contractual obligations .................................................. 13,851,000 6,155,000
Production advances ...................................................... 2,969,000 6,502,000
Convertible subordinated debentures, net of deferred issuance costs ...... 11,526,000 11,631,000
------------- -------------

Total liabilities ........................................................ 111,639,000 93,232,000

Commitments and contingencies

Stockholders' equity:
Common stock, no par value. Authorized 50,000,000 shares: issued and
outstanding 9,217,029 shares at September 30, 1998 and 9,090,080
shares at September 30, 1997 ....................................... 39,571,000 38,905,000
Accumulated deficit .................................................... (14,105,000) (7,769,000)
------------- -------------

Net stockholders' equity ......................................... 25,466,000 31,136,000
------------- -------------

Total liabilities and stockholders' equity ................................ $ 137,105,000 $ 124,368,000
============= =============
</TABLE>

See accompanying notes to consolidated financial statements.

53
<PAGE> 54

THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996

1998 1997 1996
-------------- ------------- -------------

<S> <C> <C> <C>
Operating revenues:
Film and television program licensing .......................... $67,931,000 $56,935,000 $80,157,000
Search and individual reference services ....................... 7,869,000 -- --
------------ ----------- ------------
Total operating revenues .................................. 75,800,000 56,935,000 80,157,000
------------ ------------ ------------

Costs related to operating revenues:
Film and television program licensing .......................... (58,038,000) (52,084,000) (70,648,000)
Search and individual reference services ....................... (3,589,000) -- --
------------ ------------ ------------
Total costs related to operating revenues ................. (61,627,000) (52,084,000) (70,648,000)
------------ ------------ ------------

Gross profit ............................................... 14,173,000 4,851,000 9,509,000

Selling, general and administrative expenses ........................ (12,028,000) (4,023,000) (3,096,000)

Provision for doubtful accounts and notes ........................... (2,118,000) (1,310,000) (499,000)
------------ ------------ ------------

Earnings (loss) from operations ............................ 27,000 (482,000) 5,914,000

Interest income ..................................................... 79,000 163,000 198,000
Interest expense .................................................... (6,261,000) (4,027,000) (4,027,000)
Interest expense related to Bridge Note financing ................... -- -- (943,000)
------------ ----------- ------------

Earnings (loss) before income taxes and extraordinary item (6,155,000) (4,346,000) 1,142,000

Income tax expense .................................................. (181,000) (23,000) (47,000)
------------ ----------- ------------

Earnings (loss) before extraordinary item ................. (6,336,000) (4,369,000) 1,095,000

Extraordinary item: costs associated with repayment of credit
facility .......................................................... -- -- (365,000)
------------ ------------ ------------

Net earnings (loss) .................................. $(6,336,000) $(4,369,000) $ 730,000
============ ============ ===========

Basic and diluted earnings (loss) per share:
Before extraordinary item ........................................ $ (.69) $ (.49) $ .16
Extraordinary item ............................................... -- -- (.05)
------------ ------------ ----------

Net earnings (loss) ....................................... $ (.69) $ (.49) $ .11
============ ============ ===========

Weighted average common shares outstanding .......................... 9,181,000 8,959,000 6,668,000
============ ============ ===========

</TABLE>

See accompanying notes to consolidated financial statements.

54
<PAGE> 55
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
<TABLE>
<CAPTION>

1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss) ........................................ $(6,336,000) $ (4,369,000) $ 730,000
Adjustments to reconcile net earnings (loss) to
net cash used by operating activities:
Amortization of film costs .............................. 53,916,000 50,835,000 70,068,000
Depreciation and amortization ........................... 530,000 192,000 190,000
Provision for doubtful accounts and notes .............. 2,118,000 1,310,000 499,000
Amortization of capitalized issuance costs .............. 1,013,000 969,000 299,000
Interest on bridge loan ................................. -- -- 750,000
Compensation expense .................................. 348,000 -- --
Changes in assets and liabilities:
Restricted cash ......................................... (379,000) (1,190,000) 743,000
Reserved cash ........................................... 39,000 4,021,000 (4,126,000)
Accounts receivable, net ................................ (14,755,000) (6,121,000) (15,520,000)
Other receivables ....................................... (1,708,000) 767,000 (717,000)
Film and television property costs ...................... (59,182,000) (60,879,000) (54,815,000)
Other assets .......................................... (130,000) -- --
Accounts payable and accrued liabilities ................ 1,608,000 (342,000) 32,000
Debt issuance costs ................................... (800,000) -- --
Deferred film license fees .............................. 749,000 (98,000) 707,000
Contractual obligations ................................. 6,901,000 2,643,000 2,517,000
Production advances ..................................... (3,533,000) 4,369,000 (14,476,000)
------------ ------------ ------------

Net cash used by operating activities ............... (19,601,000) (7,893,000) (13,119,000)
------------ ------------ ------------

Cash flows from investing activities:
Investments in unconsolidated entities ..................... (3,663,000) (5,621,000) (1,495,000)
Purchases of property, plant and equipment ................. (786,000) (157,000) (140,000)
------------ ------------ ------------

Net cash used by investing activities ............... (4,449,000) (5,778,000) (1,635,000)
------------ ------------ ------------
Cash flows from financing activities:
Borrowings under notes payable ............................. 42,094,000 54,716,000 34,081,000
Repayment of notes payable ................................. (31,864,000) (33,550,000) (20,998,000)
Net proceeds from issuance of common stock ................. -- -- 7,202,000
Net proceeds from exercise of stock options ................ 34,000 -- 412,000
Repayment of debentures .................................... (36,000) -- (56,000)
Other ...................................................... -- (491,000) (1,935,000)
------------ ------------ ------------

Net cash provided by financing activities ........... 10,228,000 21,657,00 18,706,000
------------ ------------ ------------

Net increase (decrease) in cash ..................... (13,822,000) 7,986,000 3,952,000
Cash and cash equivalents at beginning of year .............. 15,077,000 7,091,000 3,139,000
------------ ------------ ------------

Cash and cash equivalents at end of year .................... $ 1,255,000 $ 15,077,000 $ 7,091,000
============ ============ ============

(continued)

</TABLE>

<PAGE> 56
<TABLE>
<S> <C> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest .................................... $6,427,000 $4,487,000 $3,557,000
========== ========== ==========

Income taxes .............................. $ 40,000 $ 23,000 $ 47,000
========== ========== ==========

</TABLE>

See accompanying notes to consolidated financial statements.

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

(1) In fiscal 1996, $6,500,000 of convertible subordinated debentures were
converted into 1,182,248 adjusted shares of common stock including 105,289
adjusted shares of common stock, valued at $750,000, relating to interest on
the bridge loan. See accompanying notes to consolidated financial
statements.

(2) In fiscal 1997, $667,000 of convertible subordinated debentures were
converted into 84,562 adjusted shares of common stock.

(3) In fiscal 1998, $300,000 of convertible subordinated debentures were
converted into 51,282 adjusted shares of common stock valued at $284,000. In
addition, the Company issued warrants to Allen & Company Incorporated,
valued at $348,000. Also in fiscal 1998 the Company acquired an 80% interest
in 800-US Search in exchange for certain guaranties of indebtedness. In
conjunction with the acquisition, liabilities were assumed as follows:
<TABLE>
<CAPTION>

<S> <C>
Fair value of assets acquired: $461,000
Cash paid for the capital stock: --
Liabilities assumed: $2,557,000
</TABLE>

56
<PAGE> 57

THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
<TABLE>
<CAPTION>

NUMBER OF (ACCUMULATED
SHARES COMMON STOCK DEFICIT) NET
-------------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C>
Balance at September 30, 1995 ... 5,911,100 $23,337,000 $(4,130,000) $ 19,207,000

Issuance of common stock ............ 1,583,333 7,202,000 -- 7,202,000
Stock options exercised ............. 75,000 412,000 -- 412,000
Stock purchase warrants exercised ... 25,860 -- -- --
Issuance of bridge loan stock ....... 105,289 750,000 -- 750,000
Conversion of subordinated debentures 1,076,959 5,949,000 -- 5,949,000
Net earnings ........................ -- -- 730,000 730,000
------------ ------------ ------------ ------------

Balance of September 30, 1996 . 8,777,541 37,650,000 (3,400,000) 34,250,000

Issuance of common stock ............ 227,500 598,000 -- 598,000
Conversion of subordinated debentures 84,562 613,000 -- 613,000
Other ............................... 477 44,000 -- 44,000
Net loss ............................ -- -- (4,369,000) (4,369,000)
------------ ------------ ------------ ------------

Balance at September 30, 1997 ... 9,090,080 38,905,000 (7,769,000) 31,136,000

Stock options exercised ............. 9,000 34,000 -- 34,000
Conversion of subordinated debentures 51,282 284,000 -- 284,000
Other ............................... 66,667 348,000 -- 348,000
Net loss ............................ -- -- (6,336,000) (6,336,000)
------------ ------------ ------------ ------------

Balance at September 30, 1998 ... 9,217,029 $39,571,000 $(14,105,000) $ 25,466,000
============ ============ ============ ============

</TABLE>

See accompanying notes to consolidated financial statements.

57
<PAGE> 58

THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) Summary of Significant Accounting Policies

The Company

The Kushner-Locke Company (the "Company") primarily develops, produces and
distributes feature films, direct-to-video films, television series,
movies-for-television, mini-series and animated programming. In the last three
years, the Company expanded its operations into related business lines in
ancillary markets for its product such as merchandising, home video, cable and
interactive/multimedia applications for characters and story ideas developed by
the Company.

Generally, theatrical films are first distributed in the theatrical and home
video markets. Subsequently, theatrical films are made available for world-wide
television network exhibition or pay television, television syndication and
cable television. Generally, television films are first licensed for network
exhibition and foreign syndication or home video, and subsequently for domestic
syndication or cable television. Certain films are produced and/or distributed
directly for initial exhibition by local television stations,
advertiser-supported cable television, pay television and/or home video. The
revenue cycle generally extends 7 to 10 years on film and television products.

Basis of Presentation

The consolidated financial statements include the accounts of The Kushner-Locke
Company, its wholly-owned subsidiaries and certain less than wholly-owned
entities which the Company controls. All material intercompany balances and
transactions have been eliminated. Entities in which the Company holds a 20% to
50% interest and exercises significant influence are accounted for under the
equity method.

During fiscal 1998, the Company acquired 80% of the outstanding common stock of
800-US Search through an assumption of liabilities, and established a new
80%-owned joint venture for Latin American distribution and satellite television
broadcasting. Those entities' accounts are consolidated in the accompanying
financial statements from the date of acquisition or establishment. Pro forma
annual results of operations assuming the acquisition of 800-US Search had
occurred at the beginning of fiscal 1997 are not presented as 800-US Search
results are included for more than 10 months of fiscal 1998 and operations for
the fourteen months preceding the acquisition are minor. The acquisition of
800-US Search was accounted for as a purchase and, after revaluing acquired
assets and liabilities, the Company recorded a $2,097,000 intangible asset
representing the excess of cost over net assets acquired. That intangible asset
is being amortized straight-line over an estimated 5 year life. Because 800-U.S.
Search and Kushner-Locke's new Latin American distribution and satellite
television broadcasting subsidiaries have incurred net losses since inception or
acquisition and the Company has funded 100% of such losses, the Company has
recognized 100% of those incurred net losses in its consolidated financial
statements and no minority interest liabilities or charges against operating
results were recognized.

Certain reclassifications have been made to conform prior year balances with the
current presentation.

Revenue Recognition

Revenues from feature film and television program distribution licensing
agreements are recognized on the date the completed film or program is delivered
or becomes available for delivery, is available for exploitation in the relevant
media window purchased by that customer or licensee and certain other conditions
of sale have been met pursuant to criteria specified by SFAS No. 53, Financial
Reporting By Producers and Distributors of Motion Picture Films. Revenues

58
<PAGE> 59

from barter transactions, whereby the program is exchanged for television
advertising time which is sold to product sponsors, are recognized when the
television program has aired and all conditions precedent have been satisfied.

Producer fees received from production of films and television programs for
outside parties where the Company has no continuing ownership interest in the
project are recognized on a percentage-of-completion basis as determined by
applying the cost-to-cost method. The cost of such films and television series
is expensed as incurred.

The Company's subsidiary, 800-US Search, generates revenues by performing
various information search services for customers. Revenue is recognized when
the results of the search services are delivered. In instances where searches
are not completed to the customer's satisfaction, 800-US Search performs limited
additional customer support for up to one year following the initial sale. Such
customer support costs are estimated and provided for in the period of sale.

Accounting for Film and Television Property Costs

The Company capitalizes costs incurred to produce a film or television project,
including the interest expense funded under the production loans. Such costs
also include the actual direct costs of production, certain exploitation costs
and production overhead. Capitalized exploitation or distribution costs include
those costs that clearly benefit future periods such as film prints and
prerelease and early release advertising that is expected to benefit the film in
future markets. These costs, as well as expected revenue or profit
participations and talent residuals, are amortized each period on an individual
film or television program basis in the ratio that the current period's gross
revenues from all sources for the program bear to management's estimate of
anticipated total gross revenues for such film or program from all sources.
Revenue estimates are reviewed quarterly and adjusted where appropriate and the
impact of such adjustments could be material.

Film and television property costs are stated at the lower of unamortized cost
or estimated net realizable value. Losses which may arise because unamortized
costs of individual films or television series exceed anticipated revenues are
charged to operations through additional amortization.

The Company capitalized interest of $982,000, $1,429,000 and $1,735,000 to film
and television property costs for the years ended September 30, 1998, 1997, and
1996, respectively. During the same respective periods, $6,261,000, $4,027,000
and $ 4,970,000 of total interest costs were incurred.

Participants' Share Payable and Talent Residuals

The Company charges profit participation and talent residual costs to expense in
the same manner as amortization of production costs, based on the ratio of
current period gross revenues to management's estimate of total ultimate gross
revenues, if it is anticipated such amounts will be payable. Payments for profit
participations are made in accordance with the participants' contractual
agreements. Payments for talent residuals are remitted to the respective guilds
in accordance with the provisions of their union agreements.

Production Advances

The Company receives license fees for projects in the production phase.
Production advances are generally nonrefundable and are recognized as earned
revenue when the film or television program is available for delivery.

Allowance for Doubtful Accounts

The Company provides for doubtful accounts based on historical collection
experience and periodically adjusts the allowance based on the aging of accounts
receivable and other conditions. Receivables are written off against the
allowance in the period they are deemed uncollectible.

<PAGE> 60

Search Advertising Costs

The Company's subsidiary, 800-US Search purchases advertising time on network
television programs. Prepaid broadcast and publication expenses are expensed
when the advertisement is available. Advertising television production costs are
capitalized and recorded as expense upon first airing. Advertising expense for
fiscal 1998 was approximately $4,747,000.

Concentrations of Risk:

Credit Risks

Financial instruments which subject the Company to concentrations of credit risk
consist primarily of cash and cash equivalents and trade accounts receivable.
The Company maintains cash and cash equivalents with various domestic financial
institutions. The Company performs periodic evaluations of the relative credit
standing of these institutions. From time to time, the Company's cash balances
with any one financial institution may exceed Federal Deposit Insurance
Corporation (FDIC) limits.

The Company's customers are located throughout the world. For certain revenue
streams, the Company does not require guarantee of payment and establishes an
allowance for doubtful accounts based upon historical trends and other
information. To date, such losses have been within management's expectations.

Business Risks

The Company's subsidiary, 800-US Search, provides services to its customers
using internal and external computer systems. Operations are currently
susceptible to varying degrees of security (including physical and electronic
security breaches) as well as varying levels of internal support. A disruption
in security or internal support could cause a delay in the 800-US Search's
performance of services which would adversely affect operating results.

Cash and Cash Equivalents

The Company considers certificates of deposit and other highly liquid
investments with original maturities of three months or less to be cash
equivalents.

Restricted and Reserved Cash

At September 30, 1998, the Company had $1,988,000 in restricted cash related to
deposits held at a British bank pursuant to film sale/leaseback transactions,
and to advances made by the Company to film producers for the acquisition of
distribution rights or films not yet completed ($1,609,000 at September 30,
1997). The latter cash advances are held in escrow accounts as collateral by
financial institutions providing production loans to those producers. In
addition, the Company has $66,000 in cash collected by the Company and reserved
for use by Chase Manhattan Bank to be applied against the Company's outstanding
borrowings under the terms of the Company's credit facility ($105,000 at
September 30, 1997).

International Currency Transactions

The majority of the Company's foreign sales transactions are payable in U.S.
dollars. Accordingly, international currency transaction gains and losses
included in the consolidated statements of operations for the three years ended
September 30, 1998 were not significant.

<PAGE> 61

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statements
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in operating
results in the period encompassing the enactment date.

Use of Estimates

Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities to prepare these financial
statements in conformity with generally accepted accounting principles.
Significant estimates are primarily related to ultimate revenues and ultimate
costs relating to the Company's film and television properties and the
collectibility of accounts receivable. Actual results may differ from estimated
amounts.

Stock-Based Compensation

In October 1995, the Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock-Based Compensation." The Company accounts for stock-based
employee compensation arrangements in accordance with Accounting Principles
Board ("APB") No. 25, "Accounting for Stock Issued to Employees," and complies
with the disclosure requirements of SFAS No. 123. Under APB No. 25, compensation
cost, if any, is recognized over the respective vesting period based upon the
difference on the grant date between the fair value of the Company's Common
Stock and the grant price.

Fair Value of Financial Instruments

The recorded value of the Company's cash and cash equivalents, accounts
receivable, accounts payable and accrued liabilities, contractual obligations
and participants' share payable for talent residuals approximate their fair
value due to the relatively short maturities of these instruments. The fair
value of due from affiliates and note receivable from a related party have not
been estimated due to the related party nature of such amounts. The fair value
of notes payable and convertible subordinated debentures approximates the
recorded value due to the stated interest rate on such instruments and the
indeterminate nature of the value of the convertibility feature of such debt
instrument.

Reverse Stock Split

In September 1997 the Company effected a 1-for-6 reverse split of the issued and
outstanding shares of common stock which had been approved by the stockholders.
All references to shares outstanding give effect to this reverse stock split as
if it had occurred at the beginning of the earliest period presented.

Earnings (Loss) Per Share

Basic earnings (loss) per share is computed by dividing net earnings (loss)
available to common shareholders (the numerator) by the weighted average number
of common shares outstanding (the denominator) during the period. The
computation of diluted earnings (loss) per share is similar to the computation
of basic earnings (loss) per share except that the denominator is increased to
include the number of additional common shares that would have been outstanding
if the dilutive potential common shares had been issued. The inclusion of the
additional shares assuming the conversion of the Company's convertible
subordinated debentures or assuming the exercise of warrants or stock options
would have been antidilutive for all periods presented.

<PAGE> 62

Recent Accounting Pronouncements

(2) Film and Television Property Costs

Film and television property costs consist of the following:
<TABLE>
<CAPTION>

SEPTEMBER 30, SEPTEMBER 30,
1998 1997
----------- -----------
<S> <C> <C>
In process or development ........................ $10,570,000 $10,497,000
Released, principally feature films and television
productions, net of accumulated amortization ... 63,203,000 58,010,000
----------- -----------

Total ............................................ $73,773,000 $68,507,000
=========== ===========

</TABLE>

Based upon the Company's present estimates of anticipated future revenues at
September 30, 1998, approximately 70% of the film costs related to released
films and television series will be amortized during the three-year period
ending September 30, 2001.

(3) Investments in Unconsolidated Entities, at Equity

The Company has produced certain films and television programs and sells
Christian music utilizing entities which are not consolidated. Information
regarding the Company's investments and advances in unconsolidated entities, net
as of September 30, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>

NET EQUITY
OWNERSHIP INVESTMENT AND
INVESTEE % ADVANCES
----------------
<S> <C> <C>
1998:
BLT Ventures .......... 50% $ 827,000
Cracker Company LLC ... 50% 5,648,000
TV First .............. 50% 520,000
Grendel Productions LLC 25% 2,093,000
Swing Ventures ........ 50% 1,230,000
Others ................ Various 480,000
===========
$10,798,000
===========
1997:
BLT Ventures .......... 50% $ 1,925,000

</TABLE>

<PAGE> 63

<TABLE>

<S> <C> <C>
Cracker Company LLC ... 50% 3,003,000
TV First .............. 50% 868,000
Grendel Productions LLC 25% 1,002,000
Others ................ 50% 337,000
===========
$ 7,135,000
===========

</TABLE>

Equity in earnings (losses) of unconsolidated entities and other investments for
the years ended September 30, 1998, 1997 and 1996 which are included in
operating revenues were as follows:
<TABLE>
<CAPTION>

1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
BLT Ventures .......... $ (98,000) $ 1,896,000 $ 243,000
Cracker Company LLC ... (342,000) 313,000 --
TV First .............. (148,000) (20,000) (17,000)
Grendel Productions LLC 136,000 -- --
Swing Ventures ........ 207,000 -- --
Others ................ (85,000) -- --
=========== =========== ===========
$ (330,000) $ 2,189,000 $ 226,000
=========== =========== ===========
</TABLE>

The following representation is a condensed combined unaudited summary of
financial information of the Company's investments. Certain of the Company's
other equity investments are not considered significant and are therefore not
included.
<TABLE>
<CAPTION>

COMBINED BALANCE SHEETS COMBINED BALANCE SHEETS
SEPTEMBER 30
--------------- -------------
1998 1997
--------------- ---------------
(unaudited)

<S> <C> <C>
Film and television programming costs, net ... $11,625,000 $12,510,000

Cash ......................................... 1,956,000 1,242,000
Receivables and other assets ................. 16,794,000 3,304,000
=========== ===========
Total assets ......................... $30,375,000 $17,056,000
=========== ===========

Accounts payable ............................. $ 1,035,000 $ 1,481,000
Notes payable ................................ 8,099,000 208,000
Production advances .......................... 104,000 10,896,000
Ownership equity ............................. 21,137,000 4,471,000
=========== ===========
Total liabilities and ownership equity $30,375,000 $17,056,000
=========== ===========
</TABLE>

COMBINED OPERATING STATEMENTS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30
------------------------------------------------------
1998 1997 1996
----------------- -------------- ----------------
(unaudited) (unaudited) (unaudited)

<S> <C> <C> <C>
Operating income ................... $ 31,871,000 $ 24,681,000 $ 3,393,000

Costs relating to operating revenues (30,908,000) (20,278,000) (2,896,000)
Interest income .................... 38,000 4,000 5,000
Interest expense ................... (29,000) (29,000) (49,000)
------------ ------------ ------------
Net earnings ....................... $ 972,000 $ 4,378,000 $ 453,000
============ ============ ============

</TABLE>
No dividends were received from unconsolidated entities during fiscal 1998, 1997
or 1996.

63
<PAGE> 64

64
<PAGE> 65

(4) Notes Payable

Notes payable consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
----------------- -----------------
<S> <C> <C>
Note payable to bank, under the revolving credit
facility collateralized by substantially all
Company assets, interest at varying rates as discussed
below, outstanding principal balance due June 2000 ... $58,980,000 $56,803,000

Notes payable to banks and/or financial institutions
principally consisting of production loans
collateralized by film rights ........................ 14,171,000 5,844,000
----------- -----------

Total .................................................. $73,151,000 $62,647,000
=========== ===========

</TABLE>

In June 1996 the Company obtained a $40,000,000 syndicated revolving credit
facility. In conjunction with this new facility, the Company repaid amounts
outstanding under its previously existing $15,000,000 credit facility.
Unamortized issuance costs of $365,000 relating to this previous credit facility
were expensed as an extraordinary item in 1996. In September 1997 the facility
was increased to $60,000,000, and in December 1998 the facility was increased to
$75,000,000.

The revolving credit facility is available through June 2000 and bears interest
at the Company's option, either (i) at LIBOR (5.25% as of December 24, 1998)
plus 3% (for that portion of the borrowing base supported by accounts or
contracts receivable) or LIBOR plus 4% (for that portion of the borrowing base
supported by unamortized library film costs or for loans made under the
production tranche) or (ii) at the Alternate Base Rate (which is the greater of
(a) the agent bank's Prime Rate (7.75% as of December 24, 1998), (b) the agent
bank's Base CD Rate (5.61% as of December 24, 1998) plus 1% or (c) the Federal
Funds Effective Rate (4.72% as of December 24, 1998) plus 1/2% plus 2% (for that
portion of the borrowing base supported by accounts or contracts receivable) or
3% (for that portion of the borrowing base supported by unamortized library film
costs or for loans made under the production tranche). The credit agreement
contains restrictive covenants to which the Company must adhere. These
covenants, among other things, include limitations on additional indebtedness,
liens, investments, disposition of assets, guarantees, deficit financing,
capital expenditures, affiliate transactions and the use of proceeds, and
prohibit payment of cash dividends and prepayment of most subordinated debt. In
addition, the Company must maintain a minimum liquidity level, limit overhead
expense and to meet certain financial ratios. The bank could declare an event of
default if either of Messrs. Locke or Kushner failed to be the Chief Executive
Officer of the Company or if any person or group acquired ownership or control
of capital stock of the Company having voting power greater than the voting
power at the time controlled by Messrs. Kushner and Locke combined (other than
any institutional investor able to report its holdings on Schedule 13G which
holds no more than 15% of such voting power). In December 1998 the credit
agreement was amended to change the leverage covenant effective as of September
30, 1998, and the Company was in compliance with the amended covenant.

The Company's other borrowings, totaling $14,171,000 as of September 30, 1998,
consist of production loans from Banque Paribas (Los Angeles Agency)
("Paribas"), Equicap Financial Corporation ("Equicap") and Comerica Bank -
California ("Comerica") to consolidated production entities, and a loan to the
Company's 80%-owned subsidiary. The Kushner-Locke Company provided limited
corporate guarantees for portions of the loans which are callable in the event
that the respective borrower does not repay the loan made by the respective
maturity date. Deposits paid by distributing licensees prior to the delivery of
the financed pictures are held as restricted cash collateral by the Lenders.
During fiscal 1998 the Imperial Bank loan which was outstanding as of September
30, 1997 was fully repaid and.$1,409,000 of the principal of the Paribas loan
relating to Basil was repaid.

65
<PAGE> 66

The table below shows other collateralized loans as of September 30, 1998:

<TABLE>
<CAPTION>
KUSHNER-
LOCKE
ORIGINAL LOAN AMOUNTS WEIGHTED CORPORATE
FILM OR COMPANY LENDER AMOUNT OUTSTANDING INTEREST GUARANTY MATURITY
-------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>

Basil Paribas $6,300,000 $2,159,000 10% $2,159,000 6/15/99
Black & White Comerica 1,850,000 1,804,000 Prime + 2% - 1/31/99
Magic Adventures 3 Equicap 3,500,000 2,995,000 Cdn. Prime +2% - 4/1/99
Ringmaster Comerica 2,900,000 2,359,000 Prime + 1% 800,000 4/30/99
Susan's Plan Comerica 4,625,000 4,115,000 Prime + 1% 600,000 3/31/99
800-US Search Comerica and
trade 739,000 10.5% 345,000 Various
creditors
-------------- ------------ --------------
Total $19,175,000 $14,171,000 $3,904,000
============== ============ ==============

</TABLE>

- ------------

In April 1996, a $5,150,000 production loan was obtained from Imperial Bank to
cover a portion of the production budgets of the Magic Adventures home video
series. The loan bore interest at Prime plus 1.5%. The loan was collateralized
by the rights, title and assets related to the film series which are being
delivered to domestic and international sub-distributors. The loan was fully
repaid in November 1997.

In February 1997, a $6,300,000 production loan was obtained from Paribas to
cover a portion of the production budget of Basil. The loan bears interest at
Prime (7.75% as of December 24,1998) plus 0.5% or at LIBOR (5.25% as of December
24, 1998) plus 2.5% payable monthly plus certain loan fee amounts. The loan is
collateralized by the rights, title and assets related to the film which is
being delivered to sub-distributors. In May 1997 a third party invested
$2,000,000 in the film project in exchange for certain rights and profit
participations. In December 1998 Paribas extended the maturity of the production
loan guaranteed by the Company to June 1999.

In November 1997, an $8,200,000 production loan was obtained from Comerica by an
unconsolidated company 25%-owned by the Company to cover a portion of the
production budget of Beowulf. The loan bears interest at Prime (7.75% as of
December 24, 1998) plus 1% or at LIBOR (5.25% as of December 24, 1998) plus 2%.
The Company provided a corporate guaranty in the amount of $1,250,000 in
connection with this loan. The loan matures on January 31, 1999. The loan is
collateralized by the rights, title and assets related to the film.

In February 1998, 800-U.S. Search obtained a collateralized line of credit from
Comerica. Advances under the line bear interest at Prime (7.75% December 24,
1998) plus 2.50% payable monthly. In August 1998 the bank and the Company agreed
that the loan would be capped at the $345,000 amount outstanding as of that
date. In November 1998 Search did not repay the loan then due. In December 1998
Comerica extended the loan's maturity date to March 1999. Through September 30,
1998 the Company had also loaned 800-U.S. Search $1,152,000 and the Company
continues to provide funding to Search.

In April 1998, a $1,850,000 production loan was obtained by a consolidated
subsidiary from Comerica to cover the production budget of Black & White. The
loan bears interest at Prime (7.75% as of December 24, 1998) plus 2% or at LIBOR
(5.25% as of December 24, 1998) plus 2%. The loan is collateralized by the
rights, title and assets related to the film.

In May 1998, a Canadian dollar 5,100,000 production loan was obtained from a
Canadian financial institution, by a

<PAGE> 67

consolidated subsidiary to cover a portion of the production budgets of six
direct-to-video feature films. The loan bears interest at the Canadian Prime
Rate (6.75% as of December 24, 1998) plus 2%. The loan is collateralized by the
rights, title and assets related to the films. The Company agreed to pay
$550,000 to the subsidiary borrower upon delivery of each of the films for the
acquisition of distribution rights.

(5) Convertible Subordinated Debentures
<TABLE>
<CAPTION>

SEPTEMBER 30, SEPTEMBER 30,
1998 1997
----------- -----------
<S> <C> <C>
Series A Convertible Subordinated Debentures due December 2000,
bearing interest at 10% per annum payable June 15 and
December 15, net ................................................................... $ 73,000 $ 71,000
Series B Convertible Subordinated Debentures due December 2000,
bearing interest at 13 3/4% per annum payable monthly, net ........................... 3,061,000 3,029,000
8% Convertible Subordinated Debentures due December 2000, interest
payable February 1 and August 1, net ................................................. 4,513,000 4,710,000
9% Convertible Subordinated Debentures due July 2002, interest
payable January 1 and July 1, net .................................................... 3,879,000 3,821,000
----------- -----------

Total .................................................................................. $11,526,000 $11,631,000
=========== ===========

</TABLE>

Series A Debentures

During fiscal 1991, the Company sold $1,500,000 principal amount of Series A
Convertible Subordinated Debentures due 2000 and 4,200 units which represented
an additional $4,200,000 principal amount of Series A Debentures. Each unit
included warrants to purchase 84 shares of common stock of the Company at $12.00
per share, as adjusted for the reverse stock split. Each warrant has been valued
at $1.50 (350,000 warrants with a total value of $525,000) and is included in
common stock.

As of September 30, 1998, the Company had outstanding $77,000 principal amount
of Series A Debentures. The debentures are recorded net of unamortized
underwriting discounts, expenses associated with the offering and warrants
totaling $4,000 which are amortized using the interest method to interest
expense over the term of the debentures. Approximately $2,000 of capitalized
issuance costs have been amortized to interest expense for the year ended
September 30, 1998. The Series A Debentures are convertible into common stock of
the Company at the approximate adjusted rate of 132 shares for each $1,000
principal amount of debentures, subject to further adjustment under certain
circumstances.

The Company may redeem the debentures at par after September 30, 1997. The
debentures are subordinated to all existing and future "senior indebtedness."
The term "senior indebtedness" is defined to mean the principal of (and premium,
if any) and interest on any and all indebtedness of the Company that is (i)
incurred in connection with the borrowing of money from banks, insurance
companies and similar institutional lenders, (ii) issued as a result of a public
offering of debt securities pursuant to registration under the Securities Act of
1933, or (iii) incurred in connection with the borrowing of money with an
original principal amount of at least $100,000 secured in advance by companies
engaged in the ordinary course of their business in the entertainment industry.
Senior indebtedness does not include (i) the Series B Debentures, (ii)
indebtedness to affiliates and (iii) indebtedness expressly subordinated to or
on parity with the Series A Debentures, whether outstanding on the date of
execution of the indenture or thereafter created, incurred, assumed or
guaranteed.

<PAGE> 68

Series B Debentures

During fiscal 1991, the Company sold $6,000,000 principal amount of Series B
Convertible Subordinated Debentures due 2000.

As of September 30, 1998 the Company had outstanding $3,205,000 principal amount
of Series B Debentures due 2000. The Series B Debentures are recorded net of
unamortized underwriting discounts and expenses associated with the offering
totaling $144,000, which are amortized using the interest method to interest
expense over the term of the debentures. Approximately $68,000 of capitalized
issuance costs have been amortized as interest expense for the year ended
September 30, 1998.

The terms of the Series B Debentures are generally similar to those of the
Series A Debentures other than with respect to the interest rates, except that
(i) interest is payable monthly on the Series B Debentures and (ii) the Series B
Debentures are convertible into common stock of the Company at an adjusted rate
of $9.2664 per share. The Series B Debentures rank pari passu (i.e., equally) in
right of payment with the Company's other debentures. For the year ended
September 30, 1998 $37,000 principal amount of Series B Debentures were
repurchased upon the death of bondholders pursuant to the "Flower Bond"
provision of the Series B Debentures.

8% Debentures

During fiscal 1994, the Company sold $16,437,000 principal amount of 8%
Convertible Subordinated Debentures due 2000. In connection with the issuance,
the Company issued warrants to purchase up to 10% of the aggregate principal
amount of debentures sold at an exercise price equal to 120% of the principal
amount of the debentures which are exercisable through March 1999 for $9,613,700
principal amount and through April 1999 for $30,000 principal amount.

As of September 30, 1998, the Company had outstanding $4,700,000 principal
amount of 8% Debentures. The debentures are recorded net of unamortized
underwriting discounts and expenses associated with the offering totaling
$187,000 which are amortized using the interest method to interest expense over
the term of the debentures. Approximately $86,000 of capitalized issuance costs
have been amortized as interest expense for the year ended September 30, 1998.
During fiscal 1998, $300,000 principal amount of the 8% Debentures were
converted into 51,282 shares of common stock of the Company.

The terms of the 8% Debentures are generally similar to those of the Series A
Debentures, other than with respect to the interest rates, except that (i)
interest is payable on February 1 and August 1 in each year; (ii) the 8%
Debentures are convertible into common stock of the Company at an adjusted rate
of $5.85 per share; and (iii) the Company has the right to redeem the 8%
Debentures at redemption prices commencing at 102.7% of par in February 1998 and
declining to par commencing in February 2000. The 8% Debentures rank pari passu
in right of payment with the Company's other debentures.

9% Debentures

During fiscal 1994, the Company sold $5,050,000 principal amount of 9%
Convertible Subordinated Debentures due 2002. In connection with the issuance,
the Company issued warrants to purchase up to 9% of the aggregate principal
amount of debentures sold at an exercise price equal to 120% of the principal
amount of debentures which warrants are exerciseable until July 1999.

As of September 30, 1998, the Company had outstanding $4,100,000 principal
amount of 9% Debentures The debentures are recorded net of unamortized
underwriting discounts and expenses associated with the offering totaling
$221,000, which are amortized using the interest method to interest expense over
the term of the debentures. Approximately $59,000 of capitalized issuance costs
have been amortized as interest expense for the year ended September 30, 1998.
None of the 9% Debentures were converted into shares of common stock of the
Company in fiscal year 1998.

68
<PAGE> 69

The terms of the 9% Debentures are generally similar to those of the Series A
Debentures, other than with respect to the interest rates, except that: (i)
interest is payable on January 1 and July 1 in each year; (ii) the 9% Debentures
are convertible into common stock of the Company at an adjusted rate of $9.48
per share; and (iii) the Company has the right to redeem the 9% Debentures at
redemption prices commencing at 103% of par in July 1998 and declining to par
commencing in July 2000. The 9% Debentures rank pari passu in right of payment
with the Company's other debentures.

(6) Income Taxes

Income tax expense (benefit) consisted of the following:
<TABLE>
<CAPTION>

YEAR ENDED SEPTEMBER 30,
--------------------------------
1998 1997 1996
-------- -------- -------
<S> <C> <C>
Current:
Federal ................... $154,000 -- $ --
State ..................... 27,000 23,000 47,000
-------- -------- --------
181,000 23,000 47,000

Deferred:
Federal ................... -- -- --
State ..................... -- -- --
-------- -------- --------

Total income tax expense $181,000 $ 23,000 $ 47,000
======== ======== ========

</TABLE>

A reconciliation of the statutory Federal income tax rate to the Company's
effective rate is presented below:
<TABLE>
<CAPTION>

YEAR ENDED SEPTEMBER 30,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
(34)% (34)% 34 %
Statutory Federal income tax rate.......................................
Change in valuation allowance........................................... 31.5 34 (34)
State income taxes, net of Federal tax benefit.......................... (0.5) (1) 4
---------- --------- ---------

(3)% (1)% 4%
========== ========= =========

</TABLE>

Significant components of the Company's deferred tax assets and liabilities at
September 30, 1998 and September 30, 1997 are as follows:
<TABLE>
<CAPTION>

YEAR ENDED SEPTEMBER 30,
-----------------------------
1998 1997
-------------- ---------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards................................... $12,442,000 $14,056,000
Tax and general business tax credit carryforwards.................. 857,000 857,000
Allowance for doubtful accounts and other reserves................. 695,000 691,000
Deferred film license fees......................................... 1,571,000 1,182,000
Other reserves..................................................... 265,000 484,000
Depreciation....................................................... 53,000 30,000
-------------- ---------------

Total gross deferred assets..................................... 15,883,000 17,300,000
Valuation allowance............................................. (7,694,000) (5,198,000)
-------------- ---------------

Net deferred tax assets......................................... $8,189,000 $12,102,000
============== ===============

Deferred tax liabilities:
Film amortization.................................................. $7,239,000 $11,825,000
Partnerships....................................................... 721,000 153,000
State taxes........................................................ 229,000 124,000
-------------- ---------------

Total deferred tax liabilities.................................. $8,189,000 $12,102,000
============== ===============
</TABLE>

69
<PAGE> 70

At September 30, 1998, the Company had total net operating loss carryforwards of
approximately $35,000,000 for federal income tax purposes. Such carryforwards
expire in fiscal 2013. For state tax purposes, the Company had net operating
loss carryforwards of $6,400,000 which expire in fiscal 1999 through 2002. The
Company's international tax credits, amounting to approximately $490,000, expire
in fiscal 1998 through 2001. The Company's general business credit
carryforwards, amounting to approximately $197,000, expire through 2003.
Finally, the Company's alternative minimum tax credit carryforwards, amounting
to approximately $227,000, have no expiration date.

(7) Stockholders' Equity

Authorized Stock

In November 1996 the stockholders of the Company approved an increase in the
number of authorized shares of Common Stock of the Company from 80,000,000
shares to 150,000,000 shares. In August 1997 the stockholders of the Company
approved a reduction in the number of authorized shares of Common Stock from
150,000,000 to 50,000,000 in conjunction with a 1-for-6 reverse stock split.

Warrants

In 1994, in connection with the 8% Convertible Subordinated Debentures offering,
the Company issued warrants to the underwriter to purchase up to 10% of the
aggregate principal amount of debentures sold $1,643,700 at an exercise price
equal to 120% of the principal amount of the debentures, subject to adjustment
in certain circumstances. The warrants are exerciseable March 1999 for
$1,613,700 principal amount and April 1999 for $30,000 principal amount. In
connection with the 9% Convertible Subordinated Debenture offering, the Company
issued warrants to the underwriters to purchase up to 10% of the aggregate
principal amount of debentures sold $505,000 at an exercise price equal to 120%
of the principal amount of the debentures, subject to adjustments in certain
circumstances. The warrants are exercisable through July 1999. Through September
30, 1998, no warrants had been exercised.

In 1996, in connection with its public offering of 4,750,000 units consisting of
two (pre-reverse split) shares of common stock and one warrant to purchase one
share of common stock (a "Unit") for an adjusted price of $11.625 per unit, the
Company issued 791,667 warrants to purchase common stock, as adjusted, and
warrants to the underwriter to purchase up to 71,167 units at an exercise price
of $19.18125 per Unit, as adjusted, subject to adjustment in certain
circumstances. In addition, the Company issued warrants to a consultant to
purchase up to 47,500 Units at $19.18125 per Unit, subject to adjustment in
certain circumstances. The warrants underlying the Units are exercisable at an
adjusted exercise price of $6.8625 per share subject to adjustments in certain
circumstances through June 2001, and are redeemable at $0.10 per warrant in
certain circumstances. Through September 30, 1998, no warrants had been
exercised.

In June 1997 the Company issued warrants to a financial consultant to purchase
up to 50,000 shares of common stock of the Company at $1.6875 per share which
are exercisable from December 27, 1997 through June 2002. These warrants
replaced several earlier warrant grants to the consultant, which are no longer
exercisable.

In September 1997, in connection with a consulting agreement, the Company issued
warrants to Allen & Company, Incorporated to purchase up to 500,000 shares of
common stock of the Company at $2.0625 per share. Of the total, warrants for
166,667 shares were immediately exercisable, an additional 166,667 became
exercisable in September 1998, and the remaining 166,666 become exerciseable in
September 1999, the latter event subject to Allen & Company, Incorporated still
being engaged as consultants by the Company. The warrants expire in September
2004. Also in September 1997 the Company issued warrants to a financial
consultant to purchase up to 50,000 shares of common stock at $2.0625 per share.
The terms of that warrant are the same as that pertaining to Allen & Company
Incorporated. The fair value of such warrants are amortized over the term of the
consulting agreement.

<PAGE> 71

Options

In 1989, the Board of Directors approved a stock incentive plan (the "Plan")
that covers directors, third party consultants and advisors, independent
contractors, officers and other employees of the Company. In May 1994, the
stockholders of the Company voted to increase the authorized number of shares
available under the Plan from 250,000 to 750,000, as adjusted. In November 1996
the stockholders voted to make certain amendments to the Plan, including
increasing the number of shares of Common Stock reserved for issuance from
750,000 shares to 1,250,000 shares, as adjusted, as well as certain changes in
accordance with new rules enacted under Section 16 of the Securities Exchange
Act of 1934, as amended. The Plan allows for the issuance of options to purchase
shares of the Company's common stock at an option price at least equal to the
fair value of the stock on the date of grant. Options generally vest over a 3 to
5-year term subject to continued employment and or services rendered; however
certain options vest only upon executives' achievement of certain performance
targets. As of September 30, 1998, 1,095,526 stock options had been granted and
were outstanding under the Plan.

The schedule below reflects stock option activity through September 30, 1998:
<TABLE>
<CAPTION>

WEIGHTED
AVERAGE
EXERCISE
SHARES PRICES
---------------------------

<S> <C> <C>
Balance at September 30, 1995...................... 788,685

Granted Fiscal 1996...................................... 16,667 $4.50
Options Expired/Canceled................................. (30,833) $4.86
Options Exercised........................................ (75,000) $5.49
--------------

Balance at September 30, 1996...................... 699,519

Granted Fiscal 1997...................................... 466,673 $1.98
Options Expired/Canceled................................. (70,833) $2.58
--------------

Balance at September 30, 1997...................... 1,095,359

Granted Fiscal 1998...................................... 121,668 $2.65
Options Expired/Canceled................................. (112,501) $3.98
Options Exercised........................................ (9,000) $3.75
--------------

Balance at September 30, 1998...................... 1,095,526
==============

Exercisable at September 30, 1998........................ 671,087 $4.79
Exercisable at September 30, 1997........................ 528,141 $6.16
Exercisable at September 30, 1996........................ 397,016 $7.04

</TABLE>

At September 30, 1998, the range of exercise prices and weighted average
remaining contractual life of outstanding options was $1.86 - $15.78 and 6.4
years, respectively. At September 30, 1998, 33,752 shares remained available for
future grant.

The Company applies APB opinion No. 25 and related Interpretations in accounting
for its plan, and accordingly, no compensation cost has been recognized. Had
compensation cost for employee options been determined consistent with

71
<PAGE> 72
FASB
Statement No. 123, the Company's net earnings (loss) and earnings loss per share
would have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>

YEAR ENDED SEPTEMBER 30,
-----------------------------------------------
1998 1997 1996
------------- ------------- -----------
<S> <C> <C> <C>
Net earnings (loss) As reported $(6,336,000) $(4,369,000) $730,000
============ ============= ===========
Pro forma $(6,662,000) $(4,577,000) 730,000
============ ============= ===========

Earnings (loss) per share As reported $(.69) $(.49) $.11
============= ============= ===========
Pro forma $(.73) $(.51) $.11
============= ============= ===========
</TABLE>

The pro forma disclosure of compensation cost under this pronouncement was based
on the Black-Scholes single-option pricing model with the following weighted
average assumption for 1998, 1997 and 1996: volatility of 58%, risk-free
interest rate of 6.27%, a dividend rate of zero, and an expected option life of
10 years.

Pro forma net earnings (loss) reflects only options granted in fiscal 1998, 1997
and 1996. Therefore, the full impact of calculating compensation cost for stock
options under FASB Statement No. 123 is not reflected in the pro forma net
earnings (loss) amounts presented above because compensation cost is reflected
over the options' vesting period and compensation cost for options granted prior
to October 1, 1995 is not considered.

Search Stock Incentive Plan

In July 1998 the Board of Directors of the Company's subsidiary, 800-US Search,
adopted the 1998 Stock Incentive Plan (the "1998 Plan") in order to attract and
retain officers, key employees and consultants. Additional options may be
granted subject to Board approval. An aggregate of 2,000 shares of 800-US Search
common stock, subject to adjustment, has been authorized for issuance upon
exercise of options, stock appreciation rights ("SARs"), and other awards,
including restricted stock awards under the 1998 Plan. It is expected that the
800-US Search Compensation Committee will administer the 1998 Plan and determine
to whom options, SARs, restricted stock purchase rights and other awards are to
be granted and the terms and conditions, including the number of shares and the
period of exercisability, thereof.

Search issued a ten year warrant at a nominal exercise price to the Company to
purchase 500 shares (or 5%) of Search common stock in connection with certain
advances to Search of working capital and guarantees of certain obligations on
behalf of Search.

(8) Commitments and Contingencies

Officer Compensation

Messrs. Kushner and Locke. In March 1994, Messrs. Kushner and Locke each
amended his respective employment agreement with the Company to (i) extend the
term of the agreement to March 1999 and (ii) reduce the maximum annual
performance bonus that each may receive to 4% of pre-tax earnings for the
applicable period up to a maximum of $200,000 in fiscal 1994, $220,000 in fiscal
1995, $250,000 in fiscal 1996, $270,000 in fiscal 1997 and $290,000 in fiscal
1998. Under the revised employment agreements, Messrs. Kushner and Locke each
have a base salary of $425,000 through fiscal 1998, subject to potential
increase upon review by the Company's Board of Directors after fiscal 1995. As
approved by the Board of Directors in February 1996 and May 1996, Messrs.
Kushner and Locke's employment agreements were further amended to revise the
annual pre-tax earnings performance bonus so that no bonus would be payable
under the yearly test for fiscal 1996 if the Company's annual pre-tax earnings
were less than $1,250,000, and with an increase of the bonus rate to 6% of
annual pre-tax earnings of the Company for fiscal 1996 in excess of $1,250,000
and up to $3,166,666. The amendments left unchanged both the bonus rate of 4% of
pre-tax earnings of the Company for subsequent fiscal years and the maximum
performance bonus of $250,000 for fiscal 1996. No bonus was

<PAGE> 73

accrued or paid in fiscal 1996, 1997 or 1998.

In order to induce Messrs. Kushner and Locke to amend their employment
agreements, the Company granted to each in March 1994 options to purchase
150,000 shares of Common Stock as adjusted at an exercise price per share equal
to $5.04 (the adjusted last reported sale price of the Common Stock on the date
of the initial closing of the 8% Debentures). The options vest over a five year
period, with 20% vesting at each anniversary of the date of grant (subject to
possible acceleration following a "change-in-control").

In October 1997, Messrs. Kushner and Locke each agreed to an amendment to his
respective employment agreement with the Company to extend the term of the
agreement to October 2002. Under the revised employment agreements, Messrs.
Kushner and Locke each have a base salary of $425,000 in fiscal 1997, and a
$25,000 annual increase up to a maximum of $525,000 annual base compensation. In
the event the Company achieves earnings before income taxes in excess of
$2,000,000, each of Messrs. Kushner and Locke are entitled to certain profit
bonuses at graduated rates ranging from 5% of annual earnings before income
taxes up to $4,000,000 to 7.5% of annual earnings before income taxes in excess
of $8,000,000.

In order to induce Messrs. Kushner and Locke to enter into the amended
employment agreements, the Company granted to each, as of August 1, 1997,
options to purchase 83,333 (post reverse split) shares of Common Stock at an
exercise price per share equal to $1.875 (the last reported sale price of the
Common Stock on the date prior to the award date, as adjusted). The options vest
over a five year period, with 20% vesting respectively on each of the next five
annual anniversary dates following the date of the grant (subject to possible
acceleration following a "change-in-control" as defined in the Company's 1988
Stock Incentive Plan). The Company also granted to each of Messrs. Kushner and
Locke options to purchase an additional 83,333 (post reverse split) shares of
Common Stock at an exercise price per share equal to $1.875, vesting at the rate
of 20% per year, but exercisable only upon the achievement of certain annual
income targets to be set by the board of directors or the Company's Common Stock
reaching certain public trading prices ranging from $2.00 to $6.00 per share.

The Company also provides Messrs. Kushner and Locke with certain fringe
benefits, including $3,500,000 of term life insurance with a split dollar
ownership structure and disability insurance for each person. The Company also
agreed to assign any key-man life insurance policy to the employee after
Termination of the employment agreement. The agreements permit Messrs. Kushner
and Locke to collect outside compensation which they may be entitled and to
provide incidental and limited services outside of their employment with the
Company and to receive compensation therefor, so long as such activities do not
materially interfere with the performance of their duties under the agreements.
Each of Messrs. Kushner and Locke also may require the Company to change its
name to remove his name within one year after the expiration or termination of
his employment agreement, except that the Company may continue to use such name
for a period of one year after such notice, or for such longer period of times
as is reasonably necessary to cause the Company not to default under any
indebtedness for borrowed money or other material agreement.

Mr. Lilliston. In September 1996, the Company entered into an employment
agreement with Bruce St. J. Lilliston pursuant to which the Company hired Mr.
Lilliston as the President and Chief Operating Officer of the Company effective
October 1996 for a three year term. As part of the agreement, Mr. Lilliston is
paid a base salary of $400,000 per year. In addition, he was advanced as a loan
the sum of $100,000 on September 3, 1996 and $200,000 in October 1996 to assist
Mr. Lilliston in the transition from his private practice to his duties as Chief
Operating Officer of the Company. The loans accrue simple interest at the rate
of 8% per annum and are to be repaid over a five year period at certain
specified dates ending October 2001. Mr. Lilliston has the right to receive
bonuses equal to the amount of the payments, and interest, due for such loan
repayment if Mr. Lilliston is still employed by the Company (including the
renewal of his employment agreement if applicable) on certain applicable dates
(the "Employment Bonus").

If Mr. Lilliston is still employed by the Company (including the renewal of his
employment agreement if applicable), he shall be entitled to receive a bonus of
$100,000 the first time the "Average Closing Price" (the average closing price
of the common stock over a thirty calendar day period) is $6.00 or more greater
than the "First Day Price" (the average closing price of the common stock over
the thirty calendar day period immediately prior to October 1996). Thereafter,
if Mr. Lilliston is still employed by the Company (including the renewal of his
employment agreement if applicable), he

<PAGE> 74
shall be entitled to receive an additional $100,000 bonus the first time the
Average Closing Price exceeds the First Day Price by $12.00 or more, and each
six dollar increment through and including $60.00 (each such bonus, a "Stock
Bonus"). The aggregate of such bonuses shall not exceed $1,000,000. The
foregoing Stock Bonuses shall be reduced by an amount equal to the Employment
Bonus up to $150,000 plus interest paid thereon from September 1996. The
foregoing stock prices have been adjusted from the amounts specified in Mr.
Lilliston's employment agreement to reflect the Company's 1-for-6 reverse stock
split which became effective in September 1997.

If the Company realizes pre-tax operating profits or earnings per share for any
fiscal year of employment greater than 100% of the largest pre-tax operating
profit or earnings per share amount for any of the preceding years of Mr.
Lilliston's employment under his employment agreement or in any of the five
fiscal years immediately preceding the commencement of such agreement, and if
Mr. Lilliston is still employed by the Company at the end of the applicable
fiscal year, then Mr. Lilliston shall be entitled to receive a bonus of $50,000.

As part of the agreement, the Company granted Mr. Lilliston options to purchase
up to 41,668 shares of Common Stock as adjusted, with 20,834 of such options
being granted and vested immediately, 8,334 and 12,500 of such options to be
granted and vested one and two years, respectively, after the commencement of
the term (the "Term") of the employment agreement (in each case, subject to Mr.
Lilliston reaching certain performance criteria to be established by the Board
of Directors or a committee thereof). If Mr. Lilliston's employment is extended
for a second term pursuant to such agreement (the "Second Term"), the Company
has agreed to grant Mr. Lilliston options to purchase up to an additional 83,334
shares of Common Stock as adjusted, 41,667, 16,667, and 25,000 of such options
to be granted upon commencement and one and two years, respectively, after the
commencement of the Second Term with one-half of each such grant to vest
immediately upon grant and the remainder thereof to vest upon Mr. Lilliston
reaching certain performance criteria to be established by the Board of
Directors or a committee thereof. If Mr. Lilliston's employment is extended
beyond a Second Term, the Company has agreed to grant Mr. Lilliston options to
purchase up to an additional 41,667 shares of Common Stock as adjusted, with
such options granted in full upon such employment extension with one-half of
such grant to vest immediately upon grant and the remainder thereof to vest upon
Mr. Lilliston reaching certain performance criteria to be established by the
Board of Directors or a committee thereof. In the event the performance goals
are not met, such options vest at a fixed date in the future, contingent solely
on future employment. The exercise price for such options shall be equal to the
closing price of the Common Stock on the applicable date of grant. Finally, as
part of Mr. Lilliston's agreement, he is allowed to maintain not more than two
independent outside legal consultancy client relationships, subject to approval
by the Chief Executive Officers, with earnings from such consultancies limited
to $150,000 per year.

Subsidiary Management

The Company's subsidiary, 800-US Search, maintains employment agreements with
certain executives of that company. The employment agreements provide for
minimum salary levels and incentive compensation, among other items.

Director Compensation

Messrs. Irwin Friedman and Stuart Hersch are compensated at $25,000 per year,
and Mr. John Lannan is compensated at $15,000 per year. During fiscal 1997
Messrs. David Braun, S. James Coppersmith and Stuart Hersch received stock
options totaling 16,667 adjusted shares each at an adjusted exercise price of
$1.875. In fiscal 1998, Messrs. Braun and Coppersmith each entered into a
consulting agreement expiring in June 1999 pursuant to which they each will be
paid $31,250 over the term of such agreement. During fiscal 1998 Messrs. Irwin
Friedman and James Lannan received stock options totaling 16,667 adjusted
shares, each at an exercise price of $2.84.

Employee Benefit Plans

The Company participates in various multiemployer defined benefit and defined
contribution pension plans under union and industry agreements. These plans
include substantially all temporary film production employees covered under

<PAGE> 75

various collective bargaining agreements. The Company incurred $345,000,
$378,000 and $344,000 of multiemployer plan costs in fiscal 1998, 1997 and 1996,
respectively. Such costs are capitalized as a component of film and television
programming costs. The Company funds the costs of such plans as incurred.

Leases

The Company is obligated under a noncancelable operating lease expiring in March
2000 for office space on the 20th and 21st floors at its principal executive
offices in Los Angeles, California. The Company's 80%-owned subsidiary, 800-US
Search, is obligated under a noncancelable operating lease expiring in February
2001 for approximately 8,000 square feet of office space in Beverly Hills,
California. The Company and its subsidiary have operating lease agreements for
other office equipment.

A summary of future lease payment obligations at September 30, 1998 follows:
<TABLE>
<CAPTION>

OPERATING
LEASES
----------

<S> <C>
Fiscal 1999 .......................... $ 701,000
Fiscal 2000 .......................... 438,000
Fiscal 2001 .......................... 65,000
----------

Total minimum future lease rental payments $1,204,000
==========
</TABLE>

Rental expense for the years ended September 30, 1998, 1997 and 1996 was
approximately $657,000, $541,000 and $540,000, respectively.

Promotion and Distribution Commitments

The Company's subsidiary, 800-US Search, has several cancelable and
noncancelable promotion and distribution agreements with certain Internet
companies. The minimum noncancelable fees payable under these agreements are
$3,000,000 per year through April 2002.

From April 1998 until the earlier of December 31, 1999 or the date of
effectiveness of a registration statement for an initial public offering of
800-US Search common stock, the Company guaranteed the payment of all amounts
due under an agreement between 800-US Search and InfoSpace, Inc. The total due
through December 1999 is $4,700,000, of which $200,000 was paid through
September 30, 1998.

In May 1998, the Company guaranteed 800-US Search's obligations to PIC-TV for
advertising and related services. The accrued balance of 800-US Search's
obligations to PIC-TV as of September 30, 1998 was $514,000.

In May 1998, the Company guaranteed 800-US Search's obligations to Western
International Media Corporation for purchases of broadcast media advertising.
The accrued balance of 800-US Search's obligations to Western International
Media Corporation as of September 30, 1998 was $122,000.

Contingencies

The Company is involved in certain legal proceedings and claims arising out of
the normal conduct of its business. Management of the Company believes that the
ultimate resolution of these matters will not have a material adverse effect
upon the Company's results of operations or financial position.

In its normal course of business, the Company makes contractual down payments to
acquire film distribution rights. This

<PAGE> 76

initial advance for rights ranges from 10% to 30% of the total purchase price.
The balance of the payment is generally due upon the complete delivery by third
party producers of acceptable film and video materials and other proof of rights
held and insurance policies that may be required for the Company to begin
exploitation of the product. As of September 30, 1998 the Company had made
contractual agreements for an aggregate of $6,302,000 in payments due should
those third party producers complete delivery to the Company. These amounts are
estimated to be payable over the next eighteen months.

(9) Related Party Transactions

In December 1994, the Company loaned August Entertainment, Inc. ("August")
$650,000 against distribution rights to third party product. August is majority
owned by Gregory Cascante, former President of the Company's international film
distribution division. The loan bears interest at the lesser of (a) Prime (7.75%
at December 24, 1998) plus 2% or (b) 10%. The distribution agreement is secured
by all assets of August, including a pledge of all sales commissions due to
August from the producers of the films Sleep With Me, Lawnmower Man II and
Nostradamus. While the right of August to receive such commissions with respect
to the film Lawnmower Man II is subordinate to the interests of the production
lenders, The Allied Entertainment Group PLC, and its subsidiaries which produced
the film have guaranteed payment of such commissions to the extent they would be
payable had there been no production loan on that film. Repayment of principal
and interest is by collection of commissions assigned as collateral. As of
September 30, 1998 the Company had been repaid $577,000 toward interest and
principal and approximately $230,000 principal amount remains outstanding. The
loan matures on December 31, 1998.

In fiscal 1995 the Company became a general partner in TVFirst, which creates
and markets infomercials. The Company's investment in TVFirst on the equity
basis amounted to $503,000 as of September 30, 1998, which is included in other
assets. One of TVFirst's current projects is a Christian music infomercial.
TVFirst purchased air time for such infomercial but neither TVFirst nor either
of its partners (including the Company) had the available resources to fund such
purchases. Messrs. Locke and Kushner loaned TV First $355,000 during 1996 to
enable TVFirst to purchase such air time. Such loans bore interest at Prime
(8.25% during the loan period) plus 1% and were repaid within fiscal year 1996.
In addition, each lender received an additional amount equal to 10% of the
principal amount loaned by such lender when the loans were repaid. Furthermore,
each lender will receive a profit participation in the profits, if any, related
to this Christian music infomercial, up to an amount equal to 5% of its
principal amount, which amount will be payable on the first anniversary of such
repayment. While the infomercial has generated revenues in excess of its
programming and media costs to date, there is no assurance that future revenues
will continue to exceed costs. The foregoing transaction was approved by a
majority of the independent directors of the Company's Board of Directors.

In fiscal 1996 the Company acquired from New City Releasing ("New City"), one
half of New City's interest in the KLC/New City Tele-Ventures joint venture
(representing a 17.5% ownership interest in the joint venture as to which the
Company previously held a 65% ownership interest) for 227,500 shares of Common
Stock as adjusted.

During fiscal 1989, the Company entered into a consulting agreement with Mr.
Stuart Hersch to engage his services through September 1994 as an executive
consultant. Pursuant to the consulting agreement the Company granted Mr. Hersch
stock options to purchase 142,365 shares of common stock as adjusted at $9.33
per share, the adjusted fair market value on the date the Company committed to
make the grant. During fiscal 1990, the consulting agreement was amended,
reducing the options granted to 71,183 shares as adjusted. All of those options
are vested. Mr. Hersch sold 8,333 shares of the Company's common stock in
December 1997 at $3.625 per share.

In consideration of the elimination of certain demand registration rights, the
Company indemnified Mr. Hersch in the event Mr. Hersch sold 85,000 shares of the
Company's common stock as adjusted to third parties at an adjusted price less
than $10.50 per share. The Company paid Mr. Hersch a total of $275,000 during
the three-year period ended September 30, 1994 related to such indemnification.

Mr. Hersch became a consultant to the Company effective April 1996 for which he
is paid $90,000 per year. Mr. Hersch

<PAGE> 77

is assisting the Company in analyzing potential strategic acquisitions and is
providing the Company consulting services in connection with the Company's
involvement in infomercials. This agreement is on a month-to-month basis as
needed by the Company.

Since 1991 Mr. Irwin Friedman has rendered financial consulting services to the
Company through the firm I. Friedman Equities, Inc. That firm was paid $96,000
annually for such services through February 1998. During 1997 in connection with
rendering certain services, that firm was granted warrants exercisable for
50,000 shares of common stock at $1.69 per share and warrants exercisable for
50,000 shares of common stock at $2.06 per share.

In August 1997, Mr. Locke obtained an option to acquire 45% of the common stock
of 800-U.S.Search, a company which conducts public records searches to locate
individuals, in exchange for indemnifications of the optionor against certain
potential liabilities. From May 1997 through November 1997 Mr. Locke personally
loaned Search $397,000. In November 1997, an entity controlled by the Company
acquired 80% of the outstanding common stock of Search, and issued to the
Company an option at a nominal exercise price to acquire such 80% interest in
exchange for the assumption of certain liabilities. At such time, Mr. Locke's
option was cancelled. In January 1998, the Company exercised its option. Through
September 30, 1998 the Company has advanced Search $1,152,000 and Search has
repaid Mr. Locke the principal in full plus an additional $40,000 in
consideration for such advances.

(10) Segment Information

Prior to fiscal 1998, the Company operated in one business segment, licensing
film and television programs. During fiscal 1998 the Company obtained
controlling interest in 800-US Search, which provides people search and
customized individual reference services. Included in the Company's consolidated
statements are the following amounts by business segment.

Fiscal Year Ended September 30, 1998

FILM AND ADJUSTMENTS
TELEVISION SEARCH AND
LICENSING SERVICES ELIMINATIONS CONSOLIDATED
------------ ----------- ----------- ------------
<S> <C> <C> <C> <C>
Operating revenues ................................ $ 68,497,000 $ 7,869,000 $ (566,000) $ 75,800,000
Costs related to operating
revenues .......................................... (58,471,000) (3,156,000) -- (61,627,000)
Selling, general and administrative
expenses .......................................... (5,370,000) (7,224,000) 566,000 (12,028,000)
Provision for doubtful accounts and notes.......... (1,345,000) (773,000) (2,118,000)
------------ ----------- ----------- ------------
Earnings (loss) from operations ................... $ 3,311,000 $(3,284,000) $ -- 27,000
============ =========== ===========
Interest income ................................... 79,000
Interest expense .................................. (6,261,000)
------------
Loss before income taxes .......................... $ (6,155,000)
============
Identifiable assets at September 30, 1998 ......... $136,074,000 $ 2,786,000 $(1,755,000) $137,105,000
============ =========== =========== ============
</TABLE>

77
<PAGE> 78

Depreciation and amortization expense related to property, plant and equipment
aggregated $264,000 for the film and television licensing segment and $266,000
for the Search segment during the fiscal year ended September 30, 1998.

Expenditures for property, plant and equipment (included in other assets in the
accompanying consolidated financial statements) aggregated $468,000 for the film
and television licensing segment and $328,000 for the Search segment during the
fiscal year ended September 30, 1998.

All equity method investees described in note 3 to the consolidated financial
statements pertain to the film and television licensing segment. Those
investees' operations are conducted principally in the United States, but their
revenues are generated world-wide, generally consistent with those disclosed in
the export sales table below. Revenues from major customers which exceeded 10%
of net operating revenues represented 32% 20% and 24% of operating revenues for
the years ended September 30, 1998, 1997 and 1996, respectively, and consisted
of the following:
<TABLE>
<CAPTION>

YEAR ENDED SEPTEMBER 30,
------------------------------------------------
1998 1997 1996
-------------- --------------- -------------

<S> <C> <C> <C>
Television Network CBS....................... $ -- $ 3,029,000 $ 8,288,000
Television Network ABC....................... 500,000 4,925,000 10,550,000
Television Network NBC....................... 125,000 3,107,000 --
Home Box Office.............................. 4,353,000 -- --
Canal Plus................................... 10,651,000 -- --
Taurus....................................... 9,109,000 -- --
------------ ------------- -----------
$24,738,000 $11,061,000 $18,838,000
============ ============ ===========
</TABLE>

Accounts receivable from these major customers totaled $11,478,000, $0 and
$109,000 at September 30, 1998, 1997 and 1996, respectively.

Domestic and international accounts receivable consisted of the following:

<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
Accounts receivable:
Domestic................................................... $10,750,000 $ 8,072,000
International.............................................. 32,177,000 20,515,000
----------- -----------

42,927,000 28,587,000
Less: allowance for doubtful accounts....................... (2,509,000) (891,000)
----------- -----------

$40,418,000 $27,696,000
=========== ===========
</TABLE>

Export sales by geographic areas were as follows:

<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Europe............................... $33,354,000 $12,100,000 $22,513,000
Canada............................... -- 2,671,000 451,000
Other................................ 10,185,000 20,229,000 13,069,000
----------- ----------- -----------
$45,539,000 $35,000,000 $36,033,000
=========== =========== ===========
</TABLE>

78
<PAGE> 79

Other sales were principally to customers in Asia, Latin America and Australia.

During fiscal 1998 the Company established a Latin American joint venture to
distribute film and television programs and to broadcast movies via satellite
television. Assets so employed were minor for fiscal 1998, but are expected to
increase throughout fiscal 1999.

79
<PAGE> 80
(11) Fourth Quarter Adjustments

During the fourth quarter of 1996 and 1997, the Company revised its estimates of
future revenues for certain product no longer being produced by the Company. In
1996 the impact was immaterial. In addition during the fourth quarter of 1997,
the Company increased its provision for bad debts. The adjustments to revise
estimates of future revenues and increase the allowance for doubtful accounts
recorded in the fourth quarter of 1997 amounted to approximately $2,600,000.

(12) Subsequent Event

In December 1998 the Company issued 1,200,000 shares of common stock to certain
accredited investors in a private placement at $5.00 per share. The Company
realized $5,673,000 of net proceeds. Allen & Company Incorporated ("Allen")
acted as the placement agent and received a fee of $300,000 (5% of the aggregate
consideration received by the Company) in connection with this offering. The
Company has also reimbursed Allen for out-of-pocket expenses incurred in
connection with the offering and has indemnified Allen against certain
liabilities, including liabilities under the Securities Act.

Allen currently owns warrants to purchase up to 500,000 shares of Common Stock
at an exercise price of $2.0625 per share. Warrants to purchase approximately
333,334 shares of Common Stock are vested with the remaining warrants to
purchase 166,666 shares of Common Stock scheduled to vest in September 1999.

80
<PAGE> 81

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of The Kushner-Locke Company:

Our report on the financial statements of The Kushner-Locke Company for the
year ended September 30, 1998 is included on page 51 of this 1998 Annual Report
filed on Form 10-K/A. In connection with our audit of such financial
statements, we have also audited the related financial statement schedule for
the year ended September 30, 1998 listed in the index on page 50 of this
Form 10-K/A.

In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.

PricewaterhouseCoopers LLP

Los Angeles, California
December 24, 1998

81
<PAGE> 82

THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
SCHEDULE II

BALANCE AT ADDITIONS CHARGED
BEGINNING OF TO COSTS AND DEDUCTIONS DUE BALANCE AT
PERIOD EXPENSES TO WRITE-OFS END OF PERIOD
----------- ---------------- -------------- -------------
<S> <C> <C> <C> <C>
Allowance for Doubtful Accounts:

Year Ended 9/30/98 ............. $891,000 2,118,000 (500,000) $2,509,000
======== ========= ========== ==========
Year Ended 9/30/97 ............. $693,000 1,310,000 (1,112,000) $ 891,000
======== ========= ========== ==========
Year Ended 9/30/96 ............. $400,000 499,000 (206,000) $ 693,000
======== ========= ========== ==========
</TABLE>

82
<PAGE> 83

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C>
THE KUSHNER-LOCKE COMPANY
(Registrant)
Dated: February 22, 1999
/s/ DONALD KUSHNER

Donald Kushner
Co-Chairman of the Board, Co-Chief Executive Officer
and Secretary
Dated: February 22, 1999
/s/ ROBERT SWAN

Robert Swan
Senior Vice President and Chief Financial Officer
</TABLE>

Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and the capacities and on the dated indicated.
<TABLE>
<S> <C>
THE KUSHNER-LOCKE COMPANY
(Registrant)
Dated: February 22, 1999
/s/ PETER LOCKE

Peter Locke
Co-Chairman of the Board and Co-Chief Executive
Officer
Dated: February 22, 1999
/s/ DONALD KUSHNER

Donald Kushner
Co-Chairman of the Board, Co-Chief Executive Officer
and Secretary
Dated: February 22, 1999
/s/ ROBERT SWAN

Robert Swan
Senior Vice President and Chief Financial Officer
Dated: February 22, 1999
/s/ ADELINA VILLAFLOR

Adelina Villaflor
Controller (Chief Accounting Officer)
Dated: February 22, 1999
/s/ IRWIN FRIEDMAN

Irwin Friedman
Director
</TABLE>

83
<PAGE> 84

<TABLE>
<S> <C>
Dated: February 22, 1999
/s/ STUART HERSCH

Stuart Hersch
Director
Dated: February 22, 1999
/s/ JOHN LANNAN

John Lannan
Director

</TABLE>

84
<PAGE> 85

INDEX TO EXHIBITS
<TABLE>
<S> <C>
3 Articles of Incorporation (A)
4.1 Indenture between the Company and National City Bank of
Minneapolis, as Trustee, dated as of December 1, 1990 pertaining to
10% Convertible Subordinated Debentures Due 2000, Series A (E)
4.2 First Supplemental Indenture between the Company and National City
Bank of Minneapolis, as Trustee, dated as of March 15, 1991
pertaining to 10% Convertible Subordinated Debentures Due 2000,
Series A (F)
4.3 Indenture between the Company and National City Bank of
Minneapolis, as Trustee, dated as of December 1, 1990 pertaining to
13 3/4% Convertible Subordinated Debentures Due 2000, Series B (E)
4.4 Warrant agreement between the Company and City National Bank, as
Warrant Agent, dated as of March 19, 1991 pertaining to Common
Stock Purchase Warrants (F)
4.5 Warrant agreement dated September 5, 1997 between the Company and
Allen & Company Incorporated.(U)
4.6 Warrant agreement dated September 5, 1997 between the Company and I. Friedman Equities, Inc.
(U)
4.7 Warrant Agreement dated June 27, 1997 between the Company and I.
Friedman Equities, Inc.(U)
10.1 Amended and Restated Employment Agreement dated October 1, 1997 between the Company and Donald
Kushner. (W)
10.2 Amended and Restated Employment Agreement dated October 1, 1997 between the Company and Peter
Locke. (W)
10.3 1988 Stock Incentive Plan of the Company (A)
10.4 Form of Indemnification Agreement (A)
10.5 Kushner-Locke Shareholders' Cross-Purchase Agreement dated as of
October 1, 1988 between and among Donald Kushner, Rebecca Hight,
Peter Locke, Karen Locke, Peter Locke Productions, Inc. and Twelfth
Street Limited (A)
10.5.1 Amendment dated as of May 14, 1992 to the Kushner-Locke
Shareholders' Cross-Purchase Agreement dated as of October 1, 1988
between and among Donald Kushner, Rebecca Hight, Peter Locke, Karen
Locke, Peter Locke Productions, Inc. and Twelfth Street Limited (I)
10.6 Kushner-Locke Trust Agreement dated as of October 1, 1988 between and among Donald Kushner,
Rebecca Hight, Peter Locke, Karen Locke, Peter Locke Productions, Inc. and Twelfth Street
Limited (A)
10.6.1 Amendment dated May 14, 1992 to the Kushner-Locke Trust Agreement
dated as of October 1, 1988 between and among Donald Kushner,
Rebecca Hight, Peter Locke, Karen Locke, Peter Locke Productions,
Inc. and Twelfth Street Limited (I)
10.12 Lease Agreement, dated as of November 1989, between the Company and
11601 Wilshire Associates (G)
10.12.1 Amended Lease Agreement (G)
10.16 Warrant Agreement between the Company and Chatfield Dean & Co., Inc. dated as of November 13,
1992 (J)
10.19 Fiscal Agency Agreement dated March 10, 1994 between and among the
Company, Bank America National Trust Company and Bank of America
National Trust and Savings Association (K)
10.19.1 Side letter between the Company and BankAmerica Trust Company to
the Fiscal Agency Agreement dated March 10, 1994 between and among
the Company, BankAmerica Trust Company and Bank of America National
Trust and Savings Association (K)
10.20 Warrant Agreement dated March 10, 1994 between the Company and RAS
Securities Corp. (K)
10.21 Warrant Agreement dated March 10, 1994 between the Company and I. Friedman Equities,
Inc.(K)
10.22 Fiscal Agency Agreement dated July 25, 1994 between and among the Company,
Bank America National Trust Company and Bank of America National Trust and
Savings Association (L)
10.27 Loan and Security Agreement dated December 1, 1994 between the Company and August
Entertainment, Inc., and Guarantees between the Company, August Entertainment, Inc. and the
Allied Entertainments Group PLC and certain of its subsidiaries (M)
10.41 Letter Agreement dated December 5, 1995 from New Line Cinema to The
Kushner Locke Company summarizing New Line/Savoy deal regarding The
Legend of Pinocchio (Q)
10.44 Amendment to the 1988 Stock Incentive Plan dated May 17, 1994 (Q)
</TABLE>

85
<PAGE> 86
<TABLE>
<S> <C>
10.51 First Amendment to Cross Collateralization Agreement dated January
10, 1996 between The Kushner-Locke Company, Allied Pinocchio
Productions Ltd., Dayton Way Pictures, Inc., Dayton Way Pictures
II, Inc., Dayton Way Pictures IV, Inc. and Newmarket Capital Group,
L.P. (Q)
10.56 Letter Agreement, dated as of April 12, 1996, by and among The
Kushner-Locke Company, Chemical Bank and Chase Securities Inc. (T)
10.57 Credit, Security, Guaranty and Pledge Agreement, dated as of June
19, 1996, among The Kushner-Locke Company, the Guarantors named
therein, the lenders named therein and The Chase Manhattan Bank,
N.A., (formerly Chemical Bank) as Agent, and as Fronting Bank for
the lenders (the "Credit Agreement") (T)
10.58 Employment Agreement dated September 14, 1996 between The
Kushner-Locke Company and Bruce St. J Lilliston (V)
10.59 Loan and Security Agreement dated March 1, 1996 between The
Kushner-Locke Company and its subsidiaries and Banque Paribas, Los
Angeles Agency (V)
10.61 Waiver of Section 6.17 Overhead Expenses of the Credit Agreement,
dated as of . (V)
10.62 Amendment No. 5 dated as of December 22, 1997 to the Credit Agreement. (W)
10.63 Amendment No. 6 dated as of May 13, 1998 to the Credit Agreement. (X)
10.64 Amendment No. 7 dated as of December , 1998 to the Credit Agreement.
23.1 Consent of PricewaterhouseCoopers LLP
23.2 Consent of KPMG LLP
</TABLE>

- -----------

(A) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-18, as amended, effective December 5, 1988 (Commission File
No. 33-25101-LA).

(B) Incorporated by reference from the Exhibits to the Company's Report on Form
10-K for the fiscal year ended September 30, 1989.

(C) Incorporated by reference from the Exhibit to the Company's Report on Form
10-Q for the fiscal quarter ended March 31, 1990.

(D) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-1 (File No. 33-37192), as initially filed on October 5, 1990
or as amended on November 30, 1990.

(E) Incorporated by reference from the Exhibits to the Company's Registration
Statements on Form S-1, as amended, effective November 30, 1990 (File No.
33-37192), and effective December 20, 1990 (File No. 33-37193).

(F) Incorporated by reference to the Company's Registration Statement on Form
S-1, as amended, effective March 20, 1991.

(G) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended March 31, 1991.

(H) Incorporated by reference from the Exhibits to the Company's Report on Form
10-K for the fiscal year ended September 30, 1991.

(I) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended June 30, 1992.

(J) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-2, as amended, effective November 12, 1992 (Commission File
No. 33-51544).

86
<PAGE> 87

(K) Incorporated by reference from the Exhibits to the Company's Report on Form
10-K for the fiscal quarter ended March 31, 1994.

(L) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended June 30, 1994.

(M) Incorporated by reference from the Exhibits to the Company's Report on Form
10-K for the fiscal year ended September 30, 1994.

(N) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended March 31, 1995.

(O) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended June 30, 1995.

(P) Incorporated by reference from the Exhibits to the Company's Report on Form
10-K for the fiscal year ended September 30, 1995.

(Q) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended December 31, 1995.

(R) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended March 31, 1996.

(S) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended June 30, 1996.

(T) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-2, as amended, effective August 15, 1996 (Commission File
No. 333-05089).

(U) Incorporated by reference from the Exhibits to the Company's Registration
Statement on form S-3 as filed November 17, 1997 (Commission File No.
333-40391).

(V) Incorporated by reference from the Exhibits to the Company's Report on Form
10-K for the fiscal year ended September 30, 1996.

(W) Incorporated by reference from the Exhibits to the Company's Report on Form
10-K for the fiscal year ended September 30, 1997.

(X) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended June 30, 1998.

<PAGE> 1

EXHIBIT 10.64

AMENDMENT NO. 7 dated as of December ___, 1998 to
the Credit, Security, Guaranty and Pledge Agreement
dated as of June 19, 1996, as amended, among THE
KUSHNER-LOCKE COMPANY (the "Borrower"), the
Guarantors named therein, the Lenders referred to
therein and THE CHASE MANHATTAN BANK (formerly
known as Chemical Bank), as Agent and as Fronting
Bank for the Lenders (the "Agent") (as heretofore
amended, the "Credit Agreement").

INTRODUCTORY STATEMENT

The Lenders have made available to the Borrower a revolving credit facility
pursuant to the terms of the Credit Agreement.

The Borrower has requested certain modifications to the Credit Agreement as
hereinafter set forth.

The Borrower, the Guarantors, the Lenders and the Agent have agreed to make
revisions to the Credit Agreement, all on the terms and subject to the
conditions hereinafter set forth.

Therefore, the parties hereto hereby agree as follows:
Section 1. Defined Terms. Capitalized terms used herein and not otherwise
defined herein shall have the meaning given them in the Credit Agreement.

Section 2. Amendments to the Credit Agreement. Subject to the satisfaction of
the conditions precedent set forth in Section 3 hereof, the Credit Agreement is
hereby amended effective as of the Amendment Effective Date or the Library
Credit Effective Date, as the case may be (such terms being used herein as
defined in Section 3 hereof) as follows:

(A) Article 1 of the Credit Agreement is hereby amended by adding the following
definitions in the appropriate alphabetical sequence:

"Off-Balance Sheet Commitments" shall mean all binding commitments of the Credit
Parties for the acquisition of items of Product, including cash flow
commitments, negative pick-up obligations and print and advertising commitments
which are not, pursuant to GAAP, reflected on the Consolidated balance sheet of
the Borrower, both conditional and unconditional.

87
<PAGE> 2

"Off-Balance Sheet Receivables" shall mean all amounts contractually owed to any
Credit Party under Distribution Agreements for any item of Product, which
amounts are not, pursuant to GAAP, reflected on the Consolidated balance sheet
of the Borrower.

(B) The definition of "Consolidated Capital Base" appearing in Article 1 of the
Credit Agreement is hereby amended by adding the following proviso at the end
thereof:

"; provided that for purposes of determining compliance with Section 6.18 (Total
Unsubordinated Liabilities to Consolidated Capital Base Ratio) hereof, the
amount of any Investment in US-SEARCH by a Credit Party shall be deducted from
Stockholders' Equity."

(C) The definitions of "Consolidated", "Consolidated Subsidiaries", "EBIT" and
"Total Unsubordinated Liabilities" appearing in Article 1 of the Credit
Agreement are each hereby amended by adding the parenthetical "(other than
US-SEARCH)" after the word "Subsidiaries" appearing each time therein.

(D) The definition of "Subordinated Debt" appearing in Article 1 of the Credit
Agreement is hereby amended by adding the parenthetical "(other than US-SEARCH)"
after the words "Credit Parties" appearing therein.

(E) The definition of "Tier 1 Borrowing Base" appearing in Article 1 of the
Credit Agreement is hereby amended by adding the following proviso immediately
following clause (vii) appearing therein:

"; provided, however, that the Tier 1 Borrowing Base credit attributable to
Eligible Receivables from obligors whose principal place of business is located
in a Latin American country (other than Major Foreign Account Debtors) shall not
exceed the lesser of (x) $10,000,000 in the aggregate and (y) twenty-five
percent (25%) of the total Borrowing Base."

(F) Section 6.3 of the Credit Agreement is hereby amended by deleting clause (v)
in its entirety and inserting in lieu thereof the phrase "Intentionally
Omitted".

(G) Section 6.3 of the Credit Agreement is hereby further amended by (i)
amending clause (vi) in its entirety to read as follows and (ii) adding the
following clause (vii) at the end of such amended clause (vi):

"(vi) Guarantees by the Borrower or a Guarantor of the obligations of another
Guarantor (other than US-SEARCH), and (vii) the following Guarantees by the
Borrower of certain obligations of US-SEARCH, each in an amount not to exceed
the amounts set forth below:

(1) Guaranty of a line of credit from Comerica Bank in an amount not to exceed
$345,000; (2) Guaranty of loan from John Rich in an amount not to exceed
$68,000; (3) Guaranty of the media buying obligation of US-SEARCH in favor of
PIC-TV in an amount not to exceed $487,000; (4) Guaranty of the media buying
obligation of US-

88
<PAGE> 3

SEARCH in favor of Edward E. Finch & Co. in an amount not to exceed $349,859;
and (5) Guaranty of payment obligations of US-SEARCH to INFOSPACE, Inc. pursuant
to that certain Amended and Restated Content Provider Agreement made as of
August 24, 1998, effective as of April 25, 1998 among INFOSPACE, Inc., US-SEARCH
and the Borrower."

(H) Section 6.4 of the Credit Agreement is hereby amended by adding the
following clauses (x), (xi) and (xii) at the end thereof:

"(x) a loan to US-SEARCH by the Borrower in an amount not to exceed the net
proceeds received by the Borrower in connection with the proposed $5,000,000
private placement offering of the common stock of the Borrower organized by
Allen & Company Incorporated (the "US-SEARCH Offering"), (xi) other equity
investments in or loans to US-SEARCH by the Borrower (other than the investment
of the proceeds of the US-SEARCH Offering) in an amount not to exceed $1,000,000
in the aggregate; and (xii) deferments of management fees payable to the
Borrower by US-SEARCH."

(I) Section 6.7 of the Credit Agreement is hereby amended by deleting the
exception appearing as the last clause of such section and replacing such
exception with the following language:

"except that a Credit Party may merge with and into another Credit Party or with
and into the Borrower".

(J) Section 6.17 of the Credit Agreement is hereby amended by (i) inserting the
parenthetical "(excluding expenses attributable to US-SEARCH)" immediately after
the words "overhead expenses" appearing therein and (ii) deleting the amount
"$9,500,000" with respect to fiscal year 1998 and inserting in lieu thereof the
amount "$10,000,000".

(K) Section 6.18 of the Credit Agreement is hereby amended in its entirety to
read as follows:

"Section 6.18. Total Unsubordinated Liabilities to Consolidated Capital Base
Ratio. At any time during the periods indicated below, permit the ratio of Total
Unsubordinated Liabilities plus Off-Balance Sheet Commitments less all
Off-Balance Sheet Receivables and Borrowing Base credits that relate to items of
Product that are the subject of Off-Balance Sheet Commitments (but not more with
respect to any particular item of Product than the related amount of Off-Balance
Sheet Commitments) to Consolidated Capital Base to exceed the corresponding
ratio set forth below:
<TABLE>
<CAPTION>

Period Ratio
------ -----
<S> <C>
Closing Date through 9/29/98 2.00 to 1

9/30/98 through 9/29/99 2.75 to 1
9/30/99 and thereafter 2.00 to 1
</TABLE>

(L) The Credit Agreement is hereby amended by adding the following Section 13.17

89
<PAGE> 4

immediately following Section 13.16 appearing therein:

"Section 13.17. Increase in Commitments. \(a) After the date hereof, the amount
of the Commitments may be increased by additional financial institutions (each
an "Assuming Bank"), approved in writing by the Agent and the Borrower, each
such Assuming Bank to become a party to this Credit Agreement by executing and
delivering to the Agent, for its acceptance and recording in the Register, an
Assumption Agreement in the form of Exhibit M attached hereto; provided,
however, that no further Assumption Agreement will be permitted which would
result in the aggregate amount of the Commitments hereunder (without giving
effect to any optional or mandatory reduction of Commitments pursuant to Section
2.6 hereof) to exceed $75,000,000. Subject to Section 2.9(b), upon such
execution, delivery, acceptance and recording, (x) from and after the effective
date specified in each Assumption Agreement (each, an "Effective Date"), which
effective date shall not be earlier than 5 Business Days after the date of
acceptance and recording by the Agent, the Assuming Bank thereunder shall be a
party hereto and shall have all of the rights and obligations of a Lender
hereunder, (y) on such Effective Date, the Assuming Bank shall purchase from
each of the other Lenders a portion of their outstanding Loans such that after
giving effect thereto each of the Lenders will hold its proportionate share of
all outstanding Loans in accordance with the Commitments then in effect and (z)
the Assuming Bank shall be deemed to have irrevocably and unconditionally
purchased and received from each of the other Lenders a participation in each
outstanding Letter of Credit such that after giving effect thereto, each of the
Lenders holds a participation in all outstanding Letters of Credit in proportion
with the Commitments then in effect.

(b) As of such Effective Date, additional Loans made on or after the
effectiveness thereof shall be made by the Lenders pro rata based on the
Commitment Percentages in effect on and after such Effective Date.

(c) Within five (5) Business Days after the applicable Effective Date, the
Borrower, at its own expense, shall execute and deliver to the Assuming Bank a
Note to the order of such Assuming Bank in an amount equal to the Commitment
assumed by it pursuant to such Assumption Agreement."

(M) Schedule 1 to the Credit Agreement is hereby amended in its entirety and
replaced by Schedule 1 attached hereto.

(N) Schedule 2 to the Credit Agreement is hereby amended by adding the following
Approved Account Debtors and their respective Allowable Amounts:
<TABLE>
<CAPTION>

Name of Approved
Debtor Category Account Debtor Allowable Amount
--------------- ---------------- ----------------
<S> <C> <C>
MAJOR DOMESTIC ACCOUNT
DEBTORS

Major Domestic Account Blockbuster Video Unlimited
Debtor (95%)

ACCEPTABLE DOMESTIC ACCOUNT
DEBTORS
</TABLE>

90
<PAGE> 5
<TABLE>
<S> <C> <C>

Acceptable Domestic Account Behaviour Communications $ 750,000
Debtor (85%)

Acceptable Domestic Account Beverly Hills $ 500,000
Debtor (85%) Entertainment

Acceptable Domestic Account Bonneville (BWE $1,000,000
Debtor (85%) Distribution)

Acceptable Domestic Account Destination Films $1,000,000
Debtor (85%)

Acceptable Domestic Account Echostar $2,000,000
Debtor (85%)

Acceptable Domestic Account Hollywood Video $1,000,000
Debtor (85%)

Acceptable Domestic Account HSX Films / Ignite $ 750,000
Debtor (85%) Entertainment

Acceptable Domestic Account Paxson Communications $1,500,000
Debtor (85%)

Acceptable Domestic Account Rhino Films $1,000,000
Debtor (85%)

Acceptable Domestic Account Seagull Communications $ 750,000
Debtor (85%)

Acceptable Domestic Account Unapix $ 750,000
Debtor (85%)

Acceptable Domestic Account Telemundo $1,000,000
Debtor (85%)

Acceptable Domestic Account Television Film $ 250,000
Debtor (85%) Distributors

Acceptable Domestic Account York Home Video $ 350,000
Debtor (85%)

MAJOR FOREIGN ACCOUNT
DEBTORS

Major Foreign Account Caracol Television $2,000,000
Debtor (85%)

Major Foreign Account Entertainment Film $1,000,000
Debtor (85%) Distributors

Major Foreign Account Globo Organization $3,000,000
Debtor (85%)

Major Foreign Account Grupo Televisa $2,000,000
Debtor (85%)

Major Foreign Account Metropole Television(M6) $ 750,000
Debtor (85%)

Major Foreign Account Nine Network $ 500,000
Debtor (85%)

Major Foreign Account TV Azteca $2,000,000
Debtor (85%)

Major Foreign Account Village Roadshow $1,000,000
Debtor (85%)

ACCEPTABLE FOREIGN ACCOUNT
DEBTORS (COUNTRY LIST A)

Acceptable Foreign Account AB SAT $1,500,000
Debtor (Country List A)
</TABLE>

91
<PAGE> 6
<TABLE>
<S> <C> <C>
(80%)

Acceptable Foreign Account Andrea Leone $ 750,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Audiovisual $ 250,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Channel 4 TV $ 500,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Chilevision $1,000,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Comerex S.A. $2,000,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Dendy $ 500,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Diprom $ 500,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Fab Films $ 750,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account First Independent $1,500,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Galfin $ 750,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Grupo Video Visa $ 750,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Injuca Investment $ 250,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Megalis $ 750,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Multivision $2,000,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Patagonia Export Co. $ 250,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Play Arte $ 500,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Quality Films $2,000,000
</TABLE>

92
<PAGE> 7
<TABLE>
<S> <C> <C>
Debtor (Country List A)
(80%)

Acceptable Foreign Account Reid & Puskar $ 500,000
Debtor (Country List A)
(80%)

Acceptable Foreign Account Sogedasa $1,500,000
Debtor (Country List A)
(80%)

ACCEPTABLE FOREIGN ACCOUNT
DEBTORS (COUNTRY LIST B)

Acceptable Foreign Account Delta Video $ 250,000
Debtor (Country List B)
(50%)

Acceptable Foreign Account Ecuavisa $ 250,000
Debtor (Country List B)
(50%)

Acceptable Foreign Account Foxtel Management $ 500,000
Debtor (Country List B)
(50%)

Acceptable Foreign Account Medyavizyon $ 150,000
Debtor (Country List B)
(50%)

Acceptable Foreign Account Ovo/VA Films $ 250,000
Debtor (Country List B)
(50%)

Acceptable Foreign Account Swen $ 750,000
Debtor (Country List B)
(50%)

Acceptable Foreign Account Venavision $ 250,000
Debtor (Country List B)
(50%)
</TABLE>

(O) Schedule 2 to the Credit Agreement is hereby further amended by moving the
following Approved Account Debtors to the debtor category indicated below, and
in the case of Cinecanal, increasing the Allowable Amount to the amount set
forth below:
<TABLE>
<CAPTION>

Name of Approved New Debtor Allowable
Account Debtor Old Debtor Category Category Amount
---------------- ------------------- ---------- -----------
<S> <C> <C> <C>
Direct TV Acceptable Domestic Major Domestic unlimited
Account Debtor (85%) Account Debtor
(95%)

Cinecanal Acceptable Foreign Major Domestic $2,000,000
Account Debtor Account Debtor
(Country List B) (95%)
(50%)
</TABLE>

(P) Schedule 2 to the Credit Agreement is hereby further amended by increasing
the Allowable Amount for each account debtor listed below to the amount opposite
its name set forth below:

93
<PAGE> 8
<TABLE>
<CAPTION>

Debtor Category Approved Account Debtor Allowable Amount
-------------- ---------------------- ----------------
<S> <C> <C> <C>
Acceptable Domestic Account USA Network $1,500,000
Debtor (85%)

Acceptable Domestic Account New City Releasing $1,500,000
Debtor (85%)

Acceptable Foreign Account RCV 2001 $5,000,000
Debtor (Country List A)
(80%)
</TABLE>

(Q) Schedule 3 to the Credit Agreement is hereby amended by (i) moving Chile,
Mexico and Brazil from Country List B to Country List A and (ii) adding
Argentina as an Approved Country on Country List A.

(R) The definition of "Tier 2 Borrowing Base" appearing in Article 1 of the
Credit Agreement is hereby amended by deleting the words "thirty-five percent
(35%)" and inserting in lieu thereof the words "forty percent (40%)".

Section 3. Conditions to Effectiveness. This Amendment is effective (i) with
respect to each clause set forth in Section 2 above (other than clause (R)), as
of the first date on which all of the following conditions precedent have been
satisfied in full (the "Amendment Effective Date") and (ii) with respect to
clause (R) set forth in Section 2 above, the later to occur of (x) the Amendment
Effective Date and (y) the date on which all of the Lenders have approved the
1998 valuation of the Eligible Library Amount (the "Library Credit Effective
Date"):

(A) the Agent shall have received counterparts of this Amendment which, when
taken together, bear the signatures of the Borrower, each Guarantor, the Agent
and such of the Lenders as are required by the Credit Agreement; and

(B) all legal matters incident to this Amendment shall be satisfactory to
Morgan, Lewis & Bockius LLP, counsel for the Agent.

Section 4. Representations and Warranties. Each Credit Party represents and
warrants that:

(A) after giving effect to this Amendment, the representations and warranties
contained in the Credit Agreement are true and correct in all material respects
on and as of the date hereof as if such representations and warranties had been
made on and as of the date hereof (except to the extent that any such
representations and warranties specifically relate to an earlier date); and (B)
after giving effect to this Amendment, no Event of Default or Default will have
occurred and be continuing on and as of the date hereof.

Section 5. Further Assurances. At any time and from time to time, upon the

94
<PAGE> 9

Agent's request and at the sole expense of the Credit Parties, each Credit Party
will promptly and duly execute and deliver any and all further instruments and
documents and take such further action as the Agent reasonably deems necessary
to effect the purposes of this Amendment.

Section 6. Fundamental Documents. This Amendment is designated a Fundamental
Document by the Agent.

Section 7. Full Force and Effect. Except as expressly amended hereby, the Credit
Agreement and the other Fundamental Documents shall continue in full force and
effect in accordance with the provisions thereof on the date hereof. As used in
the Credit Agreement, the terms "Agreement", "this Agreement", "herein",
"hereafter", "hereto", "hereof", and words of similar import, shall, unless the
context otherwise requires, mean the Credit Agreement as amended by this
Amendment.

Section 8. APPLICABLE LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN
ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK.

Section 9. Counterparts. This Amendment may be executed in two or more
counterparts, each of which shall constitute an original, but all of which when
taken together shall constitute but one instrument.

Section 10. Expenses. The Borrower agrees to pay all out-of-pocket expenses
incurred by the Agent in connection with the preparation, execution and delivery
of this Amendment, including, but not limited to, the reasonable fees and
disbursements of counsel for the Agent.

Section 11. Headings. The headings of this Amendment are for the purposes of
reference only and shall not affect the construction of or be taken into
consideration in interpreting this Amendment

IN WITNESS WHEREOF, the parties hereby have caused this Amendment to be
duly executed as of the date first written above.

BORROWER:

THE KUSHNER-LOCKE COMPANY

By: /S/ BRUCE ST.J LILLISTON
--------------------------
Name:
Title:

95
<PAGE> 10

GUARANTORS:

KL PRODUCTIONS, INC.
KL INTERNATIONAL, INC.
ACME PRODUCTIONS, INC.
KUSHNER-LOCKE PRODUCTIONS, INC.
THE RELATIVES COMPANY
POST AND PRODUCTION SERVICES, INC.
L-K ENTERTAINMENT, INC.
INTERNATIONAL COURTROOM NEWS SERVICE
FAMILY PICTURES, INC.
TROPICAL HEAT, INC.
KL SYNDICATION, INC.
ANDRE PRODUCTIONS, INC.
TKLC NO. 2, INC.
TWILIGHT ENTERTAINMENT, INC.
KLC FILMS, INC.
KL FEATURES, INC.
KLF GUILD CO.
KLF DEVELOPMENT CO.
KLTV GUILD CO.
KLTV DEVELOPMENT CO.
KUSHNER-LOCKE INTERNATIONAL, INC.
KL INTERACTIVE MEDIA, INC.
DAYTON WAY PICTURES, INC.
DAYTON WAY PICTURES II, INC.
DAYTON WAY PICTURES III, INC.
DAYTON WAY PICTURES IV, INC.
FW COLD CO., INC.

By /S/ BRUCE ST.J LILLISTON
------------------------
Name:
Title:

800-U.S. SEARCH

By /S/ DONALD KUSHNER
------------------
Name:
Title:

96
<PAGE> 11

KLC/NEW CITY
By its General Partner
THE KUSHNER-LOCKE COMPANY

By /S/ BRUCE ST.J LILLISTON
-------------------------
Name:
Title:

LENDERS:

Executed in THE CHASE MANHATTAN BANK
(formerly known as Chemical Bank), as Agent
New York, New York On
_____________, 1998

By /S/ JOHN P. HALTMAIER
-------------------------
Name: John P. Haltmaier
Title: Vice President

DE NATIONALE INVESTERINGSBANK N.V.

By /S/ ERIC H. SNATERSE
-------------------------
Name: Eric H. Snaterse
Title: Senior Vice President

By /S/ H. RYNBERG
-------------------------
Name: H. Rynberg
Title: V.P.

COMERICA BANK -- CALIFORNIA

By /S/ D. JEFFREY ANDRICK
-------------------------
Name: D. Jeffrey Andrick
Title: Vice President

Schedule 1 (Revised as of December ___, 1998)

97
<PAGE> 12

Schedule of Commitments
<TABLE>
<CAPTION>

Lender Commitment
- ------ ----------
<S> <C>
The Chase Manhattan Bank $35,000,000

DeNationale Investeringsbank N.V. $15,000,000

Comerica Bank -- California $13,000,000

Total Commitments $63,000,000

</TABLE>

<PAGE> 13

EXHIBIT M

Form of Assumption Agreement

<PAGE> 1

Exhibit 23.1

The Board of Directors
The Kushner-Locke Company:

We consent to incorporation by reference in the registration statements
(Nos. 333-40391, 333-10239 and 33-82942) on Form S-3 and (Nos.
333-63297, 33-45248 and 33-86768) on Form S-8 of our reports dated
December 24, 1998, on our audit of the consolidated financial statements
and the financial statement schedule of The Kushner-Locke Company as of
and for the year ended September 30, 1998, which report is included in
the Annual Report on Form 10-K/A.

PriceWaterhouseCoopers LLP

Los Angeles, California
February 18, 1999

<PAGE> 1

Exhibit 23.2

The Board of Directors
The Kushner-Locke Company:

We consent to incorporation by reference in the registration statements
(Nos. 333-40391, 333-10239 and 33-82942) on Form S-3 and (Nos.
333-63297, 33-45248 and 33-86768) on Form S-8 of The Kushner-Locke
Company of our report dated December 26, 1997, relating to the
consolidated balance sheet of The Kushner-Locke Company and subsidiaries
as of September 30, 1997, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the years in
the two-year period ended September 30, 1997, and the related schedule
for each of the years in the two-year period ended September 30, 1997,
which report appears in the September 30, 1998 annual report on
Form 10-K/A of The Kushner-Locke Company.

KPMG LLP

Los Angeles, California
February 19, 1999