HARMONY HOLDINGS INC, 10-K405, 1998-10-13

HARMONY HOLDINGS INC
10-K405, 1998-10-13
MOTION PICTURE & VIDEO TAPE PRODUCTION

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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-K

(Mark One)

[x] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the Fiscal Year ended June 30, 1998; or

[-] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Transition Period from ______ to ______

Commission File Number 1-19577

HARMONY HOLDINGS, INC.
(Exact Name of Registrant as Specified in its Charter)

Delaware 95-4333330
- ------------------------------- ------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)

724 First Street North,
Fourth Floor
Minneapolis, Minnesota 55401
- ------------------------------- ------------------------------------
(Address of Principal Executive (Zip Code)
Offices)

Registrant's Telephone Number, Including Area Code:(612) 338-3300

Securities Registered Pursuant to Section 12(b) of the Act: NONE
Securities Registered Pursuant to Section 12(g) of the Act: Common Stock,
$.01 par value(Title of Class)

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months(or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [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 Form10-K or any amendment to this
Form 10-K. [ ]

State the aggregate market value of the voting stock held by non-affiliates of
the Registrant (based upon the closing price of such stock as reported on the
National Association of Securities Dealers Automated Quotation System as of

<PAGE>

October 9, 1998): Common Stock, $.01 par value; $5,661,535.

Indicate the number of shares outstanding of each of the Registrant's classes of
Common Stock, as of the latest practicable date.

<TABLE>
<CAPTION>
Class Outstanding at October 9, 1998
- ----- ------------------------------
<S> <C>
Common Stock, par value ______ shares 6,487,429 shares
$.01 per share
</TABLE>

DOCUMENTS INCORPORATED BY REFERENCE

The Company's definitive Proxy Statement related to its 1998 Annual Meeting of
Stockholders (incorporated by reference into Part III-Items 11 and 12)

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

Certain statements constitute "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform
Act"). Such forward-looking statements involve known and unknown risks,
uncertainties, and other factors which may cause the actual results, performance
or achievements of the Company to be materially different from any future
results, performance or achievements, expressed or implied by such
forward-looking statements.

This report on Form 10-K contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Act of 1934 which are subject to the "safe harbor" created by those
sections. The forward-looking statements include, but are not limited to,
statements related to industry trends and the future growth in the markets of
television commercial and music video production; the Company's strategies for
reducing its customers' costs; the Company's efforts to secure and protect its
proprietary rights; the effect of GAAP accounting pronouncements on the
Company's recognition of revenues; the effect of the Year 2000 Issue on the
Company's operations; the availability of future rental space; and the
sufficiency of the Company's capital resources. Discussions containing
forward-looking statements may be found in "Business" (which includes "Risk
Factors"), "Properties," "Legal Proceedings" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

The forward-looking statements involve certain risks and uncertainties that
could cause actual results to differ materially from those in such forward-
looking statements. The Company disclaims any obligation to update these
forward-looking statements as a result of subsequent events.

PART I

<PAGE>

ITEM 1. BUSINESS

GENERAL DEVELOPMENT OF BUSINESS

Harmony Holdings, Inc. was incorporated under the laws of the State of
Delaware on August 5, 1994, and conducts its operations through its wholly owned
subsidiaries, Chemistry Pictures, Inc. (fka Harmony Pictures, Inc.), Melody
Films, Inc., Lexington Films, Inc., Pure Film, Inc., The End Inc., The Beginning
Entertainment, Inc., Gigantic Entertainment, Inc., The Moment Films, Inc., The
End (London) Ltd., Curious Pictures Corporation, Furious Pictures Corporation,
Delirious Pictures Corporation, Serial Dreamer Films, Inc., Hollywood Business
Solutions, Inc., Harmony Entertainment, Inc. and Harmony Media Communications,
Inc. (ceased operations, April, 1997). Unless the context indicates otherwise,
the term "Company" includes Harmony Holdings, Inc. and one or all of these
subsidiaries. The Company holds a 99% ownership interest in Curious Pictures
Corporation. The remaining 1% interest is not presented separately as the amount
is not significant.

The Company's principal executive offices are located at 724 First Street
North, Minneapolis, Minnesota 55401. Its telephone number is (612) 338-3300.
However, the Company's principal production offices are located in Los Angeles,
New York, San Francisco and London (U.K.). See "Item 2. Properties."

NARRATIVE DESCRIPTION OF BUSINESS

The Company's primary business is the production of television commercials
which business continues to provide the majority of its revenues. Contracts for
the production of television commercials are generally awarded based on the
personal relationships between the advertising agency, the advertiser and the
television commercial production company. The expertise, reputation and creative
vision of the director roster and ability of the production company to deliver
the commercial in an efficient manner defines the production company's role.
The Company has established the base to expand the role of the production
company within the industry. The Company's customers are typically advertising
agencies acting on behalf of a television advertiser. The Company maintains
excellent relationships with many of the major advertising agencies, including
Leo Burnett Advertising, Foote, Cone & Belding, DBD Needham, Grey Advertising,
Young & Rubicam, J. Walter Thompson, McCann Erickson and Chiat/Day, among
others.

In light of the importance of the directors in this industry, the Company
has worked to build a roster of approximately 30 directors with specialties in
varied advertising categories.

The Company has produced over 2,500 commercials for national advertisers,
Fortune 500 companies, and well recognized product lines such as Acura, Anhesuer
Busch, AT&T, Bank of America, Blue Cross, Cannon, Cap Cities/ABC, Cellular One,
Chrysler, Coca-Cola, Delta Airlines, Disney, Domino's Pizza, Fox, General Mills,
Gillette, General Motors, Hallmark, HBO, Hershey Foods, Honda, JC Penney,
K-Mart, Kellogg's, Kodak, Kraft Foods, McDonald's, Nabisco, Nike, Nintendo,
Nissan, Pepsi, Reebok, Sears, Sony, State Farm and Visa, among others.

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COMMERCIAL TELEVISION PRODUCTION INDUSTRY

The television commercial production industry is a highly fragmented
$2.5 billion dollar industry, with most of the Company's competitors being
relatively small privately owned operations. The Company's large director
roster with its range of creative ability, expertise and wide experience
coupled with the Company's reputation and advertising agency relationships,
provide the Company with a competitive edge. Additionally, as the only public
company in the industry, the Company has access to capital not available to
any other production company.

MARKETING STRATEGY

The markets for television commercials consist of national/regional
television networks, regional television stations or syndication and national
cable networks. Within each of these markets there exist sub markets based on
the nature of the advertiser - national or multi-national companies versus
local businesses and high and low budget commercials. Nationally, the
advertising and commercial production industry has recently experienced a
dramatic increase in the number of markets for television commercials. The
"spots", as they are called in the business, are placed by the advertiser
through its advertising agency.

Traditionally, the Company's marketing efforts have focused on national and
multi-national advertisers, national network commercials and higher budget
commercials. Generally, the Company's budgeted price for a commercial ranges
from $100,000 to $400,000 and occasionally in excess of $1,000,000.

The Company expects to enhance this range further based on the various
level of television commercial directors within the Company. For example, many
of the newer younger directors can provide a service to clients seeking to
produce mass quantities of commercials in the $100-400,000 range. As these
directors enhance their skills, the Company can move the directors into
divisions which produce higher quality, higher revenue commercials. This allows
the directors to grow with the Company and retain equity they have built over
their tenure with the Company.

The Company's subsidiaries' services are marketed by a staff of sales
representatives who seek out available commercial projects suitable for the
Company's commercial directors. These efforts are usually directed towards
advertising agencies located in New York, Los Angeles, Chicago, Detroit, Dallas,
San Francisco and other regional markets.

Like the commercial directors, most sales personnel work exclusively for
subsidiaries out of offices located in Los Angeles and New York. The Company
also employs independent sales representatives on a select basis. The Company
will seek to coordinate its sales efforts in a more coordinated and efficient
manner rather than past practices of separate sales representatives of each
division. At a minimum, the Company would seek to lower the sales

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representatives representing a greater pool of revenue.

To sell the commercial director's work, the sales staff uses its primary
tool - the commercial director's reel. This reel is a visual "resume" containing
samples of a particular director's work (most frequently in the form of
commercials) demonstrating the director's creativity and experience. Several
reels are developed by each company (company reels) featuring its commercial
directors and highlighting different creative areas and subject matter. These
reels are consistently updated and provided to the ad agencies who generally act
as the decision maker.

The companies also advertise in trade publications on an occasional basis
to maintain visibility among advertisers and advertising agencies and to
publicize specific information such as additions to the directorial roster,
completion of a significant commercial, or the recognition of awards and
achievements.

INCREASE IN BREADTH OF EXPERIENCE OF THE COMPANY'S DIRECTORS

Historically, the Company has increased the breadth of experience of its
television commercial directors by expanding the number of directors who are
associated with the Company by forming and building new commercial production
companies. Each of these companies is built around key management and commercial
directors. Management has attempted to employ directors who fill genre gaps such
as table top items (i.e., food, packaged goods, and small items), dance and
music, cosmetics, fashion and comedy, rather than directors who duplicate
existing areas of expertise. By increasing the number of directors associated
with the Company and by increasing the breadth of experience of the Company's
directors, the Company increases the types of commercials that the Company is
able to produce. This enhances the Company's ability to bid on entire
advertising campaigns consisting of commercials in many advertising genres as
opposed to bidding on just individual commercials within a campaign.

DIRECTOR RETENTION

The Company attracts and retains commercial directors by offering such
directors the opportunity to work in an organization with a highly effective
sales force and a high-quality staff of executive producers and back-office
support. The Company offers directors the ability to work in an environment that
fosters creativity by relieving directors of the worry and burden of running a
business or financing the projects on which they work. The Company also provides
directors with a measure of financial stability that traditional, independent
operations are unable to match. The director's fees payable by the Company for
specific commercial projects tend to fall within the range of $5,000 to $15,000
per shooting day.

TELEVISION COMMERCIAL PRODUCTION

The commercial production process is divided into several stages: creating
the concept; bidding; pre-production; principal photography; and
post-production. Commercial production companies usually enter the process at
the bidding phase and leave the process prior to the post production phase.

<PAGE>

THE INITIAL CONCEPT. Advertising agencies develop commercial ideas based
upon the needs of their clients. These ideas are embodied in a story board
written and created by the advertising agency or in some cases by the client
itself. The story board combines the script and the visual story line. After the
client approves the idea, the agency approaches several production companies to
determine how each company and its director would bring the commercial concept
to fruition. It is common for the production companies to be selected for a bid
based primarily on the reputation and talent of commercial directors associated
with the production company.

BIDDING. Personnel at the television commercial production companies
analyze the commercial concept as communicated by the advertising agency. The
director and his associates at the production company determine how the story
board can best be captured on film. They ascertain what subcontractors must be
hired, what locations must be secured, what free-lance technical support is to
be employed, what equipment is to be leased and what the total cost will be to
film the commercial. During this stage, the television production company staff
and the director often suggest changes to the story board both to enhance the
commercial and to enable the commercial to be filmed within the agency's and
client's budget expectations. The time frame from submission of a budget to
completion and delivery of a commercial usually ranges from three weeks to six
weeks.

A final bid is then submitted to the agency. The bid includes the cost of
shooting locations, actors (if applicable), technical personnel, props and sets,
and other production materials.

The agency selects the production company. Several factors contribute to
the decision such as the director's ideas about how the commercial would be
shot, the bid submitted by the production company, the reputation of the
director and the relationship between the agency, advertiser and production
company.

PRE-PRODUCTION. Once the commercial is "awarded", the production company
enters the pre-production period. The production company hires a line producer
who works with the director to produce the commercial. Locations are selected;
sets are designed and built; props fabricated and/or procured, and, if
applicable, characters are cast and wardrobe selected. At a formal meeting
preceding the shooting days, the agency approves all of the creative choices
made in preparation for filming.

PRINCIPAL PHOTOGRAPHY. Principal photography usually ranges from one day to
a month depending upon the number of commercials shot and the technical
complexity of the commercial. The Company engages independent contractors and
crews on a commercial-by-commercial basis to perform the tasks involved in the
production of the commercial. Typically, for a one spot commercial, principal
photography will last one to two days. Throughout the shooting process, agency
personnel approve each scene as shot.

The commercial is shot on motion picture film which is later developed at a
laboratory. The developed images are then viewed by the agency, the advertiser
and the production company.

POST-PRODUCTION. The post production process involves editing the film

<PAGE>

footage and sound (which may or may not be recorded during production) through
color correcting the final video. This process may also involve voice-over,
titles, music and special effects. While the commercial director may or may not
be an active part of the post production process, the director of music videos
does take on the post production responsibility.

Most often the agency independently edits the commercial. The production
company director may attend the editorial sessions and may be responsible for
providing a first cut for the agency. The edit is then completed and approved by
the agency and the client. Most typically, the Company is not involved in the
post production process. The Company has sought and will seek to reduce costs
and enhance the efficiency of post production turnaround through its secondary
strategy of acquiring post production companies.

FINANCING THE PRODUCTION OF COMMERCIALS

Ad agencies award jobs to commercial production companies with an
accompanying bid. The award bid contains all of the costs associated with that
particular commercial and is broken down into direct costs of production
(pre-production and wrap, crew labor, location and travel, props, wardrobe,
studio rental, set construction, equipment rental, raw film stock and
development, director's fees and insurance) and indirect costs (the production
company's fee, talent and editorial post-production).

The bid mark-up is based on a percentage of direct costs excluding
director fees and insurance. The bid mark-ups are typically in the range of
25 - 30%. Once a company is able to generate revenues to cover its operating
costs (rent, staff, etc.) the company is then able to increasingly add profit
to its bottom line through each new job booked.

The bid submitted to the client takes one of three forms: a "cost plus
fixed-fee" bid, a "cost plus" bid or a "firm" bid. If a commercial is produced
within the framework of a "firm" bid, the production company is responsible for
variations within the budget. If the commercial is filmed under a "cost
plus/fixed fee" bid, production costs are charged to the client as incurred
within the limits of the budget and the production company receives a
predetermined fixed fee for its work. If the commercials filmed under "cost
plus" bid, production costs are charged to the client as incurred within the
limits of the budget and the production company receives a percentage of the
final costs for its work.

Despite the differences in the structure of the forms of bid, the risk
of cost overages to the company of a "firm" bid as opposed to a "cost plus
fixed fee" bid or a "cost plus" bid are not substantially different because
in each case the Company is responsible for unapproved cost overages that
exceed the budget. Typically, approximately 90% of the television commercial
productions are "firm" bid and approximately 10% are "cost plus fixed fee"
bid or "cost plus".

The production company and the producer of the commercial carefully monitor
costs throughout the filming process. The agreed upon bid is often altered

<PAGE>

because during the principal photography stage the agency, client and director
agree upon a new creative option or because of unexpected occurrences such as
inclement weather. When this occurs, and the project costs exceed the original
budget, the increased cost is paid for by the agency and its client.

In most circumstances, the Company bills the advertising agency for 33%-70%
of the entire budget as stated in the bid, to be paid in advance or on the first
day of principal photography. The remainder of the contract price is generally
paid in one or more installments by the agency within 30 to 120 days after
completion of principal photography. Traditionally, the accounts receivable have
been extremely well managed with write-offs being less than .2% of sales.

A small percentage of the Company's business is derived from the
production of music videos. The production cycles for music videos is similar
to that of television commercials, but the budgets are generally smaller, ie.
$50,000 to $100,000 and occasionally up to $1,000,000. The Company is
generally involved in the post production phase of music videos. The client
for music videos is usually the record company or the performer directly.

EMPLOYEES

The Company employs 63 persons on a full-time basis. Additionally, the
Company has approximately 35 directors of commercials under contract who are
independent contractors, and 9 salespersons who are independent
contractors. Of such persons, 9 are officers or other senior executives of
the Company. The Company does not anticipate any material change in the
number of its full-time employees in the near future. None of the Company's
full-time employees are represented by a labor union and the Company believes
that it has good relationships with its employees. The Company has never
experienced any work stoppage.

The Company, through certain of it's subsidiaries, is a party to collective
bargaining agreements with the Directors Guild of America, Screen Actors Guild
and the International Alliance of Theatrical Stage Employees. Other than these
collective bargaining agreements, the Company is not a party to any collective
bargaining agreements. It is possible that some of the Company's future business
activities will be affected by the existence of collective bargaining agreements
because many of the performing artists and technical personnel, such as
cameramen and film editors, that it employs on a free-lance basis are members of
unions who are parties to collective bargaining agreements. The extent to which
collective bargaining agreements may affect the Company in the future is not
determinable. Industry strikes in the future by members of these unions could
cause delays or disrupt the Company's activities.

COMPETITION

The television commercial production industry is a highly fragmented
multi-billion dollar industry, with most of the Company's competitors being
relatively small operations. The Company's large director roster with its
range of creative ability, expertise and wide experience coupled with the
Company's reputation, and advertising agency relationships, provide the
Company with a competitive edge.

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Due to the fragmentation of the competition in this industry, the
Company believes that it is possible for the Company to increase market
share. Since the market is very large, the Company believes that no single
company currently controls more than 3% of industry sales. Accordingly, the
Company believes there is potential for significant growth.

There is no one commercial production company or group of companies that
dominates the industry. The Company believes that its principal competition
consists of larger film companies such as Propaganda Films, Partners USA,
Ridley Scott Associates (RSA), and Industrial Light and Magic.

INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS

The Company believes that its success is heavily dependent upon its
proprietary rights. To protect its proprietary rights the Company relies on a
combination of copyright, trade secret and trademark laws as well as
nondisclosure and other contractual restrictions. The Company currently holds
the rights to the following servicemarks:

Harmony Holdings, Inc.
Curious Pictures Corporation
The End, Inc.
The Beginning Entertainment, Inc.
Harmony Pictures, Inc.
Chemistry Pictures, Inc.
Pure Film, Inc.
Melody Films, Inc.
The Moment Films, Inc.
Curious Bonz
Curious Toys
Serial Dreamer Films, Inc.
Gigantic Entertainment, Inc.
Furious Pictures Corporation
Delirious Pictures Corporation
The End (London), Ltd.
Lexington Films, Inc.
Harmony Entertainment, Inc.

Applications are pending in the Patent and Trademark Office to register each of
the above service marks.

RISK FACTORS

VOLATILITY OF STOCK PRICE. The Company's Common Stock has experienced
significant price volatility and such volatility may occur in the future.
Factors that could affect the trading price of the Common Stock include
variations in quarterly results of operations, announcements of new projects
by the Company or its competitors, developments or disputes with respect to
proprietary rights, general trends in the industry, overall market conditions
and other factors. In addition, the stock market historically has experienced
extreme price and volume fluctuations, which at times have been unrelated or
disproportionate to the operating performance of certain companies. These
market fluctuations may adversely affect the market price of the Common Stock.

EFFECT OF ANTI-TAKEOVER PROVISIONS. Certain provisions of the Company's
Certificate of Incorporation (the "Charter") and Bylaws (the "Bylaws")and
certain provisions of Delaware law could have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
attempting to acquire, control of the Company. Such provisions could limit the
price that

<PAGE>

investors might be willing to pay in the future for the Company's Common Stock.
These provisions require super-majority approval to amend certain provisions in
the Charter and Bylaws, require that all stock holder actions be taken at a duly
called annual or special meetings and not by written consent, and impose various
procedural and other requirements that could make it more difficult for stock
holders to effect certain corporate action. Further, the Company is subject to
the anti-takeover provisions of Section 203 of the Delaware General Corporation
Law, which prohibits the Company from engaging in a "business combination" with
an "interested stockholder," unless the business combination is approved in a
prescribed manner. The application of Section 203 could also have the effect of
delaying or preventing a change of control of the Company.

Based on a recent assessment, the Company is not required to modify its
support software because it will properly utilize dates past December 31, 1999.
Additionally, Management believes that its television commercial production
equipment will be not be impacted by the Year 2000 Issue because the equipment
is not date sensitive.

ITEM 2. PROPERTY

PROPERTIES AND FACILITIES

The Company's executive offices are located at 724 First Street North,
Fourth Floor, Minneapolis, Minnesota. The facility consists of approximately
3,000 square feet and is shared with Children's Broadcasting Corporation, Radio
Management, L.L.C. and Community Airwaves Corporation. The rent is covered as
part of the monthly payment the Company pays to Radio Management, L.L.C. for
providing administrative, legal, financial and accounting services to the
Company. See "Item 13. Certain Relationships and Related Transactions"

The Company currently leases office facilities at the following locations,
for the purposes of conducting its television commercial and music video
production business:

The Chemistry Pictures, Inc., facility located at 6806 Lexington Avenue in
Hollywood, California is leased at $11,320 per month for a term of seven
years ending November 30, 2001.

The End, Inc.'s current facility located at 8060 Melrose Avenue in Los
Angeles, California is leased on a month to month basis at $11,240 per
month. The End, Inc. will be relocating its facility in October, 1998 to
433 South Beverly Hills Drive in Beverly Hills, California. The lease will
be for ten years ending in October 2008 at $21,910 per month. The End,
Inc. is also currently leasing a facility located at 435 Hudson Street in
New York, New York on a month to month basis at $1,670 per

<PAGE>

month. The End, Inc. will be relocating its New York facility in December
1998 to 75 Varick Street, New York, New York. The lease will be for ten
years ending in December 2008 at a monthly rate of $9,280.

The End (London), Ltd.'s facility located at 32-33 Kingly Court in London
is leased at L81,250 per annum paid quarterly for a term of 5 yearS
ending June 23, 2003.

Curious Picture Corporation's California facility is located at 1360
Mission Street in San Francisco and is leased at $2,250 per month for a
term of three years ending August 31, 1999. The Curious Picture
Corporation's New York facility located at 440 Lafayette Street is leased
at $10,937.50 per month for a term of 10 years ending December 31, 2008.

The Company also leases storage facilities in New York, New York; Los
Angeles, California; and Sun Valley, California.

The various leases listed above range in size from approximately 2,000
square feet to approximately 20,000 square feet. The Company believes its
facilities are adequate to meet its future capacity needs.

ITEM 3.LEGAL PROCEEDINGS

Mr. Bieber alleges that the defendants, by terminating his employment
agreement before December 31, 2000, breached the covenant of good faith and fair
dealing. Mr. Bieber also alleges that defendants slandered and libeled him with
reference to the circumstances relating to his termination. Mr. Bieber seeks
damages in excess of $1,000,000 for each of the two contract claims, has asked
to have his 250,000 stock options reinstated, and has asked for an unspecified
amount of contingent compensation. On the slander and libel claims, he seeks
unspecified compensatory damages and punitive damages.

Harmony Holdings, Inc and Harmony Pictures, Inc. deny that they have any
liability to Mr. Bieber and intend to vigorously defend the lawsuit.

A wrongful death lawsuit was filed against the Company on March 22,
1996, (served August 12, 1996) in Superior Court of the State of California,
County of Los Angeles by the estate of Henry Gillermo Urgoiti, his wife and
three children for an accident that occurred during the filming of a music
video in August 1995.

<PAGE>

The complaint contains six causes of action, three causes for negligence, one
cause for negligent product liability, one cause for strict liability and one
cause for breach of warranty. Harmony Holdings, Inc., has been named in all
six causes of action, Harmony Pictures Inc., The End Inc. and three of it's
employees have been named in one of the negligence claims. Other defendants
include Southern California Edison, Virgin Records America, Inc. Bell
Helicopters and Helinet Aviation Services. While it is too early in the
discovery process to assess the economic risk, management has been advised by
the Company's insurance broker that there appears to be adequate insurance to
cover any damages assessed against the Company, although a remote possibility
exists that the potential damages will exceed the current insurance coverage.

A cross-complaint related to the preceding matter, was filed on December
23, 1996 in Superior Court of the State of California, County of Los Angeles.
The complaint has been filed by Virgin Records Limited against The End, Inc.
and Southern California Edison for contractual indemnity, equitable
indemnity, comparative contribution and declaratory relief. While it is too
early in the discovery process to assess economic risk or insurance coverage,
the Company's insurance broker has advised management that there appears to
be adequate insurance to cover any damages assessed against the Company,
although a remote possibility exists that the potential damages will exceed
the current insurance coverage.

On August 20, 1997, a complaint was filed by Ron Hoffman against Harmony
Holdings, Inc. and Harmony Pictures, Inc. in the Superior Court of the State
of California, County of Los Angeles. Mr. Hoffman was the Executive Vice
President and Head of Sales of Harmony Pictures, Inc. until his employment
was terminated on or about August 5, 1997. At the time of termination, Mr.
Hoffman did not have an employment agreement with Harmony Pictures, Inc. or
Harmony Holdings, Inc., although a remote possibility exists that the
potential damages will exceed the current insurance coverage.

Mr. Hoffman alleges that the defendants, by terminating his employment,
breached an implied employment agreement. Mr. Hoffman seeks damages of
$250,000. Harmony Holdings, Inc. and Harmony Pictures, Inc. deny that they
have any liability to Mr. Hoffman and will continue to defend the lawsuit.
The Company does not believe this matter to be material.

The Company is not a party to any other material legal proceedings.

ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.

<PAGE>

PART II

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

Upon the completion of the Company's initial public offering in November
1991, its Common Stock began trading on the Nasdaq Small Cap Market under the
symbol "HAHO." The following table sets forth the high and low bid (or trade)
price per share of the Common Stock for the fiscal periods indicated, as
provided to the Company in monthly reports from Nasdaq.

Fiscal Year - 1997 High Low
Quarter Ended Trade Trade
- ------------- ----- -----
<S> <C> <C>
September 30, 1996 $2.31 $1.44
December 31, 1996 2.00 1.19
March 31, 1997 2.38 1.28
June 30, 1997 2.31 1.59

<CAPTION>
Fiscal Year - 1998 High Low
Quarter Ended Trade Trade
- ------------- ----- -----
<S> <C> <C>
September 30, 1997 $2.31 $2.19
December 31, 1997 2.00 2.00
March 31, 1998 1.50 1.25
June 30, 1998 1.63 1.63
</TABLE>
The quotations may include inter-dealer prices, without retail mark-up,
mark-down or commission and may not necessarily represent actual transactions.

On October 9, 1998, the closing price was $1.25. As of October 9, 1998,
there were approximately 50 registered holders of the Company's Common Stock.

DIVIDEND POLICY

The Company has not declared or paid any cash dividends on its Common Stock
during any period for which financial information is provided in this Annual
Report on Form 10-K. Under the terms of the Company's revolving line of credit,
the Company current is prohibited from paying dividends on its Common Stock.
The Company currently intends to retain future earnings, if any, to fund
the development and growth of its business and does not anticipate paying any
cash dividends on its Common Stock in the foreseeable future even after the
prohibition on paying dividends under the revolving line of credit is no longer
effective.

ITEM 6. SELECTED FINANCIAL DATA

The selected financial data of the Company is set forth below (000's
omitted except for per share data). This selected financial data should be read
in conjunction with Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the audited financial statements

<PAGE>

included elsewhere in this Annual Report on Form 10-K.

STATEMENT OF OPERATIONS DATA:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
6/30/98 6/30/97 6/30/96 6/30/95 6/30/94
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Contract revenue $ 53,355 $ 64,831 $ 60,415 $ 61,227 $ 42,602
Cost of production 43,617 52,174 51,041 50,920 35,291
-------------------------------------------------------------------------------------
Gross profit 9,738 12,657 9,374 10,307 7,311
Selling expenses 2,729 3,238 3,001 2,808 2,223
General and administrative 10,801 7,677 6,639 7,647 6,286
expenses

Depreciation and 700 620 564 528 399
amortization
-------------------------------------------------------------------------------------
Income (loss) from operations (4,492) 1,472 (1,868) (676) (1,597)
Interest income (expense), net 25 40 (243) (9) 23
Income (loss) before taxes (4,467) 1,511 (2,111) (685) (1,574)
Income tax expense 22 179 20 - -
-------------------------------------------------------------------------------------
Net income (loss) $ (4,489) $ 1,332 $ (2,131) $ (685) $ (1,574)
-------------------------------------------------------------------------------------
Basic and diluted net income
(loss) per share $ (0.69) $ 0.20 $ (0.37) $ (0.12) $ (.30)
Weighted average shares outstanding 6,515 6,682 5,692 5,567 5,316
- ---------------------------------------------------------------------------------------------------------------------------

BALANCE SHEET DATA
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
6/30/98 6/30/97 6/30/96 6/30/95 6/30/94
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Cash $ 3,834 $ 2,355 $ 447 $ 230 $ 663
Current assets 12,008 9,505 4,986 7,707 5,487
Goodwill, net (1) 2,546 2,758 2,969 3,181 3,393
Total assets 16,927 14,505 9,687 12,955 10,345
Current liabilities 12,698 6,748 5,382 6,196 3,931
Subordinated notes payable - - 385 385 -
- ---------------------------------------------------------------------------------------------------------------------------

<PAGE>

<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
6/30/98 6/30/97 6/30/96 6/30/95 6/30/94
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total liabilities 12,698 6,748 5,382 6,581 3,931
Stockholders' equity $ 4,229 $ 7,757 $ 4,304 $ 6,374 $ 6,414
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>

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

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

Statements contained in this Item 7 which are not historical facts are
forward looking statements under the safe harbor of the Reform Act and
involve known and unknown risks, uncertainties and other factors. Although
the Company believes that the expectations reflected in such forward looking
statements are based on reasonable assumptions, it can give no assurance that
its expectations will be attained.

RESULTS OF OPERATIONS

GENERAL

The Company is primarily engaged in the production of television
commercials. Contract revenues are recognized using the percentage of completion
method.

The Company has established the base to expand the role of the production
company within the industry. The Company's customers are typically advertising
agencies acting on behalf of a television advertiser. The Company maintains
excellent relationships with many of the major advertising agencies, including
Leo Burnett Advertising, Foote, Cone & Belding, DBD Needham, Grey Advertising,
Young & Rubicam, J. Walter Thompson, McCann Erickson and Chiat/Day, among
others.

In light of the importance of the directors in this industry, the Company
has worked to build a roster of approximately 30 directors with specialties in
varied advertising categories.

In connection with their audit reports on the Company's financial
statements as of and for the years ended June 30, 1998 and 1997, BDO Seidman,
LLP, the Company's independent auditors, expressed substantial doubt about
the Company's ability to continue as a going concern because of its recurring
losses, negative working capital and negative cash flow from operations.

15
<PAGE>

SEASONALITY

During the year ended June 30, 1998, revenue was the highest during the
second half which was consistent with revenue in the prior year. However,
the Company is not aware of any seasonal factors which may affect the
comparability of its results of operations.

YEAR ENDED JUNE 30, 1998 AS COMPARED WITH YEAR ENDED JUNE 30, 1997

For the year ended June 30, 1998, contract revenues decreased by 18% or
$11,476,000 to $53,355,000 from $64,831,000 for the year ended June 30, 1997.
Included in revenues for the period ended June 30, 1997 were revenues of
$928,000 from unprofitable operations that have since been terminated.
Accordingly, revenues from comparable operations, excluding those from ceased
operations decreased $10,548,000. The decrease in contract revenues was
primarily attributable to the loss of one director (who left The End, Inc. on
July 1, 1997) who billed in excess of $10,000,000 in contract revenues during
his last year with The End, Inc. The End, Inc. has subsequently replaced
this director, but contract revenues decreased $4,558,000 during the year
ended June 30, 1998. Additionally, Harmony Pictures, Inc. terminated the
services of one internal sales representative in September 1997 and did not
replace him until December 1997. Contract revenues at Harmony Pictures, Inc.
decreased $9,544,000 during the year ended June 30, 1998 compared to the year
ended June 30, 1997. Over the past four years, these revenues have been
declining and the Company is in the process of realigning the director pool
and changing management at that subsidiary in order to improve revenues.
Contract revenues at Curious Pictures increased $74,000 and contract revenues
at the new subsidiary, The End (London), LTD., increased $3,501,000 during
the year ended June 30, 1998 compared to the year ended June 30, 1997.

Cost of production is directly related to revenues and includes all direct
costs incurred in connection with the production of television commercials
including film, crews, location fees and commercial directors' fees. Cost of
production for the year ended June 30, 1998 decreased by 16% or $8,557,000 to
$43,617,000 from $52,174,000 for the year ended June 30, 1997. Expressed as
a percentage of revenues, cost of production was 82% for the year ended June
30, 1998 compared with 80% for the year ended June 30, 1997 and resulted in
gross profit percentages of 18% and 20% respectively. As part of the overall
plan to increase the revenues at Harmony Pictures, Inc., the subsidiary has
prepared bids with lower margins in order to regain business, which has
contributed to the 2% decline in gross profit percentages.

Selling expenses consist of sales commissions, advertising and promotional
expenses, travel and other expenses incurred in the securing of television
commercial contracts. Selling expenses for the year ended June 30, 1998
decreased to $2,729,000 from $3,238,000 for the year ended June 30, 1997,
representing a decrease of $509,000 or 16%. Overall sales expenses decreased
due to a decrease in promotions and director speculation reels.
Additionally, sales expenses at currently inactive operations accounted for
$73,000 of the decrease in selling expense and sales commissions overall
decreased $458,000 due to the reduction in overall contract revenues.

General and administrative expenses consist of overhead costs such as office
rent and expenses, executive, general and administrative payroll, and related
items. General and administrative expenses for the year ended June 30, 1998
increased to $10,802,000 from $7,327,000 for the year ended June 30, 1997,
representing an increase of $3,475,000 or 47%. A portion of this increase
was due to the Company's recognition of $550,000 of corporate reorganization
costs during the year ended June 30, 1998. These one-time costs were
incurred in conjunction with a company-wide reorganization in which
substantially all of the Company's executive officers were changed, including
its principal financial and accounting officers. In addition the company
changed its accounting function from a system in which all financial
information was collected in central location to a decentralized system in
which each of the Company's subsidiaries maintains its own accounting systems
and account staff. The Company believes that the reorganization will
contribute to a more efficient and cost effective accounting system. During
the year ended June 30, 1998, there were, to some extent, duplicate corporate
expenses due to the management functions performed in both Minnesota and Los
Angles. Certain of the Company's new officers and directors operate from
offices in Minnesota. Additional expense of approximately $398,000 has been
incurred during this transition. Management sublet the former corporate
office in Los Angeles and eliminated eight corporate staff members.
Management expects to realize savings of $500,000 or more annually once the
corporate reorganization is completed. Of the increase in general and
administrative expense, $367,000 was attributable to the End (London) Ltd., a
new subsidiary in London, England, and $258,000 was due to the opening of a
new San Francisco office for Curious Pictures Corporation. Additionally
$391,000 of expense was incurred in the year ended June 30, 1998 related to
the share transfer agreement with the managers of Curious Pictures (described
below).

<PAGE>

Depreciation and amortization expenses increased for the year ended June 30,
1998 to $700,000 from $620,000 for the year ended June 30, 1997, and increase of
$80,000 or 13%. This change is due to the increase in depreciable assets.

The Company did not recognize any expense relating to abandoned projects,
litigation expense, or severance salaries during the year ended June 30, 1998,
thereby reflecting an aggregate decrease of $1,038,000 compared to the year
ended June 30, 1997.

Interest income overall, increased for the year ended June 30, 1998 to $125,000
from $79,000 for the year ended June 30, 1997, representing an increase of
$46,000 or 58%. In January 1998, the Company entered into a $650,000 note
receivable agreement with a corporation that holds 44% of the Company's common
stock as of June 30, 1998. Pursuant to the note, the company remitted $611,000
of proceeds to the shareholder and applied the remaining $39,000 of the note
balance to a loan fee for the note origination. Interest was accrued at 15%.
The note was repaid in full with two installments (May 1998 and June 1998).
As of June 30, 1998, the company had a $235,000 note receivable from a former
CEO of the Company. The note bore interest at a variable rate (10% at June 30,
1998) and was subsequently repaid in full in September 1998. Because of these
two notes, interest income increased $79,000 while other interest income
decreased $33,000 due to less cash held in short term investments compared to
the prior year. Interest expense increased for the year ended June 30, 1998 to
$99,000 from $39,000 for the year ended June 30, 1997, representing an increase
of $60,000 due to increased borrowings under the line of credit.

Income tax expense for the year ended June 30, 1998 decreased to $22,000 from
$179,000 for the year ended June 30, 1997, representing a decrease of
$157,000 or 88%. A full valuation allowance has been established as the
Company cannot determine that it is more likely than not that the deferred tax
assets will be realized. During the year ended June 30, 1998, the Company's
effective income tax rate varied from the statutory federal tax rate as a
result of state taxes of $22,000 and an increase in the valuation allowance
booked against the deferred tax asset. Income tax expense during the year
ended June 30, 1997 included $39,000 of federal alternative minimum tax and
$140,000 of state taxes.

The Company recognized a net loss of $4,489,000 for the year ended June 30, 1998
compared to net income of $1,332,000 for the year ended June 30, 1997,
representing a decrease in net income of $5,821,000.

YEAR 2000 COMPLIANCE. The Year 2000 Issue is the result of computer
programs being written using two digits rather than four to define the
applicable year. Any of the Company's computer programs that have date-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure of miscalculations causing
disruptions or operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar business
activities. Additionally, management believes it will not be materially
impacted by the Year 2000 compliance of third parties with which it conducts
business.

New Accounting Pronouncements:

Statement of Financial Accounting Standards No. 129 "Disclosure of
Information about Capital Structure" (SFAS No. 129) issued by the FASB
is effective for financial statements ending after December 15, 1997.
The new standard reinstates various securities disclosure requirements
previously in effect under Accounting Principles Board Opinion No. 15,
which has been superseded by SFAS No. 128. The adoption of SFAS No. 129
did not have a material effect on the Company's financial position or
results of operations.

Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" (SFAS No. 130) issued by the FASB is effective for
financial statements with fiscal years beginning after December 15,1997.
Earlier application is permitted. SFAS No 130 establishes standards for
reporting and display of comprehensive income and its components in a
full set of general-purpose financial statements. The Company has not
determined the effect on its financial position or results of
operations, if any, from the adoption of this statement.

Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" (SFAS No. 131) issued
by the FASB is effective for financial statements beginning after
December 15, 1997. The new standard requires that public business
enterprises report certain information about operating segments in
complete sets of financial statements of the enterprise and in condensed
financial statements of interim periods issued to shareholders. It also
requires that public business enterprises report certain information
about their products and services, the geographic areas in which they
operate and their major customers. The Company does not expect adoption
of SFAS No. 131 to have a material effect, if any, on its results of
operations.

Statement of Financial Standards No. 133 "Accounting for Derivative
Instruments and Hedging Activities" (SFAS No. 133) issued by the FASB
is effective for financial statements with fiscal quarters of fiscal
years beginning after June 15, 1999. SFAS 133 requires companies to
recognize ALL derivatives contracts as either assets or liabilities in
the balance sheet and to measure them at fair value. If certain
conditions are met, a derivative may be specifically designated as a
hedge, the objective of which is to match the timing of gain or loss
recognition on the hedging derivative with the recognition of (i) the
changes in the fair value of the hedged asset or liability that are
attributable to the hedged risk or (ii) the earnings effect of the
hedged forecasted transaction. For a derivative NOT designated as a
hedging instrument, the gain or loss is recognized in Income in the
period of change. SFAS 133 is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999.

Historically, the Company has not entered into derivatives contracts
either to hedge existing risks or for speculative purposes. Accordingly,
the Company does not expect adoption of the new standard to affect its
financial statements.

LIQUIDITY AND CAPITAL RESOURCES

The Company's liquidity, as measured by its working capital was deficit of
$689,000 at June 30, 1998 compared to working capital of $2,756,000 at June 30,
1997. Although the Company recognized an increase in current assets of
$2,504,000 due primarily to increase in cash, accounts receivable, and other
current assets, current liabilities increased $5,949,000 due to increases in
accounts payable, the line of credit and deferred income.

Consolidated cash was $3,834,000 at June 30, 1998 and $2,355,000 at June 30,
1997.

Accounts receivable at June 30, 1998 increased $1,280,000 from June 30, 1997.
Unbilled accounts receivable at June 30, 1998 decreased $538,000 from June
30, 1997, while other current assets increased $283,000 over the same
periods. Accounts payable at June 30, 1998 increased $1,506,000 from June 30,
1997, accrued liabilities increased $175,000 from June 30, 1997 to June 30,
1998, the line of credit increased $2,750,000 and deferred income increased
$1,519,000 during that same period. The Company used $1,156,000 of cash in
its operations. The primary source of this operating cash used was the
proceeds from the line of credit.

During the year ended June 30, 1998, $685,000 cash was used for investing
activities. This cash was used for capital expenditures incurred in the normal
course of operations.

Cash obtained through financing activities during the year ended June 30, 1998,
was $3,320,000 which was provided through borrowings of $2,750,000 by the
Company under its bank line of credit, proceeds of $1,170,250 from the exercise
of stock options, and offset by the repurchase of $600,000 of the Company's
common stock.

<PAGE>

On May 10, 1995, the Company entered into a $3,000,000 asset based revolving
line of credit with a bank, with interest at a variable rate (9.5% at June 30,
1998), collateralized by the assets of the Company. The maximum outstanding
during the year ended June 30, 1998 was $2,750,000 and $600,000 and the weighted
average interest rate was 9.5%. The loan agreement had certain financial
covenants and the Company was not in compliance with these covenants at June
30,1998. Subsequently, on July 30, 1998 the bank line of credit was replaced
with an asset based loan and security agreement due to a finance company. The
loan and security agreement provides for the following borrowings: a revolving
line of credit with maximum availability of $4,500,000 or a specified percentage
of acceptable accounts receivable with interest at a variable rate (10% at July
30, 1998), and a term note payable of $500,000 to be disbursed at the sole
discretion of the finance company. The loan and security agreement requires the
Company to comply with certain restrictive covenants and is guaranteed by
Children's Broadcasting Corporation ("CBC").

As of June 30, 1998, the Company had entered into various employment
agreements with its officers and others, which obligate it to make minimum
payments of approximately $6,633,000 over the next three years. Of these
amounts $3,556,000 are for administrative personnel and $3,077,000 are for
commercial television directors and salespeople. Certain of these agreements
provide for additional compensation based on subsidiary revenues, defined
subsidiary operating profits or other incentives. This additional
compensation is payable whether or not the Company achieves an operating
profit as a whole. Some of the television directors who are associated with
the Company receive monthly draws against the directors' compensation for
production of commercials. The monthly draws equal the minimum guaranteed
compensation payable to such directors. Although the draws are recoupable by
the Company out of compensation otherwise payable to such directors, such
directors are not obligated to repay such draws that have been paid.
Consequently, the Company is obligated to provide compensation to these
directors whether or not they are directing commercials. Most of the
Company's sales personnel receive monthly draws offset by their earned
commissions.

The Company entered into a share transfer agreement with four members of
management of Curious Pictures Corporation dated December 15, 1996. The
agreement called for stock equaling 1% of Curious Pictures Corporation's
outstanding common stock to be issued to the four members of the management,
collectively, upon the signing of the agreement. Under the agreement, the
four members of management have the ability to earn an additional 50% of the
company through yearly stock option grants with an exercise price of $1.00
per share starting with calendar year 1997. The stock options are earned
based upon the calendar year results of operations of the subsidiary and are
exercisable in December 1998 (upon completion of the second year of the
subsidiary management's employment contracts). After the four members of
management have acquired stock and options representing 51% of Curious
Pictures Corporation, the Company has the right to put its remaining 49% of
Curious Pictures Corporation to the four members of management for a price to
be determined based on fair value at the time, but not to be less than
$1,960,000. Based on the subsidiaries results of operations through June 30,
1998, management estimates that 50% of the options available under the
agreement have been earned, although no options have been formally granted to
the subsidiary management.

During 1998, the Company incurred a net loss of $4,488,580 and a
negative cash flow from operations of $1,155,873, resulting in a working
capital position of negative $689,489 and an accumulated deficit
totaling $11,643,854 at June 30, 1998. Additionally, the Company has no
firm external financing resources other than its existing asset based
loan and security agreement (Note 7), which requires that the Company
maintain minimum stockholders equity of $3,000,000. If the Company's
current level of net operating losses continue, it is foreseeable that
this requirement will not be met in the near term and that the credit
facility will no longer be available to the Company. Additionally, the
commercial production industry revenues are often variable and
unpredictable on a month by month basis. Given these circumstances,
additional capital may be necessary to sustain the Company's operations.
Accordingly, in order to obtain the proceeds that the Company expects it
may need during the next year, the Company intends to attempt to raise
additional debt and/or equity financing. The Company is currently
holding discussions with various possible financing sources and believes
that the requisite financing can be obtained. However, no assurance can
be given that the Company will, in fact, be able to obtain additional
financing or that the terms of such financing will be favorable to the
Company. In the event that the Company is unable to obtain such
additional financing, the Company may have to take steps to further
reduce its operating expenses, which may negatively impact the Company's
operations. The Company believes that both the expected benefits to be
derived from the current restructuring of the Company's operations,
including certain managerial changes that have recently been made, and
the expected level of operations during the next year, may offset a
portion of any liquidity shortage that may occur. The consolidated
financial statements do not contain any adjustments which might be
necessary if the Company is unable to continue as a going concern.

<PAGE>

YEAR ENDED JUNE 30, 1997 AS COMPARED WITH YEAR ENDED JUNE 30, 1996

For the year ended June 30, 1997, revenues increased by approximately 7%,
or $4,416,000, to $64,831,000 from $60,415,000 for the year ended June 30, 1996.
In the television commercial production industry, commercial production
contracts are awarded based on many factors, including the expertise, reputation
and creative vision of the directors associated with the television commercial
production company. The companies that ceased operations during 1996 accounted
for $4,253,000 or 7% of the Company's revenue. The remaining companies increase
in revenue for fiscal 1997 was $8,669,000. The growth in revenue was primarily
attributed to The End, Inc. and Curious Pictures Corporation.

Cost of production is directly related to revenues and includes all direct
costs incurred in connection with the production of television commercials
including film, crews, location fees and commercial directors' fees. Cost of
production for the year ended June 30, 1997, increased by approximately 2%, or
$1,133,000, to $52,174,000 from $51,041,000 for the year ended June 30, 1996.
Expressed as a percentage of revenues, cost of production for fiscal 1997 was
approximately 80% compared with 84% for fiscal 1996, and resulted in a gross
profit percentage of approximately 20% and 16%, respectively. Cost of production
decreased as a percentage of revenue and gross profit increased for the year
ended June 30, 1997, primarily due to management's continuing efforts to reduce
costs and maximize it's purchasing power. Cost of production for operations
ceased during 1996 was $4,121,000. The remaining companies net increase in cost
of production was $5,254,000 and was attributed to the increase in revenue.

Selling expenses consist of sales commissions, advertising and promotional
expenses, travel and other expenses incurred in these curing of commercial
contracts. Selling expenses for the year ended June 30, 1997, increased to
$3,238,000 from $3,001,000 for the year ended June 30, 1996 representing an
increase of $237,000. Selling commissions increased by $108,000, while other
selling expenses increased by $130,000. Selling expenses for the operations
ceased during 1996 was $246,000. The remaining companies net increase in selling
expenses was $483,000. The following account for the primary changes in selling
expense; Selling expenses for the two new subsidiaries, The End(London), Ltd.
and Harmony Entertainment, Inc. $140,000, the remaining companies had the
following: increases in selling commissions of $224,000, sales salaries of
$82,000, costs incurred for speculation commercials produced to enhance existing

19
<PAGE>

directors show reels and not as a result of a contract with an agency of
$38,000, promotional and entertainment cost of $58,000 and a decrease in
advertising expense of $61,000.

General and administrative expenses consist of overhead costs such as
office rent and expenses, executive, general and administrative payroll, and
related items. Operating expenses for the year ended June 30, 1997, increased
to $7,327,000 from $6,639,000 for the year ended June 30, 1996, representing
a increase of $688,000 or 10%. Operating expenses for the operations ceased
during 1996 was $594,000. The remaining companies net increase in operating
expenses was $1,275,000. The increases in operating expense was primarily
attributable to an increase in profit participation's at the subsidiary level
and salaries of $768,000, rent $107,000, advertising $84,000, telephone
$75,000 and entertainment $54,000 offset by decreases in accounting fees
$64,000, bad debts $59,000, insurance $54,000 and licenses $39,000. The
increase in operating expense from The End (London), Ltd. and Harmony
Entertainment was $220,000.

Depreciation and amortization expense increased for the year ended June
30, 1997, to $620,000 from $564,000 for the year ended June 30, 1996,
representing an increase of $56,000. The change is due to the increase in
depreciable assets of $793,000. The primary increase in fixed assets related
to leasehold improvements, computers and furniture and fixtures at Curious
Pictures Corporation.

Interest income increased for the year ended June 30, 1997, to $79,000 from
$5,000 for the year ended June 30, 1996, representing an increase of $74,000.
The increase was a result of more cash held in short-term investments.

Interest expense decreased for the year ended June 30, 1997, to $39,000
from $248,000 for the year ended June 30, 1996, representing a decrease of
$209,000. The decrease was primarily attributed to less borrowings under the
line of credit.

Income tax expense was $179,000 for the year ended June 30, 1997. The
tax expense is primarily attributable to federal alternative minimum tax and
state taxes imposed by various states in which the companies conduct
business. A full valuation allowance has been established as the Company
cannot determine that it is more likely than not that the deferred tax assets
will be realized. During the year ended June 30, 1997, the Company's
effective income tax rate varied from the statutory federal tax rate as a
result of state taxes of $140,000 and a $782,000 benefit from the utilization
of fully reserved operating loss carry forwards, of which $135,000 related to
state operating carry forwards.

INFLATION

Inflation has not had a significant effect on the Company.

<PAGE>

ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Inapplicable

<PAGE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO FINANCIAL STATEMENTS

PAGE
-----
<S> <C>

Report of Independent Certified Public Accountants . . . . . . . . 20

Consolidated Balance Sheets. . . . . . . . . . . . . . . . . . . . 21

Consolidated Statements of Operations. . . . . . . . . . . . . . . 22

Consolidated Statement of Stockholders' Equity . . . . . . . . . . 23

Consolidated Statements of Cash Flows. . . . . . . . . . . . . . . 24

Notes to Consolidated Financial Statements . . . . . . . . . . . . 25

Schedule II - Valuation and Qualifying Accounts. . . . . . . . . . 38
</TABLE>

<PAGE>

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

The Board of Directors
Harmony Holdings, Inc.

We have audited the accompanying consolidated balance sheets of Harmony
Holdings, Inc. as of June 30, 1998 and 1997 and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended June 30, 1998. We have also audited the schedule
listed in the accompanying index. These financial statements and schedule are
the responsibility of the Company's management. Our responsibility is to
express an opinion on the financial statements and 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 and schedule are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements and
schedule. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation of the financial statements and schedule. 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 Harmony Holdings,
Inc. as of June 30, 1998 and 1997 and the results of its operations and its cash
flows for each of the three years in the period ended June 30, 1998 in
conformity with generally accepted accounting principles.

Also, in our opinion, the schedule presents fairly, in all material respects,
the information set forth therein.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company has suffered from recurring
losses, negative working capital and negative cash flow from operations that
raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 2.
The financial statements do not include any adjustments that might result
from the outcome of this uncertainty.

BDO SEIDMAN, LLP

Milwaukee, Wisconsin
September 15, 1998

<PAGE>

HARMONY HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------

JUNE 30, 1998 JUNE 30, 1997
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 3,834,023 $ 2,354,625
Accounts receivable - net of allowance for doubtful accounts
of $43,717 and $97,646, respectively 6,560,469 5,280,665
Unbilled accounts receivable 327,475 865,560
Other current assets (Note 4) 1,051,296 794,883
Note receivable from related party (Note 11) 235,155 208,889
----------------------------
Total current assets 12,008,418 9,504,622

Property and equipment, at cost, net of accumulated
depreciation and amortization (Note 3) 2,123,412 1,953,064
Goodwill, net of accumulated amortization of $1,666,423
and $1,454,643 2,545,885 2,757,665
Other assets 249,400 289,695
----------------------------
Total assets $ 16,927,115 $ 14,505,046
----------------------------
----------------------------

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
Accounts payable $ 3,199,760 $ 1,694,219
Accrued liabilities (Note 6) 4,406,014 4,230,668
Line of credit (Note 7) 2,750,000 -
Deferred income 2,342,133 823,371
----------------------------
Total current liabilities 12,697,907 6,748,258

Commitments and Contingencies (Note 8) - -

Stockholders' Equity: (Note 9)
Preferred Stock, $.01 par value, authorized 10,000,000
shares; none issued - -
Common Stock, $.01 par value, authorized 20,000,000
shares, issued and outstanding 7,237,429 and 6,693,198,
respectively 72,375 66,933
Additional paid-in capital 15,800,687 14,845,129
Accumulated deficit (11,643,854) (7,155,274)
----------------------------
Stockholders' equit 4,229,208 7,756,788
----------------------------
Total Liabilities and Stockholders' Equity $ 16,927,115 $ 14,505,046
----------------------------
----------------------------
</TABLE>

See accompanying notes to consolidated financial statements.

<PAGE>

HARMONY HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------

<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>

Contract revenues $ 53,355,100 $ 64,830,918 $ 60,414,694
Cost of production 43,616,737 52,174,372 51,040,839
---------------------------------------------
Gross profit 9,738,363 12,656,546 9,373,855

Selling expenses 2,728,734 3,237,854 3,000,549
General and administrative expenses 10,627,368 7,326,757 7,677,257
Corporate expenses paid to affiliated
management company (Note 11) 174,348 - -
Depreciation and amortization 700,145 620,400 564,271
---------------------------------------------
Income (loss) from operations (4,492,232) 1,471,535 (1,868,222)

Interest income 25,741 58,775 4,644
Interest income - related parties
(Note 11) 98,718 19,933 -
Interest expense (99,144) (39,053) (247,663)
---------------------------------------------
Income (loss) before income taxes (4,466,917) 1,511,190 (2,111,241)

Income tax expense (Note 5) 21,663 178,763 20,000
---------------------------------------------
Net income (loss) $ (4,488,580) $ 1,332,427 $ (2,131,241)
---------------------------------------------
---------------------------------------------
Basic and diluted net income (loss) per share $ (0.69) $ 0.20 $ (0.37)
---------------------------------------------
---------------------------------------------
Weighted average shares outstanding 6,515,000 6,682,000 5,692,000
---------------------------------------------
---------------------------------------------
</TABLE>

See accompanying notes to consolidated financial statements.

<PAGE>

HARMONY HOLDINGS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------

<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT PAID IN CAPITAL DEFICIT EQUITY
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE AT JULY 1, 1995 5,660,220 $ 56,608 $ 12,673,902 $ (6,356,460) $ 6,374,050

Sale of common stock 32,978 325 61,234 - 61,559
Net Loss - - - (2,131,241) (2,131,241)
-------------------------------------------------------------------------
BALANCE AT JUNE 30, 1996 5,693,198 56,933 12,735,136 (8,487,701) 4,304,368

Sale of common stock 1,000,000 10,000 1,990,000 - 2,000,000
Issuance of stock options
(Note 9) - - 44,993 - 44,993
Subsidiary share transfer
(Note 8) - - 75,000 - 75,000
Net Income - - - 1,332,427 1,332,427
-------------------------------------------------------------------------
BALANCE AT JUNE 30, 1997 6,693,198 66,933 14,845,129 (7,155,274) 7,756,788

Exercise of stock options
(Note 9) 775,000 7,750 1,162,500 - 1,170,250
Repurchase of common
stock (Note 9) (230,769) (2,308) (597,692) - (600,000)
Subsidiary share transfer
(Note 8) - - 390,750 - 390,750
Net Loss - - - (4,488,580) (4,488,580)
-------------------------------------------------------------------------
BALANCE AT JUNE 30, 1998 7,237,429 $ 72,375 $ 15,800,687 $(11,643,854) $ 4,229,208
-------------------------------------------------------------------------
-------------------------------------------------------------------------
</TABLE>

See accompanying notes to consolidated financial statements.

<PAGE>

HARMONY HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------

YEARS ENDED JUNE 30,
1998 1997 1996
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>

OPERATING ACTIVITIES:
Net Income (Loss) $(4,488,580) $ 1,332,427 $(2,131,241)
Adjustments to reconcile net income (loss) to cash
provided by (used in) operating activities:
Depreciation and amortization 700,145 620,400 564,271
Amortization of prepaid interest - - 91,759
Provision for doubtful accounts (53,929) 22,017 49,765
Issuance of non-cash compensation expense 390,750 119,993 -
Changes in operating assets and liabilities:
Accounts receivable (1,225,875) (1,577,278) 1,519,044
Unbilled accounts receivable 538,085 (488,749) 1,057,591
Other current assets (256,413) (357,730) 311,177
Other assets 40,295 (126,869) 227,669
Accounts payable 1,505,541 451,702 (1,024,617)
Accrued liabilities 175,346 2,142,881 (727,934)
Deferred income 1,518,762 (543,729) 254,060
--------------------------------------------
Net cash provided by (used in) operating
activities (1,155,873) 1,595,065 191,544
--------------------------------------------
INVESTING ACTIVITIES:
Capital expenditures (658,713) (793,291) (336,272)
Note receivable from related party (26,266) (208,889) -
--------------------------------------------
Net cash used in investing activities (684,979) (1,002,180) (336,272)
--------------------------------------------
FINANCING ACTIVITIES:
Proceeds from issuance of stock 1,170,250 2,000,000 61,559
Repurchase of common stock (600,000) - -
Issuance of subordinated notes payable - (385,000) -
Net borrowings under bank line of credit 2,750,000 (300,000) 300,000
--------------------------------------------
Net cash provided by financing activities 3,320,250 1,315,000 361,559
--------------------------------------------
Increase in cash and cash equivalents 1,479,398 1,907,885 216,831

Cash and cash equivalents, beginning of year 2,354,625 446,740 229,909
--------------------------------------------
Cash and cash equivalents, end of year $ 3,834,023 $ 2,354,625 $ 446,740
--------------------------------------------
--------------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest $ 99,144 $ 62,905 $ 71,631
--------------------------------------------
--------------------------------------------
Income taxes $ 57,900 $ 57,289 $ 43,900
--------------------------------------------
--------------------------------------------
Non-cash compensation expense $ 390,750 $ 119,993 $ -
--------------------------------------------
--------------------------------------------
</TABLE>

See accompanying notes to consolidated financial statements.

<PAGE>

HARMONY HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization, Business, and Principles of Consolidation:

Harmony Holdings, Inc. (the "Company") was incorporated under the laws
of the State of Delaware on August 5, 1991 as a wholly owned subsidiary
of Ventura Entertainment Group Ltd. ("Ventura"). In connection with its
formation and initial capitalization, Ventura contributed all of the
capital stock of Harmony Pictures, Inc. (Harmony Pictures) and Melody
Films, Inc. ("Melody") to the Company. Harmony Pictures and Melody have
been operating since 1979. In March 1990, Ventura acquired Harmony and
Melody from its co-founders, Stuart Gross and Robert Lieberman. As of
June 30, 1995, Ventura had sold its entire interest in the Company. The
Company conducts its operations through its wholly owned subsidiaries,
Chemistry Pictures, Inc. (fka Harmony Pictures, Inc.), Melody Films,
Inc., Lexington Films, Inc., The End Inc., The Beginning Entertainment,
Inc., The Moment Films, Inc., The End (London) Ltd., Curious Pictures
Corporation, Hollywood Business Solutions, Inc., Harmony Entertainment,
Inc., Harmony Media Communications Inc., Pure Film, Inc., Serial Dreamer
Films, Inc., Furious Pictures Corporation, Delirious Pictures
Corporation and Gigantic Entertainment, Inc. Unless the context
indicates otherwise, the term "Company" includes all of these
subsidiaries. All significant intercompany accounts and transactions
have been eliminated in consolidation. Curious Pictures Corporation is
99% owned, the 1% minority interest is not presented separately as the
amounts are not significant (Note 8).

The Company operates in one reportable segment, producing television
commercials, music videos and related media. The Company's services are
usually directed towards advertising agencies located in the major
markets of New York, Los Angeles, Chicago, Detroit, Dallas, San
Francisco and in regional markets.

Cash and Cash Equivalents:

The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.

Contract Revenues:

The Company produces television commercials and music videos under firm
bid, cost plus or cost plus fixed fee contracts, which are typically less
than one month in duration. At June 30, 1998 and 1997, the Company had no
long-term contracts. Contract revenues are recognized using the
percentage of completion method. The percentage of contract revenues
recognized is computed at that percentage of estimated total revenues
that incurred costs to date bears to total estimated costs, after giving
effect to the most recent estimate of costs to complete. Revisions in
costs and revenue estimates are reflected in the period in which the facts
which require the revision become known. Deferred income represents
amounts billed in excess of revenues earned.

Property and Equipment:

Property and equipment are stated at cost. Major improvements and
replacements of property and equipment are capitalized. Maintenance and
repairs are expensed. Upon retirement or other disposition of property,
applicable cost and accumulated depreciation and amortization are
removed from the accounts and any gains or losses are included in
operations.

<PAGE>

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Property and Equipment (Continued):

Depreciation of property and equipment is computed using the straight-line
method based on estimated useful lives ranging from three to seven
years. Leasehold improvements are amortized using the straight-line
method over the term of the lease or the life of the related
improvements, whichever is shorter.

Goodwill:

Goodwill primarily represents the excess of Ventura's purchase price,
including additional payments over the fair market value of Harmony
Pictures and Melody net assets at the date of acquisition. Goodwill has
been amortized on a straight-line basis over 20 years for all periods.
The Corporation continually evaluates the existence of goodwill
impairment on the basis of whether the goodwill is fully recoverable
from projected, undiscounted net cash flows of the related business
unit. Amortization expense for the year ended June 30, 1998, 1997 and
1996 was $211,780 for all years.

Income Taxes:

The Company applies SFAS No. 109, " Accounting for Income Taxes." SFAS
No. 109 prescribes the use of the liability method to compute the
differences between the tax bases of assets and liabilities and the
related financial reporting amounts using currently enacted tax laws and
rates.

Income (Loss) Per Share:

In February 1997, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 128, Earnings Per Share ("EPS"). SFAS No. 128 requires
dual presentation of basic EPS and diluted EPS on the face of all income
statements issued after December 15, 1997, for all entities with complex
capital structures. The adoption of SFAS No. 128 had no effect on the
Company's financial statements. Basic EPS is computed as net income
available to common shareholders divided by the weighted average number
of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur from common shares issuable through
stock options and warrants. As the Company's stock options and warrants
are antidilutive for all periods presented, basic and diluted EPS are
the same.

Stock Based Compensation:

Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (SFAS 123), establishes a fair value method of
accounting for stock-based compensation plans and for transactions in
which a company acquires goods or services from non-employees in
exchange for equity instruments. The Company adopted this accounting
standard on July 1, 1996. SFAS 123 also gives the option to account for
stock-based employee compensation in accordance with Accounting
Principles Board Opinion No. 25 (APB 25), "Accounting for Stock issued
to Employees," or SFAS 123. The Company has chosen to account for
stock-based compensation utilizing the intrinsic value method prescribed
in APB 25. Accordingly, compensation cost for stock options is measured
as the excess, if any, of the fair market price of the Company's stock
at the measurement date over the amount an employee must pay to acquire
stock.

<PAGE>

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Stock Based Compensation (Continued):

If SFAS 123 is not adopted related to stock-based employee compensation,
SFAS 123 for footnote purposes requires that companies measure the cost
of stock-based employee compensation at the grant date based on the
value of the award and recognize this cost over the service period. The
value of the stock-based award is determined using a pricing model
whereby compensation cost is the excess of the fair value of the stock
as determined by the model at grant date or other measurement date over
the amount an employee must pay to acquire the stock.

Use of Estimates:

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the year. Actual results could differ from those estimates.

New Accounting Pronouncements:

<PAGE>

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Accounting for Derivatives and Hedging:

Reclassifications:

Certain amounts in the 1997 and 1996 financial statements have
been reclassified to conform with the 1998 presentation. These
reclassifications have no effect on the accumulated deficit or
the net income (loss) previously reported.

NOTE 2 CONTINUED EXISTENCE AND MANAGEMENT PLAN

The Companies consolidated financial statements are presented on the
going concern basis which contemplates the realization of assets and
the satisfaction of liabilities in the normal course of business.
However, during 1998, the Company incurred a net loss of $4,488,580 and
a negative cash flow from operations of $1,155,873, resulting in a
working capital position of negative $689,489 and an accumulated
deficit totaling $11,643,854 at June 30, 1998. Additionally, the
Company has no firm external financing resources other than its
existing asset based loan and security agreement (Note 7), which
requires that the Company maintain minimum stockholders equity of
$3,000,000. If the Company's current level of net operating losses
continue, it is foreseeable that this requirement will not be met in
the near term and that the credit facility will no longer be available
to the Company. Additionally, the commercial production industry
revenues are often variable and unpredictable on a month by month
basis. Given these circumstances, additional capital may be necessary
to sustain the Company's operations. Accordingly, in order to obtain
the proceeds that the Company expects it may need during the next year,
the Company intends to attempt to raise additional debt and/or equity
financing. The Company is currently holding discussions with various
possible financing sources and believes that the requisite financing
can be obtained. However, no assurance can be given that the Company
will, in fact, be able to obtain additional financing or that the terms
of such financing will be favorable to the Company. In the event that
the Company is unable to obtain such additional financing, the Company
may have to take steps to further reduce its operating expenses, which
may negatively impact the Company's operations. The Company believes
that both the expected benefits to be derived from the current
restructuring of the Company's operations, including certain managerial
changes that have recently been made, and the expected level of
operations during the next year, may offset a portion of any liquidity
shortage that may occur. The financial statements do not include any
adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and
classification of liabilities that may result from the possible
inability of the Company to continue as a going concern.

<PAGE>

NOTE 3 PROPERTY AND EQUIPMENT

Property and equipment is summarized as follows at June 30:

<TABLE>
<CAPTION>
1998 1997
---------------------------
<S> <C> <C>
Furniture and fixtures $ 1,465,940 $ 905,697
Computer equipment 1,364,146 1,602,756
Leasehold improvements 1,070,950 765,325
---------------------------
3,901,036 3,273,778

Less: accumulated depreciation 1,777,624 1,320,714
---------------------------
$ 2,123,412 $ 1,953,064
---------------------------
---------------------------
</TABLE>

Depreciation expense for the years ended June 30, 1998, 1997 and
1996 was $488,365, $405,900 and $352,491, respectively.

NOTE 4 OTHER CURRENT ASSETS

Other current assets consisted of the following at June 30:

1998 1997
---------------------------
<S> <C> <C>
Prepaid expenses $ 517,749 $ 299,666
Director and salesperson
compensation draws 509,446 309,579
Other 24,101 185,638
----------------------------
$ 1,051,296 $ 794,883
----------------------------
----------------------------
</TABLE>

NOTE 5 INCOME TAXES

For the year ended June 30, 1998 and 1996 income tax expense
consisted of state taxes currently payable. The Company had no
current and deferred income tax expense in any period presented.
For the year ended June 30, 1997, income tax expense consisted of
$39,234 federal alternative minimum taxes and $139,529 state
taxes currently payable.

At June 30, 1998, the Company has net federal operating loss
carryforwards as follows for income tax purposes:

<TABLE>
<CAPTION>
Carryforward Expires Net Operating Loss
----------------------------------------
<S> <C>
2005 $ 251,730
2006 1,721,893
2007 6,430
2008 2,709,559
2009 348,090
2011 1,366,208
2013 (approximate) 3,900,000
----------------
$10,303,910
----------------
----------------
</TABLE>

<PAGE>

NOTE 5 INCOME TAXES (CONTINUED)

The Company's ability to utilize the net operating loss carry
forwards is dependent upon the company's ability to generate
taxable income in future periods. Federal net operating losses
of approximately $7,400,000 million are limited to $792,000 per
year, due to ownership changes as defined under Section 382 of
the Internal Revenue Code of 1986. Any unused portion can be
carried forward and utilization of the net operating loss carry
forward may also be limited in any one year by alternative
minimum tax rules.

A reconciliation of the statutory federal income tax rate
(benefit) and the effective tax rate as a percentage of income
(loss) before taxes on income is as follows:

1998 1997 1996
-----------------------------
<S> <C> <C> <C>
Statutory rate (benefit) (34.0)% 34.0% (34.0)%
Operating losses generating no current
tax benefit 34.0 - 34.0
Current benefit of fully reserved net operating
loss carryforward utilization - (31.4) -
State taxes 0.5 9.2 0.9
-----------------------------
0.5% 11.8% 0.9%
-----------------------------
-----------------------------
</TABLE>

Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used
for income tax purposes. Significant components of the Company's
deferred tax assets and liabilities as of December 31 are as
follows:

1998 1997
-----------------------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carry forwards $ 3,725,000 $ 2,321,000
Other items not yet deductible
for tax purposes 68,000 59,000
-----------------------------
3,793,000 2,419,000
Deferred tax liabilities:
Depreciation (50,000) (40,000)
Valuation allowance (3,743,000) (2,379,000)
-----------------------------
Net deferred tax asset $ - $ -
-----------------------------
-----------------------------

</TABLE>

As the Company has posted losses in most years since inception and
utilization of the net operating losses, the Company's primary deferred
tax asset, is limited by IRS Section 382, realization of the tax benefit
related to these net deferred tax asset is uncertain. Accordingly, no
deferred tax asset has been recorded to reflect their potential value.
The net change in the deferred tax valuation allowance was an increase
(decrease) of $1,364,000, $(848,000) and $910,000 in 1998, 1997 and 1996,
respectively.

<PAGE>

NOTE 6 ACCRUED LIABILITIES

Accrued liabilities consisted of the following at June 30:

<TABLE>
<CAPTION>
1998 1997
-----------------------------
<S> <C> <C>
Accrued production costs $ 2,454,963 $ 1,717,261
Accrued director fees 780,359 1,085,024
Other 1,170,692 1,428,383
-----------------------------
$ 4,406,014 $ 4,230,668
-----------------------------
-----------------------------
</TABLE>

NOTE 7 LINE OF CREDIT

On May 10, 1995, the Company entered into a $3,000,000 asset
based revolving line of credit with a bank, with interest at a
variable rate (9.5% at June 30, 1998), collateralized by the
assets of the Company. During the years ended June 30, 1998 and
1997, the weighted average interest rate was 9.5% and 8.33%,
respectively. Borrowing is based upon certain percentages of
acceptable receivables. The loan agreement has certain financial
covenants and the Company was not in compliance with a
requirement to maintain quarterly profitability during 1998.

Subsequently, on July 30, 1998, the bank line of credit was
replaced with an asset based loan and security agreement due to a
finance company. The loan and security agreement provides for
the following borrowings: a revolving line of credit with
maximum availability of $4,500,000 or a specified percentage of
acceptable accounts receivable with interest at a variable rate
(10% at July 30, 1998), and a term note payable of $500,000 to be
disbursed at the sole discretion of the finance company. The
loan and security agreement requires the Company to comply with
certain restrictive covenants and is guaranteed by CBC (Note 2).

NOTE 8 COMMITMENTS AND CONTINGENCIES

Operating Leases:

The Company is a party to a number of noncancelable
operating lease agreements involving buildings and equipment
which expire at various dates. The future minimum lease
commitments are as follows for the years ending June 30:
<TABLE>

<S> <C>
1999 $ 1,087,481
2000 1,013,227
2001 970,779
2002 898,068
2003 857,150
Thereafter 3,283,360
-------------
Total minimum payments $ 8,110,065
-------------
-------------
</TABLE>

Total rental expense for the years ended June 30, 1998, 1997 and
1996 aggregated $807,956, $774,396 and $696,110, respectively.

<PAGE>

NOTE 8 COMMITMENTS AND CONTINGENCIES (CONTINUED)

Employment Contracts:

The Company has entered into various employment agreements with
its officers and others, which obligate it to make minimum
payments of approximately $6,633,080. The payments due are
$4,270,249, $1,981,914, and $380,917, for the years ended June
30, 1999, 2000, and 2001. Of these amounts $3,556,367 are for
administrative personnel and $3,076,713 are for commercial
television directors and salespeople. Certain of these
agreements provide for additional compensation based on
subsidiary revenues, defined subsidiary operating profits or
other incentives. This additional compensation is payable
whether or not the Company achieves an operating profit as a
whole. Some of the television directors who are associated with
the Company receive monthly draws against the directors'
compensation for production of commercials. The monthly draws
equal the minimum guaranteed compensation payable to such
directors. Although the draws are recoupable by the Company out
of compensation otherwise payable to such directors, such
directors are not obligated to repay such draws, if their fees
for commercials produced do not exceed the monthly draws that
have been paid. Consequently, the Company is obligated to
provide compensation to these directors whether or not they are
directing commercials. Most of the Company's sales personnel
receive monthly draws offset by their earned commissions.

Lawsuits:

A lawsuit was filed on March 22, 1996, (served August 12, 1996)
in Superior Court of the State of California, County of Los
Angeles. A wrongful death claim has been made by the estate of
Henry Gillermo Urgoiti, his wife and three children for an
accident that occurred during the filming of a music video in
August 1995. The complaint contains six causes of action, three
causes for negligence, one cause for negligent product liability,
one cause for strict liability and one cause for breach of
warranty. Harmony Holdings, Inc., has been named in all six
causes of action, Harmony Pictures Inc., The End Inc. and three
of it's employees have been named in one of the negligence
claims. Other defendants include Southern California Edison,
Virgin Records America, Inc. Bell Helicopters and Helinet
Aviation Services. A cross-complaint related to the preceding
matter, was filed on December 23, 1996 in Superior Court of the
State of California, County of Los Angeles. The complaint has
been filed by Virgin Records Limited against The End, Inc. and
Southern California Edison for contractual indemnity, equitable
indemnity, comparative contribution and declaratory relief.
While it is too early in the discovery process to assess complete
economic risk, management has been advised by the Company's
insurance broker that a remote possibility exists that damages
assessed against the Company will exceed current insurance
coverage. As the probability of an unfavorable outcome and the
range of possible loss is unknown, no amounts have been accrued
at June 30, 1998.

<PAGE>
HARMONY HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------

NOTE 8 COMMITMENTS AND CONTINGENCIES (CONTINUED)

Lawsuits (Continued):

On June 30, 1998, a complaint was filed by Rick Bieber against
Harmony Holdings, Inc. and Harmony Pictures, Inc. in the Superior
Court of the State of California, County of Los Angeles. Mr.
Bieber was the president of Harmony Pictures, Inc. until his
employment was terminated by Harmony Pictures, Inc. on April 23,
1998. Harmony Pictures, Inc. terminated Mr. Bieber for breaching
his written employment agreement with the company and his
fiduciary obligations to the company. The expiration date of the
employment agreement was December 31, 2000. However, the
employment agreement provided that it could be terminated before
the expiration date by Harmony Pictures, Inc. (i) for cause or
(ii) if Harmony Pictures, Inc. was not profitable by the quarter
ended June 30, 1998. Harmony Pictures, Inc. incurred losses of
(unaudited) $(252,509) and (unaudited) $(1,997,481) for the
quarter and year ending June 30, 1998, respectively. Mr. Bieber
alleges that the defendants, by terminating his employment
agreement before December 31, 2000, breached the covenant of good
faith and fair dealing. Mr. Bieber also alleges that defendants
slandered and libeled him with reference to the circumstances
relating to his termination. Mr. Bieber seeks damages in excess
of $1,000,000 for each of the two contract claims, has asked to
have his 250,000 stock options reinstated, and has asked for an
unspecified amount of contingent compensation. On the slander
and libel claims, he seeks unspecified compensatory damages and
punitive damages. Harmony Holdings, Inc. and Harmony Pictures,
Inc. deny that they have any liability to Mr. Bieber and intend
to vigorously defend the lawsuit. As the probability of an
unfavorable outcome and the range of possible loss is unknown, no
amounts have been accrued at June 30.

The Company is involved in other litigation on a number of matters
and is subject to certain claims which arise in normal course of
business, none of which, in the opinion of the Company's management
is expected to have a materially adverse effect on the Company's
financial position or results of operations.

Subsidiary Share Transfer Agreement:

The Company entered into a share transfer agreement with four
members of management of Curious Pictures Corporation ("the
Subsidiary") dated December 15, 1996. The agreement called for
stock equaling one percent (1%) of Curious Pictures Corporation
outstanding common stock to be issued to the four members of
management, collectively, upon the signing of the agreement. Under
the agreement, the four members of management have the ability to
earn an additional fifty-percent (50%) of the company through
yearly stock option grants with an exercise price of $1.00 per
share starting with calendar year 1997. The stock options are
earned based upon the calendar year results of operations of the
Subsidiary and are exercisable in December 1998 (upon completion of
the second year of the Subsidiary management's three year
employment contracts). After the four members of management have
acquired stock and options representing fifty one percent (51%) of
Curious Pictures Corporation, the Company has the right to put its
remaining forty nine percent 49% of Curious Pictures Corporation to
the four members of management for a price to be determined based
on fair value at that time, but not to be less than $1,960,000.

Based on the Subsidiary's results of operations through June 30,
1998, management estimates that 50% of the options available
under the agreement have been earned. Accordingly, management
has recognized compensation expense equal to the intrinsic value
of the earned stock options based upon a valuation of the
Subsidiary performed near the date of the agreement consummation.
For the years ended June 30, 1998 and 1997, this compensation
expense, including the value of the common stock awarded at the
agreement inception, totaled $390,750 and $75,000, respectively.

36
<PAGE>

NOTE 9 STOCKHOLDERS' EQUITY AND STOCK OPTION PLAN

Common Stock:

Pursuant to a Stock Subscription Agreement entered into in July
1996, the Company sold to Unimedia, S.A., a French company
(Unimedia), 1,000,000 shares of Common Stock of the Company at a
purchase price of $2.00 per share. The purchase price was
received by the Company on August 16, 1996.

On July 21, 1997, CBC (Note 2) and Unimedia entered into an
agreement whereby Unimedia agreed to sell, and CBC agreed to buy
Unimedia's 1,000,000 shares of Common Stock of the Company for
$2,600,000 and Unimedia agreed to dismiss the litigation entitled
Unimedia S.A. V. Harmony Holdings, Inc. and Harvey Bibicoff, Case
No. CV 96-7109 JGD (RNBx), pending in the United States District
Court for the Central District of California. CBC assigned its
right to buy 230,769 of the Shares to the Company, thereby
reducing the number of issued and outstanding shares of common
stock of the Company and resulting in a purchase price of
$2,000,000 and $600,000 to CBC and the Company, respectively.
The closing of the purchase occurred on July 25, 1997.

Incentive and Non-Qualified Stock Option Plans:

During the year ended June 30, 1997, the Company issued 257,500
stock options to certain outside board of director members and
other consultants of the Company, at prices ranging from $1.50 to
$2.00. The terms of the options are from three to five years and
compensation expense totaling $44,993 is included in the
statement of operations relating to these options.

The Company adopted a Stock Option Plan on August 7, 1991, as
amended and restated in February 1998. The purpose of the Stock
Option Plan is to secure for the Company and its stockholders the
benefits arising from stock ownership for selected employees of
the Company as the Board of Directors of the Company (the
"Board"), or a committee thereof constituted for that purpose,
may from time to time determine.

The Stock Option Plan provides for the granting of an aggregate
of incentive and non-incentive options to purchase a maximum of
3,250,000 shares of the Common Stock. The Stock Option Plan
authorizes the grant of options to employees intended to qualify
as incentive stock options ("Incentive Options") under Section
422 of the Code, and the grant of options which do not qualify
("Non-Qualified Options") as incentive stock options under
Section 422 of the Code.

The Stock Option Plan is currently administered by the Board.
The Board, subject to the provisions of the Stock Option Plan,
has full power to select the individuals to whom awards will be
granted, to fix the number of shares that each optionee may
purchase, to set the terms, conditions, and vesting of each
option, and to determine all other matters relating to the Stock
Option Plan. The Stock Option Plan provides that the Board will
select grantees from among full-time employees, officers,
directors and consultants of the Company or its subsidiaries, and
individuals or entities, subject to an acquisition or management
agreement with the Company.

<PAGE>

NOTE 9 STOCKHOLDERS' EQUITY AND STOCK OPTION PLAN (CONTINUED)

Incentive and Non-Qualified Stock Option Plans (Continued):

The option exercise price of each option shall be determined by
the Board, but shall not be less than 100% of the fair market
value of the shares on the date of grant. No Incentive Options
may be granted to any employee who owns, at the date of grant,
stock representing in excess of 10% of the combined voting power
of all classes of stock of the Company or of a parent or a
subsidiary unless the exercise price for stock subject to such
options is at least 110% of the fair market value of such stock
at the time of grant and the option term does not exceed five
years.

The term of each option shall be fixed by the Board and may not
exceed ten years from the date of grant. If a participant who
holds options ceases, for any reason, to be an employee,
consultant or director of otherwise affiliated with the Company
(the "Termination"), the option expires 30 days after the
Termination. Notwithstanding the foregoing, in the event of
Termination due to the optionee's death or incapacity, the option
will terminate 12 months following the date of such optionee's
death or incapacity. Options granted under the Stock Option Plan
may be exercisable in installments. The aggregate fair market
value of stock with regard to which Incentive Options are
exercisable by an individual for the first time in any calendar
year may not exceed $100,000.

Upon the exercise of options, the option exercise price must be
paid in full, either in cash or other form acceptable to the
Board. The Board may terminate the plan at its discretion.

A summary of the status of the Company's stock option plan as of
June 30,1998, 1997 and 1996, and the changes during the years
ending on those dates is presented below:

June 30, 1998 June 30, 1997 June 30, 1996
----------------------------------------------------------------------------------------
Weighted- Weighted- Weighted-
average average average
exercise exercise exercise
Shares price Shares price Shares price
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 2,607,000 $2.04 1,314,500 $2.45 867,000 $2.87
Granted 2,064,000 1.43 1,307,500 1.22 464,500 1.68
Exercised 775,000 1.51 - - - -
Forfeited 1,369,000 2.40 15,000 2.13 17,000 2.47
------------ ------------ -----------
Outstanding at end of year 2,527,000 $1.52 2,607,000 $2.04 1,314,500
------------ ------------ -----------
------------ ------------ ----------- $2.54

Options exercisable at year end 1,538,000 $1.58 2,198,000 $2.08 1,128,750 $2.39
------------ ------------ -----------
------------ ------------ -----------

Weighted average fair value of
options granted during the year $0.82 $0.17 $0.13
------------ ------------ -----------
------------ ------------ -----------

</TABLE>

Additionally, on March 10, 1998, the Company repriced 989,000 options
outstanding with varying exercise prices to $1.44 per share. The repricing was
considered a forfeiture of the existing options and a grant of new options for
the purposes of the table above.

<PAGE>

NOTE 9 STOCKHOLDERS' EQUITY AND STOCK OPTION PLAN (CONTINUED)

Incentive and Non-Qualified Stock Option Plans (Continued):

The following table summarizes information about stock options
outstanding at June 30, 1998:

<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------------------------------------------

Weighted
Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise Outstanding Contractual Exercise Exercisable Exercise
Prices At 6/30/98 Life Price at 6/30/98 Price

<S> <C> <C> <C> <C> <C> <C>
$1.38 - 1.50 2,209,500 4.19 $ 1.43 1,358,000 $ 1.46
1.51 - 2.00 222,500 4.58 1.79 102,500 1.89
2.01 - 3.00 72,500 5.00 2.51 55,000 2.59
$3.01 - 5.00 22,500 4.25 5.00 22,500 4.85
--------- ---------
Total 2,527,000 4.25 $ 1.52 1,538,000 $ 1.58
--------- ---------
--------- ---------
</TABLE>

SFAS Statement 123, Accounting for Stock-Based Compensation,
requires the Company to provide pro forma information regarding
net income and earnings per share as if compensation cost for the
Company's stock option plans had been determined in accordance
with the fair value based method prescribed in SFAS Statement
123. The Company estimates the fair value of each stock option
at the grant date by using the Black-Scholes option-pricing model
with the following weighted-average assumptions used for grants
in 1998, 1997 and 1996, respectively: dividend yield of zero for
all years; expected volatility of 59.5, 5.2 and 5.2 percent;
risk-free interest rates of 5.7, 5.9 and 5.9 percent and an
estimated option life of 5.0, 3.0 and 3.0 years.

Under the accounting provisions of SFAS Statement 123, the
Company's net income and earnings per share would have been
reduced to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
1998 1997 1996
------------------------------------------
<S> <C> <C> <C>
Net Income (Loss):
As reported $ (4,488,580) $ 1,332,427 $ 2,131,241
------------------------------------------
------------------------------------------

Pro forma $ (4,780,327) $ 1,218,362 $ 2,173,801
------------------------------------------
------------------------------------------
Basic and diluted earnings (loss)
per share:
As reported $ (0.69) $ .20 $ (.37)
------------------------------------------
------------------------------------------
Pro forma $ (0.73) $ .18 $ (.38)
------------------------------------------
------------------------------------------
</TABLE>

<PAGE>

NOTE 10 CONCENTRATION OF CREDIT RISKS

The Company's cash is deposited with various financial
institutions, and is insured up to a maximum of $100,000 at each
institution by the Federal Deposit Insurance Corporation
("FDIC"). At June 30, 1998, the Company's deposits with three
financial institutions exceeded the maximum amount insured by the
FDIC by $2,322,000. At June 30, 1998, the Company had bank
accounts at foreign banks with deposits aggregating $525,000.

The Company grants credit to advertising agencies, principally
based in the United States. The Company performs ongoing credit
evaluations of its customers' financial condition, and generally
requires no collateral from its customer. The Company's credit
losses are subject to the general economic conditions of the
advertising industry.

NOTE 11 RELATED PARTY TRANSACTIONS

Notes Receivable:

As of June 30, 1998 and 1997, the Company had a note receivable
from a former CEO of the Company with an outstanding balance of
$235,155 and $208,889, respectively. The note bears interest at
a variable rate (10% at June 30, 1998) and was subsequently
repaid in full in September 1998.

In January 1998, the Company entered into a $650,000 note
receivable agreement with CBC (Note 2). Pursuant to the note,
the Company advanced $611,000 of proceeds to CBC and applied the
remaining $39,000 of the note balance to a loan fee for the note
origination. Interest was accrued at 15%. The note was repaid
in full with two installments (May 1998, $322,863 and June 1998,
$327,137).

During the years ended June 30, 1998 and 1997, the Company
recognized interest and loan fee income aggregating $98,718 and
$19,933, respectively, related to these notes receivable.

Management Services Contracts:

During 1997, the Company entered into an agreement with a
corporation controlled by a former CEO, whereby the corporation
will provide investor relation services to the Company through
September 30, 2000, for a flat rate of $75,000 paid upon
execution of the agreement.

In October 1997, the Company entered into a management services
contract with a privately held affiliate (the "Management
Company") related to the Company through common control. The
contract, which is on a month to month basis and is cancelable
with a 60-day notice, requires that the Company pay a fee of
$19,372 per month for services received. The management fees
totaled $174,348 during the year ended June 30, 1998.
Subsequently, in July 1998, the contract was amended to increase
the monthly management fee to $39,372.

The Management Company also provides services for CBC (Note 2)
and another privately held affiliate each related to the Company
through common control. The management fee is based on estimated
usage of the Management Company's services.

In May 1998, the Management Company advanced the Company $225,000
pursuant to a note payable with interest at 10%. In June 1998,
the Company repaid the note in full together with accrued
interest of $3,051.

<PAGE>

Exhibit 10.4

HARMONY HOLDINGS, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------

Balance at Additions charged Balance at
Beginning of Year to costs and expenses Deductions End of Year
-----------------------------------------------------------------------------------
<C> <C> <C> <C>
1996
Allowance for
doubtful
accounts $ 25,864 $ 49,765 $ 0 $ 75,629
-----------------------------------------------------------------
-----------------------------------------------------------------

1997
Allowance for
doubtful
accounts $ 75,629 $ 97,646 $ 75,629 $ 97,646
-----------------------------------------------------------------
-----------------------------------------------------------------

1998
Allowance for
doubtful
accounts $ 97,646 $ 30,167 $ 84,096 $ 43,717
-----------------------------------------------------------------
-----------------------------------------------------------------
</TABLE>

<PAGE>

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

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS

The information relating to the Company's executive officers as of
October 5, 1998 is contained in the following table:

Name Age Position
----- --- --------
<S> <C> <C>
Christopher T. Dahl 55 Chairman of the Board and
Chief Executive Officer

Richard W. Perkins 67 Director

William E. Cameron 53 Director

Gerald Germain Director

William M. Toles 51 Director

James G. Gilbertson 37 Chief Operating Officer and
Chief Financial Officer

Lance W. Riley 47 Secretary and General Counsel
</TABLE>

CHRISTOPHER T. DAHL has been Chief Executive Officer and Chairman of the
Company since July 22, 1997. Since its inception in February, 1990, Mr. Dahl
has been the President, Chief Executive Officer and Chairman of the Board of
Directors of Children's Broadcasting Corporation ("CBC"), a publicly traded
company and the Company's largest shareholder. He is also Chairman and Chief
Executive Officer of Community Airwaves Corporation ("CAC"), a company that
owns and operates radio stations in Hawaii. Mr. Dahl serves as the managing
partner of Radio Management, L.L.C. ("RMLLC"), a company that provides
corporate, legal, accounting and financial services to the Company and CBC.
From 1969 to 1979, he was the founder and President of a group of companies
involved in photo finishing, retail photo sales, home sewing notions, toy
distribution and retail craft stores. He was employed by Campbell-Mithun and
Knox Reeves Advertising

<PAGE>

from 1965 through 1969.

RICHARD W. PERKINS has been a director of the Company since July 22,
1997. Mr. Perkins has also been a director of CBC since its inception. For
more than five years, Mr. Perkins has been President and Chief Executive
Officer of Perkins Capital Management, Inc., a registered investment advisor.
Mr. Perkins is also Partner of RMLLC, as well as a director of the following
publicly held companies: Bio-Vascular, Inc., a medical products manufacturer;
CNS, Inc., a consumer products manufacturer; Lifecore Biomedical, Inc., a
medical device manufacturer; Nortech Systems, Inc., an electronic sub-systems
manufacturer; Eagle Pacific Industries, Inc., a manufacturer of plastic pipe;
and Quantech LTD., a developer or immunological tests.

WILLIAM E. CAMERON has been a director of the Company since July 22, 1997.
Mr. Cameron has also been a director of CBC since April 2, 1998. For more than
five years, Mr. Cameron has been Head of International Business Development for
Universal Health Communications, the largest medical/health/wellness video
library in the world.

GERALD GERMAIN has been a director of the Company since May 13, 1998.
For the past four years, Mr. Germain has been recognized as a television
commercial production industry authority on a large variety of financial and
operations issues. From 1984 to 1994, he served as Chief Financial Officer
and, towards the end, as Vice Chairman of Doyle Dane Bernbach (now known as
DDB Needham). In 1978, Mr. Germain became Chief Financial Officer of Compton
Communications, Inc. (now known as Saatchi & Saatchi Worldwide) and became
its Executive Vice President in 1982. In 1967, Mr. Germain was also a staff
accountant with the advertising agency D'Arcy, Masius, Benton & Bowles, where
he eventually became Senior Vice President, Worldwide Treasurer. Mr. Germain
graduated from Brooklyn College and received a J.D. degree from the New York
University of Law School.

WILLIAM M. TOLES has been a director of the Company since July 22, 1997.
For more than five years, Mr. Toles has been the President and Chief Executive
Officer of Tol-O-Matic, a privately held manufacturer of motion control
products.

JAMES G. GILBERTSON has served as the Company's Chief Operating Officer
since November, 1997, as of October 2, 1998 as the Company's Chief Financial
Officer. Mr. Gilbertson has also served as CBC's Chief Operation Officer since
April 1996 and its Chief Financial Officer since July 1992. From June 1988 to
July 1992, he was the Chief Financial Officer of Parker Communications, which
operated a group of radio stations. From 1985 to June 1988, he was Controller of
the radio division of Palmer Communications located in Des Moines, Iowa. Prior
to joining Palmer Communications, Mr. Gilbertson was practicing certified public
accountant with the firm of Ernst & Young LLP. Mr. Gilbertson received a B.A.
from the University of Iowa and an MBA from the Carlson School of Management
at the University of Minnesota.

LANCE W. RILEY became Secretary of the Company in November, 1997, and
General Counsel of the Company in July, 1998. Mr. Riley is also Secretary and
General Counsel of CBC, and has been practicing law since 1977. Mr.
Riley held the position of Chairman of the Communications Law Section of the
Minnesota State Bar Association from 1990 to 1994. He is also Of Counsel with
the firm of Hessian & McKasy, P.A. (formerly known as Hessian, McKasy &
Soderburg, P.A.), located in Minnesota, since 1994. Prior to joining CBC, Mr.

<PAGE>

Riley was partner in the firm of Courey, Albers, Gilbert and Riley, P.A. Mr.
Riley received B.A., Magna cum laude, from Hamline University and a J.D., cum
laude, from the University of Minnesota School of Law.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated herein by reference
to the information contained in the Proxy Statement relating to the Company's
Annual Meeting of Stockholders, which will be filed with the SEC no later than
120 days after the close of the Company's fiscal year.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

On July 21, 1997, CBC and Unimedia entered into an agreement whereby
Unimedia agreed to sell, and CBC agreed to buy Unimedia's 1,000,000 shares of
Common Stock of the Company for $2,600,000 and Unimedia agreed to dismiss the
litigation entitled Unimedia S.A. vs. Harmony Holdings, Inc. and Harvey
Bibicoff, Case No. CV 96-7109 JGD (RNBx), in the United States District Court
for the Central District of California. CBC assigned its right to buy 230,769
of the Shares to the Company, thereby reducing the number of issued and
outstanding shares of Common Stock of the Company and resulting in a purchase
price of $2,000,000 and $600,000 to CBC and the Company, respectively. The
closing of the purchase occurred on July 25, 1977.

During 1997, the Company entered into an agreement with a corporation
controlled by a former CEO, whereby the corporation will provide investor
relation services to the Company through September 30, 2000, for a flat rate
of $75,000 paid upon execution of the agreement.

In January 1998, the Company entered into a $650,000 note receivable
agreement with CBC. Pursuant to the note, the Company remitted $611,000 of
proceeds to CBC and applied the remaining $39,000 of the note balance to a
loan fee for the note origination. Interest was accrued at 15%. The note was
repaid in full with two installments (May 1998, $322,863 and June 1998,
$327,137).

In May 1998, RMC (as defined below) advanced the Company $225,000
pursuant to a note payable with interest at 10%. In June 1998, the Company
repaid the note in full together with accrued interest of $3,051.

As of June 30, 1998, the Company has a $235,155 note receivable from a
former CEO of the Company. The note bears interest at a variable rate (10% at
June 30, 1998) and was subsequently repaid in full in September 1998.

CBC has guaranteed the Company's Loan and Security Agreement with Heller
Financial, Inc.

Since August, 1998, the Company has received administrative, legal,
accounting and financial services from RMLLC. RMLLC is a limited liability
company which is owned by the Chairman of the Board and Chief Executive
Officer and another director. RMLLC provides corporate, legal, accounting and
financial services to the Company and, CBC and CAC. The agreement provides for
RMLLC to receive $39,372 per month from the Company for such services. From
October 1, 1997 to July, 1998, the Company received identical administrative,
legal, accounting and financial services from Radio Management Corporation
("RMC"). The Company paid RMC an aggregate of $174,000 for such services
during the fiscal year ended June 30, 1998. These arrangements were approved
by the Related Party Transaction Committee of the Company's Board of
Directors, which is comprised of disinterested directors, and the Company
believes such arrangements were on terms at least as favorable as could have
been obtained from unaffiliated third parties.

PART IV

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

(a) Financial Statements and Financial Statement Schedules and Exhibits

(1) The audited consolidated financial statements of Harmony Holdings,
Inc. and Subsidiaries filed as a part of this Annual Report on Form 10-K are
listed in the Index to Consolidated Financial Statements preceding the Company's
Consolidated Financial Statements contained in Item 8 of this Annual Report on
Form10-K, which Index to Consolidated Financial Statements is hereby
incorporated herein by reference.

(2) Registrant's Schedule II-Valuation and Qualifying Accounts is
included with Registrant's Consolidated Financial Statements in Item 8 hereof.

<PAGE>

(3) The following documents required by Item 601 of Regulation S-K are
filed as exhibits or are incorporated by reference herein:

<TABLE>
<CAPTION>
Exhibit Number Description
- -------------- -----------
<S> <C>
3.1 Restated Certificate of Incorporation of Company, filed in
the office of the Secretary of State of the State of
Delaware, filed as Exhibit 3. 1 to the Company's
Registration Statement on Form S-1 (Registration No.
33-3342193), is hereby incorporated by reference.

3.3 By-Laws of Registrant, filed in the office of the Secretary
of State of the State of Delaware, filed as Exhibit 3. 3 to
the Company's Registration Statement on Form S-1
(Registration No. 33-3342193), is hereby incorporated by
reference.

3.3.1 Amendment No. 1 to By-laws of Registrant, filed in the
office of the Secretary of State of the State of Delaware,
filed as Exhibit 3. 3. 1 to the Company's Registration
Statement on Form S-1 (Registration No. 33-3342193), is
hereby incorporated by reference.

10.1 1991 Stock OptionPlan, filed as Exhibit 10. 1 to the
Company's Registration Statement on Form S-1 (Registration
No. 33-3342193), is hereby incorporated by reference.

10.29 Stock Purchase Agreement among Children's Broadcasting
Corporation, Harvey Bibicoff and Harmony Holdings, Inc. ,
dated July 21, 1997, filed as Exhibit 10. 1 to the Company's
Current Report on Form 8-K dated August 5, 1997, is hereby
incorporated by reference.

10.30 Stock Purchase Agreement among Children's Broadcasting
Corporation and Unimedia S.A., dated July 21, 1997, filed as
Exhibit 10. 2 to the Company's Current Report on Form 8-K
dated August 5, 1997, is hereby incorporated by reference.

10.31 Mutual General Release among, Unimedia, Harvey Bibicoff and
Harmony Holdings, Inc., filed as Exhibit 10. 3 to the
Company's Current Report on Form 8-K dated August 5, 1997,
is hereby incorporated by reference.

10.32 Loan and Security Agreement by and between the Company and
Heller Financial, Inc., dated July 30, 1998, filed as
Exhibit 10.1 to the Form 8-K filed on August 26, 1998, is
hereby incorporated by reference.

10.33 Service Agreement by and between the Company and Radio
Management, L.L.C., dated as of August 1, 1998

21 Subsidiaries of the Registrant.

27 Financial Data Schedule.
</TABLE>
45

<PAGE>

(b) Reports on Form 8-K

None.

<PAGE>

SIGNATURES

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

HARMONY HOLDINGS, INC.

By: /s/ Christopher T. Dahl
Dated: October 13, 1998 -----------------------------
Christopher T. Dahl
CEO

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 in the capacities and on the dates indicated:

SIGNATURE TITLE DATE

Chairman of the Board
and Chief Executive
/s/ Christopher T. Dahl Officer October 13, 1998
- ----------------------------
Christopher T. Dahl

/s/ Richard W. Perkins Director October 13, 1998
- ----------------------------
Richard W. Perkins

/s/ William E. Cameron Director October 13, 1998
- ----------------------------
William E. Cameron

/s/ William M. Toles Director October 13, 1998
- ----------------------------
William M. Toles

/s/ Gerald Germain Director October 13, 1998
- ----------------------------
Gerald Germain

Chief Operating Officer
and Chief Financial
/s/ James G. Gilbertson Officer October 13, 1998
- ----------------------------
James G. Gilbertson

<PAGE>
<TABLE>
<CAPTION>
Exhibit Index
- -------------
<S> <C>
10.33 Service Agreement by and between the Company and Radio
Management, L.L.C., dated as of August 1, 1998

21 Subsidiaries of the Company
</TABLE>
45

<PAGE>

EXHIBIT 10.33

SERVICE AGREEMENT

THIS AGREEMENT made this 31st day of July, 1998, and effective August 1,
1998, by and between RADIO MANAGEMENT, L.L.C., a Minnesota limited liability
company (hereinafter "RMLLC"), and HARMONY HOLDINGS, INC., a Delaware
corporation (hereinafter "HHI").

WHEREAS, RMLLC engages in the business of providing administrative, general
and legal services for companies and HHI engages primarily in the production of
television commercials and operates through its wholly-owned subsidiaries; and

WHEREAS, HHI intends to retain RMLLC to provide administrative, general and
legal services for its television commercial production operations according to
the terms and provisions set forth herein.

NOW, THEREFORE, based upon the mutual premises contained herein, and other
good and valuable consideration, the parties hereby agree as follows:

1. SERVICES. During the term hereof, RMLLC shall perform general and
administrative services for HHI, including, but not limited to, payroll
services, general accounting services, general legal services and such
other services as the parties may mutually agree to from time to time.

2. COMPENSATION. In consideration for the services performed by RMLLC
hereunder, HHI shall pay RMLLC Thirty-nine Thousand Three Hundred
Seventy-two and no/100 Dollars ($39,372.00) per month payable within thirty
(30) days from the end of each calendar month. The compensation paid to
RMLLC hereunder shall not include any fees or expenses for accounting,
legal or other services performed for HHI by third parties.

3. QUARTERLY REVIEW. The parties agree that they will review the services
provided by RMLLC hereunder and the compensation set forth herein at the
end of each calendar quarter during the term hereof, and at such time the
services and compensation may be adjusted upon the mutual agreement of the
parties.

4. EXPENSES. In addition to the compensation set forth in Section 2 above,
HHI shall pay all reasonable and necessary expenses

<PAGE>

incurred by RMLLC in connection with the services performed hereunder,
including, but not limited to, travel and lodging expenses and any other
expenses directly attributable to the services performed by RMLLC
hereunder. RMLLC shall bill HHI on a monthly basis for such expenses and
HHI shall pay the same within thirty (30) days from the date HHI receives
any such invoice.

5. INDEPENDENT CONTRACTOR. The parties hereby acknowledge that (i) RMLLC,
while preforming services hereunder, at all times acting as an independent
contractor and not as an employee of HHI; (ii) the employees of RMLLC
shall at no time be considered employees of HHI in connection with the
services performed hereunder; and (iii) RMLLC shall be solely responsible
for all federal, state and local income taxes, employment taxes,
self-employment taxes, workers' compensation insurance premiums and any and
all other similar taxes or payments RMLLC is required to make as a result
of the services RMLLC performs hereunder. HHI shall approve the engagement
of any officer of RMLLC who shall pursuant to such engagement also serve as
an officer of HHI, and HHI shall affirm and agree to the terms of such
engagement.

6. LIMITATIONS ON LIABILITY. HHI hereby agrees that in no event shall RMLLC
be liable to HHI for any indirect, special or consequential damages or lost
profits arising out of or in any way related to this Agreement or the
performance of services hereunder or any breach thereof and that RMLLC's
liability to HHI hereunder, if any, shall in no event exceed the total
compensation paid to RMLLC hereunder.

7. TERM. This Agreement shall remain in effect for a period of one (1) year
from the date hereof; provided, however, the term of this Agreement shall
automatically renew for successive one (1) year periods unless terminated
by either party, by written notice delivered to the other party, within
sixty (60) days from the end of the then current term.

8. TERMINATION. Notwithstanding Section 7 above, this Agreement shall
terminate upon the occurrence of any of the following events:

a. by RMLLC if HHI is more than sixty (60) days delinquent in its payment
of compensation or expenses pursuant to the Sections 2 or 3 above;

b. by either party if the other party is in default under any provision
hereunder and such default is not cured within sixty (60) days after
notice thereof is given to the defaulting party;

2
<PAGE>

c. by either party if the other party becomes insolvent or seeks
protection, voluntarily or involuntarily, under any bankruptcy law; or

d. upon the mutual agreement of both parties.

A termination of this Agreement pursuant to this Section 8 or Section 7
above shall not relieve HHI of its obligation to pay RMLLC compensation or
expenses for any services rendered or expenses incurred prior to the date
of termination.

9. GOVERNING LAW. This Agreement shall be construed and enforced in
accordance with the laws of the State of Minnesota.

IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of
the day and year first above written.

RADIO MANAGEMENT, L.L.C.

BY: /s/ James G. Gilbertson
------------------------
ITS: Chief Operating Officer

HARMONY HOLDINGS, INC.

BY: /s/ Patrick D. Grinde
------------------------
ITS: Chief Financial Officer

<PAGE>

EXHIBIT 21
<TABLE>
<CAPTION>
STATE OF
NAME INCORPORATION
- ----------------------------------------------------------------------
<S> <C>
Chemistry Pictures, Inc.
(fka Harmony Pictures, Inc.) Delaware

Melody Films, Inc. Delaware

Lexington Films, Inc. California

Pure Film, Inc. California

The End, Inc. California

The End, Ltd. (London) United Kingdom

The Moment Films, Inc. California

Serial Dreamer Films, Inc. California

The Beginning Entertainment, Inc. California

Gigantic Entertainment, Inc. California

Curious Pictures Corporation New York

Delirious Pictures Corporation New York

Furious Pictures Corporation New York

Hollywood Business Solutions, Inc. California

Harmony Media Communications, Inc. California

Harmony Entertainment, Inc. Delaware
</TABLE>
25

<PAGE>
<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> JUN-30-1998
<CASH> 3,834,023
<SECURITIES> 0
<RECEIVABLES> 6,604,186
<ALLOWANCES> (43,717)
<INVENTORY> 0
<CURRENT-ASSETS> 12,000,418
<PP&E> 3,901,036
<DEPRECIATION> 1,777,624
<TOTAL-ASSETS> 16,927,115
<CURRENT-LIABILITIES> 12,697,907
<BONDS> 0
0
0
<COMMON> 72,375
<OTHER-SE> 4,156,833
<TOTAL-LIABILITY-AND-EQUITY> 16,927,115
<SALES> 53,355,100
<TOTAL-REVENUES> 53,355,100
<CGS> 43,616,737
<TOTAL-COSTS> 43,616,737
<OTHER-EXPENSES> 11,185,011
<LOSS-PROVISION> (43,717)
<INTEREST-EXPENSE> 99,144
<INCOME-PRETAX> (4,466,917)
<INCOME-TAX> 21,663
<INCOME-CONTINUING> (4,488,580)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,488,580)
<EPS-PRIMARY> (0.69)
<EPS-DILUTED> (0.69)

</TABLE>