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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the Quarter Ended September 30, 2004                 Commission File No. 1-9502

MAGIC LANTERN GROUP, INC.

(Exact name of registrant as specified in its charter)

                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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

PART I.

 FINANCIAL INFORMATION

MAGIC LANTERN GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

-2-

MAGIC LANTERN GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)

-3-

MAGIC LANTERN GROUP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS)

(Unaudited)

(In thousands)

-4-

MAGIC LANTERN GROUP, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(Unaudited)

(In thousands)

See Notes to Condensed Consolidated Financial Statements.

-5-

MAGIC LANTERN GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

See Notes to Condensed Consolidated Financial Statements.

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MAGIC LANTERN GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1.        Basis of Presentation

Unaudited Interim Financial Statements

The accompanying unaudited interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and applicable Securities and Exchange Commission (SEC) regulations for interim financial information.  These financial statements are unaudited and, in the opinion of management, include all adjustments necessary to present fairly the balance sheets, statements of operations and statements of cash flows for the periods presented in accordance with accounting principles generally accepted in the United States.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to SEC rules and regulations.  Operating results for the nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.  These financial statements and notes should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2003 included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003 and are incorporated herein by reference.

Going Concern       

The accompanying financial statements have been prepared on the basis the Company will continue as a going concern. The Company has sustained substantial losses for the years ended December 31, 2003, 2002, and 2001. The Company's cash position is in excess of $50,000 at November 9, 2004 and is sufficient to cover the current rate of operating activity until November 30, 2004, (see "contractual obligations and commercial commitments" found in Management's Discussion and Analysis). The Company's working capital deficiency at September 30, 2004 was approximately $3,180,000, which has increased since December 31, 2003. Historically, the Company has sought financing from its major shareholders. The Company continues to seek new equity financing from other funds and sources to support its strategic initiatives for new sales and revenue streams and expansion into the United States.

Failing additional equity financing solutions, the Company's options for achieving a neutral cash flow portion include factoring of accounts receivable and a corporate reduction of discretionary investments and overall downsizing.  In addition, the Company is in negotiations to extend the terms of certain notes previously issued by the Company, one in the amount of $500,000 Canadian dollars and certain others amounting collectively to $950,000 U.S.  The notes due in September 2004 were extended for an additional 90 days and the company anticipates that the November 2004 note will be extended similarly .  The failure by the Company to achieve any of the aforementioned goals or to raise additional financing raises substantial doubt about its ability to continue as a going concern.

The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.

On May 3, 2004, the Company closed the private placement of a $1,500,000 principal secured convertible three-year term note (the "Note") with the Laurus Master Fund, Ltd. ("Laurus Funds") in an offering exempt from the registration requirements of the Securities Act of 1933, as amended (the "Act"), pursuant to Rule 506 of Regulation D promulgated under the Act. The Note bears interest at the prime rate, as reported in the Wall Street Journal, plus 2% (which under no circumstances will be considered to fall below 6% on a combined basis), with interest and amortizing payments of principal commencing August 1, 2004. The interest payable on the note is adjustable downward by 2% if the Company shall have registered shares of Laurus Funds' stock underlying the Note on a registration statement declared effective by the Securities and Exchange Commission, and the Company's stock is trading at a 25% or greater premium to the fixed conversion price under the Note of $0.25. The interest payment will be adjusted downward by 1% in the event the Company has not registered shares of Laurus Funds' stock underlying the Note, and the Company's stock is trading at a 25% or greater premium to the fixed conversion price under the Note of $0.25.

Payments under the Note are convertible to common stock of the Company at the option of Laurus Funds at a fixed conversion price of $0.25. The Company may prepay outstanding principal and accrued interest under the Note by delivering to Laurus Funds in cash an amount that is equal to 125% of the aggregate amount of outstanding principal of the Note plus any accrued but unpaid interest and all other sums due, accrued or payable to Laurus Funds. As part of the transaction, Laurus Funds also received a seven-year warrant to purchase 1,100,000 shares of the Company, exercisable at $0.30.

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Common shares issuable to Laurus Funds subject to Note conversion and issuable upon exercise of the warrant were registered for resale with the Securities and Exchange Commission pursuant to the terms of a registration rights agreement.

Payment of all principal and interest under the Note, as well as performance of the obligations of the Company and its subsidiaries, under all of the ancillary agreements entered into by the Company and its subsidiaries in connection with the sale of the note and warrant, are secured by a security interest in favor of Laurus Funds in all of the assets of both the Company and its subsidiaries.

The Company paid a closing fee equal to $58,500 to the manager of Laurus Funds and paid $29,500 as reimbursement for the investor's legal and due diligence expenses.

During the third quarter Laurus Funds converted a portion of the Note totaling $107,000 to common stock. The Company issued 428,942 shares of its common stock to Laurus Funds for this conversion. T he portions of the Note were converted to common stock of the Company at the option of the note holder . The number of shares issued in July and September were 212,747 and 216,195 common shares , respectively , at a fixed conversion of $0.25.

In November 2004 , an additional $50,000 payable under the Note w as converted to common stock of the Company at the option of the note holder .. The Company issued 200,000 shares of its common s tock at a fixed conversion of $0.25 to satisfy its November conversion .

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Note 2.

Accounting Policies

Stock Based Compensation

At September 30, 2004, the Company has four stock-based compensation plans, more fully described in the annual report on Form 10-K. The Company accounts for those plans under the recognition and measurement principals of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

(In thousands, except per share amounts)

Note 3.    Cash and cash equivalents

                Cash and cash equivalents consist of cash and $237,000 ( CAD $300,000) highly liquid investment in Guaranteed Investments Certificates ("GIC"), available for withdrawal by the Company upon request. The GIC has been pledged as security for a line of credit, of which approximately $131,000 has been drawn upon by the Company as of September 30, 2004.

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Note 4.

Inventories

Inventories consist of raw materials and finished goods held for sale, which are valued at the lower of cost (first-in, first-out method) or market. The following table summarizes the components of inventory as at September 30, 2004 and December 31, 2003:

(In thousands)

Note 5 .

Earnings P er Share

The Company follows Statement of Financial Accounting Standards No. 128, Earnings per Share ("FAS 128"). Under FAS 128, companies that are publicly held or have complex capital structures are required to present basic and diluted earnings per share ("EPS") on the face of the income statement. Basic EPS excludes dilution and is computed by dividing income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted and the resulting additional shares are dilutive because their inclusion decreases the amount of EPS. The following reconciles basic and diluted weighted average common shares outstanding for the three months and nine months ended September 30, 2004 and 2003.

Numerator

At September 30, 2004 and 2003, approximately 8,500,000 and 4,652,000 potential common shares respectively, are excluded from the determination of diluted net loss per share, as the effect of such shares is anti -dilutive.

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Note 6 .  Commitments and Contingencies

Miscellaneous Claims.  Various miscellaneous claims and suits arising in the ordinary course of business have been filed against the Company. In the opinion of management, none of these matters will have a material adverse effect on the results of operations or the financial position of the Company.

Other Matters.

 Lancer Management Group II, LLC, Lancer Offshore, Inc., LSPV LLC, and Omnifund Ltd. (the "Lancer Group") collectively have been a significant shareholder of the Company since the final quarter of 2002. On July 10, 2003, the Securities and Exchange Commission brought a civil action in the United States District Court for the Southern District of Florida against Michael Lauer and Lancer Management I and II alleging securities fraud in connection with portfolio transactions effected by the Lancer Group management. While the complaint does not allege any fraud in connection with the Company's securities, records produced by the SEC in the court proceeding indicate that Lancer management had either not reported the extent of its ownership in portfolio companies or had underreported the ownership. According to a Form 13D filed by the receiver to the Lancer Group on July 10, 2003, the Lancer Group, in the aggregate, controls 45.1% of the Company's outstanding shares as of that date. Even though no wrongdoing has been alleged in connection with the Lancer Group's ownership of Company securities, the Company, and the market for its shares may be adversely affected by any court findings or the negative publicity generated by the Lancer Group proceedings, or general market concerns about the possible actions by the receiver with respect to portfolio securities held by Lancer Group. In addition, on November 4, 2003 the receiver announced that he had appointed DDJ Capital to actively manage the Lancer portfolio securities.

        On October 20, 2003, Douglas Connolly, formerly President of Magic Lantern Communications, Ltd., (a subsidiary of the Company) and Wendy Connolly were terminated by the Company. Both the Company and the Connollys are in disagreement over the terms of their termination, however, the parties continue to communicate in regard to this disagreement. Wendy Connolly subsequently filed an action against the Company claiming damages in the amount of $250,000 for wrongful dismissal. On February 3, 2004, counsel to Wendy Connolly was formally served with a Statement of Defense and Counterclaim by the Company. The Statement of Defense and Counterclaim adds Doug Connolly as a defendant in the counterclaim. The counterclaim seeks damages against both Wendy and Doug Connolly in the aggregate amount of $500,000, an accounting to determine profits made by the Connollys in relation to the breach of their fiduciary duties, a permanent and interlocutory injunction restraining the Connollys from soliciting clients and utilizing confidential information, punitive damages in the amount of $1,000,000 plus interest and costs. The Company believes that claims made by Wendy Connolly are without merit.

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Note 7 .  Business Combinations

On November 7, 2002, following approval by the Company's shareholders, the Company and Zi Corporation (NASDQ: ZICA; TSE: ZIC), ("Zi"), concluded a Share Purchase Agreement, resulting in the Company's purchase of the Lantern Group. The transaction also resulted in a change to the Company's corporate name to Magic Lantern Group, Inc. and a related change in the AMEX trading symbol for its common stock to "GML," effective November  7 , 2002.

The Company has accounted for its acquisition of the Lantern Group under the purchase method of accounting. The consideration for the Lantern Group was 29,750,000 common shares of the Company, representing 45% of its common shares outstanding after giving effect to the transaction. Shares issued were valued at $.31 per share when the terms of the transaction were established in a letter of intent between the parties. In addition, the Company issued a promissory note in the amount of $3,000,000, bearing interest at 5% per annum; and incurred acquisition costs of approximately $141,000. The Share Purchase Agreement provides for a performance based consideration adjustment to the purchase consideration.

The Share Purchase Agreement also provides for a reduction in the purchase price if the Company's revenues during the performance period are less than $5 million. In that event, the Company will be entitled to offset the amount of the shortfall, up to $1 million, against the principal amount of the Note.

Magic Lantern's revenues during the performance period were less than $5 million, therefore no additional consideration will be paid to Zi and accordingly, the Note was reduced by $1 million, effective November 7, 2003. The reduction of the Note also resulted in a goodwill adjustment for the year ended December 31, 2003 in the amount of $1 million.

Note 8 .  Segment Information

The Company is involved exclusively in the marketing and distribution of educational and media resources throughout Canada through its education and distribution segment. Accordingly the results for the periods ended September 30, 2004 and 2003 are entirely derived from this segment.

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Note 9 .   Intangible Assets

Intangible assets consist of the following:

(In thousands)

Distribution agreements are being amortized on a straight-line basis over six years. Amortization expense on distribution agreements for the three and nine months ended September 30, 2004 was approximately $149,000 and $444,000, respectively ($164,000 and $448,000, three and nine months ended September 30, 2003). Amortization of software technology commenced in August 2004. The software is amortized on a straight-line basis over three years. Amortization expense on software technology for the three and nine months ended September 30, 2004 is $52,000.

Note 10 .  Stock-Based Compensation

Under FASB Interpretation No, 44, Accounting for Certain Transactions Including Stock Compensation (An interpretation of APB No.25), the Company's replacement options which were issued upon the Company's transaction with Magic Lantern Communication, Inc., and which are described in the Company's current proxy statement must be valued on a quarterly basis, and the compensation cost must be recognized and adjusted quarterly for vested options or ratably over the vesting period for unvested options. Replacement Options covering a total of 1,762,000 shares of the Company's common stock were fully vested on issuance and are exercisable at prices ranging from $.30 to $.50 per share.  On September 30, 2004, the closing price of the Company's common stock on the AMEX was $0.74 per share. The decrease in market price from the end of the prior quarter resulted in income adjustments of $335,000 and $441,000 for the three and nine months , respectively, ended September 30, 2004. As long as the Replacement Options remain outstanding, the compensation adjustments remain subject to ongoing quarterly adjustments based on changes in the market price of the Company's common stock.

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Note 11. Promissory Notes Payable

During the period ended September 30, 2004, the Company reached agreement with the holders of certain promissory notes payable (the "Notes") to extend the approximately $1,120,000 of Notes maturing during the month. The holders of the Notes have agreed to extend the Notes for three months, maturing in December 2004. In consideration, the Notes will earn 2% per month payable in arrears compounded monthly. Attached to the Notes are 400,000 warrants (the "Warrants"), exercisable for a period of five years at an exercise price of $0.25. $196,802 was allocated to the Warrants, based on their estimated fair value, as determined using the Black-Scholes model, using a volatility of 200.90%, a risk-free interest rate of 2.28%, an expected useful life of five years, and expected dividend yield of zero percent. Approximately $66,000 has been amortized in the period ending September 30, 2004 representing the interest accreted on the promissory note payable extended.

 During the period ended September 30, 2003, the Company raised approximately $998,000 on issuance of promissory notes (the "Notes") and is obligated to repay approximately $1,120,000 at maturity. The Notes are due within one year of issuance, unless extended, at the option of the holder, for a further 18 months. Of the $1.1 million, $370,000 of the notes is denominated in Canadian dollars (CAD$500,000), the remaining $750,000 in USD. As security for the Notes, Zi Corporation, a major shareholder has agreed to place in escrow six million common shares. Attached to the Notes are 1,250,000 warrants (the "Warrants"), exercisable for a period of three years at an exercise price of $.25. Of the proceeds received, $658,000 was allocated to Warrants, based on their estimated fair value, as determined using the Black-Scholes model, using a volatility of 46.30%, a risk-free interest rate of 2.28%, an expected useful life of three years, and expected dividend yield of zero percent. Notes payable were recorded at $370,000, representing a discount to the maturity value of $1,120,000. This resulted in an effective interest rate on the Notes payable of 95% and 175% (on the USD and Canadian Dollar denominated portions, respectively). Approximately $711,000 has been amortized in the period ending September 30, 2004 representing the interest accreted on the promissory notes payable.

Note 12 Subsequent Events

On November 1, 2004, t he Company formed a wholly-owned subsidiary, DigiTron Ltd., to independently create and produce original TV broadcast programs. DigiTron will initially focus on producing an educational and entertainment-oriented science series for broadcast television, hosted by well-known celebrities. The Company plans to independently fund DigiTron ' s business plan and aggressively seek to capitalize on migrating from a pure distributor of other producers content to capturing those royalties it currently pays, and improve its gross margins as other distributors contract for DigiTron ' s programs.

In November 2004 payments under the Note were converted to common stock of the Company at the option of Laurus Funds. The Company issued 200,000 shares of its common s tock at a fixed conversion of $0.25 to satisfy its conversion obligations .

On November 8, 2004, the Company increased the number of Directors to eight and elected H. Donald Hyde to the Board of Directors and Mr. Hyde was appointed to the Audit Committee of the Board of Directors. As filed November 12, 2004.

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 Item 2

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

Founded in 1975, the Company is a Canadian distributor of educational and learning content in video and other electronic formats (collectively, the "Education and Distribution" segment). Magic Lantern has primarily exclusive distribution rights to over 300 film producers representing over 12,000 titles, and its customers include 9,000 out of 12,000 English speaking schools in Canada. Its library includes content from numerous producers, including: Disney Educational Productions, Annenberg / CPB and CTV Television. Tutorbuddy Inc., a 100% owned subsidiary of Magic Lantern, is an Internet-enabled provider of content and related educational services on demand to students, teachers and parents. Sonoptic Technologies Inc., a 75% owned subsidiary of Magic Lantern (the Minister of Business New Brunswick formerly, Provincial Holdings Ltd. is the 25% shareholder) provides digital video encoding services and has developed proprietary VideoBase™ registered indexing software that allows users to aggregate, bookmark, re-sort and add their own comment boxes to existing content. The Company has a 100% wholly owned subsidiary, Magic Vision Digital Media Inc. that represents it diversification of operations into non-educational digital content delivery. The Company formed a 100% wholly-owned subsidiary DigiTron Ltd. to independently create and produce original TV broadcast programs. Magic Lantern is headquartered in Oakville Ontario, near Toronto, Canada with other offices in Saint John, New Brunswick and Vancouver, British Columbia, New York City, and Greater Boston, MA.

        Magic Lantern was acquired in October 1996 by NTN Interactive Network Inc. ("NTN"). In March 2002, members of Magic Lantern's management formed MagicVision Media Inc. ("MagicVision") to acquire 100% of Magic Lantern's capital stock from NTN and contemporaneously sold their interests to Zi Corporation ("Zi") for $1,359,000 (including transaction costs) plus 100,000 common shares of Zi valued at $499,000.

        On August 2, 2002, the Company entered into a stock purchase agreement (the "Purchase Agreement") with Zi, for the Company's purchase of Magic Lantern Communications Ltd. ("MLC") and its subsidiaries (collectively, " Magic Lantern").

        On November 7, 2002, the Company and Zi consummated the transactions contemplated by the Purchase Agreement (the "Magic Lantern Transactions") following their approval by the Company's shareholders. The Company's acquisition of Magic Lantern was implemented through its purchase from Zi of all the outstanding capital stock of MagicVision, in consideration for a three-year promissory note of the Company in the principal amount of $3,000,000 and 29,750,000 shares of the Company's common stock, representing 45% of its common shares outstanding after the closing. The Purchase Agreement provides for additional stock and cash consideration up to $2,930,000 or offsets against the Company's promissory note up to $1 million based on Magic Lantern's operating results for the first twelve months after the closing. See "Liquidity and Capital Resources - Liquidity." As part of the Magic Lantern Transactions, the Company added three designees of Zi to its board of directors, implemented a new stock option plan primarily for management and employees of Magic Lantern, changed its corporate name to Magic Lantern Group, Inc. and, effective November 8, 2002, changed its AMEX trading symbol to "GML." 

        The Company accounted for its acquisition of Magic Lantern under the purchase method. The purchase price for the acquired businesses was allocated among their assets and liabilities as of the closing date. For this purpose, the 29,750,000 shares of the Company's common stock issued to Zi as part of the purchase price for the acquired businesses were valued based on their market price in June 2002 when the terms of the Magic Lantern Transactions were established in a letter of intent between the parties. Based on the market price of $.31 per share for the Company's common stock at that time, the total purchase price and related transactions costs without regard to any adjustments for post-acquisition operating results aggregated approximately $12,363,000, of which approximately $6,868,000 has been allocated to goodwill, approximately $4,492,000 to intangible assets, and approximately $1,128,000 to property and equipment.          

.

On May 3, 2004, the Company closed the private placement of a $1,500,000 principal secured convertible three-year term note with the Laurus Master Fund, Ltd. as described herein.  

During the period ended September 30, 2004, the Company reached agreement with the holders of certain promissory notes payable to extend the approximately $1,120,000 of such notes payable maturing during the month. The holders of these notes have agreed to extend the maturity date for three months, to mature in December 2004. ( See note 11 for terms on extension of notes payable)

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   Risks Associated with the Magic Lantern Acquisition. Magic Lantern has a history of losses and may continue to incur losses from operations after its acquisition by the Company. For its last three fiscal years ending December 31, Magic Lantern incurred net losses aggregating $8.1 million.  The Company's ability to achieve profitable operations through ownership of Magic Lantern could be adversely affected by a number of business risks, including delays or inefficiencies in the development cycle for Magic Lantern's new products and services, lack of sponsor or consumer acceptance of those products and services, inability to penetrate new geographic markets, competition and changing technology.

Risks Associated with Lancer's Ownership of Company Shares.  Lancer Management Group II, LLC, Lancer Offshore, Inc., LSPV LLC, and Omnifund Ltd. (the "Lancer Group") have been collectively a significant shareholder of the Company since the final quarter of 2002. On July 10, 2003, the Securities and Exchange Commission brought a civil action in the United States District Court for the Southern District of Florida against Michael Lauer and Lancer Management I and II alleging securities fraud in connection with portfolio transactions effected by the Lancer Group management. While the complaint does not allege any fraud in connection with the Company's securities, records produced by the SEC in the court proceeding indicate that Lancer management had either not reported the extent of its ownership in portfolio companies or had underreported the ownership. According to a Form 13D filed by the receiver to the Lancer Group on July 10, 2003, the Lancer Group, in the aggregate, controls 45.1% of the Company's outstanding shares as of that date. Even though no wrongdoing has been alleged in connection with the Lancer Group's ownership of Company securities, the Company, the financial statement impact, if any, and the market for its shares may be adversely affected by any court findings or the negative publicity generated by the Lancer Group proceedings or general market concerns about the possible actions by the receiver with respect to portfolio securities held by Lancer Group. In addition, on November 4, 2003 the receiver announced that he had appointed DDJ Capital to actively manage the Lancer Group portfolio securities.

Stock-Based Compensation. Although the Company follows APB Opinion 25, Accounting for Stock Issued to Employees, and has elected to account for options issued under employee stock option plans based on the disclosure only alternative provided in SFAS 123 as amended by SFAS 148, the disclosure only alternative is not an available accounting method for the Replacement Options. Under SFAS 123, the Replacement Options must be valued on a quarterly basis, and the compensation cost must be recognized and adjusted quarterly for vested options or ratably over the vesting period for unvested options. Replacement Options covering a total of 1,762,000 shares of the Company's common stock were fully vested on issuance and are exercisable at prices ranging from $.30 to $.50 per share. Based on the AMEX closing price of $.99 per share for the common stock on December 31, 2003, the Company recorded compensation adjustment of $1,091,000 for the year ended 2003, reflecting the difference between the aggregate exercise price of the Replacement Options and the market price of the underlying shares. On September 30, 2004, the closing price of the Company's common stock on the AMEX was $0.74 per share. The decrease in market price from the end of the prior quarter resulted in an income adjustment of $335,000 and $441,000, for the three and nine months, respectively, ended September 30, 2004, adjusting the previously recorded compensation adjustment in 2003. As long as the Replacement Options remain outstanding, the compensation adjustments remain subject to ongoing quarterly adjustments based on changes in the market price of the Company's common stock.

We Have Incurred Net Losses To Date And Depend On Outside Capital. Our accumulated deficit as of September 30, 2004 was $17,230,000. We will need to continue to distribute educational and learning content in video and other electronic formats and have diversified into non-educational digital content delivery and to independently create and produce original TV broadcast programs that, together with projected general and administrative expenses, we expect will result in substantial operating losses for the next year.

Changes in Laws, Regulations And Financial Accounting Standards May Affect Our Reported Results Of Operations. The Sarbanes-Oxley Act of 2002 and related regulations, including rule changes adopted by stock exchanges in connection with such legislation, may result in changes in accounting standards or accepted practices within our industry and could add significant new costs to being a public company. New laws, regulations and accounting standards, as well as potential changes to currently accepted accounting practices, including the expensing of stock options, could adversely affect our reported financial results and negatively affect our stock price. Additional unanticipated expenses incurred to comply with new requirements could also negatively impact our results of operations.

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                We Depend on Key Individuals to Develop Our Products And Pursue Collaborations. We are highly dependent on our Chief Executive Officer and Chief Technology Officer. The loss of any of these persons, or failure to attract or retain other key personnel, could prevent us from pursuing collaborations or developing our products and core technologies. The execution of our business plan for expanding our trademark licensing and operations will be severely hampered unless we are able to attract and retain highly skilled technical, managerial and marketing personnel for that purpose. Current compensation and benefit levels could contribute to the loss or reduced productivity of personnel and impair our ability to attract new personnel, either of which could have a material adverse affect on our operations and financial prospects. In addition, our operations require specific skills for digital encoding of analog video and indexing and managing digital video content. Specialized training must take place in the workplace, requiring an ongoing investment to effectively integrate new employees and assist existing staff attain the most up-to-date skills. Because demand for these skills is high in this competitive environment, the Company risks losing staff and its investment in developing their skills to larger firms with greater resources.

                Two Principal Shareholders Own Enough Shares To Control The Company. Because the Lancer Group and Zi Corporation collectively own 92.7% of our Common Stock outstanding, our other stockholders have no control over matters submitted for stockholder approval. Most matters submitted to a vote of our stockholders will require affirmative vote by holders of a majority of the votes cast, or a majority of the outstanding common stock in the case of a business combination or charter amendment and a plurality of the votes cast for each nominee for membership on our board of directors. Accordingly, our current stockholders other than Lancer Group and Zi Corporation will be unable to control the outcome of any proposed merger or other extraordinary transaction, the election of any board members or any other aspects of corporate governance, and the voting power to determine these matters will be shared by Zi and Lancer Group so long as they continue to hold a substantial portion of their Shares

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Results of Operations

                Quarters ended September 30, 2004 and 2003. Net sales were $619,000 for the quarter ended September 30, 2004 (the "2004 Period), compared to $655,000 for the quarter ended September 30, 2003 (the "2003 Period").    The 5% reduction in net sales primarily reflects an elimination of the Company's British Columbia based dubbing operations ("Dubbing West") which were sold in November 2003. Sales gains in other operations did not make up the loss of Dubbing West sales 147,000 in the 2003 Period , and the operating costs associated with its operations were elimi n ated .