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 under the Securities Exchange Act of 1934 is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated in Part III of this Form 10-K or any amendments to this Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.).

As of December 31, 2004, there were 73,604,289 shares of Common Stock outstanding, and the aggregate market value of shares held by unaffiliated shareholders was approximately $21,345,244.

DOCUMENTS INCORPORATED BY REFERENCE

MAGIC LANTERN GROUP, INC. (formerly JKC Group, Inc. and Stage II Apparel Corp.)

PART I

Item 1. Business

Introduction

                Founded in 1975, Magic Lantern 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 13,000 titles, and its customers include over 9,000 out of 12,000 English speaking schools in Canada. Its library includes content from numerous producers, including Disney Educational, 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, provides digital video encoding services and has developed a proprietary VideoBase^TM in dexing software that allows users to aggregate, bookmark, re-sort and add their own comment boxes to existing content. Magic Lantern Group is headquartered in Oakville, Ontario near Toronto, Canada with additional offices in Saint John, New Brunswick and Vancouver, British Columbia, New York City and Greater Boston.

Recent Business Events

The Company has, since its inception as Magic Lantern Group, Inc. in Nov., 2002 faced the daunting task of being undercapitalized to position itself for future growth and to manage the ever escalating costs associated with now being a publicly reporting company in the wake of mandates put forth in the Sarbanes-Oxley Act of 2002.  Professional fees in the form on legal and audit have increased tremendously and many micro-cap companies have been considering the merits of being a pubic company vis-à-vis a private company.  The Board of Directors of the Company, seeing the ever increasing impact of this has for some time discussed the merits of de-listing and returning to the status of a private company.  As most recently at Board meetings held in March and April this was discussed and tabled for future consideration.  Given the Company's history of losses and now the recording of the recently performed independe nt valuation of goodwill and intangibles has resulted in an impairment charge to Goodwill.  That charge and its impact will need to be addressed immediately to stay above certain guidelines established by the AMEX for listed companies.  The Board of Directors will give immediate attention to this matter.

In April of 2004, the Company entered into a Convertible Promissory Note in the face amount of $1.5 million with the Laurus Master Funds, based in New York.  The fixed conversion price of $0.25 per share has predominately, since the onset of the funding ,been priced beneath current market prices and "Laurus" has chosen to exercise their right as contained in the closing documents to convert the principal and/or interest into shares registered under an S3 Registration Statement that was also a condition of the funding.  In December of 2004 a substantial pay down on that note occurred, amounting to approx. $900,000.  Based on Generally Accepted Accounting Principals (GAAP), the Company was required to take a one-time charge of $4,917,000 in interest expense for underlying shares and warrants, most of which due to the pay down will never be exercised.  This charge, and the impairment charge noted in the previous paragraph account f or the majority of the Company's Net Loss for 2004.

At a meeting of the Board of Directors, held April 14, 2005 (see subsequent events footnote) of one of the Company's two largest shareholders, ZI Corporation, a proposal was put forth to extend to the Company a bridge loan in the form of a demand note bearing interest in the amount of 12% per annum in the amount of $250,000 in consideration for securitizing the $2 million Note Payable on the Company's books.  Further consideration consists of extending the maturity date of the note to January 2, 2006 and deferring all accrued interest on the note to the new maturity date.  The Board of Directors of Magic Lantern Group, Inc. is expected to meet in the coming week to consider this proposal.

During 2004, working closely with the Agency for Instructional Technology ("AIT") the collective group responded to five (5) Request for Proposals from U.S. State Educational School Boards.  To date, the group has not been successful in competing for these contracts, with the exception of California when the results of their decision are not yet known.

                The Agency for Instructional Technology ("AIT") has been a U.S. leader in educational technology since 1962. A non-profit organization, AIT is one of the largest providers of instructional TV programs in North America and a leading developer of educational media, including online instruction, CDs, DVDs and instructional software. AIT learning resources are used on six continents and reach nearly 34 million students in North America each year. AIT products have received many national and international honors, including an Emmy and Peabody award.

                Magic Lantern and AIT have partnered to build and sell a private-labeled version of Magic Lantern's Internet-based platform InSite^TM, branded as The Learning Source ("TLS"). TLS will be marketed to instructional television stations, including more than 120 PBS stations, as well as school districts across the United States. The ultimate target is to provide user-friendly online resources to the approximately 53 million K-12 students currently enrolled in U.S. schools. TLS marks Magic Lantern Group's first third-generation, video library streaming product marketed in the United States.

                The Learning Source is an online library of learning video for K-12 educators, streamed via the Internet. The library offers more than 400 programs, indexed, searchable by keyword, and correlated to state curriculum standards. TLS makes lesson planning easier; teachers can search, play and bookmark their favorite clips for later use in their classroom. Teachers may also access online lesson plans and assessment tools created by the experienced educators at AIT.

                The launch of The Learning Source is part of Magic Lantern's aggressive expansion strategy to create a revenue-generating market presence in the United States. By offering third generation, video streaming digital services to increase revenues from educational digitized videos in the United States, a market segment carrying the potential to generate future earnings for the Company has been tapped.  To date, the Company and AIT along with another partner, Callisto have presented to five U.S. state educational boards.  Thus far, the Company has yet to secure a contract on any of these efforts.  Competition from Discovery Learning in the U.S. (who acquired the two major competitors of the Company during the past 18 months) has made success difficult as the bidding of Discovery has undermined the Company's bid's to the best of its knowledge.

                In November 2003, Magic Lantern completed final arrangements for the sale of Image Media, its Vancouver-based videotape duplication facility. The operation was sold to make way for increased investment in online service development. Gross proceeds to the Company were approximately $145,000.  The purchase of Image Media was made by BKR Productions, Inc., a British Columbia Corporation formed for holding purposes by the former manager of Image Media. Transfer of ownership and operations occurred effective January 1, 2004. Included in the sale were all installed technologies, customer lists, promotional materials and existing contracts.

                Magic Lantern operates a tape duplication facility in connection with its head office operations. The sale of Image Media, therefore has permitted Magic Lantern to reduce operational redundancies and apply capital realized from the purchase to immediate expansion targets, principally the creation of new revenue lines through roll-out and expansion of current and future online offerings which to date have been difficult to gain both in Canada and the U.S..

On January 4, 2005, the Company entered into a Subscription Agreement (the "Subscription Agreement") with Nite Capital, L.P., providing for, among other things, the unregistered sale, through a private placement, of 1,000,000 shares of common stock (the "Shares"), $0.01 par value per share (the "Common Stock") at a price of $0.30 per share, and a common stock purchase warrant to purchase an additional 500,000 shares of Common Stock exercisable at a price of $0.40 per share, subject to customary adjustments, until the fifth anniversary of January 4, 2005.  The Company also entered into a Registration Rights Agreement.  

In connection with the private placement, the Company was obliged to pay a cash fee to the placement agent, First Montauk Securities Corp. ("First Montauk"), for its services on its behalf.  In addition, the Company issued First Montauk and its assignees, common stock purchase warrants to purchase an aggregate of 100,000 shares of Common Stock, exercisable at $0.40 per share, subject to customary adjustments, until the fifth anniversary of January 4, 2005.

The Shares and the common stock purchase warrants were issued to private investors in transactions that were exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"), and/or Regulation D promulgated under the Securities Act.   

On December 30, 2004, the Company, through the private placement of equity securities, consummated the unregistered sale of 800,000 shares of common stock (the "Shares"), $0.01 par value per share (the "Common Stock"), and common stock purchase warrants to purchase an additional 800,000 shares of Common Stock (the "Warrants") to certain accredited investors.  The Shares and the Warrants were issued to private investors in transactions that were exempt from registration pursuant to Section 4(2) of the Securities Act of 1933 (the "Securities Act") and/or Regulation D promulgated under the Securities Act.  

As a result of the transactions, three term promissory note holders of the Company converted an aggregate of $200,000 of principal into 800,000 shares of Common Stock at a rate of $0.25 per share and received three-year Warrants to purchase 800,000 shares of Common Stock at an exercise price of $0.40 per share.

During December, 2004, the Company, through the private placement of equity securities, consummated the unregistered sale of 4,010,649 shares of common stock (the "Shares"), $0.01 par value per share (the "Common Stock"), and common stock purchase warrants to purchase an additional 4,010, 649 shares of Common Stock (the "Warrants") to certain accredited investors.  The Shares and the Warrants were issued to private investors in transactions that were exempt from registration pursuant to Section 4(2) of the Securities Act of 1933 (the "Securities Act") and/or Regulation D promulgated under the Securities Act.

As a result of the transactions, two term promissory note holders of the Company converted an aggregate of $750,000 of principal and $2,662 of accrued interest into 3,010,649 shares of Common Stock at a rate of $0.25 per share and received three year Warrants to purchase 3,010,649 shares of Common Stock at an exercise price of $0.40 per share.  In addition, the Company issued 1,000,000 Shares to an additional investor at a price of $0.25 per share, for gross proceeds of $250,000, along with three year Warrants to purchase 1,000,000 shares of Common Stock at an exercise price of $0.40 per share.   

On May 3, 2004, Magic Lantern Group, Inc. (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 the Company, exercisable at $0.30.

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 the 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 year Laurus Master Funds converted a portion of the Note totaling $250,000 to common stock. The Company issued 1,124,211 shares of its common stock to Laurus Funds for this conversion of debt and interest. The 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 the third quarter and fourth quarter were 428,942 and 695,269 common shares respectively, at a fixed conversion price of $0.25.

In January 2005, an additional $6,193 payable under the Note was converted to common stock of the Company at the option of the note holder. The Company issued 24,770 shares of its common stock at a fixed conversion of $0.25 to satisfy its January conversion.

In April 2005, an additional $18,750 payable under the Note was converted to common stock of the Company at the option of the note holder. The Company issued 75,000 shares of its common stock at a fixed conversion  of $0.25 to satisfy its April conversion.

 During the year ended December 31, 2003, the Company raised approximately $1,198,000 on issuance of promissory notes (the "Notes") and is obligated to repay approximately $1,337,000 on 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 $1.3 million, $387,000 of the notes are denominated in Canadian dollars, with the remaining $950,000 denominated in USD. Attached to the Notes are 1,450,000 warrants (the "Warrants"), exercisable for a period of three years at an exercise price of $.25.

                On September 25, 2003, the Company launched Tutorbuddy in both the U.S. and Canada. Tutorbuddy^TM is a revolutionary, state-of-the-art, e-learning system designed to deliver searchable, curriculum-correlated, digital video programs and learning objects online. Tutorbuddy^TM, is designed for home use by students and parents. The Company planned on targeting the U.S. market in the latest fiscal year but due to lack of adequate capital and a distribution network failed to meet the Company's goal.  The Company had also launched and received encouraging response to the Company's institutional product, Magic Lantern InSite™. On October 24, 2003, the Company announced that Red Deer Public Schools, the ninth largest school district in the province of Alberta, Canada, agreed to deploy Magic Lantern InSite^TM, the Company's latest e- learning video service for schools. InSite will be distributed to nearly 10,000 students enrolled in Red Deer Public's 21 elementary and secondary schools. As broadband infrastructure to schools and homes continues to swell, the Company continues to be challenged by capital constrictions to position itself to meet the demand for quality online educational content.  The Company determined that the technical feasibility of the product occurred in September, 2004 and commenced amortization.

 Formation of the "Company"

              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 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 Corporation, a Canadian-based provider of intelligent interface solutions ("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 (the then private parent company), 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 &quo t;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." After consummation of the Magic Lantern transactions, Alpha Omega Group ("AOG") held in record name approximately 47% of the Company's outstanding shares.

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                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 receiver to the Lancer Group o n 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 Lancer'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 proceedings or general market concerns about the possible actions by the receiver with respect to portfolio securities held by Lancer.

In addition, on November 4, 2003 the receiver announced that he had appointed DDJ Capital to actively manage the Lancer portfolio securities.

                Magic Lantern Group, Inc., formerly JKC Group, Inc., and previously Stage II Apparel Corp. (the "Company"), was engaged for over 20 years primarily as a distributor of proprietary and licensed brand name casual apparel, active wear and collection sportswear for men and boys. In response to a decline in its apparel distribution operations, the Company elected to contract those operations to third parties during the last two years as part of a strategy of reducing the costs and inventory risks associated with its historical core business and repositioning the Company through one or more acquisitions. To facilitate the change in strategic direction, in March 2002 the Company obtained $1,500,000 in financing from an entity, Alpha Omega Group ("AOG").

Following the completion of the AOG transaction, and facing continued decline in its apparel business, the Company continued to pursue its business redirection by exploring potential acquisition opportunities, with a view toward expanding existing licensing operations or adding compatible business lines, culminating in the acquisition of Magic Lantern. As part of the transaction to acquire Magic Lantern, the Company (i) added three designees of Zi Corporation, the vendor of Magic Lantern, to it's board of directors, (ii) implemented a new stock option plan primarily for management and employees of Magic Lantern, (iii) changed the Company's corporate name to Magic Lantern Group, Inc., and (iv) effective November 8, 2002, changed the AMEX trading symbol to GML.  Zi Corporation currently owns 45% of the outstanding common stock of the Company.

Products

General

                Our product focus following the transaction with Magic Lantern became the sales and distribution of educational and learning content in video, DVD and other electronic formats. As a result of this transaction we acquired distribution rights to over 300 film producers representing over 12,000 titles, and customer relationships at 9,000 out of 12,000 English speaking schools in Canada. Our library includes content from numerous producers, including: Disney Educational Productions, Annenberg / CPB and CTV Television. In addition, Tutorbuddy^TM is an Internet-enabled provider of content and related educational services on demand to students, teachers and parents. Sonoptic provides digital video encoding services and has developed the proprietary VideoBase^TM indexing software that allows users to aggregate, bookmark, re-sort and add their own comme nt boxes to existing content.

                Magic Lantern Group, Inc. ('Magic Lantern") has grown to be a source in Canada for educational video resources, educational television series, program repurposing and digital delivery. By 1994, Magic Lantern had developed a catalogue of more than 10,000 video titles covering all subject areas from pre-school through high school, post-secondary and general interest, with exclusive distribution agreements with more than 200 producers and suppliers. With over 9,000 of 12,000 Canadian schools among Magic Lantern's customer base, attention was focused on growth opportunities within the education sector. At this time, digital technologies were having an impact on video delivery methods with the continuing expansion of Broadband delivery methods along with compression technology increasing capacity of satellites and fiber-optic cable providing telephone companies wi th an opportunity to carry more than traditional voice and data. To address this ever changing technology landscape, Magic Lantern responded by creating Sonoptic Technologies, Inc, in cooperation with the Government of New Brunswick as a 25 per cent minority partner, to develop an expertise and service offering in the field of analog to digital conversion, and subsequent applications for this new digital form of video programs. Sonoptic began encoding the Magic Lantern library of educational video content and now has some 2,000+ programs that have been digitized, indexed and curriculum correlated for three provinces in Canada and all 50 states in the U.S. as part of our partnership with AIT.

                As part of our continuing "organic" growth strategy, we will require additional capital resources or partnerships, mergers or seek out entities who wish to acquire the Company  to complete the digital encoding of the Magic Lantern library as well as fund the further development of software capable of managing video delivered over the Internet. Magic Lantern acquired additional content through its acquisition of Image Media in 1998 (subsequently sold in 2003 as mentioned above), and has been attempting to expand its revenue base by utilizing its distribution channels for new products and services. Innovative programs for schools, such as its lease-to-own library program were launched (with the recommendation of the Canadian Principals Association), and the Campbell Soup Company's "Labels for Education." The debut of "Labels for Educa tion" was managed, marketed and delivered by Magic Lantern with over 3,500 Canadian schools taking part within the first six months of the program. That program has now expanded to serve nearly 7,500 schools since its launch in 1996.  Sonoptic Technologies now manages the website and certain administrative responsibilities that provide approximately $180,000 in revenue during the year ended 2004.

                Tutorbuddy^TM builds on the research & development of Sonoptic, and has developed an on-line educational video library with an extensive information search capability and content management system. Tutorbuddy^TM is branded and had been offered to Canadian schools with the ultimate market being the homes of school-age children, some five million in Canada, when the service has proven effective in Canadian schools. Concurrent with providing the Tutorbuddy^TM innovation in the current core market of Canada where certain levels of "social responsibility" have made it very difficult to penetrate the Canadian market where any form of commercialization is frowned upon in that country.  However, with the proper partner and capital resources Tutorbuddy could establish itself in the United States and other English speaking countries where buying and adoption patterns are dramatically different.

Product Mix.

Following the Company's acquisition of Magic Lantern our product mix is comprised of video sales, video dubbing, and video encoding. Video sales accounted for approximately 82%, 66% and  61% of Magic Lantern's net sales in 2004, 2003 and 2002, respectively.   Video dubbing accounted for approximately 1%, 22% and 25% of Magic Lantern's net sales in 2004, 2003 and  2002, respectively. Video encoding accounted for approximately 12%, 5% and 6% of Magic Lantern's net sales in 2004, 2003 and  2002, respectively. Sales made by the Magic Lantern Group following the company's November 7, 2002 acquisition of the group accounted for 95% of the company's sales in 2002 (stub-period)

 Marketing Strategy.

 The Company's traditional marketing strategy is focused on providing curriculum relevant content to educators through targeted advertising, faxing, and direct mailings principally to schools and school boards, public libraries, family resource centers, and other customers in Canada and the United States. The Company has adopted a marketing strategy to concentrate resources towards expanding the geographic and market reach of Magic Lantern's historic business.  As previously stated, adequate sources of capital resources mandated a nominal marketing to expand revenue as planned.

                Our market plan for growth in the Canadian market has involved multiple initiatives including: i) contracting with a Business Development professional to focus on the Province of Ontario, the most populous of any of the Canadian Provinces.  ii) entering into a province-wide paying pilot for InSite use in selected Ontario and British Columbia school districts, which was the first medium-scale commitment to online video services in Canadian education; and iii) launching of InSite (http://www.magiclanterninsite.com) based on innovative per-teacher and per-student  pricing which to date has not established significant traction in the Canadian provinces targeted thus so far.  Marketing probes during 2004 indicated the desire of educational sites preference towards having the physical video server located within the school's intranet and behind the ir own firewalls such that the students are protected from inappropriate and unprotected access to the Internet on an unfettered basis.

Business Development USA

            Leveraging the financial base of operations already established in Canada, the Company believes its only meaningful future growth lies in the United States and Southeast Asia to lesser degree. The spearhead of the Company's US strategy in 2004 was to introduce InSite into the United States reconfigured for US school markets as "The Learning Source" through the Bloomington Indiana-based Agency for Instructional Technology ("AIT"). "The Learning Source" is currently being offered to long-time PBS station customers of AIT for use with affiliated school districts. One illustration would be Las Vegas, Nevada where the local PBS station integrates with Clark County School District, and is the fastest-growing district in the US. Other PBS station-School District areas in Los Angeles and West Virginia were presented to in response to their RFP.  In the case of West Virginia, Discovery Learning captured that contract by underbidding the Consortium .  The California proposal was most recently conducted and results are unknown.   More are expected to participate as demonstrations develop.

               With the presence of Discovery Learning and its vast financial resources, it will be extremely difficult for the Company to establish a US school market presence that should it be successful might enable the Company to expand product offerings to schools and homes. In essence, the website interface of InSite makes use of the same back-end web engine as Tutorbuddy for offering to homes and other businesses, particularly health and sports related verticals, as a safe, secure video resource on the Web. Sales strategy, in conjunction with a business combination of some nature,  will focus on online marketing based on tele-sales and live demo from the Web.

Go-to-Market USA

                Additional opportunities for growth in the U.S. will totally depend on a business combination that when concluded would include i) the sub-distribution of existing learning video titles for which the Company has exclusive US distribution rights; ii)Online e-commerce sale of titles in hard copy format (disk and tape) for which the Company has exclusive distribution rights (currently some 1000 titles) through acquired educational software sales forces employing direct mail, web sales and tele-sales to established client bases; iii) E-commerce links from online applications promoting sales of hard copy offerings, such as VHS, DVD or VCD copies, of programs being accessed as online video stream; iv) sale of user information to partners, allies and competitors; v) expanded sale of production services of Sonoptic video encoding, indexing and database provisioning to own ers of video collections allowing searchable streaming collections (e.g. to viewers of content-intensive websites such as sports television, self-help, home renovation and food/cooking websites as examples).

 Customers

 The Company's customers are primarily educational institutions, family resource centers, and public libraries in Canada. Magic Lantern's ten largest customers for the year ended December 31, 2004 accounted for approximately $774,000 of revenue as compared to $695,000 for the year ended December 31, 2003  and for the twelve months ended December 31, 2002, represented $775,000 of revenue, none of which individually accounted for more than 10% of sales.

.

Distribution

 Magic Lantern's distribution strategy is to acquire licensing rights for video productions produced by other companies and to return royalties as a percentage of gross receipts. The company maintains a library of over 12,000 master versions of the titles and creates VHS, DVD, CDR and VCD copies for sale in its duplication labs in Oakville, Ontario and Saint John, New Brunswick. These are packaged together with media bought directly from suppliers for whom we do not have masters in-house, and shipped to customers. The distribution of such products is governed by distribution agreements with suppliers and producers, many of which are, generally, exclusive as to territory.

 Imports and Import Restrictions

                Magic Lantern's products consist primarily of content delivered on videotape and other electronic media. Certain of the videotapes offered for sale in Canada are sourced in the United States. There are no tariffs or taxes involved in the import of these products from the United States.

Backlog

                The Company's backlog of orders totaled approximately $86,000 and $154,000 at December 31, 2004 and 2003, respectively.

Competition

                The content delivery industry is highly competitive and consists of a large number of suppliers, certain of whom are producers and others only distributors. Magic Lantern holds exclusive rights to distribution in Canada on approximately 33% of its titles. Of the exclusive titles distributed, approximately 58% include digital rights.  In the U.S. the Company has fewer rights than in Canada, but with its license agreement with AIT that list of titles has expanded greatly.  During 2003 and 2004, Discovery Learning U.S. acquired United Streaming Learning and AIM Learning, the Company's two most significant competitors.  The technology used by United Streaming was originally developed under exclusive contract with the Altschel Group (subsequently United Streaming) and that contract prohibits the use of Videobase™ technology except for content owned by the Atlschel Group.  The Company believes that, upon review of the contract still in force, that United Streaming and its parent company, Discovery Learning, U.S. are in breach of that contract and the Company intends to seeks remedial damages and recovery of licensing revenue under the terms of the contract.  The Company believes this breach to be material and recovery of revenues and possible damages to be significant.

                Competition stems from both traditional learning video content providers and digital learning content providers. Some of these competitors are multi-national and regional firms offering services, systems and platforms through established internet sites or proprietary networks. Many of these competitors, such as Discovery Learning U.S.  have substantially greater financial, technical, marketing and deployment resources than we do. Competitors particularly in markets outside Canada have the added advantage of offering a greater diversity of products and services with a substantial installed customer base. Our analysis of its competition within these two industries is set forth below.

 Traditional Learning Video Content Providers.    

Management believes the Company is currently one of the largest educational learning video providers to the Canadian education, library and special interest group markets. In management's opinion, Magic Lantern has attained this position as a result of several competitive factors, including its knowledge of the Canadian education system and the provincial Ministries of Education, brand recognition, supply-line relationships with worldwide educational video producers and leadership in creating course correlated matching for educators for over 30 years.

Traditional format competitors of the Company in Canada include:

Digital learning video content providers   

        The Company has agreements with many of its producers for its digitization, indexing and ultimately streaming of their analog content through the Company's web-enabled Tutorbuddy^TM or stand-alone media offerings. Management believes these services offer the following competitive advantages:

                Although management believes that competitors of Tutorbuddy^TM and VBSS currently lack a comparable range of services, various distributors now offer learning video content in streaming format, providing competition worldwide through Internet-enabled services. These competitors include:

Other streaming technologies and streaming packaging, although not directly competitive, are generally available through television on the Web, production and publication, event management, entertainment, expert systems linked to education, university and test environments and promotion and sales demonstrations.

Employees

                As of December 31, 2004, the Company had 43 salaried employees. Of the 43 employees, 6 provide executive and management services, and 37 provide clerical services. None of the Company's employees are party to a collective bargaining agreement. We consider our working relationships with employees to be good and have never experienced an interruption of operations due to a labor dispute.  On April 7, 2005 a 30% reduction in employees was implemented by the Company in it's continuing efforts to cut operating costs.

Recurring Losses

                We have a history of losses and may continue to incur losses from operations. Our net losses were $15,899,000 for the year ended December 31, 2004. These losses primarily reflect recording of implicit interest expense associated with the financing transactions that occurred during the year.  The underlying shares and warrants associated with these financings and debt conversions had a material impact on the net loss reflected. It its efforts to develop and compete in the "on-line" video streaming business, substantial spending reflected in selling, general and administrative ("SG&A") expenses have historically been in excess of gross profit levels since. Our business plan, combined with business combination would contemplate continued expansion efforts that will entail a reduction of SG&A  through cost savings procedures imple mented in 2004 and related expenditures into new territories, specifically the United States without any assurance of deriving profits from operations. Our ability to achieve profitable operations through operations of the Company is questionable without a business combination.

RISK FACTORS

Risks Associated with Lancer Group

                The Lancer Group has been a significant shareholder of the Company since the last 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 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 tha t date. Even though no wrongdoing has been alleged in connection with Lancer'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 proceedings or general market concerns about the possible actions by the receiver with respect to portfolio securities held by Lancer. In addition, on November 4, 2003 the receiver announced that he had appointed DDJ Capital to actively manage the Lancer portfolio securities.  Shares held by the receiver are restricted shares and not available for sale except under Rule 144 or private sale.

Risk of Inadequate Financial Resources

                The execution of our business plan for expanding our trademark licensing and e-education businesses will  be impaired by inadequate financial resources. Both Sonoptic's and Tutorbuddy's business in particular requires ongoing upgrades to components and facilities as new technologies emerge. To maintain leading-edge technical solutions for new media and to remain competitive, the Company requires significant capital expenditure on an ongoing basis. In the absence of additional equity or a substantial increases in our revenues in the short term our working capital will likely be expended before the end of May, 2005. In that event, the Board of Directors is investigating the implications of delisting from the American Stock Exchange and disgorged of the substantial costs associated with being a publicly reporting company.  Additional, as previously mentione d the Company is seeking out a partnership or business combination that would ensure its viability beyond May, 2005.   Therefore, we will be required to either limit future development and marketing activities or raise additional equity capital or incur more debt to continue financing those activities. The issuance of additional equity could be dilutive to existing stockholders, and the alternative of financing development through borrowings could reduce our operating flexibility and further weaken our consolidated financial condition.  As of April 21, 2005 the Company's cash position was $313,000 which, given the Company's debt obligations and accounts payable obligation would provide for continuing operations until June 30, 2005.

Risk of Customer Budget Reductions

                Our goal of maintaining our existing customer base and extending our e-education products and services to new markets will be hampered by cash constraints affecting both current and prospective customers. Educational video products are acquired mainly by libraries and schools in the Company's existing Canadian markets. These institutions represent approximately 90% of the Company's current customer base. They are funded by government and are therefore subject to reductions or re-allocation of funding, either of which will adversely affect our prospects for achieving the possibility of profitability through operations of the Company. Similar constraints could impair our efforts to expand the Company's customer base to new markets.

Uncertainties in Product and Market Expansion Plans

                Our recent planned reduction  of certain of the Company operations could be adversely affected by many of the technological, business and financial risks inherent in the commercialization of new products for markets in which we are not yet an established participant. The success of the Lantern Group's e-education offerings in these markets will depend not only on securing sponsorship or licensing arrangements with educational organizations outside of Canada, but also on additional partnerships and/or and business combination and the willingness of teachers, students and their parents in existing and new geographic markets to utilize these resources. We could encounter resistance to implementation of our e-education offerings and technology for any number of fiscal, cultural or political reasons beyond our control. These factors make the ultimate success of ou r plans for expanding the Lantern Group's offerings and markets highly uncertain.

Risk of Inadequate Marketing Resources

                The limited exposure of the Lantern Group to e-education markets outside Canada could impair our ability to penetrate those markets. In the absence of substantial market penetration, our operations may fail to generate sufficient sponsorship, licensing or subscription fees to attain profitability. While we are beginning to establish relationships with distributors and other intermediaries to facilitate marketing arrangements for the Company's products and services in those markets, we expect to remain primarily dependent on our own limited marketing resources for executing our expansion plans.

Risk of Technological Obsolescence

                The e-education marketplace is characterized by rapid technological changes that could put us at a competitive disadvantage and hamper our expansion plans. E-education products and services using different or better integrated platforms could be introduced and established in markets outside Canada before our market expansion plans for the Company's products are implemented and before market acceptance is achieved for Tutorbuddy's services in the United States. Developers of similar products and services have experienced time lags of one year or more between commencement of marketing activities through the completion of field trials and ultimate sales or subscriptions. If similar or longer delays are encountered in our efforts to implement our business plan for the Company, we could face the risk of technological obsolescence, adversely affecting our prospects for any market penetration and profitability.

Dependence on Licensed Content

                Because our business is dependent on licensed content for our e-education offerings, our business is subject to the risk of license terminations or adverse changes in license renewal terms as well as the risk of intense competition in markets where our rights to licensed content are non-exclusive. We believe our e-education offerings are distinguished in large part by the popularity of our video library. Most of our distribution agreements are renewable, and some condition renewal on minimum annual royalty payments from the Company ranging from approximately $3,000 to $130,000. These thresholds generally increase for each successive contract year. The distribution agreements also provide the producers with termination rights if the Company defaults on these obligations or fails to comply with other provisions of the agreements. If the Company is unable to obt ain renewals or replacements on comparable terms, acceptance of our e-education offerings could be severely impaired.

Lack of Control Over Licensed Content

                Because the Company distributes educational videos created by unaffiliated producers, we do not control the quantity or quality of the productions, any reduction in which could cause customer dissatisfaction and result in the loss of market share.

Competition

                The intensely competitive and fragmented nature of the e-education industry creates various market risks that could impair our ability to retain and expand the Company's current markets and market share in Canada. In the United States and Southeast Asia, competitors such as Discovery Learning and their recent acquisition strategy have and will have a profound impact on our business, principally in our efforts to expand in the United States. Hence, the Company has been seeking out a partnership and/or business combination to penetrate this market. This competitor could control these markets before we obtain any meaningful market share, adversely affecting our prospects for market penetration and profitability.

Dependence on the Internet and Computer Systems

                Our ability to expand the Company's delivery platforms and penetrate new markets could be frustrated without continued growth in the use and efficient operation of the Internet. Web-based markets for information, products and services are new and rapidly evolving. If Internet usage does not continue to grow or increases more slowly than anticipated, we could be unable to secure new sponsorship and subscription arrangements for the Company's offerings. To the extent our business relies on web-based delivery platforms, our operations will also be dependent on adequate network infrastructure, consistent quality of service and availability to customers of cost-effective, high-speed Internet access. If our systems cannot meet customer demand for access and reliability, these requirements will not be satisfied, and customer satisfaction could degrade substantially, adve rsely affecting our prospects for market penetration and profitability.

Regulatory Risks

                Our dependence on the Internet for growth  makes our operations susceptible to Internet-related regulatory risks and uncertainties. The laws governing the Internet remain largely unsettled, even in areas where there have been legislative initiatives. It may take years to determine whether and how Internet services are affected by existing laws, including those governing intellectual property, privacy, libel, product liability and taxation. Future legislation or judicial precedents could reduce Internet use generally and decrease its acceptance as a communications and commercial medium, adversely affecting our prospects for achieving profitability.

Risks Associated with Dependence on Key Personnel

                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 enviro nment, the Company risks losing staff and its investment in developing their skills to larger firms with greater resources.

Control by Selling Stockholders

                Because the Lancer Group and Zi Corporation collectively own 81.2% 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 con tinue to hold a substantial portion of their Shares.

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Item 2. Properties

 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.

Item 3. Legal Proceedings

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 regards to this disagreement. Wendy Connolly subsequently filed 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 Defence and Counterclaim by the Company. The Statement of Defense and Counterclaim adds Doug Connolly as a defendant in the counterclaim. The counterclaim seeks damages as against both Wendy and Doug Connolly for damages in the 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 interlocut ory injunction restraining the Connollys from soliciting clients and utilizing confidential information, punitive damages in the amount of $1,000,000 plus interest and costs. While the Company believes that claims made by Wendy Connolly are without merit, the parties are in final negotiation for a nominal settlement to avoid the substantial legal costs associated with a possible Trial.  On April 25, 2005 the Company negotiated a settlement on the claim and counterclaims noted above, which parties agreed not to disclose the terms and conditions of the settlement.

                In February 2001, the Company brought an action in New York County Supreme Court against Wear Me Apparel Corp. for unpaid royalties aggregating in excess of $1.5 million under a license agreement entered with the Company in October 1999. The agreement provided an exclusive license to the Kid's Headquarters division of Wear Me Apparel for manufacturing and distribution of boys' sportswear lines under the Cross Colours trademark, with a scheduled launch for the Fall 2000 season. The Company settled the litigation in April 2002 for $535,000, payable in a contemporaneous installment of $335,000 and the balance of $200,000 which was received in January 2003 was applied to fully offset amounts owing to R. Siskind and Company, Inc., an affiliated company. 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.

The Lancer Group has been a significant shareholder of the Company since the last 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 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 Lancer's ownership of Comp any 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 proceedings or general market concerns about the possible actions by the receiver with respect to portfolio securities held by Lancer. In addition, on November 4, 2003 the receiver announced that he had appointed DDJ Capital to actively manage the Lancer portfolio securities.  The Company is not aware of any further actions nor developments with respect to this matter beyond what has been reported in this paragraph.

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

On June 1, 2004 the Company held its Annual meeting of shareholders to vote on (i) a proposal to elect to the Board of Directors of the Company, Howard Balloch, Richard Siskind, Michael R. MacKenzie, Michael Lobsinger, Richard Geist, Stephen Encarnacao and Ms. Tammy Wentzel, and (ii) a review of the recent Form 10-Q and to discuss a possible change in Audit Firms more focused on micro-cap companies and with resources located near the main operational center of the Company in Oakville, ON, Canada., and (iii) to hear the report of Bentley Associates recently engaged by the Board of Directors to pursue acquisition candidates and channel partner developments.  Further, the Shareholders received a presentation by Management of the Company's status and possible future plans.  Lastly, at the conclusion of the Shareholders meeting the newly elected Board of Directors met to appoint committee members for its Audit Committee and Compensatio n Committee.               

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PART II

Item 5. Market for the Company's Common Stock and Related Shareholder Matters

Trading Market

The Company's common stock is listed for trading on the AMEX under the symbol GML. The following table sets forth, for the periods indicated, its high and low sales prices as reported on the AMEX.

Security Holders

As of March 20, 2005, there were approximately 800 holders of record.

Dividends

                The Company has not paid cash dividends since its inception and does not anticipate or contemplate paying dividends in the foreseeable future. It is the present intention of the Board of Directors to employ all available funds in the development of our business.

Penny Stock Rules

                As a result of current trading prices, the Company's common stock is subject to the penny stock rules under the Securities Exchange Act of 1934 (the "Exchange Act"). In the absence of an exemption from those rules, broker-dealers making a market in our common stock are required to provide disclosure to their customers on the risks associated with its ownership, its investment suitability for the customer, information on its bid and ask prices and information about any compensation the broker-dealer will receive for a transaction in the common stock. The application of these rules generally reduces market making activities and, based on prevailing trading volumes, has substantially limited the liquidity of the our common stock.

Compliance with AMEX Listing Requirements

The Company is currently not in compliance with AMEX listing requirements as of December 31, 2004.

Registration Statement.

On December 31, 2002, the Company filed a registration statement on Form S-3 with the Securities and Exchange Commission covering 64,300,000 shares of common stock. Of the Shares covered by the Prospectus, 31,550,000 were issued by the Company in the Equity Infusion, 29,750,000 were issued by the Company as part of the consideration on the acquisition of Magic Lantern and up to 3,000,000 may be issued under an earn out arrangement for this acquisition. See "Equity Infusion" and "Magic Lantern Acquisition."

Recent Sales of Unregistered Securities

On February 9, 2005, the Company entered into a Consulting Agreement with National Financial Communications Corp. ("NFC").  In consideration for NFC's commitment to provide services in accordance with the terms of that agreement, the Company issued NFC a common stock purchase warrant to purchase 750,000 shares of Common Stock, which warrant vests upon the achievement of certain performance milestones.  The exercise price of the warrant issued to NFC is calculated based upon the timing of the acceptance of individual Statements of Work by the Marketing Committee of the Company's Board of Directors.  The Company agreed to reserve 750,000 shares of Common Stock for issuance pursuant to the warrant, which Common Stock had previously been registered for resale pursuant to a registration statement on Form S-3/A (File No. 333-116147).

The warrant was issued to NFC in a transaction that was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"), and/or Regulation D promulgated under the Securities Act.  

On January 4, 2005, the Company entered into a Subscription Agreement (the "Subscription Agreement") with Nite Capital, L.P., providing for, among other things, the unregistered sale, through a private placement, of 1,000,000 shares of common stock (the "Shares"), $0.01 par value per share (the "Common Stock") at a price of $0.30 per share, and a common stock purchase warrant to purchase an additional 500,000 shares of Common Stock exercisable at a price of $0.40 per share, subject to customary adjustments, until the fifth anniversary of January 4, 2005.  The Company also entered into a Registration Rights Agreement.  

In connection with the private placement, the Company was obliged to pay a cash fee to the placement agent, First Montauk Securities Corp. ("First Montauk"), for its services on its behalf.  In addition, the Company issued First Montauk and its assignees, common stock purchase warrants to purchase an aggregate of 100,000 shares of Common Stock, exercisable at $0.40 per share, subject to customary adjustments, until the fifth anniversary of January 4, 2005.

The Shares and the common stock purchase warrants were issued to private investors in transactions that were exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"), and/or Regulation D promulgated under the Securities Act.   

On December 30, 2004, the Company, through the private placement of equity securities, consummated the unregistered sale of 800,000 shares of common stock (the "Shares"), $0.01 par value per share (the "Common Stock"), and common stock purchase warrants to purchase an additional 800,000 shares of Common Stock (the "Warrants") to certain accredited investors.  The Shares and the Warrants were issued to private investors in transactions that were exempt from registration pursuant to Section 4(2) of the Securities Act of 1933 (the "Securities Act") and/or Regulation D promulgated under the Securities Act.  

As a result of the transactions, three term promissory note holders of the Company converted an aggregate of $200,000.00 of principal into 800,000 shares of Common Stock at a rate of $0.25 per share and received three-year Warrants to purchase 800,000 shares of Common Stock at an exercise price of $0.40 per share.

During December, 2004, the Company, through the private placement of equity securities, consummated the unregistered sale of 4,010,649 shares of common stock (the "Shares"), $0.01 par value per share (the "Common Stock"), and common stock purchase warrants to purchase an additional 4,010, 649 shares of Common Stock (the "Warrants") to certain accredited investors.  The Shares and the Warrants were issued to private investors in transactions that were exempt from registration pursuant to Section 4(2) of the Securities Act of 1933 (the "Securities Act") and/or Regulation D promulgated under the Securities Act.

As a result of the transactions, two term promissory note holders of the Company converted an aggregate of $750,000 of principal and $2,662 of accrued interest into 3,010,649 shares of Common Stock at a rate of $0.25 per share and received three year Warrants to purchase 3,010,649 shares of Common Stock at an exercise price of $0.40 per share.  In addition, the Company issued 1,000,000 Shares to an additional investor at a price of $0.25 per share, for gross proceeds of $250,000, along with three year Warrants to purchase 1,000,000 shares of Common Stock at an exercise price of $0.40 per share.   

The Company has received net proceeds of approximately $1.2 million USD from two new investors to strengthen its balance sheet and restructure certain debt obligations.

The Company will use the proceeds to prepay and restructure a significant portion of its current convertible debt and for working capital needs. The Company and Laurus Master Funds, Ltd. have reached an agreement whereby the Company will use a portion of the net proceeds from the new investors to pay approximately $800,000 of existing debt, accrued interest and prepayment premium in exchange for the removal of certain required approvals and offering restrictions in their entirety from the terms of their original financing agreement dated April 28, 2004.

On May 3, 2004, Magic Lantern Group, Inc. (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 the Company, exercisable at $0.30.

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 the 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 year Laurus Master Funds converted a portion of the Note totaling $250,000 plus accrued interest to common stock. The Company