<PAGE>   1
                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB

(Mark One)
      [X]   ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
            ACT OF 1934

            For the fiscal year ended July 31, 1998

      [ ]   TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES
            EXCHANGE ACT OF 1934

      For the transition period from               to
                                     ------------     -----------

                        Commission file number 000-20759
                                               ---------

                   AMERICAN ARTISTS ENTERTAINMENT CORPORATION
                  (FORMERLY AMERICAN ARTISTS FILM CORPORATION)
                 (Name of small business issuer in its charter)

                      MISSOURI                            58-1950450
         (State or other jurisdiction of              (I.R.S. Employer
         incorporation or organization)               Identification No.)

         6600 PEACHTREE DUNWOODY ROAD
             BUILDING 600, SUITE 250
                ATLANTA, GEORGIA                            30328
     (Address of principal executive offices)             (Zip code)

                    Issuer's telephone number (770) 390-9180

       Securities registered under Section 12(b) of the Exchange Act: 
                                      NONE

         Securities registered under Section 12(g) of the Exchange Act:
                 CLASS A COMMON STOCK, $.001 PAR VALUE PER SHARE

         Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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    No X
                                                                       --    --

         Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B is not contained in this form, and no disclosure will
be contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB [ ]

         State issuer's revenues for its most recent fiscal year:  $2,450,958

         State the aggregate market value of the voting stock held by
non-affiliates computed by reference to the price at which the stock was sold,
or the average bid and ask prices of such stock, as of the close of business on
March 2, 1999:

            Class A common stock, $.001 par value:  $ 520,744
            Class B common stock, $.001 par value:  There is no established
                                                    market for the Class B
                                                    common stock

         State the number of shares outstanding of each of the issuer's class of
common equity: 3,319,745 shares of Class A common stock, $.001 par value per
share and 3,225,516 shares of Class B common stock, $.001 par value per share
were outstanding as of March 2, 1999.

         Documents incorporated by reference:   NONE

<PAGE>   2


                   AMERICAN ARTISTS ENTERTAINMENT CORPORATION
                                   FORM 10-KSB
                                TABLE OF CONTENTS


<TABLE>
<CAPTION>
PART I                                                                      Page
                                                                            ----

<S>      <C>                                                                <C>
         Item 1.  Description of Business.....................................3
         Item 2.  Description of Property....................................16
         Item 3.  Legal Proceedings..........................................16
         Item 4.  Submission of Matters to a Vote of Security Holders........16

PART II

         Item 5.  Market for Common Equity and Related
                    Stockholder Matters......................................16
         Item 6.  Management's Discussion and Analysis or Plan
                    of Operation.............................................17
         Item 7.  Financial Statements.......................................24
         Item 8.  Changes In and Disagreements With Accountants
                    on Accounting and Financial Disclosures..................24

PART III

         Item 9.  Directors, Executive Officers, Promoters and
                    Control Persons; Compliance with Section 16(a)
                    of the Exchange Act......................................24
         Item 10. Executive Compensation.....................................26
         Item 11. Security Ownership of Certain Beneficial
                    Owners and Management....................................27
         Item 12. Certain Relationships and Related
                    Transactions.............................................28
         Item 13. Exhibits and Reports on Form 8-K...........................32

SIGNATURES...................................................................37

INDEX TO FINANCIAL STATEMENTS...............................................F-1
</TABLE>




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                                     PART I

ITEM 1.  DESCRIPTION OF BUSINESS

INTRODUCTION

         American Artists Entertainment Corporation (the "Company"), known prior
to February 1999 as "American Artists Film Corporation," legally changed its
name on February 5, 1999. The Company, organized in July 1995 as a Missouri
Corporation under the name Setab Alpha, Inc., is the successor by merger of a
Georgia corporation named American Artists Film Corporation that was founded in
July 1991. The Georgia corporation is sometimes referred to herein as "Old
American Artists"; the Missouri corporation prior to the merger is sometimes
referred to herein as "Setab." Unless otherwise indicated by the context, as
used herein, the term "the Company" includes its predecessors and subsidiaries,
and discussion of the business and operations of the Company include those of
Old American Artists; Setab had no business operations prior to the merger with
Old American Artists.

         The Company is engaged in the contract production of television
commercials and corporate/industrial videos, the development and production of
television specials and related properties, and the development of
feature-length motion picture screenplays and other media products for possible
future production or license. The Company classifies its operations into two
business segments: (i) film development and production, which includes the
development and production of both cable or television films and specials and
feature films, and (ii) commercial contract production, which includes the
production of both commercials and corporate/industrial videos. Additionally,
during fiscal 1997 and 1998, the Company incurred developmental and
organizational expenses for a new business segment focused on the development
and operation of a network of large screen video display ("LSVD") operations.
See Note 13 of the Notes to Consolidated Financial Statements for financial
information concerning the Company's business segments.

         The Company's contract commercial production operations, conducted
through its First Light Entertainment Corporation ("First Light") subsidiary,
suffered a significant decline in revenues during the fourth quarter of fiscal
1998, and as a result incurred an operating loss. In October 1998, the Company
decided to temporarily cease First Light's operations while it evaluated the
form and direction of its future contract commercial production operations. That
study is ongoing and the Company has not yet determined whether it will renew
these operations, and if so whether it will do so under the First Light name,
through American Artists Films, or through another entity. See Item 1.
Description of Business - Business of Company - Contract Commercial Production,
and Item 6. Management's Discussions and Analysis or Plan of Operation.

         As a result of the losses of this operation, the lack of film revenues
(due to the release of no new films) and the expenditures incurred in the
Company's development of television and feature film projects and LSVD
operations, the Company incurred a significant net loss in fiscal 1998, and at
July 31, 1998 had significant working capital and stockholders' equity deficits.
Additionally, the Company had negative cash flows from operations in fiscal 1998
and at July 31, 1998 was in default or past due with respect to several loans.
The Company's continued operation will be dependent on its short term ability to
obtain additional capital through debt or equity placements, or project
financing arrangements to alleviate its cash flow and liquidity problems, and
its longer term ability to successfully finance, complete and earn revenues from
one or more of its various film and/or LSVD projects. See Item 6. Management's
Discussion and Analysis or Plan of Operation - Liquidity and Capital Resources.

         The Company's executive offices are located at 6600 Peachtree Dunwoody
Road, Building 600, Suite 250 Atlanta, Georgia 30328, and its telephone number
is 770-390-9180.

BACKGROUND

          Old American Artists was founded in July 1991. In August 1993 the
Company acquired all of the outstanding capital stock of First Light, a
television commercial producer. In June 1994 the Company subscribed for 49% of
the outstanding capital stock of Diversity Filmworks, Inc. ("Diversity"),
formerly First Light Diversity, Inc., a television commercial producer organized
and 51%-owned by Tyrone C. Johnson.

         In May 1996 Setab entered into an agreement ("Merger Agreement") with
Old American Artists for the merger (the "Merger") of Setab and Old American
Artists. The Merger was consummated on October 7, 1996 (the "Merger Date") and
Setab, as the surviving corporation, subsequently changed its name to American
Artists Film



                                      -3-
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Corporation. The surviving corporation changed its name to American Artists
Entertainment Corporation in February 1999.

         Concurrent with and as a condition of the Merger, on October 7, 1996,
Setab completed a public offering (the "Public Offering") of 700,000 shares of
its Class A common stock, par value $.001 per share (the "Class A common
stock"). The net proceeds of its Public Offering were $15,477, which Setab used
to pay existing liabilities.

         By reason of the Merger, the stockholders of Old American Artists
became shareholders of the surviving corporation, the separate existence of Old
American Artists ceased and the business and management of Old American Artists
became the business and management of the Company. Each of the 9,407,837
outstanding shares of Old American Artists common stock became 0.5862 shares of
the capital stock of the Company, with the first 100 shares issued to each Old
American Artists shareholder as Class A common stock, $0.001 par value per share
and the remainder as Class B common stock, $0.001 par value per share (the
"Class B common stock"); outstanding options and warrants to purchase an
aggregate of 3,840,328 shares of common stock of Old American Artists became
options and warrants to purchase an aggregate of 2,251,200 shares of Class B
common stock. The effects of this exchange ratio have been retroactively applied
to the earliest periods presented for all share and per share amounts related to
the Company's outstanding common stock, stock options and warrants.

         As a result of the consummation of the Merger, the Old American Artists
shareholders held, immediately following the Merger Date, 88.7% of the
outstanding capital stock of the Company (including all of the outstanding
shares of Class B common stock), and the pre-Merger shareholders of Setab
(including those persons who purchased Class A common stock in the Public
Offering) held the remaining 11.3% of the capital stock of the Company.

         Each share of Class B common stock is convertible at any time at the
election of the holder into one share of Class A common stock. The Class A
common stock and the Class B common stock are substantially similar in all
respects and the holders thereof will have equal rights and privileges, except
with respect to the election of directors. In the election of directors, holders
of Class B common stock, voting as a separate class, are entitled to elect a
number of directors equal to the greater of (i) the number (rounded to the
nearest whole number) that bears to the total number of directors of the Company
the same ratio that the number of outstanding shares of Class B common stock
bears to the aggregate number of outstanding shares of Class A and Class B
common stock, or (ii) the smallest number of directors that constitutes a
majority of the board of directors. Holders of Class A common stock voting as a
separate class will be entitled to elect all of the other members of the board
of directors.

BUSINESS OF THE COMPANY

         Television - Introduction

         The Company's operations related to the television industry consist of
the development and production of specials and feature films for distribution to
both the domestic United States and foreign television markets. These operations
are conducted principally through the American Artists Films division of the
Company.

         Television - Industry Overview

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

         The foreign market for television programming includes traditional
television stations and networks as well as cable and satellite delivered
programming.

         The number and geographic coverage of television networks and cable and
satellite program delivery systems has expanded both domestically and overseas
in recent years, and the Company believes that it is likely that such expansion
will continue. Such expansion creates increases in the demand for programs
produced by major film



                                      -4-
<PAGE>   5

studios, production divisions or affiliates of the major networks, independent
station owners and independent producers such as the Company.

         Television - Production

         As a producer, the Company first develops literary properties
internally or acquires them from third parties. These properties are then
presented to various programmers (network, cable and public television)
depending upon the programmer's interest in the subject matter. A development
agreement may be entered into to further develop the programming concept. A
development agreement typically calls for the development of a production budget
and treatment for the programming concept. Once the development materials are
delivered, the programmer may order production of a single pilot episode, a
limited number of episodes in the case of a series, or the entire production in
the case of a television special, movie-for-television or mini-series.

         Once the programmer elects to order a production, the Company and
programmer negotiate and enter into a production agreement that includes
provisions for financing and production deliverables. The Company then
undertakes pre-production activities, production personnel (director, actors,
producers and technical personnel) are engaged, filming is scheduled, locations
are arranged and other steps are taken to prepare the project for principal
photography. Principal photography then commences, followed by post-production,
in which the film is edited, synchronized with music and dialogue and, in
certain cases, special effects are added. In the case of a series, if episodes
are ordered and the ratings are sufficiently strong, additional episodes may be
ordered for the entire season or for additional seasons, as applicable.

         The Company hires writers, directors, cast and crew members on a
project-by-project basis. The terms of employment and compensation are
negotiated in light of an individual's previous experience, the prevailing
market conditions and, where applicable, collective bargaining agreements. The
Company may also use certain on-staff producers, directors and technical
personnel in its productions. The Company also contracts for locations, sets,
post-production personnel and facilities, on an as-needed basis.

         In December 1998, the Company entered into a consulting agreement
("Programming Agreement") with an individual who possesses a number of years of
experience in the television industry. The Programming Agreement calls for the
consultant to assist the Company in the creation, development, packaging and
production of certain television and feature film properties ("Properties"),
including television series. As consideration for his services, the consultant
will receive, in addition to certain "on screen" credits, thirty-three percent
(33%) of all net profits, as defined (generally revenues after the recovery of
all production and distribution costs), generated from Properties introduced to
the Company under this Programming Agreement. The Programming Agreement
generally will relate to properties identified by the consultant and exclude
project ideas identified by the Company.

         Television - Projects

         The following sets forth information concerning the various television
specials or film projects the Company currently has in various stages of
development or production.

         Miracles. In October 1998, the Company entered into an agreement ("HBO
Agreement") with Home Box Office ("HBO"), a division of Time Warner
Entertainment Company, L.P., to develop a one hour special on the subject of
"miracles." The HBO Agreement provided for the payment to the Company of a
development budget of $20,663 to develop a treatment and production budget. The
development materials were delivered to HBO in October 1998, which, under the
HBO Agreement, is permitted three months in which to decide whether to fund the
production of the one hour special.

         The HBO Agreement was amended by the parties in February 1999 to
provide for the preparation of additional development materials in relation to
the one hour special. The amendment also called for a $37,376 increase in the
development budget.

         In connection with the HBO Agreement, the Company also entered into an
executive producer agreement with the originator and developer of the subject
material for this one hour special. This agreement provides for certain screen
credits, an executive producer fee, to be negotiated at the time of production
funding, and a profit participation in profits, if any, as defined.


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<PAGE>   6

         Trafford Project. In August 1998, the Company and an independent
project investor entered into a production agreement ("Trafford Agreement") to
produce a thirty minute video on the ideas and opinions of Ms. Angela Passidomo
Trafford on the subject of "spiritual healing." The Trafford Agreement calls for
the Company to provide the writer, producer, director and all other production
personnel and equipment necessary to produce the thirty minute video in exchange
for a production fee of $25,000. The Trafford Agreement also provides for joint
ownership in the completed project and a 50/50 split of revenues, after first
distributing $30,000 to the independent investor and then distributing $15,000
to the Company. The Company completed production and delivered the thirty minute
video in October 1998.

         When Souls Meet. The Company is in the final stages of post-production
on a television special, titled "When Souls Meet," featuring the ideas and
opinions of Robert Johnson and Marion Woodman, experts in the fields of Jungian
psychology, mythology and dream interpretation. This project is being
co-produced with Georgia Public Television ("GPTV"), a division of the Georgia
Public Telecommunications Commission, and in association with the Episcopal
Radio-TV Foundation.

         The "When Souls Meet" special is currently scheduled to be broadcast by
GPTV in fiscal 1999, and in addition will be made available to other member
stations of the Public Broadcasting System ("PBS") through the program sharing
arrangements between the PBS stations. The Company and GPTV, the owners of the
special, will be entitled to receive from each airing PBS station (including
GPTV) a fee of a specified percentage of the viewer pledges or donations
obtained as a result of the program's broadcast. The Company and GPTV will share
equally in such fees, after the payment of (i) 5% of such fees to each Mr.
Johnson and Ms. Woodman, and (ii) for the first five years from the date of the
first broadcast, 10% to the Episcopal Media Center ("EMC"). EMC has been granted
the rights to all revenues from certain religious markets. The Company, Mr.
Johnson and Ms. Woodman would share all book related revenues, if any, on a
50/25/25 basis.

         Fire From The Sky. In 1997 the Company co-produced with Turner Original
Productions, Inc. ("TOP") a one-hour special titled "Fire From The Sky." This
special was initially broadcast on the TBS Superstation ("TBS") in March 1997
and has been subsequently re-broadcast on TBS and The Cable News Network
("CNN"). Under the production agreement ("Production Agreement") with TOP, dated
October 11, 1996, as amended on November 13, 1996, the Company received
production fees amounting to $368,100 for the production of this special. The
terms of the Production Agreement also call for a limited participation by the
Company in certain international, internet and publishing net profits. Through
fiscal 1998 the Company has not recognized any revenues related to these limited
participations.

         Angels. In 1994 the Company produced with Greystone Communications,
Inc. ("Greystone"), two 2-hour prime time specials for the NBC television
network: "Angels: The Mysterious Messengers," hosted by Patty Duke, and "Angels
II: Beyond the Light," hosted by Stephanie Powers. Both programs were initially
licensed to NBC, which aired the first program twice and the second program
once. NBC's rights to further airings expired in November, 1996. In June 1996
the Company entered a three-year license agreement authorizing TOP to broadcast
the two Angels programs on TBS for a total license fee of $100,000. TOP is
permitted to air each of the Angels programs 18 times over the three year
period. The Company and its co-producer bear any obligation for residuals and
must refrain from licensing the programs to any other broadcaster in the United
States during the term of the license. TOP began airing the programs in October
1996.

         The Company also entered a 3-year agreement ("Haber Agreement") in July
1994 with Alfred Haber Distribution, Inc. for foreign distribution of the Angels
programs. Under this agreement, the Company and Greystone receive 75% of any
license fees, less expenses, obtained from licensing the Angels programs outside
the United States. License fees have now been received for television, cable and
satellite broadcasts of the programs in more than 55 countries. The Haber
Agreement expired in August 1997 and was extended for an additional eighteen
month period through January 1999. The Company is currently evaluating its
options, which may include an extension or replacement of this agreement.

         Under a May 1994 agreement, Calling Card Company, Inc. ("CCC") marketed
home videos of the Angels programs through advertising during the NBC network
broadcast, providing royalties, which were shared by NBC, the Company and
Greystone, of $223,000 through July 31, 1998. In addition, a video edition of
the first Angels program has been separately marketed by Time-Life Video under
an August 1994 agreement which granted Time-Life exclusive home-video rights to
the program in the United States and Canada for a five-year term. The



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agreement provided for $100,000 in non-refundable advance royalties and
guaranteed minimum royalties of $10,000 per year for the duration of the
agreement after recoupment of the advanced royalties. Royalties under the
agreement are shared among NBC, the Company, and Greystone.

         The Company also developed a book entitled Angels: The Mysterious
Messengers, edited for the Company by Mr. Hauck and published by Ballantine
Books, Inc. The book has also been published in German, Italian, French and
Spanish editions. Advance royalties for the book amounted to $250,000.

         The Company financed development of the initial Angels program
primarily through the private placement of $128,000 of its Revenue Participating
Joint Venture Investment Units with eight accredited investors. The private
placement was completed in February 1994. Investors receive 100% of the
Company's revenues from the first television special and ancillary rights until
their initial investment has been returned, 50% thereafter until an equal
additional amount has been received, and 25% of any further revenues. The
investors also receive 5% of the Company's revenues from the second television
special. Through July 1998 the investors had received an aggregate return of
$1.30 for each dollar of their investment. Additional distributions may be made
later depending on future revenues of the Angels programs.

         Windows of Heaven. The Company has completed its principal photography
and prepared a three minute trailer for a project on the subject of re-occurring
global-wide destructions throughout recorded time. This project is being
produced in association with King Arthur Productions, LLC ("KAP"). The
production agreement calls for the distribution of revenues, after the recovery
of all production costs, 46.5% to the Company and the remainder to KAP's
investors and other parties associated with the project. This allocation remains
in effect for revenues received for licensing rights covering the period from
June 1997 to December 2000, with all other revenues allocated evenly between the
Company and KAP.

         The Company has initiated discussions with several cable television
networks in relation to the licensing of the rights for the broadcast of this
production, but there can be no assurance that a suitable licensing agreement
can be reached or that the proposed project will be carried out.

         The Millennium. Since 1995 the Company has been developing the concept
for a related group of television specials and other media properties pertaining
to the forthcoming end of the second millennium of the modern era. The
development work has included historical and scientific research, development of
themes and preparation of story treatments.

         In October 1994 the Company organized Millennium Group, L.L.C. ("MG"),
as a Georgia limited liability company with itself as Manager, for the purpose
of developing an initial one-hour television special on the subject of the
millennium. MG financed certain research and development of the millennium
materials through a private placement of $50,000 of limited liability company
interests with three accredited investors. In July 1998, the Company acquired
100% of the outstanding LLC shares of MG in exchange for 25,000 shares of the
Company's Class A common stock.

         The Company has presented this "millennium" concept to several
television and cable networks, and although it has received indications of
interest, it to date has been unable to obtain a firm agreement for the
production and broadcast of any program. The production of a program based on
these materials, packaged as a "millennium" concept, would have to begin within
the first half of calendar 1999 in order to insure that the program could be
broadcast at or near the time of the year 2000 new year. There can be no
assurances that the Company will be able to obtain a production and broadcast
agreement within this time frame; however, a substantial portion of the
materials developed for this project could, in the Company's opinion, also be
utilized in a film special not directly tied to the turn-of-the-century.

         Other. The Company currently has over twenty other television
projects/proposals in various stages of development, presentation and
pre-production including both television specials and series. Negotiations are
ongoing with a cross-section of the television industry, including
representation from cable, network and public television. There can be no
assurances that these negotiations will yield production agreements that will be
acceptable to the Company or that any of the projects will result in completed
films or series.



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<PAGE>   8

         Feature Films - Introduction

         For the feature film market, the Company attempts to develop and
produce feature length films for distribution in both the domestic United States
and foreign markets. These operations are conducted principally through the
American Artists Films division of the Company.

         Feature Films - Industry Overview

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

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

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

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

         Feature Films - Production and Financing

         The production of a feature film usually involves four steps:
development, pre-production, production and post-production. The development
stage includes developing a concept internally, or obtaining an original
screenplay or a screenplay based on a pre-existing literary work, or acquiring
and rewriting a screenplay. Creative personnel may be contacted to determine
availability and for planning the timing of the project, or in some cases
actually hired. In pre-production, a budget is prepared, the remaining creative
personnel, including a director, actors and various technical personnel are
identified, shooting schedules and locations are planned and other steps
necessary to prepare for principal photography are completed. Production
commences with principal photography of the project and generally continues for
a period of not more than three months. In post-production, the film is edited
and synchronized with music and dialogue and, in certain cases, special effects
are added. The final edited synchronized product, the negative, is used to
manufacture release prints suitable for public exhibition.

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

         The Majors generally have sufficient cash flow from their feature films
and related activities, or in some cases, from unrelated businesses (e.g., theme
parks, publishing, electronics, and merchandising) to pay or otherwise provide
for their production costs. Overhead costs are, in substantial part, the
salaries and related costs of the



                                      -8-
<PAGE>   9

production staff and physical facilities which the Majors maintain on a
full-time basis. The Majors often enter into contracts with writers, producers
and other creative personnel for multiple projects or for fixed periods of time.

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

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

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

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

         Feature Films - Projects

         The following sets forth information concerning the various feature
film projects the Company currently has in various stages of development or
production.

         False River. In March 1998, the Company organized False River, LLC
("False River") for the purpose of producing a feature film, currently titled
False River. This feature films is a quirky comedy that explores a small town's
inhabitants and their eccentric behavior. The story focuses on the events
following an escape of the story's two main characters from an insane asylum and
their bizarre and sometimes unexpected crossing-of-paths.

         In exchange for nominal consideration, the Company obtained 100% of the
ordinary LLC shares of False River. The operating agreement, as amended and
restated, also provides for the issuance of preferred distribution LLC shares,
which are entitled to a preferred distribution from net profits, as defined.
However, the preferred distribution shares may not constitute more than 49% of
the ownership interest in False River. False River has sold interests in the
preferred distribution LLC shares for proceeds amounting to $740,064.

         False River's operating agreement provides for various sharings in the
distribution of any operating profits. Initially, the holders of the preferred
distribution shares will be entitled to receive 150% of their initial
investment. After that distribution, False River is next obligated to pay from
any profits an aggregate of $172,000 to certain parties who contributed creative
or organizational efforts for the False River project, including the Company,
which would be entitled to receive $57,000. Thereafter, any profits would be
distributed 49% to the holders of the preferred distribution shares and 51% to
the Company. From that 51%, the Company would be obligated to pay



                                      -9-
<PAGE>   10

20.75% of its interest (or 10.5825% of False Rivers profits) to creative and
technical personnel associated with the project to whom the Company granted such
participations as inducements. Additionally, the Company has agreed to pay
interest, at the rate of 10% per year, on the investment of $311,526 in
preferred distribution shares made by the initial investor in False River, who
is a director of the Company. Such interest will be paid until the investor
receives distributions from False River equal to his investment.

         At March 2, 1999, the Company had completed principal photography,
post-production and had prepared a negative and theatrical print of the film. In
February 1999, the Company screened False River as part of the 1998/1999
Independent Film Screening Series sponsored by the Directors Guild of America,
Inc. This screening marked the beginning of a process aimed at exposing the film
to potential distributors. The Company plans to submit False River for entry
into several film festivals as part of its strategy to market this feature film.
The Company has also entered into preliminary discussions with an experienced
producer's representative, for purposes of assisting the Company in its sales
efforts for False River.

         As a condition of employing certain union members during the production
of this feature film, False River was required to sign collective bargaining
agreements with the Screen Actors Guild and Directors Guild of America, Inc.
("DGA"). These agreements call for adherence to certain procedures and standards
related to the production of a feature film and the revenues generated from its
exploitation. The Company has guaranteed the full and complete performance by
False River in relation to its agreement with DGA.

         The Last Sunrise. The Company entered into an agreement ("THC
Agreement") in May 1998 with THC Entertainment, LLC. ("THC") for the
co-production of a feature film currently titled "The Last Sunrise." The THC
Agreement called for a joint production effort contingent upon the completion of
financing within a six-month period, with an option for an additional six-month
period. The THC Agreement expired prior to the satisfaction of the financing
contingency.

         Other. The Company also has a number of other feature film properties
(screenplay or treatment) in various stages of development, and holds an option
to acquire one feature film property. The Company has commenced the
pre-production phase (casting for the lead role) for two of its feature film
properties and anticipates entering the production phase in fiscal 1999 for at
least one of these projects. The Company believes that if the lead roles have
been cast, the financing of these projects can be accelerated. No formal
commitments have been obtained for financing production of any of those
properties and there can be no assurance that any of these properties will be
developed into completed films.

         LSVD Operations - Overview

         Large screen video displays ("LSVD") are the large screen television
quality displays typically found at major sports arenas and stadiums. These
LSVDs generally have very large displays that provide a clear and identifiable
picture to large audiences, using full motion and full color capabilities. LSVDs
are most identifiable from their uses in large sports arenas and stadiums for
display of "instance replays" and for promotional purposes.

         The Company's plans to participate in LSVD operations encompass two
facets of the LSVD industry: (i) the ownership and operation of LSVD units, and
(ii) the production and distribution of LSVD programming.

         The first aspect of this plan calls for the Company to construct, own
and operate LSVD units in certain entertainment centers, both domestically and
internationally. These operations will be very similar in nature to the LSVD
unit currently operated by an unaffiliated third party in Times Square, New
York.

         The second aspect of the plan calls for the Company to produce and
develop programming for distribution to both its owned and operated LSVD units
and to third party LSVD operators. The Company plans to produce and distribution
programming that includes a mixture of news, weather, sports, music, film,
fashion, arts, entertainment and other current events. These programming
components may be created and produced by the Company or obtained under
licensing agreements entered into with third party programming providers.

         In August 1997, the Company, together with certain members of the board
of directors and an officer of one of the Company's subsidiaries, organized
Video Communications Network, LLC ("VCN") to serve as the entity



                                      -10-
<PAGE>   11

through which the Company will pursue its LSVD operations. VCN will engage in
LSVD operations both directly and indirectly through investments in other
entities.

         The Company acquired 83.3% of the initial ownership of VCN in exchange
for nominal consideration. In January 1998, the Company sold a portion of its
interest in VCN, representing 444 LLC shares, to certain members of the board of
directors and a shareholder for nominal consideration.

         In January 1998, VCN commenced a private placement offering, under
Regulation D of the Securities Act of 1933, of an aggregate of 1,110 LLC shares
in $100,000 units comprised of 222 LLC shares together with warrants to purchase
50,000 shares of the Company's Class A common stock at an exercise price of
$3.00 per share, exercisable through January 2001. This private placement was
closed in April 1998, at which time the Company's ownership of VCN decreased to
74%, as a result of VCN's receipt of $300,000 for the sale of three private
placement units.

          VCN has incurred expenses of $507,746 and has not generated any
revenues as of July 31, 1998. These expenses have been funded by advances from
the Company and from the proceeds of VCN's private placement offering.

         LSVD Operations - Ownership and Operation of LSVD Units

         The Company's concept for the ownership and operation of LSVD units
anticipates the establishment of a brand identification "Diversity Entertainment
Television" or "DETV" to represent a contemporary brand of entertainment
containing a mix of sports, music, news, film, fashion and animated content
delivered in a seamless audio and video presentation. The Company, through VCN,
is pursuing the installation, ownership and operation of a LSVD unit at
Underground Atlanta in Atlanta, Georgia as its initial LSVD operation. VCN is
also investigating the feasibility of LSVD units in Miami, San Francisco,
Chicago, Baltimore and Dallas.

         VCN's proposed installation and operation of a LSVD unit in Atlanta,
Georgia is being pursued through its ownership of an interest in Diversity
Entertainment Television/Atlanta, LLC ("DETV/Atlanta"). DETV/Atlanta was
organized in August 1997 by VCN and an unaffiliated consultant.

         VCN acquired 6,762 of DETV/Atlanta's LLC shares, representing 98% of
the initial ownership, in exchange for nominal consideration. VCN agreed to
distribute to an officer of VCN, in consideration of his services to VCN, all of
the net cash or other assets received by VCN at any time in respect of 1,690.5
of its DETV/Atlanta LLC shares, representing 24.5% of DETV/Atlanta's outstanding
shares.

         During fiscal 1997 and 1998 DETV/Atlanta's activities involved seeking
necessary regulatory approvals, negotiating programming and advertising
agreements, and pursuing financing for the installation of the LSVD unit.

         In May 1997, the City Council for the City of Atlanta voted to amend
its existing sign ordinance to allow for the installation of large screen video
displays in certain areas designated for public entertainment (a "Public
Entertainment District" or "PED"). The amendment also provided that a PED could
only be designated by resolution of the City Council. Subsequent to the adoption
of this amendment to the sign ordinance, the City Council also adopted a
resolution designating Underground Atlanta as a PED.

         In January 1998, DETV/Atlanta entered into a third party licensing
agreement with Georgia Public Television ("GPTV") that would allow GPTV to
provide certain programming to DETV/Atlanta for broadcast on the proposed LSVD
unit at Underground Atlanta. In exchange for this programming, DETV/Atlanta
agreed to provide promotional exposure for GPTV through a promotional
identification tag on all GPTV programming. This licensing agreement had a term
of one year and was effective upon execution of the agreement. The agreement has
now expired, but the Company will pursue, and believes it can obtain, a new
agreement, having similar terms, at such time as it has obtained the financing
necessary for and begun the construction of the proposed LSVD unit at
Underground Atlanta. There can be no assurances that the Company will be able 
to execute a new agreement having similar terms.

         In February 1998, DETV/Atlanta entered into an agreement with the Cable
News Network, Inc. ("CNN") that granted CNN the exclusive right to provide
national and international news programming for broadcast on the proposed LSVD
unit at Underground Atlanta. In exchange for this programming, DETV/Atlanta
agreed to provide



                                      -11-
<PAGE>   12
 an inventory of time ("Promo Time") for CNN to use for promotional purposes.
The agreement provides that the Promo Time may be used by CNN, its parent,
subsidiary or any division thereof. This agreement commenced in February 1998
and had a one year term. The agreement has now expired, but the Company will
pursue, and believes it can obtain, a new agreement, having similar terms, at
such time as it has obtained the financing necessary for and begun the
construction of the proposed LSVD unit at Underground Atlanta. There can be no
assurrances that the Company will be able to execute a new agreement having
similar terms.

         In April 1998, DETV/Atlanta entered into an agreement with Georgia
Television Company, d/b/a WSB-TV ("WSB-TV"), the local ABC affiliate in Atlanta,
Georgia. The agreement grants WSB-TV the right to provide live and taped local
news programming for broadcast on the proposed LSVD unit at Underground Atlanta.
In exchange for this programming, DETV/Atlanta agreed to provide an inventory of
time for WSB-TV to use for promotional purposes. This agreement is for a term of
one year and commences upon the first day of operations at the Underground
Atlanta LSVD unit.

         In September 1998, DETV/Atlanta entered in a sales agreement ("Sales
Agreement"), with a supplier of contract service to various multi-national
corporation, that calls for the sale of $2,000,000 of advertising time on
DETV/Atlanta's proposed LSVD screen at Underground Atlanta. The Sales Agreement
is for a two year term and is contingent upon the completion of startup
financing by DETV/Atlanta. Under the terms of the Sales Agreement, the supplier
is to purchase a minimum of $1,000,000 of airtime per year over the two year
term of this Sales Agreement.

         To succeed in installing and then operating the proposed LSVD unit in
Atlanta, Georgia, DETV/Atlanta must obtain financing for the cost of installing
the unit (approximately $2.6 million) and agreements for sufficient sources of
programming and paid advertising. DETV/Atlanta continues to negotiate with
program providers and potential advertiser, and to pursue debt, equity or joint
venture/strategic alliance financing for the installation of the Atlanta LSVD
unit. There can be no assurance that DETV/Atlanta will succeed in these efforts.

         LSVD Operations - Distribution of LSVD Programming

         As a LSVD program producer and distributor, VCN will obtain LSVD
suitable programming from various sources, format such programming for LSVD use,
and transmit the programming to LSVD units owned and operated both by VCN (or
its subsidiaries) or third parties. In general, VCN will seek to obtain and
distribute the following types of programming:

         - Targeted Special Interests - customized programming available for
         venue specific events at multi-purpose sporting and entertainment
         center venues,

         - General Interests - featured segments to suit the audience
         demographics (e.g. daily news, weather, sports, etc.),

         - Special Events - event programming tied to cultural affairs programs,
         civic promotions/parades, sporting events/pep rallies, concerts,
         corporate sponsorships and other special events.

         VCN will obtain the majority of its programming through licensing
agreements with local and national programming providers. These would include
international, national and local news networks, network affiliates, and cable
broadcasters. VCN is currently negotiating with various programming sources.
Additionally, VCN would have access to the programming licensed to its "DETV"
subsidiaries, such as the programming licensed to DETV/ Atlanta under its
agreements with GPTV, CNN and WSB-TV.

         In July 1998, VCN entered into a letter of agreement ("Crawford
Agreement") that establishes a strategic alliance with Crawford Communications,
Inc. ("Crawford"). The Crawford Agreement calls for Crawford to originate the
signal transmission for VCN's proposed network of LSVD operations. This letter
of agreement is subject to definitive negotiations and execution of a formal
written agreement.

         To succeed in its proposed LSVD programming distribution operation, VCN
must obtain a sufficient quantity and variety of programming to make its
services attractive to LSVD operators, obtain financing for and acquire the
necessary equipment, and ultimately secure a sufficient number of LSVD operator
customers. There can be no assurances that VCN will be successful in
establishing and generating profits from its proposed LSVD programming
production and distribution operations.


                                      -12-
<PAGE>   13

         Contract Production

         Television Commercials

         The Company produces television commercials on a contract basis for
advertisers and advertising agencies, typically under short-term agreements for
the production of the commercials, whose scripts or story outlines are provided
by the client. Under these contracts, the Company generally arranges all
production aspects of the commercials, including casting, location selection and
contractual arrangements with the director and other production personnel. The
Company uses the services of a number of independent directors. These directors
are paid on a fixed fee basis determined by mutual agreement during the
commercial production budgeting process, although other compensation
arrangements may be used from time to time, including director participation in
the gross profits of commercials.

         The Company generally produces its commercials on a "firm bid" basis as
opposed to a "cost plus fixed fee" basis. If a commercial is produced on a "firm
bid" basis, the production company is responsible for any costs in excess of the
budget, unless approved by the client. If the commercial is filmed under "cost
plus fixed fee" arrangement, the Company receives a predetermined fee for its
work and approved production costs are charged to the client as incurred.
Despite the differences in the structure of the two forms of bids, the risk of
costs overage to the Company is not substantially greater for "firm bid"
contracts because the Company is also responsible for unapproved costs overages
that exceed the budget for a "cost plus fixed fee" bid. Production company
personnel, in tandem with the advertising agency responsible for the commercial,
must carefully monitor costs throughout the filming process, whether a "firm
bid" or "cost plus fixed fee" arrangement is operating. The agreed upon bid
might be altered because the agency, client and director agree upon a new
creative option or because of unexpected occurrences such as inclement weather
or unavailability of location.

         In general, the Company requires an advance payment, due on the first
day of pre-production, of 50% of the budget. The remainder of the fee is
generally paid in one or more installments within 30 to 120 days after the
completion of production. In April 1998, First Light entered into a $1,000,000
line of credit agreement with a financial institution to alleviate any working
capital shortfalls incurred as a result of these billing practices.

         In marketing their services the Company emphasizes the talents of the
directors with whom it works, its skill in cost control and timely production,
the quality of the production and the advantages of Atlanta as a production
center. Diversity especially emphasizes use of directors and other production
staff from diverse cultural and ethnic backgrounds.

         In fiscal 1998 the Company produced twelve commercials for net revenues
of $2,451,000, compared to twenty-two commercials and net revenues of $3,470,000
in fiscal 1997. In October 1998, the Company elected to reassess its television
commercial operations and is currently unable to accurately predict the effect
of this reassessment on future revenues and bidding opportunities.

         For fiscal 1998, two of the Company's customers accounted for fees
equal to 54.3% and 12.5% of consolidated revenues. The Company obtains its
revenues from discrete project assignments obtained from various clients.
Accordingly, while the fees from one or more clients may, in any year, be
significant as the result of the size of a project undertaken for that client,
the Company is not dependent on any one client for a material amount of its
continuing revenues.

         Through the end of fiscal 1998 the Company conducted its contract
commercial production operations through its First Light subsidiary. First Light
suffered a significant decline in revenues during the fourth quarter of fiscal
1998, and as a result incurred an operating loss. In October 1998, the Company
decided to temporarily cease First Light's operations while it evaluated the
form and direction of its future contract commercial production operations. That
study is ongoing, and the Company has not yet determined whether it will renew
these operations, and if so whether it will do so under the First Light name,
through American Artists Films, or through another entity. Although the Company
may use the First Light name, the temporary cessation of its operations and
uncertain future made uncertain the future recovery of the remainder of the
goodwill which was recorded in connection with the Company's fiscal 1994
acquisition of First Light.



                                      -13-
<PAGE>   14

         As a result of the Company's decision to temporarily cease First
Light's operations, Ms. Vivian Jones, the president of First Light and a
director and co-president of the Company, tendered her resignation.

         Corporate/Industrial Videos

         In February 1998, the Company organized a division, "First Draft
Films," for purposes of creating and producing corporate/industrial videos. The
Company also hired an individual with a number of years of experience in this
field to oversee its operations and to serve as its president. First Draft Films
will seek to obtain contracts to produce corporate/industrial training,
marketing and other films. Generally, First Draft Films contracts and method of
operations would be similar to those for television commercials.

COMPETITION

         All of the industries in which the Company operates are extremely
competitive and include major corporations with substantially greater resources
than the Company.

         Film Development and Production

         The success of the Company's television and feature film operations is
heavily dependent upon public taste, which is unpredictable and subject to
change. In addition, filmed entertainment operating results fluctuate due to the
timing and performance of theatrical and home video releases. Release dates are
determined by several factors, including timing of vacation and holiday periods
and competition.

         Although the demand for low-cost quality media products has expanded
dramatically with the growth of cable, video and foreign markets, the production
of television specials and feature films remains dominated by major studios and
distributors. In addition, some major distributors such as Walt Disney, Turner
Broadcasting and Fox Broadcasting have acquired or developed their own
production companies. In this environment, the Company competes on the basis of
the artistic creativity of its projects and its commitment to low-cost quality
production.

         LSVD Operations

         This segment of the LSVD industry is in its infancy and has not drawn a
great deal of domestic attention outside of the LSVD operation in Times Square,
New York. Similar to other new and highly profitable media and communication
industries, the Company expects a number of new entrants into the marketplace.
These new entrants may come from a number of other industries, including
multimedia, outdoor advertising, consumer electronics, telecommunications,
entertainment and cable/network television. Companies in these industries may
have considerable human and financial resources, and may seek to capture a
certain market share. The Company plans to compete based upon its experience
gained during the development of this concept.

         Contract Production

         The contract production industry is subject to extreme price
competition and is highly fragmented. The Company competes in this industry with
numerous national and regional companies, no one of which has a major market
share. The Company competes primarily on the basis of the skills of its
executive producers, directors and production staff, and the advantages of
Atlanta as a production center.

INTELLECTUAL PROPERTY

         The Company's success and ability to compete will be dependent in part
upon its ability to obtain and maintain protection for its current and future
literary properties, to defend its intellectual property rights and to operate
without infringing on the proprietary rights of others, See "Item 3 Legal
Proceedings." While the Company relies on a combination of copyrights and
trademarks to establish and protect its intellectual property rights, management
of the Company believes that factors such as the technical and creative skills
of its personnel are more essential to its success and ability to compete. There
can be no assurance that any intellectual property rights of the Company will
provide competitive advantages or will not be challenged, invalidated or
circumvented by competitors. There can be no assurance that disputes will not
arise concerning the ownership of intellectual property. Furthermore, there can
be no assurance that intellectual properties will not become known or be
independently



                                      -14-
<PAGE>   15

developed by competitors or that the Company will be able to maintain the
confidentiality of information relating to its literary properties.

GOVERNMENT REGULATIONS

         In a decision released September 6, 1995, the Federal Communications
Commission ("FCC") repealed its financial interest and syndication rules,
effective as of September 21, 1995. Those FCC rules, which were adopted in 1970
to limit television network control over television programming and thereby
foster the development of diverse programming sources, had restricted the
ability of the three established, major U.S. television networks (ABC, CBS and
NBC) to own and syndicate television programming. The impact of the repeal of
the FCC's financial interest and syndication rules on the Company's operations
cannot be predicted at the present time, although it is expected that there will
be increased in-house production of television programming for the network's own
use. It is possible that this change will have a negative impact on the
Company's business.

         On February 1, 1996, Congress passed the Telecommunications Act of 1996
(the "1996 Act"), and it was signed into law on February 8, 1996. The 1996 Act
is the first comprehensive re-write of the Communications Act of 1934, as
amended (the "1934 Act") and dramatically changes the ground rules for
competition and regulation in virtually all sectors of the telecommunications
industry, from local and long-distance telephone services to broadcasting, cable
television, and equipment manufacturing. The 1996 Act eliminates many entry
barriers to the telecommunications business, relaxes concentration and merger
rules, and delegates authority for implementing such Act to the FCC.

         The impact on the Company of the changes to the 1934 Act brought about
by the 1996 Act and by accompanying changes in FCC rules cannot be predicted at
the present time, although it is expected that there will be an increase in the
demand for video programming products as a result of the likelihood that these
regulatory changes will facilitate the advent of additional exhibition sources
for such programming. However, it is possible that recent alliances of certain
program producers and television station group owners, coupled with the recent
FCC rule revision allowing a single television station licensee to own
television stations reaching up to 35% of the nation's television households,
may place additional competitive pressures on program suppliers who are not
aligned with any television station group owners.

         The Company may also be subject, in certain international markets, to
local content and quota requirements which effectively prohibit or limit access
to particular markets.

         The Classification and Rating Administration of the Motion Picture
Association of America, an industry trade association, assigns ratings for
age-group suitability for motion pictures. The Company submits its feature films
for such ratings. Management's current policy is to produce motion pictures that
qualify for a rating no more restrictive than "R."

EMPLOYEES

         As of March 2, 1999, the Company has nine full-time employees. In its
production activities, the Company relies primarily upon independent third
parties for production facilities and personnel. A portion of the salaries
payable to the Company's employees are paid, from time to time, directly from
the production budgets of the projects on which the individuals are working. The
Company hires additional personnel for projects on a contract basis as needed.
Such individuals are generally paid directly from the budget of the projects on
which they are working.

         The Company is a signatory to The Writers Guild of America and is
subject to its industry-wide collective bargaining agreement. False River, LLC
is a signatory to the Screen Actors Guild and Directors Guild of America, Inc.
The Company is not a party to any other collective bargaining agreement.
However, it is possible that some of the Company's business activities may be
affected by the existence of collective bargaining agreements since many of the
performing artists and technical personnel, such as cameramen and film editors,
that it employs from time to time on specific projects are members of unions.
The extent to which collective bargaining agreements may affect the Company is
difficult to estimate and strikes related to collective bargaining or other
collective actions by union members could, in the future, delay or disrupt
activities.


                                      -15-
<PAGE>   16


ITEM 2.  DESCRIPTION OF PROPERTY

         The Company leases as its headquarters a facility of approximately
4,500 square feet located at 6600 Peachtree Dunwoody Road, Building 600, Suite
250 in Atlanta, Georgia. Rent under the lease, which expires in January 2001, is
$5,500 per month. The Company does not own sound stages and related production
facilities (generally referred to as a "studio") and, accordingly, does not have
the fixed payroll, general, administrative and other expenses resulting from
ownership and operation of a studio. Studio facilities are generally available
for rental as needed.

         DETV/Atlanta entered into a lease agreement in January 1998 for the
premises for the proposed LSVD screen in Atlanta, Georgia. This lease agreement
defined, among other things, the premises, rent provisions and operating
guidelines for the proposed LSVD operation. This lease agreement was contingent
upon the completion of financing within a specific period of time. The financing
contingency expired without resolution in July 1998. Based upon discussions with
various parties associated with the lease, management believes that despite the
expiration of the contingency period, DETV/Atlanta will be able to obtain the
lease of this proposed location, if and when it otherwise is ready to commence
operation.

ITEM 3.  LEGAL PROCEEDINGS

         In June 1997, the Company settled all known issues related to an
arbitration proceeding commenced in May 1995 by its co-producer of the Angels
television specials. As a condition of the settlement, the Company agreed to pay
its co-producer $140,000 over a period of fourteen months commencing in June
1997. The Company completed its final installment of the $140,000 payment
obligation, as directed by this agreement, in July 1998.

         There has been substantial litigation in the entertainment industry
with respect to literary properties. The Company has no formal procedure for
monitoring the possible infringement of its literary properties by others or for
confirming that its literary properties do not infringe the rights of others,
but the Company does address specific issues as they are brought to its
attention from time to time. In 1992 the Company received approximately $350,000
in settlement of its claim that a certain motion picture then in production
infringed upon a literary property of the Company.

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

         Not Applicable

                                     PART II

ITEM 5.  MARKETS FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         The Class A common stock was approved by the National Association of
Security Dealers (NASD) for an unpriced quotation on the Over-the-Counter
("OTC") Bulletin Board under the symbol "AAFC" on November 15, 1996. The Class A
common stock began trading on the OTC Bulletin Board in December 1997.

         The following table sets forth the high and low bid prices, if
applicable, for the Class A common stock during each quarter of fiscal 1998 and
1997 as reported on the OTC Bulletin Board. The prices reported reflect
inter-dealer prices, may not represent actual transactions and do not include
retail mark-ups, mark-downs or commissions.

<TABLE>
<CAPTION>
                         Fiscal 1998      Fiscal 1997
                       --------------    -------------
                       High     Low      High     Low

         <S>          <C>      <C>       <C>      <C>
         1st Quarter     (1)      (1)     (1)      (1)
         2nd Quarter  $5.88    $5.56      (1)      (1)
         3rd Quarter   6.00     5.94      (1)      (1)
         4th Quarter   5.50     1.63      (1)      (1)
</TABLE>

(1) The Class A common began trading in December 1997.


                                      -16-
<PAGE>   17

         As of March 2, 1999 there were 3,319,745 shares of Class A common stock
outstanding and 323 record holders of such shares. The Company also has
outstanding shares of Class B common stock. There is no public market for the
Class B common stock, however, shares of the Class B common stock are
convertible, at the option of the holder, into shares of the Class A common
stock on a one-for-one basis. As of March 2, 1999, there were 3,225,516 shares
of Class B common stock outstanding and 112 record holders of such shares.

         The Company has not declared or paid any cash dividends on its common
stock since its formation, and the board of directors currently intends to
retain all of its earnings, if any, for its business. The declaration and
payment of cash dividends will be at the discretion of the board of directors.

         The Company commenced a private placement of its Class A common stock
in October 1998. As of March 2, 1999, the Company had sold 240,000 shares of
Class A common stock at $.50 per share in 4.8 units of 50,000 shares each. The
purchaser also received in each unit, without additional consideration, a
warrant to purchase up to 25,000 shares of Class A common stock at $1.30 per
share, exercisable through December 2001. Purchasers of fractional units
received a prorated warrant.

         In August 1997, a member of the board of director purchased 36,364
shares of Class A common stock for an aggregate price of $100,000. In connection
with this purchase, the Company also issued a common stock purchase warrant
allowing for the purchase of 37,000 shares of Class A common stock at $2.80 per
share, exercisable through June 30, 2000.

         The Class A common stock was sold by the Company, and on behalf of the
Company by directors and executive officers of the Company without commission or
additional compensation. All sales were for cash. The sales were made in
reliance upon the exemption from registration contained in Regulation D of the
Securities Act of 1933. All of the purchasers were "accredited investors" within
the meaning of Regulation D.

ITEM 6.   MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

         GENERAL

         As discussed elsewhere herein, on October 7, 1996, Old American Artists
and Setab merged in a transaction in which each of the 9,407,837 shares of Old
American Artists common stock became .5862 shares of common stock of the
Company, and the Company succeeded to the business of Old American Artists.

         Old American Artists is considered the predecessor to the Company, and
prior to and at the completion of the Merger, the Company, then Setab, had no
material assets, liabilities or operations. Additionally, for accounting
purposes, the Merger is being accounted for as a recapitalization of Old
American Artists, with the operating results of Old American Artists prior to
the Merger becoming the operating results of the Company for that period.

         Accordingly, the following discussion of financial condition and
results of operations focuses on the financial condition and results of
operations of Old American Artists.

         The Company is engaged in two lines of business; (i) the development
and production of television, cable and feature films, and (ii) the contract
production of films, generally television commercials and corporate industrial
videos. A third line of business, LSVD operations, is in the planning and
development stage.

         Revenues from the license or sale of films produced by the Company are
generally recognized when the film is exhibited or is available for distribution
in the applicable market. In general, the majority of the revenue to be derived
from a film will be earned during the two to three years following its initial
release. Accordingly, film revenues will fluctuate dependent on the timing of
the Company's production and release of films.

         Additionally, in some instances the level of revenues generated by a
film in the periods immediately following its release may not be directly
related to the film's success. As described below, the Company might sell
certain distribution rights, in advance of production, for fixed amounts as a
means of financing production costs. In those instances, the film's success
might not affect revenues initially, but could generate revenues later as the
result of distribution in secondary markets or the sale of ancillary products.


                                      -17-
<PAGE>   18

         The Company capitalizes the costs incurred to develop, produce and
print films, as well as advertising and other costs that benefit future periods.
Capitalized film costs are amortized, using the individual film forecast method,
under which capitalized costs are amortized based on total projected gross
revenues.

         Several factors can affect the relationship that amortized film costs
bear to film revenues. The Company has in the past exchanged, and may in the
future exchange, interest in the revenues from certain or all distribution for
contributions towards the costs of production. Capitalized costs, and the
related amortization, are reduced by such contributions, while revenues are
reduced for outside interests. Accordingly, the terms of the arrangements, which
can vary from film to film, in addition to the total costs of the film, will
affect the relationship of film costs to film revenues.

         The Company's contract production services are performed under
short-term (typically less than two months) agreements generally using fixed fee
agreements. Revenues and costs will therefore vary based on the number of
production assignments obtained and completed in any particular period, and the
profitability of the individual assignments. The number of production
assignments obtained in any particular period will be influenced by both the
overall level of contract production activity in the markets in which the
Company operates, and its success in competitive biddings, and can therefore
fluctuate significantly. Overall contract production activities are influenced
by, among other things, the general economic trends that effect the advertising
plans and expenditures of commercial and not-for-profit industries and
enterprises in the Company's geographic markets. Such general economic trends
and conditions can neither be controlled, nor predicted by the Company. The
Company's success in competitive biddings will depend on the potential
customer's assessment, relative to other bidders, of the production, talent and
capabilities offered by the Company and the quoted fee.

         The Company's contract commercial production operations, which were
conducted principally through First Light, suffered a significant decline in
revenues during the fourth quarter of fiscal 1998, and as a result incurred an
operating loss. In October 1998, the Company decided to temporarily cease First
Light's operations while it evaluated the form and direction of its future
contract commercial production operations. That study is ongoing, and the
Company has not yet determined whether it will renew these operations, an if so
whether it will do so under the First Light name, through American Artists
Films, or through another entity. Although the Company may use the First Light
name, the temporary cessation of its operations and uncertain future made
uncertain the future recovery of the remainder of the goodwill, which was
recorded in connection with the Company's fiscal 1994 acquisition of First
Light. Accordingly, the goodwill of $78,286 remaining at July 31, 1998 was
charged to operations in fiscal 1998.

         Although the Company has temporarily ceased the operations of First
Light, it continues to consolidate its accounts. First Light has a line of
credit, secured by its accounts receivable and guaranteed by the Company, which
the Company repaid in the first quarter of fiscal 1999 with the collection of
those accounts receivable amounts previously outstanding at July 31, 1998. The
Company is presently deferring the payment of First Light's other liabilities,
which consists principally of its accounts payable ($86,883 at July 31, 1998 and
$113,777 as of March 2, 1999). With the exception of accounts receivable, which
the Company has collected, and certain property and equipment, which the Company
can continue to use in its other operations, First Light has no significant
assets.

         As a result of the Company's decision to temporarily cease First
Light's operations, Ms. Vivian Jones, the president of First Light and a
director and co-president of the Company, tendered her resignation.

         RISK FACTORS

         Certain statements in the following discussion of financial condition
and the results of operations, or elsewhere in this report, represent
"forward-looking" statements as defined in the Private Securities Litigation
Reform Act of 1995. Such statements involve matters that are subject to certain
risks and uncertainties, as a result of which actual future results or events
may differ materially depending on a variety of factors.

         The future results of the Company's production of television specials
and feature films will be subject to a substantial degree of risk. Each project
is an individual artistic work, and its commercial success is primarily
determined by the reactions of distributors and the general public, each of
which is unpredictable. Historically, many feature films do not generate a net
profit or a return on investment, and there is a substantial degree of risk that
the production and exploitation of a film by the Company would not allow a
recovery of the costs incurred by the Company in its production. Additionally,
as discussed elsewhere herein, the Company will be required to raise



                                      -18-
<PAGE>   19

significant capital to pursue the production of the films it is presently
developing, either through the sale of revenue interests in the films, the
pre-production sale of distribution rights, or the sale of equity or debt
securities by the Company. There can be no assurance that the Company will be
able to raise the necessary funds to pursue the production of these films, which
creates an additional uncertainty.

         The LSVD industry is in its infancy and subject to a number of
uncertainties, all of which are normally inheritant in a new and developing
industry. The Company, as an entrant into this industry, will face a number of
these uncertainties including, the need to obtain regulatory approvals, to
obtain access to sufficient programming, and to secure sufficient funding. There
can be no assurances that the Company will have either the financial and human
resources required to adequately compete and remain in this industry.

         The Company commenced a private placement of its Class A common stock 
in October 1998, with an individual unit comprised of 50,000 shares of Class A 
common stock and a warrant to purchase 25,000 shares of Class A common stock at 
$1.30 through December 2001. Each unit was priced at $25,000 or $.05 per share. 
The term for this private placement expired on March 1, 1999, however, the 
Company has elected to extend the term date by amendment. As of March 2, 1999, 
the Company had sold 4.8 units for proceeds of $120,000 and may sell additional 
units. The sale of additional private placement units may result in substantial 
dilution to existing shareholders and the per share price ($.50) may differ 
substantially from the existing market price for such shares.

         In the contract production of commercials and corporate/industrial
videos, the Company competes in an industry that is highly fragmented and the
result of the operations can vary depending on the number of production
assignments obtained. The number of production assignments the Company obtains
is affected by various factors, including those discussed above and elsewhere
herein. The Company is not currently able to accurately predict the impact upon
its operations of the reassessment of its contract commercial operations.

         RESULTS OF OPERATIONS

         YEAR ENDED JULY 31, 1998 COMPARED TO YEAR ENDED JULY 31, 1997

         Revenues for the year ended July 31, 1998 ("fiscal 1998") decreased as
compared to revenues for the year ended July 31, 1997 ("fiscal 1997") as a
result of a decrease in both commercial production and film revenues. Revenues
for fiscal 1998 were $2,450,958 which represented a $1,439,634 or 37.0% decrease
from revenues of $3,890,592 for fiscal 1997.

         Commercial production revenues for fiscal 1998 decreased by $1,018,697
or 29.4% to $2,450,958 from $3,469,655 for fiscal 1997, due to a decrease in the
number of awarded commercial productions. In fiscal 1998, the number of
commercials productions decreased to twelve from twenty-two in fiscal 1997. As
previously discussed, the decline in contract commercial production revenues
occurred in the fourth quarter of fiscal 1998 and led to the Company's decision
to temporarily cease these operations.

         The level of the Company's commercial production revenues in each
period will depend on the size and number of projects it is awarded, which can
fluctuate dependent on changes in levels of commercial advertising expenditures
by advertisers, the number and commercial appeal of the commercial producers and
directors with which the Company is working in any one period, and the success
the Company and those producers and directors have in competing for projects.
Accordingly, the level of commercial revenues or growth therein in any one
interim period may not be indicative of trends that will continue throughout the
fiscal year. The number of directors utilized by the Company varies over time.
One individual, who directed commercials representing 61.8% of the Company's
revenues in fiscal 1997, ended her relationship with the Company in December
1997. The adverse effect of the loss of the Company's relationship with this
director was, during the second and third quarters of fiscal 1998, partially
offset by increases in commercial projects obtained with other directors with
which the Company has worked with throughout fiscal 1997 and 1998.

         Commercial production costs, as a percentage of related revenues, were
73.9% for the year ended July 31, 1998 as compared to 76.6% for the year ended
July 31, 1997. This decrease in commercial production costs, relative to
revenues, was primarily the result of an increase in the average size of awarded
commercial production contracts and resulting increased levels of gross profit
during the first quarter of fiscal 1998. Gross profits for commercial production
were $638,659 and $813,591 for fiscal 1998 and 1997, respectively.

         There were no film revenues for the year ended July 31, 1998 as
compared to film revenues of $420,937 for the year ended July 31, 1997. The
decrease in film revenues relates primarily to a delay in a scheduled broadcast
date for one of the Company's television film projects, currently titled When
Souls Meet. This project was initially scheduled for broadcast in March 1998 but
has been rescheduled for broadcast in June 1999. Film cost amortization
decreased from $362,214 for the year ended July 31, 1997 to $78,943 for the year
ended July 31, 1998. Film cost amortization for the year ended July 31, 1998
resulted from the write-down of certain film properties to their estimated net
realizable value.



                                      -19-
<PAGE>   20

         Selling, general and administrative ("SG&A") expenses increased
$460,963 to $1,808,376 for the year ended July 31, 1998 from $1,347,413 for the
year ended July 31, 1997. This increase was primarily the result of the addition
of several new staff positions in the commercial production segment and the
large screen video display and corporate/industrial video operations, the
amortization of the remaining goodwill of $78,286 related to the acquisition of
First Light, an increase in legal fees and travel and related expenses of
$66,751 caused by the Company's various efforts throughout fiscal 1998 to raise
capital, promotional costs of $24,994 related to the introduction of VCN and
DETV/Atlanta to prospective clients and the $122,618 write-off of advertising
credits.

         Consulting expenses increased by $650,000 for fiscal 1998 as result of
the two significant consulting contracts entered into during the year ended July
31, 1998. See Note 10 of the Notes to the Consolidated Financial Statements.

         Interest expense increased to $57,647 for fiscal 1998 from $15,746 for
the year ended July 31, 1997. This increase was the result of an increase in
outstanding debt during the year ended July 31, 1998.

         As a result of the foregoing factors the Company incurred a net loss of
$1,956,307 for the year ended July 31, 1998 as compared to a net loss of
$580,845 for the year ended July 31, 1997.

         The Company has provided a 100% valuation allowance against deferred
tax assets associated with its net operating loss carryforwards as management
has concluded that it is not "more likely than not" that the benefit of deferred
tax assets will be realized.

         LIQUIDITY AND CAPITAL RESOURCES

         The Company's strategic goal has been to finance its operating (i.e.
selling, general and administrative) expenses from the gross profits generated
by its television film, contract production operations and proposed LSVD
operations while utilizing equity financing, pre-production license revenues,
and co-producer contributions to finance the production of feature films. Using
this strategy, the Company seeks to reduce or eliminate the burden of
significant operating losses and negative cash flows, while retaining the
potential for significant profits and positive cash flows from successful
feature films. The success of such a strategy is, however, dependent on the
Company's ability to control operating expenses, to obtain sufficient, and
sufficiently profitable, commercial production contracts and television film
projects, and to fully develop its LSVD operations.

         Operating cash flows were a negative $1,547,380 and $763,426 for the
years ended July 31, 1998 and 1997, primarily as a result of shortfalls in the
coverage of SG&A and other expenses by television film and commercial production
profits. The operating cash flow shortfalls were financed with funds obtained
from debt financing, equity financing and the issuance of minority interests by
certain consolidated subsidiaries.

         Operating cash flows were affected by certain significant increases and
decreases in assets and liabilities during the year ended July 31, 1998. Film
costs increased by $819,949 primarily as a result of production activities on
the Company's first feature film project, currently titled "False River." This
feature film project was in the first stages of post-production at July 31,
1998. Accounts receivable decreased by $408,839 as a result of the collection of
a large accounts receivable previously outstanding at July 31, 1997 and a
decrease in contract commercial production revenues in the fourth quarter of
fiscal 1998.

         Cash provided by financing activities amounted to $1,553,890 for the
year ended July 31, 1998. During fiscal 1998, the Company raised $100,000 from
the private placement of its Class A common stock with a member of the board of
directors and raised $1,071,550 (partially offset by $515,752 in repayments) in
borrowings under notes payable, including $683,000 advanced from related parties
and $388,550 advanced from shareholders or obtained from bank borrowings which
were guaranteed by board members. Additionally, $545,610 used to fund the
activities of VCN and False River, was obtained from the issuance by those
entities of minority interests.

         The Company's consolidated financial statements have been prepared on
the basis of the continuation of the Company as a going concern, which
contemplates the realization of assets and the settlement of liabilities in the
normal course of business. The consolidated financial statements do not reflect
any adjustments which might be necessary if the Company were to be unable to
continue as a going concern.



                                      -20-
<PAGE>   21

         Since its inception, the Company has experienced a history of operating
losses and constrained cash flows, and has been unable to fully implement its
business plan due to insufficient capital resources. In fiscal 1998 the Company
incurred a net loss of $1,956,307, and negative operating cash flows of
$1,547,380, due to the losses suffered by its contract commercial production
operations, and a lack of film revenues (due to the release of no new films) and
the expenses incurred in pursuing its film and LSVD projects. At July 31, 1998
the Company had a deficit in stockholders' equity of $649,631 and a significant
working capital deficit. The Company was unable to meet certain debt service
requirements both during fiscal 1998 and subsequent to July 31, 1998. A
significant portion of notes payable and notes payable to related parties, which
amount to $1,026,926, is due on demand or matures in fiscal 1999, and the
Company is in arrears on and has been unable to renew its $225,000 bank line of
credit. Since July, 31, 1998 the Company has obtained $294,764 through
additional loans, principally from officers or directors, which for the most
part have been used to fund operations. As a result, at March 2, 1999 the
Company's total indebtedness under notes payable and notes payable to related
parties, net of debt repayments, has increased to $1,307,221, of which a
substantial portion matures in fiscal 1999 or is due on demand.

         These conditions raise substantial doubt concerning the Company's
ability to continue as a going concern. To continue in operations and pursue its
business plan, the Company must over the short-term raise additional capital and
reduce expenditures so as to be able to fund its operations and the payment of
those items of indebtedness that cannot be restructured or deferred, and over
the longer term must raise the capital necessary to complete a portion of its
film and LSVD projects and generate profits and positive cash flows therefrom.

         Management has developed a plan to address these requirements. The
elements of the short-term plan include the following:

         RAISE ADDITIONAL CAPITAL

         - Private placement offering. In October 1998, the Company commenced a
         $500,000 private placement offering of units comprised of the Company's
         Class A common stock and common stock purchase warrants. The Company
         has raised $120,000 from the sale of 4.8 units through March 2, 1999.

         - Pursue other sources of capital. Subsequent to year end, the Company
         engaged several firms to assist it in its capital raising efforts. To
         date these firms have introduced the Company to a number of potential
         capital sources, and on the basis of initial meetings the Company is
         cautiously optimistic that these efforts will provide the Company with
         new equity financing opportunities.

         - Borrowings from directors and stockholders. Subsequent to July 31,
         1998 the Company obtained loans from certain members of the board of
         directors and certain stockholders. The Company will attempt to
         continue to make use, if available, of these borrowings on a short-term
         basis while it pursues other capital.

         REDUCE OPERATING EXPENSES AND NET LOSSES

         - Temporary cessation of contract commercial production operations. As
         previously discussed, in October 1998 the Company temporarily ceased
         its commercial contract production operations, which had suffered a
         decline in revenues and a net loss in the last quarter of fiscal 1998.
         The Company is evaluating the form and direction of its future contract
         commercial production operations. While such operations are suspended,
         the Company estimates that it will realize cost savings of
         approximately $30,000 per month.

         - Voluntary salary reductions. In March 1998 the Company requested that
         all employees voluntarily reduce their salary levels. All employees
         participated in this voluntary reduction, which remains in effect.

         - Reduce staffing levels. The Company has reduced its staffing levels
         subsequent to July 31, 1998, principally through attrition, and has the
         ability to temporarily eliminate certain other positions, without
         suffering short-term revenue losses, if cash flow conditions require.
         Management will therefore continue to monitor and if necessary adjust
         staffing levels for certain projects to match cash flow availability.

         - Maximize short-term cash inflows from film projects. As previously
         discussed, the Company's False River film was screened as part of a
         special screening series in February 1999. Such screening marked the
         beginning of a process aimed at exposing the film to potential
         distributors. The Company also plans to



                                      -21-
<PAGE>   22

         submit False River for entry into several film festivals as part of its
         strategy to market this feature film project. The Company will, in
         negotiating with distributors, seek a license and/or sales agreement
         that maximizes the immediate or near-term cash payment it receives and
         offers the Company commitments for additional projects, in return for
         accepting a lesser than normal, or no, participation in the revenues or
         residual payments from the distribution of the film. A larger initial
         cash payment would allow the Company to both fund its operating
         expenses and finance the completion of certain other film projects,
         which then in turn could generate cash flows over the longer term.

         The elements of management's longer term plan include:

         - Revised approach to LSVD financing. Through fiscal 1998 the Company
         has been attempting to obtain traditional debt or equity financing for
         its proposed LSVD operations. Recently the Company modified its
         approach, and is now also seeking joint venture/strategic alliance
         partners among larger companies in related businesses. The Company
         believes that this approach may be more likely to attract the financing
         necessary to commence the proposed LSVD operation in Atlanta, which in
         turn would provide cash flows for operations and the pursuit of other
         LSVD and film projects.

         - Series programming relationship. The Company has increased its
         efforts to pursue relationships with cable television networks for the
         production of a series of programs, as a means of providing the Company
         with a more predictable backlog of projects and potential revenues. The
         Company is currently in negotiations for several specific series with
         one large cable network, and additionally has engaged as a consultant
         an individual from the cable network industry whose experience and
         relationships in that industry could, management believes,
         substantially improve the Company's ability to implement this strategy.

         There can be no assurance that any or all of the elements of the
Company's short-term or longer term plans can or will be successfully
implemented. Additionally, even if such initiatives are successful, they may not
be sufficient to alleviate the Company's short term cash flow and liquidity
problems, or in the long term generate revenues sufficient to sustain profitable
operations. Should the Company fail to alleviate its short-term cash flow and
liquidity problems, or over the longer term achieve profitable operations, the
Company will have to either reduce the scope of its activities or cease its
operations.

         RECENT ACCOUNTING PRONOUNCEMENTS

         In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS
130"), which establishes standards for reporting and display of comprehensive
income, its components and accumulated balances. Comprehensive income is defined
to include all changes in equity, except those resulting from investments by
owners and distributions to owners. Among other disclosures, SFAS 130 requires
that all items that are required to be recognized under current accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements.

         SFAS 130 is effective for financial statements for periods beginning
after December 15, 1997 and requires comparative information for earlier years
to be restated. The Company will adopt SFAS 130 in fiscal 1999 and anticipates
that the implementation of this standard will not affect the Company's financial
position or results of operations.

         In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information ("SFAS 131"), which supersedes Statement of
Financial Accounting Standards No. 14, Financial Reporting for Segments of a
Business Enterprise. SFAS 131 establishes standards for the manner in which
public companies report information about operating segments in annual financial
statements and requires reporting of selected information about operating
segments in interim financial statements issued to the public. It also
establishes standards for disclosures regarding products and services,
geographic areas and major customers. SFAS 131 defines operating segments as
components of a company about which separate financial information is available
that is evaluated regularly by the chief operating decision maker in deciding
how to allocate resources and in assessing performance.


                                      -22-
<PAGE>   23

         SFAS 131 is effective for financial statements for periods beginning
after December 15, 1997 and requires comparative information for earlier years
to be restated. The Company will adopt SFAS 131 in fiscal 1999. The Company has
not yet determined whether its reportable segments, under SFAS 131, will differ
from those it currently reports under SFAS 14. However, the adoption of this
disclosure standard will not affect the Company's financial position or results
of operations.

         In February 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 132, "Employers Disclosures
about Pension and Other Postretirement Benefits" ("SFAS 132"). SFAS 132 revises
employers' disclosures about pension and other postretirement benefit plans but
does not change existing measurement or recognition requirements related to such
plans. SFAS 132 also requires additional information on changes in the benefit
obligations and fair values of plan assets. The Company does not currently offer
postretirement benefits and anticipates that the adoption of SFAS 132 will not
have an effect on the Company's financial position or results of operations.

         In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments," ("SFAS 133"). SFAS 133 establishes accounting and reporting
standards for derivative instruments and hedging activities. SFAS 133 requires
that an entity recognize all derivatives as either assets or liabilities and
measure those instruments at fair market value. Under certain circumstances, a
portion of the derivative's gain or loss is initially reported as a component of
other comprehensive income and subsequently reclassified into income when the
transaction effects earnings. For a derivative not designated as a hedging
instrument, the gain or loss is recognized in income in the period of change.
The Company does not currently use derivative instruments either in hedging
activities or for investment purposes. Accordingly, the Company anticipates that
the adoption of SFAS 133 will not have an effect on the Company's financial
position or results of operations.

         YEAR 2000

         The year 2000 issue relates to computer programs and systems that
recognize dates using two digit year data rather than four digit year data. As a
result, such programs and systems may fail or provide incorrect information for
dates after December 31, 1999. If the year 2000 issue were to cause disruption
to the Company's internal information technology systems or to the information
technology systems of entities with whom the Company has commercial
relationships, material adverse effects to the Company's operations could
result.

         The Company's internal computer programs and systems consist of
programs and systems relating to virtually all segments of the Company's
business, including customer database management, marketing, production
budgeting and accounting, financial reporting, investor relations, proposal
generation, cash management and other key information systems. These programs
and systems are primarily comprised of:

         - Personal computers. These systems are used for all of the Company's
         computer programs and systems.
         - Telecommunications systems. These systems enable the Company to
         manage all its telecommunication services, including incoming/outgoing
         telephone calls and all connections to the internet.
         - Voicemail systems. These systems are used for receiving and storing
         messages to employees.
         - Ancillary services systems. These include such systems as heating,
         ventilation and air conditioning control systems and security systems.
         - Third party software programs. These programs are used throughout the
         Company in a number of business applications, including word
         processing, spreadsheets, budgeting, financial reporting, proposal
         generation, telecommunications management and internet access.

         The Company has not yet completed its reviews of these programs and
systems, but does not expect that any remediation relating to such programs and
systems that might be necessary following such reviews will cause the Company to
incur material costs or present implementation challenges that cannot be
addressed prior to the end of calendar 1999. The Company expects to complete its
reviews of these programs and systems during fiscal 1999.

         The computer programs and operating systems used by entities with whom
the Company has commercial relationships also pose potential problems relating
to the year 2000 issue, which may affect the Company's operations in a variety
of ways. These risks are more difficult to assess than those posed by internal
programs and systems and the Company has not yet completed the process of
formulating a plan for assessing them.



                                      -23-
<PAGE>   24

         The Company expects to complete the formulation of its plan for
assessing the programs and systems of the entities with whom it has commercial
relationships and the identification of the related risks and uncertainties by
the end of fiscal 1999. Once such assessment and identification has been
completed, the Company intends to resolve any material risks and uncertainties
that are identified by: 1) communicating further with the relevant vendors and
service providers, 2) working internally to identify alternative sourcing, and
3) formulating contingency plans to deal with such material risks and
uncertainties. The Company expects the resolution of such material risks and
uncertainties to be an ongoing process until all year 2000 problems are
satisfactorily resolved.

ITEM 7.  FINANCIAL STATEMENTS

         See index to financial statements on page F-1.


ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

         Not Applicable

                                    PART III

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

           The executive officers and directors of the Company are as follows:

<TABLE>
<CAPTION>
         NAME                       AGE      POSITION
         ----                       ---      --------

         <S>                        <C>      <C>
         Glen C. Warren (1)          67      Director, Chairman of the Board

         Steven D. Brown (1) (2)     52      Director, Chief Executive Officer

         Rex Hauck (2)               47      Director, President

         Robert A. Martinez          36      Vice President - Finance, Chief Financial Officer and
                                             Treasurer

         J. Eric Van Atta            34      Vice President, Secretary

         John Boyd                   62      Director

         Malcolm C. Davenport, V     47      Director

         Dan W. Holloway             76      Director

         Norman J. Hoskin            64      Director

         Ben Noble                   46      Director
</TABLE>

------------------------------
(1) Member of the Executive Committee of the board of directors
(2) Member of the Stock Option Committee of the board of directors

         GLEN C. WARREN, has served as Chairman of the Board of River Oaks
Hospital in Jackson, Mississippi, since 1988, President of Mississippi
Diagnostic Imaging Center, Ltd., since 1986 and as a clinical professor of
neurological surgery at the University of Mississippi School of Medicine since
1972. Dr. Warren became a director of the Company in July 1994. Dr. Warren
accepted the post of Chairman of the Board in August 1998.


                                      -24-
<PAGE>   25

         STEVEN D. BROWN - Mr. Brown founded the Company in July 1991 with Mr.
Hauck and has served as Chairman of the Board from July 1997 to August 1998, as
Co-Chairman of the Board from July 1994 through July 1997 and as Chief Executive
Officer since the Company's inception.

         REX HAUCK - Mr. Hauck founded the Company in July 1991 with Mr. Brown.
He served as Executive Vice President from the inception of the Company until
July 1994, when he was elected Co-Chairman of the Board, which position he held
from July 1994 until July 1997. Mr. Hauck also served as Co-President from July
1994 to October 1998 and has served President since October 1998.

         ROBERT A. MARTINEZ - Mr. Martinez joined the Company as Vice
President-Finance in December 1995 after nine years with the accounting firm of
BDO Seidman, LLP. Mr. Martinez became Treasurer in April 1996 and also assumed
the responsibilities of Chief Financial Officer in January 1997.

         J. ERIC VAN ATTA - Mr. Van Atta has served as Vice President and
Secretary of the Company since its inception in July 1991.

         JOHN BOYD, a private investor, was a physician on the staff of
Southwest Regional Medical Clinic from 1969 to January 1996 and President of
Boyd Medical Center in McComb, Mississippi, from 1965 to December 1995. Dr. Boyd
became a director of the Company in July 1991.

         MALCOLM C. DAVENPORT, V, has practiced law in West Point, Georgia,
since October 1993, originally as a sole practitioner and since 1996 as a
partner in the firm of Coulter & Davenport. Mr. Davenport previously practiced
law in Dalton, Georgia, as a sole practitioner from 1984 to 1991 and as a
partner in Ponder & Davenport, P.C., from 1991 to 1993. He is currently a
director of ITC DeltaCom, Inc. a communications holding company, and a director
and secretary of Spintek Gaming Technologies, Inc., a gaming technology
manufacturer and licensor. Mr. Davenport became a director of the Company in
July 1994.

         DAN W. HOLLOWAY, is a physician in private practice in Las Vegas,
Nevada and has been affiliated, as a resident physician, with Desert Springs
Hospital since 1982. Dr. Holloway has also served as Chairman of the Department
of Family Practice at Desert Springs Hospital since 1993. Dr. Holloway became a
director of the Company in September 1996.

         NORMAN J. HOSKIN, has been Chairman of the Board of Atlantic
International Capital, Inc. since July 1994. He was previously Chairman of
Atlantic Capital Group, Ltd., a venture capital advisory service, from 1986. Mr.
Hoskin is a director of Aquacare Systems, Inc., a producer of water purification
equipment, Consolidated Technologies Corp., a diversified manufacturing company,
COTG Technologies Group, Inc., a technology company, Trans Global Services,
Inc., a telephone and internet communications company and Sequential Information
Systems, Inc., a high-tech aircraft equipment company. Mr. Hoskin became a
director of the Company in September 1996. Mr. Hoskin has also served as
chairman and director of Tapistron International, Inc., a textile equipment
company.

         BEN E. NOBLE, is a private investor and has been president and chairman
of The Noble Group, Inc., a management, investment and consulting firm, since
1989. Mr. Noble became a director of the Company in March 1997.

         Each of the Company's directors is elected at the annual meeting of
stockholders and serves until the next annual meeting or until his successor has
been elected and qualified. Holders of Class A common stock and Class B common
stock, respectively, can elect a number of members of the board of directors
proportionate to the percentage which shares of the respective classes
constitute of the total outstanding shares of both classes, except that holders
of Class B shares in any event elect at least a majority of the directors.
Vacancies in the board of directors are filled by a majority vote of the
remaining members of the board of directors who were elected by the same class
of shareholders. Currently, there are no standing compensation arrangements for
non-executive board of director members. Executive officers of the Company are
elected by and serve at the discretion of the board of directors.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

         Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's officers, directors, and persons who own more than 10% of the
registered class of the Company's equity securities to file reports of



                                      -25-
<PAGE>   26

ownership with the Securities and Exchange Commission. Officers, directors and
greater than 10% stockholders are required by the regulations of the Securities
and Exchange Commission to furnish the Company with copies of all Section 16(a)
forms they file.

         Based solely on a review of the Forms 3 and 4 furnished to the Company,
the Company believes that all filing requirements applicable to its officers,
directors and greater than 10% beneficial owners were complied with.

         Form 5 is not required to be filed if there are not previously
unreported transactions or holdings to report. Nevertheless, the Company is
required to disclose the name of directors, executive officers and 10%
shareholders who did not file a Form 5, unless the Company has obtained a
written statement that no filing is due. The Company has been advised by those
required to file Form 5 that no filings were due.

ITEM 10. EXECUTIVE COMPENSATION

EXECUTIVE COMPENSATION

         The following table furnishes compensation information for the year
ended July 31, 1998, for the chief executive officer; no other executive
officers earned more than $100,000 during the year ended July 31, 1998. During
fiscal 1998, the Company's chief executive officer did not receive, and as of
July 31, 1998 did not hold any stock options or SARs which have been granted in
connection with his service to the Company in any capacity.

                           SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                        ANNUAL COMPENSATION
                                                --------------------------------
         NAME AND                      FISCAL                      OTHER ANNUAL
         PRINCIPAL POSITION             YEAR     SALARY    BONUS   COMPENSATION
         ------------------             ----     ------    -----   ------------
         <S>                           <C>      <C>        <C>     <C>
         Steven D. Brown                1998    $ 89,210    -0-        -0-
         Chief Executive Officer        1997      99,360    -0-        -0-
                                        1996     104,040    -0-        -0-
</TABLE>

STOCK OPTION PLAN

         In May 1996 the Company adopted its 1996 Stock Option Plan (the "Stock
Option Plan"). The purpose of the Stock Option Plan is to encourage growth in
shareholder value by providing financial incentives to selected members of its
board of directors, employees, consultants and advisors who are in positions to
make significant contributions toward that success. The aggregate number of
shares reserved for issuance under the Stock Option Plan is 2,500,000 shares.
Options granted under the Stock Option Plan can be either (i) options intended
to qualify as "incentive stock options" under Section 422 of the Internal
Revenue Code of 1986, as amended (the "Code"), or (ii) non-qualified stock
options. The Stock Option Plan permits the grant of stock appreciation rights in
connection with the grant of stock options. The Stock Option Plan is
administered by a stock option committee of the board of directors, consisting
of Messrs. Brown and Hauck. The stock option committee has the authority to
determine exercise prices applicable to the options, the eligible directors,
employees, consultants and advisers to whom options may be granted, the number
of shares and class of common stock subject to each option, and the extent to
which options may be exercisable. The stock option committee is empowered to
interpret the Stock Option Plan and to prescribe, amend and rescind the rules
and regulations pertaining to the Stock Option Plan. No option is transferable
by the optionee other than by will or the laws of descent and distribution, and
each option is exercisable during the lifetime of the optionee only by such
optionee.

         No incentive stock option granted under the Stock Option Plan may be
granted at a price less than the fair market value of the underlying common
stock on the date of grant (or less than 110% of fair market value in the case
of holders of 10% or more of the total combined voting power of all classes of
stock). Non-qualified stock options may be granted at the exercise price
established by the stock option committee, which may not be less than the fair
market value of the common stock on the date of grant.

         Each option granted under the Stock Option Plan is exercisable for a
period not to exceed ten years from the date of grant (or five years in the case
of a holder of more than 10% of the total combined power of all classes of


                                      -26-
<PAGE>   27

stock) and shall lapse upon expiration of such period, or earlier upon
termination of the recipient's employment with the Company or as determined by
the stock option committee.

         In June 1998, the Company amended its Stock Option Plan, primarily to
allow for the issuance of an additional 2,500,000 stock options and/or stock
appreciation rights, as provided for by the Stock Option Plan. In June 1998, the
Company also filed a Form S-8 registration statement to register the potential
issuance of the 2,500,000 additional shares underlying the Stock Option Plan, as
amended, in addition to 315,051 shares underlying employee stock options
previously granted under the Stock Option Plan.

         In December 1998, the Company re-priced the exercise price of certain
stock options that had been previously granted under its employee stock option
plan. The Company re-priced these options as follows: 1) 52,345 stock options
granted between November 21, 1995 and December 8, 1997 with exercise prices
ranging from $1.45 to $3.75 were re-priced to an exercise price of $1.00, and 2)
272,844 stock options granted between November 21, 1995 and December 8, 1997
with exercise prices ranging from $1.45 to $3.75 were re-priced to an exercise
price of $.50.

         Neither the Chief Executive Officer nor President of the Company had
any stock options affected by this re-pricing and with the exception of Robert
A. Martinez and J. Eric Van Atta, no executive officer held stock options that
were affected by the re-pricing. Mr. Martinez and Mr. Van Atta held,
respectively, 70,000 and 136,689 stock options, having exercise prices ranging
from $1.45 to $3.75, which were re-priced to exercise prices of $.50.

         In February 1999, the Company entered into two consulting agreements
("Consulting Agreements") with two entities for the performance of certain
strategic financial planning services and consulting in the areas of filmed
entertainment and LSVD operations. The Consulting Agreements call for these
entities to provide these services over a period of six month in exchange for
1,200,000 shares of the Company's Class A common stock, in the aggregate. The
Company has agreed to file a Form S-8 to register the issuance of these shares.

         As a result of these transactions, the consultants' beneficial
ownership in the Company's common stock will be as follows:

<TABLE>
<CAPTION>

Entity                  Class A         Class B        Class A and Class B
------                  -------        --------        -------------------
<S>                     <C>            <C>             <C>
Fontenelle, LLC          17.7%            --                   10.3%

FT Enterprises, Inc.      8.9%            --                    5.2%
</TABLE>

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The following table shows beneficial ownership of capital stock of the
Company at March 2, 1999, for the directors and officers of the Company, and for
each beneficial owner of 5% or more of either class of the Company's common
stock


<TABLE>
<CAPTION>
                                                      SHARES OF CLASS A                SHARES OF CLASS B
                                                      -----------------                -----------------
                                                        COMMON STOCK                     COMMON STOCK
                                                        ------------                     ------------
NAME                                               NUMBER        % OF CLASS         NUMBER        % OF CLASS
----                                               ------------------------         ------------------------
<S>                                               <C>              <C>              <C>             <C>
Steven D. Brown  (1)(6)                           600,100          18.08%           606,127         18.79%

Rex Hauck  (1)(2)(6)                              660,300          19.89%           601,029         18.63%

Robert A. Martinez  (1)(3)                          9,276            *               35,448          1.09%

J. Eric Van Atta  (1)(4)                           10,567            *              183,257          5.43%

John W. Boyd  (1)(5)                              455,096          13.25%            46,210          1.41%

Glen Warren (1)(6)(7)                             138,564           4.05%           475,486         14.07%

Malcolm C. Davenport, V (1)(8)                     41,866           1.25%           152,133          4.69%

Ben E. Noble (1)(9)                               113,332           3.34%                 0            *

Norman Hoskin (1)                                       0            *                    0            *

Dan Holloway (10)                                   2,667            *               35,172          1.08%

Vivian W. Jones (6)(11)
4319 Lehaven Circle Tucker, GA  30084             250,600           7.55%           179,050          5.55%
-----------------------------------------
All Officers and Directors as a Group (10
persons total)                                  2,031,768          55.66%         2,134,862        58.23%
                                                =========          =====          =========        ======
</TABLE>

           *      Any percentages under one percent (1%) are not shown.


                                      -27-
<PAGE>   28

         (1)      The address for the officers and directors is the corporate
office of the Company located at 6600 Peachtree Dunwoody Road, Building 600,
Suite 250, Atlanta, Georgia 30328.

         (2)      Includes 11,524 shares of Class B common stock and 200 shares
of Class A common stock owned by Mr. Hauck's minor children, as to which Mr.
Hauck disclaims beneficial ownership.

         (3)      Includes 8,276 shares of Class A common stock subject to
purchase under currently exercisable options and 35,448 shares of Class B common
stock subject to purchase under currently exercisable options.

         (4)      Includes 10,000 shares of Class A common stock subject to
purchase under currently exercisable options and 150,254 shares of Class B
common stock subject to purchase under currently exercisable option.

         (5)      Includes 43,965 shares of Class B common stock subject to
purchase under currently exercisable options and 115,000 shares of Class A
common stock subject to purchase under currently exercisable warrants. Also
includes 2,245 shares of Class B common stock and 100 shares of Class A common
stock owned by Mr. Boyd's spouse, as to which Mr. Boyd disclaims beneficial
ownership.

         (6)      Under an agreement (the "Voting Agreement") dated April 1996
Messrs. Brown, Hauck and Warren and Ms. Jones agreed to vote all their shares of
common stock of the Company ("Committed Shares") as a block in accordance with
the majority vote (by shares) among themselves. The Voting Agreement will remain
in effect until April 2001, unless sooner terminated by a written agreement
executed by shareholders holding of record a majority of the Committed Shares
then subject to the Agreement.

         (7)      Includes 154,851 shares of Class B common stock subject to
purchase under currently exercisable warrants and options and 102,000 shares of
Class A common stock subject to purchase under currently exercisable warrants.
Also includes 12,315 shares of Class B common and 100 shares of Class A common
stock owned by Dr. Warren's wife, as to which Dr. Warren disclaims beneficial
ownership.

         (8)      Includes (i) 87,830 shares of Class B common stock, (ii)
20,100 shares of Class A common stock and (iii) 6,666 shares of Class A common
stock subject to purchase under currently exercisable options, all of which are
held by Mr. Davenport as trustee of a family trust. Also includes 21,127 shares
of Class B common stock subject to purchase under currently exercisable options
and 15,000 shares of Class A common stock subject to purchase under currently
exercisable warrants.

         (9)      Includes 73,332 shares of Class A common stock subject to
purchase under currently exercisable warrants.

         (10)     Includes 35,172 shares of Class B common stock subject to
purchase under currently exercisable options.

         (11)     Includes 14,555 shares of Class B common stock and 100 shares
of Class A common stock owned by Ms. Jones' minor son as to which Ms. Jones
disclaims beneficial ownership, and 72,875 shares of Class B common stock and
400 shares of Class A common stock transferred by Ms. Jones to other relatives,
which shares continue to be subject to the voting agreement between Messrs.
Brown, Hauck, Warren and Ms. Jones. See Note (6).

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         Pursuant to an agreement dated August 31, 1993, and restructured
November 3, 1995, the Company acquired all of the outstanding stock of Current
Corporation (later renamed First Light Entertainment Corporation) from Ms.
Vivian Jones in exchange for 439,650 shares of Class B common stock and an
option to purchase up to 879,300 additional shares of Class B common stock on or
before September 1, 2003, at a price of $0.85 per share. Ms. Jones' options
became exercisable in three annual increments of 293,100 shares each, the last
of which vested September 1, 1996. Ms. Jones' option expired, without exercise,
in January 1999. Current Corporation, organized by Ms. Jones in August 1993, had
acquired certain assets of Jayan House, Ltd., a commercial production business
with which she had been employed, in exchange for its 4.37%, $100,000 principal
amount note, payable in 20 equal



                                      -28-
<PAGE>   29

quarterly installments of principal and interest commencing November 1993. First
Light Entertainment Corporation had not made the last two full quarterly
installments under this note agreement as of March 1999.

         From December 1993 through July 1997, Dr. Glen Warren purchased 86,205
shares of Class B common stock at an aggregate price of $125,000 ($1.45 per
share). In connection with certain of these purchases, Dr. Warren also received
warrants for the purchase of 25,862 shares of Class B common stock at a price,
to be determined by the related agreement, between $2.56 and $3.41.
These warrants expired without exercise in June 1998.

         In July 1993, Dr. Glen Warren and Dr. John Boyd personally secured a
$100,000 revolving bank line of credit for the benefit of the Company. In
September 1994, the revolving line of credit was replaced by a note which the
Company repaid in monthly installments. This note was paid in full in fiscal
1997.

         In June 1994, the Company purchased a 49% interest in Diversity
Filmworks, Inc., a newly incorporated corporation, consisting of 490 shares of
common stock, for a purchase price of $245. The owner of the other 51% is Tyrone
C. Johnson. In September 1996, the Company and Mr. Johnson entered into a
stockholder agreement pursuant to which the size of Diversity's board of
directors was set at five, of which three will be individuals designated by the
Company.

         From December 1993 to July 1997, the Company made seven loans totaling
$71,176 to Steven D. Brown, each of which was represented by an unsecured
promissory note due December 1998, with accumulated interest of 7% per annum. In
December 1998, the Company extended the due date of these notes to December
1999.

         From December 1993 to July 1997, the Company made five loans totaling
$54,767 to Rex Hauck, each of which was represented by an unsecured promissory
note due December 1998, with accumulated interest of 7% per annum. In December
1998, the Company extended the due date of these notes to December 1999.

         From December 1993 to July 1997, the Company made four loans totaling
$87,600 to Vivian Jones, each of which was represented by an unsecured
promissory note due December 1998, with accumulated interest of 7% per annum.
Ms. Jones repaid $23,000 against these notes in October 1996. In December 1998,
the Company extended the due date of these notes to December 1999.

         In April 1996 Messrs. Brown and Hauck, Dr. Warren and Ms. Jones entered
an agreement under which they agreed to vote all their shares of Class A and
Class B common stock as a block in accordance with the majority vote (by shares)
among themselves. By reason of their corporate offices, share ownership or
voting agreements they may be deemed "controlling persons" of the Company.

         In May 1996, the Company agreed to issue to Dr. Glen Warren options,
exercisable through June 2000, for the purchase of 28,208 shares of Class B
common stock, at $1.71 per share, contingent upon Dr. Warren arranging for the
Company a three month $75,000 line of credit. The line of credit was arranged in
July 1996. In November 1996, the Company converted this line of credit into a
six month unsecured note due May 1997 with a per annum interest rate of 8.75%.
The due date of the note has been subsequently extended at each successive due
date for an additional six month period. The note is currently due in November
1998. Dr. Warren is the co-signer on the note.

         The Company's original agreement dated May 16, 1995, as amended, with
Atlantic International Capital, Ltd., ("AIC"), of which Norman Hoskin is an
officer and stockholder, was terminated by mutual consent on September 27, 1996.
The Company then entered a new agreement retaining AIC, effective October 1,
1996, (i) to advise and offer counsel concerning communications and relations
with investors and with market makers in the common stock of the Company, and
(ii) to provide other business advice and counsel. This agreement was
terminated, by mutual consent of both parties, on October 31, 1996.

         In October 1996, Dr. Glen Warren and Malcolm C. Davenport, V each
loaned $25,000 to the Company for use as working capital and to fund operating
losses. The loans are due upon demand by the respective holders, but no later
than August 1997, and bear interest at the prime rate plus 1%. As consideration,
the Company issued each of the lenders an option to purchase up to 9,403 of
Class B common stock at $1.71 per share at any time through June 2000. The
Company re-paid $25,000 of these loans in June 1997; the remaining loan's fixed
due date was extended to August 1, 1998 and was settled in February 1998.



                                      -29-
<PAGE>   30

         In a private placement completed in May 1997, two directors of the
Company subscribed as follows for units consisting of 10,000 shares of Class A
common stock and a warrant, exercisable through June 2000, to purchase 3,333
shares of Class A common stock at a price of $3.00 per share: Mr. Noble, four
units for $100,000; and Mr. Davenport, two units for $50,000 (including one unit
as trustee of the Malcolm C. Davenport Trust).

         In April 1997, Dr. Glen Warren made a short-term advance, without
interest, of $30,000 to the Company for a period of eight days.

         In June 1997, Dr. Glen Warren loaned the Company $30,000. This demand
loan, as amended, bore interest at the prime rate plus 1% and was due on demand,
but no later than August 1, 1998. The Company settled this loan in August 1997.

         In July 1997 certain directors of the Company guaranteed revolving
lines of credit, or extended personal revolving lines of credit to the Company
in the following principal amounts; Messrs. Boyd, Davenport and Dr. Warren,
$75,000 each; Mr. Noble, $100,000. The lines of credit bear interest on loan
balances outstanding at the prime rate plus 1% and are due July 1998. As
consideration, in October 1997 the Company issued each member of the group
warrants for the purchase of 5,000 shares of Class A common stock at $4.58 per
share, exercisable through June 2000, in respect of each $25,000 of revolving
line of credit guaranteed or provided. The maturity date for the line of credit
with Mr. Noble was extended, by amendment, to April 1999.

         The revolving lines of credit related to Messrs. Boyd, Davenport and
Dr. Warren, amounting to $225,000 in the aggregate, were not extended by the
bank beyond July 1998. However, the guarantees have remained in place for these
lines of credit. The Company is currently discussing its various options with
the individual guarantors and the bank.

         In August 1997, Dr. Glen Warren purchased 36,364 shares of Class A
common stock for a an aggregate price of $100,000. In connection with this
purchase Dr. Warren also received a warrant to purchase 37,000 shares of Class A
common stock at $2.80 per share, exercisable through June 2000.

         In August 1997, Messrs.. Boyd, Davenport, Noble and Dr. Warren,
participated in the organization of Video Communications Network, LLC ("VCN"), a
83.3% owned subsidiary of the Company that is in the planning and development
stage. In exchange for nominal consideration, this group received 666 Ordinary
LLC shares of VCN, representing 6.7% of the outstanding Ordinary and Deferred
LLC shares.

         In October 1997, Ben E. Noble received warrants to purchase 40,000
shares of Class A common stock at a purchase price of $4.58 per share,
exercisable through June 2000, in consideration of his having agreed to join the
board of directors.

         In January 1998, the Company sold a portion of its interest in VCN,
representing 444 LLC shares, to Messrs. Boyd, Noble, Dr. Warren and a
shareholders for nominal consideration.

         In January 1998, Ben E. Noble extended a loan to the Company in the
amount of $75,000. This loan is unsecured, bear interest at the prime rate plus
1% and is due on demand.

         In February 1998, Dr. Glen Warren subscribed for one unit of a VCN
private placement offering. Each unit in the private placement was priced at
$100,000 and consisted of 222 LLC shares and a warrant to purchase 50,000 shares
of the Company's Class A common stock, exercisable at $3.00 per share through
January 2001.

         In February 1998, John Boyd extended a loan to the Company in the
amount of $75,000. This loan is unsecured, bear interest at the prime rate plus
1% and is due on demand.

         In April 1998, the Company entered into an agreement to pay Ben E.
Noble ten percent (10%) interest on his investments into False River, LLC. The
Company agreed to pay such interest in consideration of Mr. Noble being the
initial and largest investor in False River, LLC and agreed to pay such interest
until such time that his investments were repaid from the proceed of the sale of
any and all distribution rights associated with the feature film currently
titled False River.



                                      -30-
<PAGE>   31

         During the period of April 1998 to February 1999, certain members of
the board of directors purchased preferred distribution LLC share interests in
False River, LLC. The amount of funds received from the sale of these interests
were as follows: Ben E. Noble $311,526; Dr. Glen Warren $147,000; Norman Hoskin
$7,738; John Boyd $50,000 and Steven Brown $53,800.

         During the period of May 1998 to July 1998, Dr. Warren loaned the
Company $370,500, in the aggregate. These notes are unsecured, bear interest at
the prime rate plus 1% and are due on demand but no later than September 1999.

         In July 1998, Atlantic International Entertainment, Inc., a corporation
whose chairman, Norman Hoskin, is a member of the board of directors, purchased
preferred distribution LLC share interests in False River, LLC. These interests
had a purchase price of $100,000.

         In July 1998, Dr. Glen Warren extended a non-interest bearing loan
amounting to $37,500 to the Company, which was repaid in July 1998.

         In August 1998, Robert Martinez extended a loan to the Company
amounting to $26,264. This note is secured, bears interest at the prime rate
plus 1% and is due on demand but no later than September 1999. The Company has
pledged as security its interest in the ordinary LLC shares of False River, LLC
to the extent that any principal and accrued interest remain unpaid at maturity
under this note agreement.

         During the period of August 1998 to October 1998, Dr. Glen Warren
loaned the Company $68,000, in the aggregate. These notes are unsecured, bear
interest at the prime rate and are due on demand, but no later than September
1999.

         During the period of December 1998 to January 1999, Dr. Warren extended
loans to the Company amounting to $137,000. These loans are unsecured, bear
interest at the prime rate plus 1% and are due on demand.

         In February 1999, the Company issued to John Boyd a warrant to purchase
100,000 shares of the Company's Class A common stock as additional consideration
for his commitment to invest $50,000 in False River, LLC. The warrant is
exercisable at $.20 per share, through January 2004. False River, LLC received
$25,000 in January 1999 and $25,000 in February 1999 relative to this
commitment.

         In February 1999, Steve Brown extended a loan to the Company amounting
to $11,000. This note is secured, bears interest at the prime rate plus 1% and
is due on demand but no later than September 1999. The Company has pledged as
security its interest in the ordinary LLC shares of False River, LLC to the
extent that any principal and accrued interest remain unpaid at maturity under
this note agreement.

         In February 1999, Norman Hoskin extended a loan to the Company
amounting to $10,000. This loan is unsecured, bears interest at the prime rate
plus 1% and is due on demand, but no later than September 1999.













                                      -31-
<PAGE>   32





ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K

(A)  EXHIBIT LIST


EXHIBIT NUMBER                     DESCRIPTION

     2.1*          Agreement and Plan of Merger dated as of May 1, 1996 with
                   American Artists Film Corporation
     3.1*          Articles of Incorporation of the Registrant
     3.2*          Amended and Restated Bylaws of the Registrant
     3.3*          Amendment to Articles of Incorporation of the Registrant
                   adopted May 1, 1996
     3.4*          Articles of Incorporation of American Artists
     3.5*          Bylaws of American Artists
     3.6           Third Amended and Restated Bylaws of American Artists Film
                   Corporation, dated July 24, 1998
     3.7           Amendment of Articles of Incorporation of American Artists
                   Film Corporation dated January 26, 1999
     10.1*         Form of Indemnification Agreement
     10.2*         Consulting Agreement with Douglas J. Bates
     10.3*         Consulting Agreement with Alan G. Johnson
     10.4*         Promissory Note with Douglas J. Bates
     10.5*         Promissory Note with Alan G. Johnson
     10.6*         Common Stock Investment Agreement, dated February 24, 1992,
                   and the Agreement dated February 24, 1992, between American
                   Artists and Icon International, Inc., as extended by letter
                   dated August 21, 1995
     10.7*         Asset Purchase Agreement, dated August 1, 1993, between
                   Current Corporation and First Light Entertainment Corporation
     10.8*         Lease Agreement, dated August 5, 1993, between Kee Joint
                   Venture and Current Corporation, as renewed June 15, 1995
                   between Kee Joint Venture and First Light Entertainment
                   Corporation
     10.9*         Share Purchase Agreement, dated August 31, 1993, and
                   Amendment Agreement, dated November 3, 1995, between American
                   Artists and Vivian Walker Jones, with respect to shares of
                   First Light Entertainment Corporation
     10.10*        Agreement, dated April ___, 1994, between NBC Entertainment
                   and Greystone Communications, Inc., as supplemented by letter
                   agreement dated April 7, 1994, regarding Angels I
     10.11*        License Agreement, dated April 13, 1994, between Calling
                   Card Company, Inc. and American Artists, as supplemented by
                   letter agreement dated July 28, 1994
     10.12*        Letter Agreement, dated May 13, 1994, between Calling Card
                   Company, Inc. and American Artists
     10.13*        Joint Venture Agreement, dated May 20, 1994, between
                   Greystone Communications, Inc. and American Artists
     10.14*        Subscription Agreement, dated June 29, 1994, between American
                   Artists and First Light Diversity, Inc.
     10.15*        Agreement, dated July 26, 1994, between NBC Entertainment and
                   Greystone Communications, Inc., as supplemented by agreement
                   dated July 26, 1994, regarding Angels II
     10.16*        Distribution Agreement, dated July 26, 1994, as revised
                   October 10, 1994, between Alfred Haber Distribution, Inc. and
                   American Artists
     10.17*        Agreement, dated August 3, 1994, between American Artists
                   and Ballantine Books
     10.18*        License Agreement, dated as of August 8, 1994, between Time-
                   Life Video and American Artists
     10.19*        Promissory Note, dated September 13, 1994, made by John W.
                   Boyd and Glen C. Warren, to be paid to the order of Deposit
                   Guaranty National Bank

                                      -32-
<PAGE>   33

     10.20*        Financial Consulting Agreement, dated May 6, 1995, between
                   Atlantic International Capital, Ltd. and American Artists,
                   as amended by letter agreement dated May 1, 1996
     10.21*        American Artists 1995 Stock Option Plan, approved December 1,
                   1995
     10.22*        Voting Agreement, dated april 29, 1996, among Rex Hauck,
                   Steve Brown, Dr. Glen Warren, and Vivian Jones
     10.23*        License Agreement, dated as of April 30, 1996, between
                   American Artists and Turner Original Productions, Inc.,
                   regarding Angels I and Angels II
     10.24*        Development Agreement, dated June 14, 1996, between American
                   Artists and Turner Original Productions, Inc.
     10.25*        Articles of Incorporation of Millennium Group, L.L.C.
     10.26*        Operating Agreement of Millennium Group, L.L.C.
     10.27*        Articles of Organization of Death and Taxes Film Company,
                   L.L.C.
     10.28*        Form of Operating Agreement of Death and Taxes Film Company,
                   L.L.C.
     10.29*        Articles of Incorporation of First Light Entertainment
                   Corporation
     10.30*        Bylaws of First Light Entertainment Corporation
     10.31*        Articles of Incorporation of Diversity Film Works, Inc.
     10.32*        Bylaws of Diversity Film Works, Inc.
     10.33*        Unsecured Promissory Note dated July 17, 1996 issued to
                   Deposit Guaranty National Bank
     10.34*        Agreement with Liberty Transfer Co.
     10.35**       Voting Agreement between American Artists Film Corporation
                   and Tyrone C. Johnson
     10.36*        Lease Agreement, dated August 15, 1996, between
                   Kee Joint Venture and First Light Entertainment Corporation
     10.37*        Promissory Note, dated November 21, 1996, made by American
                   Artists Film Corporation and co-signed by Glen C. Warren, to
                   be paid to the order of Deposit Guaranty National Bank
     10.38*        Financial Consulting Agreement, dated May 16, 1995, between
                   Atlantic International Capital, Ltd. and American Artists, as
                   amended by letter agreements dated May 1, 1996 and September
                   27, 1996
     10.39*        Overhead Allocation Agreement between American Artists Film
                   Corporation and Diversity Filmworks, Inc. , dated July 31,
                   1996
     10.40*        Production Agreement, dated October 11, 1996, between
                   American Artists and Turner Original Productions, Inc.
     10.41*        Common Stock Investment Agreement, dated February 24, 1992,
                   and the Agreement dated February 24, 1992, between American
                   Artists and Icon International, Inc., as extended by letter
                   agreements dated August 21, 1995 and December 10, 1996
     10.42*        Amendment to Distribution Agreement, dated July 26, 1994, as
                   revised October 10, 1994, between Alfred Haber Distribution,
                   Inc. and American Artists (Amendment of Exhibit 10.16)
     10.43*        Termination Letter to Liberty Transfer Company
     10.44*        Amendment to Production Agreement, dated October 11, 1996,
                   between American Artists and Turner Original Productions,
                   Inc. (Amendment to Exhibit 10.40)
     10.45*        Common Stock Investment Agreement, dated February 24, 1992,
                   and the Agreement dated February 24, 1992, between American
                   Artists and Icon International, Inc., as extended by letter
                   agreements dated August 21, 1995 and December 10, 1996 and
                   October 20, 1997
     10.46*        Agreement with Continental Stock Transfer & Trust Company
                   dated November 6, 1996.
     10.47*        Promissory Note, dated May 20, 1997, made by Glen C. Warren,
                   to be paid to the order of Deposit Guaranty National Bank
     10.48*        Settlement Agreement and Release, dated May 29, 1997, by and
                   between Greystone Communications, Inc. and American Artists
                   Film Corporation
     10.49*        Letter of Agreement by and between Desmond Towey & Associates
                   and American Artists Film Corporation dated June 18, 1997
     10.50*        Promissory Note, dated July 17, 1997, made by Glen C. Warren,
                   John W. Boyd, and Malcolm C. Davenport, to be paid to the
                   order of First Bank of Childersburg
     10.51*        Production Agreement between King Arthur Productions, LLC and
                   American Artists Film Corporation


                                      -33-
<PAGE>   34

     10.52*        Subscription Agreement and Stock Purchase Agreement both
                   dated September 3, 1997 for Glen C. Warren
     10.53*        Agreement between Marion Woodman and American Artists Film
                   Corporation dated September 17, 1997
     10.54*        Agreement between The Episcopal Media Center and American
                   Artists Film Corporation dated September 18, 1997
     10.55*        Agreement between Robert Johnson and American Artists Film
                   Corporation dated September 25, 1997
     10.56*        Agreement between Georgia Public Television and American
                   Artists Film Corporation
     10.57*        Unsecured Promissory Note, dated as of October 2, 1996,
                   issued to Malcolm C. Davenport
     10.58*        Unsecured Promissory Note, dated as of October 3, 1996 issued
                   to Glen C. Warren
     10.59*        Unsecured Promissory Note, dated as of October 10, 1996,
                   issued to Martin Howard
     10.60*        Unsecured Promissory Note, dated as of June 3, 1997, issued
                   to Glen C. Warren
     10.61*        Letter of Agreement, dated July 17, 1997, by and between
                   American Artists Film Corporation and Ben Noble for an
                   unsecured revolving line of credit
     10.62*        Amendment to Promissory Note, dated as of July 31, 1997,
                   issued to Glen C. Warren (Amendment of Exhibit 10.58)
     10.63*        Amendment to Promissory Note, dated as of July 31, 1997,
                   issued to Glen C. Warren (Amendment of Exhibit 10.60)
     10.64*        Termination Letter, dated October 31, 1996, to Atlantic
                   International Capital, Ltd.
     10.65         Lease Amendment-Renewal, dated December 5, 1997, between Kee
                   Joint Venture, First Light Films/American Artists Film
                   Corporation and I.J. Kapplin Co.
     10.66         Third Party Licensing Agreement, dated February 9, 1998,
                   between Diversity Entertainment Television/Atlanta, LLC, and
                   Georgia Public Television Company
     10.67         Lease Agreement, dated January 12, 1998, between Underground
                   Festival, Inc., and Diversity Entertainment
                   Television/Atlanta, LLC
     10.68         Amendment Agreement, dated January 15, 1998, between Video
                   Communications Network, LLC and its Members
     10.69         Unsecured Promissory Note, dated January 21, 1998, issued to
                   Ben E. Noble
     10.70         Agreement, dated February 12, 1998, between Cable New Network
                   ("CNN") and Diversity Entertainment Television/Atlanta, LLC
     10.71         Unsecured Promissory Note, dated February 28, 1998, issued to
                   John W. Boyd
     10.72         Unsecured Promissory Note, dated March 16, 1998, issued to
                   Joseph Litner
     10.73         Third Party Licensing Agreement, dated April 1, 1998, between
                   Diversity Entertainment Television/Atlanta, LLC, and Georgia
                   Television Company d/b/a WSB-TV
     10.74         Production Agreement, dated April 6, 1998, between Crossing
                   Point, Inc., and American Artists Film Corporation.
     10.75         Amended and Restated Operating Agreement of False River, LLC,
                   dated April 1998
     10.76         False River Interest Agreement, dated April 30, 1998, between
                   Ben Noble and American Artists Film Corporation
     10.77         Financial Advisory and Consulting Agreement, dated May 1,
                   1998, between National Securities Corporation and American
                   Artists Film Corporation
     10.78         Unsecured Promissory Note, dated May 4, 1998, issued to Glen
                   C. Warren
     10.79         Unsecured Promissory Note, dated May 14, 1998, issued to Glen
                   C. Warren
     10.80         Unsecured Promissory Note, dated May 14, 1998, issued to Glen
                   C. Warren
     10.81         "Last Sunrise" Production Agreement, dated May 21, 1998,
                   between THC Entertainment, Inc., and American Artists Film
                   Corporation
     10.82         Amendment Agreement, dated May 29, 1998, to the Amended and
                   Restated Operating Agreement .of False River, LLC, between
                   False River, LLC and its Members
     10.83         Amendment #1 to the Loan and Security Agreement dated April
                   2, 1998, between Emergent Financial Corporation and First
                   Light Entertainment Corporation
     10.84         Unsecured Promissory Note, dated June 17, 1998, issued to
                   Glen C. Warren
     10.85         Media Relations and Consulting Agreement, dated June 23,
                   1998, between Stockstowatch.com, American Artists Film
                   Corporation and Third Parties
     10.86         Unsecured Promissory Note, dated June 26, 1998, issued to
                   Glen C. Warren


                                      -34-
<PAGE>   35

     10.87         Amendment #1 dated June 30, 1998, to the Media Relations and
                   Consulting Agreement, dated June 23, 1998, between
                   Stockstowatch.com, Inc., American Artists Film Corporation
                   and Third Parties
     10.88         Operating Agreement of Diversity Entertainment
                   Television/Atlanta, dated June 30, 1998
     10.89         Unsecured Promissory Note, dated July 2, 1998, issued to
                   Glen C. Warren
     10.90         Letter of Agreement, dated July 16, 1998, between Crawford
                   Communications, Inc., and Video Communications Network, LLC.
     10.91         Extension Letter of Agreement, dated July 17, 1997, between
                   American Artists Film Corporation and Ben E. Noble
     10.92         Settlement Agreement and Release, dated July 24, 1998,
                   between American Artists Film Corporation, Millennium Group,
                   LLC and Investors.
     10.93         Unsecured Promissory Note, dated December 1, 1998, issued to
                   Glen C. Warren
     10.94         "Miracles" Co-Production Agreement, dated July 29, 1998,
                   between Jeanette Ebaugh and American Artists Film Corporation
     10.95         Unsecured Promissory Note, dated July 31, 1998, issued to
                   Glen C. Warren
     10.96         Unsecured Promissory Note, dated August 6, 1998, issued to
                   Glen C. Warren
     10.97         Production Agreement, dated August 10, 1998, between Doris
                   Reynolds and American Artists Film Corporation
     10.98         Unsecured Promissory Note, dated August 14, 1998, issued to
                   Glen C. Warren
     10.99         Operating Agreement of Video Communications Network, LLC,
                   dated August 20, 1997
     10.100        Secured Promissory Note, dated August 26, 1998, issued to
                   Robert A. Martinez
     10.101        Unsecured Promissory Note, dated August 31, 1998, issued to
                   Glen C. Warren
     10.102        Secured Promissory Note, dated  September 14, 1998, issued to
                   Sandra Smallwood
     10.103        Sales Agreement, dated September 24, 1998, between Diversity
                   Entertainment Television/Atlanta, LLC, and International Food
                   Specialties
     10.104        "Miracles" Development Agreement, dated October 5, 1998,
                   between Home Box Office ("HBO") and American Artists Film
                   Corporation.
     10.105        Unsecured Promissory Note, dated October 6, 1998, issued to
                   Glen C. Warren
     10.106        Investor Relations Services Agreement, dated November 23,
                   1998, between Makenna Delaney & Sullivan and American Artists
                   Film Corporation
     10.107        Consulting Agreement, dated December 7, 1998, between
                   American Artists Film Corporation and Ron Qurashi
     10.108        Sublease Agreement, dated December 23, 1998, between CSX
                   Intermodal, Inc, American Artists Film Corporation and
                   Steven D. Brown
     10.109        Extension Letter for Promissory Notes dated December 31,
                   1998, by and between American Artists Film Corporation and
                   Steven D. Brown
     10.110        Extension Letter for Promissory Notes dated December 31,
                   1998, by and between American Artists Film Corporation and
                   Rex Hauck
     10.111        Extension Letter for Promissory Notes dated December 31,
                   1998, by and between American Artists Film Corporation and
                   Tyrone Johnson
     10.112        Extension Letter for Promissory Notes dated December 31,
                   1998, by and between American Artists Film Corporation and
                   Vivian W. Jones
     10.113        Extension Letter for Promissory Notes dated December 31,
                   1998, by and between American Artists Film Corporation and
                   J. Eric Van Atta
     10.114        Extension Letter for Promissory Notes dated December 31,
                   1998, by and between First Light Entertainment Corporation
                   and Vivian W. Jones
     10.115        Extension Letter for Promissory Notes dated December 31,
                   1998, by and between  First Light Entertainment Corporation
                   and Steven D. Brown
     10.116        Unsecured Promissory Note, dated January 15, 1999, issued to
                   Glen C. Warren
     10.117        Secured Promissory Note, dated January 15, 1999, issued to
                   Sandra Smallwood
     10.118        Amendment Letter Agreement dated as of February 1, 1999,
                   between American Artists Film Corporation and Home Box Office
                   ("HBO") in connection with the "Miracles" Development
                   Agreement dated as of October 5, 1998 between American
                   Artists Film Corporation and HBO
     10.119        Unsecured Promissory Note, dated February 1, 1999, issued to
                   Norman J. Hoskin
     10.120        Secured Promissory Note, dated February 16, 1999, issued
                   to Steven D. Brown
     10.121        Consulting Agreement, dated February 19, 1999, between
                   American Artists Film Corporation and Fontenelle, LLC


                                      -35-
<PAGE>   36

     10.122        Consulting Agreement, dated February 19, 1999, between
                   American Artists Film Corporation and F T Enterprises, Inc.
     10.123*       Loan and Security Agreement Between First Light Entertainment
                   Corporation and Emergent Financial Corp.
     23.1          Consent of BDO Seidman, LLP
     27.1          American Artists Entertainment Corporation Financial Data
                   Schedule (for SEC use only).

------------------------------------------------------------
*    Certain of the exhibits to this Report, indicated by an asterisk, are
     incorporated by reference to other documents on file with the Securities
     and Exchange Commission with which they were physically filed, to be part
     of hereof as of their respective dates. Documents to which reference is
     made are as follows:

(1)  Registration Statement on Form SB-2 (File No. 33-97196C) of Setab Alpha,
     Inc., filed on September 16, 1996.

(2)  Registration Statement on Form S-4 (File No. 333-4159) of Setab Alpha,
     Inc., filed September 16, 1996.

(3)  Annual Report on Form 10-KSB (File No. 000-20759) of American Artists Film
     Corporation for the year ended July 31, 1996.

(4)  Annual Report on Form 10-KSB (File No. 000-20759) of American Artists Film
     Corporation for the year ended July 31, 1997.

(5)  Quarterly Report on Form 10-QSB (File No. 000-20759) of American Artists
     Film Corporation for the quarter ended April 30, 1998

(B)  REPORTS ON FORM 8-K.

         The following report was filed on Form 8-K by the Company during the
quarter ended July 31, 1998:

                  (a) Form 8-K filed on June 24, 1998
















                                      -36-
<PAGE>   37

                                   SIGNATURES

         In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

Date:  March 11, 1999
                                    AMERICAN ARTISTS ENTERTAINMENT CORPORATION



                                    By:   /s/ Steven D. Brown
                                          --------------------------------------
                                          Steven D. Brown
                                          Chief Executive Officer and Director


         In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.

<TABLE>
<S>                                 <C>                                         <C>
/s/ Dr. Glen C. Warren              Director and Chairman                       March 11, 1999
-----------------------------
Dr. Glen C. Warren

/s/ Rex Hauck                       Director and President                      March 11, 1999
------------------------------
Rex Hauck

/s/ Robert A. Martinez              Vice President/Finance, Chief               March 11, 1999
------------------------------         Financial Officer and Treasurer
Robert A. Martinez

/s/ John W. Boyd                    Director                                    March 11, 1999
-----------------------------
John W. Boyd

/s/ Malcolm C. Davenport, V         Director                                    March 11, 1999
-----------------------------
Malcolm C. Davenport, V

/s/ Dan W. Holloway                 Director                                    March 11, 1999
-----------------------------
Dan W. Holloway

/s/ Norman J. Hoskin                Director                                    March 11, 1999
-----------------------------
Norman J. Hoskin

/s/ Ben E. Noble                    Director                                    March 11, 1999
-----------------------------
Ben E. Noble
</TABLE>






                                      -37-
<PAGE>   38


                   AMERICAN ARTISTS ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                          INDEX TO FINANCIAL STATEMENTS


<TABLE>
       <S>                                                                 <C>
       REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS                  F-2

       CONSOLIDATED BALANCE SHEET S                                        F-3

       CONSOLIDATED STATEMENTS OF OPERATIONS                               F-5

       CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CAPITAL DEFICIT)   F-6

       CONSOLIDATED STATEMENTS OF CASHFLOWS                                F-7

       NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                          F-8
</TABLE>








                                      F-1
<PAGE>   39

Report of Independent Certified Public Accountants


Board of Directors and Stockholders
American Artists Entertainment Corporation

We have audited the accompanying consolidated balance sheets of American 
Artists Entertainment Corporation (formerly American Artists Film Corporation) 
and Subsidiaries as of July 31, 1998 and 1997, and the related consolidated 
statements of operations, stockholders' equity (capital deficit), and cash 
flows for each of the years then ended. These financial statements are the 
responsibility of the Company's management. Our responsibility is to express an 
opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing 
standards. Those standards require that we plan and perform the audit to obtain 
reasonable assurance about whether the financial statements are free of 
material misstatement. An audit includes examining, on a test basis, evidence 
supporting the amounts and disclosures in the financial statements. An audit 
also includes assessing the accounting principles used and significant 
estimates made by management, as well as evaluating the overall financial 
statement presentation. We believe that our audits provide a reasonable basis 
for our opinion.

In our opinion, the consolidated financial statements referred to above present 
fairly, in all material respects, the financial position of American Artists 
Entertainment Corporation (formerly American Artists Film Corporation) and 
Subsidiaries at July 31, 1998 and 1997, and the results of their operations and 
their cash flows for each of the years then ended in conformity with generally 
accepted accounting principles.

The accompanying consolidated financial statements have been prepared assuming
the Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company incurred a significant net loss in fiscal 1998
and has a capital deficiency at July 31, 1998. These matters raise substantial
doubt about the ability of the Company to continue as a going concern.
Management's plans in regard to these matters are also discussed in Note 2. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.


                                            BDO SEIDMAN, LLP

Atlanta, Georgia
March 2, 1999



                                      F-2
<PAGE>   40


                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                      July 31,
                                                            ----------------------------
                                                               1998              1997
                                                            ----------        ----------

<S>                                                         <C>               <C>
ASSETS

CASH                                                        $   35,568        $   31,379

ACCOUNTS RECEIVABLE                                             99,998           508,837

FILM COSTS, NET OF ACCUMULATED AMORTIZATION (NOTE 1)         1,230,231           493,912

PROPERTY AND EQUIPMENT, NET (NOTES 1 AND 4)                     28,221            41,193

GOODWILL, NET OF ACCUMULATED AMORTIZATION (NOTE 1)                  --           117,429

ADVANCES TO OFFICERS (NOTE 1)                                  253,012           220,719

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

                                                            $1,647,030        $1,413,469
                                                            ==========        ==========
</TABLE>

                    See accompanying notes to consolidated financial statements.


                                      F-3
<PAGE>   41

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                     CONSOLIDATED BALANCE SHEETS (CONTINUED)

<TABLE>
<CAPTION>
                                                                                July 31,
                                                                    -------------------------------
                                                                        1998                1997
                                                                    -----------         -----------
<S>                                                                 <C>                 <C>
LIABILITIES
LINE OF CREDIT (NOTE 6)                                             $    52,549         $        --
ACCOUNTS PAYABLE                                                        392,421             342,860
ACCRUED EXPENSES                                                         72,026             180,790
ACCRUED PROFESSIONAL FEES                                               161,816             193,510
COMMON STOCK ISSUABLE (NOTE 1)                                           45,313                  --
NOTES PAYABLE (NOTE 7)                                                  406,426             316,128
NOTES PAYABLE/RELATED PARTIES (NOTE 8)                                  620,500             155,000
                                                                    -----------         -----------
TOTAL LIABILITIES                                                     1,751,051           1,188,288
                                                                    -----------         -----------

MINORITY INTERESTS (NOTES 3, 4 AND 5)                                   545,610              50,000

CONTINGENCIES

STOCKHOLDERS' EQUITY (CAPITAL DEFICIT) (NOTE 9)
PREFERRED STOCK - SHARES AUTHORIZED 10,000,000;  NONE ISSUED                 --                  --
COMMON STOCK, $.001 PAR:
  CLASS A - SHARES AUTHORIZED 20,000,000; ISSUED AND
  OUTSTANDING 3,157,789 AND 876,620                                       3,158                 877
  CLASS B - SHARES AUTHORIZED 20,000,000; ISSUED AND
  OUTSTANDING 3,282,472 AND 5,502,277                                     3,282               5,502
ADDITIONAL PAID-IN CAPITAL                                            3,916,933           2,908,117
UNAMORTIZED ADVERTISING CREDITS                                              --            (122,618)
ACCUMULATED DEFICIT                                                  (4,573,004)         (2,616,697)
                                                                    -----------         -----------
TOTAL STOCKHOLDERS' EQUITY (CAPITAL DEFICIT)                           (649,631)            175,181
                                                                    -----------         -----------

                                                                    $ 1,647,030         $ 1,413,469
                                                                    ===========         ===========
</TABLE>

                     See accompanying notes to consolidated financial statements



                                      F-4
<PAGE>   42

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>
                                                       Year Ended July 31,
                                               -------------------------------
                                                   1998                1997
                                               -----------         -----------
<S>                                            <C>                 <C>
REVENUES (NOTE 1)
Commercial production                          $ 2,450,958         $ 3,469,655
Film revenues (Note 1)                                  --             420,937
                                               -----------         -----------

                                                 2,450,958           3,890,592
                                               -----------         -----------

COSTS AND EXPENSES
Cost of commercial production                    1,812,299           2,656,064
Film cost amortization                              78,943             362,214
Consulting expenses (Note 10)                      650,000                  --
Selling, general and administrative              1,808,376           1,347,413
                                               -----------         -----------

                                                 4,349,618           4,365,691
                                               -----------         -----------

LOSS FROM OPERATIONS                            (1,898,660)           (475,099)

Interest expense                                    57,647              15,746
Other expense                                           --              90,000
                                               -----------         -----------

NET LOSS                                       $(1,956,307)        $  (580,845)
                                               ===========         ===========

NET LOSS PER SHARE - BASIC AND DILUTED         $      (.30)        $      (.09)
                                               ===========         ===========
WEIGHTED AVERAGE COMMON SHARES (NOTE 1)          6,414,314           6,172,977
                                               ===========         ===========
</TABLE>

                     See accompanying notes to consolidated financial statements


                                      F-5
<PAGE>   43

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

       CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CAPITAL DEFICIT)


<TABLE>
<CAPTION>
                                                                                                                 Total
                                                                                                                 Stock-
                                                                                       Un-                       holders'
                                                                           Additional  amortized                 Equity
                       Class A            Class B                          Paid-In     advertising  Accumulated  (Capital
                     Common Stock       Common Stock      Common Stock     Capital     credits      Deficit      Deficit)
                    Shares  Amount     Shares  Amount   Shares    Amount
                 --------------------------------------------------------------------------------------------------------
<S>              <C>       <C>         <C>    <C>     <C>        <C>        <C>        <C>        <C>           <C>
Balance - July
31, 1996                -  $    -          -  $    -  9,407,837  $ 470,392  $2,125,117 $(122,618) $(2,035,852)  $ 437,039

Merger with
Setab Alpha,
Inc. accounted
for as a
recapitalization
(Note 1):

Recapitalization
of outstanding
common stock       12,600      13  5,502,277   5,502 (9,407,837)  (470,392)    464,877         -            -           -

Acquisition of
net assets of
Setab Alpha,
Inc.              700,020     700          -       -          -          -        (700)        -            -           -

Offering costs          -                  -       -          -          -    (105,000)        -            -    (105,000)

Issuances of
common stock
(Note 9(b))       164,000     164          -       -          -          -     409,836         -            -     410,000

Award of stock
options (Note
9(a))                   -       -          -       -          -          -      13,987         -            -      13,987

Net loss                -       -          -       -          -          -           -         -     (580,845)   (580,845)
                ---------------------------------------------------------------------------------------------------------
Balance - July
31, 1997          876,620   $ 877  5,502,277  $5,502          -          -  $2,908,117 $(122,618) $(2,616,697)   $175,181

Consulting
agreement (Note    
10(a))             25,000      25          -       -          -          -     149,975         -            -     150,000

Write-down of
advertising
credits (Note 1)        -       -          -       -          -          -           -   122,618            -     122,618

Contribution of
stock warrants
to VCN (Note 4)         -       -          -       -          -          -     299,933         -            -     299,933

Private
placement (Note    
9(b))              36,364      36          -       -          -          -      99,964         -            -     100,000

Consulting
agreement (Note         
10(b))                  -       -          -       -          -          -     446,450         -            -     446,450

Award of stock
options (Note           
9(a))                   -       -          -       -          -          -      12,494         -            -      12,494

Common stock
conversions     2,219,805   2,220 (2,219,805) (2,220)         -          -           -         -            -           -

Net loss                -       -          -       -          -          -           -         -   (1,956,307) (1,956,307)
                ---------------------------------------------------------------------------------------------------------
Balance - July
31, 1998        3,157,789  $3,158  3,282,472  $3,282          -          -  $3,916,933 $       -  $(4,573,004)  $(649,631)
                =========================================================================================================
</TABLE>

                       See accompany notes to consolidated financial statements.



                                      F-6
<PAGE>   44
                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS


<TABLE>
<CAPTION>
                                                                               Year Ended July 31,
                                                                       -------------------------------
                                                                          1998                1997
                                                                       -----------           ---------
<S>                                                                    <C>                   <C>
OPERATING ACTIVITIES
  Net loss                                                             $(1,956,307)          $(580,845)
  Adjustments to reconcile net loss to cash used in operating
     activities:
     Film costs amortization                                                78,943             362,214
     Depreciation and amortization                                         255,339              59,425
     Consulting expense                                                    596,450                  --
     Award of stock options                                                 12,494              13,987
      Changes in assets and liabilities:
         Accounts receivable                                               408,839            (401,380)
         Film costs additions                                             (819,949)           (380,249)
         Other assets                                                      (32,293)             (3,360)
         Accounts payable                                                   49,561             173,079
         Accrued expenses                                                 (140,457)              5,570
         Deferred revenue                                                       --             (11,867)
                                                                       -----------           ---------
Cash used in operating activities                                       (1,547,380)           (763,426)
INVESTING ACTIVITIES
  Capital expenditures                                                      (2,321)             (9,347)
                                                                       -----------           ---------
FINANCING ACTIVITIES
  Borrowings under line of credit, net                                      52,549                  --
  Repayment of notes payable                                              (515,752)           (140,848)
  Borrowings under notes payable                                         1,071,550             535,000
  Issuances of common stock                                                100,000             410,000
  Issuances of stock warrants                                              299,933                  --
  Minority interests                                                       545,610                  --
                                                                       -----------           ---------
Cash provided by financing activities                                    1,553,890             804,152

NET INCREASE IN CASH                                                         4,189              31,379

                                                                       -----------           ---------
CASH, beginning of year                                                     31,379                  --
                                                                       -----------           ---------
CASH, end of year                                                      $    35,568           $  31,379
                                                                       ===========           =========
</TABLE>

                     See accompanying notes to consolidated financial statements



                                      F-7
<PAGE>   45

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF BUSINESS

         American Artists Entertainment Corporation (the "Company" or "American
Artists"), which prior to February 1999 was known as American Artists Film
Corporation, legally changed its name on February 5, 1999. The Company, directly
and through its subsidiaries, engages in the development, production and
exploitation of made-for-television and feature length motion pictures, and in
the commercial contract production of film products, principally television
commercials and corporate/industrial videos. The Company classifies its
operations in two business segments: (i) film development and production, which
includes the development and production of both cable or television films and
specials and feature films, and (ii) contract production, which includes the
production of both commercials and corporate/industrial videos. The Company's
film development and production operations involve the granting of credit to
film exhibitors and distributors. The Company's contract production operations
involve the granting of credit to clients and advertising agencies that
represent clients in various industries.

         During fiscal 1997 and 1998, the Company incurred developmental and
organizational expenses for a new business segment focused on the development
and operation of a network of large screen video display ("LSVD") units. This
segment is in the planning and development stage and has not generated any
revenues.

         The Company obtains its revenues from discrete project assignments
obtained from various clients. Accordingly, while the fees from one or more
clients may, in any one year, be significant as the result of the size of a
project undertaken for that client, the Company is not dependent on any one
client for a material amount of its continuing revenues.

         During fiscal 1998, two of the Company's customers accounted for fees
equal to 54.3% and 12.5% of consolidated revenues. During fiscal 1997, three of
the Company's customers accounted for fees equal to 21.2%, 19.7% and 12.2% of
consolidated revenues.

BASIS OF PRESENTATION

         The consolidated financial statements include the accounts of American
Artists, First Light Entertainment Corporation ("First Light"), a wholly-owned
subsidiary, Diversity Filmworks, Inc. ("Diversity"), a 49% owned subsidiary,
Millennium Group, LLC ("Millennium"), a wholly-owned subsidiary, False River,
LLC ("False River"), a 51% owned subsidiary and Video Communications Network,
LLC ("VCN"), a majority-owned subsidiary. The Company also consolidates the
accounts of Diversity Entertainment Television/Atlanta, LLC ("DETV/Atlanta"),
which it controls through VCN's majority ownership in DETV/Atlanta. American
Artists and its subsidiaries are collectively referred to as "AAEC Group."

         AAEC Group conducts its television, feature film and television
commercial operations under the name of American Artists Films, a division of
American Artists and conducts its corporate/industrial video operations under
the name of First Draft Films, a division of American Artists.

         Through the end of fiscal 1998 the Company conducted its contract
commercial production operations through its First Light subsidiary. First Light
suffered a significant decline in revenues during the fourth quarter of fiscal
1998, and as a result incurred an operating loss. In October 1998, the Company
decided to temporarily cease First Light's operations while it evaluated the
form and direction of its future contract commercial production operations. That
study is ongoing and the Company has not yet determined whether it will renew
these operations, and if so whether it will do so under the First Light name,
through American Artists Films, or through another entity. Although the Company
may use the First Light name, the temporary cessation of its operations and
uncertain future made uncertain the future recovery of the remainder of the
goodwill which was recorded in connection with the Company's fiscal 1994
acquisition of First Light. Accordingly, the goodwill of $78,286 remaining at
July 31, 1998 was charged to operations in fiscal 1998.


                                      F-8
<PAGE>   46

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         Although the Company has temporarily ceased the operations of First
Light, it continues to consolidate its accounts. First Light has a line of
credit, secured by its accounts receivable and guaranteed by the Company, which
the Company repaid in the first quarter of fiscal 1999 with the collection of
First Light's accounts receivable. The Company is presently deferring the
payment of First Light's other liabilities, which consist primarily of its
accounts payable ($86,883 at July 31, 1998 and $113,777 as of March 2, 1999).
With the exception of accounts receivable, which the Company collected
subsequent to July 31, 1998, and certain property and equipment, which the
Company can continue to use in its operations, First Light has no significant
assets.

         As a result of the Company's decision to temporarily cease First
Light's operations, Ms. Vivian Jones, the president of First Light and a
director and co-president of the Company, tendered her resignation.

         Diversity was formed by American Artists and a qualified minority owner
to engage in contract production as a qualified minority contractor. The Company
and the other stockholder of Diversity have an agreement as to the size and
composition of Diversity's board of directors. As a result, the Company
consolidates the accounts of Diversity in its consolidated financial statements.

         Millennium, a limited liability company, was formed to produce and
distribute a sixty minute video. As of July 31, 1998, Millennium's activities
have been limited to pre-production story development. In July 1998, the Company
acquired 100% of the outstanding LLC shares of Millennium in exchange for 25,000
shares of the Company's Class A common stock. These shares were valued at
$45,313 based upon the closing share price of the Company's Class A common stock
on the date of the agreement. These shares were issued subsequent to July 31,
1998 and the liability related to the contractual obligation to issue these
shares is presented as a component of liabilities in the consolidated balance
sheet at July 31, 1998.

          Prior to this acquisition, the Company exercised control through its
capacity as manager, which position allowed it to direct the operations of
Millennium, its purchase and sale of assets, issuance of debt or equity
securities, and execution of contracts and agreements, without the approval of
the other LLC shareholders. The minority interest at July 31, 1997 relates to
Millennium.

         False River was organized in fiscal 1998 to develop and produce a
feature film, currently titled False River (See Note 3). VCN, and its subsidiary
DETV/Atlanta, were organized in fiscal 1998 in connection with the Company's
plans to develop and operate large screen video display units (See Notes 4 and
5).

         In accordance with Statement of Financial Accounting Standards No. 53
"Financial Reporting by Producers and Distributors of Motion Picture Films"
("SFAS No. 53"), AAEC Group presents an unclassified balance sheet.

         The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Certain
amounts in the consolidated balance sheet have been reclassified for comparative
purposes.

FILM COSTS AND REVENUES

         Cost incurred to develop stories, acquire story rights, produce and
print films, and advertising or other distribution costs which benefit future
markets, are capitalized as film costs when incurred. All other advertising and
distribution costs are expensed as incurred.

         AAEC Group finances certain of its projects by granting revenue
participations to outside investors in exchange for investments in the
production of the film. Capitalized film costs are reduced by the financing
provided under these arrangements.


                                      F-9
<PAGE>   47

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         Capitalized film costs are amortized using the individual film forecast
method under which capitalized costs are amortized based on the relationship
between the gross revenue realized and the estimate of the total gross revenues
to be earned by the film over its life. Revenue estimates are reviewed
periodically and, when appropriate, are revised. Where unamortized film costs
exceed a revised estimate of total future gross revenues, film costs are written
down to net realizable value. In fiscal 1998, the Company directly wrote-off
$78,943 from projects in development that were determined to be unlikely to be
pursued.

         The components of capitalized film costs were as follows:

<TABLE>
<CAPTION>
                                                        July 31,
                                          --------------------------------------
                                                 1998               1997
                                          --------------------------------------
            <S>                           <C>                       <C>
            Released                             $ 1,185,560        $ 1,185,560
            Accumulated amortization              (1,174,643)        (1,174,643)
                                          --------------------------------------
                                                      10,917             10,917
            In production                            745,632             34,181
            In development                           473,682            448,814
                                          --------------------------------------

                                                 $ 1,230,231         $  493,912
                                          ======================================
</TABLE>

         The above amounts do not include any value for four developed scripts
contributed to AAEC Group in 1991 by its founding stockholders in exchange for
common stock. In accordance with generally accepted accounting principles, the
scripts were recorded at zero, which, because no amounts had been expended for
the development of the scripts, represented the cost basis of the contributing
stockholders, and the stated value of the common shares issued, $238,000, was
charged against additional paid-in capital.

         In general, the majority of the revenue to be derived from a film will
be earned during the two to three years following its release. On the basis of
American Artists' current production projections, which could change in the
future based on the availability of production funding, film demand and other
factors, 40% of the unamortized film costs will be amortized over the two year
period that will end July 31, 2000 and 60% will amortized over the four year
period that will end July 31, 2002.

         Film revenues are recognized, in accordance with SFAS No. 53, generally
when the film has been accepted by the licensee, where applicable, collection of
license fees is reasonably assured, and the film is exhibited or is available
for distribution in the applicable market. Films are generally first exhibited
in television markets, and then are distributed on videotape. Revenues from the
foreign exhibition or sale of films are denominated in U.S. dollars. Minimum
guaranteed amounts from video license agreements, and from book royalties, are
recognized when the applicable license period begins and the film or book is
available to the distributor; amounts in excess of the minimum guarantee are
recognized when earned. Revenues are reduced for amounts payable on account of
revenue participations, which are accrued on the same basis as film costs are
amortized.

         The components of film revenues were as follows:

<TABLE>
<CAPTION>
                                             Year Ended July 31,
                                    --------------------------------------
                                          1998             1997
                                    --------------------------------------
             <S>                    <C>                  <C>
             Television                   $   -          $ 406,991
             Foreign video                    -             13,946
                                    --------------------------------------
                                          $   -          $ 420,937
                                    ======================================
</TABLE>


                                      F-10
<PAGE>   48
                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

CONTRACT PRODUCTION

         AAEC Group produces film products, primarily television commercials and
corporate/industrial videos, for customers under fixed fee arrangements, which
typically are less than two months in duration. Revenues and cost attributed to
these contracts are recognized over the life of the contract using the
percentage-of-completion method of accounting. Under that method, revenue and
related costs are recognized based on the percentage of the contract completed,
which is estimated on the basis of the relationship of the costs incurred to
total estimated costs, except that provision is made currently for the full
amount of any anticipated losses on contracts in progress.

PROPERTY AND EQUIPMENT

         Property and equipment are stated at cost. Depreciation is provided
using the straight-line method over the estimated life of the related asset. The
components of property and equipment are as follows:

<TABLE>
<CAPTION>
                                                     Useful                 July 31,
                                                                  -------------------------------
                                                     Lives           1998                1997
                                                    ---------------------------------------------
            <S>                                     <C>           <C>                  <C>
            Office furniture and fixtures           5 - 7 years   $  91,683            $ 89,362
            Leasehold improvements                   -               35,000              35,000
            Production equipment                    5 - 7 years       7,498               7,498

                                                                ---------------------------------
                                                                    134,181             131,860
            Less accumulated depreciation and
              amortization                                         (105,960)            (90,667)
                                                                ---------------------------------
                                                                  $  28,221            $ 41,193
                                                                =================================
</TABLE>

ADVANCES TO OFFICERS

         AAEC Group has, on certain occasions, made cash advances to certain
officers which generally bear interest at 7% per annum. Management anticipates
that these advances will be repaid through their offset against future
compensation. (See Note 15(i)).

UNAMORTIZED ADVERTISING CREDITS

         In fiscal 1992, American Artists issued shares of its common stock in
exchange for advertising credits that entitled American Artists to purchase
advertising credit having an aggregate "standard cost" value of $500,000. The
credits were recorded on the basis of $0.85 per share, based on per share prices
of shares of common stock issued for cash during the same period. The
unamortized advertising credits were presented as a reduction of stockholders'
equity reflecting the acquisition of the credits for common stock.

          At July 31, 1998, the Company determined that it would be unable to
fully utilize these credits prior to their expiration in December 1998. As a
result, the Company recorded a $122,618 charge to operations to fully amortize
these advertising credits at July 31, 1998.

INCOME TAXES

         AAEC Group files a consolidated income tax return and provides for
income taxes under Statement of Financial Accounting Standards No. 109
"Accounting for Income Taxes." Under that standard, deferred income taxes are
provided on the difference between the financial reporting and tax bases of
assets and liabilities. A valuation allowance is provided to the extent that
management estimates that it is more likely than not that the benefit of
deferred tax assets will be realized.

                                      F-11
<PAGE>   49

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

EARNINGS PER SHARE

         The Company adopted the requirements of Statement of Financial
Accounting Standards No. 128, "Earnings Per Share," effective January 31, 1998,
and restated the earnings per share amounts for prior periods. The restatement
did not have any effect on previously presented earnings per share amounts.

         Basic and diluted earnings per share are computed on the basis of net
income or loss divided by the weighted average number of common shares (Class A
and Class B) outstanding during the relevant period. Diluted earnings per share
excludes the effects of stock options and warrants (and is therefore the same as
basic earnings per share) as their effects would be anti-dilutive due to the net
losses. There were 3,634,618 and 2,791,972 anti-dilutive common stock options
and common stock warrants outstanding at July 31, 1998 and 1997, respectively.

CASH AND CASH EQUIVALENTS

         Cash and cash equivalents are generally comprised of demand deposits
and time deposits or highly liquid debt instruments with original maturities of
three months or less. The Company's cash balances do not involve any significant
concentrations of credit risk.

FAIR VALUE OF FINANCIAL INSTRUMENTS

         The Company believes that the estimated fair values of its financial
instruments, which are notes payable, approximates the carrying values of such
financial instruments in all material respects. The carrying value of notes
payable approximates fair value since these notes substantially bear interest at
floating rates based upon the lenders "prime" rate.

MERGER WITH SETAB ALPHA, INC.

         In October 1996 the Company completed a merger (the "Merger") with
Setab Alpha, Inc. ("Setab") whereby Setab acquired 100 percent of the
outstanding common stock of American Artists Film Corporation ("Old American
Artists") in exchange for the issuance of 12,600 shares of the Setab's Class A
common stock and 5,502,277 shares of Setab's Class B common. Upon completion of
the Merger, Setab as the surviving corporation, changed its name to American
Artists Film Corporation. In February 1999, the surviving corporation changed
its name to American Artists Entertainment Corporation.

         The Merger resulted in the issuance of a controlling interest in Setab
to the stockholders of Old American Artists. Because of this, and because Setab
did not have any material operations, the Merger was accounted for as a
recapitalization of Old American Artists in which (i) Old American Artists is
deemed to have (a) created a second class of common stock, such that its
authorized capital consisted of Class A and Class B common stock, each with a
par value of $.001, and (b) exchanged for the outstanding shares of its common
stock, an aggregate of 12,600 shares of Class A common stock and 5,502,277
shares of Class B common stock, and (ii) issued 700,020 shares of Class A common
stock (representing the number of shares outstanding after the completion of
Setab's public offering) in exchange for the net assets of Setab, recorded at
their historical costs.

         The Merger effectively resulted in a reverse split of the Company's
common stock on a basis of .5862 to 1. The effects of this reverse split has
been retroactively applied to the earliest periods presented for all share and
per share amounts related to the Company's outstanding common stock, stock
options and warrants.

RECENT ACCOUNTING PRONOUNCEMENTS

         In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS
130"), which establishes standards for reporting and


                                      F-12
<PAGE>   50
                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

display of comprehensive income, its components and accumulated balances.
Comprehensive income is defined to include all changes in equity, except those
resulting from investments by owners and distributions to owners. Among other
disclosures, SFAS 130 requires that all items that are required to be recognized
under current accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements.

         SFAS 130 is effective for financial statements for periods beginning
after December 15, 1997 and requires comparative information for earlier years
to be restated. The Company will adopt SFAS 130 in fiscal 1999 and anticipates
that the implementation of this standard will not affect the Company's financial
position or results of operations.

         In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information ("SFAS 131"), which supersedes Statement of
Financial Accounting Standards No. 14, Financial Reporting for Segments of a
Business Enterprise. SFAS 131 establishes standards for the manner in which
public companies report information about operating segments in annual financial
statements and requires reporting of selected information about operating
segments in interim financial statements issued to the public. It also
establishes standards for disclosures regarding products and services,
geographic areas and major customers. SFAS 131 defines operating segments as
components of a company about which separate financial information is available
that is evaluated regularly by the chief operating decision maker in deciding
how to allocate resources and in assessing performance.

         SFAS 131 is effective for financial statements for periods beginning
after December 15, 1997 and requires comparative information for earlier years
to be restated. The Company will adopt SFAS 131 in fiscal 1999. The Company has
not yet determined whether its reportable segments, under SFAS 131, will differ
from those it currently reports under SFAS 14. However, the adoption of this
disclosure standard will not affect the Company's financial position or results
of operations.

         In February 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 132, "Employers Disclosures
about Pension and Other Postretirement Benefits" ("SFAS 132"). SFAS 132 revises
employers' disclosures about pension and other postretirement benefit plans but
does not change existing measurement or recognition requirements related to such
plans. SFAS 132 also requires additional information on changes in the benefit
obligations and fair values of plan assets. The Company does not currently offer
postretirement benefits and anticipates that the adoption of SFAS 132 will not
have an effect on the Company's financial position or results of operations.

         In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments," ("SFAS 133"). SFAS 133 establishes accounting and reporting
standards for derivative instruments and hedging activities. SFAS 133 requires
that an entity recognize all derivatives as either assets or liabilities and
measure those instruments at fair market value. Under certain circumstances, a
portion of the derivative's gain or loss is initially reported as a component of
other comprehensive income and subsequently reclassified into income when the
transaction effects earnings. For a derivative not designated as a hedging
instrument, the gain or loss is recognized in income in the period of change.
The Company does not currently use derivative instruments either in hedging
activities or for investment purposes. Accordingly, the Company anticipates that
the adoption of SFAS 133 will not have an effect on the Company's financial
position or results of operations.

NOTE 2 - ABILITY TO CONTINUE AS A GOING CONCERN

         The Company's consolidated financial statements have been prepared on
the basis of the continuation of the Company as a going concern, which
contemplates the realization of assets and the settlement of liabilities in the
normal course of business. The consolidated financial statements do not reflect
any adjustments which might be necessary if the Company were to be unable to
continue as a going concern.


                                      F-13
<PAGE>   51

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         Since its inception, the Company has experienced a history of operating
losses and constrained cash flows, and has been unable to fully implement its
business plan due to insufficient capital resources. In fiscal 1998 the Company
incurred a net loss of $1,956,307, and negative operating cash flows of
$1,547,380, due to the losses suffered by its contract commercial production
operation, and a lack of film revenues (due to the release of no new films) and
the expenses incurred in pursuing its film and LSVD projects. At July 31, 1998
the Company had a deficit in stockholders' equity of $649,631 and a significant
working capital deficit. The Company was unable to meet certain debt service
requirements both during fiscal 1998 and subsequent to July 31, 1998. A
significant portion of notes payable and notes payable to related parties, which
amount to $1,026,926, is due on demand or matures in fiscal 1999, and the
Company is in arrears on and has been unable to renew its $225,000 bank line of
credit. Since July, 31, 1998 the Company has obtained $294,764 through
additional loans, principally from officers or directors, which for the most
part have been used to fund operations. As a result, at March 2, 1999 the
Company's total indebtedness under notes payable and notes payable to related
parties, net of debt repayments, has increased to $1,307,221, of which a
substantial portion is due on demand or matures in fiscal 1999.

         These conditions raise substantial doubt concerning the Company's
ability to continue as a going concern. To continue in operations and pursue its
business plan, the Company must over the short-term raise additional capital and
reduce expenditures so as to be able to fund its operations and the payment of
those items of indebtedness that cannot be restructured or deferred, and over
the longer term must raise the capital necessary to complete a portion of its
film and LSVD projects and generate profits and positive cash flows therefrom.

         Management has developed a plan to address these requirements. The
elements of the short-term plan include the following:

         RAISE ADDITIONAL CAPITAL

         - Private placement offering. In October 1998, the Company commenced a
         $500,000 private placement offering of units comprised of the Company's
         Class A common stock and a common stock purchase warrants. The Company
         has raised $120,000 from the sale of 4.8 units through March 2, 1999.

         - Pursue other sources of capital. Subsequent to year end, the Company
         engaged several firms to assist it in its capital raising efforts. To
         date these firms have introduced the Company to a number of potential
         capital sources, and on the basis of initial meetings the Company is
         cautiously optimistic that these efforts will provide the Company with
         new equity financing opportunities.

         - Borrowings from directors and stockholders. Subsequent to July 31,
         1998 the Company obtained loans from certain members of the board of
         directors and certain stockholders. The Company will attempt to
         continue to make use, if available, of these borrowings on a short-term
         basis while it pursues other capital.

         REDUCE OPERATING EXPENSES AND NET LOSSES

         - Temporary cessation of contract commercial production operations. As
         previously discussed, in October 1998 the Company temporarily ceased
         its contract commercial production operations, which had suffered a
         decline in revenues and a net loss in the last quarter of fiscal 1998.
         The Company is evaluating the form and direction of its future contract
         commercial production operations. While such operations are suspended,
         the Company estimates that it will realize cost savings of
         approximately $30,000 per month.

         - Voluntary salary reductions. In March 1998 the Company requested that
         all employees voluntarily reduce their salary levels. All employees
         participated in this voluntary reduction, which remains in effect.

         - Reduce staffing levels. The Company has reduced its staffing levels
         subsequent to July 31, 1998, principally through attrition, and has the
         ability to temporarily eliminate certain other positions, without

                                      F-14
<PAGE>   52

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         suffering short-term revenue losses, if cash flow conditions require.
         Management will therefore continue to monitor and if necessary adjust
         staffing levels for certain projects to match cash flow availability.

         - Maximize short-term cash inflows from film projects. As previously
         discussed, the Company's False River film was screened as part of a
         special screening series in February 1999. Such screening marked the
         beginning of a process aimed at exposing the film to potential
         distributors. The Company also plans to submit False River for entry
         into several film festivals as part of its strategy to market this
         feature film project. The Company will, in negotiating with
         distributors, seek a license and/or sales agreement that maximizes the
         immediate or near-term cash payment it receives and offers the Company
         commitments for additional projects, in return for accepting a lesser
         than normal, or no, participation in the revenues or residual payments
         from the distribution of the film. A larger initial cash payment would
         allow the Company to both fund its operating expenses and finance the
         completion of certain other film projects, which then in turn could
         generate cash flows over the longer term.

         The elements of management's longer term plan include:

         - Revised approach to LSVD financing. Through fiscal 1998 the Company
         has been attempting to obtain traditional debt or equity financing for
         its proposed LSVD operations. Recently the Company modified its
         approach, and is now also seeking joint venture/strategic alliance
         partners among larger companies in related businesses. The Company
         believes that this approach may be more likely to attract the financing
         necessary to commence the proposed LSVD operation in Atlanta, which in
         turn would provide cash flows for operations and the pursuit of other
         LSVD and film projects.

         - Series programming relationship. The Company has increased its
         efforts to pursue relationships with cable television networks for the
         production of a series of programs, as a means of providing the Company
         with a more predictable backlog of projects and potential revenues. The
         Company is currently in negotiations for several specific series with
         one large cable network, and additionally has engaged as a consultant
         (See Note 15(g)) an individual from the cable network industry whose
         experience and relationships in that industry could, management
         believes, substantially improve the Company's ability to implement this
         strategy.

         There can be no assurance that any or all of the elements of the
Company's short-term or longer term plans can or will be successfully
implemented. Additionally, even if such initiatives are successful, they may not
be sufficient to alleviate the Company's short term cash flow and liquidity
problems, or in the long term generate revenues sufficient to sustain profitable
operations. Should the Company fail to alleviate its short-term cash flow and
liquidity problems, or over the longer term achieve profitable operations, the
Company will have to either reduce the scope of its activities or cease its
operations.

NOTE 3  - FALSE RIVER, LLC

         In March 1998, the Company organized False River, LLC ("False River")
for the purpose of producing a feature film, currently titled False River. In
exchange for nominal consideration, the Company obtained 100% of the ordinary
LLC shares of False River. The operating agreement, as amended and restated,
also provides for the issuance of preferred distribution LLC shares, which are
entitled to a preferred distribution from net profits, as defined. However, the
preferred distribution shares may not constitute more than 49% of the ownership
interest in False River.

         As of July 31, 1998, False River had sold interests in the preferred
distribution shares for proceeds amounting to $545,200. An officer, certain
members of the board of directors, and a corporation whose chairman is a
director of the Company purchased $505,200 of these preferred distribution share
interests.

                                      F-15
<PAGE>   53

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         False River's operating agreement provides for various sharings in the
distribution of any operating profits. Initially, the holders of the preferred
distribution shares will be entitled to receive 150% of their initial
investment. After that distribution, False River is next obligated to pay from
any profits an aggregate of $172,000 to certain parties who contributed creative
or organizational efforts for the False River project, including the Company,
which would be entitled to receive $57,000. Thereafter, any profits would be
distributed 49% to the holders of the preferred distribution shares and 51% to
the Company. From that 51%, the Company would be obligated to pay 20.75% of its
interest (or 10.5825% of False River profits) to creative and technical
personnel associated with the project to whom the Company granted such
participations as inducements. Additionally, the Company has agreed to pay
interest, at the rate of 10% per year, on the investment of $311,526 in
preferred distribution shares made by the initial investor in False River, who
is a director of the Company. Such interest will be paid until the investor
receives distributions from False River equal to that initial investment.

         As a condition of employing certain union members during the production
of this feature film, False River was required to sign collective bargaining
agreements with the Screen Actors Guild and Directors Guild of America, Inc.
("DGA"). These agreements call for adherence to certain procedures and standards
related to the production of a feature film and the revenues generated from its
exploitation. The Company has guaranteed the full and complete performance by
False River in relation to its agreement with DGA.

         The Company consolidates the accounts of False River and reflects a
minority interest in the remaining 49% interest in its consolidated financial
statements.

NOTE 4  - VIDEO COMMUNICATIONS NETWORK, LLC

         In August 1997, the Company, certain members of the board of directors
and an officer of one of the Company's subsidiaries organized Video
Communications Network, LLC ("VCN"). The Company acquired 83.3% of the initial
ownership of VCN in exchange for nominal consideration. In January 1998, the
Company sold a portion of its interest in VCN, representing 444 LLC shares, to
certain members of the board of directors and a shareholder for nominal
consideration.

         VCN was organized for purposes of developing, managing and providing
programming for a network of large screen video display ("LSVD") operations in
domestic and international locations. VCN plans to develop LSVD operations that
deliver a mixture of programming, advertising and special events similar to the
present LSVD operation conducted by an unaffiliated company at Times Square in
the City of New York.

         In January 1998, VCN commenced a private placement offering, under
Regulation D of the Securities Act of 1933, of an aggregate of 1,110 LLC shares
in $100,000 units comprised of 222 LLC shares together with warrants to purchase
50,000 shares of the Company's Class A common stock at an exercise price of
$3.00 per share, exercisable through January 2001. The warrants were contributed
by the Company to VCN to facilitate its private placement and were recorded as
an investment in VCN, at their fair value. This private placement was closed in
April 1998 at which time the Company's ownership of VCN decreased to 74% as a
result of VCN's receipt of $300,000 for the sale of three private placement
units. A purchaser of one of the private placement units was a member of the
board of directors.

          VCN has incurred expenses of $507,746 as of July 31, 1998. These
expenses have been funded by advances from the Company and proceeds of VCN's
private placement offering.

NOTE 5 - DIVERSITY ENTERTAINMENT TELEVISION/ATLANTA, LLC

         In August 1997, VCN and an unaffiliated consultant organized Diversity
Entertainment Television/Atlanta, LLC ("DETV/Atlanta"). DETV/Atlanta was
organized for the purpose of installing and operating a LSVD operation in
Atlanta, Georgia.


                                      F-16
<PAGE>   54
                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         VCN acquired 6,762 of DETV/Atlanta's LLC shares, representing 98% of
the initial ownership, in exchange for nominal consideration. VCN agreed to
distribute to an officer of VCN, in consideration of his services to VCN, all of
the net cash or other assets received by VCN at any time in respect of 1,690.5
of its DETV/Atlanta LLC shares, representing 24.5% of DETV/Atlanta's outstanding
shares. VCN accounts for these LLC shares as a minority interest in its
consolidated financial statements.

         DETV/Atlanta had not incurred a significant level of expenses nor
generated any revenues as of July 31, 1998.

NOTE 6 - LINE OF CREDIT

         First Light Entertainment Corporation, a wholly-owned subsidiary,
entered into a line of credit agreement with a financial institution in April
1998. This asset-based credit facility provides for borrowings not to exceed
$1,000,000 and bears interest at the prime rate (8.5% at July 31, 1998) plus
2.5%, subject to a minimum monthly service fee of $500. All advances are made
based upon availability under a borrowing base calculation which allows for
borrowings up to 85% of accounts receivable. There was no unused availability
under the borrowing base calculation at July 31, 1998. This line of credit,
which was repaid in the first quarter of fiscal 1999, has a one year term and is
guaranteed by the Company.

NOTE 7 - NOTES PAYABLE

         Notes payable consisted of the following:
<TABLE>
<CAPTION>
                                                                        July 31,
                                                          ---------------------------------
                                                                 1998               1997
                                                          ---------------------------------

         <S>                                              <C>                   <C>
         Line of credit with a bank, guaranteed by
         certain members of the board of directors,
         interest at the prime rate (8.5% at July 31,
         1998) plus 1% and due quarterly, principal
         due July 1998                                       $225,000           $225,000

         Unsecured note payable to shareholder,
         interest at the prime rate (8.5% at July 31,
         1998) plus 1%, due on demand                          75,000                  -


         Unsecured note payable to shareholder,
         interest at the prime rate (8.5% at July 31,
         1998) plus 1%, due December 1998                      53,550                  -

         Unsecured installment note payable to bank,
         interest at 8.75%, $3,000 due monthly in
         principal and interest, principal due
         November 1998                                         41,750             64,055

         Secured installment note, collateralized by
         equipment and tradename of First Light, due
         with interest at 4.37% in quarterly
         installment of $5,593 through August 1998             11,126             27,073
                                                          -------------------------------
                                                            $ 406,426          $ 316,128
                                                          ===============================
</TABLE>

         The line of credit, which is unsecured, provides for maximum borrowings
not to exceed $225,000. Borrowings outstanding under this line of credit
amounted to $225,000 at July 31, 1998. In consideration for establishing the
line of credit, the Company issued, in October 1997, to certain members of the
board of directors common stock purchase warrants allowing for the purchase, in
the aggregate, of 45,000 shares of Class A common stock, priced at $4.58 per
share, through June 30, 2000.


                                      F-17
<PAGE>   55

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         The Company was unable to renew this line of credit with the bank at
July 31, 1998. The Company, its guarantors and the bank are currently exploring
various alternative means to renew or replace this line of credit. The Company
made the quarterly interest payment due on this line of credit in October 1998.
As of March 1999, the Company had not made the quarterly interest payment due
January 1999 on this line of credit.

          In November 1997, the Company received an extension of the maturity
date for its $41,750 unsecured installment note payable to bank. This
installment note's maturity date was extended to November 1998 with all other
terms remaining unchanged. As of March 1999, the Company had not received an
extension of the November 1998 maturity date on this unsecured installment note.

         At July 31, 1998, the Company was in arrears for the quarterly payment
due May 1, 1998 on the $11,126 secured installment note. As of March 1999, the
Company was in arrears for the final two full quarterly installments, due May 1
and August 1, on this secured installment note.

         As of March 1999, the Company was in arrears in the amount of $9,000 in
relation to the unsecured installment note payable to bank.

         Aggregate maturities of notes payable amount to $406,426 for the year
ending July 31, 1999.

NOTE 8 -  NOTES PAYABLE/RELATED PARTIES

         Notes payable to related parties consisted of the following:

<TABLE>
<CAPTION>
                                                                      July 31,
                                                          -------------------------------
                                                               1998               1997
                                                          -------------------------------
         <S>                                             <C>                    <C>
         Unsecured notes due to certain member of the
         board of directors, due on demand but no
         later than September 1999, interest at the
         prime rate (8.5% at July 31, 1998) plus 1%          $ 370,500          $       -

         Unsecured notes due to certain members of
         the board of directors, due on demand,
         interest at the prime rate (8.5% at July 31,
         1998) plus 1%                                         150,000                  -

         Line of credit with member of the board of
         directors, interest at the prime rate (8.5%
         at July 31, 1998) plus 1%, due monthly,
         principal due April 1999                              100,000            100,000

         Unsecured notes due certain member of board
         of directors, due on demand, but no later
         than August 1998, interest at the prime rate
         plus 1%                                                     -             55,000
                                                          -------------------------------
                                                             $ 620,500          $ 155,000
                                                          ===============================
</TABLE>

         The line of credit, which is unsecured, provides for maximum borrowings
not to exceed $100,000. Borrowings outstanding under this line of credit
amounted to $100,000 at July 31, 1998. In consideration for establishing the
line of credit, the Company issued, in October 1997, this member of the board of
directors common stock purchase warrants allowing for the purchase of 20,000
shares of Class A common stock, priced at $4.58 per share, through June 30,
2000. The maturity date for this line of credit was extended, by amendment, to
April 1999.



                                      F-18
<PAGE>   56

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         In April 1997, a board of directors member made a non-interest bearing
advance amounting to $30,000 to the Company, which was repaid in April 1997.
This board of director member also made a loan of $30,000, bearing interest at
the prime rate plus 1%, to the Company in June 1997. This note was settled by
the Company in August 1997.

         In July 1998, a board of directors member made a non-interest bearing
advance amounting to $37,500 to the Company, which was repaid in July 1998.

         In September 1996, three shareholders, two of whom are members of the
board of directors, loaned the Company $75,000. These notes were due on demand,
but no later than August 1997, and bore interest at the prime rate plus 1%. The
Company re-paid these loans in February 1997, June 1997 and February 1998. In
consideration of the original loans, the Company issued each shareholders an
option to purchase 9,403 shares of Class B common stock at a price of $1.71,
exercisable through June 30, 2000.

         Aggregate maturities of notes payable/related parties amount to
$620,500 for the year ending July 31, 1999.

NOTE 9 - STOCKHOLDERS' EQUITY

(A)      STOCK OPTIONS

         The Company has a stock option plan ("Stock Option Plan") which allows
for the issuance of stock options as either incentive stock options,
non-qualified stock options, or stock appreciation rights. The Stock Option Plan
initially provided for the grant of up to 2.5 million stock options, but was
amended in June 1998 to provide for the grant of up to an additional 2.5 million
options (aggregate grants of 5.0 million options).

         Stock options may be granted to officers, directors, employees and
consultants and may be either "incentive stock options" (as defined in the
Internal Revenue Code) or non-qualified stock options. Stock options are
generally granted at an exercise price equal to the grant date fair value of
American Artists' common stock, and vest at varying rates over periods ranging
from one to ten years, with certain grants contingent upon continued service
with the Company.

         The following summarizes stock option activity:
<TABLE>
<CAPTION>
                                                                                  Weighted average
                                                             Number of options     exercise price
                                                          -----------------------------------------
            <S>                                          <C>                      <C>
            Outstanding, July 31, 1996                               1,933,369              $1.22
                            Granted                                    503,673               3.88
                            Exercised                                        -                  -
                            Forfeited or expired                       (17,587)              1.54
                                                          ----------------------------------------
            Outstanding, July 31, 1997                               2,419,455               1.77
                            Granted                                  1,048,500               2.08
                            Exercised                                        -                  -
                            Forfeited or expired                      (180,000)              2.55
                                                          ----------------------------------------
            Outstanding, July 31, 1998                               3,287,955              $1.81
                                                          ========================================

            Options exercisable at:
                            July 31, 1997                            1,677,504              $1.16
                                                          ========================================
                            July 31, 1998                            3,022,904              $1.70
                                                          ========================================
</TABLE>


                                      F-19
<PAGE>   57

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         Options exercisable at July 31, 1998 were as follows:
<TABLE>
<CAPTION>
                                                                              Weighted average
                                       Number of options     Option price      exercise price
                                       ---------------------------------------------------------
                                       <S>                   <C>               <C>
                                                   70,344      $       0.085             $0.085
                                                  879,300               0.85               0.85
                                                  746,818       1.45 to 1.71               1.51
                                                1,000,000               2.00               2.00
                                                   83,683       2.25 to 2.56               2.53
                                                   87,518       3.00 to 4.00               3.62
                                                  105,241               4.58               4.58
                                                   50,000      $        4.75               4.75
                                       -------------------
                                                3,022,904                                $ 1.70
                                       ===================
</TABLE>

         Options outstanding at July 31, 1998 were as follows:

<TABLE>
<CAPTION>
                                        Weighted Average
                                           Remaining
                                        Contractual Life                      Weighted average
                    Number of options       in Years         Option price      exercise price
                    ----------------------------------------------------------------------------
                    <S>                 <C>                  <C>              <C>
                                82,068               4.31      $       0.085             $0.085
                               879,300               5.09               0.85               0.85
                               797,818                2.2       1.45 to 1.71               1.51
                             1,000,000               0.42               2.00                  2
                               111,235               2.82       2.25 to 2.56               2.54
                               212,293               8.12       3.00 to 4.00               8.12
                               105,241                  2               4.58               4.58
                               100,000               1.84      $        4.75               4.75
                    -------------------
                             3,287,955               2.87                                $ 1.81
                    ===================
</TABLE>

         The Company adopted the provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123")
effective August 1, 1996. As permitted by SFAS 123, the Company continues to
measure compensation expense for stock options issued to employees using the
intrinsic-value only provisions of Accounting Principles Board Opinion No. 25.
Expense for stock options granted to non- employees is measured at fair value
using methods consistent with the requirements of SFAS 123. The Company
recognized stock option compensation costs of $12,494 and $13,987 for the years
ended July 31, 1998 and 1997, respectively.

         If the Company had elected to recognize compensation costs based on the
fair value at the grant date of all options, including employee awards, issued
under the plan described above, consistent with the method prescribed by SFAS
123, net loss and net loss per share would have been changed to the pro forma
amounts indicated below:


                                      F-20
<PAGE>   58

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                   Year Ended July 31,
                                                          --------------------------------------
                                                                 1998               1997
                                                          --------------------------------------
             <S>                                          <C>                       <C>
             Net loss
                    As reported                                 $(1,956,307)         $(580,845)
                    Pro forma                                    (2,731,887)          (733,689)

             Net loss per share (basic and diluted)
                    As reported                                        (.30)              (.09)
                    Pro forma                                     $    (.43)          $   (.12)
</TABLE>

         The weighted average grant date fair value of options, calculated using
the Black-Scholes option pricing model, was as follows:

<TABLE>
<CAPTION>
                                                                   Year Ended July 31,
                                                                 1998               1997
                                                          ----------------------------------
              <S>                                         <C>                       <C>
              Options granted at market price                    $630,000           $272,434

              Options granted at above market price              $ 24,480           $  1,200
</TABLE>

         The significant weighted average assumptions used to estimate the fair
value of stock options for the year ended July 31, 1998 were: a risk-free
interest rate of 6.5%, an expected option life of six months, no dividend yield
and a violatility factor of 110%. The significant weighted average assumptions
used to estimate the fair value of stock options for the year ended July 31,
1997 were: a risk-free interest rate of 6.5%, an expected option life of four
years and no dividend yield. A trading market for the Company's common stock had
not developed as of July 31, 1997, therefore, the minimum value method was used
in estimating fair value.

(B)    COMMON STOCK PURCHASE WARRANTS

         During fiscal 1997, American Artists completed a private placement of
16.4 units priced at $25,000 per unit ($2.50 per share), with each unit
comprised of 10,000 shares of its Class A common stock and 3,333 Class A common
stock purchase warrants. American Artists issued 54,663 Class A common stock
purchase warrants under this private placement in fiscal 1997.

         In August 1997, a member of the board of director purchased 36,364
shares of common stock for an aggregate price of $100,000. In connection with
this purchase, the Company also issued a common stock purchase warrant allowing
for the purchase of 37,000 shares of Class A common stock at $2.80 per share,
exercisable through June 30, 2000.

         In October 1997, the Company issued a member of the board of directors
a common stock purchase warrant for the purchase of 40,000 shares of Class A
common stock at $4.58 per share, exercisable through June 30, 2000, in
consideration for his election to join the board of directors in March 1997.

         As disclosed in Note 4, in January 1998 the Company contributed 150,000
warrants, exercisable at a price of $3.00 per share through January 2001, to VCN
which VCN reissued to outside investors, in a private placement, to raise
minority interest capital for its operations.


                                      F-21
<PAGE>   59

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         Outstanding warrants were as follows:
<TABLE>
<CAPTION>
                                                                Shares
                                                          -------------------
          <S>                                             <C>
           Outstanding, July 31, 1996                                317,854
                           Issued                                     54,663
                           Exercised                                       -
                           Forfeited                                       -
                                                          -------------------
           Outstanding, July 31, 1997                                372,517
                           Issued                                    292,000
                           Exercised                                       -
                           Forfeited                                (317,854)
                                                          -------------------
           Outstanding, July 31, 1998                                346,663
                                                          ===================
</TABLE>

         Warrants outstanding at July 31, 1998 were as follows:

<TABLE>
<CAPTION>
                                          Warrants            Exercisable
                      Exercise Price     Outstanding           Through
                --------------------------------------------------------------
                <S>                  <C>                      <C>
                       $2.80                      37,000      June 2000
                       $3.00                      54,663      June 2000
                       $3.00                     150,000      June 2001
                       $4.58                     105,000      June 2000
                                     --------------------
                                                 346,663
                                     ====================

</TABLE>

NOTE 10 - CONSULTING AGREEMENTS

         The Company entered into two significant consulting agreements during
the year ended July 31, 1998 as follows:

         (a) The Company entered into a Financial Advisory and Consulting
Agreement in May 1998 whereby a consulting group agreed to perform certain
financial advisory services. In exchange for these services, the Company agreed
to issue 25,000 shares of the Company's Class A common stock as a means of
compensation. These shares were valued at $150,000, based upon the closing share
price for the Company's Class A common stock on the date of the agreement.

         (b) The Company entered into a Media Relations and Consulting Agreement
in June 1998 whereby a consulting group ("Consulting Group") agreed to perform a
number of services including the development and maintenance of a worldwide
website and the preparation of an independent analysis of the Company to be
featured on the Consulting Group's investor service website. In exchange for
these services, two unaffiliated shareholders of the Company agreed to
compensate the Consulting Group with 223,225 shares of the Company's Class A
common stock. The Company recorded this transaction as an expense, offset by a
contribution of capital by these shareholders, of $446,450, based upon the
closing share price for the Company's Class A common stock on the date of the
agreement. The Company also executed a note payable amounting to $53,550 as
additional compensation to the Consulting Group. This consulting agreement was
terminated by the Company in November 1998.


                                      F-22
<PAGE>   60

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11 - INCOME TAXES

         Deferred tax assets result from the following temporary differences
between book and tax bases of assets:

<TABLE>
<CAPTION>
                                                                              July 31,
                                                               ---------------------------------------
                                                                      1998                1997
                                                               ---------------------------------------
       <S>                                                     <C>                        <C>
       Deferred tax assets:
         Net operating loss carryforwards                             $ 1,356,000          $  800,000
         Investment in Diversity Filmworks, Inc.                          159,000             164,000
         Investment in Video Communications Network, LLC                  193,000                   -
        Valuation allowance                                            (1,708,000)           (964,000)
                                                               ---------------------------------------
                                                                      $         -          $        -
                                                               =======================================
</TABLE>

         The book and tax bases differences for Diversity Filmworks, Inc. and
Video Communications Network, LLC result from the fact that the Company
consolidates such entities for financial reporting purposes, but does not own
the level (80%) required to consolidate them for income tax reporting purposes.

         The effective tax rate differed from the U.S. statutory federal income 
tax rate as a result of the following:

<TABLE>
<CAPTION>
                                                                   Year Ended July 31,
                                                          --------------------------------------
                                                                 1998               1997
                                                          --------------------------------------
               <S>                                        <C>                       <C>
               U.S. statutory federal income tax rate                (34)%              (34)%
               Valuation allowance                                    34%                34%
                                                          --------------------------------------
               Effective tax rate                                      -                  -
                                                          ======================================
</TABLE>

         AAEC Group has net operating loss carryforwards for federal tax
purposes amounting to approximately $3,569,000 at July 31, 1998. These net
operating loss carryforwards expire principally in fiscal years 2008 through
2013. As a result of such net operating loss carryforwards and the related 100%
valuation allowance, AAEC Group has not provided a provision for income taxes
for the years ended July 31, 1998 and 1997.

NOTE 12 - SETTLEMENT OF ARBITRATION

         The Company was involved in an arbitration with one of its co-producers
concerning the accounting for costs and revenues received by each company
relating to two co-produced network television specials.

         The Company executed an agreement (the "Agreement") in June 1997 in
settlement of all known issues related to this arbitration. Under the Agreement,
the Company agreed to pay the co-producers $140,000, over a period of fourteen
months commencing in June 1997. The Company completed its payment obligations,
as called for by this agreement, in July 1998.

         The Agreement also calls for the Company and its co-producer to pay
certain residuals related to the two co-produced network television specials.
The amount of these residuals is not presently determinable, however, they are
not considered to be material to the Company's financial position, results of
operations or cash flows.

                                      F-23
<PAGE>   61

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 13 - SEGMENT INFORMATION

         Financial information by business segment is as follows:

<TABLE>
<CAPTION>
                                                  Development and         Contract
          1998                                    Film Production        Production         Consolidated
-------------------------------------------------------------------------------------------------------------
<S>                                               <C>                    <C>                 <C>
             Revenues                                    $         -          $2,450,958         $ 2,450,958
             Loss (income) from operations                (1,827,412)            (71,248)         (1,898,660)
             Identifiable assets                           1,264,136              94,314           1,358,450
             Capital expenditures                              2,321                   -               2,321
             Depreciation and amortization               $   203,961          $  130,321         $   334,282

             1997
------------------------------------------------

             Revenues                                    $   420,937          $3,469,655         $ 3,890,592
             Loss (income) from operations                   621,138            (146,039)            475,099
             Identifiable assets                             561,091             600,280           1,161,371
             Capital expenditures                                  -               9,347               9,347
             Depreciation and amortization               $   364,878          $   56,761         $   421,639
</TABLE>


NOTE 14 - SUPPLEMENTAL CASH FLOW INFORMATION

<TABLE>
<CAPTION>
                                                                   1998               1997
                                                          --------------------------------------
            <S>                                           <C>                         <C>
            Cash paid for interest                                   $44,934            $ 8,221
            Cash paid for income taxes                                     -                  -
                                                          --------------------------------------
                                                                     $     -            $ 8,221
                                                          ======================================
</TABLE>

         Non-cash investing and financing transactions were as follows:

         (a) The Company completed the Merger, as described in Note 1, which
included a reverse split of the Company's common stock, a non-cash transaction.

         (b) The Company adjusted certain of its film costs in the amount of
$4,687 related to negative goodwill recognized as a result of the acquisition of
the minority interest in Millennium Group, LLC during the year ended July 31,
1998.

         (c) In fiscal 1998, the Company contributed 150,000 Class A common
stock purchase warrants to VCN (see Note 4).


                                      F-24
<PAGE>   62

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 15 - SUBSEQUENT EVENTS

         (a) In October 1998, the Company commenced a private placement of units
comprised of the Company's Class A common stock and common stock warrants.
Subsequent to July 31, 1998, the Company issued, at a price of $25,000 per unit
($.50 per share), 4.8 units with each unit comprised of 50,000 shares of Class A
common stock and 25,000 Class A common stock purchase warrants. The warrants are
exercisable at $1.30 per share through December 2001.

         (b) During the period from August 1998 to October 1998, a member of the
board of directors extended loans to the Company amounting to $68,000 in the
aggregate. These amounts are unsecured, bear interest at the prime rate plus 1%
and are due on demand but no later than September 1, 1999.

         (c) In August 1998, an officer extended a loan to the Company in the
amount of $26,264. This note is secured, bears interest at the prime rate plus
1% and is due on demand but no later than September 1, 1999. The Company has
pledged as security its interest in the ordinary LLC shares of False River, LLC
to the extent that any principal and accrued interest remain unpaid at maturity
under this note agreement.

         (d) During the period from August 1998 to February 1999, False River
sold additional interests in its preferred distribution LLC shares for proceeds
amounting to $194,864. An officer and certain members of the board of directors
purchased $164,864 of these preferred distribution LLC share interests.

         (e) During the period from September 1998 to January 1999, a
shareholder extended loans to the Company amounting to $42,500. These notes are
secured, bear interest at the prime rate plus 1% and are due on demand but no
later than September 1, 1999. The Company has pledged as security its interest
in the ordinary LLC shares of False River, LLC to the extent that any principal
and accrued interest remain unpaid at maturity under these note agreements.

         (f) In November 1998, the Company entered into an investor relation
services agreement with an investor relations firm, that calls for, among other
things, certain investor relations and capital formation services. The
consideration for this agreement included the issuance of 50,000 shares of the
Company's Class A common stock.

         (g) In December 1998, the Company entered into a consulting agreement
("Programming Agreement") with an individual who possesses a number of years of
experience in the television programming industry. The Programming Agreement
calls for the consultant to assist the Company in the creation, development,
packaging and production of certain television and feature film properties
("Properties"), including television series. As consideration for his services,
the consultant will receive, in addition to certain "on screen" credits,
thirty-three percent (33%) of all net profits, as defined (generally revenues
after the recovery of all production and distribution costs), generated from
Properties introduced to the Company under this Programming Agreement. The
Programming Agreement generally will relate to properties identified by the
consultant and exclude project ideas identified by the Company.

         (h) In December 1998, the Company re-priced the exercise price of
certain stock options that had been previously granted under its employee stock
option plan. The Company re-priced these options as follows: 1) 52,345 stock
options granted between November 21, 1995 and December 8, 1997 with exercise
prices ranging from $1.45 to $3.75 were re-priced to an exercise price of $1.00,
and 2) 272,844 stock options granted between November 21, 1995 and December 8,
1997 with exercise prices ranging from $1.45 to $3.75 were re-priced to an
exercise price of $.50. Neither the Chief Executive Officer nor President of the
Company had any stock options affected by this re-pricing.

         (i) In December 1998, the Company extended the due dates of all of its
notes issued in connection with certain advances to officers. The due dates were
extended from December 1998 to December 1999.

                                      F-25
<PAGE>   63

                   AMERICAN ARTIST ENTERTAINMENT CORPORATION
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (j) During the period from December 1998 to January 1999, a member of
the board of directors extended loans to the Company amounting to $137,000.
These loans are unsecured, bear interest at the prime rate plus 1% and are due
on demand.

         (k) In February 1999, the Company issued a member of the board of
directors a warrant to purchase 100,000 shares of the Company's Class A common
stock as additional consideration for his commitment to invest $50,000 in False
River, LLC. The warrant is exercisable at $.20 per share, through January 2004.

         (l) In February 1999, an officer extended a loan to the Company in the
amount of $11,000. This note is secured, bears interest at the prime rate plus
1% and is due on demand but no later than September 1, 1999. The Company has
pledged as security its interest in the ordinary LLC shares of False River, LLC
to the extent that any principal and accrued interest remain unpaid at maturity
under this note agreement.

         (m) In February 1999, a member of the board of directors extended a
loan to the Company in the amount of $10,000. This loan is unsecured, bears
interest at the prime rate plus 1% and is due on demand, but no later than
September 1, 1999.

         (n) In February 1999, the Company entered into two consulting
agreements ("Consulting Agreements") with two entities for the performance of
certain strategic financial planning services and consulting in the areas of
filmed entertainment and LSVD operations. The Consulting Agreements call for
these entities to provide these services over a period of six month in exchange
for 1,200,000 shares of the Company's Class A common stock, in the aggregate.
The Company has agreed to file a Form S-8 to register the issuance of these
shares.

         (o) In February 1999, the Company legally effected a change in name
from "American Artists Film Corporation" to "American Artists Entertainment
Corporation." This name change had been previously approved by the shareholders
of the Company in January 1998.












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