<PAGE>
 
                    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, 1997
 
   [   ] 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 FILM CORPORATION
                 (Name of small business issuer in its charter)

            MISSOURI                                       43-1717111
   (State or other jurisdiction of                      (I.R.S. Employer
   incorporation or organization)                      Identification No.)

        1245 FOWLER ST., N.W.
          ATLANTA, GEORGIA                                    30318
(Address of principal executive offices)                    (Zip code)

Issuer's telephone number (404) 876-7373

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  X     No
    ---       ---
 
     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:  $3,890,592

     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 October 29,
1997:  There were 287,646 shares of Class A, $.001 par value, common stock held
by non-affiliates; however, a trading market has not developed for the Class A
common stock.  There is no established market for the Class B common stock,
$.001 par value.

     State the number of shares outstanding of each of the issuer's class of
common equity:  912,984 shares of Class A common stock, $.001 par value per
share and 5,502,277 shares of Class B common stock, $.001 par value per share
were outstanding as of October 29, 1997.

     Documents incorporated by reference:   NONE
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                                  FORM 10-KSB
                               TABLE OF CONTENTS
 
 
PART I                                                                Page
                                                                      ----
 
     Item 1.     Description of Business............................    3
     Item 2.     Description of Property............................    9
     Item 3.     Legal Proceedings..................................    9
     Item 4.     Submission of Matters to a Vote of Security Holders    9
 
PART II
 
     Item 5.     Market for Common Equity and Related
                 Stockholder Matters................................   10
     Item 6.     Management's Discussion and Analysis or Plan
                 of Operation.......................................   10
     Item 7.     Financial Statements...............................   15
     Item 8.     Changes In and Disagreements With Accountants
                 on Accounting and Financial Disclosures............   15
 
PART III
 
     Item 9.     Directors, Executive Officers, Promoters and
                 Control Persons; Compliance with Section 16(a)
                 of the Exchange Act................................   15
     Item 10.    Executive Compensation.............................   17
     Item 11.    Security Ownership of Certain Beneficial
                 Owners and Management..............................   18
     Item 12.    Certain Relationships and Related
                 Transactions.......................................   19
     Item 13.    Exhibits and Reports on Form 8-K...................   22
 
SIGNATURES..........................................................   25
 
INDEX TO FINANCIAL STATEMENTS ......................................  F-1

                                      -2-
<PAGE>
 
                                     PART I

ITEM 1. DESCRIPTION OF BUSINESS

INTRODUCTION

   American Artists Film Corporation (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 production of television commercials, 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, and
(ii) commercial contract production (See Note 7 of the Notes to Consolidated
Financial Statements for financial information on the Company's business
segments).  Additionally, during fiscal 1997, 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 operations.

   The Company's executive offices are located at 1245 Fowler Street, N.W.,
Atlanta, Georgia 30318, and its telephone number is 404-876-7373.

BACKGROUND

    Old American Artists was founded in 1991.  In August 1993 the Company
acquired all of the outstanding capital stock of First Light Entertainment
Corporation ("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.

   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.

   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 Corporation.

   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

                                      -3-
<PAGE>
 
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 identical 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.

   Pursuant to the Merger Agreement, for a period of 365 days after the Merger
Date, none of the shares of Class A or Class B common stock received in the
Merger, the shares of Class B common stock issued upon exercise of options and
warrants outstanding at the Merger Date, or shares of Class A common stock
issued upon conversion of Class B common stock issued in the Merger, could be
sold, transferred or otherwise disposed of without the prior written consent of
the Company prior to October 1997.

BUSINESS OF THE COMPANY

   Film Development and Production

   Since its organization by Steven D. Brown and Rex Hauck in July 1991, the
Company's activities have consisted primarily of producing network television
specials, developing other television specials for possible future production,
developing various feature-film screenplays and treatments for possible future
production, and seeking to arrange financing for production and exploitation of
one or more of its feature-film properties.  During fiscal 1997, the Company re-
aligned its television and film activities into a separate division called
American Artists Films.

   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 any foreign revenues.  Through fiscal 1997 the Company has not
recognized any foreign revenues related to this limited participation.

   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.

   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 that 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.

   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, 1997.  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 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.

                                      -4-
<PAGE>
 
    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 bears 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.

   Another short treatment of the Angels theme was developed and produced for
CCC at a cost to the Company of approximately $30,000.  Payments to the Company
are based on revenues generated by CCC through use of the treatment as a sales
aid.  In fiscal 1996, the Company determined that because of the low current
level of sales experienced by CCC, revenues due to the Company from CCC for this
project are likely to be insufficient to cover the associated costs to the
Company.

   The Company also developed a book entitled Angels: The Mysterious Messengers,
edited for American Artists 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 agreement among the Company, Greystone and NBC provided for (i) the
payment of license fees by NBC to American Artists and Greystone and (ii) the
payment to NBC of 50% of the royalties from videos sold during the NBC
broadcasts and 20% of the royalties from videos sold by Time-Life Videos.  Under
an agreement dated May 1994, the Company and Greystone agreed to divide equally
all revenues from the two television specials and certain derivative properties.
The scope of that agreement and the definition of allowable expenses were the
subject of a dispute between the parties that was settled in May 1997.  See
"Intellectual Property" and Item 3.  "Legal Proceedings."

   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 1997 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.

   Other Television Projects.  The Company currently has over twenty television
   --------------------------                                                  
projects/proposals in various stages of development, presentation, pre-
production and 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.

   Johnson/Woodman Project.  The Company has completed principal photography for
   ------------------------                                                     
a television special 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
Company anticipates that editing and post-production will yield a completed
project available for release on GPTV or the Public Broadcasting System in
fiscal 1998.

   The Company has executed several agreements related to this production which
provide for a sharing of revenues, after recovery of all production costs, as
follows: equal shares to the Company and GPTV after an allocation of 10% to the
Episcopal Media Center ("EMC") and 5% each to Mr. Johnson and Ms. Woodman.  The
portion allocable to EMC remains in effect for a period of five years from the
date of first sale.  The agreements also provides EMC with exclusive rights for
certain religious markets and a 50/25/25 sharing between the Company, Mr.
Johnson and Ms. Woodman, respectively, of any revenues related to sale of book
rights.

   Windows of Heaven.  The Company has also 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, as follows:  46.5% to the Company and the remainder to

                                      -5-
<PAGE>
 
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 rights for 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, under Mr.
   ---------------                                                       
Hauck's supervision, 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.

   The Company has presented its "millennium" concept and certain treatments to
several over-the-air and cable television networks.  Several networks have
indicated interest in the properties but the Company is unable to state whether
the interest will continue or whether the parties will reach a mutually
satisfactory agreement through negotiation.  The Company's goal is also to
derive related video and book properties from any television program that might
be produced.
 
   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 has 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.  If MG is able to obtain network or
other funding for producing the program, the investors are entitled to recover
100% of MG's net income from the program until their initial investment has been
returned, 50% thereafter until an equal additional amount has been received, and
10% of any further net income.  All other net income would be paid to the
Company as management fees.

     Feature Films.  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
casting for the lead roles for two of its feature film properties and
anticipates entering the production phase in fiscal 1998 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.

   Under a February 1992 agreement, as amended,  the Company issued shares of
its common stock to Icon International, Inc. ("Icon"), in exchange for $500,000
in credits for certain media advertising.  The availability of the media credits
expires December 31, 1998, but up to one-half of any credits not used by that
date may be returned to Icon in exchange for a portion of the shares previously
issued (calculated at the rate of $3.41 of unused media credits for each share
of stock).  The Company anticipates using the credits, at least in part, for
promoting its film and video properties.

   Commercial Contract Production

   First Light Entertainment Corporation ("First Light") and Diversity
Filmworks, Inc. ("Diversity"), (collectively, the "Commercial Companies")
produce television commercials on a contract basis for advertisers and/or their
agencies.  They typically enter short-term agreements for the production of the
commercials, whose scripts or story outlines ("story boards") are provided by
the client.  The Commercial Companies then typically arrange all production
aspects of the commercials, including casting, location selection and
contractual arrangements with the director and other production personnel.  The
Commercial Companies use on a regular basis, the services of approximately seven
independent directors, some of whom direct only commercials produced by the
Commercial Companies.  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.

                                      -6-
<PAGE>
 
   The Commercial Companies generally produce their commercials on a "firm bid"
basis as opposed to a "cost plus fixed fee" basis. If a commercial is produced
within the framework of "firm bid," 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 Commercial
Companies receive a predetermined fee for their 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 Commercial
Companies are not substantially greater for "firm bid" because the Commercial
Companies are 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 most circumstances, the Commercial Companies bill the advertising
agency for 50% of the entire budget as stated in the bid, to be paid in advance
or on the first day of principal photography.  The remainder of the bid price is
generally paid in one or more installments by the agency within 30 to 120 days
after completion of principal photography.

   In marketing their services the Commercial Companies emphasize the talents of
the directors with whom they work, their skills in cost control and timely
production, the quality of the production and the advantages of Atlanta as a
production center.  In its work, Diversity especially emphasizes use of
directors and other production staff from diverse cultural and ethnic
backgrounds. Although most of the commercials produced by the Commercial
Companies are filmed in Atlanta, they are experienced at producing commercials
throughout North America.

   In fiscal 1997 the Commercial Companies produced 22 commercials for net
revenues of $3,470,000, compared to 41 commercials and $2,467,000 in net
revenues for fiscal 1996.  Based on the volume of story boards presently being
submitted to it for bids or cost estimates, management of the Company
anticipates a continued improvement in revenue levels of the Commercial
Companies during fiscal 1998.  The Commercial Companies have a backlog of
awarded commercial production contracts (either in-process or not yet commenced)
of approximately $1,500,000, in fiscal 1998 through October 29, 1997.

   For fiscal 1997, three of the Commercial Companies' customers accounted for
fees equal to 21.2%, 19.7% and 12.2% of consolidated revenues.  The Commercial
Companies obtain their 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 Commercial Companies are not dependent on any one client for a
material amount of their revenues.

   Large Screen Video Display ("LSVD") Operations

   In August 1997 the Company, certain members of its Board of Directors and an
officer of Diversity, organized Video Communications Network, LLC ("VCN").  The
Company acquired 83.3% of the initial ownership of VCN in exchange for nominal
consideration. VCN was organized for purposes of developing, managing and
providing programming for a network of 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.

   VCN has commenced negotiations with potential advertisers, investors and
other parties for its planned initial location at Underground Atlanta in
Atlanta, Georgia.  VCN is in the development stage and is subject to a variety
of conditions, including sufficient commitments by advertisers, the availability
of financing,  and compliance with applicable regulatory requirements.

   The Company anticipates that the Atlanta LSVD operation will be organized as
a separate limited liability company which may seek financing from investors
through a private placement of equity interests.  However, other possible
financing alternatives are also being evaluated.

   There is no assurance that the project can be brought to fruition or would be
profitable for the Company if completed.  Additionally, in order to raise
financing for the development of VCN's projects, VCN may issue LLC shares or
other equity securities to third party investors, in which case the Company's

                                      -7-
<PAGE>
 
ownership of VCN, and the portion of any VCN profits to which it would be
entitled, would be diluted.  To date, VCN has not generated any revenues nor
incurred a significant level of expenses.

COMPETITION

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

   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.

     Commercial Contract Production
     ----------                    

   The television commercial 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.

   LSVD Operations

   An identifiable LSVD industry for the type of operations in which VCN plans
to engage has not fully developed.  However, the Company anticipates that other
companies will pursue LSVD projects, and that as a result VCN will encounter
substantial competition, including competition from other companies with greater
financial resources.  The Company plans to compete based upon its experience
gained during the development of this industry.

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

EMPLOYEES

   In its production activities, the Company relies primarily upon independent
third parties for production facilities and personnel.  The Company currently
has fourteen full-time employees.  A portion of the salaries payable to the
Company's employees is 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 of The Writers Guild of America and is subject to
its industry-wide collective bargaining agreement.  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

                                      -8-
<PAGE>
 
collective bargaining agreements may affect the Company is difficult to estimate
and strikes related to collective bargaining or other collective action by union
members could, in the future, delay or disrupt activities.

ITEM 2. DESCRIPTION OF PROPERTY

   The Company leases as its headquarters a facility of approximately 8,000
square feet located at 1245 Fowler St., N.W., in Atlanta, Georgia. Rent under
the lease, which expires in November 1997, is $3,300 per month.  The Company
plans to negotiate for an extension of its existing lease.  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.

ITEM 3. LEGAL PROCEEDINGS

   On or about May 1, 1995, Greystone Communications, Inc. (Greystone"), the
Company's co-producer of the Angels television specials, commenced an
arbitration proceeding against the Company before the American Arbitration
Association Commercial Arbitration Tribunal ("AAA") in Los Angeles, California,
concerning relations under their 1994 co-production agreement.  Greystone's
principal issues related to certain costs claimed by the Company and to
Greystone's contention that it was entitled to participate in revenues from the
book  Angels:  The Mysterious Messengers. The Company, in its counterclaim,
alleged that Greystone received excess revenue distributions based upon
overstatement of its expenses.

   In June 1997, the Company settled all known issues related to this
arbitration by signing an agreement under which the Company agreed to pay
Greystone $140,000 over a period of fourteen months commencing in June 1997.
The Company also agreed to a stipulated arbitral award of $190,000 in the event
that the Company defaults on the payment arrangement contained in the agreement.

   The agreement also calls for the Company to pay certain residuals related to
the two co-produced network television specials.  These amounts are not
presently determinable; however, they are not considered to be material to the
Company's financial position or results of operations.

   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.

   In 1996 counsel for MovieAmerica Corporation expressed to the Company
"concerns" that the four feature film properties transferred by Messrs. Steven
D. Brown and Rex Hauck to the Company at the time of its organization in 1991
were or should have been properties of MovieAmerica Corporation by reason of Mr.
Brown's duties while he was an employee of MovieAmerica Corporation, See Item 9
- "Directors, Executive Officers, Promoters, and Control Persons; Section 16(a)
Beneficial Ownership Reporting Compliance."  Messrs. Brown and Hauck have
assured the Company that MovieAmerica Corporation has no ownership interest in
the four literary properties.

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

   Not Applicable

                                      -9-
<PAGE>
 
                                    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. However, there have been no
trades in the Company Class A common stock as of October 29, 1997. As of the
October 29, 1997 there were 912,984 shares of Class A common stock outstanding
and 332 record holders of such shares. The Class B common stock by its form may
not be publicly traded. As of the October 29, 1997, there were 5,502,277 shares
of Class B common stock outstanding and 126 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.

   In a private placement of its Class A common stock commenced in November 1996
and completed in May 1997, the Company sold 164,000 shares of Class A common
stock at $2.50 per share in 16.4 units of 25,000 shares each.  The purchaser
also received in respect of each unit, without additional consideration, a
warrant to purchase up to 3,333 shares of Class A common stock at $3.00 per
share, exercisable through June 2000. Purchasers of fractional units received a
prorated warrant.

   The units were sold 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.  A third line of
business, LSVD Operations, is in the organizational and developmental stage and
has not incurred a significant level of expenses nor commenced operations.

   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.

                                      -10-
<PAGE>
 
   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 engages in the commercial production business through its wholly-
owned subsidiary, First Light, and through American Artists' 49% ownership
interest in Diversity.  The Company's commercial production services are
performed by the Commercial Companies under short-term (typically less than two
months) agreements. The Commercial Companies generally use 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 commercial production activity in the markets in which the
Commercial Companies operate, and their success in competitive biddings, and can
therefore fluctuate significantly.  Overall commercial 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 Commercial Companies' geographic markets. Such general
economic trends and conditions can neither be controlled, nor predicted by the
Company. The Commercial Companies' 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.

   In anticipation of the Merger, in September 1996, Old American Artists and
the other stockholder of Diversity entered into an agreement concerning the size
and composition of Diversity's board of directors.  See "Item 12 - Certain
Relationships and Related Transactions."  Therefore, effective August 1, 1996,
the Company consolidated the accounts of Diversity in its consolidated financial
statements, as a result of which the consolidated financial statements in fiscal
1997 lack comparability in certain respects to those for fiscal 1996.

   The consolidated financial statements for fiscal 1996 included elsewhere
herein reflect the investment in Diversity accounted for using the equity method
of accounting, under which the Company's interest in Diversity's operating
results is presented as a single, separate line item in the consolidated
statement of operations, and the Company's net investment in and advances to
Diversity are presented as a single item in the consolidated balance sheet.
Revenues, as reflected in the consolidated statement of operations, do not
include the revenues of Diversity. Financial information for Diversity is
presented separately in Note 1 of the Notes to the  Consolidated Financial
Statements.

   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 1996.
Such statements involve matters that are subject to certain risks and
uncertainties, as a result of which actual future results or events many differ
materially depending on a variety of factors.

   The future results of the Company's television specials is, and the planned
production of 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 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.

                                      -11-
<PAGE>
 
   In the commercial production of commercials and other properties by the
Commercial Companies, the Company competes in an industry that is highly
fragmented, and the result of the operations of the Commercial Companies will
vary depending on the number of production assignments obtained.  The number of
production assignments the Commercial Companies obtain is affected by various
factors discussed above.

   RESULTS OF OPERATIONS

   YEAR ENDED JULY 31, 1997 COMPARED TO YEAR ENDED JULY 31, 1996

   Revenues for the year ended July 31, 1997 ("fiscal 1997") increased as
compared to revenues for the year ended July 31, 1996 ("fiscal 1996") as a
result of an increase in both commercial production and film revenues and the
consolidation of Diversity.

   Revenues for fiscal 1997 were $3,890,592 which represented a $2,178,953 or
127.3% increase over revenues of $1,711,639 for fiscal 1996.  However, revenues
for Diversity, which was accounted for on the equity basis during fiscal 1996,
and therefore not included in consolidated revenues, were $777,309 for fiscal
1996.  As discussed in Note 1 of the Consolidated Financial Statements,
beginning in fiscal 1997 the Company consolidated the accounts of Diversity.

   Commercial production revenues for the year ended July 31, 1997 increased by
$1,780,011 or 105.3% to $3,469,655 from $1,689,644 for the year ended July 31,
1996, due to an increase in the average size of awarded commercial production,
which more than offset a decrease in the number of commercial production
projects performed, and the inclusion of Diversity's revenues in fiscal 1997.
In fiscal 1997 the number of commercials productions decreased to 22 from 41 in
fiscal 1996.  Adjusted to include Diversity's revenues in the earlier period,
commercial production revenues increased by $1,002,702 or 40.6%.

   Commercial production costs, as a percentage of related revenues, were 76.6%
for the year ended July 31, 1997 as compared to 78.8% for the year ended July
31, 1996.  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.
Gross profits for commercial production were $813,591 and $359,040 for fiscal
1997 and 1996, respectively.

   Film revenues for the year ended July 31, 1997 were $420,937 which
represented a $398,942 or 1,813.8% increase from film revenues of $21,995 for
the year ended July 31, 1996.  This increase in film revenues was primarily the
result of the recognition of film revenues related to the release in March 1997
of the cable television special, "Fire From The Sky", which was co-produced by
the Company.  The Company did not release any films in fiscal 1996 and therefore
had no significant film revenues in that year.

   Film cost amortization for the year ended July 31, 1997 was $362,214 and
represented an increase of $346,251 from film cost amortization of $15,963 for
the year ended July 31, 1996.  This increase in film cost amortization is
related to the release, in March 1997,  of the Company's co-produced  cable
television special.

   Selling, general and administrative ("SG&A") expenses decreased $3,814 to
$1,347,413 for the year ended July 31, 1997 from $1,351,227 for the year ended
July 31, 1996.  Adjusted for the inclusion of Diversity in fiscal 1996, SG&A
expenses for fiscal 1997 decreased by $326,639.  These decreases were primarily
the result of efforts by the Company to reduce expenses, in relation to fiscal
1996, in all expense categories, focusing primarily on the areas of professional
services, marketing and financing activities.

   Interest expense increased to $15,746 for fiscal 1997 from $6,777 for the
year ended July 31, 1996.  This increase was the result of an increase in
outstanding debt during the year ended July 31, 1997.

   Other expense increased by $90,000 for the year ended July 31, 1997 and
resulted from an accrual for the settlement by the parties of a dispute
discussed in Note 6 to the consolidated financial statements.

   As a result of the foregoing factors the Company incurred a net loss of
$580,845 for the year ended July 31, 1997 as compared to a net loss of
$1,186,938 for the year ended July 31, 1996.

                                      -12-
<PAGE>
 
   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 is to finance its operating (i.e. selling,
general and administrative) expenses from the gross profits generated by its
television film and commercial production 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 highly 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 to produce profitable television film projects.

   Operating cash flows were a negative $763,426 for the year ended July 31,
1997 primarily the result of a $565,099 shortfall in the coverage of SG&A and
other expenses by television film and commercial production profits.  The
operating cash flow shortfall was financed with funds obtained from new debt and
equity financing.

   Operating cash flows were a negative $1,074,135 for the year ended July 31,
1996, due to a $986,155 shortfall in the coverage of SG&A expenses by television
film and commercial productions profits.  This operating cash flow shortfall was
primarily financed from equity investments.

   Operating cash flows for the year ended July 31, 1997 were also affected by a
net increase in accounts receivables, in excess of an increase in accounts
payable, amounting to $228,301 at July 31, 1997.  The net accumulation of
accounts receivable at July 31, 1997 was a direct result of an increase in
commercial contract production revenues in the fourth quarter of fiscal 1997 as
compared to the fourth quarter of fiscal 1996.  Commercial contract production
revenues were $1,370,728 for the fourth quarter of fiscal 1997 as compared to
$749,738 for the fourth quarter of fiscal 1996.  Accounts receivable were
$508,837 at July 31, 1997 and aggregate accounts receivable collections amounted
to $422,001 in August and September 1997.

   The Company had film cost additions of $380,249 in fiscal 1997, of which
$362,214 related to cost incurred in the co-production of "Fire From The Sky."
This cable television special was released in fiscal 1997 and these costs were
fully amortized during the year ended July 31, 1997.

   Cash provided by financing activities amounted to $804,152 for the year ended
July 31, 1997 as compared to $951,938 for the year ended July 31, 1996.  During
fiscal 1997, the Company raised $410,000 from the private placement of its Class
A common stock and raised $535,000 (partially offset by $140,848 in repayments)
in borrowings under notes payable, including $235,000 advanced from related
parties and $300,000 advanced from lenders which are guaranteed by shareholders
and/or board members.

   The Company's negative operating cash flows have, as previously stated,
generally been caused by a shortfall in the coverage of SG&A by television film
and commercial  production profits.  Such shortfalls in the coverage of SG&A by
television film and commercial production profits will cause the Company's
liquidity to be constrained until television film and commercial production
revenues, and the resulting profits, increase. The use of equity or debt
financing will continue to be necessary until television film and commercial
production profits are sufficient to cover SG&A expenses, which cannot be
assured.

   The Company's operating cash flows were positively affected in the fourth
quarter of fiscal 1997 and have been positively affected in the first quarter of
fiscal 1998 by increases in commercial production revenues.  Revenues for the
fourth quarter of fiscal 1997 amounted to $1,370,728 and awarded commercial
contract production amounted to approximately $1,500,000 for the first quarter
of fiscal 1998.  Awarded commercial contract production for the first quarter of
fiscal 1998 is not necessarily indicative of future results for the year ending
July 31, 1998.

   Notes payable and notes payable/related parties aggregating $465,593 will
mature during fiscal 1998, resulting in a significant demand upon the Company's
operating cash flows.  If operating cash flows are unavailable to repay these
notes, the Company will attempt to either negotiate an extension of the due

                                      -13-
<PAGE>
 
dates for these notes or attempt to raise additional funds through new equity
financing.  Additionally,  the Company is currently considering asset based
financing as a means of addressing short-term cash flow requirements.  In
October 1997 the Company received a non-binding commitment letter from a
financing institution for the establishment of an asset based line of credit not
to exceed $1,000,000.  There can be no assurance that such a line of credit will
be established nor that the terms offered will be acceptable to the Company.

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

   The Company has had discussions concerning additional private placements of
its debt or equity securities, and as a result thereof, believes that there will
be available sufficient capital to finance its business plans for fiscal 1998.
However, there can be no assurances that any such debt or equity financing will
be available to the Company, or if available, that such financing would be
available on terms considered acceptable to the Company. The inability to obtain
such equity or debt financing as needed would require the Company to have to
materially reduce the scope of its operations.

   RECENT ACCOUNTING PRONOUNCEMENTS

   In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS No. 128").
SFAS No. 128, which is effective for periods ending after December 15, 1997,
revises the manner in which earnings per share is calculated and requires the
restatement, when first applied, of prior period earnings per share data.  The
Company will initially apply SFAS No. 128 in the first quarter of fiscal 1998.
Upon the adoption of SFAS No. 128, the Company will restate previously reported
earnings per share data.  The Company has not yet determined what effect, if
any, the restatement will have on previously reported data.

   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.  Because of the recent issuance of this standard, management has been
unable to fully evaluate the impact, if any, the standard may have on future
financial statement disclosures.  Results of operations and financial position,
however, will be unaffected by implementation of this standard.

   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.  Because of the recent issuance of this standard, management has been
unable to fully evaluate the impact, if any, the standard may have on future
financial statement disclosures.  Results of operations and financial position,
however, will be unaffected by implementation of this standard.

                                      -14-
<PAGE>
 
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>
   Steven D. Brown (1) (2)      50  Director, Chairman of the Board, Chief 
                                    Executive Officer
 
   Rex Hauck (2)                46  Director, Co-President
 
   Vivian W. Jones (1)          45  Director, Co-President
 
   Robert A. Martinez           34  Vice President - Finance, Chief Financial 
                                    Officer and Treasurer
 
   J. Eric Van Atta             33  Vice President, Secretary
 
   John Boyd                    61  Director
 
   Malcolm C. Davenport, V      45  Director
 
   Dan W. Holloway              75  Director
 
   Norman J. Hoskin             63  Director
 
   Ben Noble                    45  Director
 
   Glen C. Warren (1)           65  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

   STEVEN D. BROWN - Mr. Brown founded the Company in July 1991 with Mr. Hauck
and has served as Chairman of the Board since July 1997, 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, and Co-President.

   VIVIAN W. JONES - Ms. Jones, who has been involved in the film industry for
19 years, founded First Light Entertainment Corporation ("First Light"),
originally Current Corporation, in 1993 to purchase certain assets of Jayan
House, Ltd., a commercial production company, where she had been employed as
General Manager and Executive Producer since 1990. She has been president of
First Light since its founding and, since First Light's acquisition by the
Company in 1993, Co-president of the Company as well.

                                      -15-
<PAGE>
 
   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 Directors 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.

   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.

   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 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.

                                      -16-
<PAGE>
 
   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, except
that:  1) Malcolm C. Davenport V, a director, failed to timely file Form 4 in
relation to one transaction, 2) Ben E. Noble, a director, failed to timely file
Form 3 in relation to one transaction, 3) Dr. Glen C. Warren, a director, failed
to timely file Form 4 in relation to one transaction, 4) Robert A. Martinez, an
officer, failed to timely file Form 4 in relation to two transactions, and 5) J.
Eric Van Atta, an officer, failed to timely file Form 4 in relation to two
transactions.  These Forms 3 and 4 were filed with the Securities and Exchange
Commission prior to October 24, 1997.

   The Company, which first became subject to Section 16(a) reporting
requirements in September 1996, has now initiated a reporting compliance program
that will substantially eliminate the possibility of inadvertent reporting
oversights in the future.

   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, 1997, for the chief executive officer; no other executive officers
earned more than $100,000 during the year ended July 31, 1997.  During fiscal
1997 the Company's chief executive officer did not receive, and as of July 31,
1997 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                 1997      $ 99,360    -0-           -0-
Chairman of the Board           1996       104,040    -0-           -0-
Chief Executive Officer         1995        94,500    -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.

                                      -17-
<PAGE>
 
   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 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.

   Pursuant to the Merger Agreement, options to purchase 2,251,200 shares of the
Company's Class B common stock were issued under the Stock Option Plan to
replace options previously granted by Old American Artists (under a comparable
stock option plan) and then outstanding, to purchase shares of Old American
Artists' common stock. No shares of common stock have been issued upon exercise
of options granted under the Stock Option Plan.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

   The following table shows beneficial ownership of capital stock of the
Company at October 29, 1997, 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)(7)                 100           -             1,256,127         22.83%
                                                                               
Rex Hauck (1)(2)(7)                    300           -             1,311,029         23.83%
                                                                               
Vivian W. Jones (1)(3)(7)              600           -             1,318,350         20.66%
                                                                               
Robert A. Martinez (1)(4)                -           -                25,586             -
                                                                               
J. Eric Van Atta (1)(5)              2,767           -               160,057          2.85%
                                                                               
John W. Boyd (1)(6)                 15,400        1.60%              385,906          6.96%
                                                                               
Malcolm C. Davenport, V(1)(9)       41,866        4.48%              142,730          2.59%
                                                                               
Norman J. Hoskin (1)                     -           -                     -             -
                                                                               
Dan Holloway (1)                     2,667           -                35,172             -
                                                                               
Ben E. Noble(1)(10)                113,332       11.49%                    -             -
                                                                               
Glen C. Warren (1)(7)(8)            88,564        9.18%              491,945          8.67%
                                                                               
Douglas J. Bates                   117,020       12.82%                    -             -
 244 B Greenwood Drive                                                         
 Ballwin, Missouri 63011                                                       
                                                                               
Alan G. Johnson                    125,720       13.77%                    -             -
 325 Highway DD                                                                
 Defiance, Missouri 63341                                                      
                                                                               
Australian Advisors Corp.          300,000       32.86%                    -             -
 Bay & Deveaux St. 2nd Fl.                                                     
 P.O. Box N-1000                                                               
 Nassau, Bahamas                                                               
                                                                               
All Officers and Directors as a                                                
Group (11 persons)                 265,596       24.71%            5,126,902         75.49%
</TABLE>

                                      -18-
<PAGE>
 
    *   Any percentages under one percent (1%) are not shown.

   (1) The address for the officers and directors is the corporate office of the
Company located at 1245 Fowler St., N.W., Atlanta, Georgia 30318.

   (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 879,300 shares of Class B common stock subject to purchase under
currently exercisable options. Also 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 (7) below.

   (4) Includes 25,586 shares of Class B common stock subject to purchase under
currently exercisable options.

   (5) Includes 122,054 shares of Class B common stock subject to purchase under
currently exercisable options.

   (6)   Includes 43,965 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.  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.

   (7) 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.

   (8) Includes 171,310 shares of Class B common stock subject to purchase under
currently exercisable warrants and options and 52,000 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.

   (9) Includes 87,830 shares of Class B common stock and 20,100 shares of Class
A common stock, held by Mr. Davenport as trustee of a family trust.  Also
includes 11,724 shares of Class B common stock subject to purchase under
currently exercisable options and 21,666 shares of Class A common stock subject
to purchase under currently exercisable warrants.

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

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. Jones in exchange
for 439,650 shares of Class B common stock and an option to purchase up to

                                      -19-
<PAGE>
 
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. 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% note,
$100,000 principal amount, payable in 20 equal quarterly installments of
principal and interest commencing November 1993.

   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
are exercisable through 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.

   In November 1995, the Company granted Dr. Glen Warren an option to purchase
117,240 shares of Class B common stock at $1.45 per share, exercisable through
June 1999.

   From December 1993 to July 1997, the Company made seven loans totaling
$70,844 to Steven D. Brown, each of which was represented by an unsecured
promissory note due December 1998, with accumulated interest of 7% per annum.

   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.

   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 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 the majority vote (by shares) among
themselves.  By reason of their corporate offices, share ownership and 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.  The line of credit was converted at its expiration into a six
month unsecured note due in May 1997 with a per annum interest rate of 8.75%.
The due date of the note was subsequently extended to November 1997.  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.

                                      -20-
<PAGE>
 
   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.

   In a private placement completed in May 1997, several 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. Loveless, one
unit for $25,000; 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.

   In August 1997, Glen C. 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, a 83.3% owned
subsidiary of the Company that has not yet commenced operations.  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.

                                      -21-
<PAGE>
 
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
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
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

                                      -22-
<PAGE>
 
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, dated October 15, 1997, 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
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

                                      -23-
<PAGE>
 
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.
27.1    American Artists Film Corporation Financial Data Schedule
------------------------------------

 *  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.


(B)  REPORTS ON FORM 8-K.

   No reports on form 8-K have been filed by the Company during the quarter
ended July 31, 1997.

                                      -24-
<PAGE>
 
                                   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:  November 7, 1997
                                  AMERICAN ARTISTS FILM CORPORATION



                                  By:  /s/ Steven D. Brown
                                      -----------------------------------
                                       Steven D. Brown
                                       Chief Executive Officer and
                                        Chairman of the Board


   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.
 
/s/ Rex Hauck                Director and Co-President        November 7, 1997
---------------------------
Rex Hauck
 
/s/ Vivian W. Jones          Director and Co-President        November 7, 1997
---------------------------
Vivian W. Jones
 
/s/ Robert A. Martinez       Vice President/Finance, Chief    November 7, 1997
---------------------------  Financial Officer and Treasurer
Robert A. Martinez         
 
/s/ John W. Boyd             Director                         November 7, 1997
---------------------------
John W. Boyd
 
/s/ Malcolm C. Davenport, V  Director                         November 7, 1997
---------------------------
Malcolm C. Davenport, V
 
/s/ Dan W. Holloway          Director                         November 7, 1997
---------------------------
Dan W. Holloway
 
/s/ Norman J. Hoskin         Director                         November 7, 1997
---------------------------
Norman J. Hoskin
 
/s/ Ben E. Noble             Director                         November 7, 1997
---------------------------
Ben E. Noble
 
/s/ Glen C. Warren           Director                         November 7, 1997
-------------------------
Glen C. Warren

                                      -25-
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                         INDEX TO FINANCIAL STATEMENTS
 
 
      REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS               F-2
                                                                          
      CONSOLIDATED BALANCE SHEETS                                      F-3
                                                                          
      CONSOLIDATED STATEMENTS OF OPERATIONS                            F-5
                                                                          
      CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY                  F-6
                                                                          
      CONSOLIDATED STATEMENTS OF CASHFLOWS                             F-7
                                                                          
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                       F-8 
 

                                      F-1
<PAGE>
 
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS


Board of Directors
American Artists Film Corporation
Atlanta, Georgia

We have audited the accompanying consolidated balance sheets of American Artists
Film  Corporation and Subsidiaries as of July 31, 1997 and 1996, and the related
consolidated statements of operations, stockholders' equity, 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 consolidated financial position of 
American Artists Film Corporation and Subsidiaries as of July 31, 1997 and 1996,
and the consolidated results of their operations and their cash flows for each 
of the years then ended, in conformity with generally accepted accounting 
principles.


                                        BDO SEIDMAN, LLP


Atlanta, Georgia
November 5, 1997

                                      F-2
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                            July 31,
                                                         ------------------------------------------------
                                                                   1997                        1996
                                                         -------------------        ---------------------
<S>                                                           <C>                           <C>
ASSETS                                                                                     
CASH                                                             $    31,379                 $         -
ACCOUNTS RECEIVABLE                                                  508,837                      107,457
FILM COSTS, NET OF ACCUMULATED AMORTIZATION (NOTE 1)                 493,912                      475,877
PROPERTY AND EQUIPMENT, NET (NOTES 1 AND 2)                           41,193                       52,128
GOODWILL, NET OF ACCUMULATED AMORTIZATION (NOTE 1)                   117,429                      156,572
DEFERRED OFFERING COSTS (NOTE 1)                                           -                      105,000
ADVANCES TO OFFICERS (NOTE 1)                                        220,719                      217,247
OTHER (NOTE 1)                                                             -                          112
                                                         -------------------        ---------------------

                                                                 $ 1,413,469                  $ 1,114,393
                                                         ===================        =====================
                                              Se accompanying notes to consolidated financial statements.
</TABLE> 

                                      F-3
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                   CONSOLIDATED BALANCE SHEETS (CONTINUED)
<TABLE> 
<CAPTION> 
                                                                                    July 31,
                                                              ---------------------------------------------------
                                                                           1997                         1996
                                                              ----------------------        ---------------------
<S>                                                                     <C>                           <C> 
LIABILITIES
Accounts payable                                                             342,860                  $   169,781
Accrued expenses                                                              72,087                      112,115
Accrued accounting and legal                                                 193,510                      152,985
Accrued compensation and payroll taxes                                       108,703                      103,630
Deferred revenue                                                                   -                       11,867
Notes payable (Note 2)                                                       316,128                       76,976
Notes payable/related parties (Note 3)                                       155,000                            -
                                                              ----------------------        ---------------------
TOTAL LIABILITIES                                                          1,188,288                      627,354
                                                              ----------------------        ---------------------
 
MINORITY INTEREST (NOTE 1)                                                    50,000                       50,000
 
CONTINGENCIES
 
STOCKHOLDERS' EQUITY (NOTE 4)
Preferred stock - shares authorized 10,000,000;  none issued                       -                            -
Preferred stock, $.001 par - shares authorized  10,000,000;
 none issued                                                                       -                            -
 
Common Stock, $.001 par:
  Class A - shares authorized 20,000,000; issued and
   outstanding 876,620                                                           877                            -
 
  Class B - shares authorized 20,000,000; issued and
   outstanding 5,502,277                                                       5,502                            -
 
Common stock, par value $.05 per share - shares authorized
 30,000,000;  issued and outstanding none and 9,407,837                            -                      470,392
 
Additional paid-in capital                                                 2,908,117                    2,125,117
Unamortized advertising credits                                             (122,618)                    (122,618)
Accumulated deficit                                                       (2,616,697)                  (2,035,852)
                                                              ----------------------        ---------------------
TOTAL STOCKHOLDERS' EQUITY                                                   175,181                      437,039
                                                              ----------------------        ---------------------
 
                                                                           1,413,469                  $ 1,114,393
                                                              ----------------------        ---------------------
</TABLE>


                     See accompanying notes to consolidated financial statements

                                      F-4
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>
                                                                                Year Ended July 31,
                                                               ---------------------------------------------------
                                                                        1997                          1996
                                                               ----------------------         --------------------
<S>                                                              <C>                            <C>
REVENUES
Commercial production                                                      $3,469,655                  $ 1,689,644
Film revenues (Note 1)                                                        420,937                       21,995
                                                               ----------------------         --------------------
 
                                                                            3,890,592                    1,711,639
                                                               ----------------------         --------------------
 
COSTS AND EXPENSES
Cost of commercial production                                               2,656,064                    1,330,604
Film cost amortization                                                        362,214                       15,963
Selling, general and administrative                                         1,347,413                    1,351,227
                                                               ----------------------         --------------------
 
                                                                            4,365,691                    2,697,794
                                                               ----------------------         --------------------
 
LOSS FROM OPERATIONS                                                         (475,099)                    (986,155)
 
Interest expense                                                               15,746                        6,777
Other expense (Note 6)                                                         90,000                            -
Equity in net loss of
   Diversity Filmworks, Inc. (Note 1)                                               -                      194,006
                                                               ----------------------         --------------------
 
NET LOSS                                                                   $ (580,845)                 $(1,186,938)
                                                               ----------------------         --------------------
 
NET LOSS PER SHARE                                                              $(.09)                       $(.22)
                                                               ----------------------         --------------------
WEIGHTED AVERAGE COMMON
   SHARES AND EQUIVALENT SHARES
   OUTSTANDING (NOTE 1)                                                     6,172,977                    5,305,652
                                                               ----------------------         --------------------
</TABLE>


                     See accompanying notes to consolidated financial statements

                                      F-5
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                          Class A           Class B                                                                         Total   
                       Common Stock      Common Stock          Common Stock     Additional   Unamortized   Accumulated     Stock-  
                                                                                 Paid-In     advertising     Deficit       holders'
                      Shares   Amount   Shares    Amount    Shares     Amount    Capital       credits                     Equity
                    --------------------------------------------------------------------------------------------------------------
<S>                   <C>      <C>     <C>        <C>     <C>          <C>         <C>        <C>         <C>             <C>
Balance - July 31,                                                                                        
1995                       -  $  -          -  $    -   8,368,220   $ 418,411    $1,221,397  $(122,618)  $  (848,914)  $   668,276
                                                                                                          
Issuances of common                                                                                       
stock                      -     -          -       -   1,039,617      51,981       903,720           -            -       955,701
                                                                                                          
Net loss                   -     -          -       -           -           -             -           -   (1,186,938)   (1,186,938)
                    ---------------------------------------------------------------------------------------------------------------
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 4(b))    164,000   164          -       -           -           -       409,836           -            -       410,000
                                                                                                          
Award of stock                                                                                            
options (Note 4(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
                   ================================================================================================================
 
                                                                           See accompany notes to consolidated financial statements
</TABLE>

                                      F-6
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
 
 
                                                                                 Year Ended July 31,
                                                                 -------------------------------------------------
                                                                         1997                         1996
                                                                 --------------------         --------------------
<S>                                                                <C>                          <C>
OPERATING ACTIVITIES
  Net loss                                                                   (580,845)                 $(1,186,938)
  Adjustments to reconcile net loss to cash used in operating
     activities:
     Film costs amortization                                                  362,214                       15,963
     Depreciation and amortization                                             59,425                       63,354
     Award of stock options                                                    13,987                            -
     Loss on disposition of assets                                                  -                        2,622
      Equity in net income of Diversity Filmworks, Inc.                             -                      194,006
      Changes in assets and liabilities:
         Accounts receivable                                                 (401,380)                      79,336
         Film costs additions                                                (380,249)                     (76,119)
         Other assets                                                          (3,360)                    (227,890)
         Accounts payable                                                     173,079                       (9,292)
         Accrued expenses                                                       5,570                      157,169
         Film revenues participations                                               -                      (41,910)
         Deferred revenue                                                     (11,867)                     (44,436)
                                                                 --------------------         --------------------
Cash used in operating activities                                            (763,426)                  (1,074,135)
INVESTING ACTIVITIES
  Capital expenditures                                                         (9,347)                           -
                                                                 --------------------         --------------------
FINANCING ACTIVITIES
  Repayment of notes payable                                                 (140,848)                     (53,763)
  Borrowings under notes payable                                              535,000                            -
  Issuances of common stock                                                   410,000                      955,701
  Minority interest                                                                 -                       50,000
                                                                 --------------------         --------------------
Cash provided by financing activities                                         804,152                      951,938
NET INCREASE (DECREASE) IN CASH                                                31,379                     (122,197)
CASH, beginning of year                                                             -                      122,197
                                                                 --------------------         --------------------
CASH, end of year                                                              31,379                            -
                                                                 ====================         ====================
</TABLE>


                     See accompanying notes to consolidated financial statements

                                      F-7
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF BUSINESS

  American Artists Film Corporation ("American Artists," and together with its
subsidiaries "AAFC Group"), 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 productions of film
products, principally television commercials.  The Company classifies its
operations in two business segments:  (i)  film development and production and
(ii)  contract production.  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
advertising agencies that represent clients in various industries.

  During fiscal 1997, 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
developmental stages and has not generated revenues nor incurred a significant
amount of expenses.

  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 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.  During fiscal 1996, three of the Company's customers accounted for
fees equal to 18.5%, 12.5% and 10.3% of consolidated revenues.

  The Company incurred net losses of $580,845 and $1,186,938 for the years ended
July 31, 1997 and 1996.  These losses have been historically funded through
private placements of equity securities and loans made available by members of
the board of directors, accordingly, the Company's continuing operations have
been dependent upon such fundings.  The Company anticipates that future net
losses, if any, would be funded by these same means.

  The Company has had discussions concerning additional private placements of
its debt or equity securities, and as a result thereof, believes that there will
be available sufficient capital to finance its business plans for fiscal 1998.
However, there can be no assurances that any such debt or equity financing will
be available to the Company, or if available, that such financing would be
available on terms considered acceptable to the Company.  The inability to
obtain such equity or debt financing as needed would require the Company to
materially reduce the scope of its operations.

MERGER WITH SETAB ALPHA, INC.

  On October 7, 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.  The consummation of the Merger
was conditioned upon, among other things, Setab's completion of its public
offering, with not fewer than 200 shareholders.  Setab completed its public
offering on October 7, 1997 and upon completion of the Merger, Setab as the
surviving corporation, changed its name to American Artists Film 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

                                      F-8
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

  Old American Artists (referred to hereinafter and previously as the "Company")
is the continuing entity for accounting and financial reporting purposes, and
accordingly the results of operations to be reported for periods prior to the
Merger are those of the Company.  Earnings (loss) per share for periods prior to
the recapitalization have been computed giving retroactive effect to the
recapitalization of Old American Artists' outstanding common stock.  Setab had
no material operations, and as a result the pro forma results of operations
would not differ materially from the Company's historical results of operations.
Accordingly, pro forma results of operations are not presented.

BASIS OF PRESENTATION

  The consolidated financial statements include the accounts of American Artists
and First Light Entertainment Corporation ("First Light"), a wholly-owned
subsidiary, Diversity Filmworks, Inc. ("Diversity"), a 49% owned subsidiary and
Millennium Group, L.L.C. ("Millennium"), as discussed further below.

  Diversity was formed by American Artists and a qualified minority owner to
engage in contract production as a qualified minority contractor.  In
anticipation of the Merger, in September 1996, the Company and the other
stockholder of Diversity entered into an agreement concerning the size and
composition of Diversity's board of directors.  As a result, effective August 1,
1996, the Company consolidated the accounts of Diversity in its consolidated
financial statements.

  Prior to August 1, 1996, the Company accounted for its 49% interest in
Diversity using the equity method of accounting, under which the Company's
interests in Diversity's operating results were presented as a single, separate
line item in the consolidated statements of operations, and the Company's net
investment in and advances to Diversity were presented as a single item in the
consolidated balance sheet.  Revenues, as reflected in the consolidated
statement of operations, did not include the revenues of Diversity.    As a
result, the consolidated financial statements for fiscal 1997 will lack
comparability in certain respects to the consolidated financial statements for
fiscal 1996.

  Millennium is a limited liability corporation over which the company exercises
control through its capacity as manager, which position allows 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 stockholders.  Millennium was formed to produce and
distribute a sixty minute video. American Artists will be entitled to (i)  50%
of net income after the minority stockholders have recovered their investment up
to a point where the minority stockholders have received a 200% return and (ii)
90% thereafter.  As of July 31, 1997, Millennium's activities have been limited
to organization and pre-production story development.  The minority interest at
July 31, 1997 relates to Millennium.

  In accordance with Statement of Financial Accounting Standards No. 53
"Financial Reporting by Producers and Distributors of Motion Picture Films"
("SFAS No. 53"), AAFC 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.

                                      F-9
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

INVESTMENT IN DIVERSITY FILMWORKS, INC.

  American Artists accounted for its investment in Diversity using the equity
method of accounting in fiscal 1996.  Diversity's net losses were financed by
American Artists, and accordingly, in fiscal 1996 American Artists recorded 100%
of Diversity's losses.  Diversity had revenues of $777,309 and operating
expenses of $971,315 resulting in a net loss of $194,006 for the year ended July
31, 1996.

  Effective July 31, 1996, American Artists and Diversity executed an agreement
that changed, retroactively to August 1, 1995, the manner in which certain of
American Artists operating expenses were allocated and charged to Diversity.  As
a result, expenses of $151,308 relating to the first three quarters of fiscal
1996 were charged to Diversity in the fourth quarter of fiscal 1996.  The change
had no effect on the consolidated net loss as American Artists recorded 100% of
Diversity's loss.

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.

  AAFC 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.

  Capitalized film cost 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.

 The components of capitalized film costs were as follows:

<TABLE>
<CAPTION>
                                                                 July 31,
                                                  --------------------------------------
                                                            1997              1996
                                                  --------------------------------------
<S>                                               <C>                 <C>
     Released                                           $ 1,185,560            $ 867,256
     Accumulated amortization                            (1,174,643)            (812,429)
                                                  --------------------------------------
                                                             10,917               54,827
     In production                                           34,181              128,366
     In development                                         448,814              292,684
                                                  --------------------------------------
                                                        $   493,912            $ 475,877
                                                  --------------------------------------
</TABLE>


  The above amounts do not include any value for four developed scripts
contributed to AAFC 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.
       
       

                                     F-10
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

  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, 1999 and 60% will amortized over the three year
period that will end July 31, 2000.

  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 fee 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,
                                                         -------------------------------------
                                                                 1997               1996
                                                         -------------------------------------
<S>                                                      <C>                  <C>
             Television                                           $406,991            $      -
             Foreign video                                          13,946              21,995
                                                         -------------------------------------
                                                                  $420,937            $ 21,995
                                                         =====================================
</TABLE>


COMMERCIAL PRODUCTION

  AAFC Group produces film products, primarily television commercials, 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 percentage-of-completion 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                1997                1996
                                                     --------------------------------------------------
<S>                                                 <C>                 <C>                 <C>
            Office furniture and fixtures           5 - 7 years           $ 89,362             $ 80,015
            Leasehold improvements                  4 months                35,000               35,000
            Production equipment                    5 - 7 years              7,498                7,498
                                                                 --------------------------------------
                                                                           131,860              122,513
            Less accumulated depreciation and
             amortization                                                  (90,667)             (70,385)
 
                                                                ---------------------------------------
                                                                          $ 41,193             $ 52,128
                                                                =======================================
</TABLE>

                                     F-11
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ADVANCES TO OFFICERS

  AAFC 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.

GOODWILL

  Goodwill results from American Artists' 1993 acquisition of 100% of the common
stock of First Light.  The goodwill is being amortized on a straight-line basis
over seven years.  AAFC Group annually assesses the recoverability of the
unamortized goodwill by comparison to projections of undiscounted cash flows
from First Light's operations over the remaining amortization period.

DEFERRED OFFERING COSTS

  Deferred offering costs were comprised principally of audit and other fees
incurred in connection with AAFC Group's merger with Setab Alpha, Inc.  Such
costs were charged against stockholders' equity as a result of the completion of
the merger in October 1996.

UNAMORTIZED ADVERTISING COSTS

  In fiscal 1992 AAFC Group issued shares of its common stock in exchange for
advertising credits that entitle AAFC Group to purchase media 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 in issuances
of shares of common stock for cash during the same period.  The unamortized
advertising credits are presented as a reduction of stockholders' equity
reflecting the acquisition of the credits for common stock.  The recoverability
of the advertising credits is assessed based on the current market price for
similar advertising and AAFC Group's ability to utilize the credits.  The
credits may be used by AAFC Group through December 31, 1998.

INCOME TAXES

  AAFC 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 not more likely than not that the benefit of deferred tax
assets will be realized.

EARNINGS PER SHARE

  Earnings per share are computed on the basis of the weighted average common
shares and dilutive common share equivalents outstanding.  Common stock
equivalents consist of outstanding stock options and warrants.

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.

                                     F-12
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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.

RECENT ACCOUNTING PRONOUNCEMENTS

  In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings Per Share ("SFAS No. 128").
SFAS No. 128, which is effective for periods ending after December 15, 1997,
revises the manner in which earnings per share is calculated and requires the
restatement, when first applied, of prior period earnings per share data.  The
Company will initially apply SFAS No. 128 in the first quarter of fiscal 1998.
Upon the adoption of SFAS No. 128, the Company will restate previously reported
earnings per share data.  The Company has not yet determined what effect, if
any, the restatement will have on previously reported data.

  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.  Because of the recent issuance of this standard, management has been
unable to fully evaluate the impact, if any, the standard may have on future
financial statement disclosures.  Results of operations and financial position,
however, will be unaffected by implementation of this standard.

  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.  Because of the recent issuance of this standard, management has been
unable to fully evaluate the impact, if any, the standard may have on future
financial statement disclosures.  Results of operations and financial position,
however, will be unaffected by implementation of this standard.

                                     F-13
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 - NOTES PAYABLE

 Notes payable consisted of the following:
<TABLE>
<CAPTION>
                                                                       July 31,
                                                         -------------------------------------
                                                                 1997               1996
                                                         -------------------------------------
<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, 1997)               
            plus 1%, due quarterly,
            principal due July 1998                             $225,000            $      - 
 
            Unsecured installment note payable to bank,
            interest at 8.75%, monthly principal and
            interest of $3,000, principal                         
            due November 1997                                     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                            27,073              47,696
                                                                                            
            Unsecured installment note payable to bank,                                     
            interest at the prime rate plus 1%,                                             
            monthly principal and                                                           
            interest, due March 1997                                   -              29,280 
                                                         -------------------------------------
                                                                $316,128             $76,976
                                                         =====================================
</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, 1997.  In consideration for establishing the line of
credit, the Company issued, in October 1997, 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.

  In July 1996 a member of the board of directors, as a co-signer on the note
payable to bank, established a three month line of credit in favor of the
Company for borrowings not to exceed $75,000.  The initial terms of this line of
credit were agreed to in May 1996 in return for the issuance of 28,208 Class B
common stock options, with an exercise price of  $1.71, exercisable through June
30, 2000.  In November 1996, the Company converted this line of credit into a
six-month note due May 1997 and received an additional six month extension to
November 1997.

  Aggregate maturities of notes payable are as follows:
<TABLE>
<CAPTION>
 
<S>                                                        <C>
            1998                                                     $310,593
            1999                                                        5,535
                                                           ------------------
                                                                     $316,128
                                                           ==================
</TABLE>

                                     F-14
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 -  NOTES PAYABLE/RELATED PARTIES

  Notes payable to related parties consisted of the following:

<TABLE>
<CAPTION>
                                                                       July 31,
                                                         -------------------------------------
                                                                 1997               1996
                                                         -------------------------------------
<S>                                                      <C>                <C>
            Line of credit with member of the board of
            directors, interest at the prime rate
            (8.5% at July 31, 1997) plus
            1%, due monthly, principal due                        100,000                   -
            July 1998
 
            Unsecured notes due certain member of board
            of directors, due on demand
            but no later than                                      55,000                   -
            August 1998, interest at the prime rate
            plus 1%
                                                         -------------------------------------
                                                                 $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, 1997.  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.

  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 $50,000 of these loans in February and June of 1997.  The
maturity date of the remaining note was extended to August 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.

  In April 1997, a board of director 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.

  Aggregate maturities of notes payable/related parties amount to $155,000 in
the year ending July 31, 1998.

NOTE 4 - STOCKHOLDERS' EQUITY

(A)    STOCK OPTIONS

  AAFC Group adopted a stock option plan in 1991 which, as revised,
permits the issuance of stock options for the purchase of up to 4 million shares
of American Artists' common stock.  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 four years.

                                     F-15
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

  In December 1995, AAFC Group replaced its existing stock option plan with the
1995 stock option plan ("1995 Option Plan"). The 1995 Option Plan allows for the
issuance of up to 2.5 million stock options as either incentive stock options,
non-qualified stock options, or stock appreciation rights. 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 Company adopted, effective August 1, 1996,  the disclosure-only
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS 123"), but applies Accounting Principles
Board Opinion No. 25 and related interpretations in accounting for its stock
option plan.  The Company recognized compensation costs of $13,987 related to
awards of stock options for the year ended July 31, 1997.

  The following summarizes stock option activity:

<TABLE>
<CAPTION>
                                                                                      Weighted 
                                                                                  average exercise 
                                                          Number of options            price
                                                         -----------------------------------------
<S>                                                      <C>                  <C>
 Outstanding, August 1, 1995                                      1,005,333               $0.81
   Granted                                                        1,056,415                1.70
   Exercised                                                              -                   -
   Forfeited or expired                                            (128,379)               1.94
                                                         -------------------------------------- 
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
                                                         ======================================
Options exercisable at:
   July 31, 1996                                                    747,405               $0.87
                                                         --------------------------------------
   July 31, 1997                                                  1,677,504               $1.16
                                                         ======================================
</TABLE>


  Options exercisable at July 31, 1997 were as follows:

<TABLE>
<CAPTION>
                                                                     Weighted
                                   Number of                         average
                                    options       Option price    exercise price
                               -------------------------------------------------
                               <S>                <C>             <C>
                                         64,482           $0.085          $0.085
                                        879,300             0.85            0.85
                                        650,902     1.45 to 1.71            1.51
                                         77,820             2.56            2.56
                                          5,000           $ 4.00            4.00
                               ----------------
                                      1,677,504                           $ 1.16
                               ================
</TABLE>

                                     F-16
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

  Options outstanding at July 31, 1997 were as follows:

<TABLE>
<CAPTION>
                                    Weighted
                                    Average
                                   Remaining                         Weighted
                   Number of      Contractual                        average
                    options      Life in Years    Option price    exercise price
               -----------------------------------------------------------------
<S>              <C>             <C>             <C>              <C>
                         82,068          5.00           $0.085          $0.085
                        879,300          6.09             0.85            0.85
                        838,853          3.42     1.45 to 1.71            1.50
                        413,993          7.10     2.56 to 3.75            3.19
                        205,241          2.99   4.00 to $ 4.75            4.65
               ----------------
                      2,419,455          5.04                           $ 1.77
               ================
</TABLE>



   If the Company had elected to recognize compensation costs based on
the fair value at the grant date of options 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:

<TABLE>
<CAPTION>
                                                                   Year Ended July 31,
                                                         --------------------------------------
                                                                  1997                1996
                                                         --------------------------------------
<S>                                                            <C>                  <C>

             Net loss
                    As reported                                    (580,845)         (1,186,938)
                    Pro forma                                      (733,689)         (1,210,386)
 
             Net loss per share
                   As reported                                         (.09)               (.22)
                   Pro forma                                           (.12)               (.23)
</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,
                                                                   1997                1996
                                                           -------------------------------------
<S>                                                        <C>                 <C>
              Options granted at market price                        $272,434           $286,432
              Options granted at above market price                  $  1,200           $      -
</TABLE>


          The significant weighted average assumptions used to estimate the fair
value of stock options for the years ended July 31, 1997 and 1996 were:  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 has not
developed, therefore, the minimum value method was used in estimating fair
value.

                                     F-17
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(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.

   During fiscal 1996, American Artists completed two private placements
of units comprised of common stock and Class B common stock purchase warrants.
American Artists completed a private placement in fiscal 1996, initially started
in fiscal 1995, of 15.7 units priced at $25,000 per unit ($1.45 per share), with
each unit comprised of 17,241 shares of common stock and 8,621 Class B common
stock purchase warrants.  The Company issued 135,347 Class B common stock
purchase warrants under this private placement in fiscal 1996.

   The second private placement consisted of units priced at $25,000 per
unit ($1.71 per share), comprised of 14,655 shares of common stock and 7,328
Class B common stock purchase warrants. American Artists completed a private
placement of 22.55 units and issued 165,265 Class B commons stock purchase
warrants in fiscal 1996.

   Outstanding warrants were as follows:
<TABLE>
<CAPTION>
 
                                                               Shares
                                                         ------------------
<S>                                                      <C>
  Outstanding, August 1, 1995                                        17,242
    Issued                                                          300,612
    Exercised                                                             -
    Forfeited                                                             -
                                                         ------------------ 
 Outstanding, July 31, 1996                                         317,854
   Issued                                                            54,663
   Exercised                                                              -
   Forfeited                                                              -
                                                         ------------------
Outstanding, July 31, 1997                                          372,517
                                                         ==================
</TABLE>
                                                                               
  Warrants outstanding at July 31, 1997 were as follows:
<TABLE>
<CAPTION>
 
                                    Warrants        Exercisable
                Exercise Price     Outstanding        Through
               --------------------------------------------------
<S>            <C>               <C>              <C>
                $2.56 to $3.41           317,854     June 1998
                    $3.00                 54,663     June 2000
</TABLE>


(C)  SUBSEQUENT EVENTS

  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.

                                     F-18
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

  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 in March 1997

NOTE 5 - INCOME TAXES

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

<TABLE>
<CAPTION>
                                                                        July 31,
                                                         --------------------------------------
                                                                 1997                 1996
                                                         --------------------------------------
Deferred tax assets:
<S>                                                      <C>                 <C>
               Investment in Diversity Filmworks, Inc.             164,000               97,000
               Net operating loss carryforwards                    800,000              647,000
               Valuation allowance                                (964,000)            (744,000)
                                                         --------------------------------------
                                                                         -                    -
                                                         ======================================
</TABLE>


  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,
                                                         ---------------------------------------
                                                                 1997                   1996
                                                         ---------------------------------------
<S>                                                      <C>                    <C>
               U.S. statutory federal income tax rate                (34%)                 (34%)
               Valuation allowance                                    34%                   34%
                                                         ---------------------------------------
               Effective tax rate                                      -                     -
                                                         =======================================
</TABLE>


  AAFC Group has net operating loss carryforwards for federal tax
purposes amounting to approximately $2,105,000 at July 31, 1997.  These
net operating loss carryforwards expire principally in fiscal years 2008 through
2012.  As a result of such net operating loss carryforwards and the related 100%
valuation allowance, AAFC Group has not provided a provision for income taxes
for the years ended July 31, 1997 and 1996.

NOTE 6 - 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, of which $50,000
was accrued at July 31, 1996 with the balance accrued at July 31, 1997, over a
period of fourteen months commencing in June 1997.  The Agreement provides for a
stipulated abitral award of $190,000 upon default by the Company of the payment
arrangements outlined in the Agreement.

                                     F-19
<PAGE>
 
                       AMERICAN ARTISTS FILM CORPORATION
                               AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

   The Agreement also calls for the Company 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.

NOTE 7 - SEGMENT INFORMATION

   Financial information by business segment is as follows:

<TABLE>
<CAPTION>
                                                 Development and    Contract Production
1997                                             Film Production                            Consolidated
-----------------------------------------------------------------------------------------------------------
<S>                                            <C>                  <C>                  <C>
             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
 
             1996
---------------------------------------------
 
            Revenues                                        21,995           1,689,644            1,711,639
            Loss from operations                           598,072             388,083              986,155
            Identifiable assets                            491,982             300,052              792,034
            Capital expenditures                                 -                   -                    -
            Depreciation and amortization                   21,013              58,304               79,317
</TABLE>


NOTE 8 - SUPPLEMENTAL CASH FLOW INFORMATION

<TABLE>
<CAPTION>
                                                                  1997                1996
                                                         ---------------------------------------
<S>                                                      <C>                  <C>
            Cash paid for interest                                  $  8,221            $  6,777
            Cash paid for income taxes                                     -                   -
                                                         ---------------------------------------
                                                                    $  8,221            $  6,777
                                                         =======================================
</TABLE>


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

                                     F-20