**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D. C. 20549**

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**FORM10-QSB**

**(Mark One)**
| **x**                                              | **QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|----------------------------------------------------|----------------------------------------------------------------------------------------|
| ** **                                         | ** **                                                                             |
| **For the  quarterly period ended March 31, 2007** |
| ** **                                         |
| **o**                                              | **TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF  THE EXCHANGE ACT**                   |

 

**For thetransition period from                       to                       **

**CommissionFile Number: 000-50638**

**GRAYMARKPRODUCTIONS, INC.**

(Exact name ofsmall business issuer in its charter)

| **OKLAHOMA**                     |   | **20-0180812**       |
|----------------------------------|--------|----------------------|
| (State or other  jurisdiction of |   | (I.R.S. Employer     |
| incorporation or  organization)  |   | Identification  No.) |

 

**101 N.Robinson, Suite 920**

**OklahomaCity, Oklahoma 73102**

(Address of principal executive offices)

**(405)601-5300**

(Issuer’s telephone number)

(Former name,former address and former fiscal year, if changed since last report)

Check whether the issuer(1) filed all reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 12 months (or for shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes x No o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).    Yes oNo x

**APPLICABLEONLY TO ISSUERS INVOLVED IN BANKRUPTCY**

**PROCEEDINGSDURING THE PRECEDING FIVE YEARS**

Check whether theregistrant filed all documents and reports required to be filed by Section 12,13 or 15(d) of the Exchange Act after the distribution of securities under aplan confirmed by a court.  Yes oNo o

**APPLICABLEONLY TO CORPORATE ISSUERS**

State the number ofshares outstanding of each of issuer’s classes of common equity, as of thelatest practicable date:As of May 4, 2007, 8,745,183 shares of the issuer’s common stock, $0.0001 parvalue, were outstanding.

Transitional SmallBusiness Disclosure Format (Check One): Yes oNo x

 

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**GRAYMARKPRODUCTIONS, INC**.

FORM 10-QSB

For the QuarterEnded March 31, 2007

TABLE OF CONTENTS
| Part I.    | Financial Information                                           |   |
|------------|-----------------------------------------------------------------|--------|
| Item 1.    | Financial Statements                                            |   |
| Item 2.    | Management’s  Discussion and Analysis or Plan of Operation |   |
| Item 3.    | Controls and  Procedures                                        |   |
|       |                                                            |   |
| Part II.   | Other Information                                               |   |
| Item 1.    | Legal Proceedings                                               |   |
| Item 2.    | Unregistered  Sale of Equity Securities and Use of Proceeds     |   |
| Item 3.    | Defaults Upon  Senior Securities                                |   |
| Item 4.    | Submission of  Matters to a Vote of Security Holders            |   |
| Item 5.    | Other Information                                               |   |
| Item  6.   | Exhibits                                                        |   |
| SIGNATURES |                                                            |

 

Throughout thisreport the first personal plural pronoun in the nominative case form “we” andits objective case form “us”, its possessive and the intensive case forms “our”and “ourselves” and its reflexive form “ourselves”  refer collectively to Graymark Productions,Inc., its predecessor, Graymark Productions, L.L.C., and its executive officersand directors.  The term “independent,”as used in this report, is used to distinguish us from the term “major studios”that is generally regarded in the entertainment industry to mean UniversalPictures, Warner Bros., Twentieth Century Fox, Sony Pictures Entertainment,Paramount Pictures, The Walt Disney Company, Metro Goldwyn Mayer and theirrespective affiliates.  The terms “low-budgetmotion pictures,” “low-budget films” or “low-budget movie” within this report,refer to motion pictures that have a production budget of $250,000 to $3million.

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**PARTI. FINANCIAL INFORMATION**

**Item1.****           FinancialStatements**

Ourfinancial statements presented in this report were prepared and included inthis report in accordance with Regulation S-X and Regulation S-B and appear inthis report beginning on page F-1.

**Item 2.****           Management’s Discussionand Analysis or Plan of Operation**

Youshould read the following discussion in conjunction with our financialstatements and notes thereto appearing elsewhere in this report.

**Overview**

Sincecommencement of our operations in August 2001, 2005 was the first year that wereceived significant revenue from our motion picture productions.  During 2006 and 2005, we earned revenue of$404,276 and $450,000, respectively, from our motion picture filmprojects.  During the three months endingMarch 31, 2007, we earned revenue of $24,945 from the internationaldistribution of *Cloud 9,**The Hunt, Surveillance*and*Soul’s Midnight*.  During March 2007, *The Hunt* was released domestically.  We anticipate the domestic release of *Surveillance* and *Soul’s Midnight* later in 2007.  We have completed, but not released ourmotion picture film project, *Fingerprints*.

Thefollowing discussion covers our plan of operations for the next 12 months.  As with any plan, there is no assurance thatour operations as described will go as planned or that we will be successful inachieving the anticipated results.

**MovieDevelopment and Production**

**Themovie industry generally consists of two principal activities, production anddistribution.  Production encompasses thedevelopment, financing and creation of feature-length movies.  Distribution entails the promotion andmarketing of movies in the various media markets, including theatrical, homevideo and television presentation.  Wetypically acquire developed or “packaged” films from third parties, rather thanretain and employ personnel to develop films for our production.  Furthermore, our movies are typicallydistributed pursuant to licensing arrangements with unrelated third-partiesthat are independently engaged in the promotion and distribution ofmovies.  Our approach to acquisition,production, and distribution is to balance our financial risks against theprobability of commercial success of each movie project.**

Weproduce English language motion pictures intended for domestic ancillary marketrelease (home video and television, including pay-per-view, cable, satelliteand network broadcast) that have production budgets of $250,000 to $3 million (“low-budgetmotion pictures,” “low budget movies” or “low-budget films”).  We initially anticipated producing motionpictures that had production budgets of $2 million to $5 million, but based onthe production of our motion pictures to date, we believe that a range of$250,000 to $3 million is appropriate.

Thedevelopment and production costs of a low-budget film and each cost categoryvaries from movie-to-movie and this variation may be substantial.  Each movie is unique and the storyline,special effects, production locations, creative personnel involved, etc. affectthe budget amount of each cost category. Accordingly, we believe the cost categories are somewhat indeterminableuntil the particular movie is identified and developed.

Ratherthan retain and employ personnel to develop screenplays and perform other moviedevelopment activities, we typically acquire low-budget movie projects forproduction that are in the development phase, generally to the point that theinitial screenplay has been written.  Inthe pre-production and production phases of a motion picture, we hire skilledcreative and production personnel, including cinematographers, editors, costumedesigners, set designers, sound and lighting technicians and actors on an asneeded basis.

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Weenter into various production cost and revenue sharing arrangements, includingjoint ventures, partnerships and limited liability companies, on amovie-by-movie basis.  These sharingarrangements are intended to complement or expand our business to permit theproduction of a greater number of movies, while sharing the financial risks ofthe movie.  We may not realize theanticipated financial benefits when we enter into these arrangements.  In addition, the negotiation of thesearrangements, whether successful or not, may require us to incur significantcosts and cause diversion of management’s time and resources.  Accordingly, the costs of obtaining thesesharing arrangements increase our invested cost in a movie without providing acorrelating increase in the movie’s revenues and, consequently, adverselyaffect the financial performance of the movie.

Followingour production of a movie, we intend to arrange for distribution through thirdparties primarily into the domestic (United States and Canada) andinternational ancillary market (home video or pay and free television).  Depending upon our ability to obtainfavorable distribution arrangements, which depends in many cases upon thedistributor’s assessment of the movie’s revenue potential, a particular moviemay be distributed in the domestic and international theatrical markets as wellas the ancillary markets. As of the date of this report, we have not enteredinto any arrangements for the theatrical release of our produced andin-production motion pictures.  Asubstantial amount of time may elapse between our expenditure of funds in theproduction of a motion picture and the receipt of revenue from the motionpicture we produce.

Ourproduced movies are distributed domestically pursuant to licensing arrangementswith unrelated third parties that are independently engaged in the promotionand distribution of movies.  Our foreignmarket distribution arrangements are pursuant to sale or license of theinternational distribution rights to an unrelated third-party  distributor for either a single up-frontpayment (in U.S. currency) without any retained participation in internationalsource revenues or for the right to receive a percentage of gross receiptsreceived by the distributor.  As of thedate of this report, we have entered into domestic (United States and Canada)distribution arrangements covering all of our motion picture projects and haveentered into international distribution arrangements covering *Cloud 9, The Hunt,**Surveillance*and*Soul’s Midnight*.

Ourinternational market distribution, whether in the ancillary market or thetheatrical market, will be subject to:

·                                          changesin local regulatory requirements, including restrictions on content,

·                                          changesin the laws and policies affecting trade, investment and taxes (including lawsand policies relating to the repatriation of funds and withholding taxes),

·                                          differingdegrees of protection for intellectual property,

·                                          instabilityof foreign economies and governments,

·                                          culturalbarriers, and

·                                          warsand acts of terrorism.

Any of thesefactors could have a material adverse effect on the international distributionrights of any motion picture.

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**RecentDevelopments**

***Cloud 9.**** *In conjunction withthe production of *Cloud 9*, withthe other producers of *Cloud 9*,we formed Out of the Blue Productions, LLC (the “Production Company”).  The Production Company has entered into threeagreements covering the domestic (United States and Canada) and internationaldistribution of *Cloud 9* in theancillary market (home video market) and the broadcast rights (pay and freetelevision, video on demand and pay-per-view) for *Cloud 9*.  Pursuant tothe agreement covering domestic distribution (“Domestic Agreement”), theProduction Company received in June 2005 a non-refundable advance of $450,000on our share of the net receipts from the domestic distribution of *Cloud 9* that was distributed to us.  This advance was recognized as revenue inJune 2005 upon delivery of the completed film. The Domestic Agreement allows the licensee to receive a distribution feeequal to 20% of gross domestic receipts of *Cloud9*after its recoupment of all manufacturing, distribution andmarketing costs from those receipts.  *Cloud 9* was released in the domestic videomarket during January 2006.  The domesticdistributor of *Cloud 9* is notrequired to report revenue results to us until 60 days after the end of eachcalendar quarter.  We will record revenuefrom the domestic distribution of *Cloud 9*on the date that we receive detailed reporting of the sales results from thedomestic distributor and can accurately determine our revenues from thisdistribution.  In July 2006, we receivedthe first reporting from the domestic distributor and based on the sales datarevised our ultimate revenue estimate. This resulted in an impairment charge to film costs of $1,445,014.

DuringJune 2005, the Production Company entered in to an agreement for theinternational distribution of *Cloud 9*(“InternationalAgreement”).  Under the InternationalAgreement the licensee is entitled to receive recoupment  of its manufacturing, distribution andmarketing costs and thereafter a distribution fee of equal to 15% of grossinternational receipts up to $2,000,000 and 10% of gross international receiptsabove $2,000,000.  During 2006, we earnedapproximately $278,000 of revenue under this agreement.  In December 2006, based on the actualinternational receipts to date and the number of international territoriesremaining to be exploited, we revised our ultimate revenue estimate.  This resulted in an additional impairment chargeto film costs of $100,000.  This broughtthe total impairment charge for *Cloud 9*to $1,545,014.  During the three monthsended March 31, 2007, we earned approximately $6,000 of revenue under thisagreement.

Furthermore,during June 2005, the Production Company entered in to a Sales Agency Agreementfor the marketing of the broadcast rights (pay and free television,video-on-demand and pay-per-view) of *Cloud 9*(“Broadcast Agreement”).  Pursuant to theBroadcast Agreement, the licensee is entitled to a fee equal to 20% of thegross receipts from broadcast of *Cloud 9*on pay and free television, video-on-demand and pay-per-view after itsrecoupment of its distribution expenses.

As aresult of the agreements with the director, casting company, actors andco-finance providers, our residual net profits interest in *Cloud 9* is 30.6% after recoupment andpayment of all distribution costs, expenses and fees.  Furthermore, our co-finance providers wereentitled to receive the first $500,000 of proceeds we receive from thelicensing of the distribution rights of *Cloud9* of which we have paid in whole. After giving effect to the recovery of the $500,000 contributions to theproduction costs of *Cloud 9* underthe co-financing agreements and then the recovery of our production costs andother invested costs and interest, our net profits interest in *Cloud 9* will be 30.6%.  Our entitlement to distributions from theProduction Company and the profits interest granted to Bert Reynolds providefor interest at a rate of 2% above the prime rate (limited to 5%) for purposesof determining recovery of the production and other costs of *Cloud 9*.

***The Hunt*.** During March 2005, we commenced and completedprincipal filming of our second motion picture project titled, *The Hunt*. *The Hunt* has been releasedin both the domestic and international markets. We have incurred total production costs for *The Hunt* of approximately $385,000.

InJuly 2005, we entered into an agreement for the domestic distribution of *The Hunt*. The agreement grants the licensee a distribution fee equal to 22.5% ofgross receipts and allows for the recoupment of all manufacturing, distributionand marketing costs.  We have alsoentered into an agreement for the international distribution of *The Hunt*. The agreement grants the licensee a distribution fee equal to 20% ofgross receipts and allows for the recoupment of all manufacturing, distributionand marketing costs.  During the threemonths ended March 31, 2007, we earned approximately $4,000 from theinternational distribution of *The Hunt*.  During 2006, we earned approximately $36,000from the international distribution of *TheHunt*.

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Inaddition, we sold 35% of the copyright interest in *The Hunt* to the licensee for approximately $214,000, anamount equal to 50% of the budget of *TheHunt*.  The company that developedthe story concept for *The Hunt*retained a 25% interest in the net receipts of *TheHunt*.  Net receipts is definedas receipts after we recoup our production costs, interest and overhead.  In addition, we entered in to netparticipation agreements with the director, casting company and others equal to7% of the net receipts of *The Hunt*.

***Surveillance*. **During August 2005, we commenced andcompleted principal filming of our third motion picture project titled, *Surveillance*.  *Surveillance*has been released in the international market and is expected to bereleased domestically later in 2007.  Wehave incurred total production costs for *Surveillance*of approximately $587,000.

InJuly 2005, we entered into an agreement for the domestic distribution of *Surveillance*.  The agreement grants the licensee adistribution fee equal to 25% of gross receipts and allows for the recoupmentof all manufacturing, distribution and marketing costs.  We have also entered into an agreement forthe international distribution of *Surveillance*.  The agreement grants the licensee adistribution fee equal to 20% of gross receipts and allows for the recoupmentof all manufacturing, distribution and marketing costs.  During the three months ended March 31, 2007,we earned approximately $15,000 from the international distribution of *Surveillance*.  During 2006, we earned approximately $31,000from the international distribution of *Surveillance*.

Inaddition, we sold 50% of the copyright interest in *Surveillance* to the licensee for approximately $312,000, anamount equal to 50% of the budget of *Surveillance*.  In addition, we entered in to netparticipation agreements with the director, casting company and others equal to8% of the net receipts of *Surveillance*.

***Soul’s Midnight*. **During November 2005, we commenced andcompleted the filming of our fourth motion picture titled, *Soul’s Midnight*.  We have incurred total production costs for *Soul’s Midnight* of approximately $663,000.

Wehave entered into an agreement for the domestic distribution of *Soul’s Midnight*.  The agreement grants the licensee adistribution fee equal to 25% of gross receipts and allows for the recoupmentof all manufacturing, distribution and marketing costs.  We have also entered into an agreement forthe international distribution of *Soul’sMidnight*.  The agreementgrants the licensee a distribution fee equal to 20% of gross receipts andallows for the recoupment of all manufacturing, distribution and marketingcosts.  During 2006, we received anon-refundable advance of $60,000 from the international distribution of *Soul’s Midnight*.

Inaddition, we sold 25% of the copyright interest in *Soul’s Midnight* to the licensee for approximately, $171,000an amount equal to 25% of the budget of *Soul’sMidnight*.  We also sold 50% ofthe copyright interest in *Soul’s Midnight*to the creators of the script for approximately $342,000, an amount equal to50% of the budget.

***Fingerprints.*** During April 2006, we commenced and completedthe filming of our fifth motion picture project titled, *Fingerprints*.  We have incurred total production costs for *Fingerprints* of approximately $616,000 asof March 31, 2007.

Wehave entered into an agreement for the domestic distribution of *Fingerprints*.  The agreement grants the licensee adistribution fee equal to 25% of gross receipts and allows for the recoupmentof all manufacturing, distribution and marketing costs.  In addition, we sold 42.5% of the copyrightinterest in *Fingerprints* to thelicensee for approximately $291,000, an amount equal to 42.5% of the budget of *Fingerprints*.  We also sold 20% of the copyright interest in*Fingerprints* to the creators ofthe script for approximately $137,000, an amount equal to 20% of the budget.

***Summary Motion Picture RevenueParticipation and Net Rights in Distribution.***  The following summarizes the revenueparticipations before and after net profit participations in our films *The Hunt*, *Surveillance,Soul’s Midnight* and *Fingerprints*:

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|                              | ** ** | **Before Payout** | ** ** | **After Payout** | ** ** |
|------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **Company**            | ** ** | **Other  Members**    | ** ** | **Company** | ** ** | **Other  Members** | ** ** | **Third-  Party  Interest** | ** ** |
|                         |       |                   |       |                  |       |   |   |   |   |   |   |
| The Hunt                     |       |                   |       |                  |       |   |   |   |   |   |   |
| Revenue allocation           |       | 65                     | %          | 35                    | %          | 44 | % | 24 | % | 32 | % |
| Production costs to be paid  |       | 50                     | %          | 50                    | %          |   |   |   |   |   |   |
|                         |       |                   |       |                  |       |   |   |   |   |   |   |
| Surveillance                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Revenue allocation           |       | 50                     | %          | 50                    | %          | 46 | % | 46 | % | 8 | % |
| Production costs to be paid  |       | 50                     | %          | 50                    | %          |   |   |   |   |   |   |
|                         |       |                   |       |                  |       |   |   |   |   |   |   |
| Soul’s Midnight         |       |                   |       |                  |       |   |   |   |   |   |   |
| Revenue allocation           |       | 25                     | %          | 75                    | %          | 24 | % | 72 | % | 4 | % |
| Production costs to be paid  |       | 25                     | %          | 75                    | %          |   |   |   |   |   |   |
|                         |       |                   |       |                  |       |   |   |   |   |   |   |
| Fingerprints                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Revenue allocation           |       | 35                     | %          | 65                    | %          | 34 | % | 62 | % | 4 | % |
| Production costs  to be paid |       | 35                     | %          | 65                    | %          |   |   |   |   |   |   |

 

Thetable below summarizes the distribution fees negotiated as of March 31, 2007 ona per movie basis (markets that have no distribution agreements in place areidentified as “n/a”):
|                      | ** ** | **Cloud 9** | ** ** | **The  Hunt** | ** ** | **Surv-  eillance** | ** ** | **Soul’s  Midnight** | ** ** | **Finger-  prints** | ** ** |
|----------------------|------------|------------------|------------|---------------|------------|---------------------|------------|---------------------------|------------|---------------------|------------|
|                 |       |             |       |          |       |                |       |                      |       |                |       |
| Domestic DVD  market |       | 20               | %          | 22.5          | %          | 25                  | %          | 25                        | %          | 25                  | %          |
| Broadcast            |       | 20               | %          | n/a           |       | n/a                 |       | n/a                       |       | n/a                 |       |
| International        |       | 15               | %          | 20            | %          | 20                  | %          | 20                        | %          | n/a                 |       |

 

***Convertible Note Financing.***  In August and October 2005, we issued twopromissory notes (the “Notes”) in the aggregate principal amount of$1,500,000.  The Notes are secured by allof our assets and the assets of our current and future subsidiaries.  The Notes bear interest at the rate of 8% perannum that is payable quarterly and can be paid in cash or shares of our commonstock.  The Notes become due and payableon the first to occur of:

·                                          July27, 2007 for the first note and October 25, 2007 for the second note (the “MaturityDates”);

·                                          theconsummation of a “Qualified Financing;” or

·                                          thecontinuation of and Event of Default, as defined, for more than 30 daysfollowing notice of the occurrence of an Event of Default.

Uponconsummation of a Qualified Financing, the outstanding principal amount of theNotes and all accrued and unpaid interest (collectively the “Note Balance”)will automatically convert into shares of our common stock or other equitysecurities equal to 120% of the Note Balance divided by the price per share ofour common stock or other  equitysecurities sold in the Qualified Financing. The maximum price or value of our common stock or other equitysecurities into which the Note Balance converts may not exceed the equivalentof $1.10 per common stock share. Qualified Financing refers to any equity financing pursuant to which wereceive aggregate gross cash proceeds of $2,000,000 or more on or before theMaturity Date.

Inconjunction with issuance of the Notes, we and the holder of the Notes enteredinto common stock purchase warrant agreements, each evidencing warrantsexercisable on or before August 5, 2010 for the first note and October 25, 2010for the second note.  Two agreementsprovide for the purchase of 250,000 (500,000 total) common stock shares at$2.00 and the other two agreements provide for the purchase of 250,000 (500,000total) common stock shares at $3.00.

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Thefair value of each warrant issued was estimated on the date of issuance usingthe Black-Scholes option pricing model. The fair value of the options were based on the difference between thepresent value of the exercise price of the option and the estimated fair valueprice of the common share.  The fairvalue of the warrants was estimated to be $349,459 and was recorded as paid-incapital and as a discount to the value of the notes.  The value of the warrants will be amortizedto interest expense over the respective terms of the Notes.

InMarch 2007, we executed amendment agreements with the holder of its convertiblenotes payable.  Under the amendments, thematurity date of both Notes is extended to January 31, 2008.  Interest on the Notes is increased from 8% to12% per annum from the date of the amendment until maturity.  As additional consideration for executing theamendments, we lowered the strike price of the previously issued warrantagreements, which allow for the purchase of 1,000,000 shares of common stockshares, to $0.50 per share from the original strike prices of $2.00 and $3.00per share.  In addition, we and theholder of the Notes entered into an additional common stock purchase warrantagreement, evidencing warrants exercisable on or before April 1, 2012.  The agreement provides for the purchase of500,000 common stock shares at $0.50.

Thefair value of the repriced and newly issued warrants was estimated on the dateof repricing or issuance using the Black-Scholes option pricing model.  The fair value of the options were based onthe difference between the present value of the exercise price of the optionand estimated fair value of the common share. The fair value of the newly issued warrants was estimated to be $51,614and will be recorded as paid-in capital. The value of the warrants will increase interest expense over the newlife of the Notes.  We determined thatthere was no additional fair value (over the value previously recorded)attributable to the repricing of the previously issued warrants and noadditional expense has been recorded for this modification.

***Output Agreement.***  In June 2005, we entered into an agreementproviding Image Entertainment (“Image”) with the first-look right at the movieswe produce (the “Output Agreement”). Image has a “first look” on all projects up to $2,000,000 that weundertake during the three-year period beginning on the date of delivery of *The Hunt* which was delivered in February2006.  If Image were to choose not tobecome involved in a motion picture project, we have the right to produce anddistribute the motion picture with another person without any further obligationto Image.  Image agreed to fund up to 50%of each production budget for mutually agreed upon motion pictureprojects.  This funding is payable inthree installments:  20% of the approvedproduction budget through pre-production, 60% through the physical shootingschedule, and 20% through the post-production process.

Fora term of 20 years, Image will have domestic distribution rights of each motionpicture we co-produce with Image. Image is entitled to receive a 25% distribution fee from gross domesticsales and a back-end profit participation from all sales after payment of thedistribution fee.  In general, theback-end profit participation  interestand ownership interest in each co-produced motion picture will be based uponImage’s funding of the budgeted share of production costs.  The actual back-end profit participationpercentage is equal to the percentage Image funds of the motion picture projectafter recovery from sales of the mutually approved expenses.  Our joint exploitation of the broadcastrights with Image have been left to future negotiation.

**AccountingMethods**

Theapplication of the following accounting policies, which are important inpresenting our financial position and results of operations, requiressignificant judgments and estimates on the part of management. For a summary ofall of our accounting policies, including the accounting policies discussedbelow, see note 2 to the unaudited consolidated financial statements appearingelsewhere in this report.

InJune 2000, the Accounting Standards Executive Committee of the AmericanInstitute of Certified Public Accountants issued Statement of Position 00-2,Accounting by Producers or Distributors of Films (“SoP 00-2”).  SoP 00-2 establishes accountingstandards for producers or distributors of films, including changes in revenuerecognition, capitalization and amortization of costs of acquiring films andtelevision programs and accounting for exploitation costs, includingadvertising and marketing expenses. These accounting standards are as follows:

·                                          advertisingand marketing costs are expensed the first time the advertising takes place;and

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·                                          thecapitalization of production costs for episodic television series is limited torevenue that has been contracted for on an episode-by-episode basisuntil the time that the criteria for recognizing secondary market revenues aremet.

Wecapitalize the costs of production, including financing costs, to investment inmotion pictures.  These costs areamortized to direct operating expenses in accordance with SoP 00-2. Thesecosts are stated at the lower of unamortized motion picture costs or fair value(net present value).  Costs for anindividual motion picture are amortized in the proportion that current periodactual revenues bear to management’s estimates of the total revenue expected tobe received from the motion picture over a period not to exceed 10 years fromthe date of delivery.  We are required toregularly review and revise when necessary the total revenue estimates of eachmotion picture produced.  As a result, ifrevenue estimates change with respect to a motion picture, it may be necessaryto write down all or a portion of the unamortized costs of the motionpicture.  There is no assurance thatrevised revenue estimates will not occur that result in significant write-downsaffecting our results of operations and financial condition.

Revenuefrom the sale or licensing of motion pictures will be recognized upon meetingall recognition requirements of SoP 00-2. Revenue from the theatrical release of motion pictures will berecognized at the time of exhibition based on our participation in box officereceipts.  If applicable, revenue fromthe sale of DVDs in the retail market, net of an allowance for estimatedreturns, is recognized on the later of shipment to the customer or “street date”(when it is available for sale by the customer).  Furthermore, if applicable, under revenuesharing arrangements, rental revenue is recognized when we become entitled toreceipts.  For contracts that provide forrights to exploit a motion picture on multiple media (e.g. theatrical, video,television) with a fee for a single motion picture where the contract specifiesthe permissible timing of release to various media, the fee is allocated to thevarious media based on an assessment of the relative fair value of the rightsto exploit each media and will be recognized as the movie is released to eachmedia.  For multiple-titlecontracts with a fee, the fee is allocated on a title-by-titlebasis, based on an assessment of the relative fair value of each title.  If applicable, revenues from televisionlicensing are recognized when the motion picture becomes available to thelicensee for telecast.  Cash paymentsreceived are recorded as deferred revenue until all the conditions of revenuerecognition have been met.  Ifapplicable, we accrue for video returns and provide for allowances in thefinancial statements based on previous returns and our allowances history on atitle-by-title basis in each of the video businesses. In this case,there may be differences between actual returns and allowances and ourhistorical experience that we currently do not have.  Revenues earned from the sale of DVDs throughdistribution agreements are recognized when sales from these distributors areknown or can be accurately estimated.

Wedepend on the distributors of any motion picture we produce to account for andaccurately report our share of exhibition revenue.  While we expect to have certain audit rightsto verify exhibition revenues received by our North American distributors,

·                                          distributorsare often in a position to account for revenues in a manner that understates orfails accurately to account for revenues or

·                                          distributorsmay fail to maintain appropriate accounting records making it difficult todetermine a producer’s actual share of revenues upon audit.

Althoughwe do not have any experience related to auditing distributors’ revenueaccounting, we anticipate that the costs associated with this type of audit maybe substantial and may vary significantly from distributor-to-distributor andeven picture-to-picture.  Therefore,there is no assurance that, in all cases, we will be able to obtain an accurateaccounting of exhibition revenues or that audits will result in increases inthe revenues that justify the associated audit costs.

**RecentAccounting Pronouncements**

*SFAS 123(R)* – In December 2004, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards (SFAS) No. 123(R), *Share-BasedPayment*.  SFAS 123(R) replacesSFAS No. 123, *Accounting for Stock-BasedCompensation*, and supersedes *AccountingPrinciples*

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*Board*(APB) Opinion No. 25, *Accounting for StockIssued to Employees*.  Weadopted SFAS 123(R) on January 1, 2006 using the modified prospective method asdescribed in the standard.  Under themodified prospective method, we are required to record compensation cost fornew and modified awards over the related vesting period of such awardsprospectively and record compensation cost prospectively for the unvestedportion at time of adoption, of previously issued and outstanding awards overthe remaining vesting period of such awards. As of January 1, 2006, we had no unvested outstanding awards and as aresult, the adoption of SFAS123(R) had no impact on our consolidated financialstatements or consolidated results of operations.

*SFAS 155* – In February 2006, the FASBissued Statement No. 155, *“Accounting forCertain Hybrid Financial Instruments”* (“SFAS 155”), which amendsFASB Statements No. 133 and 140.   ThisStatement permits fair value remeasurement for any hybrid financial instrumentcontaining an embedded derivative that would otherwise require bifurcation, andbroadens a Qualified Special Purpose Entity’s (“QSPE”) permitted holdings toinclude passive derivative financial instruments that pertain to otherderivative financial instruments.  ThisStatement is effective for all financial instruments acquired, issued orsubject to a remeasurement event occurring after the beginning of an entity’sfirst fiscal year beginning after September 15, 2006.  This Statement has no current applicabilityto our financial statements.  Managementadopted this Statement on January 1, 2007 and the initial adoption of thisStatement did not have a material impact on our financial position, results ofoperations, or cash flows.

*FIN 48* – In June 2006, the FASB issuedInterpretation 48, *“Accounting forUncertainty in Income Taxes”* (“FIN 48”), an interpretation of FASBStatement No. 109, *“Accounting for IncomeTaxes.”*  FIN 48 clarifies theaccounting and reporting for income taxes where interpretation of the law isuncertain.  FIN 48 prescribes acomprehensive model for the financial statement recognition, measurement,presentation and disclosure of income tax uncertainties with respect to positionstaken or expected to be taken in income tax returns.  FIN 48 is effective for fiscal yearsbeginning after December 15, 2006.  ThisStatement has no current applicability to our financial statements.  Management adopted this Statement on January1, 2007 and the initial adoption of FIN 48 did not have a material impact onour financial position, results of operations, or cash flows.

*SFAS 157* – In September 2006, the FASBissued Statement No. 157, *“Fair ValueMeasurements”*  (“SFAS  157”). SFAS 157 addresses how companies should measure fair value when they arerequired to use a fair value measure for recognition or disclosure purposesunder GAAP.   SFAS 157 defines fairvalue, establishes a framework for measuring fair value and expands disclosuresabout fair value measurements.  SFAS 157is effective for fiscal years beginning after November 15, 2007, with earlieradoption permitted.  Management isassessing the impact of the adoption of this SFAS 157.

*SFAS 158* – In September 2006, the FASBissued Statement No. 158, *“Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans”*(“SFAS 158”), an amendment of FASB Statements No. 87, 88, 106 and 132(R).  SFAS 158 requires (a) recognition of thefunded status (measured as the difference between the fair value of the planassets and the benefit obligation) of a benefit plan as an asset or liabilityin the employer’s statement of financial position, (b) measurement of thefunded status as of the employer’s fiscal year-end with limited exceptions,and (c) recognition of changes in the funded status in the year in which thechanges occur through comprehensive income. The requirement to recognize the funded status of a benefit plan and thedisclosure requirements are effective as of the end of the fiscal year endingafter December 15, 2006.  The requirementto measure the plan assets and benefit obligations as of the date of theemployer’s fiscal year-end statement of financial position is effective forfiscal years ending after December 15, 2008. SFAS 158 has no current applicability to our financial statements.  Management plans to adopt this Statement onDecember 31, 2006 and it is anticipated the adoption of SFAS 158 will not havea material impact to our financial position, results of operations, or cashflows.

*SFAS 159* – In February 2007, the FASBissued Statement No. 159, “The Fair Value Option for Financial Assets andLiabilities” (“SFAS 159”).  SFAS 159permits companies to choose to measure many financial assets and liabilities atfair value.  Unrealized gains and losseson items for which the fair value option has been elected are reported inearnings.  SFAS 159 is effective forfiscal years beginning after

8

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November 15,2007.  Management is currently assessingthe impact of SFAS 159 on our consolidated financial statements.

*SAB 108* – In September 2006, theSecurities Exchange Commission issued Staff Accounting Bulletin No. 108 (“SAB108”).  SAB 108 addresses how the effectsof prior year uncorrected misstatements should be considered when quantifyingmisstatements in current year financial statements.  SAB 108 requires companies to quantifymisstatements using a balance sheet and income statement approach and toevaluate whether either approach results in quantifying an error that is materialin light of relevant quantitative and qualitative factors.  When the effect of initial adoption ismaterial, companies will record the effect as a cumulative effect adjustment tobeginning of year retained earnings and disclose the nature and amount of eachindividual error being corrected in the cumulative adjustment.  SAB 108 was effective beginning January 1,2007 and the initial adoption of SAB 108 did not have a material impact on ourfinancial position, results of operations, or cash flows.

**Resultsof Operations**

The followingtable sets forth selected results of our operations for the three months endedMarch 31, 2007 and 2006.  The followinginformation was derived and taken from our unaudited financial statementsappearing elsewhere in this report.
|                                                      | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                                           | ** ** | **2006** | ** ** |
| Revenue                                              |       | $                                                                  | 24,945     |   | $ | 189,286 |   |
| Expenses:                                            |       |                                                               |       |   |   |
| Direct operating                                     |       | 20,952                                                             |       | 160,011 |   |
| General and administrative                           |       | 93,661                                                             |       | 105,667 |   |
| Depreciation                                         |       | 764                                                                |       | 1,216 |   |
|                                                 |       |                                                               |       |   |   |
| Total expenses                                       |       | 115,377                                                            |       | 266,894 |   |
|                                                 |       |                                                               |       |   |   |
| Operating loss                                       |       | (90,432                                                            | )          | (77,608 | ) |
|                                                 |       |                                                               |       |   |   |
| Other income  (expense):                             |       |                                                               |       |   |   |
| Interest and other income                            |       | 7,995                                                              |       | 9,133 |   |
| Interest expense                                     |       | (96,142                                                            | )          | (91,577 | ) |
|                                                 |       |                                                               |       |   |   |
| Net other income (expense)                           |       | (88,147                                                            | )          | (82,444 | ) |
|                                                 |       |                                                               |       |   |   |
| Net loss before  minority interests and income taxes |       | (178,579                                                           | )          | (160,052 | ) |
| Minority  interests                                  |       | (2,777                                                             | )          | (382 | ) |
| Provision for  income taxes                          |       | —                                                             |       | — |   |
|                                                 |       |                                                               |       |   |   |
| Net loss                                             |       | $                                                                  | (181,356   | ) | $ | (160,434 | ) |

 

**Comparisonof the Three-Month Periods Ended March 31, 2007 and 2006**

Ourconsolidated revenues for the three months ended March 31, 2007 (the “2007 1stQuarter”) were $24,945 and were attributable to the international distributionof *Cloud 9,**The Hunt* and*Surveillance*.  Wegenerated revenue in the prior year’s first quarter of $189,286 from theinternational distribution of *Cloud 9*and *The Hunt*.

Directoperating expenses primarily include amortization of film costs andparticipation costs.  Our directoperating expenses of $20,952 for the 2007 1st Quarter were 84% of revenues.  The ratio of direct operating expenses torevenue is dependent on our estimate of the ultimate revenue of each film.  During the first quarter of 2006, we incurreddirect operating expenses of $160,011 which represented 85% of revenues.

9

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Generaland administration expenses of $93,661 for the 2007 1st Quarter decreased$12,006, or 11%, from $105,667 in the prior year’s quarter.  The decrease in general and administrationexpenses was primarily due to a decrease in salaries and employee benefitswhich were offset by an increase in our monthly lease expense, generalinsurance expense and travel expenses.

Duringthe 2007 1st Quarter, we realized interest income of $7,995, compared to $9,133in the prior year’s third quarter.  Thisdecrease was attributable to a corresponding decrease in the balance of cashand cash equivalents held in interest bearing accounts and an increase in theyield earned on those accounts.

Weincurred interest expense of $96,142 during the 2007 1st Quarter that wasattributable to our convertible notes payable, amortization of prepaid loanfees and amortization of warrants issued with the convertible notespayable.  We incurred interest expense of$91,577 during the first quarter of 2006.

Minorityinterests in our earnings for the 2007 1st Quarter were $2,777 and wereattributable to minority interests in our movies *The Hunt*, *Surveillance*and *Soul’s Midnight*.

**Liquidityand Capital Resources**

Our liquidity andcapital resources are provided principally through cash generated fromoperations, issuance of convertible notes payable and equity offerings.  Our cash and cash equivalents at March 31,2007 totaled approximately $887,000.  Asof March 31, 2007, we had a working capital deficiency of approximately$708,000.

We expect to meetour obligations as they become due through available cash and funds generatedfrom our completed motion pictures supplemented as necessary by debt and equityfinancing.  We expect to generatepositive working capital through our operations.  However, there are no assurances that we willbe able to either (1) achieve a level of revenues adequate to generatesufficient cash flow from operations or (2) obtain additional financing throughdebt and equity financing to support our working capital requirements.  These conditions raise substantial doubtabout our ability to continue as a going concern.  The accompanying financial statements do notinclude any adjustments that might be necessary should we be unable to continueas a going concern.

In an effort tomanage our working capital, during March 2007, we executed amendment agreementswith the holder of its convertible notes payable.  Under the amendments, the maturity date ofboth Notes is extended to January 31, 2008. Interest on the Notes is increased from 8% to 12% per annum from thedate of the amendment until maturity.  Asadditional consideration for executing the amendments, we lowered the strikeprice of the previously issued warrant agreements, which allow for the purchaseof 1,000,000 shares of common stock shares, to $0.50 per share from theoriginal strike prices of $2.00 and $3.00 per share.  In addition, we entered into an additionalcommon stock purchase warrant agreement with the holder of the Notes,evidencing warrants exercisable on or before April 1, 2012.  The agreement provides for the purchase of500,000 common stock shares at $0.50.

Operating activities forthe three months ended March 31, 2007, provided net cash of $37,961 compared tooperating activities for the three months ended March 31, 2006 which used$132,819.  The increase in cash flowsfrom operating activities was primarily attributable to unearned revenuereceived on a film project currently in progress.

Therewere no investing activities for the three months ended March 31, 2007.  Investing activities for the three monthsended March 31, 2006, generated net cash of $119,500 as a result ofcontributions made by our minority interests on certain film projects.

Therewere no financing activities during the three months ended March 31, 2007.  Financing activities for the three monthsended March 31, 2006, used cash of $50,000 for the repayment of filmobligations.

10

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***Financial Commitments***

***FilmCapital, Inc. Agreement.**** *InMarch 2002, Messrs. Frederickson and Stansberry, members of Graymark Productions,L.L.C., entered into an agreement to pay FilmCapital, Inc. $50,000 for servicesperformed.  This liability is onlypayable in the event Graymark Productions, L.L.C. or its affiliates obtainfunding for film projects from outside investors.  Messrs. Frederickson and Stansberry have eachrepresented that their intent was not to cause Graymark Productions, L.L.C. tobe liable for this obligation and each has agreed to indemnify us for anyliability that may arise out of this agreement. In December 2003, we recorded a consulting expense and liability of$50,000 related to the agreement with FilmCapital.  At the time that we pay this recordedliability, Messrs. Frederickson and Stansberry will be required immediately toreimburse us for the payment.

***Registration Obligations.***** Weagreed, at our expense, to register the common stock shares and redeemablewarrants offered for sale pursuant to our private placement of 2,995,000 commonstock shares and redeemable warrants exercisable for the purchase of 2,995,000common stock shares under the 1933 Act and to maintain effectiveness of theregistration for a seven-year period ending on April 14, 2010.  Registration of the common stock shares andredeemable warrants became effective July 13, 2004.

Furthermore,we also similarly agreed to register (and maintain effective of theregistration under the 1933 Act for the seven-year period) the 443,250 commonstock shares underlying the placement agent warrants sold to the underwriter ofour private placement offering, Viewtrade Financial, and 383,425 common stockshares issued pursuant to the  one-yearFinancial Advisor Agreement to Viewtrade Financial.  In accordance with this obligation, we initiallyincluded these common stock shares in the registration statement thatregistered the private placement common stock shares and redeemable warrants;however, on February 27, 2004, Viewtrade Financial, on its own behalf as wellas the other holders of the placement agent warrants and the recipients andholders of the common stock shares assigned to affiliates of ViewtradeFinancial, elected to remove those shares from the registration statement.

Wehave been informed by our legal counsel that the common stock shares andredeemable warrants, other than those underlying the redeemable warrants andthe placement agent warrants, may be sold without further restriction pursuantto Rule 144 as promulgated by the Securities and Exchange Commission.  Because the exercise prices of the redeemablewarrants and the placement agent warrants are substantially in excess of themarket price of our common stock,  we donot intend to file a registration statement covering the underlying commonstock shares until the market price of our common stock increases to a levelabove the applicable exercise prices.

***Office Space Arrangement*.** Our corporate headquarters andoffices are located at 101 North Robinson, Suite 920, Oklahoma City,Oklahoma.  These office facilitiesconsist approximately of 1,500 square feet and are occupied under an writtenmonth-to-month lease arrangement, requiring monthly rental payments ofapproximately $2,100.  The costs ofbuilding-out and improving our offices was approximately $15,000 which we paidrather than Corporate Tower, LLC, our landlord. Roy T. Oliver, one of our greater than 5% shareholders and affiliates,controls Corporate Tower, LLC.  Mr.Oliver on behalf of Corporate Tower, LLC has orally indicated that as of thedate of this report there is no intent to terminate our occupancy of the officefacilities.  Under Oklahoma law,termination of our month-to-month lease arrangement requires at least 30 daysprior written notice.  In the event ofthis termination, we believe there is adequate office space and facilitiesavailable in the Oklahoma City area.

***12-Month Overhead Budget***

Our budgetedoverhead expenses for the next 12 months are as follows:
| Expenditure                    | ** ** | **Monthly** | ** ** | **12  Months** | ** ** |
|--------------------------------|------------|-------------|------------|----------------|------------|
| Administrative  expenditures:  |       |        |       |           |       |
| Executive officer compensation |       | $           | 12,000     |           | $          | 144,000 |   |
| Administrative salaries        |       | 3,000       |       | 36,000         |       |
| Payroll taxes                  |       | 1,200       |       | 14,400         |       |
| Telephone                      |       | 600         |       | 7,200          |       |
|                                |            |             |            |                |            |  |  |

 

11

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| Expenditure                        | ** ** | **Monthly** | ** ** | **12  Months** | ** ** |
|------------------------------------|------------|-------------|------------|----------------|------------|
| Rent                               |       | 2,100       |       | 25,200         |       |
| Legal                              |       | 3,000       |       | 36,000         |       |
| Accounting                         |       | 3,000       |       | 36,000         |       |
| Public relations                   |       | 500         |       | 6,000          |       |
| Insurance                          |       | 500         |       | 6,000          |       |
| Stock transfer                     |       | 800         |       | 9,600          |       |
| Miscellaneous                      |       | 1,000       |       | 12,000         |       |
| Total  Administrative Expenditures |       | $           | 27,700     |           | $          | 332,400 |   |
|                                    |            |             |            |                |            |  |  |

 

***Additional Financial Commitments***

Other than ourcommitments discussed above, we do not have any capital  commitments. Although we do not have any commitments, we may enter into long-termlending arrangements during the next 12 months to provide additional workingcapital and fund additional movie projects we desire to undertake.  In addition, we may receive additional fundsfrom the exercise of outstanding warrants and stock options, the exercise ofwhich is generally not within our control.

Ifour production activities are successful (of which there is no assurance) ormovie production budgets increase, we may be required to increase overhead byhiring additional employees and increase our office facilities.  We anticipate that during the next 12 monthswe will not be required to increase the number of our employees or increase ouroffice facilities.

Webelieve that our operations as a result of our motion picture projects willachieve profitability.  We provide noassurance that

·                                          we will besuccessful in implementing our business plan or

·                                          unanticipatedexpenses or problems or technical difficulties will not occur which wouldresult in significant delays.

Either one ofthese will adversely affect our ability to become profitable or to maintainprofitability.

Futurecommitments under contractual obligations by expected maturity date at March31, 2007 are as follows:
|                            | ** ** | **< 1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **> 5 years** | ** ** | **Total** | ** ** |
|----------------------------|------------|---------------------------|------------|--------------------|------------|--------------------|------------|----------------------------|------------|-----------|------------|
|                       |       |                      |       |               |       |               |       |                       |       |      |       |
| Convertible  notes payable |       | $                         | 1,650,000  |               | $          | —             |       | $                          | —     |      | $          | — |   | $ | 1,650,000 |   |
| Operating leases           |       | 25,608                    |       | —             |       | —             |       | —                     |       | 25,608    |       |
|                       |       |                      |       |               |       |               |       |                       |       |      |       |
|                       |       | $                         | 1,675,608  |               | $          | —             |       | $                          | —     |      | $          | — |   | $ | 1,675,608 |   |

 

**CautionaryStatement Relating to Forward Looking Information**

Wehave included some forward-looking statements in this section and other placesin this report regarding our expectations. These forward-looking statements involve known and unknown risks,uncertainties and other factors which may cause our actual results, levels ofactivity, performance or achievements, or industry results, to be materiallydifferent from any future results, levels of activity, performance orachievements expressed or implied by these forward-lookingstatements.  Some of these forward-lookingstatements can be identified by the use of forward-looking terminologyincluding “believes,” “expects,” “may,” “will,” “should” or “anticipates” orthe negative thereof or other variations thereon or comparable terminology, orby discussions of strategies that involve risks and uncertainties.  You should read statements that contain thesewords carefully because they:

12

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·                                          discuss ourfuture expectations;

·                                          containprojections of our future operating results or of our future financialcondition; or

·                                          state other “forward-looking”information.

Webelieve it is important to discuss our expectations; however, it must berecognized that events may occur in the future over which we have no controland which we are not accurately able to predict.  Readers are cautioned to consider thespecific business risk factors described under the caption “Additional Factorsthat May Affect Our Future Results” appearing under “Item 1. Description ofBusiness” of our Annual Report on Form 10-KSB filed with the United StatesSecurities and Exchange Commission on March 30, 2007, and not to place unduereliance on the forward-looking statements contained herein, which speak onlyas of the date of this report.  Weundertake no obligation to publicly revise forward-looking statements toreflect events or circumstances that may arise after the date of this report.

**Item3.  Controls and Procedures**

Our Chief ExecutiveOfficer and Chief Financial Officer are responsible primarily for establishingand maintaining disclosure controls and procedures designed to ensure thatinformation required to be disclosed in our reports filed or submitted underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”) isrecorded, processed, summarized and reported within the time periods specifiedin the rules and forms of the U.S. Securities and Exchange Commission.  These controls and procedures are designed toensure that information required to be disclosed in our reports filed orsubmitted under the Exchange Act is accumulated and communicated to ourmanagement, including our principal executive and principal financial officers,or persons performing similar functions, as appropriate to allow timelydecisions regarding required disclosure.

Furthermore,our Chief Executive Officer and Chief Financial Officer are responsible for thedesign and supervision of our internal controls over financial reporting  that are then effected by and through ourboard of directors, management and other personnel, to provide reasonableassurance regarding the reliability of our financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. These policies and procedures (i) pertain to the maintenance of recordsthat, in reasonable detail, accurately and fairly reflect the transactions anddispositions of our assets; (ii) provide reasonable assurance that transactionsare recorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that our receiptsand expenditures are being made only in accordance with authorizations of ourmanagement and directors; and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof our assets that could have a material effect on our financial statements.

OurChief Executive Officer and Chief Financial Officer, based upon theirevaluation of the effectiveness of our disclosure controls and procedures andthe internal controls over financial reporting as of the last day of the periodcovered by this report, concluded that our disclosure controls and proceduresand internal controls over financial reporting were fully effective as of thelast day of the period covered by this report and reported to our auditors andboard of directors that no change occurred in our disclosure controls andprocedures and internal control over financial reporting occurred during theperiod covered by this report that would materially affect or is reasonablylikely to materially affect our disclosure controls and procedures or internalcontrol over financial reporting.  Inconducting their evaluation of our disclosure controls and procedures andinternal controls over financial reporting, these executive officers did notdiscover any fraud that involved management or other employees who have asignificant role in our disclosure controls and procedures and internalcontrols over financial reporting. Furthermore, there were no significant changes in our disclosurecontrols and procedures, internal controls over financial reporting, or otherfactors that could significantly affect our disclosure controls and proceduresor internal controls over financial reporting subsequent to the date of theirevaluation.  Because no significantdeficiencies or material weaknesses were discovered, no corrective actions werenecessary or taken to correct significant deficiencies and material weaknessesin our internal controls and disclosure controls and procedures.

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**PART II OTHER INFORMATION**

**Item 1.****           Legal Proceedings**

None

**Item 2.****           Unregistered Sales of Equity Securities andUse of Proceeds**

(a)                                     Duringthe three months ended March 31, 2007, we issued 60,000 shares of our commonstock to SXJE, LLC, the holder of certain convertible promissory notes, inpayment of the accrued interest of $30,000 (see Item 2. Management’s Discussionand Anaylsis or Plan of Operation – Recent Developments – Convertible NoteFinancing).  These were issued pursuantto registration exemptions under Section 4(6) of the Securities Act and Rule506 of Regulation D.  SXJE, LLC qualifiesas an “accredited investor” within the meaning of Rule 501(a) of RegulationD.  No commissions or other form ofremuneration was paid in connection with the issuance of these shares of commonstock.

(b)                                 None

(c)                                  None

**Item 3.****           Defaults Upon Senior Securities**

None

**Item 4.****           Submission of Matters to a Vote of SecurityHolders**

None

**Item 5.****           Other Information**

None

**Item 6.****           Exhibits**
| Exhibit No. | ** ** | **Description**                                                                                                                                                                             |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **  | ** ** | ** **                                                                                                                                                                                  |
| 3.1         |       | Registrant’s Certificate of Incorporation,  incorporated by reference to Registration Statement on Form SB-2 (No. 333 -111819) filed with  the Commission on January 9, 2004.     |
|        |       |                                                                                                                                                                                        |
| 3.2         |       | Registrant’s Bylaws, incorporated by reference to  Registration Statement on Form SB-2 (No. 333-111819) filed with the  Commission on January 9, 2004.                                 |
|        |       |                                                                                                                                                                                        |
| 31.1        |       | Certification of John Simonelli, Chief Executive  Officer of Registrant.                                                                                                                    |
|        |       |                                                                                                                                                                                        |
| 31.2        |       | Certification of Mark R. Kidd, Chief Financial  Officer and Controller of Registrant.                                                                                                       |
|        |       |                                                                                                                                                                                        |
| 32.1        |       | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of Sarbanes-Oxley Act of 2002 of John  Simonelli, Chief Executive Officer of Registrant.              |
|        |       |                                                                                                                                                                                        |
| 32.2        |       | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of Sarbanes-Oxley Act of 2002 of Mark R.  Kidd, Chief Financial Officer and Controller of Registrant. |

** **

14

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**SIGNATURES**

In accordance withthe Exchange Act, the Registrant caused this report to be signed on its behalfby the undersigned, thereunto duly authorized.
|               | GRAYMARK PRODUCTIONS, INC. |
|--------------------|----------------------------|
|               | (Registrant)               |
|               | By:                        | /S/JOHN  SIMONELLI |   |
|               |                       | John Simonelli |
|               |                       | Chief Executive Officer |
| Date: May 4,  2007 |                       |
|               |                       |
|               | By:                        | /S/MARK R. KIDD |   |
|               |                       | Mark R. Kidd |
|               |                       | Chief Financial Officer and Controller |
| Date: May 4,  2007 |                       |
|                    |                            |  |  |  |

 

15

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**GRAYMARK PRODUCTIONS, INC.**

**INDEX TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**
| Condensed Consolidated  Balance Sheets as of March 31, 2007 and December 31, 2006                          |   |
|------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                       |   |
| Condensed  Consolidated Statements of Operations for the Three Months Ended March 31,  2007 and 2006       |   |
|                                                                                                       |   |
| Condensed  Consolidated Statements of Shareholders’ Equity for the Three Months Ended  March 31, 2007 |   |
|                                                                                                       |   |
| Condensed  Consolidated Statements of Cash Flows for the Three Months Ended March 31,  2007 and 2006       |   |
|                                                                                                       |   |
| Notes  to Condensed Consolidated Financial Statements                                                      |   |

** **

F-1

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**GRAYMARKPRODUCTIONS, INC.**

**CondensedConsolidated Balance Sheets**
| ** **                                                                                                                                                                         | ** ** | **March 31,  2007** | ** ** | **December  31,  2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **(Unaudited)**          | ** ** | ** **              | ** ** |
| **ASSETS**                                                                                                                                                                         | ** ** | ** **               | ** ** | ** **              | ** ** |
| ** **                                                                                                                                                                         | ** ** | ** **               | ** ** | ** **              | ** ** |
| Cash and cash  equivalents                                                                                                                                                         |       | $                        | 886,865    |                    | $          | 848,904 |   |
| Accounts receivable                                                                                                                                                                |       | 18,895                   |       | 7,456                   |       |
|                                                                                                                                                                               |       |                     |       |                    |       |
| Total current  assets                                                                                                                                                              |       | 905,760                  |       | 856,360                 |       |
|                                                                                                                                                                               |       |                     |       |                    |       |
| Fixed assets, net                                                                                                                                                                  |       | 10,983                   |       | 11,747                  |       |
| Prepaid loan fees                                                                                                                                                                  |       | 33,493                   |       | 51,986                  |       |
| Investment in films                                                                                                                                                                |       | 2,382,302                |       | 2,387,966               |       |
|                                                                                                                                                                               |       |                     |       |                    |       |
| Total assets                                                                                                                                                                       |       | $                        | 3,332,538  |                    | $          | 3,308,059 |   |
| ** **                                                                                                                                                                         | ** ** | ** **               | ** ** | ** **              | ** ** |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                     |       |                     |       |                    |       |
|                                                                                                                                                                               |       |                     |       |                    |       |
| Liabilities:                                                                                                                                                                       |       |                     |       |                    |       |
| Accounts payable  and accrued liabilities                                                                                                                                          |       | $                        | 107,269    |                    | $          | 104,650 |   |
| Unearned revenue                                                                                                                                                                   |       | 124,790                  |       | —                  |       |
| Current portion  of convertible notes payable, net of discounts of $118,443 and $112,478 at  March 31, 2007 and December 31, 2006, respectively                                    |       | 1,381,557                |       | 1,387,522               |       |
|                                                                                                                                                                               |       |                     |       |                    |       |
| Total current  liabilities                                                                                                                                                         |       | 1,613,616                |       | 1,492,172               |       |
|                                                                                                                                                                               |       |                     |       |                    |       |
| Minority interests                                                                                                                                                                 |       | 1,449,929                |       | 1,447,152               |       |
|                                                                                                                                                                               |       |                     |       |                    |       |
| Shareholders’ Equity:                                                                                                                                                         |       |                     |       |                    |       |
| Preferred stock  $0.0001 par value, 10,000,000 authorized; no shares issued and outstanding                                                                                        |       | —                   |       | —                  |       |
| Common stock  $0.0001 par value, 90,000,000 shares authorized; 8,622,107 issued and  outstanding at March 31, 2007 (8,562,107 shares issued and outstanding at  December 31, 2006) |       | 862                      |       | 856                     |       |
| Paid-in capital                                                                                                                                                                    |       | 4,457,609                |       | 4,376,001               |       |
| Accumulated  deficit                                                                                                                                                               |       | (4,189,478               | )          | (4,008,122              | )          |
|                                                                                                                                                                               |       |                     |       |                    |       |
| Total  shareholders’ equity                                                                                                                                                   |       | 268,993                  |       | 368,735                 |       |
|                                                                                                                                                                               |       |                     |       |                    |       |
| Total  liabilities and shareholders’ equity                                                                                                                                   |       | $                        | 3,332,538  |                    | $          | 3,308,059 |   |

 

See Accompanying Notes toCondensed Consolidated Financial Statements

F-2

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**GRAYMARKPRODUCTIONS, INC.**

**CondensedConsolidated Statements of Operations**

**(Unaudited)**
| ** **                                                               | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                               | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
|                                                                     |       |                                             |       |   |   |
| Revenues                                                                 |       | $                                                | 24,945     |   | $ | 189,286 |   |
|                                                                     |       |                                             |       |   |   |
| Expenses:                                                                |       |                                             |       |   |   |
| Direct operating                                                         |       | 20,952                                           |       | 160,011 |   |
| General and  administrative                                              |       | 93,661                                           |       | 105,667 |   |
| Depreciation                                                             |       | 764                                              |       | 1,216 |   |
|                                                                     |       |                                             |       |   |   |
| Total expenses                                                           |       | 115,377                                          |       | 266,894 |   |
|                                                                     |       |                                             |       |   |   |
| Operating loss                                                           |       | (90,432                                          | )          | (77,608 | ) |
|                                                                     |       |                                             |       |   |   |
| Other Income (Expense):                                                  |       |                                             |       |   |   |
| Interest and  other income                                               |       | 7,995                                            |       | 9,133 |   |
| Interest expense                                                         |       | (96,142                                          | )          | (91,577 | ) |
|                                                                     |       |                                             |       |   |   |
| Net other income  (expense)                                              |       | (88,147                                          | )          | (82,444 | ) |
|                                                                     |       |                                             |       |   |   |
| Net loss before  minority interests and provision for income taxes       |       | (178,579                                         | )          | (160,052 | ) |
|                                                                     |       |                                             |       |   |   |
| Minority interests                                                       |       | (2,777                                           | )          | (382 | ) |
| Provision for income  taxes                                              |       | —                                           |       | — |   |
|                                                                     |       |                                             |       |   |   |
| Net loss                                                                 |       | $                                                | (181,356   | ) | $ | (160,434 | ) |
|                                                                     |       |                                             |       |   |   |
| Net loss per share of  common stock, basic and diluted                   |       | $                                                | (0.02      | ) | $ | (0.02 | ) |
|                                                                     |       |                                             |       |   |   |
| Weighted average number of common shares outstanding, basic and  diluted |       | 8,622,107                                        |       | 8,310,425 |   |

 

See AccompanyingNotes to Condensed Consolidated Financial Statements

F-3

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**GRAYMARKPRODUCTIONS, INC.**

**CondensedConsolidated Statements of Shareholders’ Equity**

**(Unaudited)**
| ** **                                        | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|
| ** **                                        | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit** | ** ** |
|                                              |       |                  |       |        |       |            |       |   |   |
| Balance, December 31,  2005                       |       | 8,289,151             |       | $           | 829        |            | $          | 4,221,852 |   | $ | (1,793,162 | ) |
|                                              |       |                  |       |        |       |            |       |   |   |
| Issuance of  stock for convertible notes interest |       | 272,956               |       | 27          |       | 116,140         |       | — |   |
| Issuance of  stock options                        |       | —                |       | —      |       | 38,009          |       | — |   |
| Net loss                                          |       | —                |       | —      |       | —          |       | (2,214,960 | ) |
|                                              |       |                  |       |        |       |            |       |   |   |
| Balance, December 31,  2006                       |       | 8,562,107             |       | 856         |       | 4,376,001       |       | (4,008,122 | ) |
|                                              |       |                  |       |        |       |            |       |   |   |
| Issuance of  stock for convertible notes interest |       | 60,000                |       | 6           |       | 29,994          |       | — |   |
| Issuance of  common stock warrants                |       | —                |       | —      |       | 51,614          |       | — |   |
| Net loss                                          |       | —                |       | —      |       | —          |       | (181,356 | ) |
|                                              |       |                  |       |        |       |            |       |   |   |
| Balance, March 31, 2007                           |       | 8,622,107             |       | $           | 862        |            | $          | 4,457,609 |   | $ | (4,189,478 | ) |

 

See AccompanyingNotes to Condensed Consolidated Financial Statements

F-4

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**GRAYMARKPRODUCTIONS, INC.**

**CondensedConsolidated Statements of Cash Flows**

**(Unaudited)**
| ** **                                                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
|                                                                         |       |                                             |       |   |   |
| Operating activities:                                                        |       |                                             |       |   |   |
| Net loss                                                                     |       | $                                                | (181,356   | ) | $ | (160,434 | ) |
| Adjustments to  reconcile net loss to net cash used by operating activities: |       |                                             |       |   |   |
| Depreciation                                                                 |       | 764                                              |       | 1,216 |   |
| Amortization of  film costs                                                  |       | 20,952                                           |       | 159,581 |   |
| Issuance of  common stock for convertible notes interest                     |       | 30,000                                           |       | 26,167 |   |
| Interest expense  allocated to warrants                                      |       | 45,650                                           |       | 43,084 |   |
| Minority  interests                                                          |       | 2,777                                            |       | 382 |   |
| Changes in  assets and liabilities –                                    |       |                                             |       |   |   |
| Film deposits                                                                |       | —                                           |       | 32,500 |   |
| Accounts  receivable                                                         |       | (11,439                                          | )          | (58,612 | ) |
| Prepaid loan  fees                                                           |       | 18,493                                           |       | 18,493 |   |
| Investment in  films                                                         |       | (15,288                                          | )          | (226,976 | ) |
| Accrued  liabilities                                                         |       | 2,618                                            |       | 31,780 |   |
| Unearned revenue                                                             |       | 124,790                                          |       | — |   |
|                                                                         |       |                                             |       |   |   |
| Net cash  provided (used) by operating activities                            |       | 37,961                                           |       | (132,819 | ) |
|                                                                         |       |                                             |       |   |   |
| Investing activities:                                                        |       |                                             |       |   |   |
| Minority  interests - contributions                                          |       | —                                           |       | 119,500 |   |
|                                                                         |       |                                             |       |   |   |
| Net cash  provided by investing activities                                   |       | —                                           |       | 119,500 |   |
|                                                                         |       |                                             |       |   |   |
| Financing activities:                                                        |       |                                             |       |   |   |
| Repayment of  film obligations                                               |       | —                                           |       | (50,000 | ) |
|                                                                         |       |                                             |       |   |   |
| Net cash used in  financing activities                                       |       | —                                           |       | (50,000 | ) |
|                                                                         |       |                                             |       |   |   |
| Net change in cash and  cash equivalents                                     |       | 37,961                                           |       | (63,319 | ) |
|                                                                         |       |                                             |       |   |   |
| Cash and cash  equivalents at beginning of period                            |       | 848,904                                          |       | 1,153,840 |   |
|                                                                         |       |                                             |       |   |   |
| Cash and cash  equivalents at end of period                                  |       | $                                                | 886,865    |   | $ | 1,090,521 |   |
|                                                                         |       |                                             |       |   |   |
| Noncash Investing and  Financing Activities:                                 |       |                                             |       |   |   |
| Issuance of  stock for convertible notes interest                            |       | $                                                | 30,000     |   | $ | 26,167 |   |
| Issuance of  common stock warrants                                           |       | $                                                | 51,614     |   | $ | — |   |
|                                                                         |       |                                             |       |   |   |
| Cash Paid for Interest  and Income Taxes:                                    |       |                                             |       |   |   |
| Interest expense                                                             |       | $                                                | —     |   | $ | — |   |
| Income taxes                                                                 |       | $                                                | —     |   | $ | — |   |

 

See AccompanyingNotes to Condensed Consolidated Financial Statements

F-5

----

**GRAYMARKPRODUCTIONS, INC.**

**Notes to Condensed ConsolidatedFinancial Statements**

**(Unaudited)**

**Forthe Periods Ended March 31, 2007 and 2006**

Note 1 – Nature ofBusiness

GraymarkProductions, Inc. (the “Company”) is organized in Oklahoma and is anindependent producer and distributor of film entertainment content.  The Company began operations in 2001 asGraymark Productions, L.L.C. (“Graymark LLC”), all of the assets of which wereacquired by the Company through our incorporation-reorganization, effectiveAugust 18, 2003.

The Companyproduces and distributes films that are completed and marketed using smallerbudgets than those of major studios.  TheCompany has completed the production and released its motion picture projectstitled, *Cloud 9*, *The Hunt, Surveillance* and*Soul’s Midnight*.  The Company has completed, but not releasedits motion picture titled, *Fingerprints*.  The Company has negotiated agreements for themarketing and distribution of all its films. Management believes that producing and distributing low- ormodest-budget, commercially successful films affords the Company access toHollywood talent and scripts and third-party production packages foracquisition, without compromising management’s approach to managing financialrisk.

Note 2 – Summaryof Significant Accounting Policies

*InterimFinancial Information* – The unaudited condensed consolidatedfinancial statements included herein have been prepared in accordance withgenerally accepted accounting principles for interim financial statements andwith Regulation S-X.  Accordingly, theydo not include all of the information and footnotes required by generallyaccepted accounting principles for complete financial statements.  In the opinion of management, all adjustments(consisting of normal recurring adjustments) considered necessary for a fairpresentation have been included. Operating results for the three months ended March 31, 2007 are notnecessarily indicative of results that may be expected for the year endedDecember 31, 2007.  The condensedconsolidated financial statements should be read in conjunction with theconsolidated financial statements and notes thereto included in the Company’sForm 10-KSB for the year ended December 31, 2006.  The December 31, 2006 condensed consolidatedbalance sheet was derived from audited financial statements.

*Consolidation*– The accompanying consolidated financial statements include the accounts ofGraymark Productions, Inc. and its majority owned and controlledsubsidiaries.  The Company controls asubsidiary company through a combination of existing voting interests and theability to exercise various rights under certain shareholder or operating agreements.  The Company’s subsidiaries include GraymarkProductions, L.L.C. (the “LLC”), Out of the Blue Productions, LLC (“Out of theBlue”), The Hunt, The Motion Picture LLC (“The Hunt”), Surveillance, The MotionPicture LLC (“Surveillance”), Soul’s Midnight LLC (“Soul’s Midnight”) andFingerprints LLC (“Fingerprints”).  TheLLC became a subsidiary of the Company in August 2003 as a result of theincorporation-reorganization of the Company. Out of the Blue was formed in December 2003 as the entity under whichthe Company’s first motion picture project, *Cloud9*, was produced.  The Companyhas funded 100% of the acquisition and production costs of *Cloud 9*. The Company is entitled to recover its capital contributions to Out ofthe Blue plus interest at 2% above the prime rate (defined as “investmentrecoupment”) from cash distributions before the other interest owners andthereafter 50% of cash distributions and is entitled to receive a majority ofthe proceeds from rights sales, distribution and any and all exploitation ofthe Picture.  Under the terms of the Outof the Blue operating agreement, the Company has 100% voting control of Out ofthe Blue.  The Hunt, Surveillance, Soul’sMidnight and Fingerprints are 100% owned by the Company.

F-6

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*Useof estimates* – The preparation of financial statements inconformity with generally accepted accounting principles requires management ofthe Company to make estimates and assumptions that affect the amounts reportedin the financial statements and accompanying notes.  Actual results could differ from thoseestimates.

*Goingconcern* – The accompanying financial statements have beenprepared assuming the Company will continue as a going concern.  As of March 31, 2007, the Company had aworking capital deficit of approximately $708,000, primarily because theCompany’s convertible notes payable mature on January 31, 2008.  The Company expects to meet its obligationsas they become due through available cash and funds generated from itscompleted motion pictures supplemented as necessary by debt and/or equityfinancing.  The Company expects togenerate positive working capital through its operations.  However, there are no assurances that theCompany will be able to either (1) achieve a level of revenues adequate togenerate sufficient cash flow from operations or (2) obtain additionalfinancing through debt and/or equity financing to support the Company’s workingcapital requirements.  These conditionsraise substantial doubt about the Company’s ability to continue as a goingconcern.  The accompanying financialstatements do not include any adjustments that might be necessary should theCompany be unable to continue as a going concern.

*Revenuerecognition* – Revenues from the sale of the rights to a filmare recognized when the feature film is available to the distributor forexploitation and no conditions for delivery exist, which under most salescontracts requires that full payment has been received from thedistributor.  Revenues from the theatricaldistribution of motion pictures are recognized when motion pictures areexhibited.  Revenues from video sales arerecognized on the date that video units are made widely available for sale byretailers.  Revenues from the licensingof motion picture films are recorded when the material is available fortelecasting by the licensee and when certain other conditions are met.  Revenues from consulting services arerecognized when earned.

*Investmentin Films* – Investment in films includes capitalized directnegative costs, production overhead, interest and development costs and arestated at the lower of cost, less accumulated amortization, or fair value.  Film production and participation costs areexpensed based on the ratio of the current period’s gross revenues to estimatedremaining total gross revenues from all sources on an individual productionbasis.

Investment infilms is stated at the lower of amortized cost or estimated fair value on anindividual film basis.  The valuation ofinvestment in films is reviewed on a title-by-title basis, when an event orchange in circumstances indicate that the fair value of a film is less than itsunamortized cost.  The fair value of thefilm is determined using management’s future revenue and cost estimates and adiscounted cash flow approach.  Additionalamortization is recorded in the amount by which the unamortized costs exceedthe estimated fair value of the film. Estimates of future revenue involve measurement uncertainty and it istherefore possible that reductions in the carrying value of investment in filmsmay be required as a consequence of changes in management’s future revenueestimates.

*RecentlyIssued Accounting Standards* –

*SFAS 123R* – InDecember 2004, the Financial Accounting Standards Board (FASB) issued Statementof Financial Accounting Standards (SFAS) No. 123R, *Share-Based Payment*. SFAS 123R replaces SFAS No. 123, *Accountingfor Stock-Based Compensation*, and supersedes *Accounting Principles Board* (APB) OpinionNo. 25, *Accounting for Stock Issued toEmployees*.  The Companyadopted SFAS 123R on January 1, 2006 using the modified prospective method,under which prior periods are not revised for comparative purposes.  Under the modified prospective method,stock-based compensation cost is measured at the grant date based on the fairvalue of the award and is recognized as expense on a straight-line basis overthe requisite service period, which is the vesting period.  In addition, the Company must recordcompensation cost prospectively for the unvested portion at time of adoption,of previously issued and outstanding awards over the remaining vesting periodof such awards.  As of January 1, 2006,the Company had no unvested outstanding awards and as a result, the adoption ofSFAS123R had no impact on the Company’s financial position or results ofoperations.

F-7

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*SFAS 155* – InFebruary 2006, the FASB issued Statement No. 155, *“Accounting for Certain Hybrid Financial Instruments”* (“SFAS155”), which amends FASB Statements No. 133 and 140.  This Statement permits fair valueremeasurement for any hybrid financial instrument containing an embeddedderivative that would otherwise require bifurcation, and broadens a QualifiedSpecial Purpose Entity’s (“QSPE”) permitted holdings to include passivederivative financial instruments that pertain to other derivative financialinstruments.  This Statement is effectivefor all financial instruments acquired, issued or subject to a remeasurementevent occurring after the beginning of an entity’s first fiscal year beginningafter September 15, 2006.  This Statementhas no current applicability to the Company’s financial statements.  Management adopted this Statement on January1, 2007 and the initial adoption of this Statement did not have a materialimpact on the Company’s financial position, results of operations, or cashflows.

*FIN 48* – In June2006, the FASB issued Interpretation 48, *“Accountingfor Uncertainty in Income Taxes”* (“FIN 48”), an interpretation ofFASB Statement No. 109, *“Accounting forIncome Taxes.”*  FIN 48clarifies the accounting and reporting for income taxes where interpretation ofthe law is uncertain.  FIN 48 prescribesa comprehensive model for the financial statement recognition, measurement,presentation and disclosure of income tax uncertainties with respect topositions taken or expected to be taken in income tax returns.  FIN 48 is effective for fiscal yearsbeginning after December 15, 2006.  ThisStatement has no current applicability to the Company’s financialstatements.  Management adopted thisStatement on January 1, 2007 and the initial adoption of FIN 48 did not have amaterial impact on the Company’s financial position, results of operations, orcash flows.

*SFAS 157* – InSeptember 2006, the FASB issued Statement No. 157, *“Fair Value Measurements”* (“SFAS No. 157”).  SFAS 157addresses how companies should measure fair value when they are required to usea fair value measure for recognition or disclosure purposes under GAAP.   SFAS 157 defines fair value, establishes aframework for measuring fair value and expands disclosures about fair valuemeasurements.  SFAS 157 is effective forfiscal years beginning after November 15, 2007, with earlier adoptionpermitted.  Management is assessing theimpact of the adoption of this Statement.

*SFAS 158* – InSeptember 2006, the FASB issued Statement No. 158, *“Employers’ Accounting for Defined Benefit Pension and OtherPostretirement Plans”* (“SFAS 158”), an amendment of FASB StatementsNo. 87, 88, 106 and 132(R).  SFAS 158requires (a) recognition of the funded status (measured as the differencebetween the fair value of the plan assets and the benefit obligation) of abenefit plan as an asset or liability in the employer’s statement of financialposition, (b) measurement of the funded status as of the employer’s fiscal year-endwith limited exceptions, and (c) recognition of changes in the funded status inthe year in which the changes occur through comprehensive income.  The requirement to recognize the fundedstatus of a benefit plan and the disclosure requirements are effective as ofthe end of the fiscal year ending after December 15, 2006.  The requirement to measure the plan assetsand benefit obligations as of the date of the employer’s fiscal year-endstatement of financial position is effective for fiscal years ending afterDecember 15, 2008.  This Statement has nocurrent applicability to the Company’s financial statements.  Management plan adopted this Statement onDecember 31, 2006 and the adoption of SFAS 158 did not have a material impactto the Company’s financial position, results of operations, or cash flows.

*SFAS 159* – InFebruary 2007, the FASB issued Statement No. 159, “The Fair Value Option forFinancial Assets and Liabilities” (“SFAS 159”). SFAS 159 permits companies to choose to measure many financial assetsand liabilities at fair value. Unrealized gains and losses on items for which the fair value option hasbeen elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15,2007.  The Company is currently assessingthe impact of SFAS 159 on its consolidated financial statements.

*SAB 108* – InSeptember 2006, the Securities Exchange Commission issued Staff AccountingBulletin No. 108 (“SAB 108”).  SAB 108addresses how the effects of prior year uncorrected misstatements should be consideredwhen quantifying misstatements in current year financial statements.  SAB 108 requires companies to quantifymisstatements using a balance sheet and income statement approach and toevaluate whether either approach results in quantifying an error that ismaterial in light of relevant quantitative and qualitative factors.  When the effect of initial adoption ismaterial, companies will record the effect as a cumulative effect adjustment tobeginning of year retained earnings and disclose the nature and amount of eachindividual error being corrected in the cumulative adjustment.  SAB 108 became effective on January 1,

F-8

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2007 and the initial adoption of SAB 108 did not have a material impacton the Company’s financial position, results of operations, or cash flows.

Note3 – Investment in Films
|                                                           | ** ** | **March 31,  2007** | ** ** | **December  31,  2006** | ** ** |
|-----------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
|                                                      |       |                     |       |                    |       |
| Released, net of  accumulated amortization and impairment |       | $                        | 1,746,802  |                    | $          | 1,767,795 |   |
| Completed and not  released                               |       | 616,420                  |       | 615,171                 |       |
| In progress                                               |       | 19,080                   |       | 5,000                   |       |
|                                                      |       |                     |       |                    |       |
| Total                                                     |       | $                        | 2,382,302  |                    | $          | 2,387,966 |   |

 

The Company estimates that 100% of the unamortizedinvestment in films at March 31, 2007 will be amortized within the next threeyears.  Approximately $1,911,000 of filmcosts are expected to be amortized during the next twelve months.  No participation liabilities are expected tobe paid during the next 12 months.

Note4 – Convertible Note Payable

In August and October 2005, the Company issuedpromissory notes (the “Notes”) in the principal amount of $750,000,respectively, $1,500,000 in total.  TheNotes are secured by all assets of the Company including all purchaseagreements and any options or rights to acquire, all intellectual and realproperty, all assets and properties of the Company and all of its existing andfuture subsidiaries.  The Notes bearinterest at the rate of 8% per annum. Interest due on the Notes is payable quarterly and can be paid in cashor shares of Company stock.

The Notes become due and payable on the first to occurof: (i) July 27, 2007 for the first note and October 25, 2007 for the secondnote (the “Maturity Dates”); (ii) the consummation of a Qualified Financing; or(iii) the continuation of an Event of Default, as defined, for more than 30days following notice of the occurrence of an event of default.  Upon consummation of a Qualified Financing,the outstanding principal amount of the Notes and all accrued and unpaidinterest (collectively the “Note Balances”) will automatically convert intoshares of equity securities of the Company equal to 120% of the Note Balancesdivided by the price per share of the equity securities sold in the QualifiedFinancing.  The maximum price or value ofthe equity securities into which the Note Balances convert may not exceed theequivalent of $1.10 per common stock share. Qualified Financing refers to any equity financing pursuant to which theCompany receives aggregate gross cash proceeds of $2,000,000 or more on orbefore the Maturity Dates.

In conjunction with issuance of the Notes, the Companyand the holder of the Notes entered into common stock purchase warrantagreements, each evidencing warrants exercisable on or before August 5, 2010for the first note and October 25, 2010 for the second note.  The two agreements provide for the purchaseof 250,000 (500,000 total) common stock shares at $2.00 and the other twoagreements provide for the purchase of 250,000 (500,000 total) common stockshares at $3.00.

The fair value of each warrant issued was estimated onthe date of issuance using the Black-Scholes option pricing model.  The fair value of the options were based onthe difference between the present value of the exercise price of the optionand the estimated fair value price of the common share.  The fair value of the warrants was estimatedto be $349,459 and was recorded as paid-in capital.  The value of the warrants will increaseinterest expense over the life of the Notes.

In addition, the Company’s financial advisor was paidfees of $150,000 for services rendered in conjunction with execution of theNotes.  The fees were recorded as  prepaid loan fees and will be amortized

F-9

----

overthe life of the Notes.

In March 2007, the Company executed amendmentagreements with the holder of its convertible notes payable.  Under the amendments, the maturity date ofboth Notes is extended to January 31, 2008. Interest on the Notes is increased from 8% to 12% per annum from thedate of the amendment until maturity.  Asadditional consideration for executing the amendments, the Company lowered thestrike price of the previously issued warrant agreements, which allow for thepurchase of 1,000,000 shares of common stock shares, to $0.50 per share fromthe original strike prices of $2.00 and $3.00 per share.  In addition, the Company and the holder ofthe Notes entered into an additional common stock purchase warrant agreement,evidencing warrants exercisable on or before April 1, 2012.  The agreement provides for the purchase of500,000 common stock shares at $0.50.

The fair value of the repriced and newly issuedwarrants was estimated on the date of repricing or issuance using theBlack-Scholes option pricing model.  Thefair value of the options were based on the difference between the presentvalue of the exercise price of the option and estimated fair value of thecommon share.  The fair value of thenewly issued warrants was estimated to be $51,614 and will be recorded aspaid-in capital.  The value of thewarrants will increase interest expense over the new life of the Notes.  The Company determined that there was noadditional fair value (over the value previously recorded) attributable to therepricing of the previously issued warrants and no additional expense has beenrecorded for this modification.

Note5 – Film Profit Participation and Contingent Compensation

Pursuant to an investor agreement between the Companyand the developers of the screenplay for *Cloud9*(the “Picture”), the Company shares the development andproductions costs and revenue of *Cloud 9*.  For its financial contribution to the costsof making *Cloud 9*, the Company isentitled to receive the following:

·                                          100%of revenue and proceeds from the rights sales, distribution and/or any and allexploitation of *Cloud 9* until theCompany recovers its investment in the Picture, plus interest at the prime rateplus 2% per annum from the date of the contribution until the Company is repaidits investment in the Picture.

·                                          50%of “net profits” received from the rights sales, distribution and/or any andall exploitation of the Picture.  “Net Profits”is defined as the sum remaining after deduction of third party distributionfees; cash deferments  to cast, equipmentsuppliers, rights holders or any other approved party.

The Company’s subsidiary, Out of the Blue Productions,LLC (the “Production Company”), entered into contingent compensation agreementswith the director and certain cast members of *Cloud9* in the form of “net and gross profit participations” that are customary in the film industry.  These participations are typically based onthe profit of a film after all production and distribution costs have beenrecouped (“gross participation”) or all production and distribution costs andoverhead have been recouped (“net participations”).  A percentage of these “gross and net profits”,as negotiated between the participants, are paid out as contingent compensationfor creative participants in a motion picture film.  The participations negotiated by theProduction Company for *Cloud 9*total 23.5% of which the Company’s interest in *Cloud9* is burdened by one-half of these net profit participations.  The Company’s residual profits interest in *Cloud 9* is 30.6% after giving effect tothe gross and net profits participations given pursuant to contingentcompensation arrangements and the co-finance agreements.

The Production Company also agreed to pay additionalcontingent bonuses to certain cast members when aggregate United States andCanada box office receipts as reported in Daily Variety reach various levelsbetween $8,500,000 and $20,000,000.  Thetotal contingent amounts that would be paid if box office receipts reach$20,000,000 is $300,000.

Pursuant to an output agreement between the Companyand a third-party distribution company (“Distributor”), the Distributor has afirst-look right at the movies produced by the Company.  Pursuant to the agreement, the Distributor

F-10

----

hasagreed to fund up to 50% of each production budget on mutually agreed uponmotion picture projects.  The Distributorwill be entitled to a respective percentage of all gross receipts on thoseprojects.

The following summarizes the revenue participationsbefore and after net profit participations on the Company’s films *The Hunt*, *Surveillance,Soul’s Midnight* and *Fingerprints*:
|                              | ** ** | **Before Payout** | ** ** | **After Payout** | ** ** |
|------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **Company**            | ** ** | **Other  Members**    | ** ** | **Company** | ** ** | **Other  Members** | ** ** | **Third-  Party  Interest** | ** ** |
|                         |       |                   |       |                  |       |   |   |   |   |   |   |
| The Hunt                     |       |                   |       |                  |       |   |   |   |   |   |   |
| Revenue  allocation          |       | 65                     | %          | 35                    | %          | 44 | % | 24 | % | 32 | % |
| Production costs  to be paid |       | 50                     | %          | 50                    | %          |   |   |   |   |   |   |
|                         |       |                   |       |                  |       |   |   |   |   |   |   |
| Surveillance                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Revenue  allocation          |       | 50                     | %          | 50                    | %          | 46 | % | 46 | % | 8 | % |
| Production costs  to be paid |       | 50                     | %          | 50                    | %          |   |   |   |   |   |   |
|                         |       |                   |       |                  |       |   |   |   |   |   |   |
| Soul’s Midnight         |       |                   |       |                  |       |   |   |   |   |   |   |
| Revenue  allocation          |       | 25                     | %          | 75                    | %          | 24 | % | 72 | % | 4 | % |
| Production costs  to be paid |       | 25                     | %          | 75                    | %          |   |   |   |   |   |   |
|                         |       |                   |       |                  |       |   |   |   |   |   |   |
| Fingerprints                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Revenue allocation           |       | 35                     | %          | 65                    | %          | 34 | % | 62 | % | 4 | % |
| Production costs to be  paid |       | 35                     | %          | 65                    | %          |   |   |   |   |   |   |

 

Note6 – Distribution Agreements

The Company has entered into various distributionagreements for the marketing and distribution of it’s films in the domestic,broadcast and international markets. These agreements provide for the distributor to earn a distribution feefrom the gross proceeds generated by each picture in the applicablemarket.  The table below summarizes thedistribution fees negotiated as of March 31, 2007 (markets that have nodistribution agreements in place are identified as “n/a”):
|                     | ** ** | **Cloud 9** | ** ** | **The  Hunt** | ** ** | **Surv-  eillance** | ** ** | **Soul’s  Midnight** | ** ** | **Finger-  prints** | ** ** |
|---------------------|------------|------------------|------------|---------------|------------|---------------------|------------|---------------------------|------------|---------------------|------------|
|                |       |             |       |          |       |                |       |                      |       |                |       |
| Domestic DVD market |       | 20               | %          | 22.5          | %          | 25                  | %          | 25                        | %          | 25                  | %          |
| Broadcast           |       | 20               | %          | n/a           |       | n/a                 |       | n/a                       |       | n/a                 |       |
| International       |       | 15               | %          | 20            | %          | 20                  | %          | 20                        | %          | n/a                 |       |

 

Note7 – Capital Structure

During the three months ended March 31, 2007, theCompany issued 60,000 shares of common stock to pay accrued interest due on theCompany’s convertible notes payable.

Note8 – Related Party Transactions

The Company’s corporate offices are located in abuilding owned by an entity controlled by one of our greater than 5%shareholders.  The office space isoccupied under a month to month lease. Rent expense applicable to the corporate offices for the three monthsended March 31, 2007 and 2006 was $6,402 and $1,766, respectively.

Note9 – Subsequent Events

In April 2007, the Company issued 123,076 shares ofcommon stock to pay accrued interest of $32,000 due, as of March 31, 2007, onthe Company’s convertible notes payable.

F-11

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