**U. S. SECURITIES AND EXCHANGE COMMISSION**

**Washington,D. C. 20549**

 

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**FORM** **10-QSB**

 

**(MarkOne)**

 

**ý****QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934**

 

**For thequarterly period ended March 31, 2005**

 

**o****                                ****TRANSITIONREPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT**

 

**For thetransition period from          to          **

 

**CommissionFile Number: 000-50638**

 

**GRAYMARK PRODUCTIONS, INC.**

(Nameof small business issuer in its Charter)

 

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

 

**101 N. Robinson, Suite 920**

**Oklahoma City, Oklahoma 73102**

(Addressof principal executive offices)

 

**(405) 601-5300**

(Issuer’stelephone number)

 

 

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

 

**APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY**

**PROCEEDINGS DURING THE PRECEDING FIVE YEARS**

 

Check whether the registrantfiled all documents and reports required to be filed by Section 12, 13 or15(d) of the Exchange Act after the distribution of securities under aplan confirmed by a court.  Yes ý No o

 

**APPLICABLE ONLY TO CORPORATE ISSUERS**

 

State the number of sharesoutstanding of each of issuer’s classes of common equity, as of the latestpracticable date:  As of May 5,2005, 8,258,425 shares of the issuer’s common stock, $0.0001 par value, wereoutstanding.

 

Transitional Small BusinessDisclosure Format (Check One): Yes o No ý

 

 

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**GRAYMARK PRODUCTIONS, INC**.

FORM 10-QSB

Forthe Quarter Ended March 31, 2005

 

TABLEOF 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 this report thefirst personal plural pronoun in the nominative case form “we” and itsobjective 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 officers and directors.  The term “independent,” as used in thisreport, is used to distinguish us from the term “major studios” that isgenerally regarded in the entertainment industry to mean Universal Pictures,Warner Bros., Twentieth Century Fox, Sony Pictures Entertainment, ParamountPictures, The Walt Disney Company, Metro Goldwyn Mayer and their respectiveaffiliates.  The terms “low-budget motionpictures,” “low-budget films” or “low-budget movie” within this report, referto motion pictures that have a production budget of $250,000 to $3 million.

 

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**PART I.FINANCIAL INFORMATION**

 

**Item 1.****          ****Financial Statements**

 

Our financial statementspresented in this report were prepared and included in this report inaccordance with Regulation S-X and Regulation S-B an appear in this reportbeginning on page F-1.

 

**Item 2.****          ****Management’s Discussion andAnalysis or Plan of Operation**

 

You should read thefollowing discussion in conjunction with our financial statements and notesthereto appearing elsewhere in this report.

 

**Overview**

 

**DevelopmentStage Company**

 

We are a development stagecompany.  We operated historically as alimited liability company, GrayMark Productions, L.L.C. that was formed in August 2001.  Since commencement of our operations in August 2001,we have not generated a material amount of revenue from operations.  Effective August 18, 2003, pursuant toan exchange agreement, the owners of the member interests in GrayMarkProductions, L.L.C. exchanged their respective member interests in GrayMarkProductions, L.L.C. for 4,870,000 shares of our common stock.  As a result of this exchange, GrayMarkProductions, L.L.C. became a wholly-owned subsidiary of GrayMark Productions, Inc.and the plan of operation of GrayMark Productions, L.L.C. became that ofGrayMark Productions, Inc.

 

We have completed productionof our first motion film project, *Cloud 9*,and are in the process of marketing both the foreign and domestic rights to thefilm.  We have not generated any revenueto date from *Cloud 9*.  We have recently competed the filming of oursecond motion picture film project, *The Hunt*.

 

The following discussioncovers 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**

 

The movie industry generallyconsists of two principal activities, production and distribution.  Production encompasses the development,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.

 

We primarily produce Englishlanguage motion pictures intended for domestic theatrical release and ancillarymarket release (home video and television, including pay-per-view, cable,satellite and network broadcast), that have production budgets of $250,000 to$3 million (“low-budget motion pictures,” “low budget movies” or “low-budgetfilms”).  We initially anticipatedproducing motion pictures that had production budgets of $2 million to $5million, but based on the production of our first two motion pictures, webelieve that a range of $250,000 to $3 million is appropriate.

 

The development andproduction costs of a low-budget film and each cost category varies frommovie-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.

 

Rather than retain andemploy personnel to develop screenplays and perform other movie developmentactivities, we typically acquire movies for production that are in thedevelopment phase, generally to the point that the 

 

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initialscreenplay has been written, and that are low-budget films.  In the pre-production and production phasesof a motion picture, we intend to hire skilled creative and production personnel,including cinematographers, editors, costume designers, set designers, soundand lighting technicians and actors on an as needed basis.

 

We expect to enter intovarious production cost and revenue sharing arrangements, including jointventures, partnerships and limited liability companies, on a movie-by-moviebasis.  These sharing arrangements areintended to complement or expand our business to permit the production of agreater number of movies, while sharing the financial risks of the movie.  We may not realize the anticipated financialbenefits when we entered into these arrangements.  In addition, the negotiation of thesearrangements, whether successful or not, could require us to incur significantcosts and cause diversion of management’s time and resources.  Accordingly, the costs of obtaining thesesharing arrangements will increase our invested cost in a movie withoutproviding a correlating increase in the movies revenues and, consequently,adversely affect the financial performance of the movie.

 

Following our production ofthe movie, we intend to arrange for distribution through third-partiesprimarily into the domestic (United States and Canada) and international theancillary 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. A substantial amount of time may elapse between ourexpenditure of funds and the receipt of revenue from the motion picture.

 

Our produced movies will bedistributed domestically pursuant to licensing arrangements with unrelated third-partiesthat are independently engaged in the promotion and distribution ofmovies.  Our foreign market distributionarrangements will be pursuant to sale of the distribution rights to anunrelated third-party international 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 not entered into any distribution arrangements.

 

Our ability to obtaininternational market distribution, whether in the ancillary market or thetheatrical market, will be subject to:

 

•                                          changes in local regulatory requirements,including restrictions on content,

 

•                                          changes in the laws and policies affectingtrade, investment and taxes (including laws and policies relating to therepatriation of funds and withholding taxes),

 

•                                          differing degrees of protection forintellectual property,

 

•                                          instability of foreign economies and governments,

 

•                                          cultural barriers,

 

•                                          wars and acts of terrorism, and

 

•                                          the spread of severe acute respiratorysyndrome, or SARS.

 

Any of these factors could have a materialadverse effect on our ability to sell the international distribution rights ofany motion picture.

 

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**RecentDevelopments**

 

*Distribution of Cloud 9. *We arenegotiating the domestic (United States and Canada) and internationaldistribution of *Cloud 9* in theancillary market (home video market). These agreements have not been consummated.  As a result, the finalized terms of thesedistribution arrangements have not been determined as of the date of thisreport.

 

As a result of theagreements with the director, casting company, actors and co-finance providers,our residual net profits interest in *Cloud 9*will be 30.6%.  Furthermore, ourco-finance providers are entitled to receive the first $500,000 of proceeds wereceive from the rights sales and distribution of *Cloud 9*. After giving effect to the recovery of the $500,000contributions to the production costs of *Cloud9* under the co-financing agreements and then the recovery of ourproduction costs and other invested costs and interest, our net profitsinterest in *Cloud 9* will be30.6%.  In conjunction with theproduction of *Cloud 9*, theproducers formed Out of the Blue Productions, LLC (the “Production Company”).  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 co-finance agreements provide for interest, but do not specify theapplicable interest rate.

 

*Pre-Production and Filming of The Hunt*. During January 2005, we commenced the pre-production phase of oursecond motion picture project titled, *TheHunt*.  We commenced andcompleted principal filming of this movie in March 2005.  We anticipate that our total production costsfor *The Hunt* will beapproximately $300,000.

 

**AccountingMethods**

 

The application of thefollowing accounting policies, which are important in presenting our financialposition and results of operations, requires significant judgments andestimates on the part of management. For a summary of all of our accountingpolicies, including the accounting policies discussed below, see note 2 to theunaudited consolidated financial statements appearing elsewhere in this report.

 

In June 2000, theAccounting Standards Executive Committee of the American Institute of CertifiedPublic Accountants issued Statement of Position 00-2, Accounting by Producersor Distributors of Films (“SoP 00-2”). SoP 00-2 establishes accounting standards for producers or distributorsof films, including changes in revenue recognition, capitalization andamortization of costs of acquiring films and television programs and accountingfor exploitation costs, including advertising and marketing expenses. Theseaccounting standards are as follows:

 

•                                          advertising and marketing costs are expensedthe first time the advertising takes place; and

 

•                                          the capitalization of production costs forepisodic television series is limited to revenue that has been contracted foron an episode-by-episode basis until the time that the criteria for recognizingsecondary market revenues are met.

 

We capitalize the costs ofproduction, including financing costs, to investment in motion pictures.  These costs will be amortized to directoperating expenses in accordance with SoP 00-2. These costs are stated at thelower of unamortized motion picture costs or fair value (net presentvalue).  These costs for an individualmotion picture will be amortized in the proportion that current period actualrevenues bear to management’s estimates of the total revenue expected to bereceived from the motion picture over a period not to exceed 10 years from thedate of delivery.  We will be 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 motion picture.  There is no assurance that revised revenueestimates will not occur that result in significant write-downs affecting ourresults of operations and financial condition.

 

Revenue from the sale orlicensing of motion pictures will be recognized upon meeting all recognitionrequirements of SoP 00-2.  Revenue fromthe theatrical release of motion pictures will be recognized at the time ofexhibition based on our participation in box office receipts.  If applicable, revenue from the sale of DVDsin the retail 

 

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market,net of an allowance for estimated returns, will be recognized on the later ofshipment to the customer or “street date” (when it is available for sale by thecustomer).  Furthermore, if applicable,under revenue sharing arrangements, rental revenue would be recognized when wewould become entitled to receipts.  Forcontracts that provide for rights to exploit a motion picture on multiple media(e.g. theatrical, video, television) with a fee for a single motion picturewhere the contract specifies the permissible timing of release to variousmedia, the fee will be allocated to the various media based on an assessment ofthe relative fair value of the rights to exploit each media and will berecognized as the movie is released to each media.  For multiple-title contracts with a fee, thefee will be allocated on a title-by-title basis, based on an assessment of therelative fair value of each title.  Ifapplicable, revenues from television licensing are recognized when the motionpicture becomes available to the licensee for telecast.  Cash payments received are to be recorded asdeferred revenue until all the conditions of revenue recognition have beenmet.  If applicable, we will accrue forvideo returns and provide for allowances in the financial statements based onprevious returns and our allowances history on a title-by-title basis in eachof the video businesses. In this case, there may be differences between actualreturns and allowances and our historical experience that we currently do nothave.

 

We will depend on thedistributors of any motion picture we produce to account for and accuratelyreport our share of exhibition revenue. While we expect to have certain audit rights to verify exhibitionrevenues received by our North American distributors,

 

•                                          distributors are often in a position toaccount for revenues in a manner that understates or fails accurately toaccount for revenues or

 

•                                          distributors may fail to maintain appropriateaccounting records

 

making it difficult to determine a producer’sactual share of revenues upon audit.

 

Although we do not have anyexperience related to auditing distributors’ revenue accounting, we anticipatethat the costs associated with this type of audit may be substantial and mayvary significantly from distributor-to-distributor and evenpicture-to-picture.  Therefore, there isno 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, the Financial Accounting Standards Board(FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123(R),*Share-Based Payment*.  SFAS 123(R) replaces SFAS No. 123, *Accounting for Stock-Based Compensation*,and supersedes *Accounting Principles Board*(APB) Opinion No. 25, *Accounting forStock Issued to Employees*. SFAS 123(R) requires compensation costs related to share-based paymenttransactions to be recognized in the financial statements over the period thatan employee provides service in exchange for the award.  Public companies are required to adopt thenew standard using a modified prospective method and may elect to restate priorperiods using the modified retrospective method.  Under the modified prospective method,companies are required to record compensation cost for new and modified awardsover the related vesting period of such awards prospectively and recordcompensation cost prospectively for the unvested portion at time of adoption,of previously issued and outstanding awards over the remaining vesting periodof such awards.  No change to priorperiods presented is permitted under the modified prospective method.  Under the modified retrospective method,companies record compensation costs for prior periods retroactively throughrestatement of such periods using the exact pro forma amounts disclosed in thecompanies’ footnotes.  Also, in theperiod of adoption and after, companies record compesation cost based on themodified prospective method.  SFAS 123(R)is effective for periods beginning after December 15, 2005.  Early application is encouraged, but notrequired.

 

We have not yet determinedthe date or method of adoption.  If wewere to adopt SFAS 123(R) on December 15, 2005 using the modifiedprospective method, we estimate that there will be no stock-based compensationexpense

 

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forthe year ending December 31, 2005. If we elect to adopt SFAS 123(R) using the modified retrospectivemethod, we are permitted to either retroactively restate only the 2005 interimperiods or restate all prior periods.  Ifwe elect to restate prior periods using the modified retrospective method, netloss for the year ended December 31, 2004, would be restated and wouldincrease by $63,574.  Net loss for thethree months ended March 31, 2005, would not be impacted.

 

**Results ofOperations**

 

The following table setsforth selected results of our operations for the three month periods ended March 31,2005 and 2004.  The following informationwas derived and taken from our unaudited financial statements appearingelsewhere in this report.

 
| ** **                                                         | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
| Revenue                                                            |       | $                                              | —     |   | $ | — |   |
| Operating expenses:                                                |       |                                           |       |   |   |
| Salaries and employee benefits                                     |       | 67,320                                         |       | 58,371 |   |
| Legal and professional fees                                        |       | 20,480                                         |       | 15,656 |   |
| Stock transfer and reporting costs                                 |       | 2,136                                          |       | — |   |
| Consulting and management fees                                     |       | —                                         |       | 5,000 |   |
| Obligation related to non-timely filing of  registration statement |       | —                                         |       | 44,325 |   |
| Other                                                              |       | 5,952                                          |       | 10,080 |   |
|                                                               |       |                                           |       |   |   |
| Total operating expenses                                           |       | 95,888                                         |       | 133,432 |   |
|                                                               |       |                                           |       |   |   |
| Operating loss                                                     |       | (95,888                                        | )          | (133,432 | ) |
|                                                               |       |                                           |       |   |   |
| Other income (expense):                                            |       |                                           |       |   |   |
| Interest and other income                                          |       | 3,733                                          |       | 7,982 |   |
|                                                               |       |                                           |       |   |   |
| Net loss before income taxes                                       |       | (92,155                                        | )          | (125,450 | ) |
| Provision for income taxes                                         |       | —                                         |       | — |   |
|                                                               |       |                                           |       |   |   |
| Net loss                                                           |       | $                                              | (92,155    | ) | $ | (125,450 | ) |

 

**Comparisonof the Three-Month Periods Ended March 31, 2005 and 2004**

 

During the three monthsended March 31, 2004, our operations had advanced to the development andproduction of motion picture projects and we were in the pre-production phaseon our first motion picture project titled *Cloud9*.  During the three monthsended March 31, 2004, we incurred salary and benefits expense of $58,371for the management and administrative team put in place during 2004.  Legal and professional fees of $15,656 wereincurred during the three months ended March 31, 2004 and wereattributable to legal and auditing services incurred in conjunction with ourpublic filings.  During the three monthsended March 31, 2004, we paid a $5,000 consulting fee for servicesperformed in relation to rewriting a script for a potential film project.  In December 2003, we concluded a privateplacement offering of common stock.  Inconjunction with the offering, we agreed to register under the Securities Actof 1933 the common stock shares issued as a result of the private placementoffering and to obtain effectiveness of the registration on or before July 14,2004. As of March 31, 2004, due to the uncertainty of when ourregistration would become effective, we recorded a $44,325 obligation tosecurity holders.  This obligation wasreversed in June 2004 when we determined that the effectiveness of theregistration was within the requirements of the private placement.  Other expenses of $10,080 were incurredduring the three months March 31, 2004 and were primarily comprised ofexpenses associated with the day to day operations of our corporate office.

 

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During the three monthsended March 31, 2005, we were in the post-production phase of *Cloud 9* and in the pre-production andfilming phases of our second motion picture project, *The Hunt*.  Ouroperational expenses were similar in nature to those incurred in 2004.  During the three months ended March 31,2005, we incurred salary and benefits expense of $67,320, a $8,949 increaseover 2004.  This increase is attributableto increased salaries for our President and our Chief Financial Officer.  Legal and professional fees of $20,480 wereincurred during the three months ended March 31, 2005 and wereattributable to legal and auditing services incurred in conjunction with ourpublic filings.  We also incurred stocktransfer and reporting costs of $2,136. Other expenses of $5,952 were incurred during the three months March 31,2005 and were primarily comprised of expenses associated with the day to dayoperations of our corporate office.

 

**Liquidityand Capital Resources**

 

In April 2004, wecompleted our private placement offering of our common stock shares andredeemable warrants in units of one common stock share and one redeemablewarrant. During 2003 and 2004, we received net proceeds of $2,535,224 from thisprivate placement offering.  Based uponour cash and cash equivalents at March 31, 2005 (that totaled $557,732)and the anticipated revenue from our motion picture projects,*Cloud 9*and*The Hunt*, we anticipate that our cash requirements will bemet for at least the next 12 months.

 

At March 31, 2005, wehad working capital of $418,616. Operating activities for the three months ended March 31, 2005,used net cash of $320,201.  We used cashas the result of a net loss of $92,155, which was reduced by depreciation andamortization of $1,216, a decrease in film deposits of $37,201 and an increasein accrued liabilities of $71,386. Additional operating uses of cash included the costs we incurred in theproduction of our motion picture projects, *Cloud9*and*The Hunt*,totaling $337,849.  During the firstthree months of 2004, our operating activities used net cash of $433,515 as theresult of a net loss of $125,450 that was offset by depreciation of $1,217 anda decrease in accrued liabilities of $35,404. Additional operating uses of cash during the three months ended March 31,2004, included the costs we incurred in the production of our motion pictureproject, *Cloud 9*, totaling$344,686.

 

***Financial Commitments***

 

***FilmCapital, Inc. Agreement.**** *In March 2002, Messrs. Frederickson and Stansberry, membersof GrayMark Productions, L.L.C., entered into an agreement to pay FilmCapital, Inc.$50,000 for services performed.  Thisliability is only payable in the event GrayMark Productions, L.L.C. or itsaffiliates obtain funding for film projects from outside investors.  Messrs. Frederickson and Stansberry haveeach represented that their intent was not to cause GrayMark Productions,L.L.C. to be liable for this obligation and each has agreed to indemnify us forany liability that may arise out of this agreement.  In December 2003, we recorded aconsulting expense and liability of $50,000 related to the agreement withFilmCapital.  At the time that we paythis recorded liability, Messrs. Frederickson and Stansberry will berequired immediately to reimburse 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 alsosimilarly agreed to register (and maintain effective of the registration underthe 1933 Act for the seven-year period) the 443,250 common stock sharesunderlying the placement agent warrants sold to the underwriter of our privateplacement offering, Viewtrade Financial, and 383,425 common stock shares issuedpursuant to the one-year Financial Advisor Agreement to ViewtradeFinancial.  In accordance with thisobligation, we initially included these common stock shares in the registrationstatement that registered the private placement common stock shares andredeemable warrants; however, on February 27, 2004, Viewtrade Financial,on its own behalf as well as the other holders of the placement agent warrantsand the recipients and holders of the common stock shares assigned to 

 

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affiliatesof Viewtrade Financial, elected to remove those shares from the registrationstatement.  These common stock shares arecurrently subject to a one-year agreement that does not permit sale or transferexcept under very limited circumstances. Although we have been informed by our legal counsel that the commonstock shares other than those underlying the placement agent warrant may besold without further restriction pursuant to Rule 144 as promulgated bythe Securities and Exchange Commission, we intend to file a registrationstatement in accordance with this registration obligation during our 2005second quarter.

 

***Office Space Arrangement*****.** Ourcorporate headquarters and offices are located at 101 North Robinson, Suite 920,Oklahoma City, Oklahoma.  These officefacilities consist approximately of 1,500 square feet and are occupied under anunwritten month-to-month lease arrangement, requiring monthly rental paymentsof $500.  The costs of building-out andimproving our offices was approximately $15,000 which we paid rather thanCorporate Tower, LLC, our landlord.  RoyT. Oliver, one of our greater than 5% shareholders and affiliates, controlsCorporate Tower, LLC.  Mr. Oliver onbehalf of Corporate Tower, LLC has orally indicated that as of the date of thisreport 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.  Inthe event we are required to move from our current office facilities, the termsof occupancy, including the increased rental payments, will be substantiallydifferent than those under which our office space is currently occupied and theannual rental rate will probably be from $8 to $12 per square foot ($12,000 to $18,000per year based upon 1,500 square feet of office facilities).

 

***12-Month Overhead Budget***

 

Our budgeted overheadexpenses for the next 12 months are as follows:

 
| **Expenditure**                   | ** ** | **Monthly** | ** ** | **12  Months** | ** ** |
|-----------------------------------|------------|-------------|------------|----------------|------------|
| Administrative expenditures:      |       |        |       |           |       |
| Executive officer compensation    |       | $           | 18,333     |           | $          | 220,000 |   |
| Administrative salaries           |       | 1,517       |       | 18,200         |       |
| Payroll taxes                     |       | 2,527       |       | 30,330         |       |
| Film marketing                    |       | 2,000       |       | 24,000         |       |
| Telephone                         |       | 700         |       | 8,400          |       |
| Rent                              |       | 500         |       | 6,000          |       |
| Legal                             |       | 2,917       |       | 35,000         |       |
| Accounting                        |       | 2,917       |       | 35,000         |       |
| Public relations                  |       | 417         |       | 5,000          |       |
| Travel                            |       | 4,167       |       | 50,000         |       |
| Health insurance                  |       | 1,020       |       | 12,240         |       |
| Automobile                        |       | 500         |       | 6,000          |       |
| Miscellaneous                     |       | 485         |       | 5,820          |       |
| Total Administrative Expenditures |       | $           | 38,000     |           | $          | 455,990 |   |

 

***Additional Financial Commitments***

 

Other than our commitmentsdiscussed above, we do not have any capital commitments.  Although we do not have any commitments, wemay enter into long-term lending arrangements during the next 12 months toprovide additional working capital and fund additional movie project we desireto undertake.  In addition, we mayreceive additional funds from the exercise of outstanding warrants and stockoptions, the exercise of which is generally not within our control.

 

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If our production activitiesare successful (of which there is no assurance) or movie production budgetsincrease, we may be required to increase overhead by hiring additionalemployees and increase our office facilities. We anticipate that during the next 12 months we will not be required toincrease the number of our employees or increase our office facilities.

 

We believe that ouroperations as a result of our motion picture projects, *Cloud 9*and*The Hunt*, will achieve profitability.  We provide no assurance that

 

•                                          we will be successful in implementing ourbusiness plan or

 

•                                          unanticipated expenses or problems ortechnical difficulties will not occur which would result in significant delays.

 

Any one of these will adversely affect ourability to become profitable or to maintain profitability.

 

**CautionaryStatement Relating to Forward Looking Information**

 

We have included someforward-looking statements in this section and other places in this reportregarding our expectations.  Theseforward-looking statements involve known and unknown risks, uncertainties andother factors which may cause our actual results, levels of activity,performance or achievements, or industry results, to be materially differentfrom any future results, levels of activity, performance or achievementsexpressed or implied by these forward-looking statements.  Some of these forward-looking statements canbe identified by the use of forward-looking terminology including “believes,” “expects,”“may,” “will,” “should” or “anticipates” or the negative thereof or othervariations thereon or comparable terminology, or by discussions of strategiesthat involve risks and uncertainties. You should read statements that contain these words carefully becausethey:

 

•                                          discuss our future expectations;

 

•                                          contain projections of our future operatingresults or of our future financial condition; or

 

•                                          state other “forward-looking” information.

 

We believe it is importantto discuss our expectations; however, it must be recognized that events mayoccur in the future over which we have no control and which we are notaccurately able to predict.  Readers arecautioned to consider the specific business risk factors described under thecaption “Additional Factors that May Affect Our Future Results” appearingunder “Item 1. Description of Business” of our Annual Report on Form 10-KSBfiled with the United States Securities and Exchange Commission on March 29,2005, and not to place undue reliance on the forward-looking statementscontained herein, which speak only as of the date of this report.  We undertake no obligation to publicly reviseforward-looking statements to reflect events or circumstances that may ariseafter the date of this report.

 

**Item 3.****  Controls and Procedures**

 

Our Chief Executive Officerand Chief Financial Officer are responsible primarily for establishing andmaintaining 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 ExchangeCommission.  These controls andprocedures are designed to ensure that information required to be disclosed inour reports filed or submitted under the Exchange Act is accumulated andcommunicated to our management, including our principal executive and principalfinancial officers, or persons performing similar functions, as appropriate toallow timely decisions regarding required disclosure.

 

8

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Furthermore, our ChiefExecutive Officer and Chief Financial Officer are responsible for the designand supervision of our internal controls over financial reporting that are theneffected by and through our board of directors, management and other personnel,to provide reasonable assurance regarding the reliability of our financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles.  These policies and procedures (i) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of our assets; (ii) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that our receipts and expenditures are being made only inaccordance with authorizations of our management and directors; and (iii) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of our assets that could have a material effecton our financial statements.

 

Our Executive Officer andChief Financial Officer, based upon their evaluation of the effectiveness ofour disclosure controls and procedures and the internal controls over financialreporting as of the last day of the period covered by this report, concludedthat our disclosure controls and procedures and internal controls overfinancial reporting were fully effective as of the last day of the periodcovered by this report and reported to our auditors and board of directors thatno change occurred in our disclosure controls and procedures and internalcontrol over financial reporting occurred during the period covered by thisreport that would materially affect or is reasonably likely to materiallyaffect our disclosure controls and procedures or internal control overfinancial reporting.  In conducting theirevaluation of our disclosure controls and procedures and internal controls overfinancial reporting, these executive officers did not discover any fraud thatinvolved management or other employees who have a significant role in ourdisclosure controls and procedures and internal controls over financialreporting.  Furthermore, there were nosignificant changes in our disclosure controls and procedures, internalcontrols over financial reporting, or other factors that could significantlyaffect our disclosure controls and procedures or internal controls overfinancial reporting subsequent to the date of their evaluation.  Because no significant deficiencies ormaterial weaknesses were discovered, no corrective actions were necessary ortaken to correct significant deficiencies and material weaknesses in ourinternal controls and disclosure controls and procedures.

 

**PART II OTHER INFORMATION**

 

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

 

None

 

**Item 2.****          ****Unregistered Sales of Equity****Securities and Use ofProceeds**

 

(a)                                  None

 

(b)                                 On July 13, 2004, our RegistrationStatement (No. 333-111819) became effective under the Securities Act of1933 for the resale of 2,955,000 common stock shares, 2,955,000 redeemablewarrants and the 2,955,000 common stock shares for which the redeemablewarrants are exercisable and 100,000 common stock shares underlying a stockoption granted to E. Peter Hoffman.  The2,955,000 common stock shares and 2,955,000 redeemable warrants were soldpursuant to our private placement offering that commenced in September 2003.  These common stock shares and redeemablewarrants were offered in units consisting of one common stock share and oneredeemable warrant for $1.00 each, resulting in gross proceeds of $2,955,000.  The placement agent received a 10% commissionand a 3% non-accountable expense allowance of the gross proceeds for anaggregate of $384,150.  Additionaloffering expenses were $57,376 resulting in net proceeds of $2,513,474.  The following expenditures have been madefrom the net proceeds:

 

•                                          $2,077,194 for the costs of producing anddeposits outstanding relating to our motion picture projects titled, *Cloud 9*and*The Hunt*,

 

•                                          $392,929 for working capital, and

 

•                                          the balance has been invested in high grade,short-term interest bearing investments.

 

(c)                                  None

 

9

----

 

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

 

None

 

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

 

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. |

 

**SIGNATURES**

 

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

 
|                   | GRAYMARK PRODUCTIONS, INC. |
|------------------------|----------------------------|
|                   | (Registrant)               |
|                   |                       |
|                   | By:                        | /S/JOHN SIMONELLI |   |
|                   |                       | John Simonelli |
|                   |                       | Chief Executive Officer |
|                   |                       |
| Date: May 9, 2005 |                       |
|                   |                       |
|                   | By:                        | /S/MARK R. KIDD |   |
|                   |                       | Mark R. Kidd |
|                   |                       | Chief Financial Officer and Controller |
|                   |                       |
| Date: May 9, 2005 |                       |
|                        |                            |  |  |  |

 

10

----

 

**GRAYMARK PRODUCTIONS, INC.**

 

**INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

 
| Condensed  Consolidated Balance Sheets as of March 31, 2005 and December 31,  2004                                                                            |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                                    |   |
| Condensed  Consolidated Statements of Operations for the Three Months Ended March 31,  2005 and 2004 and from Inception (August 2001) to March 31, 2005       |   |
|                                                                                                                                                                    |   |
| Condensed  Consolidated Statements of Shareholders’ Equity for the Three Months Ended  March 31, 2005                                                         |   |
|                                                                                                                                                                    |   |
| Condensed  Consolidated Statements of Cash Flows for the Three Months Ended  March 31, 2005 and 2004 and from Inception (August 2001) to  March 31, 2005 |   |
|                                                                                                                                                                    |   |
| Notes  to Condensed Consolidated Financial Statements                                                                                                                   |   |

 

F-1

----

 

**GRAYMARK PRODUCTIONS, INC.**

**(a Development Stage Enterprise)**

 

**Condensed Consolidated Balance Sheets**

**(Unaudited)**

 
| ** **                                                                                      | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                          |       |                     |       |                        |       |
|                                                                                            |       |                     |       |                        |       |
| Cash and cash equivalents                                                                       |       | $                        | 557,732    |                        | $          | 877,933 |   |
| Film deposits                                                                                   |       | 11,400                   |       | 48,601                      |       |
|                                                                                            |       |                     |       |                        |       |
| Total current assets                                                                            |       | 569,132                  |       | 926,534                     |       |
|                                                                                            |       |                     |       |                        |       |
| Fixed assets, net                                                                               |       | 19,974                   |       | 21,190                      |       |
| Investment in films                                                                             |       | 2,565,794                |       | 2,227,945                   |       |
|                                                                                            |       |                     |       |                        |       |
| Total assets                                                                                    |       | $                        | 3,154,900  |                        | $          | 3,175,669 |   |
|                                                                                            |       |                     |       |                        |       |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                      |       |                     |       |                        |       |
|                                                                                            |       |                     |       |                        |       |
| Liabilities:                                                                                    |       |                     |       |                        |       |
| Accrued liabilities                                                                             |       | $                        | 150,516    |                        | $          | 79,130 |   |
|                                                                                            |       |                     |       |                        |       |
| Total current liabilities                                                                       |       | 150,516                  |       | 79,130                      |       |
|                                                                                            |       |                     |       |                        |       |
| Film obligations                                                                                |       | 500,000                  |       | 500,000                     |       |
|                                                                                            |       |                     |       |                        |       |
| Total liabilities                                                                               |       | 650,516                  |       | 579,130                     |       |
|                                                                                            |       |                     |       |                        |       |
| 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; 8,258,425 issued and outstanding |       | 826                      |       | 826                         |       |
| Paid-in capital                                                                                 |       | 3,837,689                |       | 3,837,689                   |       |
| Deficit accumulated during development  stage                                                   |       | (1,334,131               | )          | (1,241,976                  | )          |
|                                                                                            |       |                     |       |                        |       |
| Total shareholders’ equity                                                                 |       | 2,504,384                |       | 2,596,539                   |       |
|                                                                                            |       |                     |       |                        |       |
| Total liabilities and shareholders’ equity                                                 |       | $                        | 3,154,900  |                        | $          | 3,175,669 |   |

 

SeeAccompanying Notes to Condensed Consolidated Financial Statements

 

F-2

----

 

**GRAYMARK PRODUCTIONS, INC.**

**(a Development Stage Enterprise)**

 

**Condensed Consolidated Statements of Operations andAccumulated Deficit**

**(Unaudited)**

 
| ** **                                                         | ** ** | **Three Months Ended  March 31,** | ** ** | **Inception  (August 2001)  to  March 31,** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                               | ** ** | **2004**                                              | ** ** | **2005** | ** ** |
|                                                               |       |                                   |       |                                                  |       |   |   |
| Revenues                                                           |       | $                                      | —     |                                                  | $          | — |   | $ | 13,391 |   |
|                                                               |       |                                   |       |                                                  |       |   |   |
| Operating expenses:                                                |       |                                   |       |                                                  |       |   |   |
| Salaries and employee benefits                                     |       | 67,320                                 |       | 58,371                                                |       | 301,534 |   |
| Legal and professional fees                                        |       | 20,480                                 |       | 15,656                                                |       | 130,774 |   |
| Stock transfer and reporting costs                                 |       | 2,136                                  |       | —                                                |       | 28,036 |   |
| Film marketing                                                     |       | —                                 |       | —                                                |       | 13,880 |   |
| Consulting and management fees                                     |       | —                                 |       | 5,000                                                 |       | 794,535 |   |
| Travel and entertainment                                           |       | 510                                    |       | 285                                                   |       | 41,434 |   |
| Obligation related to non-timely filing of  registration statement |       | —                                 |       | 44,325                                                |       | — |   |
| Other                                                              |       | 5,442                                  |       | 9,795                                                 |       | 64,175 |   |
|                                                               |       |                                   |       |                                                  |       |   |   |
| Total operating expenses                                           |       | 95,888                                 |       | 133,432                                               |       | 1,374,368 |   |
|                                                               |       |                                   |       |                                                  |       |   |   |
| Operating loss                                                     |       | (95,888                                | )          | (133,432                                              | )          | (1,360,977 | ) |
|                                                               |       |                                   |       |                                                  |       |   |   |
| Other Income (Expense):                                            |       |                                   |       |                                                  |       |   |   |
| Interest and other income                                          |       | 3,733                                  |       | 7,982                                                 |       | 26,846 |   |
|                                                               |       |                                   |       |                                                  |       |   |   |
| Net loss before provision for income taxes                         |       | (92,155                                | )          | (125,450                                              | )          | (1,334,131 | ) |
|                                                               |       |                                   |       |                                                  |       |   |   |
| Provision for income taxes                                         |       | —                                 |       | —                                                |       | — |   |
|                                                               |       |                                   |       |                                                  |       |   |   |
| Net loss - deficit accumulated during  development stage           |       | $                                      | (92,155    | )                                                     | $          | (125,450 | ) | $ | (1,334,131 | ) |
|                                                               |       |                                   |       |                                                  |       |   |   |
| Net loss per share of common stock, basic  and diluted             |       | $                                      | (0.01      | )                                                     | $          | (0.02 | ) | $ | (0.22 | ) |
|                                                               |       |                                   |       |                                                  |       |   |   |
| Weighted average number of common shares  outstanding              |       | 8,258,425                              |       | 8,208,425                                             |       | 6,094,768 |   |

 

SeeAccompanying Notes to Condensed Consolidated Financial Statements

 

F-3

----

 

**GRAYMARK PRODUCTIONS, INC.**

**(a Development Stage Enterprise)**

 

**Condensed Consolidated Statements of Shareholders’ Equity**

**(Unaudited)**

 
| ** **                           | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Accumulated** | ** ** |
|--------------------------------------|------------|------------------|------------|-------------------------|------------|-----------------|------------|
| ** **                           | ** ** | **Shares**       | ** ** | **Amount**              | ** ** | **Capital**     | ** ** | **Deficit** | ** ** |
|                                 |       |             |       |                    |       |            |       |   |   |
| Balance, December 31, 2003      |       | 8,208,425        |       | $                       | 821        |            | $          | 3,790,944 |   | $ | (846,119 | ) |
|                                 |       |             |       |                    |       |            |       |   |   |
| Sale of stock                        |       | 25,000           |       | 2                       |       | 21,748          |       | — |   |
| Issuance of stock for legal services |       | 25,000           |       | 3                       |       | 24,997          |       | — |   |
| Net loss                             |       | —           |       | —                  |       | —          |       | (395,857 | ) |
|                                 |       |             |       |                    |       |            |       |   |   |
| Balance, December 31, 2004      |       | 8,258,425        |       | 826                     |       | 3,837,689       |       | (1,241,976 | ) |
|                                 |       |             |       |                    |       |            |       |   |   |
| Net loss                             |       | —           |       | —                  |       | —          |       | (92,155 | ) |
|                                 |       |             |       |                    |       |            |       |   |   |
| Balance, March 31, 2005         |       | 8,258,425        |       | $                       | 826        |            | $          | 3,837,689 |   | $ | (1,334,131 | ) |

 

SeeAccompanying Notes to Condensed Consolidated Financial Statements

 

F-4

----

 

**GRAYMARK PRODUCTIONS, INC.**

**(a Development Stage Enterprise)**

 

**Condensed Consolidated Statements of Cash Flows**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended  March 31,** | ** ** | **Inception  (August 2001)  to  March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                               | ** ** | **2004**                                              | ** ** | **2005** | ** ** |
|                                                                         |       |                                   |       |                                                  |       |   |   |
| Operating activities:                                                        |       |                                   |       |                                                  |       |   |   |
| Net loss                                                                     |       | $                                      | (92,155    | )                                                     | $          | (125,450 | ) | $ | (1,334,131 | ) |
| Adjustments to reconcile net loss to net  cash used by operating activities: |       |                                   |       |                                                  |       |   |   |
| Depreciation                                                                 |       | 1,216                                  |       | 1,217                                                 |       | 6,718 |   |
| Issuance of stock for legal services                                         |       | —                                 |       | —                                                |       | 25,000 |   |
| Issuance of common stock to investment  banking firm                         |       | —                                 |       | —                                                |       | 383,425 |   |
| Issuance of stock options to non-employee  consultant                        |       | —                                 |       | —                                                |       | 40,200 |   |
| Changes in assets and liabilities –                                     |       |                                   |       |                                                  |       |   |   |
| Film deposits                                                                |       | 37,201                                 |       | —                                                |       | (11,400 | ) |
| Investment in films                                                          |       | (337,849                               | )          | (344,686                                              | )          | (2,565,794 | ) |
| Accrued liabilities                                                          |       | 71,386                                 |       | 35,404                                                |       | 150,516 |   |
|                                                                         |       |                                   |       |                                                  |       |   |   |
| Net cash used by operating activities                                        |       | (320,201                               | )          | (433,515                                              | )          | (3,305,466 | ) |
|                                                                         |       |                                   |       |                                                  |       |   |   |
| Investing activities:                                                        |       |                                   |       |                                                  |       |   |   |
| Purchase of fixed assets                                                     |       | —                                 |       | —                                                |       | (26,692 | ) |
|                                                                         |       |                                   |       |                                                  |       |   |   |
| Net cash used by investing activities                                        |       | —                                 |       | —                                                |       | (26,692 | ) |
|                                                                         |       |                                   |       |                                                  |       |   |   |
| Financing activities:                                                        |       |                                   |       |                                                  |       |   |   |
| Capital contributions                                                        |       | —                                 |       | —                                                |       | 854,667 |   |
| Sale of stock                                                                |       | —                                 |       | —                                                |       | 2,535,223 |   |
| Proceeds from film co-financing agreement                                    |       | —                                 |       | —                                                |       | 500,000 |   |
|                                                                         |       |                                   |       |                                                  |       |   |   |
| Net cash provided by financing activities                                    |       | —                                 |       | —                                                |       | 3,889,890 |   |
|                                                                         |       |                                   |       |                                                  |       |   |   |
| Net change in cash and cash equivalents                                      |       | (320,201                               | )          | (433,515                                              | )          | 557,732 |   |
|                                                                         |       |                                   |       |                                                  |       |   |   |
| Cash and cash equivalents at beginning of  period                            |       | 877,933                                |       | 2,953,159                                             |       | — |   |
|                                                                         |       |                                   |       |                                                  |       |   |   |
| Cash and cash equivalents at end of period                                   |       | $                                      | 557,732    |                                                  | $          | 2,519,644 |   | $ | 557,732 |   |

 

SeeAccompanying Notes to Condensed Consolidated Financial Statements

 

F-5

----

 

**GRAYMARK PRODUCTIONS, INC.**

**(a Development Stage Enterprise)**

 

**Notes to CondensedConsolidated Financial Statements**

**(Unaudited)**

 

**For the Periods Ended March 31, 2005 and 2004**

 

Note 1 – Nature of Business

 

GrayMark Productions, Inc.(the “Company”) is a development stage company organized in Oklahoma and anindependent producer and distributor of film entertainment content.  The Company began operations in 2001 asGrayMark Productions, L.L.C. (the “LLC”), all of the assets of which wererecently acquired by the Company through our incorporation-reorganization,effective August 18, 2003.

 

The Company has completedthe production of its first motion picture project titled, *Cloud 9*and completed the filming of itssecond motion picture titled, *The Hunt*.  The Company is in the post-production phaseof Cloud 9 and is currently marketing both the domestic and foreign rights tothe film.  The Company intends to produceand distribute additional films that are completed and marketed using smallerbudgets than those of major studios. Management believes that producing and distributing low- ormodest-budget, commercially successful films will afford the Company access toHollywood talent and scripts and third-party production packages foracquisition, without compromising management’s approach to managing financialrisk.

 

Note 2 – Summary of Significant AccountingPolicies

 

*Interim Financial Information* – The unaudited condensed consolidatedfinancial statements have been prepared in accordance with generally acceptedaccounting principles for interim financial information, they do not includeall of the information and footnotes required by generally accepted accountingprinciples for complete financial statements.

 

The accompanying financialstatements are unaudited, but include all adjustments (consisting only ofnormal recurring adjustments) which are, in the opinion of management,necessary for a fair presentation of the financial position at such dates andof the operations and cash flows for the periods then ended.  Operating results for the periods ended March 31,2005 and 2004 are not necessarily indicative of results that may be expectedfor the entire year.

 

*Development stage operations* – The accompanying financial statements havebeen prepared in conformity with generally accepted accounting principles,which contemplate continuation of the Company as a going concern.  The Company has generated a limited amount ofconsulting revenues; however, the Company has yet to generate any revenue fromthe sale and/or distribution of film entertainment content and has no assuranceof future revenues from such sales and/or distribution.  In addition, the Company plans to spendsignificant amounts on the production and distribution of its film projects.

 

In view of the mattersdescribed in the preceding paragraph, the ability of the Company to establish asource of recurring revenue is dependent upon the Company’s ability to develop,produce and market film entertainment content. The accompanying consolidated financial statements do not include anyadjustments relating to the recoverability and classification of recorded assetamounts or amounts and classifications of liabilities that might be necessary shouldthe Company be unable to continue in existence.

 

F-6

----

 

*Consolidation* – The accompanying consolidated financial statements include theaccounts of GrayMark Productions, Inc. and its majority owned and controlledsubsidiaries, with a provision for minority interests.  The Company controls a subsidiary companythrough a combination of existing voting interests and the ability to exercisevarious 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”) and The Hunt, The Motion Picture LLC (“The Hunt”).  The LLC became a subsidiary of the Company inAugust 2003 as a result of the incorporation-reorganization of theCompany.  Out of the Blue, a variableinterest entity, was formed in December 2003 as the entity under which theCompany’s first motion picture project, *Cloud9*, was produced.  At March 31,2005, the Company has funded $2,347,643 of the acquisition and production costsof *Cloud 9*.  The Company is entitled to recover itscapital contributions to Out of the Blue plus interest at 2% above the primerate (defined as “investment recoupment”) from cash distributions before theother interest owners and thereafter 50% of cash distributions and entitled toreceive a majority of the proceeds from rights sales, distribution and any andall exploitation of the Picture.  TheCompany has 100% voting control of Out of the Blue.  The Hunt is 100% owned by the Company.

 

*Use of estimates* – The preparation of financial statements in conformity with generallyaccepted accounting principles requires management of the Company to makeestimates and assumptions that affect the amounts reported in the financialstatements and accompanying notes. Actual results could differ from those estimates.

 

*Accounting Changes* –

 

*SFAS 123(R)* – In December 2004, the Financial Accounting Standards Board(FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123(R),*Share-Based Payment*.  SFAS 123(R) replaces SFAS No. 123, *Accounting for Stock-Based Compensation*,and supersedes *Accounting Principles Board*(APB) Opinion No. 25, *Accounting forStock Issued to Employees*. SFAS 123(R) requires compensation costs related to share-based paymenttransactions to be recognized in the financial statements over the period thatan employee provides service in exchange for the award.  Public companies are required to adopt thenew standard using a modified prospective method and may elect to restate priorperiods using the modified retrospective method.  Under the modified prospective method,companies are required to record compensation cost for new and modified awardsover the related vesting period of such awards prospectively and recordcompensation cost prospectively for the unvested portion at time of adoption,of previously issued and outstanding awards over the remaining vesting periodof such awards.  No change to priorperiods presented is permitted under the modified prospective method.  Under the modified retrospective method,companies record compensation costs for prior periods retroactively throughrestatement of such periods using the exact pro forma amounts disclosed in thecompanies’ footnotes.  Also, in theperiod of adoption and after, companies record compesation cost based on themodified prospective method.  SFAS 123(R)is effective for periods beginning after December 15, 2005.  Early application is encouraged, but notrequired.

 

The Company has not yetdetermined the date or method of adoption. If the Company were to adopt SFAS 123(R) on December 15, 2005 usingthe modified prospective method, the Company estimates that there will be nostock-based compensation expense for the year ending December 31,2005.  If the Company elects to adoptSFAS 123(R) using the modified retrospective method, it is permitted to eitherretroactively restate only the 2005 interim periods or restate all priorperiods.  If the Company elects torestate prior periods using the modified retrospective method, net loss for theyear ended December 31, 2004, would be restated and would increase by$63,574.  Net loss for the three monthsended March 31, 2005, would not be impacted.

 

Note 2 – Investment in Films

 
| ** **                 | ** ** | **March 31,   2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------|------------|---------------------------|------------|-----------------------------|------------|
|                       |       |                      |       |                        |       |
| Completed and not released |       | $                         | 2,347,643  |                        | $          | 2,217,945 |   |
| In development             |       | 218,151                   |       | 10,000                      |       |
|                       |       |                      |       |                        |       |
| Total                      |       | $                         | 2,565,794  |                        | $          | 2,227,945 |   |

 

F-7

----

 

Note 3 – Film Obligations

 

During May 2004, theCompany obtained $500,000 of funding under co-finance agreements for its motionpicture project, *Cloud 9*.  The terms of the co-financing provide for theinvestors to recoup their contribution from the first proceeds of *Cloud 9*. After all *Cloud 9* costsare recouped by the Company, the investors are entitled to a profitparticipation in the Company’s profit from *Cloud9*.  As a group, the investorsare entitled to 20% of the net profits paid to the Company, but the investorsdo not have any ownership rights in the film. The $500,000 received under the co-financing agreements represents 21%of the anticipated total cost of *Cloud 9*.  The funding under the co-financing agreementscame from related parties to the Company as described below:

 
| **Source of Funding**                                              | ** ** | **Amount** | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|
|                                                               |       |       |       |
| Greater than 5% shareholder                                        |       | $          | 250,000    |   |
| Company’s president and chief operating  officer              |       | 100,000    |       |
| A company 50% owned by the Company’s chief  financial officer |       | 100,000    |       |
| Company shareholder                                                |       | 50,000     |       |
|                                                               |       |       |       |
| Total                                                              |       | $          | 500,000    |   |

 

Note 4 – Film Profit Participation andContingent Compensation

 

Pursuant to an investoragreement between the Company and the developers of the screenplay for *Cloud 9*(the “Picture”), the Companyshares the development and productions costs and revenue of *Cloud 9*. For its financial contribution to the costs of making *Cloud 9*, the Company is entitled toreceive the following:

 

•                                          100% of revenue and proceeds from the rightssales, distribution and/or any and all exploitation of *Cloud 9* until the Company recovers itsinvestment in the Picture, plus interest at the prime rate plus 2% per annumfrom the date of the contribution until the Company is repaid its investment inthe Picture.

 

•                                          50% of “net profits” received from the rightssales, distribution and/or any and all exploitation of the Picture.  “Net Profits” is defined as the sum remainingafter deduction of third party distribution fees; cash deferments to cast,equipment suppliers, rights holders or any other approved party.

 

The Company’s subsidiary,Out of the Blue Productions, LLC (the “Production Company”), entered intocontingent compensation agreements with the director and certain cast membersof *Cloud 9* in the form of “netand 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 (see Note 5 – FilmObligations).

 

The Production Company alsoagreed to pay additional contingent bonuses to certain cast members whenaggregate United States and Canada box office receipts as reported in DailyVariety reach various levels between $8,500,000 and $20,000,000.  The total contingent amounts that would bepaid if box office receipts reach $20,000,000 is $300,000.

 

F-8

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Note 5 – Capital Structure

 

In September 2004, theCompany issued 25,000 shares of stock to the Company’s legal counsel forservices rendered and fully performed. The shares were valued at the fair value of the services received of$25,000.

 

Note 6 – Stock Options and Warrants

 

Information with respect tostock options and warrants outstanding follows:

 
| ** **                            | ** ** | **Shares** | ** ** | **Average   Exercise  Price** | ** ** |
|---------------------------------------|------------|------------|------------|-------------------------------|------------|
|                                  |       |       |       |                          |       |
| Outstanding at December 31, 2003 |       | 3,498,250  |       | $                             | 1.86       |   |
| Granted at market value               |       | 165,000    |       | 1.24                          |       |
| Exercised                             |       | —     |       | —                        |       |
| Forfeited                             |       | —     |       | —                        |       |
|                                  |       |       |       |                          |       |
| Outstanding at December 31, 2004 |       | 3,663,250  |       | 1.84                          |       |
| Granted at market value               |       | —     |       | —                        |       |
| Exercised                             |       | —     |       | —                        |       |
| Forfeited                             |       | —     |       | —                        |       |
|                                  |       |       |       |                          |       |
| Outstanding at March 31, 2005    |       | 3,663,250  |       | $                             | 1.84       |   |

 

In September 2004, theCompany issued options to the Company’s officers and directors for the purchaseof 140,000 shares of the Company’s stock at an exercise price of $1.10.  The options were issued under the Company’s2003 Stock Option Plan and 2003 Non-Employee Stock Option Plan These became exercisableon January 1, 2005 and will expire on December 31, 2009.

 
| ** **     | ** ** | **Options and Warrants Outstanding** | ** ** | **Options and Warrants  Exercisable** | ** ** |
|----------------|------------|--------------------------------------|------------|---------------------------------------|------------|
| ** **     | ** ** | **Shares  Outstanding  at 3/31/05**  | ** ** | **Average  Remaining  Life (Years)**  | ** ** | **Average  Exercise  Price** | ** ** | **Shares  Outstanding  at 3/31/05** | ** ** | **Average  Exercise  Price** | ** ** |
|           |       |                                 |       |                                  |       |   |   |   |   |   |   |
| $1.00 to $2.00 |       | 3,663,250                            |       | 3.6                                   |       | $ | 1.84 |   | 3,663,250 |   | $ | 1.84 |   |
|                |            |                                      |            |                                       |            |  |  |  |  |  |  |  |  |

 

F-9

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