** **

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

**Washington, D. C. 20549**

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**FORM10-QSB**

 

(Mark One)

 

**ý****                                 QUARTERLYREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period endedSeptember 30, 2004**

 

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

 

**For the transition period from           to           **

** **

**Commission File Number: 000-50638**

 

**GRAYMARKPRODUCTIONS, INC.**

(Name of small businessissuer in its Charter)

 

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

 

 

**101 N.Robinson, Suite 920**

**OklahomaCity, Oklahoma 73102**

(Addressof principal executive offices)

** **

**(405)601-5300**

(Issuer’stelephone number)

 

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

 

**APPLICABLEONLY TO ISSUERS INVOLVED IN BANKRUPTCY**

**PROCEEDINGSDURING THE PRECEDING FIVE YEARS**

 

Check whether the registrant filed all documents andreports required to be filed by Section 12, 13 or 15(d) of the Exchange Actafter the distribution of securities under a plan confirmed by a court.  Yes o  No o

 

**APPLICABLEONLY TO CORPORATE ISSUERS**

 

State the number of shares outstanding of each ofissuer’s classes of common equity, as of the latest practicable date:  As of November 10, 2004, 8,258,425 shares ofthe issuer’s common stock, $0.0001 par value, were outstanding.

 

Transitional Small Business Disclosure Format (CheckOne): Yes o  No ý

 

 

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**GRAYMARKPRODUCTIONS, INC**.

FORM 10-QSB

For the Quarter Ended September30, 2004

 

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.   |   | Changes  in 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 and  Reports on Form 8-K                               |   |
| SIGNATURES |   |

 

Throughout this report the first personal pluralpronoun in the nominative case form “we” and its objective case form “us”, itspossessive and the intensive case forms “our” and “ourselves” and its reflexiveform “ourselves”  refer collectively toGrayMark Productions, Inc., its predecessor, GrayMark Productions, L.L.C., andits executive officers and directors. The term “independent,” as used in this report, is used to distinguishus from the term “major studios” that is generally regarded in theentertainment industry to mean Universal Pictures, Warner Bros., TwentiethCentury Fox, Sony Pictures Entertainment, Paramount Pictures, The Walt DisneyCompany, Metro Goldwyn Mayer and their respective affiliates.  The terms “low-budget motion pictures,” “low-budgetfilms” or “low-budget movie” within this report, refer to motion pictures thathave a production budget of $2 to $5 million.

 

 

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**PART I. FINANCIAL INFORMATION**

 

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

 

Our financial statements which are prepared inaccordance with Regulation S-B are set forth in this report beginning on pageF-1.

 

**Item2.****          ****Management’s Discussion and Analysisor Plan of Operation**

 

You should read the following discussion inconjunction with our financial statements and notes thereto appearing elsewherein this report.

 

**Overview**

 

**Development Stage Company**

 

We are a development stage company.  We operated historically as a limitedliability company, GrayMark Productions, L.L.C., that was formed in August2001.  Since commencement of ouroperations in August 2001, we have not generated a material amount of revenuefrom operations.  Effective August 18,2003, pursuant to an exchange agreement, the owners of the member interests inGrayMark Productions, L.L.C. exchanged their respective member interests inGrayMark Productions, 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 production of our first motion filmproject, *Cloud 9*, and are in theprocess of marketing both the foreign and domestic rights to the film.  We have not generated any revenue to datefrom *Cloud 9*.

 

The following discussion covers our plan of operationsfor the next 12 months.  As with any plan,there is no assurance that our operations as described will go as planned orthat we will be successful in achieving the anticipated results.

 

**Movie Development and Production**

 

The movie industry generally consists of two principalactivities, production and distribution. Production encompasses the development, financing and creation offeature-length movies.  Distributionentails the promotion and marketing of movies in the various media markets,including theatrical, home video and television presentation.

 

We anticipate primarily producing English languagemotion pictures intended primarily for domestic theatrical release and to amuch lesser extent the ancillary market (home video and television, includingpay-per-view, cable, satellite and network broadcast), that have productionbudgets of $2 to $5 million (“low-budget motion pictures,” “low budget movies”or “low-budget films”).

 

The development and production costs of a low-budgetfilm and each cost category varies from movie-to-movie and this variation maybe substantial.   Each movie is uniqueand the storyline, special effects, production locations, creative personnelinvolved, etc. affect the budget amount of each cost category.  Accordingly, we believe the cost categoriesare somewhat indeterminable until the particular movie is identified anddeveloped.

 

Rather than retain and employ personnel to developscreenplays and perform other movie development activities, we typicallyacquire movies for production that are in the development phase, generally tothe point that the initial screenplay has been written, and that are low-budgetfilms.  In the pre-production andproduction phases of a motion picture, we intend to hire skilled creative andproduction personnel, including cinematographers, editors, costume designers,set designers, sound and lighting technicians and actors on an as needed basis.

 

 

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We expect to enter into various production cost andrevenue sharing arrangements, including joint ventures, partnerships andlimited liability companies, on a movie-by-movie basis.  These sharing arrangements are intended tocomplement or expand our business to permit the production of a greater numberof movies, while sharing the financial risks of the movie.  We may not realize the financial benefits weanticipated when we entered into these arrangements.  In addition, the negotiation of these  arrangements, whether successful or not,could require us to incur significant costs and cause diversion of management’stime and resources.  Accordingly, thecosts of obtaining these sharing arrangements will increase our invested costin a movie without providing a correlating increase in the movies revenues;thus, adversely affecting the financial performance of the movie.

 

Following our production of the movie, we intend toarrange for distribution through third-parties primarily into the domestic andinternational theatrical markets.  We donot have any plans to release our movies directly to the ancillary market (homevideo or pay and free television). However, we may distribute our movies into the ancillary markets if the opportunity were to develop.  Our primary distribution market will be thedomestic and international theatrical markets.

 

A substantial amount of time may elapse between ourexpenditure of funds and the receipt of revenue from the motion picture.  Accordingly, we plan on producing one movieduring 2004 and not undertake the production of any additional movies unless wehave sufficient funds with which to complete production.

 

Our produced movies will be distributed domesticallypursuant to licensing arrangements with unrelated third-parties that areindependently engaged in the promotion and distribution of movies.  Any foreign distribution will be pursuant tosale of the distribution rights to an unrelated third-party internationaldistributor for a single up-front payment. As of the date of this report, we have not entered into any distributionarrangements.

 

We expect to distribute each motion picture we produceoutside North America by sale of the international distribution rights to aninternational distributor for lump-sum single payment (in U.S. currency)without any retained participation in international source revenues.  As a result, our ability to sell theinternational distribution rights will be subject to:

 

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

 

•                                          changes in the laws and policiesaffecting trade, investment and taxes (including laws and policies relating tothe repatriation of funds and withholding taxes),

 

•                                          differing degrees of protection forintellectual property,

 

•                                          instability of foreign economies andgovernments,

 

•                                          cultural barriers,

 

•                                          wars and acts of terrorism, and

 

•                                          the spread of severe acute respiratorysyndrome, or SARS.

 

Any of these factors could have a material adverse effect on ourability to sell the international distribution rights of any motion picture.

 

The financial success of each motion picture weproduce will depend principally on theatrical exhibition.  We do not expect to realize significantrevenues from release and distribution of our produced movies into theancillary markets.  As reported by theMotion Picture Association of America (MPAA), in 2002 the average theatricalcosts of a MPAA company increased 14% that was attributable to the increase inproduction costs, studio overhead and capitalized interest.  The increases in production costs, studiooverhead and capitalized interest were at a faster rate than theater admissions(an increase of 10.2%) and ticket prices (an increase of 2.7%) in 2002.  The production company 

 

 

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receives a portion of the theatrical admission revenues or box officereceipts of a movie, generally 30% to 40%, after the distributor recovers itscosts of distribution.  Consequently, asproduction costs increase box office receipts must increase as much as threetimes the amount of increase in production costs to keep pace.  These rising production costs withoutcommensurate increases in movie admissions and admission ticket pricesadversely affect the financial performance of a movie and the ability torecover the invested costs in the movie as well as realize any profit.  There is no assurance that this trend willreverse in the near term or continue for an extended period.

 

**Production Budget of Cloud 9**

 

In January 2004, we commenced pre-production of themovie currently titled *Cloud 9*(formerly*Out of the Blue*).  The budgeted production and development costsof this movie project are as follows:

 
| ** **                          | ** ** | **$2,000,000  Budget** | ** ** |
|-------------------------------------|------------|------------------------|------------|
| Screenplay rights                   |       | $                      | 40,970     |   |
| Producers unit                      |       | 74,000                 |       |
| Direction                           |       | 87,100                 |       |
| Cast                                |       | 379,695                |       |
| Travel and living costs             |       | 825                    |       |
| Fringe benefits and payroll taxes   |       | 43,275                 |       |
| Production staff                    |       | 139,475                |       |
| Extra talent                        |       | 47,750                 |       |
| Set design                          |       | 27,325                 |       |
| Set operations                      |       | 52,150                 |       |
| Set dressing                        |       | 78,250                 |       |
| Property                            |       | 29,700                 |       |
| Wardrobe                            |       | 69,400                 |       |
| Makeup and hair                     |       | 23,550                 |       |
| Lighting                            |       | 53,600                 |       |
| Camera                              |       | 115,650                |       |
| Production sound                    |       | 27,750                 |       |
| Transportation                      |       | 116,170                |       |
| Location                            |       | 83,775                 |       |
| Tape and transfers                  |       | 59,250                 |       |
| Production period - fringe benefits |       | 84,705                 |       |
| Film editing                        |       | 112,000                |       |
| Music                               |       | 40,000                 |       |
| Post-production sound               |       | 35,000                 |       |
| Main end and titles                 |       | 1,000                  |       |
| Publicity                           |       | 2,000                  |       |
| Post-production - fringe benefits   |       | 5,560                  |       |
| Insurance                           |       | 20,000                 |       |
| General expense                     |       | 10,000                 |       |
| Contingencies                       |       | 140,075                |       |
| Total budget costs                  |       | $                      | 2,000,000  |   |

 

As of September 30, 2004, total production costs of *Cloud 9*were $2,173,218.  As of the filing of this report, we expectthat total production costs of *Cloud 9*willbe approximately $2,200,000.

 

 

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**Production Agreement**

 

Pursuant to the Investor Agreement with A&AProductions, LLC and Frozen Televison, Inc., dated November 20, 2003, GrayMarkProductions, Inc. shares the development and production costs and revenue ofthe picture known as  *Cloud 9*(formerly *Out of the Blue*) (the “Picture”). Thescreenplay was developed and written by Brett Hudson, Burt Kearns and Albert S.Ruddy. The following is a summary of the material terms of the InvestorAgreement:

 

***Exploitation Efforts.*** A&AProductions, LLC and Frozen Television, Inc. (the “Producer”) are to use theirbest efforts to arrange for third parties to distribute and/or exploit thePicture on such commercially reasonable terms as the Producer might be able toobtain subject to the rights of GrayMark Productions, Inc.

 

***Premium Recoupment and Profit Participation.*** For its financial contribution to the costs ofmaking the Picture, GrayMark Productions, Inc. is entitled to receive thefollowing:

 

•                                          100% of revenue and proceeds received byProducer from the rights sales, distribution and exploitation of the Pictureuntil GrayMark Productions, Inc. recovers its investment in the Picture (“PremiumRecoupment”), plus interest at the rate of prime plus 2% per annum from thedate of the contribution until GrayMark Productions, Inc. is repaid the PremiumRecoupment in full, and

 

•                                          50% of “net profits” received by Producerfrom the rights sales, distribution and/or any and all exploitation of thePicture (“Profit Participation”). “Net profits” is defined as the sum remainingafter deduction of third-party distribution fees and expenses; cash deferments(paid out on a equal priority basis with GrayMark Productions, Inc.) to cast,equipment suppliers, rights holders or any other approved party.

 

In addition to the Profit Participation of GrayMark Productions, Inc.,the Producer is permitted to grant similar net profit participation intereststo third parties without obtaining the consent of GrayMark Productions,Inc.  However, the Producers are notpermitted to grant participation interests that may in any way adversely affector reduce the Premium Recoupment and Profit Participation of GrayMarkProductions, Inc.

 

***Financial Contributions. ***Pursuantto amendment of the Investor Agreement (dated January 5, 2004), GrayMarkProductions, Inc. agreed to make financial contributions to the production ofthe Picture of $2,000,000, all of which has been made.  Because the production costs of the Pictureexceed $2,000,000, Producer is obligated to pay $25,000 of the productioncosts, and GrayMark Productions, Inc. is responsible for the balance of theproduction costs of the Picture.

 

***Ownership and Decision Controls.*** Each of GrayMark Productions, Inc. and theProducer owns 50% of the copyright to the Picture and all underlying rights andmaterials.  Producer exercises creativecontrols, subject to the following approval rights (not to be unreasonablywithheld) of GrayMark Productions, Inc.:

 

•                                          any proposed increase in the productionbudget;

 

•                                          any re-allocation of budgetary line itemsin excess of $5,000;

 

•                                          all above-the-line agreements (agreementswith creative personnel, producer unit, story rights, etc.);

 

•                                          locations of the production mutually withProducer;

 

•                                          shortening of the Picture run-time toless than 85 minutes or lengthening of the Picture to more than 100 minutes;

 

•                                          approve production legal counsel (RobertM. Angel, Esq. has been approved);

 

•                                          production accountant;

 

 

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•                                          all distribution agreements;

 

•                                          unit production manager; and

 

•                                          rating of the Picture (pre-approved thatthe Picture will be rated PG-13 or PG, subject to review by the MPAA).

 

Gray Frederickson is the designated representative of GrayMarkProductions to exercise all approval rights and to view daily photography,production notes, script changes, and otherwise review any other aspects of theproduction during principal photography of the Picture.

 

**Credits.** Subject to third-party distributor approval, credit presentation will be“A Ruddy Morgan Organization/Frozen Films Production in Association withGraymark Productions” and the main title single-card credits will be asfollows:

 

•                                          “Produced by Gray Frederickson”

 

•                                          “Produced by Albert S. Ruddy and AndreMorgan”

 

•                                          “Produced by Brett Hudson and Burt Kearns”

 

•                                          “Executive Producer John Simonelli”

 

•                                          “Written by Brett Hudson, Burt Kearns andAlbert S. Ruddy”

 

***Sequel/Remake Options.*** In the eventProducer proposes to produce a remake, sequel, prequel or television projectbased upon the Picture (“subsequent production”), GrayMark Productions, Inc.has the right (for a 120-day period) to elect to provide financing for the subsequentproduct on the same terms and conditions as the Picture.  Initially failing timely to elect to providethis financing, prior to Producer’s acceptance of a third-party financing,GrayMark Productions will have 10 days in which to match the material financialterms of any bona fide written third-party financing offer received byProducer.

 

***Security Interest.*** Producergranted GrayMark Productions, Inc. a security interest in the Picture to secureProducer’s obligations, representations, warranties and covenants under theInvestor Agreement.  GrayMarkProductions, Inc. has been appointed Producer’s attorney-in-fact to execute anddeliver any required security documents in the event Producer fails to do so ifnot executed and delivered within 30 days following the request by GrayMarkProductions, Inc.

 

***Indemnification.*** Each ofGrayMark Productions, Inc. and Producer agreed to indemnify and hold harmlessthe other against claims, demands, causes of action, obligations, liability,loss, damage, cost and expenses (including reasonable outside attorneys’ fees),incurred or sustained for any breach or alleged breach of the InvestorAgreement.

 

***Accounting and Producer Reports***. Producer agreed to maintain complete books and records with respect tothe distribution and exploitation of the Picture and provide periodicaccounting statements.  Any accountingstatement provided by Producer will be deemed conclusively true and correct andincontestable unless GrayMark Productions, Inc. delivers to Producer writtenobjections within two years from the date the applicable accounting statementwas received from Producer.  GrayMarkProductions, Inc. has the right to examine the books and records of Producer(and make copies thereof) to the extent they pertain to the Picture. Withrespect to any accounting period for which an accounting statement has beenrendered by Producer, this examination shall be permitted only for a period ofone year from the date the Accounting Statement was received by GrayMarkProductions, Inc.

 

***Segregation of Funds.*** All fundsreceived by Producer that are payable to GrayMark Productions, Inc. are to beimmediately deposited upon receipt in a separate interest-bearing bank accountnaming GrayMark Productions, Inc. as the beneficiary thereof.

 

 

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***No Agency Relationship.*** Therelationship between GrayMark Productions, Inc. and Producer is that ofindependent contractors and no partnership, joint venture, agency or employmentrelationship is created by the Investor Agreement.

 

***Assignment.*** The right orobligations under the Investor Agreement are not assignable without the priorwritten consent of the other party; however, a party may assign its right toreceive monies under the Investor Agreement.

 

***Arbitration.*** In the event adispute arises under the Investor Agreement that the Producer and GrayMarkProductions, Inc. are unable to resolve, the dispute is to be decided byarbitration pursuant to the regulations and procedures of the AmericanArbitration Association.

 

***Insurance.*** Producer is toobtain certificates of insurance, upon commencement of pre-production, namingGrayMark Productions, Inc. as an additional insured, indicating that allinsurance normally obtained in connection with the production of a motionpicture, including general liability and errors and omissions insurance, hasbeen obtained with commercially reasonable liability limits and deductibles,and that these policies cannot be cancelled or amended without first giving 30days’ prior written notice.

 

**A&A Productions, LLC**

 

A&A Productions, LLC (“A&A”) is a limitedliability company owned by Albert S. Ruddy and André E. Morgan.  Mr. Ruddy is a writer and with Burt Kearnsdeveloped and wrote the screenplay for *Cloud9*.  Each of Messrs. Ruddy andMorgan have produced feature length motion pictures and television programing,acted and worked on film crews.

 

Mr. Ruddy produced (and wrote the screenplay orscript) *Flatland*(2002,television series), *Mean Machine*(2001,executive producer), Running Mates (2000, executive producer), Married to aStranger(1997, executive producer), *Heaven’sPrisoners*(1996), *The Scout*(1994),*Walker, Texas Ranger*, (1993,television series, produced and wrote the script), *The Godfather Trilogy:  1901-1980*(1992), *Miracle in the Wilderness*(1992, executive producer), *Ladybugs*(1992), *Impulse*(1990),*Speed Zone!*(1989, executiveproducer), *Cannonball Run II*(1984,produced and wrote the screenplay), *Lassiter*(1984), *Megaforce*(1982,produced and wrote the screenplay), *DeathHunt*(1981), *The Cannonball Run*(1981),*Matilda*(1978, produced and wrotethe screenplay), *The Macahans*(1976),*Coonskin*(1975), *The Longest Yard*(1974, produced and wrotethe screenplay), *The Godfather*(1972,won Academy Award for Best Picture-Production), *Making It*(1971), *LittleFauss and Big Halsy*(1970) and*Wild Seed*(1965).  He alsowrote *Bad Girls*(1994), *Revenue for a Rape*(1976, televisionproduction), and*Hogan’s Heroes*(1965,co-wrote one episode).

 

Mr. Morgan is the Executive Producer of Golden HarvestEntertainment Co., Ltd., a Chinese entertainment conglomerate engaged in a widerange of activities from film production, stars management, film distribution,cinema exhibition and print processing. Golden Harvest Entertainment has produced more than 500 films, many ofwhich have won awards and critical acclaim at the world’s most prestigiousinternational film festivals including Cannes, Berlin, Edinburgh, London, NewYork, Chicago, San Francisco and many others. We do not have any contractual arrangements with Golden HarvestEntertainment and do not anticipate developing any contractual arrangements.

 

Mr. Morgan has produced (and acted in) *Lei ting zhan jing*(2000), *Martial Law*(1998, television series,executive producer), *Mr. Magoo*(1997, executive producer),  *Heaven’s Prisoners*(1996), *The Scout*(1994), *Bad Girls*(1994), *Miracle in the Wilderness*(1992), *Ladybugs*(1992), *Impulse*(1990), *Speed Zone!*(1989, executive producer), *Farewell to the King*(1989), *Cannonball Run II*(1984, executiveproducer), *Megaforce*(1982), *Death Hunt*(1981, unaccredited executiveproducer),  *The Cannonball Run*(1981, executive producer), *Si wang ta*(1981), *Night Games*(1980), *Game of Death*(1978, produced and actedin), *The Boys of Company C*(1978),*The Amsterdam Kill*(1977), *The Man from Hong Kong*(1975, produced andacted in ), *Himalayans*(1978), *Tie jin gang da po zi yang guan*(1974,unaccredited producer and acted in), *Enterthe Dragon*(1973, associate producer), *Meng long guojiang*(1972, associate producer) and *Jing wu men*(1972, unaccredited associateproducer).  Mr. Morgan also appeared in *Twisted*(1986), *Parting Glances*(1986), *Taiquan zhen jiu zhou*(1973) and *Menglong guojiang*(1972).

 

 

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***Frozen Television,Inc.***

 

Brett Hudson andBurt Kearns control Frozen Television, Inc. *Cloud 9*is the firstfeature length motion picture produced by Messrs. Hudson and Kearns and FrozenTelevision, Inc.  Mr. Kearns has producedfor television *My First Time*(2003,a series, executive producer), *Mark DavidChapmen:  Death of a Beatle*(2001),*Hard Copy*(1989, a televisionseries) and *A Current Affair*(1986,television series).

 

Mr. Hudson has appeared in or on *Chantamania: The Benzedrine Monks of Santo Damonica* (1994), *Hysterical*(1983), *Bonkers!*(1979,a hosted television series), *The Millionaire*(1978), *Zero to Sixty*(1978)and *The Hudson Brothers Razzle Dazzle Show*(1974,a hosted television series).

 

**Formation of Production Company**

 

On December 22, 2003, with A&A Productions, LLCand Frozen Television, we formed Out of the Blue Productions, LLC, a Californialimited liability company (the “Production Company”) and the entity under which*Cloud 9*is being produced.  We are a 50% owner and each of A&AProductions, LLC and Frozen Television, Inc. is a 25% owner of the ProductionCompany (collectively the “members”).

 

***Summary of Operating Agreement***

 

 On April 23,2004, the members amended and restated the Operating Agreement of theProduction Company, effective December 22, 2003. Under the terms of theOperating Agreement, as amended and restated, to the extent that the OperatingAgreement and the Investor Agreement conflict or are inconsistent, theOperating Agreement is to control.

 

***Place of Business; Purpose. ***Theinitial address of the Production Company is 9300 Wilshire Blvd., Ste 508,Beverly Hills, CA 90212, which may be changed by majority vote of the members,from its business will be conducted or such other place or places as themembers determine. The Production Company may engage in all business activitiesthat are legal for a limited liability company to engage in underCalifornia  law.

 

***Production Budget.*** The membersagreed to the production budget of *Cloud 9*(the “Production Budget”),  subject toincrease by agreement of the Members.  Nogeneral overhead of A&A Productions, LLC or Frozen Television, Inc. wasincluded in the Production Budget.

 

***Capital Contribution Obligations.*** Upon formation of the Production Company, wecontributed $50 and each of A&A Productions, LLC and Frozen Television,Inc. contributed $25.  Furthermore, wecontributed more than $2,200,000 to the Production Company to fund theproduction costs of *Cloud 9*.  The capital contributions under the OperatingAgreement are the same as our cash flow funding obligations under the InvestorAgreement.  Any capital contributions wemake to the Production Company are also deemed made under the InvestorAgreement.

 

***Banking.*** Funds and moneyreceived by the Production Company are to be deposited in the bank account oraccounts as the members determine. Checks, wire transfers or any otherwithdrawals from these bank accounts require our signature and the signature ofA&A Productions, LLC or Frozen Television, Inc.  No disbursements of these accounts of anynature are to be made without the signature of our representative, GrayFrederickson.

 

***Budget Overrun.*** The actualcosts of producing *Cloud 9*(includingscript rights acquisition, legal fees, setup of production offices, casting;location scouting) exceed the $2,000,000 budget**(“Budget Overrun”).  Weanticipate that the total Budget Overrun will be approximately $250,000.  We will bear all of the Budget Overrun, otherthan $25,000 that A&A Productions, LLC and Frozen Television, Inc. areobligated to bear through contributions to the Production Company.  A&A Productions, LLC and FrozenTelevision, Inc. have not made their $25,000 contributions to the ProductionCompany in payment of their shares of the Budget Overrun.

 

***Cash Distributions and Income and Loss Allocations.*** Distributions of the cash to the members willbe made quarterly or more frequently as determined by majority vote of themembers as follows:

 

 

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•                                          100% to us until we receive cumulativeaggregate cash distributions of equal to our aggregate capital contributions tothe Production Company, plus interest on the capital contributions at the rateof the prime rate plus 2% per annum from the date of the capital contributionto the Production Company (“Investment Recoupment”); and thereafter,

 

•                                          50% to us and  25% to each of A&A Productions, LLC andFrozen Television, Inc.

 

However, a portion of cash available for distribution may be retainedby the Production Company upon majority vote of the members to be used for thereasonable needs of the Production Company.

 

All net income of the Production Company will beallocated among the members in the same proportion that distributions of cashavailable for distribution for the applicable fiscal year were distributed orwould have been distributed in the event no distributions of cash available fordistribution were made during the applicable year.

 

All net loss will be allocated among the members inproportion to their respective capital contributions to the Production Company.

 

***Accounting Matters.*** The ProductionCompany has elected to use the accrual method of accounting. The accounting isto be maintained to disclose the items (of income, gain, loss, deduction orcredit) that the members are required to take into account separately forincome tax purposes.  As to matters ofaccounting not provided for in the Operating Agreement, if any, generallyaccepted accounting principles are to govern. The fiscal year of the ProductionCompany ends on December 31 of each year. Each member is to be provided areport and statement within two and one-half months after the end of eachfiscal year.

 

***Management Decisions.*** Managementdecisions related to the Production Company are to be made by the affirmativevote, or written consent by proxy or otherwise, of the members entitled toreceive 51% or more of distributions of cash available for distribution priorto Investment Recoupment at the applicable time of the decision.  Accordingly, we have 100% voting control ofthe Production Company.  No member isobligated to devote full-time to the business of the Production Company.

 

***Member Indemnification.*** The ProductionCompany has agreed to indemnify the costs and expenses of any person who was oris a party or is threatened to be made a party to any threatened, pending orcompleted action or suit by reason that the person is or was a member of theProduction Company, if the person acted in good faith and in a manner theperson reasonably believed to be in or not opposed to the best interests of theProduction Company.

 

***Transferability of Member Interest.*** Amember is not permitted to sell its interest in the Production Company withoutthe unanimous consent of the members. Each member has the first right of refusal to purchase a selling member’sinterest in the Production Company within 30 days following receipt of noticeof the proposed sale.

 

***Termination.*** The ProductionCompany will terminate on December 31, 2025, unless sooner terminated by

 

•                                          agreement of all members, or

 

•                                          in accordance with law (the laws ofCalifornia, including the statutory provisions, all applicable provisions ofthe California Constitution, and reported judicial decisions interpreting thoselaws).

 

***Dissolution of a Member.*** In the event ofdissolution of a member, the Production Company has the right and option topurchase the dissolved member’s interest in the Production Company within threemonths following the dissolution.  Thepurchase price for the interest is the average of the value established by two independentappraisers and is payable over a 36-month period.

 

 

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**Literary Purchase Agreement**

 

As of December 22,2003, the Production Company entered into the Literary Purchase Agreement withBrett Hudson, Burt Kearns and Albert S. Ruddy. This agreement provides for the purchase by the Production Company ofthe motion picture, television, radio, stage, home video, sequel and remakerights, interactive/multimedia, publishing, novelization, music publishing, soundtrackalbum, internet, merchandising, and promotional and advertising rights inthe  screenplay then titled *Out of the Blue*for $34,470.  These rights did not include any writtenpublishing rights including “books on tape,” but these rights include publishingrights limited to 10,000 words for advertising and publicity of the movie.  Messrs. Hudson, Kearns and Ruddy agreed toindemnify and hold harmless the Production Company for all claims sustained orincurred by the Production Company based upon breach of any warranty,undertaking, representation or agreement by Messrs. Hudson, Kearns andRuddy.  The Production Company agreed toindemnify and hold harmless Messrs. Hudson, Kearns and Ruddy with respect tomaterial added to the screenplay or resulting from the development, production,distribution, exhibition, broadcast, advertising, publicity, promotion orexploitation of the movie.

 

The Production Company has the right to assign itsrights under the Literary Purchase Agreement to any person, but the assignmentwill not relieve the Production Company of its obligations unless the assigneeis a major studio, mini-major studio or network or other financiallyresponsible party that assumes the obligations of the Production Company.

 

**Production and Distribution of *Cloud 9***

 

The storyline of *Cloud9*is about Billy, a down-and-out promoter living in Malibu,California.  A consummate hustler, Billyconvinces a group of beautiful dancers from the local strip club to form a teamto play beach volleyball.  The moneystarts pouring in as the girls play exhibition matches for the jeering crowds,but they become an embarrassment to the professional beach volleyballassociation.  Although Billy is enjoyinghis new success, the girls convince him that they can be a real team and playcompetitive beach volleyball.  Billy andthe girls learn that winning respect is more important than money.  We expect to obtain a PG-13 rating of *Cloud 9*.

 

The production phase of *Cloud 9*has been substantially completed.  *Cloud 9*is currently in the post-production phase. We are editing the movie, and music and dialogue will be finalized andsynchronized with the movie’s photography shortly.  It is expected that this phase will becompleted by the end of November 2004.

 

We anticipate that *Cloud9* will be theatrically released prior to end of 2004.  *Cloud 9*will be distributed domestically pursuant to licensing arrangements withunrelated third-parties and any foreign distribution will be pursuant to saleof the distribution rights to an unrelated third-party internationaldistributor without retaining any right to receive revenue from theinternational distribution of *Cloud 9*.  We have not entered into any commitments orarrangements for distribution, domestically or internationally.  It is expected that as the production phaseprogresses, distribution companies will become more interested in obtainingdistribution rights.

 

**Director’s Loanout Agreement**

 

Pursuant to our Freelance Director’s Loanout Contract —Theatrical Motion Picture Photoplay, dated as of January 19, 2004 (the “LoanoutAgreement”), with Genco Olive Oil, Inc., we obtained the services of HarryBasil to direct *Cloud 9*.  Under the Loanout Agreement, Genco Olive Oil,Inc. provided the direction services of Mr. Basil on a non-union engagementbasis, through completion of all services required by the Production Company(completion of *Cloud 9*) incompliance with instructions, directions, requests, rules and regulations madeor issued by the Production Company.  TheProduction Company retained control of matters involving artistic taste andjudgment.  Without the consent of theProduction Company, Mr. Basil was not permitted to engage the services orfacilities of any third party in connection with the production of *Cloud 9*or deviate or permit deviationfrom the final screenplay or otherwise utilize any element not approved by theProduction Company.

 

For the direction services, the Production Companypaid Genco Olive Oil, Inc. $75,000.  Inaddition, Genco Olive Oil, Inc. will be entitled to receive 5% of theProduction Company’s gross receipts from exploitation of *Cloud 9*

 

 

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after the Production Company has recouped its costs (including costs ofproduction and distribution) in connection with *Cloud 9*.  Other thanas described above, Genco Olive Oil, Inc. is not entitled any additionalcompensation.

 

**Filmographyof Harry Basil.**  Harry Basil is a writer, actor, director andproducer of feature length motion pictures. He wrote or co-wrote *Back by Midnight*(2002), *The 4th Tenor*(2002),*My Five Wives*(2000) (also knownas *Mes ciq chéris*(Canada: Frenchtitle)), *Meet Wally Sparks*(1997),and *Guide to Golf Style and Etiquette*(1995).  As an actor, Mr. Basil had roles in *Meet Wally Sparks*(1997), *Ladybugs*(1992), *Martians Go Home*(1990), *The Seventh Sign*(1988) and *Peggy Sue Got Married*(1986).  Mr. Basil has previously directed threemovies, *Hairy Tale*(2004), *Back by Midnight*(2002) and *The 4th Tenor*(2002), and produced twomovies, *Meet Wally Sparks*(1997,co-producer) and *Ladybugs*(1992,associate producer).

 

**Casting and Actor Agreements**

 

**Pixie,Inc./Fenton-Cowitt Casting.**  On January 20,2004, Gray Frederickson on our behalf and Mike Fenton as agent for Pixie, Inc.,f/s/o Fenton-Cowitt Casting entered into the Fenton-Cowitt Casting Agreementfor the providing of casting services for four weeks .  For these services, we paid Fenton-CowittCasting $31,600 and agreed to pay $3,000 per week if casting services were tobe required after March 5, 2004. Furthermore, Fenton-Cowitt Casting is entitled to receive 1% of the netprofits of *Cloud 9*.

 

**BurtReynolds.**  On February 20, 2004, the Production Companyentered into a letter agreement with Clematis Productions, Inc. and a SAGMotion Picture Contract — Weekly Performer with Burt Reynolds for the providingof the employment of Mr. Reynolds to perform the role of Billy Cole in *Cloud 9*. For his services, we paid Mr. Reynolds guaranteed compensation of$100,000 and agreed to pay $5,000 per day in the event his services are used inwork days in excess of four production weeks. The $100,000 guaranteed compensation is a recoupable, non-reimbursableadvance against 10% of the Production Company’s gross receipts after theProduction Company fully recoups all actual, direct, out-of-pocket “negative”costs of production of *Cloud 9*,plus interest of 2% in excess of the prime rate (limited to 5%) per annum.  In addition, the Production Company providedone first class round trip airfare from Florida to Los Angeles, localtransportation, a $2,000 weekly expense allowance, two hairpieces during thefour-week production period, hairdresser and make-up person at $275 per 14-hourday.

 

**D.L.Hughley.**  As revised on April 15, 2004, the ProductionCompany entered into a letter agreement with Five Timz Productions and a SAGMotion Picture Contract — Weekly Performer with D.L. Hughley for the providingof the employment of Mr. Hughley to perform the role of Tenspot in *Cloud 9*. For his services, we paid Mr. Hughley guaranteed compensation of$100,000 and agreed to pay $5,000 per day in the event his services are used inwork days in excess of four production weeks. The Production Company also agreed to pay Mr. Hughley an amount equal to2.5% of the net profits of *Cloud 9*.

 

**AngieEverhart.**  On April 16, 2004, the Production Companyentered the SAG Motion Picture Contract — Weekly Performer with Angie Everhartpursuant to which Ms. Everhart was employed to perform the role of Julie in *Cloud 9*. For her services, we paid Ms. Everhart $30,000.  The Production Company also agreed to pay Ms.Everhart the following contingent amounts:

 

•                                          a bonus of $25,000 when aggregate UnitedStates and Canada box office receipts as reported in *Daily Variety* are $10,000,000 or more;

 

•                                          a bonus of $25,000 when aggregate UnitedStates and Canada box office receipts as reported in Daily Variety are$15,000,000 or more;

 

•                                          a bonus of $25,000 when aggregate UnitedStates and Canada box office receipts as reported in Daily Variety are$20,000,000 or more; and

 

•                                          an amount equal to 2.5% of the netprofits of *Cloud 9*.

 

 

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**GabrielleReece.**  On April 14, 2004, the Production Companyentered into the SAG Motion Picture Contract — Weekly Performer with GabrielleReece pursuant to which Ms. Reece was employed to perform the role of Christinain *Cloud 9*.  For her services, we paid Ms. Reece $3,564(110% of the applicable minimum low budget scale for two non-consecutive workor production weeks pursuant to the 2001 Screen Actors Guild Agreement),including the fee payable to her agent. The Production Company also agreed to pay Ms. Reece the followingcontingent amounts:

 

•                                          a bonus of $50,000 when aggregate UnitedStates and Canada box office receipts as reported in *Daily Variety* are $5,000,000 or more;

 

•                                          a bonus of $75,000 when aggregate UnitedStates and Canada box office receipts as reported in Daily Variety are$7,500,000 or more;

 

•                                          a bonus of $100,000 when aggregate UnitedStates and Canada box office receipts as reported in Daily Variety are$10,000,000 or more; and

 

•                                          an amount equal to 2.5% of the netprofits of *Cloud 9*.

 

**Co-Finance Agreements**

 

In May 2004, we entered into a Co-Finance Agreementwith each of Roy T. Oliver, one of our major shareholders, John Simonelli, ourPresident and Chief Operating Officer, 36th Street Properties LLC (of whichMark R.  Kidd, our Chief FinancialOfficer is a 50% owner) and Larry E. Howell. Pursuant to these Co-Finance Agreements each of Messrs. Oliver,Simonelli, and Howell and 36th Street Properties LLC made contributions toshare in the production costs of *Cloud 9*of $250,000, $100,000, $50,000 and $100,000, respectively, for the aggregatesum of $500,000.  Their contributions tothe production costs of *Cloud 9*are recoverable from all proceeds we receive from the rights sales anddistribution of *Cloud 9*,commencing from the first dollar we receive until Messrs. Oliver, Simonelli andHowell and 36th Street Properties LLC are repaid their respective contributionsin full.  In addition, each of Messrs.Oliver, Simonelli and Howell and 36th Street Properties are entitled to receivein the aggregate 20% (10%, 4%,2% and 4%, respectively) of the “net profits” wereceive from the rights sales and distribution of *Cloud 9*.  “Net profits”is defined as the sum remaining of the proceeds from the rights sales anddistribution of *Cloud 9*afterdeduction of third-party distribution fees and expenses, our recoupment of allcosts plus interest, production costs, distribution costs, cash deferments tocast, crew or producers, equipment suppliers, rights holders or any otherparty.

 

**GrayMark Productions’ Recovery ofProduction Costs and Participation in *Cloud9*  Net Profits**

 

As a result of the agreements with the director,casting company, actors and the Co-Finance Agreements, our residual net profitsinterest in *Cloud 9* will be30.6%.  Messrs. Oliver, Simonelli andHowell and 36th Street Properties LLC are entitled to receive the first$500,000 of proceeds we receive from the rights sales and distribution of *Cloud 9*. After giving effect to therecovery of the $500,000 contributions to the production costs of *Cloud 9* under the Co-Financing Agreementsand then the recovery of our production costs and other invested costs andinterest, our net profits interest in *Cloud9* will be 30.6%.  The netprofits interests of Genco Olive Oil, Inc., Fenton-Cowitt Casting, D.L.Hughley, Angie Everhart, and Gabrielle Reece do not provide for an interestrate on the production and other costs of *Cloud9*, while our entitlement to distributions from the ProductionCompany and the net profits interest granted to Bert Reynolds provide forinterest at a rate of 2% above the prime rate (limited to 5%) for purposes ofdetermining recovery of the production and other costs of *Cloud 9*. The Co-Finance Agreements with Messrs. Oliver, Simonelli and Howell and36th Street Properties LLC provide for interest, but do not specify theapplicable interest rate.

 

**Accounting Methods**

 

The application of the following accounting policies,which are important in presenting our financial position and results ofoperations, requires significant judgments and estimates on the part ofmanagement. For a summary of all of our accounting policies, including theaccounting policies discussed below, see note 2 to the unaudited consolidatedfinancial statements appearing elsewhere in this report.

 

 

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In June 2000, the Accounting Standards ExecutiveCommittee of the American Institute of Certified Public Accountants issuedStatement of Position 00-2, Accounting by Producers or Distributors ofFilms (“SoP 00-2”).  SoP 00-2establishes accounting standards for producers or distributors of films,including changes in revenue recognition, capitalization and amortization ofcosts of acquiring films and television programs and accounting forexploitation costs, including advertising and marketing expenses. Theseaccounting standards are as follows:

 

•                                          Advertising and marketing costs areexpensed the first time the advertising takes place.

 

•                                          The capitalization of production costsfor episodic television series is limited to revenue that has been contractedfor on an episode-by-episode basis until the time that the criteriafor recognizing secondary market revenues are met.

 

We capitalize the costs of production, includingfinancing costs, to investment in motion pictures.  These costs will be amortized to directoperating expenses in accordance with SoP 00-2. These costs are stated atthe lower 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 motionpicture.  There is no assurance thatrevised revenue estimates will not occur that result in significant write-downsaffecting our results of operations and financial condition.

 

Revenue from the sale or licensing of motion pictureswill be recognized upon meeting all recognition requirements of SoP 00-2.  Revenue from the theatrical release of motionpictures will be recognized at the time of exhibition based on ourparticipation in box office receipts.  Ifapplicable, revenue from the sale of DVDs in the retail market, net of anallowance for estimated returns, will be recognized on the later of shipment tothe 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 afee, the fee will be allocated on a title-by-title basis, based onan 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 to be recorded as deferred revenue until all the conditions ofrevenue recognition have been met.  Ifapplicable, we will 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.

 

We will depend on the distributors of any motionpicture we produce to account for and accurately report our share of exhibitionrevenue.  While we expect to have certainaudit rights to verify exhibition revenues received by our North Americandistributors,

 

•                                          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 maintainappropriate accounting records

 

making it difficult to determine a producer’s actual share of revenuesupon audit.

 

Although we do not have any experience related toauditing distributors’ revenue accounting, we anticipate that the costsassociated with this type of audit may be substantial and may varysignificantly from distributor-to-distributor and even picture-to-picture.  Therefore, there is no assurance that, in allcases, we will be able to obtain an accurate 

 

 

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accounting of our exhibition revenues or that audits will result inincreases in the revenues that justify the associated audit costs.

 

**Results of Operations**

 

The following table sets forth selected results of ouroperations for the three months and nine months periods ended September 30,2004 and 2003.  The following informationwas derived and taken from our unaudited financial statements appearing elsewherein this report.

 
| ** **                        | ** ** | **For the Three Months Ended September 30,** | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|-----------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **2004**                                          | ** ** | **2003**                                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenue                           |       | $                                                 | —     |                                             | $          | 13,391 |   | $ | — |   | $ | 13,391 |   |
| Operating expenses:               |       |                                              |       |                                             |       |   |   |   |   |
| Salaries and employee benefits    |       | 58,960                                            |       | —                                           |       | 176,951 |   | — |   |
| Legal and professional fees       |       | 3,100                                             |       | 7,104                                            |       | 77,918 |   | 7,943 |   |
| Consulting and management fees    |       | 261                                               |       | 31,999                                           |       | 10,261 |   | 115,697 |   |
| Film marketing                    |       | 6,000                                             |       | —                                           |       | 10,200 |   | — |   |
| Other                             |       | 11,605                                            |       | 720                                              |       | 33,998 |   | 15,409 |   |
| Total operating expenses          |       | 79,926                                            |       | 39,823                                           |       | 309,328 |   | 139,049 |   |
| Operating income (loss)           |       | (79,926                                           | )          | (26,432                                          | )          | (309,328 | ) | (125,658 | ) |
| Other income (expense):           |       |                                              |       |                                             |       |   |   |   |   |
| Interest and other income         |       | 2,551                                             |       | 279                                              |       | 13,926 |   | 1,306 |   |
| Income (loss) before income taxes |       | (77,375                                           | )          | (26,153                                          | )          | (295,402 | ) | (124,352 | ) |
| Provision for income taxes        |       | —                                            |       | —                                           |       | — |   | — |   |
|                              |       |                                              |       |                                             |       |   |   |   |   |
| Net loss                          |       | $                                                 | (77,375    | )                                                | $          | (26,153 | ) | $ | (295,402 | ) | $ | (124,352 | ) |
|                                   |            |                                                   |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Comparison of the Three-Month PeriodsEnded September 30, 2004 and 2003**

 

During the three months ended September 30, 2003, ouroperations involved the development a business plan and a plan to raise capitalfor the production of low-budget motion picture projects.  We did generate $13,391 of revenue during thethree months ending September 30, 2003 from consulting services performed byour chief executive officer. Expenditures during the three months ended September 30, 2003, includedconsulting and management fees of $31,999 paid to two shareholders who wereinvolved in the development of the business and capital plan.  Legal and professional fees of $7,104 wereincurred during the three months ended September 30, 2003 and were comprised ofgeneral accounting services.

 

During the three months ended September 30, 2004, wewere in the post-production phase on our first motion picture project titled *Cloud 9*. During the three months ended September 30, 2004, we incurred salary andbenefits expense of $58,960 for the management and administrative team put inplace during 2004.  Legal andprofessional fees of $3,100 were incurred during the three months endedSeptember 30, 2004 and were attributable to our auditors review of our June 30,2004 quarterly report.  We incurred filmmarketing costs of $6,000 in conjunction with *Cloud9*.  Other expenses of $11,605were incurred during the three months ended September 30, 2004 that wereprimarily associated with the day-to-day operations of our corporate office.

 

**Comparison of the Nine-Month PeriodsEnded September 30, 2004 and 2003**

 

During the nine months ended September 30, 2003, ouroperations involved the development a business plan and a plan to raise capitalfor the production of low-budget motion picture projects.  During the nine months ended September 30,2003 we paid consulting and management fees of $115,697 to two shareholders whowere involved in the development of our business and capital resourcesplan.  Legal and professional fees of$7,943 were incurred during 

 

 

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the nine months ended September 30, 2003 and were comprised of generalaccounting services.  Other expenses of$15,409 were incurred during the nine months ended September 30, 2003 and wereprimarily comprised of travel, entertainment and other expenses associated withthe development of our business and capital resources plan.

 

During the nine months ended September 30, 2004, ouroperations advanced to the development and production of motion pictureprojects and we were in the production and post-production phases on our firstmotion picture project titled *Cloud 9*.  During the nine months ended September 30,2004, we incurred salary and benefits expense totaling $176,951 for themanagement and administrative team we put in place during 2004.  Legal and professional fees of $77,918 wereincurred during the nine months ended September 30, 2004 and were attributableto the registration of the shares of common stock issued under our privateplacement and general legal and auditing services.  We incurred film marketing costs of $10,200in conjunction with *Cloud 9*.  Consulting fees of $10,261 were incurredduring the nine months ended September 30, 2004 and were primarily attributableto writing services performed on a script that may be used for a future filmproject.  Other expenses of $33,998 wereincurred during the nine months ended September 30, 2004 that were primarilyassociated with the day-to-day operations of our corporate office.

 

**Liquidity and Capital Resources**

 

In April 2004, we completed our private placementoffering of our common stock shares and redeemable warrants in units consistingof one common stock share and one redeemable warrant.  During 2003 and 2004, we received netproceeds of $2,535,224 from this private placement offering.  Based upon our cash and cash equivalents atSeptember 30, 2004 (that totaled $951,185) and the anticipated revenue from ourmotion picture project,*Cloud 9*,we anticipate that our cash requirements will be met for at least the next 15months.

 

At September 30,2004, we had working capital of $491,370. Operating activities for the nine months ended September 30, 2004, usednet cash of $2,523,724.  We used cash asthe result of a net loss of $295,402, which was reduced by depreciation andamortization of $3,650 and the issuance of 25,000 shares of common stock to ourlegal counsel for legal services rendered and fully performed and valued at$25,000.  Additional operating uses ofcash included the costs we incurred in the production of our first motionpicture project, *Cloud 9*,totaling $2,148,748, deposits paid-out during the production phase of *Cloud 9* totaling $106,916 and a reductionof $1,308 in accrued liabilities.  Duringthe first nine months of 2003, our operating activities used net cash of$55,970 as the result of a net loss of $124,352 that was offset by a decreasein accrued liabilities of $43,830, an advance on potential film project of$70,000 and increased by deferred offering costs totaling $45,448.  During the first nine months of 2004, (I) wesold 25,000 shares of our common stock in a private placement for grossproceeds of $25,000 (net proceeds of $21,750) and (ii) we received $500,000 infunding under a co-financing agreement associated with our motion pictureproject, *Cloud 9*.  During the first nine months of 2003, wereceived capital contributions from shareholders totaling $610,413.

 

***FinancialCommitments***

 

***FilmCapital, Inc. Agreement.**** *In March 2002, Messrs. Frederickson and Stansberry,members of GrayMark Productions, L.L.C., entered into an agreement to payFilmCapital, Inc. $50,000 for services performed.  This liability is only payable in the eventGrayMark Productions, L.L.C. or its affiliates obtain funding for film projectsfrom outside investors.  Messrs.Frederickson and Stansberry have each represented that their intent was not tocause GrayMark Productions, L.L.C. to be liable for this obligation and eachhas agreed to indemnify us for any liability that may arise out of thisagreement.  In December 2003, we recordeda consulting expense and liability of $50,000 related to the agreement withFilmCapital.  At the time that we paythis recorded liability, Messrs. Frederickson and Stansberry agreed toimmediately 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.

 

 

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Furthermore, we also similarly agreed to register (andmaintain effective of the registration under the 1933 Act for the seven-yearperiod) the common stock shares underlying the placement agent warrants sold tothe underwriter of our private placement offering, Viewtrade Financial, and383,425 common stock shares issued pursuant to the  one-year Financial Advisor Agreement toViewtrade Financial.  In accordance withthis obligation, we initially included these common stock shares in theregistration statement that registered the private placement common stockshares and redeemable warrants; however, on February 27, 2004, ViewtradeFinancial, on its own behalf as well as the other holders of the placementagent warrants and the recipients and holders of the common stock sharesassigned to affiliates of Viewtrade Financial, elected to remove those sharesfrom the registration statement.  Thesecommon stock shares are currently subject to a one-year agreement that does notpermit sale or transfer except under very limited circumstances.  Prior to expiration of this one-year periodending on April 14, 2005, we intend to file a registration statement inaccordance with our registration obligation.

 

***Office Space Arrangement*****.** Our corporate headquarters and offices arelocated at 101 North Robinson, Suite 920, Oklahoma City, Oklahoma.  These office facilities consist approximatelyof 1,500 square feet and are occupied under a 12-month unwritten lease,requiring monthly rental payments of $500. The costs of building-out and improving our offices was approximately$15,000 that we paid rather than Corporate Tower, LLC, our landlord.  These improvements included removal andconstruction of new walls, ceilings and doorways, and painting of the wallsthroughout and installation of carpeting in the offices and reception area andvinyl flooring in a utility room, and installation of computer cabling forcommunications, including internet access services and telephone services.  Roy T. Oliver, one of our greater than 5%shareholders and affiliates, controls Corporate Tower, LLC.  Mr. Oliver on behalf of Corporate Tower, LLChas orally indicated that there is no intent to terminate our occupancy of theoffice facilities following the end of the 12-month period and that the term ofthe lease will simply be on a month-to-month basis, requiring 30-day priorwritten notice of termination under Oklahoma law.  Upon termination of this occupancyarrangement, we believe there is adequate office space and facilities availablein the Oklahoma City area.  In the eventwe are required to move from our current office facilities, the terms ofoccupancy, 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$18,000 per year based upon 1,500 square feet of office facilities).

 

***12-Month OverheadBudget***

 

Our budgeted overhead expenses for the next 12 monthsare as follows:

 
| **Expenditure**                   | ** ** | **Monthly** | ** ** | **12 Months** | ** ** |
|-----------------------------------|------------|-------------|------------|---------------|------------|
| Administrative expenditures:      |       |        |       |          |       |
| Executive officer compensation    |       | $           | 15,333     |          | $          | 184,000 |   |
| 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 |       | $           | 35,000     |          | $          | 419,990 |   |

 

 

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***Additional FinancialCommitments***

 

Other than ourcommitments discussed above, we do not have any capital  commitments. We neither have any plans nor anticipate the need to raise additionalfunds during the next 12 months; however, we may receive additional funds fromthe exercise of outstanding warrants and stock options, the exercise of whichis generally not within our control.

 

If our production activities are successful (of whichthere is no assurance) or movie production budgets increase, we may be requiredto increase overhead by hiring additional employees and increase our officefacilities.  We anticipate that duringthe next 12 months we will not be required to increase our number of employeesor increase our office facilities.

 

We believe that our operations as a result of ourmotion picture project, *Cloud 9*,will achieve profitability.  We provideno assurance that

 

•                                          we will be successful in implementing our businessplan or

 

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

 

Any one of these will adversely affect our ability to become profitableor to maintain profitability.

 

**Cautionary Statement Relating toForward Looking Information**

 

We have included some forward-looking statements in thissection and other places in this report regarding our expectations.  These forward-looking statementsinvolve known and unknown risks, uncertainties and other factors which maycause our actual results, levels of activity, performance or achievements, orindustry results, to be materially different from any future results, levels ofactivity, performance or achievements 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:

 

•                                          discuss our future expectations;

 

•                                          contain projections of our future operating results orof our future financial condition; or

 

•                                          state other “forward-looking” information.

 

We believe it is important to discuss ourexpectations; however, it must be recognized that events may occur in thefuture over which we have no control and which we are not accurately able topredict.  Readers are cautioned toconsider the specific business risk factors described in the prospectus that isa part of our Amendment No. 4 to Registration Statement on Form SB-2 filed withthe United States Securities and Exchange Commission on June 29, 2004, and notto place undue reliance on the forward-looking statements contained herein,which speak only as of the date hereof. We undertake no obligation to publicly revise forward-looking statementsto reflect events or circumstances that may arise after the date of this report.

 

**Item 3.  Controls and Procedures**

 

Our ChiefExecutive Officer and Chief Financial Officer are responsible primarily forestablishing and maintaining disclosure controls and procedures designed toensure that information required to be disclosed in our reports filed orsubmitted under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”) is recorded, processed, summarized and reported within the time periodsspecified in 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 

 

 

16

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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 ChiefFinancial Officer are responsible for the design and supervision of ourinternal controls over financial reporting that are then effected by and through our board of directors, managementand other personnel, to provide reasonable assurance regarding the reliabilityof our financial reporting and the preparation of financial statements forexternal purposes in accordance with generally accepted accountingprinciples.  These policies andprocedures (i) pertain to the maintenance of records that, in reasonabledetail, accurately and fairly reflect the transactions and dispositions of ourassets; (ii) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles, and that our receipts andexpenditures 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.

 

Our Executive Officer and Chief Financial Officer,based upon their evaluation of the effectiveness of our disclosure controls andprocedures and the internal controls over financial reporting as of the lastday of the period covered by this report, concluded that our disclosurecontrols and procedures and internal controls over financial reporting werefully effective as of the last day of the period covered by this report andreported to our auditors and board of directors that no change occurred in ourdisclosure controls and procedures and internal control over financialreporting occurred during the period covered by this report that wouldmaterially affect or is reasonably likely to materially affect our disclosurecontrols and procedures or internal control over financial reporting.  In conducting their evaluation of ourdisclosure controls and procedures and internal controls over financialreporting, these executive officers did not discover any fraud that involved managementor other employees who have a significant role in our disclosure controls andprocedures and internal controls over financial reporting.  Furthermore, there were no significantchanges in our disclosure controls and procedures, internal controls overfinancial reporting, or other factors that could significantly affect ourdisclosure controls and procedures or internal controls over financialreporting 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.  However, because we only became subject tothe reporting requirements of the Securities Exchange Act of 1934, as amended(the “Exchange Act”) in July, the disclosure controls and procedures andinternal control over financial reporting that have been developed are beingfurther reviewed, enhanced, and further developed to comply with theSarbanes-Oxley Act of 2002.  In thisprocess we may discover deficiencies or material weaknesses that have not beenpreviously recognized and reported.  Weanticipate that our disclosure controls and procedures and internal controlsover financial reporting will be fully compliant with Sarbanes-Oxley bymid-2005.

 

**PART II OTHER INFORMATION**

 

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

 

None

 

**Item 2.    Changes in Securities and Use of Proceeds**

 

(a)           None

 

(b)           None

 

(c)                                  In September 2004, we issued to MichaelE. Dunn for legal services rendered and fully performed 25,000 common stockshares. The services were performed in the State of Oklahoma, the state of Mr.Dunn’s residence. Mr. Dunn qualified as an accredited investor within themeaning of Rule 501 and Section 4(6) of the Securities Act of 1933, as amended,at all applicable times. The common stock shares issued to Mr. Dunn were exemptsecurities within the meaning of Section 3(a)(11) and Rule 147 and qualifiedfor the registration exemption under Section 4(6) of the Securities Act.

 

 

17

----

 

We relied on Rule 506 of Regulation D, and Sections4(2)and 4(6) of the Security Act of 1933, as amended.  The purchaser of the common stock shares wasfurnished information concerning our operations and had the opportunity toverify the information supplied. Additionally, we obtained a signed representation from the purchaser inconnection with the sale of the common stock shares of his intent to acquirethe securities for the purpose of investment only, and not with a view towardthe subsequent distribution thereof, and the qualification of each as an “accreditedinvestor” as defined in Rule 501 and Section 4(6) of the Act; the certificateevidencing the securities carries a legend restricting transfer of thesecurities, and we issued stop transfer instructions to UMB Bank, N.A., thetransfer and warrant agent and registrar of our common stock, with respect to the certificate evidencing the commonstock shares acquired by the purchaser.

 

(d)                                 On July 13, 2004, our RegistrationStatement (No. 333-111819) became effective under the Securities Act of 1933for the resale of 2,955,000 common stock shares, 2,955,000 redeemable warrantsand the 2,955,000 common stock shares for which the redeemable warrants areexercisable and 100,000 common stock shares underlying a stock option grantedto E. Peter Hoffman.  The 2,955,000common stock shares and 2,955,000 redeemable warrants were sold pursuant to ourprivate 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:

 

•                                          $1,790,134 for the costs of producing anddeposits outstanding relating to our motion picture project titled, *Cloud 9*,

 

•                                          $286,536 for working capital, and

 

•              thebalance has been invested in high grade, short-term interest bearinginvestments.

 

**Item3.****          ****Defaults Upon Senior Securities**

 

None

 

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

 

None

 

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

 

None

 

**Item 6.    Exhibits and Reports on Form 8-K**

 

**(a) 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.                       |

 

 

18

----

 

|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1   |   | Co-Finance Agreement, dated May 7, 2004 between  Registrant and John Simonelli, incorporated by reference to the Form 10-QSB  filed with the Commission on October 12, 2004.                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.2   |   | Co-Finance Agreement, dated May 7, 2004 between  Registrant and 36th Street Properties LLC, incorporated by reference to the  Form 10-QSB filed with the Commission on October 12, 2004.                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.3   |   | Co-Finance Agreement, dated May 7, 2004 between  Registrant and Larry E. Howell, incorporated by reference to the Form 10-QSB  filed with the Commission on October 12, 2004.                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.4   |   | Co-Finance Agreement, dated May 10, 2004 between  Registrant and Roy T. Oliver, incorporated by reference to the Form 10-QSB  filed with the Commission on October 12, 2004.                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.5   |   | SAG Motion Picture Contract — Weekly Performer  between Angie Everhart and Out of the Blue Productions, LLC, dated April 16,  2004, incorporated by reference to the Form 10-QSB filed with the Commission  on October 12, 2004.                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.6   |   | Letter agreement between Five Timz Productions and  Out of the Blue Productions, LLC dated April 15, 2004 with the SAG Motion  Picture Contract — Weekly Performer between D.L. Hughley and Out of the Blue  Productions, LLC dated April 15, 2004 attached as Exhibit A, incorporated by  reference to the Form 10-QSB filed with the Commission on October 12, 2004.               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.7   |   | SAG Motion Picture Contract — Weekly Performer  between Gabrielle Reece and Out of the Blue Productions, LLC, dated April 14,  2004, incorporated by reference to the Form 10-QSB filed with the Commission  on October 12, 2004.                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.8   |   | Letter agreement between Out of the Blue  Productions, LLC and Clematis Productions, Inc., dated February 20, 2004 with  the SAG Motion Picture Contract — Weekly Performer between Burt Reynolds and  Out of the Blue Productions, LLC attached as Exhibit A dated February 20,  2004, incorporated by reference to the Form 10-QSB filed with the Commission  on October 12, 2004. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.9   |   | Fenton-Cowitt Casting Agreement between Gray  Frederickson and Pixie, Inc., dated January 20, 2004, incorporated by  reference to the Form 10-QSB filed with the Commission on October 12, 2004.                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 31.1   |   | Certification of Harry Gray Frederickson, Jr., 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 Harry Gray  Frederickson, Jr., 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.                                                                                                                                                                                               |

 

**(b) Reports on Form 8-K:** None

 

 

19

----

 

**SIGNATURES**

 

In accordance with Section 13 or 15(d) of the ExchangeAct, the Registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                    | GRAYMARK PRODUCTIONS, INC.  (Registrant) |
|-------------------------|------------------------------------------|
|                    |                                     |   |
|                    | By:                                      | /S/HARRY G. “GRAY” FREDERICKSON, JR. |
|                    |                                     | Harry G. “Gray” Frederickson, Jr. |
|                    |                                     | Chief Executive Officer |
| Date: November 12, 2004 |                                     |   |
|                    | By:                                      | /S/MARK R. KIDD |
|                    |                                     | Mark R. Kidd |
|                    |                                     | Chief Financial Officer and Controller |
| Date: November 12, 2004 |                                     |   |

 

 

20

----

**GRAYMARKPRODUCTIONS, INC.**

 

**INDEX TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 
| ** **                                                                                                                                                                              | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| Condensed  Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003                                                                                                   |       |       |
|                                                                                                                                                                                    |       |       |
| Condensed  Consolidated Statements of Operations for the Three Months Ended September  30, 2004 and 2003                                                                                |       |       |
|                                                                                                                                                                                    |       |       |
| Condensed  Consolidated Statements of Operations and Accumulated Deficit for the Nine  Months Ended September 30, 2004 and 2003 and from Inception (August 2001) to  September 30, 2004 |       |       |
|                                                                                                                                                                                    |       |       |
| Condensed  Consolidated Statements of Shareholders’ Equity for the Nine Months Ended  September 30, 2004                                                                           |       |       |
|                                                                                                                                                                                    |       |       |
| Condensed  Consolidated Statements of Cash Flows for the Nine Months Ended September 30,  2004 and 2003 and from Inception (August 2001) to September 30, 2004                          |       |       |
|                                                                                                                                                                                    |       |       |
| Notes  to Condensed Consolidated Financial Statements                                                                                                                                   |       |       |

 

 

F-1

----

 

 

**GRAYMARKPRODUCTIONS, INC.**

**(aDevelopment Stage Enterprise)**

 

**Condensed Consolidated Balance Sheets**

**(Unaudited)**

 

 

 

 
| ** **                                                                                                                                                                            | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| ASSETS                                                                                                                                                                                |       |                        |       |                       |       |
|                                                                                                                                                                                  |       |                        |       |                       |       |
| Cash and cash equivalents                                                                                                                                                             |       | $                           | 951,185    |                       | $          | 2,953,159 |   |
| Film deposits                                                                                                                                                                         |       | 106,916                     |       | —                     |       |
| Total current assets                                                                                                                                                                  |       | 1,058,101                   |       | 2,953,159                  |       |
|                                                                                                                                                                                  |       |                        |       |                       |       |
| Fixed assets, net                                                                                                                                                                     |       | 22,406                      |       | 26,056                     |       |
| Investment in films                                                                                                                                                                   |       | 2,183,218                   |       | 34,470                     |       |
| Total assets                                                                                                                                                                          |       | $                           | 3,263,725  |                       | $          | 3,013,685 |   |
|                                                                                                                                                                                  |       |                        |       |                       |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                                                                            |       |                        |       |                       |       |
|                                                                                                                                                                                  |       |                        |       |                       |       |
| Liabilities:                                                                                                                                                                          |       |                        |       |                       |       |
| Accrued liabilities                                                                                                                                                                   |       | $                           | 66,731     |                       | $          | 68,039 |   |
| Film obligations                                                                                                                                                                      |       | 500,000                     |       | —                     |       |
| Total liabilities                                                                                                                                                                     |       | 566,731                     |       | 68,039                     |       |
|                                                                                                                                                                                  |       |                        |       |                       |       |
| 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 at September 30, 2004 (8,208,425 shares  issued and outstanding at December 31, 2003) |       | 826                         |       | 821                        |       |
| Paid-in capital                                                                                                                                                                       |       | 3,837,689                   |       | 3,790,944                  |       |
| Deficit accumulated during development stage                                                                                                                                          |       | (1,141,521                  | )          | (846,119                   | )          |
| Total shareholders’ equity                                                                                                                                                       |       | 2,696,994                   |       | 2,945,646                  |       |
| Total liabilities and shareholders’ equity                                                                                                                                       |       | $                           | 3,263,725  |                       | $          | 3,013,685 |   |
|                                                                                                                                                                                       |            |                             |            |                            |            |  |  |  |  |  |

 

 

 

 

See AccompanyingNotes to Condensed Consolidated Financial Statements

 

 

 

F-2

----

 

**GRAYMARKPRODUCTIONS, INC.**

**(aDevelopment Stage Enterprise)**

 

**Condensed Consolidated Statements ofOperations**

**(Unaudited)**

 

 

 

 
| ** **                                            | ** ** | **Three Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                            | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| Revenues                                              |       | $                                          | —     |   | $ | 13,391 |   |
|                                                  |       |                                       |       |   |   |
| Operating expenses:                                   |       |                                       |       |   |   |
| Salaries and employee benefits                        |       | 58,960                                     |       | — |   |
| Film marketing                                        |       | 6,000                                      |       | — |   |
| Consulting and management fees                        |       | 261                                        |       | 31,999 |   |
| Legal and professional fees                           |       | 3,100                                      |       | 7,104 |   |
| Other                                                 |       | 11,605                                     |       | 720 |   |
| Total operating expenses                              |       | 79,926                                     |       | 39,823 |   |
| Operating loss                                        |       | (79,926                                    | )          | (26,432 | ) |
|                                                  |       |                                       |       |   |   |
| Other Income (Expense):                               |       |                                       |       |   |   |
| Interest and other income                             |       | 2,551                                      |       | 279 |   |
|                                                  |       |                                       |       |   |   |
| Net loss                                              |       | $                                          | (77,375    | ) | $ | (26,153 | ) |
|                                                  |       |                                       |       |   |   |
| Net loss per share of common stock, basic and diluted |       | $                                          | (0.01      | ) | $ | (0.01 | ) |
|                                                  |       |                                       |       |   |   |
| Weighted average number of common shares outstanding  |       | 8,241,758                                  |       | 4,870,000 |   |

 

 

 

 

See AccompanyingNotes to Condensed Consolidated Financial Statements

 

 

 

F-3

----

 

**GRAYMARKPRODUCTIONS, INC.**

**(aDevelopment Stage Enterprise)**

 

**CondensedConsolidated Statements ofOperations and Accumulated Deficit**

**(Unaudited)**

 

 

 

 
| ** **                                              | ** ** | **Nine Months Ended  September 30,** | ** ** | **Inception (August 2001) to September 30, 2004** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                              | ** ** | **2004**                             | ** ** | **2003**                                                    | ** ** | ** ** |
| Revenues                                                |       | $                                    | —     |                                                        | $          | 13,391 |   | $ | 13,391 |   |
|                                                    |       |                                 |       |                                                        |       |   |   |
| Operating expenses:                                     |       |                                 |       |                                                        |       |   |   |
| Salaries and employee benefits                          |       | 176,951                              |       | —                                                      |       | 176,951 |   |
| Legal and professional fees                             |       | 77,918                               |       | 7,943                                                       |       | 93,404 |   |
| Consulting and management fees                          |       | 10,261                               |       | 115,697                                                     |       | 794,535 |   |
| Film marketing                                          |       | 10,200                               |       | —                                                      |       | 10,200 |   |
| Other                                                   |       | 33,998                               |       | 15,409                                                      |       | 99,319 |   |
| Total operating expenses                                |       | 309,328                              |       | 139,049                                                     |       | 1,174,409 |   |
| Operating loss                                          |       | (309,328                             | )          | (125,658                                                    | )          | (1,161,018 | ) |
| Other Income (Expense):                                 |       |                                 |       |                                                        |       |   |   |
| Interest and other income                               |       | 13,926                               |       | 1,306                                                       |       | 19,497 |   |
| Net loss - deficit accumulated during development stage |       | $                                    | (295,402   | )                                                           | $          | (124,352 | ) | $ | (1,141,521 | ) |
|                                                    |       |                                 |       |                                                        |       |   |   |
| Net loss per share of common stock, basic and diluted   |       | $                                    | (0.04      | )                                                           | $          | (0.03 | ) | $ | (0.20 | ) |
| Weighted average number of common shares outstanding    |       | 8,227,869                            |       | 4,870,000                                                   |       | 5,753,138 |   |
|                                                         |            |                                      |            |                                                             |            |  |  |  |  |  |  |  |

 

 

 

 

See AccompanyingNotes to Condensed Consolidated Financial Statements

 

 

 

F-4

----

 

**GRAYMARKPRODUCTIONS, INC.**

**(aDevelopment Stage Enterprise)**

 

**CondensedConsolidated Statements of Shareholders’Equity**

**(Unaudited)**

 

 

 

 
| ** **                                           | ** ** | **Common Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Accumulated Deficit** | ** ** |
|------------------------------------------------------|------------|------------------|------------|----------------------------------|------------|-------------------------|------------|
| ** **                                           | ** ** | **Shares**       | ** ** | **Amount**                       | ** ** |
| Balance, Inception (August 2001)                     |       | —           |       | $                                | —     |                    | $          | — |   | $ | — |   |
|                                                 |       |             |       |                             |       |                    |       |   |   |
| Capital contributions                                |       | —           |       | —                           |       | 21,263                  |       | — |   |
| Net loss                                             |       | —           |       | —                           |       | —                  |       | (21,089 | ) |
|                                                 |       |             |       |                             |       |                    |       |   |   |
| Balance, December 31, 2001                           |       | —           |       | —                           |       | 21,263                  |       | (21,089 | ) |
|                                                 |       |             |       |                             |       |                    |       |   |   |
| Capital contributions                                |       | —           |       | —                           |       | 222,991                 |       | — |   |
| Net loss                                             |       | —           |       | —                           |       | —                  |       | (178,768 | ) |
|                                                 |       |             |       |                             |       |                    |       |   |   |
| Balance, December 31, 2002                           |       | —           |       | —                           |       | 244,254                 |       | (199,857 | ) |
|                                                 |       |             |       |                             |       |                    |       |   |   |
| Capital contributions                                |       | —           |       | —                           |       | 610,412                 |       | — |   |
| Issuance of stock in incorporation-reorganization    |       | 4,870,000        |       | 487                              |       | (487                    | )          | — |   |
| Sale of stock                                        |       | 2,955,000        |       | 296                              |       | 2,513,178               |       | — |   |
| Issuance of stock to investment banking firm         |       | 383,425          |       | 38                               |       | 383,387                 |       | — |   |
| Issuance of stock options to non-employee consultant |       | —           |       | —                           |       | 40,200                  |       | — |   |
| Net loss                                             |       | —           |       | —                           |       | —                  |       | (646,262 | ) |
|                                                 |       |             |       |                             |       |                    |       |   |   |
| 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                                             |       | —           |       | —                           |       | —                  |       | (295,402 | ) |
|                                                 |       |             |       |                             |       |                    |       |   |   |
| Balance, September 30, 2004                          |       | 8,258,425        |       | $                                | 826        |                    | $          | 3,837,689 |   | $ | (1,141,521 | ) |

 

 

 

 

See AccompanyingNotes to Condensed Consolidated Financial Statements

 

 

 

F-5

----

 

 

**GRAYMARKPRODUCTIONS, INC.**

**(aDevelopment Stage Enterprise)**

 

**Condensed Consolidated Statements ofCash Flows**

**(Unaudited)**

 

 

 

 
| ** **                                                                   | ** ** | **Nine Months Ended  September 30,** | ** ** | **Inception  (August 2001) to  September 30,  2004** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2004**                             | ** ** | **2003**                                             | ** ** | ** ** |
| Operating activities:                                                        |       |                                 |       |                                                 |       |   |   |
| Net loss                                                                     |       | $                                    | (295,402   | )                                                    | $          | (124,352 | ) | $ | (1,141,521 | ) |
| Adjustments to reconcile net loss to net cash used by operating  activities: |       |                                 |       |                                                 |       |   |   |
| Depreciation                                                                 |       | 3,650                                |       | —                                               |       | 4,286 |   |
| Issuance of stock for legal services                                         |       | 25,000                               |       | —                                               |       | 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                                                                |       | (106,916                             | )          | —                                               |       | (106,916 | ) |
| Investment in films                                                          |       | (2,148,748                           | )          | —                                               |       | (2,183,218 | ) |
| Deferred offering costs                                                      |       | —                               |       | (45,448                                              | )          | — |   |
| Accrued liabilities                                                          |       | (1,308                               | )          | 43,830                                               |       | 66,731 |   |
| Film advance payable                                                         |       | —                               |       | 70,000                                               |       | — |   |
|                                                                         |       |                                 |       |                                                 |       |   |   |
| Net cash used by operating activities                                        |       | (2,523,724                           | )          | (55,970                                              | )          | (2,912,013 | ) |
|                                                                         |       |                                 |       |                                                 |       |   |   |
| Investing activities:                                                        |       |                                 |       |                                                 |       |   |   |
| Purchase of fixed assets                                                     |       | —                               |       | —                                               |       | (26,692 | ) |
|                                                                         |       |                                 |       |                                                 |       |   |   |
| Net cash used by investing activities                                        |       | —                               |       | —                                               |       | (26,692 | ) |
|                                                                         |       |                                 |       |                                                 |       |   |   |
| Financing activities:                                                        |       |                                 |       |                                                 |       |   |   |
| Capital contributions                                                        |       | —                               |       | 610,413                                              |       | 854,667 |   |
| Sale of stock                                                                |       | 21,750                               |       | —                                               |       | 2,535,223 |   |
| Proceeds from film co-financing agreement                                    |       | 500,000                              |       | —                                               |       | 500,000 |   |
|                                                                         |       |                                 |       |                                                 |       |   |   |
| Net cash provided by financing activities                                    |       | 521,750                              |       | 610,413                                              |       | 3,889,890 |   |
|                                                                         |       |                                 |       |                                                 |       |   |   |
| Net change in cash and cash equivalents                                      |       | (2,001,974                           | )          | 554,443                                              |       | 951,185 |   |
|                                                                         |       |                                 |       |                                                 |       |   |   |
| Cash and cash equivalents at beginning of period                             |       | 2,953,159                            |       | 51,514                                               |       | — |   |
|                                                                         |       |                                 |       |                                                 |       |   |   |
| Cash and cash equivalents at end of period                                   |       | $                                    | 951,185    |                                                 | $          | 605,957 |   | $ | 951,185 |   |
|                                                                              |            |                                      |            |                                                      |            |  |  |  |  |  |  |

 

 

 

 

See AccompanyingNotes to Condensed Consolidated Financial Statements

 

 

 

F-6

----

 

**GRAYMARKPRODUCTIONS, INC.**

**(aDevelopment Stage Enterprise)**

 

**Notes to Condensed Consolidated Financial Statements**

**(Unaudited)**

 

 

Note 1 — Nature ofBusiness

 

GrayMarkProductions, Inc. (the “Company”) is a development stage company organized inOklahoma and an independent producer and distributor of film entertainmentcontent.  The Company began operations in2001 as GrayMark Productions, L.L.C. (the “LLC”), all of the assets of whichwere acquired by the Company through a incorporation-reorganization, effectiveAugust 18, 2003.

 

The Companyrecently completed the production of its first motion picture project titled, *Cloud 9*. The Company is in the post-production phase of *Cloud 9*and is currently marketing boththe domestic and foreign rights to this film. The Company intends to produce and distribute additional films that arecompleted and marketed using smaller budgets than those of major studios.  Management believes that producing anddistributing low- or modest-budget, commercially successful films will affordthe Company access to Hollywood talent and scripts and third-party productionpackages for acquisition, without compromising management’s approach tomanaging financial risk.

 

Note 2 — Summaryof Significant Accounting Policies

 

*InterimFinancial Information* — The unaudited condensed consolidated financial statements have beenprepared in accordance with generally accepted accounting principles forinterim financial information, they do not include all of the information andfootnotes required by generally accepted accounting principles for complete financialstatements.

 

The accompanyingfinancial statements are unaudited, but include all adjustments (consistingonly of normal 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 endedSeptember 30, 2004 and 2003 are not necessarily indicative of results that maybe expected for the entire year.

 

*Developmentstage operations* —The accompanying financial statements have been prepared in conformity withgenerally accepted accounting principles, which contemplate continuation of theCompany as a going concern.  The Companyhas generated a limited amount of consulting revenues; however, the Company hasyet to generate any revenue from the sale and distribution of filmentertainment content and has no assurance of future revenues from such salesand distribution.  In addition, theCompany plans to spend significant amounts on the production and distributionof its film projects.

 

In view of thematters described in the preceding paragraph, the ability of the Company toestablish a source of recurring revenue is dependent upon the Company’s abilityto develop, produce and market film entertainment content.  The accompanying consolidated financialstatements do not include any adjustments relating to the recoverability andclassification of recorded asset amounts or amounts and classifications ofliabilities that might be necessary should the Company be unable to continue inexistence.

 

*Useof estimates* —The preparation of financial statements in conformity with generally acceptedaccounting principles requires management of the Company to make estimates andassumptions that affect the amounts reported in the financial statements andaccompanying notes.  Actual results coulddiffer from those estimates.

 

 

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Note 2 —Investment in Films

 

| ** **                 | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Completed and not released |       | $                       | 2,173,218  |                        | $          | — |   |
| In development             |       | 10,000                  |       | 34,470                      |       |
|                       |       |                    |       |                        |       |
| Total                      |       | $                       | 2,183,218  |                        | $          | 34,470 |   |

 

 

Note 3 — FilmObligations

 

During May 2004,the Company obtained $500,000 of funding under co-finance agreements for itsmotion picture project, *Cloud 9*.  The terms of the co-financing provide for theinvestors to recoup their contribution from the Company’s 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 22%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 — FilmProfit Participation and Contingent Compensation

 

Pursuant to aninvestor agreement between the Company and the developers of the screenplay for*Cloud 9*(the “Picture”), theCompany shares the development and productions costs and revenue of thePicture.  For its financial contributionto the costs of making the Picture, the Company is entitled to receive thefollowing:

 

•                                          100% of revenue and proceeds from therights sales, distribution and exploitation of *Cloud9* until the Company recovers its investment in the Picture, plusinterest at the prime rate plus 2% per annum from the date of the contributionuntil the Company is repaid its investment in the Picture.

 

•                                          50% of “net profits” received from therights sales, distribution and 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 holdersor any other approved party.

 

The Company’ssubsidiary, Out of the Blue Productions, LLC (the “Production Company”), hasentered into contingent compensation agreements with the director and certaincast members of the Picture in the form of “net profit participations” that arecustomary in the film industry.  Thesenet participations are typically based on the net profit of a film after allproduction and distribution costs have been recouped.  A percentage of these “net profits,” asnegotiated between the participants,  arepaid out as contingent compensation for creative participants in a motionpicture.  The net participationsnegotiated by the Production Company for the Picture total 23.5% of which theCompany’s interest in the Picture is burdened by one-half of these net profitparticipations.  The Company’s residualnet profits interest in the Picture is 30.6% after giving effect to the netprofits participations given pursuant to contingent compensation arrangementsand the co-finance agreements (see Note 3 — Film Obligations).

 

 

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The ProductionCompany also agreed to pay certain cast members, in the aggregate, the followingcontingent amounts:

 

•                                          a bonus of $50,000 when aggregate UnitedStates and Canada box office receipts as reported in *Daily Variety* are $5,000,000 or more;

•                                          a bonus of $75,000 when aggregate UnitedStates and Canada box office receipts as reported in *Daily Variety* are $7,500,000 or more;

•                                          a bonus of $125,000 when aggregate UnitedStates and Canada box office receipts as reported in *Daily Variety* are $10,000,000 or more;

•                                          a bonus of $25,000 when aggregate UnitedStates and Canada box office receipts as reported in *Daily Variety* are $15,000,000 or more;

•                                          a bonus of $25,000 when aggregate UnitedStates and Canada box office receipts as reported in *Daily Variety* are $20,000,000 or more.

 

Note 5 — CapitalStructure

 

In December 2003,the Company conducted a private placement of common stock and issued 2,955,000shares of common stock.  The net proceedsof the private placement offering were$2,513,474 ($0.85 per share) afterdeduction of $441,526 in offering costs. In April 2004, the Company issued anadditional 25,000 shares under the private placement.  The net proceeds of the April 2004 sale ofstock was $21,750 ($0.87 per share) after deduction of $3,250 in offeringcosts.  The Company issued a total of2,980,000 shares under the private placement for net proceeds of $2,535,224($0.85 per share) after deduction of $444,776 in offering costs.

 

In September 2004,the Company 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 — StockOptions and Warrants

 

Information withrespect to stock options and warrants outstanding follows:

 

| ** **                        | ** ** | **September 30, 2004** | ** ** |
|-----------------------------------|------------|------------------------|------------|
| ** **                        | ** ** | **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 September 30, 2004 |       | 3,663,250              |       | $ | 1.84 |   |

 

In September 2004,the Company issued options to the Company’s officers and directors for thepurchase of 140,000 shares of the Company’s stock at an exercise price of$1.10.  The options were issued under theCompany’s 2003 Stock Option Plan and 2003 Non-Employee Stock Option Plan  The options do not become exercisable untilJanuary 1, 2005 and expire on December 31, 2009.

 

The fair value ofeach option grant is estimated on the date of grant using the Black-Scholesoption pricing model with the following assumptions used for grants: weightedaverage risk free interest rate of 4.0%; no dividend yield; volatility of 50%;and expected life less than five years. 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 140,000 options was estimated to be $63,574.  In accordance with Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees”, nocompensation expense was recorded.  Ifthe Company had elected to recognize compensation expense based on the fairvalue of the options granted at the grant date as prescribed 

 

 

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by “Statement ofFinancial Accounting Standards No. 12’’, (“SFAS 123”), net loss and net lossper share would have been as follows:

 

| ** **                           | ** ** | **Nine Months Ending  September 30,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| Net loss                             |       | $                                          | (295,402   | ) | $ | (124,352 | ) |
| Stock-based compensation expense     |       | (63,574                                    | )          | — |   |
|                                 |       |                                       |       |   |   |
| Pro form net loss                    |       | $                                          | (358,976   | ) | $ | (124,352 | ) |
|                                 |       |                                       |       |   |   |
| Earnings per share:                  |       |                                       |       |   |   |
| Basic and diluted — as reported |       | $                                          | (0.04      | ) | (0.03 | ) |
| Basic and diluted — pro forma   |       | $                                          | (0.04      | ) | (0.03 | ) |

 

 

 

 

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