CINEMASTAR LUXURY THEATERS INC, 10QSB, 1997-11-14

CINEMASTAR LUXURY THEATERS INC
10QSB, 1997-11-14
MOTION PICTURE THEATERS

Previous: FREEDOM CHEMICAL CO, 10-Q, 1997-11-14

Next: PANAMSAT INTERNATIONAL SYSTEMS INC, 10-Q, 1997-11-14

<PAGE>

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-QSB

(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.

For the Quarterly period ended September 30, 1997

[ ] Transition report under section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition

Commission File Number 0-25252

CinemaStar Luxury Theaters, Inc.
(Exact Name of Registrant as specified in its charter)

California 33-0451054
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)

431 College Blvd., Oceanside, CA 92057-5435
(Address of principal executive offices) (Zip Code)

(760) 630-2011
(Registrant's telephone number, including area code)

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

Check whether the issuer (1) has filed all reports required to be filed by
section 13 or 15 (d) of the Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.

YES [ X ] NO [ ]

Common stock, no par value: 8,019,182 shares outstanding as of
November 14, 1997.

Transitional Small Business Disclosure Format. (check one):

YES
-----
NO X

<PAGE>

CINEMASTAR LUXURY THEATERS, INC.

TABLE OF CONTENTS

PAGE NO.
PART I. Financial Information:

Item 1. Financial Statements

Condensed Consolidated Balance Sheet as of September 30, 1997 3

Condensed Consolidated Statements of Operations for the three
and six months ended September 30, 1997 and 1996 4

Condensed Consolidated Statements of Cash Flows for the
six months ended September 30, 1997 and 1996 5

Notes to Condensed Consolidated Financial Statements 6-7

Item 2. Management's Discussion and Analysis of Financial Condition 7-24
and Results of Operations.

PART II. Other Information

Item 3. Default of Senior Securities 24

Item 5. Other Information 24

Item 6. Exhibits and Reports on Form 8-K 24

Signatures 25

2
<PAGE>

PART I. Financial Information
ITEM 1. Financial Statements

CinemaStar Luxury Theaters, Inc.
and Subsidiaries
Condensed Consolidated Balance Sheet

(Unaudited)

September 30, 1997
------------------
ASSETS
CURRENT ASSETS
Cash $ 1,067,822
Commissions and other receivables 193,080
Prepaid expenses 226,517
Other current assets 597,808
-------------
Total current assets 2,085,227

Property and equipment, net 13,572,913
Preopening costs, net 4,494
Deposits and other assets 606,685
-------------

TOTAL ASSETS $ 16,269,319
-------------
-------------

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES
Current portion of long-term debt and capital lease
obligations $ 8,508,785
Accounts payable 2,632,560
Accrued expenses 281,887
Deferred revenue 133,638
Advances from stockholders 94,863
-------------
Total current liabilities 11,651,733
Long-term debt and capital lease obligations, net of
current portion 220,683
Deferred rent liability 2,731,575
-------------
TOTAL LIABILITIES 14,603,991
-------------

STOCKHOLDERS' EQUITY
Preferred stock, no par value; 100,000 shares
authorized; Series A redeemable preferred
stock, no par value, 25,000 shares designated;
no shares issued or outstanding 0
Common stock, no par value; 15,000,000 shares
authorized; 8,019,182 shares issued and outstanding 9,474,618

Additional paid-in capital 3,759,027
Accumulated deficit (11,568,317)
-------------

TOTAL STOCKHOLDERS' EQUITY 1,665,328

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 16,269,319
-------------
-------------

See accompanying notes to condensed consolidated financial statements

3
<PAGE>

CinemaStar Luxury Theaters, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
(Unaudited)

<TABLE>
<CAPTION>
Three Months Ended September 30 Six Months Ended September 30
------------------------------- -----------------------------
1997 1996 1997 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES
Admissions $ 4,676,618 $ 3,493,385 $ 8,591,676 $ 6,456,914
Concessions 2,069,989 1,453,061 3,788,995 2,655,983
Other operating revenues 139,347 100,502 258,016 194,454
----------- ----------- ----------- -----------

TOTAL REVENUES 6,885,954 5,046,948 12,638,687 9,307,351
----------- ----------- ----------- -----------

Costs and expenses:
Film rental and booking costs 2,688,093 1,963,790 4,936,617 3,567,519
Cost of concession supplies 742,578 482,909 1,335,772 841,893
Theater operating expenses 2,682,543 1,702,860 4,963,109 3,109,202
General & administrative expense 911,680 687,799 1,786,112 1,221,606
Depreciation & amortization 531,757 331,428 986,355 557,069
----------- ----------- ----------- -----------

TOTAL COSTS AND EXPENSES 7,556,651 5,168,786 14,007,965 9,297,289
----------- ----------- ----------- -----------

OPERATING INCOME (LOSS) (670,697) (121,838) (1,369,278) 10,062
----------- ----------- ----------- -----------

OTHER INCOME (EXPENSE)
Interest Income 2,929 12,514 9,482 15,158
Interest Expense (288,779) (152,204) (475,648) (302,865)
Non-cash interest expense
related to convertible debentures - (1,071,429) - (2,048,997)
----------- ----------- ----------- -----------

TOTAL OTHER (EXPENSE) (285,850) (1,211,119) (466,166) (2,336,704)
----------- ----------- ----------- -----------

LOSS BEFORE PROVISION FOR INCOME TAXES (956,547) (1,332,957) (1,835,444) (2,326,642)
PROVISION FOR INCOME TAXES (1,600) (1,600) (1,600) (1,600)
----------- ----------- ----------- -----------

NET LOSS (958,147) (1,334,557) (1,837,044) (2,328,242)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------

NET LOSS PER COMMON SHARE (0.12) (0.21) (0.23) (0.37)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------

WEIGHTED AVERAGE NUMBER OF COMMON SHARES
AND SHARE EQUIVALENTS OUTSTANDING 7,993,633 6,441,512 7,891,902 6,348,514
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>

See accompanying notes to condensed consolidated financial statements

4
<PAGE>

Cash Flow 10Q

CINEMASTAR LUXURY THEATERS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

Six Months Ended September 30,
1997 1996
Cash flows from operating activities:
Net loss $ (1,837,044) $(2,328,242)

Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:

Depreciation and amortization 986,355 557,069
Deferred rent liability 445,229 413,031
Non-cash interest expense 107,000 2,048,997
Increase (decrease) from changes in:
Commission and other receivables (162,399) (40,760)
Prepaid expenses and other current assets 141,622 (271,131)
Accounts payable (97,250) 578,022
Accrued expenses and other liabilities (28,796) (240,048)
Deposits and other assets - (63,705)
Preopening costs 105,852 (97,014)
------------- ----------
Cash provided by (used in) operating activities (339,431) 556,219
------------- ----------

Cash flows from investing activities:

Purchases of property and equipment (3,629,422) (3,448,531)
Refundable construction deposit - 600,000
------------- ----------
Cash used in investing activities (3,629,422) (2,848,531)
------------- ----------

Cash flows from financing activities:
Principal payments on long term debt and capital (898,394) (321,899)
lease obligations
Proceeds from issuance of long term debt 5,500,000 500,000
Proceeds from issuance of convertible debentures - 3,000,000
Advances from stockholders-net 67,863 60,000
Repayment of advances from stockholder - (320,000)
Payment of debt issuance costs (234,440) (474,813)
------------- ----------
Cash provided by financing activities 4,443,029 2,443,288
------------- ----------

Net increase in cash 466,176 150,976
Cash, beginning of period 601,646 458,550
------------- ----------
Cash, end of period $ 1,067,822 $ 609,526
------------- ----------
------------- ----------

5
<PAGE>

CINEMASTAR LUXURY THEATERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(UNAUDITED)

NOTE 1

The interim accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with generally accepted
accounting principles for interim financial information and the instructions
to Form 10-QSB. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. For further information, refer to the
audited financial statements for the year ended March 31, 1997, and footnotes
thereto, included in the Company's Annual Report on Form 10-KSB which was
filed with the Securities and Exchange Commission. Operating results for the
three and six month periods ended September 30, 1997 are not necessarily
indicative of the results of operations that may be expected for the year
ending March 31, 1998.

NOTE 2

On April 23, 1997, the Company amended its Concession Lease Agreement with
Pacific Concessions Inc. (PCI) in exchange for a $2,000,000 loan at an
interest rate of prime plus two percent. The loan is for a period of two
years with monthly interest payments and $1,000,000 principal payments due at
the end of twelve and twenty-four months. In connection with this financing
transaction PCI received warrants to purchase 150,000 shares of common stock.
As a result of the amended agreements PCI now supplies concessions to all of
the current theaters in exchange for specified commissions. On August 29,
1997 an additional $500,000 was borrowed from PCI as a short term loan and
was paid back with interest on September 24, 1997. In respect to this loan
PCI was issued warrants to purchase 400,000 shares of stock.

NOTE 3

On September 23, 1997 the Company signed a definitive agreement for
CinemaStar Acquisition Partners, L.L.C. ("CAP') to acquire a majority equity
interest in the Company through a $15 Million purchase of newly issued shares
of the Company's common stock, and concurrent with the signing of the Stock
Purchase Agreement, the Company received a $3 million Bridge Loan from an
affiliate of CAP to complete existing projects and to pay off certain
indebtedness. The bridge loan is convertible into three million shares of
common stock of the Company at $1.00 per share. In connection with the bridge
loan, the Company issued to Reel Partners, L.L.C. warrants to purchase
4,500,000 shares of Common Stock at an exercise price of $0.848202. 1,500,000
of such warrants will be canceled in the event that the equity financing
transaction with CAP is completed. The Company issued a Convertible Secured
Promissory Note evidencing the bridge loan and the bridge loan is secured by
a security interest in the Company's assets at the Mission Grove 14 theater
complex and the Mission Marketplace 13 theater complex as well as the
Company's grant of leasehold deeds of trust with respect to the leases of
these two theater complexes.

In connection with the signing of the definitive agreement CAP received a
warrant to purchase 1,000,000 shares of common stock at the same conversion
price. At closing of the equity financing transaction CAP will receive a
warrant to purchase 1,630,624 shares of common stock at an exercise price of
the lessor of $0.848202 or the average closing price of the Company's common
stock for the five trading days prior to the date of closing.

NOTE 4

6
<PAGE>

earnings of an entity, similar to fully diluted earnings per share. This
pronouncement is effective for fiscal years and interim periods ending after
December 15, 1997; early adoption is not permitted. The Company does not
believe that the adoption of this pronouncement will have a material impact
on the net loss per share presented in the accompanying statements of
operations.

Statement of Financial Accounting Standards No. 129 "Disclosure of
Information about Capital Structure" ("SFAS No. 129") issued by the FASB is
effective for financial statements ending after December 15, 1997. The new
standard reinstates various securities disclosure requirements previously in
effect under Accounting Principles Board Opinion No. 15, which has been
superseded by SFAS No. 128. The Company does not expect adoption of SFAS No.
129 to have a material effect on its financial position or results of
operations.

Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS No. 130") issued by the FASB is effective for financial
statements with fiscal years beginning after December 15, 1997. Earlier
application is permitted. SFAS No. 130 establishes standards for reporting
and display of comprehensive income and its components in a full set of
general-purpose financial statements. The Company has not determined the
effect on its financial position or results of operations from the adoption
of this statement.

Statement of Financial Accounting Standards No. 131 "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS No. 131") issued by
the FASB is effective for financial statements beginning after December 15,
1997. The new standard requires that public business enterprises report
certain information about operating segments in complete sets of financial
statements of the enterprise and in condensed financial statements of interim
periods issued to shareholders. It also requires that public business
enterprises report certain information about their products and services, the
geographic areas in which they operate and their major customers. The Company
does not expect adoption of SFAS 131 to have a material effect on its results
of operations.

NOTE 5

Certain reclassifications have been made to the September 30, 1996 financial
statements to conform to the September, 1997 presentation.

ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS

GENERAL

RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the
Company's Condensed Consolidated Financial Statements and notes thereto
included elsewhere in this Form 10-QSB. Except for the historical information
contained herein, the discussion in this Form 10-QSB contains certain forward
looking statements that involve risks and uncertainties, such as statements
of the Company's plans, objectives, expectations and intentions. The
cautionary statements made in this Form 10-QSB should be read as being
applicable to all related forward-

7
<PAGE>

looking statements wherever they appear in this Form 10-QSB. The Company's
actual results could differ materially from those discussed here. Factors
that could cause or contribute to such differences include those discussed in
"Risk Factors," as well as those discussed elsewhere herein.

At September 30, 1996 the company was comprised of six theater locations with
a total of 54 screens. During the twelve months ended September 30, 1997, the
company added in November 1996 one location with an additional 10 screens and
added in July 1997 an additional five screens to another location. Thus at
September 30, 1997 the Company is comprised of 7 locations and 69 screens.
This addition during the past twelve months resulted in an increase in
revenues and expenses for the three and six months ended September 30, 1997
compared to September 30, 1996.

Three months ended September 30, 1997 compared to three months ended
September 30, 1996.

Total revenues for the three months ended September 30, 1997 increased 36.4%
to $6,885,954 from $5,046,948 for the three months ended September 30, 1996.
The increase consisted of a $1,183,233, or 33.9%, increase in admission
revenues and a $655,773, or 42.2%, increase in concession revenues and other
operating revenues. The increases in admission revenue and concession and
other operating revenue were due primarily to the increase in the number of
theaters and screens and, to a lesser extent, an increase in revenues at
certain theaters in existence for both 1996 and 1997, due to greater
attendance.

Film rental and booking costs for the three months ended September 30, 1997
increased 36.9% to $2,688,093 from $ 1,963,790 for the three months ended
September 30, 1996. The increase was due to the greater revenue generated from
more screens and additional revenue at the existing theaters.

Cost of concession supplies for the three months ended September 30, 1997
increased 53.7% to $ 742,271 from $482,909 for the three months ended
September 30, 1996. The dollar increase was due to increased concession costs
associated with increased concession revenues and was also the result of an
amendment to the concession agreement with the Company's primary concession
vendor resulting in higher concession costs.

Theater operating expenses for the three months ended September 30, 1997
increased 57.5% to $2,682,199 from $1,702,860 for the three months ended
September 30, 1996. The dollar increase in theater operating costs was
primarily due to the increased costs attributable to the addition of new
theaters. Costs also increased due to the increase in minimum wages. As a
percentage of total revenues, theater operating expenses increased to 39.0%
from 33.7% during the applicable periods.

General and administrative expenses for the three months ended September 30,
1997 increased 32.6% to $911,680 from $687,799 for the three months ended
September 30, 1996. The increase was primarily due to costs associated with
expansion in Mexico, costs incurred for consulting fees related to expansion
and financing plans and other costs associated with the expansion of
corporate operations. As a percentage of total revenues, general and
administrative expenses decreased to 13.2% from 13.6% during the three months
ended September 30, 1997.

Depreciation and amortization for the three months ended September 30, 1997
increased 60.4% to $531,757 from 331,428 for the three months ended September
30, 1996. The increase was primarily the result of depreciation on additional
equipment associated with the opening of the new theaters and the
amortization of preopening costs during the three months ended September 30,
1997.

8
<PAGE>

Interest expense for the three months ended September 30, 1997 increased to
$288,779 from $152,204 for the three months ended September 30, 1996. This
increase was primarily due to the increased debt incurred by the Company in
its expansion and borrowing of funds for working capital.

Non-cash interest expense of $1,071,429 for the three months ended September
30, 1996 result from issuing debentures which were convertible at a discount
from the market price of the common stock. The non-cash interest recorded on
the convertible debentures was amortized over the periods which the
debentures first became convertible and had no effect on stockholders' equity
and operating income.

Interest income for the three months ended September 30, 1996 decreased to
$2,929 from $12,514 for the three months ended September 30, 1996. This
decrease is attributable to lower cash balances as the Company used its funds
for expansion and working capital.

As a result of the factors discussed above, the net loss for the three months
ended September 30, 1997 was $958,147 or $ .12 per common share, compared to
a net loss of $1,334,557, or $.21 per common share, for the three months
ended September 30, 1996.

Six months ended September 30, 1997 compared to six months ended September
30, 1996.

Total revenues for the six months ended September 30, 1997 increased 35.8% to
$12,638,687 from $9,307,351 for the six months ended September 30, 1996. The
increase consisted of a 2,134,762, or 33.1%, increase in admission revenues
and a $1,196,574, or 41.9%, increase in concession and other operating
revenues. The admission revenue and concession and other operating revenue
increase was due to both the increase in the number of theaters and screens
and an increase in attendance.

Film rental and booking costs for the six months ended September 30, 1997
increased 38.4% to $4,936,617 from $3,567,519 for the six months ended
September 30, 1996. The increase was due to higher film rental and booking
costs paid on increased admission revenues, resulting from the addition of
new theaters and increased attendance at existing theaters.

Cost of concession supplies for the six months ended September 30, 1997
increased 58.7% to $1,335,772 from $841,893 for the six months ended
September 30, 1996. The dollar increase was due to increased concession costs
associated with higher concession revenues as well as a change in concession
agreeements with one of the Company's primary concession vendors resulting in
higher concesson costs. As a percentage of concession revenues, concession
costs for the six months ended September 30, 1997 and September 30, 1996
increased to 35.3% from 31.7%. The increase was primarily due to the higher
concession costs associated with an amendment to the concession agreement
with the Company's primary concession vendor.

Theater operating expenses for the six months ended September 30, 1997
increased 59.6% to $4,963,109 from $3,109,202 for the six months ended
September 30, 1996. As a percentage of total revenues, theater operating
expenses increased to 39.3% from 33.4%. The dollar increase was primarily
attributable to the operating costs associated with the new theaters. Costs
also increased due to the increase in minimum wage.

General and administrative expenses for the six months ended September 30,
1997 increased 46.2% to $1,786,112 from $1,221,606 for the six months ended
September 30, 1996. The increase was primarily due to costs associated with
expansion in Mexico, costs incurred for consulting fees

9
<PAGE>

related to expansion and financing plans and other costs associated with
the expansion of corporate operations. As a percentage of total revenues,
general and administrative costs increased to 13.9% from 13.1% during the
period.

Depreciation and amortization for the six months ended September 30, 1997
increased 77.1% to 986,355 from $557,069 for the six months ended September
30, 1996. The increase was primarily the result of depreciation on additional
equipment associated with the opening of the new theaters.

Interest expense for the six months ended September 30, 1997 increased to
$475,648 from $302,865 for the six months ended September 30, 1996. This
increase is primarily attributable to the increased debt incurred by the
Company for its expansion and working capital.

Non-cash interest expense of $2,048,997 for the six months ended September
30, 1996 result from issuing debentures which were convertible at a discount
from the market price of the common stock. The non-cash interest recorded on
the convertible debentures was amortized over the periods which the
debentures first became convertible and had no effect on stockholders' equity
and operating income.

Interest income for the six months ended September 30, 1997 decreased to
$9,482 from $15,158 for the six months ended September 30, 1996. This
decrease is attributable to lower interest earning balances as the Company
used funds for expansion and working capital.

As a result of the factors discussed above, the net loss for the six months
ended September 30, 1997 decreased to $1,837,044, or $ .23 per common share,
from $2,328,242, or $.37 per common share, for the six months ended September
30, 1996.

LIQUIDITY AND CAPITAL RESOURCES

The Company's revenues are collected in cash, principally through box office
admissions and concession sales. Because its revenues are received in cash
prior to the payment of related expenses, the Company has an operating
"float" which partially finances its operations.

The Company's capital requirements arise principally in connection with new
theater openings and acquisitions of existing theaters. In the past new
theater openings have typically been financed with internally generated cash
flow and long-term debt financing arrangements for facilities and equipment.
The Company lacks the ability to finance its current capital obligations
through internally generated funds and is seeking additional capital. On June
24, 1997, the Company signed a non-binding letter of intent to sell $15
million of newly issued common stock to Rust Capital, Ltd. The letter of
intent was subject to various conditions and approval by the Company's
current shareholders. Upon completion of the transaction, Rust Capital, Ltd.
would own no less than 51% of the Company's common stock on a fully diluted
basis. With the additional $15 million, the Company would have enough funds
to complete current capital obligations, pay off a portion of long-term debt,
and have working capital sufficient to continue its expansion plans. On July
25 and July 29, 1997 the Company granted extensions to Rust Capital, Ltd. for
continued due diligence and preparation of a definitive agreement. As of
August 5, 1997, the letter of intent expired without further extension.
However, the Company and Rust Capital, Ltd. continued actively to discuss a
possible transaction and on September 23, 1997 the continued discussions
resulted in the signing of a definitive agreement for CinemaStar Acquisition
Partners, L.L.C. ("CAP") an affiliate of Rust Capital, Ltd., to acquire a
majority equity interest in the Company through a $15 million purchase of
newly issued shares of the Company's common stock. Concurrently with the
signing of the Stock Purchase Agreement, the Company received a $3 million
Bridge Loan from Reel Partners, L.L.C., an affiliate of CAP, to complete
existing projects and to pay off certain indebtedness.

10
<PAGE>

Pursuant to the Stock Purchase Agreement, CAP will purchase 17,684,464 shares
of common stock for a purchase price of $0.848202 per share. CAP will also
receive at closing warrants to purchase 1,630,624 shares of common stock at
an exercise price equal to $0.848202 per share, or the previous five day
trading price of the Company's common stock.

Upon execution of the Stock Purchase Agreement, CAP received an additional
warrant to purchase one million shares of common stock at an exercise price
of the lower of $0.848202.

Pursuant to the terms Stock Purchase Agreement, the Company may be obligated
to issue additional shares of common stock to CAP with respect to certain
expenses, liabilities and operating losses of the Company arising or
disclosed after August 31, 1997 or arising prior to August 31, 1997 and not
disclosed or quantified before August 31, 1997.

The Company's board of directors will be reconstituted to reflect the
majority interest of CAP.

Completion of the transaction is subject to a number of conditions including
the continued listing of the Company's Common Stock on the Nasdaq SmallCap
Market, as well as shareholder approval of an amendment to the Company's
Articles of Incorporation. A special shareholder meeting has been scheduled
for this purpose.

Failure of the Company to consummate this transaction would have a material
adverse effect on the Company's business, results of operations, and/or
liquidity, and raises substantial doubt about the Company's ability to
continue as a going concern.

In the event that the closing of the equity financing transaction with CAP
does not occur for reasons other than as a result of a breach of the Stock
Purchase Agreement by CAP or Reel Partners, L.L.C., the Company will be
required to pay a termination fee (the "Break Fee") equal to $600,000. In the
event that (i) the Stock Purchase Agreement is terminated prior to closing as
a result of the Company's breach of the non-solicitation provisions of the
Stock Purchase Agreement or (ii) prior to September 23, 1998, the Company
consummates a merger, consolidation, sale of assets, sale of capital stock,
financing transaction (other than financing in the ordinary course of
business, consistent with past practices, not to exceed $100,000 in the
aggregate and not involving securities convertible into capital stock of the
Company), or any similar transaction, arising out of any proposal received
during the non-solicitation period, then the Break Fee shall equal $800,000.

Pursuant to the terms of an Agreement, dated September 15, 1996 and amended
May 15, 1997 and further amended as of October 24, 1997, between the Company
and The Watley Group, LLC ("Watley"), upon a closing of the pending equity
financing, Watley will receive a cash fee equal to $962,250. In addition,
Watley shall purchase for cash at closing, for a purchase price of $0.12 per
warrant, warrants to purchase 10% of the total number of shares issued to CAP
at such closing at an exercise price per share equal to $0.848202. Assuming
that there are no adjustments to the number of shares issued to CAP, Watley
would purchase at closing warrants to purchase 1,768,446 shares of Common
Stock. The terms and conditions of the warrant to be purchased by and issued
to Watley will be substantially identical to those contained in the warrants
granted to CAP at closing. The Company has been informed that Watley has
agreed to pay $150,000 of its cash fee to CAP or other members of the
investor group to reimburse such members for legal expenses and other costs
incurred in connection with the negotiation and closing of the financing
transactions. In addition, the Company has been informed that all but 750,000
of the warrants to be issued to Watley at closing will be transferred by
Watley as directed by CAP.

Concurrent with the signing of the Stock Purchase Agreement the Company
received a $3 million bridge loan from Reel Partners, L.L.C., an affiliate of
CAP, to complete existing projects and to pay off certain indebtedness. The
bridge loan is convertible into three million shares of common stock of the
Company at $1.00 per share. In connection with the bridge loan, the Company
issued to Reel Partners, L.L.C. warrants to purchase 4,500,000 shares of
Common Stock at an exercise price of $0.848202. 1,500,000 of such warrants
will be canceled in the event that the equity financing transaction with CAP
is completed. The Company issued a Convertible Secured Promissory Note
evidencing the bridge loan and the bridge loan is secured by a security
interest in the Company's assets at the Mission Grove 14 theater complex and
the Mission Marketplace 13 theater complex as well as the Company's grant of
leasehold deeds of trust with respect to the leases of these two theater
complexes.

On April 23, 1997, the Company amended its Concession Lease Agreement with
Pacific Concessions Inc. (PCI) in exchange for a $2,000,000 loan at an
interest rate of prime plus two percent. The loan is for a period of two
years with monthly interest payments and $1,000,000 principal payments due at
the end of twelve and twenty-four months. As a result of the amended
agreements PCI now supplies concessions to all of the current theaters in
exchange for specified commissions which will result in a reduction in the
profitability of concession sales by the Company. On August 29, 1997 the
Company borrowed an additional $500,000 to be used for working capital and
the loan was repaid with interest on September 24, 1997.

The Company's current credit agreements with its bank contain certain
financial covenants which the Company is required to meet. At September 30,
1997 the Company was not in compliance with certain covenants. The bank has
agreed to forbear any adverse action through December 31, 1997

11
<PAGE>

pending the outcome of the proposed CAP transaction. If the CAP transaction
is consummated by December 31, 1997, it is expected the bank will waive the
related covenants. If the transaction is not consummated the Company will
continue to be out of compliance with the bank credit agreements and there
can be no assurance that the bank will not declare the credit agreement in
default and require immediate payment of the outstanding balance. At
September 30, 1997, the outstanding balance due was $1,232,150.

The Company also is in violation of certain covenants in several other
financing agreements; these covenants prohibit the Company from incurring
other indebtedness or further encumbering property, and/or require security
interests to be of first priority. No event of default has been declared to
date. The financiers could terminate equipment leases, accelerate loans,
foreclose the Chula Vista 6 property and take other remedial actions. In such
an event the Company would be unable to continue some or all of its
operations, and its business, results of operations and/or liquidity would be
materially and adversely affected. The Company is attempting to obtain
waivers of these violations, although no assurance can be given that it will
obtain any or all of these waivers.

The Company leases six theater properties and various equipment under
noncancelable operating lease agreements which expire through 2021 and
require various minimum annual rentals. At September 30, 1997, the aggregate
future minimum lease payments due under noncancelable operating leases was
approximately $75,400,000. The Company has also signed lease agreements for
two additional theater locations. The Company had signed a third lease with
the City of San Marcos. The Company had determined that it will not oppose
the City of San Marcos' termination of the ground lease entered into in June
1996. It is not anticipated that there will be any material expense
associated with the termination of this lease. The two leases will require
expected minimum rental payments aggregating approximately $50,000,000 over
the life of the leases. Accordingly, existing minimum lease commitments as of
September 30, 1997 plus those expected minimum commitments for the proposed
theater locations would aggregate minimum lease commitments of approximately
$125,400,000.

During the six months ended September 30, 1997, the Company used cash of
$449,778 from operating activities, as compared to generating $556,219 cash
from operating activities for the six months ended September 30, 1996.

During the six months ended September 30, 1997, the Company used cash in
investing activities of $3,753,515, as compared to $2,848,531 for the six
months ended September 30, 1996. Purchases of equipment, deposits on
equipment and construction of leasehold improvements account for the increase
in use of cash in investing activities.

During the six months ended September 30, 1997, the Company provided net cash
of $4,669,469 from financing activities, as compared to providing $2,443,288
for the six months ended September 30, 1996. The cash generated for the six
months ended September 30, 1997 came primarily from loans from Pacific
Concessions Inc., and Reel Partners, L.L.C. partially offset by debt
repayment.

The Company, at September 30, 1997, had a working capital deficit of
$9,566,506.

The Company's plans for expansion are dependent upon its ability to raise
capital through outside sources. In this regard, the Company has entered into
lease and other binding commitments with respect to the development of 30
additional screens at two locations. Regarding the one location, the Company
has completed and will open a 10 screen theater in Tijuana, Mexico on
November 15, 1997. The Company has paid for the equipment at this theater and
its subsidiary, CinemaStar Luxury Theaters, S.A. de C.V. will either purchase
or lease this equipment from the Company. Pursuant to terms of the operating
lease for the premises, CinemaStar Luxury Theaters, S.A. de C.V. was to obtain
a Fianza or bond to secure the payment of rent. Such bond was not able to be
obtained and the landlord, Inmobiliaria Lumar S.A. de C. V., ("Lumar"), has
agreed to accept a pledge of certain of the theater equipment as collateral
to satisfy the lease requirement. This pledge of collateral will be done
through a Trust Agreement with the bank designated by Lumar. The Company is
presently in the process of fulfiling the requirements of Lumar.

Regarding the second location, the Company on December 20, 1996 entered into
a long-term lease for the development of a 20 screen theater in San
Bernardino, California. The estimated cost to equip this theater is between
$2,000,000 and $2,500,000. On November 7, 1997, MDA Associates, the Landlord,
filed an action for Unlawful Detainer which sought to remove the Company as
Tenant. This action was filed because the Landlord believed the Company has
not satisfied certain financial conditions under the Lease. The Company is
filing an answer to the action. The Landlord has indicated that the suit will
be dismissed if sufficient financing can be obtained in early December, 1997.

In order to meet its obligations under the San Bernardino lease, the Company
will need to raise substantial amounts of new financing, in the form of
additional equity or loan financing, during fiscal 1998. The Company believes
the proceeds from the closing of the equity financing transaction with CAP
would be sufficient to enable the Company to meet its obligations under the
San Bernardino lease. However, there can be no

12
<PAGE>

assurance that the Company will be able to obtain such additional financing
on terms that are acceptable to the Company and at the time required by the
Company, or at all. If the Company is unable to obtain such additional equity
or loan financing, the Company's financial condition, results of operations
and/or liquidity will be materially adversely affected. Moreover, the
Company's estimate of its cash requirements to develop and operate such
theaters and service any debts incurred in connection with the development of
such theaters are based upon certain assumptions, including certain
assumptions as to the Company's revenues, earnings and other factors, and
there can be no assurance that such assumptions will prove to be accurate or
that unbudgeted costs will not be incurred. Future events, including the
problems, delays, expenses and difficulties frequently encountered by
similarly situated companies, as well as changes in economic, regulatory or
competitive conditions, may lead to cost increases that could have a material
adverse effect on the Company and its expansion and development plans. The
Company used a substantial portion of its available cash to purchase the
Chula Vista 6 in August 1995 but obtained mortgage financing in January 1996
for part of the purchase price of such complex. If the Company is not
successful in obtaining loans or equity financing for future developments, it
is unlikely that the Company will have sufficient cash to open additional
theaters.

The Company has had significant net losses in each fiscal year of its
operations, including net losses of $509,336, $1,551,002, $2,086,418,
$638,585 and $4,304,370 in the fiscal years ended March 31, 1993, 1994, 1995,
1996 and 1997, respectively. There can be no assurance as to when the Company
will be profitable, if at all. Continuing losses would have a material
adverse effect on the liquidity and operations of the Company. In addition,
the Company may encounter difficulties in obtaining the necessary debt and/or
equity financing and complying with the conditions and covenants of its loan
and other agreements. These factors, among others, raise substantial doubt
about the Company's ability to continue as a going concern.

The Company is not current in its payments due to the contractor and
subcontractors for improvements at one of its theaters. Failure to pay these
parties within a reasonable period of time may result in these parties
placing liens on the Company's theater which would likely have a material
adverse effect on the Company's business, results of operations, and/or
liquidity.

As of March 31, 1997, the Company had net operating loss carryforwards
("NOLs") of approximately $4,175,000 and $2,080,000 for Federal and
California income tax purposes, respectively. The Federal NOLs are available
to offset future years taxable income and expire in 2006 through 2012, while
the California NOLs are available to offset future years taxable income and
expire in 1998 through 2002. The utilization of these NOLs could be limited
due to restrictions imposed under the Federal and state laws upon a change in
ownership.

At September 30, 1997, the Company has total net deferred income tax assets
in excess of $2,000,000. Such potential income tax benefits, a significant
portion of which relates to the NOLs discussed above, have been subjected to
a 100% valuation allowance since realization of such assets is not more
likely than not in light of the Company's recurring losses from operations.

Because of the Company's present financial condition, normal sources of
external financing may not be available to the Company in the future,
including additional private placements of convertible debentures. The
Company has identified potential sources of financing other than CAP.,
however if the CAP financing is not consummated there can be no assurance
that the other potential sources will consummate any proposed financing and
therefore it is uncertain whether any additional financing will be available
to the Company in the future.

13
<PAGE>

As a result of its operating losses, the Company requires an immediate
infusion of cash in order to meet its current obligations and continue
operations. The Company believes that negative consequences will result with
its creditors if additional cash is not obtained in the very near future. The
Company's failure to obtain sufficient additional financing within the
requisite time frame could make it impossible for the Company to continue
operations, force the Company to seek protection under Federal bankruptcy
law, and/or result in a delisting of the Company's securities on the Nasdaq
SmallCap Market. On November 7, 1979, the Company received notice that The
Nasdaq Stock Market, Inc. had decided to delist the Company's securities from
trading on the Nasdaq SmallCap Market due to a failure of the Company to meet
applicable listing standards and the Company's failure to demonstrate an
adequate plan of compliance with such listing standards in the future. On
November 12, 1997, the Company appealed such decision and has been informed
that its securities will continue to trade on the Nasdaq SmallCap Market
until such appeal has been resolved. See "Risk Factors -- No Assurance of
Continued Nasdaq Inclusion; Risk to Low Priced Securities" below.

If the equity financing transaction with CAP is completed, the Company
anticipates that it will not need additional financing during the next twelve
months. If the equity financing transaction with CAP is not completed the
Company anticipates it will need approximately $6,500,000 of additional
financing during the next twelve months. This estimate is based on a number
of assumptions, including the assumption that the Company is able to achieve
its current revenue and expense projections for the third quarter of fiscal
1998 and succeeding quarters, without material variance. There can be no
assurance, however, that these assumptions will prove correct or that changes
affecting the Company's operating expenses, capital expenditures, business
strategy, supplier credit arrangements, and other matters will not result in
the expenditure of any available resources before the end of such twelve
month period. Thereafter, the Company may require additional equity and/or
debt financing from third party sources. Moreover, the Company's cash
requirements may vary materially from those now planned because of changes in
the Company's business or capital expenditure plans, or acquisitions or
dispositions of businesses or assets and/or other factors.

As a consequence of its recent operating losses and its financial condition,
the Company is currently in violation of loan covenants in its banking
facility. The Company is in ongoing discussions with its bank regarding what
actions are to be taken as a result of the covenant violations. The bank has
temporarily waived the violations, but in the future could accelerate the
indebtedness or take certain other actions in order to protect its interests.

In March 1997, the FASB issued Statement of Financial Accounting Standards
No. 128, "Earnings Per Share" ("SFAS No. 128"). This pronouncement provides a
different method of calculating earnings per share than is currently used in
accordance with APB Opinion 15, "Earnings Per Share." FAS 128 provides for
the calculation of Basic and Diluted earnings per share. Basic earnings per
share includes no dilution and is computed by dividing income available to
common shareholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution of securities that could share in the earnings of an entity, similar
to fully diluted earnings per share. This pronouncement is effective for
fiscal years and interim periods ending after December 15, 1997; early
adoption is not permitted. The Company does not believe that the adoption of
this pronouncement will have a material impact on the net loss per share
presented in the accompanying statements of operations.

Statement of Financial Accounting Standards No. 129 "Disclosure of
Information about Capital Structure" (SFAS No. 129) issued by the FASB is
effective for financial statements ending after

14
<PAGE>

December 15, 1997. The new standard reinstates various securities disclosure
requirements previously in effect under Accounting Principles Board Opinion
No. 15, which has been superseded by SFAS No. 128. The Company does not
expect adoption of SFAS No. 129 to have a material effect on its financial
position or results of operations.

RISK FACTORS

Except for the historical information contained herein, the discussion in
this Form 10-QSB contains certain forward-looking statements that involve
risks and uncertainties, such as statements of the Company's plans,
objectives, expectations and intentions. The cautionary statements made in
the Form 10-QSB should be read as being applicable in all related forward
looking statements wherever they appear in this Form 10-QSB. The Company's
actual results could differ materially from those discussed here. Factors
that could cause or contribute to such differences include those discussed
below, as well as those discussed elsewhere herein, and in the Company's most
recently filed Annual Report on Form 10-KSB.

HISTORY OF LOSSES; DOUBT ABOUT ABILITY TO CONTINUE AS A GOING CONCERN. The
Company was founded in April 1989. Operations began with the completion of
construction of the Company's first theater in November 1991. The Company has
had significant net losses in each fiscal year of its operations, including
net losses of $4,304,370 and $638,585 in the fiscal years ended March 31,
1997, and 1996, and net losses of $878,897 and $993,685 in the six months
ended September 30, 1997 and 1996, respectively. The Company's independent
certified public accountants have highlighted the uncertainty related to
substantial doubt about the Company's ability to continue as a going concern
in their independent auditors' report on the Company's consolidated financial
statements for the years ended March 31, 1997 and 1996. The Company requires
an immediate infusion of cash in order to meet its current obligations and
continue operations. The Company's failure to complete the pending financing
transaction with CAP or any other failure by the Company to obtain sufficient
additional financing within the requisite time frame could make it impossible
for the Company to continue operations, force the Company to seek protection
under federal bankruptcy law, and/or affect the Company's listing on the
Nasdaq SmallCap Market.

15
<PAGE>

NEED FOR ADDITIONAL FINANCING; USE OF CASH. The Company has had aggressive
expansion plans. In this regard, the Company has entered into lease and other
binding commitments with respect to the development of 30 additional screens
at two locations during fiscal 1998. The capital requirements necessary for
the Company to complete its development plans is estimated to be between
$2,000,000 and $2,500,000 which would be satisfied in the event that the CAP
financing transaction is completed. In the event that the CAP financing
transaction is not completed, such developments will require the Company to
raise substantial amounts of new financing, in the form of additional equity
investments or loan financing, during fiscal 1998. There can be no assurance
that the CAP financing transaction can be completed or that the Company will
be able to obtain such additional financing on terms that are acceptable to
the Company and at the time required by the Company, or at all. If the
Company is unable to obtain such additional equity or loan financing, the
Company's financial condition, results of operations, and/or liquidity will
be materially and adversely affected.

NO ASSURANCE OF CONTINUED NASDAQ INCLUSION; RISK OF LOW-PRICED SECURITIES.
In connection with the signing of the definitive agreement CAP received a
warrant to purchase 1,000,000 shares of common stock at the same conversion
price. At closing of the equity financing transaction CAP will receive a
warrant to purchase 1,630,624 shares of common stock at an exercise price of
the lessor of $0.848202 or the average closing price of the Company's common
stock for the five trading days prior to the date of closing.

On August 5, 1997, the Company received notice from The Nasdaq Stock Market,
Inc. ("Nasdaq") stating that unless (i) the Company's capital surplus equaled
$2,000,000 or more and the market value of the public float of the Company's
Common Stock equaled $1,000,000 or more for ten consecutive trading days, or
(ii) the bid price of the Company's Common Stock exceeded $1.00 for a period
of ten consecutive trading days, prior to November 5, 1997, and, if such
tests are not met prior to such date, the Company is unable to submit (prior
to November 5, 1997) a proposal for achieving compliance acceptable to
Nasdaq, the Company's securities would be delisted from trading on the Nasdaq
SmallCap Market. Subsequent to receipt of such letter, the Company submitted
information to Nasdaq regarding the Financing Proposal and expressed the
Company's belief that the closing of the Equity Financing would enable the
Company to meet the Nasdaq SmallCap Market continued listing requirements.

On November 7, 1997, the Company received notice that Nasdaq had not accepted
the Company's plan of compliance with the Nasdaq SmallCap Market listing
requirements due primarily to the fact that there could be no assurance that
the Equity Financing would occur and that no alternative plan of compliance
was offered by the Company. In addition, Nasdaq indicated that its
determination that the Company had failed to demonstrate compliance with the
continued listing requirements of The Nasdaq SmallCap Market on a short or
long-term basis was based, in part, upon Nasdaq's belief that the Company's
long-term capital needs were in excess of the funds raised as a result of the
Equity Financing, its limited working capital and history of losses, as well
as its failure to comply with the covenants in its bank credit lines.

On November 11, 1997, the Company submitted an appeal of the decision of
Nasdaq and was informed that, pending resolution of the appeal, the Company's
securities would continue to be listed on the Nasdaq SmallCap Market. As of
November 14, 1997, the Company had not been notified of the date of the
appeal hearing. However, based on conversation with representatives of
Nasdaq, the Company believes that the appeal hearing will be scheduled for
mid-December 1997.

The continued listing of the Company's Common Stock on the Nasdaq SmallCap
Market is a condition to the closing of the pending equity financing with
CAP. In the event that the Company is not able to maintain its Nasdaq
SmallCap Market listing, there can be no assurance that the equity financing
with CAP will occur. Although the Company believes that upon completion of
such financing the Company will meet the requirements for its securities to
continue to be listed on the Nasdaq SmallCap Market, there can be no
assurance that Nasdaq appeal procedures will result in a favorable decision
for the Company. Moreover, in the event that the CAP equity financing is not
completed and the Company is unable to immediately locate alternate sources
of equity capital, it is likely that the Company's securities will be
delisted from the Nasdaq SmallCap Market. Any such delisting would have a
material adverse effect on price, liquidity and trading market for the
Company's Common Stock and on the Company's reputation and standing in the
motion picture theater industry. Subsequent to any such delisting, there can
be no assurance that the securities would be traded in any market.

If the Company is unable to satisfy the maintenance requirements for
quotation on NASDAQ, of which there can be no assurance, it is anticipated
that the Company's Common Stock, Redeemable Warrants and Class B Redeemable
Warrants (collectively, the "Securities") would be quoted in the
over-the-counter market National Quotation Bureau ("NQB") "pink sheets" or on
the NASD OTC Electronic Bulletin Board. As a result, an investor may find it
more difficult to dispose of, or obtain accurate quotations as to the market
price of, the Securities, which may materially adversely affect the liquidity
of the market for the Securities. In addition, if the Securities are delisted
from NASDAQ, they might be subject to the low-priced security or so-called
"penny stock" rules that impose additional sales practice requirements on
broker-dealers who sell such securities. For any transaction involving a
penny stock, the rules require, among other things, the delivery, prior to
the transaction, of a disclosure schedule required by the Securities and
Exchange Commission (the "Commission") relating to the penny stock market.
The broker-dealer also must disclose the commissions payable to both the
broker-dealer and the registered representative and current quotations for
the securities. Finally, monthly statements must be sent disclosing recent
price information for the penny stocks held in the customer's account.

Although the Company believes that the Securities are not defined as a penny
stock due to their continued listing on NASDAQ, in the event the Securities
subsequently become characterized as a penny stock, the market liquidity for
the Securities could be severely affected. In such an event, the regulations
relating to penny stocks could limit the ability of broker-dealers to sell
the Securities.

POTENTIAL DILUTION. The Company recently has financed certain expansion
activities through the private placement of debt instruments convertible into
shares of its common stock. In order to induce parties to purchase such
securities, the instruments were convertible into common stock of the Company
at a conversion price that was significantly lower than the price at which
the Company's common stock was trading. The Company believes that because of
its history of operating losses, limited equity, and rapid growth plans, it
has limited options in acquiring the additional debt and/or equity. The
Company believes that any equity financing would likely result in substantial
dilution of current shareholders. The Company has entered into a definitive
agreement for $15 million of equity financing that will, if completed, result
in significant dilution of current shareholders.

DEPENDENCE ON FILMS. The ability of the Company to operate successfully
depends upon a number of factors, the most important of which is the
availability of marketable motion pictures. Poor relationships with film
distributors, a disruption in the production of motion pictures or poor
commercial success of motion pictures would have a material adverse effect
upon the Company's business, results of operations, and/or liquidity.

LONG-TERM LEASE OBLIGATIONS; PERIODIC RENT INCREASES. The Company operates
most of its current theaters pursuant to long-term leases which provide for
large monthly minimum rental payments which increase periodically over the
terms of the leases. The Chula Vista 6 is owned by the Company and not
subject to such lease payments. The Company will be dependent upon increases
in box office and other revenues to meet these long-term lease obligations.
In the event that box office and other revenues decrease or do not
significantly increase, the Company will likely not have sufficient revenues
to meet its lease obligations, which would have a material adverse effect on
the Company's business, results of operations, and/or liquidity.

POSSIBLE DELAY IN THEATER DEVELOPMENT AND OTHER CONSTRUCTION RISKS. In
connection with the development of its theaters, the Company typically
receives a construction allowance from the property owner and oversees the
design, construction and completion of the theater site. The Company is
generally responsible for construction costs in excess of the negotiated
construction allowance. As a result, the Company is subject to many of the
risks inherent in the development of real estate, many of which are beyond
its control. Such risks include governmental restrictions or changes in
Federal, state or local laws or regulations, strikes, adverse weather,
material shortages and increases in the costs of labor and materials. There
can be no assurance that the Company will be able to successfully complete
any theater development in a timely manner or within its proposed
construction allowance. The Company has experienced costs materially in
excess of its allowances in two theaters and delays in connection with the

16
<PAGE>

development of one of its existing theaters and no assurance can be given
that such overruns and delays will not occur with respect to any future
theater developments. Failure of the Company to develop its theaters within
the construction allowance allocated to it will likely have a material
adverse effect on the Company's business, results of operations, and/or
liquidity.

In addition, the Company will be dependent upon unaffiliated contractors and
project managers to complete the construction of its theaters. Although the
Company believes that it will be able to secure commitments from contractors,
project managers and other personnel needed to design and construct its
theaters, the inability to consummate a contract for the development of a
theater or any subsequent failure of any contractor or supplier to comply
with the terms of its agreement with the Company might have a material
adverse effect on the Company's business, results of operations, and/or
liquidity.

DEPENDENCE ON ABILITY TO SECURE FAVORABLE LOCATIONS AND LEASE TERMS. The
success of the Company's operations is dependent on its ability to secure
favorable locations and lease terms for each of its theaters. There can be no
assurance that the Company will be able to locate suitable locations for its
theaters, and even if the Company can locate suitable locations to lease, its
current financial condition may prevent it from obtaining favorable lease
terms. The failure of the Company to secure favorable locations for its
theaters or to lease such locations on favorable terms would have a material
adverse effect on the Company's business, results of operations, and/or
liquidity.

COMPETITION. The motion picture exhibition industry is highly competitive,
particularly with respect to licensing films, attracting patrons and finding
new theater sites. There are a number of well-established competitors with
substantially greater financial and other resources than the Company that
operate in Southern California. Many of the Company's competitors, including
Pacific Theaters and Mann Theaters, each of which operates one or more
theaters in the same geographic vicinity as the Company's current theaters,
have been in existence significantly longer than the Company and are both
better established in the markets where the Company's theaters are or may be
located and better capitalized than the Company. Competition can also come
from other sources such as television, cable television, pay television,
direct satellite television and video cassettes.

Many of the Company's competitors have established, long-term relationships
with the major motion picture distributors (Paramount, Disney/Touchstone,
Warner Brothers, Columbia/Tri-Star, Universal and 20th Century Fox), who
distribute a large percentage of successful films. Although the Company
attempts to identify film licensing zones in which there is no substantial
current competition, there can be no assurance that the Company's competitors
will not develop theaters in the same film zone as the Company's theaters. To
the extent that the Company directly competes with other theater operators
for patrons or for the licensing of first-run films, the Company may be at a
competitive disadvantage. The Company presently has relationships with all
major distributors and exhibits their films in all of its existing theaters.

Although the Company attempts to develop theaters in geographic areas that it
believes have the potential to generate sufficient current and future box
office attendance and revenues, adverse economic or demographic developments,
over which the Company has no control, could have a material adverse effect
on box office revenues and attendance at the Company's theaters. In addition,
there can be no assurance that new theaters will not be developed near the
Company's theaters, which development might alter existing film zones and
might have a material adverse effect on the Company's revenues and earnings.
In addition, future advancements in motion picture

17
<PAGE>

exhibition technology and equipment may result in the development of costly
state-of-the-art theaters by the Company's competitors which may make the
Company's current theaters obsolete. There can be no assurance that the
Company will be financially able to pay for or able to incorporate such new
technology or equipment, if any, into its existing or future theaters.

In recent years, alternative motion picture exhibition delivery systems have
been developed for the exhibition of filmed entertainment, including cable
television, direct satellite delivery, video cassettes and pay-per-view. An
expansion of such delivery systems could have a material adverse effect on
motion picture attendance in general and upon the Company's business, results
of operations, and/or liquidity.

GEOGRAPHIC CONCENTRATION. Each of the Company's current theaters is located
in San Diego or Riverside Counties, California and the proposed theaters are
all in Southern California or Mexico. As a result, negative economic or
demographic changes in these areas will have a disproportionately large and
adverse effect on the success of the Company's operations as compared to
those of its competitors having a wider geographic distribution of theaters.

DEPENDENCE ON CONCESSION SALES. Concession sales accounted for 29.9% and
28.5% of the Company's total revenues in the six months ended September 30,
1997 and 1996, respectively. Therefore, the financial success of the Company
depends, to a significant extent, on its ability to successfully generate
concession sales in the future. The Company currently depends upon Pacific
Concessions, Inc. ("Pacific Concessions"), a creditor of the Company, to
operate and supply the lobby concession stands located in all of the
Company's theaters. The Company's long-term concession agreements with
Pacific Concessions may be terminated by the Company prior to the expiration
of their respective terms only upon payment of a substantial early
termination fee.

RELATIONSHIP WITH PACIFIC CONCESSIONS. The Company utilizes loans from
Pacific Concessions to fund a portion of its operations. In the Company's
loan agreements with Pacific Concessions, an event of default is defined to
include, among other things, any failure by the Company to make timely
payments on its loans from Pacific Concessions. In the event that an event of
default occurs under such loan agreements, Pacific Concessions has certain
remedies against the Company in addition to those afforded to it under
applicable law, including, but not limited to, requiring the Company to
immediately pay all loan amounts due to Pacific Concessions and requiring the
Company to sell, liquidate or transfer any of its theaters and related
property to third parties in order to make timely payments on its loans. If
the Company were to default under any of its agreements with Pacific
Concessions, and if Pacific Concessions enforced its rights thereunder, the
Company would be materially adversely affected.

CONTROL OF THE COMPANY. At September 30, 1997 the current officers and
directors of the Company own approximately 27.3% of the Common Stock (17.1%
assuming exercise in full of the redeemable warrants). In addition, in the
event that the pending financing transaction with CAP is completed, CAP will
own a substantial majority of the outstanding Common Stock of the Company and
will have the right to acquire additional shares upon exercise of warrants.
As a result, these individuals are or may be in a position to materially
influence, if not control, the outcome of all matters requiring shareholder
approval, including the election of directors. Certain officers and directors
in the past have obtained loans secured by their shareholdings and the sale
of shares from margin calls may from time to time have adversely affected,
and may in the future adversely affect, the market price of the Company's
securities.

18
<PAGE>

EXPANSION; MANAGEMENT OF GROWTH. The Company's plan of operation calls for
the addition of new theaters and screens. The Company's ability to expand
will depend on a number of factors, including the selection and availability
of suitable locations, the hiring and training of sufficiently skilled
management and personnel and other factors, such as general economic and
demographic conditions, which are beyond the control of the Company. Such
growth, if it occurs, could place a significant strain on the Company's
management and operations. To manage such growth, the Company will be
required to increase the depth of its financial, administrative, and theater
management staffs. There can be no assurance, however, that the Company will
be able to identify and hire additional qualified personnel or take such
other steps as are necessary to manage its growth, if any, effectively. Given
the Company's recent performance and financial condition, hiring qualified
executives and professional staff is difficult. In addition, there is no
assurance that the Company will be able to open any new theaters or that, if
opened, those theaters can be operated profitably.

RISKS OF INTERNATIONAL EXPANSION. Construction has been completed on a leased
10 screen theater in Tijuana, Mexico through CinemaStar Luxury Theaters, S.A.
de C.V., a Mexican corporation in which the Company has a 75% ownership
interest. The long-term lease is guaranteed by the Company. Under this lease
rent is paid in U.S. dollars. Completion of this theater in Mexico, or the
development of theaters in other foreign countries, will subject the Company
to the attendant risks of doing business abroad, including adverse
fluctuations in currency exchange rates, increases in foreign taxes, changes
in foreign regulations, political turmoil, deterioration in international
economic conditions and deterioration in diplomatic relations between the
United States and such foreign country. Recently the value of the Mexican
Peso has fallen in relation to the U.S. Dollar and Mexico is experiencing
substantial inflation.

FLUCTUATIONS IN QUARTERLY RESULTS OF OPERATIONS. The Company's revenues have
been seasonal, coinciding with the timing of major releases of motion
pictures by the major distributors. Generally, the most marketable motion
pictures have been released during the summer and the Thanksgiving through
year-end holiday season. The unexpected emergence of a hit film during other
periods can alter the traditional trend. The timing of such releases can have
a significant effect on the Company's results of operations, and the results
of one quarter are not necessarily indicative of results for subsequent
quarters.

19
<PAGE>

POTENTIAL BUSINESS INTERRUPTION DUE TO EARTHQUAKE. All of the Company's
current and proposed theaters are or will be located in seismically active
areas of Southern California and Mexico. In the event of an earthquake of
significant magnitude, damage to any of the Company's theaters or to
surrounding areas could cause a significant interruption or even a cessation
of the Company's business, which interruption or cessation would have a
material adverse effect on the Company, its operations and any proposed
theater development. Although the Company maintains business interruption
insurance, such insurance does not protect against business interruptions due
to earthquakes.

CONFLICTS OF INTEREST. Several possible conflicts of interest may exist
between the Company and its officers and directors. In particular, certain
officers and directors have directly or indirectly advanced funds or
guaranteed loans or other obligations of the Company. As a result, a conflict
of interest may exist between these officers and directors and the Company
with respect to the determination of which obligations will be paid out of
the Company's operating cash flow and when such payments will be made.

COMPENSATION OF EXECUTIVE OFFICERS. Effective August 1994 and amended in
December 1996, or April 1997 the Company has employment agreements through
December 2001, or April 2002 with each of John Ellison, Jr., Alan Grossberg
Jerry Willits and Jon Meloan, pursuant to which their annual salaries are
$197,106, $197,860 $94,380 and $90,000, respectively, some of which are
subject to annual increases of between 10% and 12%. Mr. Grossberg's
employment agreement has been amended to increase his salary by $52,000 to
reflect compensation previously paid to him for film booking services. In
addition, Messrs. Ellison, Grossberg and Willits will be entitled to receive
substantial bonuses based on a percentage of net income in the event that the
Company's net income for a given year exceeds $2 million and additional
bonuses in the event that the Company has net income in excess of $7 million
in a given year. Each of Messrs. Ellison, Grossberg and Willits will also
receive an automobile allowance of up to $650 per month and certain insurance
and other benefits. Moreover, in the event that Mr. Ellison, Mr. Grossberg,
Mr. Willits or Mr. Meloan is terminated or is not reelected or appointed as a
director or executive officer of the Company for any reason other than for an
uncured breach of his obligations under his employment agreement or his
conviction of a felony involving moral turpitude, he shall have the right to
receive his annual salary and bonuses for the remainder of the original
five-year term of the contract. See "Executive Compensation --Employment and
Consulting Agreements." The employment agreements described above require
that the Company pay substantial salaries during each year of the five year
terms thereof to each of Messrs. Ellison, Grossberg, Willits, and Meloan
regardless of the Company's financial condition or performance. As a result,
the agreements could have a material adverse effect on the Company's
financial performance and condition.

20
<PAGE>

RISK OF LIMITATION OF USE OF NET OPERATING LOSS CARRYFORWARDS. As of March
31, 1997, the Company had net operating loss carryforwards of approximately
$4,175,000 for federal income tax purposes, which may be utilized through
2006 to 2012, and approximately $2,080,000 for state income tax purposes,
which may be utilized through 1998 to 2002 (subject to certain limitations).
The initial public offering and certain other equity transactions resulted or
may have resulted in an "ownership change" as defined in Section 382 of the
Internal Revenue Code of 1986, as amended (the "Code"). As a result, the
Company's use of its net operating loss carryforwards to offset taxable
income in any post-change period may be subject to certain specified annual
limitations. If there has been an ownership change for purposes of the Code,
there can be no assurance as to the specific amount of net operating loss
carryforwards, if any, available in any post-change year since the
calculation is based upon fact-dependent formula.

21
<PAGE>

POSSIBLE VOLATILITY OF COMMON STOCK. The trading prices of the Company's
securities may respond to quarterly variations in operating results and other
events or factors, including, but not limited to, the sale or attempted sale
of a large amount of the securities into the market. In addition, the stock
market has experienced extreme price and volume fluctuations in recent years,
particularly in the securities of smaller companies. These fluctuations have
had a substantial effect on the market prices of many companies, often
unrelated to the operating performance of the specific companies, and similar
events in the future may adversely affect the market prices of the
Securities.

CURRENT PROSPECTUS AND STATE REGISTRATION REQUIRED TO EXERCISE REDEEMABLE
WARRANTS AND CLASS B REDEEMABLE WARRANTS. The Redeemable Warrants and Class B
Redeemable Warrants are not exercisable unless, at the time of the exercise,
the Company has a current prospectus covering the shares of Common Stock upon
exercise of the Redeemable Warrants and Class B Redeemable Warrants and such
shares have been registered, qualified or deemed to be exempt under the
securities or "blue sky" laws of the state of residence of the exercising
holder of the Redeemable Warrants and Class B Redeemable Warrants. Although
the Company has undertaken to use its best efforts to have all of the shares
of Common Stock issuable upon exercise of the Redeemable Warrants and Class B
Redeemable Warrants registered or qualified on or before the exercise date
and to maintain a current prospectus relating thereto until the expiration of
the Redeemable Warrants and Class B Redeemable Warrants, there is no
assurance that it will be able to do so. The value of the Redeemable Warrants
and Class B Redeemable Warrants may be greatly reduced if a current
prospectus covering the Common Stock issuable upon the exercise of the
Redeemable Warrants or Class B Redeemable Warrants is not kept effective or
if such Common Stock is not qualified or exempt from qualification in the
states in which the holders of the Redeemable Warrants or Class B Redeemable
Warrants then reside.

Investors may purchase the Redeemable Warrants and Class B Redeemable
Warrants in the secondary market or may move to jurisdictions in which the
shares underlying the Redeemable Warrants or Class B Redeemable Warrants are
not registered or qualified during the period that the Redeemable Warrants
and Class B Redeemable Warrants are exercisable. In such event, the Company
will be unable to issue shares to those persons desiring to exercise their
Redeemable Warrants or Class B Redeemable Warrants unless and until the
shares are qualified for sale in jurisdictions in which such purchasers
reside, or an exemption from such qualification exists in such jurisdictions,
and holders of the Redeemable Warrants and Class B Redeemable Warrants would
have no choice but to attempt to sell the Redeemable Warrants and Class B
Redeemable Warrants in a jurisdiction where such sale is permissible or allow
them to expire unexercised.

SPECULATIVE NATURE OF REDEEMABLE WARRANTS AND CLASS B REDEEMABLE WARRANTS;
ADVERSE EFFECT OF POSSIBLE REDEMPTION OF REDEEMABLE WARRANTS OR CLASS B
REDEEMABLE WARRANTS. The Redeemable Warrants and Class B Redeemable Warrants
do not confer any rights of Common Stock ownership on the holders thereof,
such as voting rights or the right to receive dividends, but rather merely
represent the right to acquire shares of Common Stock at a fixed price for a
limited period of time. Specifically, holders of the Redeemable Warrants may
exercise their right to acquire Common Stock and pay an exercise price of
$6.00 per share, subject to adjustment in the event of certain dilutive
events, on or prior to February 6, 2000, after which date any unexercised
Redeemable Warrants will expire and have no further value. Specifically,
holders of the Class B Redeemable Warrants may exercise their right to
acquire Common Stock and pay an exercise price of $6.50 per share, subject
to adjustment in the event of certain dilutive events, on or prior to
September 15,

22
<PAGE>

2001, after which date any unexercised Class B Redeemable Warrants will
expire and have no further value. There can be no assurance that the market
price of the Common Stock will ever equal or exceed the exercise prices of
the Redeemable Warrants or Class B Redeemable Warrants, and consequently,
whether it will ever be profitable for holders of the Redeemable Warrants or
Class B Redeemable Warrants to exercise them.

The Redeemable Warrants and Class B Redeemable Warrants are subject to
redemption by the Company, at any time on 30 days prior written notice, at a
price of $0.25 per Redeemable Warrant or Class B Redeemable Warrant if the
average closing bid price for the Common Stock equals or exceeds $7.00 per
share for any 20 trading days within a period of 30 consecutive trading days
ending on the fifth trading day prior to the date of the notice of
redemption. Redemption of the Redeemable Warrants or Class B Redeemable
Warrants could force the holders thereof to exercise them and pay the
exercise price at a time when it may be disadvantageous for such holders to
do so, to sell the Redeemable Warrants and Class B Redeemable Warrants at the
current market price when they might otherwise wish to hold them , or to
accept the redemption price, which may be substantially less than the market
value of the Redeemable Warrants and Class B Redeemable Warrants at the time
of redemption. The holders of the Redeemable Warrants and Class B Redeemable
Warrants will automatically forfeit their rights to purchase shares of Common
Stock if they are redeemed before being exercised.

NO DIVIDENDS. The Company has not paid any dividends on its Common Stock and
does not intend to pay any dividends in the foreseeable future. Earnings, if
any, are expected to be retained for use in expanding the Company's business.

SHARES ELIGIBLE FOR FUTURE SALE. Sales of substantial amounts of Securities
in the public market or the perception that such sales could occur may
adversely affect prevailing market prices of the Securities. The Redeemable
Warrants and the Redeemable Warrants being registered for the account of the
Selling Security Holders entitle the holders of such Redeemable Warrants to
purchase up to an aggregate of 4,500,000 shares of Common Stock at any time
through February 6, 2000. Class B Redeemable Warrants entitle the holder to
purchase up to an aggregate of 226,438 shares of common stock at any time
through September 15, 2001. In connection with the initial public offering,
the Company issued to A.S. Goldmen & Co., Inc. Underwriter's Warrants to
purchase up to 150,000 shares of Common Stock and/or Redeemable Warrants to
purchase up to an additional 150,000 shares of Common Stock. In connection
with the pending financing transactions with CAP, the Company has or is
expected to issue to CAP and Reel Partners L.L.C., approximately 17.7 million
shares of Common Stock and warrants to purchase an additional 5.7 million
shares of Common Stock. Pursuant to the terms of the financing transactions
the Company will be required to register all such shares for resale. Sales of
either the Redeemable Warrants, the underlying shares of Common Stock or the
shares of Common Stock issued to or purchasable by CAP or its affiliates, or
even the existence of the Redeemable Warrants or the CAP shares or warrants,
may depress the price of the Common Stock or the Redeemable Warrants in the
market for such Securities. In addition, in the event that any holder of
Redeemable Warrants, Class B Redeemable Warrants or warrants issued to CAP or
its affiliates exercises his warrants, the percentage ownership of the
Common Stock by current shareholders would be diluted. Finally, the Company
has reserved 587,500 shares of Common Stock for issuance to key employees and
officers pursuant to the Company's Stock Option Plan. Fully-vested options to
purchase 400,805 shares of Common Stock have been granted pursuant to such
Stock Option Plan. In the event that these or any other stock options granted
pursuant to such Stock Option Plan are exercised, dilution of the percentage
ownership of

23
<PAGE>

Common Stock owned by the public investors will occur. Moreover, the mere
existence of such options may depress the price of the Common Stock.

CAUTIONARY STATEMENT

This 10-QSB contains forward looking statements, within the meaning of the
Private Securities Litigation Reform Act of 1995, with respect to the
financial condition, results of operations, and business of the Company and
its subsidiary (collectively, unless the context otherwise requires). Such
statements are subject to certain risks and uncertainties that could cause
actual results to differ materially and adversely from those set forth in the
forward-looking statements, including without limitation the risks and
uncertainties described from time to time in the Company's public
announcements and SEC filings, including without limitation the 10-QSB and
10-KSB, respectively. The Company does not undertake to update any written or
oral forward-looking statement that may be made from time to time by or on
behalf of the Company.

PART II -- OTHER INFORMATION
ITEM 3 -- DEFAULTS UPON SENIOR SECURITIES

The Company is currently in material default under two of its existing
financing arrangements, each of which prohibit the Company from incurring
additional indebtedness or granting additional security interests in its
assets without the prior consent of the applicable lender. As a result of
these prohibitions, the Company is currently in default under its Business
Loan Agreement with and related Promissory Notes (collectively, the "FNB
Loans") issued in favor of First National Bank ("FNB") as the result of
borrowing additional monies and granting additional security interests
pursuant to one of its existing Loan Agreements with Pacific Concessions,
Inc. ("PCI") after the date of the FNB Loans. Similarly, the Company is
currently in default under each of its existing Loan Agreements, as amended,
with PCI (the "PCI Loan Agreements") as a result of the making of the FNB
Loans and the granting of security interests in favor of FNB. As of September
30, 1997, the outstanding principal balance of the FNB Loans was $1,232,150
and the outstanding aggregate principal balance owed to PCI under the PCI
Loan Agreements was $2,692,167.

The Company has not defaulted in the payment of principal, interest or any
other obligation under any of the FNB Loans or under either of the PCI Loan
Agreements, and neither FNB nor PCI has declared any event of default or
attempted to accelerate the due date of any payment obligation of the Company
thereunder.

ITEM 5 -- OTHER INFORMATION
ANTI-DILUTION ADJUSTMENTS TO PUBLIC WARRANTS

The terms of the Company's publicly traded Redeemable Warrants and Class B
Redeemable Warrants contain anti-dilution provisions that provide for
adjustments in the exercise price and number of shares issuable upon exercise
of such warrants in the event of issuance of Common Stock (or securities
convertible into Common Stock) at a price per share below the exercise price
of such warrants. Pursuant to such anti-dilution provisions, by September 1,
1997, the exercise price of the Redeemable Warrants and Class B Redeemable
Warrants had been reduced to $5.32 and $5.90, respectively, and the number of
shares of Common Stock issuable upon exercise of each Redeemable Warrant and
Class B Redeemable Warrant had increased to 1.1657318 and 1.1016967 shares of
Common Stock. As a result of the signing of the September 23, 1997 Stock
Purchase Agreement with CAP and the concurrent completion of the $3,000,000
bridge financing with an affiliate of CAP, the exercise price of the
Company's Redeemable Warrants was reduced from the $5.32 price in effect
immediately prior to such transactions to $3.70 per share. Concurrently, the
number of shares of Common Stock issuable upon exercise of each Redeemable
Warrant was increased from 1.1657318 to 1.6216216 shares of Common Stock.
Similarly, the exercise price of the Class B Redeemable Warrant was
automatically reduced to $4.06 from a pre-Bridge Financing exercise price of
$5.90 and the number of shares of Common Stock issuable upon exercise of each
Class B Redeemable Warrant was increased from 1.1016967 to 1.6009852 shares
of Common Stock.

Additional adjustments will occur in the event that the equity financing
transaction with CAP is completed. In particular, upon Closing and assuming
the repayment of the $3,000,000 bridge loan from an affiliate of CAP, the as
adjusted exercise price of the Redeemable Warrants and Class B Redeemable
Warrants will be approximately $2.56 and $2.78, respectively. Concurrently,
the number of shares of Common Stock issuable upon exercise of each
Redeemable Warrant and Class B Redeemable Warrant will be adjusted to 2.34375
and 2.3381295 shares, respectively.

ITEM 6 - Exhibits and Reports on Form 8-K

(a) Exhibits

Item 27. Financial Data Schedule

(b) Reports on Form 8-K

The Company filed one Report on Form 8-K during the quarter
ended September 30, 1997. It was filed on September 26, 1997
and reported the execution of the September 23, 1997 Stock
Purchase Agreement with CAP and Reel Partners, L.L.C. and the
$3,000,000 bridge loan from Reel Partners, L.L.C. to the
Company.

24
<PAGE>

SIGNATURES

In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized

Dated: November 14, 1997

CinemaStar Luxury Theaters, Inc.

by: /s/ JOHN ELLISON, JR.
------------------------------------
John Ellison, Jr.
President, Chief Executive Officer
(principal executive officer)

by: /s/ ALAN GROSSBERG
------------------------------------
Senior Vice President and Chief
Operating Officer (principal
financial officer and principal
accounting officer)

25
<PAGE>

EXHIBIT INDEX

EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
27 Financial Data Schedule

<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEET AND STATEMENT OF OPERATIONS FOR THE QUARTER ENDED SEPTEMBER 30, 1997, AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>

<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 1,067,822
<SECURITIES> 0
<RECEIVABLES> 193,080
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,085,227
<PP&E> 17,429,282
<DEPRECIATION> 3,856,369
<TOTAL-ASSETS> 16,269,319
<CURRENT-LIABILITIES> 11,651,733
<BONDS> 0
0
0
<COMMON> 9,474,618
<OTHER-SE> (7,809,290)
<TOTAL-LIABILITY-AND-EQUITY> 16,269,319
<SALES> 12,638,687
<TOTAL-REVENUES> 12,638,687
<CGS> 6,272,389
<TOTAL-COSTS> 14,007,965
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 475,648
<INCOME-PRETAX> (1,835,444)
<INCOME-TAX> 1,600
<INCOME-CONTINUING> (1,837,044)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,837,044)
<EPS-PRIMARY> (0.23)
<EPS-DILUTED> (0.23)

</TABLE>