CINEMASTAR LUXURY THEATERS INC, 10QSB, 1997-08-14

CINEMASTAR LUXURY THEATERS INC
10QSB, 1997-08-14
MOTION PICTURE THEATERS

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 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 JUNE 30, 1997

/ / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 0-25252

CINEMASTAR LUXURY THEATERS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

CALIFORNIA 33-0451054
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER ID 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
August 14, 1997.

Transitional Small Business Disclosure Format (check one): YES NO X
--- ---

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CINEMASTAR LUXURY THEATERS, INC.

TABLE OF CONTENTS

PAGE NO.
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Balance Sheet as of June 30, 1997.... 1

Condensed Consolidated Statements of Operations for the
three months ended June 30, 1997 and 1996................... 2

Condensed Consolidated Statements of Cash Flows for the
three months ended June 30, 1997 and 1996................... 3

Notes to Condensed Consolidated Financial Statements........ 4

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations......................... 5-15

Item 3. Defaults Upon Senior Securities............................. 16

PART II. OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K............................ 16

Signatures.................................................. 17

<PAGE>

PART I -- FINANCIAL INFORMATION

ITEM 1 -- FINANCIAL STATEMENTS

CINEMASTAR LUXURY THEATERS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)

<TABLE>
<CAPTION>
JUNE 30, 1997
-------------
<S> <C>
ASSETS
CURRENT ASSETS
Cash................................................................. 568,421
Commission and other receivables..................................... 107,775
Prepaid expenses..................................................... 62,772
Other current assets................................................. 327,024
-----------
Total current assets................................................. 1,065,992
Property and equipment, net.......................................... 12,284,328
Preopening costs..................................................... 51,980
Deposits and other assets............................................ 773,274
-----------
TOTAL ASSETS......................................................... $14,175,574
-----------
-----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt and capital lease obligations...... $ 6,304,682
Accounts payable..................................................... 3,244,049
Accrued expenses..................................................... 298,670
Deferred revenue..................................................... 146,264
Advances from stockholder............................................ 97,428
-----------
Total current liabilities............................................ 10,091,093
Long-term debt and capital lease obligations, net of current
portion............................................................ 211,799

Deferred rent liability.............................................. 2,499,207
-----------
TOTAL LIABILITIES.................................................... 12,802,099
-----------

COMMITMENTS AND CONTINGENCIES

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...................... --
Common stock, no par value; 15,000,000 shares authorized;
7,944,182 shares issued and outstanding.......................... 9,424,618
Additional paid-in capital........................................... 2,559,027

Accumulated deficit.................................................. (10,610,170)
-----------

TOTAL STOCKHOLDERS' EQUITY........................................... 1,373,475
-----------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........................... $14,175,574
-----------
-----------
</TABLE>

See accompanying notes to condensed consolidated financial statements.

1
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CINEMASTAR LUXURY THEATERS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
---------------------------
1997 1996
---------- ----------
<S> <C> <C>
REVENUES:
Admissions........................................................... $3,915,058 $2,963,529
Concessions.......................................................... 1,719,006 1,202,922
Other operating revenues............................................. 118,669 93,952
---------- ----------

TOTAL REVENUES....................................................... 5,752,733 4,260,403
---------- ----------
Cost and expenses:
Film rental and booking costs........................................ 2,248,524 1,603,729
Cost of concession supplies.......................................... 593,194 358,984
Theater operating expenses........................................... 2,280,566 1,406,343
General and administrative expenses.................................. 874,432 533,806
Depreciation and amortization........................................ 454,598 225,641
---------- ----------

TOTAL COSTS AND EXPENSES............................................. 6,451,314 4,128,503
---------- ----------

OPERATING INCOME (LOSS).............................................. (698,581) 131,900
---------- ----------

OTHER INCOME (EXPENSE):
Interest income.................................................... 6,553 2,644
Interest expense................................................... (186,869) (150,661)
Non-cash interest expense related to convertible debentures........ -- (977,568)
---------- ----------

TOTAL OTHER (EXPENSE)................................................ (180,316) (1,125,585)
---------- ----------

LOSS BEFORE PROVISION FOR INCOME TAXES............................... (878,897) (993,685)
PROVISION FOR INCOME TAXES........................................... -- --
---------- ----------

NET LOSS............................................................. $ (878,897) $ (993,685)
---------- ----------
---------- ----------

NET LOSS PER COMMON SHARE............................................ $ (.11) $ (.16)
---------- ----------
---------- ----------

WEIGHTED AVERAGE NUMBER OF COMMON SHARES AND SHARE EQUIVALENTS
OUTSTANDING.......................................................... 7,790,747 6,254,000
---------- ----------
---------- ----------
</TABLE>

See accompanying notes to condensed consolidated financial statements.

2
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CINEMASTAR LUXURY THEATERS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
---------------------------
1997 1996
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................................ $ (878,897) $ (993,685)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization..................................... 454,598 259,749
Deferred rent liability........................................... 212,861 236,834
Non-cash interest expense......................................... -- 977,568
Increase (decrease) from changes in:
Commission and other receivables............................... (77,094) (23,194)
Prepaid expenses and other current assets...................... 26,151 (122,065)
Deposits and other assets...................................... (82,516) (138,406)
Accounts payable............................................... 514,239 492,774
Accrued expenses and other liabilities......................... 613 (178,912)
----------- -----------
Cash provided by operating activities............................... 169,955 510,663
----------- -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment................................. (1,750,714) (1,336,802)

Deposits and other assets........................................... (332,514) 600,000
----------- -----------
Cash used in investing activities................................... (2,083,228) (736,802)
----------- -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt............................ 2,000,000 500,000
Principal payments on long-term debt and capital lease
obligations....................................................... (204,381) (157,342)
Proceeds from issuance of convertible debentures.................... -- 1,000,000
Advances from stockholder........................................... 84,429 60,000
Repayment of advances from stockholder.............................. -- (320,000)
Payment of debt issuance costs...................................... -- (172,772)
----------- -----------
Cash provided by financing activities............................... 1,880,048 909,886
----------- -----------
Net increase (decrease) in cash..................................... (33,225) 683,747
Cash beginning of period............................................ 601,646 458,550
----------- -----------
Cash end of period.................................................. $ 568,421 $ 1,142,297
----------- -----------
----------- -----------
</TABLE>
See accompanying notes to condensed consolidated financial statements.

3
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CINEMASTAR LUXURY THEATERS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 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 month period ended June 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. As a result of the amended
agreements PCI now supplies concessions to all of the current theaters in
exchange for specified commissions.

NOTE 3

On June 24, 1997, the Company signed a letter of intent to sell
$15,000,000 of newly issued common stock to Rust Capital, Ltd. (the "Buyer").
The proposed agreement would allow the Buyer to purchase at least 51% of the
Company's common stock upon completion of the transaction, which is subject
to certain conditions and a vote by the current stockholders. 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. continue actively to discuss a
possible transaction. The Company expects the transaction to be completed
during the second quarter of fiscal year 1998, however there can be no
assurance that this transaction will ultimately be consummated.

NOTE 4

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 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 June 30, 1996 financial
statements to conform to the June 30, 1997 presentation.

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

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-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.

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

At June 30, 1996, the Company operated five theater locations with a
total of 44 screens. During the twelve months ended June 30, 1997, the
Company added two locations with an additional 20 screens. At June 30, 1997
the Company operated 7 locations and 64 screens. The addition of the two
theaters resulted in an increase in revenues and expenses for the three
months ended June 30, 1997 compared to June 30, 1996. Of the two new theater
locations, one of these locations has not met the Company's expectations
regarding attendance and revenue. The Company is continually evaluating the
situation and attempting to develop means with which to increase attendance
and revenue at that location.

Total revenues for the three months ended June 30, 1997 increased 35.0%
to $5,752,733 from $4,260,403 for the three months ended June 30, 1996. The
increase consisted of a $951,529, or 32.1%, increase in admission revenues, a
$516,084, or 42.9%, increase in concession revenues, and a $24,717, or 26.3%,
increase in other operating revenues. New theaters had admission revenues of
$790,468, concession sales of $354,046, and other operating revenues of
$32,348 making total revenues from new theaters $1,176,862. There was an
increase in total revenues from continuing theaters of $315,468, or 7.4%.
Management believes the increase in revenues at continuing theaters reflects
higher movie attendance based on more successful film releases.

Film rental and booking costs for the three months ended June 30, 1997
increased 40.2% to $2,248,524 from $1,603,729 for the three months ended June
30, 1996. The increase was due to additional film rental and booking costs
paid on increased admission revenues and new theaters. New theaters had film
rental and booking costs of $434,565. As a percentage of admission revenues,
film rental and booking costs for the three months ended June 30, 1997
increased to 57.4% from 54.1% for the three months ended June 30, 1996. This
increase can be attributable to a shorter film run for the more popular
movies.

Cost of concession supplies for the three months ended June 30, 1997
increased 65.2% to $593,194 from $358,984 for the three months ended June 30,
1996. The dollar increase is primarily due to additional concession costs
associated with increased concession sales and higher costs under the amended
concession agreement with Pacific Concessions Inc. New theaters had
concession costs of $99,546. As a percentage of concession revenues,
concession costs for the three months ended June 30, 1997 increased to 34.5%
from 29.8% for the three months ended June 30, 1996. On April 23, 1997, the
Company amended its concession agreements with Pacific Concessions, Inc.
("PCI") and as a result PCI now receives a specified commission for
providing concessions to all of the Company's theaters. The long-term
contract with PCI is tied to loans PCI has made to the Company and there is a
substantial penalty to end the contract earlier than its negotiated terms.
This amended concession agreement is the reason for the increase in
concession costs as a percentage of concession revenues.

<PAGE>

Theater operating expenses for the three months ended June 30, 1997
increased 62.2% to $2,280,566 from $1,406,343 for the three months ended June
30, 1996. As a percentage of total revenues, theater operating expenses
increased to 39.6% from 33.0% during the applicable periods. New theaters had
operating expenses of $725,167 which accounted for a portion of the increase.
Increased wages due to an increase in the minimum wage as well as a general
increase in certain costs including utilities and repairs and maintenance
also contributed to the increase in theater operating expenses.

General and administrative expenses for the three months ended June 30,
1997 increased 63.8% to $874,432 from $533,806 for the three months ended
June 30, 1996. As a percentage of total revenues, general and administrative
costs increased to 15.2% from 12.5% during the applicable periods. The
increase is primarily due to start up costs for the Mexican theater.

Depreciation and amortization for the three months ended June 30, 1997
increased 101.5% to $454,598 from $225,641 for the three months ended June
30, 1996. The increase is a result of additional purchases of equipment,
the costs associated with the new theaters, and related amortization of
preopening costs.

Interest expense for the three months ended June 30, 1997 increased to
$186,869 from $150,661 for the three months ended June 30, 1996. This is
attributable to new debt used to finance new theater development and fund
working capital.

Non-cash interest expense of $977,568 for the three months ended June
30, 1996 resulted 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 June 30, 1997 increased to
$6,553 from $2,644 for the three months ended June 30, 1996. Higher bank cash
balances for a period of time account for the higher interest income.

As a result of the factors discussed above, the net loss for the three
months ended June 30, 1997 decreased to $878,897 or $0.11 per common share,
from $993,685 or $0.16 per common share, for the three months ended June 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. continue actively to discuss a possible
transaction, however, there can be no assurance that this transaction will be
consummated. 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.

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

<PAGE>

of the current theaters in exchange for specified commissions which will
result in a reduction in the profitability of concession sales by the
Company.

The Company's current credit agreements with its bank contain certain
financial covenants which the Company is required to meet. At June 30, 1997
the Company is not in compliance with certain covenants. The bank has agreed
to forbear any adverse action pending the outcome of the proposed Rust
Capital Ltd. transaction. If the Rust Capital Ltd. transaction is consummated
by September 30, 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 June 30, 1997, the
outstanding balance due was $1,265,717. The loan is secured by a trust deed
on the Company's Chula Vista 6 Theater.

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 June 30, 1997, the aggregate future
minimum lease payments due under noncancelable operating leases was
approximately $82,500,000. The Company has also signed lease agreements for
three additional theater locations. The new leases will require expected
minimum rental payments aggregating approximately $73,000,000 over the life
of the leases. Accordingly, existing minimum lease commitments as of June 30,
1997 plus those expected minimum commitments for the proposed theater
locations would aggregate minimum lease commitments of approximately
$155,500,000.

During the three months ended June 30, 1997, the Company generated cash of
$169,955 from operating activities, as compared to generating $510,663 in
cash from operating activities for the three months ended June 30, 1996.

During the three months ended June 30, 1997, the Company used cash in
investing activities of $2,083,228, as compared to $736,802 for the three
months ended June 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 three months ended June 30, 1997, the Company provided net cash of
$1,880,048 from financing activities, as compared to providing $909,886 for
the three months ended June 30, 1996. The cash generated for the three months
ended June 30, 1997 came primarily from a loan from Pacific Concessions Inc.,
partially offset by debt repayment.

The Company, at June 30, 1997, had a working capital deficit of $9,025,101.

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
40 additional screens at three locations. The capital requirements necessary
for the Company to complete its development plans is estimated to be at least
$10,750,000 in fiscal 1998. Included in these amounts are screens currently
under construction in Tijuana, Mexico. Such developments will require the
Company to raise substantial amounts of new financing, in the form of
additional equity or loan financing, during fiscal 1998. There can be no
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

<PAGE>

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 June 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 Rust Capital
Ltd., however if the Rust Capital, Ltd. 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.

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 affect the Company's listing on the Nasdaq Small Cap Market. The
Company was informed by NASDAQ on August 5, 1997 that since the Company's
Common Stock failed to maintain a closing bid price greater than or equal to
$1.00 and the Company did not have capital and surplus of $2,000,000 or a
public float market value of $1,000,000, the Company fails to maintain NASDAQ
eligibility standards for listing on the Nasdaq SmallCap Market. NASDAQ has
given the Company 90 days to regain its eligibility or otherwise provide a
plan to NASDAQ of how the Company intends to achieve compliance. A delisting
from the Nasdaq SmallCap Market could adversely affect the market for and
price of the Company's securities.

The Company anticipates that it will need approximately $15,000,000 of
additional financing during the next twelve months. This estimate, which is
subject to change without notice, assumes that the Company is able to achieve
its current revenue and expense projections for the second 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

<PAGE>

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.

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 quarters ended
June 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 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.

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 40 additional screens
at three locations during fiscal 1998. The capital requirements necessary for
the Company to complete its development plans is estimated to be at least
$10,750,000. 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
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.

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

<PAGE>

entered into a letter of intent 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
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

<PAGE>

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.

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 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
28.2% of the Company's total revenues in the quarter ended June 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.

<PAGE>

CONTROL OF THE COMPANY. At June 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). As a result, these individuals
are 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.

DEPENDENCE ON MANAGEMENT. The Company is significantly dependent upon the
continued availability of John Ellison, Jr., Alan Grossberg and Jerry
Willits, its President and Chief Executive Officer, Senior Vice President and
Chief Operating Officer, and Vice President, respectively. The loss or
unavailability of any one of these officers to the Company for an extended
period of time could have a material adverse effect on the Company's business
operations and prospects. To the extent that the services of these officers
are unavailable to the Company for any reason, the Company will be required
to procure other personnel to manage and operate the Company and develop its
theaters. There can be no assurance that the Company will be able to locate
or employ such qualified personnel on acceptable terms. In December 1996, the
Company amended the five-year employment agreements with each of Messr.
Ellison, Grossberg and Willits. The amendments provide for each employment
agreement to expire in December 2001. The Company maintains "key man" life
insurance in the amount of $1,250,000 on the lives of each of John Ellison,
Jr., Alan Grossberg and Russell Seheult (the Chairman of the Company's Board
of Directors), with respect to which the Company is the sole beneficiary. The
Company's anticipated equity financing transaction with Rust Capital, Ltd.
could result in a significant change in the management of the Company.

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 is in progress 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

<PAGE>

Company's results of operations, and the results of one quarter are not
necessarily indicative of results for subsequent quarters.

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. If the anticipated financing with Rust
Capital, Ltd. is completed, it is anticipated that the foregoing compensation
agreements will be amended.

NO ASSURANCE OF CONTINUED NASDAQ INCLUSION; RISK OF LOW-PRICED SECURITIES. In
order to qualify for continued listing on NASDAQ, a company, among other
things, must have $1,000,000 in total assets, $2,000,000 in capital and
surplus and a minimum bid price of $1.00 per share. From time to time the
minimum bid price has been below $1.00 per share. 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

<PAGE>

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.

The Company was informed by NASDAQ on August 5, 1997 that since the Common
Stock failed to maintain a closing bid price greater than or equal to $1.00
and the Company did not have capital and surplus of $2,000,000 or a public
float market value of $1,000,000, the Company fails to maintain NASDAQ
eligibility standards for listing on the Nasdaq SmallCap Market. NASDAQ has
given the Company 90 days to regain its eligibility or otherwise provide a
plan to NASDAQ of how the Company intends to achieve compliance. A delisting
from the Nasdaq SmallCap Market could adversely affect the market for and
price of the Company's securities.

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.

POSSIBLE VOLATILITY OF COMMON STOCK, REDEEMABLE WARRANT, AND CLASS B
REDEEMABLE WARRANT PRICES. On or about October 25, 1996, a registration
statement filed with the Securities and Exchange Commission became effective
in connection with a temporary reduction in the exercise price of its
Redeemable Warrants and the issuance of certain new warrants to holders of
Redeemable Warrants who chose to exercise the Redeemable Warrants.

On or about November 15, 1996, the Warrant Reduction Offer expired. Each of
226,438 Redeemable Warrants had been converted to one share of common stock
and one Class B Redeemable Warrant. Under the terms of the Warrant Reduction
Offer, $3.50 was received by the Company for each warrant converted to common
stock and a Class B Redeemable Warrant. Thus $792,533 of additional capital
before expenses was acquired.

The trading prices of the 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

14
<PAGE>

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, 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.

The Company anticipates that the sale of shares to Rust Capital, Ltd. would
result in a significant reduction in the exercise price of the Company's
Redeemable Warrants and Class B Redeemable Warrants in accordance with the
anti-dilution provisions of such warrant agreements. The precise amount of
the reduction in the exercise price will not be known until the final terms
of the sale of shares have been determined.

<PAGE>

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. Sales of either
the Redeemable Warrants or the underlying shares of Common Stock, or even the
existence of the Redeemable 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 or Class B
Redeemable Warrants 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 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 June 30,
1997, the outstanding principal balance of the FNB Loans was $1,285,714 and
the outstanding aggregate principal balance owed to PCI under the PCI Loan
Agreements was $2,750,914

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 6 -- EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

27 Financial Data Schedule

(b) Reports on Form 8-K

The Company filed one Report on Form 8-K during the quarter ended June
30, 1997. It was filed on June 24, 1997. The Report on Form 8-K reported the
Letter of Intent with Rust Capital Ltd.

<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: August 14, 1997

CinemaStar Luxury Theaters, Inc.

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

By: /s/ ALAN GROSSBERG
--------------------------------------
Executive Vice President and Chief
Financial Officer (principal
financial officer and principal
accounting officer)

<PAGE>

EXHIBIT INDEX

SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- ------- ----------- ------------
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 JUNE 30, 1997 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>

<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> JUN-30-1997
<CASH> 568,421
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,065,992
<PP&E> 15,660,921
<DEPRECIATION> 3,376,593
<TOTAL-ASSETS> 14,175,574
<CURRENT-LIABILITIES> 10,091,093
<BONDS> 0
0
0
<COMMON> 9,424,618
<OTHER-SE> 2,559,027
<TOTAL-LIABILITY-AND-EQUITY> 14,175,574
<SALES> 5,752,733
<TOTAL-REVENUES> 5,752,733
<CGS> 5,122,284
<TOTAL-COSTS> 6,451,314
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 186,869
<INCOME-PRETAX> (878,897)
<INCOME-TAX> 0
<INCOME-CONTINUING> (878,897)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (878,897)
<EPS-PRIMARY> (.11)
<EPS-DILUTED> (.11)

</TABLE>