U.S. SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB
(Mark One)
[X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996

[ ]      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934
For the transition period from                  to                 .
Commission File Number 0-28254 ----------------    ----------------

                                LASER STORM, INC.
                  --------------------------------------------
                 (Name of small business issuer in its charter)
        Colorado                                        84-1139159
 ------------------------------              -----------------------------------
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
incorporation or organization)

7808 Cherry Creek South Drive, Unit 301, Denver, Colorado            80231
---------------------------------------------------------          ---------
(Address of principal executive offices)                           (Zip Code)

Issuer's telephone number: (303) 751-8545

Securities registered under Section 12(b) of the Exchange Act:

   Title of each class              Name of each exchange on which registered
   -------------------              -----------------------------------------
        None                                          None

Securities registered under Section 12(g) of the Exchange Act:
                          $0.001 Par Value Common Stock
                           ----------------------------
                                (Title of Class)
                       Redeemable Stock Purchase Warrants
                       ----------------------------------
                                (Title of Class)
     Check  whether  the Issuer (1) 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 [ ]

     Check if no  disclosure  of  delinquent  filers in  response to Item 405 of
Regulation S-B is contained in this form,  and no disclosure  will be contained,
to the best of Issuer's knowledge, in definitive proxy or information statements
incorporated  by reference  in Part III of this Form 10-KSB or any  amendment to
this Form 10- KSB. YES [ ] NO [X]

     The Issuer's revenues for its most recent fiscal year were $5,898,211.

     The aggregate  market value of the voting stock held by  non-affiliates  of
the Issuer as of March 31, 1997 was approximately $1,059,428.

     Check whether the Issuer has filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the  distribution  of
securities under a plan confirmed by a court. YES [ ] NO [X] (The Issuer was not
subject to the Exchange Act Reporting  Requirements  at the time of the Issuer's
filing under the Bankruptcy Act.)

     As of March 31, 1997 the Issuer had 3,824,836  outstanding shares of common
stock.

         DOCUMENTS INCORPORATED BY REFERENCE:  None.
         Transitional Small Business Disclosure Format:  YES  [ ] NO  [X]
<PAGE>


                                LASER STORM, INC.
                         1996 FORM 10-KSB ANNUAL REPORT
                                TABLE OF CONTENTS

PART I                                                              PAGE NUMBER
------                                                              -----------
Item 1.  Description of Business

Item 2.  Description of Property

Item 3.  Legal Proceedings

Item 4.  Submission of Matters to Vote of Security Holders

PART II
-------
Item 5.  Market for Common Equity and Related Stockholder Matters

Item 6.  Management's Discussion and Analysis or Plan of Operation

Item 7.  Financial Statements

Item 8.  Changes in and Disagreements With Accountants on
                  Accounting and Financial Disclosures

PART III
--------
Item 9.  Directors, Executive Officers, Promoters and Control
                  Persons; Compliance With Section 16(a) of the Exchange Act

Item 10. Executive Compensation

Item 11. Security Ownership of Certain Beneficial Owners and Management

Item 12. Certain Relationships and Related Transactions

Item 13. Exhibits and Reports on Form 8-K

Signatures


<PAGE>


                                     PART I

ITEM 1.           DESCRIPTION OF BUSINESS

General

     Laser Storm,  Inc. (the  "Company")  designs and  manufactures  interactive
laser tag game  systems  which the Company  markets  under the  trademark  Laser
Storm(R).  The Laser  Storm(R) game systems which are computer  controlled,  are
capable of being varied to fit individual  operator  needs and customer  demands
and are  designed  to  incorporate  a themed  adventure  within  an  interactive
environment emphasizing team play.

     Each game system is comprised of blasters,  controllers,  adjustable vests,
headsets and targets, and may include themed arenas with special effects such as
moveable and fixed colored  barriers,  fog, sound,  specialty  lighting effects,
software  developed  by the  Company  and other  elements.  The  Company's  game
equipment  is  designed  to be  lightweight  and easy  for all ages to use.  The
Company currently markets five different,  themed game systems: Galaxy 2000(TM),
Galactic  Marauders(TM),  Circuit  Commandos(TM),  STARGATE  and Marvel  Comics'
X-Men.  The  Company  recently  obtained  a license  to  utilize  the comic book
characters  owned by Marvel  Characters,  Inc.  as part of a themed  game system
which  the  Company  introduced  and began to market  in  November  1996.  Games
typically  are played in arenas  ranging in size from 1,000 square feet to 4,000
square  feet.  Additional  space is  required  for  support,  retail  sales  and
administration.  Operators  of Laser  Storm(R)  game  systems  generally  charge
admissions  ranging from $3.00 to $7.00 and game  durations can be programmed to
vary from one minute to 40 minutes but typically last 10 minutes.

     The Company has been developing and producing state of the art themed laser
tag game systems and,  since its inception in March 1990 through  December 1996,
the Company has sold a total of  approximately  190 Laser Storm(R) game systems,
of which 161 were sold in the United  States and 29 were sold for use outside of
the United  States.  Although  since its  inception the Company has been engaged
principally in developing,  marketing and selling Laser Storm(R) game systems to
independent  operators,  the Company also owns and operates five Laser  Storm(R)
game facilities and has entered into revenue sharing arrangements that are still
in effect for seven Laser  Storm(R)  game  facilities.  The  Company  intends to
increase the number of facilities  in which it will have an ownership  interest.
The Company  estimates  that the actual cost of any Company owned  facility will
vary from approximately $100,000 to $500,000 based primarily on the location and
size of the facility.  The actual number of new Laser  Storm(R) game  facilities
that the Company will be able to acquire and open will depend on the  percentage
interest  the  Company  will  have in each  facility  and  the  availability  of
financing.

     The  Company  was  incorporated  in  Colorado  in 1990  under the name "The
Crimsom  Corporation--a  Holding Company" and conducted business under the names
"Space Sport,  Ltd." and "Laser Storm." In November,  1994, the Company  changed
its name to "Laser Storm,  Inc." The Company  elected in November,  1992 to file


<PAGE>


for  reorganization  under Chapter 11 of the United States  Bankruptcy  Code. In
November,  1993, the Company's  Plan of  Reorganization  was confirmed,  and, in
November, 1994, the court ordered the proceedings to be closed.

     In April  1996,  the  Company  completed  an  initial  public  offering  of
1,495,000  Units from which the Company  realized net proceeds of  approximately
$4,700,000.  Each Unit consisted of one share of Common Stock and one Warrant to
purchase  one share of Common Stock  initially  at $4.00 per share.  The Company
expects that after March 31, 1997,  the exercise  price will be reduced to $1.00
per share pursuant to the terms of the Warrants.

Products

     The Laser Storm(R) interactive game system uses proprietary custom software
developed  by the  Company and is  designed  to allow  operators  to set up live
action themed, "tag" type games staged between or among teams of opponents.  The
Company  has  developed  and  currently  markets  game  systems  embodying  five
different themes, each with numerous  configurations.  These games are played in
themed arenas,  which contain special  effects,  including  colored,  movable or
fixed  barriers,  fog,  sound,  lighting  and  other  decorative  elements.  The
equipment is designed to be lightweight and easy to use for all ages. The arenas
are flexible, easily reconfigured, safe and may accommodate 2 to 48 players.

     The Laser  Storm(R)  player unit includes a blaster  which emits  simulated
laser beams from a solid-state  light source.  Unlike an actual laser,  the beam
will  project,  in tight  disbursement,  a harmless  colored light for up to 100
feet. The blaster is attached to a belt or vest that contains a battery pack and
electronics  and a lightweight  headset that is similar to a set of  headphones.
All of the equipment weighs under three pounds.  The unit is designed for use by
persons  three  years of age and  older.  The  battery  pack  utilizes  a velcro
fastener which may be adjusted to fit almost any customer.  The compact  blaster
and unique thumb trigger accommodate a variety of hand sizes.

     All Laser  Storm(R) game systems are designed to emphasize  teamwork.  Each
team has a mission to accomplish  during the game.  Players are instructed by an
operator  or watch a  pre-game  video  which set the stage for the game,  give a
brief introduction to the theme and explain the mission's parameters.

     A computer  controls the play of the game.  An operator can change the game
configuration easily before each game, making every game a different experience.
Game components,  such as duration, points per player hit, points per target hit
and target duration, can be varied by the operator with the click of a mouse.

     During  the  game,  players  can keep  track of the  score  by  watching  a
scoreboard in the center of the arena.  A database  keeps track of the number of
times each player's blaster achieves the activation of another player's unit. At

                                        2

<PAGE>


the end of the game, each player receives an individualized,  computer generated
scorecard, showing details of the mission, as well as each player's performance.

     Games typically last approximately 10 minutes, though the time of each game
may be  programmed  to last from one  minute  to 40  minutes.  Charges  per play
generally  range from  approximately  $3.00 to $7.00.  Efficient  operators with
sufficient working equipment can run up to six 10-minute games per hour.

     The Company presently offers five totally different interactive game themes
for use with the Laser Storm(R) game system.

     1. Galaxy  2000(TM).  Galaxy 2000(TM) is a high tech version of dodge ball,
where two teams blast for control of the "neutral  zone." This is the oldest and
one of the most popular of the current games.

     2.  Galactic  Marauders(TM).  Galactic  Marauders(TM)  is a series of games
based on the story of evil estranged twin brothers,  Ick and Yuck DuVraggo,  who
are  battling  over the rights to control the "Milky  Main" in deep  space.  The
first game in the Galactic  Marauders(TM) series is staged in the DNA laboratory
of the fictional Minerex Corporation,  where Dr. Carl Sterling first created raw
DNA  strands.  Each  team's  mission is for its leader to capture as much DNA as
possible in order to create either Northern Monsters or Southern  Zombies.  With
the help of these hideous  creatures,  each team hopes to mine the riches of its
home planet, thus giving it the ultimate ability to rule the galaxy.

     3. Circuit  Commandos(TM).  Circuit  Commandos(TM)  is the themed adventure
involving a crack team of computer  experts whose assigned mission is to blast a
virus,  created  by a team  of  brilliant  hackers,  out  of the  "International
Economic  Computer  Network."  Players  go through a  simulated  miniaturization
chamber and then enter an arena,  which is designed to look like the inside of a
huge computer.  Each team's  immediate  objective is to capture as many computer
chips as possible in the correct sequence,  thus activating the  microprocessor.
The first team to activate  and destroy the  microprocessor  wins the game.  The
Company is developing  variations of this theme to accommodate  different levels
of special effects sophistication and facility cost.

     4.  STARGATE.   Themes  from  the  motion  picture   "STARGATE"  have  been
incorporated  into  a  series  of  games  designed  to  be  progressively   more
challenging.  Players  are  briefed  in a central  control  room in  advance  of
commencing  play and then are sent  through a  mysterious  Stargate to a distant
galaxy on an exploratory  mission to find seven symbols and save the planet from
extinction.  The players are instructed  that hostile forces may be encountered,
but not to fire upon them unless they feel  threatened.  The story progresses as
new targets and diversions are introduced. The arena is designed to resemble the
inner  sanctum of an ancient  pyramid  with exotic,  fluorescent  hieroglyphics,
Anubis  targets,  Horace  targets that shoot back,  and other  special  effects.
Management  intends  to add new  variations  or  enhancements  to keep  the game
exciting even for the most avid repeat players.

                                        3

<PAGE>



     5. Marvel Comics' X-Men Laser Tag. Themes based on the Marvel Comics' X-Men
comic books and the Marvel Comics' X-Men  animated  series are being used by the
Company to develop  Marvel Comics' X-Men games which offer players the chance to
train alongside superheroes Wolverine, Rogue, Cyclops, and Storm. The games take
place inside Marvel Characters, Inc.'s ("Marvel") well known "Danger Room." From
the  moment  players  enter a Marvel  Comics'  X-Men  game  center  they will be
escaping  into a fantasy  based  experience.  Every aspect of the facility  from
staff  uniforms  to the  "Danger  Room"  itself has been  carefully  designed to
support  a  seamless,  fantasy  based  theme.  The  actual  "Danger  Room"  game
introduces new game play features.

     The Company is producing four different scorecards for Marvel Comics' X-Men
games featuring original artwork from Marvel artists.  With the help of Marvel's
illustration  team,  each scorecard will feature a different,  unique  character
rendering to encourage  collecting.  The strategy is to entice players to return
to play again and to collect all four scorecards.

     The Company  obtained its license to utilize  themes and develop and market
merchandise  based on the motion  picture  STARGATE in October 1995. The term of
the license  continues  until August 17, 1997,  after which date no new licensed
articles may be manufactured,  sold or distributed by the Company.  However, the
Company may continue to use and operate the licensed  articles through August 1,
2000.  The  Company is required  to pay the  licensor a royalty on gross  ticket
sales for all  locations  using the  licensed  articles.  Credited  against  the
royalty is an amount of $50,000 which has been paid by the Company as an advance
royalty.

     The Company has  obtained a license  from Marvel  granting  the Company the
exclusive right to use trademarked  cartoon  characters  owned by Marvel through
February  1,  2000,   solely  upon  and  in   connection   with  the   Company's
licensee-owned  and sublicensee  owned laser tag facilities in the United States
and Canada. Marvel reserves the right to approve the site location of each Laser
Storm  facility,  which  facilities  may not be  located  within 60 miles of any
Marvel  themed  amusement  park.  The Company must pay  royalties to Marvel of a
percentage of gross  revenues.  The term of the Marvel license  agreement may be
extended for successive one year periods through December 31, 2003 provided that
no breach has occurred and provided that a minimum amount of royalties have been
paid in the  preceding  term.  The  term  for  Laser  Storm(R)  game  facilities
sublicensed  (rather  than owned by Laser  Storm) is limited to three years from
the date of original purchase.  The Company does not believe, but cannot assume,
that Marvel's  recent filing for  reorganization  under Chapter 11 of the United
States  Bankruptcy  Code will  have any  effect on the  Company's  license  from
Marvel.



                                        4

<PAGE>



Product Development

     The Company  continuously  designs and develops new and modified equipment,
computer  software  and  hardware,  game  themes  and  related  accessories  and
merchandise,  and applications for the software. Such developments have included
alphanumeric   scoreboards  with  messaging   capabilities,   new  targets  with
individual programmability,  updated infrared and audio transmissions, new color
optics for use in LED beams  emitted by the  blasters  which help  differentiate
team members and merchandise for retail sales.

     There is no  assurance  that  the  products  and  promotions  currently  in
development  will lead to final products or that any such products or promotions
will be commercially viable or profitable to the Company.

Intellectual Property

     The Laser  Storm(R)  game system is an  interactive  experience.  Game play
involves  interacting  with both the  player's own team members and those of the
opposing team.  Through a computer  tracking system developed by the Company,  a
playability log unfolds over the course of the game which is recorded and logged
by the  software.  Upon  exiting  the  arena,  each  player  receives a computer
generated score card  quantifying the player's  achievements.  In this instance,
the software helps  conclude the activity by giving  players the  opportunity to
take a tangible piece of their game experience home.

     The software  controls the Laser  Storm(R) game systems.  Accordingly,  the
systems can be altered with relatively simple software adjustments.  The Company
continuously makes system enhancements that make the games more interactive.

     The Company's current operating  software is proprietary,  functioning only
with the  Company's  hardware  system.  While the  software  controls  the game,
players  interface  with the software  through  unique  infrared  communications
platforms  made up of individual  player  units.  Without  these  blasters,  the
software  itself is  useless.  Nevertheless,  when the two are  coupled  and set
inside a themed arena environment,  an interactive  entertainment  experience is
created.  While  the  software  is a  critical  element  of the  game  mix,  the
management  of the  Company  believes  that  the  software  has  little  utility
separated from the laser tag game environment.

     The Company  attempts to protect its  trademarks,  trade  secrets and other
intellectual  property by the use of the trademark and copyright  laws,  through
license agreements with customers and by use of confidentiality  agreements with
certain  suppliers,  employees and  consultants.  There can be no assurance that
these measures will be successful in protecting the Company's  trade secrets and
know how, or that the  trademarks  will afford the Company with any  competitive
advantages.  The Company has  registered  Laser  Storm(R) as a trademark  in the
United States and Korea and has applied to register the trademark in Japan.  The

                                        5

<PAGE>


Company  also intends to apply to register  the  trademark  in other  countries.
Currently,  the  Company  does not hold any patents but may apply for patents in
the future where applicable.

Markets

     Domestic

     Laser  Storm(R)  game  facilities  attract  a  wide  demographic  range  of
customers.  Customer  demographics  by age and gender vary depending on location
selection,  advertising,  facility activities, operations hours and game themes.
The Company has not  developed  any  accurate  data on the game users and relies
entirely  on  anecdotal  verbal  remarks  from  operators   regarding   customer
demographics.  Based upon this information  supplied by the Company's operators,
the Company  estimates  that the Laser  Storm(R) game system users are one-third
aged 12 and  under,  one-third  aged 13 to 17,  and  one-third  age 18 and over.
However,  two of the owners of indoor  playground  facilities  which  cater to a
younger age group and which have Laser Storm(R) game systems,  have indicated to
the Company that they estimate that  approximately 80% of their customer base is
in the age 12 and under category and the remaining 20% are parents.  Conversely,
another owner of a Laser  Storm(R) game system has estimated to the Company that
80% of its  customer  base is in the age 16 and over  category.  The  Company is
unaware  of any  independent  information  available  to support  the  Company's
estimates.

     Laser  Storm(R)  game systems are  currently  located in  amusement  parks,
family entertainment centers, skating rinks, movie theaters,  shopping malls and
bowling centers. The Company currently bases its marketing plan on the placement
of not more than one facility per five mile radius or 200,000  population  base,
depending on population density.

     International

     Although  the  Company  has sold a number of Laser  Storm(R)  game  systems
outside of the United States,  the Company has recently  determined to focus its
marketing  efforts more in the United States in order to increase its efforts to
open additional  Company owned Laser Storm(R) game  facilities.  Therefore,  the
Company is not currently  actively  marketing its Laser Storm(R) game systems in
foreign  countries.  However,  the  Company  will  affirmatively  respond to any
inquiries from prospective customers in foreign countries.

     The Company has an exclusive  agreement with Target Technology P.T.E., Ltd.
("Target"),  a Singapore  Company,  pursuant to which the Company has authorized
Target to sell Laser  Storm(R)  equipment in Singapore  and Malaysia  until July
2000.  The Company has sold three game  systems to Target to date.  There are no
assurances  Target will  purchase any  additional  Laser  Storm(R)  game systems
pursuant to the agreement.


                                        6

<PAGE>



         The Company has entered into an  agreement  with Cyber  Amusement  Co.,
Ltd. ("Cyber") whereby the Company has appointed Cyber as the sole and exclusive
distributor  and licensee for the Company's  Laser  Storm(R) game systems in the
country of Thailand.  Cyber has agreed to purchase  five or more Laser  Storm(R)
game systems by January 31, 1999.  The  agreement is in effect  through  January
1999 and can be renewed annually  thereafter by Cyber. The Company does not have
Cyber  financial  information  and there are no  assurances  that  Cyber has the
financial  capability  to purchase  any Laser  Storm(R)  game  systems  from the
Company.  To date, Cyber has not purchased any, and there are no assurances that
Cyber will purchase any, Laser Storm(R) game systems pursuant to the agreement.

         The Company has entered into an  non-exclusive  letter agreement with a
company to market the Company's Laser Storm(R) game systems  throughout  Central
and South America on a commission  basis. The agreement is for an initial period
of one year commencing July 24, 1996, and is renewed automatically unless either
party provides 60 days notice of cancellation.  As of the date hereof,  no sales
have been made pursuant to the letter agreement.

Sales and Facilities Operations

         The Company's business plan currently contemplates three types of Laser
Storm(R) game facilities: 1) those owned by independent  owner/operators to whom
the Company  sells Laser  Storm(R)  game  systems and arenas;  2) Company  owned
facilities;  and 3) revenue  sharing  facilities  in which the Company  provides
equipment  at little or no charge  and  shares  the  revenue  with the  facility
operator.  Each of these  formats has  various  advantages  and each  requires a
somewhat  different  marketing  strategy.  The  Company  believes  that  it must
integrate all three sales approaches in its marketing plan to pursue  profitable
growth.

         Sales

         Since its inception in March 1990 through  December  1996,  the Company
has sold and shipped  approximately  190 Laser Storm(R) systems  worldwide.  For
most  sales of its  systems,  the  Company  utilizes  agreements  which  contain
provisions relating to site protection,  change orders, warranty,  liability and
responsibilities of ownership. The Company usually requires the buyer to pay 50%
of the purchase price to the Company upon signing the sales agreement,  with the
balance to be paid in two equal  installments 60 days prior to delivery and upon
installation,  respectively. For a limited time in 1996, the Company provided an
alternative to the buyers to make an advance  deposit ranging from 30% to 40% of
the purchase  price to the Company upon  signing the sales  agreement,  with the
balance to be paid over 24 months.  These payment  schedules relieve the Company
of  most  out  of  pocket   manufacturing   expenditures,   since  the  cost  of
manufacturing  is covered in the initial  deposit.  In connection with each sale
the Company generally grants a license to the operator to use the Laser Storm(R)
trademark and computer software in connection with the operation of the facility
for so long as the  operator  maintains  the Laser  Storm(R)  game system at the


                                        7

<PAGE>


original  site.  Under these  agreements,  if an operator moves a system without
Company approval,  which will not be unreasonably  withheld,  the license to use
the software and trademark ceases.

         The Company usually  installs the system for a fee and provides initial
training on its proper use. The Company also services the system under  warranty
against  material  defects.  The warranty is typically  90 days,  however,  most
customers  purchasing  systems also  participate  voluntarily  in the  Company's
warranty  program under renewable  annual contracts for a current charge of from
$0.10 to $0.15 per play.

         The Company also sells to operators  merchandise,  such as T-shirts and
hats,  containing the Company's logos, as well as operating supplies,  including
fog fluid and scorecards.

         Although the Company does not require its operators to purchase  arenas
(the themed,  moveable  barriers,  props and, in some cases,  lighting and sound
packages,  all of which  together  create the theme  atmosphere)  at  operators'
facilities,  approximately 77% of the Laser Storm(R) operators have acquired the
entire system.

         Domestic Sales.  Since  inception in March 1990 through  December 1996,
the Company has sold and shipped 161 Laser  Storm(R)  game systems for operation
in 43 states.

         International  Sales.  Since  inception in March 1990 through  December
1996,  the Company has sold and shipped 29 Laser  Storm(R)  game systems for use
outside of the United States.

         Company Owned Facilities

         The Company  intends to acquire  existing  and open new Laser  Storm(R)
game facilities  which will be owned and operated by the Company or in which the
Company will participate under a revenue sharing arrangement.  The actual number
of such  facilities  that the Company  will be able to acquire and develop  will
vary  depending  principally  on factors  such as the  percentage  interest  the
Company will have in each  facility,  the location of each facility and the size
of each  facility and the  availability  of  financing.  The Company owned Laser
Storm(R) game facilities  usually will be entertainment  centers that feature at
least one Laser Storm(R) arena and may include any combination of video, arcade,
food and party rooms and a retail-style  store featuring licensed Laser Storm(R)
merchandise  and  related  items.  The  Company  anticipates  that  the cost for
furniture, fixtures and equipment of a typical Company owned Laser Storm(R) game
facility will be approximately $250,000. However, the Company estimates that the
actual cost of any Company owned facility will vary from approximately  $100,000
to $500,000  based  primarily on the location  and size of the  facility.  As of
March 28,  1997,  the  Company  owned and  operated  five  Laser  Storm(R)  game
facilities.  One of the five  Laser  Storm(R)  game  facilities  is a  48-player
facility,  featuring a STARGATE  theme, in an  entertainment  and amusement area
leased by Namco  Cybertainment,  Inc. ("Namco"),  which operates over 500 family

                                        8

<PAGE>


entertainment  centers in the United States. The Company pays Namco a percentage
of the  Company's  adjusted  gross  sales (with a  specified  minimum)  from the
facility. In addition, the Company has entered into agreements and/or leases for
an additional six Laser Storm(R) game facilities that will be owned and operated
by the Company.  All six Laser Storm(R) game facilities will be in entertainment
and  amusement  areas  leased or owned by Namco.  The  Company  will pay Namco a
percentage of the Company's adjusted gross sales (with specified  minimums) from
such facilities.

         No assurance  can be given that the Company will be  successful  in its
plans to acquire, open and operate any additional facilities.

         Revenue Participation Facilities

         The Company  intends to enter into  agreements  with certain  operators
whereby  the  Company  will  provide  equipment  at  minimal  or no  cost to the
operators who will operate Laser  Storm(R) game  facilities  and share the gross
revenue with the Company. The Company will evaluate the quality of the location,
commitment and stability of the operator and the possible  return on investment,
among other factors, to determine whether to enter into such an arrangement.

         The Company is currently  pursuing revenue sharing ventures for several
reasons:  1) the ongoing  annual gross revenue  stream  participation  from such
facilities  historically  has exceeded the profits  involved in system sales, 2)
the Company believes it needs to have greater  involvement in operations than it
currently has through  systems sales if it is to manage its corporate  image and
accelerate  revenue  growth,  and  3)  management   believes  there  are  family
entertainment  centers,  bowling  centers and skating  rinks whose owners may be
interested in adding a Laser Storm(R) game facility to their operations if those
owners have little risk,  minimal or no outlay of capital and limited managerial
oversight.

         As of the date hereof, the Company is involved in the following revenue
sharing arrangements:

         Funplex  Center:  The  Company owns a 50% interest in Laser Hall L.L.C.
which was formed in September 1995, as a Colorado limited liability company,  to
renovate  and operate an  approximately  2,700 square foot Laser  Storm(R)  game
facility  within FunPlex  Center,  a 144,000 square foot  amusement  center,  in
Littleton,  Colorado.  The Company sold Laser Hall L.L.C.  the equipment for the
FunPlex  facility  at the  Company's  cost.  The  balance of Laser  Hall  L.L.C.
membership interests are owned by unaffiliated parties.

         The Company, on behalf of Laser Hall L.L.C.,  agreed with the owners of
Funplex  Center,  in which a Laser Storm(R) game system has operated since March
1990, to renovate that facility.  The facility  affords a local showcase for the
Company's product which will provide an ongoing revenue source; and will provide
a  location  where  new  products  and  merchandise  can be test  marketed  in a

                                        9

<PAGE>


Company-controlled,  fully operational  environment.  Laser Hall L.L.C. owns the
system,  and pays a space rental fee to Funplex Center. The Company provides all
facility upgrades, as well as the equipment and operational personnel. The newly
renovated facility opened in November 1995.

         Fun City Amusement Centers,  Inc. ("Fun City"): The Company has entered
into  an  agreement   with  Fun  City,  a  150,000  square  foot  indoor  family
entertainment  center in North  York,  Ontario,  Canada,  a  Northern  suburb of
Toronto,  which currently  operates a 24- player Laser Storm(R) game system in a
2,500  square  foot  arena.  Facility  attractions  include an indoor,  electric
go-cart  track,  major  arcade  area and  multiple  party  rooms and  concession
facilities.  The  agreement  provides  for the  participation  by the Company in
revenue  from  operations  and  requires  that  Fun City  pay to the  Company  a
per-person-per-game  use fee based on 45% of the price per game, currently $2.68
Canadian,  exclusive  of any sales,  use or other taxes that may be imposed upon
each use. Payments are made to the Company monthly based on the number of player
activations  utilized in the previous month of operation.  Fun City paid $24,250
to the Company as a prepayment under the revenue sharing  agreement.  These fees
are to be recovered by Fun City before the Company participates in revenues from
operations. The Company provided and retains ownership of the equipment.

         M. W. Recreation  Corporation  ("Fun  Machine"):  In November 1995, the
Company entered into a verbal agreement  whereby the Company installed a Circuit
Commando(TM)  inflatable  unit for a Fun  Machine  location  on a revenue  share
basis.  The term of the  revenue  share is for a period of 12 months,  renewable
annually and the Company is to receive 50% of the gross  revenues  realized from
the unit. In exchange for the use of the inflatable  unit, the Company agreed to
pay the  manufacturer  30% of the payments  received by the Company which result
from the use of the unit. The inflatable  unit is included in a full service Fun
Machine  amusement  center  located in Longwood,  Florida.  This  revenue  share
agreement was renewed in 1996.

         Tunica  Partners II, LP  ("Harrah's"):  In February  1996,  the Company
entered into an agreement with Tunica  Partners II, LP ("Tunica  Partners") that
owns the casino business which is managed for Tunica Partners by Harrah's Tunica
Corporation  ("Harrah's").  Pursuant to the agreement,  the Company  installed a
STARGATE Laser Storm(R) game system in approximately  2,400 square feet of space
in a new arcade and child care facility operated for Tunica Partners by Planet 4
Kidz, Inc.  ("Planet Kidz") in the Harrah's Casino in Tunica,  Mississippi.  The
Company supplied all equipment,  service,  repair and warranty work for the game
system for which the Company is to receive  50% of the revenue  (less any taxes)
received from the operation of the game system.  The Laser  Storm(R) game system
opened in April 1996.

         Harrah's  Vicksburg:   In  November  1996,  the  Company  finalized  an
agreement pursuant to which the Company provided the equipment,  service, repair
and  warranty  work  for  a  Galaxy  2000(TM)  Laser  Storm(R)  game  system  in
approximately 1,000 square feet in a Harrah's Casino in Vicksburg,  Mississippi.

                                       10

<PAGE>


The Company  supplied all equipment,  service,  repair and warranty work for the
Laser  Storm(R)  game  system.  The Company  receives  50% of the gross  revenue
(excluding  taxes) from the operation of the Laser  Storm(R) game system,  which
opened in February 1996.

         Harrah's St. Louis,  Missouri: In February 1997, the Company negotiated
an agreement with Harrah's Maryland Heights Operating Company to provide a Laser
Storm(R) game system for a new location in Maryland Heights,  Missouri, a suburb
of St. Louis. The 50/50 revenue share agreement  required the Company to provide
and install an 18 player  Galaxy Laser  Storm(R)  game system for a 1,200 square
foot arena. The agreement will provide for Planet 4 Kidz to operate the arena on
behalf of Harrah's Maryland Heights Operating Company and the Company.  The term
of the agreement will be for two years, with annual renewals thereafter.

         Mexico City Revenue Share:  In March 1997,  the Company  entered into a
revenue share  agreement with  D.I.F.A.D.I.S.A.  de C.V., a Mexican  corporation
("DIFADISA").  The agreement  provides for DIFADISA to operate a Laser  Storm(R)
game system within  DIFADISA's family  entertainment  center in Mexico City. The
Company supplied all equipment,  service, repair and warranty work for the Laser
Storm(R)  game system.  A 38-player  Circuit  Commando  system was  installed in
approximately  2,780 square feet of playing  space.  The agreement  provides the
Company  a base  revenue  of $1.00  which is paid on a per play  rate  basis and
adjusts  downward  every 100,000 plays.  The agreement is for a three-year  term
with annual renewals thereafter.

Marketing and Sales

         The  Company  employs  a variety  of  marketing  techniques,  including
placing  advertisements  in trade and  business  publications,  attending  trade
shows, telemarketing, conducting direct mail efforts.

         Print. The Company advertises in industry-specific  magazines and trade
publications to generate leads for direct sales.  All  advertisements  emphasize
new themes and games as they become available,  as management believes these new
themes and games are the basis for the Company's competitive strength.

         Trade Shows.  In 1995 and 1996 the Company  attended  and  exhibited at
major  trade  shows  worldwide.  The  Company  plans to  continue  to exhibit at
selected  trade shows in the United  States,  Asia,  Europe,  South  America and
Mexico. This marketing strategy will primarily support direct sales. Trade shows
constitute the primary source of leads for sales of Laser Storm(R) game systems.
The  Company's  ability  to  demonstrate  its  thematic  games will be a primary
consideration  in  selecting  shows.  In  November  1995,  at the  International
Association of Amusement Parks and Attractions  (IAAPA) annual convention in New
Orleans,  Louisiana,  the  Company  was  awarded a First  Place Best New Product

                                       11

<PAGE>


award, in the category of Family  Entertainment  Center  Ride/Attraction for the
Company's STARGATE themed game system.

         Telemarketing.   The  Company's  telemarketing  activities  consist  of
responding to inquiries and contacting  potential  customers from names obtained
at trade shows.  The Company also  utilizes  various  other lists  acquired from
industry organizations and developed by others for its telemarketing activities.
These activities are conducted by the Company's sales and marketing personnel.

         Direct Mail. Management believes that direct mail efforts support sales
of systems and promote revenue participation  activities,  as direct mail may be
aimed at highly focused target markets. The Company utilizes a number of mailing
lists from different  amusement  industry sources.  The Company also has special
lists  prepared from time to time for certain  promotions or to target  specific
markets.

         The Company plans to make additional  mailings to very specific markets
such as to military  entertainment service buyers. It is also planned that sales
letters  will be sent out in  locations  where the Company is  participating  in
trade shows to encourage meeting with potential operators and to demonstrate the
Company's products.

         Public  Relations.  To  enhance  name and brand  recognition,  engender
customer  loyalty  and  quickly  disseminate  news of  product  development  and
offerings,  the  Company  has  employed  a public  relations  firm which will be
responsible  for  generating  stories  in print and  broadcast  media  about the
Company and its Laser Storm(R) game systems.

         The Company has sales video  tapes  which  contain  information  on the
Company's thematic games (Circuit Commandos(TM) and STARGATE), professional exit
interviews,  owner/operator  sound bytes,  entertainment  statistics and imagery
that are intended to appeal to landlords, entrepreneurs, potential operators and
the general public. The Company is also preparing a television  commercial which
will feature the  reactions of families  exiting a typical  Laser  Storm(R) game
facility intercut with flash cuts of family play.

         Credit.  Within  the  past  18  months,  the  Company  has  established
arrangements  with various leasing companies to consider lease financing for the
Company's  customers.  All require an advance  payment and can finance leases in
principal amounts ranging between $10,000 and $150,000,  with terms varying from
24 to 72  months.  Lease  terms  and  dollar  amounts  will  vary  based  on the
creditworthiness  of the  applicant  and no  assurance  can be  given  that  any
applicant will be approved.

Competition

         In general, the Company faces competition from numerous other companies
in the  entertainment  and amusement  industry and more  specifically from other
providers of laser tag game systems.

                                       12

<PAGE>



         The  Company  believes  that  its  current  success  has been due to an
emphasis on thematic game  environments  and the simplicity of its  electronics,
which are  combined  to provide  games that are  exciting  and fun to play,  yet
challenging.

         Because  the  laser  tag game  market is in its  infancy  and  growing,
management  anticipates  that  additional  competitors  are  likely to enter the
market.  To remain  competitive,  the Company intends to offer enhanced products
(price  competitive,  thematically  unique) and to expedite its  domestic  sales
growth to enter and expand in markets as quickly as  possible  within the limits
of economic and  personnel  resources.  The Company  believes that the games its
competitors  produce  generally are more complicated to play than Laser Storm(R)
games, are more costly and complex to maintain and are more difficult to modify.
There is no  assurance  that the Company  will be able to sustain a  competitive
position for its products.

Manufacturing; Customer Service

         The Company typically manufactures and builds game systems to order and
generally  maintains an inventory of raw  materials,  finished goods and product
held for replacement which totalled approximately $977,896 at December 31, 1996.
During 1996, the Company  increased its  inventories in  anticipation of opening
additional Company owned and operated Laser Storm(R) game facilities.

         The Company  currently  outsources  the  fabrication of the game system
components   to  multiple   vendors.   Virtually   every   component  is  either
multi-sourced or has multiple sources available.  The exception involves plastic
blaster shells and plastic  headset parts,  which are fabricated  from injection
molds.  While there are any number of injection molders  available,  the Company
only has one  multi-cavity  mold for each of these  components.  Therefore,  the
Company only uses one source of supply at a time for  components  using  plastic
shells.  Upon receipt of the components from various vendors,  Company personnel
configure the "systems" to suit each customer's  needs.  Currently,  the Company
offers system  configurations  ranging in size from 12- to 48-player units which
can accommodate a variety of peripheral components such as target pods.

         With the  exception  of turn key arenas  which are  provided by a third
party manufacturer,  arena barriers are printed by outside vendors, then cut and
assembled  in the  Company's  Denver  facility.  The  Company  provides  CAD/CAM
generated three dimensional renderings of proposed arena layouts to the facility
operator, and, once approved, the facility is constructed by the owner/operator.
After construction,  the Company personnel install the game system components at
the facility site for a moderate  installation charge which covers the Company's
costs.

         The Company currently provides annual  maintenance  contracts for a per
play charge of from $0.10 to $0.15. The Company offers a 90-day factory warranty
period and assesses  surcharges  for obvious  abuses of  equipment.  The Company
believes  it  excels in the  areas of  customer  service  and  warranty  repair,

                                       13

<PAGE>


offering  24-hour  customer  service access and overnight  advanced  shipment to
replace failed  components.  The Company strives to assure its operators that it
will keep all equipment serviceable and has generated a database program capable
of tracking each  facility  operator and the  operator's  repair  history.  This
information  is  intended  to direct  research  efforts  to  replace  parts that
commonly  fail  and  to  forecast  the  Company's  parts  and  warranty  service
requirements. One of the facts learned by reviewing operator service reports was
a high rate of "No Problem Found" ("NPF") components.  In an effort to eliminate
NPF returns, management has increased both its customer service and installation
training and now is charging customers for NPF returns. Management believes that
these efforts will allow most NPF problems to be resolved by the operator.

         Customer  service   representatives  are  also  encouraged  to  provide
operators with  marketing  information,  such as industry  trends and operations
techniques, and to apprise operators of new Company product offerings.

Governmental Regulation

         Various   state  and  federal  laws  define  and  govern  the  sale  of
"franchises"  and  "business  opportunities."  These laws  require,  among other
things,  that  sellers of  franchises  and business  opportunities  register the
offering of such sales and provide prescribed  written  disclosures to potential
purchasers. State franchise laws provide customers who have been sold franchises
in violation of such laws recourse against the franchisor,  including rescission
of the purchase agreements with the franchisor.  In addition,  federal and state
laws   prescribe   remedies   against   sellers  of   franchises   and  business
opportunities,  consisting of fines, penalties, injunctions, or a combination of
these,   being   levied   against  the  sellers  of   franchises   and  business
opportunities. Management believes that sales of Laser Storm(R) game systems are
not  subject  to such  laws.  If a  determination  were made that  franchise  or
business  opportunity  laws and  regulations  are  applicable to the Company and
customers or  governmental  regulators  were  successful in prosecuting  actions
against the  Company,  there could be a material  adverse  effect on the Company
selling its Laser  Storm(R)  game systems in a  particular  market or in general
and,  depending upon the remedies imposed against the Company,  there could be a
material  adverse  effect  on the  Company's  business,  operating  results  and
financial condition.

         The   Department   of   Corporations   of  the   State  of   California
("Department")  has  reviewed  the issue as to whether or not the prior sales by
the Company of Laser  Storm(R) game systems in California  may have involved the
sale of "franchises" under the California  Franchise  Investment Law ("Act"). No
formal determination was issued by the Department after such review. The Company
then sought an interpretive  opinion  pursuant to Section 31510 of the Act as to
whether  proposed future sales by the Company of Laser Storm (R) game systems in
California  would  constitute  the  sale of  "franchises"  under  the  Act.  The
Department declined to issue an interpretive  opinion because the response might
impact a past  transaction.  The  Department  did  offer  the  Company  informal
guidance as to whether the sale of Laser  Storm(R)  game  systems in  California
would constitute the sale of "franchises" under the Act. Until the matter can be
resolved with the Department or through administrative or legal proceedings, the
Company  will  prohibit  future  purchasers  of Laser  Storm(R)  game systems in

                                       14

<PAGE>


California  from using the Company's  trademark in connection with the Company's
game systems. Although the Company can provide no assurances in this regard, the
Company  does not believe  that  prohibiting  future  purchasers  from using the
Company's  trademarks  in  California  will limit future sales by the Company in
California.

         To date,  the Department has not indicated to the Company what, if any,
action the Department will take against the Company if the Department determines
the Company's prior sales in California  involved the sale of "franchises" under
the Act. Such actions may include instituting  proceedings to enjoin the Company
from  violating  the Act or to force the Company to comply with the Act, to seek
restitution  or  disgorgement  or  damages  on  behalf of any  persons  that the
Department  may deem to have  been  injured  by the  Company's  sales or to seek
penalties, including a penalty of up to $2,500 for each violation of the Act. If
persons who purchased the  Company's  Laser  Storm(R) game systems in California
believe that the sale to them by the Company  violated the Act, such persons may
be able to sue the Company for damages caused thereby or for rescission, if they
believe the violation was willful. In such event, the Company may have the right
to offset any such claim by the amount of any income  realized  by such  persons
from their operation of the game systems. At this time, the Company has not been
threatened  with any suit for  violation of the Act by any person who  purchased
the Company's  Laser  Storm(R) game  systems.  There are no assurances  that the
Company  will not be  threatened  with such suits in the future.  If a claim for
damages or rescission  were brought against the Company or if the Company deemed
it otherwise  appropriate  to offer  rescission  to previous  purchasers  of the
Company's  Laser Storm(R) game systems in California,  the Company.  Upon making
any such  purchase,  the  Company  would  either  continue  to operate the Laser
Storm(R)  game  facility or utilize the  equipment to open a new Laser  Storm(R)
game facility.

         No assurance can be given that other  jurisdictions will not review the
Company's  activities to determine  whether or not they deem such  activities to
involve the sale of "franchises" or "business opportunities." As of December 31,
1996,  there  were  11  Laser  Storm(R)  game  systems  that  had  been  sold in
California.

Research and Development

         During the two fiscal  years ended  December 31,  1996,  and 1995,  the
Company spent an estimated $321,000 and $140,000,  respectively, on research and
product development.  None of the cost of such research and development is borne
by the Company's customers.

Environmental Laws

         Compliance with federal,  state and local  environmental  laws does not
have a measurable cost or effect on the Company's business.



                                       15

<PAGE>



Financial Public Relations

         The Company has entered into an agreement  with Michelson  Group,  Inc.
("Michelson")  pursuant  to  which  Michelson  is to  provide  financial  public
relations to the  Company.  The  agreement is to be in effect until  October 28,
1997.  The  Company  pays  Michelson  monthly  fees of  $6,000  and has  granted
Michelson an option to purchase  100,000 shares of the Company's Common Stock at
a price of $2.25 per share.

Employees

         As of March 28,  1997,  the Company had 45 full-time  employees  and 42
part-time employees. The Company's employees are not unionized.


ITEM 2.           DESCRIPTION OF PROPERTY

         The  Company  leases  approximately  26,350  square  feet of office and
warehouse space pursuant to a lease which expires on January 31, 2006. The lease
requires base rental  payments of $20,645 per month for the first 36 months with
increases  thereafter  tied to the Consumer Price Index.  Robert J. Cooney,  the
Company's  Chairman of the Board and Chief Executive  Officer,  has individually
guaranteed the obligations of the Company under the new lease until December 31,
2000.  The Company also leases space for the Company  owned Laser  Storm(R) game
facilities. See Note 7 of Notes to Financial Statements.

ITEM 3.           LEGAL PROCEEDINGS

         The Company is not involved in any litigation.

ITEM 4.           SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         No matter was submitted to a vote of the Company's  shareholders during
the quarter ended December 31, 1996.

                                     PART II

ITEM 5.           MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
                  MATTERS

         Market  Information.  The Company's Common Stock has been quoted on the
Nasdaq  Small-Cap  Market under the symbol LAZR,  only since April 23, 1996. For
the period from April 23, 1996 to June 30, 1996,  the high and low bid prices of
the Common Stock were $4.25 and $2.91, respectively. For the period from July 1,
1996,  to September  30,  1996,  the high and low bid prices of the Common Stock

                                       16

<PAGE>



were $3.50 and $2.13,  respectively.  For the period  from  October 1, 1996,  to
December 31,  1996,  the high and low bid prices of the Common Stock were $2.875
and $0.625, respectively.

         Holders.  As of February 28, 1997, the Company had 53 holders of record
of the Company's Common Stock.

         Dividends.  To date,  the  Company has  neither  declared  nor paid any
dividends on its Common Stock,  nor does the Company  anticipate  that dividends
will be paid on its Common Stock in the foreseeable  future. The Company's board
of  directors  presently  intends  to cause  the  Company  to follow a policy of
retaining  earnings,  if any, for the purpose of  expanding  the business of the
Company.  Any future  determination  to pay  dividends  on the Common Stock will
depend on the Company's results of operations,  financial  condition and capital
requirements.  No  assurance  can be given that any holder of Common  Stock will
receive any cash,  stock or other dividends in respect of the holder's shares of
Common Stock.

         The  following  is  information   with  respect  to  all   unregistered
securities sold by the Company within the past three years:

         (a)  Since  the  inception  of the  Company,  the  Company  has  issued
1,601,250  shares of Company's Common Stock to nine persons who at the time were
either  officers,  directors  and/or  employees of the Company.  The shares were
issued in reliance upon the exemption from registration provided by Section 4(2)
of the Securities Act of 1933, as amended  ("Securities  Act"). The facts relied
upon for such exemption are that the purchasers had full  information  available
to them concerning the Company because of their relationships to the Company and
did not need the  protection  afforded  by the  registration  provisions  of the
Securities  Act and the  certificates  representing  the shares of Common  Stock
issued have an  appropriate  restrictive  legend under the  Securities Act typed
thereon and are  restricted  from  transfer.  No  underwriters  were involved in
connection with the issuances of the 1,601,250 shares of Common Stock.

         (b) In October 1995,  Company  completed a private placement of 140,000
shares of Series A 12% Convertible Cumulative Preferred Stock ("Series A Stock")
for a total offering price of $700,000.  The Series A Stock was sold in reliance
upon the exemption from registration  provided by Section 4(6) of the Securities
Act and  Regulation  D  promulgated  thereunder.  The facts relied upon for such
exemption  are  that  the 16  purchasers  represented  that  they  acquired  the
securities for their own accounts for investment  purposes only and not with the
present  intent of  distributing  or reselling  the Series A Stock and that they
were  accredited  investors as such term is defined in Regulation D and a Form D
was timely filed. The Series A Stock certificates had an appropriate restrictive
legend under the Securities Act typed thereon and were restricted from transfer.
The firm of  Laidlaw  Equities,  Inc.  sold the  Series A Stock as agent for the
Company  and was paid a  commission  of  $70,000  and a  nonaccountable  expense
allowance  of $21,000.  In April  1996,  all Series A Stock was  converted  into

                                       17

<PAGE>



shares of Common Stock and  Warrants to purchase  shares of Common  Stock.  Such
issuances  were  made  by the  Company  in  reliance  upon  the  exemption  from
registration provided by Section 3(a)(9) of the Securities Act.

         (c) Effective August 9, 1995, the Company issued one accredited  person
an option to purchase  50,000 shares of the Company's  Common Stock as a part of
the  compensation  payable  to the person  pursuant  to a  consulting  agreement
between the Company and the person.  The option was issued in reliance  upon the
exemption from Registration  provided by Section 4(2) of the Securities Act. The
facts relied upon for such  exemption  are that the person had full  information
available to him concerning  the Company  because of his  relationship  with the
Company and did not need the protection afforded by the registration  provisions
of the  Securities  Act.  Further,  the  option is  nontransferable  other  than
pursuant to the laws of descent and distribution.  No underwriters were involved
in connection with the issuance of the option.

         (d) The Company has issued stock options to the Company's employees and
non-employee  directors  to  purchase  shares  of  Company's  Common  Stock.  No
consideration  was paid by the  employees  or  directors  for such  options  and
Company does not consider  that any sales  occurred as a result of the issuances
of such options.

         (e) In February 1996,  Company completed a private placement of 200,000
shares of Series B 12% Convertible Cumulative Preferred Stock ("Series B Stock")
for a total  offering  price  of  $1,000,000.  The  Series  B Stock  was sold in
reliance upon the exemption  from  registration  provided by Section 3(b) of the
Securities  Act and Rule 504 of Regulation D promulgated  thereunder.  The facts
relied upon for such exemption are that the 26 purchasers  represented that they
acquired the securities for their own accounts for investment  purposes only and
not with the present intent of  distributing or reselling the Series B Stock and
that they were accredited  investors as such term is defined in Regulation D and
a Form D was timely filed.  The Series B Stock  certificates  had an appropriate
restrictive  legend under the Securities  Act typed thereon and were  restricted
from transfer.  The firms of Laidlaw Equities Inc. and Rocky Mountain Securities
and Investments, Inc. sold the Series B Stock as agents for the Company and were
paid commissions of $86,000 and $14,000, respectively. In April 1996, all Series
B Stock was  converted  into  shares of Common  Stock and  Warrants  to purchase
shares of Common Stock. Such issuances were made by the Company in reliance upon
the exemption from  registration  provided by Section  3(a)(9) of the Securities
Act.

         (f)  Effective  February  9,  1996,  the  Company  agreed  to issue one
corporation an option to purchase  175,000 shares of the Company's  Common Stock
as a part of an agreement to settle a lawsuit. The option was issued in reliance
upon the exemption from registration  provided by Section 4(2) of the Securities
Act.  The  facts  relied  upon for  such  exemption  are  that  the  corporation
represented  that it was an  accredited  investor and did not desire any further
information  concerning the Company.  Company  believes the  corporation did not
need the protection  afforded by the  registration  provisions of the Securities
Act. No  underwriters  were  involved  in  connection  with the  issuance of the
option.


                                       18

<PAGE>


         (g) In July 1996,  Company  issued  32,500  shares of Company's  Common
Stock to one person in connection with the purchase by the Company of the assets
of Laser Storm of  Longmont,  Inc.  The shares were issued in reliance  upon the
exemption from  registration  provided by Section 4(2) of the Securities Act and
the  facts  relied  upon for such  exemption  are  that the  purchaser  had full
information available to him concerning the Company, did not need the protection
afforded  by  the  registration   provisions  of  the  Securities  Act  and  the
certificate  representing  the shares of Common Stock issued has an  appropriate
restrictive legend under the Securities Act typed thereon and is restricted from
transfer.  No underwriters  were involved in connection with the issuance of the
32,500 shares of Common Stock.

         (h) In  October  1996,  Company  issued an option to  purchase  100,000
shares of  Company's  Common  Stock to one  corporation  pursuant to a financial
public relations agreement. The option was issued in reliance upon the exemption
from  registration  provided by Section  4(2) of the  Securities  Act. The facts
relied upon for such exemption are that Company believes the corporation did not
need the  protection  afforded  by the  Securities  Act.  No  underwriters  were
involved in connection with the issuance of the option.

         (i) In November 1996,  Company issued 35,625 shares of Company's Common
Stock to one person in connection with the purchase by the Company of the assets
of Ridgeworld  North, Inc. The shares were issued in reliance upon the exemption
from  registration  provided by Section  4(2) of the  Securities  Act. The facts
relied  upon for such  exemption  are that the  purchaser  had full  information
available to it concerning the Company,  did not need the protection afforded by
the   registration   provisions  of  the  Securities  Act  and  the  certificate
representing  the shares of Common Stock issued has an  appropriate  restrictive
legend under the Securities  Act typed thereon and is restricted  from transfer.
No  underwriters  were  involved in  connection  with the issuance of the 35,625
shares of Common Stock.

         (j) Between  July and  December  1996,  four  employees  of the Company
exercised stock options to purchase 30,500 shares of the Company's Common Stock.
The shares were issued in reliance upon the exemption from registration provided
by Section 4(2) of the Securities  Act. The facts relied upon for such exemption
are that the purchasers had full  information  available to them  concerning the
Company, did not need the protection afforded by the registration  provisions of
the Securities Act and the certificates  representing the shares of Common Stock
issued have an  appropriate  restrictive  legend under the  Securities Act typed
thereon and are  restricted  from  transfer.  No  underwriters  were involved in
connection with the issuance of the 30,500 shares of Common Stock.

         (k) The Company has stated one exemption from registration  relied upon
in each of the issuances of unregistered  securities described in paragraphs (a)
through (c) and (e) through (j). Other  exemptions  from  registration  may have
been  available  with  respect  to some or all of such  issuances.  The  Company
reserves  the right to assert in the  future  any or all other  exemptions  from
registration which were available with respect to such issuances.


                                       19

<PAGE>


ITEM 6.           MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
                  OPERATION

Liquidity and Capital Resources

         The  Company's  operations  used cash flow of  $4,023,153  for the year
ended  December  31,  1996,  and used cash flow of  $104,404  for the year ended
December 31, 1995. Cash flow was used during 1996 to fund the loss of $2,745,866
which  occurred  primarily in the fourth  quarter.  The  operating  loss in 1996
negatively impacted the Company's  liquidity position,  however the Company does
still  maintain  over  $750,000  in  working  capital  and  over  $3,300,000  in
stockholders  equity. A large portion of the loss in 1996 was the result of some
non-recurring  issues such as: the development and  introduction of a new themed
game  ($460,000),   the  investigation  of  potential  acquisitions  ($250,000),
severance and  termination  costs  ($249,000) and bad debts  associated with the
return of equipment from a single independent operator ($120,000). Additionally,
the Company  incurred over $550,000 in costs  associated  with  identifying  and
opening  Company-owned  and operated  facilities,  several of which will open in
1997.  A  substantial  portion of these costs are not  necessarily  recurring in
1997. To address the losses in 1996 the Company reduced its corporate  headcount
by  approximately  50%.  Annualized  salaries were reduced by  approximately  $1
million and the non-recurring costs discussed above are not planned for in 1997.
The Company is pursuing financial  alternatives to assist in its working capital
needs as well as capital that will be required to open additional  Company-owned
facilities.  If such financing does not occur, management believes it will still
have adequate cash flow to sustain operations through 1997, but will not be able
to realize its objectives of diversifying  more into  Company-owned and operated
facilities.

         The Company  funded  $1,408,110  in sales made through an extended term
financing  program  offered  beginning in the second quarter of 1996. In October
1996, the Company entered into an agreement with a financial  institution  which
purchases  certain notes receivable under the Company's  extended terms program.
The financial  institution  determines the credit worthiness of the customer and
then, if  appropriate,  purchases the  receivables at a price which results in a
fixed yield (14% as of December 31, 1996).  As of December 31, 1996, the Company
had  sold a  principal  amount  of  $116,918  of these  notes to this  financial
institution  and had a  principal  amount  of  $1,169,745  of these  notes  that
remained unsold.  As of December 31, 1996, the Company does not have the working
capital to  internally  finance  future sales  through  this type of  financing.
However,  the  Company  has  been  able to  establish  alliances  with  external
financial  institutions  in order to make  financing  options  available to it's
customers.

         The Company also increased its inventory by $535,351 in anticipation of
stronger sales and the opening of Company-owned and operated  facilities.  While
1996  sales  were not as  strong  as  originally  expected,  this  inventory  is
available for future sales and will help cash flows in 1997.


                                       20

<PAGE>


         Capital  expenditures  for  the  year  ended  December  31,  1996  were
$1,763,117  compared to  $194,858  for the year ended  December  31,  1995.  The
Company opened four  Company-owned and operated  facilities in 1996. The capital
requirements necessary to acquire and open the four facilities was approximately
$1,300,000.  The  Company  also  purchased  and  upgraded a trade show booth for
$207,000.  The booth was used to present the new Marvel  Comics  X-Men laser tag
arena at the IAAPA show in November  1996 and maybe used for future trade shows.
Additionally the Company purchased $175,000 of office furniture and equipment to
accommodate  the corporate  staff  increases  and incurred  $82,000 in leasehold
improvements for the new facility which the Company moved into in February 1996.

         Financing  activities  provided  $5,982,176  of cash  flow for the year
ended  December 31, 1996 and  provided  $377,022 of cash flow for the year ended
December 31, 1995. In February 1996,  the Company  completed the sale of 200,000
shares of  Series B 12%  Convertible  Cumulative  Preferred  Stock and  received
proceeds of $900,000.  In April 1996,  the Company  completed the public sale of
1,495,000  units at $4.00 per unit.  Each  unit sold  consisted  of one share of
common stock and one warrant.  Proceeds from the sale were $5,202,600.  Offering
costs  associated  with common and preferred  stock  financings were $320,362 in
1996 and $311,211 in 1995.

         The Company also entered into a $200,000  capital lease  arrangement to
assist in the financing of one of its  Company-owned  facilities  that opened in
November  1996.  The Company will require  additional  capital to finance future
Laser  Storm(R)  game  facilities.  Although  no  assurance  can be  given  that
financing will be available on terms acceptable to the Company,  the Company may
seek  additional  funds,  from time to time,  through  public or private debt or
equity offerings, bank borrowings or leasing arrangements.

         The Company has entered into the  following  financial  commitments  in
anticipation of continued  growth from ongoing  operations and in  Company-owned
and revenue participation Laser Storm(R) game facilities:

                  In 1995,  the  Company  entered  into a ten year lease for new
         office,  warehouse and assembly space, the term of which began in March
         1996.  Annual   commitments  under  the  lease  will  be  approximately
         $248,000,  with  periodic  escalation  beginning  in 1999.  This annual
         commitment was made to accommodate the Company's continued growth. With
         the restructuring that took place during the fourth quarter of 1996 the
         Company feels it has the capacity  available to which it may be able to
         sublease  part  of  its  corporate  headquarters  without  compromising
         administrative or operating functions.

                  The  Company  has  employment   agreements  with  two  of  the
         Company's   executive   officers   which   provide   aggregate   annual
         compensation  of $300,000 in 1997 and $225,000 in 1998.  The agreements
         may be terminated by the Company without cause upon 30 days notice.  In
         the event of a termination without cause, the Company would be required
         to pay 100% of the remaining payments until expiration of the agreement

                                       21

<PAGE>


         with  the Company's chief executive  officer and for a six-month period
         for the  president.  The Company entered into the employment agreements
         with the  two  executives  to  formalize  their  employment  status  at
         existing salary levels.

         In July 1996,  the Company  purchased an existing  Laser  Storm(R) game
center  located in  Longmont,  Colorado  from  unaffiliated  persons.  The total
consideration was $160,000,  which was paid at closing by paying $30,000 in cash
and by paying the balance of $130,000 by issuing  32,500 shares of the Company's
common  stock to one of the  sellers.  Pursuant  to the  terms  of the  purchase
agreement,  the Company  registered the 32,500 shares for resale. The seller has
until May 2, 1997 to sell the shares.  If by May 2, 1997 the seller has sold all
or a portion of the shares for less than $130,000,  the Company will immediately
pay the  seller  the  difference  between  the  sales  price of the  shares  and
$130,000.  Any  remaining  shares will be returned to the Company.  If the sales
price of the  shares  sold is more than  $130,000,  the  Company  has no further
obligation to the seller and the seller is entitled to retain any unsold shares.
In  connection   with  the   purchase,   the  Company  also  loaned  the  seller
approximately  $46,380 to pay  seller's  bank loan.  The loan is  evidenced by a
promissory  note, and is secured by a first in priority  interest in the shares.
All proceeds from the sales of the shares shall be applied first to retiring the
loan.

         In November 1996, the Company purchased an existing Laser Storm(R) game
center located in Coral Springs,  Florida from unaffiliated  persons.  The total
consideration  was  $300,000,  which was paid at closing by paying  $142,500  in
cash,  the  cancellation  of a $15,000  receivable  and by paying the balance of
$142,500 by issuing 35,625 shares of the Company's common stock. Pursuant to the
terms of the asset purchase agreement,  the Company registered the 35,625 shares
for resale.  The seller has until June 1, 1997 to sell the shares. If by June 1,
1997 the seller has sold the shares for less than  $142,500,  the  Company  will
immediately pay the seller the difference  between the sales price of the shares
and $142,500. Any remaining shares will be returned to the Company. If the sales
price is more than $142,500, the Company has no further obligation to the seller
and the seller is entitled to retain any excess shares or purchase price.

         As of March 31, 1997,  the closing price of the Company's  common stock
was $0.44 per  share.  Based upon this price the  Company  is  expecting  to pay
approximately  $195,000 to satisfy the agreements on both the Longmont and Coral
Springs agreements.

Results of Operations

         Overview

         The Company's primary source of revenue has been from the sale of Laser
Storm(R) game systems,  including  arenas.  The Company's  systems consist of an
"electronics  platform"  comprised of various  components,  including  blasters,
controllers,  headsets,  targets,  infrared  data  links  and  a  computer  with
operating  software.  The arenas consist of themed,  moveable or fixed barriers,

                                       22

<PAGE>


props and, in most cases,  lighting and sound  packages.  The Company  contracts
third-party  manufacturers  to assemble the system  electronics and incurs labor
costs mainly upon final  configuration of the systems and system software.  With
the  exception  of  turn  key  arenas,  which  are  provided  by  a  third-party
manufacturer, the arena components are final assembled by the Company.

         Utilizing  part of the  proceeds  from the initial  public  offering in
April,  1996, the Company  intended to either acquire  existing  and/or open new
Laser  Storm(R)  game  facilities.  As of  December  31,  1996,  the Company had
acquired two facilities and opened two new facilities. Revenues from the Company
owned and operated facilities for 1996 were $268,129.  Additionally, the Company
had revenues of $144,426 from its revenue sharing arrangements.

         The Company has a warranty  program under a renewable  annual  contract
whereby  customers pay a monthly usage fee.  Historically,  the Company's  total
revenue under this program has not been significant (i.e., less than 7% of total
revenue).  The Company has incurred a marginal financial loss from this program,
but believes it is beneficial for continuing customer  satisfaction.  Management
has recently  implemented a program of increasing fees charged for warranty work
and believes  that the program will result in less of a loss for the year ending
December  31,  1997.  The Company  also  provides  its  customers  with a 90-day
material defects warranty on all system components.

         1996 compared to 1995

         Net Sales from Laser Storm(R) Game Systems and Related Revenues

         Net sales from laser tag game systems and related revenues for the year
ended  December  31,  1996  increased  by 1.5% to  $5,487,899,  as  compared  to
$5,408,745  for the year ended  December  31, 1995.  The  marginal  increase was
primarily  due to increases  in warranty  sales.  The Company  offers a warranty
program to its  customers  whereby the  customer is charged a fee based upon the
number of games played per month. The number of customers  participating in this
program  increased from 64 at December 31, 1995 to 115 at December 31, 1996. The
increase in the number of  participating  customers is the result of  additional
system sales made during 1996 and efforts to convert existing  customers to this
program.

The number of systems  sold in 1996  declined  approximately  17.2%  compared to
1995,  however  revenues  from the sales were only 0.6% lower than the  revenues
from system  sales in 1995.  The primary  reason for revenues  being  marginally
lower on 17.2% fewer number of systems  sold was the average  system sales price
increased  from $80,000 in 1995 to $96,000 in 1996.  The increase in the average
system sales price  resulted from more  customers  purchasing  the themed arenas
offered by the  Company.  The Company  has  developed  five  themes  through the
efforts of its design and marketing  staff as well as through the acquisition of
two  intellectual  property  rights.  A  specific  breakdown  of net sales is as
follows:


                                       23

<PAGE>

                                                  December 31,
                                                  -------------
                                            1995                    1996
                                            ----                    ----

     System and Arena Sales              $5,107,258              $5,078,832

     Warranty Sales                         285,983                 386,407

     Accessories Sales                       15,504                  22,660
                                          ---------               ---------

     Net Sales                          $5,408,745              $5,487,899



         The Company  introduced a financing  program  during the quarter  ended
June 30, 1996 which accounted for 38.5% of net sales for the year ended December
31, 1996. This program  required a 30-40% down payment with the balance financed
over 24 months.  The Company  believes  this program was a necessity to meet the
increased  pressure from the growing number of competitors  offering  aggressive
sales and financing programs.

         System sales are cyclical  during the  calendar  year,  with most sales
typically occurring in the third quarter,  and the least number of sales usually
occurring in the first  quarter.  Management  believes that the increased  sales
during the third quarter are primarily  attributable  to desires of customers to
upgrade their indoor  entertainment  facilities  prior to the  Thanksgiving  and
Christmas   holiday   seasons.   Third  quarter  1996  sales  were   $2,160,777,
representing  39.4% of net sales for the year  ended  December  31,  1996.  This
compares to third quarter 1995 sales of  $1,856,088,  representing  33.8% of net
sales for the year ended December 31, 1995.  Fourth quarter 1996 sales were only
$525,710,  representing  9.6% of net sales for the year ended December 31, 1996.
This compares to the fourth quarter 1995 sales of $1,394,362, representing 25.8%
of net sales for the year ended  December 31,  1995.  Management  believes  that
there has been a decline in capital  purchasing within the family  entertainment
center  industry.  Management also believes that the decline began in the middle
of 1996,  which  necessitated the attractive  financing  packages offered by the
Company  during  the  second  and third  quarters.  Net sales  during the fourth
quarter  of 1996 were at the  lowest  level in over two  years and came  after a
record setting third quarter of $2,160,777.

         Net Sales from Retail Operations

         The Company opened four  Company-owned  Laser Storm(R) game  facilities
during 1996 and is currently involved in seven revenue participation facilities.
Net sales from retail  operations for the year ended December 31, 1996 increased
to $410,312  compared  to $68,404 for the year ended  December  31,  1995.  This
increase  is  primarily  the  result  of the  sales  generated  by the  four new
Company-owned  facilities.  Subsequent  to  year  end  the  Company  opened  one
additional  facility and management  expects to open six more  facilities by the
end of the second  quarter.  The  Company  will  require  additional  capital to
finance the costs of opening these and future  facilities.  A specific breakdown
of net sales from retail operations is as follows:

                                       24

<PAGE>


                                                  Year Ended December 31,
                                                 -----------------------
                                                 1995              1996
                                                 ----               ----

     Company-owned Laser Storm(R)              $  --              $268,129
     Game Facilities

     Revenue Participation Facilities           68,404             142,183
                                               -------             -------

       Net Sales                               $68,404            $410,312

         Net sales from the revenue  participation  facilities  increased 107.9%
primarily  as a result  of the  Funplex  revenue  share  facility  which is also
operated by the Company.  The Funplex facility,  which is located in the Denver,
Colorado metropolitan area, opened in November 1995 and represents approximately
50% of the  total  sales  generated  by all seven of the  revenue  participation
facilities in 1996.

         Gross Profit from Laser Storm(R) Game Systems and Related Revenue

         Gross  profit from laser tag game  systems and related  revenue for the
year ended  December 31, 1996  decreased 2.4% to $3,010,484 as compared to gross
profit of  $3,085,274  for the year ended  December 31, 1995.  Gross profit as a
percentage of net sales  decreased  2.1% during the year ended December 31, 1996
to 54.9% compared to 57.0% for the year ended December 31, 1995.

         The  decrease in the gross profit  percentage  in 1996 is the result of
selling three  "hardwall"  arenas which have lower margins.  The hardwall arenas
have lower  margins  because they are  manufactured  by an  independent  vendor,
rather  than  by the  Company.  The  hardwall  arena  is  considered  a  turnkey
opportunity  for the customer in that it includes the normal themed barriers and
other game  components  as well as carpet,  sales  counters  and sign  packages.
Without the impact of the hardwall  arenas,  the Company  would have  realized a
slight improvement in its gross profit percentage. This slight improvement would
have been primarily the result of the Company having realized some  efficiencies
from improved purchasing management and improved assembly processes.

         Gross Profit from Retail Operations

         Gross profit from retail operations for the year ended December 31,1996
increased to $258,651  compared to $39,269 for the year ended December 31, 1995.
The  increased  gross  profit  in  1996  is  the  result  of  opening  the  four
Company-owned  Laser Storm(R) game  facilities.  Two of the four facilities were
opened  in  late  July  1996  and  the  other  two  in  November  of  1996.  The
Company-owned  facility  sales and operating  expense  results were in line with
management's estimates for the facilities.


                                       25

<PAGE>


         General and Administrative Expenses

         General and administrative  expenses ("GA expense") increased by 130.8%
to $3,515,768  for the year ended  December 31, 1996 compared to $1,523,038  for
the year ended  December 31, 1995.  As a percentage  of net revenues  (net sales
from laser tag game  systems  and  related  revenues  plus net sales from retail
operations)  GA expenses  increased to 59.6% in 1996  compared to 27.8% in 1995.
The increased GA expenses are the result of increased costs  associated with the
following items:

         Diversification of the business;
         Travel and professional  fees related to the investigation of potential
            acquisitions;
         Public company reporting requirements;
         Facility expansion;
         Executive personnel additions;
         Increased bad debts provision.

         The  Company  had  previously  recognized  the  attractiveness  of  the
recurring  revenues and  profitability  generated by its independent  operators.
However, prior to the public offering in April of 1996, the Company did not have
the financial  resources to open and operate the  facilities.  Subsequent to the
public offering the Company has acquired or opened five  facilities.  During the
year ended December 31, 1996,  the Company  incurred  approximately  $550,000 in
staffing,  travel and set up costs in identifying and opening the  Company-owned
and operated facilities.

         During the latter half of 1996 the  Company  entered  into  discussions
with two  potential  acquisition  candidates  which  would have  allowed for the
Company to acquire a large Family  Entertainment Center ("FEC") and a competitor
within the laser tag industry.  The  acquisition  of the FEC would have fit into
the long term plan of opening  Company-owned  facilities and the  acquisition of
the competitor would have allowed for enhanced technology and diversification of
the Laser Storm(R)  products.  The Company  incurred  approximately  $250,000 in
legal fees,  accounting fees,  travel expenses and other  professional  costs in
connection  with the two  acquisitions.  Letters of intent were  drafted and due
diligence efforts were nearly completed on both acquisitions.  In December 1996,
the Company decided to withdraw its offers when the Company's common stock price
declined  from $1.88 per share to $1.00 per share.  The Company was  notified in
December  that the  underwriter  of its public  offering and its primary  market
maker in its common  stock was  discontinuing  making a market in the  Company's
common stock in connection with the closing of an office of the market maker.

         The Company incurred increased  professional  fees,  investor relations
costs,  insurance  costs and outside board member fees as a result of its public
offering in April of 1996. The public reporting requirements required additional
accounting  and legal fees to be  incurred.  The Company  also hired an investor
relations firm to assist in establishing and maintaining adequate communications
to its shareholders.  The above costs were approximately $270,000 higher in 1996
than in 1995.

                                       26

<PAGE>



         The Company moved into a new facility in February  1996. The rent costs
for the new facility  along with the associated  costs of utilities,  telephone,
repairs,  maintenance  and other costs  increased by  approximately  $300,000 in
1996.  The Company  moved from a 17,500  square foot  facility  into the current
facility which has  approximately  26,350 square feet.  The increased  space has
been utilized to allow for more efficient  production and warehousing efforts as
well as office space for the  additional  staffing  required to support  opening
Company-owned and operated facilities.

         Executive compensation in 1996 increased by approximately $226,000 with
the addition of a Vice  President of Retail  Operations  and a Vice President of
Marketing and Product Development in December of 1995.  Additionally the Company
hired a Vice President of Real Estate and  Construction  in October of 1996. All
three of these positions were eliminated during a staff restructuring that began
in December 1996.

         The  Company  increased  its  provision  for bad debts  during  1996 by
approximately  $193,000. A portion of the 1996 bad debts provision resulted from
notification  by a  customer  of the  return  of  equipment  as a result  of the
customer's   inability  to  place  the  equipment  in  an  acceptable  location.
Additionally,  the  Company  had a number  of  smaller  receivables  which  were
determined to be uncollectible and were written off in 1996.

         Selling and Marketing Expenses

         Selling and marketing  expenses ("SM expenses")  increased  $809,309 or
98.6% to $1,629,780 for the year ended  December 31, 1996,  compared to $820,471
for the year ended  December 31, 1995.  The primary  reason for the increase was
the  marketing of the Company's  newest themed arena,  Marvel Comics X-Men laser
tag. In July 1996,  the Company  entered  into a license  agreement  with Marvel
Characters, Inc. to utilize the characters of the popular comic book and cartoon
series X-Men.  The Company  increased its marketing,  advertising and trade show
expenditures  by over  $350,000  in order to present the X-Men arena and game at
the International  Association of Amusement Parks and Attractions ("IAAPA") show
in November  1996.  While the  presentation  and game were well received by game
players,  many of the independent  operators  considered the Company's  proposed
selling  price to be too high.  Rather  than  sacrifice  a portion  of the gross
margin for this  product,  the  Company has decided to  initially  utilize  this
licensed  theme  in its  Company-owned  facilities  rather  than  sell it to the
independent  operators.  Management  believes the well known  recognition of the
Marvel Comics X-Men  characters  and the new game features  which were developed
for the X-Men laser tag theme, will help the Company-owned  facilities establish
a separate identity from the Company's independent licensed operators. The first
X-Men laser tag  facility  owned and operated by the Company is expected to open
in May 1997.

         The Company also  increased its marketing  staff  expenditures  by over
$200,000 in an effort to support the  introduction  of the X-Men game as well as
to support the rollout of Company-owned facilities.  Additionally, the Company's
sales department salaries increased by approximately  $190,000. The increase was

                                       27

<PAGE>


the result of adding additional sales and sales support staff With the increased
number of competitors  entering the market place, it was felt the Company needed
to increase its sales presence with the independent operators..

         Severance and Termination Costs

         Late in the fourth  quarter of 1996 the Company  recognized  that there
was going to be a significant decline in sales. Accordingly,  management decided
to reduce the Company's  workforce.  In December 1996, the Company concluded its
internal evaluation of its corporate overhead requirements and reduced its staff
by approximately 25% and again in February 1997 by approximately another 25%. As
a result  of these  staff  reductions  the  Company  terminated  the  employment
contracts with three of its executive officers. These individuals had employment
contracts with the Company which allowed for six month severance  packages.  The
Company accrued  approximately  $195,000 in severance and termination  costs for
these three agreements during the fourth quarter of 1996. In accordance with the
terms of the three employment agreements,  $115,000 in compensation will be paid
to two of the executives by June 30, 1997, and $50,000 in  compensation  will be
paid to the third executive by July 31,1997.

         Product Development Costs

         Product  development costs increased by 129.1% to $320,671 for the year
ended  December 31, 1996,  compared to $139,979 for the year ended  December 31,
1995. As a percentage of net revenues,  product  development  costs increased to
5.4% for the year ended  December  31, 1996  compared to 2.6% for the year ended
December 31, 1995.  These  increases  are  primarily  the result of staffing and
design  consulting fees incurred to develop the new game features for the Marvel
Comics  X-Men  laser  tag  game as  well as to  enhance  the  Company's  current
electronics platform.

         Contingent Settlements

         In  December  1995,  the  Company  was served  with two  lawsuits.  The
Company's  legal  counsel was retained and believed the Company had a defendable
position;  however,  to avoid  extensive  litigation,  the Company  entered into
settlement  agreements  with both parties.  Also, in January 1996, a court ruled
that the Company must pay a former employee approximately $90,000. Therefore, at
December 31, 1995 the Company accrued a total of $270,000 in connection with the
settlements and the court ruling.

         Operating Income (Loss)

         The Company incurred an operating loss of $2,743,561 for the year ended
December 31, 1996  compared to  operating  income of $254,872 for the year ended
December 31, 1995.  Most of the loss incurred  during 1996  occurred  during the
fourth quarter. The decline in sales and many of the GA and SM expenditures that
occurred  during  the  fourth  quarter  resulted  in a  $2,624,228  loss for the

                                       28

<PAGE>



quarter.  Management responded to the fourth quarter performance by reducing its
corporate  overhead beginning in December 1996. As a result of the unpredictable
nature of the system sales cycle and the recurring revenue opportunity presented
by opening Company-owned facilities,  management feels the Company must continue
to move in the  direction of becoming  primarily a facility  owner and operator.
Subject to obtaining  sufficient  financing,  delays that may be  encountered in
obtaining suitable locations and in construction, management is planning to open
up to 22 new Company-owned and operated facilities during 1997.

         Depreciation and Amortization

         Depreciation  and  amortization  increased  from  $116,183 for the year
ended  December 31, 1995 to $297,709 for the year ended  December 31, 1996.  The
increase is primarily the result of the capital expenditures made related to the
opening and acquisition of the four Company-owned and operated facilities.

         Loss on Disposal of Equipment

         The Company recognized a loss of $86,934 in 1996 on the disposal of two
inflatable arenas. One of the arenas had been used in a revenue sharing facility
and the other used as demonstration equipment for trade shows.

         Interest Income

         Interest  income  increased from $2,282 for the year ended December 31,
1995 to $97,202 for the year ended December 31, 1996. The increase was primarily
the result of interest  income earned on the investment of funds  generated from
the public offering in April 1996.

         The foregoing  discussion contains certain  forward-looking  statements
within the meaning of Section 27A of the  Securities Act of 1933 and Section 21E
of the Securities  Exchange Act of 1934, which are intended to be covered by the
safe harbors created thereby.  These statements include the plans and objectives
of management for future  operations.  Such  statements are dependent on certain
risks and  uncertainties  including  such factors among others as,  construction
delays  that may be  encountered  in  opening  new  stores,  market or  customer
acceptance,  market demand,  entertainment product  introductions,  competition,
pricing, changing regulatory environment, changing economic conditions, risks in
new product  and service  development,  the effect of the  Company's  accounting
policies and other risk factors. The forward-looking  statements included herein
are based on current expectations that involve numerous risks and uncertainties.
Assumptions  relating to the foregoing  involve judgments with respect to, among
other things,  future  economic,  competitive  and market  conditions and future
business  decisions,  all of  which  are  difficult  or  impossible  to  predict
accurately and many of which are beyond the control of the Company. Although the
Company believes that the assumptions underlying the forward-looking  statements
are reasonable, any of the assumptions could be inaccurate and, therefore, there

                                       29

<PAGE>



can be no assurance that  the forward-looking  statements  included in this Form
10-KSB  will prove to be  accurate.  In light of the  significant  uncertainties
inherent in the  forward-looking  statements  included herein,  the inclusion of
such information  should not be regarded as a  representation  by the Company or
any other person that the objectives and plans of the Company will be achieved.

ITEM 7.           FINANCIAL STATEMENTS

         The financial statements are attached following the Signature Page.

ITEM 8.           CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                  ACCOUNTING AND FINANCIAL DISCLOSURES

         Not Applicable.

                                    PART III

ITEM 9.           DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
                  PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EX-
                  CHANGE ACT

         The  following  table  sets  forth the  names  and ages of the  current
directors  and  executive  officers of the Company,  the  principal  offices and
positions with the Company held by each person and the date such person became a
director or executive  officer of the Company.  Each director  serves a one year
term and until the  director's  successor  is  elected  or until the  director's
death, resignation or removal.

<TABLE>
<CAPTION>
                                                        Officer
                                                         and/or
Names of Executive                                      Director
Officers and Directors                   Age              Since          Position
----------------------                   ---            --------         --------

<S>                                       <C>             <C>            <C>
Robert J. Cooney...................       33              1990           Chairman of the Board, Chief
                                                                         Executive Officer and Director

William R. Bauerle.................       46              1994           President, Chief Operating Officer,
                                                                         Secretary and Director

John E. McNutt.....................       40              1996           Chief Financial Officer, Treasurer
                                                                         and Director

Frank J. Ball......................       42              1994           Director

Harold Skripsky....................       48              1995           Director

------------------
</TABLE>

         Robert J. Cooney has been the Chairman of the Board and Chief Executive
Officer of the  Company  since March 1990 and was the  Treasurer  of the Company

                                       30

<PAGE>



from October 1994 to February 1997. Mr. Cooney was President of the Company from
February 1992 to April 1994. From September 1989 to March 1990, Mr. Cooney was a
Manager with NBSI Capital  Corp.,  a company  which had  developed a rudimentary
laser tag game.

         William  R.  Bauerle  has been the  President  and the Chief  Operating
Officer of the Company  since April 1994 and a director and the Secretary of the
Company  since July 1994.  From 1985 to 1994,  Mr.  Bauerle  was  President  and
Director of Asset Development  Corporation,  a software development and business
consulting firm. From 1989 to 1991, Mr. Bauerle was the Executive Vice President
and, from 1990 to 1991 was a director, of Analytical Development Corporation,  a
company  which  provides a wide range of  analytical  services  to the  chemical
industry.  Mr. Bauerle received a bachelor's  degree in business  administration
from the University of Notre Dame with a major in marketing research.

         John E. McNutt has been the Chief  Financial  Officer,  Treasurer and a
director of the Company since  February  1997 and was Vice  President of Finance
from  July  1996 to  February  1997.  From  1981 to July  1996  Mr.  McNutt  was
associated  with CAIRE,  Inc.,  formerly  Mountain  Medical  Equipment,  Inc., a
manufacturer  and seller of home health care  respiratory  equipment,  where Mr.
McNutt served in various  capacities  including  corporate  controller  and Vice
President of a subsidiary,  Mountain  Medical  Leasing Co. From 1979 to 1991 Mr.
McNutt  was a staff  accountant  with  Dewey A.  Rippy,  CPA.  Mr.  McNutt  is a
certified  public  accountant  with over 15 years  experience  in corporate  and
manufacturing   accounting  and  finance   including  public   accounting.   His
responsibilities  have included  designing and  implementation  of manufacturing
accounting systems,  development of budgeting and forecasting systems, corporate
taxation,  directing  external audits and financial  reporting to the Securities
and Exchange  Commission.  Mr. McNutt  received a bachelor of science  degree in
business administration, accounting from Colorado State University.

         Frank J. Ball has been a director of the Company since October 1995 and
was Vice  President  of  Manufacturing  of the  Company  from  November  1996 to
December  1996,  Executive  Vice  President of the Company from November 1994 to
October 1996 and General  Counsel of the Company  from  inception of the Company
until October 1996. From 1989 to the present,  Mr. Ball has also been engaged in
the private practice of law focusing on trial work regarding domestic relations,
criminal and  commercial  litigation.  Mr. Ball received a bachelor's  degree in
marketing and organizational management from the University of Colorado, masters
degrees in business administration and public administration, and a Juris Doctor
degree from the University of Denver.

         Harold  Skripsky has been a director of the Company since October 1995.
Mr. Skripsky has been engaged in the restaurant and entertainment business since
1973.  Since February 1996, Mr.  Skripsky has been the owner and operator of The
Enchanted Castle, a theme oriented restaurant and entertainment  center which he
co-founded and owned from 1981 to 1993. In 1993, Mr. Skripsky sold the Enchanted
Castle to Discovery  Zone.  From 1993 to February  1996,  Mr.  Skripsky was Vice
President  of  Operations  for  the  Family  Entertainment  Center  Division  of

                                       31

<PAGE>



Discovery  Zone where he has headed  special  projects  and new concepts for the
Discovery  Zone Fun Centers and corporate  operations.  Discovery Zone filed for
reorganization  under Chapter 11 of the United States  Bankruptcy  Code in March
1996. From 1981 to 1992, Mr. Skripsky was engaged in the development,  ownership
and operation of family style restaurants, including the development and opening
of the Enchanted Castle, a theme-oriented  restaurant and entertainment  center.
In 1993 Mr.  Skripsky  expanded  Enchanted  Castle and included a 32-player live
action laser game from Q-Zar.  Mr. Skripsky is a director for the  International
Family  Entertainment  Center  Association  and is a member of a number of other
industry  organizations.  He received  his  bachelor of science in business  and
marketing from Northwest Missouri State University.

         There  are  no  family  relationships  among  any of  the  officers  or
directors of the Company.

         The Company has purchased  insurance in the amounts of  $1,000,000  and
$532,258 on the lives of Robert J. Cooney and William R. Bauerle,  respectively.
At death or surrender of the policies,  the Company will recover its  cumulative
share of the premiums paid for the cash values (in the case of surrender) or the
death benefit (in the case of death).  The employees or their  beneficiaries are
entitled to receive  cash values in excess of the  cumulative  premiums  (in the
case of policy surrender) or the death benefit in excess of cumulative premiums.
The  Company  has  also  obtained  key man  life  insurance  in the  amounts  of
$2,000,000 each on the lives of Messrs.  Cooney and Bauerle,  respectively.  The
Company is the sole beneficiary of this insurance.

Compliance with Section 16(a) of the Securities Exchange Act of 1934

         Section  16(a) of the  Securities  Exchange  Act of 1934,  as  amended,
requires the Company's  directors and officers and persons who own more than 10%
of a registered class of the Company's equity securities to file various reports
with the  Securities  and Exchange  Commission  and the National  Association of
Securities Dealers concerning their holdings of, and transactions in, securities
of the Company. Copies of these filings must be furnished to the Company.

         Based on a review of the copies of such forms  furnished to the Company
and written  representations  from the  Company's  officers and  directors,  the
Company believes that all of the Company's  officers and directors have made all
filings  required  under  Section  16(a) on a timely basis during the year ended
December 31, 1996, except for James E. Johnson,  a former officer of the Company
who was late in filing his Form 3.

ITEM 10.          EXECUTIVE COMPENSATION

         The  following  table sets forth  certain  information  concerning  the
compensation  paid by the Company for services rendered in all capacities to the
Company for the fiscal years ended  December 31, 1996,  1995 and 1994,  of those
persons who were, at December 31, 1996 (i) the chief executive  officer and (ii)

                                       32

<PAGE>



the other most highly compensated executive officers of the Company whose annual
salary and bonus from the Company  exceeded  $100,000  for the fiscal year ended
December 31, 1996.

<TABLE>
<CAPTION>
                           Summary Compensation Table

                                                                                          Long Term
                                                                  Annual Compensation    Compensation
                                                       --------------------------------- ------------
                                                                                          Securities
Name and Principal                                                         Other Annual   Underlying    All Other
Positions at 12/31/96                          Year     Salary    Bonus    Compensation    Options    Compensation
----------------------------------------    ----------  -------  --------  ------------   ----------  ------------

<S>                                            <C>    <C>          <C>     <C>                 <C>     <C>    
Robert J. Cooney............................   1996...$ 150,000  - 0 -     $28,942(1)         -0-         None
Chairman of the Board and                      1995...$ 150,000  - 0 -     $24,335(1)         -0-         None
Chief Executive Officer                        1994...$  97,500  - 0 -     $ 3,883(1)         -0-         None

William R. Bauerle..........................   1996...$ 150,000   -0-      $26,681(2)         -0-          -0-
President and Secretary                        1995...$ 150,000   -0-      $21,099(2)       75,000         -0-
                                               1994...$  71,250   -0-      $ 2,934(2)       75,000     $21,727(3)

Eric B. Schwartzman.........................   1996...$ 100,000   -0-        $11,294          -0-          -0-
Vice President of Marketing                    1995...$  -0-      -0-          -0-          75,000         -0-
and Product Development until January 1997     1994...$  -0-      -0-          -0-            -0-          -0-

Frank J. Ball...............................   1996...$ 120,000   -0-        $12,016          -0-      $15,238(6)
Vice President of Manufacturing,               1995...$  45,411   -0-      $ 5,685(5)         -0-      $14,020(6)
Executive Vice President,                      1994...$  -0-      -0-          -0-            -0-      $14,000(6)
Operations and General
Counsel until December
1996, October 1996 and
October 1996, respectively,
and Director

Michael D. Kessler..........................   1996...$ 110,000   -0-      $43,571(7)         -0-          -0-
Vice President of Retail                       1995...$  13,749   -0-          -0-          75,000         -0-
Operations until December                      1994...$  -0-      -0-          -0-            -0-          -0-
1996
------------------
</TABLE>

         (1)  Includes  amounts  paid by the  Company  for  automobile  expenses
($12,159 in 1996,  $8,988 in 1995 and $3,218 in 1994),  health club dues ($1,490
in 1996, $1,559 in 1995 and $665 in 1994),  life insurance  premiums advanced on
behalf of Mr.  Cooney  ($12,110  in 1996 and  $12,111  in 1995)  and  disability
insurance  premiums  ($3,183 in 1996 and $1,677 in 1995).  Does not  include any
value that may have been  realized by Mr.  Cooney when he used  whatever  equity
there was in a Company  automobile  as a down payment on a personal  automobile.
The Company estimates the amount of the equity to be less than $5,000.

         (2)  Includes  amounts  paid by the  Company  for  automobile  expenses
($11,637 in 1996 and $7,204 in 1995), health club dues ($250 in 1995 and $660 in
1994),  life insurance  premiums  advanced on behalf of Mr. Bauerle  ($11,635 in
1996,  $11,635 in 1995 and  $1,939 in 1994) and  disability  insurance  premiums
($3,407 in 1996, $2,010 in 1995 and $335 in 1994).


                                       33

<PAGE>



         (3)  Represents  consulting  fees  paid to a  corporation  owned by Mr.
Bauerle prior to Mr. Bauerle becoming an employee of the Company.

         (4)  Includes  amounts  paid by the  Company  for  automobile  expenses
($11,244 in 1996).

         (5)  Includes  amounts  paid by the  Company  for  automobile  expenses
($10,526  in 1996 and  $4,605 in 1995),  health  club dues  ($1,490  in 1996 and
$1,080 in 1995).

         (6) Represents  amounts paid in legal fees for services rendered by the
law firm owned by Mr. Ball.

         (7)  Includes  amounts  paid by the  Company  for  automobile  expenses
($8,742 in 1996, health club dues ($1,320 in 1996) and a commission  ($33,509 in
1996).

Option Grants in the Last Fiscal Year

         No options were granted by the Company to Robert J. Cooney,  William R.
Bauerle,  Eric B.  Schwartzman,  Frank J. Ball or Michael D. Kessler  during the
Company's fiscal year ended December 31, 1996.

Value of Options at December 31, 1996

<TABLE>
<CAPTION>
                                                  Aggregate Fiscal Year End Option Values
                                    -------------------------------------------------------------------------
                                     Number of Securities Underlying Un-        Value of Unexercised In-the-
                                    exercised Options at Fiscal Year End        Money Options at Fiscal Year
                                          Exercisable/Unexercisable             End Exercisable/Unexercisable
                                    ------------------------------------        -----------------------------
<S>                                             <C>                                  <C>
Robert J. Cooney...............                      -0-                                     -0-
William R. Bauerle.............                 50,000/25,000                        $40,000/$20,000(1)
Eric B. Schwartzman............                 25,000/50,000                                -0-
Frank J. Ball..................                      -0-                                     -0-
Michael D. Kessler.............                 25,000/50,000                                -0-

----------------------
</TABLE>

         (1) The  value  is  based  on the  closing  sale  price of $1.00 of the
Company's  Common  Stock on December  31, 1996 minus the  exercise  price of the
options.

         No options to purchase the  Company's  Common  Stock were  exercised by
Messrs.  Cooney,  Bauerle,  Schwartzman,  Ball or Kessler  during the  Company's
fiscal year ended December 31, 1996.

         Until  December 31, 1997,  the Company has agreed with Laidlaw that the
Company will not increase,  without  shareholder  approval,  the compensation of
Messrs.  Cooney and  Bauerle by more than an  aggregate  of 15% per annum  above
current levels. Subject to the foregoing limitations, the Company may reserve up
to 10% of net pre-tax profits over $1,000,000 for bonuses to Company  executives
and employees.

                                       34

<PAGE>


Employment Agreements

         Messrs. Cooney and Bauerle have employment agreements with the Company.
Each  employment  agreement  contains  provisions  that  the  employee  will not
disclose Company confidential  information and will not compete with the Company
for 24 months after termination of their agreements.

         Mr. Cooney's  agreement was effective October 1, 1994,  extends through
September  10, 1998 and  provides for an annual  salary of  $150,000.  Effective
February 1, 1997, Mr. Cooney temporarily  reduced his annual salary to $100,000.
The amount not being paid is being accrued by the Company for later payment. The
Company  may  terminate  the  agreement  with or without  cause.  If the Company
terminates Mr. Cooney's  agreement  without cause,  the Company must continue to
pay Mr. Cooney his salary until September 10, 1998.

         Mr. Bauerle's  agreement was effective October 1, 1994, extends through
September  10, 1998 and  provides for an annual  salary of  $150,000.  Effective
February 1, 1997, Mr. Bauerle temporarily reduced his annual salary to $100,000.
The amount not being paid is being accrued by the Company for later payment. The
Company  may  terminate  the  agreement  with or without  cause.  If the Company
terminates  Mr.  Bauerle's  agreement  without  cause,  the Company must pay Mr.
Bauerle his salary for six months after the termination.

         Mr. McNutt does not have an employment  agreement with the Company. Mr.
McNutt  receives  a salary of  $78,000  annually,  and was  granted  options  to
purchase  75,000  shares of the Company's  Common Stock at an exercise  price of
$2.25 per share.  The options vest 25,000 on August 15,  1997,  25,000 on August
15, 1998, and 25,000 on August 15, 1999,  and expire on August 15, 2002,  August
15, 2003, and August 15, 2004, respectively.

         Each executive officer also receives a $725 per month vehicle allowance
and is reimbursed for all other business related expenses.

Termination Arrangements with Former Officers

         Frank J. Ball, the former  Executive Vice President and General Counsel
of the Company and a Director of the Company had an  employment  agreement  with
the Company that was  terminated on December 6, 1996.  As a result,  the Company
must pay Mr. Ball his salary and benefits through June 1997.

         Michael D. Kessler,  the former Vice President of Retail  Operations of
the Company, had an employment agreement with the Company that was terminated on
December 6, 1996. As a result,  the Company must pay Mr.  Kessler his salary and
benefits through June 1997.

         Eric B. Schwartzman, the former Vice President of Marketing and Product
Development, had an employment agreement with the Company that was terminated on

                                       35

<PAGE>


January 16, 1997. As a result,  the Company must pay Mr.  Schwartzman his salary
and benefits through July, 1997.

Amended Stock Incentive Plan

         The Company has adopted an Amended Stock  Incentive Plan ("Plan") which
authorizes  the Company to grant  incentive  stock options within the meaning of
Section  422A of the  Internal  Revenue  Code of  1986,  as  amended,  to  grant
nonstatutory stock options and to make restricted stock grants. The Plan relates
to a total of 300,000 shares of Common Stock.  Options relating to 30,500 shares
have been exercised and options  relating to 257,580 shares were  outstanding at
December  31,  1996.  The  options  vest in  equal  annual  installments  over a
three-year  period  from  their  respective  dates of  grant.  The  options  are
exercisable  at $0.20 per share for 135,500  shares,  $2.00 per share for 28,500
shares, $4.00 per share for 43,500 shares and $2.25 per share for 50,000 shares.
The  outstanding  options must be  exercised  within five years from the date of
vesting and no later than three months after  termination of employment,  except
that any  optionee  who is  unable  to  continue  employment  due to  total  and
permanent  disability  may exercise such options  within one year of termination
and the options of an optionee  who is employed or disabled and who dies must be
exercised within one year after the date of death.

         The Plan requires that the exercise  prices of options  granted must be
at least equal to the fair market  value of a share of Common  Stock on the date
of grant,  provided  that if an  employee  owns  more than 10% of the  Company's
outstanding  Common Stock then the exercise price of an incentive option must be
at least 110% of the fair market value of a share of the Company's  Common Stock
on the date of grant,  and the maximum term of such option may be no longer than
five years.  The aggregate fair market value of Common Stock,  determined at the
time the option is granted, for which incentive stock options become exercisable
by an employee during any calendar year is limited to $100,000.

         The Plan is to be administered by the Company's Board of Directors or a
committee  thereof which determines the terms of options granted,  including the
exercise price, the number of shares of Common Stock subject to the option,  and
the terms and  conditions  of  exercise.  No  option  granted  under the Plan is
transferrable  by the  optionee  other than by will or the laws of  descent  and
distribution, and each option is exercisable during the lifetime of the optionee
only by such optionee.

         Restricted stock grants to employees may also be made under the Plan on
such terms and conditions as the Board of Directors or committee determines.

1996 Incentive and Nonstatutory Stock Option Plan

         The Company has  adopted,  subject to  shareholder  approval,  the 1996
Incentive and Nonstatutory  Stock Option Plan ("1996 Plan") which authorizes the
Company to grant  incentive  stock options  within the meaning of Section 422 of

                                       36

<PAGE>


the Internal Revenue Code of 1986, as amended,  and to grant  nonstatutory stock
options.  The 1996 Plan relates to a total of 1,000,000  shares of common stock.
No shares  have been  exercised  and  options  relating  to  25,000  shares  are
outstanding,  all of which  were  granted to John E.  McNutt,  an officer of the
Company. The options vest in 1999. The outstanding  incentive stock options must
be exercised  within five years from the date of vesting and no later than three
months  after the  termination  of  employment,  except that any optionee who is
unable to continue employment due to total and permanent disability may exercise
such options within one year of  termination  and the options of an optionee who
is employed or disabled and who dies must be exercised within one year after the
date of death.

         The per share  exercise  price for the shares to be issued  pursuant to
exercise of an option is determined by the board of directors. However, the 1996
Plan requires that the exercise  prices of incentive  stock options granted must
be at least  equal to the fair  market  value of a share of common  stock on the
date of grant,  provided that if an employee owns more than 10% of the Company's
common stock,  then the exercise  price of an incentive  stock option must be at
least 110% of the fair market value of a share of the Company's  common stock on
the date of grant,  and the  maximum  term of such  option may be no longer than
five years.  The aggregate fair market value of common stock,  determined at the
time the option is granted, for which incentive stock options become exercisable
by an employee during any calendar year is limited to $100,000.  The options may
be granted to any person  selected by the board.  Incentive stock options may be
granted only to employees.  The 1996 Plan is to be administered by the Company's
board of directors or a committee of two or more  non-employee  directors  which
determines  the terms of the options  granted,  including  the  exercise  price,
number of  shares  of common  stock  subject  to the  option,  and the terms and
conditions of exercise. No incentive stock option granted under the 1996 Plan is
transferable  by the  optionee  other  than by will or the laws of  descent  and
distribution.  Each option is  exercisable  during the  lifetime of the optionee
only by such optionee.

Compensation of Directors

         During 1996,  the Company  paid to each of Harrison A. Price,  a former
director of the Company, and Harold Skripsky, a current director of the Company,
$20,000 per year.  In 1997,  the  Company  will pay $5,000 per quarter to Harold
Skripsky.  In 1995,  the Company  also  granted to each of Harrison A. Price and
Harold Skripsky an option to purchase 50,000 shares of Common Stock at $4.00 per
share.  One-half  of each  option  vested in October  1995,  one quarter of each
option vested in October 1996 and one quarter of Harold  Skripsky's  option will
vest in October 1997.  One quarter of Harrison A. Price's  option (i.e.,  12,500
shares)  terminated when he resigned as a director of the Company in March 1997.
The options  must be  exercised  within five (5) years from the date of vesting.
The options were not granted under the Plan or the 1996 Plan.



                                       37

<PAGE>



ITEM 11.          SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                  MANAGEMENT

         The  following  table  sets forth  certain  information  regarding  the
beneficial ownership of the Company's Common Stock,  outstanding as of March 15,
1997,  by (i) each person who is known to the Company to own  beneficially  more
than 5% of the  outstanding  Common  Stock with the address of each such person,
(ii)  each  of the  Company's  directors  and  officers,  and  (iii)  all of the
Company's officers and directors as a group.

<TABLE>
<CAPTION>

Name and Address of Beneficial Owner                             Amount and Nature of                   Percent of
or Name of Officer or Director                                  Beneficial Ownership(1)                   Class(2)
------------------------------------                            -----------------------                  ---------
<S>                                                                <C>                                     <C>  
Robert J. Cooney....................................               841,800                                 22.0%
7808 Cherry Creek South Drive, Unit 301
Denver, Colorado 80231

William R. Bauerle.....................................            151,250(3)                               3.9%
7808 Cherry Creek South Drive, Unit 301
Denver, Colorado 80231

John E. McNutt.........................................             75,000(4)                               1.9%
7808 Cherry Creek South Drive, Unit 301
Denver, Colorado 80231

Frank J. Ball..........................................             76,250                                  2.0%
216 16th Street, Suite 800
Denver, Colorado 80202

Harold Skripsky........................................             50,000(5)                               1.3%
1103 South Main Street
Lombard Pines Plaza
Lombard, Illinois 60148

All Officers and Directors as a Group (5                         1,114,300(6)                              27.7%
Persons)...............................................

Edward J. Bonis........................................            411,750                                 10.2%
7808 Cherry Creek South Drive, Unit 301
Denver, Colorado 80231
-----------------
</TABLE>

         (1) The beneficial  owners listed have sole voting and investment power
with respect to the shares of Common Stock.

         (2) Assumes the stock  option of each person who has a stock  option is
exercised whether or not the stock option is vested.

                                       38

<PAGE>


         (3) Includes  75,000 shares of Common Stock  underlying  stock options,
50,000 shares of which are currently exercisable and the balance of which become
exercisable in December 1997.

         (4) Consists of 75,000 shares of Common Stock underlying stock options,
none of which are exercisable until August 1997.

         (5)  Consists  of  50,000  shares of Common  Stock  underlying  a stock
option,  37,500 of which are currently  exercisable  and 12,500 of which are not
exercisable until October 1997.

         (6) Includes  250,000 shares of Common Stock underlying the outstanding
stock options described above.

ITEM 12.          CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         Robert  J.  Cooney,  the  Company's  Chairman  of the  Board  and Chief
Executive  Officer,  has individually  guaranteed,  until December 31, 2000, the
obligations  of the Company  under the lease for the Company's  facilities.  The
lease  expires on January 31,  2006 and  requires  base rental rate  payments of
$20,645 per month for the first 36 months with increased rentals thereafter tied
to the Consumer Price Index.

         Robert J. Cooney also has personally  guaranteed an equipment lease for
Laser Storm of Arapahoe Village,  Inc., a wholly owned subsidiary of the Company
that owns and operates a Laser Storm(R) game system.  The lease is for a term of
36 months and requires monthly rental payments of approximately $4,929.

         Harold Skripsky, a director of the Company since October 1995, was Vice
President  of  Operations  for  the  Family  Entertainment  Center  Division  of
Discovery  Zone from 1993 to February  1996.  Discovery Zone purchased six Laser
Storm(R)  systems  from the Company  during the summer of 1994.  Discovery  Zone
filed for  reorganization  under Chapter 11 of the United States Bankruptcy Code
in March 1996. The Company has made no  determination  what effect,  if any, the
reorganization will have on any future purchases by Discovery Zone.


                                       39

<PAGE>


ITEM 13.          EXHIBITS AND REPORTS ON FORM 8-K

         (a)      The following documents are filed as part of this report:


Exhibit No.      Description and Method of Filing

     (3.1) Restated Articles of Incorporation With Amendments of Registrant.*

     (3.2) Articles of Amendment  to Restated  Articles  of  Incorporation  With
           Amendments of Registrant filed on September 27, 1995.*

     (3.3) Articles of Amendment  to Restated  Articles  of  Incorporation  With
           Amendments of Registrant filed on October 3, 1995.*

     (3.4) Bylaws of Registrant.*

     (3.5) Certificate of  Correction  to the  Articles of Amendment to Restated
           Articles of Incorporation  With  Amendments  of  Registrant  filed on
           January 29, 1996.*

     (3.6) Articles of Amendment  to Restated  Articles of  Incorporation  With
           Amend ments of Registrant filed on February 13, 1996.*

     (4.5) Warrant Agreement between Registrant and American Securities Transfer
           Incorporated, as Warrant Agent.*

     (10.1)  Employment  Agreement  dated  effective  October 1,  1994,  between
          Registrant and Robert J. Cooney and  amendments  thereto dated October
          4, 1995 and October 6, 1995.*

     (10.2)  Employment  Agreement  dated  effective  October 1,  1994,  between
          Registrant and William R. Bauerle and amendments thereto dated October
          4, 1995 and October 6, 1995.*

     (10.3) Employment  Agreement  dated effective  September 13, 1995,  between
          Registrant  and  Frank J. Ball and amendment  thereto dated October 6,
          1995.*

     (10.4) Employment  Agreement  dated effective  September 13, 1995,  between
          Registrant  and  Robert S. Scholz and amendment  thereto dated October
          6, 1995.*

     (10.5) Amended Stock Incentive Plan.*

     (10.6) Forms of Option Granted to Employees.*

     (10.7) Agreement between Registrant and Bertrand T. Ungar.*

     (10.8) Agreement dated July 17, 1995, among Registrant,  Creative Licensing
          Corporation and Le Studio Canal + (U.S.).*

     (10.9) Lease Agreement dated May 10, 1995, between Registrant and Dennis A.
          Trescott and addenda  thereto  dated June 22, 1995,  October 13, 1995,
          and November 6, 1995.*


                                       40

<PAGE>


     (10.10) Exclusive  Agreement  dated July 10, 1995,  between  Registrant and
          Target Technology Pte., Ltd.*

     (10.11) Articles of Organization of Laser Hall L.L.C. and Laser Hall L.L.C.
          Operating Agreement.*

     (10.12) Agreement dated January 27, 1994 between  Registrant and Sports and
          Games.*

     (10.13)  Agreement  dated August 8, 1995  between  Registrant  and Fun City
          Amusement Centers, Inc.*

     (10.14)  Agreement  dated  effective  July 1, 1995 between  Registrant  and
          Santa's Village, Ltd.*

     (10.15) Sales  Agreement  dated in August 1995 between  Registrant and TAMS
          Stationers.*

     (10.16) Options Granted to Harrison A. Price and Harold Skripsky.*

     (10.17) Lease  Agreement  dated October 19, 1995,  between  Registrant  and
          Funplex Partnership.*

     (10.18) Employment  Agreement  dated  effective  December 1, 1995,  between
          Registrant and Michael D. Kessler.*

     (10.19) Employment  Agreement  dated effective  December 16, 1995,  between
          Registrant and Eric Schwartzman.*

     (10.20) Options granted to Michael D. Kessler and Eric Schwartzman.*

     (10.21) Agreement  dated  February 8, 1996,  between  Registrant and Tunica
          Partners II, LP.*

     (10.22) Addendum  dated March 27, 1996, to the Employment  Agreement  dated
          effective  September  13,  1995,  between  Registrant  and  Robert  S.
          Scholz.*

     (10.23) License Agreement dated August 1, 1996,  between Marvel Characters,
          Inc. and Registrant.**/***

     (10.24) Amendment dated August 15, 1996, to Amended Stock Incentive Plan.**

     (10.25) Asset  Purchase  Agreement  dated July 23,  1996 among  Registrant,
          Laser Storm of Longmont, Inc. and Kevin J. Barker.**/****

     (10.26) Asset Purchase  Agreement dated November 1, 1996 between Registrant
          and Ridgeworld North, Inc.**/****

     (10.27) 1996 Incentive and Nonstatutory Stock Option Plan.**


                                       41

<PAGE>



     (10.28) Agreement  between  NAMCO  CYBERTAINMENT  INC. and  Registrant  and
          Amendment thereto.

     (10.29)  User  Agreement   between  Harrah's   Vicksburg   Corporation  and
          Registrant.

     (10.30) User Agreement between D.I.F.A.D.I.S.A. de C.V. and Registrant.

     (21) List of Subsidiaries.

     (23) Consent of HEIN + ASSOCIATES LLP.

     (27) Financial Data Schedule.



          *    Incorporated  by  reference  to the  exhibits  filed as a part of
               Registration Statement No. 33-98578.

          **   Incorporated  by  reference  to the  exhibits  filed as a part of
               Registration Statement No. 333-14525.

          ***  Confidential treatment granted in a separate filing.

         ****  Certain  of the  Schedules  and  Exhibits  to the Asset  Purchase
Agreements  have  been  omitted  and  will  be  provided  to the  United  States
Securities and Exchange Commission upon request.

         (b) The Company filed no Current  Reports on Form 8-K during the fiscal
quarter ended December 31, 1996.


                                       42

<PAGE>


                                   SIGNATURES


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

                                     LASER STORM, INC.


Dated:  April 14, 1997               By: /s/ Robert J. Cooney
                                         --------------------
                                         Robert J. Cooney, Chairman of the Board


      In accordance  with the Exchange Act, this report has been signed below by
the following  persons on behalf of the  registrant and in the capacities and on
the dates indicated.
<TABLE>
<CAPTION>

Signature                                                       Title                         Date
---------                                                       -----                         ----

<S>                                                             <C>                           <C> 
/s/Robert J. Cooney                                             Principal Executive           April 14, 1997
----------------------------------------                        Officer and
Robert J. Cooney                                                Director


/s/William R. Bauerle                                           Director                      April 14, 1997
----------------------------------------
William R. Bauerle



/s/John E. McNutt                                               Principal Financial           April 14, 1997
----------------------------------------                        Officer, Principal
John E. McNutt                                                  Accounting Officer
                                                                and Director
                                                                

/s/Frank J. Ball                                                Director                      April 14, 1997
----------------------------------------
Frank J. Ball



/s/Harold Skripsky                                              Director                      April 14, 1997
----------------------------------------
Harold Skripsky
</TABLE>

<PAGE>
                                LASER STORM, INC.
                          INDEX TO FINANCIAL STATEMENTS



                                                                            PAGE
                                                                            ----

Independent Auditor's Report ............................................... F-2

Balance Sheet - December 31, 1996 .......................................... F-3

Statements of Operations - For the Years Ended December 31, 1995
     and 1996 .............................................................. F-4

Statements of Changes in Stockholders' Equity - For the Years Ended
         December 31, 1995 and 1996 ........................................ F-5

Statements of Cash Flows - For the Years Ended December 31, 1995 
     and 1996 .............................................................. F-6

Notes to Financial Statements .............................................. F-8



                                       F-1

<PAGE>




                          INDEPENDENT AUDITOR'S REPORT




Board of Directors
Laser Storm, Inc.
Denver, Colorado



We have  audited  the  accompanying  balance  sheet of Laser  Storm,  Inc. as of
December  31,  1996  and  the  related  statements  of  operations,  changes  in
stockholders'  equity,  and cash flows for the years ended December 31, 1995 and
1996.  These  financial  statements  are  the  responsibility  of the  Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all  material  respects,  the  financial  position  of Laser  Storm,  Inc. as of
December 31, 1996,  and the results of its operations and its cash flows for the
years ended December 31, 1995 and 1996, in conformity  with  generally  accepted
accounting principles.



/s/ HEIN & ASSOCIATES LLP
HEIN + ASSOCIATES LLP

Denver, Colorado
March 21, 1997



                                       F-2

<PAGE>

<TABLE>
<CAPTION>
                                LASER STORM, INC.

                                  BALANCE SHEET
                                DECEMBER 31, 1996

                                     ASSETS
<S>                                                                                     <C>        
CURRENT ASSETS:
    Cash ............................................................................   $   272,633
    Receivables - net of allowance for doubtful accounts of $170,000:
        Trade notes, current portion ................................................       535,256
        Trade accounts ..............................................................       433,463
        Landlord reimbursement and other ............................................       132,235
        Income taxes ................................................................        56,000
    Inventories .....................................................................       977,896
    Prepaid expenses and other ......................................................        97,172
                                                                                        -----------
            Total current assets ....................................................     2,504,655
                                                                                        -----------
PROPERTY AND EQUIPMENT, net:
    Laser game systems and facilities ...............................................     1,339,081
    Other ...........................................................................       546,805
                                                                                        -----------
                                                                                          1,885,886
                                                                                        -----------
OTHER ASSETS:
    Trade notes receivable, less current portion ....................................       514,489
    License and design costs, net of accumulated amortization of $50,958 ............       191,731
    Goodwill, net of accumulated amortization of $2,917 .............................       172,083
    Deposits and other ..............................................................        77,505
    Software development, net of accumulated amortization of $105,298 ...............        54,792
                                                                                        -----------
            Total other assets ......................................................     1,010,600
                                                                                        -----------
TOTAL ASSETS ........................................................................   $ 5,401,141
                                                                                        ===========
                      LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
    Current maturities of capital lease obligations .................................   $    69,034
    Accounts payable ................................................................       783,998
    Accrued expenses and other ......................................................       172,337
    Accrued compensation ............................................................       161,574
    Accrued severance costs .........................................................       195,441
    Customer deposits and deferred revenue ..........................................       171,770
    Acquisition costs payable .......................................................       195,000
                                                                                        -----------
            Total current liabilities ...............................................     1,749,154

CAPITAL LEASE OBLIGATIONS, less current maturities ..................................       143,885

DEFERRED LEASE INDUCEMENTS ..........................................................       158,143

COMMITMENTS AND CONTINGENCIES (NOTES 2, 3, 7, AND 8)

STOCKHOLDERS' EQUITY:
    Preferred stock, $.001 par value; 2,000,000 shares authorized,
        no shares issued ............................................................          --
    Common stock, $.001 par value; 20,000,000 shares authorized;
        3,824,836 shares issued and outstanding .....................................         3,825
    Additional paid in capital ......................................................     6,256,174
    Accumulated deficit .............................................................    (2,910,040)
                                                                                        -----------
            Total stockholders' equity ..............................................     3,349,959
                                                                                        -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ..........................................   $ 5,401,141
                                                                                        ===========
</TABLE>
              See accompanying notes to these financial statements.

                                       F-3
<PAGE>

<TABLE>
<CAPTION>
                                LASER STORM, INC.

                            STATEMENTS OF OPERATIONS

                                                                                              FOR THE YEARS ENDED
                                                                                                  DECEMBER 31,
                                                                                  --------------------------------------
                                                                                             1995               1996
                                                                                             ----               ----
<S>                                                                               <C>                   <C>             
LASER SYSTEMS AND RELATED REVENUE:
    Net sales .......................................................             $        5,408,745    $      5,487,899
    Cost of sales ...................................................                      2,323,471           2,477,415
                                                                                  ------------------    ----------------
         Gross profit ...............................................                      3,085,274           3,010,484
                                                                                  ------------------    ----------------

RETAIL OPERATIONS:
    Net sales .......................................................                         68,404             410,312
    Cost of sales ...................................................                         29,135             151,661
                                                                                  ------------------    ----------------
         Gross profit ...............................................                         39,269             258,651
                                                                                  ------------------    ----------------

EXPENSES:
    General and administrative ......................................                      1,523,038           3,515,768
    Selling and marketing ...........................................                        820,471           1,629,780
    Severance and termination costs .................................                           --               248,768
    Depreciation and amortization ...................................                        116,183             297,709
    Product development .............................................                        139,979             320,671
    Contingent settlements ..........................................                        270,000                --
                                                                                  ------------------    ----------------
         Total expenses .............................................                      2,869,671           6,012,696
                                                                                  ------------------    ----------------
OPERATING INCOME (LOSS) .............................................                        254,872          (2,743,561)

OTHER INCOME (EXPENSE):
    Interest income .................................................                          2,282              97,202
    Interest expense ................................................                         (9,252)            (12,573)
    Loss on disposal of equipment ...................................                        (16,054)            (86,934)
                                                                                  ------------------    ----------------
INCOME (LOSS) BEFORE INCOME TAXES ...................................                        231,848          (2,745,866)
    Income tax expense ..............................................                         (9,000)               --
                                                                                  ------------------    ----------------
NET INCOME (LOSS) ...................................................             $          222,848    $     (2,745,866)
                                                                                  ==================    ================
NET INCOME (LOSS) APPLICABLE TO COMMON STOCKHOLDERS .................             $          204,848    $     (2,791,756)
                                                                                  ==================    ================
NET INCOME (LOSS) PER SHARE APPLICABLE TO
  COMMON STOCKHOLDERS ...............................................             $              .10    $           (.86)
                                                                                  ==================    ================
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING ..........................                      2,033,000           3,244,000
                                                                                  ==================    ================

</TABLE>

              See accompanying notes to these financial statements.

                                       F-4

<PAGE>

<TABLE>
<CAPTION>
                                LASER STORM, INC.

                  STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                 FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1996

                                                                         PREFERRED STOCK               COMMON STOCK
                                                                    Shares          Amount         Shares         Amount
                                                                    ------          ------         ------         ------ 

<S>                                                                 <C>          <C>            <C>         <C>       
BALANCES, January 1, 1995 ....................................          --       $    --        1,601,250   $    1,601

     Private placement of Series A 12% Convertible Cumulative                
           Preferred Stock ...................................      140,000           140            --            --   
     Offering costs related to private placement .............          --            --             --            --   
     Net income ..............................................          --            --             --            --   
                                                                 -----------   -----------    -----------   ----------- 

BALANCES, December 31, 1995 ..................................       140,000           140      1,601,250         1,601 

     Private placement of Series B 12% Convertible Cumulative     
           Preferred Stock, net of offering costs ............       200,000           200           --            --   
     Public Offering of 1,495,000 units, net of offering costs          --            --        1,495,000         1,495 
     Conversion of Series A and B 12% Convertible Cumulative
           Preferred Stock ...................................      (340,000)         (340)       629,961           630 
     Issuance of common stock for:
           Exercise of employee stock options ................          --            --           30,500            31 
           Acquisition of Laser Storm game centers ...........          --            --           68,125            68 
     Fair value of options granted for consulting services ...          --            --             --            --   
     Net loss ................................................          --            --             --            --   
                                                                 -----------   -----------    -----------   ----------- 

BALANCES, December 31, 1996 ..................................          --     $      --        3,824,836   $     3,825 
                                                                 ===========   ===========    ===========   ===========

<CAPTION>
                                                                    ADDITIONAL
                                                                     PAID-IN     ACCUMULATED
                                                                     CAPITAL       DEFICIT         TOTAL
                                                                    ----------   -----------       -----
<S>                                                                 <C>          <C>            <C>       
BALANCES, January 1, 1995 ....................................   $   18,529    $(387,022)     $  (366,892)

     Private placement of Series A 12% Convertible Cumulative                
           Preferred Stock ...................................      699,860           --          700,000
     Offering costs related to private placement .............     (143,253)          --         (143,253) 
     Net income ..............................................          --         222,848        222,848  
                                                                 -----------   -----------    -----------  
BALANCES, December 31, 1995 ..................................       575,136      (164,174)       412,703  

     Private placement of Series B 12% Convertible Cumulative     
           Preferred Stock, net of offering costs ............       889,985          --          890,185  
     Public Offering of 1,495,000 units, net of offering costs     4,706,471          --        4,707,966  
     Conversion of Series A and B 12% Convertible Cumulative .       
           Preferred Stock ...................................          (290)         --             --    
     Issuance of common stock for:
           Exercise of employee stock options ................        19,820          --           19,851
           Acquisition of Laser Storm game centers ...........        31,052          --           31,120  
     Fair value of options granted for consulting services ...        34,000          --           34,000  
     Net loss ................................................          --      (2,745,866)    (2,745,866)
                                                                 -----------   -----------    -----------  

BALANCES, December 31, 1996 ..................................   $ 6,256,174   $(2,910,040)   $ 3,349,959  
                                                                 ===========   ===========    ===========  
</TABLE>
              See accompanying notes to these financial statements.

                                       F-5

<PAGE>

<TABLE>
<CAPTION>
                                                    LASER STORM, INC.

                                                STATEMENTS OF CASH FLOWS
                                                                                                         FOR THE YEARS ENDED
                                                                                                              DECEMBER 31,
                                                                                                       ------------------------  
                                                                                                       1995                1996
                                                                                                       ----                ----
<S>                                                                                                <C>                  <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
      Net income (loss) ..................................................................         $   222,848          $(2,745,866)
      Adjustments to reconcile net income (loss) to net cash used in
         operating activities:
            Depreciation and amortization ................................................             116,183              297,709
            Loss on disposals of equipment ...............................................              16,054               86,934
            Notes receivable for sale of Laser Systems ...................................                --             (1,408,110)
            Provision for bad debts ......................................................              21,540              193,280
            Deferred income taxes ........................................................             (51,000)              51,000
            Fair value of options granted for consulting services ........................                --                 34,000
      Changes in operating assets and liabilities:
         (Increase) decrease in:
              Receivables ................................................................            (362,288)             (81,029)
              Inventories ................................................................             (80,410)            (535,351)
              Prepaid expenses and other .................................................             (87,032)            (155,948)
         Increase (decrease) in:
              Accounts payable ...........................................................             139,516              175,372
              Accrued expenses ...........................................................             146,266              219,749
              Customer deposits and deferred revenue .....................................            (456,081)             (43,035)
              Contingent settlements .....................................................             270,000             (270,000)
              Deferred lease inducements .................................................                --                158,142
                                                                                                   -----------          -----------
            Net cash used in operating activities ........................................            (104,404)          (4,023,153)
                                                                                                   -----------          -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
      Proceeds from sale of notes receivable .............................................                --                107,432
      Principal payments collected on notes receivable ...................................                --                117,010
      Proceeds from sale of equipment ....................................................                --                 10,000
      Capital expenditures for property and equipment ....................................            (194,858)          (1,763,117)
      Software development costs .........................................................             (31,015)                --
      License and design costs ...........................................................             (52,500)            (168,188)
                                                                                                   -----------          -----------
            Net cash used in investing activities ........................................            (278,373)          (1,696,863)
                                                                                                   -----------          -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
      Proceeds from sale of 12% Convertible Cumulative Preferred Stock ...................             700,000              900,000
      Proceeds from public offering of 1,495,000 units ...................................                --              5,202,600
      Proceeds from exercise of employee stock options ...................................                --                 19,851
      Proceeds from capital lease ........................................................                --                200,000
      Offering costs .....................................................................            (311,211)            (320,362)
      Principal payments on capital lease obligations ....................................             (11,767)             (19,913)
                                                                                                   -----------          -----------
            Net cash provided by financing activities ....................................             377,022            5,982,176
                                                                                                   -----------          -----------
              See accompanying notes to these financial statements.

                                       F-6

<PAGE>


                                                    LASER STORM, INC.

                                                STATEMENTS OF CASH FLOWS
                                                       (continued)

                                                                                                            FOR THE YEARS ENDED
                                                                                                                 DECEMBER 31,
                                                                                                       ---------------------------  
                                                                                                       1995                   1996
                                                                                                       ----                   ----
<S>                                                                                                <C>                     <C>
INCREASE (DECREASE) IN CASH ..............................................................               (5,755)             262,160

CASH, at beginning of year ...............................................................               16,228               10,473
                                                                                                       --------             --------
CASH, at end of year .....................................................................             $ 10,473             $272,633
                                                                                                       ========             ========
SUPPLEMENTAL CASH FLOW INFORMATION:
      Cash paid for interest .............................................................             $  9,252             $ 12,573
                                                                                                       ========             ========
      Cash paid for income taxes .........................................................             $-                   $ 64,744
                                                                                                       ========             ========
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING
   ACTIVITIES:
      Acquisition costs payable for Laser Storm game centers .............................             $-                   $195,000
                                                                                                       ========             ========
      Acquisition of Laser Storm game centers for common stock ...........................             $-                   $ 31,120
                                                                                                       ========             ========
      Offering costs paid from proceeds of offerings .....................................             $-                   $877,400
                                                                                                       ========             ========
      Capital lease obligations for equipment ............................................             $ 30,025             $-
                                                                                                       ========             ========
</TABLE>

              See accompanying notes to these financial statements.

                                      F-7
<PAGE>

                                LASER STORM, INC.

                          NOTES TO FINANCIAL STATEMENTS


1.      NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES:

        Nature  of  Operations  -  Laser  Storm,   Inc.  (the   "Company")   was
        incorporated in Colorado in 1990. The Company has developed  interactive
        laser tag game systems  ("Laser  Systems")  which it sells  primarily to
        independent  operators  generally  throughout  the  United  States.  The
        Company's  revenues  are  predominantly  derived  from the sale of Laser
        Systems and arenas.  The games are played  between teams of opponents in
        themed arenas utilizing special effects for sound,  lighting,  barriers,
        and other decorative elements.  The Company also owns and operates Laser
        Systems at various retail locations in the United States.

        In November 1992, the Company filed for reorganization  under Chapter 11
        of the United States  Bankruptcy  Code. In November  1993, the Company's
        Plan  of  Reorganization  was  confirmed  by the  Bankruptcy  Court.  In
        November  1994,  the Court  ordered the  proceedings  to be closed.  The
        confirmed  plan  provided  for the payment of $26,000 in  settlement  of
        $172,000 of trade payables.  The bankruptcy proceeding did not result in
        an alteration of the relative ownership interests of the Company.

        Notes  Receivable - Notes  receivable are stated at the amount of unpaid
        principal, reduced by an allowance for loan losses. Interest on loans is
        calculated by using the simple  interest method on daily balances of the
        principal amount outstanding.

        Notes are considered  impaired when,  based on current  information  and
        events,  it is probable  that the Company  will be unable to collect all
        amounts due according to the  contractual  terms of the loan  agreement.
        Periodic loan loss evaluations take into  consideration  such factors as
        changes  in the  nature  of the  volume of the loan  portfolio,  overall
        portfolio  quality,  past loan loss  experience,  review of any specific
        problem  loans,  and  current  economic  conditions  that may affect the
        borrower's ability to pay.

        Inventories - Inventories are stated at the lower of cost, determined by
        the first-in,  first-out method, or market, and consist of the following
        at December 31, 1996:


               Raw materials                                   $548,993
               Finished goods                                   458,024
               Product held for replacement                     170,879
                                                               --------

                    Total inventory                           1,177,896

               Less inventory designated for retail
                operations (Note 4)                            (200,000)
                                                               --------

                                                               $977,896
                                                                =======

        Product held for replacement is used to replace  components of the Laser
        Systems received under the Company's warranty program.  These components
        are  stated  net of a  reserve  of  $10,500  for the  estimated  cost to
        refurbish.


                                       F-8

<PAGE>

                                LASER STORM, INC.

                          NOTES TO FINANCIAL STATEMENTS


        Property  and  Equipment  - Property  and  equipment  is stated at cost.
        Leasehold  improvements  are amortized  over the lesser of the estimated
        life of the asset or the term of the lease.  Depreciation  is calculated
        using  declining  balance and  straight-line  methods over the estimated
        useful lives of the respective assets as follows:

                                                              Years
                                                              -----
          Leasehold improvements                              5-10
          Trade show demonstration equipment                   2-5
          Office furniture and equipment                       3-7
          Laser Systems and arenas                             3-5
          Tooling equipment and other                          1-5
          Restaurant and retail equipment                      3-5

        The cost of normal  maintenance  and  repairs is  charged  to  operating
        expenses as incurred.  Material  expenditures which increase the life of
        an asset are capitalized and  depreciated  over the estimated  remaining
        useful life of the asset.  The cost of  properties  sold,  or  otherwise
        disposed of, and the related  accumulated  depreciation are removed from
        the  accounts,  and  any  gains  or  losses  are  reflected  in  current
        operations.

        Impairment  of  Long-Lived   Assets  -  In  the  event  that  facts  and
        circumstances  indicate that the cost of property and equipment or other
        long-lived  assets may be impaired,  an evaluation of  recoverability of
        net carrying costs will be performed.  If an evaluation is required, the
        estimated future  undiscounted cash flows associated with the asset will
        be compared to the asset's  carrying amount to determine if a write-down
        to estimated fair value is required.

        Income  Taxes  -  Income  taxes  are  provided  for in  accordance  with
        Statement of Financial  Accounting  Standards No. 109,  "Accounting  for
        Income Taxes." SFAS No. 109 requires an asset and liability  approach in
        the  recognition of deferred tax liabilities and assets for the expected
        future tax  consequences of temporary  differences  between the carrying
        amounts and the tax bases of the Company's assets and liabilities.

        Revenue  Recognition - The Company  generally  recognizes sales of Laser
        Systems  and  arenas  upon  shipment  to the  customer  if there  are no
        unresolved  conditions  related  to the  sale.  Prior to  shipment,  the
        Company generally collects a substantial deposit.

        Revenue Participation Interests - The Company has an interest in certain
        revenue participation  arrangements whereby it will receive a continuing
        revenue interest from Laser System operations. At December 31, 1996, the
        Company's  investment  in these  ventures  amounted to $63,000  which is
        included in property and equipment.  Revenue participation is recognized
        as earned;  however,  through  December 31,  1996,  such revenue was not
        significant in relation to net sales.

        Warranty - The Company generally provides a 90-day warranty on all sales
        of Laser Systems. In addition,  the Company has a warranty program under
        renewable  annual contracts  whereby  customers pay a monthly usage fee.
        Such fees are recognized in the month in which they are earned.


                                       F-9

<PAGE>


                                LASER STORM, INC.

                          NOTES TO FINANCIAL STATEMENTS


        Research and Development Costs - Research and product  development costs
        are charged to operations in the period incurred.

        Intangible   Assets  -  The  Company   capitalizes   computer   software
        development costs to develop and update software for which technological
        feasibility has been established. This software is an integral component
        in the Company's Laser Systems and is not sold  separately.  These costs
        are  capitalized  and  amortized  over an estimated  useful life of five
        years.

        License  fees relate to the  purchase of rights which permit the Company
        to utilize a specific theme for the  development  of arenas.  Such costs
        are being amortized over three years utilizing the straight-line method.
        Design costs relate to artistic  development  of graphics which are used
        in the  arenas.  These costs are being  amortized  over one to two years
        utilizing the straight-line method.

        Goodwill  relates to the  acquisition of a retail  facility and is being
        amortized over 10 years utilizing the straight-line method.

        Amortization   expense   related  to  intangible   assets   amounted  to
        approximately  $35,000 and $82,000 for the years ended December 31, 1995
        and 1996, respectively.

        Deferred  Lease  Inducements  - In  connection  with an operating  lease
        entered into during 1996, the landlord  agreed to reimburse a portion of
        the Company's leasehold improvement costs as an inducement to enter into
        the lease.  Additionally,  some of the Company's  other  operating lease
        agreements  provide for non-level  rental  payments over the term of the
        leases.  These rental  inducements  are  recognized  and  amortized in a
        manner  which  results  in an  equal  monthly  rental  charge  over  the
        respective term of each lease.

        Net Income  (Loss) Per Share - Net  income  (loss) per common  share was
        computed  by  dividing  the  net  income  (loss)  applicable  to  common
        stockholders (which includes accrued but unpaid preferred  dividends) by
        the weighted  average  number of common  shares  outstanding  during the
        year.  For 1996,  all common stock  equivalents  were  excluded from the
        computation because their effect was anti-dilutive.

        Net income per common share for 1995 was computed  based on common stock
        outstanding  and common stock  equivalents.  For common stock and common
        stock  equivalents,  including the preferred  stock  discussed in Note 9
        issued at prices below the $4.00 per unit price for the Company's public
        offering,  the  Company  included  such  stock  and  equivalents  in the
        weighted  average  calculation  (using the treasury  stock method) as if
        they were outstanding for the full year ended December 31, 1995.

        Stock-Based   Compensation  -  The  Company   accounts  for  stock-based
        compensation  using the intrinsic value method  prescribed in Accounting
        Principles  Board  Opinion  No.  25,  "Accounting  for  Stock  Issued to
        Employees," and related interpretations.  Accordingly, compensation cost
        for stock  options  granted to employees  is measured as the excess,  if
        any, of the quoted  market  price of the  Company's  common stock at the
        measurement  date  (generally,  the date of  grant)  over the  amount an
        employee must pay to acquire the stock.

        In October 1995,  the Financial  Accounting Standards Board issued a new
        statement  titled "Accounting for  Stock-Based  Compensation" (FAS 123).
        FAS 123  requires that options,  warrants, and similar instruments which
 

                                      F-10

<PAGE>

                                LASER STORM, INC.

                          NOTES TO FINANCIAL STATEMENTS

        are  granted to  non-employees   for goods  and  services be recorded at
        fair  value on the grant date. Fair value is generally determined  under
        an option pricing model using the criteria set forth in FAS 123.
      
        Accounting  Estimates  - The  preparation  of  financial  statements  in
        conformity  with  generally  accepted  accounting   principles  requires
        management  to make  estimates and  assumptions  that affect the amounts
        reported in the financial  statements and the  accompanying  notes.  The
        actual results could differ from those estimates.

        The Company's financial  statements are based on a number of significant
        estimates,  including  the  allowance  for doubtful  accounts,  possible
        technological  obsolescence of inventories,  realizability of intangible
        assets,  the estimated useful lives selected for property and equipment,
        warranty  reserve,  and  assumptions  affecting  the fair value of stock
        options and warrants.

        Significant  Concentrations  - The Company's sales are generally  higher
        dollar value items with no major  concentrations  among customer groups.
        At December 31, 1996, the Company,  however, had a trade note receivable
        of approximately $226,000, which was due from a single customer.

        Reclassifications - Certain reclassifications have been made to the 1995
        financial  statements  to  conform  to the  presentation  in  1996.  The
        reclassifications had no effect on the 1995 net income.


2.      LIQUIDITY:

        The Company  incurred a  loss  from operations in 1996 in excess of $2.7
        million and  used  cash in  operating  activities  of  approximately  $4
        million.   This  use of  working  capital  has  adversely  impacted  the
        Company's  liquidity.  Furthermore,  management expects the Company will
        incur   additional   operating    losses   of   approximately   $350,000
        (unaudited)  for the first  quarter  of  1997,  of  which  approximately
        $165,000   (unaudited)  is   non-cash   depreciation   and  amortization
        expenses. To implement the Company's  plan of opening  new company-owned
        Laser Storm  game facilities,  additional financing will be required. If
        significant  additional losses  are incurred,  or if cash is invested in
        facilities  which do  not provide adequate  returns,  it would adversely
        impact  the  Company's  liquidity  position and possibly its  ability to
        continue future operations.

        As  of  December   31,  1996,   the  Company  has  working   capital  of
        approximately  $750,000 and  stockholders'  equity of over $3.3 million.
        Furthermore, the Company's assets are generally unencumbered of debt. In
        late 1996 and early 1997,  the  Company has taken  actions to reduce its
        overhead, including significant reductions in personnel. Management also
        believes  many of the expenses  incurred in 1996 will not recur in 1997.
        The Company is pursuing  additional capital for financing future growth,
        however,  there are  currently no definitive  arrangements.  The Company
        will  continue to evaluate  its  liquidity  position  and may take other
        actions as deemed  appropriate  by  management,  which could  ultimately
        impact future operations. However, management believes the actions taken
        will enable the Company to continue  operations  through the forthcoming
        year.



                                      F-10

<PAGE>

                                LASER STORM, INC.

                          NOTES TO FINANCIAL STATEMENTS


3.      NOTES RECEIVABLE:

        During  1996,  the Company  began  offering a  financing  program to its
        customers  for sales of systems  and  arenas.  Under this  program,  the
        customer  was  required  to  make  an  advance  deposit  which  averaged
        approximately  33% of the  purchase  price and the balance was  financed
        over 24 months with  interest  at 9% to 11%.  The notes  receivable  are
        unsecured.  During the fourth  quarter  of 1996,  management  decided to
        cease offering this financing alternative to the Company's customers.

        In the fourth  quarter of 1996,  the Company  entered  into an agreement
        with a financial  institution to sell some of the notes  receivable.  If
        the financial institution is unsuccessful in collecting the receivables,
        the Company is required to pay the deficiency. At December 31, 1996, the
        outstanding  principal  balance  for which the  Company is  contingently
        liable  amounted  to  approximately  $100,000.  At  December  31,  1996,
        $535,256 of the notes  receivable  are classified as a current asset and
        the remaining $514,489 are included in long-term assets.


4.      PROPERTY AND EQUIPMENT:

        At  December 31, 1996,  laser game systems and facilities consist of the
        following:


               Leasehold improvements                             $388,120
               Laser Systems and arenas                            801,136
               Restaurant and retail equipment                      62,630
               Uninstalled laser systems and arenas                200,000
                                                                 ---------
                    Total laser game systems and facilities      1,451,886

               Less accumulated depreciation and amortization     (112,805)
                                                                 ---------
                                                                $1,339,081
                                                                 =========

      At December 31, 1996, management estimates that approximately  $200,000 of
      the  Company's  inventory of laser  systems and arenas will be utilized at
      retail  laser  facilities  which are  expected to be opened  during  1997.
      Accordingly,  this  amount was  reclassified  from  inventory  and will be
      depreciated when the retail facilities are opened.

      At  December  31,  1996,  other  property  and  equipment  consists of the
      following:


          Leasehold improvements                                    $68,662
          Trade show demonstration equipment                        304,871
          Office furniture and equipment                            290,781
          Tooling equipment and other                                84,810
                                                                    -------
                     Total property and equipment                   749,124

          Less accumulated depreciation                            (202,319)
                                                                    -------
                                                                   $546,805
                                                                    =======
                                      F-11
<PAGE>


                                LASER STORM, INC.

                          NOTES TO FINANCIAL STATEMENTS


      Depreciation expense was approximately  $81,000 and $216,000 for the years
      ended December 31, 1995 and 1996, respectively.

5.    CAPITAL LEASE OBLIGATIONS:

      In December 1996, the Company entered into sale/leaseback arrangements for
      certain laser systems, arenas, and restaurant equipment that were acquired
      in 1996,  resulting  in total  proceeds of  $200,000.  No gain or loss was
      recognized on the  transaction  and the lease is being  accounted for as a
      capital  lease,  since the Company can acquire the  equipment  for nominal
      consideration at the end of the lease term. The leases provide for monthly
      payments of $7,349 through October 1999.

      At December 31, 1996,  equipment under all capital leases is recorded at a
      cost of approximately  $252,000 with accumulated  amortization of $20,700.
      The following is a schedule of future minimum lease payments under capital
      leases at December 31, 1996:

          Future minimum lease payments                                $278,605
          Less amount representing interest                             (49,540)
          Less amount representing taxes                                (16,146)
                                                                        -------

                Present value of net minimum lease payments             212,919

          Less current portion                                          (69,034)
                                                                        -------
                                                                       $143,885
                                                                       ========
6.    INCOME TAXES:

      A reconciliation of the income tax benefit (expense) at the statutory rate
      to  income  tax  benefit  (expense)  from  continuing  operations  at  the
      Company's effective rate is as follows:

<TABLE>
<CAPTION>
                                                                         YEARS ENDED DECEMBER 31,
                                                                      ---------------------------
                                                                          1995            1996
                                                                          ----            ----
<S>                                                                   <C>               <C>     
      Computed tax benefit (expense) at the expected statutory rate   $(78,800)         $934,000
      Increase (reduction) in income taxes resulting from:
         State income taxes, net of Federal benefit                     (7,000)           91,000
         Nondeductible expenses                                        (14,700)          (18,000)
         Reduction in valuation allowance due to
           utilization of net operating loss carryovers                 91,500             --
         Increase in valuation allowance                                 -            (1,007,000)
                                                                      --------         ---------

                                                                      $ (9,000)         $  --
                                                                      ========          ========
</TABLE>

                                      F-12
<PAGE>


                                LASER STORM, INC.

                          NOTES TO FINANCIAL STATEMENTS

     The  components of the Company's  provision for income taxes consist of the
     following:


                                                     YEARS ENDED DECEMBER 31,
                                                   ---------------------------
                                                       1995            1996
                                                       ----            ----

          Current benefit (provision)             $  (60,000)       $   56,000
          Deferred benefit (expense)                  51,000           (56,000)
                                                    --------          --------

               Total                              $   (9,000)       $    --
                                                    ========          ========

     At December 31, 1996, tax effects of temporary  differences  that give rise
     to  significant  portions of the  deferred tax assets and  liabilities  are
     presented below:

     Deferred Tax Assets:
        Net operating loss carryforwards ..................         $   875,000
        Accounts receivable ...............................              63,000
        Accrued vacation and warranty .....................              21,000
        Accrued severance costs ...........................              73,000
        Other .............................................               4,000
                                                                     ----------
            Total .........................................           1,036,000
        Less valuation allowance ..........................          (1,007,000)
                                                                      ---------
                                                                         29,000
                                                                      ---------
     Deferred tax liabilities:
        Property and equipment ............................              (8,000)
        Software development costs ........................             (21,000)
                                                                      ---------
            Net long-term asset ...........................         $      --
                                                                      =========

       At December  31, 1996, the Company has a net operating loss  carryforward
       for income taxes of approximately $2.3 million which expires in 2011.


7.      COMMITMENTS:

        Operating Leases - The Company leases office space,  retail  facilities,
        equipment  and  warehouse  facilities  under  noncancellable   operating
        leases. Total rental expense was approximately  $87,000 and $361,000 for
        the years ended December 31, 1995 and 1996,  respectively.  In 1995, the
        Company  entered into a new ten-year  lease which  commenced in February
        1996. An officer of the Company has personally  guaranteed the Company's
        obligations under two leases,  which amount to approximately  $1,170,000
        as of December 31, 1996.

                                      F-13

<PAGE>

                                LASER STORM, INC.

                          NOTES TO FINANCIAL STATEMENTS


     As of  December  31,  1996,  the  total  minimum  cash  payments  under all
     operating leases are as follows:

                    YEARS ENDING DECEMBER 31,
                    ------------------------
                            1997                 $  632,000
                            1998                    703,000
                            1999                    872,000
                            2000                    889,000
                            2001                    840,000
                         After 2001               2,545,000
                                                  ---------
                                                 $6,481,000
                                                  =========
     
      The rental commitment amounts shown above excludes an aggregate commitment
      of $600,000 related to a five-year lease entered into in January 1997.

      Royalty  Arrangements - The Company has entered into arrangements  whereby
      the Company has obtained the rights to utilize certain names,  logos,  and
      characters  which are protected by trademarks and copyrights.  The Company
      has paid non-refundable minimum royalties of $110,000 through December 31,
      1996  and  the  Company  is  required  to make  additional  non-refundable
      payments of $120,000 in 1997 and $120,000 in 1998.

      The  agreements  provide  that the Company is  required  to pay  royalties
      ranging from 2% to 5% of gross revenues related to the licensed  property.
      The  Company is required  to make  additional  payments to the extent that
      actual  royalties  exceed the amounts  prepaid for minimum  royalties.  At
      December 31, 1996, approximately $60,000 of advance royalties are included
      in prepaid expenses in the accompanying balance sheet.

      Employment Agreements - The Company has entered into employment agreements
      with two of the Company's  executive  officers which provide for aggregate
      annual  compensation  of  $300,000  in 1997,  and  $225,000  in 1998.  The
      agreements  may be terminated  by the Company  without cause upon 30 days'
      notice. In the event of a termination  without cause, the Company would be
      required to pay 100% of the  remaining  payments  until  expiration of the
      agreement with the Company's chief executive officer, and the president is
      entitled to receive his respective salary for six months.

      During  1996,  the  Company  terminated  employment  agreements  with four
      executive  officers of the  Company.  At December  31,  1996,  the Company
      accrued the remaining obligations under these agreements of $195,441.

      Consulting  Arrangement  - In October  1996,  the Company  entered  into a
      consulting  agreement with an entity that  specializes in financial public
      relations  services.  The agreement is in effect for one year and provides
      for  monthly  payments  of $6,000.  As  additional  consideration  for the
      consulting  services,  the Company granted an option to the consultant for
      100,000 shares of the Company's common stock at an exercise price of $2.25
      per share. Options for 25,000 shares are exercisable at December 31, 1996,
      and  options for the  remaining  75,000  shares  will  become  exercisable
      through August 1, 1997. If not previously exercised, the options expire in


                                      F-14

<PAGE>

                                LASER STORM, INC.

                          NOTES TO FINANCIAL STATEMENTS


     October 1999. The estimated fair value of the options  amounted to $65,000,
     of which $34,000 was  recognized in 1996 and the remaining  $31,000 will be
     recognized in 1997 as vesting occurs.


8.    CONTINGENCIES:

      For the year ended December 31, 1995,  the Company  recognized a provision
      of $270,000 for legal contingencies.  A discussion of the underlying legal
      proceedings and settlements is presented below.

      In December  1995, the Company was served with a lawsuit that was filed by
      a previous  manufacturer (the  "Manufacturer")  of the Company's laser tag
      system  alleging,  among other  things,  past due  royalties.  The Company
      believes prior royalty  arrangements with the Manufacturer were terminated
      as part  of its  Plan  of  Reorganization.  However,  to  avoid  extensive
      litigation,  the Company  entered  into a  settlement  agreement  with the
      Manufacturer  pursuant  to which the  Manufacturer  agreed to dismiss  its
      complaint  without  prejudice,  and the  Company  agreed  to  dismiss  its
      counterclaims  against the Manufacturer  without  prejudice.  In 1996, the
      Company paid the  Manufacturer  $100,000 out of the proceeds of its public
      offering of the  Company's  units,  granted the  Manufacturer  a five-year
      option to purchase  175,000 shares of the Company's  common stock at $4.00
      per share, and agreed to purchase $35,000 of inventory.

      In November 1994, the Company  entered into an agreement with a consulting
      firm (the "Consultant") which agreed to provide consulting services to the
      Company  for the  six-month  period  ended  April 30,  1995,  for a fee of
      $10,000  per  month.  The  Company  made  one  payment  in  November  1994
      conditioned  on the  Consultant  providing  the  Company  with a letter of
      intent for a public offering. The Consultant never provided such letter of
      intent and the Company made no further  payments.  In December  1995,  the
      Consultant  filed a lawsuit  against the Company.  In February  1996,  the
      Company entered into a settlement  agreement with the Consultant  pursuant
      to which the Consultant  agreed to dismiss its complaint without prejudice
      and the Company agreed to pay the  Consultant  $60,000 out of the proceeds
      of the Company's public offering.

      During 1995, an employee was  terminated  and a lawsuit was filed alleging
      wrongful termination. In January 1996, a court ruled that the Company must
      pay the former employee $90,000 plus interest,  attorney's fees, and other
      costs of litigation.


9.    EQUITY FINANCING ARRANGEMENTS:

      Preferred  Stock - In September 1995, the Company's Board of Directors and
      shareholders  approved the  authorization of 2,000,000 shares of preferred
      stock which may be issued in series with such  rights and  preferences  as
      determined by the Company's Board of Directors.

      The  Board of  Directors  has  designated  140,000  shares as Series A 12%
      Convertible  Cumulative  Preferred  Stock (Series A Preferred  Stock).  In
      October 1995, the Company sold 140,000 shares of Series A Preferred  Stock
      for $5.00 per share.  These shares of Series A Preferred Stock were voting
      and convertible into units (as discussed below).

      In February  1996,  the Board of Directors  designated  200,000  shares of
      preferred  stock as Series B 12% Cumulative  Convertible  Preferred  Stock
      (Series B Preferred Stock) and the Company completed the sale  of all

                                      F-15

<PAGE>


                                LASER STORM, INC.

                          NOTES TO FINANCIAL STATEMENTS

     October  1999.  The  estimated  fair value of the  options  the sale of all
     200,000  shares of Series B  Preferred  Stock  for $5.00 per  share.  After
     payment of commissions,  the Company received net proceeds of $900,000. The
     Series B Preferred Stock has similar rights and preferences as the Series A
     Preferred Stock.

      Upon completion of the Company's public offering in April 1996, all of the
      holders of Series A and Series B Preferred  Stock elected to convert their
      shares  (including  accumulated  dividends of approximately  $64,000) into
      629,961 units.

      Public  Offering - In April 1996, the Company  completed a public offering
      of 1,300,000  units at $4.00 per unit.  Each unit consists of one share of
      common stock and one warrant. The warrants are exercisable for a period of
      five years and entitle the holder to purchase one share of common stock at
      an exercise  price of $5.00 per share.  However,  if the Company  does not
      report  net after  tax  earnings  of at least  $.40 per share for the four
      fiscal  quarters  ending March 31, 1997, then the exercise price per share
      will be reduced.  Based on losses  incurred by the  Company,  the exercise
      price of the warrants will be $1.00 per share. The underwriter  received a
      warrant,  exercisable  for 130,000 units at $5.00 per unit for a period of
      four years,  beginning  one year after the offering,  to purchase  130,000
      units.


10.   STOCK-BASED COMPENSATION:

      Stock  Option  Plan - The  Company's  shareholders  have  approved a stock
      option  plan that  authorizes  an  aggregate  of 300,000  shares for stock
      options that may be granted to officers,  directors,  and  employees.  The
      plan permits the issuance of incentive  options and provides for a minimum
      exercise  price  equal to 100% of the fair market  value of the  Company's
      common  stock on the date of grant.  The maximum  term of options  granted
      under the plan is 10 years and options  granted to employees  expire three
      months after the  termination  of  employment.  None of the options may be
      exercised  during the first six months of the option term.  No options may
      be  granted  after  10 years  from  the  adoption  date of the  plan.  The
      following  is a summary of activity  under this stock option plans for the
      years ended December 31, 1995 and 1996:

<TABLE>
<CAPTION>
                                                   1995                         1996
                                      -------------------------------  -------------------------
                                                     Weighted                          Weighted
                                                      Average                           Average
                                       Number         Exercise          Number          Exercise
                                     of Shares         Price          of Shares          Price
                                     ---------       ---------        ---------         --------
<S>                                   <C>                <C>           <C>               <C>  
Outstanding, beginning of year        141,000            $.20          300,000           $1.21

       Canceled                         -                 -            (62,000)           1.38
       Exercised                        -                 -            (30,500)            .65
       Granted                        159,000            2.11           50,000            2.25
                                      -------                          -------
Outstanding, end of year              300,000            1.21          257,500            1.44
                                      =======                          =======
</TABLE>
                                      F-16

<PAGE>

                                LASER STORM, INC.

                          NOTES TO FINANCIAL STATEMENTS


        For all options  granted during 1996, the weighted  average market price
        of the  Company's  common  stock  on the  grant  date  was  equal to the
        weighted  average  exercise  price.  For  options  granted in 1995,  the
        approximate market value of the common stock on the grant date was equal
        to the exercise price for 103,500  shares.  For options  granted for the
        remaining  55,500 shares in 1995,  the  approximate  market price on the
        grant date was $2.80 per share  compared to the exercise  price of $4.00
        per share.  At  December  31,  1996,  options  for  120,000  shares were
        exercisable  at a weighted  average  exercise  price of $1.04 per share.
        Options for 96,000 shares at a weighted  average exercise price of $1.49
        per share will vest in 1997, and options for 41,500 shares at a weighted
        average exercise price of $2.49 per share will vest in 1998.

        If not  previously exercised,  options outstanding at December 31, 1996,
        will expire as follows:
 
<TABLE>
<CAPTION>
                                        Year Ending December 31,
         Exercise Price       -------------------------------------------------  
            Per Share         2000        2001      2002      2003        Total
         --------------       ----        ----      ----      ----        -----
         <S>           <C>            <C>        <C>        <C>          <C>  
              $.20           43,833     45,833     45,834      -         135,500
              2.00            -          9,500      9,500      9,500      28,500
              2.25            -          -         25,000     25,000      50,000
              4.00            7,500     14,500     14,500      7,000      43,500
                            -------    -------    -------    -------     -------
                             51,333     69,833     94,834     41,500     257,500
                            =======    =======    =======    =======     =======
</TABLE>

        Non-Qualified  Options - In October through  December 1995, the Board of
        Directors  approved  the  grant  of  non-qualified  options  to  certain
        officers and directors of the Company for an aggregate of 250,000 shares
        at an exercise price of $4.00 per share.  At December 31, 1996,  options
        for 125,000  shares were  exercisable  and options for 75,000 and 50,000
        shares vest in 1997 and 1998,  respectively.  During  1997,  options for
        162,500 shares were canceled due to  termination  of employment.  If not
        previously exercised, options for the remaining 87,500 shares expire for
        50,000,  25,000 and 12,500 shares  during the years ending  December 31,
        2000, 2001, and 2002, respectively.

        Options Subject to Shareholder Approval - In November 1996, the Board of
        Directors approved the 1996 Incentive and Nonstatutory Stock Option Plan
        which reserves 1,000,000 shares of common stock for options which may be
        granted to officers, directors, employees, and consultants. The adoption
        of this plan is  contingent  upon  obtaining  approval of the  Company's
        shareholders  by October 1997.  Accordingly,  incentive  options granted
        pursuant to this plan are not  considered  to be granted for  accounting
        purposes until shareholder approval is obtained.

        In November 1996, inventive options were granted to officers for 100,000
        shares at an  exercise  price of $2.25 per  share.  Options  for  75,000
        shares were canceled in December 1996 due to  termination of employment.
        If the plan is  approved  by the  shareholders,  incentive  options  for
        25,000 shares will vest in 1999 and expire in 2004. If  shareholders  do
        not  approve  the new plan,  the option for 25,000  shares will have the
        same terms but will be granted as a non-qualified stock option.


                                      F-17

<PAGE>
                                LASER STORM, INC.

                          NOTES TO FINANCIAL STATEMENTS


        Warrants  and Options  Granted to  Non-Employees  - The Company has also
        granted  warrants and options to purchase common stock to  non-employees
        which are  summarized  as follows for the years ended  December 31, 1995
        and 1996:

<TABLE>
<CAPTION>
                                                               1995                  1996
                                                       ---------------------   ----------------------
                                                        Number     Exercise      Number      Exercise
                                                       of Shares    Price      of Shares      Price
                                                       ---------   --------    ---------     --------
<S>                                                                  <C>          <C>      <C>     
Outstanding, beginning of year ...................        --         $-           50,000   $    .75
       Granted to:
            Consultants for services .............      50,000         .75       100,000       2.25
            Manufacturer (Note 8) ................        --         --          175,000       1.75
            Investors in public offering .........        --         --        1,495,000       1.00
       Issued to former holders of preferred stock
            upon conversion ......................        --         --          629,961       1.00
                                                      --------                 ---------
Outstanding, end of year .........................      50,000        .75      2,449,961       1.26
                                                      ========                 =========
</TABLE>

        Additionally,  as discussed in Note 9, the Company  granted a warrant to
        the underwriter of the Company's public offering for 130,000 units. This
        warrant is excluded from the table above.

        For stock options  granted to consultants for services in 1995 and 1996,
        the  exercise  prices were equal to the  estimated  market  value of the
        Company's  common  stock on the  date of  grant.  For the 1996  grant of
        175,000 shares to the manufacturer, the market price of the common stock
        was $2.80 per share compared to the exercise price of $4.00 per share.

        All  of  the  warrants  and  options  granted  to   non-employees   were
        exercisable at December 31, 1996. If not previously exercised,  warrants
        and options outstanding at December 31, 1996, will expire as follows:

                                         Number          Exercise
          Year Ending December 31,     of Shares          Price
          ------------------------     ---------         --------
                    1997                  50,000         $   .75
                    1999                 100,000            2.25
                    2001               2,124,961            1.00
                    2001                 175,000            4.00
                                       ---------
                    Total              2,449,961            1.26
                                       =========


       During the year ended  December 31, 1996,  the Company  granted an option
       for 100,000 shares for consulting  services.  The estimated fair value of
       this option was determined using the Black-Scholes  option pricing model,
       which  resulted in  compensation  cost of $65,000,  of which  $34,000 was
       recognized in 1996 and the  remaining  $31,000 will be recognized in 1997

                                      F-18

<PAGE>

                                LASER STORM, INC.

                          NOTES TO FINANCIAL STATEMENTS

        as  vesting  occurs.   Significant  assumptions  included  a   risk-free
        interest   rate  of  6.0%,  expected   volatility  of 75%,  and  that no
        dividends   would be declared  during the expected term of the  options.
        The  weighted  average  contractual  term  of the  options  was  3 years
        compared to a weighted average expected term of 1.4 years.

        Pro Forma Stock-Based Compensation Disclosures - The Company applies APB
        Opinion 25 and related  interpretations  in accounting for stock options
        which are granted to employees.  Accordingly,  no compensation  cost has
        been  recognized  for grants of options to employees  since the exercise
        prices were not less than the fair value of the  Company's  common stock
        on the grant dates. Had  compensation  cost been determined based on the
        fair value at the grant dates consistent with the method of FAS 123, the
        Company's  net income  (loss)  and  earnings  per share  would have been
        changed to the pro forma amounts indicated below.

<TABLE>
<CAPTION>
                                                                    Year Ended December 31,
                                                                     ----------------------
                                                                      1995              1996
                                                                      ----              ----
          <S>                                                    <C>          <C>
          Net income (loss) applicable to common stockholders:
               As reported ...................................   $   204,848   $  (2,791,756)
               Pro forma .....................................       198,000      (2,813,000)
          Net income (loss) per common share:
               As reported ...................................   $       .10   $        (.86)
               Pro forma .....................................           .10            (.87)
</TABLE>

        Fair value of options  granted in 1995 was determined  using the minimum
        value method  (which  assumes no  volatility)  since the Company was not
        publicly-held in 1995. Additionally,  since options granted to employees
        vest over  several  years and the Company  typically  makes  grants each
        year, the pro forma  disclosures  during the initial phase-in period for
        FAS 123 are not  representative  of the impact expected in future years.
        The fair  value of each  employee  option  granted  in 1995 and 1996 was
        estimated  on the date of grant using the  Black-Scholes  option-pricing
        model with the following weighted average assumptions:

                                                 Year Ended December 31,
                                                 ----------------------
                                                      1995    1996
                                                      ----    ----
         Expected volatility .....................       0%     75%
         Risk-free interest rate .................     6.8%    6.5%
         Expected dividends ......................      --      --
         Expected terms (in years) ...............     4.0     3.5


11.     FINANCIAL INSTRUMENTS:

        Statement of Financial  Accounting  Standards  No. 107 requires that the
        Company disclose the fair value of financial instruments at December 31,
        1996.  Management's  best estimate is that the carrying  amount of cash,
        receivables,  accounts  payable and accrued expenses  approximates  fair

                                      F-19

<PAGE>
                                LASER STORM, INC.

                          NOTES TO FINANCIAL STATEMENTS


        value  due to  the  short  maturity  of  these  instruments.  Management
        estimates that fair value  is approximately  equal to the carrying value
        of capital  lease  obligations  since  market  interest  rates have  not
        changed significantly since the leases were executed.

        Management  estimates  that  the  fair  value  of  notes  receivable  is
        approximately  $950,000  at  December  31,  1996,  compared  to the  net
        carrying  value of  approximately  $1,050,000.  Fair  value of the notes
        receivable was determined by management based on recent  negotiations to
        sell some of the receivables to financial institutions.


                                      F-20

<PAGE>


                                                    LASER STORM, INC.

                                              NOTES TO FINANCIAL STATEMENTS


                                                          F21

<PAGE>



<PAGE>

                                  EXHIBIT INDEX

<TABLE>
<CAPTION>

Exhibit No.      Description and Method of Filing                                         Page No.
----------       --------------------------------                                         -------
<S>            <C>                                                                        <C>
      (3.1)      Restated Articles of Incorporation With Amendments of Registrant.*         N/A

      (3.2)      Articles of Amendment to Restated Articles of Incorporation With           N/A
                 Amendments of Registrant filed on September 27, 1995.*

      (3.3)      Articles of Amendment to Restated Articles of Incorporation With           N/A
                 Amendments of Registrant filed on October 3, 1995.*

      (3.4)      Bylaws of Registrant.*                                                     N/A

      (3.5)      Certificate of Correction to the Articles of Amendment to Restated         N/A
                 Articles of Incorporation With Amendments of Registrant filed on
                 January 29, 1996.*

      (3.6)      Articles of Amendment to Restated Articles of Incorporation With           N/A
                 Amendments of Registrant filed on February 13, 1996.*

      (4.5)      Warrant Agreement between Registrant and American Securities               N/A
                 Transfer Incorporated, as Warrant Agent.*

     (10.1)      Employment Agreement dated effective October 1, 1994, between              N/A
                 Registrant and Robert J. Cooney and amendments thereto dated
                 October 4, 1995 and October 6, 1995.*

     (10.2)      Employment Agreement dated effective October 1, 1994, between              N/A
                 Registrant and William R. Bauerle and amendments thereto dated
                 October 4, 1995 and October 6, 1995.*

     (10.3)      Employment Agreement dated effective September 13, 1995, between           N/A
                 Registrant and Frank J. Ball and amendment thereto dated October 6,
                 1995.*

     (10.4)      Employment Agreement dated effective September 13, 1995, between           N/A
                 Registrant and Robert S. Scholz and amendment thereto dated October
                 6, 1995.*

     (10.5)      Amended Stock Incentive Plan.*                                             N/A

     (10.6)      Forms of Option Granted to Employees.*                                     N/A

     (10.7)      Agreement between Registrant and Bertrand T. Ungar.*                       N/A

     (10.8)      Agreement dated July 17, 1995, among Registrant, Creative Licensing        N/A
                 Corporation and Le Studio Canal + (U.S.).*

     (10.9)      Lease Agreement dated May 10, 1995, between Registrant and Dennis          N/A
                 A. Trescott and addenda thereto dated June 22, 1995, October 13,
                 1995, and November 6, 1995.*


<PAGE>

<CAPTION>

Exhibit No.      Description and Method of Filing                                         Page No.
----------       --------------------------------                                         -------
<S>            <C>                                                                        <C>

     (10.10)     Exclusive Agreement dated July 10, 1995, between Registrant and            N/A
                 Target Technology Pte., Ltd.*

     (10.11)     Articles of Organization of Laser Hall L.L.C. and Laser Hall L.L.C.        N/A
                 Operating Agreement.*

     (10.12)     Agreement dated January 27, 1994 between Registrant and Sports and         N/A
                 Games.*

     (10.13)     Agreement dated August 8, 1995 between Registrant and Fun City             N/A
                 Amusement Centers, Inc.*

     (10.14)     Agreement dated effective July 1, 1995 between Registrant and              N/A
                 Santa's Village, Ltd.*

     (10.15)     Sales Agreement dated in August 1995 between Registrant and TAMS           N/A
                 Stationers.*

     (10.16)     Options Granted to Harrison A. Price and Harold Skripsky.*                 N/A

     (10.17)     Lease Agreement dated October 19, 1995, between Registrant and             N/A
                 Funplex Partnership.*

     (10.18)     Employment Agreement dated effective December 1, 1995, between             N/A
                 Registrant and Michael D. Kessler.*

     (10.19)     Employment Agreement dated effective December 16, 1995, between            N/A
                 Registrant and Eric Schwartzman.*

     (10.20)     Options granted to Michael D. Kessler and Eric Schwartzman.*               N/A

     (10.21)     Agreement dated February 8, 1996, between Registrant and Tunica            N/A
                 Partners II, LP.*

     (10.22)     Addendum  dated March 27,  1996,  to the  Employment  Agreement            N/A
                 dated  effective  September 13, 1995,  between  Registrant  and
                 Robert S.
                 Scholz.*

     (10.23)     License Agreement dated August 1, 1996, between Marvel Characters,         N/A
                 Inc. and Registrant.**/***

     (10.24)     Amendment dated August 15, 1996, to Amended Stock Incentive                N/A
                 Plan.**

     (10.25)     Asset Purchase Agreement dated July 23, 1996 among Registrant,             N/A
                 Laser Storm of Longmont, Inc. and Kevin J. Barker.**/****

     (10.26)     Asset Purchase Agreement dated November 1, 1996 between Regis-             N/A
                 trant and Ridgeworld North, Inc.**/****

     (10.27)     1996 Incentive and Nonstatutory Stock Option Plan.**                       N/A



<PAGE>

<CAPTION>

Exhibit No.      Description and Method of Filing                                         Page No.
----------       --------------------------------                                         -------
<S>            <C>                                                                        <C>

     (10.28)     Agreement between NAMCO CYBERTAINMENT INC. and Regis-
                 trant and Amendment thereto.

     (10.29)     User Agreement between Harrah's Vicksburg Corporation and Regis-
                 trant.

     (10.30)     User Agreement between D.I.F.A.D.I.S.A. de C.V. and Registrant.

      (21)       List of Subsidiaries.

      (23)       Consent of HEIN + ASSOCIATES LLP.

      (27)       Financial Data Schedule

</TABLE>


          *    Incorporated  by  reference  to the  exhibits  filed as a part of
               Registration Statement No. 33-98578.

          **   Incorporated  by  reference  to the  exhibits  filed as a part of
               Registration Statement No. 333-14525.

          ***  Confidential treatment granted in a separate filing.

         ****  Certain of  the Schedules and  Exhibits  to  the  Asset  Purchase
Agreements  have  been  omitted  and  will  be  provided  to the  United  States
Securities and Exchange Commission upon request.