IRATA INC, 10KSB40, 1996-10-15

IRATA INC
10KSB40, 1996-10-15
NONSTORE RETAILERS

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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM 10-KSB

(MARK ONE)

[X] ANNUALREPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934 [FEE REQUIRED] FOR THE FISCAL YEAR ENDED JUNE 30, 1996 OR

[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 1-13068

IRATA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

TEXAS 76-0366015

(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)

8554 KATY FREEWAY, SUITE 100
HOUSTON, TEXAS 77024
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (713) 467-4300

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: CLASS A COMMON
STOCK, PAR VALUE $.10; REDEEMABLE WARRANT TO PURCHASE A SHARE OF CLASS A
COMMON STOCK AT AN EXERCISE PRICE OF $7.00 PER SHARE.

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 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 [_]

Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best registrant'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 [X]

State Issuer's revenues for the most recent fiscal year: $7,451,098

State the aggregate market value of the voting stock held by nonaffiliates
of the registrant. As of June 30, 1996 nonaffiliates of the registrant held an
aggregate of 1,728,184 shares of Class A Common Stock, having a market value
of $5,400,575 at the $3.125 bid price at June 30, 1996.

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.

Class A Common Stock, $.10 Par Value 2,550,071 Shares
Class B Common Stock, $.01 Par Value 1,500,000 Shares
(CLASS) (OUTSTANDING AS OF SEPTEMBER 30,
1996)

DOCUMENTS INCORPORATED BY REFERENCE

None

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PART I

ITEM 1. BUSINESS

GENERAL

Irata, Inc. a Texas Corporation (the "Company") was incorporated on March
22, 1992. The Company has developed and operates a computerized version of the
traditional self service photo booth known as Video Foto. Video Foto booths
combine traditional photo options with a variety of souvenir, novelty, and
amusement options, utilizing computer imaging technology, a laser printing
device, and other hardware and software. Booths provide customers a variety of
photo product options, including various traditional prints ranging in size up
to 8"x10", and novelty items such as Wanted Posters, newspaper front page,
photo greeting cards, and photo calendars. At June 30, 1996 the Company had
738 Video Foto booths operating.

Video Foto is a free standing, self service, vending machine which accepts
paper currency and coins. The current consumer price is $1.00 per transaction.
An external black & white TV monitor advertises the booth's products and
services utilizing a computerized advertising loop which plays continually
while the booth is not in use. Customers wishing to purchase products begin
the transaction by entering the booth and depositing the appropriate amount in
bills or coins. Following a simple series of computer prompts on the booth's
internal TV monitor, the customer's image is captured four different times at
five second intervals. Customers are then directed to step outside the booth
to conclude their transaction on the external TV monitor, thereby freeing the
booth to accept another customer. Outside the booth, the customer is shown a
preview of the four captured images and are directed to select their favorite
pose by activating the corresponding button. Following pose selection,
customers see a preview of four different product options, and are directed to
make their selection. Following product selection, the finished black & white
laser printed photo is delivered through a corresponding slot on the exterior
of the booth within 30-60 seconds.

The Company believes that by replacing the chemical photographic development
process or instant film process used by others with its own technology, the
Company is not subject to the handicaps of chemical waste or high consumable
costs incurred by others. Product stability is increased using the Company's
process. The Company believes that its ability to offer multiple product
selections gives it an advantage over most of its competitors, who typically
offer only one customer option per transaction. The combination of
environmental, economic, and technological benefits are believed by the
Company to appeal to site owners.

The Company's strategy is to grow the Company by placing on location a
steadily increasing number of additional Video Foto booths. The Company also
is attempting to maximize average revenue per booth by placing them in
locations that meet the Company's criteria. This involves locating booths
primarily in the larger Metropolitan Statistical Areas ("MSA's") and further
developing its route structure. The primary focus will be to place the new
booths in these areas, but in addition any booths determined to be operating
in sites that are below standard will be moved and placed in more profitable
locations.

PRODUCTS

Booths occupy 18 square feet of merchandising space and require a standard
110 volt outlet provided by the landlord. Much of the computer and imaging
equipment used to construct booths involves off-the-shelf components from
major equipment manufacturers. Booths have the capability of providing a wide
range of black & white traditional portrait products in a variety of sizes
(postage stamp through 8"x10") as well as different seasonal, amusement, or
custom souvenirs, combining the customer's photo with entertaining boarders
and print formats. Products are produced in black & white using plain paper
and toner through the use of laser printers. The Company offers competitively
priced, consumer attractive products at prices significantly less than similar
services. The Company believes its ability to offer multiple product choices
(four per transaction) and rotate selections seasonally (through software)
give it a retailing advantage over most of its competitors.

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Traditional photography. The Company believes that traditional style photo
products constitute its core business in most locations. It anticipates that
its composite products will generate higher than average customer traffic, and
will assist in acquiring customers for its core business. These services will
be directed toward children, adults, groups, and families.

Composite photographic products. The Company believes that the concept of
inserting an image of an individual or group of individuals into a scene or
product through a self service kiosk will appeal to children, teenagers,
single adults, groups, and families. The Company believes that the majority of
users are females between the ages of 6 and 25 years of age. The Company
expects to serve its customers by permitting them to be photographed on
seasonal photo greeting cards, local themes and fun products, as well as
traditional photo settings, all offered within 30-60 seconds for $1.00 per
product.

Similar to photographic studios and competitive products, the Company
anticipates that its business will be stimulated largely due to the increased
customer traffic near its booths by time-specific events such as major
holidays and promotions by the landlords.

GEOGRAPHIC AND DEMOGRAPHIC LOCATION OF BOOTHS

The Company locates booths throughout the United States, predominantly in
shopping malls, discount stores, amusement arcades, theme parks, and tourist
attractions. The Company believes that an MSA having a population base of
250,000 is the minimum population density required for the establishment and
operation of profitable service routes. The Company has identified 166 MSA's
within the United States with a population base of more than 250,000. The
Company is focusing its efforts on the top 50 MSA's, all of which support a
population base in excess of 1,000,000 potential customers. The Company
believes there are in excess of 14,000 potential locations which meet its
criteria within the top 50 MSA's. These potential locations consist of super
regional/regional malls, discount stores, arcades and family entertainment
centers, theme parks, and other high traffic outlets. As of June 30, 1996, the
Company had operations in 40 of the top 50 MSA's within the U.S. and in 19 of
the top 20 MSA's. While the Company plans to create new route operations in
other MSA's, its main focus will be the increase in the number of booths
within its existing service areas. Although it is the Company's intention to
focus expansion on the top 50 MSA's, it recognizes that it will be required to
expand within smaller markets to accommodate commitments made to existing or
future national accounts. The Company believes that locations that meet its
criteria will afford its booths with a relatively consistent flow of
customers, and widespread exposure to potential patrons whose demographic
profile constitute the primary market for its products and service.

MARKETING

From the Company's inception, its primary marketing focus was on
establishing relationships with multi-outlet national discount store chains
and amusement arcades. As the Company has matured it has shifted its marketing
emphasis to malls and theme parks. Management believes that the average
monthly revenue per booth will be higher in malls and theme parks and that
there will be an adequate market for its booths in these locations. If the
Company is successful in this effort, then sales from national accounts should
represent a smaller percentage of revenues even as the number of locations in
these chains increases.

Booths are placed on a fixed rental, revenue sharing or a revenue sharing,
with a minimum rental payment, in each case at no cost to the landlord except
the insignificant cost of power. The Company is responsible for all other
operational, service, and product costs including commissions to independent
service contractors. Individual booth sales performance is assessed monthly by
the Company against minimum performance standards. Booths producing
unsatisfactory sales results are identified monthly for removal and re-siting
in new locations. The Company continues to seek sites for additional booths in
high profile, high traffic locations through its own personnel as well as
through the use of third party locator services and outside operating
companies. The Company anticipates it will own the equipment operated in these
locations, although it may enter into joint ventures, licensing, or similar
collaborative arrangements with others to operate such locations in the future
in both the U.S. and elsewhere.

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SERVICE

The Company's operating strategy calls for the establishment of service
routes and hubs for the conduct of its daily business. Each route is
maintained by an independent contractor service person. The independent
service contractors are responsible for maintaining the overall appearance of
the booths, keeping them supplied with paper and toner and making minor
adjustments and repairs where necessary. It is anticipated that service will
continue to be performed by independent contractors who will be recruited
locally. Independent service contractors typically visit booths a minimum of
twice weekly. Account/customer initiated service calls are routinely responded
to within 24 hours. Independent service contractors also collect the money
from the coin and bill collectors on a frequent basis and are responsible for
maintaining local contact with the site operators. Typically, the independent
service contractor is paid a percentage based upon the net receipts from the
booths serviced by him.

MANUFACTURING AND SUPPLIERS

The Company purchases hardware and consumables such as paper and toner from
several suppliers. Although the Company does not maintain formal agreements
with any of its manufacturers or suppliers of hardware or consumables, the
Company believes that its current manufacturing and supply arrangements will
satisfy the Company's present and anticipated production requirements, and
that the Company has suitable alternative manufacturing and supply sources
available to it in the event that its current arrangements are terminated or
that current manufacturers and suppliers are otherwise unable to fulfill its
needs. As of June 30, 1996, the Company estimated that current booths
manufactured for use by the Company have a unit cost of approximately $7,500.

SEASONALITY

The Company anticipates that seasonality will play a part in determining
monthly sales revenue, largely due to increases and decreases in customer
traffic within its accounts. The Company believes that June, July, August, and
December will generate the highest levels of traffic through its booths, with
peak revenues experienced during school break periods and holiday shopping
periods. Additionally, revenues of the Company will generally be affected by
adverse weather conditions or any economic downturn having a material affect
on retail traffic patterns or the tourist industry.

TECHNOLOGY AND PRODUCT DEVELOPMENT

The Company has developed hardware and software that, when used in
conjunction with a variety of off-the-shelf computer and imaging equipment,
delivers a high quality, black & white laser printed image to its customers.
The Company has worked closely with several manufacturers to develop and
integrate equipment to meet its specifications. Certain of these manufacturers
have supplied the Company on a test basis with key components for its current
and future systems. Booths operated by the company as of June 30, 1996
function with either 300 or 600 dots per inch ("dpi") resolution depending on
printer model. The Company intends to upgrade high volume locations to 600 dpi
resolution.

The Company has introduced a series of new customer products with themes for
specific holidays, events, and circumstances such as Christmas and future
seasonal products will incorporate such holiday periods as Valentine's Day,
Mother's Day, Father's Day, and Thanksgiving. The Company believes that by
rotating product selections periodically, it will maintain a higher level of
sales per booth. The Company is exploring the possibility of selling
advertising space on its photo products to host locations, or other large
national advertisers who might benefit from reaching the Company's demographic
base.

The Company continues to develope new exterior cabinets for its booths,
designed with interchangeable advertising and cosmetic panels. The Company
believes this has enhanced its ability to procure high profile, high traffic
locations, without having to customize exteriors for limited production runs.
These enhancements allow

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the Company to periodically remerchandize existing booths on locations in
conjunction with promotional or seasonal events, for advertising purposes, or
in the event an existing booth is moved to a new location requiring a specific
cosmetic appearance.

The Company is presently in the final stages of completing its initial
market research to determine the potential for a booth which produces a color
product. Management anticipates that such a product should have a favorable
impact on both sales and net revenues. There can be no assurance that the
Company will be successful in its efforts to develop and market such a
product.

COMPETITION

The Company competes with two major companies, Photo-Me Intl. P.L.C. ("PMI")
and Polaroid, as well as various independent and regional operators of self
service photographic booths. Many of the firms with which the Company competes
have far greater financial resources, experience, or industry relationships
than the Company. In addition, such organizations have proven operating
histories, which may afford these firms significant advantages in negotiating
and obtaining future merchandise licenses and retail leases, arranging
financing, attracting skilled personnel and developing technology and
products. The Company attempts to compete based upon product quality,
selection, and competitive pricing.

Wet Process Photo Booths. Wet process photo booths are self service, paper
currency or coin operated booths which produce a photograph (black & white or
color) through the use of photographic paper and photographic chemicals.
Typical products are a strip of three or four black & white or color photos
(1"x2" in size), four passport/visa size photos, or one 4"x5" photo. Retail
prices typically range from $1.00-$10.00, with most selling in the $2.00-$3.00
range.

PMI is a publicly traded company on the London Stock Exchange. Through
subsidiaries, PMI operates in approximately 100 countries including the United
States through Auto Photo Systems. In addition to its photo booth operations,
PMI operates a variety of other coin/bill operated equipment, including,
business card machines, scales, kiddie rides, etc. PMI operates approximately
20,000 photo booths and an unknown number of other vending pieces throughout
the world.

Instant Process Photo Booths. The Company defines instant process photo
booths in two ways: those using Polaroid instant film, and units which produce
products through digital computer signals on thermal paper. Polaroid
Corporation has for approximately the past fifteen years attempted to produce
an instant process photo booth for sale to outside operators. Customers
receive a one pose photograph on Polaroid instant film for between $3.00-$5.00
per photo. The Company is unaware of any large territorial operators of these
units.

During the past five years, a number of individuals and small companies have
developed different approaches to electronic or digital photo booths.
Technology is similar to that used by the Company, but is generally directed
toward the production of small format (4"x5") color thermal prints, in either
postcard or souvenir form. The Company believes that the cost of the
technology is expensive ($15,000-$40,000 per booth) and the cost of
consumables is high ($.60-$1.00 per image). Typical retail prices for products
of this nature are $3.00-$5.00 per photo.

The Company is aware of several entities that are exploring the concept of
composite photography through attended operations. There are a number of
independent and company owned vendors currently utilizing technology similar
to the Company's to produce coffee mugs, T-shirts, photo buttons, etc. These
products are currently being sold at prices that are generally higher than
those the Company charges.

PATENTS AND PROPRIETARY RIGHTS

Although certain of the technology currently utilized in the Company's
booths has been treated by the Company as proprietary, none of it is protected
by patents or copyrights. The Company has no outstanding license agreements.
Although the Company is not aware of any patents or proprietary rights of
others that its

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technology may violate, there can be no assurance that such rights do not
exist. The Company does anticipate the possibility of entering into licensing
agreements involving well known persons or characters which grant the Company
the right to manufacture, distribute and sell, in defined geographic areas,
computer generated personalized photographs incorporating a customer's
photograph into a still image. Such license agreements may include the rights
to characters, designs, and visual representations as they appear on
television, motion pictures, or print media. Such licensing agreements
typically require an advance, non-refundable payment against royalties, as
well as a stipulated guarantee of minimum annual royalty payments to be made
to the Licensers during the term of the agreement.

EMPLOYEES

As of June 30, 1996 the Company had 27 full-time employees and 216
independent contractors to service booths on location. None of the Company's
employees or independent contractors are represented by labor organizations.
The Company considers its relationships with its employees and independent
contractors to be excellent.

ITEM 2. DESCRIPTION OF PROPERTY

The Company has a sixty-five month lease agreement for approximately 11,000
square feet in an office and warehouse complex at 8554 Katy Freeway, Suite
100, Houston, Texas 77024 and 8560 Katy Freeway, Suite 172, Houston, Texas
77024. The lease provides for minimum monthly rent obligations of
approximately $7,800. The Company uses the space for its administrative
offices and warehouse. To facilitate the lease, the Company entered into a
twelve month letter of credit in the amount of $50,000 with a financial
institution as temporary collateral for the lease. The financial institution
is entitled to a 2% fee. At the present time, no monies have been drawn down.

In October 1995, the Company entered into an agreement to lease temporary
warehouse space. The lease provides for minimum monthly payments approximating
$1,360. The lease is a 12 month non-cancelable operating lease.

ITEM 3. LEGAL PROCEEDINGS

In August 1996, the Company successfully concluded a restructuring of
certain trade payables totaling $734,000. The trade creditors holding these
payables agreed to exchange the amounts owed for a combination of 15% cash,
18% cash payable in 15 equal monthly installments and 67% stock. Two of the
trade creditors holding a combined total of $130,000 of the Company's payables
filed law suits for collection of their indebtedness in April and May 1996,
respectively. The aforementioned exchange agreements signed by these two
creditors also released the Company from all claims alleged in the respective
law suits. The restructuring is subject to completion of the Private
Placement.

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

Not applicable

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PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

There is no public trading market for the Company's Class B Common Stock,
all of which are held of record by one securityholder.

On May 11, 1994 the Company commenced an initial public offering pursuant to
which an aggregate of 1,265,000 shares of the Class A Common Stock were issued
and sold as part of 1,265,000 units, with each unit consisting of one share of
Class A Common Stock and one Redeemable Warrant to purchase one share of Class
A Common Stock at an exercise price of $7.00 per share at any time for three
years after issuance. The stock warrants are subject to redemption by the
Company six months following the date of the offering for $.01 per warrant in
the event the Class A Common Stock trades in excess of $9.00 per share for 20
consecutive business days.

The Class A Common Stock did not separately trade until August 9, 1994. The
Class A Common Stock and the redeemable warrants are listed on the Boston
Stock Exchange. For the year ended June 30, 1996, the high bid and low bid
price for Class A Common Stock as reported by NASDAQ was $5.625 and $3.125,
respectively. Based upon information provided by the Company's transfer agent
the Company has approximately 80 holders of record of its equity securities
who are believed by the Company to hold for the benefit of approximately 1,100
shareholders.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

GENERAL

The following discussion and analysis should be read in conjunction with the
Financial Statements and Notes thereto, and is qualified in its entirety by
the foregoing and by other more detailed financial information appearing
elsewhere.

The Company's principal business is the placement and operation of Video
Foto booths throughout the United States. Booth manufacturing is subcontracted
with the Company providing limited assembly and extensive testing and quality
control. The Company seeks what it considers to be desirable locations (sites)
and then contracts with the site owner to place the booths in operation.
Typically the contracts are from month-to-month with rents based on a
percentage of the revenue collected. In most cases there is a minimum
guarantee and occasionally a simple monthly rate, or some combination.

The Company's financial results are dependent on (i) number of booths in
operation (operating days), and (ii) revenue per booth. The historical results
for the Company for the years ending June 30, 1995 and 1996 are shown in the
table below:

<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1995 1996
---------- -----------
<S> <C> <C>
Revenues........................................ $5,520,452 $ 7,451,098
Net Loss........................................ $ (595,800) $(2,114,557)
Operating Days.................................. 180,108 249,175
Booths End of Period............................ 706 738
Average Monthly Revenue/Booth................... $ 932 $ 910
</TABLE>

(Average monthly revenue per booth is calculated by dividing the revenues by
the number of operating days and multiplying by 30.42, the average number of
days per month)

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permanently removed approximately 120 booths from operations. These early
prototype booths, which were acquired in 1992, contained older components,
which had high failure rates and, in some cases, replacement parts were no
longer available to supply them. Also, the cabinet construction was not
designed for high traffic, unattended locations, resulting in security
problems. These booths were replaced with the current booth, which has a
sturdier cabinet and more reliable up-to-date components. As a result of this
decision, the Company incurred a charge of approximately $300,000,
representing the undepreciated book value of these older booths. In addition,
the Company reduced the carrying value of hardware and components by
approximately $470,000, to account for obsolescence and to value used parts at
the lower of cost or realizeable value. The removal and replacement of these
booths accounted for a significant part of the installation costs.

During May 1996, the State of Texas conducted a sales and use tax audit for
the period March 1992 to March 1996. In connection with the auditor's review
of sales records, the Company was unable to provide documentation to show that
certain third party operators, who collect cash from the photo booths, had
paid the appropriate sales tax or that they had obtained sales tax exemption
cetificates from the appropriate state tax authority. As a result of this
review, the Company was issued a preliminary delinquent sales tax assessment
of approximately $150,000. Management is pursuing collection of taxes or
submission of certificates from third party operators to mitigate the sales
tax liability. Additionally, the Company has been assessed use tax of
approximately $150,000 on booth components acquired from out of state vendors.
The use tax obligation was capitalized and is being depreciated over the life
of the related components. Accordingly, the sales and use tax has been charged
to operations or capitalized in the accompanying financial statements for
1996. The provision did not have a material effect on the Company's financial
position or results of operations for 1996.

The Company has been in default on its loan covenants with its Lender since
July 1995. In August 1996, the Company negotiated an agreement with its Lender
to revise certain covenants to bring the Company into compliance. Among other
provisions, the negotiated terms provide for extensive revisions to all
financial ratio covenants consistent with a revised detailed financial plan
developed by Management. In addition, the Company must satisfy certain
conditions including raising $1,500,000 through a Private Placement with net
proceeds of at least $1,250,000.

The level of past due trade payables has increased significantly since March
1996. To resolve this situation, the Company successfully concluded a
restructuring of certain trade payables totaling $734,000. The trade creditors
holding these payables agreed to exchange the amounts owed for a combination
of 15% cash, 18% cash payable in 15 equal monthly installments and 67% stock.
The restructuring is subject to completion of the Private Placement. The price
of the stock to be issued to the trade creditors is to be the greater of $2.25
per share or the lower of: (a) 80% of the average closing price at which the
Class A Common Stock of the Company trades during the 30 calendar day period
following the date of closing of this offering or (b) the lowest closing price
at which the Class A Common Stock trades during such 30-day period.

If the Company is unsuccessful in completing the Private Placement, the
Lender Agreement or the Trade Payable Agreement, the Company's ability to
continue as a going concern will be in doubt.

RESULTS OF OPERATIONS

Twelve Months Ended June 30, 1995 Compared to Twelve Months Ended June 30,
1996

Revenues. Revenues increased 35% from $5,520,452 for the twelve month period
ended June 30, 1995 to $7,451,098 for the twelve month period ended June 30,
1996. The growth in revenues was primarily attributable to the 38% increase in
operating days from 180,108 in 1995 to 249,175 in 1996. However, average
monthly revenue per booth dropped from $932 to $910. This decrease was due to
attrition in revenue at booths installed for more than one year.

Cost of Services. Cost of services increased from 73% to 91% of gross
revenues or $4,014,428 and $6,746,601 for the twelve months ended June 30,
1995 and 1996, respectively. The dollar increase is primarily

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due to losses on disposal on of property and equipment and site rent expense.
The $770,000 loss on disposal of property and equipment expense in 1996 is
attributable to the removal of older version booths and the writedown of
hardware and components. Management believes that these are one time
occurences. Site rent expense as a percentage of revenue increased to 37% in
1996 for two reasons. First, the number of theme park locations, which have a
50% site rent percentage, increased at a greater rate than locations with
lower rent factors. Second, revenues at certain mall locations with fixed
monthly rents decreased causing the site rent expense to increase as a
percentage of revenue. Management believes that a combination of lower fixed
rent at mall locations and relocation of booths to sites with higher revenue
will reduce the site rent percentages in the future.

Selling, General, and Administrative Expense. Selling, general, and
administrative expenses increased 7% from $2,057,789 for the twelve months
ended June 30, 1995 to $2,209,285 for the twelve months ended June 30, 1996.
This expense category decreased as percentage of revenue from 37% in 1995 to
30% in 1996. Management believes that this positive trend will continue in the
future.

Other Income and Expense. Interest expense and financing costs increased
from a total of $57,885 for the twelve moths ended June 30, 1995 to a total of
$613,531 for the twelve months ended June 30, 1996. This increase is
attributable to the $3,500,000 line of credit loan entered into in June 1995.

LIQUIDITY AND CAPITAL RESOURCES

For the year ended June 30, 1996 net cash provided by operating activities
was $1,053,482 as compared to $497,317 for the twelve months ended June 30,
1995. The net cash provided in 1996 was due to continued utilization of vendor
credit lines and increases in other categories of current liabilities,
primarily sales and use tax payable. The net cash provided in 1995 was due
primarily to the utilization of vendor credit lines.

The Company's revenues and booths in operation have increased in each of the
first four years in business; however, the Company has yet to achieve an
operating profit. Management's plan for fiscal 1997 is to relocate
approximately 200 existing booths, with below average revenue, to new
locations and utilize approximately $750,000 of the proposed Private Placement
to build approximately 100 booths. Other than the purchase of new booths, the
Company does not expect to have any significant capital expenditures for the
foreseeable future.

The Company had a working capital deficit of $3,496,537 as of June 30, 1996.
After receiving the Private Placement proceeds, finalizing the Lender
Agreement and completing the Trade Payable Agreement, the Company will have
working capital of approximately $500,000. In addition to building new booths,
Management intends to use the proceeds of the Private Placement for the
initial payments under the Trade Payable Agreement, payment of delinquent
sales and use taxes and other working capital purposes.

ITEM 7. FINANCIAL STATEMENTS

The financial statements required to be filed under this item are presented
on pages 14 through 29 of this Form 10-KSB, and are incorporated herein by
reference.

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

The Company's financial statements were previously audited by Ernst & Young
LLP, whose resignation, effective June 11, 1996, was accepted by the Board of
Directors. The Company subsequently engaged Lane Gorman Trubitt, L.L.P. to
perform audit services for the year ended June 30, 1996. Ernst & Young's
report on the Company's financial statements for the two years ended June 30,
1995 contained an unqualified opinion. However, the audit report included an
explanatory paragraph that raised substantial doubt about the Company's
ability to continue as a going concern existed. At no time was there any
disagreement between the Company and Ernst & Young LLP on any matter of
accounting principles or practices, financial statement disclosure or auditing
scope or procedure.

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<PAGE>

PART III

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

MANAGEMENT

DIRECTORS AND EXECUTIVE OFFICERS

In November 1995, M.G. Morgan resigned as Vice President and Chief Financial
Officer and as a member of the Company's Board of Directors. To fill the
vacancy created by his resignation, the board appointed John D. Higgins,
Senior Vice President of Royce Investment Group, Inc. Richard Fairchild, then
Chairman of the Board further increased his management responsibilities by
temporarily assuming Mr. Morgan's duties as Chief Financial Officer. In April
1996, the Company engaged the firm of Wimmer Associates, Inc. to assist
management with: (1) operations and controls for enhancing profitability, (2)
development and implementation of plans and programs designed to achieve
financial projections and (3) financial restructuring. Subsequently, in June
1996, Mr. Fairchild resigned as Chairman of the Board of Directors and in
August 1996, Mr. C.W. Moody, Jr., one of the Company's founders, a principal
stockholder and member of the Board of Directors, died. In August 1996, the
remaining members of the Board of Directors approved resolutions authorizing
(i) the Company to enter into an agreement with Lance P. Wimmer, Managing
Director, Wimmer Associates, Inc. providing for Mr. Wimmer to become Chairman,
President, and Chief Executive Officer of the Company and (ii) the Company to
enter into a consulting agreement with Robert R. Salyard, a founder of the
Company for Mr. Salyard to become a consultant to the Company and a member of
its Board of Directors. The agreements with each of Mr. Wimmer and Mr. Salyard
provide for them to assume their duties as members of the board only upon
completion of the proposed Private Placement. At such time, Mr. Searles,
currently President of the Company, will become Executive Vice President The
agreements provide for annual compensation to Messrs. Wimmer and Salyard of
$135,000 and $18,000, respectively, with Mr. Wimmer being entitled to earn
bonus compensation of up to $40,000 based on the achievement of plan
projections and with additional bonus potential for exceeding plan
projections. The agreements provide for Messrs. Wimmer and Salyard to receive
options, exercisable for six years at $0.50 per share for 300,000 and 125,000
shares, respectively. The Company intends to seek shareholder approval for the
adoption of a stock option plan covering such securities at the next annual
meeting of shareholders.

The following persons are the current executive officers and directors of
the Company:

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Robert A. Searles, Jr....... 40 President, Chief Executive Officer and Director
Andrew J. Clark, III........ 58 Director
John D. Higgins............. 64 Director
</TABLE>

ROBERT A. SEARLES, JR. has been President and Chief Executive Officer since
June 23, 1992. From 1988 until joining the Company, Mr. Searles served as Vice
President of Sales & Marketing for Auto Photo Systems (APS), wholly owned
subsidiary of Photo-Me Int. APS is the operator of approximately 2,000 wet
process photo booths within the U.S.

ANDREW J. CLARK, III is an attorney and has been engaged in the full-time
practice of law as a sole practitioner since June 1, 1994. For more than five
years prior to becoming a sole practitioner, he was a partner in Butler &
Binion, L.L.P. in Houston, Texas.

JOHN D. HIGGINS has been Senior Vice President, Director of Corporate
Finance with Royce Investment Group, Inc. since 1990. He is also an outside
director for Iatros Health Network, Inc., which manages and operates health
care facilities.

9
<PAGE>

The following persons have been authorized by the current Board of Directors
and will assume their duties as members of the Board of Directors upon
completion of the proposed Private Placement:

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Lance P. Wimmer......... 52 Chairman, President, Chief Executive Officer and Director
Robert R. Salyard....... 69 Director
</TABLE>

LANCE P. WIMMER has been Managing Director of Wimmer Associates, Inc., a
professional consulting and management firm since 1992. From 1991 to forming
Wimmer Associates in 1992, he managed the Southwest Region for Buccino
Associates, Inc., a leading operations restructuring consulting firm.

ROBERT R. SALYARD has been Chairman of Salyard Manangement Company for more
than five years. The firm provides advisory services to chief executive
officers and presidents. Mr. Salyard is a founder of the Company and has
provided advisory services since 1992. He is also on the board of directors of
Spencer Trask Securities, Inc., one of the underwriters of the proposed
Private Placement.

All Directors were elected at the Company's annual meeting held January 10,
1996, and will hold office until the next annual meeting of shareholders,
scheduled to be held November 12, 1996, and until their successors are
elected. Officers are elected to serve, subject to the discretion of the Board
of Directors, until their successors are appointed.

OTHER KEY MANAGEMENT

The following persons are key employees of the Company:

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Sue Camp................... 63 Secretary and Logistics Manager
Roger Osgood............... 42 Manufacturing and Engineering Technology Manager
Sonya Presley.............. 25 Controller
Richard W. Bell............ 61 Sales and Marketing Manager
</TABLE>

SUE CAMP joined the Company in September, 1992 as Administrative Manager and
Secretary. Prior to joining the Company she worked with Century 21 Real Estate
in a variety of Sales and Administrative capacities for more than five years.

ROGER OSGOOD joined the Company in December, 1992. Prior to joining the
Company on a full time basis, Mr. Osgood served as technical consultant since
the Company's inception. Previously, he was employed as technical engineer for
Data East, Inc. in San Jose, California.

SONYA PRESLEY joined the Company in October 1994. Ms Presley graduated from
East Texas State University with a BBA degree in August 1993.

RICHARD BELL joined the Company in April of 1994. Prior to joining the
Company, Mr. Bell spent more than the past five years as Marketing Manager
South Central Region for Auto Photo Systems.

There is no family relationship between any present executive officers and
directors.

Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
directors and executive officers, and persons who own more than ten percent of
a registered class of the Company's equity securities, to file with the
Commission, the Boston Stock Exchange and NASDAQ initial reports of ownership
and reports of changes in ownership of Common Stock of the Company. Officers,
directors and greater than ten-percent shareholders are required by Commission
regulations to furnish the Company with copies of all Section 16(a) forms they
file. To the Company's knowledge, based solely on review of the Company's
copies of such reports furnished to the Company and written representations
that no other reports were required, during the fiscal year ended June 30,
1996, all Section 16(a) filing requirements applicable to its officers,
directors and greater than ten-percent beneficial owners were complied with.

10
<PAGE>

ITEM 10. EXECUTIVE COMPENSATION

The following table summarizes all cash compensation paid or accrued by the
Company to the Company's President and Chief Executive Officer, former
Chairman of the Board and former Vice-President--Chief Financial Officer for
services rendered in all capacities to the Company for the years ended June
30, 1994, 1995 and 1996.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
ANNUAL LONG-TERM COMPENSATION
COMPENSATION AWARDS SECURITIES UNDERLYING
---------------- ----------------------------
ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OPTIONS/SARS(1) COMPENSATION
--------------------------- ---- -------- ------- --------------- ------------
<S> <C> <C> <C> <C> <C>
Richard W. Fairchild, Jr
(Resigned June 1996)....... 1996 $ 67,167 $ -0- -0- N/A
Chairman of the Board 1995 16,667 -0- 57,410 N/A
1994 N/A N/A 17,590 N/A
Robert A. Searles, Jr....... 1996 $115,000 $ -0- -0- $12,502(3)
President and Chief 1995 120,000 -0- -0- 15,555(2)
Executive Officer 1994 120,000 37,500 52,770 15,555(2)
M. G. Morgan (Resigned
November 1995)............. 1996 $ 76,250 $ -0- -0- $ 2,400(4)
Vice President Finance and 1995 120,000 -0- 21,150 7,200(4)
Chief Financial Officer 1994 110,000 15,000 52,770 -0-
</TABLE>
- --------
(1) Includes 52,770 options to Mr. Searles, 73,920 options to Mr. Morgan and
57,410 options to Mr. Fairchild all exercisable at $5.00 per share.
(2) Represents employer contributions for insurance ($8,355) and a car
allowance ($7,200).
(3) Represents employer contributions for insurance ($6,802) and a car
allowance ($5,700).
(4) Represents employer contributions for a car allowance.

OPTIONS EXERCISED IN LAST FISCAL YEAR AND YEAR-END VALUE

The following table sets forth information with respect to the named
executive officers with respect to the exercise of stock options during the
year ended June 30, 1996 and unexercised stock options held as of June 30,
1996.

<TABLE>
<CAPTION>
NUMBER OF SECURITIES
SHARES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED IN
ACQUIRED OPTIONS HELD AT THE MONEY OPTIONS AT
ON VALUE JUNE 30, 1996 JUNE 30, 1996(2)
EXERCISE REALIZED ------------------------- -------------------------
NAME (#) ($)(1) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- -------- -------- ------------------------- -------------------------
<S> <C> <C> <C> <C>
Richard W. Fairchild,
Jr..................... -0- $N/A 75,000/-0- N/A/ N/A
Robert A. Searles, Jr... -0- N/A 52,770/-0- N/A/ N/A
M.G. Morgan............. -0- N/A 73,920/-0- N/A/ N/A
</TABLE>
- --------
(1) Represents the difference between the market price of the underlying
shares of Class A Common Stock at exercise date and the exercise price.
(2) Based on the closing price on the Nasdaq National Market of the Company's
Class A Common Stock on that date.

EMPLOYMENT AGREEMENTS

The Company entered into an Employment Agreement on June 15, 1993 with Mr.
Searles providing for a base salary of $10,000 per month and a primary term of
three years. On September 1, 1993, the employment

11
<PAGE>

agreement between the Company and Mr. Searles was amended to extend the term
until June 30, 1997, to restrict Mr. Searles from competing with the Company
for a two-year period upon termination of the employment relationship and to
provide for a $30,000 bonus to be paid on January 15, 1994 to assist him with
federal tax liability with respect to the exercise of certain stock options.
Under the terms of the employment relationship with Mr. Searles, he has been
provided with a car allowance, medical insurance and other customary employee
benefits.

Additionally, the Company entered into agreements with Mr. Lance P. Wimmer
and Mr. Robert R. Salyard. See Item 9.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

PRINCIPAL SHAREHOLDERS

All 1,500,000 shares of Class B Common Stock were issued to and remain owned
of record by Names 'N Faces, Inc. It has been the Company's understanding that
Names 'N Faces was beneficially owned by Buffalo, Inc. It is the Company's
knowledge that both Names 'N Faces and Buffalo, Inc. are insolvent and have
had their charters revoked for failure to pay franchise tax. The Company has
no specific knowledge as to the identity of the beneficial owners of Buffalo,
Inc. The following table sets forth certain information as of June 30, 1996,
with respect to the beneficial ownership of shares Class A Common Stock held
by (i) each person known by the Company to be the owner of more than 5% of the
outstanding shares Class A Stock, (ii) each director, (iii) each of the
executive officers named under Executive Compensation, and (iv) all officers
and directors as a group.

<TABLE>
<CAPTION>
PERCENTAGE OF OUTSTANDING
SHARES OWNED(2)
----------------------------
AMOUNT AND NATURE
OF BENEFICIAL PERCENTAGE
NAME OF BENEFICIAL OWNER OWNERSHIP(1)(2) OF CLASS
------------------------ ----------------- ----------
<S> <C> <C>
Petrus Fund, L.P.(3).......................... 470,000 15.56%
1700 Lakeside Square
12377 Merit Drive
Dallas, TX 75251
J.T. Trotter(4)............................... 244,234 9.28%
1000 Louisiana, Suite 3600
Houston, TX 77002
Royce Investment Group, Inc(5)................ 455,000 16.43%
199 Crossways Park Drive
Woodbury, NY 11797
Kevin Kimberlin............................... 147,076 5.77%
9 Oak Lane
Old Greenwich, CT 06870
Robert A. Searles, Jr.(6)..................... 103,966 3.99%
8554 Katy Freeway, Suite 100
Houston, TX 77024
Mr. M.G. Morgan(7)............................ 73,920 2.82%
1819 Augusta
Houston, TX 77057
Richard W. Fairchild, Jr.(7).................. 75,000 2.86%
4545 Post Oak Place, Suite 130
Houston, TX 72027
Andrew J. Clark, III(7)....................... 25,000 0.97%
1000 Louisiana, Suite 3640
Houston, TX 77002
All officers and directors as a group(8)
(4 persons)................................... 277,886 10.01%
</TABLE>

12
<PAGE>

- --------
(1) Unless otherwise noted, the Company believes that all persons named in the
table have sole voting and investment power with respect to all shares of
Class A Common Stock beneficially owned by them.
(2) A person is deemed to be the beneficial owner of securities that can be
acquired by such person within 60 days from the date of this Annual Report
upon the exercise of warrants or options. Each beneficial owner's
percentage ownership is determined by assuming that options or warrants
that are held by such person and which are exercisable within 60 days from
the date of this annual report have been exercised.
(3) Includes 470,000 shares issuable under Warrants granted under a Loan
Agreement and Loan Commitment to Petrus Fund, L.P. that are currently
exercisable. Petrus Fund, L.P. was granted an additional 40,000 warrants
that are not currently exercisable.
(4) Includes 50,000 shares issuable upon exercise of the Bridge Warrants,
25,000 shares upon exercise of the warrants issued in connection with a
loan guarantee provided by Mr. Trotter related to the $500,000 bank
financing paid off in June 1995 and 5,700 shares issuable upon exercise of
the warrants issued with a short-term note from Dominion Investments, a
corporation beneficially owned by Mr. Trotter.
(5) Includes 110,000 Units comprised of 110,000 options to purchase 110,000
shares of Class A Common Stock and 110,000 warrants to purchase 110,000
shares of Class A Common Stock.
(6) Includes 52,770 shares issuable upon exercise of currently exercisable
options granted under the Company's Stock Option Plan.
(7) Represents shares issuable upon exercise of currently exercisable options
granted under the Company's Stock Option Plan.
(8) Includes 226,690 shares issuable upon exercise of Stock Options that are
immediately exercisable at $ 5.00 per share granted under the Company's
Stock Option Plan.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Mr. Clark was among the trade creditors accepting the restructuring
arrangement in August 1996. He has agreed to exchange a legal services claim of
$55,585 for $8,338 in cash, the right to receive $697 cash payments for 15
months and 16,467 shares of Class A Common Stock.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.

(a) The following financial statements of the Company are set forth herein
commencing on page 14.

(i) Reports of Independent Auditors

(ii) Financial Statements

<TABLE>
<S> <C>
Reports of Independent Auditors.......................................... 14-15
Financial Statements
Balance Sheet as of June 30, 1996...................................... 16-17
Statements of Operations for Years Ended June 30, 1995 and 1996........ 18
Statements of Stockholders' Equity for Years Ended June 30, 1995 and
1996.................................................................. 19
Statements of Cash Flows for Years Ended June 30, 1995 and 1996........ 20
Notes to Financial Statements.......................................... 21-29
</TABLE>

(b) Reports on Form 8-K--

Change in Registrant's Certifying Accountant filed on June 17, 1996

Reference is made to the Index to Exhibits on page 31.

13
<PAGE>

REPORT OF INDEPENDENT AUDITORS

Board of Directors and Stockholders
Irata, Inc.

We have audited the accompanying balance sheet of Irata, Inc. as of June 30,
1996, and the related statements of operations, stockholders' equity, and cash
flows for the year then ended. 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 audit.

We conducted our audit 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 audit provides 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 Irata, Inc. at June 30,
1996, and the results of its operations and its cash flows for the year then
ended, in conformity with generally accepted accounting principles.

The accompanying financial statements as of and for the year ended June 30,
1996 have been prepared assuming that Irata, Inc. will continue as a going
concern. As more fully described in Note 2, the Company has incurred recurring
losses and has a working capital deficiency. In addition, the Company has not
complied with certain covenants of a loan agreement with a Lender. These
conditions raise substantial doubt about the Company's ability to continue as
a going concern. Management's plans in regard to these matters are also
described in Note 2. The financial statements do not include any adjustments
to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.

Lane Gorman Trubitt, L.L.P.

Dallas, Texas
August 29, 1996

14
<PAGE>

IRATA, INC. REPORT OF INDEPENDENT AUDITORS

Board of Directors and Stockholders
Irata, Inc.

We have audited the accompanying statements of operations, stockholders'
equity, and cash flows of Irata, Inc. for the year ended June 30, 1995. 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 audit.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the results of operations and cash flows of Irata,
Inc. for the year ended June 30, 1995, in conformity with generally accepted
accounting principles.

The accompanying financial statements have been prepared assuming that
Irata, Inc. will continue as a going concern. As more fully described in Note
2, the Company has incurred recurring losses and has a working capital
deficiency. In addition, the Company has not complied with certain covenants
of a loan agreement with a Lender. These conditions raise substantial doubt
about the Company's ability to continue as a going concern. Management's plans
in regard to these matters are also described in Note 2. The financial
statements do not include any adjustments to reflect the possible future
effects on the recoverability and classification of assets or the amounts and
classification of liabilities that may result from the outcome of this
uncertainty.

Ernst & Young LLP

Houston, Texas
September 22, 1995

15
<PAGE>

BALANCE SHEET

JUNE 30, 1996

<TABLE>
<CAPTION>
ASSETS
------
<S> <C>
Current assets:
Cash............................................................. $ 174,352
Accounts receivable-trade, net of $10,000 allowance.............. 472,587
Accounts receivable-other........................................ 10,185
Consumable inventory............................................. 200,581
Prepaids and other current assets................................ 71,368
-----------
Total current assets........................................... 929,073
Property and equipment, at cost:
Equipment-Booths................................................. 6,318,711
Components and hardware.......................................... 507,499
Furniture, fixtures and equipment................................ 203,931
-----------
7,030,141
Accumulated depreciation......................................... (1,624,354)
-----------
Total property and equipment, net.............................. 5,405,787
Other assets:
Deferred loan costs, net......................................... 463,838
Other, net....................................................... 66,347
-----------
530,185
-----------
Total assets................................................... $ 6,865,045
===========
</TABLE>

16
<PAGE>

LIABILITIES AND STOCKHOLDERS' EQUITY

<TABLE>
<S> <C>
Current liabilities:
Trade accounts payable.......................................... $ 1,129,829
Long-term debt in default....................................... 2,150,000
Sales and use tax payable....................................... 620,660
Short-term notes-stockholders................................... 160,000
Short-term note-vendor.......................................... 63,389
Site rents payable.............................................. 135,018
Other accrued liabilities....................................... 166,714
-----------
Total current liabilities..................................... 4,425,610
Commitments
Stockholders' equity:
Preferred stock, $1 par value:
100,000 shares authorized, zero issued........................ --
Class A common stock, $.10 par value:
20,000,000 shares authorized, 2,550,071 issued and
outstanding.................................................. 255,007
Class B common stock, $.01 par value:
1,500,000 shares authorized, issued and outstanding........... 15,000
Additional paid-in-capital...................................... 6,504,991
Accumulated deficit............................................. (4,335,563)
-----------
Total stockholders' equity.................................... 2,439,435
-----------
Total liabilities and stockholders' equity.................... $ 6,865,045
===========
</TABLE>

See accompanying notes.

17
<PAGE>

IRATA, INC.

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-----------------------
1995 1996
---------- -----------
<S> <C> <C>
Revenues.............................................. $5,520,452 $ 7,451,098
Cost of services:
Site rent........................................... 1,724,559 2,778,502
Route labor......................................... 622,723 780,431
Equipment depreciation.............................. 650,822 1,111,191
Consumables......................................... 528,771 760,530
Freight and installation costs...................... 174,063 329,976
Loss on disposal of property & equipment............ 188,925 771,363
Other costs of service.............................. 124,565 214,608
---------- -----------
Total cost of services................................ 4,014,428 6,746,601
---------- -----------
Gross profit.......................................... 1,506,024 704,497
Selling, general and administrative expenses:
Salaries and wages.................................. 982,356 1,101,870
Professional fees................................... 480,745 405,042
Insurance........................................... 101,218 154,212
Marketing........................................... 99,447 117,251
Travel and entertainment............................ 41,647 52,818
Depreciation and amortization....................... 37,865 42,834
Personal property and franchise taxes............... 19,941 51,465
Office expense...................................... 230,111 267,167
Bad debt............................................ 64,459 16,626
---------- -----------
Total selling, general and administrative expenses.... 2,057,789 2,209,285
---------- -----------
Operating loss........................................ (551,765) (1,504,788)
Other income (expense):
Interest expense.................................... (43,778) (342,166)
Financing costs..................................... (14,107) (271,365)
Interest income..................................... 29,128 284
Other, net.......................................... (15,278) 3,478
---------- -----------
Total other income (expense).......................... (44,035) (609,769)
---------- -----------
Net loss.............................................. (595,800) (2,114,557)
========== ===========
Net loss per share.................................... $ (0.24) $ (0.83)
========== ===========
Weighted average number of common or equivalent shares
outstanding.......................................... 2,534,711 2,545,409
========== ===========
</TABLE>

See accompanying notes.

18
<PAGE>

IRATA, INC.

STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
CLASS A COMMON CLASS B COMMON
STOCK STOCK
------------------ ----------------- ADDITIONAL TOTAL
NUMBER OF NUMBER OF PAID-IN ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT EQUITY
--------- -------- --------- ------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at June 30,
1994................... 2,367,992 $236,799 1,500,000 $15,000 $5,471,004 $(1,625,206) $ 4,097,597
Exercise of
overallotment, net of
costs.................. 165,000 16,500 -- -- 676,193 -- 692,693
Stock awards............ 9,619 962 -- -- 28,983 -- 29,945
Value of warrants issued
in connection with Loan
Agreement.............. -- -- -- -- 313,200 -- 313,200
Net loss................ -- -- -- -- -- (595,800) (595,800)
--------- -------- --------- ------- ---------- ----------- -----------
Balance at June 30,
1995................... 2,542,611 254,261 1,500,000 15,000 6,489,380 (2,221,006) 4,537,635
Stock awards............ 7,460 746 -- -- 13,311 -- 14,057
Value of warrants issued
in connection with Loan
Agreement.............. -- -- -- -- 2,300 -- 2,300
Net loss................ -- -- -- -- -- (2,114,557) (2,114,557)
--------- -------- --------- ------- ---------- ----------- -----------
Balance at June 30,
1996................... 2,550,071 $255,007 1,500,000 $15,000 $6,504,991 $(4,335,563) $ 2,439,435
========= ======== ========= ======= ========== =========== ===========
</TABLE>

See accompanying notes.

19
<PAGE>

IRATA, INC.

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-----------------------
1995 1996
---------- -----------
<S> <C> <C>
Operating activities
Net loss............................................ $ (595,800) $(2,114,557)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization....................... 688,687 1,154,025
Financing costs..................................... 14,107 271,365
Loss on disposal of property and equipment.......... 188,925 771,363
Stock awards........................................ 29,945 14,057
Changes in operating assets and liabilities:
Accounts receivable--trade.......................... (277,681) (51,724)
Accounts receivable--other.......................... (20,921) 16,445
Other current assets................................ (221,112) 21,200
Other assets........................................ (10,615) (33,976)
Accounts payable.................................... 690,058 301,544
Sales and use tax payable........................... 62,628 518,541
Site rents payable.................................. (30,312) 121,518
Other accrued liabilities........................... (38,592) 63,681
---------- -----------
Net cash provided by operating activities............. 479,317 1,053,482
Investing activities
Purchases of property and equipment................. (4,762,891) (1,447,646)
Maturity of short-term investments.................. 1,016,765 --
Proceeds from insurance claim for damaged property.. 25,294 --
---------- -----------
Net cash used in investing activities................. (3,720,832) (1,447,646)
Financing activities
Proceeds from bank notes............................ 600,000 --
Principal payments on bank notes.................... (600,000) --
Proceeds from short-term notes...................... -- 160,000
Proceeds from exercise of overallotment, net........ 692,693 --
Proceeds from Loan Agreement, net................... 1,404,107 315,000
Principal payments on short-term notes.............. (67,459) (92,536)
---------- -----------
Net cash provided by financing activities............. 2,029,341 382,464
---------- -----------
Net (decrease) increase in cash and cash equivalents.. (1,212,174) (11,700)
Cash and cash equivalents at beginning of year........ 1,398,226 186,052
---------- -----------
Cash and cash equivalents at end of year.............. $ 186,052 $ 174,352
========== ===========
</TABLE>

See accompanying notes.

20
<PAGE>

IRATA, INC.

NOTES TO FINANCIAL STATEMENTS

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

IRATA, Inc. (the "Company") was incorporated March 20, 1992 under the laws
of the State of Texas, for the purpose of acquiring and operating Video Foto
("Booths") throughout the United States at shopping malls, theme parks, retail
stores and other areas of high pedestrian traffic. The Booths produce a
computer generated laser printed image with various background options.

Revenue Recognition

The Company recognizes revenue as products and services are provided.
Landlords are paid a fixed rental, percentage of net revenues or a combination
thereof, which is recorded as site rent. The independent service contractor is
also paid a fixed commission, a percentage based upon the net revenues
generated by the Booths serviced by him, or a combination thereof, which is
recorded as route labor.

Statement of Cash Flows

Supplemental disclosures of cash flow information are as follows:

<TABLE>
<CAPTION>
1995 1996
------- --------
<S> <C> <C>
Interest paid........................................... $22,140 $264,162
Taxes paid.............................................. -- --
Conversion of vendor payable to note.................... 223,384 35,000
Warrant value associated with the Loan Agreement........ 313,200 2,300
</TABLE>

Property and Equipment

Property and equipment is recorded at cost. Expenditures for major additions
and improvements are capitalized while minor replacements, maintenance and
repairs which do not improve or extend the life of such assets are charged to
operations as incurred. Depreciation is provided using the straight line
method over the estimated useful lives of the various classes of assets, as
follows:

<TABLE>
<CAPTION>
ESTIMATED
USEFUL LIFE
------------
<S> <C>
Equipment-Booths............................................. 5 to 7 Years
Furniture, Fixtures and Equipment............................ 3 to 7 Years
</TABLE>

Components and hardware consist of parts used to construct and repair
Booths. No depreciation is provided for these parts until they are installed
into a Booth and that Booth is placed into service. Used parts are recorded at
the lower of cost or net realizeable value.

Other Assets

Organization costs are amortized using the straight-line method over five
years. Deferred loan costs are amortized over the life of the loan (see Note
4).

Certain technology currently utilized in the Company's Booths has been
treated by the Company as proprietary. The Company has determined that seven
years is an appropriate life for proprietary process.

Expenditures related to printer software upgrades are capitalized and
amortized over three years which the Company has determined to be the
estimated useful life.

21
<PAGE>

IRATA, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

Income Taxes

The liability method is used in accounting for income taxes. Under this
method, deferred tax liabilities are determined based upon differences between
financial reporting and tax bases of assets and liabilities and are measured
using the enacted marginal tax rates and laws that will be in effect when the
differences reverse.

Estimates

In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and
assumptions that affect the reported amount of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements, and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.

Loss Per Share

Loss per share has been computed based upon the weighted average number of
common and common equivalent shares outstanding. The Class B Common Stock has
not been considered in the loss per share computation because it is not
considered a Senior security or a common stock equivalent based on rights
associated with the Class B Common Stock. Options and warrants have not been
included in the computation as they have an antidilutive effect.

Reclassifications

Certain reclassifications have been made to conform to the 1996
presentation.

Inventory

Consumable inventory is stated at the lower of cost or market. Cost is
determined principally by the first-in, first-out method.

Newly Issued Accounting Standards

In March 1995, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Standards (SFAS) No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of",
which is effective for the Company's 1997 fiscal year end. The adoption of
SFAS No. 121 is not expected to have a material impact on the Company's
financial position, liquidity, cash flow or results of operations.

In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation" which requires companies to measure employee stock compensation
plans based on the fair value method of accounting or to continue to apply APB
No. 25, "Accounting for Stock Issued to Employees" and provide pro forma
footnote disclosures under the fair value method in SFAS No. 123. The Company
has decided to adopt SFAS No. 123 through disclosure only, and accordingly,
pro forma fair value disclosures will be made in the 1997 financial
statements.

Fair Value of Financial Instruments

Fair value of financial instruments are estimated to approximate the related
book values, unless otherwise indicated, based on market information available
to the Company.

22
<PAGE>

IRATA, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

2. LIQUIDITY AND WORKING CAPITAL DEFICIT

As of June 30, 1996 the Company recognized a net loss of $2,114,557. A
significant portion of this loss is attributable to the costs associated with
certain non-recurring events. During the current fiscal year, the Company
permanently removed approximately 120 booths from operations. These early
prototype booths, which were acquired in 1992, contained older components,
which had high failure rates and, in some cases, replacement parts were no
longer available to supply them. Also, the cabinet construction was not
designed for high traffic, unattended locations, resulting in security
problems. These booths were replaced with the current booth, which has a
sturdier cabinet and more reliable up-to-date components. As a result of this
decision, the Company incurred a charge of approximately $300,000,
representing the undepreciated book value of these older booths. In addition,
the Company reduced the carrying value of hardware and components by
approximately $470,000, to account for obsolescence and to value used parts at
the lower of cost or realizeable value. The removal and replacement of these
booths accounted for a significant part of the installation costs.

In summary, Management believes that the charges discussed in the above two
paragraphs are not representative of the costs associated with its normal
operations.

If the Company is unsuccessful in completing the Private Placement, the
Lender Agreement or the Trade Payable Agreement, the Company's ability to
continue as a going concern will be in doubt.

The Company had a working capital deficit of $3,496,537 as of June 30, 1996.
If the Company receives the Private Placement proceeds, finalizes the Lender
Agreement and completes the Trade Payable Agreement, it will

23
<PAGE>

IRATA, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
have working capital of approximately $500,000. Management intends to use the
proceeds for the initial payments under the Trade Payable Agreement, payment
of delinquent sales and use taxes, building of approximately 100 new booths
and other working capital purposes.

3. STOCKHOLDERS' EQUITY

Preferred Stock

The Company is authorized to issue up to 100,000 shares of preferred stock,
none of which are outstanding. The Company's Board of Directors is authorized
to provide for the issuance of the preferred stock in series, to establish the
number of shares to be included in each such series and to fix the
designation, powers, preferences and rights of the shares of each such series
and the qualifications, rights, conversion privileges, dividend rates,
redemption rights, sinking fund provisions and liquidation rights which shall
be superior to the common stock.

Common Stock

The Company is authorized to issue up to 20,000,000 shares of Class A Common
Stock with a par value of $.10 per share and 1,500,000 shares of Class B
Common Stock with a par value of $.01 per share. Class B Common Stock
shareholders are entitled to receive the same distribution as Class A Common
Stock shareholders, up to the Distribution Amount after the Company has
accumulated retained earnings equal to $1,000,000. The Distribution Amount is
the lessor of $1,000,000 or the aggregate of $750,000 plus interest at a rate
of 3% per annum compounded yearly, computed on the amount by which $750,000
plus any accrued interest exceeds the amount distributed to the holders of
Class B Common Stock. The accrual started with the filing of the Articles of
Incorporation (March 12, 1992). On September 29, 1993 the shareholders
approved an amendment to the Company's Articles of Incorporation providing for
the cancellation and retirement of the Class B Common Stock once the holders
receive the Distribution Amount.

The holders of Class A Common Stock are each entitled to one vote for every
share held and have the exclusive right to vote for the election of directors,
unless the Board of Directors includes the right to vote for directors in any
series of preferred stock issued. Holders of Class B Common Stock have no
voting privileges, except as provided by law. Holders of Class B Common Stock
will not share in dissolution until $1,000,000 is received by holders of Class
A Common Stock and their share is limited to the Distribution Amount.

During the years ended June 30, 1995 and 1996, the Company awarded 9,619 and
3,413 shares, respectively, of Class A Common Stock to employees. Compensation
expense was recognized for the stock awards totalling $29,945 and $13,652,
respectively, based on the fair value of the common stock awarded. In March
1996 the Company issued 4,047 shares of Class A Common Stock to a stockholder
in connection with a 1993 agreement. The shares were valued at $405.

Options

In October 1994, the Board of Directors of the Company increased the number
of Class A Common Stock shares available to the stock option plan from 175,900
to 350,000. Stock options granted may be either qualified incentive stock
options or non qualified options. The exercise price must be at least 100% of
the fair market value per share of the stock on the date of grant, except that
such price must be at least 110% of the fair market value per share for any
grantee who owns more than 10% of the outstanding shares of Class A Common
Stock. The options are exercisable over a period of ten years with the initial
right to exercise starting on the date of grant.

In October 1993, the Company granted 52,770 options each to an officer and
former officer of the Company and 17,590 options each to a director and former
director of the Company to purchase Class A Common Stock

24
<PAGE>

IRATA, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
at $5.00 per share. The options have a five year term and are immediately
exercisable. In January 1995 the Company amended options granted to the
director and former director of the Company from 17,590 to 25,000 options.

In May 1994, the Company granted 45,000 options to a former officer of the
Company to purchase Class A Common Stock at $5.00 per share. The options are
exercisable in increments of 15,000 over a three year period commencing May
1995 subject to the officer being in the employ of the Company on the
anniversary dates. The officer resigned in June 1996, therefore, 15,000 shares
were cancelled and 30,000 shares remain exercisable.

In connection with the registration statement, the underwriters received an
option to purchase up to 110,000 Equity Units at $7.25 per Equity Unit
exercisable over a four year period commencing one year from the effective
date of the registration statement.

In January 1995, the Company granted up to 50,000 options to a former
officer of the Company to purchase Class A Common Stock exercisable at $5.00
per share. The options vest in increments of one share for each $100 in
financing achieved by the Company prior to December 31, 1995. In June 1995,
the Company entered into the Loan Agreement for a $3,500,000 line of credit.
The Lender advanced $2,115,000 prior to this date. Therefore, 21,150 options
were exercisable as of June 30, 1996. The options have a five year term.

In May 1995, the Company granted 50,000 options to purchase Class A Common
Stock at $5.00 per share in connection with an employment agreement entered
into between the Company and a former officer. The options have a five year
term and are immediately exercisable.

The following schedule summarizes the changes in employee and other stock
options:

<TABLE>
<CAPTION>
OPTION PRICE
------------------------
NUMBER OF TOTAL OPTION
SHARES PER SHARE PRICE
--------- ----------- ------------
<S> <C> <C> <C>
Outstanding at June 30, 1994
(250,720 exercisable).................... 295,720 $5.00-$7.25 $1,726,100
For the year ended June 30, 1995:
Granted................................. 99,820 $5.00 499,100
Canceled................................ -- --
------- ----------
Outstanding at June 30, 1995
(348,540 exercisable).................... 395,540 2,225,200
For the year ended June 30, 1996:
Granted................................. -- --
Canceled................................ (28,850) $5.00 (144,250)
------- ----------
Outstanding at June 30, 1996
(366,690 exercisable).................... 366,690 $2,080,950
======= ==========
</TABLE>

Warrants

In connection with a private placement in fiscal year 1993, the Company
issued warrants to soliciting brokers to purchase 8,464 shares of Class A
Common Stock at $3.66 per share through March 31, 1997.

In connection with the Bridge Financing completed in January 1994, the
Company issued 300,000 warrants to purchase Class A Common Stock at an
exercise price of $2.50 per share through December 20, 1996.

25
<PAGE>

IRATA, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

The 1,100,000 redeemable stock warrants included in the Equity Units from
the public offering and the 165,000 redeemable stock warrants from the
exercise of the overallotment are exercisable for $7.00 at any time for three
years after issuance. The stock warrants are subject to redemption by the
Company six months following the date of the offering for $.01 per warrant in
the event the Class A Common Stock trades in excess of $9.00 per share for 20
consecutive business days.

In connection with the short-term financing in March 1995, the Company
issued 25,000 warrants to purchase Class A Common Stock at an exercise price
of $5.00 per share. The warrants have a 5 year term.

In connection with the Loan Agreement (see Note 4), the Company issued
warrants to purchase Class A Common Stock at an exercise price of $6.63 per
share of Class A Common Stock subject to anti-dilution provisions. As of June
30, 1996, 470,000 warrants were exerciseable through June 1, 2000. An
additional 21,000 warrants to purchase Class A Common Stock was issued to a
third party in connection with the private placement at an exercise price of
$5.00. These warrants are all exerciseable and expire on June 1, 2000.

In connection with the short-term financing in December 1995 (see Note 4),
the Company issued 16,000 warrants to purchase Class A Common Stock at an
exercise price of $4.00 per share through December 21, 2000.

4. DEBT

In June 1995, the Company entered into a Loan Agreement with a Lender for a
$3,500,000 line of credit, evidenced by a Note and Security Agreement granting
to the Lender a first lien security interest in the assets of the Company. The
terms of the Loan Agreement provided an initial draw of $1,800,000 on June 5,
1995 which was used to pay an existing bank loan of $500,000, pay fees and
costs associated with obtaining this line of credit, and provide working
capital needs. Subsequent loan draws are to provide the Company with amounts
equal to $5,000 for each new Video Foto booth placed in service during the
term of the Loan Agreement. The Loan Agreement provides for payments of
interest only at an annual rate of 12% due on July 1, 1995, and the first day
of each month thereafter until maturity on June 2, 1998 at which time all
outstanding principal is due and payable. The Company may pay off the loan at
an earlier date incurring a penalty not to exceed 2% of the total available
borrowing limit available during the preceding year. The Company also will pay
the Lender an annual commitment fee of $35,000. As part of the Loan Agreement
the Company also entered into a Warrant Purchase Agreement whereby the Lender
may receive warrants to purchase up to 260,000 shares of the Company's Class A
Common Stock. The warrants must be exercised within 5 years from the closing
date of the loan agreement and the exercise price is $6.63 per share of Class
A Common Stock subject to anti-dillution provisions. The warrants are
exercisable as follows:

<TABLE>
<C> <S>
100,000 exercisable from June 2, 1995 to June 1, 2000
120,000 exercisable from June 2, 1996 to June 1, 2000
40,000 exercisable from June 2, 1997 to June 1, 2000
-------
260,000
=======
</TABLE>

The 120,000 and 40,000 warrants are only exercisable if the Company has not
paid off the remaining balance of the line of credit prior to the exercisable
dates noted in the table above.

Additionally, in June 1995, the Company and the Lender entered into a Loan
Commitment Agreement whereby the Lender agreed to enter into an additional
$2,000,000 Loan Agreement upon satisfaction of certain conditions including
the full funding of the $3,500,000 line of credit. The terms of the $2,000,000
line of credit are to be similar to the terms of the $3,500,000 line of credit
and the funds are for the construction of new Video Foto booths. As a result
of this Loan Commitment, the Lender and the Company entered into a Warrant
Purchase

26
<PAGE>

IRATA, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Agreement whereby the Lender may receive warrants to purchase up to 250,000
shares of the Company's Class A Common Stock. The warrants must be exercised
within 5 years from June 2, 1995. The exercise price is $6.63 per share of
Class A Common Stock subject to anti-dilution provisions. The warrants are
exercisable as follows:

<TABLE>
<C> <S>
140,000 exercisable from June 2, 1995 to June 1, 2000
110,000 exercisable from January 10, 1996 to June 1, 2000
-------
250,000
=======
</TABLE>

The Company also issued 21,000 warrants to purchase Class A Common Stock
with an exercise price of $5.00 to a third party in connection with the Loan
Agreement. These warrants are all exercisable and expire in the year 2000.

The Company capitalized the costs of obtaining the financing totaling
$709,093, which includes the 240,000 warrants exercisable by the Lender at
June 30, 1995 and the 21,000 issued to the third party all at a value of
$1.20, as deferred loan costs, to be amortized over the life of the Loan
Agreement. The warrants were determined to have a fair value, by independent
appraisal, of $1.20 for each share of Class A Common Stock the warrant holder
is entitled to purchase. The remaining 270,000 warrants will be capitalized as
deferred loan costs at their fair value if and when they become exercisable as
noted above.

In June 1996 an additional 230,000 warrants became exercisable. These
warrants were determined to have a fair value of $.01 for each share of Class
A Common Stock the warrant holder is entitled to purchase. The Company
capitalized the costs of the warrants as deferred loan costs, to be amortized
over the life of the Loan Agreement.

Subsequent to June 5, 1995, the Lender provided the Company with $315,000 in
additional draws for booths placed in service. In connection with the Lender
Agreement negotiated in August 1996, the annual commitment fee due June 1996
was added to the outstanding principal.

The Loan Agreement contains various loan covenants and the Company is in
default. (See note 2)

In February 1995, the Company issued an unsecured promissory note to a
vendor for $223,384. The note bore interest at 15% with a maturity date of
January 3, 1996. The unpaid principal balance of $63,389 is included in the
Trade Payable Agreement. (See note 2)

In February 1995, the Company borrowed $100,000 from a financial institution
to be utilized as short-term working capital. The note bore interest at 11%
and was due in November 1995. However, the Company paid the principal and
interest due in March 1995.

In March 1995, the Company borrowed $500,000 from a financial institution to
be utilized as short-term working capital. The note bore interest at 11% and
was due in September 1995. However, the Company paid the principal and
interest due in June 1995.

In December 1995, the Company borrowed $160,000 from related parties,
issuing unsecured promissory notes. The notes bear interest at prime plus 1%
with a maturity date of June 5, 1996. In connection with the borrowing, the
Company issued warrants to purchase 16,000 shares of Class A Common Stock at
$4.00 per share. Interest expense on these loans for 1996 was $5,415.

5. COMMITMENTS

Leases

The Company leases its office and warehouse facilities under noncancelable
operating leases expiring at various dates through April 30, 2001. In May 1995
the Company entered into a noncancelable operating lease

27
<PAGE>

IRATA, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
for its marketing office space expiring May 31, 1998. The Company closed this
office in May 1996 and entered into a sub-lease for approximately 70% of base
rent. Rental expense for the leases were $48,593 and $111,636 for the years
ended June 30, 1995 and 1996, respectively.

Future minimum lease payments, by year and in the aggregate, excluding
sublease income, under these leases consisted of the following at June 30,
1996:

In addition to the noncancelable operating leases, the Company leases space
for each Booth operating under cancelable lease agreements. The lease terms
for each Booth location are generally less than three months and the
agreements are renewable on a month-to-month basis.

In connection with certain Booth leases, the Company recognized revenue of
approximately $630,000 and $780,000 for the years ended June 30, 1995 and
1996, respectively from Booths located in various stores owned by one national
discount store chain. The Company also recognized revenue of approximately
$416,000 and $507,000 for the years ended June 30, 1995 and 1996, respectively
from Booths located in various stores owned by one national arcade.

License Agreements

The Company has an agreement to use software and pays a monthly maintenace
fee of $2.50 for each booth in operation up to a cap of $3,000 per month. In
addition, the Company pays an initial $100 fee for each new 600 dpi printer
software installed in a booth up to 500 copies. Additional copies may be
purchased at $75 each. The Company incurred obligations of $9,535 and $34,837
in 1995 and 1996, respectively. The maintenance fee is charged to cost of
sales when incurred and the initial fee is amortzed over three years.

Litigation

The Company, in the normal course of business, is a party to a number of
lawsuits and other proceedings. The company's Management does not expect that
the results of these lawsuits and proceedings will have a material impact on
the Company's financial position or results of operations.

6. INCOME TAXES

At June 30, 1996, the Company has net operating loss carryforwards of
approximately $4,980,000, subject to limitations as described below and will
expire in 2009 through 2011.

In May 1994, the Company successfully filed a registration statement
experiencing an ownership change and consequently is subject to limitation on
the utilization of $1,385,000 of its net operating loss under the Internal
Revenue Code of 1986. The annual limitation for utilizing the net operating
losses prior to the ownership change is $240,000. To the extent the annual
limitation exceeds the Company's taxable income for a given year, the excess
may be added to a subsequent year's limitation.

28
<PAGE>

IRATA, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax liabilities and assets are as follows:

<TABLE>
<CAPTION>
1995 1996
---------- -----------
<S> <C> <C>
Deferred tax liabilities:
Tax over book depreciation........................... $ 309,852 $ 363,266
---------- -----------
Total deferred tax liabilities..................... 309,852 363,266
Deferred tax assets:
Net operating loss carryforwards..................... 1,008,298 1,693,082
Other................................................ 36,968 60,041
---------- -----------
Total deferred tax assets.......................... 1,045,266 1,753,123
---------- -----------
Net deferred tax asset............................. 735,414 1,389,857
Valuation allowance for deferred tax assets.......... (735,414) (1,389,857)
---------- -----------
Net deferred taxes................................. $ -- $ --
========== ===========
</TABLE>

7. RELATED PARTY TRANSACTIONS

The Company expensed $120,000 and $59,700 during the year ended June 30,
1995 and 1996, respectively, in exchange for consulting and legal services
from a stockholder and a director. At June 30, 1996, the Company owed related
parties $59,000 which is included in accounts payable.

29
<PAGE>

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on
its behalf by the undersigned thereunto duly authorized, in the City of
Houston, State of Texas, on the 15th day of October, 1996.

Irata, Inc.

/s/ Robert A. Searles, Jr.
By: _________________________________
Robert A. Searles, Jr.
President and Chief Executive
Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Amendment was signed by the following persons in the capacities stated on
October 15, 1996.

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Robert A. Searles, Jr. President, Chief Executive October 15, 1996
- ------------------------------------ Officer and Director
Robert A. Searles, Jr.

/s/ Andrew J. Clark, III Director October 15, 1996
- ------------------------------------
Andrew J. Clark, III
/s/ John D. Higgins Director October 15, 1996
- ------------------------------------
John D. Higgins
</TABLE>

30
<PAGE>

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
1.1* --Form of Underwriting Agreement between the Company and the
Underwriters.
1.2* --Form of Unit Purchase Option between the Company and the
Underwriter.
2.1* --Formation and Settlement Agreement dated effective as of March 23,
1992 by and among the Company, Buffalo Incorporated, Names 'N Faces, Inc.,
Lone Star Photo Video, Inc. and the C. W. Moody Family Trust.
3.1* --Articles of Incorporation of the Company.
3.2* --Articles of Amendment to the Articles of Incorporation of the
Company filed October 8, 1993.
3.3* --Articles of Amendment to the Articles of Incorporation of the
Company filed December 22, 1993.
3.4* --By-laws of the Company.
4.1* --Form of Warrant to purchase shares of Class A Common Stock issued to
Hill Branscomb, Steve Ewing Kevin Kimberlin, J. T. Trotter and George V. Kane, Jr.
4.2* --Warrant Agreement dated December 20, 1993 by and among the Company,
the Underwriter and American Stock Transfer & Trust Company,
including form of Selling Securityholder Warrant Certificate.
4.3* --Form of Warrant Agreement among the Company, the Underwriter and
Continental Stock Transfer & Trust Company, including form of
Redeemable Warrant Certificate.
4.4* --Form of the Company's 8% Convertible Notes dated September 1, 1993.
4.5* --Loan Agreement and exhibits dated June 2, 1995 between the Company
and the Lender.
4.6* --Warrant Purchase Agreement dated June 2, 1995 between the Company
and the Lender.
4.7* --Security Agreement between the Company and Lender for a first lien
security interest in the assets of the Company.
4.8* --Form of Warrant to purchase shares of Class A Common Stock issued to
a third party in connection with the Loan Agreement.
10.1* --Release and Exchange Agreement dated effective as of March 23, 1992
between the Company and Hill Branscomb.
10.2* --Form of Investor Release and Exchange Agreement dated effective as
of March 31, 1992 between the Company and an investor in Buffalo
Incorporated.
10.3* --Assignment dated June 22, 1992 from the C. W. Moody, Jr. Family
Trust to the Company.
10.4* --General Conveyance, Assignment and Transfer dated effective as of
June 22, 1992 from Lone Star Photo Video, Inc. to the Company.
10.5* --Letter Agreement dated April 8, 1992 Between Data East U.S.A., Inc.
and the Company.
10.6* --Settlement and Release Agreement dated effective as of August 11,
1993 between Data East U.S.A., Inc., and the Company.
10.7* --Employment Agreement dated June 15, 1992 between the Company and
Robert A. Searles, Jr.
10.8* --First Amendment to Employment Agreement between the Company and
Robert A. Searles dated September 1, 1993.
10.9* --Employment Agreement dated September 1, 1993 between the Company and
M. G. Morgan.
10.10* --First Amendment to Employment Agreement between the Company and M.
G. Morgan dated effective as of January 19, 1994.
10.11* --Stock Option Plan of the Company.
10.12* --Stock Option Agreement dated February 8, 1994 between the Company
and Robert A. Searles, Jr.
10.13* --Stock Option Agreement dated February 8, 1994 between the Company
and M. G. Morgan.
10.14* --Stock Option Agreement dated February 8, 1994 between the Company
and Andrew J. Clark, III.
10.15* --Stock Option Agreement dated February 8, 1994 between the Company
and Richard W. Fairchild.
10.16* --Memorandum of Agreement dated effective February 1994 between the
Company, J. T. Trotter and George V. Kane, Jr.
10.17* --Form of Consulting Agreement to be dated the Effective Date of the
Registration Statement between the Company and Royce Investment
Group, Inc.
</TABLE>

31
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.18* --Form of Warrant to purchase shares of Class A Comon Stock issued to
J. T. Trotter.
10.19* --Employment Agreement dated May 1, 1995 between the Company and
Richard W. Fairchild.
10.20* --Stock Option Agreement dated January 17, 1995 between the Company
and Andrew J. Clark, III.
10.21* --Stock Option Agreement dated January 17, 1995 between the Company
and Richard W. Fairchild, Jr.
10.22* --Stock Option Agreement dated January 17, 1995 between the Company
and M.G. Morgan.
10.23* --Stock Option Agreement dated January 17, 1995 between the Company
and Deborah Schmid.
10.24* --Stock Option Agreement dated May 1, 1995 between the Company and
Richard W. Fairchild, Jr.
10.25* --Letter of Credit dated August 24, 1996 between a financial
institution and the Company.
</TABLE>
- --------
* Filed as exhibits to the Company's Form SB2 Registration Statement (File
No. 33-75216) effective May 11, 1994 and to the Company's Form 10-KSB for
the fiscal year ended June 30, 1995.

<PAGE>

<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1996
<PERIOD-START> JUL-01-1995
<PERIOD-END> JUN-30-1996
<CASH> 174,352
<SECURITIES> 0
<RECEIVABLES> 472,587
<ALLOWANCES> 0
<INVENTORY> 200,581
<CURRENT-ASSETS> 929,073
<PP&E> 7,031,141
<DEPRECIATION> (1,624,354)
<TOTAL-ASSETS> 6,865,045
<CURRENT-LIABILITIES> 4,425,610
<BONDS> 0
0
0
<COMMON> 270,007
<OTHER-SE> 2,169,428
<TOTAL-LIABILITY-AND-EQUITY> 6,865,045
<SALES> 7,451,098
<TOTAL-REVENUES> 7,451,098
<CGS> 6,746,601
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<EPS-PRIMARY> (.83)
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</TABLE>