<PAGE>   1
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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K
(MARK ONE)
[X]                ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
                                       OR
[ ]            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
           FOR THE TRANSITION PERIOD FROM ____________ TO ____________

                         COMMISSION FILE NUMBER: 0-21802

                                   ----------

                        N-VIRO INTERNATIONAL CORPORATION
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

            DELAWARE                                     34-1741211
    (STATE OR OTHER JURISDICTION OF         (I.R.S. EMPLOYER IDENTIFICATION NO.)
    INCORPORATION OR ORGANIZATION)

  3450 W. CENTRAL AVENUE, SUITE 328
              TOLEDO, OHIO                                        43606
 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                       (ZIP CODE)

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (419) 535-6374

                                   ----------

        SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None

    SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock,
                            par value $.01 per share

                  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 the filing requirements for at least the past 90 days. Yes X No
                                                             ---   ---

                  The aggregate market value of the voting stock held by
non-affiliates of the registrant, based upon the last sale price of registrant's
Common Stock in the Nasdaq National Market as of March 1, 1997, was
approximately $1,319,848

                  The number of shares of Common Stock of the registrant
outstanding as of March 1, 1997, was 2,094,250.

                       DOCUMENTS INCORPORATED BY REFERENCE
                  Portions of the Proxy Statement for the registrant's 1997
Annual Meeting of Stockholders to be filed with the Securities and Exchange
Commission not later than 120 days after the end of the fiscal year covered by
this Form 10-K are incorporated by reference into Part III, Items 10, 11, 12 and
13 of this Form 10-K.

                  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 of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [x]

================================================================================

<PAGE>   2




                                      INDEX



                                                                           PAGE
                                                                           ----

                                     PART I

    Item 1.      Business                                                   3

    Item 2.      Properties                                                11

    Item 3.      Legal Proceedings                                         12

    Item 4.      Submission of Matters to a Vote of Security Holders       12

                                 PART II

    Item 5.      Market for Registrant's Common Equity and Related         13
                 Stockholder Matters

    Item 6.      Selected Financial Data                                   13

    Item 7.      Management's Discussion and Analysis of                   15
                 Financial Condition and Results of Operations

    Item 8.      Financial Statements and Supplementary Data               21

    Item 9.      Changes in and Disagreements with Accountants             22
                 on Accounting and Financial Disclosure

                                 PART III

    Item 10.     Directors and Executive Officers of the Registrant        22

    Item 11.     Executive Compensation                                    22

    Item 12.     Security Ownership of Certain Beneficial Owners           22
                 and Management

    Item 13.     Certain Relationships and Related Transactions            22

                                 PART IV

    Item 14.     Exhibits, Financial Statement Schedules, and              23
                 Reports on Form 8-K

                                      -2-

<PAGE>   3


                                     PART I

ITEM 1.           BUSINESS

GENERAL

         N-Viro International Corporation (the "Company"), incorporated in
April, 1993, owns and licenses the N-Viro Process, a patented technology to
treat and recycle wastewater sludges and other bio-organic wastes, utilizing
certain alkaline by-products produced by the cement, lime and other industries.
See "The N-Viro Process."

         In 1979, Mr. J. Patrick Nicholson and several investors formed N-Viro
Energy Systems, Limited (the "Partnership"). The Partnership's initial strategy
was to license the N-Viro Process to third parties through independent agents.
Each independent agent acted in its respective territory as a marketing and
distribution agent of the Partnership, and the Partnership retained the
marketing and distribution rights to certain other territories. In early 1993,
as a result of the then pending implementation of the Section 503 Sludge
Regulations (as defined below) and the market environment, the Partnership
concluded that a strategy that also included the development and operation, on a
contract management basis, of N-Viro facilities for third parties, and of
Company-owned and/or co-owned N-Viro facilities, would potentially expand the
opportunities to capitalize on the N-Viro Process.

         In order to implement this strategy, the Partnership agreed to combine
with American N-Viro Resources, Inc., National N-Viro Tech, Inc., N-Viro
Midwest, Inc., N-Viro Soil South, Inc. and Tennessee-Carolina N-Viro
(collectively, the "Company Agents") to form the Company. The Company was
incorporated in April 1993 primarily to expand the opportunities for
capitalizing on the N-Viro Process. The Company assumed the Partnership's
agreements with the remaining agents who are continuing to market the N-Viro
Process in their respective territories.

         The Company became a public company on October 12, 1993 with an initial
public offering (the "IPO") of 2,000,000 shares of Common Stock at $9.50 per
share. On October 19, 1993, the Partnership contributed to the Company all of
its assets (except certain marketable securities and accounts receivable from
certain related parties), subject to all liabilities (except certain retained
liabilities), and the stockholders of the Company Agents contributed to the
Company all of the outstanding capital stock of such entities in exchange for a
total of 6,000,000 shares of Common Stock of the Company and organization notes
totaling $5,221,709 (including notes of $276,909 which resulted from a partial
exercise of an over-allotment option). The organization notes were repaid out of
the proceeds from the IPO. On November 10, 1993, an additional 112,000 shares
were sold pursuant to the exercise by the Underwriters of their over-allotment
option.

         On October 30, 1995, at a Special Meeting of the Shareholders, the
shareholders approved a one for four reverse stock split which reduced the
number of issued and outstanding shares of the Common Stock. This reverse split
did not affect the Company's retained deficit and the stockholders' equity
remained substantially unchanged. This action was deemed necessary by management
of the Company to remain in compliance with the minimum bid price requirement of
The Nasdaq Stock Market, Inc. or the alternative net tangible assets requirement
and for continued listing of the Common Stock on the Nasdaq National Market. The
reverse split reduced the number of issued and outstanding shares of the Common
Stock to approximately 2,037,000 (net of 57,250 treasury shares).

         In late 1995, the Company's business strategy changed from being a low
cost provider of a process to marketing the N-Viro Process that produces an
"exceptional quality" sludge product, as defined in the Section 503 Sludge
Regulations under the Clean Water Act of 1987 (the "Section 503 Sludge
Regulations"), with multiple commercial uses. In this strategy, the primary
focus is to identify allies, public and private, who will build and operate the
N-Viro facility. To date, the Company's revenues primarily have been derived
from the licensing of the N-Viro Process to treat and recycle wastewater sludges


                                      -3-
<PAGE>   4


generated by municipal wastewater treatment plants and from the sale to
licensees of the alkaline admixture used in the N-Viro Process. The Company has
also operated N-Viro facilities for third parties on a start-up basis and
currently operates one N-Viro facility on a contract management basis. The
Company has granted 45 licenses to use the N-Viro Process. There are currently
37 N-Viro facilities operating throughout the world using the N-Viro Process.
The Company estimates that these operating N-Viro facilities are treating and
recycling sludge at an annualized rate of approximately 150,000 dry tons per
year. The eight licensees not currently operating include both international and
domestic contractors or public generators who are developing or designing site
specific N-Viro facilities.

         Since 1995, the Company has marketed licenses for the N-Viro Process
through its own sales and marketing force in the United States in 30 states and
the District of Columbia and internationally throughout the world except in
Canada, Mexico, Puerto Rico, Australia, Israel, Italy and countries located in
Central and South America. In the remaining states, and in these other parts of
the world, the Company licenses the N-Viro Process through agents (the
"Agents"). Typically, the agreements with the Agents provide for the Company to
receive a portion of the up-front license fees and ongoing royalty fees paid by
the licensees and a portion of the proceeds from the distribution and resale of
alkaline admixture and the sale of N-Viro SoilTM. Agents have total
responsibility and control over the marketing and contracts for N-Viro
technology subject only to license models or minimum agreements with the
Company.

         The Company is marketing the use of the N-Viro Process through its own
sales and marketing in house staff and manufacturers representatives. Revenues
are derived from domestic and international licensing of the N-Viro Process, the
sale of alkaline admixtures used in some N-Viro Processes, management fees from
the operation of the Toledo, Ohio facility, one time sales of the N-Viro Process
technology, and sale of ancillary products and services. The sales
representative network is the key component of the Company's domestic sales
strategy. The manufacturers representatives network was started by the Company
after acquiring eight of eleven domestic agents. These representatives receive a
commission on certain revenue.

         The Toledo, Ohio facility is a "Contract Management Agreement" with the
City of Toledo. Revenue from the Toledo operation accounts for about 25% of the
Company's total revenue. The Company processes Toledo's bio-solids and sells the
N-Viro Soil product.

THE N-VIRO PROCESS

         The N-Viro Process is a patented process for the treatment and
recycling of bio-organic wastes, utilizing certain alkaline by-products produced
by the cement, lime and other industries. To date, the N-Viro Process has been
commercially utilized for the recycling of wastewater sludges from municipal
wastewater treatment facilities. N-Viro Soil produced according to N-Viro
Process specifications is an "exceptional quality" sludge product under the
United States Environmental Protection Agency (the "EPA") 40 CFR part 503 Sludge
Regulations.

         The N-Viro Process involves mixing the wastewater sludge with an
alkaline admixture and then subjecting the mixture to a controlled period of
storage, mechanical turning and accelerated drying in which a blending of the
sludge and the alkaline admixture occurs. The N-Viro Process stabilizes and
pasteurizes the wastewater sludge, reduces odors to acceptable levels,
neutralizes or immobilizes various toxic components and generates N-Viro Soil, a
product which has a granular appearance similar to soil and has multiple
commercial uses. These uses include agricultural lime, soil enrichment, top soil
blend, landfill cover and filter, and land reclamation.

         The alkaline admixture used in the N-Viro Process consists of
by-product dusts from cement or lime kilns, certain fly ashes and other products
of coal, coke or petroleum combustion and by-product dusts from sulfuric acid
"scrubbers" used in acid rain remediation systems and from fluidized bed coal
fired systems used in electric power generation. The particular admixture that
is used usually depends upon cost and availability in local markets. In certain
cases, commercial lime may also be added to the admixture. 



                                      -4-
<PAGE>   5


Initially, the Company required licensees to buy all alkaline admixtures from
the Company. This requirement has been eliminated by increasing the royalty or
professional services revenue to offset the lost revenue from alkaline sales.

         The Company and the Agents act as distributors of alkaline admixture
within their respective marketing and distribution territories and are
responsible for quality control of the admixture. The Company also works with
established by-product marketers. The Company generally charges a mark-up over
its cost for alkaline admixture sold directly by the Company, and receives a
royalty fee from the Agents based on a percentage of the Agents' gross profits
from alkaline admixture sales.

         N-Viro Soil is sold for agricultural use as a bio-organic and mineral
fertilizer with agricultural liming and nutrient values, as landfill cover
material, as a topsoil blending ingredient and for land reclamation projects.
The Company estimates that approximately one-quarter of the N-Viro Soil produced
is sold to landfills for cover material, small amounts are sold for land
reclamation and similar projects, and a substantial portion of the remainder is
sold for agricultural use or as a topsoil blend. Although the use of N-Viro Soil
is not subject to any federal regulations or restrictions, each N-Viro facility
is typically required to obtain a state and/or local permit for the sale of
N-Viro Soil. In addition, many states and/or local governments require
site-specific permits for the use of sludge products in bulk amounts.

RESEARCH AND DEVELOPMENT

         Research and development on the N-Viro Process is performed primarily
by BioCheck Laboratories, Inc. ("BioCheck"), formerly a wholly-owned subsidiary
of the Company.

         Research and development on N-Viro Soil has been, to date, performed
primarily by Dr. Terry J. Logan and his staff at The Ohio State University
pursuant to a consulting arrangement with the Company. To date, Dr. Logan has
acted as an independent consultant to the Company on a part-time basis and is a
director of the Company.

         In 1996 the Company spent approximately $125,000 on research and patent
development. In addition, the United States Department of Agriculture (the
"USDA") and the Ohio Coal Development Authority (the "OCDA") have provided
substantial grants to N-Viro International, Rodale Institute, and Compost
Council (USDA) and to BioCheck (OCDA) to demonstrate the effectiveness of
compost and bio-mineral technology on manure (USDA) and ash utilization or
bio-mineral processes (OCDA). Both these grants have exceeded $100,000 per year.

         The Company's initial pasteurization patents have over ten years of
patent life remaining. Newer technologies for accelerated stabilization and use
of carbon dioxide have a longer life cycle. Two patents, including dryer and
"BioBlend" technology are still pending so the patent life has not begun to
expire.

         The Company continues to investigate methods to shorten drying time,
substitute various other materials for use as alkaline admixture and improve the
quality and attractiveness of N-Viro Soil to a variety of end-users. Several new
developments are the subject of issued patents, including the use of carbon
dioxide in the N-Viro Process as a means to (i) reduce by-product carbon dioxide
emissions from industrial processes by fixating carbon dioxide in the N-Viro
Soil and (ii) improve the quality and value of N-Viro Soil. In addition, the
Company has been working with Cemen Tech, an Iowa-based manufacturer of concrete
and sludge processing equipment, to develop a dryer system which will reduce
processing time while continuing to permit the survival of beneficial
microflora. The Company's Phillipsburg, New Jersey and Leamington, Canada
facilities began use of dryers in late 1995. The Company's "BioBlend", which
uses N-Viro Soil as a reagent to accelerate and deodorize yard waste composting,
was fully integrated into Middlesex County operations in 1996.

ORGANIZATION


                                      -5-
<PAGE>   6


         The Company has continued to restructure and streamline its operations
in 1996 to provide for an effective, efficient and customer responsive
organization. Domestic Sales and Marketing and Management of the Toledo, Ohio
facility is directed by the Company's Vice-President of Sales and Marketing and
assisted by sales and marketing personnel who coordinate their actions within
the network of manufacturers representatives. Staff personnel are responsible
for the sales and promotions of the N-Viro Process in assigned states.
International Sales and Marketing is directed by the Company's Chief Executive
Officer.

Prior to late 1995, the marketing and distribution territories were assigned
specifically to divisions of the Company or to its Agents.

<TABLE>
<CAPTION>

-------------------------------------------------------------------------------------
                                                The Agents
-------------------------------------------------------------------------------------

<S>                                                           <C>             
     Synagro Technologies, Inc. (1)...........................Arizona, Arkansas, Louisiana, New Mexico,
                                                              Oklahoma and Texas
     N-Viro Resources, Inc....................................Colorado, Iowa, Kansas, Minnesota,
                                                              Montana, Nebraska, North Dakota, South
                                                              Dakota and Wyoming
     Pan-American N-Viro, Inc. (2)............................Central America, South America and the
                                                              Caribbean
     N-Viro Systems Canada, Inc...............................Canada
     CRM Technologies, Inc....................................Israel
     Bio-Recycle Pty. Ltd.....................................Australia, New Zealand and Singapore

<FN>
     (1) Synagro Technologies, Inc. is a public company whose shares are traded
         in the Nasdaq Stock Market.

     (2) Pan-American N-Viro, Inc. is owned 50% by N-Viro International
         Corporation and 50% by Synagro Technologies, Inc.
</TABLE>

         In 1995, the Company sold the territorial rights of Europe, Africa and
the Middle East and granted an exclusive license for these territories to an
investor group headed by Mr. Robin Millard. This group acquired one of the
Company's wholly owned subsidiaries, N-Viro Worldwide.

         In their respective territories, the Agents market licenses for the
N-Viro Process, serve as distributors of alkaline admixture, oversee quality
control of the N-Viro Process and N-Viro Soil, enforce the terms of the license
agreements with licensees and market N-Viro Soil (or assist licensees in
marketing N-Viro Soil). In general, the Agents have paid one-time, up-front fees
to the Company for the rights to market or use the N-Viro Process in their
respective territories. Typically, the agreements with the Agents provide for
the Company to receive a portion of the up-front license fees and ongoing
royalty fees paid by the licensees and a portion of the proceeds from the
distribution and resale of alkaline admixture and the sale of N-Viro Soil.

INDUSTRY OVERVIEW

         Sludge Management Practices and the 40 CFR part 503 Sludge Regulations.
Historically, sludge management has involved either disposal, principally by
landfilling, incineration, ocean dumping and surface disposal, or land
application for beneficial use. On February 19, 1993, the EPA published the 40
CFR part 503 Sludge Regulations ("part 503 Regs") under the Clean Water Act of
1987 implementing the EPA's "exceptional quality" sludge program. The Sec 503
Regs establish sludge use and disposal standards applicable to approximately
35,000 publicly and privately-owned wastewater treatment plants in the United
States, including primary publicly-owned treatment works ("POTWs"), secondary
and advanced treatment POTWs, privately-owned treatment works, federally-owned
treatment works and domestic septage haulers. The EPA currently estimates that
the 13,000 to 15,000 POTWs generate 110 to 150 million wet metric tons of sewage
sludge per year. Under the part 503 Regs, sludge may be disposed of in municipal
solid waste 


                                      -6-
<PAGE>   7


landfills approved under Subtitle D of the Resource Conservation and Recovery
Act ("RCRA"), or may be surface disposed, incinerated or land applied for
beneficial use in accordance with the requirements established by the part 503
Regs.

         Disposal. Landfilling, incineration and ocean dumping have
traditionally provided inexpensive, reliable methods of sludge disposal. Ocean
dumping was banned in the United States in December 1992. Under the part 503
Regs, landfilling and incineration remain permissible sludge management
alternatives but have become subject to more stringent regulatory standards. The
vast majority of states have some site restrictions or other management
practices governing the disposal of sludge in landfills. Recent amendments to
the Clean Air Act governing incineration and disposal of residual ash also
impose stricter air emission standards for incineration in general, and the part
503 Regs impose additional specific pollutant limits for sludges to be
incinerated and for the resulting air emissions.

         Surface disposal of sludge involves the placement of sludge on the land
at a dedicated site for disposal purposes. The part 503 Regs subject surface
disposal to increased regulation by requiring, among other things, run-off and
leachate collection systems, methane monitoring systems and monitoring of, and
limits on, pollutant levels. In addition, sludge placed in a surface disposal
site is required to meet certain standards with respect to pathogen levels
relating to coliform or salmonella bacteria counts ("Class B" pathogen levels),
levels of various pollutants, including metals, and elimination of
attractiveness to pests, such as insects and rodents.

         Land Application for Beneficial Use. Land application for beneficial
use involves the application of sludge or sludge-based products, for
non-disposal purposes, including agricultural, silvicultural and horticultural
uses and for land reclamation. Under the part 503 Regs, sludge products that
meet certain stringent standards with respect to pathogen levels relating to
coliform, salmonella, enteric viruses and viable helminth ova counts ("Class A"
pathogen levels), levels of various pollutants, including metals, and
elimination of attractiveness to pests, such as insects and rodents, are
considered by the EPA to be "exceptional quality" sludge products. The Class A
pathogen levels are significantly more stringent than the Class B levels; for
example, permitted Class B fecal coliform levels are 2,000 times higher than
Class A levels.

         "Exceptional quality" sludge products are treated by the EPA as
fertilizer material, thereby exempting these products from federal restrictions
on their agricultural use or land application. N-Viro Soil which is produced
according to N-Viro Process specifications meets the pollutant concentration
limits and other standards set forth in the part 503 Regs and, therefore, is an
"exceptional quality" sludge product that exceeds the EPA's standards for
unrestricted agricultural use and land application. Lower quality sludges,
including sludge-based products that meet Class B pathogen levels and certain
pollutant control and pest attraction requirements, may also be applied to the
land for beneficial use but are subject to greater record keeping and reporting
requirements and restrictions governing, among other items, the type and
location of application, the volume of application and limits on cumulative
levels of metals. Sludges applied to the land for agricultural use must meet
Class B pathogen levels and, if applied in bulk, require an EPA permit.

COMPETITION

         The Company is in direct and indirect competition with other
businesses, including disposal and other wastewater sludge treatment businesses,
some of which are larger and more firmly established and may have greater
marketing and development budgets and capital resources than the Company. There
can be no assurance that the Company will be able to maintain a competitive
position in the sludge treatment industry.

         A 1988 EPA survey estimated that sludge generators in the United States
utilized landfilling, incineration, surface disposal and ocean dumping as sludge
management alternatives for approximately two-thirds of wastewater sludges
generated. Although ocean dumping was banned in December 1992, other methods of
sludge disposal remain permissible sludge management alternatives under the part
503 Regs, and in many instances will be less expensive than treatment methods,
including the N-Viro Process.


                                      -7-
<PAGE>   8


         Sludge treatment alternatives other than disposal include processes,
such as aerobic and anaerobic digestion and lime stabilization, that typically
produce lower quality sludge products, and other processes, such as
pelletization, composting, high heat lime sterilization and high heat en-vessel
lime pasteurization, that produce "exceptional quality" sludge products. Some of
these processes have established a significant market presence, and the Company
cannot predict whether any of such competing treatment processes will be more or
less successful than the N-Viro Process. In 1996, the primary competition to
N-Viro technology was the dumping of raw sewage sludge in landfills. While such
practices are prohibited in some states, e.g. North Carolina, New Jersey and
Ohio, the practice is accepted by the USEPA.

ENVIRONMENTAL REGULATION

         Various environmental protection laws have been enacted and amended
during recent decades in response to public concern over the environment. The
Company's operations and those of its licensees are subject to these evolving
laws and the implementing regulations. The United States environmental laws
which the Company believes are, or may be, applicable to the N-Viro Process and
the land application of N-Viro Soil include RCRA, as amended by the Hazardous
and Solid Waste Amendments of 1984 ("HSWA"), the Federal Water Pollution Control
Act of 1972 (the "Clean Water Act"), the Clean Air Act of 1970, as amended (the
"Clean Air Act"), CERCLA, the Pollution Prevention Act of 1990 and the Federal
Insecticide, Fungicide and Rodenticide Act ("FIFRA"). These laws regulate the
management and disposal of wastes, control the discharge of pollutants into the
air and water, provide for the investigation and remediation of contaminated
land and groundwater resources and establish a pollution prevention program.
Many of these laws have international counterparts, particularly in Europe and
elsewhere in North America. In addition, various states have implemented
environmental protection laws that are similar to the applicable federal laws
and, in addition, states may require, among other things, permits to construct
N-Viro facilities and to sell and/or use N-Viro Soil. There can be no assurance
that any such permits will be issued.

         The 40 CFR part 503 Sludge Regulations. Sewage sludge and the use and
disposal thereof is regulated under the Clean Water Act. On February 19, 1993,
the EPA published the 40 CFR part 503 Sludge Regulations ("part 503 Regs") under
the Clean Water Act implementing the EPA's "exceptional quality" sludge program.
These regulations establish sludge use and disposal standards applicable to
approximately 35,000 wastewater treatment plants in the United States, including
approximately 12,750 publicly owned treatment works ("POTWs"). Under the part
503 Regs, sludge products that meet certain stringent standards are considered
to be "exceptional quality" sludge products and are not subject to any federal
restrictions on agricultural use or land application. N-Viro Soil produced
according to N-Viro Process specifications is an "exceptional quality" sludge
product. Lower quality sludges and sludge products are subject to federal
restrictions governing, among other items, the type and location of application,
the volume of application and the cumulative application levels for certain
pollutants. Agricultural application of these lower quality sludges in bulk
amounts also requires an EPA permit. Agricultural and land applications of all
sludges and sludge products, including N-Viro Soil and other "exceptional
quality" sludge products, are typically subject to state and local regulation
and, in most cases, require a permit.

         In order to ensure compliance with the part 503 Regs, the Company
reviews the results of regular testing of sludges required by the EPA to be
conducted by wastewater treatment plants, and itself tests N-Viro Soil produced
at N-Viro facilities on a regular basis. In general, the Company does not
license or permit the ongoing use of the N-Viro Process to treat any sludge that
may not be processed into an "exceptional quality" sludge product. In one N-Viro
facility, however, the Company has permitted the use of the N-Viro Process to
produce a product that is not an "exceptional quality" sludge product due to the
high pollutant levels of the resulting product. This product is not considered
to be N-Viro Soil and is used solely for landfill cover at an adjacent landfill.
In addition, the Company had previously licensed for use at five treatment
facilities an earlier sludge treatment process that is designed to produce a
sludge product that meets only Class B pathogen levels, and therefore does not
produce an "exceptional quality" sludge product.

         Although N-Viro Soil exceeds the current federal standards imposed by
the EPA for unrestricted agricultural use and land application, state and local
authorities are authorized under the Clean Water Act to 



                                      -8-
<PAGE>   9


impose more stringent requirements than those promulgated by the EPA. Most
states require permits for land application of sludge and sludge based products
and several states, such as Rhode Island, Massachusetts and New Jersey,
currently have regulations that impose more stringent numerical concentration
limits for certain pollutants than the federal rules.

         The Resource Conservation and Recovery Act. RCRA regulates all phases
of hazardous waste generation, management and disposal. A waste is subject to
regulation as a hazardous waste under RCRA if it is a solid waste specifically
listed as a hazardous waste by the EPA or exhibits a defined hazardous
characteristic. Although domestic sewage and mixtures of domestic sewage and
other wastes that pass through a sewer system to a POTW are specifically
exempted from the definition of solid waste, once treated by the POTW, the
sewage sludge is considered a solid waste. However, such sewage sludge is not
considered a hazardous waste unless it exhibits a hazardous characteristic.
While it is possible that sewage sludge could exhibit the toxicity
characteristic, the Company believes that regular tests for hazardous
constituent levels provide assurance that the sewage sludge used in the N-Viro
Process does not exhibit the toxicity characteristic. The alkaline admixtures
used in the N-Viro Process are specifically exempted from RCRA regulation by the
so-called "Bevill Amendments" to RCRA. Although the benefit of the exemption
provided by the "Bevill Amendments" can be lost if the alkaline admixture is
derived from or mixed with a hazardous waste, the Company has adopted and
implemented policies and operational controls, including review of operating
permits held by alkaline admixture suppliers and periodic testing of such
admixtures, to ensure that the alkaline admixtures used in the N-Viro Process by
itself and its licensees are not derived from or mixed with hazardous wastes.

         Although neither the alkaline admixture nor wastewater sludges used in
the N-Viro Process are regulated as hazardous waste under RCRA, states may
impose restrictions that are more stringent than federal regulations.
Accordingly, the raw materials used in the N-Viro Process may be regulated under
some state hazardous waste laws as "special wastes," in which case specific
storage and record keeping requirements may apply.

         The Clean Air Act. The Clean Air Act empowers the EPA to establish and
enforce ambient air quality standards and limits of emissions of pollutants from
specific facilities. The Clean Air Act Amendments of 1990 (the "Clean Air Act
Amendments") impose stringent requirements upon owners and operators of
facilities which discharge pollutants into the environment.

         Existing N-Viro facilities generally have installed "baghouse"
technology for alkaline admixture storage and handling operations in order to
collect airborne dust. The Company does not believe that N-Viro facilities will
be required to undertake any further measures in order to comply with the Clean
Air Act or the Clean Air Act Amendments. Ammonia odors of varying strength
typically result from sludge treatment processes, including the N-Viro Process.
A number of N-Viro facilities have installed ammonia "scrubbers" to reduce
ammonia odors produced to varying degrees by the N-Viro Process. The
installation of ammonia "scrubbers" is not required by the Clean Air Act or the
Clean Air Amendments. However, the Company or its licensees may be required
under the Occupational Safety and Health Act and state laws regulating
nuisances, odors and air toxic emissions to install odor control technology to
limit ammonia emissions and odors produced during the N-Viro Process,
particularly at N-Viro facilities located near populated residential areas. The
amount of ammonia gas produced is dependent upon the type of sludge being
treated and the amount and type of alkaline admixture being used.

         The Comprehensive Environmental Response, Compensation and Liability
Act of 1980. CERCLA imposes strict, joint and several liability upon owners and
operators of facilities where a release of hazardous substances has occurred,
upon parties who generated hazardous substances that were released at such
facilities and upon parties who arranged for the transportation of hazardous
substances to such facilities.

         The Company believes that the N-Viro Process poses little risk of
releasing hazardous substances into the environment which could result in
liability under CERCLA. Although the sewage sludge and alkaline waste products
could contain hazardous substances (as defined under CERCLA), the Company has
developed plans to manage the risk of CERCLA liability, including training of
operators, regular testing of 


                                      -9-
<PAGE>   10

the sludge and the alkaline admixture to be used in the N-Viro Process and
reviewing incineration and other permits held by the entities from whom alkaline
admixtures are obtained.

         Other Environmental Laws. The Pollution Prevention Act of 1990
establishes pollution prevention as a national objective, naming it a primary
goal wherever feasible. The act states that where pollution cannot be prevented,
materials should be recycled in an environmentally safe manner. The Company
believes that the N-Viro Process contributes to pollution prevention by
providing an alternative to disposal.

         The alkaline admixtures used in the N-Viro Process may be required to
be registered as pesticides under FIFRA because of their effect on pathogens in
sludge. The EPA does not currently regulate commercial lime or any alkaline
by-products under FIFRA and has not attempted to assert such jurisdiction to
date. In the event the alkaline by-products are required to be registered under
FIFRA, the Company would likely be required to submit certain data as part of
the registration process and might be subject to further federal regulation.

         State Regulations. State regulations typically require an N-Viro
facility to obtain a permit for the sale of N-Viro Soil for agricultural use,
and may require a site-specific permit by the user of N-Viro Soil. In addition,
in some jurisdictions, state and/or local authorities have imposed permit
requirements for, or have prohibited, the land application or agricultural use
of sludge products, including "exceptional quality" sludge products. There can
be no assurance that any such permits will be issued or that any further
attempts to require permits for, or to prohibit, the land application or
agricultural use of sludge products will not be successful.

         In addition, many states enforce landfilling restrictions for
nonhazardous sludge. These regulations typically require a permit to sell or use
sludge products as landfill cover material. There can be no assurance that
N-Viro facilities or landfill operators will be able to obtain required permits.

         Environmental impact studies may be required in connection with the
development of future N-Viro facilities. Such studies are generally time
consuming and may create delays in the construction process. In addition,
unfavorable conclusions reached in connection with such a study could result in
termination of, or expensive alterations to, the N-Viro facility being
developed.

EMPLOYEES

         As of December 31, 1996, the Company had 18 employees in the following
capacities: 7 engaged in sales and marketing, 6 in finance and administration,
and 5 in operations. The Company considers its relationships with its employees
to be satisfactory.

         The Company is a party to a collective bargaining agreement covering
certain employees of National N-Viro Tech, Inc. The employees that are covered
by the collective bargaining agreement work at the Toledo, Ohio N-Viro facility
which is operated by the Company on a contract management basis for the City of
Toledo. The Company considers its relationships with such collective bargaining
organization to be satisfactory.

N-VIRO FACILITIES

         To date, the Company principally has licensed the N-Viro Process to
municipalities for use in municipally-owned wastewater treatment plants. The
Company has also operated, generally on a start-up basis, N-Viro facilities for
municipalities and currently operates one municipally-owned N-Viro facility on a
contract management basis. In most cases, however, municipal licensees have
elected to design, construct and operate N-Viro facilities independently.

         There are 37 N-Viro facilities currently operating throughout the
world. The sludge processing capacity of these facilities ranges from one to 160
dry tons per day; the Company estimates that these N-Viro facilities are
processing wastewater sludge at an annualized rate of approximately 150,000 dry
tons 


                                      -10-
<PAGE>   11

per year. In 1996 three new licenses were executed by N-Viro. Moreover, one
of the largest cities on the East Coast has selected N-Viro for a substantial
portion of their sludge treatment, and Raleigh, North Carolina began using
N-Viro technology in January 1997.

         The N-Viro Soil produced is typically sold within 100 miles of the
N-Viro facility and used for a variety of purposes, depending upon the needs of
the local market. The chart below summarizes the current annualized sludge
processing volume for each of the ten largest N-Viro facilities.

<TABLE>
<CAPTION>

                                                            Approximate Sludge
                                                             Processing Volume
                      Facility Location                         (dry tons/year)
     ----------------------------------                    --------------------
<S>                                                               <C>   
     Middlesex County, New Jersey                                 55,000
     Phillipsburg, New Jersey                                     15,000
     Wilmington, Delaware                                         12,000
     Syracuse, New York                                           10,000
     Toledo, Ohio                                                  8,000
     Minneapolis/St. Paul, Minnesota                               6,000
     Riverstone, Australia                                         4,000
     Asheville, North Carolina                                     4,000
     Greenville, South Carolina                                    3,000
     Ft. Smith, Arkansas                                           3,000
</TABLE>

         All of the existing N-Viro facilities are owned and operated by third
parties, with the exception of the Toledo, Ohio facility which has been operated
by the Company on a contract management basis since January 1990 and the Fort
Meade, Florida facility which has been owned jointly by the Company and VFL
Technologies, Ltd. since January 1996, after start-up in February 1995.

         Design and construction of a facility using the N-Viro Process is
typically undertaken by local independent engineering and construction firms.
Such a facility can be completed in approximately six months, but could take
substantially longer, depending on the size and complexity of the facility. The
N-Viro Process produces ammonia in various concentrations, depending on the
characteristics of the sludge. A number of N-Viro facilities, typically those
located near residential areas, have installed odor control systems in order to
minimize the release of ammonia odors resulting from the N-Viro Process. An odor
control system can significantly increase construction time and cost.
Construction of N-Viro facilities generally requires state and local permits and
approvals and, in certain instances, may require an environmental impact study.

         The Company had previously licensed for use at five treatment
facilities an earlier sludge treatment process that is designed to produce a
sludge product that meets only Class B pathogen levels, and therefore does not
produce an "exceptional quality" sludge product. Royalty payments from sludge
processed at the five facilities using such earlier technology currently account
for less than two percent of total royalty payments to the Company and the
Company does not actively market the use of this process.


ITEM 2.           PROPERTIES

         The Company's executive and administrative offices are located in
Toledo, Ohio, under a lease that expires on December 31, 1997.

         In early 1994 the Company purchased a site in Fort Meade, Florida to
develop a Company-owned N-Viro processing facility. Construction was started at
the site in late 1994 and the facility became operational in early 1995. In
December 1995, the Company entered in to a Memorandum of Understanding with VFL
Technologies, Inc. to jointly own, through a limited liability partnership named
Florida N-Viro, LLP ("Florida N-Viro"), the Fort Meade, Florida facility,
beginning January 1, 1996. Under this agreement, the Company would contribute
the property, plant and equipment to Florida N-Viro in return for 


                                      -11-
<PAGE>   12

approximately $1,000,000. Additionally, each partner would contribute $250,000
each to Florida N-Viro for working capital and property improvements. The
employees of Fort Meade would become employees of the new company, however, the
purpose of this facility would remain essentially unchanged.

         The agreement was amended in 1996 to provide that the Company would
receive $881,000 for the contribution of property, each partner would not
contribute $250,000 for working capital, and the Company would receive a 47%
interest in Florida N-Viro. All monies due under the amended agreement have been
received by the Company as of December 31, 1996.

         In 1995, the Company and MCO agreed that the rights of MCO to any
intellectual property of value to the Company which currently may be in
development or patentable is equivalent to $25,709 for MCO's portion of
royalties through the year ending December 31, 1996. The Company and MCO have
also agreed that future claims to the N-Viro Soil process is only 1/4 of 1% of
technical revenues. MCO rights to BioBlend and other new N-Viro technologies
range from 2% to 4% of technical revenues derived form these newer technologies.

ITEM 3.           LEGAL PROCEEDINGS.

         In May 1993, a complaint was filed against N-Viro Energy Systems, Ltd.,
N-Viro International Corporation, N-Viro Energy Systems, Inc., and American
N-Viro Resources, Inc., as well as one N-Viro licensee and related companies by
Frank Manchak, Jr. The complaint alleged that the N-Viro Process infringes a
patent (the "Manchak patent") relating to the treatment of sludge. The parties
to the pending lawsuit styled Frank Manchak, Jr. v. N-Viro et al., filed in the
United States District Court for the Central District of California, have
reached a compromise and settlement of the lawsuit brought by Mr. Manchak
against N-Viro. The terms and conditions of the February, 1995 settlement are
confidential, but the parties are pleased that the settlement now avoids the
expense and inherent risks of further litigation. All licensees of N-Viro
technology were indemnified by the court settlement. However, users of
alternative lime processes face the risk of future lawsuits by Manchak. Some
such lawsuits are now active in the federal courts.

         In 1993, Simon-Hartley Limited ("Simon-Hartley"), a former foreign
licensee of the N-Viro Process, threatened to bring proceedings against the
Company and the Partnership, demanding that the Company and/or the Partnership
bear responsibility for handling any claims brought against Simon-Hartley by
sub-licensees of the N-Viro Process appointed by Simon-Hartley. Simon-Hartley
further claimed that it should be indemnified in respect of all costs and
expenses arising in respect of any such claim as a result of the terms on which
Simon-Hartley's license of the N-Viro Process was terminated. Pursuant to the
terms of a settlement reached with Simon-Hartley in December 1994, it has been
agreed that, where possible, a joint approach will be adopted in defending or
settling these claims by any sub-licensees, and that any costs and expenses
incurred in connection with such claims will be shared equally with
Simon-Hartley.

         Simon Waste Solutions ("Simon Waste") had Agency rights for Mexico and
Puerto Rico. Simon Waste has ceased operations, and in 1996 the Company
terminated their license and called for arbitration as provided in their
contract. Simon Waste has failed to respond and the Company is proceeding with
arbitration to obtain a definitive ruling. 


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

         None.



                                      -12-
<PAGE>   13


                                     PART II

ITEM 5.           MARKET FOR REGISTRANT'S COMMON EQUITY
                                     AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

         The Company's Common Stock is listed in the Nasdaq National Market
under the symbol "NVIC". The price range of the Common Stock in the Nasdaq
National Market since October 12, 1993, the date upon which the Company's Common
Stock was first publicly traded, was as follows:

<TABLE>
<CAPTION>

------------------------------------------------------------------------
                    Quarter           High               Low
------------------------------------------------------------------------
<S>                                  <C>               <C>    
First 1995                             13              5 & 1/4
------------------------------------------------------------------------
Second 1995                             8              5 & 1/2
------------------------------------------------------------------------
Third 1995                           6 & 1/2           1 & 3/4
------------------------------------------------------------------------
Fourth 1995                             4              1 & 5/8
------------------------------------------------------------------------
First 1996                              6              1 & 3/4
------------------------------------------------------------------------
Second 1996                             6                 3
------------------------------------------------------------------------
Third 1996                              6              2 & 3/8
------------------------------------------------------------------------
Fourth 1996                          4 & 1/4           1 & 7/8
------------------------------------------------------------------------
</TABLE>

Above figures have been restated to reflect a one-for-four reverse stock split,
effective 10/31/95.

The Company's stock price closed at $2.00 per share on March 31, 1997.

HOLDERS

         As of March 1, 1997, the approximate number of holders of record of the
Company's Common Stock was 195.

DIVIDENDS

         The Company has never paid dividends with respect to its Common Stock.

ITEM 6.           SELECTED FINANCIAL DATA

         The Company was incorporated in April 1993. In September 1993, an
agreement was entered into pursuant to which N-Viro Energy Systems, Ltd., an
Ohio Limited Partnership contributed to the Company all of its assets (except
certain marketable securities and accounts receivable from certain related
parties) subject to all liabilities (except certain retained liabilities), and
the stockholders of the Company Agents contributed to the Company all of the
outstanding capital stock of each of such entities, in each case in exchange for
Common Stock and promissory notes (the "Organization"). The Organization was
accounted for as if the Partnership and the Company Agents (collectively, the
"Company Entities") had always been members of the same operating group.
Accordingly, historical financial statements of each of such entities have been
combined throughout all relevant periods herein. Certain adjustments have been
made to eliminate intercompany transactions between the Company Entities.

         The following selected combined statement of operations data for the
years ended December 31, 1992, the period January 1, 1993 through October 19,
1993, the consolidated statement of operations data for the period October 20,
1993 through December 31, 1993, the consolidated statement of operations data
for the years ended December 31, 1994, 1995 and 1996; and the combined and
consolidated balance sheet 


                                      -13-
<PAGE>   14


data set forth below as of December 31, 1992, 1993, 1994, 1995 and 1996
respectively, have been derived from the financial statements of the Company
which have been audited by Ernst & Young LLP, independent auditors for the years
ending December 31, 1994, and the period January 1, 1993 through October 19,
1993 and the period October 20, 1993 through December 31, 1993, and McGladrey &
Pullen, LLP for the years ending December 31, 1995 and 1996. In the opinion of
management, the financial data presented below reflect all adjustments (which
are of a normal recurring nature) necessary to present fairly the Company's
financial position and results of operations. The data presented below should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Financial Statements and
Supplementary Data appearing elsewhere in this Form 10-K. Prior to the IPO, the
Company Entities operated as separate, independent entities. The financial data
presented below for periods prior to October 20, 1993 are not necessarily
indicative of what the historical financial performance of the Company would
have been, or what the future financial performance of the Company will be, as a
combined entity.


STATEMENT OF OPERATIONS DATA (IN THOUSANDS, EXCEPT PER SHARE DATA):

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------
                        12/31/96    12/31/95   12/31/94   Total for   10/20/93    1/1/93   12/31/92
                                                            1993        thru       thru
                                                                     12/31/93  10/19/93
                                                                        (1)         (1)
---------------------------------------------------------------------------------------------------
<S>                       <C>        <C>        <C>        <C>        <C>        <C>       <C>   
Revenues                  $4,224     $5,214     $4,552     $4,619     $1,128     $3,491    $4,449
---------------------------------------------------------------------------------------------------
Net income (loss)           (193)    (1,815)    (7,342)    (1,622)      (686)      (936)       61
---------------------------------------------------------------------------------------------------
Net loss per share (2)    $(0.09)    $(0.89)    $(3.66)       n/a     $(0.34)       n/a       n/a
---------------------------------------------------------------------------------------------------
Pro Forma Net loss (3)       n/a        n/a        n/a        n/a        n/a       (936)      n/a
---------------------------------------------------------------------------------------------------
</TABLE>



BALANCE SHEET DATA  (IN THOUSANDS):
<TABLE>
<CAPTION>

------------------------------------------------------------------------------------
                     12/31/96  12/31/95  12/31/94   12/31/93              12/31/92
------------------------------------------------------------------------------------
<S>                   <C>       <C>       <C>       <C>        <C>   <C>   <C>    
Total assets          $4,1672   $5,0622   $6,5600   $12,8600   n/a   n/a   $4,6599
------------------------------------------------------------------------------------
Notes payable         $1,1880   $1,5400   $1,6611      $4200   n/a   n/a     $6755
------------------------------------------------------------------------------------
Shareholder Advance     $1970       n/a       n/a        n/a   n/a   n/a   $1,5855
------------------------------------------------------------------------------------

<FN>
(1)  Amounts represent the total of the combined results of the Company Entities
     for the period from January 1 through October 19, 1993 and the consolidated
     results of the Company for the period from October 20 through December 31,
     1993. These amounts have been accounted for as if the Partnership and the
     Company Agents (collectively, the "Company Entities") had always been
     members of the same operating group.

(2)  Per share amounts have been restated for a one-for-four reverse stock split
     effective October 31, 1995.

(3)  Certain of the Company Entities operated as subchapter S corporations or,
     in one case, as a limited partnership, and therefore were not subject to
     federal and state income taxes at the corporate or partnership level; as a
     result, their income or losses were passed through to their respective
     shareholders or partners. Pro forma net income (loss) reflects a provision
     for pro forma income taxes that would have been recorded had the Company
     Entities been taxed on a combined basis as a C corporation for all periods
     presented.
</TABLE>

         The Company's auditors have set forth in the financial statements
issues of "going concern". These issues are discussed in the financial statement
and in the liquidity section of the Management's Discussion and Analysis of
Financial Condition and Results of Operations.



                                      -14-
<PAGE>   15



ITEM 7.           MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                           FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

         The following discussion should be read in conjunction with "Selected
Financial Data" and the Financial Statements and Supplementary Data appearing
elsewhere in this Form 10-K.

         The following table sets forth, as a percentage of total revenues for
the periods presented, revenues related to each of (i) agency, license and
royalty, (ii) facility management and sludge processing, (iii) alkaline
admixture, (iv) N-Viro Soil and (v) miscellaneous revenues:

<TABLE>
<CAPTION>

                                                            FOR THE YEAR ENDED DECEMBER 31:
-------------------------------------------------------------------------------------------
                                                           1996         1995         1994
-------------------------------------------------------------------------------------------
<S>                                                       <C>          <C>          <C>   
Agency, license and royalty                                34.0%        18.8%        17.7%
-------------------------------------------------------------------------------------------
Facility management and sludge processing                  30.0%        34.9%        21.8%
-------------------------------------------------------------------------------------------
Alkaline admixture                                         28.1%        30.6%        42.7%
-------------------------------------------------------------------------------------------
N-Viro Soil                                                 1.5%         1.2%         1.1%
-------------------------------------------------------------------------------------------
Laboratory                                                  3.3%         3.2%         8.3%
-------------------------------------------------------------------------------------------
Miscellaneous revenues                                      3.1%        11.3%         8.4%
-------------------------------------------------------------------------------------------

-------------------------------------------------------------------------------------------
                                          Totals          100.0%       100.0%       100.0%
-------------------------------------------------------------------------------------------
</TABLE>

         Agency revenues represent non-recurring payments for the right to
market the N-Viro Process in a specified territory. License revenues represent
non-recurring payments for the right to use the N-Viro Process in a specified
geographic area or at a particular N-Viro facility. The Company's policy is to
record fully revenues payable pursuant to agency and license agreements when the
Company has fulfilled substantially all of its obligations under the relevant
contract. Royalty revenues represent ongoing amounts received from licensees for
continued use of the N-Viro Process and are typically based on volumes of sludge
processed. Facility management and sludge processing revenues are recognized
under contracts where the Company itself utilizes the N-Viro Process to treat
sludge, either pursuant to a fixed price contract or based on volumes of sludge
processed. Alkaline admixture revenues represent ongoing payments from licensees
arising from the sale and distribution of alkaline admixture by the Company and
the Agents to N-Viro facilities. N-Viro Soil sales represent revenues derived
from the sale of N-Viro Soil, either through royalties from sales of N-Viro Soil
sold by N-Viro facilities, or through sales of N-Viro Soil sold directly by the
Company. Miscellaneous revenues represent: commissions earned on sales, rental
of equipment to a licensee or agent, or testing income.

         In 1996 the Company redrafted its standard technology license to
include all royalty and alkaline commission income in its on-going professional
services fee. This change allows licensees to directly acquire all alkaline
admixtures, providing such materials meet N-Viro specifications. Moreover, in
1996 the Company offered new and old licensees the opportunity to pre-pay
on-going professional services fees on a one-time up-front basis. A
present-value concept is used to determine the revenue on an up-front basis.
Also, the Company is planning to license its international technology through
either an international sales company, a small number of large regional
companies or on a country by country basis.

         Cost of goods sold expenses principally reflect sludge processing costs
(principally labor and equipment), costs of acquiring alkaline admixture and
fees paid to outside consultants.


                                      -15-
<PAGE>   16




RESULTS OF OPERATIONS

         The following tables set forth, for the periods presented, (i) certain
items in the Combined Statement of Operations, (ii) the percentage change of
each such item from period to period and (iii) each such item as a percentage of
total revenues in each period presented.

<TABLE>
<CAPTION>

                                   ------------------------------------------------------------------
       (Dollars in thousands)        Year Ended   Period to     Year Ended    Period to    Year Ended
       ----------------------       December 31,    Period     December 31,     Period    December 31
                                        1996      Percentage       1995       Percentage      1994
                                                    Change                      Change
                                   ------------------------------------------------------------------
<S>                                     <C>            <C>         <C>             <C>       <C>   
COMBINED STATEMENT OF
OPERATIONS DATA:
Revenues                                $4,224         (19.0%)     $5,214          14.5%     $4,552
Cost of revenues                         1,798         (43.2%)      3,167          24.8%      2,537
                                        ------                     ------                    ------
Gross profit                             2,426          18.5%       2,047           1.6%      2,015

Selling, general & administrative        2,751         (22.6%)      3,552         (47.1%)     6,712
Other operating expenses                     0        (100.0%)        372         (87.0%)     2,856
                                        ------                     ------                    ------

Operating loss                            (325)           *        (1,877)           *       (7,553)

Non-operating income                       132         112.9%          62         (74.8%)       246
                                        ------                     ------                    ------

Loss before income taxes                  (193)           *        (1,815)           *       (7,307)
Income taxes                                 0            *            0         (100.0%)        35
                                        ------                     ------                    ------

Net loss                                  (193)           *        (1,815)          *        (7,342)
                                        ======                     ======                    ======

PERCENTAGE OF REVENUES:
Revenues                                 100.0%                     100.0%                    100.0%
Cost of revenues                         42.6                       60.7                      55.7
                                        ------                     ------                    ------
Gross profit                              57.4                       39.3                      44.3
                                                                                           
Selling, general & administrative         65.1                       68.1                     147.5
Other operating expenses                   0.0                        7.2                      62.7
                                        ------                     ------                    ------

Operating loss                            (7.7)                     (36.0)                   (165.9)
                                                                                           
Non-operating income                       3.1                        1.2                       5.4
                                        ------                     ------                    ------
                                                                                           
Loss before income taxes                  (4.6)                     (34.8)                   (160.5)
Income taxes                               0.0                        0.0                       0.8
                                        ------                     ------                    ------

Net loss                                  (4.6%)                    (34.8%)                  (161.3%)

<FN>
* Period to period percentage change comparisons have only been calculated for positive numbers.

</TABLE>



                                      -16-
<PAGE>   17


COMPARISON OF YEAR ENDED DECEMBER 31, 1996 WITH YEAR ENDED DECEMBER 31, 1995

         Revenues decreased $990,000, or 19.0%, to $4,224,000 for the year ended
December 31, 1996 from $5,214,000 for the year ended December 31, 1995. This
decrease was due primarily to the sale of one of its wholly-owned subsidiaries,
N-Viro Worldwide, and the contribution to a joint venture of the Fort Meade,
Florida, facility. In 1995, N-Viro Worldwide was sold to a group of investors,
led by Mr. Robin Millard, and was granted an exclusive license for Europe,
Africa and the Middle East. In December of 1995, the Company entered in to a
Memorandum of Understanding with VFL Technologies, Inc. to form a joint venture
to be known as Florida N-Viro, LLP, in which the Company would contribute the
Fort Meade, Florida facility. Revenue from N-Viro Worldwide and the Ft. Meade
facility provided $605,000 and $609,000 respectively, to 1995 revenue. Revenues
from one-time license fees increased $593,000 to $700,000 for 1996 from $107,000
for 1995. Revenues from existing on-line facilities, excluding N-Viro Worldwide
and Fort Meade, decreased $356,000 to $3,470,000 from $3,826,000 for 1995. In
1996 the Company received approximately $100,000 in gross revenue from our
European licensee, N-Viro Worldwide. Activities in 1997 and 1998 are expected to
substantially increase due to the 1998 ban on ocean dumping of sewerage sludge
by European Economic Community countries.

         Gross Profit increased $379,000, or 18.5% to $2,426,000 for the year
ended December 31, 1996 from $2,047,000 for the year ended December 31, 1995.
The gross profit margin increased to 57.4% from 39.3% for the year ended
December 31, 1995. This increase in gross profit margin was primarily due to the
increase in one-time license fee income of $593,000, at no cost of revenue, and
the elimination in lower gross profit margins of both the Fort Meade, Florida
and BioCheck Laboratories operations, sold December 31, 1995 and March 31, 1996,
respectively. The gross profit margin from existing on-line facilities,
excluding Fort Meade and BioCheck, increased to 49.4% from 47.3% for 1995.

         Selling, General and Administrative expenses decreased 22.6% to
$2,751,000 for the year ended December 31, 1996 from $3,552,000 for the year
ended December 31, 1995. In 1996, the Company continued streamlining its
operations, primarily through regional sales office closings and staff
reduction. The Company reduced expenditures for salaries and employee benefits
by $701,000, for professional services by $329,000, and for insurance by
$70,000. Offsetting these decreases was a $600,000 charge to bad debts, to fully
reserve the license fee income for the sale of the territory rights to Malaysia.

         Other Operating Expenses declined 100% to $-0- for the year ended
December 31, 1996 from $372,000 for the year ended December 31, 1995. The 1995
expense relate to an extension of the terms of the settlement of an alleged
patent infringement litigation as reported in 1994.

         The Company incurred a loss of $193,000 for the year ended December 31,
1996 compared to a loss of $1,815,000 for the year ended December 31, 1995. This
loss includes $250,000 of other income for the settlement of a legal fee dispute
relating to an alleged patent infringement lawsuit, and $109,000 of the
investment losses in their Florida N-Viro joint venture.

         In early 1996 the Company completed the transfer of its interest in the
Fort Meade, Florida facility. This sale resulted in the Company receiving
$881,000 in 1995 and 1996 from VFL Technologies for a 47% ownership position.
The Company incurred a loss of approximately $108,000 on its share of Florida
N-Viro LLP in 1996, but it anticipates that this investment can be 
profitable in the future.

         On March 31, 1996, the Company sold its remaining wholly-owned
subsidiary, BioCheck Labs, to their employees for a nominal sum. The sale was
motivated by the fact that BioCheck produced losses, and would continue to do
so.

         The Company has agreed to acquire the remaining 50% ownership in
Pan-America N-Viro from Synagro, Inc., a public company headquartered in
Houston, Texas. The Company will give Synagro 75,000 unregistered shares of the
Company's common stock for the interest. The Company anticipates that these 
shares will be registered in the

                                      -17-
<PAGE>   18


future. Pan-American N-Viro has exclusive licensing rights for all N-Viro
technology in Central and South America.

         In August of 1996, the Company signed an exclusive licensing agreement
with Rockland Power (M) Sdn. Bhd. of Kuala Lumpur, Malaysia, for $600,000. In
December of 1996, the Company terminated Rockland for failure to pay this fee.
The entire $600,000 was reserved in allowance for bad debts. The Rockland effort
however, generated substantial interest in Southeast Asia, and increased sales
activity is expected in this area for 1997 and beyond. In September of 1996, the
Company sold exclusive rights to Singapore to its Australian licensee,
Bio-Recycle Pty. Limited, for $100,000.



LIQUIDITY AND CAPITAL RESOURCES

         In its February 26, 1997 Report of Independent Auditors to the
Company's Board of Directors, the Company's auditors raise the issue of the
Company's ability to continue as a "going concern", in light of the Company's
current financial position. Please see Page F-1 as an attachment to this Form
10-K.

         The Company had working capital of ($286,000) at December 31, 1996
compared to ($34,000) at December 31, 1995. Current assets at December 31, 1996
included cash and investments of $284,000, which is an increase of about $59,000
from December 31, 1995. The decrease in working capital was principally due to
the net loss, and the payments on and conversion of long-term debt to current
liabilities as a result of the passage of time.

         During 1994, the Company began construction of a new Company-owned
facility in Fort Meade, Florida. The new facility started producing N-Viro Soil
from wastewater solids in February 1995. The Company paid for the facility out
of the proceeds of the initial public offering. In December, 1995, the Company
entered in to a Memorandum of Understanding with VFL Technologies, Inc. and
agreed to contribute the Fort Meade facility to a equally owned joint venture,
to be known as N-Viro Florida, LLP. This joint venture started January 1, 1996.
In 1996 the Company received a total of $630,700 in payments from VFL
Technologies, Inc. as its contribution to the joint venture.

         Much of the Company's funds have been used to reduce its long-term
litigation settlement obligation to Frank Manchak, that originated in 1995. The
Partnership and the Company's Chief Executive Officer loaned the Company
approximately $207,000 in 1996 to assist in meeting this obligation to Mr.
Manchak. The Company paid Mr. Manchak $780,000 in 1996, which created a
substantial drain on the Company's funds.

         At December 31, 1996, the Company had a balance due Mr. Manchak of
$700,000. All of this obligation was required to be paid in cash by July of
1997. In January, 1997, the Company entered into a letter agreement with Mr.
Manchak to satisfy its remaining obligation to him. Under the terms of this
agreement, the Company agreed to make cash payments totaling $260,000 through
March of 1997, and the balance to be satisfied through either the delivery to
Mr. Manchak of shares of the Company's common stock, or cash payment. The
Company has agreed to deliver 250,000 shares of the Company's common stock to
Mr. Manchak on or before May 1, 1997. Mr. Manchak will then attempt, over a
period of four months, to sell a sufficient volume of shares to satisfy the
remaining obligation. The Company has guaranteed that Mr. Manchak will be able
to generate at least $60,000 per month from his sale of not more than 30,000
shares of the Company's common stock and also that Mr. Manchak will generate
sufficient funds from his sales of the Company's common stock to discharge the
Company's remaining debt to him, by September 5, 1997. If Mr. Manchak either
fails to raise a total of $440,000 from his sales of the Company's common stock
on or before September 5, 1997, or fails to realize income of at least $60,000
per month for sales of the Company's common stock, the Company will be required
to make up any shortfall in cash. Once the Company has satisfied all of its
obligation to Mr. Manchak, he is required to surrender to the Company, without
payment of any additional consideration, the lesser of 100,000 shares of the
Company's common stock and such number of shares that are in his possession at
such time. The Company has paid Mr. Manchak the $260,000 provided for in the
agreement. The final terms of the amendment to 


                                      -18-
<PAGE>   19


the settlement, as outlined in the letter agreement, are in the process of being
incorporated into an amendment of the final settlement agreement. This agreement
will significantly help reduce the Company's cash flow concerns in 1997.

         The other debt of the Company includes an interest bearing short-term
note payable to a bank with an outstanding balance of $26,664 that matures in
June, 1997; and, an interest bearing short-term note payable to its former legal
counsel with an outstanding balance of $59,589 that matures in March, 1997; and,
an interest bearing short-term note payable to its former legal counsel who
represented the Company in the alleged patent infringement lawsuit with an
outstanding balance of $50,000 that matures in December, 1997; and, three
interest bearing long-term notes payable to the Partnership with a total
outstanding balance of $196,920 that matures in 1998.

         The Company incurred costs through 1996 for engineering work for a
privately operated facility to be constructed in Honolulu, Hawaii. In February,
1997, the Company made a formal request with the City of Honolulu to reimburse
all costs incurred to date, plus incidental costs. The Company anticipates these
monies to be recovered in 1997. However, there can be no assurance that such
sums will be recovered.

         The Company is prepared to initiate litigation against Honolulu if
necessary. Moreover, the Company is reviewing its claim to damages caused by
business interference and possible conspiracy by certain companies and
individuals against both its Honolulu project and against the Federal Court
Order that caused the Honolulu Project. The monies directly invested in the
Honolulu project to date are approximately $860,000. Recovery of these funds
would provide the Company a significant capital resource. The Honolulu N-Viro
facility was set to begin construction by the end of 1996 as all permits were
nearly in place. On October 30, 1996, the Mayor of Honolulu unilaterally and
suddenly rejected the site that both the City of Honolulu and the Company had
supported for over two years. The monies that the Company is seeking to recover
represents its investment in design, engineering and specification, contracts,
and permits for the site.

         In February, 1997, the Company obtained a working capital line of
credit of $100,000. Borrowings against the line bear interest at prime plus
1.75%, and are collateralized by accounts receivable, inventories and equipment,
and assignment of the wastewater treatment contract with the City of Toledo,
Ohio, and are due on demand.

         The Company believes that its working capital together with the line of
credit and reduction of debt through the delivery of unregistered shares of
stock to creditors, will provide sufficient cash to meet the Company's cash
requirements through 1997. Recovery of the Honolulu investment would help ensure
liquidity.

         The Company's ability to license its technology during the last three
years has been severely hampered, in part, by three events. These are:

         1.   Lack of enforcement of Federal Regulations and failure of states
              to accept delegation of responsibility.

         2.   Low cost of landfill disposal and land application of Class B
              (N-Viro is Class A) sludges; this problem is created in part by a
              nearly nationwide lack of governmental enforcement of existing
              regulations.

         3.   Efforts by competition to induce operators and contractors to
              infringe the Company's intellectual property.

We believe these "roadblocks" of the past are being overcome by:

         a.   Enforcement: The entire industry is concerned by "bad practices".
              States are now taking responsibility after convincing USEPA to
              modify 40CFR501, the Administrative requirements for state
              management of Federal regulations.


                                      -19-
<PAGE>   20


         b.   Cost: While landfill cost and competition are still aggressive,
              both the public and operators are now aware of both the
              sociological and environmental problems of placing raw (as now
              allowed by USEPA) sludge in landfills. Moreover, land application
              problems, including impact on food safety from bad practices, is
              creating substantial generator concern for both public and
              personal liability.

         c.   Infringement: The Company has been gathering evidence to support
              its claims of infringement, and hopes to become more aggressive in
              protecting its patent rights in 1997. However, the significant
              costs associated with this type of litigation, and the Company's
              cash flow situation, may interfere with such efforts.

         As a result of the market development discussed above and also due to a
significant increase in public and private interest in the safe and responsible
management of animal manure (2.2 billion USA market vs. 40 million USA sewer
sludge market), the Company is optimistic that 1997 and beyond will see an
increase in the sale and use of N-Viro technology. Moreover, public recognition
(e.g., President's Commission on Food Safety) of the dangers of farm-derived
pathogens in our food and water supply, and awareness of the highly negative
impact of currently acceptable organic disposal practices on the ozone and
global warming crisis, is creating renewed awareness of the long term ecological
sustainability of N-Viro type concepts.

         Finally, the Company's decision that it is not a contractor and simply
wishes to make its patented technology available to all public and private
sludge or manure treatment managers in exchange for license and royalty
revenues, should help the Company's financial performance.

         The Company cautions that words used in this document such as
"expects", "anticipates", "believes" and "may" as well as similar words and
expressions used herein identify and refer to statements describing events to
occur in the future. These forward-looking statements and the matters to which
they refer are subject to considerable uncertainty that may cause actual results
to be materially different from those described herein.

INFLATION

         The Company believes that inflation has not had a material impact to
date on the Company's operations.



                                      -20-
<PAGE>   21


ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



                   INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
                   ------------------------------------------
<TABLE>
<CAPTION>

                                                                                                    PAGE
                                                                                                    ----

<S>                                                                                                 <C>
Reports of Independent Auditors..................................................................   F-1
(Ernst & Young, LLP).............................................................................   F-2

Financial Statements:


          Consolidated Balance Sheets as of December 31, 1996 and 1995...........................   F-3



          Consolidated Statements of Operations for the years ended December 31, 1996,
              1995 and 1994......................................................................   F-4

          Consolidated Statement of Stockholders' Equity for the years ended
              December 31, 1996, 1995 and 1994...................................................   F-5

          Consolidated Statements of Cash Flows for the years ended December 31, 1996,
              1995 and 1994                                                                         F-6


          Notes to Financial Statements..........................................................   F-7


Financial Statement Schedule:


          Schedule II     Valuation and Qualifying Accounts and Reserves.........................   F-14
</TABLE>

          All other schedules are omitted since the required information is not
          present or is not present in amounts sufficient to require submission
          of the schedule, or because the information required is included in
          the financial statements and notes thereto.




                                      -21-
<PAGE>   22


ITEM 9.           CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                                      ACCOUNTING AND FINANCIAL DISCLOSURES

         None


                                    PART III


ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The information required by this Item 10 is hereby incorporated by
reference from the N-Viro International Corporation Proxy Statement for its 1997
Annual Meeting of Stockholders to be filed with the Securities and Exchange
Commission not later than 120 days after the end of the fiscal year covered by
this Form 10-K.

ITEM 11. EXECUTIVE COMPENSATION

         The information required by this Item 11 is hereby incorporated by
reference from the N-Viro International Corporation Proxy Statement for its 1997
Annual Meeting of Stockholders to be filed with the Securities and Exchange
Commission not later than 120 days after the end of the fiscal year covered by
this Form 10-K.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The information required by this Item 12 is hereby incorporated by
reference from the N-Viro International Corporation Proxy Statement for its 1997
Annual Meeting of Stockholders to be filed with the Securities and Exchange
Commission not later than 120 days after the end of the fiscal year covered by
this Form 10-K.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information required by this Item 13 is hereby incorporated by
reference from the N-Viro International Corporation Proxy Statement for its 1997
Annual Meeting of Stockholders to be filed with the Securities and Exchange
Commission not later than 120 days after the end of the fiscal year covered by
this Form 10-K.




                                      -22-
<PAGE>   23


                                     PART IV

ITEM 14.            EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON 
                    FORM 8-K

(a) 1. AND (a) 2.   FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE

                           See "Index to Financial Statements and Schedule" set
                    forth in Item 8 at page 22 of this Form 10-K.


(a) 3.              EXHIBITS

                           The exhibits designated by an asterisk are management
                    contracts and compensatory plans and arrangements required
                    to be filed as exhibits to this Form 10-K.

                    Exhibit
                    Number     Description
                    -------    -----------

                       3.1     Certificate of Incorporation of the Company
                               (incorporated by reference to Exhibit 3.1 to the
                               Registration Statement of the Registrant on Form
                               S-1 (Reg. No. 33-62766) (the "Registration
                               Statement").)
                       3.2     By-Laws of the Company (incorporated by reference
                               to Exhibit 3.2 to the Registration Statement).
                     *10.1     The Amended and Restated N-Viro International
                               Corporation Stock Option Plan (incorporated by
                               reference to Exhibit 10.1 to the 1993 Form 10-K).
                     *10.2     Employment Agreement, dated May 10, 1993, between
                               N-Viro International Corporation and J. Patrick
                               Nicholson (incorporated by reference to Exhibit
                               10.2 to the Registration Statement).
                      10.8     Agency/Distributor Agreement, dated July 29,
                               1993, between N-Viro Energy Systems, Ltd. and
                               N-Viro Recovery, Inc. (incorporated by reference
                               to Exhibit 10.8 to the Registration Statement).
                      10.10    Letter Agreement amending the Agency/Distributor
                               Agreement, dated July 29, 1991, between N-Viro
                               Energy Systems, Ltd. and New England N-Viro, Inc.
                               (incorporated by reference to Exhibit 10.10 to
                               the Registration Statement).
                      10.11    Agency/Distributor Agreement, dated April 4,
                               1988, between N-Viro Energy Systems, Ltd. and
                               George B. Carey, Individual (incorporated by
                               reference to Exhibit 10.11 to the Registration
                               Statement).
                      10.13    Agency/Distributor Agreement, dated December 7,
                               1987, between N-Viro Energy Systems, Ltd. and
                               Power Plant Aggregates of Iowa (incorporated by
                               reference to Exhibit 10.13 to the Registration
                               Statement).
                      10.19    License Agreement, dated July 24, 1992, between
                               N-Viro Energy Systems, Ltd. and N-Viro Recovery,
                               Inc. (incorporated by reference to Exhibit 10.19 
                               to the Registration Statement).
                      10.20    License Agreement, dated May 23, 1990, between
                               N-Viro Energy Systems, Ltd. and Norcal Canada
                               Solid Waste Systems, Inc. (incorporated by
                               reference to Exhibit 10.20 to the Registration
                               Statement).
                      10.25    Patent License Agreement, dated February 23,
                               1990, between N-Viro Energy Systems, Ltd. and
                               Waste Stream Environmental, Inc.


                                      -23-
<PAGE>   24


                               (incorporated by reference to Exhibit 10.25 to 
                               the Registration Statement).  

                      10.27    Patent License Agreement, dated April 16, 1991,
                               between N-Viro Energy Systems, Ltd. and VFL
                               Technology Corporation (incorporated by reference
                               to Exhibit 10.27 to the Registration Statement).
                      10.28    Equipment Representation Agreement, dated
                               December 8, 1992, between N-Viro Energy Systems,
                               Ltd. and Cemen Tech, Inc. (incorporated by
                               reference to Exhibit 10.28 to the Registration
                               Statement).
                      10.35    Lease, dated November 7, 1990, between Westgate
                               Village Shopping Center and N-Viro Energy
                               Systems, Inc. (incorporated by reference to
                               Exhibit 10.35 to the Registration Statement).
                      10.36    Amendment to Lease, dated October 22, 1992,
                               between Westgate Village Shopping Center and
                               N-Viro Energy Systems, Inc. (incorporated by
                               reference to Exhibit 10.36 to the Registration
                               Statement).
                      10.47    Promissory Note of National N-Viro Tech, Inc.,
                               dated September 3, 1992, in the amount of
                               $594,000 (incorporated by reference to Exhibit
                               10.47 to the Registration Statement).
                      10.49    N-Viro PFRP (Pasteurization) Licensee Agreement,
                               dated July 6, 1993, between N-Viro Energy
                               Systems, Ltd. and The City of Anderson
                               (incorporated by reference to Exhibit 10.49 to
                               Amendment No. 1).
                      10.57    Patent License Agreement, dated June 1, 1992,
                               between N-Viro Energy Systems, Ltd. and N-Viro
                               Recovery Systems, Inc. (incorporated by reference
                               to Exhibit 10.57 to Amendment No. 1).
                      10.58    Sludge Management Services Agreement, dated
                               September 1, 1990, between The Metropolitan Waste
                               Control Commission and N-Viro Minnesota, Inc.
                               (incorporated by reference to Exhibit 10.58 to
                               Amendment No. 1).
                      10.59    N-Viro Soil PFRP (Pasteurization) Licensee
                               Agreement, dated March 12, 1992, between N-Viro
                               Energy Systems, Ltd and The City of Galion
                               (incorporated by reference to Exhibit 10.59 to
                               Amendment No. 1).
                      10.60    Patent License Agreement, dated December 23,
                               1991, between Tennessee-Carolina N-Viro, Inc. and
                               Fourth Creek Wastewater Treatment Plant, City of
                               Statesville, North Carolina (incorporated by
                               reference to Exhibit 10.60 to Amendment No. 1).
                      10.61    Patent License Agreement, dated February 1, 1987,
                               between Pozzolanic Contracting & Supply Co., Inc.
                               and Pozzolanic Contracting & Supply Co., Inc.
                               (incorporated by reference to Exhibit 10.61 to
                               Amendment No. 1).
                      10.62    Patent License Agreement, dated December 31, 1992
                               between Tennessee-Carolina N-Viro, Inc. and
                               Athens Utilities Board (incorporated by reference
                               to Exhibit 10.62 to Amendment No. 1).
                      10.63    Specifications and Agreement for an Alkaline
                               Stabilization System for Municipal Wastewater
                               Sludge City of Des Moines ICA Wastewater
                               Treatment, dated November 19, 1990, between
                               N-Viro Resources, Inc. and the City of Des Moines
                               (incorporated by reference to Exhibit 10.63 to
                               Amendment No. 1).
                      10.64    Patent License Agreement, dated November 1, 1990,
                               between N-Viro Midwest, Inc. and the City of
                               Troy, Illinois (incorporated by reference to
                               Exhibit 10.64 to Amendment No. 1).
                      10.65    Patent License Agreement, dated January 23, 1989,
                               between N-Viro Resources, Inc. and the City of
                               Norfolk, Nebraska (incorporated by reference to
                               Exhibit 10.65 to Amendment No. 1).

                                      -24-
<PAGE>   25

                      10.66    Patent License Agreement, dated June 1, 1988,
                               between N-Viro Resources, Inc. and the City of
                               Boone, Iowa (incorporated by reference to Exhibit
                               10.66 to Amendment No. 1).
                      10.67    Patent License Agreement, dated February 1, 1989,
                               between N-Viro Resources and the City of West
                               Liberty, Iowa (incorporated by reference to
                               Exhibit 10.67 to Amendment No. 1).
                      10.68    Patent License Agreement, dated June 19, 1991,
                               between N-Viro Energy Systems, Ltd. and the City
                               of Tarpon Springs, Florida (incorporated by
                               reference to Exhibit 10.68 to Amendment No. 1).
                      10.69    Patent License Agreement, dated April 22, 1991,
                               between N-Viro Energy Systems, Ltd. and the
                               Village of Saugerties, New York (incorporated by
                               reference to Exhibit 10.69 to Amendment No. 1).
                      10.70    Patent License Agreement, dated June 20, 1990,
                               between Middlesex County Utilities Authority,
                               N-Viro Energy Systems, Ltd. and VFL Technology
                               Corporation (incorporated by reference to Exhibit
                               10.70 to Amendment No. 1).
                      10.72    Patent License Agreement, dated November 20,
                               1990, between Tennessee-Carolina N-Viro, Inc. and
                               the Town of Maggie Valley Wastewater Treatment
                               Plant (incorporated by reference to Exhibit 10.72
                               to Amendment No. 1).
                      10.73    Patent License Agreement, dated September 19,
                               1990, between N-Viro Energy Systems, Ltd. and the
                               Loxahatchee River Environmental Control District
                               (incorporated by reference to Exhibit 10.73 to
                               Amendment No. 1).
                      10.74    Patent License Agreement, dated September 17,
                               1990, between Tennessee-Carolina N-Viro, Inc. and
                               Easley Combined Utilities (incorporated by
                               reference to Exhibit 10.74 to Amendment No. 1).
                      10.75    Patent License Agreement, dated August 27, 1990,
                               between Tennessee-Carolina N-Viro, Inc. and First
                               Utility District of Knox County, Turkey Creek
                               Wastewater Treatment Plant (incorporated by
                               reference to Exhibit 10.75 to Amendment No. 1).
                      10.78    Agreement, dated October 10, 1990, between the
                               City of Toledo and National N-Viro Tech, Inc.
                               Pertaining to Marketing and Distribution of
                               N-Viro Soil (incorporated by reference to Exhibit
                               10.78 to Amendment No. 1).
                      10.79    Supplemental Agreement, dated September 3, 1992,
                               between the City of Toledo and National N-Viro
                               Tech., Inc. (incorporated by reference to Exhibit
                               10.79 to Amendment No. 1).
                      10.80    Patent License Agreement, dated September 1,
                               1987, between N-Viro Energy Systems, Ltd. and
                               George B. Carey, Individual (incorporated by
                               reference to Exhibit 10.80 to Amendment No. 1).
                      10.81    Patent License Agreement, dated January 29, 1993,
                               between N-Viro Energy Systems, Ltd. and Bossier
                               City (incorporated by reference to Exhibit 10.81
                               to Amendment No. 1).
                      10.82    Patent License Agreement, dated May 10, 1993,
                               between N-Viro Energy Systems, Ltd. and Sheffield
                               Utilities (incorporated by reference to Exhibit
                               10.82 to Amendment No. 1).
                      10.84    Patent License Agreement, dated September, 1991,
                               between N-Viro Energy Systems, Ltd. and
                               Hydropress N-Viro Services Inc. (incorporated by
                               reference to Exhibit 10.84 to Amendment No. 1).
                      10.85    Patent License Agreement, dated June 2, 1993,
                               between N-Viro Energy Systems, Ltd. and the City
                               of Baraboo, Wisconsin (incorporated by reference
                               to Exhibit 10.85 to Amendment No. 1).
                      10.86    Patent License Agreement, dated June 30, 1993,
                               between Tennessee-Carolina N-Viro Energy Systems,
                               Ltd. and West Knox Utility District (incorporated
                               by reference to Exhibit 10.86 to Amendment No.
                               1).

                                      -25-
<PAGE>   26

                      10.88    Termination Agreement, dated August 27, 1993,
                               between N-Viro Energy Systems Limited and
                               Simon-Hartley Limited (incorporated by reference
                               to Exhibit 10.88 to Amendment No. 1).
                      10.100   Memorandum of Understanding, dated August 26,
                               1993, by and among MCO, N-Viro International
                               Corporation and N-Viro Energy Systems, Ltd.
                               (incorporated by reference to Exhibit 10.100 to
                               Amendment No. 1).
                      10.102   Transitional Consulting and Sales Representative
                               Agreement, dated September 2, 1993, between
                               N-Viro International Corporation and Bobby B.
                               Carroll (incorporated by reference to Exhibit
                               10.102 to Amendment No. 1).
                      10.103   Supplemental Agreement, dated September 7, 1993,
                               between N-Viro Energy Systems, Ltd. and
                               Simon-Hartley Limited (incorporated by reference
                               to Exhibit 10.103 to Amendment No. 1).
                     *10.107   Promissory Note of Patrick T. Karney, dated
                               December 1, 1993, in the amount of $50,000
                               (incorporated by reference to Exhibit 10.107 to
                               the 1993 Form 10-K).
                      10.109   Research and Development Agreement, dated October
                               21, 1993 between N-Viro Energy Systems, Ltd.,
                               N-Viro Minnesota, Inc. and Metropolitan Waste
                               Control Commission (incorporated by reference to
                               Exhibit 10.109 to the 1993 Form 10-K).
                     *10.110   Letter Agreement, dated November 22, 1993, from
                               Jeffrey C. Burnham, Ph.D. on behalf of BioCheck
                               Laboratories, Incorporated to Terry J. Logan,
                               Ph.D. relating to research at The Ohio State
                               University (incorporated by reference to Exhibit
                               10.110 to the 1993 Form 10-K).
                      10.117   Agreement, dated December 30, 1994, by and among
                               Hydropress Environmental Service, Inc., New
                               England N-Viro, Inc. and N-Viro International
                               Corporation.
                      10.118   Settlement Statement, dated January 5, 1995, re:
                               Settlement Agreement dated December 30, 1994
                               between Hydropress Environmental Services, Inc.
                               and N-Viro International Corporation.
                      10.119   Registration Rights Agreement between N-Viro
                               International Corporation and Hydropress
                               Environmental Services, Inc., dated December 30,
                               1994.
                      10.120   Trademark License Agreement, dated December 30,
                               1994, between N-Viro International Corporation
                               and Hydropress Environmental Service, Inc.
                     *10.121   Promissory Note of Douglas Borgatti, dated
                               December 9, 1994, in the amount of $25,000.
                      10.122   Assignment, dated September 8, 1994, of License
                               Agreement dated July 24, 1992 between N-Viro
                               Energy Systems Limited and N-Viro Recovery, Inc.
                               re: Central and South America and the Caribbean,
                               by Synagro Technologies, Inc. to Pan-American
                               N-Viro, Inc.
                      10.124   Trademark License Agreement, dated April 30,
                               1994, between N-Viro International Corporation
                               and Waste Stream Environmental, Inc.
                      10.125   Letter of Agreement, dated September 21, 1994,
                               between N-Viro Systems Canada, Inc. and N-Viro
                               International Corporation and N-Viro
                               International Corporation re: minimum royalties
                               outstanding.
                      10.126   Consent to Assignment, dated September 21, 1994,
                               by N-Viro International Corporation to N-Viro
                               Systems Canada Inc. and Trimin Enterprises Inc.
                      10.127   Amendment to Transitional Consulting and Sales
                               Representative Agreement, dated January 1, 1994,
                               between N-Viro International Corporation and
                               Bobby B. Carroll.


                                      -26-
<PAGE>   27


                      10.128   Security Agreement, dated January 1, 1994,
                               between N-Viro International
                               Corporation/Tennessee-Carolina N-Viro, Inc. and
                               Bobby B. Carroll.
                      10.130   Agreement between the City of Toledo and Great
                               Lakes N-Viro, dated December 29, 1994.
                      10.131   Agreement for Removal, Processing, Marketing and
                               Distribution of Biosolids, dated February 8,
                               1995, between N-Viro International Corporation
                               and The City of Kissimmee.
                      10.132   Patent License Agreement, dated January 1, 1994,
                               between N-Viro International Corporation and CDR
                               Environmental, Inc.
                      10.133   Letters of Intent to terminate discussions
                               relative to the Memorandum of Understanding
                               between N-Viro International Corporation and the
                               Medical College of Ohio, dated August 26, 1993.
                      10.134   Settlement Agreement, dated December 5, 1994,
                               between Simon-Hartley Limited and N-Viro Energy
                               Systems, Ltd.
                      10.135   Consulting Agreement between Logan Environmental,
                               Inc., Terry J. Logan and N-Viro International
                               Corporation, dated February 15, 1996.
                      10.136   Consulting Agreement between David R. Dickson and
                               N-Viro International Corporation, dated January
                               19, 1996
                      10.137   License Agreement between Medical College of Ohio
                               and N-Viro International Corporation, dated
                               January 25, 1996
                      10.138   Equipment Lease Agreement between Urbana &
                               Champaign Sanitary District, Urbana, Illinois and
                               N-Viro International Corporation, dated February
                               2, 1996
                      10.139   Memorandum of Understanding relative to
                               establishment of Florida N-Viro, LP , dated
                               December 20, 1995; Limited Partnership Agreement
                               for Florida N-Viro, L.P., dated January 31, 1996
                      10.140   Limited Liability Company Agreement of Florida
                               N-Viro Management, LLC, dated January 31, 1996
                      10.141   Patent and Technology License Agreement between
                               Florida N-Viro, L.P. and N-Viro International
                               Corporation, dated February 1, 1996.
                      10.142   Articles of Incorporation for N-Viro Honolulu
                               Incorporated, dated December 12, 1995.
                      10.143   Assignment of Conditional Award of Contract
                               Rights between N-Viro International Corporation
                               and N-Viro Honolulu Incorporated, dated February
                               21, 1996.
                      10.144   Letter of Intent regarding Honolulu, Hawaii
                               Project dated October 19, 1995.
                      10.145   Agreement between International Brotherhood of
                               Teamsters, Chauffers, Warehousemen and Helpers of
                               American, Local Union 20 and National N-Viro
                               Tech., Inc., dated November 1, 1994.
                      10.146   Patent License Agreement between Waste Stream
                               Environmental, Inc. and N-Viro International
                               Corporation, dated December 1, 1995.
                      10.147   Patent License Agreement between West Central
                               Wisconsin Biosolids Commission and N-Viro
                               International Corporation, dated September 29,
                               1995.
                      10.148   Research Agreement between Rodale Institute and
                               N-Viro International, dated April 1, 1995.
                      10.149   License Agreement between CR.M Technologies Ltd.
                               and N-Viro Energy Systems Limited, dated
                               September 4, 1993.
                      10.150   Settlement Agreement between Frank Manchak, Jr.
                               and N-Viro International Corporation, N-Viro
                               Energy Systems, Inc., American N-Viro Resources,
                               Inc., Sanifill, Inc., Residuals Processing, Inc.,
                               Redwood Landfill, Inc., dated February 24, 1995
                               with Amendment, dated February 1, 1996.

                                      -27-
<PAGE>   28
   

                      10.151   Agreement for the Sale of N-Viro Worldwide
                               Limited, dated August 1, 1995.
                      10.152   Statement regarding method used to determine per
                               share loss computation.
                      10.153   Letter appointing McGladrey & Pullen LLP the
                               Company's Independent Auditors for the year
                               ending December 31, 1995.
                      10.154   Letter Agreement between Frank Manchak, Jr. and
                               N-Viro International Corporation, dated February
                               25, 1997 amending the Settlement Agreement dated
                               February 24, 1995.
                      10.155   Settlement Agreement between Jones, Day, Reavis &
                               Pogue, and N-Viro International Corporation,
                               dated February 10, 1997.
                      10.156   License Agreement between Rockland Power Sdn.
                               Bhd. Kuala Lumpur, Malaysia, and N-Viro 
                               International Corporation, dated
                               August 14, 1996.               
                      21.1     List of subsidiaries of the Company.
                      27.1     Financial Data Schedule
    


(b)                        REPORTS ON FORM 8-K
                           The Company filed a report on Form 8-K dated December
                           13, 1996, Item 5., Other Items, to disclose a press 
                           release on recent management changes, with an 
                           attached exhibit of the press release from the 
                           Company.


                                      -28-
<PAGE>   29



                                   SIGNATURES


         Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                          N-VIRO INTERNATIONAL CORPORATION

Dated: April 14, 1997

                          By: /s/ J. Patrick Nicholson
                              ---------------------------------------------
                              J. Patrick Nicholson, President, Chairman and
                              Chief Executive Officer
                              (Principal Executive Officer)


         Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.

Dated: April 14, 1997

<TABLE>


<S>                                                  <C>    
/s/ J. Patrick Nicholson                             /s/ John Graham
---------------------------------------------        ---------------------------------
J. Patrick Nicholson, President, Chairman,           John Graham, Director
Chief Executive Officer and Director
(Principal Executive Officer)


/s/ Frederick H. Kurtz                               /s/ Charles B. Kaiser, Jr.
---------------------------------------------        ---------------------------------
Frederick H. Kurtz, Vice-Chairman and Director       Charles B. Kaiser, Jr., Director


/s/ James K. McHugh                                  /s/ Terry J. Logan, Ph.D.
---------------------------------------------        ---------------------------------
James K. McHugh                                      Terry J. Logan, Ph.D., Director
Chief Financial Officer, Secretary and Treasurer
(Principal Financial and Accounting Officer)         /s/ Wallace G. Irmscher
                                                    ----------------------------------
                                                    Wallace G. Irmscher, Director




</TABLE>

<PAGE>   30


                         REPORT OF INDEPENDENT AUDITORS


To the Board of Directors
N-VIRO INTERNATIONAL CORPORATION
Toledo, Ohio

We have audited the accompanying consolidated balance sheets of N-VIRO
INTERNATIONAL CORPORATION as of December 31, 1996 and 1995, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years then ended. Our audit also includes the financial statement schedule
listed in the Index at Item 8. These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

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

In our opinion, the 1996 and 1995 consolidated financial statements referred to
above present fairly, in all material respects, the financial position of N-VIRO
INTERNATIONAL CORPORATION as of December 31, 1996 and 1995, and the results of
its operations and its cash flows for the years then ended, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations.
This raises substantial doubt about the Company's ability to continue as a going
concern. The Company's ability to meet its current and future obligations is
primarily dependent upon realizing the costs incurred on the Hawaii processing
facility and its ability to achieve profitable operations and obtain additional
debt financing. Management's plans in regards to these matters are discussed in
Note 1. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.



/s/ McGladrey & Pullen, LLP
McGLADREY & PULLEN, LLP
Elkhart, Indiana
February 26, 1997



                                      F-1
<PAGE>   31






Report of Independent Auditors

The Board of Directors
N-Viro International Corporation

We have audited the accompanying consolidated balance sheet of N-Viro
International Corporation as of December 31, 1994, and the related consolidated
statements of operations, stockholders' equity and cash flows for the year ended
December 31, 1994. Our audit also included the financial statement schedule
listed in the Index at Item 8. These financial statements and schedule 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 consolidated financial position of N-Viro
International Corporation at December 31, 1994, the consolidated results of its
operations and its cash flows for the year ended December 31, 1994, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic financial statements taken as whole, presents fairly in all material
respects the information set forth therein.

As discussed in Note 1, the accompanying financial statements have been prepared
assuming the Company will continue as a going concern. The Company has incurred
a loss of $7,342,204 for the year ended December 31, 1994. This loss and
negative cash flows from operating activities have significantly weakened the
Company's financial position. The amount of cash and investments available at
December 31, 1994 are not sufficient to finance the current level of operations
and satisfy other cash requirements throughout 1995. Consequently, the Company
is currently negotiating with third parties in an attempt to obtain additional
sources of funds which, in management's opinion, would provide adequate cash
flows to finance the Company's cash requirements. The satisfactory completion of
these negotiations is essential as these avenues are the Company's principal
means of providing sufficient cash flows to meet 1995 requirements. Because the
negotiations are still in progress, there can be no assurance that the Company
will have sufficient funds to finance its operations, which continue to show
unaudited consolidated losses of $404,454 for the period January I through
February 28, 1995. All of these matters raise substantial doubt about the
Company's ability to continue as a going concern. The financial statements do
not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts or classifications of
liabilities that may result from the outcome of this uncertainty.


/s/ ERNST & YOUNG LLP

Toledo, Ohio
February 24, 1995



                                      F-2
<PAGE>   32






N-VIRO INTERNATIONAL CORPORATION

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                            December 31,
                                                                   ---------------------------
                                                                      1996              1995
                                                                   ---------------------------

ASSETS

<S>                                                              <C>               <C>      
Current Assets
   Cash and cash equivalents                                     $   282,115       $   223,942
   Securities available-for-sale                                       1,401             1,401
   Trade receivables                                                 788,628           961,681
   Other receivables                                                 113,544           254,718
   Assets held for sale                                              780,108         1,095,024
   Prepaid expenses and other assets                                 225,597           189,669
                                                                 -----------------------------
                                   
              TOTAL CURRENT ASSETS                                 2,191,393         2,726,435

Property and Equipment                                               621,558           703,495

Investment in Florida N-Viro, L.P.                                   919,352         1,184,334

Intangible and Other Assets                                          434,634           448,047
                                                                 -----------------------------

                                                                 $ 4,166,937       $ 5,062,311
                                                                 =============================
LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities
   Current maturities of long-term debt                          $   911,706       $   819,990
   Accounts payable                                                1,306,862         1,396,793
   Accrued expenses                                                  258,779           543,403
                                                                 -----------------------------

              TOTAL CURRENT LIABILITIES                            2,477,347         2,760,186
                                                                 -----------------------------

Long-Term Debt, less current maturities                              276,031           720,000
                                                                 -----------------------------

Commitments and Contingencies

Stockholders' Equity
   Common stock, $.01 par value; authorized
      45,000,000 shares; issued 2,094,250 shares                      20,943            20,943
   Additional paid-in capital                                     12,048,455        12,024,060
   Retained earnings (deficit)                                   (10,037,862)       (9,844,901)
                                                                 -----------------------------
                                                                   2,031,536         2,200,102
   Less treasury stock, at cost, 57,250 shares                       617,977           617,977
                                                                 -----------------------------
                                                                   1,413,559         1,582,125
                                                                 -----------------------------

                                                                 $ 4,166,937       $ 5,062,311
                                                                 =============================
</TABLE>

See Notes to Financial Statements.



                                      F-3
<PAGE>   33











N-VIRO INTERNATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>

                                                                              Year Ended December 31,
                                                             ------------------------------------------------
                                                                       1996            1995             1994
                                                             ------------------------------------------------
<S>                                                            <C>             <C>             <C>          
Revenues                                                       $   4,223,873   $   5,214,113   $   4,551,851

Cost of revenues                                                   1,797,796       3,166,922       2,536,648
                                                             ------------------------------------------------

              GROSS PROFIT                                         2,426,077       2,047,191       2,015,203
                                                             ------------------------------------------------

Operating expenses:
   Selling, general, and administrative                            2,708,866       3,522,878       6,635,482
   Research and development                                           41,784          29,500          76,461
   Other                                                                             371,525       2,856,477
                                                             ------------------------------------------------
                                                                   2,750,650       3,923,903       9,568,420
                                                             ------------------------------------------------

              OPERATING (LOSS)                                      (324,573)     (1,876,712)     (7,553,217)
                                                             ------------------------------------------------

Nonoperating income (expense):
   Interest income, net                                               18,215          34,354         215,798
   Miscellaneous income                                              154,941          71,463          76,004
   Equity in losses of joint venture                                 (41,544)        (44,032)        (46,089)
                                                             ------------------------------------------------
                                                                     131,612          61,785         245,713
                                                             ------------------------------------------------

              (LOSS) BEFORE INCOME TAXES                            (192,961)     (1,814,927)     (7,307,504)

Federal and state income taxes                                                                        34,700
                                                             ------------------------------------------------

              NET (LOSS)                                        $   (192,961)   $ (1,814,927)   $ (7,342,204)
                                                             ================================================

Net (loss) per common share                                     $      (0.09)   $      (0.89)   $      (3.66)
                                                             ================================================

Weighted average common
   shares outstanding                                              2,037,000       2,037,000       2,005,310
                                                             ================================================
</TABLE>


See Notes to Financial Statements.



                                      F-4
<PAGE>   34









N-VIRO INTERNATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>

                                       Common       Additional    Retained     Unrealized    Treasury       Total
                                        Stock        Paid-In       Earnings    Losses On      Stock
                                                     Capital      (Deficit)    Available-
                                                                               For-Sale
                                                                               Securities
----------------------------------------------------------------------------------------------------------------------
<S>                                  <C>         <C>           <C>            <C>                                    
Balance December 31, 1993            $    81,120 $  11,639,258 $    (685,968) $             $           $  11,034,410
   Issuance of common stock                2,650       321,975                                                324,625
   Net (loss)                                                     (7,342,204)                              (7,342,204)
   Unrealized losses on
      available-for-
      sale securities, net of tax                                                  (52,090)                   (52,090)
      effect
   Repurchase of 229,000 shares
      of common stock                                                                         (617,977)      (617,977)
   Other                                                              (1,802)                                  (1,802)
                                     ---------------------------------------------------------------------------------
Balance, December 31, 1994                83,770    11,961,233    (8,029,974)      (52,090)   (617,977)     3,344,962
   Net (loss)                                                     (1,814,927)                              (1,814,927)
   Sale of securities                                                               52,090                    52,090
   Effect of 1-for-4 reverse stock
      split                              (62,827)      62,827
                                     ---------------------------------------------------------------------------------
Balance, December 31, 1995                20,943    12,024,060    (9,844,901)                 (617,977)     1,582,125
   Net (loss)                                                       (192,961)                                (192,961)
   Other                                                24,395                                                 24,395
                                     =================================================================================
Balance, December 31, 1996           $    20,943 $  12,048,455 $ (10,037,862) $             $ (617,977) $   1,413,559
                                     =================================================================================
</TABLE>

See Notes to Financial Statements.



                                      F-5
<PAGE>   35




N-VIRO INTERNATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>

                                                                 Year Ended December 31,
                                                        -----------------------------------------
                                                             1996          1995           1994
                                                        -----------------------------------------
<S>                                                     <C>            <C>            <C>         
CASH FLOWS FROM OPERATING  ACTIVITIES
   Net (loss)                                           $  (192,961)   $(1,814,927)   $(7,342,204)
   Adjustments to reconcile net (loss) to net
     cash (used in) operating activities:
     Depreciation and amortization                          164,353        209,071        162,299
     Provision for bad debts                                656,000         70,000        173,163
     Loss on contractual obligation                                        300,000      1,500,000
     Reacquisition of territory rights                                                    324,625
     Other                                                 (360,985)       168,482         22,903
     Change in assets and liabilities:
       Decrease (increase) in:
          Trade receivables                                (341,773)        (2,094)       714,334
          Prepaid expenses and other                        (35,928)        81,644        (84,863)
       Increase in accounts payable
          and accrued liabilities                             5,901        513,543         61,306
                                                        -----------------------------------------
            NET CASH (USED IN) OPERATING ACTIVITIES        (105,393)      (474,281)    (4,468,437)
                                                        -----------------------------------------

CASH FLOWS FROM INVESTING ACTIVITIES
   Purchase of securities                                                              (4,078,595)
   Proceeds from sale of securities                                      2,001,710      1,951,334
   Purchase of property and equipment                      (122,434)    (1,398,795)    (1,680,669)
   Proceeds from sale of property and equipment             945,147        250,000        138,231
   Investment in joint venture                                             (85,000)       (65,000)
   Expenditures for intangible and other assets            (203,833)      (123,545)       (34,345)
                                                        -----------------------------------------
              NET CASH PROVIDED BY (USED IN)
                      INVESTING ACTIVITIES                  618,880        644,370     (3,769,044)
                                                        -----------------------------------------

CASH FLOWS FROM FINANCING ACTIVITIES
   Borrowings under long-term obligations                   375,683                        91,937
   Principal payments on long-term debt                    (855,392)      (420,988)      (351,457)
   Purchase of treasury stock                                                            (617,977)
   Other                                                     24,395
                                                        -----------------------------------------
            NET CASH (USED IN) FINANCING ACTIVITIES        (455,314)      (420,988)      (877,497)
                                                        -----------------------------------------
            INCREASE (DECREASE) IN CASH
                AND CASH EQUIVALENTS                         58,173       (250,899)    (9,114,978)

                Cash and cash equivalents, beginning        223,942        474,841      9,589,819
                                                        -----------------------------------------
                Cash and cash equivalents, ending       $   282,115    $   223,942    $   474,841
                                                        =========================================
</TABLE>

See Notes to Financial Statements.


                                      F-6
<PAGE>   36


      NOTE 1 - NATURE OF BUSINESS, USE OF ESTIMATES, BASIS OF PRESENTATION,
                       AND SIGNIFICANT ACCOUNTING POLICIES


NATURE OF BUSINESS:

The Company owns and licenses the N-Viro Process, a patented technology to treat
and recycle wastewater sludges and other bio-organic wastes, utilizing certain
alkaline by-products. Revenue and the related accounts receivable are due from
companies acting as independent agents or licensees, principally municipalities.
Credit is generally granted on an unsecured basis. Periodic credit evaluations
of customers are conducted and appropriate allowances are established.

USE OF ESTIMATES:

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities as the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

BASIS OF PRESENTATION:

The Company's financial statements have been presented on the basis that it is a
going concern. Such basis assumes the realization of assets and satisfaction of
liabilities, each in the normal course of business. The Company has incurred
losses from operations and negative cash flows from operating activities. The
amount of cash and investments available at December 31, 1996 are not sufficient
to finance the current level of operations and satisfy other cash requirements
throughout 1997. Consequently, the Company's ability to meet its current and
future obligations is primarily dependent upon realizing the costs incurred on
the Hawaii processing facility and its ability to achieve profitable operations
and obtain additional debt financing. Although there are no assurances that
payment of the Hawaii obligation will be made, the Company is attempting to
realize its costs on the Hawaii processing facility and has restructured
operations which management believes will return the Company to profitability.
The Company is negotiating to satisfy certain liabilities through the issuance
of stock and obtain short-term debt financing which, in management's opinion,
would provide adequate cash flow to finance the Company's cash requirements. The
satisfactory completion of those plans are the Company's principal means of
providing sufficient cash flows to meet 1997 obligations.

SIGNIFICANT ACCOUNTING POLICIES:

PRINCIPLES OF CONSOLIDATION AND COMBINATION:

The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.

The Company accounts for its investments in joint ventures under the equity
method.

CASH AND CASH EQUIVALENTS:

The Company has cash on deposit in one financial institution which, at times,
may be in excess of the FDIC insurance limits.

For purposes of the statements of cash flows, the Company considers all highly
liquid debt instruments purchased with a maturity of three months or less to be
cash equivalents.



                                      F-7
<PAGE>   37


PROPERTY AND EQUIPMENT:

Depreciation has been computed primarily by the straight-line method over the
estimated useful lives of the assets. Generally, useful lives are thirty-one
years for leasehold improvements and five to fifteen years for equipment and
furniture and fixtures.

INTANGIBLE ASSETS:

Organization and patent costs are being amortized by the straight-line method
over 5 and 17 year periods respectively.

REVENUE RECOGNITION:

License and agency revenues are generated by selling the right to market or use
the N-Viro process in a specified territory. The Company's policy is to record
revenue for the agency and license agreements when it has fulfilled all it
obligations under the relevant contract.

Facility management revenue, sludge processing revenue, and royalty revenue are
recognized under contracts where the Company or licensees utilize the N-Viro
process to treat sludge, either pursuant to a fixed-price contract or based on
volumes of sludge processed. Revenue is recognized as services are performed.

Alkaline admixture revenue and N-Viro Soil revenue is recognized upon shipment.

OTHER OPERATING EXPENSES:

Other operating expenses include principally the settlement of alleged patent
infringement litigation and related legal fees and the cost of reacquisition of
territory rights.

NET LOSS PER COMMON SHARE:

Earnings per common share has been computed based on the weighted average number
of shares out- standing for the years ended December 31, 1996, 1995, and 1994.
The effects of the stock options are excluded from the earnings per share
calculation because they would be antidilutive.

During 1995, the Company's Board of Directors approved a 1-for-4 reverse stock
split. All share and per share data has been restated to reflect this split.


                           NOTE 2 - BALANCE SHEET DATA


TRADE RECEIVABLES:

Trade receivables in the accompanying balance sheets at December 31, 1996 and
1995 are stated net of an allowance for doubtful accounts of $691,000 and
$110,000 respectively.

ASSETS HELD FOR SALE:

The Company has incurred costs as of December 31, 1996 and 1995 of $780,108 and
$595,024 respectively in connection with obtaining a contract and the design of
a processing facility in Hawaii. The Company expects to recover the costs in
1997.

At December 31, 1995, the Company also classified $500,000 of costs of the
Florida operating facility that were transferred into the Florida N-Viro, L.P.
as assets held for sale.



                                      F-8
<PAGE>   38


PROPERTY AND EQUIPMENT:
<TABLE>
<CAPTION>
                                                       1996         1995
                                                    -----------------------
<S>                                                 <C>          <C>       
   Land and leasehold improvements                  $   41,618   $   44,684
   Equipment                                         1,014,652    1,133,899
   Furniture and fixtures                              211,178      229,956
                                                    -----------------------
                                                     1,267,448    1,408,539
   Less accumulated depreciation and amortization      645,890      705,044
                                                    -----------------------
           Net property and equipment               $  621,558   $  703,495
                                                    =======================
</TABLE>

The Company rents certain equipment to customers under short-term arrangements.

INVESTMENT IN FLORIDA N-VIRO, L.P.:

Florida N-Viro, L.P. was formed in January 1996 pursuant to a joint venture
agreement between the Company and VFL Technology Corporation (VFL). The Company
contributed its Florida operating facility with a carrying value of $1,934,334.
In exchange, the Company received $880,700 in cash and retains a 47% interest in
the facility.

Condensed financial information as of December 31, 1996 is as follows:

<TABLE>
<S>                                                              <C>        
   Current assets                                                $   153,866
   Long-term assets                                                1,946,350
                                                                 -----------
                                                                 $ 2,100,216
                                                                 ===========

   Current liabilities                                               183,301
   Stockholders' equity                                            1,916,915
                                                                 -----------
                                                                 $ 2,100,216
                                                                 ===========

   Net sales                                                     $   761,631
   Net (loss)                                                        (83,085)
</TABLE>


INTANGIBLE AND OTHER ASSETS:
<TABLE>
<CAPTION>
                                                            1996       1995
                                                          -------------------
<S>                                                       <C>        <C>     
   Patents and other intangibles, less accumulated
      amortization 1996 $151,286; 1995 $122,871           $378,495   $388,168
   Investment in Pan-American N-Viro, Inc.                  56,139     59,879
                                                          -------------------
                                                          $434,634   $448,047
                                                          ===================
</TABLE>

Pan-American N-Viro, Inc. (Pan-Am) was formed pursuant to a joint venture
agreement between the Company and Synagro Technologies, Inc. The purpose of
Pan-Am is to promote the N-Viro process in Central and South America and the
Caribbean. Under the terms of the agreement, the Company's original capital
contribution was $150,000 in cash. The Company will provide administrative
services and forego annual minimum royalties. Condensed financial information
has not been presented as the investment is not significant to the Company's
financial position or results of operations.

ACCRUED LIABILITIES:
<TABLE>
<CAPTION>
                                                       1996               1995
                                                     ---------------------------
<S>                                                  <C>                <C>     
   Employee benefits                                 $122,759           $296,522
   Legal fees                                          50,000            150,000
   Other                                               86,020             96,881
                                                     ---------------------------
                                                     $258,779           $543,403
                                                     ===========================
</TABLE>




                                      F-9
<PAGE>   39

         NOTE 3 - PLEDGED ASSETS, LINE OF CREDIT, AND LONG-TERM DEBT


On February 12, 1997, the Company obtained a $100,000 line of credit with a
bank. Borrowings against the line of credit bear interest at prime plus 1.75%,
are collateralized by accounts receivable, inventories, equipment, and
assignment of a wastewater treatment contract with City of Toledo, and are due
on demand.

Long-term debt at December 31, 1996 and 1995 consists of the following:
<TABLE>
<CAPTION>
                                                                              1996         1995
                                                                          -----------------------
<S>                                                                       <C>          <C>       
   Contractual obligation, non-interest bearing                           $  700,000   $1,480,000
   Notes payable, related partnership                                        196,920
   Term note payable, bank                                                    26,664       59,990
   Other notes payable                                                       264,153
                                                                          -----------------------
                                                                           1,187,737    1,539,990
   Less current maturities                                                   911,706      819,990
                                                                          -----------------------
                                                                          $  276,031   $  720,000
                                                                          =======================
</TABLE>

The contractual obligation is the result of a settlement of an alleged patent
infringement litigation. During the year ended December 31, 1995, the Company
agreed to extend the payment terms of the settlement in exchange for additional
consideration of $300,000, which has been charged to operations. This agreement
requires monthly payments of $60,000 with a final balance due July 1997. The
obligation is collateralized by certain payments to be received from the sale of
the Hawaii project and a 50% security interest in all patents now owned or later
acquired by the Company, including the proceeds thereof (see Note 9).

The notes payable is to a partnership controlled by the majority stockholder.
The notes are unsecured, bear interest at 8.25%, and are due at varying dates
through January 1, 1999.

The bank note requires monthly payments of $3,333 plus interest at prime (8.25%
at December 31, 1996) plus .5%, is unsecured, and is due June 1997.

The other notes payable are notes signed for amounts owed to vendors. The notes
bear interest at approximately 9% and are due at varying dates through June
2000.

Aggregate maturities of long-term debt for the years ending December 31, 1998
through 2000 are as follows: 1998 $145,725; 1999 $127,709; and 2000 $2,597.

Interest expensed and paid was approximately $20,148, $34,700, and $27,200 for
the years ended December 31, 1996, 1995, and 1994 respectively


                         NOTE 4 - EQUITY TRANSACTIONS


The Company has authorized 5,000,000 shares of preferred stock, par value $.01
per share, of which no shares were outstanding at December 31, 1996 and 1995
(see Note 9).

The Company has adopted a stock option plan for directors and key officers under
which 1,000,000 shares of common stock may be issued. The options were 20%
vested on the date of grant, with the balance vesting 20% per year over the next
four years. Options are granted at fair market value.



                                      F-10
<PAGE>   40


The following summarizes the number of grants and their respective exercise
prices and grant date fair values per option, for the years ended December 31,
1996 and 1995 and the number outstanding and exercisable at those dates:

<TABLE>
<CAPTION>
                                                           1996                 1995
                                                   -----------------------------------------
                                                             WEIGHTED               Weighted
                                                             AVERAGE                Average
                                                             EXERCISE               Exercise
                                                   SHARES     PRICE      Shares      Price
                                                   -----------------------------------------
<S>                                                <C>       <C>         <C>        <C>     
   Outstanding, beginning of year                  168,750   $  34.21    151,750    $  37.37
      Granted                                       37,400       4.35     18,000        6.00
      Expired during the year                      (54,625)     35.29     (1,000)       6.00
                                                   -------                ------
   Outstanding, end of year                        151,525      26.45    168,750       34.21
                                                   =========================================

   Eligible for exercise at end of year             78,525                91,250        
                                                   ==========         ==============        
   Weighted average fair value per option
             for options granted during the year             $   4.30               $   5.41
                                                             ========               ========
</TABLE>

A further summary of stock options is as follows:
<TABLE>
<CAPTION>
                                             Options Outstanding                    Options Exercisable
                                  ----------------------------------------------------------------------------------
                                                  Weighted
                                                  Average          Weighted                        Weighted
                                                  Remaining        Average                         Average
                                      Number     Contractual       Exercise         Number         Exercise
                                    Outstanding     Life             Price        Exercisable       Price
                                  ----------------------------------------------------------------------------------
<S>                                  <C>            <C>             <C>               <C>           <C>   
   Range of exercise prices,
      $1.75 to $38.00                151,525        7.28            $ 26.45           78,525        $29.74
</TABLE>


As permitted under generally accepted accounting principles, the Company's
present accounting with respect to the recognition and measurement of
stock-based employee compensation costs, primarily related to the Company's
stock option plan, is in accordance with APB Opinion No. 25, which generally
requires that compensation costs be recognized for the difference, if any,
between the quoted market price of the stock and the amount an employee must pay
to acquire the stock. The Company has not adopted the provisions of SFAS
Statement No. 123 which prescribes a fair-value based method of measurement that
results in the disclosure of computed compensation costs for essentially all
awards of stock-based compensation to employees. This requirement is to be
applied prospectively to any options granted.

Had compensation cost been determined based upon the fair value method
prescribed in SFAS Statement No. 123, reported net (loss) would have been
$(263,833) and $(1,825,751) and net (loss) per share would have been $(.13) and
$(.90) for the years ended December 31, 1996 and 1995 respectively.

In determining the pro forma amounts above, the value of each grant is estimated
at the grant date using the fair value method prescribed in Statement No. 123,
with weighted-average assumptions for grants in 1995 and 1996 of no anticipated
dividend rates for all years and risk-free interest rates of 5.25% on expected
lives of 10 years.


              NOTE 5 - MAJOR CUSTOMER AND RELATED PARTY TRANSACTIONS


Revenues for the years ended December 31, 1996, 1995, and 1994 include sales to
one major customer which represented 30%, 26%, and 34% respectively of total
revenues. The accounts receivable balance due from this customer at December 31,
1996 and 1995 was approximately $114,000 and $106,000 respectively.



                                      F-11
<PAGE>   41

The Company paid a consulting fee to the former stockholder of one of the
Company agents of $150,000, $80,000, and $180,000 for the years ended December
31, 1996, 1995, and 1994 respectively. On January 1, 1994, the Company granted
this individual a security interest in all present and future receivables and
contract rights from licenses in the states of Tennessee, North Carolina, and
South Carolina. The secured receivables amounted to approximately $154,000 and
$141,000 at December 31, 1996 and 1995 respectively.


                     NOTE 6 - COMMITMENTS AND CONTINGENCIES


The Company leases office space under an agreement which requires monthly
payments of $4,700. The lease expires in December 1997. The total minimum rental
commitment at December 31, 1996 is $56,000. The total rental expense included in
the statements of operations for each of the years ended December 31, 1996,
1995, and 1994 is approximately $110,000.

During 1994, the Company reacquired territory rights to several states from a
former agent. In consideration for the rights, the Company paid $200,000 in cash
and issued 66,250 shares of unregistered common stock with a designated value of
$324,625. In the event the former agent elects to sell all these shares at the
earliest date possible, the Company has guaranteed the former agent $6 per
share. If the former agent receives in excess of $10 per share, the Company will
receive 50% of the excess amount.

The Company is involved in legal proceedings and subject to claims which have
arisen in the ordinary course of business. These actions, when concluded and
determined, will not, in the opinion of management, have a material adverse
effect upon the financial position of the Company.


                           NOTE 7 - INCOME TAX MATTERS


Deferred income tax assets and liabilities are computed annually for differences
between the financial statement and tax bases of assets and liabilities that
will result in taxable or deductible amounts in the future based on enacted tax
laws and rates applicable to the periods in which the differences are expected
to affect taxable income. Valuation allowances are established when necessary to
reduce deferred tax assets to the amount expected to be realized. Income tax
expense is the tax payable or refundable for the current period plus or minus
the change during the period in deferred tax assets and liabilities.

Since the incorporation of the entities, the Company has incurred losses,
therefore, there are no federal and state income taxes for the years ended
December 31, 1996 and 1995. The provision for income taxes for the year ended
December 31, 1994 is comprised of deferred tax expense of $34,700.

The composition of the deferred tax assets and liabilities at December 31, 1996
and 1995 is as follows:

<TABLE>
<CAPTION>
                                                    1996           1995
                                                --------------------------
<S>                                             <C>            <C>         
   Gross deferred tax liability,
      accelerated depreciation                  $    (2,000)   $    (3,000)
                                                --------------------------
   Gross deferred tax assets:
      Loss carryforwards                          3,187,000      3,365,000
      Patent costs                                  743,000        819,000
      Allowance for doubtful accounts               370,000        108,000
      Property and equipment basis difference        24,000         27,000
      Other                                          69,000        178,000
                                                --------------------------
                                                  4,393,000      4,497,000
                                                --------------------------
   Less valuation allowance                      (4,391,000)    (4,494,000)
                                                --------------------------
                                                 $        -     $        -
                                                ==========================
</TABLE>



                                      F-12
<PAGE>   42

The net operating losses available at December 31, 1996 to offset future taxable
income total approximately $7,918,000 and expire in 2008 and 2009.


                NOTE 8 - DISCONTINUED AND TRANSFERRED OPERATIONS


At the beginning of the year ended December 31, 1996, the Company transferred
its Florida operating facility to a joint venture which is being accounted for
under the equity method, and sold its wholly-owned subsidiary, BioCheck
Laboratories. In addition, during 1995, the Company sold its wholly-owned
subsidiary, N-Viro Worldwide.

Unaudited pro forma consolidated net sales, net (loss) and net (loss) per common
share for the year ended December 31, 1995, if the Company had sold these
entities as of January 1, 1995 would have been $3,811,146, $(1,514,986), and
$(.75) respectively.


                           NOTE 9 - SUBSEQUENT EVENTS


Subsequent to December 31, 1996, the Company reached a settlement agreement on
the $700,000 contractual obligation discussed in Note 3. As part of the
agreement, the Company will pay $260,000 in cash, issue 250,000 shares of
unregistered common stock, and issued an option to acquire 100,000 shares of
unregistered common stock at a price of $2.50 per share. Of the 250,000 shares
transferred, a maximum of 30,000 shares per month may be sold effective May 1,
1997 through September 1, 1997 to satisfy the obligation.

On September 1, 1997, in the event that the aggregate proceeds from the sale of
stock is inadequate to cover the remaining liability of $440,000, the Company
will be obligated to repurchase the number of shares at $2 per share to satisfy
the remaining obligation. In addition, if shares sold have been adequate to
cover the $440,000 outstanding liability, the Company will be entitled to the
return of any unsold shares up to a maximum of 100,000 shares.



                                      F-13
<PAGE>   43












N-VIRO INTERNATIONAL CORPORATION

SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
 December 31, 1994, 1995, and 1996

<TABLE>
<CAPTION>
                                         Balance At       Charged To        Deductions      Balance At
                                        Beginning of      Operations           From          Close Of
                                           Period                             Reserves        Period
---------------------------------------------------------------------------------------------------------
<S>                                   <C>             <C>              <C>               <C>            
Allowance for doubtful accounts 
   - deducted from trade receiv-
   ables and long-term receivables 
   in the balance sheets:
   1994                               $        50,000 $        173,163 $          23,163 $       200,000
                                      ===================================================================

   1995                               $       200,000 $         88,877 $          18,877 $       270,000
                                      ===================================================================

   1996                               $       270,000 $        656,000 $           - 0 - $       926,000
                                      ===================================================================
</TABLE>



                                      F-14