<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

                [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                      OF THE SECURITIES EXCHANGE ACT OF 1934
                    [NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996]
                   For the Fiscal Year Ended December 31, 1996


              [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
                     For the Transition Period From ____ to ____

                         COMMISSION FILE NUMBER 1-12986

                           INTERNATIONAL LOTTERY, INC.
             (Exact name of Registrant as specified in its charter)

        DELAWARE                                        31-1297916
(State of incorporation)                             (I.R.S. Employer
                                                   Identification Number)

                     6665 CREEK ROAD, CINCINNATI, OHIO 45242
          (Address of principal executive offices, including zip code)

                                 (513) 792-7000
              (Registrant's telephone number, including area code)

                                  ------------

           Securities registered pursuant to Section 12(b) of the Act:

     Title of each class               Name of each exchange on which registered
----------------------------           -----------------------------------------
COMMON STOCK, $.01 PAR VALUE                   AMERICAN STOCK EXCHANGE

        Securities registered pursuant to Section 12(g) of the Act: None

                                  ------------

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes  X  No
                                       ---    ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the 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
                             ---

The aggregate market value of the Registrant's outstanding Common Stock held by
non-affiliates of the Registrant on March 25, 1997 was $9,128,125. There were
3,210,000 shares of Common Stock outstanding as of March 25, 1997.

                       DOCUMENTS INCORPORATED BY REFERENCE
                       -----------------------------------
Portions of the Registrant's 1996 Annual Report are incorporated by reference in
Part II hereof. Portions of the Registrant's Proxy Statement for the 1997 Annual
Meeting of Stockholders to be held on May 8, 1997 are incorporated by reference
in Part III hereof.
<PAGE>   2
                           INTERNATIONAL LOTTERY, INC.
                           ANNUAL REPORT ON FORM 10-K
                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
Item                                                                                                    Page
Number                                                                                                 Number
------                                                                                                 ------
                                                  PART I
<S>     <C>                                                                                             <C>
  1.    Business ......................................................................................   3

  2.    Properties ....................................................................................  23

  3.    Legal Proceedings .............................................................................  24

  4.    Submission of Matters to a Vote of Security Holders ...........................................  25

  4(A). Executive Officers of the Registrant ..........................................................  25

                                                  PART II

  5.    Market for Registrant's Common Equity and Related Stockholder Matters .........................  27

  6.    Selected Financial Data .......................................................................  27

  7.    Management's Discussion and Analysis of Financial Condition and Results of Operations .........  27

  8.    Financial Statements and Supplementary Data ...................................................  27

  9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ..........  28

                                                 PART III

 10.    Directors and Executive Officers of the Registrant ............................................  28

 11.    Executive Compensation ........................................................................  28

 12.    Security Ownership of Certain Beneficial Owners and Management ................................  28

 13.    Certain Relationships and Related Transactions ................................................  28

                                                 PART IV

 14.    Exhibits, Financial Statement Schedules, and Reports on Form 8-K ..............................  29

                                      SIGNATURES ......................................................  35

                                      INDEX OF FINANCIAL STATEMENT SCHEDULES .......................... S-1

                                      INDEX OF EXHIBITS ............................................... E-1
</TABLE>

                                      -2-
<PAGE>   3
                                     PART I

ITEM 1. BUSINESS
----------------
General

         International Lottery, Inc. (the "Company") is engaged primarily in the
design, manufacture, sale, lease and service of instant winner lottery ticket
vending machines ("ITVMs"). ITVMs are used by public lotteries operated by
states and foreign public entities to dispense instant winner lottery tickets
primarily in retail locations such as supermarkets and convenience stores. An
instant lottery commonly is played by players scratching off a latex coating
from a pre-printed ticket or tearing pull-tabs from a pre-printed ticket to
determine the outcome of the game. The Company's ITVMs dispense instant lottery
tickets without the assistance of an employee of the lottery instant ticket
retailer or agent, thereby permitting the retailer or agent to sell tickets
without disrupting the normal duties of its employees.

         The Company's ITVMs dispense scratch-off instant lottery tickets using
a dispensing process that incorporates the Company's patented "burster
technology." The Company believes that this burster technology is superior to
any other ITVM scratch-off dispensing technology on the market and considers it
to be a key to its marketing efforts and the ITVM procurement decisions of the
various lotteries. The Company is unaware of any competitor that incorporates a
substantially equivalent or superior scratch-off dispensing mechanism in its
ITVMs. To dispense pull-tab instant lottery tickets, the Company has developed
an ITVM that incorporates a patented dispensing technology which is different
than the burster technology but that is also believed by the Company to be
superior to any other currently available pull-tab dispensing technology. ITVMs
that dispense pull-tab tickets are sometimes referred to herein as "pull tab
vending machines" or "PTVMs." The term "ITVM" includes both scratch-off vending
machines and PTVMs unless the context indicates otherwise.

         As of December 31, 1996, the Company had sold or leased 10,523 ITVMs
under agreements with 16 different state lotteries and three foreign
jurisdictions, or their licensees or contractors. The Company has been awarded
contracts to provide ITVMs for nine of the last ten state lotteries that have
requested bid proposals and was the recipient of all domestic ITVM contracts
that were awarded in 1995 and four of the five domestic ITVM contracts that were
awarded in 1996. Additionally, lotteries in eight states and eight foreign
jurisdictions currently are testing the Company's ITVMs or have requested the
Company to provide ITVMs for testing.

         The Company continually seeks to enhance its existing product lines and
develop new products. The Company has developed a prepaid phone card dispensing
machine ("PCDM") that enables providers of long distance telephone service to
dispense prepaid telephone calling cards in retail locations without the
assistance of an employee of the retailer. The dispensing process used in the
Company's PCDM incorporates the same patented technology used in the Company's
PTVM, and the Company believes that this dispensing technology is superior to
any other PCDM dispensing technology on the market. Sales of the Company's PCDMs
began in the latter part of 1995, and as of December 31, 1996, the Company had
sold or leased a total of 318 PCDMs. PCDM revenues in 1995 and 1996 represented
2.2% and 2.0% of total revenues, respectively.

         The Company was incorporated on February 20, 1990 under the laws of
Ohio and was reincorporated under the laws of Delaware on March 18, 1994. In
April 1994, the Company completed an initial public offering of Common Stock,
and the Company's Common Stock now trades on the American Stock Exchange under
the symbol "ILI."

                                      -3-
<PAGE>   4
         The words "expect", "anticipate", "intend", "plan", "believe", "seek",
"estimate" and similar expressions used in this report are intended to identify
forward-looking statements, although this report also contains other
forward-looking statements. Any forward-looking statements in this report are
made pursuant to the "safe harbor" provisions of the Private Securities
Litigation Act of 1995. Investors are cautioned that actual results may differ
substantially from such forward-looking statements. Forward-looking statements
involve risks and uncertainties including, but not limited to, continued
acceptance of the Company's products and services in the marketplace,
competitive factors, new products and technological changes, dependence upon
third party vendors, a limited number of customers, political and other
uncertainties related to customer purchases, and other risks detailed in the
Company's periodic filings with the Securities and Exchange Commission.

INDUSTRY OVERVIEW

         ITVMs
         ------

         The popularity and success of lotteries has increased worldwide in
recent years, and the popularity of instant lotteries has increased at a rate
that is greater than that of lotteries generally. Currently 37 states and the
District of Columbia operate lotteries as compared to 29 states as of June 30,
1989, and 37 states and the District of Columbia currently operate instant
lotteries as compared to 28 states as of June 30, 1989. The Company believes
that factors contributing to the rapid growth in the popularity and success of
instant ticket games, which now comprise 43% of total lottery sales in the
United States as compared to 24% in 1989, include more sophisticated marketing
techniques, the introduction of new state instant ticket lotteries, a broader
appeal among lottery consumers and increased technological advances in the
distribution of instant tickets.

         ITVMs were first deployed to serve the instant lottery market in 1991,
and the market for ITVMs has grown rapidly in subsequent years. The number of
installed ITVMs has increased from approximately 900 in 2 states in 1991 to
approximately 23,000 in 26 states, the District of Columbia and 3 foreign
jurisdictions as of December 31, 1996. Eight states and eight foreign
jurisdictions currently are testing or preparing to test ITVMs in the field, and
the Company believes that several other states and foreign jurisdictions are
considering the use of ITVMs. Additionally, because states that utilize ITVMs
typically introduce the ITVMs into the instant ticket distribution system in
stages (preferring to test retail reception to a limited initial deployment of
ITVMs before fully committing funds to the deployment of a significantly larger
number of ITVMs), the Company believes that states currently utilizing ITVMs
represent a growing market for the Company's ITVMs.

         Although the Company believes that sales of instant lottery tickets and
the use of ITVMs will continue to increase, any decline in the popularity of
instant lottery games or in the market acceptance of ITVMs, as well as any other
event that results in a decrease in leasing or purchasing ITVMs by lotteries,
would have a material adverse effect on the Company. The Company's ability to
generate additional revenues and earnings will depend upon the continuation of
existing leases of ITVMs, orders for additional ITVMs by the lotteries that
currently utilize ITVMs, the implementation of programs that use ITVMs to
distribute tickets in the 11 additional states as well as foreign jurisdictions
that have instant ticket lotteries, and the approval of lotteries by the
remaining states and foreign jurisdictions. Future orders of ITVMs by lotteries
will depend in large part on continued market acceptance of ITVMs, of which
there can be no assurance. Accordingly, there can be no assurance that any
significant number of jurisdictions will implement or expand lottery programs
that utilize ITVMs.

                                      -4-
<PAGE>   5
         PCDMs
         -----
         Like instant lottery tickets, the use of prepaid telephone calling
cards also has grown significantly in the past few years. Prepaid telephone
calling cards enable callers to make long distance calls at rates that typically
are lower than the rates ordinarily charged for credit card or collect long
distance telephone calls. This factor, together with the usage control that
results from the pre-established value of the card, is perceived as a distinct
value of the card and is believed to be responsible for the popularity of
prepaid telephone calling cards.

         The use of PCDMs as a method of distribution of prepaid telephone
calling cards has paralleled the market acceptance of the card. PCDMs are now
being used successfully to sell prepaid telephone calling cards in truck stops,
military bases, convenience stores, airports, and numerous other types of retail
locations. The Company believes that the sale of prepaid long distance calling
cards and the use of PCDMs are in the very early stages of market development in
the United States and anticipates the continued development of the market.
However, any decline in the popularity of prepaid telephone calling cards or in
the market acceptance of PCDMs would limit the Company's ability to generate
revenues and earnings from its PCDM. There can be no assurance that the Company
will be able to develop successfully the market for its PCDMs.

BUSINESS STRATEGY

         The Company's business strategy involves the following elements:

         -        Expansion of the Company's ITVM into new domestic and
                  international markets. Lotteries are becoming increasingly
                  aware of the success of ITVMs in increasing instant ticket
                  revenues, and many domestic and international jurisdictions
                  are currently testing and evaluating ITVMs. In the United
                  States, the Company currently is testing or preparing for
                  testing of ITVMs for lotteries in Iowa, Kansas, Kentucky,
                  Georgia, Louisiana, Missouri, New York and West Virginia.
                  Internationally, the Company currently is testing ITVMs for
                  lotteries in Argentina, Australia, Brazil, Denmark, Iceland,
                  Ireland, Israel and Norway. The Company plans to expand
                  further into new and existing lottery jurisdictions by
                  expanding its marketing efforts and lowering the cost
                  associated with the procurement of its ITVMs. The Company also
                  intends to continue to aggressively market its ITVM products
                  and services to its existing customers to encourage expanded
                  use of ITVMs in existing distribution systems.

         -        PCDM market penetration. The Company has made only an initial
                  and limited penetration of the PCDM market to date, but the
                  Company is actively seeking to become a significant presence
                  in the PCDM market in the United States. The Company believes
                  that its ITVM has a reputation for quality, performance and
                  reliability, and the Company intends to capitalize on this
                  reputation in marketing its PCDM to providers of long distance
                  telephone services. The Company also intends to demonstrate to
                  such providers the advantages which its PCDM affords to the
                  retailers that sell prepaid telephone calling cards, which in
                  turn should lead to increased sales of prepaid calling cards
                  by such providers. To this end, the Company is working closely
                  with several providers of long distance telephone service to
                  expand the use of PCDMs in the distribution of prepaid
                  telephone calling cards. Eight such providers are currently
                  testing or preparing to test the Company's PCDM. The Company
                  also intends to aggressively market its PCDM products to its
                  existing customers and to expand its marketing efforts to both
                  the providers and resellers of long distance services, as well
                  as to market its PDCMs to retailers of prepaid telephone
                  cards.

                                      -5-
<PAGE>   6
         -        Continued product innovation and technological advances.
                  Management believes that the Company's products are more
                  technologically advanced than the products of its competitors
                  and that the technological superiority of the Company's ITVM
                  is a principal reason for its success to date. To further
                  expand the Company's market opportunities, the Company
                  continually seeks to enhance its existing products and develop
                  complementary products that offer the superior operating
                  performance of its ITVMs and PCDMs. For example, the Company
                  has developed what it believes to be the smallest footprint
                  six and twelve bin ITVMs in the marketplace. The Company
                  believes that these ITVMs will be attractive to lotteries
                  primarily because of their small footprint, which will enable
                  lotteries to deploy them in lottery locations where space and
                  other considerations often have prohibited the installation of
                  the Company's eight-game ITVMs. The Company has also
                  redesigned its eight game ITVM, reducing the width of the
                  cabinet by 34% to 21". The Company believes that this design
                  addresses the space considerations of lotteries and retailers.
                  In 1995, the Company developed an ITVM that incorporates both
                  the burster technology and the pull-tab dispensing technology
                  in one cabinet, thus enabling lotteries that market both types
                  of instant ticket games to merchandise the games in one ITVM.
                  Additionally, the Company's ITVMs may be purchased with an
                  on-line communications system that allows lotteries to gather
                  sales data at any time from, and communicate directly with,
                  ITVMs located throughout the lottery's jurisdiction.

         -        Manufacturing efficiencies. The Company continually seeks to
                  enhance its manufacturing operations to improve its gross
                  margins and overall profitability. The Company believes that
                  through design refinements and continued higher production
                  volumes, it will continue to achieve lower manufacturing costs
                  by receiving more favorable terms from vendors.

         -        Develop dispensing devices for other markets. The Company
                  intends to expand its existing product lines by developing new
                  dispensing devices for markets other than lotteries. For
                  example, the Company is developing and testing a device which
                  dispenses stored value "smart" cards for possible use by the
                  financial services industry to the extent that consumer use of
                  smart cards develops in the future.

PRODUCTS

         The ITVM
         --------

         In 1987, the Company's President, Edmund F. Turek, developed the
technology for what the Company believes to be the first automated ITVM. This
burster dispensing technology is a key component of the Company's ITVM for
scratch-off instant lottery tickets and is protected by a patent that the
Company acquired from Mr. Turek's family-owned corporation. See "Patents,
Trademarks, and Copyrights" below.

         The Company's ITVMs automatically dispense instant lottery tickets upon
payment from the user. Unlike the products of some of the Company's competitors,
the burster technology in the Company's ITVMs automatically separates one
scratch-off instant ticket from another along the perforations between tickets
to help prevent tearing of the tickets or scarring of the latex on the tickets.
The Company's burster technology, which the Company believes to be the most
technologically advanced scratch-off dispensing system in the ITVM industry,
also enables the Company's ITVM to dispense and account for virtually any known
type of scratch-off instant lottery ticket, allowing the use of a wide range of
sizes, shapes, paper stocks or perforations, without the intervention of a
lottery retailer or agent. This feature allows lotteries to purchase virtually
any known type of scratch-off instant ticket from their instant ticket
manufacturer

                                      -6-
<PAGE>   7
without having to request from the manufacturer major alterations in the ticket
perforations. For example, the Company's ITVM, unlike the products of the
Company's competitors, can dispense recyclable scratch-off tickets without
tearing or scarring the tickets. The Company believes that lotteries will
increasingly require the use of recyclable tickets in their ITVMs. This feature
also is particularly beneficial to foreign lottery jurisdictions that may use
non-standard sizes, shapes and paper stocks. In addition, the ITVM for
scratch-off tickets is faster than manual sales of scratch-off tickets as the
ITVM's entire dispensing process is completed in less than 1.5 seconds once the
ticket selector button has been pushed.

         The Company's ITVMs for scratch-off tickets have a proven record of
reliability. Based on an analysis of actual field service data regarding the
dispensing of approximately 55 million scratch-off instant tickets by the
Company's ITVMs during a 48 week period, the Company determined that the Mean
Time Between Failure of these ITVMs is approximately 3.78 years and that the
Mean Time to Repair is approximately 15 minutes. The data indicated that these
ITVMs dispense an average of 392,800 scratch-off instant tickets between
failures. The Company believes that it has developed an ITVM that has proven to
be reliable and that requires less maintenance than the products of its
competitors. The Company believes that the reliability of its ITVM and the lower
maintenance requirements distinguish the Company's ITVM for scratch-off tickets
from those of its competitors. See "Competition" below.

         The Company's ITVMs for scratch-off tickets have the capacity to
dispense tickets from one to twelve different bins. Because each bin can
dispense tickets of different sizes, paper stocks and price levels, lotteries
can sell scratch-off tickets for up to twelve different instant winner games
with a single ITVM. The ITVM can accommodate up to 12,000 tickets in the
twelve-game unit and can dispense all tickets in the bin without manual
intervention. When all of the tickets in a bin have been dispensed, tickets can
be easily reloaded by an employee of the retailer or agent. This is in contrast
to the products of the Company's competitors, which the Company believes require
the retailer or other agent to tape the last few tickets in each bin to the next
pack of tickets provided by the retailer or other agent. The ability of the
Company's ITVM to dispense every ticket in each bin not only facilitates the
ticket reloading process but also enhances the accuracy of the inventory and
accounting functions.

         All of the Company's ITVMs accept bills in $1, $2, $5, $10 and $20
denominations and, in some applications, accept foreign currency. The size of
the Company's ITVMs for scratch-off tickets varies from 69 inches tall, 28
inches wide and 24 inches deep for a twelve-game unit to 19.75 inches tall, 15.5
inches wide and 20.5 inches deep for a countertop unit.

         All models are anchored to the floor or counter. The ITVMs typically
are custom designed to meet any color and other appearance specifications that a
lottery may desire. All models are Underwriters Laboratory ("UL(R)") listed and
Federal Communications Commission ("FCC") approved, which ensures that the ITVM
has passed nationally recognized safety standards and stringent requirements
designed to preclude machine damage and personal injury due to non-approved
components, devices, installation or application. The Company was the first
manufacturer of ITVMs to obtain UL(R) listing and FCC approval for its ITVMs.

         Each ITVM is standardized with an information display that provides the
player with easy-to-read instructions on how to use the machine and gives the
lottery retailer or agent the ability to read sales reports without printing the
report. The ITVM can be ordered with a "BETA BRITE(R)" multi-color LED sign
mounted on the top of the ITVM which is intended to increase attention to the
machine and thereby increase ticket sales. The BETA BRITE(R) sign is programmed
at the Company's manufacturing facility and can display any message the lottery
may desire. The BETA BRITE(R) also may be programmed by the retailer or agent or
can be programmed from the lottery headquarters by utilizing the Company's
optional modem communications system. The Company currently is utilizing the
BETA BRITE(R) on ITVMs installed throughout Arizona, Colorado, Georgia, Idaho,
Indiana, New Hampshire and Rhode Island.

                                      -7-
<PAGE>   8
         For security and durability purposes, each of the Company's ITVM
cabinets is manufactured with 16 gauge and 11 gauge steel. The surface of the
ITVM is coated with durable and fade resistant paints. The display windows are
fabricated from a flame resistant, high impact polycarbonate sheet material.
This material is shatter resistant, and to date to the knowledge of the Company,
none of the Company's installed ITVMs has had a polycarbonate window broken or
shattered. Additionally, to the knowledge of the Company, the cabinets have not
had any fading, marring, scratching, chipping or rusting. All of the Company's
ITVMs are manufactured with high security locks which are coded to prevent
unauthorized duplication, and each ITVM is keyed separately, except for ITVMs
deployed in Maryland where the Lottery desired a master key system. For further
security, each of the Company's bill acceptor units must be accessed with a key
unique to the particular acceptor unit.

         All of the Company's ITVMs for scratch-off tickets utilize copyrighted
software that can supply up to eleven different reports for accounting and
inventory purposes. These reports can provide to the lottery and its retailers
or agents a complete summary of daily sales, weekly sales, total sales, sales by
game, current status of the machine, inventory of the product currently in the
ITVM, the last three transactions of the ITVM and other types of information.
The software system allows for a simple diagnostic test to identify any
malfunction of the ITVM. The diagnostic mode communicates various information
such as ticket size setting, status of electronics, status of each game and
other information concerning the system software. The Company's ITVM software
system may be programmed to the detail specifications of the specific lottery.

         In 1995, the Company completed the development of a common electronic
system to be incorporated in all of the Company's equipment, providing
efficiency in development of common software as well as cost efficiencies in
acquiring electronic components.

         To dispense pull-tab instant lottery tickets, the Company's PTVM uses
the same technology, design and specifications as are incorporated in the
Company's PCDM. The Company's PCDM is described in detail below.

         The PCDM
         --------

         Like the Company's ITVM for scratch-off tickets, the key component of
the Company's PCDM is the dispensing technology. The Company has the exclusive
right to the use of this patented dispensing technology, which it acquired from
a company owned by Kazmier J. Kasper, a director of the Company. See "Item 13.
Certain Relationships and Related Transactions."

         Similar to the Company's ITVM for scratch-off tickets, the Company's
PCDM automatically dispenses prepaid telephone calling cards upon payment from
the user. Unlike the products of some of the Company's competitors, the
dispenser technology in the Company's PCDMs automatically pulls one prepaid
telephone calling card from the bottom of the stack of cards without the jamming
that is associated with other dispensing processes. The Company's dispensing
technology, which the Company believes to be the most technologically advanced
dispensing system in the PCDM industry, also enables the Company's PCDM to
dispense and account for virtually any known thickness of calling card without
the intervention of the retailer. In addition, the PCDM is faster than manual
sales of prepaid telephone calling cards as the PCDM's entire dispensing process
is completed in less than 3 seconds once the selector button has been pushed.

         The Company's PCDMs have the capacity to dispense cards from two to six
different bins. The PCDM can accommodate up to 2,400 cards in the six bin unit
and can dispense all prepaid telephone calling cards in the bin without manual
intervention. When all of the cards in a bin have been dispensed,

                                      -8-
<PAGE>   9
cards easily can be reloaded by an employee of the retailer. The ability of the
Company's PCDM to dispense every card in each bin not only facilitates the card
reloading process but also enhances the accuracy of the inventory and accounting
functions.

         All of the Company's PCDMs accept bills in $1, $2, $5, $10 and $20
denominations and, in some applications, accept foreign currency. The size of
the Company's PCDMs varies from 66 inches tall, 26 inches wide and 19 inches
deep for a 6-bin dispenser unit to 22 inches tall, 14 inches wide and 10 inches
deep for a countertop unit. All models are anchored to the floor or counter,
except that the two bin model may be mounted on an optional pedestal. All models
are UL(R) listed and FCC approved. Each PCDM is standardized with an information
display that provides the user with easy-to-read instructions on how to use the
machine and gives the retailer the ability to read sales reports without
printing the report.

         For security and durability purposes, each of the Company's PCDM
cabinets is manufactured with 16 gauge and 11 gauge steel. The surface of the
ITVM is coated with durable and fade resistant paints. The display windows are
fabricated from a flame resistant, high impact polycarbonate sheet material. To
the knowledge of the Company, the cabinets have not had any fading, marring,
scratching, chipping or rusting. All of the Company's PCDMs are manufactured
with high security locks that are coded to prevent unauthorized duplication, and
each PCDM is keyed separately. For further security, each of the Company's bill
acceptor units must be accessed with a key unique to the particular acceptor
unit.

         All of the Company's PCDMs utilize copyrighted software that can supply
up to nine different reports for accounting and inventory purposes. These
reports can provide retailers a complete summary of daily sales, weekly sales,
total sales, sales by bin, current status of the machine, inventory of the
product currently in the PCDM, the last three transactions of the PCDM and other
types of information. The software system allows for a simple diagnostic test to
identify any malfunction of the PCDM.

MARKETING AND SALES

         ITVMs
         -----

         The Company markets its ITVMs to both domestic and international
lotteries and their licensees or prime contractors. The Company attends lottery
and gaming trade shows, maintains personal contact with lottery officials
through its sales force of five employees and advertises in trade publications
to increase its presence in the lottery industry.

         The focus of the Company's marketing strategy is on the superior
performance and reliability of its ITVMs, as well as continued competitive
pricing. Information developed through actual field use and product field tests
demonstrates that a significant factor in increasing instant ticket sales is the
reliability of the ITVM. Increased maintenance visits impair the ITVM "uptime,"
which in turn reduce ticket sales. The Company believes that its ITVMs, based on
actual field performance and product testing, are the most reliable and
technologically superior in the industry. Management believes that actual field
demonstrations comparing the Company's ITVM with those of its competitors is the
Company's best method of marketing. The Company has been awarded contracts to
provide ITVMs for nine of the last ten state lotteries that have requested bid
proposals and was the recipient of all domestic ITVM contracts that were awarded
in 1995 and four of the five domestic ITVM contracts that were awarded in 1996.
The Company currently is participating or preparing to participate in 16 tests
with domestic or international lotteries.

         The Company's ITVMs require preventive maintenance only twice a year.
The ITVM "downtime" resulting from this semi-annual preventive maintenance
averages approximately 20 minutes. On the other hand, the Company's principal
competitor, On-Point Technology Systems, Inc. ("On-Point"), for example,
recommends that preventive maintenance be performed on its ITVMs once a month.
All of the Company's

                                      -9-
<PAGE>   10
existing contracts which require the Company to provide preventive maintenance
on its ITVMs provide for semi-annual preventive maintenance except for the
Company's contract with the Ohio Lottery, which, at the request of the Ohio
Lottery, provides for quarterly preventive maintenance. In each case, the
Company is required to provide less preventive maintenance on its ITVMs than
On-Point provides on its ITVMs.

         To further increase the likelihood of receiving ITVM orders from
lotteries, the Company intends to offer additional and more flexible financing
alternatives to the lotteries. The Company believes that many state lotteries,
due to budget considerations, cannot afford the high capital costs required to
purchase ITVMs. However, if the Company can provide attractive variations of its
standard and percentage lease financing options for the lotteries, the lotteries
can more affordably deploy ITVMs. The Company believes that these types of
financing alternatives will prove to be increasingly popular.

         The Company's ability to generate additional revenues and earnings from
deployments of its ITVMs will depend upon continued market acceptance of ITVMs.
The Company intends to expand its marketing presence with the retail grocers
associations, convenience store operators associations, retail stores at both
the corporate and store levels, and other types of corporate or association
member entities to familiarize these groups with the Company's ITVM. These
retailers are the lotteries' distribution system for all scratch-off and
pull-tab lottery tickets, and management believes that increased exposure to
lottery retailers will be a significant factor in the Company's ability to
expand the market for its lottery products. As the distribution system for all
lottery products, lottery retailers may advise the lotteries with regard to such
matters as new lottery products, improved marketing strategy and improved
product distribution. In many lottery jurisdictions, retailer advisory boards
provide input to the lotteries on various issues affecting the lottery. While
the lotteries must abide by the established procurement laws of their respective
jurisdictions in selecting an ITVM manufacturer, the lotteries may solicit the
opinions of the lottery retailers concerning the ITVMs under consideration by
the lottery because the retailers are directly affected by the selection
decision. The Company believes that retailers' opinions may be a significant
factor in a customer's decision regarding which manufacturer's ITVM to deploy in
its instant ticket distribution system.

         The Company believes it is the only company in the industry to use a
selected group of retailers as a Retailers Advisory Board. This group, which
consists of 15 retailers throughout Ohio that utilize the Company's ITVM, meets
at various times to provide their opinions to the Company on matters such as new
products, improved service techniques, player analysis, lottery trends, expanded
merchandising opportunities and any other items that the Advisory Board or the
Company believes to be important to the success of the product. Actions
resulting from the opinions of Advisory Board members then can be implemented
with respect to all jurisdictions.

         The Company will continue to participate in cooperative service
arrangements with other lottery suppliers as the lotteries increasingly rely on
these types of arrangements. These arrangements allow lotteries to reduce their
operating costs while increasing lottery revenues. Additionally, these
arrangements allow for a more efficient means for contracting products and
services. The Company's ITVMs are deployed in Georgia and West Virginia pursuant
to cooperative service arrangements between the Company and Scientific Games,
Inc., which is a primary contractor for the Georgia and West Virginia Lotteries,
and will be deployed in New Jersey pursuant to a purchase agreement between the
Company and GTECH Corporation, which is the on-line supplier to the New Jersey
Lottery. Under these arrangements, the Company supplies ITVMs to Scientific
Games, Inc. for use in Georgia and West Virginia and will supply ITVMs to GTECH
Corporation for use in New Jersey. The Company is responsible for installing,
servicing and maintaining the ITVMs in Georgia but is not required to provide
preventive maintenance or servicing for the ITVMs supplied for use in West
Virginia and New Jersey. Management believes that the deployment of the
Company's ITVMs in Georgia, West Virginia and New Jersey resulted in part from
the Company's cooperative service arrangements with Scientific Games, Inc. and
GTECH Corporation and

                                      -10-
<PAGE>   11
that such cooperative service arrangements will prove to be increasingly
attractive to both domestic and international lotteries in the future.

         PCDMs
         -----
         The Company has been marketing its PCDMs since late 1995 and to date
has employed a marketing strategy that is similar to the strategy that it has
used successfully to market its ITVMs. The focus of the Company's marketing
strategy is on the superior performance and reliability of its PCDMs as well as
on competitive pricing. The Company markets its PCDMs to both domestic and
international providers of long distance telephone service. The Company attends
telecommunications trade shows, maintains personal contact with
telecommunications companies through its sales force of two employees and
advertises in trade publications to increase its presence in the
telecommunications industry.

         The Company's ability to generate additional revenues and earnings from
the deployment of its PCDMs will depend upon continued market acceptance of
PCDMs. The Company intends to expand its marketing presence with the retail
grocers associations, convenience store operators associations, retail stores at
both the corporate and store levels, and other types of corporate or association
member entities to familiarize these groups with the Company's PCDM. These
retailers are the distribution system for prepaid telephone calling cards, and
management believes that increased exposure to PCDM retailers will be a
significant factor in the Company's ability to expand the market for its PCDM
products. To further increase the likelihood of receiving PCDM orders from
sellers of prepaid telephone calling cards, the Company intends to offer
additional and more flexible financing alternatives.

CONTRACTS

         ITVMs
         -----
         General. The Company's lottery contracts typically are entered into
following a competitive bidding process. Once a lottery has determined to
utilize ITVMs in its distribution network, the lottery usually will request
proposals from ITVM providers. Lotteries within the United States typically
follow a procedure whereby the lottery issues a Request for Proposal ("RFP") to
determine the contract award for installation of ITVMs. The RFP generally seeks
information concerning each company's products, cost of the products or services
to be provided, quality of management, experience in the industry and other
factors that the lottery may deem material to a contract award. The RFP also may
specify product criteria and other qualifications or conditions that must be
satisfied, such as UL(R) listing and FCC approval of the ITVM and in-state or
minority supplier requirements. Generally, an evaluation committee comprised of
key lottery staff members appraise the proposals based on an established point
system, and the contract is awarded to the company with the most points.

         The nature of the RFP process varies from jurisdiction to jurisdiction.
The length of time that a lottery might take to award a contract can be
difficult to predict, and delays in the contract award process are frequent and
unpredictable. Additionally, the point system or the weighing of the various
points varies from jurisdiction to jurisdiction, which often makes it difficult
for the bidding companies to determine the relative importance of the various
factors to be considered by the evaluation committee. In certain cases the
contract award is challenged by the losing bidder, which can result in
protracted legal proceedings for all parties.

         The Company offers lotteries a choice of three types of contracts: (i)
Standard Lease Agreements; (ii) Sales Agreements; and (iii) Percentage Lease
Agreements. ITVM lease revenues as a percentage of the Company's total revenues
were 95.4%, 47.3% and 63.3% in 1994, 1995 and 1996, respectively.

                                      -11-
<PAGE>   12
         The Standard Lease Agreements provide that the lottery will pay a fixed
monthly price per machine for a specific period of time. These agreements
typically specify a number of years for the initial contract term with
additional option periods at the election of the lottery. The lottery may award
a separate service contract for the maintenance of the machines, incorporate the
cost of service into the established monthly lease price or perform machine
service themselves. The lotteries also may select a similar type of arrangement
as described above to procure the necessary supply of replacement parts for the
ITVMs.

         As noted above, the lease payments provided for in the typical Standard
Lease Agreement are fixed in most cases during the term of the agreement, and
these agreements typically permit the lottery to order additional ITVMs at any
time during the lease term. If the lottery orders a significant number of ITVMs
near the end of the lease term, the Company would have to incur significant
manufacturing costs but may receive lease payments for only a relatively short
period of time through the remainder of the lease term. However, the Company
believes that it is more likely that the lottery would elect to extend the lease
term rather than return the ITVMs after only a short period of use.
Additionally, the Company is unable to pass along to the lottery any increase in
its manufacturing and service costs during the term of the typical Standard
Lease Agreement. In the case of a Standard Lease Agreement which provides for a
short initial term (such as one year) with an option for the lottery to extend
the lease term for additional one-year periods, if the lottery does not extend
the initial lease term, the Company might incur a loss on the manufacture of the
ITVMs leased to the lottery under the initial lease agreement.

         Sales Agreements typically provide that the lottery will buy a certain
number of ITVMs over a specific period of time. Under the Sales Agreement, the
lottery generally pays for the ITVMs when delivered and has complete ownership
of the ITVMs. The lottery usually will contract with a vendor to maintain and
service the ITVMs, although some lotteries provide the maintenance and service
with their own service staffs. The lottery generally will enter into a parts
replacement contract with the vendor for replacement parts.

         Percentage Lease Agreements typically allow the lottery to pay a
minimal base fee per month for a designated number of machines. In addition, the
lottery pays to the ITVM vendor a percentage of the revenues of each machine.
Consequently, any decrease in sales of instant tickets through the Company's
ITVMs leased to a lottery under such an agreement could adversely affect the
Company's revenues under such an agreement. Generally, under a Percentage Lease
Agreement, the vendor is responsible for service, maintenance and parts
replacement. Other Percentage Lease Agreements provide for the lease fee to be
based upon a percentage of the dollar value sold through the ITVM, with a
minimum monthly rental established in the event that sales through an ITVM are
low for any given period.

         All types of the ITVM contracts typically contain stringent
installation, performance and maintenance requirements. Failure to perform the
contract requirements may result in significant liquidated damages or contract
termination. The Company has various contract performance standards to which it
must adhere. The most rigorous of these performance and maintenance standards
are contained in the Company's lease agreement with the Ohio Lottery Commission.
Under that agreement, the Company must provide service support to the retailer
within two hours of the retailer's call, and the ITVM must be repaired within an
additional two hours. The Company also must provide preventive maintenance every
three months for each ITVM. To date, the Company has satisfied all of its
contractual installation, performance and maintenance requirements and therefore
has not had any contracts terminated by any lotteries.

         The Company's lottery contracts also typically require the Company to
indemnify the lottery, its officers and retailers for any liabilities arising
from the operation of the ITVMs or any services provided by the Company. The
Company typically is required to obtain liability insurance, fidelity insurance
and performance and litigation bonds to protect itself and the lottery from
potential liability. No such indemnification or insurance claims have ever been
asserted against the Company.

                                      -12-
<PAGE>   13
         The Company's contracts generally have an initial term of one to five
years with options to extend the duration of the contracts for periods of
between one and five years. The option extensions generally are at the lottery's
discretion and are exercised under the same terms and conditions as the original
contract. As of December 31, 1996, the initial term of five of the Company's
contracts had expired, and in each case, the lottery exercised its option to
extend the term. The Company's contracts with lotteries, like most other types
of state contracts, typically permit a lottery to terminate the contract upon 30
days written notice for any reason. Upon termination of a lease contract, the
lottery would return the leased equipment to the Company. It is uncertain,
however, whether the Company would be able to re-lease or sell any ITVMs that
may be returned to the Company following the expiration or cancellation of a
lease. To date, no lottery has terminated its contract with the Company. Upon
termination of a contract, the lottery may award new contracts through a
competitive bid process.

         As noted above, the Company believes that 26 states and the District of
Columbia utilize ITVMs in some manner as part of their instant ticket
distribution system. The Company's ITVMs have been deployed in 16 of those
states as well as 3 foreign jurisdictions, and 8 additional states and 8 foreign
jurisdictions currently are testing the Company's ITVMs or have requested that
the Company provide ITVMs for testing. Set forth below is certain information
regarding the Company's contract status and the number of Company ITVMs sold or
leased in each of these jurisdictions as of December 31, 1996. All of the
Company's existing contracts, except for the contract with the Maryland Lottery,
have provisions that allow the lotteries to order additional ITVMs in the
future.









<TABLE>
<CAPTION>
                                                                        TYPE OF                NO. OF ITVMS
STATE                      STATUS OF CONTRACT AWARD                     CONTRACT               SOLD OR LEASED
-----                      ------------------------                     --------               --------------
<S>                        <C>                                          <C>                        <C>
Arizona                    Awarded in October 1993;                     Standard Lease/            222
                           renewed through December 1997,               Maintenance
                           with a one-year renewal
                           option by the lottery

Colorado                   Awarded in June 1996; expires                Standard Lease/            306
                           in June 1998, with two one-year              Maintenance
                           renewal options by the lottery

Georgia (1)                Awarded in May 1993;                         Standard Lease/            502
                           expires in May 1998,                         Maintenance
                           with a subsequent five-
                           year renewal option by the
                           lottery

Idaho                      Purchases made by purchase                   Sales                      155
                           order in May and August 1995
                           and in August 1996

Indiana                    Awarded in July 1995;                        Standard Lease             569
                           expires in October 1997, with
                           two one-year renewal options
                           by the lottery; first renewal
                           option has been exercised
</TABLE>

                                      -13-
<PAGE>   14
<TABLE>
<S>                        <C>                                          <C>                     <C>
Iowa                       Awarded in August 1994;                      Standard Lease/            531
                           expires in December 1998,                    Maintenance
                           with two one-year renewal
                           options by the lottery

Kentucky                   Awarded in June 1991;                        Sales                      912
                           expires in June 1997,
                           with three subsequent
                           one-year extensions
                           at lottery's option

Maine                      Awarded in July 1995; expires                Standard Lease/            200
                           in July 1998, with two one-year              Maintenance
                           extensions at the
                           lottery's option

Maryland                   Awarded in September 1993;                   Sales/Maintenance          301
                           expires in September 1998

Minnesota                  Awarded in December 1996;                    Standard Lease/            -0-
                           expires three years from                     Maintenance
                           acceptance of each ITVM, with
                           two one-year renewal options
                           by the lottery

New Hampshire              Awarded in August 1994;                      Standard Lease             250
                           expires in June 1997, with
                           one three-year renewal option
                           as mutually agreed

New Jersey (2)             Purchase order received in                   Sales                      -0-
                           December 1996


New York (3)               Awards of purchase contracts                 Sales/                   2,491
                           made in May 1992 and January                 Maintenance/
                           January 1993; deployment                     Standard Lease
                           completed in June 1992 and
                           February 1993, respectively;
                           initial one-year purchase and
                           three-year maintenance contract
                           entered  into in March 1995, with
                           a one-year renewal option by the
                           lottery; initial five-year lease
                           contract awarded in January
                           1997 for up to 1,000 units,
                           with two one-year renewal options

Ohio                       Awarded in January                           Standard Lease/          2,100
                           1992; extended in June 1993 and              Maintenance
                           June 1995; expires in June 1997
</TABLE>

                                      -14-
<PAGE>   15
<TABLE>
<S>                        <C>                                          <C>                     <C>
Oregon                     Purchase order issued in May 1995            Sales                      500

Rhode Island (4)           Awarded in June 1994;                        Standard Lease/            170
                           renewed through June 1997,                   Maintenance
                           with two one-year renewal options
                           by the lottery

Texas                      Awarded in January 1995;                     Standard Lease/          1,221
                           renewed through February                     Maintenance
                           1998, with a one-year renewal
                           option by the lottery

West Virginia (3)          Awarded in May 1992;                         Sales                       55
                           initial deployment completed in
                           June 1992; additional units
                           deployed in April 1994

Western                    Australia Purchase order received in         Sales                        8
                           May 1995.

Brazil                     Purchase order received in                   Sales                        4
                           October 1996

Barcelona, Spain (5)       Awarded in February 1994;                    Standard Lease              11
                           additional units deployed in
                           October 1995

         Total Sold or Leased                                                                   10,523
</TABLE>

--------------------

(1)      The Company's contract is for the lease of ITVMs to Scientific Games,
         Inc., the primary contractor for the Georgia Lottery. In September
         1994, the Company and Scientific Games, Inc. agreed to convert the
         contract from a Percentage Lease Agreement to a Standard Lease
         Agreement. The Georgia Lottery is currently testing the Company's PTVM.

(2)      The Company's contract is for the sale of 200 ITVMs to GTECH
         Corporation for use by the New Jersey Lottery.

(3)      The Company's contract was for the sale of ITVMs to Scientific Games,
         Inc. for use by the New York and West Virginia Lotteries. The Company
         is not the sole manufacturer of ITVMs for the New York Lottery. The
         Company entered into a sales/maintenance contract in March 1995
         directly with the New York Lottery, including maintenance of ITVMs
         previously provided. The West Virginia Lottery also currently is
         conducting field tests on the Company's PTVM.

(4)      Effective October 1, 1995, the Company and the Rhode Island Lottery
         agreed to convert the contract from a Percentage Lease Agreement to a
         Standard Lease Agreement.

(5)      The Company's contract is with Entitat Autonomas, which provides
         lottery services to various Spanish lotteries.

                                      -15-
<PAGE>   16
                                 --------------

         Information regarding field testing of the Company's ITVMs is set forth
in the table below.

<TABLE>
<CAPTION>
STATE/                                                                  NO. OF ITVMS
JURISDICTION                                                              TESTING
------------                                                            ------------
<S>                                                                       <C>
Georgia ...................................................                   10

Iowa ......................................................                    1

Kansas ....................................................                    1

Kentucky (1) ..............................................                    1

Louisiana .................................................                    1

Missouri ..................................................                    1

New York ..................................................                    2

West Virginia .............................................                    7

Total Under Field Tests ...................................                   40
                                                                          ------

     Total ................................................               10,563
</TABLE>

----------------------

(1)      The Kentucky Lottery Corporation is conducting tests on the Company's
         combination ITVM/PTVM.

                                 --------------

         Substantially all of the Company's revenues are derived from its
contracts with a limited number of state lottery authorities or their
representatives for the lease, sale or service of ITVMs. During 1994 and 1995,
contracts with the Ohio Lottery, the New York Lottery and Scientific Games, Inc.
(the primary contractor for the Georgia Lottery) accounted for 83.3% and 72.9%,
respectively, of the Company's revenues, and during 1996, contracts with the New
York Lottery, the Ohio Lottery and the Texas Lottery accounted for 67.6% of the
Company's revenues. The loss of any of these contracts would have a material
adverse impact on the Company's financial condition, business operations and
prospects.

         PCDMs
         -----
         Unlike the competitive bidding process applicable to the lotteries'
awards of ITVM contracts, purchasers of PCDMs typically do not issue RFPs or
otherwise mandate a competitive bidding process. Information regarding the
Company and its PCDM, and information regarding a telephone company's product
needs and criteria and other qualifications or conditions that must be
satisfied, typically is exchanged on a less formal basis in sales presentations
and subsequent meetings between representatives of the Company and
representatives of the telephone company. Due to the often complex and highly
structured organization of some telephone companies, the length of time that a
company might take to

                                      -16-
<PAGE>   17
decide whether to select the Company's PCDM can be difficult to predict and,
similar to the lotteries' contract award process, delays in PCDM selection
decisions can be frequent and unpredictable.

         Unlike the Company's experience in the ITVM industry in which a lottery
typically enters into a lease or sales contract with the successful bidder, most
purchasers of the Company's PCDMs to date have ordered PCDMs solely through
purchase orders rather than contracts, although two customers entered into a
lease agreement for PCDMs. Like contracts with the lotteries, however, these
purchase orders may contain stringent installation, performance and service
requirements. As of December 31, 1996, the Company had sold 300 PCDMs to 30
customers and had 18 PCDMs under lease to 6 customers.

MANUFACTURING PROCESS

         The manufacturing process consists of purchasing component parts,
assembling the ITVMs and PCDMs and then testing the final products. Generally,
the Company's machines use components which are built to Company specifications
and are available from multiple sources. The Company has a strict policy of
product procurement that emphasizes quality, satisfactory inventory of raw
materials, and cost. The Company has a primary vendor and secondary suppliers
for most of its components, and the Company typically has been able to obtain
adequate supplies of required components on a timely basis from its suppliers
or, when necessary, from alternative sources of supply. However, certain
important components, such as components of the Company's ITVM burster and PCDM
dispensing mechanisms and its bill acceptor mechanism, currently are purchased
from a single source. The purchase of components from single-source suppliers
subjects the Company to certain risks, including the continued availability of
suppliers, price increases, potential quality assurance problems and lead time
considerations. Because other suppliers exist that can duplicate these
components should the Company elect or be forced to use a different supplier,
the Company does not believe that any such change in suppliers would result in
the termination of a production contract. However, the Company could experience
a delay of 30 to 60 days in the production of machines should it elect or be
forced to use other suppliers for these components. Such a delay adversely could
affect the Company's ability to make timely deliveries of machines and to obtain
new contracts. The single-source supplier of certain components of the Company's
burster mechanism, PTVM dispensing mechanism and PCDM dispensing mechanism is
Algonquin Industries, Inc. Kazmier J. Kasper, a director of the Company, is the
President and owner of Algonquin Industries. See "Item 13. Certain Relationships
and Related Transactions."

         The Company assembles the components utilizing a core group of
manufacturing employees and, on an as needed basis, contracting with an
employment agency for appropriately trained manufacturing labor. The use of
temporary, contract manufacturing labor gives the Company the flexibility to
meet the production schedules required by large orders.

         The Company's Quality Control Department has responsibility for
measuring quality levels and overseeing appropriate corrective action in all
areas of the business. This includes supplier performance, in-house
manufacturing and field performance. The Quality Control Department is
responsible for measuring part, operator and assembly quality performance at all
stages of the production process, stopping the assembly line or stopping
shipments if necessary to assure that quality standards are met. The Quality
Control Department also is responsible for measuring vendor product quality and
taking appropriate actions, including rejection and disposition of substandard
material. The Quality Control Department also is responsible for vendor quality
system evaluation and vendor disqualification if necessary to ensure superior
product quality.

         The Company's manufacturing facility is located in Cincinnati, Ohio and
has the capacity to produce and provide inventory for approximately 250 machines
per week. The Company believes that this facility is suitable and adequate for
its current and anticipated manufacturing needs at the present time.

                                      -17-
<PAGE>   18
RESEARCH AND NEW PRODUCT DEVELOPMENT

         Since its inception, the Company has developed many of the
technological advancements used in the ITVM industry. The Company believes that
its ITVM was the first to obtain UL(R) listing and FCC approval. The Company
also believes that it was the first to (i) manufacture and deliver ITVMs under a
lease contract agreement, (ii) offer a "random play" push button selector option
through which the ITVM rather than the player randomly selects the game to be
played and (iii) receive patent protection for the technology used in its ITVM
burster dispensing mechanism.

         The Company currently employs three engineers and two technicians for
research and development but currently subcontracts the majority of its research
and development projects to independent contractors to reduce costs. The
Company's copyrighted software is upgraded continually to meet the different
demands of the various lotteries. In many instances, after an ITVM feature has
been developed for a specific lottery, it is incorporated into the product line
as a standard feature of the machine. The Company retains proprietary rights in
all such developments.

         The Company's ITVM may be purchased with an optional modem
communication system which allows lotteries to gather sales data from each ITVM
on an hourly, daily, weekly or monthly basis, depending on the needs of the
customer. This data includes the daily or weekly sales totals and breakdown of
these totals by game, including the total tickets sold. The Company currently is
developing the software to enable each ITVM equipped with the system to
communicate to the host system automatically if there is a malfunction with the
ITVM, thus greatly enhancing the Company's ability to provide prompt service for
the ITVM. The Company currently is developing the software to enable an ITVM
equipped with the system to communicate with the host computer if a ticket bin
is empty, which allows the lottery to call the retailer or agent and inform them
of the situation. Additionally, by utilizing this system with the optional BETA
BRITE(R) message display, the lottery can change the message display on any or
all of itS ITVMs.

         The Company has incorporated its patented pull-tab lottery ticket
dispensing mechanism into a combination ITVM which also contains the Company's
patented burster mechanism. The Company currently has six combination ITVMs
under lease to the Iowa Lottery. The pull-tab dispensing mechanism also has been
incorporated into the Company's PCDMs, and the Company believes that the ability
of the mechanism to dispense a variety of thicknesses of prepaid telephone
calling cards significantly differentiates the Company's PCDMs from those of its
competitors.

         In an effort to expand its product lines into new markets, the Company
is developing and testing a device which dispenses stored value "smart cards."
This product may be marketed in the future to the financial services industry to
the extent that consumer use of smart cards develops in the future.

         Research and development expenditures were $92,817, $145,310 and
$665,449 for 1994, 1995, and 1996, respectively. The Company expects that its
research and development efforts for the foreseeable future will be conducted by
both Company employees and independent contractors.

CUSTOMER SERVICE AND PRODUCT REPAIR

         Typically, the Company or its subcontractors install and service the
machines purchased or leased by the Company's customers. The Company also
provides maintenance of the ITVMs leased or sold to certain lotteries.
Additionally, the Company provides part replacement, repair and technical
services for various customers that have leased or purchased the Company's ITVMs
and PCDMs. Service is provided to the retailers by the Company's staff of
trained service technicians and dispatchers after a customer's representative
informs the Company of the problem via the Company's toll-free telephone service
line. The


                                      -18-
<PAGE>   19
service dispatcher either resolves the matter over the telephone or immediately
dispatches one of the Company's service technicians to the machine's location.
The modular design and manufacturing standards of the Company's machines enable
the Company to conduct any necessary repairs and maintenance quickly and
efficiently. The Company estimates that meantime for all repairs is less than 15
minutes after the Company's service technician arrives at the machine's
location.

         The most rigorous ITVM maintenance standards are contained in the
Company's lease agreement with the Ohio Lottery. Under that agreement, the
Company must provide support service to the retailer within two hours of the
retailer's call, and the ITVM must be repaired within an additional two hours.
The Company also must provide preventive maintenance every three months for each
ITVM. The Company maintains a staff of twelve service technicians for the Ohio
ITVMs from 8:00 a.m. to 6:00 p.m., six days a week.

         The Company believes, based on actual data collected from various
customers that have installed the Company's ITVMs and PCDMs, that the Company's
machines have experienced substantially fewer mechanical problems and machine
failures than machines currently sold by other industry participants. The
Company also believes that the superior performance of its ITVMs and PCDMs will
assist in the increased acceptance of these products among lotteries and
providers of long distance telephone service.

         The Company generally grants a 360-day repair or replacement warranty
covering all parts and components of its machines. However, the warranty period
may vary depending on the bid specifications. In certain circumstances the
Company may warrant the product for the complete life of the contract. In these
instances the contract generally will be a lease with the Company retaining
ownership of the machine. Provisions for estimated warranty costs are recorded
at the time of sale and are periodically adjusted to reflect actual experience.
See Note 1 of Notes to Financial Statements contained in the Company's 1996
Annual Report, which is filed as Exhibit 13 to this report.

PATENTS, TRADEMARKS AND COPYRIGHTS

         The Company currently has four U.S. patents and one pending patent
application relating to its ITVMs and has filed a disclosure document with the
United States Patent and Trademark Office ("PTO"), all as described below.

         The Company owns by assignment U.S. Patent No. 4,982,337 entitled
"System for Distributing Lottery Tickets." The assignment is recorded at the
PTO. This patent is for the Company's burster technology, which is the key
component of the Company's ITVM. The patent expires no later than December 31,
2007. The Company believes this patent is essential to the Company's business.
Additionally, the Company has developed an improvement to the burster technology
disclosed in this patent and has a patent application pending with the PTO on
this improvement.

         The Company was issued U.S. Patent No. 5,330,185 on July 19, 1994 for
the "Method and Apparatus for Random Play of Lottery Games." This patent expires
no later than March 30, 2013 and has been assigned to the Company, and the
assignment is recorded at the PTO. The technology disclosed in this patent
allows a lottery game user to select a random play button as opposed to
selecting a specific game of a multiple game ITVM. Once the random play button
is pressed, the ITVM selects the game to be played based upon a random number
generation algorithm, thereby adding another element of chance to the lottery
ticket purchase. The Company believes that this patent gives the Company a
competitive advantage over other manufacturers that do not have ITVMs with
similar capabilities. The patent for the random play feature is considered
important but not essential to the Company's business.

                                      -19-
<PAGE>   20
         The Company was issued U.S. Patent No. 5,472,247 on December 5, 1995,
for a "Multi-Point High Security Locking Mechanism for Lottery Machines." This
patent expires no later than July 18, 2014 and has been assigned to the Company,
and the assignment is recorded at the PTO. Because of the threat of break-in and
theft of cash and lottery tickets contained within the ITVMs, the machines must
be secured against unauthorized break-in or theft. The technology disclosed in
this patent is a locking mechanism which provides a number of resistance points,
all of which function to impede the unauthorized opening of a door located on
the chassis of the Company's ITVM. The patent for the multi-point, high security
locking mechanism is considered important but not essential to the Company's
business.

         The Company was issued U.S. Design Patent No. 376,621 on December 17,
1996 for the Company's double-game countertop ITVM. This patent expires no later
than December 17, 2010 and has been assigned to the Company, and the assignment
is recorded at the PTO. The Company believes that this patent is important but
not essential to the Company's business.

         The Company has submitted an Information Disclosure Document to the PTO
for the purpose of identifying technology relating to its "Software Release
Control and Data Security for ITVMs." The technology allows secure remote
transmission of software updates and operations data between the ITVM and the
Company or the respective lottery. The invention also includes a key management
system to control the keys used to encrypt data sent to and decrypt the data
received at the ITVM. The Disclosure Document was filed on April 28, 1993.

         The dispensing technology used in the Company's PTVM and PCDM was
developed by Algonquin Industries, Inc. and is licensed to the Company pursuant
to an exclusive license agreement with Algonquin Industries. Algonquin
Industries has been granted U.S. Patent No. 5,335,822 for this mechanism. Under
the terms of the license agreement, the Company is the sole entity entitled to
use this technology on its ITVMs. See "Item 13. Certain Relationships and
Related Transactions."

         The Company currently uses operating software to perform all functions
required to dispense and account for instant lottery tickets and prepaid
telephone calling cards. This software is a stand-alone program which does not
require any other software to operate. The software is designed to allow updates
to be made quickly and inexpensively. The software was designed by Future
Designs, a subcontractor to the Company, and employees of the Company. Future
Designs has assigned all of its right, title and interest in and to the software
to the Company. The Company intends to continue to develop software using both
employees and subcontractors who agree to assign the copyright to developed
software to the Company.

         The Company has obtained federal registration in the United States of
the following trademarks: INTERLOTT, INTERLOTT and design, and INSTANT SUCCESS.
The Company also has obtained registration of the trademark INTERLOTT in
Benelux, Hungary, Mexico and Spain. The Company does not deem the trademarks to
be critical to the future of its business.

         The Company enforces a policy requiring all of its employees and
subcontractors to execute confidentiality and proprietary rights agreements at
the commencement of their employment or contract for service with the Company.
The agreements generally provide that all inventions or discoveries and all
confidential information developed or made known to the employees or
subcontractors during the term of their employment or contract for service will
be assigned to the Company and will be kept confidential and not disclosed to
third parties.

         There can be no assurance that current or future patents and other
intellectual property rights of the Company will afford meaningful protection of
the Company's competitive position. Furthermore, the Company's competitors may
have filed patent applications for, or have been issued patents relating to,

                                      -20-
<PAGE>   21
products or technologies competitive with or superior to those of the Company.
The scope and validity of others' patents, the extent to which the Company or
its suppliers may be required to obtain licenses thereunder, and the
availability and cost of any such licenses are unknown, and there is no
assurance that the necessary licenses could be obtained on terms or conditions
which would not have a material adverse effect upon the Company. If the
Company's intellectual property rights are violated, the costs of litigation
could be significant and could divert funds that otherwise would have been
available for other purposes. Moreover, litigation concerning the alleged
violation of intellectual property rights is inherently uncertain, and the
claims and counterclaims that might be asserted against the Company, if
successful, could have a material adverse effect upon the Company's financial
condition and business operations.

COMPETITION

         Competition in the markets for the Company's ITVM and PCDM is based on
a number of factors, including technological features, product quality and
reliability, price, compatibility, ease of installation and use, marketing and
distribution capabilities, product delivery time, and service and support. The
Company is aware of four manufacturers of ITVMs and approximately forty
manufacturers of PCDMs in the United States, and competition among these
manufacturers is intense. Of the four ITVM competitors, the Company has the
largest share of the ITVM market in the United States, followed by On-Point and
two smaller manufacturers. The Company is not aware of any published data
regarding market shares in the PCDM industry. The Company believes that of the
forty PCDM competitors, Opal Manufacturing Co. has the largest PCDM market share
in the United States, but there is no clear indication of the market shares of
the remaining companies.

         In addition, the ITVM and PCDM markets are relatively new markets that
have grown rapidly, and additional domestic and foreign manufacturers, some of
which have substantially greater resources and experience than the Company, may
elect to enter these markets. The instant ticket market also may face
competition from other types of lottery and gaming products, including
particularly on-line lottery products. The long distance telephone market
similarly may face competition from other types of communications products,
including facsimile, e-mail and other on-line products.

         The Company believes that its patented dispensing technologies make its
ITVM and PCDM dispensing mechanisms technologically superior to the dispensing
mechanisms of its competitors and that this is a significant competitive
advantage for the Company. The Company also believes that its products have
earned a strong reputation for their performance, reliability and cost
effectiveness. To remain competitive, the Company believes that it will need to
continue to incorporate new technological developments into its existing
products and to develop new products, as well as to maintain a competitive price
for its products. These efforts, together with the Company's continuing sales
and marketing efforts, will be critical to the Company's future success.
Although the Company believes that its current successes, coupled with its
history of continued product enhancement and cost reduction, will enable it to
compete favorably with its competitors, there can be no assurance that the
Company will be able to maintain or improve its competitive position in the ITVM
and PCDM markets.

GOVERNMENT REGULATION

         ITVMs
         -----

         Lotteries are not permitted in the various states and jurisdictions of
the United States unless expressly authorized by legislation in the subject
jurisdiction. Similarly, the commencement of ITVM sales and leasing in new
jurisdictions requires authorizing legislation and implementing regulations at
the state level. The Company cannot predict the nature of the regulatory process
in any jurisdiction that may authorize the purchase and lease of ITVMs in the
future. Any such regulatory process may be burdensome

                                      -21-
<PAGE>   22
to the Company or its key personnel and stockholders and could include
requirements that the Company would be unable to satisfy.

         Currently, 37 states and the District of Columbia have enacted
legislation to allow for the operation of a lottery, and 27 of these
jurisdictions utilize ITVMs in some manner as part of their instant ticket
distribution process. The operation of the lotteries in each of these
jurisdictions is strictly regulated. The formal rules and regulations governing
lotteries vary from jurisdiction to jurisdiction but typically authorize the
lottery, create the governing authority, dictate the prize structure, establish
allocation of revenues, determine the type of games permitted, detail
appropriate marketing structures, specify procedures for selecting vendors and
define the qualifications of lottery personnel. No assurance can be given that
there will not be an adverse change in the lottery laws of any jurisdiction in
which the Company does business. Although the Company believes that it is
unlikely that states which have enacted legislation that expressly authorize the
use of ITVMs will adopt legislation in the foreseeable future that prohibits the
use of ITVMs, there can be no assurance that such legislation will not be
adopted in one or more jurisdictions in the foreseeable future.

         To ensure the integrity of the lottery, state laws provide for
extensive background investigations of each of the lottery's vendors and their
affiliates, subcontractors, officers, directors, employees and principal
stockholders. These investigations generally require detailed disclosure on a
continuous basis with respect to the vendors, affiliates, subcontractors,
officers, directors, employees and principal shareholders and, in the event the
lottery deems any of such persons to be unsuitable, the lottery may require the
termination of such persons. The failure of any such persons associated with the
Company to obtain or retain approval in any jurisdiction could have a material
adverse effect on the Company. Generally, regulatory authorities have broad
discretion when granting such approvals. Although the Company has never been
disqualified from a lottery contract as a result of a failure to obtain any such
approvals, no assurance can be given that such approvals will be obtained or
retained in the future.

         The Federal Gambling Devices Act of 1962 (the "Act") makes it unlawful,
with certain exceptions, for a person or entity to transport any gambling
devices across interstate lines unless that person or entity has first
registered with the United States Department of Justice. Although the Company
believes that it is not required to register under such Act, the Company has
voluntarily registered under the Act and intends to renew its registration
annually. The Act also imposes various record keeping and equipment
identification requirements. Violation of the Act may result in seizure or
forfeiture of equipment, as well as other penalties.

         The Company may retain governmental affairs representatives in various
jurisdictions of the United States to monitor legislation, advise the Company on
contract proposals, and assist with other issues that may affect the Company.
The Company believes it has complied with all applicable state regulatory
provisions relative to disclosure concerning the activities of itself and its
advisors. The Company is not dependent on any such representative for any
material contract.

         International jurisdictions that operate lotteries also impose strict
regulations. International regulations may vary from those in the United States.
Additionally, international regulations frequently impose restrictions on
foreign corporations doing business within the specific jurisdiction. As a
result, the Company may contract with local representation or align itself with
a local partner when pursuing international contracts.

         Laws and regulations of individual states and countries are subject to
change. The failure to comply with such laws and regulations could have an
adverse impact on the operations of the Company.

                                      -22-
<PAGE>   23
         PCDMs
         -----

         The Company is not aware of any federal, state or local regulations
that apply to the manufacture, lease or sale of PCDMs.

BACKLOG

         The Company's backlog of ITVMs committed for production as of December
31, 1996 was approximately $1,097,400, which was equal to the total base lease
payments or sales value for the 294 ITVMs that were committed for production but
had not been shipped to the Colorado, Indiana, New York and Texas Lotteries as
of December 31, 1996. See "Lottery Contracts." At December 31, 1995, the
Company's backlog of ITVMs committed for production was approximately
$2,173,400, which was equal to the total base lease payments or sales value for
the 460 ITVMs that were committed for production but had not been shipped to the
Indiana Lottery and the New York Lottery as of December 31, 1995. It is
anticipated that substantially all of the Company's backlog at December 31, 1996
will be shipped on or before June 30, 1997. The Company had no backlog of PCDMs
committed for production at December 31, 1996.

         The Company has entered into various lease or sales agreements that
permit the lotteries, at their sole option, to lease or purchase up to a total
of 761 additional ITVMs as of December 31, 1996. However, the Company does not
include in backlog ITVMs that may be sold or leased under existing contracts
unless the Company has received a firm order for the ITVMs. Due to the
relatively large size of individual orders, the small number of customers and
the long sales cycle of the lottery industry, management considers backlog to be
an indicator of current activity and not necessarily predictive of future
orders.

EMPLOYEES

         The Company utilizes a work force of full-time employees supported from
time to time by temporary or contract manufacturing and engineering personnel.
As of December 31, 1996, the Company had 93 full-time employees, of which 34
were manufacturing employees, 6 were engineering employees, 43 were service
employees, 1 was a project manager and 13 were executives or senior managers.
Eight of the executives and senior managers were devoted to sales and 5 were
devoted to management and administration. The Company intends to increase sales
and marketing personnel during 1997 through the addition of one employee, to
increase engineering personnel through the addition of one employee and to
increase management and administrative personnel through the addition of two
employees.

         The Company's business requires that it continue to attract and retain
additional personnel with a variety of skills, especially with engineering and
marketing expertise. Significant competition exists for such personnel, and
there can be no assurance that the Company will be able to attract and retain
personnel with the skills and experience needed to achieve and manage growth.

         No Company employees are represented by any union, and the Company
believes that its relations with its employees are good.

ITEM 2.  PROPERTIES
-------------------

         The Company's corporate headquarters, manufacturing, distribution, and
research and development facilities currently are located in a single facility
containing approximately 35,000 square feet of leased space in Cincinnati, Ohio.
The facility is comprised of approximately 5,000 square feet of office space and

                                      -23-
<PAGE>   24
approximately 30,000 square feet of manufacturing space with the capacity to
produce and provide inventory for approximately 250 machines per week. The lease
is for a fixed term through December 31, 1999.

         Effective January 1, 1997, the Company entered into a lease for a
second facility containing approximately 11,750 square feet of space located a
very short distance from the current facility in Cincinnati. The second facility
will serve as the executive office of the Company housing the executive,
administrative, sales, engineering and service personnel, and the current
facility will be used entirely for the manufacturing operations beginning in the
second quarter of 1997. The lease for the second facility also expires on
December 31, 1999. The Company believes that these two facilities are suitable
for and adequate to support its operations for the foreseeable future.

         The Company also leases approximately 1,000 square feet of warehouse
and office space in Alpharetta, Georgia for the purpose of storing and repairing
ITVMs used in connection with the Georgia Lottery. Scientific Games, Inc.
provides this space to the Company at no cost under the terms of the Company's
contract with Scientific Games. The lease is effective for the entire term of
the contract, which has an initial term that expires in May 1998. See "Item 1.
Business -- Contracts -- ITVMs." The Company believes that this facility is
suitable for and adequate to support its operations for the Georgia Lottery.


ITEM 3.  LEGAL PROCEEDINGS
--------------------------

         On May 17, 1994, the Company and its directors were named as defendants
in a lawsuit filed in the United States District Court for the Southern District
of Ohio, Western Division, by First Vista, L.P. ("First Vista") on behalf of
itself and all other persons who purchased Common Stock of the Company in and
subsequent to the Company's initial public offering of Common Stock in April
1994. The Complaint alleged violations of securities laws in connection with the
Company's initial public offering and a subsequent announcement that certain
revenues that had been previously anticipated to be received in the fourth
quarter of 1994 instead would likely be received in early 1995. After the Court
denied the plaintiff's motion for class certification, the parties agreed to
settle the lawsuit for a nominal sum (which is largely payable by the Company's
insurer). The parties anticipate the exchange of final settlement documentation,
and the entry of the final order of dismissal, in the near future.

         In January 1996, the Company filed a lawsuit now pending in the United
States District Court for the Southern District of Ohio against Lottery
Enterprises, Inc. ("LEI," which subsequently changed its name to On-Point
Technology Systems, Inc.) to collect sums that the Company alleges are owed to
it under an Agreement in Principle dated March 23, 1995, relating to the
Company's potential acquisition of LEI by merger (the "Transaction"). The
parties did not consummate the Transaction. The Agreement in Principle required
LEI to reimburse the Company's reasonable out-of-pocket expenses incurred in
connection with the Transaction in the event the parties failed to execute a
definitive merger agreement within 120 days of March 23, 1995, and the primary
reason that the parties did not execute a definitive merger agreement was other
than a breach of the Agreement in Principle by the Company. The Agreement in
Principle also required LEI to pay the Company a "breakup fee" in the event
that, within one year after the termination or abandonment of the Transaction by
LEI, LEI entered into a binding commitment to engage in a recapitalization, debt
issuance or working capital financing other than in the ordinary course of
business, and the primary reason for the termination or abandonment of the
Transaction was other than termination or breach of the Agreement in Principle
by the Company. The Company seeks the reimbursement of approximately $241,000 in
out-of-pocket expenses and a breakup fee of approximately $988,000.

                                      -24-
<PAGE>   25
         LEI denied any liability to the Company and also asserted counterclaims
against the Company seeking unspecified money damages exceeding $500,000. LEI
claims that the Company competed unfairly with LEI and wrongfully interfered
with LEI's business by misrepresenting LEI's financial condition to the
Pennsylvania state lottery agency and by utilizing information about LEI
received during the due diligence conducted in connection with the Transaction.
LEI also claims that it is entitled to recover from the Company unspecified
costs and expenses that it incurred in connection with the Transaction and seeks
a declaration from the Court that it is not obligated to pay the Company a
breakup fee under the Agreement in Principle.

         On February 25, 1997, the Court granted partial summary judgment in the
Company's favor. The Court ruled that LEI is obliged to reimburse approximately
$241,000 in out-of-pocket expenses incurred by the Company in connection with
the Transaction because a definitive merger agreement was not signed within 120
days of March 23, 1995 for a reason other than a breach of the Agreement in
Principle by the Company. The Court also ruled that within one year after the
Transaction was abandoned or terminated, LEI did enter into a recapitalization,
debt issuance or working capital financing other than in the ordinary course of
business. The Court left open the question of whether LEI abandoned or
terminated the Transaction (as opposed to the Company), which will be determined
at trial. LEI has moved for reconsideration of the Court's decision. The Court
has not yet ruled on that motion. The Court also is still considering whether to
grant summary judgment in the Company's favor on LEI's counterclaim for unfair
competition and tortious interference. LEI recently has made the claim that it
will seek damages of approximately $2.5 million on its counterclaim. If the
Court does not grant summary judgment in the Company's favor on LEI's
counterclaim, the question of whether the Company competed unfairly with LEI and
tortiously interfered with its business will be determined at trial.

         The Company is unable to predict the likelihood of success on its
remaining claims or on LEI's counterclaim. The Company is seeking approximately
$988,000 on its claim for the breakup fee but is unable to predict how much, if
any, of any judgment would be collectible. The Company is also unable to predict
whether LEI will prevail on its counterclaim and, if so, the amount of damages
that LEI might recover against the Company. The Company also is unable to
predict the amount of any settlement that might be agreed upon by the parties in
the future or the timing of any such events. However, the Company believes that
LEI's counterclaim is without merit and that the amount of any damages that
ultimately may be awarded to LEI will not have a material adverse effect on the
business, operations or financial condition of the Company.

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

         No matters were submitted by the Company to a vote of its stockholders
during the fourth quarter ended December 31, 1996.

ITEM 4(A).  EXECUTIVE OFFICERS OF THE REGISTRANT
------------------------------------------------

         Set forth below, in accordance with General Instruction G(3) to Form
10-K and Instruction 3 to Item 401(b) of Regulation S-K, is certain information
regarding the executive officers of the Company.

         L. ROGERS WELLS, JR., age 59, is Chairman of the Board and Chief
Executive Officer of the Company and has been the principal stockholder of the
Company since purchasing 80% of the Common Stock of the Company in September
1992. Mr. Wells served as a director of the Company from September 1992, and as
Chairman of the Board and Chief Executive Officer of the Company from October
1993, until his resignation from these positions in October 1994. He was
re-elected to these positions in February

                                      -25-
<PAGE>   26
1995. Additionally, Mr. Wells owns American Materials, Incorporated, which
assembles and distributes automobile and truck components and serves as a
regional warehousing and distribution center for various businesses. Mr. Wells
also owns International Investments, Inc. ("III"), which invests in and provides
financing to various businesses, including the Company. See "Item 13. Certain
Relationships and Related Transactions." Mr. Wells has been active in various
other industries, including manufacturing, mining, explosives and banking. From
1987 through 1991, Mr. Wells served as Secretary of Finance and Administration
for the Commonwealth of Kentucky, and from 1989 through 1991 served as Secretary
to the Governor's Executive Cabinet. During his tenure as Secretary of Finance
and Administration, Mr. Wells served as Chairman of various finance and
development authorities, including the Kentucky Rural Economic Development
Authority, the Kentucky Infrastructure Authority and the Kentucky Housing
Corporation.

         EDMUND F. TUREK, age 70, has served as President and a director of the
Company since February 1990 and served as Chairman of the Board and Chief
Executive Officer of the Company from February 1990 to September 1992. Mr. Turek
began to develop the Company's ITVM in 1987 and has guided the product through
six generations to the current model. Mr. Turek was Vice President of Peripheral
Products in the computer division of SCI Systems, Inc. from 1984 to 1989 where
he developed business opportunities in the commercial market for the design and
manufacture of computer products. From 1953 to 1984, Mr. Turek held management,
product development and operations positions with various companies in the
computer and aerospace industries.

         DAVID F. NICHOLS, age 35, has been Senior Vice President of Sales and
Marketing of the Company since August 1994 and was Vice President-Operations of
the Company from March 1993 until August 1994. From December 1991 to December
1992, he was Executive Director of the Board of Tax Appeals of the Commonwealth
of Kentucky. From March 1990 to December 1991, he was Principal Assistant to the
Secretary of Finance and Administration for the Commonwealth of Kentucky, and
from March 1989 to March 1990, he was Principal Assistant to the Kentucky Office
for Social Security. In these two capacities, he advised senior agency officials
on policies, programs and operations of the agency and served as a liaison with
the state legislature and other elected officials. From June 1988 to December
1988, he was Deputy Director of the Kentucky Democratic Party.

         H. JEAN MARSHALL, age 51, has been Vice President-Marketing and a
director of the Company since October 1993 and was the Company's Director of
Retailer Relations from 1992 until October 1993. In these capacities, she
primarily is responsible for marketing to the lotteries and vendor support
services for the Company. Ms. Marshall served from 1983 to 1987 as Regional
Manager and then as Regional Coordinator of the Ohio Lottery Commission. From
1987 to 1989 she was an Account Manager for British American Bank Note Company,
a Canadian manufacturer of instant lottery tickets, and in this position had
substantial involvement with the Pennsylvania and New Jersey Lotteries. In 1989,
Ms. Marshall served as a consultant for the Ohio Department of Rehabilitation
and Corrections, Bureau of Community Services. Ms. Marshall returned to the Ohio
Lottery in 1990 as Deputy Director of Sales, where she was responsible for the
development of retailer policies and procedures and coordinating, directing and
managing the sales division. Ms. Marshall currently serves as Vice President of
the Board of Trustees of the Cincinnati Arts Consortium and as a director of the
Cincinnati Minority Business Development Center.

         JEROME J. CAIN, age 52, has been Chief Financial Officer of the Company
since 1992. From 1979 until 1991, he was Vice President-Finance and
Administration of American Sign and Marketing Services, Inc., a sign
manufacturing company. From 1972 to 1979, he was Controller of Lockwood
Manufacturing Company, a sheet metal fabricating company. Mr. Cain also served
as an auditor and management consultant with Coopers & Lybrand, certified public
accountants. Mr. Cain is a certified public accountant.

                                      -26-
<PAGE>   27
         The executive officers of the Company are appointed by and serve at the
discretion of the Board of Directors.

                                     PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
--------------------------------------------------------------------------------

         Information relating to the market for holders of and dividends paid on
the Company's Common Stock is set forth under the caption "Corporate Data and
Shareholder Information" on the inside back cover page of the Company's 1996
Annual Report. Such information is incorporated herein by reference. The 1996
Annual Report is filed as Exhibit 13 to this report.


ITEM 6. SELECTED FINANCIAL DATA
-------------------------------

         Selected financial data for the Company for each year of the five-year
period ended December 31, 1996 are set forth under the caption "Selected
Financial Data" on page 6 of the 1996 Annual Report. Such financial data are
incorporated herein by reference.


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

         A discussion of the financial condition and results of operations of
the Company at and for the dates and periods covered by the financial statements
set forth in the 1996 Annual Report is set forth under the caption "Management's
Discussion and Analysis " on pages 6 through 9 of the 1996 Annual Report. Such
discussion is incorporated herein by reference.


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
---------------------------------------------------

         The following financial statements of the Company and the independent
auditors' report thereon, which are set forth beginning on pages 9 through 16 of
the 1996 Annual Report, are incorporated herein by reference:

         Balance Sheets at December 31, 1995 and 1996

         Statements of Operations for each of the years in the three-year period
         ended December 31, 1996

         Statements of Stockholders' Equity (Deficit) for each of the years in
         the three-year period ended December 31, 1996

         Statements of Cash Flows for each of the years in the three-year period
         ended December 31, 1996

         Notes to Financial Statements

         The Company is not required to provide the supplementary financial
information specified by Item 302 of Regulation S-K.

                                      -27-
<PAGE>   28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
-----------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
         Within the two-year period ended December 31, 1996 and subsequently,
the Company had no change in independent accountants or disagreements with
independent accountants on accounting and financial disclosure.


                                    PART III
                                    --------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
-----------------------------------------------------------
         Information relating to the directors of the Company is set forth under
the captions "Proposal 2 -- Election of Directors -- Nominees" and "Proposal 2
-- Election of Directors -- Information Regarding Nominees and Continuing
Directors" in the Company's Proxy Statement for its 1997 Annual Meeting of
Stockholders to be held on May 8, 1997. Such information is incorporated herein
by reference. Pursuant to Instruction 3 to Item 401(b) of Regulation S-K and
General Instruction G(3) to Form 10-K, information relating to the executive
officers of the Company is set forth in Part I, Item 4(A) of this report under
the caption "Executive Officers of the Registrant." Information regarding
compliance with Section 16(a) of the Securities Exchange Act of 1934, as
amended, by directors and executive officers of the Company and beneficial
owners of more than 10% of the Company's Common Stock is set forth under the
caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy
Statement referred to in this Item 10 above. Such information is incorporated
herein by reference.


ITEM 11. EXECUTIVE COMPENSATION
-------------------------------
         Information relating to executive compensation is set forth under the
captions "Proposal 2 -- Election of Directors -- Director Compensation" and
"Executive Compensation" in the Proxy Statement referred to in Item 10 above.
Such information is incorporated herein by reference.


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
-----------------------------------------------------------------------
         Information regarding ownership of the Company's Common Stock as of
December 31, 1996 by certain persons is set forth under the captions "Voting --
Principal Stockholders" and "Proposal 2 -- Election of Directors -- Information
Regarding Nominees and Continuing Directors" in the Proxy Statement referred to
in Item 10 above. Such information is incorporated herein by reference.


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
-------------------------------------------------------
         Information regarding certain relationships and transactions between
the Company and certain of its affiliates is set forth under the caption
"Certain Transactions" in the Proxy Statement referred to in Item 10 above. Such
information is incorporated herein by reference.

                                      -28-
<PAGE>   29
                                     PART IV
                                     -------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
-------------------------------------------------------------------------
         (a)      Documents Filed as Part of This Report.

                  1.       Financial Statements

                           The following financial statements of the Company and
                           the independent auditors' report thereon are included
                           in the Company's 1996 Annual Report and are
                           incorporated by reference in Item 8 hereof:

                           Balance Sheets at December 31, 1995 and 1996

                           Statements of Operations for each of the years in the
                           three-year period ended December 31, 1996

                           Statements of Stockholders' Equity (Deficit) for each
                           of the years in the three-year period ended December
                           31, 1996

                           Statements of Cash Flows for each of the years in the
                           three-year period ended December 31, 1996

                           Notes to Financial Statements

         2.       Financial Statement Schedules

                           The following financial statement schedule and the
                  independent auditors' report thereon are set forth beginning
                  on page S-1 of this report:

                           Schedule II - Valuation and Qualifying Accounts

                           All other schedules for which provision is made in
                  the applicable accounting regulations of the Securities and
                  Exchange Commission have been omitted because such schedules
                  are not required under the related instructions or are
                  inapplicable or because the information required is included
                  in the financial statements or notes thereto.

         3.       Exhibits

                           The following exhibits are filed with or incorporated
                  by reference in this report. Where such filing is made by
                  incorporation by reference to a previously filed registration
                  statement or report, such registration statement or report is
                  identified in parentheses. The Company will furnish any
                  exhibit upon request to Jerome J. Cain, Chief Financial
                  Officer of the Company, 6665 Creek Road, Cincinnati, Ohio
                  45242. There is a charge of $.50 per page to cover expenses of
                  copying and mailing.

                  3.1      Certificate of Incorporation of the Company, as
                           amended, including Certificate of Designation of
                           Series A Preferred Stock (Exhibit 3.1 to the
                           Company's Registration Statement on Form S-1, No.
                           33-75142).

                                      -29-
<PAGE>   30
                  3.2      Bylaws of the Company (Exhibit 3.2 to the Company's
                           Registration Statement on Form S-1, No. 33-75142).

                  4.1      Promissory Note of the Company dated September 22,
                           1992 to Baumgartner & Brucher Radiology Associates,
                           Inc. Profit Sharing Plan for the benefit of Thomas E.
                           Turek, M.D. (Exhibit 4.2 to the Company's
                           Registration Statement on Form S-1, No. 33-75142).

                  4.2      Promissory Note of the Company dated September 22,
                           1990 to Mr. Thomas Goila (Exhibit 4.3 to the
                           Company's Registration Statement on Form S-1, No.
                           33-75142).

                  4.3      Invoice Financing Corporate Promissory Note dated as
                           of September 13, 1995 to Princeton Capital Finance
                           Company LLC in the principal amount of $10,000,00
                           (Exhibit 4.3 to the Company's Annual Report on Form
                           10-K for the year ended December 31, 1995).

                  4.4      Purchase Order Corporate Promissory Note dated as of
                           September 13, 1995 to Princeton Capital Finance
                           Company LLC in the principal amount of $2,500,000
                           (Exhibit 4.4 to the Company's Annual Report on Form
                           10-K for the year ended December 31, 1995).

                  4.4(a)   Contracts Financing Agreement dated as of September
                           20, 1995 between Princeton Capital Finance Company
                           LLC and the Company (Exhibit 4.4(a) to the Company's
                           Annual Report on Form 10-K for the year ended
                           December 31, 1995).

                  4.4(b)   Corporate Guaranty dated as of September 20, 1995 by
                           the Company in favor of Princeton Capital Finance
                           Company LLC (Exhibit 4.4(b) to the Company's Annual
                           Report on Form 10-K for the year ended December 31,
                           1995).

                  10.5     Assignment of United States Letters Patent from BLM
                           Resources, Inc. to the Company with respect to United
                           States Patent No. 4,982,337, "System for Distributing
                           Lottery Tickets" (Exhibit 10.5 to the Company's
                           Registration Statement on Form S-1, No. 33-75142).

                  10.6     Pull-Tab Manufacturing and License Agreement between
                           Algonquin Industries, Inc., Kazmier Kasper and the
                           Company dated as of January 13, 1994 (Exhibit 10.6 to
                           the Company's Registration Statement on Form S-1, No.
                           33-75142).

                  10.7     Lease Agreement dated January 14, 1991 by and between
                           Gallenstein & Gallenstein and the Company related to
                           the Company's premises located at 6665 Creek Road,
                           Cincinnati, Ohio 45242 (Exhibit 10.7 to the Company's
                           Registration Statement on Form S-1, No. 33-75142).

                  10.7(a)  Addendum dated May 2, 1994 to Lease Agreement dated
                           January 14, 1991 (Exhibit 10.7) by and between
                           Gallenstein & Gallenstein and the Company related to
                           the Company's premises located at 6665 Creek Road,
                           Cincinnati, Ohio 45242 (Exhibit 10.7(a) to the
                           Company's Annual Report on Form 10-K for the year
                           ended December 31, 1994).

                                      -30-
<PAGE>   31
                  10.19    Price Contract (No. KL-91-039) dated June 25, 1991
                           between the Company and the Kentucky Lottery
                           Corporation with respect to the sale of ITVMs to the
                           Kentucky Lottery Corporation (Exhibit 10.17 to the
                           Company's Registration Statement on Form S-1, No.
                           33-75142).

                  10.20    Term Contract dated March 1, 1992, between the
                           Company and the Ohio Lottery Commission with respect
                           to the lease of ITVMs to the Ohio Lottery Commission
                           (Exhibit 10.18 to the Company's Registration
                           Statement on Form S-1, No. 33-75142).

                  10.21    Instant Ticket Vending Machine Agreement dated May
                           12, 1993 between the Company and Scientific Games,
                           Inc. with respect to the ITVMs leased for use in the
                           Georgia Lottery (Exhibit 10.19 to the Company's
                           Registration Statement on Form S-1, No. 33-75142).

                  10.22    Instant Ticket Vending Machines Contract dated
                           September 17, 1993 by and between the Company, the
                           State of Maryland and the Maryland State Lottery
                           Agency with respect to the sale of ITVMs to the
                           Maryland Lottery (Exhibit 10.20 to the Company's
                           Registration Statement on Form S-1, No. 33-75142).

                  10.23    Arizona State Lottery Request for Proposal and
                           Contract No. 93-002 dated December 8, 1993, as
                           amended, between the Company and the Arizona State
                           Lottery with respect to the lease of ITVMs to the
                           Arizona Lottery (Exhibit 10.21 to the Company's
                           Registration Statement on Form S-1, No. 33-75142).

                  10.23(a) Letter dated November 21, 1994 from the Arizona State
                           Lottery to the Company extending Contract No. 93-002
                           by one year with respect to the lease of ITVMs to the
                           Arizona State Lottery (Exhibit 10.23(a) to the
                           Company's Annual Report on Form 10-K for the year
                           ended December 31, 1994).

                  10.23(b) Letter dated November 20, 1995 from the Arizona State
                           Lottery to the Company extending Contract No. 93-002
                           by one year with respect to the lease of ITVMs to the
                           Arizona State Lottery (Exhibit 10.23(b) to the
                           Company's Annual Report on Form 10-K for the year
                           ended December 31, 1995).

                  10.23(c) Letter dated December 3, 1996 from the Arizona State
                           Lottery to the Company extending Contract No. 93-002
                           by one year with respect to the lease of ITVMs to the
                           Arizona State Lottery - filed herewith.

                  10.24    Agreement dated September 12, 1994 between the
                           Company and the Iowa Lottery with respect to the
                           lease of ITVMs to the Iowa Lottery (Exhibit 10.24 to
                           the Company's Annual Report on Form 10-K for the year
                           ended December 31, 1994).

                  10.25    Instant Ticket Vending Machine Lease and Maintenance
                           Agreement dated effective as of July 1, 1994 between
                           the Company and the New Hampshire Sweepstakes
                           Commission with respect to the lease of ITVMs to the
                           New Hampshire Sweepstakes Commission (Exhibit 10.25
                           to the Company's Annual Report on Form 10-K for the
                           year ended December 31, 1994).

                                      -31-
<PAGE>   32
                  10.26    Instant Ticket Vending Machine Agreement dated June
                           24, 1994 between the Company and The Rhode Island
                           Lottery with respect to the lease of ITVMs to The
                           Rhode Island Lottery (Exhibit 10.26 to the Company's
                           Annual Report on Form 10-K for the year ended
                           December 31, 1994).

                  10.27    Contract for Instant Ticket Vending Machines and
                           Services effective as of February 13, 1995 between
                           the Company and the Texas Lottery Commission with
                           respect to the lease of ITVMs to the Texas Lottery
                           (Exhibit 10.27 to the Company's Annual Report on Form
                           10-K for the year ended December 31, 1994).

                  10.28    Purchase Order dated May 10, 1995 from the Idaho
                           Lottery for the purchase of ITVMs (Exhibit 10.28 to
                           the Company's Annual Report on Form 10-K for the year
                           ended December 31, 1995).

                  10.29    Contract for Instant Ticket Vending Machines and
                           Related Services dated October 20, 1995 between the
                           Company and the State Lottery Commission of Indiana
                           with respect to the lease of ITVMs to the State
                           Lottery Commission of Indiana (Exhibit 10.29 to the
                           Company's Annual Report on Form 10-K for the year
                           ended December 31, 1995).

                  10.29(a) Exercise of Option to Extend Contract No. 1 dated
                           October 20, 1995 by the State Lottery Commission of
                           Indiana (Exhibit 10.29(a) to the Company's Annual
                           Report on Form 10-K for the year ended December 31,
                           1995).

                  10.29(b) Supplement to Contract dated August 2, 1996 between
                           the Company and the State Lottery Commission of
                           Indiana to add twelve-game IVTM to contract dated
                           October 20, 1995 - filed herewith.

                  10.30    Contract for Special Services effective as of July
                           11, 1995 between the Company and the Bureau of Liquor
                           and Lottery Operations for the State of Maine with
                           respect to the lease of ITVMs to the Bureau of Liquor
                           and Lottery Operations for the State of Maine
                           (Exhibit 10.30 to the Company's Annual Report on Form
                           10-K for the year ended December 31, 1995).

                  10.31    Purchase Order dated May 12, 1995 from the Oregon
                           State Lottery for the purchase of ITVMs (Exhibit
                           10.31 to the Company's Annual Report on Form 10-K for
                           the year ended December 31, 1995).

                  10.32    Agreement dated December 5, 1994 between the Company
                           and the New York State Division of the Lottery with
                           respect to the purchase of ITVMs by the New York
                           State Division of the Lottery (Exhibit 10.32 to the
                           Company's Annual Report on Form 10-K for the year
                           ended December 31, 1995).

                  10.32(a) Letter dated October 6, 1995 from the New York State
                           Lottery to the Company for the purchase of ITVMs
                           (Exhibit 10.32(a) to the Company's Annual Report on
                           Form 10-K for the year ended December 31, 1995).

                  10.32(b) Letter dated November 30, 1995 from the New York
                           State Lottery to the Company for the purchase of
                           ITVMs (Exhibit 10.32(b) to the Company's Annual
                           Report on Form 10-K for the year ended December 31,
                           1995).
                                     -32-
<PAGE>   33
                  10.32(c) Letter dated February 7, 1996 from the New York State
                           Lottery to the Company for the purchase of ITVMs
                           (Exhibit 10.32(c) to the Company's Annual Report on
                           Form 10-K for the year ended December 31, 1995).

                  10.32(d) Letter dated February 20, 1996 from the New York
                           State Lottery to the Company for the purchase of
                           ITVMs (Exhibit 10.32(d) to the Company's Annual
                           Report on Form 10-K for the year ended December 31,
                           1995).

                  10.32(e) Letter dated February 21, 1996 from the New York
                           State Lottery to the Company amending the order of
                           February 20, 1996 (Exhibit 10.32(e) to the Company's
                           Annual Report on Form 10-K for the year ended
                           December 31, 1995).

                  10.32(f) Purchase Order dated August 2, 1996 from the Idaho
                           Lottery for the purchase of ITVMs - filed herewith.

                  10.33    Contract dated June 13, 1996 between the Company and
                           the State of Colorado for the use and benefit of the
                           Department of Revenue, State Lottery Division with
                           respect to the lease of ITVMs to the State Lottery
                           Division - filed herewith.

                  10.34    Technical Assistance and Sales Agreement dated
                           November 22, 1996 between the Company and Garza
                           Argentina, S.A. with respect to the sale of PCDMs to
                           Garza Argentina, S.A. for use in Argentina - filed
                           herewith.

                  10.35    Agreement for Instant Ticket Vending Machines (ITVMs)
                           dated December 1, 1996 between the Company and the
                           Minnesota State Lottery and related Purchase Order
                           dated December 4, 1996 from the Minnesota State
                           Lottery for the lease of ITVMs - filed herewith.

                  10.36    Purchase Order dated December 4, 1996 from GTECH
                           Corporation for the purchase of ITVMs for use by the
                           New Jersey Lottery - filed herewith.

                  10.37    Agreement for Instant Ticket Vending Machines dated
                           January 7, 1997 between the Company and the Florida
                           Department of the Lottery with respect to the lease
                           of ITVMs to the Florida Department of the Lottery -
                           filed herewith.

                  10.38    Management Contracts and Compensatory Plans

                           (a)      1994 Stock Incentive Plan (Exhibit 10.24 to
                                    the Company's Registration Statement on Form
                                    S-1, No. 33-75142).

                           (b)      1994 Directors Stock Incentive Plan (Exhibit
                                    10.25 to the Company's Registration
                                    Statement on Form S-1, No. 33-75142).

                           (c)      Employment Agreement dated as of April 21,
                                    1994 between L. Rogers Wells, Jr. and the
                                    Company (Exhibit 10.28(c) to the Company's
                                    Annual Report on Form 10-K for the year
                                    ended December 31, 1994).

                                     -33-
<PAGE>   34
                           (d)      Employment Agreement dated as of April 21,
                                    1994 between Edmund F. Turek and the Company
                                    (Exhibit 10.28(d) to the Company's Annual
                                    Report on Form 10-K for the year ended
                                    December 31, 1994).

                           (e)      Compensation Agreement dated as of October
                                    26, 1994 between the Company and W. Whitlow
                                    Wyatt (Exhibit 10.28(f) to the Company's
                                    Annual Report on Form 10-K for the year
                                    ended December 31, 1994).



                  11       Statement Regarding Computation of Per Share Earnings
                           - filed herewith.

                  13       1996 Annual Report - filed herewith.

                  23       Consent of KPMG Peat Marwick LLP - filed herewith.

                  24       Powers of Attorney - filed herewith.

                  27       Financial Data Schedule (for SEC use only).

         (b)      Reports on Form 8-K. No Current Reports on Form 8-K were
                  filed by the Company during the quarter ended December 31,
                  1996.

         (c)      See Item 14(a)(3) above.

         (d)      See Item 14(a)(2) above.

                                     -34-
<PAGE>   35
                                   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, on March 28, 1997.

                           INTERNATIONAL LOTTERY, INC.
                           (REGISTRANT)


                           By: /s/ L. Rogers Wells, Jr.
                              --------------------------------------------------
                              L. Rogers Wells, Jr.
                              Chairman of the Board and Chief 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 indicated on March 28, 1997.

       Signature                              Title


/s/ L. Rogers Wells, Jr.                   Chairman of the Board and Chief
-------------------------------------      Executive Officer
L. Rogers Wells, Jr.

/s/ Edmund F. Turek                        President and Director
-------------------------------------
Edmund F. Turek

/s/ H. Jean Marshall                       Vice President - Marketing and
-------------------------------------      Director
H. Jean Marshall

Gary S. Bell*                              Secretary, Treasurer and Director
-------------------------------------
Gary S. Bell

Kazmier J. Kasper*                         Director
-------------------------------------
Kazmier J. Kasper

John J. Wingfield*                         Director
-------------------------------------
John J. Wingfield

W. Whitlow Wyatt*                          Director
-------------------------------------
W. Whitlow Wyatt

/s/ Jerome J. Cain                         Chief Financial and Accounting
-------------------------------------      Officer
Jerome J. Cain

*By:     /s/ L. Rogers Wells, Jr.
         ----------------------------
         L. Rogers Wells, Jr.
         as attorney-in-fact

                                     -35-

<PAGE>   36






                     INDEX OF FINANCIAL STATEMENT SCHEDULES

<TABLE>
<CAPTION>
                                                                          PAGE
                                                                          ----
<S>                                                                        <C>
Report of Independent Auditors...............................              S-2

Schedule II - Valuation and Qualifying Accounts..............              S-3

</TABLE>



















                                     S-1

<PAGE>   37


                           INTERNATIONAL LOTTERY, INC.

                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
 -------------------------------------------------------------------------------------------------------------
 COLUMN A          COLUMN B                     COLUMN C                      COLUMN D           COLUMN E
 -------------------------------------------------------------------------------------------------------------
                                               ADDITIONS
 -------------------------------------------------------------------------------------------------------------
                   BALANCE AT          CHARGED TO         CHARGED TO                            BALANCE AT
                   BEGINNING           COSTS AND            OTHER                                   END
 DESCRIPTION       OF PERIOD           EXPENSES            ACCOUNTS          DEDUCTIONS          OF PERIOD
 -------------------------------------------------------------------------------------------------------------

 Allowance for
 doubtful accounts
 -------------------------------------------------------------------------------------------------------------
       <S>         <C>                 <C>                   <C>              <C>                 <C>
       1994         21,650              33,500               0                     0               55,150
 -------------------------------------------------------------------------------------------------------------
       1995         55,150             145,000               0                98,537              101,613
 -------------------------------------------------------------------------------------------------------------
       1996        101,613              57,500               0                43,688              115,425
 -------------------------------------------------------------------------------------------------------------
</TABLE>















                                     S-2

<PAGE>   38
                          INDEPENDENT AUDITORS' REPORT
                          ----------------------------


The Board of Directors and Stockholders
International Lottery, Inc.:

Under date of February 21, 1997, we reported on the balance sheets of
International Lottery, Inc. as of December 31, 1995 and 1996, and the related
statements of operations, stockholder's equity (deficit), and cash flows for
each of the years in the three-year period ended December 31, 1996, as contained
in the 1996 annual report to shareholders.  These financial statements and our
report thereon are incorporated by reference in the annual report on Form 10-K
for the year 1996.  In connection with our audits of the aforementioned
financial statements, we also audited the related financial statement schedule
as listed in the accompanying index.  This financial statement schedule is the
responsibility of the Company's management.  Our responsibility is to express an
opinion on this financial statement based on our audits.

In our opinion, such 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.


                                          /s/ KPMG Peat Marwick LLP


Louisville, Kentucky
February 21, 1997

                                     S-3
<PAGE>   39





                           INTERNATIONAL LOTTERY, INC.

                                INDEX OF EXHIBITS
                                -----------------

         The following exhibits are filed with or incorporated by reference in
this report. Where such filing is made by incorporation by reference to a
previously filed registration statement or report, such registration statement
or report is identified in parenthesis.

<TABLE>
<CAPTION>
EXHIBIT NO.                                           DESCRIPTION                      PAGE
-----------                                          -------------                     ----
     <S>                <C>
     3.1                Certificate of Incorporation of the Company, as amended,
                        including Certificate of Designation of Series A Preferred
                        Stock (Exhibit 3.1 to the Company's Registration Statement
                        on Form S-1, No. 33-75142).

     3.2                Bylaws of the Company (Exhibit 3.2 to the Company's
                        Registration Statement on Form S-1, No. 33-75142).

     4.1                Promissory Note of the Company dated September 22, 1992 to
                        Baumgartner & Brucher Radiology Associates, Inc. Profit
                        Sharing Plan for the benefit of Thomas E. Turek, M.D.
                        (Exhibit 4.2 to the Company's Registration Statement on
                        Form S-1, No. 33-75142).

     4.2                Promissory Note of the Company dated September 22, 1990
                        to Mr. Thomas Goila (Exhibit 4.3 to the Company's
                        Registration Statement on Form S-1, No. 33-75142).

     4.3                Invoice Financing Corporate Promissory Note dated as of
                        September 13, 1995 to Princeton Capital Finance Company
                        LLC in the principal amount of $10,000,00 (Exhibit 4.3 to the
                        Company's Annual Report on Form 10-K for the year ended
                        December 31, 1995).

     4.4                Purchase Order Corporate Promissory Note dated as of
                        September 13, 1995 to Princeton Capital Finance Company
                        LLC in the principal amount of $2,500,000 (Exhibit 4.4
                        to the Company's Annual Report on Form 10-K for the year
                        ended December 31, 1995).

     4.4(a)             Contracts Financing Agreement dated as of September 20, 1995
                        between Princeton Capital Finance Company LLC and the
                        Company (Exhibit 4.4(a) to the Company's Annual Report
                        on Form 10-K for the year ended December 31, 1995).

</TABLE>



                                     E-1

<PAGE>   40


<TABLE>
     <S>                <C>
     4.4(b)             Corporate Guaranty dated as of September 20, 1995 by the Company
                        in favor of Princeton Capital Finance Company LLC
                        (Exhibit 4.4(b) to the Company's Annual Report on Form 10-K
                        for the year ended December 31, 1995).

     10.5               Assignment of United States Letters Patent from BLM
                        Resources, Inc. to the Company with respect to United
                        States Patent No. 4,982,337, "System for Distributing
                        Lottery Tickets" (Exhibit 10.5 to the Company's
                        Registration Statement on Form S-1, No. 33-75142).

     10.6               Pull-Tab Manufacturing and License Agreement between
                        Algonquin Industries, Inc., Kazmier Kasper and the Company
                        dated as of January 13, 1994 (Exhibit 10.6 to the Company's
                        Registration Statement on Form S-1, No. 33-75142).

     10.7               Lease Agreement dated January 14, 1991 by and between
                        Gallenstein & Gallenstein and the Company related to the
                        Company's premises located at 6665 Creek Road,
                        Cincinnati, Ohio 45242 (Exhibit 10.7 to the Company's
                        Registration Statement on Form S-1, No. 33-75142).

     10.7(a)            Addendum dated May 2, 1994 to Lease Agreement
                        dated January 14, 1991 (Exhibit 10.7) by and between
                        Gallenstein & Gallenstein and the Company related to the
                        Company's premises located at 6665 Creek Road, Cincinnati,
                        Ohio 45242 (Exhibit 10.7(a) to the Company's Annual Report on
                        Form 10-K for the year ended December 31, 1994).

     10.19              Price Contract (No. KL-91-039) dated June 25, 1991 between
                        the Company and the Kentucky Lottery Corporation with
                        respect to the sale of ITVMs to the Kentucky Lottery
                        Corporation (Exhibit 10.17 to the Company's Registration
                        Statement on Form S-1, No. 33-75142).

     10.20              Term Contract dated March 1, 1992, between the Company
                        and the Ohio Lottery Commission with respect to the
                        lease of ITVMs to the Ohio Lottery Commission (Exhibit
                        10.18 to the Company's Registration Statement on Form
                        S-1, No. 33-75142).

     10.21              Instant Ticket Vending Machine Agreement dated May 12,
                        1993 between the Company and Scientific Games, Inc.
                        with respect to the ITVMs leased for use in the Georgia
                        Lottery (Exhibit 10.19 to the Company's Registration
                        Statement on Form S-1, No. 33-75142).

</TABLE>


                                     E-2


<PAGE>   41


<TABLE>
      <S>               <C>
     10.22              Instant Ticket Vending Machines Contract dated September
                        17, 1993 by and between the Company, the State of
                        Maryland and the Maryland State Lottery Agency with
                        respect to the sale of ITVMs to the Maryland Lottery
                        (Exhibit 10.20 to the Company's Registration Statement
                        on Form S-1, No. 33-75142).

     10.23              Arizona State Lottery Request for Proposal and Contract
                        No. 93-002 dated December 8, 1993, as amended, between
                        the Company and the Arizona State Lottery with respect
                        to the lease of ITVMs to the Arizona Lottery (Exhibit
                        10.21 to the Company's Registration Statement on
                        Form S-1, No. 33-75142).

     10.23(a)           Letter dated November 21, 1994 from the Arizona State
                        Lottery to the Company extending Contract No. 93-002 by
                        one year with respect to the lease of ITVMs to the
                        Arizona State Lottery (Exhibit 10.23(a) to the Company's
                        Annual Report on Form 10-K for the year ended December
                        31, 1994).

     10.23(b)           Letter dated November 20, 1995 from the Arizona State
                        Lottery to the Company extending Contract No. 93-002 by
                        one year with respect to the lease of ITVMs to the
                        Arizona State Lottery (Exhibit 10.23(b) to the Company's
                        Annual Report on Form 10-K for the year ended December
                        31, 1995).

     10.23(c)           Letter dated December 3, 1996 from the Arizona State Lottery to the
                        Company extending Contract No. 93-002 by one year with respect to
                        the lease of ITVMs to the Arizona State Lottery - filed herewith

     10.24              Agreement dated September 12, 1994 between the Company
                        and the Iowa Lottery with respect to the lease of ITVMs
                        to the Iowa Lottery (Exhibit 10.24 to the Company's
                        Annual Report on Form 10-K for the year ended December
                        31, 1994).

     10.25              Instant Ticket Vending Machine Lease and Maintenance
                        Agreement dated effective as of July 1, 1994 between the
                        Company and the New Hampshire Sweepstakes Commission
                        with respect to the lease of ITVMs to the New Hampshire
                        Sweepstakes Commission (Exhibit 10.25 to the Company's
                        Annual Report on Form 10-K for the year ended December
                        31, 1994).

</TABLE>






                                       E-3



<PAGE>   42


<TABLE>
     <S>                <C>
     10.26              Instant Ticket Vending Machine Agreement dated June 24,
                        1994 between the Company and The Rhode Island Lottery
                        with respect to the lease of ITVMs to The Rhode Island
                        Lottery (Exhibit 10.26 to the Company's Annual Report on
                        Form 10-K for the year ended December 31, 1994).

     10.27              Contract for Instant Ticket Vending Machines and Services
                        effective as of February 13, 1995 between the Company and the
                        Texas Lottery Commission with respect to the lease of ITVMs to the
                        Texas Lottery (Exhibit 10.27 to the Company's Annual Report on
                        Form 10-K for the year ended December 31, 1994).

     10.28              Purchase Order dated May 10, 1995 from the Idaho Lottery for the
                        purchase of ITVMs (Exhibit 10.28 to the Company's Annual Report
                        on Form 10-K for the year ended December 31, 1995).

     10.29              Contract for Instant Ticket Vending Machines and Related
                        Services dated October 20, 1995 between the Company and
                        the State Lottery Commission of Indiana with respect to
                        the lease of ITVMs to the State Lottery Commission of
                        Indiana (Exhibit 10.29 to the Company's Annual Report on
                        Form 10-K for the year ended December 31, 1995).

     10.29(a)           Exercise of Option to Extend Contract No. 1 dated October 20, 1995
                        by the State Lottery Commission of Indiana (Exhibit 10.29(a)
                        to the Company's Annual Report on Form 10-K for the year
                        ended December 31, 1995).

     10.29(b)           Supplement to Contract dated August 2, 1996 between the
                        Company and the State Lottery Commission of Indiana to add
                        twelve-game IVTM to contract dated October 20, 1995 - filed herewith

     10.30              Contract for Special Services effective as of July 11,
                        1995 between the Company and the Bureau of Liquor and
                        Lottery Operations for the State of Maine with respect
                        to the lease of ITVMs to the Bureau of Liquor and
                        Lottery Operations for the State of Maine (Exhibit 10.30
                        to the Company's Annual Report on Form 10-K for the year
                        ended December 31, 1995).

     10.31              Purchase Order dated May 12, 1995 from the Oregon State
                        Lottery for the purchase of ITVMs (Exhibit 10.31 to the
                        Company's Annual Report on Form 10-K for the year ended
                        December 31, 1995).
</TABLE>


                                     E-4

<PAGE>   43


<TABLE>
     <S>                <C>
     10.32              Agreement dated December 5, 1994 between the Company and the
                        New York State Division of the Lottery with respect to the purchase of
                        ITVMs by the New York State Division of the Lottery
                        (Exhibit 10.32 to the Company's Annual Report on Form 10-K for
                        the year ended December 31, 1995).

     10.32(a)           Letter dated October 6, 1995 from the New York State Lottery to the
                        Company for the purchase of ITVMs (Exhibit 10.32(a) to the
                        Company's Annual Report on Form 10-K for the year ended
                        December 31, 1995).

     10.32(b)           Letter dated November 30, 1995 from the New York State Lottery to
                        the Company for the purchase of ITVMs (Exhibit 10.32(b) to the
                        Company's Annual Report on Form 10-K for the year ended
                        December 31, 1995).

     10.32(c)           Letter dated February 7, 1996 from the New York State Lottery to the
                        Company for the purchase of ITVMs (Exhibit 10.32(c) to the
                        Company's Annual Report on Form 10-K for the year ended
                        December 31, 1995).

     10.32(d)           Letter dated February 20, 1996 from the New York State Lottery to the
                        Company for the purchase of ITVMs (Exhibit 10.32(d) to the
                        Company's Annual Report on Form 10-K for the year ended
                        December 31, 1995).

     10.32(e)           Letter dated February 21, 1996 from the New York State
                        Lottery to the Company amending the order of February
                        20, 1996 (Exhibit 10.32(e)
                         to the Company's Annual Report on Form 10-K for the
                        year ended December 31, 1995).

     10.32(f)           Purchase Order dated August 2, 1996 from the Idaho Lottery for the
                        purchase of ITVMs - filed herewith.

     10.33              Contract dated June 13, 1996 between the Company and the
                        State of Colorado for the use and benefit of the
                        Department of Revenue, State Lottery Division with
                        respect to the lease of ITVMs to the State Lottery
                        Division - filed herewith.

     10.34              Technical Assistance and Sales Agreement dated November 22,
                        1996 between the Company and Garza Argentina, S.A. with
                        respect to the sale of PCDMs to Garza Argentina, S.A. for use
                        in Argentina - filed herewith.
</TABLE>



                                     E-5

<PAGE>   44


<TABLE>
     <S>                <C>
     10.35              Agreement for Instant Ticket Vending Machines (ITVMs) dated
                        December 1, 1996 between the Company and the Minnesota State
                        Lottery and related Purchase Order dated December 4, 1996
                        from the Minnesota State Lottery for the lease of ITVMs - filed herewith.

     10.36              Purchase Order dated December 4, 1996 from GTECH
                        Corporation for the purchase of ITVMs for use by the New
                        Jersey Lottery - filed herewith.

     10.37              Agreement for Instant Ticket Vending Machines dated
                        January 7, 1997 between the Company and the Florida
                        Department of the Lottery with respect to the lease of
                        ITVMs to the Florida Department of the Lottery - filed
                        herewith.

     10.38              Management Contracts and Compensatory Plans

                        (a)     1994 Stock Incentive Plan (Exhibit 10.24 to
                                the Company's Registration Statement on
                                Form S-1, No. 33-75142).

                        (b)     1994 Directors Stock Incentive Plan (Exhibit
                                10.25 to the Company's Registration Statement
                                on Form S-1, No. 33-75142).

                        (c)     Employment Agreement dated as of April 21, 1994
                                between L. Rogers Wells, Jr. and the Company
                                (Exhibit 10.28(c) to the Company's Annual Report
                                on Form 10-K for the year ended December 31, 1994).

                        (d)     Employment Agreement dated as of April 21, 1994
                                between Edmund F. Turek and the Company (Exhibit
                                10.28(d) to the Company's Annual Report on Form
                                10-K for the year ended December 31, 1994).

                        (e)     Employment Agreement dated October 3, 1994
                                between Joseph T. Brittain and the Company
                                (Exhibit 10.28(e) to the Company's Annual Report
                                on Form 10-K for the year ended December 31,
                                1994).

                        (f)     Compensation Agreement dated as of October 26,
                                1994 between the Company and W. Whitlow Wyatt
                                (Exhibit 10.28(f) to the Company's Annual Report
                                on Form 10-K for the year ended December 31,
                                1994).

     11                 Statement Regarding Computation of Per Share Earnings - filed herewith.

     13                 1996 Annual Report - filed herewith.

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<PAGE>   45



<TABLE>
     <S>                <C>
     23                 Consent of KPMG Peat Marwick LLP - filed herewith.

     24                 Powers of Attorney - filed herewith.

     27                 Financial Data Schedule (for SEC use only).
</TABLE>


















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