<PAGE>   1
                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-KSB
                                 --------------
(Mark One)

[X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
         EXCHANGE ACT OF 1934 (Fee required)

For the fiscal year ended October 31, 1996

[  ]     TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES 
         EXCHANGE ACT OF 1934 (No fee required)

For the transition period from ______ to _______

                           Commission File No. 0-25668

                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.
                 (Name of Small Business Issuer in Its Charter)


                DELAWARE                             11-319748
     (State or Other Jurisdiction of             (I.R.S. Employer
     Incorporation or Organization)           Identification Number)

                             4041 N. CENTRAL AVENUE
                             PHOENIX, ARIZONA 85012
                    (Address of Principal Executive Offices)

                                 (602) 200-8900
                (Issuer's Telephone Number, Including Area Code)


         Securities registered under Section 12(b) of the Exchange Act:  None.

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

<TABLE>
<CAPTION>
                           Title of Each Class                Name of Each Exchange on Which Registered
                           -------------------                -----------------------------------------

<S>      <C>                                                                    <C>
         Class A Common Stock, $0.01 par value per share                        Nasdaq SmallCap Market

         Redeemable Class B Warrants                                            Nasdaq SmallCap Market
</TABLE>


         Check whether the Issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.

                                    Yes X                     No__

         Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B is not contained in this form, and no disclosure will
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-KSB
or any amendment to this Form 10-KSB. /X/

         The Issuer's revenues for the fiscal year ended October 31, 1996 were
$2,985,402.

         The aggregate market value of the voting stock held by non-affiliates
of the Registrant on January 17, 1997 was approximately $174,000,000, based on
the closing sales price of the Class A Common Stock on such date as reported by
the Nasdaq SmallCap Market.

         The number of shares outstanding of each of the Issuer's classes of
common equity, as of January 17, 1997 was: 17,962,488 shares of Class A Common
Stock, $0.01 par value, and 3,960,000 shares of Class B Common Stock, $0.01 par
value.

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

                       DOCUMENTS INCORPORATED BY REFERENCE

         The Registrant's Definitive Proxy Statement relating to the
Registrant's 1997 Annual Meeting of Stockholders, to be filed by the Registrant
with the Securities and Exchange Commission on or before February 28, 1997, is
hereby incorporated by reference into Part III of this Annual Report on Form
10-KSB.

                 Transitional Small Business Disclosure Format:

                             Yes  __         No X
<PAGE>   2
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                          ANNUAL REPORT ON FORM 10-KSB

                                TABLE OF CONTENTS
<TABLE>
<CAPTION>
                                                                                                               PAGE
                                                                                                               ----

<S>                                                                                                             <C>
PART I   .......................................................................................................  1
         ITEM 1 --  DESCRIPTION OF BUSINESS.....................................................................  1
                  The Company...................................................................................  1
                  Business Background...........................................................................  2
                  Strategic Alliance With Hyatt Group...........................................................  2
                  The Entertainment Network.....................................................................  3
                           General  ............................................................................  3
                           Entertainment Options................................................................  4
                           Technological Aspects of the Entertainment Network...................................  7
                  Airline Contracts.............................................................................  8
                  Sales and Marketing........................................................................... 11
                  Product Development........................................................................... 12
                  Competition................................................................................... 14
                  Intellectual Property and Proprietary Rights.................................................. 14
                  Customer Maintenance and Support.............................................................. 15
                  Manufacturing, Assembly and Installation...................................................... 16
                  Government Regulation......................................................................... 16
                  Employees..................................................................................... 18
         ITEM 2 --  DESCRIPTION OF PROPERTY..................................................................... 18
         ITEM 3 --  LEGAL PROCEEDINGS........................................................................... 19
         ITEM 4 --  SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS......................................... 19

PART II  ....................................................................................................... 21
         ITEM 5 --  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
               MATTERS.......................................................................................... 21
         ITEM 6  --  MANAGEMENT'S  DISCUSSION AND ANALYSIS OF
               FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................................................... 22
                  General  ..................................................................................... 22
                  Results of Operations......................................................................... 24
                  Liquidity and Capital Resources............................................................... 26
                  Forward Looking Statements.................................................................... 27
         ITEM 7 --  FINANCIAL STATEMENTS........................................................................ 28
         ITEM 8 --  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
               ACCOUNTING AND FINANCIAL DISCLOSURE.............................................................. 28

PART III ....................................................................................................... 29
         ITEMS 9 -- 12 --  DOCUMENTS INCORPORATED BY REFERENCE.................................................. 29
         ITEM 13  --  EXHIBITS AND REPORTS ON FORM 8-K.......................................................... 29

SIGNATURES...................................................................................................... 32

FINANCIAL STATEMENTS............................................................................................F-1
</TABLE>

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<PAGE>   3
                                     PART I

ITEM 1  --  DESCRIPTION OF BUSINESS

THE COMPANY

         Interactive Flight Technologies, Inc. (the "Company") is engaged in the
development, assembly, installation and operation of a computer-based in-flight
entertainment network (the "Entertainment Network"). The first generation of the
Entertainment Network provided aircraft passengers the opportunity to view
movies, to play computer games and, in certain cases where permitted by
applicable law, to gamble through an in-seat video touch screen. The Company has
also recently developed a second generation of the Entertainment Network (the
"IFEN-2") which includes additional features such as secure casino gaming, the
ability for passengers to pay for IFEN-2 usage through their credit cards, and
increased video-on-demand capacity. The IFEN-2 system can also support
interactive advertising and shopping once arrangements are made with advertisers
and vendors and once programming for particular products is created. The Company
anticipates that the IFEN-2 will support a telephone interface system in late
1997. See "-- The Entertainment Network."

         To date, the Company has entered into three contracts with airlines for
the sale and operation of the Entertainment Network: (i) an agreement with
Swissair VKB ("Swissair") to sell to Swissair twenty-one IFEN-2 Entertainment
Networks and to install and operate these systems on Swissair MD-11 and B-747
aircraft; (ii) an agreement with Debonair Airlines ("Debonair") to sell to
Debonair six IFEN-2 systems and to operate these systems on Debonair RJ-146
aircraft; and (iii) an agreement with Alitalia Airlines S.p.A. ("Alitalia") to
sell to Alitalia five first generation Entertainment Network systems and to
operate these systems on Alitalia MD-11 aircraft. Although the transactions with
Swissair and Debonair are classified as sales, the purchase price of the
Debonair and Swissair systems is expected to be paid over time out of revenues
from passenger use. See "-- Airline Contracts."

         The Company is also marketing the Entertainment Network to additional
airlines (primarily international carriers) and is in various stages of
negotiations and proposals with certain airlines. As a result, the Company has
been invited to participate as a preferred provider in a bid alignment process
being conducted by Qantas Airways Limited ("Qantas") regarding its longhaul
fleet. The Company has also executed nonbinding letters of intent with certain
smaller carriers, including PetrolAir S.A. ("PetrolAir"). However, there can be
no assurance that the Company will successfully negotiate definitive agreements
with PetrolAir, Qantas or any other airlines. The Company has formed a strategic
alliance with Hyatt Ventures, Inc., and its affiliates to assist the Company in
marketing and selling the Entertainment Network, in exchange for which Hyatt
will receive, among other things, warrants to purchase shares of Class A Common
Stock and the right to participate in a specified number of airline projects.
See "-- Strategic Alliance With Hyatt Group" and "-- Sales and Marketing."

         Since commencement of operations, the Company has developed and
licensed a catalogue of proprietary technology and know-how relating to the
Entertainment Network and its related systems. In addition, the Company has a
license for technology from FortuNet, Inc. ("FortuNet"), a gaming equipment
manufacturer that distributes video gaming networks to casinos and other gaming
establishments. The Chief Executive Officer of the Company, who is also a
director and principal stockholder of the Company, is a former employee of
FortuNet and
<PAGE>   4
was a substantial contributor to the development of the technology licensed from
FortuNet. See "-- Intellectual Property and Proprietary Rights."

         In July 1996, the Company relocated its principal executive offices and
its primary manufacturing and development facilities from Las Vegas, Nevada to
Phoenix, Arizona.

         The Company was incorporated in Delaware in August 1994 and is the
successor by merger to In-Flight Entertainment Services Corp., a New York
corporation incorporated in February 1994. The Company completed an initial
public offering of its securities in March 1995. Unless the context requires or
as otherwise indicated, all references to the "Company" include the predecessor
company. The Company's principal executive offices are located at 4041 N.
Central Avenue, Suite 2000, Phoenix, Arizona 85012, and its telephone number is
(602)200- 8900.

BUSINESS BACKGROUND

         The market for in-flight entertainment networks has developed as the
number and length of long-haul flights has increased, as passengers on these
flights seek additional and more sophisticated entertainment options and as
airlines compete more aggressively for passengers. While market factors,
particularly in the United States, limit the ability of many airlines to raise
fares, technological advances in computer processing capabilities, operating
systems and digital media technologies have created opportunities for airlines
to provide passengers with increasingly sophisticated services. Several domestic
and international airlines have installed or are in the process of installing
video displays that allow passengers to view movies of their choice, with
several movies to choose from. However, since movies are traditionally provided
free of charge to first-class and business-class passengers, many of these
systems do not provide the potential revenue source available from interactive
services, including secure casino gaming, pay-per-view movies and shopping
channels. Moreover, it has been reported that certain in-flight entertainment
systems installed in aircraft by other entities have not proven reliable. The
Company believes that its Entertainment Network combines improved hardware,
software and communications technologies to meet the growing demand by consumers
for additional in-flight entertainment options and by airlines for additional
revenue opportunities.

STRATEGIC ALLIANCE WITH HYATT GROUP

         In November 1996, the Company executed a Strategic Alliance Agreement
(the "Alliance Agreement") to form a strategic alliance with Hyatt Ventures,
Inc. ("Hyatt"), an affiliate of Hyatt Corporation. Under the terms of the
Alliance Agreement, Hyatt, directly and through certain of its affiliates
(collectively, the "Hyatt Group"), has agreed to use its best commercial efforts
to assist the Company in advancing the Company's business with respect to the
Entertainment Network. In return, Hyatt will receive warrants to purchase Class
A Common Stock comprising up to ten percent of the fully-diluted outstanding
Class A and Class B Common Stock (after giving effect to the exercise of these
warrants and the exercise of all other rights, options and warrants outstanding
as of that date). One-ninetieth of these warrants will be issued for each
airplane with respect to which the Company, or a joint venture subsidiary of the
Company, obtains a binding purchase commitment from an airline (excluding
Swissair, Debonair, Alitalia and certain smaller airlines with which the Company
has had prior negotiations). Under the Alliance Agreement, Hyatt also purchased
shares of the Company's Class A Common Stock aggregating $1 Million in the open
market.

                                       -2-
<PAGE>   5
         Hyatt also has the right to designate no less than two nominees to the
Board of Directors of the Company (the "Board"), and may designate additional
nominees if the size of the Board is increased. Hyatt has designated John
Pritzker, President of Hyatt Ventures, Inc., and Adam Aron, Chairman and Chief
Executive Officer of Vail Resorts, Inc. to be its representatives on the Board.
Under the terms of the Alliance Agreement, these individuals received options to
purchase an aggregate of 250,000 shares of Class A Common Stock under the
Company's Amended and Restated 1994 Stock Option Plan.

         Hyatt also has the right under the Alliance Agreement to invest in each
of up to six joint ventures in order to raise up to one-third of the financing
required by the Company for specified airline projects and up to two such joint
ventures relating to non-airline projects (each, a "Joint Venture"). The
Alliance Agreement further provides that, at any time following completion of
the installation of all Entertainment Networks initially contemplated to be
financed and sold by a specified airline Joint Venture (or at a similar mutually
agreed upon milestone with respect to any non-airline Joint Venture), Hyatt
shall have the right to convert between fifty percent and one hundred percent of
its initial equity interest in such Joint Venture into shares of Class A Common
Stock. This conversion would be at a rate based on the then market price of a
share of Class A Common Stock and a valuation of Hyatt's equity interest in the
Joint Venture on the conversion date (as mutually agreed by the parties or,
absent such agreement, as determined by an independent appraiser using a
discounted cash flow method). Such a conversion may not be fully exercised if,
after giving effect thereto, the aggregate ownership of Class A Common Stock by
Hyatt or the Hyatt Group (excluding shares of Class A Common Stock acquired
under the above-described warrants, shares acquired in the above-described $1
Million open market purchases and shares received for executing the Qantas
agreement as described below) would exceed twenty percent of the aggregate
number of shares of voting securities of the Company then outstanding,
calculated on a fully diluted basis.

         The Alliance Agreement and related agreements also provide Hyatt with
the right to demand up to four registrations, and unlimited "piggyback"
registration rights, in connection with its resale of any shares acquired under
the Alliance Agreement (other than shares acquired in the open market).

         Following execution of the Alliance Agreement, Hyatt agreed to execute
an agreement with Qantas which was necessary in order for the Company to become
a preferred provider in the Qantas bid alignment process, in exchange for which
Hyatt received an additional 60,000 shares Class A Common Stock. See "Sales and
Marketing."

THE ENTERTAINMENT NETWORK

         GENERAL

         The Company believes that the Entertainment Network is the most
technologically advanced interactive in-flight entertainment system currently
available on a commercial airline. The Entertainment Network is a distributed
network that combines computer, video and audio technologies in an interactive
system capable of providing a variety of entertainment options for airline
passengers on an in-seat terminal. These options currently include secure casino
gaming, video-on-demand and video-in-progress movies, arcade games, the ability
for passengers to pay for gaming and other features directly through their
credit cards, and the ability (subject to arrangements with advertisers and
vendors) to support in-flight interactive advertising and

                                       -3-
<PAGE>   6
shopping. The Entertainment Network is expected also to include by late 1997
audio-on-demand and a telephone interface system.

         When installed, the IFEN-2 version of the Entertainment Network will
provide each first-class and business-class seat with a 10.4" (as opposed to
9.5" in the first generation Entertainment Network) in-seat video terminal
featuring individual color touch screens which are compatible with airline
headphones, enabling passengers to hear the audio portion of the programming.
The first and business class in-seat video terminals are attached via a hinged
arm that fully retracts into the armrest compartment that separates seats. The
IFEN-2 version of the Entertainment Network also contains a smaller version
(8.4") of the video touch screen for installation in coach class seats where the
in-seat video terminal will be mounted as a flip-up attachment to the tray
table. In both cases, the in-seat video terminal is sealed to allow cleaning and
to avoid operational disruptions due to accidental food or beverage spills.

         Passengers operate the in-seat video terminal by touching the screen on
which various touch buttons are displayed such as "movies," "shopping," "arcade
games," "casino games," "credit card," "help" and others. In order to access the
IFEN-2's features which require payment, including casino gaming, the passenger
will first open an account with the cabin file server (the Entertainment
Network's proprietary central computer) by swiping his or her credit card
through the credit card reader slot. Following the flight, records of the use
charges and gaming losses and winnings will be downloaded to the Central Ground
System, which will then post the charges, losses and/or winnings to the
passenger's account. See "-- Technological Aspects of the Entertainment Network
-- Central Ground System." The Company has agreements in place with MasterCard
International(R), Visa International(R) and American Express to accept credit
cards as payment for in-flight transactions.

         The Company believes that the size and resolution of the Entertainment
Network screen (640 horizontal dots by 480 vertical dots) provides passengers
with a better viewing experience. The Company believes that earlier generations
of in-flight systems have typically utilized significantly smaller screens and
provided maximum resolution significantly lower than the Entertainment
Network's.

         ENTERTAINMENT OPTIONS

         Video on Demand. The Entertainment Network currently offers passengers
the ability to choose from up to approximately 20 feature length movies and
short subjects, depending upon their length, from which any passenger can select
a desired movie or short subject for personal viewing. The video-on-demand
capability incorporated into the Entertainment Network permits multiple
passengers to watch the same or different movies on his individual in-seat video
terminal, with each passenger having the capability of starting and stopping
their personal display of the movie at any time. The Company believes that the
Entertainment Network remains the only video-on-demand system currently
available to commercial airlines.

         The Company believes that the video-on-demand capability of the
Entertainment Network System is highly advantageous over that of video tape
players. The video-on-demand feature of the Entertainment Network enables a
passenger to watch selected movies at any time without the need for individual
video tapes or video tape players or assistance from any in-flight personnel. In
addition, because individual video tape players are mechanical, over time these
players get dirty and experience tape jams and may therefore be less reliable.
By comparison, because the

                                       -4-
<PAGE>   7
Entertainment Network's movies are stored in a digital database, the quality of
the transmission should remain consistently high. Further, by distributing
passenger demands among a number of video-on-demand servers, the Entertainment
Network is designed to be a cost-, weight- and space-efficient system.

         The Entertainment Network is designed to support MPEG (Motion Picture
Experts Group) 1 compression and video-on-demand capability. The MPEG 1 format
has been selected by an international consortium of consumer electronics
manufacturers and movie production companies as a standard for distribution of
digital video information. In addition to the video information, the
video-on-demand server has also been designed to store stereo audio tracks in
multiple languages. The Company has arrangements with certain movie distributors
pursuant to which the Company chooses from lists of available movies from each
distributor and compiles the lists for presentation to the airlines.

         Audio-on-Demand. The IFEN-2 is being designed to offer passengers the
ability to choose from a variety of musical and other audio selections for
personal listening. This "audio-on-demand" capability would permit multiple
passengers to listen the same or different selections on their individual
headsets with each passenger having the capability of starting and stopping
their personal selections at any time.

         Gaming. The Entertainment Network is designed to offer a variety of
video gaming options such as Slots, Keno, Lotto, Poker, Bingo, Blackjack and (on
the Swissair system) certain games offered by the Swiss lottery such as
"Risiko." These games feature outstanding graphics and superior ease of
passenger use. The installed version of the Entertainment Network on Alitalia
only permits passenger use of arcade (i.e., non-gambling) games. However, the
IFEN-2 versions to be installed on Swissair and Debonair aircraft are expected
to include some or all of the Entertainment Network's gaming options.

         The Company's gaming software includes, among other things, certain
casino gaming software which is included in the license from FortuNet described
below and various additional casino games developed by the Company. The IFEN-2's
advanced distributed network provides security for all video gaming transactions
on the system, which is necessary to avoid tampering and fraud. See "--
Distributed Network Architecture." Additionally, the IFEN-2 design permits all
payout tables and betting and loss limits on the system's video gaming to be
customized to meet an airline's exact specifications. While the Company believes
that video gaming options represent the Entertainment Network's most significant
means of revenue generation for the Company and the airlines, the use of gaming
devices is prohibited on flights to and from the United States and is subject to
other local government regulations. See "-- Government Regulation."

         Arcade Games. The Entertainment Network is designed to include a choice
of arcade- type games. The system's Seat Electronics Boxes (SEB's) operate under
the Windows NT(R) operating system, through which the Company believes that
numerous games will be adaptable to the Entertainment Network once a mouse or
joystick is integrated into the system. The large local hard disk storage
capacity of the system's SEB's (a feature the Company believes is unique)
eliminates lengthy downloads of passenger selected games. The Company has
developed one video arcade game ("Squish") internally and has licensed rights to
one additional game ("Reversi"). In addition, the Company has commenced
discussions with various entertainment

                                       -5-
<PAGE>   8
software developers, but has not yet entered into any agreements or arrangements
to obtain any rights to any other arcade games.

         In-Flight Shopping. The IFEN-2 version of the Entertainment Network
will permit passengers to access both in-flight catalog and duty free shopping,
provided that the Company and/or the airlines have suitable arrangements with
product distributors and that product programming is produced. Products and
services can then be viewed on the in-seat terminal screen in a variety of
formats in which a video of a product is shown while concurrently information
about that product is displayed graphically on the screen, much like a televised
home shopping channel format. Passengers would purchase a product by swiping a
credit card through the card reader and entering delivery information through
the use of the touch screen keyboard. A passenger's catalog orders would then be
sent to the cabin file server which would later be downloaded to the Central
Ground System. The Central Ground System would then process all of the
passengers' orders and post the appropriate charges with the passengers' credit
card centers.

         Duty free shopping orders are expected to be processed similarly,
although the cabin file server will preprocess such orders in order to account
for any on-board inventory of duty free items. The preprocessed orders can be
displayed on the screen of the cabin file server for the flight attendants'
convenience. The Company expects to assist each airline that elects to utilize
the shopping feature in incorporating the airline's duty-free shopping program
into an online information and sales system. In addition, the Company expects
that it will coordinate the implementation of new in-flight shopping options
based both on catalog sales and "infomercial" advertising, which would allow
passengers to watch a program about a product and then purchase the product
during or after the program.

         Advertisements. The IFEN-2 also has the ability to display
advertisements. These advertisements are expected to be interspersed between
movies and other video programs, between portions of the audio programs, or
shown on the arcade games, casino games and shopping channels either as ticker
tape messages scrolling across the top or bottom of the screen or as messages
flashing periodically on the screen. The Company expects to assist airlines in
selling advertising time and in creating in-flight advertising in exchange for a
share of the resulting advertising revenue.

         Language Selection. The Entertainment Network provides passengers with
the convenience of using the in-seat video terminals in multiple languages which
are accessible by using the touch screen. If the passenger chooses a particular
language selection, the operation of the in-seat video terminal is designed to
switch to the selected language (although movies may only be available in a
limited number of languages).

         Telephone. The Company is commencing development of a telephone
interface system on the IFEN-2 through which passengers would be able to pay for
telephone calls via credit cards or prepaid debit cards. This feature is
expected to be available in late 1997.

         The options that will actually be available on any particular flight
will depend upon applicable regulations, the ability of the Company to license
or otherwise obtain the rights to programming software, the preferences of the
airline and the performance and reliability of the installed system. The price,
if any, charged to passengers for various entertainment options will be
determined by each airline and/or the Company and will be based upon a number of
factors,

                                       -6-
<PAGE>   9
including airline marketing strategies, the cost of similar entertainment
options available in other media, the fee, if any, charged by a licensor of such
programming and other factors. In addition, use of passenger identification and
other information, especially information obtained via credit cards, is limited
by certain privacy statutes and regulations.

         TECHNOLOGICAL ASPECTS OF THE ENTERTAINMENT NETWORK

         Gaming Management. The Entertainment Network is designed to provide
airline management with the capability for real time gaming management by
tracking the entire gaming process on all of the system's in-seat video
terminals collectively or individually. In particular, the Entertainment Network
is designed to store the complete history of all wagers and game outcomes on all
of the in-seat video terminals. The stored information may include
passenger/player identification numbers, the times of transactions, the bet
amounts, the amounts won or lost, the cards played, the keno balls called and
alarms for management, such as of large consistent winnings and progressive
jackpot hits. If desired, the IFEN-2 design can be customized to permit all
gaming related information, including the alarms, to be observable in flight on
the screen on the cabin file server, or on the ground after periodic downloading
using a Central Ground System described below. The system is also designed to
limit the wagers, aggregate losses and winnings by any individual player to any
amounts selected by the airline.

         The Entertainment Network is also designed to provide security for
in-flight gaming by centralizing the critical process of generating random
numbers at remote points, instead of generating random numbers in each in-seat
video terminal independently. Since the in-seat video terminals do not generate
the random numbers, passengers are unable to fix outcomes by tampering with the
in-seat video terminals, as may happen with regular slot machines. The software
and the electronics of the Entertainment Network are designed to also contain
multiple layers of proprietary security measures.

         Distributed Network Architecture. The capabilities and reliability of
any interactive system are determined, to a large extent, by the architecture of
the communication network. The Entertainment Network is based on a distributed
network designed to provide centralized control while reducing the possibility
that a single point of failure will disrupt the operation of more than a small
portion of the network. The Entertainment Network is centrally controlled on an
aircraft by the cabin file server. The cabin file server is the central computer
designed to coordinate and control all functions of the Entertainment Network.
The cabin file server provides security for transactions on the Entertainment
Network by providing multiple layers of software and hardware security systems.
These security systems are designed to record all transactions for later
downloading to the Central Ground System, as well as control the generation of
all random factors that determine the outcome of any casino games being played
by the passengers.

         The cabin file server controls a number of cluster controllers, and
each cluster controller controls a group of approximately 32 in-seat video
terminals. Consequently, the failure of one in-seat video terminal should not
affect the operation of other terminals on the aircraft. Similarly, the failure
of an individual cluster controller is expected to affect only the in-seat video
terminals controlled by that cluster controller, and not the operation of the
other in-seat video terminals on the aircraft. Further, even if the cabin file
server fails, each cluster controller is designed to continue to operate
autonomously without the cabin file server, except for certain gaming management
functions which are performed by the cabin file server.

                                       -7-
<PAGE>   10
         The distributed network architecture is also designed to permit the
Entertainment Network to deliver the short transaction response time required
for interactive applications, while using lightweight and inexpensive hardware.
Since interactive applications generally require several computerized
communications transactions per event, an ordinary cabin file server can
experience software overload, thereby creating a system failure at some or all
of the in-seat video terminals. By designing the Entertainment Network to shift
a portion of the workload to each cluster controller, the Company believes the
distributed network architecture can reduce those performance problems.

         Central Ground System. Located at the Company's executive offices in
Phoenix, Arizona, the Central Ground System is a computer system developed by
the Company to serve as the control focal point for all of the Company's
installed Entertainment Networks. The Central Ground System is provided with
accounting and statistical data accumulated by the Entertainment Networks during
flight. The Central Ground System can then process this data in order to, among
other things, post the passenger transactions to their respective credit card
processing centers and provide airline management with a variety of accounting
and statistical reports. In addition, the Central Ground System can upload new
information to the Entertainment Networks as needed, such as new games, shopping
catalogs or other programming software. If real time downloading is not
implemented, the data interchange between the aircraft and the Central Ground
System will occur on the ground via a direct local telephone or radio link, or
by using a removable magnetic cartridge. The Central Ground System is intended
to store the complete history of all passenger transactions and allow airline
management to access comprehensive data logs for each individual in-seat video
terminal, subject to applicable privacy rules governing credit card processing.

AIRLINE CONTRACTS

         Swissair

         Effective July 18, 1996, the Company entered into an agreement with
Swissair (which was amended and restated effective October 22, 1996) to provide
for delivery and installation by the Company of IFEN-2 systems on sixteen
Swissair MD-11 aircraft and five Swissair B-747 aircraft (as amended, the
"Swissair Agreement"). Under the Swissair Agreement, the Company will also
provide various maintenance and operational services for the installed IFEN-2
systems. Effective October 22, 1996, the Company also executed an agreement (the
"ILL Agreement") with Interkantonale Landeslotterie ("ILL"), the operator of the
Swiss lottery based in Zurich, Switzerland, under which the IFEN-2 systems
installed on Swissair aircraft will allow passengers to participate in various
Swiss lottery games. The IFEN-2 shipsets installed on Swissair aircraft are
expected to include various gaming options, including Slots, Keno and Risiko (a
Swiss lottery game). The Swissair system may also feature other casino-style
games pending, among other things, approval of Swissair, ILL and Swiss
authorities.

         In addition to the standard IFEN-2 features described above under "--
The Entertainment Network," the Swissair systems are also designed to permit
passengers to view, among other things, the Swissair "moving map" (which shows
aircraft location, airspeed and other flight information) and certain Swissair
flight and airport information.

         Under the Swissair Agreement and the ILL Agreement, subject to the
terms thereof, the Company is entitled to receive an aggregate purchase price
for the twenty-one IFEN-2 systems of

                                       -8-
<PAGE>   11
approximately $72 Million, plus costs of installation and upgrades and certain
design modification costs. The Company's cost of goods sold for the Swissair
systems is expected to be substantially comparable to the aggregate purchase
price. The Company is also entitled to be reimbursed for certain costs to be
incurred in connection with maintaining and operating the installed systems.
However, the Company's operating expenses and the purchase price are payable
only out of net revenues (after deducting credit card and lottery permit fees)
received from passenger participation in the lottery and, if any, casino games.
Further, the Company may receive such amounts only after Swissair is first
reimbursed from the net lottery revenues for certain expenses incurred in
connection with the installation and operation of the IFEN-2 systems. ILL is
entitled to any net gaming revenues remaining after payment of Swissair's
operating expenses, the Company's operating expenses and the aggregate system
purchase price. The Company will also receive a percentage of revenues and
commissions from advertising and shopping services available on the installed
IFEN-2 systems.

         The Swissair Agreement also provides the Company, subject to
satisfaction of certain conditions, the exclusive right to install and operate
gaming equipment on these twenty-one airplanes and on all other longhaul
aircraft operated by Swissair, and a right of first negotiation to operate
gaming equipment on all shorthaul aircraft operated by Swissair.

         Installation of the IFEN-2 on the first Swissair aircraft is scheduled
to be completed on or about January 26, 1997. The remaining installations are
scheduled to take place at the rate one to two shipsets per month through
February 1998. Subject to certain exceptions, the Swissair Agreement subjects
the Company to certain penalties if IFEN-2 systems are not timely installed.

         The Swissair Agreement requires the Company to provide certain support
and maintenance services, upgrades, installation, initial training of Swissair
personnel and other support services during the life of each system, for which
the Company will be reimbursed through gaming revenues as described above. The
Swissair Agreement shall remain in force through December 31, 2003 as to each
MD-11 aircraft and through December 31, 2001 as to each B-747 aircraft.

         Debonair

         In March 1996, the Company entered into a contract (the "Debonair
Agreement") with Debonair, a start-up European airline. The Debonair Agreement
provides for the Company to deliver IFEN-2 systems (including video casino-style
gambling) for all seats on Debonair's entire fleet, which consists of six RJ-146
aircraft. The aggregate purchase price to be paid by Debonair for the hardware
components of the six IFEN-2 systems and related spare parts is approximately
$5.8 Million. However, the Debonair Agreement provides that, provided Debonair
utilizes the casino gaming feature of the Entertainment Networks, Debonair is
not required to pay any up- front funds to the Company for the six Entertainment
Networks. Instead, payments to the Company will be made solely through a
revenue-sharing arrangement, which provides that the Company will receive a
percentage of revenues generated by the Entertainment Networks, principally
casino gaming revenues, until the aggregate purchase price plus accrued interest
for all six Entertainment Networks is paid, and thereafter the Company will
receive a reduced percentage of such revenues. The Debonair Agreement further
provides that, if the use of the casino gaming features of the IFEN-2 systems is
ordered by law to cease, then no further payments of purchase price for each
delivered system shall be due.

                                       -9-
<PAGE>   12
         The Entertainment Network is currently scheduled to be delivered for
the first Debonair aircraft in March 1997. The system is expected to be
delivered for the remaining Debonair aircraft at subsequent dates which will be
determined based on aircraft groundtime schedules and resolution of any other
technical issues. Subject to certain exceptions, the Debonair Agreement subjects
the Company to certain penalties if the IFEN-2 systems are not timely delivered.

         The Debonair Agreement requires the Company to provide, free of charge,
certain support and maintenance services, upgrades, installation support,
initial training of Debonair personnel and other support services during the
life of each system. In addition, the Company is required to provide Debonair
with spare parts free of charge so long as gaming is in operation.

         The Debonair Agreement shall remain in force, as to each aircraft upon
which an Entertainment Network is installed, for a period of eight years from
the operation of such Entertainment commences.

         Alitalia

         The Alitalia Agreement provides for the Company to sell, service and
support the first generation Entertainment Network in the first/business class
section on five Alitalia aircraft and (for additional compensation) to provide
certain spare parts, in exchange for the payment by Alitalia of an aggregate of
approximately $2.7 Million for the hardware components ($3.25 Million if certain
spare parts are ordered). The system provided to Alitalia is designed to feature
video-on-demand capability, offering passengers up to 20 movies and/or short
subjects to choose from, and various arcade games. The Alitalia Agreement does
not presently provide for, and is not expected to provide for, passenger use of
gambling features of the Entertainment Network.

         The Company has delivered five systems to Alitalia and, to date, four
of such systems have been installed and are in operation. Alitalia has used the
fifth system delivered by the Company to provide spare parts for the four
installed systems. Consequently, the fifth system has yet to be installed and
will not be installed unless Alitalia orders additional spare parts. Of the
approximately $2.7 Million purchase price, the Company has received
approximately $1.1 Million to date, and $1.6 Million is currently due. See "Item
6 -- Management's Discussion and Analysis of Financial Condition and Results of
Operations."

         In addition to the foregoing prices for the hardware, the Alitalia
Agreement provides that in the event Alitalia determines to charge its
passengers for any entertainment options, then, after deducting any applicable
licensing or other acquisition fees, all revenues will be divided between the
parties based upon specified percentages. In addition, the Alitalia Agreement
provides that if Alitalia determines to include gaming on the system, a
specified percentage of all Entertainment Network revenues will be credited to
Alitalia until such time as it shall have recovered all amounts previously
expended for hardware purchases. Moreover, the Alitalia Agreement permits
Alitalia to utilize the Entertainment Network for the exhibition of up to 90
minutes of programming not supplied by the Company. However, the Company has the
sole and exclusive right to operate all channels on the Entertainment Network
during the term of the agreement.

         The Alitalia Agreement shall remain in force, as to each aircraft upon
which an Entertainment Network is installed, for a period of eight years from
completion of the installation

                                      -10-
<PAGE>   13
of such system. However, in the event gaming is commenced on any such aircraft,
the term shall be extended to a period of eight years from the date gaming is
commenced.

SALES AND MARKETING

         Concurrently with its efforts to further develop the Entertainment
Network and perform under its existing contracts, the Company is marketing the
Entertainment Network to additional airlines. The Company markets the
Entertainment Network to airlines directly with the assistance of Hyatt, as well
as through independent sales representatives, and generally seeks to obtain
long-term contracts to provide the Entertainment Network to airlines. See "--
Airline Contracts." Although the Company has commenced negotiations with several
airlines, it has thus far entered into agreements only with Swissair, Debonair
and Alitalia for the purchase of the Entertainment Network. The Company
generally expects that, as with its existing contracts, any future airline
contracts will be exclusive to the Company, thereby restricting the ability of
competitors from providing programming over the Entertainment Network. However,
in order to take advantage of market opportunities, the Company could elect to
depart from this strategy in some cases, such as by permitting a limited amount
of time to be allotted to programming acquired by the airline from third parties
while retaining ultimate control over operation of the systems.

         Because the Company believes the demand for in-flight entertainment
systems is greater on longer flights, the Company is focusing its marketing
assistance on airlines with long-haul routes. In addition, because gaming can
generally be expected to generate greater revenues and profitability than other
features of the Entertainment Network, and because the use of gaming devices is
prohibited on flights to and from the United States, the Company is directing
its sales efforts primarily toward international carriers or domestic carriers
with international routes. However, the Company will also be subject to the laws
of foreign jurisdictions which may similarly restrict or prohibit the gaming or
other activities offered on the Entertainment Network.
See Government Regulation."

         The Company has in the past entered into agreements with several
non-affiliated sales representatives in foreign countries to market and promote
the Company's products and assist in the negotiations with airlines. Such
agreements typically provided for the sales representative to act as the
Company's exclusive representative in a particular territory or with respect to
a particular airline.

         In November 1996 the Company restructured its approach to sales and
marketing by entering into the Alliance Agreement. See "-- Strategic Alliance
With Hyatt Group." Consequently, the Company intends to reduce its use of
foreign sales representatives (subject to existing contracts) and instead
utilize the marketing efforts of Hyatt and its own efforts to promote sales of
the Entertainment Network. The Company also expects to increase its
participation in industry trade shows, including air shows, and to further
develop its library of brochures and other marketing materials.

         The purchase price of an Entertainment Network is relatively high -
estimated to range from approximately $700,000 to $6,500,000 per aircraft
depending upon various factors such as the size and type of the aircraft, the
requested system features and the degree of demonstrated commercial viability
and market penetration of the Entertainment Network. To counter this fact, the
Company's marketing efforts emphasize the many features of the Entertainment
Network as a

                                      -11-
<PAGE>   14
way to generate increased revenues to the airline. In addition, the Company in
some cases helps to defray this high up-front cost by structuring its contracts
such that, in lieu of receiving all (or even a portion) of the purchase price
upon delivery, it receives a percentage of the net revenue derived from
passengers' use of the fee-based interactive entertainment options on the system
(particularly the gaming features). In such cases, the net revenues (after
deducting direct operating costs) may be divided between the Company and the
airline on a negotiated bases. Alternatively, in lieu of such revenue sharing,
the Company may agree that the purchase price will be paid only from such
revenues.

         The high system purchase price also tends to result in a relatively
extensive sales cycle, which can include the evaluation of the Company's
technology, a test installation of the Entertainment Network and negotiation of
related agreements. The sales cycle is also dependent upon a number of other
factors beyond the Company's control such as the financial condition, safety and
maintenance concerns and purchasing patterns of particular airlines and the
airline industry generally. Historically, airline profitability has been
extremely cyclical and, since the passage of deregulation legislation, many
airlines have had difficulty operating at a profit.

         In connection with its ongoing marketing and sales efforts, the Company
is in various stages of negotiations and proposals with certain airlines.
Specifically, in December 1996, the Company was notified that it had been
selected by Qantas as the preferred in-flight entertainment tenderer to
participate in a bid alignment process for the possible supply of an in-flight
entertainment system which may be installed on Qantas' long haul fleet. The bid
alignment process, which is expected to be completed at the end of February
1997, is part of Qantas' evaluation of tenderers to provide an integrated
interactive in-flight entertainment system. Qantas has indicated that, at the
conclusion of the bid alignment process, it will review the project and assess
if an integrated solution which meets its requirements can be provided by the
preferred tenderers. At this time a decision is expected from Qantas as to
whether to continue the project further with the preferred tenderers or to seek
other potential suppliers. However, a decision by the Qantas Board of Directors
whether (and with which supplier) to install an interactive in-flight
entertainment system is not expected until later in 1997.

         The Company has also executed nonbinding letters of intent with certain
other carriers, including a letter of intent with PetrolAir to install the
Entertainment Network (including video casino style gambling) on two PetrolAir
aircraft.

         There can be no assurance that the Company will successfully negotiate
definitive agreements with Qantas, PetrolAir or any other airlines.

         The Company anticipates that its marketing efforts, and the expenses
associated therewith, will continue to be substantial in the first few years of
its operation.

PRODUCT DEVELOPMENT

         The Company has continued to expand the functionality of the
Entertainment Network to include additional features, and the IFEN-2 version now
includes new features such as secure casino gaming, the ability for passengers
to pay for gaming and other features directly through their credit cards,
interactive in-flight shopping and advertising capability, and enhanced video on
demand. Further, the IFEN-2 version is lighter and, the Company believes, easier
to maintain

                                      -12-
<PAGE>   15
than the first generation Entertainment Network and includes in-seat terminals
for coach class seats as well as first and business classes.

         Research and development expenses during fiscal 1996 and fiscal 1995
were approximately $5.3 Million and $2.4 Million, respectively. Such amounts
have not been borne by customers. The Company intends to seek to include an
undetermined portion of such amounts in the purchase price of the Swissair
systems, but there can be no assurance that any portion of such amounts will be
recoverable. See "-- Airline Contracts -- Swissair."

         The Company believes that continued investment in product development
is required in order for the Entertainment Network to continue to be competitive
in the in-flight entertainment industry. The Company intends to broaden the
entertainment options and other features available on the Entertainment Network
through internal development, the use of independent software developers and has
licensing or acquiring other rights to products, generally in digitized format,
for in-flight use. The Company intends to continue to expand its in-house
development staff and to acquire additional software development equipment.

         Specifically, the Company is continuing its efforts to expand the
functionality of the Entertainment Network to include by late 1997 such
additional features as a telephone interface system and audio-on demand. The
Company intends to continue to develop further enhancements to the Entertainment
Network as technological advances permit improved graphics, audio and other
features and to take advantage of emerging interactive software technologies.
The Company anticipates that it will, from time to time, further reconfigure the
hardware components of the System to accommodate different aircraft seat
designs. The Company also must continue to develop software interfaces to ensure
compatibility of interactive entertainment and educational programming and
software which the Company plans to add to the Entertainment Network, as
described below.

         The Company also intends to continue to expand its library of movies,
games and other programming available to passengers. The Company has
arrangements with certain movie distributors pursuant to which the Company
chooses from lists of available movies from each distributor, and compiles the
lists for presentation to the airlines. However, with the exception of certain
casino gaming software licensed from FortuNet and a limited number of casino and
arcade games developed to date by the Company, the Company does not currently
own or have rights to use or include any entertainment or other programming
software for use on the Entertainment Network. See "-- The Entertainment Network
-- Entertainment Options." As part of its overall business strategy, the Company
intends to evaluate additional programming software for availability on the
Entertainment Network. Because of the digital-based technology incorporated in
the Entertainment Network, the Company believes that the network will be able to
accommodate a variety of interactive multi-media software products and services
available or under development in digitized format. However, although the
Company has had discussions with certain entertainment software developers, it
has not yet entered into any long term agreements or arrangements to obtain
rights to any such programming software other than "Reversi." In addition to
casino gaming, arcade games and movies, the Company intends to obtain rights to
television and news broadcasts, shopping (catalog or video), sporting events and
educational programs.

         The foregoing plans for product development contain forward looking
statements, and no assurance can be given as to which, if any, of the
above-described features and enhancements

                                      -13-
<PAGE>   16
under development will ultimately be fully developed. The Company's ability to
continue further developing the Entertainment Network will be dependent on
several factors including technical difficulties encountered in development,
availability of commercial software, technological advances in the electronics
industry generally, and the Company's ability to raise significant additional
capital. See "Item 6 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Forward Looking Statements."

COMPETITION

         The Company believes that the market for technologically advanced
in-flight entertainment systems is still emerging and that competition to
provide such services to the airlines will be intense. The Company is aware of
several other companies that provide systems that compete with the Entertainment
Network, some of which have been installed on aircraft. Most of these
competitors have substantially greater financial and other resources than the
Company and, accordingly, may have a significant competitive advantage over the
Company. The Company's principal competitors include BE Aerospace, TNCI,
Hughes-Avicom, Matsushita and Sony. The Company is also aware of several other
companies that are attempting to develop in-flight entertainment systems or
seeking joint ventures in the field.

         The Company believes it will compete with other companies primarily on
the basis of its advanced hardware and software technology and the variety of
entertainment options both currently available on and under development for the
Entertainment Network. In addition, the Company believes that components of the
Entertainment Network are smaller and weigh considerably less than those of
several competing in-flight entertainment systems. Because aircraft weight
directly affects operating costs, the weight and size of in-flight systems may
be a critical factor for an airline seeking to conserve fuel or generate
additional cargo revenue. There can be no assurance, however, that the Company
will be able to compete successfully in the in-flight entertainment market.

INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS

         Since the commencement of operations, the Company has developed a
catalogue of proprietary technology and know-how relating to the Entertainment
Network and its related systems. To date, the Company has not filed any patent
applications with respect to such proprietary technology and know-how, but may
elect in the future to do so.

         In October 1994, the Company entered into an Intellectual Property
License and Support Services Agreement with FortuNet, which was amended and
restated on November 7, 1996 (as amended, the "FortuNet License"). FortuNet is a
licensed gaming equipment manufacturer that distributes to casinos and other
gaming establishments video gaming networks which incorporate certain of the
technologies developed by FortuNet and licensed to the Company for airline use.
The FortuNet License grants the Company a worldwide, perpetual license to
FortuNet's current and future patents, copyrights, trade secrets and related
know-how covering a computerized system for use in all fields other than bingo
halls. Further, this license is exclusive to the Company within the airline
industry. As consideration, the Company must pay FortuNet an annual license fee
of $100,000 in monthly installments through November 2002. The Company was
previously required to compensate FortuNet for certain development, support and
maintenance services, but this obligation has been terminated. Further, the
restated version of the FortuNet License no longer prohibits the Company from
engaging in any gaming activities

                                      -14-
<PAGE>   17
outside of airplanes. In exchange for these amendments and certain other
modifications, the Company issued to FortuNet a warrant to purchase
fifty-thousand shares of Class A Common Stock.

         The FortuNet License covers three United States patents and three
foreign patents as well as certain unpatented technology. The licensed patents
include United States patents claiming (i) an electronic bingo game, (ii) an
electronic game network and a predetermined set of game cards, and (iii) an
electronic game network capable of executing concurrently at least two different
games. The Fortunet License also covers certain corresponding foreign patents.
The FortuNet License also includes United States and foreign copyrights, trade
secrets, know-how and any other proprietary technology and intellectual
properties now owned by FortuNet that cover the technology.

         The use of the Company's technology, including the patented technology
licensed from FortuNet, may give rise to claims that the Company's products
infringe the patents of others. The Company is aware of a number of United
States and foreign patents which include claims relating to technologies similar
to those included in the Entertainment Network. The Company has agreed to pay
costs and damages in connection with any patent infringement claims brought
against Swissair, Debonair or Alitalia as a result of their use of the
Entertainment Network.

         There can be no assurance that the issued patents licensed from
FortuNet will provide the Company with any significant competitive advantage or
that challenges will not be instituted against the validity or enforceability of
any patent licensed by the Company or, if instituted, that such challenges will
not be successful. Certain of the patents underlying the technology licensed
from FortuNet are the subject of litigation to which the Company is not a party.
The cost of litigation to uphold the validity and protect against infringement
of patents can be substantial. Furthermore, there can be no assurance that
others will not independently develop substantially equivalent or more advanced
proprietary information and techniques or otherwise gain access to the Company's
current or future-created unpatented trade secrets or obtain such technology or
duplicate the Entertainment Network. In addition, to the extent that consultants
(including FortuNet), key employees or other third parties apply technological
information developed by them or by others to Company projects, disputes may
arise as to the proprietary rights to such information which may not be resolved
in favor of the Company. In addition, there can be no assurance that the Company
can meaningfully protect its intellectual property in foreign countries,
particularly in countries where there are no patents corresponding to those
patents licensed from FortuNet.

CUSTOMER MAINTENANCE AND SUPPORT

         The Company's airline contracts generally call for the Company to
provide airline customers with periodic upgrades of the software incorporated in
the Entertainment Network. The Company trains airline personnel on the use of
the network after an initial airline installation and for a short period
thereafter. The Company is also generally obligated to provide ongoing
maintenance and support for the installed systems over the life of the
contracts. The Company's strategy is to contract with one or more third parties
to provide international customer support and maintenance service for the
Entertainment Network. In addition to service and repair functions, it is
expected that such entity would be responsible for removing and replacing, on a
regular basis, any software products which are not transmitted via the Central
Ground System (a capability currently being developed), and, in the event
satellite or cellular transmission from the

                                      -15-
<PAGE>   18
aircraft to the Central Ground System is not available, for removing and
transmitting to the Central Ground System the removable magnetic cartridge
containing transaction data and billing information generated by the aircraft's
Entertainment Network (a capability currently being developed). Because the
Company is not expected to have the personnel or financial resources to perform
this function directly, the failure to obtain such an arrangement could have a
material adverse affect on the Company's ability to perform under its contracts
or to obtain purchase commitments from additional airlines. See "-- Airline
Contracts."

MANUFACTURING, ASSEMBLY AND INSTALLATION

         The Company obtains most of the components of the Entertainment Network
from commercially available sources. To date, the Company has engaged in only
limited manufacturing operations and, when required components have not been
commercially available, has subcontracted out substantially all component
manufacturing. The Company has leased manufacturing and warehouse facilities in
Phoenix which it uses to assemble the Entertainment Networks. The Company
anticipates that this facility will be sufficient to satisfy the Company's needs
through 1998. See "Item 2 -- Description of Property."

         Installation of the Entertainment Network on an aircraft is estimated
to require at least four to seven days, depending upon the number of installed
seats, and longer for the initial installations. Moreover, due to the high cost
of grounding an airplane, the Company anticipates that installations are more
likely to be scheduled during the off-season for the airline customer, generally
the winter months. Because of the manpower and experience required to perform
installations, and due to the inherent relationship between installation and the
STC application and compliance process, the Company has contracted with
Hollingsead International to perform system installation on all Swissair
aircraft. Alitalia made, and Debonair is expected to make, its own arrangements
for installation of the system on its aircraft. The Company anticipates that
future installations, if any, will be performed by an experienced third-party
subcontractor such as Hollingsead International. See "-- Government Regulation."

GOVERNMENT REGULATION

         The installation and use of the Entertainment Network on any particular
aircraft will require prior certification and approvals from the FAA and
certification and approvals from aeronautical agencies of foreign governments.
Because the installation of the Entertainment Network is considered a major
modification to an aircraft, the Company must apply for and be granted a
Supplemental Type Certificate ("STC") from the FAA. This is a multi-step process
involving required interim approvals. A separate STC will be required with
respect to each aircraft type on which the Entertainment Network will be
installed. Once an STC is issued with respect to an aircraft type, the unit may
be installed on other aircraft of the same type with the same configuration
provided each installation is performed in a manner as specified by the aircraft
specific STC. To date, the Company has obtained one STC for Alitalia MD-11
aircraft.

         Because the process of obtaining an STC is highly technical, the
Company has entered into agreements with Hollingsead International and its
subsidiary Elsinore Aerospace Services (collectively, "Hollingsead") to assist
the Company in the application and approval process. Hollingsead is an FAA
designated engineering representative experienced in-flight entertainment
systems and has the authority to approve, subject to final FAA review, certain
aspects of the Company's STC applications.

                                      -16-
<PAGE>   19
         Once the Company identifies the specific aircraft type on which the
Entertainment Network will be installed, it will, through the subcontractor,
make application to the FAA for the STC for that aircraft type. Thereafter, the
FAA will initially establish the certification criteria required to be met for
approval, which will include an in-flight test. The FAA, or its designee,
subject to FAA review, will review all necessary certification and technical
drawings, manuals and procedures for adequacy and compliance; issue necessary
interim approvals including permission to conduct a flight test of the
Entertainment Network; review the results of the flight test; perform
inspections to ensure that both the components of the Entertainment Network and
their installation and operation conform to the certification requirements; and
issue the STC. In addition, the Company or its subcontractor must obtain from
the FAA a Parts Manufacturer Approval ("PMA") with respect to the components of
the Entertainment Network to be installed on each specific aircraft type for
which an STC is granted. There can be no assurance that the Company will be
issued the STCs and PMAs for which it applies or that if such approvals are
granted, that they will be granted within a reasonable time frame or within the
amount budgeted by the Company for such approvals. See "Item 6 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Forward Looking Statements."

         The FAA, in the issuance of the STC, will consider such factors as
whether the Entertainment Network will interfere with the operational and
navigational equipment installed on the aircraft; whether the electrical
components of the Entertainment Network are compatible with those of the
aircraft; whether the components of the Entertainment Network installed in the
passenger seats will interfere with emergency egress from the aircraft; whether
the components of the Entertainment Network will, if subjected to heat or fire,
emit toxic fumes; and similar safety and flight-related concerns.

         Federal law grants to the FAA the authority to reexamine at any time
the basis upon which certification and approval of the Entertainment Network may
be granted and, if appropriate, to amend or revoke such certifications and
approvals, subject to certain appeal rights.

         In addition to approvals required to be obtained from the FAA, the
Company may be required to obtain certification and approval of the
Entertainment Network from the aeronautical authorities of foreign countries. In
many cases, through technical working agreements between the FAA and the foreign
aeronautical authorities, such authorities accept the FAA issuance of the STC as
approval, although certain country authorities reserve the right to
independently review the data and the compliance criteria which support the
issuance of the STC and to reach an independent determination on whether to
approve the equipment for installation and operation. There can be no assurance
that necessary foreign government approvals will be obtained, or if obtained,
within a reasonable time frame or within the amount budgeted by the Company for
this aspect of the project.

         United States law, with certain exceptions, currently prohibits the
knowing transportation of gaming devices on aircraft operated in interstate air
transportation. In addition, states may prohibit the transportation and use of
gaming devices on flights operating between two points in a single state.
Federal law also prohibits the installation, transportation or operation of
gaming devices by any U.S. or foreign air carrier or for such carriers to permit
their use on aircraft operated to or from the United States in foreign air
transportation. However, Federal law does not restrict flights by foreign air
carriers between non-U.S. points, even if the aircraft routing includes a
segment to or from the U.S. Federal law does not restrict the transportation of

                                      -17-
<PAGE>   20
gaming devices installed on aircraft operating into or out of the U.S., provided
that such devices are disabled. The United States Secretary of Transportation
was directed by law to conduct a study and to report to Congress on the safety,
commercial and operational issues posed by gaming devices aboard commercial
aircraft. However, in a study released in 1996, the Secretary did not recommend
that Congress take any action to revise current law and recommended that further
studies be conducted to determine, among things, the competitive need for gaming
devices gaming on such flights. Moreover, the laws regarding the transmission of
gaming data into, out of, or within United States territory, even where such
data was lawfully obtained in another jurisdiction, are unclear. As a result,
there can be no assurance that the transmission of such data will not be
restricted or prohibited. Because gaming can generally be expected to generate
greater revenues and profitability than other entertainment options expected to
be available on the Entertainment Network, the inability to offer gaming on
flights may have a material adverse impact on the Company's business and on the
market acceptance by airlines of the Entertainment Network. The Company will
also be subject to the laws of foreign jurisdictions which may similarly
restrict or prohibit the gaming or other activities offered on the Entertainment
Network.

EMPLOYEES

         As of January 17, 1997, the Company employed 110 people on a full-time
basis and 14 people on a temporary basis. None of the employees is covered by a
collective bargaining agreement. The Company considers its relations with its
employees to be good. The Company also retains consultants to conduct specific
engineering or development activities. In order to meet its current business
plan, the Company will need to continue to expand its staff of technical and
administrative personnel.


ITEM 2  --  DESCRIPTION OF PROPERTY

         The Company's principal executive offices and assembly and warehouse
facilities, located in Phoenix, Arizona, contain approximately 57,900 square
feet of space and are occupied pursuant to three separate leases providing for
an annual aggregate rental of approximately $64,000, subject in part to annual
increases. Two of the leases expire in July 1999 and the other (covering
assembly space) expires in October 1998. The Company believes that its Phoenix
facilities will be sufficient for its executive office, assembly and warehouse
facilities through 1998. The Company also leases approximately 2,500 square feet
of office space in New York, New York (at an annual rent of approximately
$53,000 under a lease expiring in October 1998), and an additional 2,300 square
feet of office space in Los Angeles, California (at an annual rent of $40,000
under a lease expiring in August 1998). As a result of the consolidation of the
Company's operations to Phoenix, the Company is attempting to terminate the New
York and Los Angeles leases or to sublet the space to third parties.

         The Company has no policy regarding investments in real estate, real
estate mortgages or securities of persons primarily engaged in real estate
activities. However, the Company currently holds no such investments.

                                      -18-
<PAGE>   21
ITEM 3  --  LEGAL PROCEEDINGS

         The Company is not currently a party to any pending legal proceedings.


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

         The Company held its 1996 Annual Meeting of Stockholders (the "Annual
Meeting") on August 12, 1996 and held adjournments thereof on August 26, 1996,
September 10, 1996 and October 1, 1996. At the Annual Meeting, the following
matters were submitted to a vote of stockholders, and the inspector of elections
has indicated the results of stockholder voting were as indicated below.

         1.  ELECTION OF DIRECTORS

         At the Annual Meeting, the stockholders elected the directors of the
Company to serve for the coming year.

         The following individuals were elected as new directors:

<TABLE>
<CAPTION>
                                                          For                     Withheld                Broker Non-Votes
                                                          ---                     --------                ----------------
<S>                                                    <C>                         <C>                        <C>
         General Alexander M. Haig, Jr.                25,384,890                  28,050                     0
</TABLE>

         The following individuals were elected to continue to serve as
directors:

<TABLE>
<CAPTION>
                                                                  For                     Withheld            Broker Non-Votes
                                                                  ---                     --------            ----------------
<S>                                                            <C>                         <C>                    <C>
         Michail Itkis                                         25,393,190                  19,750                 0
         Steven M. Fieldman                                    25,392,690                  20,250                 0
         Yuri Itkis                                            25,390,990                  21,950                 0
         Boris Itkis                                           25,390,490                  22,450                 0
         Howard J. Tytel                                       25,392,690                  20,250                 0
         James H. Zukin                                        25,393,190                  19,750                 0
</TABLE>

         2.  MODIFICATION OF ESCROW AGREEMENT

         At the Annual Meeting and at each adjournment thereof, the stockholders
were also asked to approve a proposed modification (the "Modification") of the
terms of an escrow agreement (the "Escrow Agreement") pursuant to which an
aggregate of 3,200,000 shares of Class B Common Stock owned by current and
former officers and directors of the Company are held. The Escrow Agreement
currently contains conditions providing for the release of the subject shares if
certain stock price and/or net income levels are reached within certain
specified time frames. The Modification, if approved, would have reduced certain
of the stock price levels and extend certain of the specified times.

                                      -19-
<PAGE>   22
         As of the third adjourned meeting, the results of the vote to approve
the Modification were as follows:

<TABLE>
<CAPTION>
<S>      <C>                               <C>      
         Votes For:                         2,417,410
         Votes Against:                       893,354
         Votes Abstaining:                    142,663
         Broker Non-Votes:                  4,454,307
</TABLE>

         3.  APPROVAL OF AMENDMENT TO THE 1994 STOCK OPTION PLAN

         At the Annual Meeting, the stockholders were also asked to approve an
amendment to the Company's 1994 Stock Option Plan (the "Plan") to increase to
2,400,000 the number of shares of the Company's Class A Common Stock which may
be issued upon exercise of options granted under the Plan.

         The results of the vote to approve the amendment to the Plan were as
follows:

<TABLE>
<CAPTION>
<S>      <C>                              <C>       
         Votes For:                        21,334,899
         Votes Against:                       973,659
         Votes Abstaining:                     90,315
         Broker Non-Votes:                  3,014,067
</TABLE>

         4.  APPROVAL OF APPOINTMENT OF INDEPENDENT AUDITORS

         At the Annual Meeting, the stockholders were also asked to approve the
appointment, by the Board, of KPMG Peat Marwick LLP, certified public
accountants ("KPMG"), as independent auditors of the Company for the fiscal year
ended October 31, 1996.

         The results of the vote to approve the appointment of KPMG were as
follows:

<TABLE>
<CAPTION>
<S>      <C>                              <C>       
         Votes For:                        25,333,110
         Votes Against:                        34,265
         Votes Abstaining:                     45,565
         Broker Non-Votes:                          0
</TABLE>

                                      -20-
<PAGE>   23
                                     PART II

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

         The Company's Class A Common Stock and Class B Warrants have traded
separately on the Nasdaq SmallCap Market under the symbols FLYT and FLYTZ,
respectively, since March 7, 1995, the date of the Company's initial public
offering. The following table sets forth the high and low last sale prices for
the Company's securities for the periods commencing March 7, 1995 as reported by
the Nasdaq SmallCap Market. These prices do not reflect retail mark-ups,
markdowns or commissions.


<TABLE>
<CAPTION>
CLASS A COMMON STOCK                                                               HIGH             LOW
--------------------                                                               ----             ---
<S>                                                                               <C>            <C>
 March 7, 1995 through April 30, 1995.................................            $5 1/2          $4 1/2
 May 1, 1995 through July 31, 1995....................................             6 1/4           4 7/8
 August 1, 1995 through October 31, 1995..............................            10 5/8           5
 November 1, 1995 through January 31, 1996 ...........................            12 1/4           7 1/2
 February 1, 1996 through April 30, 1996..............................            12 3/4           9 1/4
 May 1, 1996 through July 31, 1996....................................            16 1/8           8 3/8
 August 1, 1996 through October 31, 1996 .............................            15 3/4           9
 November 1, 1996 through January 17, 1997............................            12 1/2           7 7/8

CLASS B WARRANTS

 March 7, 1995 through April 30, 1995.................................           $   5/8          $  1/2
 May 1, 1995 through July 31, 1995....................................             1 1/8             1/2
 August 1, 1995 through October 31, 1995..............................             4 1/2           1 1/8
 November 1, 1995 through January 31, 1996............................             6 5/8           3 5/8
 February 1, 1996 through April 30, 1996..............................             7 7/8           3 1/8
 May 1, 1996 through July 31, 1996....................................             8               5 1/8
 August 1, 1996 through October 31, 1996..............................             7 1/2           3 1/4
 November 1, 1996 through January 17, 1997............................             4 3/8           0 1/32
</TABLE>

         The closing sales prices of these securities as of January 17, 1997 as
reported by the Nasdaq SmallCap Market were $9 3/4 per share of Class A Common
Stock and $01/32 per Class B Warrant.

         As of January 17, 1997, there were 61 record holders of Class A Common
Stock and 6 holders of record of Class B Warrants.

                                      -21-
<PAGE>   24
ITEM 6  --  MANAGEMENT'S  DISCUSSION AND ANALYSIS OF RESULTS OF
               OPERATION AND FINANCIAL CONDITION

GENERAL

         Interactive Flight Technologies, Inc. ("the Company") is engaged in the
development, manufacture, installation and operation of a computer based
in-flight entertainment network (the "Entertainment Network"), which provides
aircraft passengers the opportunity to view movies, to purchase goods and
services, to play computer games and, in certain cases where permitted by
applicable law, to gamble through an in-seat video touch screen.

         In March 1995, the Company raised approximately $13.9 Million through
its initial public offering of 3,220,000 Units, each Unit consisting of one
share of Class A Common Stock, one Class A Warrant and one Class B Warrant. The
Company has subsequently raised additional capital aggregating approximately
$95.1 Million from exercises of its Class A and Class B Warrants.

         To date, the Company has generated revenues of approximately $3.0
Million and has incurred a cumulative losses of approximately $25.0 Million
through October 31, 1996, and further losses since that date. See "Item 7 --
Financial Statements."

         The Company's current plan of operations consists of the following
primary elements:

         -        Performing under the Swissair Agreement, including
                  manufacturing, assembling, delivering, installing, certifying,
                  operating and maintaining the Entertainment Networks for all
                  twenty-one Swissair aircraft;

         -        Performing under the Debonair Agreement, including
                  manufacturing, assembling, delivering, installing, operating
                  and maintaining the Entertainment Networks on all six Debonair
                  aircraft;

         -        Performing under the Alitalia Agreement, including providing
                  installation assistance for the fifth system and operating and
                  maintaining the Entertainment Networks on all five aircraft;

         -        Marketing and selling the Entertainment Network to other
                  airlines, focusing primarily on international carriers;

         -        Negotiating and performing under contracts, if any, with
                  additional airlines including Qantas and PetrolAir;

         -        Updating and enhancing the programming and software included
                  in Entertainment Network, and developing and/or acquiring from
                  third parties new programming and software; and

         -        Continuing to develop hardware enhancements to the
                  Entertainment Network to meet rapidly changing market and
                  customer demands and technology.

                                      -22-
<PAGE>   25
         In November 1996, pursuant to the Alliance Agreement, the Company and
Hyatt formed a strategic alliance whereby Hyatt agreed to use its best
commercial efforts to assist the Company in advancing the Company's business
with respect to the Entertainment Network. The Alliance Agreement also provides
that the Hyatt Group will help develop and coordinate entrepreneurial and
institutional financing sources for the Company. See "Item 1 -- Description of
Business -- Strategic Alliance With Hyatt Group" and "-- Sales and Marketing."

         In return, Hyatt will receive warrants to purchase Class A Common Stock
comprising up to ten percent of the Company's fully-diluted outstanding Class A
and Class B Common Stock (after giving effect to the exercise of these warrants
and the exercise of all other rights, options and warrants outstanding as of
that date). One-ninetieth of these warrants will be issued for each airplane
with respect to which the Company, or a joint venture subsidiary of the Company,
obtains a binding purchase commitment from an airline (excluding Swissair,
Debonair, Alitalia and certain smaller airlines with which the Company has had
prior negotiations). Hyatt also has the right to participate in up to six
airline projects through joint ventures to be partially-funded by Hyatt. Hyatt's
interest in the joint ventures will be convertible into Class A Common Stock of
the Company. Hyatt was also granted rights to demand four registrations, along
with unlimited "piggyback" registration rights, in connection with the resale of
any shares of Class A Common Stock acquired under the Alliance Agreement (other
than shares acquired in the open market). In addition, Hyatt has the right to
designate and has designated two individuals to serve on the Board, and these
individuals received options aggregating 250,000 shares of Class A Common Stock.
Hyatt also received an additional 60,000 shares of Class A Common Stock as
consideration for its execution of an agreement with Qantas, which was necessary
for the Company to participate in Qantas' bid alignment process. Issuance and
exercise of the Hyatt warrants, conversion of Hyatt's joint venture interests,
and/or issuance of the aforementioned 60,000 shares may dilute the interests of
existing stockholders. See "Item 1 -- Description of Business -- Strategic
Alliance With Hyatt Group" and "-- Sales and Marketing."

         The Company anticipates that any revenues derived in the future will
primarily be from sales or leases of the Entertainment Network to airlines and
the participation in the revenues generated from the use by passengers of the
Entertainment Network, especially the gaming features. Some additional revenue
is expected to arise from advertising sales and product sales. The date of
revenue recognition in each case will vary depending upon the structure and
terms of the applicable contract and the timing of the Company's performance
thereunder. Revenues related to sales and leases are expected to constitute a
substantially larger portion of the Company's revenues during the first several
years of operations and can be expected to decline over time. Similarly, certain
costs, particularly those related to product development and sales and
marketing, may be higher during the early years of the Company's business than
in subsequent years and will have an adverse effect on the Company's financial
condition and results of operations. The Company has utilized, and in some cases
has continuing contracts with, sales representatives in foreign countries who
are entitled to a commission for their services, generally a percentage of the
purchase price ranging from 7.5% to 18%. The Company generally expects to reduce
its utilization of such representatives in the future and, where possible, to
terminate those sales representative agreements which have not already expired.

         As the installed customer base of Entertainment Networks increases, and
assuming the Company is able to enter into agreements with airlines containing
revenue sharing provisions, it expects to generate a greater portion of its
revenues from revenue sharing with the airlines and a

                                      -23-
<PAGE>   26
lesser percentage from sales of the Entertainment Network. The Company's
percentage participation in such revenues is expected to vary depending upon
factors such as the entertainment options included on a particular airline's
network, the initial purchase price to the airline and the payment method and
schedule.

         System installation generally requires at least four to seven days per
aircraft (or longer for initial installations), depending on the number of
installed seats, and therefore the Company anticipates that most installations
will occur during an airline's off-season, generally during the winter months.
As a result, the Company might experience related seasonality in its operation
and wide fluctuations in revenues. In addition, the Company might not receive
any portion of the purchase price until 60 to 90 days after the related
installation is complete, which may strain the Company's cash resources or lead
to cash flow shortages.

         In connection with the Company's March 1995 initial public offering,
stockholders of the Company deposited 3,200,000 shares of Class B Common Stock
into escrow, which will be released if the Company attains certain earnings
levels. In the event that any of such shares beneficially owned by current and
former officers, directors, employees and consultants of the Company are
released from escrow, such releases will be deemed compensatory and accordingly
will result in a substantial non-cash charge to reportable earnings, which would
equal the fair market value of such shares on the date of release. Such a charge
could substantially increase the Company's loss or reduce or eliminate the
Company's net income, if any, for financial reporting purposes for the period(s)
during which such shares are or become probable of being released from escrow.
Although the amount of compensation expense recognized by the Company will not
effect the Company's total stockholders' equity, it may have a depressive effect
on the market price of the Company's securities.

         The foregoing represents the Company's current plan of operations.
Future events, including changes in technological, economic, regulatory or
competitive conditions or the results of the Company's sales and marketing
activities may require changes in the Company's plans.

RESULTS OF OPERATIONS

         The Company generated $2,985,402 in revenues and incurred a net loss of
approximately $19,266,901 for the year ended October 31, 1996, compared to
$15,523 in revenues and a net loss of $5,331,278 for the year ended October 31,
1995. The increase in revenues resulted primarily from the delivery and
acceptance of the Entertainment Networks under the Alitalia Agreement. The
increased losses were due to an increase in staff and facilities in order to
fulfill the Company's requirements under the Alitalia Agreement, Debonair
Agreement and Swissair Agreement, increased administrative fees and increased
research and development expenses. The Company may incur additional losses in
the future. At October 31, 1996, the Company had an accumulated deficit of
approximately $25.0 Million.

         Cost of sales was $4,577,277 (153% of sales) and $2,130 (14% of sales),
respectively, for the years ended October 31, 1996 and October 31, 1995.
Although the Company expects to reduce the cost of sales as a percentage of
sales for future periods, these percentages are likely to remain high over the
next few quarters since the Company's business plan is to derive a substantial
portion of its revenues from future passenger use of the Entertainment Network.

                                      -24-
<PAGE>   27
         Provisions for doubtful accounts were $1,732,377 for the year ended
October 31, 1996, compared to $0 for the year ended October 31, 1995. The
increase was due to a provision for the last three shipsets under the Alitalia
Agreement. The Company recognized the revenue associated with these shipsets
upon delivery and acceptance of the equipment in accordance with the contract.
The receivable was greater than 120 days old and was deemed uncollectible after
repeated failed attempts to collect.

         Research and development expenses during the year ended October 31,
1996 were $5,278,583, an increase of $2,898,389 (or 122%) from $2,380,194 for
the year ended October 31, 1995. This increase reflects the Company's use of
proceeds from the Class A Warrant Exercise Offer (whereby the exercise price of
Class A Warrants was reduced to $5.75 and an extra 1/2 Class B Warrant was
issued upon such exercise) to fund the continuing development of the
Entertainment Network. See "Item 1 -- Description of Business -- Product
Development."

         Marketing and administrative expenses were $9,973,867 for the year
ended October 31, 1996, an increase of $7,531,452 (or 308%) from $2,442,415 for
the year ended October 31, 1995. This increase was primarily due to increased
marketing efforts and increase in staff and related expenses. Additionally, the
Company recorded charges of $1,545,847 and $919,596 upon the issuance of
warrants and Class A Common Stock, respectively. The warrants were issued
pursuant to an agreement whereby Banner Aerospace, Inc. agreed to provide
logistical support to enhance the Company's chances of obtaining business with a
major European airline. The stock was issued upon the exercise of employee stock
options which, because of a cashless exercise, resulted in a charge to
compensation expense equal to the value of the shares issued. In addition, in
July 1996 the Company relocated its principal offices and its design and
assembly facilities to Phoenix, Arizona, and recorded relocation costs of
$591,000 in connection therewith.

         Expenses for unusual items were $1,266,390 during the year ended
October 31, 1996, as compared to $0 for the year ended October 31, 1995 In April
1996, the Company's President resigned but agreed to continue to serve as a
consultant for one year. In October 1996, the Company's Vice President of
Business Development, the Company's Vice President of Sales and Secretary, and
the Company's Chief Financial Officer resigned, although each agreed to continue
to serve as a consultant for one year. In connection with these resignations,
the Company recognized severance expense in the amount of $752,500. In addition,
the Company terminated an agreement with a foreign sales representative and
consultant and, as a result, recorded $420,000 as unusual charges. The Company
also settled an outstanding breach of contract claim with an individual with
whom the Company had engaged in prior negotiations to become an officer, and in
connection therewith recorded unusual charges of $93,890.

         The Company incurred $2,076 of interest expense during the year ended
October 31, 1996, a decrease of $849,142 (or 99%) from $851,218 for the year
ended October 31, 1995. The substantial decrease is a result of the repayment of
a $3,100,000 loan from proceeds of its 1995 public equity offering.

         The Company received $578,267 in interest during the year ended October
31, 1996, an increase of $249,111 (or 76%) from $329,156 for the year ended
October 31, 1995. This interest arose principally out of short term investments
of working capital. The increase was attributable to increased funds available
for such investments as a consequence of the Company's Class A Warrant Exercise
Offer in May 1996 and the subsequent exercise of remaining Class A Warrants in
July 1996.

                                      -25-
<PAGE>   28
LIQUIDITY AND CAPITAL RESOURCES

         At October 31, 1996, the Company had working capital of approximately
$13.6 Million. The Company's primary source of funding has been through sales of
its equity. Since the repayment of its 1994 bridge financing loan, the Company
has not utilized significant debt financing. The Company increased its working
capital in May 1996 from the proceeds of its Class A Warrant Exercise Offer from
which the Company received proceeds (net of expenses and commissions of
approximately $1.6 Million) of approximately $25.2 Million. The Company also
increased its working capital in July 1996 from Class A Warrant exercises
(prompted by the Company's notice of redemption of the remaining Class A
Warrants) from which the Company received proceeds (net of expenses of
approximately $40,000) of approximately $0.7 Million.

         Since October 31, 1996, the Company has experienced further losses;
however, the Company increased its working capital in December 1996 from the
proceeds of its Class B Warrant Exercise Offer (whereby the exercise price of
Class B Warrants was reduced to $7.50) from which the Company received
approximately $69.1 Million (net of expenses and commissions of approximately
$4.5 Million).

         At October 31, 1996, the Company's material capital commitments were
(i) purchase orders of approximately $18.0 Million, primarily relating to
inventory purchases and (ii) its obligations under the Swissair Agreement and
the Debonair Agreement.

         The Company's revenues have been generated, and are anticipated to be
generated, primarily from sales, leasing installation and servicing of the
Entertainment Network aboard commercial and charter aircraft. The contracts the
Company has executed and is currently negotiating generally provide for the
Company to install the Entertainment Network on an aircraft and to be paid for
the equipment and its installation and maintenance out of revenue generated by
passenger use of the installed network on the aircraft. As a result, the Company
must expend significant capital amounts for the test installations (which
require the assembly and installation of approximately 30 to 280 in-seat video
terminals, cabin file servers, cluster controllers, video-on-demand servers and
SEBs and cabling the first, business and/or economy class sections of the
aircraft) and subsequent assembly, installation and maintenance of the
Entertainment Network on each aircraft. However, revenue as payment for the
system will typically be received, if at all, only as a result of the use of the
system over a potentially significant period of time. Moreover, the Company may
also enter into commitments to purchase equipment necessary for additional
installations, even in the absence of a purchase commitment from an airline, if
such action is determined to be necessary or desirable to pursue business
opportunities. The Company also expects its cash requirements to increase in
future periods due to higher expenses associated with increased sales and
marketing activities and financing of inventory purchases, installations and
accounts receivable.

         The Company is currently using its working capital to finance all of
its current expenses, including test installations, equipment purchases, product
development, inventory and other expenses associated with the delivery and
installation of the Swissair and Debonair Entertainment Networks, as well as for
payment of continued marketing and research and development expenses. See "--
General." The Company plans to continue to use a substantial portion of its cash
resources to fund its plan of operations described above. The Company believes
that its current cash reserves will be sufficient to fund the Company's
performance under its current contracts and to fund its other planned operations
through approximately December 31, 1997.

                                      -26-
<PAGE>   29
However, after that date, the Company will require significant additional
financing to continue its operations. Furthermore, although the Company is in
various stages of negotiations with certain airlines, the Company's budgeted
operations do not include any costs or expenses associated with any future
airline contracts for the Entertainment Network. Thus, in the event that the
Company obtains any additional orders for the Entertainment Network (as to which
there can be no assurance), the Company would require significant additional
financing in order to finance the customization, manufacture, assembly and
installation of any such future orders of the Entertainment Network (which
requirement may arise prior to December 31, 1997). The Company may also in the
future elect to explore additional applications for its technologies other than
in-flight entertainment. To do so, the Company would require significant
additional capital for research and development and, if such development efforts
are successful, for marketing, manufacturing and installing its new products.

         In November 1996, the Company entered into a nonbinding arrangement
pursuant to which it will work with BT Securities in structuring a proposed
financing of up to $150 Million of debt and equity securities (the "BT
Arrangement"). The ability of BT Securities to act as placement agent is
conditioned upon the satisfaction of several significant conditions. If each of
the conditions is satisfied and the parties elect to effect the placement, it is
expected that the placement would occur in the second quarter of calendar 1997.
The Company has paid BT an aggregate of $125,000 as a work fee for services
performed or to be performed under the BT Arrangement.

         As part of its obligations under the Alliance Agreement to assist the
Company, Hyatt has agreed to develop and coordinate entrepreneurial and
institutional financing sources for the Company.

         The Company continues to seek other sources of additional capital;
however, as of January 17, 1997, the Company did not have any commitments or
other definitive arrangements relating thereto other than the BT Arrangement.
There can be no assurance that the Company will be able to secure significant
capital or as to the amount or the terms thereof. The Company is exploring a
range of financing alternatives, including the sale of debt securities and
securing credit facilities.

FORWARD LOOKING STATEMENTS

         Except for historical information contained herein, the matters
discussed in this ITEM 6 and elsewhere in this Annual Report on Form 10-KSB are
forward-looking statements (within the meaning of Section 27A of the Securities
Act of 1993, as amended (the "Securities Act") and Section 21E of the Securities
Exchange Act of 1934, as amended (the "Exchange Act")) that are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those set forth in such forward-looking statements. Such risks
and uncertainties include, but are not limited to, the failure of passenger use
of the Entertainment Network to generate sufficient revenues, the failure to
execute definitive agreements with additional airlines on favorable terms or at
all, cost overruns in connection with the Company's current contracts, the
failure of the Company to receive sufficient financing to perform under any new
airline contracts or to perform sufficient future research and development, the
impact of competition and downward pricing pressures, the effect of changing
economic conditions and conditions in the airline industry, the impact of any
changes in domestic and foreign regulatory environments or the Company's

                                      -27-
<PAGE>   30
inability to obtain requisite government approvals, risks in technology
development, the risks involved in currency fluctuations, and the other risks
and uncertainties detailed herein.


ITEM 7  --  FINANCIAL STATEMENTS

         The audited financial statements of the Company for the fiscal year
ended October 31, 1996 are located beginning at page F-1 of this Annual Report
on Form 10-KSB.

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

         There are no items or circumstances to be disclosed under this Item 8.

                                      -28-
<PAGE>   31
                                    PART III

ITEMS 9 -- 12 --  DOCUMENTS INCORPORATED BY REFERENCE

         Information with respect to Items 9, 10, 11 and 12 of Form 10-KSB is
hereby incorporated by reference into this Part III of Form 10-KSB from the
Registrant's Definitive Proxy Statement relating to the Registrant's 1997 Annual
Meeting of Stockholders to be filed by the Registrant with the Securities and
Exchange Commission on or before February 28, 1997.

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

         The exhibits listed in the Index to Exhibits below are filed as part of
the Annual Report on Form 10-KSB, as amended.

         (a)      EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                     DESCRIPTION
------                     -----------
<S>       <C>    <C>
1.1(1)     -      Revised Form of Underwriting Agreement
3.1(1)     -      Certificate of Ownership and Merger
3.2(1)     -      Amended and Restated Certificate of Incorporation of the Registrant
3.3(1)     -      Certificate of Amendment of Amended and Restated Certificate of Incorporation of
                  Registrant
3.4(1)     -      By-laws of the Registrant
4.1(1)     -      Warrant Agreement, dated as of March 7, 1995, by and among the Registrant, D.
                  H. Blair Investment Banking Corp. and American Stock Transfer & Trust
                  Company
4.2(6)     -      Form of Amendment to March 7, 1995 Warrant Agreement, to be entered into by
                  and among the Registrant, D. H. Blair Investment Banking Corp., and American
                  Stock Transfer & Trust Company
4.3(6)     -      Warrant Agreement, dated as of October 24, 1996, by and among the Registrant,
                  D. H. Blair Investment Banking Corp., and American Stock Transfer & Trust
                  Company
4.4(6)     -      Form of Amendment to October 24, 1996 Warrant Agreement, to be entered into
                  by and among the Registrant, D. H. Blair Investment Banking Corp., and
                  American Stock Transfer & Trust Company
4.5(1)     -      Form of Underwriter's Unit Purchase Option
4.6(1)     -      Specimen of Class A Common Stock Certificate
4.7(1)     -      Specimen of Class B Common Stock Certificate
4.8(6)     -      Specimen of Class B Warrant Certificate
4.9(3)     -      Specimen of Class C Warrant Certificate
4.10(3)    -      Specimen of Class D Warrant Certificate
4.11(6)    -      Stock Purchase Warrant, dated as of November 7, 1996, issued to FortuNet, Inc.
4.12(6)    -      Stock Purchase Warrant, dated as of November 12, 1996, issued to Houlihan
                  Lokey Howard & Zukin
10.1(4)    -      Amended and Restated 1994 Stock Option Plan
</TABLE>


                                      -29-
<PAGE>   32
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                               DESCRIPTION
------                                               -----------
<S>      <C>     <C>
10.2(6)    -      Severance Agreement between the Registrant and Steven M. Fieldman dated as of
                  November 4, 1996
10.3(1)    -      Employment Agreement between the Registrant and Michael Itkis dated as of
                  October 31, 1994
10.4(6)    -      Employment Agreement between the Registrant and John Alderfer, dated as of
                  October 2, 1996
10.5(6)    -      Severance Agreement between the Registrant and Lance Fieldman dated as of
                  November 4, 1996
10.6(1)    -      Amended and Restated Shareholders' Agreement by and among Yuri Itkis, Michael
                  Itkis, Boris Itkis, Steven M. Fieldman, Donald H. Goldman, Lance Fieldman and
                  Registrant dated as of October 6, 1994
10.7(6)    -      Amended and Restated Intellectual Property License and Support Services
                  Agreement by and between FortuNet, Inc. and Registrant dated as of November 7,
                  1996
10.8(1)    -      Amended and Restated Escrow Agreement by and between the Registrant,
                  American Stock Transfer & Trust Company, Yuri Itkis, Michael Itkis, Boris Itkis,
                  Steven M. Fieldman, Donald H. Goldman and Lance Fieldman
10.9(6)    -      Sublease and Consent, dated July 16, 1996 between the Registrant and AGF 4041
                  Limited Partnership
10.10(6)   -      Office Lease, dated July 15, 1996, between the Registrant and AGF 4041 Limited
                  Partnership
10.11(6)          - Standard Industrial/Commercial Single-Tenant Lease-Net;
                  dated as of June 27, 1996, between the Registrant and 44th
                  Street and Van Buren Limited Partnership
10.12(1)   -      Form of Indemnification Agreement
10.13(1)   -      Form of International Sales Representative Agreement
10.14(6)   -      Strategic Alliance Agreement, dated as of November 12, 1996, between the
                  Registrant and Hyatt Ventures, Inc.
10.15(6)   -      Registration Rights Agreement, dated as of November 12, 1996, between the
                  Registrant and Hyatt Ventures, Inc.
10.16(6)   -      Amendment No. 2 to Amended and Restated Shareholders' Agreement, dated as of
                  November 12, 1996
10.17(6)   -      Agreement, dated as of May 10, 1996, between the Registrant and Donald H.
                  Goldman
23         -      Consent of KPMG Peat Marwick LLP
27         -      Financial Data Schedule
</TABLE>


---------------
 (1)     Incorporated by reference from the Registrant's Registration Statement
         on Form SB-2, Registration No. 33-86928.
 (2)     Incorporated by reference from the Registrant's Annual Report on Form
         1O-KSB for the fiscal year ended October 31, 1995, filed with the
         Securities and Exchange Commission on February 13, 1996, File No.
         0-25668.
 (3)     Incorporated by reference from the Registrant's Quarterly Report on
         Form 1O-QSB for the fiscal year ended July 31, 1996, filed with the
         Securities and Exchange Commission on September 16, 1996, File No.
         0-25668.


                                      -30-
<PAGE>   33
 (4)     Incorporated by reference from the Registrant's Registration Statement
         on Form SB-2, Registration No. 333-02044.
 (5)     Incorporated by reference from the Registrant's Registration Statement
         on Form S-8, Registration No. 333-15767.
 (6)     Incorporated by reference from the Registrant's Registration Statement
         on Form S-3, Registration No. 333-14013.

         (b)      REPORTS ON FORM 8-K.

                  The Company did not file any reports on Form 8-K during the
         fourth quarter of the fiscal year ended October 31, 1996.


                                      -31-
<PAGE>   34
                                   SIGNATURES

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

                                           INTERACTIVE FLIGHT TECHNOLOGIES, INC.

Dated:  January 21, 1997                   By: /s/ Michail Itkis
                                              --------------------------------
                                                    Michail Itkis
                                                    Chief Executive Officer

         In accordance with the Exchange Act, this report has been signed by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.

<TABLE>
<CAPTION>
Signature                                 Title                                                      Date
---------                                 -----                                                      ----
<S>                                   <C>                                                        <C>
                                                       
  /s/ Michail Itkis
-----------------------------
Michail Itkis                          Chief Executive Officer and Director                        January 21, 1997

  /s/ Thomas M. Metzler
-----------------------------
Thomas M. Metzler                      President and Chief Operating Officer                       January 21, 1997

  /s/ John W. Alderfer
-----------------------------
John W. Alderfer                       Chief Financial Officer
                                       (Principal Financial Officer)                               January 21, 1997

  /s/ Lauren A. Snopkowski
-----------------------------
Lauren A. Snopkowski                    Controller
                                       (Principal Accounting Officer)                              January 21, 1997

  /s/ Adam Aron
-----------------------------
Adam Aron                              Director                                                    January 17, 1997

  /s/ Brian E. Barents
-----------------------------
Brian E. Barents                       Director                                                    January 21, 1997

  /s/ Alexander M. Haig, Jr.
-----------------------------
General Alexander M. Haig, Jr.         Director                                                    January 21, 1997

  /s/ Yuri Itkis
-----------------------------
Yuri Itkis                             Director                                                    January 21, 1997
                                                                  
</TABLE>


                                      -32-
<PAGE>   35
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.



                          Index to Financial Statements



<TABLE>
<CAPTION>
                                                                            Page
                                                                            ----
<S>                                                                         <C>
Independent Auditors' Report                                                 F-2

Balance Sheets as of October 31, 1996 and 1995                               F-3

Statements of Operations for the years ended October 31, 1996 and 1995       F-4


Statements of Stockholders' Equity for the years ended October 31, 1996
     and 1995                                                                F-5

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

Notes to Financial Statements                                                F-7
</TABLE>




                                      F-1
<PAGE>   36
                          INDEPENDENT AUDITORS' REPORT



The Stockholders and Board of Directors
Interactive Flight Technologies, Inc.:


We have audited the accompanying balance sheets of Interactive Flight
Technologies, Inc. as of October 31, 1996 and 1995, and the related statements
of operations, stockholders' equity, and cash flows for the years then ended.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.

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

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



                           /s/ KPMG Peat Marwick LLP

Las Vegas, Nevada
January 6, 1997




                                      F-2
<PAGE>   37
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                                 Balance Sheets



<TABLE>
<CAPTION>
                                                                                        OCTOBER 31
                                                                             --------------------------------
                                  ASSETS                                         1996                1995
                                                                             ------------        ------------
<S>                                                                          <C>                 <C>         
Current assets:
    Cash and cash equivalents                                                $  7,736,345        $  5,036,582
    Investment securities                                                       6,810,275                  --
    Accounts receivable, net of allowance for doubtful
      accounts of $1,732,377 and $0                                               106,602              34,913
    Inventories                                                                 4,726,935           2,046,224
    Deferred costs                                                                 48,242             300,000
    Prepaid expenses                                                              138,629             134,498
    Other current assets                                                          987,932              96,469
                                                                             ------------        ------------
                Total current assets                                           20,554,960           7,648,686
Property and equipment, net                                                     4,659,500           1,637,172
Deposits                                                                           93,030              28,944
                                                                             ------------        ------------

                Total assets                                                 $ 25,307,490        $  9,314,802
                                                                             ============        ============

                   LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
    Accounts payable                                                         $  4,073,940        $    585,697
    Accrued expenses                                                              289,983             160,033
    Due to related parties                                                         69,240                  --
    Due to officers, directors, and employees                                      25,840                  --
    Accrued product warranties                                                  1,166,010                  --
    Accrued severance costs                                                       567,500                  --
    Other current liabilities                                                     792,071                  --
                                                                             ------------        ------------
                Total current liabilities                                       6,984,584             745,730
Noncurrent accrued severance costs                                                110,000                  --
Noncurrent accrued product warranties                                             505,035                  --
                                                                             ------------        ------------
                Total liabilities                                               7,599,619             745,730
                                                                             ------------        ------------

Stockholders' equity:
    Preferred stock, par value $0.01 per share.  5,000,000 shares
      authorized, none issued                                                          --                  --
    Class A common stock, one vote per share, par value
      $0.01 per share, 40,000,000 shares authorized, 8,102,047
      and 3,220,000 shares issued and outstanding, respectively                    81,020              32,200
    Class B common stock, six votes per share, par value
      $0.01 per share, 4,000,000 shares authorized; 3,960,000 and
      4,000,000 shares issued and outstanding, respectively, including
      3,200,000 shares placed in escrow                                            39,600              40,000
    Additional paid-in capital                                                 42,587,712          14,230,432
    Accumulated deficit                                                       (25,000,461)         (5,733,560)
                                                                             ------------        ------------
                Total stockholders' equity                                     17,707,871           8,569,072
                                                                             ------------        ------------

                Total liabilities and stockholders' equity                   $ 25,307,490        $  9,314,802
                                                                             ============        ============
</TABLE>

See accompanying notes to financial statements.

                                      F-3
<PAGE>   38
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                            Statements of Operations



<TABLE>
<CAPTION>
                                                                    YEARS ENDED OCTOBER 31,    
                                                                -------------------------------
                                                                    1996                1995
                                                                ------------        -----------
<S>                                                             <C>                 <C>        
Revenue:
    Equipment sales                                             $  2,671,924        $        --
    Service income                                                   313,478             15,523
                                                                ------------        -----------
                                                                   2,985,402             15,523
                                                                ------------        -----------

Costs and expenses:
    Cost of equipment sales                                        3,711,702                 --
    Cost of service income                                           865,575              2,130
    Provision for doubtful accounts                                1,732,377                 --
    Research and development expenses                              5,278,583          2,380,194
    Marketing and administrative expenses                          9,973,867          2,442,415
    Unusual items                                                  1,266,390                 --
                                                                ------------        -----------
                                                                  22,828,494          4,824,739
                                                                ------------        -----------

                Loss from operations                              19,843,092          4,809,216

Other:
    Interest expense and amortization of debt issue costs             (2,076)          (851,218)
    Interest income                                                  578,267            329,156
                                                                ------------        -----------

                Net loss                                        $ 19,266,901        $ 5,331,278
                                                                ============        ===========



Net loss per share of common stock                              $      (3.11)       $     (1.86)
                                                                ============        ===========


Weighted average shares outstanding                                6,198,366          2,859,384
                                                                ============        ===========
</TABLE>



See accompanying notes to financial statements.




                                      F-4
<PAGE>   39
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                       Statements of Stockholders' Equity


<TABLE>
<CAPTION>
                                                                                  CLASS A                         CLASS B           
                                                   PREFERRED STOCK              COMMON STOCK                    COMMON STOCK        
                                               -----------------------     -----------------------       -------------------------- 
                                               SHARES         AMOUNT        SHARES         AMOUNT          SHARES           AMOUNT  
                                               ------         ------        ------         ------          ------           ------  
<S>                                            <C>          <C>            <C>             <C>           <C>               <C>      
Balance at November 1, 1994                       --                --            --            --        4,000,000          40,000 
Initial public offering                           --                --     2,800,000        28,000               --              -- 
Over-allotment to underwriters - held in
    escrow                                        --                --       420,000         4,200               --              -- 
Sale of unit purchase option to underwriter
    for 280,000 shares                            --                --            --            --               --              -- 
Registration costs                                --                --            --            --               --              -- 
Warrants issued in connection with bridge
    financing (537,500 warrants)                  --                --            --            --               --              -- 
Net loss                                          --                --            --            --               --              -- 
                                                ----        ----------     ---------       -------       ----------        -------- 
Balance at October 31, 1995                       --                --     3,220,000        32,200        4,000,000          40,000 
Class A common stock issued pursuant to
    Class A warrant exercise offer                --                --     4,655,320        46,553               --              -- 
Class A common stock issued pursuant to
    Class A warrant call                          --                --       112,020         1,120               --              -- 
Class A common stock issued under stock
    option plan for cash                          --                --         4,750            48               --              -- 
Class A common stock issued under stock
    option plan pursuant to cashless
    exercise option                               --                --        69,957           699               --              -- 
Warrants issued for services received
    (624,250 warrants)                            --                --            --            --               --              -- 
Redemption of Class A warrants                                                                                                 
Registration costs                                --                --            --            --               --              -- 
Automatic conversion of Class B shares to
    Class A shares upon sale to non-holder
    of Class B shares                             --                --        40,000           400          (40,000)           (400)
Net loss                                          --                --            --            --               --              -- 
                                                ----        ----------     ---------       -------       ----------        -------- 

Balance at October 31, 1996                       --        $       --     8,102,047       $81,020        3,960,000        $ 39,600 
                                                ====        ==========     =========       =======       ==========        ======== 
</TABLE>

<TABLE>
<CAPTION>
                                                  
                                                      ADDITIONAL
                                                       PAID-IN           ACCUMULATED
                                                       CAPITAL             DEFICIT     
                                                       -------             -------     
<S>                                                  <C>                 <C>
Balance at November 1, 1994                               276,000            (402,282)
Initial public offering                                13,972,000                  --
Over-allotment to underwriters - held in
    escrow                                              2,095,800                  --
Sale of unit purchase option to underwriter
    for 280,000 shares                                        280                  --
Registration costs                                     (2,221,148)                 --
Warrants issued in connection with bridge
    financing (537,500 warrants)                          107,500                  --
Net loss                                                       --          (5,331,278)
                                                     ------------        ------------
Balance at October 31, 1995                            14,230,432          (5,733,560)
Class A common stock issued pursuant to
    Class A warrant exercise offer                     26,721,537                  --
Class A common stock issued pursuant to
    Class A warrant call                                  783,020                  --
Class A common stock issued under stock
    option plan for cash                                   36,640                  --
Class A common stock issued under stock
    option plan pursuant to cashless
    exercise option                                       918,897                  --
Warrants issued for services received
    (624,250 warrants)                                  1,545,847                  --
Redemption of Class A warrants                               (133)                 --
Registration costs                                     (1,648,528)                 --
Automatic conversion of Class B shares to
    Class A shares upon sale to non-holder
    of Class B shares                                          --                  --
Net loss                                                       --         (19,266,901)
                                                     ------------        ------------

Balance at October 31, 1996                          $ 42,587,712        $(25,000,461)
                                                     ============        ============
</TABLE>

See accompanying notes to financial statements.




                                      F-5
<PAGE>   40
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                            Statements of Cash Flows


<TABLE>
<CAPTION>
                                                                                           YEARS ENDED OCTOBER 31,     
                                                                                       --------------------------------
                                                                                           1996                1995
                                                                                       ------------        ------------
<S>                                                                                    <C>                 <C>          
Cash flows from operating activities:
    Net loss                                                                           $(19,266,901)       $ (5,331,278)
    Adjustments to reconcile net loss to net cash used in
      operating activities:
        Depreciation and amortization                                                       544,569              69,483
        Amortization of debt discount and deferred financing costs                               --             738,418
        Expense recognized upon issuance of stock options and
          stock purchase warrants                                                         2,465,443                  --
        Changes in assets and liabilities:
          Increase in accounts receivable                                                (1,804,066)                 --
          Increase in allowance for doubtfull accounts                                    1,732,377                  --
          Increase in inventories                                                        (2,680,711)         (2,046,224)
          Decrease (increase) in deferred costs                                             193,844            (300,000)
          Increase in prepaid expenses and other current assets                            (895,594)           (248,135)
          Increase in accounts payable                                                    3,488,243             585,697
          Increase in accrued expenses                                                      129,950              46,003
          Increase in accrued product warranties                                          1,671,045                  --
          Increase in due to related parties, officers, directors, and employees
                                                                                             95,080                  --
          Increase in accrued severance costs                                               677,500                  --
          Increase in other liabilities                                                     792,071                  --
                                                                                       ------------        ------------
                Net cash used in operating activities                                   (12,857,150)         (6,486,036)
                                                                                       ------------        ------------

Cash flows from investing activities:
    Purchase of short-term investments                                                   (6,810,275)                 --
    Purchase of property and equipment                                                   (3,508,983)         (1,696,917)
    Deposits                                                                                (64,086)            (14,046)
                                                                                       ------------        ------------
                Net cash used in investing activities                                   (10,383,344)         (1,710,963)
                                                                                       ------------        ------------

Cash flows from financing activities:
    Proceeds from issuance of common stock                                               27,588,918          16,100,000
    Proceeds from issuance of notes                                                              --           1,075,000
    Proceeds from sale of unit purchase options                                                  --                 280
    Payment of bridge notes                                                                      --          (3,100,000)
    Registration costs                                                                   (1,648,528)         (2,154,962)
    Redemption of Class A warrants                                                             (133)                 --
    Financing costs                                                                              --            (117,934)
                                                                                       ------------        ------------
                Net cash provided by financing activities                                25,940,257          11,802,384
                                                                                       ------------        ------------

                Net increase in cash and cash equivalents                                 2,699,763           3,605,385

Cash and cash equivalents at beginning of year                                            5,036,582           1,431,197
                                                                                       ------------        ------------

Cash and cash equivalents at the end of year                                           $  7,736,345        $  5,036,582
                                                                                       ============        ============

Supplemental disclosure of cash flow activities:
    Cash paid for interest                                                             $      2,076        $    112,800
                                                                                       ============        ============
Noncash financing activities:
    Issuance of stock under stock option plan pursuant to cashless
      exercise option                                                                  $    919,596        $         --
                                                                                       ============        ============
    Issuance of warrants for services received                                         $  1,545,847                  --
                                                                                       ============        ============
</TABLE>

See accompanying notes to financial statements.




                                      F-6
<PAGE>   41
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                          Notes to Financial Statements

                            October 31, 1996 and 1995



(1)    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES

       DESCRIPTION OF BUSINESS

       Interactive Flight Technologies, Inc. (the Company or IFT), a Delaware
       Corporation, was organized in February 1994 to develop, manufacture and
       market a computer-based in-flight entertainment network intended to
       provide a wide variety of entertainment options for airline passengers.
       The Company currently has contracts in place with three European airlines
       for the sale, installation, and/or operation of the Company's
       computer-based in-flight entertainment network product.

       DEVELOPMENT STAGE COMPANY

       The Company was a development stage company through January 31, 1996
       where the Company's activities consisted of developing, testing and
       receiving FAA approval for their in-flight entertainment system. On
       February 1, 1996, the Company began revenue generation operations with
       the acceptance of their first in-flight entertainment network by Alitalia
       Airlines, S.p.A.

       REVENUE RECOGNITION

       The Company's revenue derived from sales and installation of equipment is
       recognized upon delivery and acceptance by the customer. Fees derived
       from servicing installed systems is recognized when earned, according to
       the terms of the service contract. Revenue pursuant to contracts which
       provide for revenue sharing with the airlines and/or others will be
       recognized as cash is received in the amount of IFT's retained portion of
       the cash pursuant to the revenue sharing agreement.

       CASH AND CASH EQUIVALENTS

       The Company considers all highly liquid investments with a maturity of
       three months or less at the time of purchase to be cash equivalents.

       INVESTMENT SECURITIES

       Investment securities consist of debt securities maturing within one year
       with a maturity greater than three months at the time of purchase. In
       accordance with Statement of Financial Accounting Standards No. 115,
       "Accounting for Certain Investments in Debt and Equity Securities", these
       securities, which the Company has the ability and intent to hold to
       maturity, are carried at amortized cost.

                                      F-7
<PAGE>   42
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                    Notes to Financial Statements, Continued

       INVENTORIES

       Inventories are stated at the lower of cost or market. Cost is determined
       using the first-in, first-out method for all inventories. Inventory costs
       includes material, labor and manufacturing overhead. Once a part has
       become an integral component identifiable to a specific contract,
       pursuant to which the Company will retain title to the entertainment
       system for a period of time after it becomes operational, it is
       transferred to shipsets under construction.

       PROPERTY AND EQUIPMENT

       Property and equipment are carried at cost, less accumulated
       depreciation. Depreciation and amortization is provided on the
       straight-line method over the estimated useful life of the asset, which
       is generally 3-7 years. The costs of major remodeling and improvements on
       leased offices are capitalized as leasehold improvements. Leasehold
       improvements are depreciated on the straight-line method over the shorter
       of the life of the applicable lease or the useful life of the asset.
       Shipsets will be depreciated over the lesser of the estimated useful life
       of the asset or the life of the contract for which it was built.

       DEFERRED COSTS

       Deferred costs consist of prepaid video licensing and processing fees.
       These costs will be expensed to properly match revenues and expenses.

       RESEARCH AND DEVELOPMENT

       Research and development costs are expensed as incurred.

       WARRANTY COSTS

       The Company provides, by a current charge to income, an amount it
       estimates will be needed to cover future warranty obligations for
       products sold during the year.

       LOSS PER SHARE

       Loss per share is computed by dividing net earnings by the weighted
       average number of common shares outstanding. Usually equivalent shares in
       the form of stock options or other common stock equivalents are included
       in the calculation only when the effects are dilutive. Primary and fully
       diluted earnings per share is presented when the difference between the
       methods is greater than 3%. However, pursuant to certain rules of the
       Securities and Exchange Commission, the calculation also includes equity
       securities, including options and warrants, issued within one year of an
       initial public offering with an issue price less than the initial public
       offering price, even if the effect is anti-dilutive. The treasury stock
       approach was used in determining the dilutive effect of such issuances.
       The computation of fully dilutive loss per share results in antidilution.
       Shares held in escrow are not treated as outstanding during any period.

                                      F-8
<PAGE>   43
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                    Notes to Financial Statements, Continued



       FAIR VALUE OF FINANCIAL INSTRUMENTS

       FASB Statement No. 107, Disclosures About Fair Value of Financial
       Instruments, defines the fair value of a financial instrument as the
       amount at which the instrument could be exchanged in a current
       transaction between willing parties. The carrying amounts of cash and
       cash equivalents, investment securities, accounts receivable, other
       current assets, accounts payable, accrued expenses, due to related
       parties, due to officers, directors and employees , and other current
       liabilities approximate fair value because of the short term maturity of
       those instruments.

       STOCK-BASED EMPLOYEE COMPENSATION AWARDS

       The Company accounts for its stock-based employee compensation awards in
       accordance with Accounting Principles Board Opinion No. 25, Accounting
       for Stock Issued to Employees (APB No. 25). In 1995, Statement of
       Financial Accounting Standards No. 123, Accounting for Stock-Based
       Compensation (SFAS No. 123), was issued which will be effective for the
       Company's year ending October 31, 1997. SFAS No. 123 provides alternative
       accounting treatment to APB No. 25 with respect to stock-based
       compensation and requires certain additional disclosures, including
       disclosures if the Company elects not to adopt the measurement and
       recognition criteria of SFAS No. 123. At this point, the Company does not
       anticipate adopting the measurement and recognition criteria of SFAS No.
       123 and therefore in future years would expect to provide the required
       additional disclosures in the footnotes to the financial statements.

       INCOME TAXES

       Income taxes are accounted for under the asset and liability method.
       Deferred tax assets and liabilities are recognized for the future tax
       consequences attributable to differences between the financial statement
       carrying amounts of existing assets and liabilities and their respective
       tax bases and operating loss and tax credit carryforwards. Deferred tax
       assets and liabilities are measured using enacted tax rates expected to
       apply to taxable income in the years in which those temporary differences
       are expected to be recovered or settled. The effect on deferred tax
       assets and liabilities of a change in tax rates is recognized in income
       in the period that includes the enactment date.

       RECLASSIFICATION

       Certain reclassifications have been made to the 1995 financial statements
       to conform with the 1996 presentation.

       USE OF ESTIMATES

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

                                      F-9
<PAGE>   44
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                    Notes to Financial Statements, Continued



 (2)   INVENTORIES

       Inventories consist of the following at October 31, 1996 and 1995:
<TABLE>
<CAPTION>

                                                                                1996              1995
                                                                            -------------     --------------

<S>                                                                      <C>                      <C>
               Raw materials                                             $    3,554,656           803,716
               Work in process                                                  176,228           764,020
               Finished goods                                                   996,051   $       478,488
                                                                            -------------     --------------

                            Total inventories                            $    4,726,935   $     2,046,224
                                                                            =============     ==============
</TABLE>

 (3)   PROPERTY AND EQUIPMENT

       Property and equipment consist of the following at October 31, 1996 and
1995:

<TABLE>
<CAPTION>
                                                                               1996              1995
                                                                           --------------    --------------

<S>                                                                     <C>               <C>
              Leasehold improvements                                    $      375,708    $      164,055
              Purchased software                                               245,710            60,829
              Furniture                                                        214,366           134,003
              Equipment                                                      1,904,644         1,348,468
                                                                           --------------    --------------
                                                                             2,740,428         1,707,355
              Less accumulated depreciation                                   (451,801)          (70,183)
                                                                           --------------    --------------
                                                                             2,288,627         1,637,172
              Shipsets under construction                                    2,370,873                --
                                                                           --------------    --------------

                            Net property and equipment                  $    4,659,500    $    1,637,172
                                                                           ==============    ==============
</TABLE>


 (4)   LICENSE AGREEMENT

       The Company has an Intellectual Property License and Support Services
       Agreement (the License Agreement) for its core system technology for
       airline use from FortuNet, Inc. (FortuNet). FortuNet is owned by a
       principal stockholder of the Company.

       The License Agreement provides for an annual license fee of $100,000
       commencing in October 1994 and continuing for so long as the Company owns
       current and future rights that remain unexpired, valid and enforceable.
       The Company also has to compensate FortuNet at the rate of 108% of costs
       for development, enhancement, installation, support and maintenance
       services required under the License Agreement. The Company paid FortuNet
       $100,000 during each year ended October 31, 1996 and 1995.

       Concurrent with the License Agreement, the Company has entered into a
       consulting agreement with Yuri Itkis, a related party, who is a principal
       stockholder and director of the Company and sole stockholder of FortuNet.
       The term of the consulting agreement is consistent with the term of the
       licensing agreement. The Company paid Yuri Itkis $100,000 during each
       year ended October 31, 1996 and 1995.

                                      F-10
<PAGE>   45
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                    Notes to Financial Statements, Continued



 (5)   NOTES PAYABLE

       In October and November 1994, the Company issued bridge notes bearing
       interest at 10% per annum which were due the earlier of one year from
       date of issue or the closing of the proposed public offering. The notes
       were paid in March 1995. In connection with the sale of the notes, the
       Company issued warrants for the purchase of 1,550,000 shares of Class A
       common stock at $3.00 per share. Upon completion of the public offering,
       the warrants were converted into warrants containing the same terms as
       the warrants included in units sold in the public offering. The warrants,
       which have been valued at $310,000, were accounted for as debt discount,
       amortized over the life of the loan, and fully written off at the time of
       repayment, resulting in a $306,105 charge to the statement of operations
       for the year ended October 31, 1995. In addition, the Company incurred
       costs in connection with obtaining the financing of approximately
       $460,000, which was amortized over the period of the loan and fully
       written off at the time of repayment, resulting in a $432,313 charge in
       the statement of operations for the year ended October 31, 1995.


(6)    STOCK OPTION PLAN

       In October 1994, the Company adopted a stock option plan in which options
       to acquire an aggregate of 600,000 shares of the Company's Class A common
       stock may be granted to employees, officers, directors and consultants or
       advisers. In November 1996, the Company amended and restated the stock
       option plan to increase the maximum shares which may be issued and sold
       under the plan to 2,400,000. The Company has granted options to purchase
       stock to various parties. All options were issued at a price equal to or
       greater than the market price of the Company's common stock at the date
       immediately prior to the grant and have a term of ten years. Options
       generally become exercisable after one to three years, at the discretion
       of the board of directors. At October 31, 1996 and 1995, 414,700 and
       175,750 options were exercisable, respectively. The following schedule
       summarizes options granted, exercised and canceled for the years ended
       October 31, 1996 and 1995.

<TABLE>
<CAPTION>
                                                                      SHARES          OPTIONS PRICE
                                                                   -------------  ----------------------

<S>                                                                <C>             <C>
              Outstanding at October 31, 1994                               --              --
                  Granted                                              259,000         4.40 - 6.50
                  Canceled                                             (15,250)            5.00
                                                                   -------------
              Outstanding at October 31, 1995                          243,750         4.40 - 6.50
                  Granted                                            1,529,500        9.125 - 16.125
                  Exercised                                           (124,300)        4.40 - 11.00
                  Canceled                                             (44,250)        5.00 - 9.563
                                                                   =============
              Outstanding at October 31, 1996                        1,604,700         4.40 - 16.125
                                                                   =============
</TABLE>

       At the discretion of the board of directors, the Company may allow
       optionees to elect to receive shares equal to the market value of the
       option, in lieu of delivery of the exercise price in cash. The market
       value of the shares issued is charged to compensation expense. As a
       result of optionees selecting this exercise option, only 74,707 shares of
       stock were issued upon the exercise of 124,300 options and $919,596 was
       charged to compensation expense for the year ended October 31, 1996.

                                      F-11
<PAGE>   46
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                    Notes to Financial Statements, Continued



       At October 31, 1996, 2,275,700 shares of Class A common stock were
       reserved for issuance upon exercise of options granted under the
       Company's stock option plan.


(7)    STOCKHOLDERS' EQUITY

       The Company's capital stock consists of Class A and Class B common stock.
       Holders of Class A common stock have one vote per share and holders of
       Class B common stock have six votes per share. Shares of Class B common
       stock are automatically convertible into an equivalent number of shares
       of Class A common stock upon the sale or transfer of such shares to a
       non-holder of Class B common stock.

       PUBLIC OFFERING

       In March 1995, the Company completed an initial public offering and
       received net proceeds of approximately $11,961,000 net of the
       underwriter's commissions and expenses approximating $2,011,000. The
       offering consisted of 2,800,000 Units at $5.00 per unit, each unit
       consisting of one share of Class A common stock, one redeemable Class A
       warrant and one redeemable Class B warrant. On April 24, 1995, the
       Company received net proceeds of approximately $1,886,000, net of
       commissions and expenses approximating $210,000, for the sale of an
       additional 420,000 Units in connection with the exercise of the
       over-allotment options granted to the underwriter of the initial public
       offering.

       In connection with the offering, the underwriter has required, as a
       condition of the offering, that an aggregate of 3,200,000 shares of the
       Company's Class B common stock be designated as escrow shares. The escrow
       shares are not assignable or transferable until certain earnings or
       market price criteria have been met. If the conditions are not met by
       January 31, 1999, such shares will be canceled and contributed to the
       Company's capital. Of the escrow shares, 1,250,000 shares will be
       released from escrow, on a pro rata basis, if and only if, one or more of
       the following conditions is/are met:

       -   the Company's pretax income, exclusive of extraordinary items amount
           to at least $5,900,000 for fiscal 1995 or fiscal 1996, $8,000,000 for
           fiscal 1997 or $10,100,000 for fiscal 1998;

       -   the closing bid price of the Company's Class A common stock is in
           excess of $16.00 for a 30-day period during the 18-month period
           following the public offering or in excess of $20.00 for a 30-day
           period in the subsequent 18-month period.

       The remaining 1,950,000 escrow shares will be released from escrow, if
       and only if, one or more of the following conditions is/are met:

       -   the Company's pretax income, exclusive of extraordinary items,
           amounts to at least $8,500,000 for fiscal 1995 or fiscal 1996,
           $11,500,000 for fiscal 1997 or $14,500,000 for fiscal 1998;

                                      F-12
<PAGE>   47
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                    Notes to Financial Statements, Continued



       -   the closing bid price of the Company's Class A common stock is in
           excess of $22.00 for a 30-day period during the 18-month period
           following the public offering or in excess of $28.00 for a 30-day
           period in the subsequent 18-month period.

       The shares will also be released under certain circumstance if the
       Company is acquired or merged.

       As restrictions on such shares are removed, they will be accounted for 
       as issued for services rendered and the fair value of such shares will 
       be charged to operations as compensation expense.

       WARRANTS

       The following table summarizes warrant activity for the years ended
       October 31, 1996 and 1995:

<TABLE>
<CAPTION>
                                                       CLASS A         CLASS B       CLASS C      CLASS D
                                                     -------------   -------------  -----------  -----------

<S>                                                 <C>             <C>           <C>           <C>
         Outstanding at October 31, 1994               1,012,500             --            --           --
             Issued in connection with bridge
               financing                                 537,500             --            --           --
             Issued in connection with initial
               public offering                         2,800,000      2,800,000            --           --
             Issued in connection with
               underwriter's over-allotment              420,000        420,000            --           --
                                                     -------------   -------------  -----------  -----------
         Outstanding at October 31, 1995               4,770,000      3,220,000            --           --
             Issued in connection with sales                  --        294,250       165,000      165,000
               contract
             Exercise of Class A warrants             (4,767,340)     7,095,196            --           --
             Redemption of Class A warrants               (2,660)            --            --           --
                                                     ------------   -------------  -----------   -----------
         Outstanding at October 31, 1996                      --     10,609,446       165,000      165,000
                                                     =============   =============  ===========  ===========

         Exercise price                                $  7.00         $  9.75       $ 11.00       $ 14.00
                                                     =============   =============  ===========  ===========
</TABLE>

       Each Class A warrant entitles the holder to one share of Class A common
       stock and one Class B warrant. Each Class B, Class C, and Class D warrant
       entitles the holder to one share of Class A common stock. All outstanding
       warrants were exercisable at October 31, 1996.

       On April 12, 1996, the Company offered to the holder of its Class A
       warrants to reduce the exercise price of the Class A warrants to $5.75
       per share from $7.00 per share and to issue an extra one-half Class B
       warrant (in addition to one share of Class A common stock and one Class B
       warrant regularly issuable upon the exercise of each Class A warrant)
       upon the exercise of each Class A warrant exercised by May 17, 1996. As a
       result of this offer, 4,655,320 shares of Class A common stock and
       6,983,176 Class B warrants were issued upon the exercise of 4,655,320
       Class A warrants, yielding net proceeds of approximately $25,160,000, net
       of commissions and expenses approximating $1,609,000.

                                      F-13
<PAGE>   48
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                    Notes to Financial Statements, Continued



       Commencing one year from the date of the public offering, the Class A and
       Class B warrants become redeemable by the Company on 30 day's written
       notice at a redemption price of $.05 per warrant if the "closing price"
       of the Company's Class A common stock for any 30 consecutive trading days
       ending within five days of the notice of redemption averages in excess of
       $9.80 and $13.65 per share for Class A and Class B warrants,
       respectively. On June 25, 1996, the Company notified the remaining Class
       A warrant holders of its intent to call all outstanding Class A warrants
       for redemption on July 25, 1996. As a result, 112,020 Class A warrants
       were exercised, resulting in the issuance of 112,020 shares of Class A
       common stock and Class B warrants and net proceeds of approximately
       $744,000, net of commissions and expenses approximating $40,000. The
       remaining 2,660 Class A warrants were redeemed at $.05 per warrant.

       In April and May 1996, the Company issued stock purchase warrants to
       purchase 624,250 shares of Class A common stock at various exercise
       prices (see above schedule) in connection with an agreement with Banner
       Aerospace to provide logistical support to enhance the Company's chances
       of obtaining business with a major European airline, resulting in a
       $1,614,596 charge in the statement of operations for the year ended
       October 31, 1996.

       UNIT PURCHASE OPTIONS

       In conjunction with the public offering, the Company has agreed to sell
       to the underwriter and its designees, for nominal consideration, a unit
       purchase option to purchase up to 280,000 units substantially identical
       to the units being offered to the public, except that the warrants
       included therein are not subject to redemption by the Company unless, on
       the redemption date, the unit purchase option has been exercised and the
       underlying warrants are outstanding. The unit purchase option will be
       exercisable during the four year period commencing one year from the date
       of the initial public offering at an exercise price of $6.00 per unit,
       subject to certain events.


(8)    INCOME TAXES
       Income tax expense differed from the amounts computed by applying the
       U.S. Federal income tax rate of 34% to net loss as a result of the
       following:

<TABLE>
<CAPTION>
                                                                               1996              1995
                                                                           --------------    --------------

<S>                                                                     <C>               <C>
              Computed expected tax benefit                             $    6,550,746    $    1,812,635
              Change in valuation allowance                                 (6,544,334)       (1,805,532)
              Other nondeductible expense                                       (6,412)           (7,103)
                                                                           --------------    --------------

                                                                        $           --    $           --
                                                                           ==============    ==============
</TABLE>

                                      F-14
<PAGE>   49
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                    Notes to Financial Statements, Continued



       The tax effects that give rise to significant portions of the deferred
       tax assets are presented below:

<TABLE>
<CAPTION>
                                                                               1996              1995
                                                                           --------------    --------------

<S>                                                                    <C>                 <C>
              Deferred tax assets:                                      $                 $
                  Net operating loss carryforward                            4,925,697           819,708
                  Deferred start-up costs                                    1,281,599         1,128,849
                  Commissions not currently deductible
                    for tax purposes                                           818,267                --
                  Compensation expenses not currently
                    deductible for tax purposes                                258,171            18,982
                  Allowance for doubtful accounts                              589,008                --
                  Warranty expenses not currently deductible
                    for tax purposes                                           568,155                --
                  Other                                                         44,380           (26,596)
                                                                           --------------    --------------
                                                                             8,485,277         1,940,943
              Less valuation allowance                                      (8,485,277)       (1,940,943)
                                                                           --------------    --------------

                            Net deferred tax assets                     $           --    $           --
                                                                           ==============    ==============
</TABLE>

       In assessing the realizability of deferred tax assets, management
       considers whether it is more likely than not that some portion or all of
       the deferred tax assets will not be realized. The ultimate realization of
       deferred tax assets is dependent upon the generation of future taxable
       income during the periods in which those temporary differences become
       deductible. Management has provided a valuation allowance for 100% of the
       deferred tax assets as the likelihood of realization cannot be
       determined. As of October 31, 1996, the Company has a net operating loss
       (NOL) carryforward for federal income tax purposes of approximately
       $14,487,000, which begins to expire in 2009. The Company likely under
       went a change in ownership in accordance with Internal Revenue Code
       Section 382, the effect of which has not yet been determined by the
       Company. This change would effect the timing of the utilization of the
       NOL.

(9)    RELATED PARTY TRANSACTIONS

       The Company has an exclusive license agreement for its core system
       technology from FortuNet, Inc. FortuNet is owned by a principal
       stockholder of the Company. Additionally, the Company has a consulting
       agreement with a director who is also a principal stockholder of the
       Company and sole stockholder of FortuNet, Inc.

       The Company has a letter agreement dated May 28, 1996 with a specialty
       investment banking firm (the Firm) to act as the Company's financial
       advisor. The senior managing director of this Firm is also a director of
       the Company. The terms of the agreement call for a $50,000 non-refundable
       retainer fee upon execution of the agreement and additional retainer fees
       of $20,000 per month through December 31, 1997. In the event that certain
       specified transactions occur, to which the Firm has advised the Company,
       the Firm will be paid 10% of the first $100,000,000 of the aggregate
       consideration and .75% of all consideration in excess of $100,000,000.
       The Company paid the Firm $169,190 during the year ended October 31,
       1996. Due to related parties includes $69,240 payable to the Firm at
       October 31, 1996.

                                      F-15
<PAGE>   50
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                    Notes to Financial Statements, Continued



       The Company has a consulting agreement with Worldwide Associates
       (Worldwide) to perform various consulting services. The chairman and
       president of Worldwide is also a director of the Company. The terms of
       the agreement call for annual consulting fees of $50,000 and a fee equal
       to 1% of gross revenues received by the Company pursuant to contracts
       obtained through significant advice or assistance provided by Worldwide.
       The Company paid Worldwide $41,667 during the year ended October 31,
       1996.

       As consideration for services rendered in connection with obtaining
       additional sources of financing, a certain director has received $100,000
       during the year ended October 31, 1996. During the year ended October 31,
       1996, the Company executed severance agreements with three former
       officers, pursuant to which the Company has paid approximately $75,000 in
       the year ended October 31, 1996 and has agreed to pay $677,500 over the
       next three years. Severance expense totaling $752,500 is included as an
       unusual item in the accompanying statement of operations for the year
       ended October 31, 1996.

       Amounts due to officers, directors, and employees represent directors'
       fees and expense reimbursements unpaid at October 31, 1996.

 (10)  COMMITMENTS AND CONTINGENCIES

       EMPLOYMENT AGREEMENTS

       As of October 31, 1996, the Company has employment agreements with two
       officers for aggregate annual base salaries of $450,000, which expire
       August 1997 through October 1999.

       STOCKHOLDERS' AGREEMENT

       In October 1994, the Company entered into a stockholders' agreement with
       principal stockholders covering certain corporate governance matters. The
       agreement provides for among other matters, prior consent for any future
       issuance of Class A common stock under certain conditions, rights for
       nomination of directors by each group of the principal stockholders, a
       right of first refusal to purchase any shares of a principal stockholder
       offering to sell and not to compete with the Company while being a
       stockholder of the Company and for a period of three years thereafter.

       LEASE OBLIGATIONS

       The Company leases its facilities under operating leases. Minimum future
       obligations on the leases in effect as of October 31, 1996 are as
       follows:
<TABLE>
<CAPTION>
                                                                               AMOUNT
                                                                           --------------
<S>                                                                     <C>

                   YEAR ENDING OCTOBER 31
                         1997                                           $      940,936
                         1998                                                  833,154
                         1999                                                  574,610
                                                                           --------------
                                                                             2,348,700
                   Less amounts representing sublease income                  (104,418)
                                                                           --------------

                                                                        $    2,244,282
                                                                           ==============
</TABLE>

                                      F-16
<PAGE>   51
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                    Notes to Financial Statements, Continued



       Rent expense was $398,250 and $107,549 for the years ended October 31,
1996 and 1995, respectively.

       LAWSUITS

       On October 25, 1996, the Company settled a lawsuit in which an individual
       who performed certain services for the Company and with whom the Company
       had been engaged in negotiations to become an officer of the Company
       claimed breach of an alleged contract and wrongful discharge. The terms
       of the settlement require the Company to pay the plaintiff $54,885 over
       the next nine months and issue an option to purchase 5,800 shares of
       Class A common stock at a exercise price of $4.40 per share. As a result,
       $93,890 is included as an unusual item for the year ended October 31,
       1996.

       SALES REPRESENTATIVE AGREEMENTS

       As of October 31, 1996, the Company has entered into agreements with
       several non-affiliated sales representatives in foreign countries to
       market and promote the Company's product and to assist in the
       negotiations with airlines. Such agreements typically provide for the
       sales representatives to act as the Company's exclusive representative in
       a particular territory or with respect to a particular airline. The
       Company currently has agreements covering specified areas of and/or
       airlines in Europe, the Middle East, North and South America, the Far
       East, Africa, Australia and Egypt. Such arrangements generally provide
       for a commission based on a percentage of the purchase price ranging from
       7.5% to 18% and expire December 1, 1996 through March 18, 1998.

       SALES REPRESENTATIVE TERMINATION AGREEMENT

       On November 2, 1996, the Company entered into a termination agreement
       with Starlite Aviation Services, a sales representative for the Company.
       The terms of the termination agreement provide for the payment of
       $210,000 immediately, $210,000 upon the closing of the Class B Warrant
       Exercise Offer, and an additional $286,929 upon the installations of the
       entertainment network pursuant to certain contracts. As of October 31,
       1996, execution of the termination agreement was probable and the loss
       was estimable based on the terms of the proposed agreement, Therefore,
       termination expense totaling $420,000 has been accrued and included as an
       unusual item in the accompanying statement of operations for the year
       ended October 31, 1996.

       SALES COMMITMENTS

       As of October 31, 1996, the Company has commitments under three sales
       contracts to manufacture and install 27 shipsets of the in-flight
       entertainment network, to service the Company's installed in-flight
       entertainment networks, and to provide hardware and software upgrades, as
       defined in the agreements.

       Pursuant to the agreement with Alitalia Airlines, S.p.A. (Alitalia), the
       Company has delivered 5 shipsets of the in-flight entertainment network,
       for which Alitalia is responsible for installing. So long as the
       in-flight entertainment network is installed on any aircraft


                                      F-17
<PAGE>   52
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                    Notes to Financial Statements, Continued



       operated by Alitalia, the Company must maintain adequate facilities,
       qualified personnel and spare parts availability to provide Alitalia the
       support services needed to maintain and operate the in-flight
       entertainment networks. The Company will perform maintenance, repair,
       overhaul and modifications of the in-flight entertainment network, as
       needed, at no charge to Alitalia for a period of five years from
       acceptance by Alitalia. Also, for a period of eight years from
       installation, all upgrades in the basic entertainment network which may
       be developed by the Company will be provided to Alitalia free of charge.
       The estimated cost of warranties and upgrades has been accrued and
       included in cost of sales.

       Pursuant to the agreement with Debonair Airways, Ltd. (Debonair), the
       Company will manufacture, install, support, and maintain six shipsets of
       the in-flight entertainment network for a period of eight years from
       installation. Installation is expected to occur during the year ended
       October 31, 1997. Management anticipates that operating and product costs
       will be recovered over the term of the contract through casino gaming
       revenue sharing between Debonair and the Company.

       Pursuant to the agreements with Schweizerische Luftverkehr AG, a Swiss
       corporation (Swissair) and Interkantonale Landeslotterie, a Swiss
       non-profit organization which organizes lotteries in Switzerland (ILL),
       the Company will manufacture, install, support, and maintain twenty-one
       shipsets of the in-flight entertainment network until December 31, 2001
       as to five B-747 airplanes and until December 31, 2003 as to sixteen
       MD-11 airplanes. Installation is expected to occur during the two years
       ended October 31, 1998. The Swissair agreement subjects the Company to
       certain penalties, which could be substantial, if the in-flight
       entertainment networks are not installed on a timely basis. Management
       anticipates that operating and product costs will be recovered over the
       term of the contract through casino gaming revenue sharing between
       Swissair, ILL, and the Company. In anticipation of the fulfillment of the
       Swissair contract, the Company has entered into an agreement with
       Hollingsead International, Inc. (Hollingsead) pursuant to which
       Hollingsead will provide engineering services, manufacture installation
       kits, provide installation labor, and perform airworthiness certification
       procedures in accordance with Federal Aviation Administration
       regulations.

       PURCHASE COMMITMENTS

       As of October 31, 1996, the Company had approximately $17,989,000 of
       purchase commitments with various vendors in anticipation of the
       fulfillment of the Company's sales commitments.

 (11)  SUBSEQUENT EVENTS

       In November 1996, the Company entered into a Strategic Alliance Agreement
       (the Agreement) with Hyatt Ventures, Inc.(Hyatt), an affiliate of the
       Hyatt Corporation. Under the terms of the Agreement, Hyatt will use their
       marketing resources to enhance IFT's relationship with international and
       domestic air carriers, as well as non air-carrier potential users of the
       entertainment network. In addition, Hyatt will assist the Company in
       negotiations of contractual relationships with potential customers,
       service providers and vendors; development and implementation of
       marketing programs; and development and coordination of financing
       sources.

                                      F-18
<PAGE>   53
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                    Notes to Financial Statements, Continued



       The Agreement provides for Hyatt to invest an aggregate of $1,000,000 in
       the acquisition of shares of Class A common stock through open market
       purchases within 90 days of the agreement. Additionally, subject to
       satisfaction of certain conditions, Hyatt will invest up to $20,000,000
       in each of up to six joint ventures in order to raise up to one-third of
       the money required for specified airline projects, and up to two such
       joint ventures relating to non-airline projects. At the option of Hyatt,
       their interest in any joint venture will be convertible into the
       Company's Class A common stock, based on independent valuation of the
       joint venture, provided that Hyatt's beneficial ownership will not exceed
       20% of the Company, on a fully diluted basis.

       Hyatt will receive stock purchase warrants to purchase up to 10% of the
       Company, fully diluted, at an exercise price of $9.875 per share, which
       will be issued incrementally as airline contracts are executed, subject
       to certain events as defined in the Agreement. All warrants will expire
       on the fifth anniversary of the date of the Agreement. Additionally, as
       provided in the Agreement, John Pritzker, President of Hyatt Ventures,
       Inc. and Adam Aron, currently Chairman and CEO of Vail Resorts, formerly
       a Sr. Vice president at United Airlines, have been elected to serve on
       the Board of Directors. Under the terms of the Agreement, these
       individuals received options to purchase an aggregate of 250,000 shares
       of Class A common stock under the Company's Amended and Restated Stock
       Option Plan. In the event the number of directors constituting the Board
       is increased, Hyatt shall be entitled to nominate two-ninths (rounded up)
       of the Board of Directors.

       The Agreement may be terminated by either party upon the delivery of
       written notice, provided that this notice may not be delivered until the
       later of two years from the date of the Agreement and the date on which
       Hyatt no longer owns equity interests in any joint ventures with the
       Company and beneficially owns less than 5% of the outstanding Class A
       common stock of the Company.

       In conjunction with the Agreement, the Company and Hyatt executed an
       agreement providing for the registration of securities issued to Hyatt,
       which entitles Hyatt to certain demand registration rights and piggyback
       registration rights, subject to certain limitations. Additionally, the
       Shareholders' Agreement was amended and restated to include Hyatt and
       exclude two former officers; the License Agreement with FortuNet was
       amended and restated to expand the field of use of the license and to
       provide for additional consideration in the form of stock purchase
       warrants to purchase 50,000 shares of Class A common stock exercisable
       for a five-year period at an exercise price equal to the closing price of
       the stock on the day prior to the date of the Agreement; and the Amended
       and Restated Consulting Agreement between Yuri Itkis and the Company has
       been terminated in consideration of the execution of the Amended and
       Restated Intellectual Property License and Support Services Agreement.

       On November 18, 1996, the Company hired a President and Chief Operating
       Officer. The two year employment agreement calls for an annual base
       salary of $325,000 and the issuance of 250,000 stock options to purchase
       Class A common stock of the Company, one-third of which shall vest ninety
       days after the date of employment and the remaining two-thirds of which
       shall vest in equal portions on each of the next two employment
       anniversary dates.

                                      F-19
<PAGE>   54
                      INTERACTIVE FLIGHT TECHNOLOGIES, INC.

                    Notes to Financial Statements, Continued



       On November 22, 1996, the Company offered to the holders of its Class B
       warrants to reduce the exercise price of the Class B warrants to $7.50
       per share from $9.75 per share, exercised by December 24, 1996, subject
       to extension by the Company. The Company also announced its intention to
       call its Class B warrants for redemption on January 17, 1997. As of
       January 6, 1997, 9,815,135 shares of Class A common stock were issued
       pursuant to this offer, yielding net proceeds of approximately
       $69,100,000, net of commissions and expenses approximating $4,517,000.

       On January 6, 1997, the Company lowered the exercise price of all
       employee stock options, as well as certain stock purchase warrants, which
       have an exercise price which exceeds $8 per share, to reduce the exercise
       price of such options and warrants to $8 per share, such price being the
       trading price of the Class A common stock at the close of the previous
       business day.

                                      F-20