SECURITIES AND EXCHANGE COMMISSION
                                      WASHINGTON, D.C. 20549

                                           FORM 10-KSB
(Mark One)
(X) ANNUAL REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
    EXCHANGE ACT OF
    1934

For the Fiscal Year Ended December 31, 1997

( ) TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
    EXCHANGE ACT OF 1934
                           Commission File No. 0-26826

                               APPLIED COMPUTER TECHNOLOGY, INC.
                    (Name of Small Business Issuer in its charter)

                  Colorado                                84-1164570
           (State of incorporation)            (IRS Employer Identification No.)

       2573 Midpoint Drive, Fort Collins, CO                 80525
      (Address of Principal Executive Office)              Zip Code

             Registrant's telephone number, including Area Code: (970) 490-1849

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

              Title of Class                        Name of Exchange
              Common Stock                          Pacific Stock Exchange
              Warrants                              Pacific Stock Exchange

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

                                    Common Stock and Warrants
                                         (Title of Class)

Check whether the Registrant  (1) has filed all reports  required to be filed by
Section 13 or 15(d) of the  Securities  Exchange  Act of 1934 during the 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 []     No [X ]

Check if 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  Company's  revenues for the most recent fiscal year were  $25,555,000.  The
aggregate  market  value of the voting stock held by  non-affiliates  (3,385,000
shares),  based upon the average bid and asked  prices of the  Company's  Common
Stock on June 15, 1998 was approximately $2,300,000

As of June 15, 1998 the Company had 4,800,102 shares of common stock issued and
outstanding.
Documents Incorporated by Reference: None
Transitional Small Business Disclosure Format: Yes [ ] No [X]


<PAGE>

                                       
                        
Item 1. DESCRIPTION OF BUSINESS

General

      Applied  Computer  Technology,  Inc. (the  "Company")  markets,  installs,
services  and supports  microcomputer  systems and related  peripheral  products
principally  for  use by  business  and  large  institutional  customers  in the
corporate,  government and retail markets. The Company provides a broad range of
microcomputer products and services including hardware, software, system design,
consulting,  maintenance  and training,  as well as internet  access and related
services. The Company assembles custom PCs and peripheral hardware under its own
brand name and markets  well-known  national brands including Compaq,  Apple and
IBM. The Company also markets and installs  operating  systems and  applications
software  developed by Microsoft  Corporation,  Novell,  Inc. and other software
developers.  In May 1998 the Company was notified that it was awarded  contracts
to supply  microcomputers  to Johnson  Space  Center in  Houston,  the Air Force
Academy in Colorado  Springs,  Colorado,  and the United States Naval Academy in
Annapolis,  Maryland.  The amount for these  three  contracts  is  approximately
$7,500,000.  The Company's  Federal and State Bid Teams  continue to submit bids
for similar  quantities to customers of a similar  profile.  Many of these bids,
including  a $4.5m  proposal  to the U.S.  Military  Academy,  have not yet been
awarded.  Although the Company cannot  guarantee  that any of these  outstanding
contracts will be awarded to the Company,  management is optimistic that certain
additional contracts will be awarded to the Company this year.

      The Company's current  customers include Colorado State University,  NASA,
the University of Colorado,  Metropolitan State College, University of Oklahoma,
U.S.  Military  Academy,  the U.S. Air Force Academy and the U.S. Naval Academy.
Management  estimates the Company and its predecessors,  which from 1986 to 1991
carried on the  business now  conducted  by the  Company,  have sold over 60,000
microcomputers.

      The   microcomputer   products  segment  of  the  computer   industry  was
characterized  in its early  development by stand alone personal  computers with
limited  capabilities.  Advances in  semiconductor  technology  were the driving
force behind significant upgrades in the capabilities of microcomputer products,
which in turn  resulted  in a wider range of  software  applications  which were
suitable for use on microcomputers. This expansion in microcomputer capabilities
has been  accompanied  by significant  price  reductions in  microcomputers  and
peripheral   products  as  the  cost  of  semiconductor  chips  has  fallen  and
manufacturing efficiencies have been realized.

      The growth in the  microcomputer  industry is also the result of local and
wide area networks which permit a wide distribution of applications software and
databases  throughout a business or other organization,  the use of a variety of
different  hardware and software products from location to location or even user
to user, and the flexible addition or deletion of software applications. In most
cases, hardware and software products produced by a variety of manufacturers can
be used interchangeably in PCs.

      The Company's customers desire a system's integrator who has the technical
know how, the purchasing discretion,  and the production capacity to manufacture
personal  computers  custom  configured to meet their needs. The Company has the
technical staff,  purchasing experience,  and manufacturing  flexibility to meet
these needs.

      Today lower performance computers,  "off the shelf" computers, and much of
the end user market are catered to through large discount  computer chains.  The
Company   markets  its  products  and  services  to  clients  who  require  more
sophisticated  computers with a range of technical support  services.  Many high
volume clients, including State and Federal agencies and institutions and highly
technical  private and public  corporations,  evaluate  criteria such as product
life  cycle,  future  expansion  capabilities,  the  availability  of  technical
services, and installed client referrals when selecting a PC vendor. The Company
markets its products to clients who evaluate their  purchases of  microcomputers
according to these criteria.

      The  microcomputer  products  segment of the  computer  industry is highly
competitive.  A number of computer resellers which compete with the Company with
respect  to  some  or  all  of the  products  or  services  offered  by it  have
experienced  downturns  in  operating  results  due in  part,  in the  Company's
opinion,  to  excessive  competition.   Because  of  an  industry  trend  toward
decreasing  prices for microcomputer  products and peripherals,  the Company has
adopted a "just in time" inventory  management system. The Company believes that
by  selling  various  microcomputer   products,   peripherals  and  services  as
customized  integrated systems,  the Company is able to charge higher prices and
thereby earn higher gross profits than those  attributable to commodity hardware
sales.

Products and Services

      The Company  provides  turnkey  solutions  designed to meet its customers'
information  system  requirements.  Systems typically include  microcomputer and
networking hardware, peripheral equipment, operating system software and network
system  software.  The Company  also  derives a portion of its sales and service
revenues from installation,  integration,  consulting, upgrades, maintenance and
training.

      The Company  believes  that its  customers  have,  and will  continue,  to
utilize  computer  networks to allow a wider  distribution  of  information  and
applications. The Company offers network hardware and software to its customers,
providing  support and maintenance for network systems,  and focusing certain of
its  marketing  and sales  resources on  developing  customers  with  networking
requirements.

      Hardware.  The Company's  microcomputer systems are customarily sold using
components  and  peripherals  provided  by  the  Company's  suppliers.  Hardware
included in these systems may include, among other items, personal computers and
PC  workstations  (including  monitors,  disk  drives and  memory),  peripherals
including modems, printers and scanners,  network file servers, hard disks, tape
drives, power supplies, printers, high speed modems, network interface cards and
cabling.  The Company assembles its microcomputer  systems using products from a
number of manufacturers.  In addition to branded computer products,  the Company
purchases components from a number of suppliers from which the Company assembles
microcomputers which bear the Company's brand name and logo. The majority of the
Company's  revenues  are  generated  through  the  sale of PCs  which  bear  the
Company's name. The Company believes that its customers have accepted  assembled
microcomputers  using the Company's  brand name, as opposed to national  brands,
due  to  the   increasingly   common   performance   characteristics   of   most
microcomputers.  Furthermore, the Company believes that its customers choose the
Company's  computers  because  of the  Company's  ability  to  custom  configure
computers at a price acceptable to the client.  Custom  configuration allows the
Company and client to work closely  together to select the right  components and
service  and  support  options  for  the  user's   environment  and  information
technology  needs.  The Company intends to continue to provide  custom-assembled
microcomputers  to its customers,  both as a means of servicing each  customer's
particular  automation  requirements as well as achieving  significantly  higher
margins than those associated with mass produced national brand microcomputers.

      Because  the  Company  is  frequently  able to  source  microcomputers  or
components from different  suppliers,  the Company has generally not experienced
delays in obtaining  hardware to satisfy customer  orders.  Although the Company
believes   microcomputers   and  components  are  available  from  a  number  of
alternative  suppliers,  any significant  interruption in delivery of such items
could have a material adverse effect on the Company's operations.

      Software.  The Company  purchases  complete software  programs,  including
operating systems,  application software and networking software, from a variety
of vendors.  The vast  majority of  operating  systems  installed by the Company
operate  through the  DOS/Windows  environment.  The Company has also  installed
Novell,  UNIX and NT Network operating  systems.  Operating systems installed by
the Company  typically  allow  customers  to migrate to  different  hardware and
software  technologies  and to upgrade to new releases of application  software.
The Company has  established  reseller and support  agreements  with two leading
software development firms.

      Services.  The Company  offers a full  complement  of  services  which are
designed to meet the Company's  goals of providing a customized  solution to the
customers information requirements.  The services offered by the Company include
component  reliability,  compatibility and reliability testing,  integration and
networking services.

      In many bid situations the client desires a specific  configuration  which
the Company provides. In other situations, the client relies upon the Company to
provide  recommendations.  In both  cases,  the  Company  differentiates  itself
competitively  by offering a customized  solution.  These up front  services are
built into the Company's pricing structure.

      The Company's  customer  service program  provides  customers with ongoing
hardware and software  maintenance  and hotline  telephone  support.  Agreements
which provide for upgrades maintain the customers'  hardware,  operating systems
or  documentation  to the then current  standard  release level supported by the
Company.  Where  contracted  for  separately,  maintenance  services  are billed
monthly in advance and implementation and consulting services are billed monthly
as incurred.



<PAGE>


Sales and Marketing

      The Company's products and services are marketed and sold principally on a
direct basis by the  Company's  sales and marketing  personnel.  As of March 31,
1998 the  Company  had 8  full-time  employees  engaged  in sales and  marketing
activities,  including  representatives serving the corporate and government and
in-house sales  associates.  The sales  representatives  are compensated using a
combination of salary and commissions.

      The other  principal  means by which the Company  markets its products and
services is through its Business Centers.  Each Business Center is designed as a
showroom with key demonstration  models, but stocks relatively little inventory.
Orders  received  at the  Company's  Business  Centers  are  transmitted  to the
Company's headquarters,  where products are ordered or assembled for delivery to
the Business Center. Although the Company has adopted a "just in time" inventory
management  system,  the  Company has been  successful  in  delivering  products
ordered by its Business Centers in an average of 10 to 14 days. If required, the
Company can have components or microcomputers  delivered by overnight  delivery,
at an additional charge to the customer, and generally fill an order in three to
five days.

      The Company's customer base principally  consists of various corporate and
government  entities.  During 1997,  approximately 79% of the Company's revenues
were the result of sales to  government  and  educational  institutions,  11% to
commercial accounts, and 10% to retail customers,  although a significant amount
of these retail sales were to smaller  businesses.  The Company's  three largest
customers  during  1997 were:  the U.S.  Air Force  Academy,  the U.S.  Military
Academy,  and U.S. Naval Academy.  The Company anticipates that its sales to the
Departments  of the Army,  Air  Force,  and Navy will be in excess of 30% of the
Company's sales and service revenues in 1998.

      Sales  to  the   Company's   government   customers  in   particular   are
characterized by a lengthy sales cycle which generally extends for a period from
six to 12 months.  Purchases by government  entities are often  characterized by
bidding and contracting  procedures which may place  significant  demands on the
Company's administrative and sales personnel. Although the Company's status as a
non-exclusive  approved  vendor to the State of Colorado has simplified  some of
the bidding procedures to state-funded colleges and governmental entities, there
can be no assurance  the Company will  continue to remain an approved  vendor by
the State of Colorado.

      The Company actively attends Federal trade shows and utilizes a variety of
bid services to generate  State and Federal  leads.  The Company also engages in
print and radio advertising when appropriate.

      The Company  offers  installation,  upgrades,  maintenance,  training  and
technical  support to its customers and estimates that  approximately 75% of its
customers  purchase one or more of these  services  from the Company  within one
year of the purchase of hardware.

      The Company sells its computer  systems at prices which are  comparable to
competitor's  systems  having similar  features.  The Company sets its rates for
service,  repair and training so as to be  comparable  with the rates charged by
competitors.  The Company believes that its pricing policy allows the Company to
differentiate itself from competitors on the basis of service.

      Because the Company  ships  microcomputer  products and  software  shortly
after  receipt of an order,  the Company  typically  does not have a significant
backlog of unfilled  orders,  and  revenues  in any  quarter  are  substantially
dependent on orders received and delivered in that quarter. However, the Company
from time to time  experiences  higher than normal backlog  depending on factors
such as the  configuration of the  microcomputer  systems  ordered,  the size of
orders received and availability of hardware or software from suppliers.

      As of March 31,  1998 the  Company  had a sales  backlog of  approximately
$474,000.

Business Centers

      The  Company  believes  that  the  Business  Centers  establish   customer
recognition of the Company,  its products and services and provide the Company a
venue through which higher margin services can be provided to its customer base.
The Company also utilizes its Business  Centers as a sales and marketing tool to
identify and provide services to its corporate and government customers.

      The  following  table  provides  information  concerning  the location and
services offered by the Company's Business Centers:


                              Current
                              Services          Monthly           Lease
      Location                Offered           Rental(1)         Termination

2573 Midpoint Dr.             (2)(3)            $10,650           01/00
Fort Collins, Colorado

2601 Midpoint Dr.             (4)               $15,114           12/02
Fort Collins, Colorado

One Tabor Center              (3)                $5,092           09/01
1200 17th St.
Denver, Colorado

5975 N. Academy Blvd.         (3)               $ 2,312           08/97
Colorado Springs, Colorado

6501 E. Belleview Ave.        (3) (*)           $12,895           12/01
Suite l20
Englewood, CO  80lll

1640 Range Street             (3)               $ 2,600           07/00
Boulder, Colorado

3 Bethesda Metro Center, Ste. 700   (3)          $1,440           12/98
Bethesda, MD  20814

(1) Base rent plus common area and maintenance  fees,  excluding taxes. (2) This
facility includes the Company's  Executive  Offices,  Computer Assembly Facility
and Service Center. (3) Sales, technical service, repairs and training services.
(4) Manufacturing facility (*) In the process of subletting.

      The Company  expects that its existing  executive and assembly  facilities
will be adequate for the Company's  needs for the  foreseeable  future.  In late
1997 the  Company  expanded  its  manufacturing  facility.  However,  should the
Company  require  additional  space for  assembly  of  microcomputers  for large
contracts,  the Company  believes  additional  facilities are available near the
Company's  existing  headquarters  at a cost  comparable  to that now paid.  The
Company  recently  negotiated a release from half its space at E. Belleview Ave.
effective June 30, 1998 saving $5,900 in monthly rent.

Suppliers

      The Company purchases microcomputers,  software and components used in the
assembly of its own brand of microcomputers from outside suppliers.  The Company
has no long term  agreements  with its  suppliers  with  respect to the price or
supply of components or peripherals purchased by the Company.

      The  Company  is an  authorized  reseller  of network  operating  software
developed by Microsoft  and Novell.  The  agreements  with  Microsoft and Novell
authorize the Company to sell and support Microsoft and Novell network operating
software.  These agreements obligate Microsoft and Novell to provide the Company
with sales leads,  technical  support,  introductory  product releases,  product
promotion literature and technical documentation and may be terminated by either
party without cause on 30 days notice.

Proprietary Rights

      Neither the Company nor any of its directors, officers or shareholders own
any patents or patent rights respecting  products  marketed by the Company.  The
Company holds  license  agreements  with one supplier  which grant the Company a
limited, nonexclusive license to use the trademarks,  service marks and logos of
such supplier in the  promotion of the software  provided by the supplier to the
Company.  The Company has registered its Applied  Computer  Technology name as a
trademark and service mark, and has registered the stylized handprint logo, as a
trademark and service marks with the United States Patent and Trademark  Office.
The Company intends to maintain the integrity of its service marks,  trade names
and trademarks against  unauthorized use and to protect against infringement and
unfair competition where circumstances  warrant. The Company is not aware of any
currently infringing uses.

Competition

      The   microcomputer   segment  of  the  computer   industry  is  intensely
competitive  and is  characterized  by rapid  technological  advances,  evolving
industry standards and technological obsolescence. Many of the Company's current
competitors  have  longer  operating   histories  and  have  greater  financial,
technical,  sales,  marketing and other resources than the Company. In addition,
there are a number of large,  well  capitalized  firms that  could,  should they
choose to do so,  market  microcomputer  hardware,  peripherals  and software in
direct  competition  with the Company.  The Company  believes that the principal
competitive  factors in the market for  microcomputer  products  include  price,
service  and  support,  ease of use and the  ability  to  integrate  with  other
technologies,  brand  availability  and market presence.  The Company  currently
views Dell,  Gateway,  Tangent,  and Micron as its principal  competition in the
microcomputer  market in which the Company is active.  The Company also competes
to a lesser extent with a number of value added resellers,  computer  retailers,
electronic   specialty  stores  and  mail  order  distributors   active  in  the
microcomputer  hardware  or  software  markets.  There can be no  assurance  the
Company will be able to compete successfully against its competitors or that the
competitive  pressures  faced by the  Company  will  not  adversely  affect  its
financial performance.

Internet Services

      In  October  1996,  the  Company  began  offering  internet  access to the
Company's customers and the general public. As an Internet Service Provider, the
Company  provides  Internet  access  to  persons  wishing  to  view  and/or  use
information  stored on the  Internet.  Persons  using the Company  for  Internet
access have  unlimited  E-Mail usage  through the  Internet.  In  addition,  the
Company offers World Wide Web ("Web") sites (one or more pages of information on
the Internet) to businesses that want to advertise their products or services on
the Web. The Company presently  provides 56K dial up connections along the front
range and installs ISDN and T1  connections,  including  hardware,  to corporate
clients.  Customers  can  establish  initial  access to the  Internet  using the
Company's  dial-up  service and standard analog modems.  Basic service  includes
unlimited  usage for  non-commercial  purposes and E-Mail.  Customers can obtain
additional  E-Mail names (so that family members can receive E-mail addressed to
them) without incurring the full expense of an additional account. Each personal
account  also  includes,  at no extra  charge,  10Mb of  storage  space  for Web
documents.

      The Company  believes that its primary source of Internet related revenues
will be fees from providing Internet access and  telecommunications  integration
services to businesses.

Employees

The Company employed 66 persons as of March 31, 1998. Of these, 16 were employed
in administration,  14 in assembly and shipping, 8 in sales and marketing and 25
in support,  services,  training and technical support.  The Company's employees
are not covered by any collective  bargaining  agreements.  The Company believes
that its employee relations are good.

Item 2. DESCRIPTION OF PROPERTY

      See "Business Centers" in Item 1 of this report.

Item 3. LEGAL PROCEEDINGS

    In November 1996 the Securities and Exchange  Commission  (SEC)  commenced a
formal  investigation of the Company. The Company understands this investigation
relates  primarily to the  Company's  capitalization  of labor and related costs
associated with enhancements to the Company's  internal  software  systems,  the
development of software for the Company's  internet service,  the development of
the Company's new marketing program and the opening of new business centers.  At
December 31, 1996 the Company  changed its accounting  policy  concerning  these
costs and  elected  to  expense a  substantial  portion  of the costs  which had
previously  been  capitalized  during 1996 in the areas  mentioned  above. As of
March 31, l998, the  investigation  is still open. The Company  intends to enter
into discussions with the SEC to resolve this matter.

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

         Not Applicable.

Item 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         As of March 31, 1998, there were  approximately 500 beneficial  holders
of the  Company's  Common Stock and  Warrants.  The  Company's  Common Stock and
Warrants are traded on the National  Association of Securities Dealers Automatic
Quotation  ("NASDAQ")  System. Set forth below are the range of high and low bid
quotations  for  the  periods  indicated  as  reported  by  NASDAQ.  The  market
quotations reflect  inter-dealer  prices,  without retail mark-up,  mark-down or
commissions and may not necessarily represent actual transactions.

         Quarter Ending                Common Stock              Warrants
                                        High       Low        High       Low

          12/31/95 (1)               $4.50      $4.31        $0.88      $0.63

           3/31/96                   $5.63      $5.00        $1.06      $0.69
           6/30/96                   $5.63      $3.88        $1.06      $0.56
           9/30/96                   $5.00      $4.25        $0.82      $0.82
          12/31/96                   $5.44      $3.50        $l.00      $0.38

           3/31/97                   $4.06      $2.62        $0.50      $0.25
           6/30/97                   $3.43      $1.75        $0.25      $0.12
           9/30/97                   $8.06      $1.50        $1.62      $0.06
          12/31/97                   $5.25      $2.25        $0.81      $0.37

(1) The Company's  Common Stock and Warrants  began trading on October 26, 1996.
Holders  of Common  Stock are  entitled  to  receive  such  dividends  as may be
declared  by the  Board of  Directors  out of funds  legally  available  for the
payment of dividends and, in the event of liquidation,  to share pro rata in any
distribution of the Company's assets after payment of liabilities.  The Board of
Directors is not  obligated to declare a dividend.  The Company has not paid any
dividends and the Company does not have any current plans to pay any  dividends.
The Company  has issued  shares of Series A  Preferred  Stock (see below)  which
restrict the payment of dividends.

         Recent  Sales  of  Unregistered  Securities.  During  the  year  ending
December 31, 1996 the Company  issued  22,116 shares of common stock to a former
employee  as the  result of the  exercise  of stock  options  held by the former
employee.  The issuance of the shares was exempt from  registration  pursuant to
section 4(2) of the  Securities Act of 1933 since the issuance of the shares was
not a transaction involving a public offering.  The shares issued as a result of
the exercise of the options were  restricted  securities as that term is defined
in Rule 144 of the Securities and Exchange Commission.

            In November  1997, the Company sold 900 shares of Series A Preferred
Stock to a supplier of the Company for $900,000. Payment for the shares was made
by the vendor cancelling $900,000 of payables owed by the Company to the vendor.
At the option of the  holder of the Series A  Preferred  Shares,  the  Preferred
Shares may be converted  into shares of the Company's  common stock on the basis
of one share of  Preferred  Shares for shares of Common Stock equal in number to
the amount  determined  by dividing  $1,000 by the Average  Closing Price of the
Corporation's  Common Stock over the five-day  trading  period ending on the day
prior to the conversion of the Preferred Stock. The conversion price however may
not be less than $1.00 per share of more than  $3.00 per  share.  As of June 15,
1998 none of the Series A Preferred Shares had been converted into shares of the
Company's common stock.

            On November 24, 1997,  the Company sold 1,500 shares of its Series B
Preferred  Stock,  plus 82,192  Common  Stock  Purchase  Warrants,  to a foreign
investor for  $1,500,000.  The number of shares  issuable upon the conversion of
each Series B Preferred  Share is determined by dividing  $1,000 by the lower of
(i) $3.65, or (ii) 75% of the average closing bid price of the Company's  common
stock on the five trading  days  preceding  the  conversion  date.  Each Warrant
allows the holder to purchase one share of the Company's  common stock for $4.02
at any time prior to November 21, 2000. The sale of the Series B Preferred Stock
and  Warrants  was made in reliance  upon  Regulation  S of the  Securities  and
Exchange  Commission.  As of May 31,  1998 all shares of the Series B  Preferred
Stock had been converted into 1,679,859 shares of the Company's Common Stock.

Item 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

         The following  selected  financial  data should be read in  conjunction
with the Financial  Statements and related Notes thereto appearing  elsewhere in
this Report and "Management's Discussion and Analysis of Financial Condition and
Results of  Operations."  The  selected  financial  data  provided  below is not
necessarily  indicative  of  the  future  results  of  operations  or  financial
performance of the Company.

                                               Years Ended December 31,
                                      1997                 1996
                                           (in thousands, except per share data)
Statements of Operations Data:

Sales and service revenues             $25,555        $20,239
Cost of goods sold                      25,730         17,577
Gross profit (loss)                       (175)         2,662
Operating expenses                       4,332          3,951

Loss from operations                    (4,507)        (1,289)
Other income (expense), net               (429)          (228)
Income tax benefit                          --            175
Net loss                               $(4,936)       $(l,342)
Preferred Stock Dividends                $(257)             0
Net loss per common share               $(1.69)        $(0.44)

Weighted Avg Common Shares Outstanding    3             3,042

Balance Sheet Data as of December 31, 1997 (in thousands):

Current Assets                            4,165
Current Liabilities                       5,723
Working capital deficit                  (1,558)

Total assets                             $6,507
Total liabilities                        $6,164
Shareholders' equity                       $343

GENERAL

Revenues from product and system sales are recognized  when title to the product
or system  passes to the  customer.  Revenues from  maintenance  agreements  are
recognized ratably over the term of the maintenance agreement.

The Company may  experience  significant  fluctuations  in  quarterly  operating
results due to a number of factors including,  among others, the size and timing
of customer orders.

DISCUSSION OF 1997 AND 1996

The Company has suffered  significant losses during the years ended December 31,
1997 and 1996.  These  losses are the result of  increases in the areas of Sales
and Marketing,  Network  Services,  and reductions in gross margin.  These costs
include  wages,  depreciation,   rents,  and  impairment  of  long-lived  assets
(leasehold improvements).  The Company's communicated strategy was to expand its
business into the Corporate  marketplace  by offering the Company's  traditional
products  and  services  as  well  as  training  services,  systems  integration
services,  and `branded'  products  including  Compaq,  IBM, and HP. The Company
established Business Centers with sales and technical staff to this end.

These expansion  efforts did not yield the anticipated  results,  and Management
began  discontinuing  investments in these areas during the 2nd quarter of 1997.
In June of 1997,  the Company  accepted the  resignation  of its VP of Sales and
Marketing  and  began  eliminating  much  of its  expansion  related  Sales  and
Marketing  related  expenses.  In the 3rd and 4th  quarters of 1997,  Management
restructured its Sales and Marketing department and its products and services to
redirect its efforts back into the Company's  traditional  markets.  During this
restructuring,   the  Company  intensified  its  sales  resources  dedicated  to
expanding the Company's  business on the State of Colorado  contract.  A Federal
bid team was also  established  to solicit  and  respond to  Federal  bids.  The
Company  continues  to  service  certain  Corporate   accounts  with  purchasing
requirements  consistent  with the  Company's  core  focus but has  discontinued
investments in expanding this market. Management believes that its restructuring
will enable the Company to continue  sales growth at margins  acceptable  to the
Company while  eliminating  much of the expense  associated  with expansion into
other  markets.  There can,  however,  be no assurance  that the Company will be
successful in returning to a state of operational profitability.

Throughout  the 3rd and 4th  quarters  of 1997  and  into  1998  Management  has
implemented  significant cost reduction  programs.  The Company has consolidated
its  operations  to run more  efficiently,  and  inventory  controls and pricing
structures have been deployed to improve margins.  The Company's sales force has
been focused on expanding the  Company's  business in its  traditional  markets,
including   State  and  Federal   agencies  and   institutions   and  High  Tech
Manufacturing  firms.  The  Company  believes  that  it will  be  successful  in
expanding  its business in its  traditional  markets and that the  Company's new
conservative  budget will enable the Company to return to a state of operational
profitability.  There  can,  however,  be no  assurance  that the  Company  will
successfully  expand its business in its traditional markets or that the Company
will be successful in returning to a state of operational profitability.

Management is  disappointed by results for the years ended December 31, 1996 and
1997, but it is encouraged by the reduced spending in the 1st quarter of 1998 as
wage  expense  has fallen by 40%.  Other  expenses,  including  advertising  and
promotions,  have decreased as well. The Company declined to renew its lease for
its Ft Collins  based  Business  Center  during the 3rd  quarter of 1997 and has
moved  those  operations  to its  Corporate  Service  Center.  The  Company  has
successfully  negotiated out of its lease on one Business Center facility in the
Denver Tech Center and is working to terminate  another  Business  Center lease.
While the Company  believes  that these  activities  will improve its  financial
results,  there can be no  assurance  that these  reductions  in  overhead  will
restore the  Company to a state of  operational  profitability,  and the Company
expects to continue to incur operational losses at least through the 1st quarter
of 1998.


<PAGE>


Sales

The Company is highly focused on participation in numerous new Federal agencies'
bids which will be awarded throughout 1998. The Company is selectively targeting
agencies which intend to purchase large quantities of custom configured systems.
The Company has  experience  with these types of contracts  and believes that it
compares  favorably  against its  competitors  in these  markets.  The  recently
announced NASA contract for $1.5 million  demonstrated the Company's  ability to
compete  successfully in this market.  There can, however,  be no assurance that
the Company  will be awarded  additional  contracts.  The Company  continues  to
de-emphasize  retail and corporate accounts in favor of State,  Federal and high
tech accounts.

The Company's  annual contract with the State of Colorado was renewed during the
1st qtr of 1998.  Sales,  nevertheless,  remained soft during that quarter.  The
Company has mobilized to capitalize on this and other on-going opportunities and
is aggressively pursuing orders for the State's fiscal year end this June. Sales
orders in the 2nd quarter  improved  over those of 1st quarter due to  increased
demand on the State of Colorado.  contract and the award of some smaller Federal
contracts.  During the 2nd quarter  sale of 1998,  the  Company's  sales  orders
include a  significant  order to NASA and  orders to several  State of  Colorado
colleges  and  school  districts,  the  University  of  Oklahoma,  the  State of
Colorado.  Dept of Labor,  and a small order to the US Military  Academy at West
Point. As of May 31, 1998 the Company had  approximately  $850,000 in backlog in
addition to the major contracts  recently  announced in press releases which are
expected to provide for total sales of $6.5 million during fiscal 1998.

The National Institute of Health (NIH) Contract awarded to the Company last fall
has been slow to develop sales for the Company.  This five year award allows the
Company  and  approximately  40 other  information  technology  vendors  to sell
directly to the government  without the need to competitively  bid each of their
purchases.  The Company realizes that, even with this contract, a targeted sales
force  calling  on  federal  agency  procurement  personnel  is  mandatory.  The
Company's  representative  in Washington DC has been  actively  attending  trade
shows in the Washington,  D.C. area. The Company's  Federal bid team,  which was
established  during the 2nd  quarter of 1997,  is  actively  soliciting  Federal
business using the NIH contract and other  procurement  vehicles  established by
the Federal  government.  Additionally,  the Company is pursuing inclusion under
other government procurement schedules. There can, however, be no assurance that
the Company will be successful  in generating  sales from the NIH contract or in
being included in other government procurement schedules.

Margin

Margins  continue to be under  increased  pressure  from  competition.  With the
advent of the sub $1,000 computer system, certain markets have become more price
sensitive.  Manufacturing  costs for these systems,  however,  are less than for
more  sophisticated  systems,  as these systems typically  integrate more on the
system  board.  The Company  believes that it can compete  favorably  with a sub
$1,000 PC within its traditional  markets by leveraging its quality products and
its reputation  for service and support  within its existing  customer base. The
Company is  further  addressing  margins  by  focusing  on  customers  with more
sophisticated  technical  and  servicing  requirements.   It  is  the  Company's
experience that sales to this group of customers permit better margins.

Overalls margin suffered in 1997 due to significant inventory  adjustments.  The
Company  experienced  $681,000  in  adjustments  in the 2nd  quarter of 1997 due
primarily to significant  reduction  within the industry on costs of parts below
the amounts  such items were  carried in the  Company's  inventory.  The Company
experienced  an  additional  $65,000  in  inventory  adjustments  during the 3rd
quarter,  1997.  Management has implemented inventory procedures and controls to
reduce the Company's  inventory  exposure going forward.  Whereas  Management is
satisfied that the problems of the 2nd and 3rd quarter have been  resolved,  the
Company will be challenged,  as is the industry, with inventory valuation issues
as  component  costs  continue  to  decrease.  In the  fourth  quarter  of 1997,
approximately  $305,000 was recorded as expense from inventory valuation related
to the year end  lower  of cost or  market  analysis.  This  adjustment  reduced
overall margins by 1% of sales. Management is addressing this valuation issue by
reducing the number of components which are inventoried, implementing strict JIT
(Just in Time) purchasing  procedures,  and implementing  secondary distribution
channels for older inventory.

The Company's  large contracts  generally allow the Company to obtain  favorable
pricing due to the  increased  volume of  purchases.  The  Company's  ability to
command  preferred  vendor status and receive  favorable  pricing has come under
increased pressure due to working capital constraints.

Overhead

Staffing reductions,  particularly in the area of Sales and Marketing, were made
during the 3rd and 4th qtrs of 1997. Additional staffing reductions were made at
the end of December  1997 and early  January  1998 which will reduce  unabsorbed
service costs and production  overhead which Management expects will improve the
Company's gross margins in 1998.  Manufacturing volume, which was low in the 4th
quarter of 1997 caused the cost of overhead to increase as a percentage of gross
sales.  Increased  volume in subsequent  quarters would improve gross margins as
indirect  fixed costs  expenses  would be absorbed by the higher  sales  volume.
Other significant  overhead  reductions include the elimination of the Company's
Ft Collins Business Center and the termination of one of the Company's leases in
the Denver Tech Center. Negotiations are underway to assign the Company's second
Denver Tech Center lease.

The  Company  experienced  losses in 1997 and in 1996 due to  expansion  related
spending.  Although the marketplace remains highly competitive,  the Company has
demonstrated  its  ability to retain  long term  customers  and to  successfully
obtain new  business  from new clients.  The  Company's  production  capacity is
flexible, and it is adequate to sustain significant volume.  Management believes
that increased volume at acceptable margins combined with significantly  reduced
spending will restore the Company to a state of operational profitability. There
can,  however,  be no assurance that the Company will be successful in obtaining
additional  orders  or  that  Management  will  be  successful  in  implementing
additional expense controls.


<PAGE>


RESULTS OF OPERATIONS

The Company  generated a net loss of $4.9  million on $25.6  million in sales in
1997.  The  Company  attributes  much of this loss to  expenses  incurred  in an
unsuccessful  attempt  to gain  market  share in new  markets  and to expand its
Network Services Organization.  These expansion programs, which were launched in
1996,  added  significant  expense to the Company,  particularly in the areas of
wages,  rents, and depreciation.  When the anticipated sales did not materialize
according to plan, the Company accepted the resignation of its Vice President of
Sales and Marketing and restructured  the Company's Sales and Marketing  efforts
to be more consistent with the Company's traditional business. Concurrently, the
Company began  significant cost cutting  programs,  particularly in the areas of
Sales and Marketing.  These restructuring activities began in the 3rd quarter of
1997 and continue into 1998.

COMPARISON OF FISCAL YEARS ENDED DECEMBER 31, 1997 AND 1996

NET REVENUES. Net revenues increased $5.3 million, or 26.3%, to $25.6 million in
fiscal 1997 from $20.2  million in fiscal  1996.  The  increase in net sales was
attributable to sales to new customers,  increased sales to existing  customers,
and increased sales of value-added services.  WEBAccess,  the Company's internet
subsidiary  increased  its  revenues  $300,000  to  $311,000 in fiscal 1997 from
$11,000 in fiscal 1996 (startup period).

GROSS PROFIT (LOSS).  Gross profit decreased $2.8 million, or 81.1% to a loss of
($175,000) in fiscal 1997 from $2.6 million profit in fiscal 1996, and decreased
as a percentage of net sales to (0.7%) in fiscal 1997 from 13.1% in fiscal 1996.
Gross  profit is  displayed  below as  (Revenues  -  Materials  and  Overhead  -
Inventory Adjustments - Unabsorbed Service Cost - Internet Access
Cost).

COST OF GOODS SOLD.  Presented below is a breakdown of the principal
components of Cost of Goods Sold for the years ended 1997 and 1996.

                        .                      ($ in thousands)
                                     1997         %        1996         %
Cost of materials and overhead     $22,256      86.50    $16,181      92.06
Inventory Adjustments                1,051       4.08         88       0.50
Unabsorbed Service Cost              1,620       6.30        815       4.64
Internet Access Cost                   803       3.12        493       2.80
                                   $25,730     100.00    $17,577     100.00


Presented below is a  reconciliation  of the  approximate  impact of key factors
affecting the change in margins from 1996 to 1997.

                                                ($ in thousands)
                                                            $               %
1996 Gross Profit                                         2,662           13.1
Margin lost from competitive market conditions             (874)          (4.3)
Margin lost from additional inventory cost adjustments     (900)          (4.4)
Margin lost from additional service cost                   (753)          (3.7)
Margin lost from additional internet cost                  (310)          (1.4)
1997 Gross Loss                                           $(175)          (0.7)%

Materials  costs  have  been  negatively  impacted  by more  competitive  market
conditions.  During 1997, the industry introduced a sub $1,000 PC which has been
accepted  by many  computer  users.  This sub  $1,000 PC is  desirable  to price
conscious  buyers but is not suitable for purchasers who desire high performance
PCs.  Management  has  responded to market  conditions by focusing its sales and
marketing  efforts on specific  clients  who  recognize  value in the  Company's
products and services. The Company has refocused its Sales and Marketing efforts
on traditional  Federal and State  Government and  Institutional  clients and on
high tech and  Manufacturing  firms.  The  Company  has  de-emphasized  sales of
products and  services to certain  SOHO (Small  Office Home Office) and end user
market  segments  which tend to favor  commodity  prices.  The  Company has also
developed a sub $1,000 PC using 3rd party  components  to offer this  product to
its traditional  markets.  There can, however,  be no guarantee that the Company
will be  successful  in  improving  margins on its  products  and services or in
gaining market share in its target markets.

The 4th quarter of 1997  physical  inventory  resulted  in a slight  increase to
inventory prior to valuation.  Management  attributes this to the enforcement of
strict inventory  controls which were implemented after a significant  inventory
adjustment  was  posted  in the 2nd  quarter  of  1997.  However,  the  year end
computation  of lower of cost or  market  resulted  in an  approximate  $300,000
inventory  valuation  write down.  This write down reflects a downward  trend in
component  pricing  in the  computer  industry.  Management  believes  that this
exposure can be  minimized  by adhering to strict Just in Time (JIT)  purchasing
practices  and by  reducing  the  variety of  products  offered by the  Company.
Management  is also  researching  certain  secondary  distribution  channels  to
liquidate 'end of life' inventory  components  before they  valuations  decline.
There can, however,  be no assurance that these strategies will be successful in
reducing future inventory valuation write downs.

The Company  believes that direct labor was higher than necessary,  particularly
in the 3rd  quarter  1997,  due to the  limitations  of the  Company's  previous
manufacturing facility.  Additionally,  the Company outsourced certain contracts
at  additional  expense.  The  Company has leased  additional  space to increase
capacity and believes that the implementation of this new facility will decrease
overall  direct labor and eliminate  the need to outsource  during peak periods.
There can,  however,  be no assurance that the  implementation  of this facility
will reduce these costs.

Unabsorbed  service costs increased as the result of the Company's  expansion of
its  Network  Services  Organization  and as the  result of  service  technician
overhead  associated with  performing  warranty work. Late in the 4th quarter of
1997, the Company eliminated under utilized technical staff and consolidated its
Network services. During the 1st quarter, of 1998, a central dispatch system was
implemented  to maximize  technician  efficiency and reduce  unabsorbed  service
costs.  Additional  programs  designed  to  increase  revenue  in the  Company's
hardware   maintenance,   networking  and  integration  services  are  currently
underway.  There  can,  however,  be no  assurance  that  the  Company  will  be
successful in eliminating these unabsorbed service costs.

In accordance  with FAS 121, the Company  reserved  $120,000 for impairment of a
long-lived  asset. This reserve was established to provide for certain leasehold
improvements which will not be utilized as intended.

Internet  access costs for the Company from its  investment  in  WEBAccess,  the
Company's internet subsidiary, increased $310,000 or 62.9% to $803,000 in fiscal
1997 from  $493,000  in fiscal  1996.  Sales of internet  services  rose 311% to
$300,000 over fiscal 1996. As a percentage of net sales,  internet  access costs
increased to 3.1% in fiscal 1997 from 2.8% in fiscal 1996.

SALES AND MARKETING EXPENSES.  Sales and marketing expenses decreased $91,000 or
3.8% to $2.3 million in fiscal 1997 from $2.4 million in fiscal 1996,  primarily
as a result of less  advertising and wage expenses.  With this decrease in Sales
and Marketing expense,  the Company increased its revenues 26.3% over 1996. As a
percentage  of net sales,  selling and marketing  expenses  decreased to 9.1% in
fiscal  1997 from 11.9% in fiscal  1996.  The  Company is  continuing  to reduce
expenses in the Sales and Marketing  area,  including  expenses  associated with
certain  unprofitable  Business  Centers.  The  Company has been  successful  in
negotiating  out of one of its leases in the Denver Tech Center  location and is
working to eliminate other lease and  depreciation  expenses  related to Sales &
Marketing.  There  can,  however,  be no  assurance  that  the  Company  will be
successful in further reducing Sales and Marketing related expenses.

Mid 1997,  Management  began cost  cutting  programs  designed  to  flatten  the
organizational  structure of the Sales and Marketing  department  and to refocus
the Company's Sales and Marketing efforts on the Company's  traditional markets.
The results of these  programs  are evident in a decline in Sales and  Marketing
expenses from the 4th quarter of 1996 to the 4th quarter of 1997. As compared to
the 4th quarter in 1996, Sales and Marketing wages were down 71.2% from $472,642
to  $136,078,  and  Advertising  and  Promotion  expenses  were down  51.4% from
$356,859  to  $173,416.  Prior to  Management's  restructuring,  the Company had
invested  in  expanding  into  the  Corporate  marketplace  and in  growing  the
Company's  Professional Services  Organization.  The Company was unsuccessful in
obtaining  sufficient  market share in that market at margins  acceptable to the
Company and began eliminating the associated expenses in mid 1997.

GENERAL  AND  ADMINISTRATIVE  EXPENSES.   General  and  administrative  expenses
increased $352,000, or 22.8% to $1.9 million in fiscal 1997 from $1.5 million in
fiscal 1996. Wage expense held constant while  professional fees, cash discounts
and telephone expenses accounted for a majority of the increase. As a percentage
of net sales,  general and  administrative  expenses decreased to 7.4% in fiscal
1997 from 7.6% in fiscal 1996.

OPERATING LOSS. Operating loss increased $3.2 million or 350% to $4.5 million in
fiscal 1997 from $1.3  million in fiscal 1996  primarily  as a result of tighter
margins and additional  overhead costs including  inventory  adjustment expenses
and  increased  sales and  marketing  spending.  As a  percentage  of net sales,
operational  losses  increased to 17.6% in fiscal 1997 from 6.4% in fiscal 1996.
Management has been working since mid 1997 to improve margins, cut costs, and to
restructure  the  Company's  Sales  and  Marketing   efforts  on  the  Company's
traditional markets and products (see discussions above). There can, however, be
no assurance  that the Company will be  successful in returning the Company to a
state of profitability.

A significant portion of the Company's losses occurred during the 4th quarter as
the result of were significantly  lower than projected sales which resulted in a
net loss of approximately $2M for the quarter.  Management believes that this is
largely the result of the Company's restructuring activities.  4th quarter sales
of personal  computers  have  typically  come from retail and SOHO clients.  The
Company has  identified  these  market  segments as being  unprofitable  and has
discontinued  investments  in  these  markets.  State  of  Colorado  buying  has
historically  been flat 4th quarter,  and the Company's  Federal bid team, which
was launched during this restructuring period,  experiences buy cycles of 6 - 12
months. Because of this ramp up period, only one Federal contract was awarded to
the Company during the 4th quarter.  As a result,  revenues for 4th quarter were
just under $3.4M and at very low margin.  Although disappointed with the results
of 4th quarter,  Management  believes that its decision to cut costs and refocus
its Sales and  Marketing  efforts for 1998  better  position  the Company  going
forward.  The Company is  currently  bidding on multiple  significant  State and
Federal  contracts  which are due to be awarded 4th  quarter,  1998.  There can,
however be no assurance that the Company will be awarded any or all of these 4th
quarter  contracts or that the Company's  redirected  Sales and Marketing effort
will be successful in meeting sales projections.

INTEREST EXPENSE.  Interest expense  increased  $286,000 or 26.3% to $461,000 in
fiscal 1997 from $125,000 in fiscal 1996.  The increase in interest  expense was
primarily due to increased  borrowing due to working  capital  constraints.  The
Company's new operating loan agreement effective October 1997 had interest rates
from approximately 14% to 18%.

NET LOSS.  Net loss  increased  $3.6 million to $4.9 million in fiscal 1997 from
$1.3 million in fiscal 1996.  The increase in net loss resulted  primarily  from
the gross profit decline and additional interest expense. As a percentage of net
sales, the net loss increased to 19.3% in fiscal 1997 from 6.6% in fiscal 1996.

SUMMARY.  Management  is  disappointed  with  the  results  of 1997 and with the
results  of its  expansion  efforts.  Management  has taken  proactive  steps to
control  costs and to focus the Company's  Sales and Marketing  activities in an
effort  to  return  the  Company  to  a  state  of  operational   profitability.
Significant savings, particularly in the areas of wages, are already evident. At
present the Company  has been  awarded  several  contracts  for 1998,  including
contracts  with  NASA,  the US Air  Force  Academy,  and the US  Naval  Academy.
Additionally, the Company has submitted proposals for additional contracts which
have not yet been awarded..  The Company is pursuing the  elimination of certain
other  expenditures  and is working to leverage its existing  customer  base and
other  potential  customers  of  similar  profile.  There  can,  however,  be no
assurance that Management will be successful in returning the Company to a state
of operational profitability.



<PAGE>


LIQUIDITY AND CAPITAL RESOURCES

      The Company's  losses in 1997 have impaired  working capital by $2,599,000
as the Company's  working  capital  balance from December 31, 1996 of $1,241,000
has gone to a deficit of  $1,558,000  at December  31,  1997.  Current  year net
losses  have  caused  liquidity  problems  and may impact the  Company's  future
operations. The Company is pursuing additional cash generating strategies, which
include  cutting losses,  liquidation of certain  Company assets,  and near term
equity infusions.  There can, however,  be no assurance that the Company will be
successful in any of these strategies.

The Company  completed an equity  infusion  for  $1,500,000  in November  1997
(Preferred  Series B) and  converted  $900,000 of  accounts  payable to equity
(Preferred Series A) in October 1997.

The Company has been in  negotiations  with various parties to provide an equity
infusion  for  approximately  $2 million and received a letter of intent to fund
from a prospective investor. Additionally, the Company is also contemplating the
sale of its internet subsidiary.

The Company's  current assets were $4,165,000 on December 31, 1997 and decreased
by $2,703,000  during the year ended  December 31, 1997.  The Company's  current
liabilities   increased  slightly  from  $5,627,000  on  December  31,  1996  to
$5,723,000  on  December  31,  1997.  The  Company's  accounts  payable  balance
increased  approximately  $1,200,000  while current debt  maturities and accrued
liabilities decreased by $1,296,000 principally from less borrowing.

The Company's  property and  equipment  increased by $765,000 for the year ended
December  31, 1997.  Depreciation  and  amortization  expense for the period was
$614,000 compared with $274,000 for the comparable prior year period.

As of December 31, 1997, the Company's  principal  sources of liquidity were its
cash, accounts  receivable of $1,377,000 and inventories of $2,404,000.  Efforts
are continuing to decrease `days sales  outstanding'  (DSO) and inventory levels
to increase cash. At March 31, 1998 the Company has reduced accounts  receivable
and inventory by $960,000. There can be no assurance the Company will be capable
of raising  additional capital or that the terms upon which such capital will be
available to the Company will be acceptable.

The Company  continues to reduce its manufacturing  overhead,  as well as sales,
general and administrative  expenses.  There can, however,  be no assurance that
the Company can generate  profits,  and  management  may require other  actions.
Management,  however, believes that the actions taken to reduce overhead and the
additional  bid efforts will increase  revenues and efforts to raise  additional
capital will enable the Company to continue operations through 1998.

As of May 31, 1998, the Company had a sales backlog of  approximately  $850,000.
These sales are at margins acceptable to the Company,  and the Company continues
to pursue  additional  sales for 1998 through its  increased  bid  efforts.  The
Company was recently  awarded the annual  contracts to provide  computers to the
incoming  freshman at the U.S.  Air Force  Academy and the U.S.  Naval  Academy.
These contracts are estimated to be worth $4 million  dollars in revenue.  Also,
NASA has awarded the Company a contract worth $1.3 million.

Disclosure Regarding Forward-Looking Statements
This  report on Form 10-KSB  includes  "forward-looking  statements"  within the
meaning  of  Section  27A of  the  Securities  Act  of  1933,  as  amended  (the
"Securities  Act"),  and Section 21E of the Securities  Exchange Act of 1934, as
amended (the "Exchange Act"). All statements other than statements of historical
facts included in this report, including,  without limitation,  statements under
"Business and Properties" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" regarding the Company's financial position,
business strategy,  plans and objectives of management of the Company for future
operations are  forward-looking  statements and the assumptions  upon which such
forward-looking  statements are based are believed to be reasonable. The Company
can give no assurance that such  expectations  and assumptions  will prove to be
correct.  Additionally,  any  statements  contained  in  this  report  regarding
forward-looking  statements  are  subject to various  known and  unknown  risks,
uncertainties  and  contingencies,  many of which are beyond the  control of the
Company.  Such things may cause actual  results,  performance,  achievements  or
expectations to differ  materially form the  anticipated  results,  performance,
achievements  or  expectations.  Factors  that may affect  such  forward-looking
statements  include,  but are not limited to: the Company's  ability to generate
additional capital to fund operating  activities;  risks inherent in production;
competition;  government  regulation;  environmental  matters; and other matters
beyond the Company's control.  All written and oral  forward-looking  statements
attributable  to the Company or persons  acting on its behalf  subsequent to the
date  of  this  report  are  expressly  qualified  in  their  entirety  by  this
disclosure.

Year 2000 Issue
The Company has begun to address  possible  remedial  efforts in connection with
computer software that could be affected by the Year 2000 problem. The Year 2000
problem is the result of computer programs being written using two digits rather
than four to define the applicable  year. Any programs that have  time-sensitive
software  may  recognize a date using "00" as the year 1900 rather than the year
2000.  This  could  result in a major  system  failure or  miscalculations.  The
Company has been informed by the suppliers of substantially all of the Company's
software  that all of those  suppliers'  software that is used by the Company is
Year 2000 compliant.  After  reasonable  investigation,  the Company has not yet
identified  any Year 2000  problems  but will  continue  to  monitor  the issue.
However,  there can be no assurance  that Year 2000 problems will not occur with
respect to the  Company's  computer  systems.  The Year 2000  problem may impact
other entities with which the Company transacts  business and the Company cannot
predict the effect of the Year 2000 problem on such entities.

Item 7.  FINANCIAL STATEMENTS

         See the financial statements attached to this report.

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

         Not applicable.

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

Directors and Executive Officers

             Name              Age                      Position

     Wiley E. Prentice, Jr.     34        President,  Chief Executive  Officer
                                          and a Director
     Cynthia E. Koehler         33        Executive Vice President,  Secretary
                                          and a Director
     Daniel T. Radford          46        Vice  President  of  Finance - Chief
                                          Financial Officer
     J. Roger Moody             64        Director
     Collis Woodward            52        Director

     Officers  are  appointed  by and  serve at the  discretion  of the Board of
Directors.  Each  director  holds  office  until  the  next  annual  meeting  of
shareholders  or until a successor has been duly elected and  qualified.  All of
the Company's  officers  devote their  full-time to the  Company's  business and
affairs.

         Wiley E.  Prentice,  Jr. is the  founder of the  Company and has been
the  President,  Chief  Executive  Officer and a director  since the Company's
inception.  Mr.  Prentice also served as Treasurer  from inception to February
1995.  Mr.  Prentice's   principal   responsibilities  now  include  strategic
planning,  vendor relationships,  and sales and marketing activities. In 1986,
Mr.   Prentice   formed   Applied   Computer   Technology,   a  Colorado  sole
proprietorship  which until 1989  conducted the business now engaged in by the
Company.  In 1989, Mr. Prentice  co-founded  Applied  Computer  Technology,  a
Colorado  general  partnership,  which  continued  the  business  of the  sole
proprietorship  until 1991, at which time the assets of the  partnership  were
acquired by the Company.

         Cynthia E. Koehler has been Executive Vice  President,  Secretary and
a  director  of the  Company  since its  inception.  Ms.  Koehler's  principal
responsibilities  include human resources,  corporate policy and practices and
logistics.  Ms.  Koehler also  co-founded  Applied  Computer  Technology,  the
general  partnership  which from 1989 through 1991  conducted the business now
engaged in by the  Company.  Ms.  Koehler  received  her  Bachelor  of Science
degree in computer science from Colorado State University in 1987.

         Daniel T. Radford has been the Company's  Vice President of Finance and
Chief  Financial  Officer  since June 1997.  From 1994 through 1997 Mr.  Radford
served as chief financial officer of Brite-Line Industries, Inc., a manufacturer
of highway marking  products.  From 1992 to 1993 Mr. Radford was chief financial
officer  of  Waveframe   Corporation,   a  digital  sound  recording   equipment
manufacturer.   Prior  to  that,   Mr.   Radford   served   for  four  years  at
MiniScribe/Maxtor  in various  positions  including  Group CFO,  Orient CFO, and
Director  of Treasury  and Finance  Systems.  Mr.  Radford  obtained a Master of
Business Administration from Chapman College,  Syracuse, New York in 1988, and a
Bachelor  of  Science  in  Business  Administration  from  Syracuse  University,
Syracuse, New York, He earned his CPA and CMA from the State of New York

         J. Roger Moody has been a director of the Company since July 1995.  Mr.
Moody has been an independent business consultant since 1994 providing advice in
the areas of marketing and operations to development stage companies.  From 1991
to 1994, Mr. Moody served as president,  chief executive  officer and a director
of Data Switch Corp., a publicly traded manufacturer of computer products.  From
1986 to 1991,  Mr.  Moody served as  president,  chief  executive  officer and a
director of Coordination  Technology,  Inc., Trumbull,  Connecticut,  a software
development and marketing  company.  From 1985 to 1986, he was president,  chief
executive  officer and a director of InfoCenter  Software,  Inc., New Paltz, New
York, a software  development and marketing  company.  From 1983 to 1984, he was
president,  chief executive  officer and a director of U.S.  Satellite  Systems,
Inc., New York, New York, a satellite design and production  company.  From 1981
to  1983,  he was a vice  president  of CBS and  between  1974 to  1981,  a vice
president  of AT&T.  From 1959 to 1972,  he held  various  sales and  management
positions  with IBM.  Mr.  Moody  received  his  Bachelor  of Science  degree in
electrical  engineering  from  Columbia  University  in 1958 and his  Master  of
Business Administration degree from the University of Michigan in 1959.

    Collis R.  Woodward  has been a director  of the Company  since  February of
1998.  Since 1991 Mr.  Woodward  has been the  managing  director  for  Westerly
Partners,  an investment  firm. In this capacity Mr. Woodward is responsible for
fund  management,  business  development  and  operations.  Prior to  that,  Mr.
Woodward  was the Chief  Executive  Officer  of UVP,  Inc.,  a  manufacturer  of
ultraviolet light products,  for three years. Prior to his association with UVP,
Inc. Mr. Woodward was the Chief Operating Officer and Chief Financial Officer of
Gish  Biomedical for seven years. He began his career with Ernst and Young where
he planned and managed a wide range of consulting  services for seven years. Mr.
Woodward  earned his Backelor of Science  degrees in Electrical  Engineering and
Accounting at UCLA and is a non practicing CPA.

Item 10. EXECUTIVE COMPENSATION

           The following table sets forth the annual and long-term  compensation
for services in all capacities to the Company for the three years ended December
31, 1997 of Wiley E. Prentice, Jr., the President and Chief Executive Officer of
the Company  (the "Named  Officer"),  and any other  officers of the Company who
received  annual  salary and bonus  exceeding  $100,000  during such  three-year
period.


Name and              Annual compensation         All Other
 Position             Year    Salary     Bonus   Compensation(1)
Wiley E. Prentice, Jr.1997    $66,495    -0-            $ --
President and Chief   1996    $71,910    -0-            $ --
Executive Officer     1995    $44,263    -0-            $ --

(1) Excludes personal use of a Company-furnished  automobile valued at less than
$l,000 and car allowance of $l,800.

         During the period  covered by the above table,  no shares of restricted
stock were  issued as  compensation  for  services  to the person  listed in the
table. As of December 31, 1997, the number of shares of the Company's restricted
common stock,  owned by the officer included in the table, and the value of such
shares at such date,  based upon the market price of the Company's  common stock
were:

Name                              Shares                        Value

Wiley E. Prentice, Jr.          1,060,000                    $2,650,000

         Dividends  may be paid on  shares  of  restricted  stock  owned  by the
Company's  officers  and  directors,  although  the  Company has no plans to pay
dividends.  The  Company  has issued a Series A  Preferred  Stock  series  which
prohibits the payment of dividends on common stock.

         No employee of the Company receives any additional compensation for his
or her services as a director.  Non-management  directors  receive a retainer of
$500 per month  plus  $1,000 per  meeting  attended.  Additionally,  each of the
non-management directors received a grant of 10,000 options exercisable at $2.00
per share which vest 25% on grant and 25%  following  each year of service.  The
Company has also agreed to grant each of the non-management directors options to
acquire 10,000 shares of the Company's Common Stock on the first  anniversary of
service  and  options to  acquire  10,000  shares of Common  Stock on the second
anniversary  of service.  These options will be granted at market value and will
vest at the rate of 25% per year.  The Board of  Directors  has also  authorized
payment  of  reasonable  travel  or other  out-of-pocket  expenses  incurred  by
non-management directors in attending meetings of the Board of Directors.

         The Company has no retirement,  pension or profit  sharing  program for
the  benefit of its  directors,  officers or other  employees,  but the Board of
Directors may recommend one or more such programs for adoption in the future.

         Employment   Agreements.   The  Company  has  entered  into  employment
agreements with Mr. Prentice and Ms. Koehler.  Each agreement  requires that the
executive devote their full business time to the Company,  and may be terminated
by the Company for "cause" (as defined in the agreements).  The Company has also
entered into  agreements  with Mr.  Prentice and Ms.  Koehler which prohibit the
executive from directly competing with the Company for one year within a 50 mile
radius  of  Fort  Collins,  Colorado  following  termination  of the  agreement.
Pursuant to their  employment  agreements,  Mr. Prentice and Ms. Koehler were to
receive  annual  salaries of $80,000 and $60,000,  respectively,  with scheduled
minimum increases of 5% annually.  Both officers elected to go unpaid during the
last 2  months  of  1997.  Both  officers  may  also  receive  such  bonuses  or
compensation  as may be  awarded  by the  Board  of  Directors.  The  employment
agreement  with Mr.  Prentice  extends  through  March  2000 and the  employment
agreement with Ms. Koehler extends  through March 1998,  subject to the right on
the part of either the Company or the  executive  to  terminate  the  employment
agreement at any time upon 30 days written notice.

Stock Option and Bonus Plans

         The Company has an Incentive Stock Option Plan, a  Non-Qualified  Stock
Option  Plan and a Stock  Bonus  Plan.  A  summary  description  of these  Plans
follows. In some cases these Plans are collectively referred to as the "Plans".

         Incentive Stock Option Plan. The Incentive Stock Option Plan authorizes
the issuance of up to 600,000  shares of the  Company's  Common Stock to persons
that exercise options granted  pursuant to the Plan. Only Company  employees may
be granted options pursuant to the Incentive Stock Option Plan.

         To be classified as incentive stock options under the Internal  Revenue
Code,  options  granted  pursuant  to the Plans must be  exercised  prior to the
following dates:

         (a) The  expiration  of three  months after the date on which an option
holder's  employment by the Company is terminated (except if such termination is
due to the death or permanent and total disability);

         (b) The  expiration  of 12  months  after  the date on which an  option
holder's employment by the Company is terminated,  if such termination is due to
the Employee's permanent and total disability;

         (c) In the event of an option holder's death while in the employ of the
Company,  his  executors or  administrators  may  exercise,  within three months
following  the  date  of his  death,  the  option  as to any of the  shares  not
previously exercised;

         The total fair market value of the shares of Common  Stock  (determined
at the time of the grant of the  option) for which any  employee  may be granted
options  which  are  first  exercisable  in any  calendar  year  may not  exceed
$100,000.

         Options  may not be  exercised  until  one year  following  the date of
grant.  Options  granted to an employee  then owning more than 10% of the Common
Stock of the Company may not be  exercisable  by its terms after five years from
the date of the grant.  Any other option granted pursuant to the Plan may not be
exercisable by its terms after ten years from the date of grant.

         The  purchase  price  per share of Common  Stock  purchasable  under an
option is  determined  by the  Committee but cannot be less than the fair market
value of the Common Stock on the date of the grant of the option (or 110% of the
fair market value in the case of a person  owning more than 10% of the Company's
outstanding shares).

         Non-Qualified  Stock Option Plan. The  Non-Qualified  Stock Option Plan
collectively  authorizes  the issuance of up to 600,000  shares of the Company's
Common Stock to persons that exercise options granted pursuant to the Plans. The
Company's employees,  directors, officers, consultants and advisors are eligible
to be granted  options  pursuant to the Plans,  provided  however that bona fide
services  must be in  connection  with  the  offer  or sale of  securities  in a
capital-raising  transaction.  The option  exercise  price is  determined by the
Committee but cannot be less than the market price of the Company's Common Stock
on the date the option is granted.

         Stock Bonus Plan.  Up to 200,000  shares of Common Stock may be granted
under the Stock Bonus Plan.  Such shares may  consist,  in whole or in part,  of
authorized but unissued shares, or treasury shares.  Under the Stock Bonus Plan,
the  Company's  employees,  directors,  officers  consultants  and  advisors are
eligible to receive a grant of the Company's shares,  provided however that bona
fide services must be rendered by consultants or advisors and such services must
not be in connection  with the offer or sale of securities in a  capital-raising
transaction.

         Other  Information  Regarding the Plans.  The Plans are administered by
the Company's Compensation Committee ("the Committee"),  each member of which is
a director of the Company.  The members of the  Committee  were  selected by the
Company's  Board of  Directors  and serve for a one-year  tenure and until their
successors are elected.  A member of the Committee may be removed at any time by
action of the Board of Directors. Any vacancies which may occur on the Committee
will be filled by the  Board of  Directors.  The  Committee  is vested  with the
authority  to  interpret   the   provisions  of  the  Plans  and  supervise  the
administration  of the Plans. In addition,  the Committee is empowered to select
those  persons to whom  shares or options are to be granted,  to  determine  the
number of shares  subject  to each  grant of a stock  bonus or an option  and to
determine  when, and upon what  conditions,  shares or options granted under the
Plans will vest or otherwise be subject to forfeiture and cancellation.

         In the discretion of the Committee,  any option granted pursuant to the
Plans may include installment  exercise terms such that the option becomes fully
exercisable  in  a  series  of  cumulating  portions.  The  Committee  may  also
accelerate  the date upon which any option (or any part of any options) is first
exercisable.  Any shares issued pursuant to the Stock Bonus Plan and any options
granted pursuant to the Incentive Stock Option Plan or the  Non-Qualified  Stock
Option Plan will be  forfeited  if the  "vesting"  schedule  established  by the
Committee  administering  the Plan at the time of the grant is not met. For this
purpose,  vesting  means the period  during  which the  employee  must remain an
employee  of the  Company  or the  period of time a  non-employee  must  provide
services to the Company.  At the time an employee ceases working for the Company
(or at the time a non-employee ceases to perform services for the Company),  any
shares or options  not fully  vested will be  forfeited  and  cancelled.  At the
discretion  of the Committee  payment for the shares of Common Stock  underlying
options may be paid through the delivery of shares of the Company's Common Stock
having an aggregate  fair market value equal to the option price,  provided such
shares have been owned by the option  holder for at least one year prior to such
exercise. A combination of cash and shares of Common Stock may also be permitted
at the discretion of the Committee.

         Options are generally  non-transferable except upon death of the option
holder.  Shares  issued  pursuant to the Stock Bonus Plan will  generally not be
transferable  until the  person  receiving  the  shares  satisfies  the  vesting
requirements imposed by the Committee when the shares were issued.

         The Board of Directors of the Company may at any time, and from time to
time, amend,  terminate,  or suspend one or more of the Plans in any manner they
deem appropriate,  provided that such amendment,  termination or suspension will
not  adversely  affect rights or  obligations  with respect to shares or options
previously  granted.  The  Board  of  Directors  may  not,  without  shareholder
approval:  make any  amendment  which would  materially  modify the  eligibility
requirements  for the Plans;  increase or decrease the total number of shares of
Common  Stock which may be issued  pursuant to the Plans except in the case of a
reclassification  of the Company's capital stock or a consolidation or merger of
the Company;  reduce the minimum  option price per share;  extend the period for
granting options;  or materially increase in any other way the benefits accruing
to employees who are eligible to participate in the Plans.

         Summary. The following sets forth certain information,  as of March 31,
1998,  concerning  the stock options and stock  bonuses  granted by the Company.
Each option  represents the right to purchase one share of the Company's  Common
Stock.

                      Total         Shares         Shares        Remaining
                      Shares        Reserved for   Issued        Options/
                      Reserved      Outstanding    as Stock      Bonus Shares
Name of Plan          Under Plan    Options        Bonus         Under Plan

Incentive Stock
 Option Plan            600,000    328,500            --            232,784
Non-Qualified Stock
 Option Plan            600,000         --            --            600,000
Stock Option Plan       200,000        N/A            --            200,000

Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The following table sets forth certain information regarding beneficial
ownership of the Company's  Common Stock as of June 15, 1998, by (i) each person
who is known by the Company to own  beneficially  more than 5% of the  Company's
outstanding  Common  Stock,  (ii) each of the Company's  executive  officers and
directors, and (iii) all executive officers and directors as a group. Shares not
outstanding  but  deemed  beneficially  owned  by  virtue  of  the  right  of an
individual to acquire them within 60 days are treated as  outstanding  only when
determining the amount and percentage of Common Stock owned by such  individual.
Each person has sole voting and sole investment power with respect to the shares
shown except as noted.

                            Shares beneficially owned
Name and Address               Number       Percent

Wiley E. Prentice, Jr.        1,060,000 (1)    22%
2573 Midpoint Drive
Fort Collins, CO  80525

Cynthia E. Koehler              355,000 (1)   7.4%
2573 Midpoint Drive
Fort Collins, CO  80525
Daniel T. Radford                    --        --
2573 Midpoint Drive
Fort Collins, CO  80525

J. Roger Moody                  30,000 (2)      *
7319 East Black Rock Road
Scottsdale, AZ 85255

Collis R. Woodward                  --         --
1716 Cottonwood Point Drive
Fort Collins, Co. 80524

All directors and officers
 as a group (five persons)   1,445,000 (2)   30%


*    Less than one percent.

(1) Includes  shares of Common  Stock  currently  held in an escrow  account and
subject to release on or before  December  31,  2002.  For  further  information
regarding the terms of such escrow, see the information set forth below.

(2) Includes  options which currently allow for the purchase of 30,000 shares of
the Company's Common Stock.

         In September  1995, Mr. Prentice and Ms. Koehler entered into an escrow
agreement (the "Escrow  Agreement")  with U.S. Escrow  Services,  Inc.,  Denver,
Colorado, pursuant to which 330,000 shares of Common Stock owned by Mr. Prentice
and 110,000  shares of Common Stock owned by Ms.  Koehler  were  deposited in an
escrow  account  (the "Escrow  Account").  In  accordance  with the terms of the
Escrow  Agreement  150,000  shares  deposited by Mr.  Prentice and 50,000 shares
deposited  by Ms.  Koehler  were  released  from  escrow  since the  Company had
earnings per share equal to or exceeding $.23 in the fiscal year ending December
31, 1995. The shares remaining in escrow will be returned by the escrow agent to
Mr. Prentice and Ms. Koehler on December 31, 2002.


<PAGE>


Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         Between January 1, 1996 and December 31, 1997, the Company paid certain
payroll  and  other  expenses  on  behalf of MCTI,  a  partnership  owned by Mr.
Prentice and Ms. Koehler as well as made advances to these persons individually.
As of December 31, 1997,  these advances totaled  approximately  $98,000 and are
shown on the Company's  Balance Sheet at December 31, 1997 as Notes  Receivable,
Related  Party.  These  advances  bear  interest  at 9% per annum and are due on
demand and are collateralized by shares of Company's stock owned by Mr. Prentice
and Ms. Koehler.

         Mr.  Prentice  and  Ms.  Koehler  have   personally   guaranteed  the
Company's  repayment of amounts  advanced  under the business  loan  agreement
with Norwest  Business  Credit.  Neither Mr. Prentice nor Ms. Koehler received
any  compensation  from the Company for providing  such  personal  guarantees.
Mr.  Prentice  has also  guaranteed  certain of the  Company's  real  property
leases, for which he received no compensation.



<PAGE>


Item 13. EXHIBITS AND REPORTS ON FORM 8-K

Exhibits
         The  following  is a complete  list of  Exhibits  filed as part of this
Report and which are incorporated herein.

Exhibit No.                                                            Page

3.1.1  Articles of Incorporation.                                        *
3.1.2  Amendment to Articles of Incorporation as filed on May 19, 1995   *
3.1.3  Amendment to Articles of Incorporation as filed on June 6, 1995   *
3.2.1  By-Laws.                                                          *
4.1    Form of specimen certificate for Common Stock of the Company.     *
4.2    Form of specimen certificate for Warrants of the Company.         *
4.5    Warrant Agreement between the Company and American Securities
       Transfer, Inc.                                                    *
10.1.1 Employment Agreement, dated April 1, 1995, by and between
       Wiley E. Prentice, Jr. and the Company.                           *
10.1.2 Employment Agreement, dated April 1, 1995, by and between
Cynthia E. Koehler and the Company.                                      *
10.2   1995 Incentive Stock Option Plan, adopted March 1, 1995,
       authorizing 600,000 shares of Common Stock for issuance upon
       exercise of options issued pursuant to the Plan.                  *
10.7   Retail Lease, dated May 29, 1992, by and between Clarmont
       Enterprises, Inc. and the Company.                                *
10.8   Retail Lease, dated August 13, 1990, by and between
       University Hill Plaza Partnership, Ltd. and the Company.          *
10.9   Lease Agreement, dated August 16, 1989, by and between
       G.B. Ventures and the Company, as amended by Lease
       Extension Agreement #1, dated September 15, 1994
       and Lease Addendum No. 2, dated July 7, 1995.                     *
10.10  Shopping Center Lease, dated August 13, 1991, by and
       between Colorado & Wesley Partners, Ltd. and the Company.         *
10.11  Shopping Center Lease, dated July 16, 1993, by and between
       Crow-Watson #8, a Texas limited partnership, and the Company.     *
10.12  Shopping Center Lease, dated September 14, 1992, by and
       between First Interstate Bank, N.A., as Trustee of Heron
       North America Property Trust, and the Company.                    *
10.13  Lease, dated July 8, 1991, by and between Westside
       Investment Company and the Company.                               *
10.24  Share  Escrow  Agreement.  * 23.2  Consent  of  Hein +  Associates  LLP *
Incorporated  by  reference to same exhibit  filed with  Company's  Registration
Statement on Form SB-2 (Commission File #33-95782-D).


Reports on Form 8-K

         During the quarter  ending  December 31, 1997 the following 8-K reports
were filed:

         Report dated  November 24, 1997  concerning  the sale of the  Company's
Series B Preferred Stock.


<PAGE>
 INDEX TO FINANCIAL STATEMENTS



                                                                           PAGE

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

Consolidated Balance Sheet - December 31, 1997..............................F-3

Consolidated  Statements  of  Operations  - For the Years Ended  December 31,
 1997 and 1996..............................................................F-4

Consolidated  Statements of  Stockholders'  Equity - For the Years Ended
  December 31, 1997 and 1996................................................F-5

Consolidated  Statements  of Cash Flows - For the Years Ended December 31, 1997
and 1996....................................................................F-6

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

                                 F-1


<PAGE>

                           INDEPENDENT AUDITOR'S REPORT




Board of Directors
Applied Computer Technology, Inc.
Fort Collins, Colorado

We have audited the accompanying  consolidated balance sheet of Applied Computer
Technology,  Inc. and  subsidiaries  as of December  31,  1997,  and the related
consolidated statements of operations,  stockholders' equity, and cash flows for
the years ended December 31, 1997 and 1996.  These financial  statements are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements based on our audits.

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

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all material  respects,  the financial  position of Applied Computer
Technology,  Inc. and  subsidiaries  as of December 31, 1997, and the results of
their  operations and their cash flows for the years ended December 31, 1997 and
1996, in conformity with generally accepted accounting principles.

The accompanying  consolidated  financial statements have been prepared assuming
that the  Company  will  continue as a going  concern,  which  contemplates  the
realization  of assets and  liquidation  of  liabilities in the normal course of
business.  As discussed in Note 2 to the financial  statements,  the Company has
suffered  substantial  operating  losses in 1996 and 1997 and the  Company has a
working  capital  deficit of $1,558,000 at December 31, 1997.  These  conditions
raise  substantial  doubt  about the  Company's  ability to  continue as a going
concern.  Management's  plans in regard to these  matters are also  discussed in
Note 2. The  financial  statements  do not  include any  adjustments  that might
result from the outcome of this uncertainty.





HEIN + ASSOCIATES LLP

Denver, Colorado
April 3, 1998
                                      F-2

<PAGE>


                APPLIED COMPUTER TECHNOLOGY, INC. AND SUBSIDIARIES

                            CONSOLIDATED BALANCE SHEET
                                 DECEMBER 31, 1997



                        ASSETS
CURRENT ASSETS:
   Cash                                                              $24,000
   Receivables:
      Trade, less allowance for doubtful accounts of               1,377,000
      $55,000
      Other                                                           99,000
   Inventories                                                     2,404,000
   Prepaid expenses and other                                        261,000
                                                                  ----------
         Total current assets                                      4,165,000

PROPERTY AND EQUIPMENT, at cost, net                               1,852,000

OTHER ASSETS:
   Customer list, net of accumulated amortization of $34,000         116,000
   Notes receivable, related parties                                  98,000
   Deposits and other                                                276,000
                                                                  ---------- 
        Total other assets                                           490,000
                                                                  ----------
TOTAL ASSETS                                                      $6,507,000
                                                                  ==========

          LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
   Current maturities of obligations under capital leases           $172,000
   Current maturities of long-term debt                            1,108,000
   Accounts payable                                                3,952,000
   Accrued liabilities                                               491,000
                                                                   --------- 
         Total current liabilities                                 5,723,000

LONG-TERM DEBT, less current maturities                               42,000

OBLIGATIONS UNDER CAPITAL LEASES, less current maturities            399,000

COMMITMENTS AND CONTINGENCIES (Notes 2 and 7)

STOCKHOLDERS' EQUITY:
   Preferred stock, no par value; 5,000,000 shares                   
      authorized:

      Series A Preferred Shares, 1,000 shares                        
         authorized; 900 shares issued and outstanding
         (liquidation preference $919,000)                           900,000

      Class B Convertible Preferred Shares, 1,500 shares           
         authorized; 1,500 shares issued and outstanding
         (liquidation preference $1,509,000)                       1,326,000

   Common stock, no par value; 25,000,000 shares                   
      authorized; 3,085,243 shares issued and outstanding          4,183,000

   Accumulated deficit                                            (6,066,000)
                                                                  -----------
         Total stockholders' equity                                  343,000
                                                                  -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                        $6,507,000
                                                                  ===========
The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                      F-3
<PAGE>
 
                APPLIED COMPUTER TECHNOLOGY, INC. AND SUBSIDIARIES

                       CONSOLIDATED STATEMENTS OF OPERATIONS


                                                        YEARS ENDED DECEMBER 31,
                                                            1997           1996
                                                        -----------   ---------

NET REVENUES                                            $25,555,000  $20,239,000
                                                            
   Cost of goods sold                                    25,730,000  17,577,000

GROSS PROFIT (LOSS)                                        (175,000)  2,662,000
                                                         ----------  ----------
OPERATING EXPENSES:
   Marketing and selling                                  2,319,000   2,410,000
   General and administrative                             1,893,000   1,541,000
   Impairment of long-lived assets                          120,000      -
                                                          ---------   ---------
         Total operating expenses                         4,332,000   3,951,000
                                                          ---------   ---------

LOSS FROM OPERATIONS                                     (4,507,000) (1,289,000)

OTHER INCOME (EXPENSE):
   Other (expense) income                                    32,000     (53,000)

   Interest expense                                        (461,000)   (175,000)
                                                            --------   --------

LOSS BEFORE INCOME TAXES                                 (4,936,000) (1,517,000)

   Income tax benefit                                             -    (175,000)
                                                        -----------   ----------

NET LOSS                                                 (4,936,000) (1,342,000)

PREFERRED STOCK DIVIDENDS:
   Accrued                                                  (28,000)       -
   Imputed                                                 (229,000)       -
                                                           ---------   --------
         Net loss applicable to common stockholders     $(5,193,000)$(1,342,000)
                                                        ============ ===========
NET LOSS PER COMMON SHARE                                    $(1.69)   $ (.44)
                                                              ======    ======

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING                3,067,000   3,042,000
                                                          =========   =========

The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                      F-4
<PAGE>




               APPLIED COMPUTER TECHNOLOGY, INC. AND SUBSIDIARIES

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                 FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996

<TABLE>
 <S>                                        <C>         <C>           <C>      <C>               <C>           <C>
                                                                                           RETAINED
                                           COMMON STOCK            PREFERRED STOCK         EARNINGS
                                        SHARES      AMOUNT         SHARES     AMOUNT       (DEFICIT)      TOTAL


BALANCES, January 1, 1996             3,040,000  $4,139,000           -        $-          $212,000     $4,351,000

   Exercise of options                   40,000      80,000           -         -                 -         80,000
   Surrender of shares                  (16,873)    (80,000)          -         -                 -        (80,000)
   Net loss                                   -           -           -         -        (1,342,000)    (1,342,000)
                                           -----      -----         -----     -----       ----------     ----------
BALANCES, December 31, 1996           3,063,127   4,139,000           -         -        (1,130,000)     3,009,000
   Exercise of stock options             22,116      44,000           -         -                 -         44,000
   Conversion of debt to equity            -          -             900      900,000              -        900,000
   Issuance of Series B Preferred stock    -          -           1,500    1,500,000              -      1,500,000
   Offering costs                          -          -               -     (174,000)             -       (174,000)
   Net loss                                -          -               -         -        (4,936,000)    (4,936,000)
                                           -----      -----        -----      -----        ----------   ----------
BALANCES, December 31, 1997           3,085,243  $4,183,000       2,400   $2,226,000    $(6,066,000)      $343,000
                                      =========  ==========       =====   ==========     ===========      ========
</TABLE>

             The accompanying  notes are an integral part of these  consolidated
financial statements.

                                      F-5
<PAGE>



                                      

                APPLIED COMPUTER TECHNOLOGY, INC. AND SUBSIDIARIES

                       CONSOLIDATED STATEMENTS OF CASH FLOWS


                                                        FOR THE YEARS ENDED
                                                        DECEMBER 31,
                                                          1997        1996
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net loss                                            $(4,936,000) $(1,342,000)
   Adjustments to reconcile net loss to 
   net cash used in operating activities:
         Depreciation and amortization                     614,000      274,000
         Impairment of long-lived assets                   120,000            -
         Loss on disposal of assets                         10,000       68,000
         Provision for obsolete and slow-moving
         inventories                                     1,051,000            -
         Deferred income taxes                                   -      (22,000)
         Changes in operating assets and liabilities:
            Decrease (increase) in:
              Accounts receivable                          323,000     (364,000)
              Inventories                                  (74,000)  (1,809,000)
              Prepaid expenses and other                   126,000     (317,000)
              Income tax refund receivable                 280,000     (133,000)

            Increase (decrease) in:
              Accounts payable                           2,150,000    2,270,000
              Customer deposits                                  -      (53,000)
              Accrued liabilities and other                 95,000      143,000
                                                            ------      -------
         Net cash used in operating activities            (241,000)  (1,285,000)
                                                           --------   ----------

CASH FLOWS FROM INVESTING ACTIVITY -
   Property and equipment acquisitions                    (276,000)  (1,159,000)
                                                          --------   ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from issuance of Class B Preferred Stock     1,370,000            -
   Principal payments under notes payable               (7,595,000)  (5,697,000)
   Borrowings under notes payable                        6,199,000    7,602,000
   Principal payments under capital leases                (143,000)     (28,000)
   Offering costs                                          (44,000)           -
   Net proceeds from exercise of common stock options       44,000            -
                                                            ------      -------
         Net cash provided by financing activities        (169,000)   1,877,000
                                                           --------    ---------

NET DECREASE IN CASH AND EQUIVALENTS                      (686,000)    (567,000)

CASH AND EQUIVALENTS, at beginning of year                 710,000    1,277,000
                                                          ----------

CASH AND EQUIVALENTS, at end of year                       $24,000     $710,000
                                                           =======     ========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION -
   Cash paid (received) for:
      Interest                                            $461,000     $150,000
                                                          ========     ========

      Income taxes                                       $(280,000)    $(25,000)
                                                          =========     ========

SUPPLEMENTAL DISCLOSURE OF NON-CASH FLOW INVESTING AND
  FINANCIAL ACTIVITIES:
   Purchase of equipment for notes and capital leases     $489,000     $253,000
                                                          ========     ========

   Issuance of Series A Preferred Stock for cancellation
   of trade payables                                      $900,000    $      -
                                                          ========    =========
      

   Issuance of common stock under option for common 
   stock surrendered                                       $-           $80,000
                                                           ======      =======
      

The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                      F-6
<PAGE>


              APPLIED COMPUTER TECHNOLOGY, INC. AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



1    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

     Nature of Operations - Applied  Computer  Technology,  Inc. (the "Company")
     principally  assembles  and  distributes  personal  computers  and  related
     products  and  services  to  customers   throughout   the  United   States.
     Additionally,  the Company  has six retail and  training  locations  within
     Colorado.  During 1996,  the Company also expended  substantial  amounts in
     establishing the infrastructure to become an Internet provider.

     Principles of  Consolidation - In 1996, the Company  established two wholly
     owned  subsidiaries,  ACT Far East Limited and ACTNET,  Inc. The  financial
     statements  include the accounts of the Company and its  subsidiaries.  All
     intercompany   balances   and   transactions   have  been   eliminated   in
     consolidation.

     Use of Estimates - The preparation of the Company's  consolidated 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 disclosures 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.

     The Company's  financial  statements  are based on a number of  significant
     estimates including the allowance for obsolete and slow-moving inventories,
     the allowance for doubtful accounts receivable,  assumptions  affecting the
     fair value of stock options and warrants,  selection of the useful lives of
     property and equipment,  and estimates of fair value of long-lived  assets.
     Accordingly,  the  Company's  estimates  are  expected  to change as future
     information becomes available.  Due to the nature of the computer industry,
     it is reasonably  possible that the allowance for obsolete and  slow-moving
     inventories will materially change in the forthcoming year.

     Cash Equivalents - The Company considers all highly liquid debt investments
     purchased  with an  original  maturity  of three  months or less to be cash
     equivalents.

     Inventories - Inventories  consist  principally of component  parts and are
     recorded at the lower of cost (using the first-in, first-out (FIFO) method)
     or  market.  Inventories,  net  of  obsolescence  reserve,  consist  of the
     following at December 31:

           
           Computer components, peripherals and                  $2,243,000
           software
           Completed computer systems                               161,000
                                                                  ----------
                                                                 $2,404,000
                                                                 ===========
     Property  and  Equipment - Property and  equipment  is stated at cost.  The
     Company capitalizes costs associated with major improvements.  During 1996,
     the Company  capitalized  payroll costs associated with software  developed
     for internal  communication and information systems and to provide Internet
     access to its customers.


                                      F-7
<PAGE>


     The Company provides for depreciation of equipment using the  straight-line
     method over the  estimated  useful lives of the assets which are  generally
     five years for computer and promotion  equipment  and  vehicles,  and seven
     years for office equipment.  Leasehold  improvements are amortized over the
     life of the leases.

     Customer List - These costs  primarily  represent the  acquisition  in
     December 1996 from third parties of certain customer bases. These customers
     are utilizing the Company's  Internet  access  services.  The cost of these
     acquisitions  is being  amortized  over five years using the  straight-line
     method.  Amortization expense for the year ended December 31, 1997 amounted
     to $34,000.

     Impairment of Long-Lived  Assets - The Company  performs an assessment  for
     impairment  whenever events or changes in  circumstances  indicate that the
     carrying amount of a long-lived  asset may not be  recoverable.  If the net
     carrying value exceeds estimated  undiscounted  future net cash flows, then
     impairment is recognized to reduce the carrying value to the estimated fair
     value.

     Fair  Value of  Financial  Instruments  - The  estimated  fair  values  for
     financial  instruments  are determined at discrete  points in time based on
     relevant market  information.  These estimates  involve  uncertainties  and
     cannot be determined  with  precision.  At December 31, 1997,  management's
     best  estimate is that the  carrying  amount of all  financial  instruments
     approximates fair value.

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

     In October 1995,  the  Financial  Accounting  Standards  Board issued a new
     statement titled Accounting for Stock-Based Compensation (FAS 123). FAS 123
     requires that options,  warrants, and similar instruments which are granted
     to  non-employees  for goods and  services be recorded at fair value on the
     grant date.  Fair value is  generally  determined  under an option  pricing
     model using the  criteria  set forth in FAS 123.  The Company did not adopt
     FAS 123 to  account  for  stock-based  compensation  for  employees  but is
     subject to the pro forma disclosure requirements.

     Revenue  Recognition  - The Company  recognizes  revenues  from product and
     system sales upon shipment to the customer. Revenue from service agreements
     are  recognized  ratably  over the terms of the  agreements.  Revenue  from
     performance contracts are recognized on the completed contract method.

     Warranty  - The  Company  provides  a  warranty  to its  customers  and the
     expected costs are accrued at the time of sale.

     Advertising - Advertising  costs are charged to operations in the period in
     which the advertising  first takes place. The Company incurred  advertising
     expenses of $180,000 and $494,000 in 1997 and 1996, respectively.

                                      F-8
<PAGE>


     Income Taxes - Deferred tax assets and  liabilities  are recognized for the
     future tax  consequences  attributable  to  differences  between  financial
     statement  carrying  amounts of existing  assets and  liabilities and their
     respective  tax bases.  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  previously  recorded  deferred  tax  assets and  liabilities
     resulting  from a change  in tax rates is  recognized  in  earnings  in the
     period in which the change is enacted.

     Earnings Per Share - Net loss per common  share is presented in  accordance
     with the provisions of Statement of Financial Accounting Standards No. 128,
     Earnings Per Share (FAS 128). FAS 128 replaces the  presentation of primary
     and fully diluted  earnings per share (EPS),  with a presentation  of basic
     EPS and  diluted  EPS.  Under FAS 128,  basic  EPS  excludes  dilution  for
     potential  common  shares  and is  computed  by  dividing  income  or  loss
     applicable  common  shareholders  by the weighted  average number of common
     shares  outstanding  for the period.  Diluted EPS  reflects  the  potential
     dilution that could occur if securities or other  contracts to issue common
     stock were  exercised  or  converted  into common stock and resulted in the
     issuance  of common  stock.  Basic and diluted EPS are the same in 1997 and
     1996 as all potential common shares were antidilutive.

     Impact of Recently  Issued  Accounting  Standards - Statement  of Financial
     Accounting  Standards 130 Reporting  Comprehensive  Income and Statement of
     Financial  Accounting  Standards  131  Disclosures  About  Segments  of  an
     Enterprise  and Related  Information  were recently  issued.  Statement 130
     establishes  standards for reporting and display of  comprehensive  income,
     its components and accumulated balances. Comprehensive income is defined to
     include all changes in equity except those  resulting  from  investments by
     owners and distributions to owners. Among other disclosures,  Statement 130
     requires  that all items that are required to be  recognized  under current
     accounting standards as components of comprehensive income be reported in a
     financial  statement  that  displays  with  the  same  prominence  as other
     financial  statements.  Statement  131  supersedes  Statement  of Financial
     Accounting  Standards  14  Financial  Reporting  for Segments of a Business
     Enterprise.  Statement  131  establishes  standards  on the way that public
     companies report financial  information about operating  segments in annual
     financial  statements and requires reporting of selected  information about
     operating segments in interim financial statements issued to the public. It
     also establishes standards for disclosures regarding products and services,
     geographic  areas,  and major  customers.  Statement 131 defines  operating
     segments  as  components  of  a  company  about  which  separate  financial
     information is available that is evaluated regularly by the chief operating
     decisionmaker  in  deciding  how to  allocate  resources  and in  assessing
     performance.

     Statements  130 and 131 are effective for financial  statements for periods
     beginning after December 15, 1997 and require  comparative  information for
     earlier  years to be  restated.  Because  of the recent  issuance  of these
     standards, management has been unable to fully evaluate the impact, if any,
     the  standards  may have on the  future  financial  statement  disclosures.
     Results of operations and financial position,  however,  will be unaffected
     by implementation of these standards.

     Reclassifications - Certain reclassifications have been made to conform the
     1996   financial    statements   to   the   presentation   in   1997.   The
     reclassifications had no effect on net loss.

                                      F-9

<PAGE>


2    LIQUIDITY AND LOSSES INCURRED IN OPERATIONS:

The  accompanying  consolidated  financial  statements have been prepared on the
going  concern  basis,   which   contemplates  the  realization  of  assets  and
liquidation  of  liabilities  in the normal course of business.  The Company has
incurred losses of $1,342,000 and $4,936,000 in 1996 and 1997, respectively, and
expects to incur  additional  losses in the first quarter of 1998.  These losses
have adversely impacted the Company's working capital. At December 31, 1997, the
Company  has  a  working   capital   deficit  of  $1,558,000   and  $343,000  of
stockholders'  equity.  Should  losses  continue,  they would cause  significant
liquidity  problems and may ultimately  impact the Company's ability to continue
future operations.

Subsequent  to December 31,  1997,  the Company has taken action to decrease its
overhead and has been  successful in obtaining  additional  contracts for future
sales. In addition,  management  believes that certain start-up costs associated
with  opening new stores,  and  establishing  the  infrastructure  for  Internet
provider  services  incurred in 1996 and 1997 should result in increased related
revenues in 1998.  However,  there can be no assurance  that these  efforts will
ultimately enable the Company to return to profitability,  and other actions may
be required by  management.  However,  management  believes the actions taken to
reduce  overhead  and  increase  revenues  will  enable the  Company to continue
operations through 1998.


3 PROPERTY AND EQUIPMENT:

     Property and equipment consist of the following at December 31, 1997:

           Office and computer equipment            $2,420,000
           Vehicles                                    156,000
           Leasehold improvements                      334,000
           Other                                         9,000
                                                    ----------
                                                     2,919,000
           Less accumulated depreciation and        
           amortization                             (1,067,000)
                                                    ----------           
                                                    $1,852,000
                                                    ==========
     Depreciation  and  amortization  expense  related to property and equipment
     amounted to $580,000 and $274,000 for the years ended December 31, 1997 and
     1996, respectively.


                                      F-10

<PAGE>


4    NOTES PAYABLE:

     The Company has the  following  notes payable  outstanding  at December 31,
1997:

      Note payable to vendor,  bears  interest at 9% and is due on    
      demand.  The note is collateralized by accounts  receivable,
      inventory,   and   equipment.   The   note   is   personally
      guaranteed by a director and major stockholder.                 $500,000
      
      Notes  payable to financial  institution  related to initial    
      payment of accounts  receivable  sold with  recourse,  bears
      interest at an  effective  rate of 18% and is due on demand.
      Note is  collateralized  by substantially  all assets of the
      Company.  The  amounts  due  are  personally  guaranteed  by
      certain stockholders.                                            588,000
     
      Notes payable to financial institutions; interest at 9% to  10%.
      The notes are collateralized by vehicles.                          62,000 
                                                                       --------
                                                                      1,150,000
      
      Less current maturities                                        (1,108,000)
                                                                     -----------
           Long-term debt, less current maturities                      $42,000
                                                                      ==========

     Future principal payments required under notes payable,  as of December 31,
1997, are as follows:

           
            Year Ending
           December 31,
               1998                                                  $1,108,000
               1999                                                      22,000
               2000                                                      20,000
                                                                       ---------
          
                                                                     $1,150,000
                                                                    ============

5    OBLIGATIONS UNDER CAPITAL LEASES:

     The Company leases certain equipment under agreements classified as capital
     leases. Equipment under these leases has a cost of $726,000 and accumulated
     amortization  of $135,000 at December 31, 1997. The following is a schedule
     of future minimum lease payments under capital leases at December 31, 1997.
          
                Future minimum lease payments                        $665,000
                Less amount representing interest                     (94,000)
                                                                     ---------
                Present value of net minimum lease                    571,000
                payments
                Less current maturities                              (172,000)
                                                                     ---------
                                                                     $399,000
                                                                     =========
                                      F-11
<PAGE>


6    INCOME TAXES:

     Income taxes consist of the following at December 31:

           
                                                     1997          1996
                                                  ---------      --------
           Current                                $      -      $(153,000)
           Deferred                                      -        (22,000)
                                                  --------       --------
           Income tax expense (benefit)           $      -      $(175,000)
                                                  ========      ==========
           
     The Company's  effective  tax benefit was less than the statutory  rate for
     the  years  ended  December  31,  1997 and 1996 due to an  increase  in the
     valuation  allowance  related  to the  realization  of net  operating  loss
     carryforwards.   This  valuation  allowance  increased  by  $1,720,000  and
     $350,000 for the years ended December 31, 1997 and 1996, respectively.

     Deferred  tax  assets    are  comprised  of the  following  at
     December 31, 1997:

           Assets:
                Net operating loss carryforward            $1,980,000
                Reserve for obsolete inventory                 90,000
                Property and equipment                          4,000
                Deferred revenue and other                     40,000
                                                           ----------
                                                            2,114,000
            Valuation allowance                            (2,114,000)
                                                           ----------
            Balance                                        $        -
                                                           ==========
     At December 31, 1997, the Company has a net operating loss  carryforward of
     approximately $5,300,000. This carryforward expires in 2010 through 2012.


7 COMMITMENTS AND CONTINGENCIES:


                                      F-12
<PAGE>


     SEC   Investigation  -  In  November  1996,  the  Securities  and  Exchange
     Commission  (SEC)  commenced a formal  investigation  of the  Company.  The
     Company  understands this investigation  relates primarily to the Company's
     capitalization  of labor and related costs associated with  enhancements to
     the Company's  internal software  systems,  the development of software for
     the Company's Internet Access service, the development of the Company's new
     marketing program and the opening of new business centers. During 1996, the
     Company changed its accounting policy concerning these costs and elected to
     expense a  substantial  portion  of the costs  which  had  previously  been
     capitalized  by the  Company  in  the  areas  mentioned  above.  The  SEC's
     investigation  is  continuing,  however,  the Company  does not believe the
     investigation  will have a significant  financial impact upon the Company's
     December 31, 1997 financial condition.

     Operating Leases - The Company leases office,  production,  warehouse,  and
     retail  facilities  under various  noncancellable  lease  agreements  which
     expire through September 2007. The agreements generally provide for certain
     rent-free,  or reduced rent periods and escalating rents in future periods.
     The Company, however, recognizes rent expense ratably over the terms of the
     leases.  Rent  expense for the years ended  December  31, 1997 and 1996 was
     $426,000 and $253,000, respectively.

     At  December  31,  1997,  future  minimum  lease  payments  required  under
     noncancellable operating leases are as follows:

              Year Ending
              December 31,
                1998                                                $538,000
                1999                                                 537,000
                2000                                                 524,000
                2001                                                 420,000
                2002                                                 263,000
                                                                     -------
                                                                  $2,282,000
                                                                ============


     Retirement  Plan - The Company has a defined  contribution  retirement plan
     under  Section  401(k)  of the  Internal  Revenue  Code.  The  plan  covers
     substantially all of the Company's employees and allows the Company to make
     discretionary contributions. No contributions have been made by the Company
     since the plan's inception.

     Contingencies  - The  Company  may from time to time be involved in various
     claims,   lawsuits,   disputes  with  third  parties,   actions   involving
     allegations  of  discrimination,  or breach of contract  incidental  to the
     operations  of its business.  The Company is not currently  involved in any
     such  incidental  litigation  which it  believes  could  have a  materially
     adverse effect on its financial condition or results of operations.


8    PREFERRED STOCK:

     The Company has 5,000,000  shares of preferred stock authorized with no par
     value.  During 1997,  the Company  authorized  a Series of 1,000  Preferred
     Shares designated as Series A Preferred Shares. The Company also authorized
     a Series  of  1,500  Preferred  Shares  designated  as Class B  Convertible
     shares.

                                      F-13

<PAGE>


     Series A Preferred Shares - Holders of Series A Preferred Shares (Series A)
     have no voting  rights.  Dividends on Series A are at 12% per annum payable
     quarterly  commencing December 31, 1997. Dividends not declared will accrue
     on a cumulative basis.

     Shares of Series A are  convertible  into  common  stock at any time at the
     option of the  holder,  on the basis of one  share of  preferred  stock for
     shares of Common Stock equal in number to the amount determined by dividing
     $1,000 by an amount equal to the average closing bid price of the Company's
     common stock over the five-day  trading  period  ending on the day prior to
     the  conversion,  which  may not be less  than  $2.50 or more  than  $4.25.
     Subsequent to year-end,  the Company agreed to reduce the conversion  range
     to not  less  than  $1.00 or more  than  $3.00.  If the  fair  value of the
     Company's  common stock is greater than the conversion price the difference
     will  be  accounted  for  as an  imputed  dividend.  This  amount  will  be
     recognized  as  a  charge  in  computing  net  loss  applicable  to  common
     shareholders.

     In the event of  liquidation,  dissolution,  or winding up of the  Company,
     Series A holders are entitled to receive a liquidation preference of $1,000
     per share plus all dividends in arrears.  On November 4, 1997,  the Company
     sold 900 shares of Series A  Preferred  Stock to a supplier  of the Company
     for  $900,000.  Payment  for the shares  was made by the  vendor  canceling
     $900,000 of  payables  owed by the  Company to the  vendor.  The  remaining
     balance  included in accounts  payable to this vendor at December  31, 1997
     amounts to approximately $1.1 million.

     Class B Convertible  Shares - Holders of Class B Convertible Shares (Series
     B)  generally  have no  voting  rights.  Dividends  on  Series B are at 7%,
     payable  quarterly  in  cash  or  shares  of the  Company's  common  stock,
     commencing on January 31, 1998.

     Shares of Series B are  convertible  into common stock at the option of the
     holder as follows: one-third of the shares 45 days after closing, one-third
     of the shares 60 days after  closing,  and  one-third of the shares 90 days
     after  closing.  However,  no more  than  10% may be  converted  in any one
     calendar week.

     The conversion rate is one share of Series B for the shares of Common Stock
     equal to the stated  value plus all  accrued but unpaid  dividends  of such
     shares divided by the lessor of (1) 75% of the average closing bid price of
     the  common  stock  during  the  period of five  trading  days  immediately
     preceding the date of conversion or (2) $3.65.  The difference  between the
     fair  value of the  Company's  common  stock  and the  conversion  price is
     accounted for as an imputed dividend. This amount is recognized as a charge
     in computing net loss applicable to common  shareholders  and is recognized
     during the period  between  issuance of the Series B and the  initial  date
     convertible.

     The  Company  may redeem  the Series B in whole or in part if the 5-day
     average closing bid price for the Company's common stock is less than $3.00
     per share by paying to the holder an amount equal to 115% of the 
     liqiudation  preference plus all accrued but unpaid dividends.

     In the event of  liquidation,  dissolution,  or winding up of the  Company,
     Series B holders are entitled to receive a liquidation preference of $1,000
     per share plus accrued but unpaid dividends.


                                      F-14
<PAGE>


     On  November  24,  1997,  the Company  sold 1,500  shares of Series B, plus
     82,192  Common  Stock  Purchase   Warrants,   to  a  foreign  investor  for
     $1,500,000. In connection with this transaction,  the Company put 3,000,000
     shares of common stock in an escrow  account.  These shares of common stock
     may only be  released  from  escrow to satisfy  conversion  of  outstanding
     Series B Preferred shares.  Accordingly,  these shares are not reflected as
     issued  and  outstanding  common  shares  in  the  accompanying   financial
     statements.  Through December 31, 1997, no shares of Series B had converted
     to  common  stock.  Through  April 3,  1998,  900  shares  of  Series B had
     converted to 810,045 shares of common stock. Each Warrant allows the holder
     to purchase one share of the  Company's  common stock for $4.02 at any time
     prior to November 21, 2000.

     In  connection  with the  Company's  sale of Series B Preferred  Shares and
     Warrants, the sales agent for such offering, received an 8% commission plus
     warrants to purchase  41,096  shares of the Company's  Common Stock.  These
     warrants are exercisable at a price of $4.02 per share at any time prior to
     November 21, 2000.

     The Company recognized  $229,000 of imputed dividends through December 31,
     1997, and the Company will recognize  additional  imputed dividends of
     $215,000 during the first quarter of 1998.


9.   STOCK-BASED COMPENSATION:

     A summary of warrants outstanding at December 31, 1997 is as follows:

                                            Number of  Exercise     Expiration
             Issued For                     Shares      Price         Date
            -----------                    ----------  --------    ------------
           Private offering, underwriter    40,000      $4.55      October 2000
           Public offering, unit holders   575,000       4.50      October 1998
           Public offering, underwriter     60,000       4.55      October 2000
           Public offering, underwriter     50,000       4.83      October 2000
           Series B offering                82,192       4.02      November 2000
           Series B offering, selling agent 41,096       4.02      November 2000
                                            ------
                                                                       
           Total shares reserved for           
           warrants                        848,288
                                           =======
     Stock Option Plans - During March 1995, the Board of Directors  adopted the
     1995 Incentive  Stock Option Plan (Plan).  The Plan authorizes the issuance
     of up to 600,000 shares of the Company's common stock to employees. Options
     granted pursuant to the plan are incentive stock options within the meaning
     of the Internal  Revenue Code.  The exercise  price of the options  granted
     under the plan is not less than the fair market value of the common  stock.
     The options are granted for terms of five or ten years and may be increased
     at such times as may be determined by the Plan's administrator. Options are
     subject to certain acceleration and termination provisions.

                                      F-15
<PAGE>


     A summary of incentive stock option activity is as follows:

                                     1997                  1996
                                    ---------             -------
                                             Weighted              Weighted
                                             Average               Average
                                  Number    Exercise    Number    Exercise
                                 of Shares    Price    of Shares    Price
      
      Outstanding, beginning   
      of year                     350,500   $ 4.54      212,500      $2.32
      
          Granted                 257,000     2.06      249,000       5.04
          Exercised               (22,116)    2.00      (40,000)      2.00
          Canceled               (221,000)    5.04      (71,000)      2.23
          Repriced                (63,000)    3.52            -         -
                                  -------              ---------
     Outstanding, end of year     301,384     2.14      350,500       4.54
                                  =======               =======
      
      During 1996, a former officer  exercised  40,000 options.  Pursuant to the
      Plan, the former officer surrendered shares with a market value equivalent
      to the exercise price.

For all options granted during 1997 and 1996, the weighted  average market price
of the Company's common stock on the grant date was  approximately  equal to the
weighted  average  exercise  price.  At December 31,  1997,  options for 115,259
shares were  exercisable  (at a weighted  average  exercise price of $2.23) with
85,325 shares  becoming  exercisable  in 1998 and the remaining  100,800  shares
becoming exercisable by December 31, 2000. If not previously exercised,  options
outstanding at December 31, 1997, will expire as follows:
                                                                   Weighted
                                                                   Average
                                                        Number    Exercise
       Year Ending December 31,                        of Shares    Price
              2000                                      20,000    $  2.00
              2001                                      20,000       4.62
              2005                                     104,675       2.00
              2006                                      83,709       2.00
              2007                                      73,000       2.00
                                                      --------
                                                       301,384       2.14
                                                      ========     
                                      F-16

<PAGE>


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

                                                       Year Ended December 31,
                                                         1997           1996
 Net income (loss) applicable to common stockholders:
          As reported                               $(5,193,000)   $(1,342,000)
          Pro forma                                 $(5,351,000)   $(1,795,000)
 Net income (loss) per common share:
          As reported                               $     (1.69)    $     (.44)
          Pro forma                                 $     (1.74)    $     (.59)
          
     The  weighted  average fair value of options  granted to employees  for the
     years  ended  December  31,  1997 and  1996,  was  $1.52  and  $1.41,
     respectively. The fair value of each employee option and warrant granted in
     1997 and 1996 was  estimated  on the date of grant using the  Black-Scholes
     option-pricing model with the following weighted average assumptions:

   
                                                         Year Ended December 31,
                                                              1997       1996
     
     Expected volatility                                     124.40%    50.84%
     Risk-free interest rate                                   5.9%      6.5%
     Expected dividends                                         -           -
     Expected terms (in years)                                 5.0       5.0
      

10.  RELATED PARTY TRANSACTIONS:

      During fiscal 1996, the Company  provided  services  totaling $36,000 to a
      related party.  As of December 31, 1997, the Company has notes  receivable
      of $98,000 from its stockholders, which are collateralized by their common
      stock ownership. These notes bear interest at 8.5% and are due on demand.
                                      F-17
<PAGE>


11. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMER:

      Financial   instruments   which   potentially   subject   the  Company  to
      concentrations  of credit risk consist  principally  of cash and temporary
      cash investments.  At times, cash balances held at financial  institutions
      were in excess of FDIC insurance limits.

      The Company sells its products and services  primarily to customers in the
      education,  corporate,  and governmental markets. Credit is extended based
      on an evaluation of the customer's  financial  condition and collateral is
      generally not required.

      Sales in excess of 10% or more of the Company's sales are as follows:

           
           Customer                                  1997       1996
           --------                                 --------   ------
               A                                      10%        15%
               B                                       -         10%
               C                                      17%        16%
               D                                      10%         -
          
     At  December  31,  1997,  the Company  had trade  receivables  due from two
customers for $191,000 and $177,000.

                                      F-18

<PAGE>

SIGNATURES

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

                        APPLIED COMPUTER TECHNOLOGY, INC.


                            By: /s/Wiley E. Prentice
                                Wiley E. Prentice, Jr., President and
                                Chief Executive Officer


                             By: /s/ Daniel Radford
                                Daniel Radford, Principal Financial and
                                Accounting Officer


                               Date: June 15, 1998

         In accordance with the requirements of the Securities Act of 1934, this
Report  has  been  signed  below  by the  following  persons  on  behalf  of the
Registrant and in the capacities and on the dates indicated.

Signature                               Title                    Date

/s/Wiley E. Prentice           President, Chief Executive    June 15,  1998
---------------------
Wiley E. Prentice, Jr.         Officer and Director


/s/ Cynthia E. Koehler         Executive Vice President,     June 15,  1998
---------------------
Cynthia E. Koehler             Secretary and Director


/s/ J. Roger Moody             Director                      June 15, 1998
-----------------
J. Roger Moody

---------------            Director                      June 15, 1998
Collis Woodward