UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

(Mark One)

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

                    For the fiscal year ended March 28, 1997
                                       OR

[_]  TRANSITION  REPORT  PURSUANT  TO  SECTION  13 OR  15(d)  OF THE  SECURITIES
     EXCHANGE ACT OF 1934

     For the transition period from ________________ to ___________________

                         Commission file number 0-28352

                         TECHNOLOGY SERVICE GROUP, INC.
             (Exact name of registrant as specified in its charter)

               Delaware                                       59-1637426
    (State or other jurisdiction of                        (I.R.S. Employer
    incorporation or organization)                       Identification Number)

   20 Mansell Court East - Suite 200                             30076
            Roswell, Georgia                                   (Zip Code)
(Address of  principal executive offices)

                                 (770) 587-0208
                         (Registrant's telephone number,
                              including area code)

           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

                                      None

           SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                     Common Stock, Par Value, $.01 Per Share
                                (Title of Class)
                               Redeemable Warrants
                                (Title of Class)

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

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of Registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

The aggregate market value of the voting Common Stock held by  non-affiliates of
the  Registrant  at May 30,  1997,  based  on the  closing  price  on such  date
($5 3/4), was approximately $6,891,157.

At May 30, 1997, there were 4,701,760  shares of the  Registrant's  Common Stock
outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

                                      None

<PAGE>

                         TECHNOLOGY SERVICE GROUP, INC.

                           ANNUAL REPORT ON FORM 10-K

                                TABLE OF CONTENTS

                                                                           Page
                                                                          Number

PART I
Item 1.   Business                                                            3
Item 2.   Properties                                                         18
Item 3.   Legal Proceedings and Disputes                                     19
Item 4.   Submission of Matters to a Vote of Security Holders                19

PART II
Item 5.   Market for Registrant's Common Stock and
            Related Stockholder Matters                                      20
Item 6.   Selected Financial Data                                            21
Item 7.   Management's Discussion and Analysis of Financial
            Condition and Results of Operations                              22
Item 8.   Financial Statements and Supplementary Data                        39
Item 9.   Changes in and Disagreements with Accountants on
            Accounting and Financial Disclosures                             39

PART III
Item 10.  Directors and Executive Officers of the Registrant                 68
Item 11.  Executive Compensation                                             71
Item 12.  Security Ownership of Certain Beneficial Owners
            and Management                                                   80
Item 13.  Certain Relationships and Related Transactions                     82

PART IV
Item 14.  Exhibits, Financial Statement Schedules, and Reports
            on Form 8-K                                                      83

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


                                       2
<PAGE>

                                     PART I

Item 1.  BUSINESS

General

     The  Company   designs,   develops,   manufactures   and   markets   public
communication   products   including   wireline  and   wireless  pay   telephone
("payphone")  systems,   electronic  wireline  payphone  products  and  payphone
components.  The  Company's  payphone  systems  are  based  upon  microprocessor
technology  and perform a variety of functions,  including  calling card,  debit
("prepay")  card  and  credit  card  operations,  data  storage,  call  progress
detection,  call  rating and  maintenance,  diagnostic  and coin  administration
functions. The Company's payphone software management system, CoinNet(TM), is an
integral component of the Company's  microprocessor-based  payphone systems. The
Company also provides payphone and payphone component repair,  refurbishment and
upgrade conversion  services to the regulated  telephone  operating companies in
the United States,  which consist of the seven Regional Bell Operating Companies
("RBOCs") and other local exchange carriers. See "Products and Services," below.

     The  Company  operates  in one  business  segment as a  provider  of public
communication systems,  products and services to communications providers in the
United States and foreign markets.  The Company  presently  markets its products
and services  primarily to the seven RBOCs in the United  States and to cellular
service  providers  in certain  international  markets.  The Company has derived
substantially  all of its  revenues  from  sales to four  RBOCs.  See "Sales and
Markets," below. The Company is presently developing a new  microprocessor-based
wireline  payphone  processor  for  international  markets  and for the RBOC and
independent markets in the United States.

     Unless the context requires  otherwise,  Technology Service Group, Inc. and
its subsidiary, International Service Technologies, Inc., are referred to herein
collectively  as the "Company" or "TSG".  The term  "Predecessor"  refers to the
Company for all  periods  prior to October 31,  1994,  the date TSG  Acquisition
Corp., a wholly-owned subsidiary of Wexford Partners Fund, L.P., acquired all of
the  outstanding  capital  stock of the Company (see  "History --  Acquisition,"
below;  Item 7 -- "Management's  Discussion and Analysis of Financial  Condition
and  Results  of   Operations;"   and  Item  8  --  "Financial   Statements  and
Supplementary  Data"). The Company's  principal executive offices are located at
20 Mansell Court East,  Suite 200,  Roswell,  Georgia  30076,  and its telephone
number at that address is (770) 587-0208.

Forward Looking Statements

     This report  contains  certain forward  looking  statements  concerning the
Company's  operations,   economic  performance  and  financial  condition.  Such
statements are subject to various risks and uncertainties.  Actual results could
differ  materially from those currently  anticipated due to a number of factors,
including  those  identified  under  this  Item  1  --  "Business;"  Item  7  --
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations;" and elsewhere herein.

Developments During Fiscal 1997

     Initial  Public  Offering.  In May 1996,  the Company  completed an initial
public  offering (the  "Offering") of 1,150,000  units (the "Units"),  each Unit
consisting of one share of common  stock,  $.01 par value per share (the "Common
Stock") and one redeemable  warrant  ("Redeemable  Warrant") at a price of $9.00
per Unit for gross proceeds of $10,350,000. In connection with the Offering, the
Company issued warrants to the  underwriter of the offering to purchase  100,000
shares of Common Stock (the  "Underwriter  Warrants") for gross proceeds of $10.
Net proceeds from the  offering,  after  underwriting  discounts and expenses of
$1,231,897  and other  expenses of  $824,953,  amounted to  $8,293,169.  The net
proceeds  of the  Offering  were used to repay the  Company's  then  outstanding
indebtedness  of  $2,509,524  under bank term and  installment  notes;  to repay
$3,808,589 of indebtedness  outstanding under a bank revolving credit agreement;
and to repay $2.8 million of 


                                       3
<PAGE>

outstanding  indebtedness  under 10% interest  bearing  subordinated  promissory
notes payable to stockholders.  See "History -- Acquisition,"  below;  Item 7 --
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations;" and Item 8 -"Financial Statements and Supplementary Data."

     Stock  Purchase  Agreement.  The Company and Wexford  Partners  Fund,  L.P.
("Wexford"),  Acor S.A.  ("Acor") and Firlane  Business Corp.  ("Firlane"),  and
A.T.T.  IV, N.V.  ("ATTI") entered into a Stock Purchase and Option Agreement on
May 3,  1996  (the  "Stock  Purchase  Agreement").  Wexford,  Acor and  Firlane,
concurrently  with the Offering,  sold to ATTI an aggregate of 366,300 shares of
Common Stock at a price of $8.14 per share and options to purchase an additional
183,150  shares of Common  Stock at an  exercise  price of $11.00 per share (the
"Options")  at a price of $.10 per  Option.  Wexford  sold  285,714  shares  and
Options to  purchase  142,857  shares.  Acor sold  53,114  shares and Options to
purchase  26,557  shares.  Firlane  sold  27,472  shares and Options to purchase
13,736  shares.  The  consideration  received by  Wexford,  Acor and Firlane was
$2,339,998,  $435,004 and $224,995,  respectively. No consideration was received
by the Company.

     Fiscal 1997 Facilities Consolidation. During the year ended March 28, 1997,
the Company closed its Kentucky  facility and  consolidated  service  operations
into its  Virginia  manufacturing  facility.  Also,  during the year ended March
28,1997, the Company assigned the capital lease obligation related to the closed
facility to an  unaffiliated  third party,  and recorded the  retirement  of the
outstanding  capital lease  obligation and the disposition of the property.  See
Item 7 --  "Management's  Discussion  and  Analysis of Financial  Condition  and
Results of Operations"  and Item 8 -- "Financial  Statements  and  Supplementary
Data."

     In November 1996, the Company  executed a lease agreement with respect to a
39,200 square foot facility  located in Georgia that commenced on April 1, 1997.
The  Company  intends to close its  present  corporate  office  facility  and to
consolidate its product assembly  operations and corporate  activities into this
new facility.

     Sales  Agreements.  In November 1996, TSG entered into a new  non-exclusive
supply  agreement,  effective  July 1, 1996,  to provide  its  Gemini(TM)  smart
payphones and processors,  CoinNet payphone management system and other payphone
components to Telesector  Resources Group,  Inc.  ("NYNEX") for a period of five
years. See "Sales and Markets -- Domestic," below.

     In June 1997, the Company entered into an agreement with  Southwestern Bell
Telephone  Company  ("SWB")  that  supersedes  and  terminates  a December  1994
agreement between the parties.  Under the new agreement,  the Company agreed (i)
to reduce SWB's  remaining  purchase  commitment of  GemStar(TM)  processors and
electronic locks to approximately $3 million from approximately $8 million under
the former  agreement  and, (ii) among other things,  to upgrade SWB's  payphone
management  system. In return,  SWB made a $250,000 cash payment to the Company,
terminated  the  Company's  obligation  to pay  royalties  on sales  of  GemStar
processors to other  customers and terminated the Company's  obligation to repay
$375,000  received  from the sale of product  software  under the December  1994
agreement.  SWB also  agreed to make  additional  cash  payments  to the Company
aggregating  up to $750,000  between  July 2, 1997 and March 31, 1998 subject to
the  Company's  compliance  with  the  terms  and  conditions  contained  in the
agreement.  See "Sales and Markets -- Domestic,"  below; Item 7 -- "Management's
Discussion and Analysis of Financial  Condition and Results of Operations;"  and
Item 8 -- "Financial Statements and Supplementary Data."

History

     General.  The  Company was  incorporated  in the State of Delaware in 1975.
Between  1975 and 1986,  the Company was  engaged in the  high-speed  dot matrix
printer  business.  In 1986,  the  Company  acquired  International  Teleservice
Corporation,  Inc.,  a  company  engaged  in the  repair  and  refurbishment  of
telecommunication  products consisting of residential  telephones and payphones.
During 1987 and 1988, the Company discontinued its high-speed dot-matrix printer
business,  sold the assets of its residential telephone repair and refurbishment
business, and began to focus its business on the public communications industry.
The Company established International Service Technologies,  Inc. ("IST"), which
established a foreign division in 


                                       4
<PAGE>

Taiwan,  and  Technology  Service  Enterprises,  Inc.,  and  expanded its public
communications  business to include the  manufacture  and marketing of payphones
and  payphone  components  and the  provision of services to convert and upgrade
payphones  with  components  designed  and  manufactured  by the Company and its
subsidiaries.  In 1991, Technology Service Enterprises, Inc. acquired the assets
of the Public Communication  Systems Division of Executone  Information Systems,
Inc. ("PCS"), including its microprocessor-based technology. In fiscal 1993, the
Company   established   Wireless   Technologies,   Inc.  and  began  to  develop
microprocessor-based  wireless payphone products for international applications.
In April 1993, International  Teleservice Corporation,  Inc., Technology Service
Enterprises, Inc. and Wireless Technologies, Inc. were merged into the Company.

     Acquisition.  On October 31, 1994,  TSG  Acquisition  Corp., a wholly-owned
subsidiary  of Wexford,  acquired all of the  outstanding  capital  stock of the
Company.  The  consideration  paid  by TSG  Acquisition  Corp.  aggregated  $3.5
million.  In  connection  with this  transaction,  the Company  entered  into an
Investment  Agreement  with  Wexford,  Acor and Firlane.  The Company  issued an
aggregate of 3.5 million shares of Common Stock at a price of $1.00 per share to
Wexford.  Wexford, in turn, sold to Acor and Firlane 507,500 and 262,500 shares,
respectively,  of Common  Stock.  The  consideration  paid by Wexford,  Acor and
Firlane for their shares of Common Stock was $2,730,000,  $507,500 and $262,500,
respectively.  Also, the Company borrowed $2.8 million from Wexford and Acor and
issued subordinated  promissory notes due November 1, 1999 that bear interest at
a rate of 10% per annum (the "Affiliate Notes"). The Affiliate Notes were repaid
during  the year  ended  March  28,  1997 with a portion  of the  proceeds  from
Company's initial public offering.

     Fiscal 1994 Restructuring.  During the three years ended April 1, 1994, the
Company generated net losses due to poor operating  performance  caused in large
part by the termination of a sales agreement with respect to a first  generation
microprocessor-based  payphone  product  between the Company and one of its then
significant RBOC customers as a result of technical and delivery problems (which
were  subsequently  remedied)  and  the  non-renewal  of a  refurbishment  sales
agreement  with that RBOC.  In the fourth  quarter of fiscal  1994,  the Company
initiated a plan (the  "fiscal 1994  Restructuring")  to change  certain  senior
management,  restructure  its operations,  refocus its  development  activities,
increase sales and attain  profitable  operations.  Although the Company reduced
its  operating  costs and expenses,  the Company  continued to operate at a loss
during the seven months  ended  October 31, 1994 and five months ended March 31,
1995.  However,  during  fiscal  1996  and  fiscal  1997,  the  Company's  sales
performance improved and the Company returned to profitability.

The Public Payphone Industry

     Domestic Market.  Public  telecommunication  services,  including "coin" or
"pay"  telephone  service,  in the  United  States  are  provided  by  regulated
telephone operating companies,  including those owned by the RBOCs,  referred to
as  local  exchange  carriers  ("LECs"),   AT&T  and  other  long  distance  (or
"inter-exchange")  carriers  ("IXCs") and independent  payphone  providers.  The
operations of long distance and local exchange carriers are subject to extensive
regulation by the Federal Communications Commission ("FCC") and state regulatory
agencies (see "Government Regulation," below). Virtually all services offered by
LECs and IXCs,  including  payphone  services,  are provided in accordance  with
tariffs  filed  with  appropriate   regulatory  agencies,   including  the  FCC.
Independent  payphone  providers are subject to regulations of state  regulatory
agencies.

     The Company believes that the RBOCs control approximately 1.4 million of an
estimated 2 million  payphones in service in the United  States.  The  remaining
installed  base of  payphones  are owned and  operated by the large  independent
telephone  operating  companies (such as GTE), other local exchange carriers and
independent payphone providers.

     The majority of payphones deployed by the RBOCs are essentially  mechanical
devices that perform the functions of normal  residential  telephones,  with the
additional  ability to hold and collect or refund coins.  In these  conventional
payphone systems, all of the intelligence required to provide service is located
at central offices or other network locations of long distance or local exchange
carriers and is supplied to the  payphone  via a "coin line." In June 1984,  the
FCC approved the operation of  independently  owned  payphones,  which permitted
independent payphone providers to enter the industry. However, barriers to entry
into the industry by 


                                       5
<PAGE>

independent  payphone  providers  were  substantial.  The RBOCs had in place and
available  the  services of the  central  offices to provide  payphone  service,
including  call rating and  routing  information,  the "bong" tone that  signals
callers to input calling card numbers, and  collection/return  signaling for the
payphone to collect or return coins. These services were not required to be made
available to independent  payphone  providers and placed them at a disadvantage.
Regulatory  actions,  together with the development of technologically  advanced
microprocessor-based  payphones that perform the functions of the central office
within the telephone  (referred to in the industry as "smart  payphones"),  have
enabled  independent  payphone  operators  to enter  the  industry  and  compete
effectively    with    the    regulated    telephone    operating     companies.
Microprocessor-based technology provided independent payphone providers with the
capability to route and determine the proper  charges  ("rate") for calls and to
deploy payphones containing maintenance diagnostics and reporting features, coin
administration  and credit card features,  and station message detail  recording
and reporting features.  These features enable independent payphone providers to
either  route  calls to  Alternate  Operator  Services  ("AOS")  or to store and
retrieve call data and billing information,  thereby allowing the owner to share
in the  long-distance  revenues  generated  by the  phone,  reduce  the  cost of
maintenance and collection, and to monitor coin pilferage, among other things.

     On February 8, 1996, the President  signed into law the  Telecommunications
Act of 1996 (the  "Telecommunications  Act"), the most  comprehensive  reform of
communications  law since the enactment of the  Communications  Act of 1934. The
Telecommunications Act eliminates  long-standing legal barriers separating LECs,
long distance carriers,  and cable television companies and preempts conflicting
state laws in an effort to foster greater competition in all  telecommunications
market sectors, improve the quality of services and lower prices.

     The  Telecommunications  Act expressly  supersedes the consent decree which
led  to  the  break-up  of  AT&T,   the   formation   of  the  RBOCs,   and  the
line-of-business  restrictions  that  prohibited  the RBOCs from  providing long
distance services and from manufacturing telecommunications equipment. The RBOCs
are now permitted to provide long distance  service  outside their local service
areas and to seek approval from the FCC to provide  long-distance service within
their local service areas based upon a showing that they have opened their local
exchange  markets  to  competition.  After the FCC has given its  approval  to a
request to provide in-region long distance  service,  an RBOC may also engage in
the   manufacture  and  provision  of   telecommunications   equipment  and  the
manufacture  of customer  premises  equipment,  including pay  telephones.  Such
manufacturing  enterprises must be conducted through separate  affiliates for at
least three years after the date of enactment of the Telecommunications  Act. In
addition,  an RBOC  may not  discriminate  in  favor of  equipment  produced  or
supplied by an affiliate, but rather must make procurement decisions based on an
objective assessment of price, quality, delivery and other commercial factors.

     The Company believes that as a result of the reform legislation, the public
communications  industry  will undergo  fundamental  changes,  many of which may
affect the Company's business.  The legislation is likely to increase the number
of providers of  telecommunications  services,  including  perhaps  providers of
payphone  services.  This  increase  in the  number  of  providers  is likely to
stimulate demand for new payphone equipment. In that event, the Company believes
that existing  payphone  providers,  including the RBOCs,  could seek to enhance
their  technology base in order to compete more  effectively with each other and
with new  entrants.  In  addition,  as the local  exchange and  intrastate  long
distance markets are opened to competition,  inter-exchange  carriers seeking to
serve these markets may deploy greater numbers of payphones to capture local and
intrastate traffic.  There can be no assurance,  however, that these trends will
develop,  or that if they do develop,  they will have a beneficial impact on the
payphone  market  generally  or on the  Company's  business in  particular.  See
"Government Regulation," below.

     Over the past couple of years,  in response  to the  competitive  pressures
from  independent  payphone  providers  and in  anticipation  of  passage of the
Telecommunications  Act, several of the RBOCs and other local exchange  carriers
began to upgrade their payphone base with microprocessor-based  "smart" payphone
technology.  The Company believes that approximately 15% to 20% of the installed
based of payphones  


                                       6
<PAGE>

operated by the RBOCs have been upgraded with smart payphone systems,  including
those provided by the Company.  The Company's prospects for future and continued
profitability  are largely  dependent on such trend  continuing.  See "Sales and
Markets --Domestic," below.

     International  Market.  Internationally,  it is  estimated  that  there are
several million payphones in the installed base. Public  communication  services
in  foreign  countries  are  provided  by large  government  controlled  postal,
telephone  and  telegraph  companies  ("PTTs"),   former  PTTs  that  have  been
privatized  for the  purpose of  investing  in and  expanding  telecommunication
networks and services,  and cellular carriers. The Company believes that a trend
toward  privatization and liberalization of the international  telecommunication
industry is opening the international markets,  previously dominated by monopoly
and  government  infrastructure,  to increased  competition.  In addition,  many
countries are allowing private firms to construct  cellular networks and compete
with  national  telecommunication  authorities.  It is believed that some of the
large United States based telecommunications companies, including certain RBOCs,
have  invested  in   telecommunication   opportunities   abroad   including  the
acquisition  of  interests  in the  privatized  PTTs  and  consortiums  for  the
acquisition  of  licenses  and  construction  of  cellular  networks  to provide
cellular communication  services. On February 15, 1997, over 60 countries signed
a World Trade  Organization  pact aimed at opening the global  telecommunication
industry to  competition.  This agreement  provides for most of the countries to
end their telephone monopolies by the year 2000. However,  the agreement,  which
must be ratified by the individual countries,  will likely encounter substantial
opposition.  Accordingly,  there  is no  assurance  that the  agreement  will be
ratified   or   facilitate   free   market    conditions   within   the   global
telecommunications market.

     Presently,  the density of payphone installations in many foreign countries
on a per capita  basis is far less than that in the United  States.  The Company
believes  that many of these  countries  are seeking to expand and upgrade their
telecommunications  systems  and are funding  programs to provide  communication
services to the public.  The  expansion  programs  include the  construction  of
wireless networks,  and the Company believes that wireless payphone service will
become one of the primary  avenues of  providing  communication  services to the
public in certain  foreign  markets.  The  Company  believes  that  large  scale
payphone deployment  programs are underway in several foreign markets,  and that
the international public communications  industry will continue to evolve and be
a significant  growth  industry over the next several decades to the extent that
privatization  and the investment in and expansion of both wireline and wireless
networks progresses.

     Although  foreign  markets  are  believed  to  be  a  potential  source  of
significant  demand for the Company's  products,  there are  impediments  to the
Company's  ability to penetrate such markets,  including  resource  limitations,
regulations and the normal  difficulties  attendant on conducting  international
business.

Products and Services

     The Company  manufactures  and markets  "coin" and "coinless" pay telephone
("payphone")  systems and products that connect to and operate as integral parts
of domestic  and foreign  telecommunication  networks.  The Company also markets
payphone and payphone  component repair,  refurbishment  and conversion  upgrade
services to local exchange carriers in the United States. The Company's products
include payphones  equipped with non-smart  payphone  electronics (for coin line
installations) and payphones equipped with  microprocessor-based  smart payphone
processors  (for coin line and/or non-coin line  installations)  that connect to
wireline   telecommunication   networks  ("wireline  payphones")  and  payphones
equipped with a specially  designed  smart  cellular  processor  that connect to
cellular  telecommunication  networks  ("wireless  payphones").  Smart  payphone
processors (and non-smart  electronics) are the primary electronic assemblies or
"engines" of payphones.  The Company also supplies smart payphone  retrofit kits
and a wide-range of payphone components  (including,  among other things, dials,
handsets,  chrome doors, credit card readers and volume  amplification  modules)
required  to  manufacture  payphones  and  to  repair  and/or  upgrade  deployed
payphones with enhanced  technology.  The Company's  smart payphone  systems are
provided with CoinNet payphone  management  software.  This management system is
used by customers to remotely  manage  networks of the Company's  smart payphone
products  interactively.  A  significant  portion of the  Company's  revenues is
derived from the sale of smart 


                                       7
<PAGE>

payphone  processors  and  payphone  retrofit  kits to  certain  RBOCs  that are
upgrading  their  installed  base of  payphones  with  technologically  advanced
processors.

     The Company's  wireline payphone  products were developed  specifically for
the regulated  telephone operating companies in the United States. The design of
the  Company's  wireline  coin  payphones  is based  upon the  Western  Electric
configuration  developed for use in the Bell system versus the GTE configuration
developed for the independent  telephone  companies and also used by most of the
independent  payphone  providers.  The Company's coinless wireless  ("cellular")
payphone   products  were  developed  for  use  in  foreign  markets,   and  are
manufactured in several different configurations, including the Western Electric
configuration, depending on the application.

     The  majority  of foreign  countries  follow the network  standards  of the
Consultative Committee for International Telephone and Telegraph ("CCITT").  One
of the primary  technical  network  differences in the payphone industry between
the countries following the CCITT network standards and those following the U.S.
network standards relates to call rating.  The Company has not to date offered a
wireline product that operates with networks following the CCITT standards.  The
Company is presently  developing a new smart payphone processor that it believes
will be capable of  operating  with  networks  following  either  standard.  The
Company  believes that this technology will enable the Company to compete in the
independent market in the United States and in foreign countries that follow the
CCITT  standard.  The  Company's  new  smart  payphone  processor  is  currently
undergoing  limited  field  trial  testing  and  evaluation  in coin line and in
non-coin  line  installations  domestically.  The Company  believes that its new
smart  payphone  processor will be available to market during the next year. See
"Design and Product Development," below.

     The following table outlines products currently offered by the Company:

PRODUCT                       DESCRIPTION

GEMINI SYSTEM II(R)   The   Gemini   System   II(R)("Gemini")   product   is   a
                      sophisticated    microprocessor-based    smart    payphone
                      processor  which is  programmable  to  operate in either a
                      coin line mode or a non-coin line mode. The coin line mode
                      uses the rating and answer  supervision  services provided
                      by the central  office ("CO") and associated  network.  In
                      contrast,  rating  and  answer  supervision  services  are
                      performed  within the processor when programmed to operate
                      in the non-coin line mode. Programmable billing, reporting
                      and operating  cost  reduction  features  offered with the
                      Gemini  product   include:   (i)  station  message  detail
                      recording, which provides for the storage of all call data
                      within  the  phone;   (ii)   maintenance   reporting   and
                      diagnostics,   which  provides  for  remote  diagnosis  of
                      payphone and  component  operating  status via  telemetry;
                      (iii) coin administration,  which provides coin accounting
                      capability  and  reporting  of coin box status;  (iv) call
                      routing,  which  provides  for the routing of calls to the
                      programmed  carrier;  and  (v)  credit  card  billing  and
                      auditing,  which  provides the ability to bill credit card
                      calls and to identify  invalid cards or card numbers.  The
                      Gemini  product  is also  designed  to  interface  with an
                      electronic lock to control and to permit remote monitoring
                      of collection activities. Programmable revenue enhancement
                      features  offered  with the Gemini  product  include:  (i)
                      voice  messaging,  which  enables  the  user to  record  a
                      message to the called  party rather than allow the call to
                      go  uncompleted;  and  (ii)  usage  based  pricing,  which
                      administrates local call costing on the basis of time. The
                      features available with the Gemini product are designed to
                      enable  customers to enhance  revenues and to reduce costs
                      of operation and maintenance  through accurate  scheduling
                      of maintenance and collection activities. All programming,
                      retrieval,  reporting and telemetry features are performed
                      remotely using the Company's payphone software  management
                      system.


                                       8
<PAGE>

GEMSTAR(TM)           The  GemStar  product  is  a  microprocessor-based   smart
                      payphone  processor  designed  for coin line  applications
                      which require the rating and answer supervision  functions
                      performed by the CO network.  The GemStar  product  offers
                      the primary cost  reduction and reporting  features of the
                      Gemini  product,   including   maintenance  reporting  and
                      diagnostics  and coin  administration.  With added memory,
                      the GemStar  product also provides  station message detail
                      recording.   The  GemStar  product  is  also  designed  to
                      interface with an electronic lock to control and to permit
                      remote monitoring of collection activities.

INMATE(TM)            The  InMate  product  is  a   microprocessor-based   smart
                      payphone   processor   designed  for  prisons  where  cost
                      reduction  and  revenue  enhancement  features  as well as
                      other  specialized  features  are  required.   The  InMate
                      product   offers   station   message   detail   recording,
                      maintenance  reporting and  diagnostics,  voice messaging,
                      usage  based  pricing  and  call  routing.   In  addition,
                      specialized    features   include:   (i)   outgoing   call
                      restriction,   which  can  restrict   calls  to  specified
                      numbers;  (ii)  call  duration,   which  limits  the  time
                      duration  of  calls;  and  (iii)  personal  identification
                      numbers,   which  permit  valid  user  access  only.  Coin
                      administration  features are not provided in this coinless
                      environment.

GEMCELL(TM)           The  GemCell  product is a  microprocessor-based  cellular
                      payphone   processor   that   interfaces   to  a  cellular
                      transceiver for use in domestic and international wireless
                      networks.  The GemCell  product  was  designed to have the
                      primary features  available with the Gemini product except
                      coin  administration.  Instead,  the  GemCell  product was
                      designed to accept debit ("prepay") cards,  smart ("chip")
                      cards or credit cards as the form of payment.  The GemCell
                      product is not currently marketed in the U.S.

COINNET(TM)           The  CoinNet  product  is  a  remote   payphone   software
                      management system which operates on personal  computers in
                      a multi-tasking  environment.  This  proprietary  software
                      product provides the Company's  customers with the ability
                      to manage networks of installed  payphones  interactively.
                      Downloading  software changes,  retrieving station message
                      detail  recording data,  maintenance and diagnostics  data
                      and coin box data are a few of the  functions of this Unix
                      or MSDOS-based software system.

PAYPHONES             The  Company  offers  its  payphones  in a wide  range  of
                      electronic  and smart  configurations  depending  upon the
                      application  requirements of its customers.  The Company's
                      wireline  payphones  include  coin  (or  token)  payphones
                      and/or   coinless   payphones,   including   credit   card
                      applications.  The Company's wireless,  coinless payphones
                      include debit  ("prepay") and smart (chip") card payphones
                      which  are  offered  in  fixed  configurations  as well as
                      configurations  for  mobile  deployment,  such  as  taxis,
                      trains and buses.  The Company's  smart wireline  payphone
                      technology   derives  power  from  the   telephone   line,
                      eliminating  the  need for  external  power  sources.  The
                      Company's  wireless  payphones  are powered by  commercial
                      electric line power or by a solar powered platform so that
                      they can be deployed without network wiring and cabling.

CELLULAR
ASSISTANCE PHONE      The Company also offers a specialized  Cellular Assistance
                      Phone  designed  to  provide  emergency  phone  service in
                      specific  applications,  such  as  along  highways  and in
                      remote areas.  The Cellular  Assistance  Phone is provided
                      with a cellular  transceiver  and is powered by commercial
                      electric line power or by a solar powered platform so that
                      it can be deployed without network wiring and cabling. The


                                       9
<PAGE>

                      features of the Cellular  Assistance  Phone are limited to
                      those  required for  emergency  situations  and permit the
                      user to automatically  dial a preset emergency  assistance
                      number.  The Cellular  Assistance  Phone is not  currently
                      marketed in the United States.

PAYPHONE
COMPONENTS            Payphone components supplied by the Company include, among
                      others,  non-smart payphone electronics,  touchtone dials,
                      handsets,    coin   relays,   and   volume   amplification
                      assemblies.  These  components  are  manufactured  at  the
                      Company's facilities to Bellcore specifications.

SERVICES              The  Company  provides  payphone  and  payphone  component
                      repair,  refurbishment and upgrade conversion services for
                      its   customers.   Refurbishment   services   involve  the
                      rebuilding of payphone  components  and sets to "like new"
                      condition.   Upgrade   conversion   services  include  the
                      modification of payphone components and sets to an updated
                      or enhanced technology.

Sales and Markets

     Domestic.   The  Company   markets  its  payphone   products  and  services
predominately  to the RBOCs. In fiscal years 1995, 1996 and 1997, sales to RBOCs
accounting for greater than 10% of the Company's  sales  aggregated 72%, 88% and
90%,  respectively,  of  the  Company's  sales  revenues.  During  fiscal  1995,
Ameritech Services, Inc.  ("Ameritech"),  Bell Atlantic Corp. ("Bell Atlantic"),
Southwestern   Bell   Telephone   Company   ("SWB")  and  NYNEX   accounted  for
approximately  $2.8  million,  $5.8  million,  $3.8  million  and $2.2  million,
respectively,  of the Company's sales. During fiscal 1996, Bell Atlantic,  NYNEX
and SWB  accounted  for  approximately  $5.6  million,  $7.9  million  and $15.5
million,  respectively,  of the Company's sales. During fiscal 1997,  Ameritech,
Bell Atlantic and NYNEX accounted for approximately  $4.6 million,  $5.2 million
and $20.2 million, respectively, of the Company's sales. The Company anticipates
that it will continue to derive most of its revenues from these  customers,  and
other regional telephone companies,  for the foreseeable future. During the last
year,  mergers between Pacific  Telesis Inc. and SBC  Communications,  Inc. (the
parent of SWB), and between Bell Atlantic and NYNEX were announced.  The Company
cannot  predict the impact that these  mergers will or may have on the Company's
business.

     The Company competes for and enters into non-exclusive  supply contracts to
provide products,  components and services to the RBOCs. The Company has entered
into sales agreements to provide payphone components to Bell Atlantic, NYNEX and
SWB.  The  Company  has  entered  into  sales   agreements  to  provide  repair,
refurbishment  and  conversion  services  to  Ameritech  Services,   Inc.,  Bell
Atlantic,  NYNEX and SWB. These  agreements have terms ranging from two to three
years, are renewable at the option of and subject to the procurement  process of
the particular RBOC,  contain fixed sales prices for the Company's  products and
services with limited provisions for price increases and expire at various dates
from June 1997 to March 1999.  These sales agreements are frameworks for dealing
on open account and do not specify or commit the Company's customers to purchase
a specific  volume of products or  services.  If orders are made,  however,  the
Company  has  agreed  to fill  such  orders  in  accordance  with  the  contract
specifications.  The  agreements  are generally  subject to  termination  at the
option of the  customer  upon 30 days notice to the  Company,  or if the Company
defaults  under any material  provision of the agreement,  including  provisions
with respect to performance.

     In November 1996, the Company entered into a non-exclusive sales agreement,
effective  July 1, 1996, to provide its Gemini smart  payphones and  processors,
CoinNet payphone  management system and other payphone components to NYNEX for a
period of five years.  This  agreement  superseded a December 1995 smart product
sales agreement  between the Company and NYNEX. The November 1996 agreement sets
forth the terms and  conditions  relating to the sale of products to NYNEX,  and
does not specify or commit NYNEX to purchase a specific  volume of products from
the Company.  If orders are made,  however,  the Company has agreed to fill such
orders in accordance with NYNEX's  specifications  and at fixed prices set forth
in the  


                                       10
<PAGE>

agreement.  The Company has agreed not to increase its prices during the term of
the  agreement and has agreed to implement a continuous  improvement  program to
improve  productivity and quality and to reduce product costs during the term of
the agreement.  The agreement includes provisions for reductions in sales prices
to  NYNEX  based  on  product  cost  reductions  achieved  from  the  continuous
improvement program and based on NYNEX's purchase volume. The agreement contains
a "most  favored  customer"  clause  pursuant to which the Company has agreed to
provide  price and other terms at least as  favorable  as those  extended by the
Company to other customers for similar  purchase  volumes of products covered by
the  agreement.  The Company has agreed to  indemnify  NYNEX  against  expenses,
liabilities,   claims  and  demands  resulting  from  products  covered  by  the
agreement,  including  those  related  to patent  infringement  and  performance
specifications.  The agreement may be terminated by either party upon default by
the other party upon thirty days'  written  notice,  provided the default is not
cured within thirty days from the receipt of notice of default.  Further,  NYNEX
may  terminate  the  agreement  upon 120 days'  written  notice to the  Company.
However,  upon such a  termination,  NYNEX has agreed to purchase the  Company's
inventories  related to the products  covered by  agreement,  provided that such
obligation shall not exceed the value of NYNEX's purchases for a 120-day period,
determined  based upon the average  monthly  volume for the  previous  six-month
period,  less the  value of  outstanding  orders  to be  shipped,  the  value of
products  which may be sold to other  customers and the value of inventory  that
may be returned to the Company's  suppliers.  The  agreement  expires on July 1,
2001.

     In  June  1997,  the  Company  entered  into an  agreement  with  SWB  that
supersedes and terminates a December 1994 agreement  between the parties.  Under
the new  agreement,  the  Company  agreed to  reduce  SWB's  remaining  purchase
commitment  of GemStar  processors  and  electronic  locks to  approximately  $3
million from  approximately  $8 million under the former  agreement  and,  among
other things,  upgrade SWB's payphone  management  system. In return, SWB made a
cash payment of $250,000 to the Company,  terminated the Company's obligation to
pay royalties on sales of GemStar  processors to other  customers and terminated
the  Company's  obligation to repay  $375,000  received from the sale of product
software under the December 1994  agreement.  SWB also agreed to make additional
cash  payments  of  $250,000 on July 2, 1997,  $100,000  on  September  1, 1997,
$150,000  on  December  31,  1997 and  $250,000 on March 31, 1998 to the Company
subject  to the  Company's  compliance  with the  terms  and  conditions  of the
agreement, including conditions with respect to product quality and performance,
service and repair.  SWB has the right to cancel the agreement  without  further
obligation to TSG,  including any obligation to make  additional  payments or to
purchase  additional  products,  upon a  default  by TSG of any of the terms and
conditions  contained  in the  agreement.  SWB also has the right to cancel  the
agreement  without notice and without further  obligation to TSG,  including any
obligation to make additional  payments or to purchase additional  products,  in
the event TSG defaults on its  obligation to upgrade SWB's  payphone  management
system by July 2, 1997.  Further,  SWB may terminate the agreement by giving the
Company  thirty days prior written  notice,  in which case,  SWB is obligated to
purchase the products and make the  payments  sets forth in the  agreement.  See
Item 7 --  "Management's  Discussion  and  Analysis of Financial  Condition  and
Results of Operations"  and Item 8 -- "Financial  Statements  and  Supplementary
Data."

     The Company sells its products and services directly to its customers.  The
Company involves a wide-range of personnel in its sales and marketing activities
including  its Vice  President of Sales and  Marketing,  two  experienced  sales
directors,  three  service  technicians,  its  engineering  staff,  its  quality
managers and its President and CEO. The Company's  engineering staff and service
technicians provide support and technical services via telephone without charge,
and the Company provides field  engineering  support services during the initial
deployment  of  products  and when  customers  encounter  unusual  or  technical
problems.  The  Company's  commitment  to service  and  support  throughout  its
organization  is directed at maintaining  strong  relationships  with customers'
operating,  technical and  administrative  personnel.  The Company also conducts
training  seminars and provides  assistance to customers in the installation and
set-up of the Company's payphone software management system.


                                       11
<PAGE>

     International.  The Company markets its smart wireless  payphones in Korea,
Mexico, Ecuador,  Venezuela and other South American countries,  primarily under
distributor and reseller  relationships.  The Company  presently has distributor
relationships in Venezuela,  for the South American  markets,  and in Korea. The
Company  also  markets its  products in Central  American  markets  directly and
through an independent sales representative.

     The Company's  export sales during fiscal 1995, 1996 and 1997  approximated
$1.4 million, $856,000 and $461,000, respectively. The Company believes that the
international public communications market represents a growth opportunity.  The
Company,  however,  has limited  experience  exporting  products  and  operating
outside the United States and there can be no assurance that the Company will be
able to generate  significant revenues from international  business.  Conducting
business  internationally is subject to a number of risks,  including  political
instability, foreign currency fluctuations, adverse movements in exchange rates,
economic instability,  the imposition of tariffs and import and export controls,
changes  in  governmental   policies   (including  U.S.  policy  toward  foreign
countries),  general credit and business risks and other factors, one or more of
which, if they occur,  could have an adverse effect on the Company's  ability to
generate  international  sales or operations.  The Company's  sales to date have
been denominated in U.S. dollars and as a result,  no losses related to currency
fluctuations  have been  incurred.  For the same  reason,  the  Company  has not
engaged in currency hedging activities. There is no assurance, however, that the
Company  will be  able  to  continue  to  export  its  products  in U.S.  dollar
denominations  or that its  business  will not  become  subject  to  significant
exposure to foreign currency risks. In addition, the Company intends to complete
the development and begin marketing wireline payphone products for international
CCITT  applications  during  fiscal  1998,  and there is no  assurance  that the
Company will be able to  successfully  complete the development of such products
or that it will be able to successfully market such products.  Finally,  many of
the Company's known and potential  international  competitors have substantially
greater  financial  and other  resources  than the Company and,  therefore,  are
formidable competitors. See "Competition," below."

     The Company believes that wireless payphone services will become one of the
primary avenues of providing communication services to the public in many of the
developing  nations in South America and Central  America and that these markets
represent  a  significant  growth  opportunity.  Many of the  cellular  licenses
awarded to companies in foreign markets to provide  services in competition with
national  communication   authorities  have  been  awarded  to  consortiums  and
companies  in which  the RBOCs  have  invested.  The  Company  believes  that an
opportunity  exists  to expand  its  market  channel  within  the RBOC  arena by
deployment  of  its  wireless  payphone  technology  to  international  wireless
concerns affiliated with the RBOCs. The Company intends to continue to invest in
the  development  of wireless  products and  hardware for non-coin  technologies
including prepay and debit cards, including smart ("chip") cards.

Competition

     The Company believes that it is a significant provider of payphone products
and  payphone  repair  services to the RBOCs.  The Company  operates in a highly
competitive  environment  and  competes  against  numerous  domestic and foreign
providers  of  payphones  and  payphone  repair  services  that have  financial,
management  and  technical  resources  substantially  greater  than those of the
Company.  In addition,  there are many other firms which have the  resources and
ability to develop and market  products  which could  compete with the Company's
products.  The Company believes its ability to compete depends upon many factors
within and outside its control,  including  the timing and market  acceptance of
new products developed by the Company and its competitors,  performance,  price,
reliability and customer service and support.

     The  Telecommunications  Act lifts the restriction on the  manufacturing of
telecommunications  equipment by the RBOCs. After the FCC finds that an RBOC has
opened its local exchange  market to competition,  the RBOC,  through a separate
affiliate,  may  manufacture  and provide  telecommunications  equipment and may
manufacture customer premises equipment,  such as payphones.  As a result of the
legislation,  the  Company  could face new  competitors  in the  manufacture  of
payphones  and  payphone  components  from  one or more of the  


                                       12
<PAGE>

RBOCs or their  affiliates.  The RBOCs have financial,  management and technical
resources substantially greater than the Company.  However, the legislation does
not permit RBOCs to create joint  manufacturing  operations  with each other. In
addition,  the legislation  provides that as long as Bellcore is an affiliate of
more than one RBOC, Bellcore may not engage in manufacturing  telecommunications
equipment  or  customer  premises  equipment.  The  Telecommunications  Act also
incorporates  numerous safeguards to ensure that standards setting organizations
conduct themselves fairly and requires the FCC to establish a dispute resolution
process  for  equipment  manufacturers  involved  in  conflicts  over  standards
setting.

     The Company  believes that the primary  competitive  factors  affecting its
business with the RBOCs are quality,  price,  service and delivery  performance.
The Company  competes  aggressively  with respect to the pricing of its products
and services,  and since the  Company's  contractual  agreements  with the RBOCs
generally  provide  the  Company  with  limited  ability to  increase  prices if
manufacturing  costs increase,  the Company attempts to reduce its manufacturing
costs  rather than  increase its prices.  The Company also  attempts to maintain
inventory at levels which enable the Company to provide immediate service and to
fulfill the delivery requirements of its customers.

     The Company  believes that its principal  competitors  in the United States
include Protel Inc., Elcotel, Inc.,  Intellicall,  Inc., Lucent Technologies and
International   Totalizing  Systems,  Inc.,  and  with  respect  to  repair  and
refurbishment services,  Restor Industries,  Inc. The Company also competes with
numerous foreign companies  marketing  products in the United States,  including
Northern  Telecom,  Inc.  However,  the Company  does not believe  that  foreign
competitors have yet been able to successfully  penetrate the payphone  industry
in the United States. Some of the Company's competitors,  including Protel Inc.,
Intellicall,  Inc. and Elcotel,  Inc.  supply  payphone  products to independent
payphone providers which compete with the RBOCs. During fiscal 1997, the Company
did not actively market its products to independent payphone providers.

     Many of the Company's competitors are substantially larger than the Company
and have significantly greater financial,  technical and marketing resources. As
a  result,  they  may be  able  to  respond  more  quickly  to  new or  emerging
technologies  and  changes  in  customer  requirements,  or  to  devote  greater
resources to the  development,  promotion  and sale of their  products  than the
Company.  It is also  possible  that new  competitors  may  emerge  and  acquire
significant  market  share.  Possible  new  competitors  include  large  foreign
corporations,  the Company's RBOC customers and other entities with  substantial
resources.  Increased  competition  is likely  to  result  in price  reductions,
reduced  gross  margins  and loss of market  share,  any of which  would  have a
material  adverse  effect on the Company's  business,  results of operations and
financial condition.  There can be no assurance that the Company will be able to
compete  successfully  against current or future competitors or that competitive
pressures  will not have a material  adverse  effect on the Company's  business,
results of operations and financial condition.  In addition, it is unlikely that
the Company will become a significant supplier of smart payphone products to all
of the RBOCs since competition for business with the RBOCs is intense.

     Internationally,  the Company competes with numerous  foreign  competitors,
all of which have financial,  management and technical  resources  substantially
greater than the Company.  These foreign  competitors  market payphone  products
predominately  to the PTT's and  thereby  dominate  the  international  payphone
market. The Company believes that the primary  competitive factors affecting its
international  business  are the  ability  to  provide  products  that  meet the
specific application requirements of the customers, quality and price.

     The Company expects that a number of personal  communications  technologies
will become  increasingly  competitive  with payphone  services  provided by the
telephone  companies  and  independent  payphone  providers.  Such  technologies
include  radio-based  paging services,  cellular mobile  telephone  services and
personal communication services. However, the Company believes that the payphone
industry will continue to be a major provider of telecommunications access.


                                       13
<PAGE>

     Prior to 1984,  the regulated  telephone  companies  held a monopoly in the
United States payphone market, and they continue to have a dominant share of the
payphone market. The regulated  telephone  companies have financial,  marketing,
management and technical resources  substantially  greater than those of private
payphone providers.  The Company believes that the regulated telephone companies
will continue to experience  increasing  competition from  independent  payphone
providers.  Accordingly,  the  Company  believes,  but cannot  ensure,  that the
telephone  operating  companies can be expected to upgrade their technology base
and protect their market share.

Manufacturing, Assembly and Sources of Supply

     The Company performs repair, refurbishment and conversion services and most
of its product  assembly  operations  at its  facilities.  In addition,  certain
components including low-density electronic circuit board assemblies,  dials and
handsets,  are  assembled at the  Company's  facilities.  Other  components  are
purchased  from  various  distributors  and  manufacturers,  including  contract
manufacturers  engaged by the Company. The Company generally assembles its smart
payphone  products from assemblies  produced by manufacturers  under contractual
arrangements.

     On October 21, 1994,  the Company  entered into a  manufacturing  agreement
with Avex  Electronics,  Inc.  ("Avex"),  a large  contract  manufacturer,  that
provided for the production of the Company's  GemStar  circuit board  assemblies
and  payphone  processor.  The Company  committed to purchase  $12.2  million of
GemStar assemblies. At March 28, 1997, the Company had purchased the majority of
its initial  commitment.  The Company has also engaged Avex to  manufacture  the
printed  circuit  board  assemblies  for its  Gemini  processors,  its new smart
payphone  processor  presently under  development  and other  products,  and has
committed to purchase approximately $5.5 million of assemblies for its new smart
payphone  processor  during  the first  year of  production.  The  manufacturing
agreement may be  terminated by either party for default upon a material  breach
of the terms of the  agreement by the other party,  provided  such breach is not
cured within a 30-day  notice  period.  Further,  the Company may  terminate the
agreement  at any time.  However,  upon a  termination  of the  agreement by the
Company,   the  Company  is  obligated  to  purchase  inventories  held  by  the
manufacturer  and  pay  vendor  cancellation  and  restocking  charges,   and  a
reasonable  profit thereon.  In addition,  upon a cancellation by the Company of
its purchase  obligation,  or a substantial portion thereof,  related to its new
smart payphone processor, the Company is obligated to pay a cancellation penalty
of up to $500,000. This cancellation obligation varies depending upon quantities
purchased by the Company and expires when the Company has  substantially met its
purchase  commitment.  The Company is  dependent  upon Avex to  manufacture  and
supply products  required to meet sales commitments under the terms of its smart
product sales agreements.

     On  November  18,  1994,  the  Company  entered  into an  exclusive  dealer
agreement with Control Module, Inc. that provided the Company with the rights to
purchase and supply  electronic lock devices to SWB in accordance with the terms
of a December  1994 sales  agreement  between the  Company and SWB.  The Company
committed to purchase  approximately $3.5 million of the electronic lock devices
at specified prices over a two-year  period.  At March 28, 1997, the Company had
satisfied its purchase  commitment,  and has an adequate inventory of electronic
lock devices to meet its remaining sales commitment to SWB. The dealer agreement
expired upon the Company's purchase of the committed volume.

     On September  16, 1991,  the Company  entered into a  Manufacturing  Rights
Agreement (the  "Manufacturing  Agreement")  with Commtek  Industries,  Inc., an
unaffiliated Taiwan corporation. The Company granted Commtek the exclusive right
to utilize the assets owned by the  Company's  foreign  division for a period of
five years to manufacture many of the  non-electronic  components and assemblies
for the Company's  products.  The Company agreed to purchase a minimum aggregate
annual  volume of $2.5  million  during the first year of the  agreement  and $3
million  for each  year  thereafter.  The  Manufacturing  Agreement  expired  on
September 15, 1996. However,  the parties have continued the supply relationship
under  standard  purchase  arrangements.  The  Company  believes  that there are
alternative  sources  of supply  for the  components  and  assemblies  currently


                                       14
<PAGE>

purchased from Commtek.  However,  if a shortage or termination of the supply of
any one or more of such  components or assemblies  were to occur,  the Company's
business could be materially and adversely affected.

Warranty and Service

     The  Company  provides  warranties  of 90  days  with  respect  to  repair,
refurbishment  and  conversion  services  and  from  one to  three  years on its
products.  Under the Company's warranty program, the Company repairs or replaces
defective  parts and  components  at no charge to its  customers.  The Company's
contract  manufacturers  provide  warranties  on the  electronic  circuit  board
assemblies  ranging  from 90 days to 120  days.  Under  warranties  provided  by
contract  manufacturers,  defective  electronic  circuit  board  assemblies  are
replaced or repaired at no charge to the Company.

     The Company  generally  enters into repair  agreements  with respect to its
smart  products under which the Company  agrees to perform  non-warranty  repair
services at specified  prices.  The Company also provides repair,  refurbishment
and conversion  services  under  agreements  with its customers.  See "Sales and
Markets," above.

Licenses, Patents and Trademarks

     The  engineering  designs on which the  Company's  electronic  products and
components  are based were  internally  developed by the  Company's  engineering
staff.  The  Company  owns eight  United  States  patents  relating  to payphone
components,  its smart  payphone  platform  and other  technology  which  expire
between  April  2010  and May  2014.  The  Company  has one  patent  application
outstanding.  Although the Company  believes that its patents and trademarks are
important  to its  business,  it does not  believe  that  patent  protection  or
trademarks are critical to the operation or success of its business. The Company
does not believe that it is infringing on the patents of others and would defend
itself  against  any  allegations  to that  effect.  There can be no  assurance,
however, that infringement claims will not be asserted in the future or that the
results  of any patent  related  litigation  would not have a  material  adverse
affect on the Company's business.

     The Company  regards its  manufacturing  processes  and circuit  designs as
proprietary  trade  secrets  and  confidential  information.   To  protect  this
information,  the Company relies  largely upon a combination of agreements  with
its contract manufacturers, confidentiality procedures, and employee agreements.
However,  there can be no assurance that the Company's trade secrets will not be
disclosed or misappropriated.

     The  Company  licenses  certain   technologies  from  third  parties  under
agreements  providing for the payment of royalties.  Royalty  expense during the
year  ended  March  28,  1997  approximated  $196,100.  See Item 8 -- "Financial
Statements and Supplementary Data".

Design and Product Development

     The Company's engineering  department is staffed with software,  electrical
and mechanical engineering professionals.  Their activities are dedicated to the
development  of new products,  enhancements  of the Company's  deployed  product
line,  including the CoinNet  management  system,  and  enhancements  to improve
product  reliability.  Their efforts are also directed to reducing product costs
through new  manufacturing  methods.  During  fiscal 1995 and 1996,  the Company
expended approximately $938,000 and $1.2 million,  respectively, on engineering,
research  and  development  activities  consisting  primarily  of the design and
development  of GemStar,  Gemini and GemCell  products.  During fiscal 1997, the
Company  expanded  its research and  development  activities  for the purpose of
designing and developing a new smart payphone  processor capable of operating in
domestic coin line  installations,  domestic non-coin line  installations and in
foreign CCITT network  installations.  During the year ended March 28, 1997, the
Company  expended  approximately  $1.8  million  on  engineering,  research  and
development   activities,   and  in  addition  thereto,   capitalized   software
development expenses of $421,693.


                                       15
<PAGE>

     The Company  believes that new products and product  enhancements  have the
potential  to  increase  its  market  opportunities  and  are  essential  to its
long-term  growth,  particularly  in  international  wireline  markets,  and the
Company's ability to fund future research and development  activities,  in turn,
will be dependent  upon its ability to generate  cash in excess of its operating
needs.  See  Item  7 --  "Management's  Discussion  and  Analysis  of  Financial
Condition and Results of Operations."

Employees

     At March 28, 1997,  the Company had 149  full-time  employees,  3 part-time
employees and 22 temporary contract employees  consisting of 112 persons engaged
in  direct  labor  activities,  22  persons  engaged  in  manufacturing  support
activities,  20 persons engaged in administrative,  sales and finance activities
and 20 persons  engaged in engineering and engineering  support  activities.  In
addition,  the  Company  has three  independent  contractors  engaged in product
development  activities.  The Company considers its relations with its employees
to be satisfactory.

     At March 28, 1997,  none of the Company's  employees were  represented by a
collective bargaining unit.

Backlog

     The  amount of the  Company's  backlog  is  subject  to large  fluctuations
because the  Company's  business  depends upon a small  number of customers  and
large orders.  The Company  calculates  its backlog by including  only items for
which  there are  purchase  orders  with firm  delivery  schedules.  Contractual
commitments  are not included in backlog until  purchase  orders are received by
the  Company.  At March 28,  1997,  the backlog of all products and services was
approximately  $2.6 million as compared to  approximately  $3.8 million at March
29, 1996.  The  Company's  objective is to ship orders within 30 days of receipt
and, therefore,  the Company does not expect its backlog, other than orders with
scheduled  deliveries  under  contractual  commitments,  to exceed monthly sales
levels.  Accordingly,  the Company's backlog at any given date is not indicative
of future revenues. Seasonality

     The Company's sales are generally stronger during periods when weather does
not interfere with the maintenance and installation of payphone equipment by the
Company's  customers.  Accordingly,  the  Company's  sales  could  be  adversely
affected  during certain  periods of the year.  The Company's  sales may also be
adversely  impacted  near the end of the calendar year by the budget short falls
of  customers.  As a result,  the  Company's  sales during its third quarter may
decline  significantly  in relation to other quarters.  Potential  Environmental
Liabilities

     During the year ended March 28, 1997, the Company completed the evaluation,
assessment and monitoring of soil and  groundwater  contamination  at one of the
Company's  former   facilities  in  Florida  in  accordance  with   requirements
stipulated by the Florida  Department of Environmental  Protection (the "FDEP"),
and in April 1997 received a formal "no further action status"  notification for
the site from the FDEP. Accordingly,  the Company has not accrued any additional
costs with respect to this site.  It is possible,  however,  that the FDEP could
reopen the  investigation  in the future and require the Company to take further
actions at the site. The Company cannot  estimate a range of costs, if any, that
it could incur in the future since such costs would be dependent  upon the scope
of additional actions, if any, that may be required by the State of Florida.

     During  the year  ended  March 28,  1997,  the  Company  was a  Potentially
Responsible Party ("PRP") for undertaking response actions at a facility for the
treatment,  storage,  and disposal of hazardous  substances operated by Seaboard
Chemical  Corporation from 1975 to 1989 at Jamestown,  North Carolina.  However,
the  Company,  as a small  generator  "De  Minimis"  party,  executed  a buy-out
agreement with respect to the remediation  activities at a cost of approximately
$8,200  during the year ended March 28,  1997.  The Company  believes,  based on
information  presently  available  to  the  Company,  that  it  has  no  further
obligations with respect to the site. However, if additional waste is attributed
to the Company,  it is possible that the Company could be liable for  additional
costs. The Company cannot estimate a range of costs, if any, that it could incur
in the future


                                       16
<PAGE>

since such costs would be dependent upon the amount of additional waste, if any,
that could be attributed to the Company.

     The  Company  has  also  been  notified  that it is a PRP with  respect  to
response actions at the Galaxy/Spectron  Superfund Site in Elkton, Maryland. The
Company,  however, is also a De Minimis party with respect to this site, and its
proportionate  share  of  costs  to  undertake  response  actions,  the  Company
believes,  will likely be insignificant.  The Company has received  notification
that the De Minimis  parties  will be able to buy out and obtain a release  from
any further  clean-up  liability  at the site at a cost  presently  estimated at
$3.70 per gallon of contributed waste, which would amount to $2,849 with respect
to the  Company's  contribution.  The  Company has not  incurred  any costs with
respect to this site and believes that its ultimate costs will not be material.

Government Regulation

     The Company's  operations are subject to certain  Federal,  state and local
regulatory  requirements  relating to environmental,  health and safety matters.
Management  believes that the Company's  business is operated in compliance with
applicable  regulations  promulgated  by  the  Occupational  Safety  and  Health
Administration and the Environmental  Protection Agency and corresponding  state
agencies  which  pertain  to health  and  safety in the work  place and the use,
discharge  and storage of chemicals  employed in its  operations,  respectively.
Current  costs of  compliance  with such  regulations  are not  material  to the
Company.  However,  the adoption of new or modified  requirements  not presently
anticipated could create additional expense for the Company.

     The Federal  Communications  Commission  ("FCC") regulates under Part 15 of
its rules the  operation  and  marketing of devices  which emit  radio-frequency
energy,  whether  intentionally or unintentionally,  and which do not require an
individual license. The marketing of such devices is also regulated under Part 2
of the  FCC's  rules.  The FCC  regulates  the  direct  connection  of  terminal
equipment to the public  switched  telephone  network and the  marketing of such
equipment  under  Part 68 of its  rules.  Parts  15 and 68  establish  technical
standards and  procedural  and labeling  requirements  for equipment  subject to
these rules. Certain modifications to equipment subject to these rules must also
comply with these technical standards and procedural and labeling  requirements.
Manufacturers  of products  subject to Part 68 also must  implement a continuing
compliance  program under which products  currently in production must be tested
every six months to ensure  continued  compliance with the applicable  technical
standards.  Certain  types of devices sold as components  or  subassemblies  are
exempt from the technical standards and procedural and labeling  requirements of
Parts 15 and 68. If such components or subassemblies  are incorporated  into and
marketed as part of systems or sets subject to Part 15 or Part 68, however, such
systems or sets must comply with the applicable rules. The Company believes that
it is in compliance  with Parts 15 and 68 of the FCC's rules and  regulations at
March 28, 1997.

     The Company believes that the regulatory  climate in the United States over
recent years has begun to influence the RBOCs deployment of public communication
products.  The Company also  believes that the RBOCs have begun to upgrade their
payphone  base  with  smart  products  that  reduce  their  cost of  management,
maintenance  and  coin  administration  and  that  include  revenue  enhancement
features.  The  deployment and business  strategies of the public  communication
divisions of the RBOCs have  affected and will  continue to affect the Company's
business.  To the extent  that these  business  strategies  were to change,  for
regulatory reasons or otherwise, the Company's prospects would be materially and
adversely affected.

     On September 20, 1996, the FCC released its order  adopting  regulations to
implement  the  section  of  the  Telecommunications  Act  which  mandated  fair
compensation  for  all  payphone  providers.  Among  other  matters,  the  order
addressed  compensation for non-coin calls; local coin calling rates; removal of
subsidies  and  discrimination  favoring  payphones  operated by local  exchange
carriers  ("LECs") and  authorized  RBOCs and other  providers to select service
providers.


                                       17
<PAGE>

     The order  prescribed  interim  dial-around  compensation  for  independent
payphone  providers for both access code and subscriber 800 dial-around calls on
a flat-rate  basis of $45.85 per phone per month,  as  compared to the  previous
compensation of $6.00 per month.  This new interim rate will expire on September
1, 1997, and replaces all other dial around compensation prescribed at the state
or federal level.  This  compensation  will be paid by the major  inter-exchange
carriers  based on their  share of toll  revenues in the long  distance  market.
Payphones  owned by the RBOCs  and  other  LECs  will be  eligible  for  interim
compensation  when  they have  removed  their  payphones  from  their  regulated
accounts,  which was to be completed by April 15, 1997. By October 1, 1997,  the
inter-exchange   carriers  ("IXCs")  are  required  to  have  per-call  tracking
instituted.  At that point, all payphones will switch to a per-call compensation
rate set at $.35 per call. Under this system, compensation will be paid on every
completed  800-subscriber and access code call. The carrier which is the primary
beneficiary  of the call will pay the per-call  compensation.  After one year of
deregulation  of coin rates (October 1, 1998),  the  compensation  rate would be
adjusted to equal the local coin rate charge in a particular payphone.

     The order required LEC payphones to be removed from regulation,  separating
payphone costs from regulated  accounts by April 15, 1997.  This  requirement is
intended to eliminate all  subsidies  that favor LEC  payphones.  LECs were also
required to reduce interstate access charges to reflect  separation of payphones
from regulated  accounts.  In order to eliminate  discrimination,  LECs are also
required to offer coin line services to  independent  providers if LECs continue
to connect their payphones to central office driven coin line services.  The FCC
did not mandate unbundling of specific coin line related services,  but did make
provisions to allow states to impose further payphone services requirements that
are consistent with the order.

     The order  authorizes RBOCs to select the operator service provider serving
their  payphones and for independent  payphone  providers to select the operator
service provider serving theirs.  This provision preempts state regulations that
require  independent  providers to route  intralata  calls to the LECs. The FCC,
however, did not establish conditions that require operator service providers to
pay  independent  payphone  providers  the same  commission  levels as the RBOCs
demand.

     Although dramatic regulatory changes,  particularly those created by recent
legislative  actions  have  occurred  and may  continue  to occur,  the  Company
believes that the  telecommunications  industry will continue to be regulated in
some form by Federal  and/or state  authorities.  There can be no assurance that
changes in regulations affecting the telecommunications  industry would not have
an adverse impact on the operations of the Company's  customers and,  therefore,
on the operations of the Company.

Item 2. PROPERTIES

     The Company's  administration,  sales, marketing and engineering activities
are located at its  headquarters in  approximately  11,800 square feet of leased
office space. The lease expires on December 31, 1997.

     In November 1996, the Company  executed a lease agreement with respect to a
39,200 square foot facility  located in Georgia that commenced on April 1, 1997.
The  Company  intends to close its  present  corporate  office  facility  and to
consolidate its product  assembly  operations and corporate  activities into the
new  facility.  The lease has an initial term of five years and is renewable for
an additional five-year term.

     The Company performs payphone assembly operations and repair, refurbishment
and  conversion  service  operations  in a 53,400  square-foot  leased  facility
located in Orange, Virginia. The Orange, Virginia facility is leased pursuant to
the terms of an operating lease agreement dated August 1, 1986. The lease had an
initial term of five years and was renewed for an additional  five-year  term on
August 1, 1991.  During fiscal 1997,  the Company and the lessor  entered into a
lease  extension  agreement that extended the term of the lease to July 31, 1997
and provided  the Company with the right to renew the lease for five  additional
terms of one year each.


                                       18
<PAGE>

     During the third quarter of fiscal 1997,  the Company  closed a one hundred
thousand  square-foot  facility  located in Paducah,  Kentucky and  consolidated
service operations into its Orange, Virginia facility.

     The Company believes its facilities are adequate for its business.

Item 3. LEGAL PROCEEDINGS

     None.

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

     No  matter  was  submitted  to a  vote  of  security  holders  through  the
solicitation of proxies or otherwise during the fourth quarter of fiscal 1997.

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


                                       19
<PAGE>

                                     PART II

Item 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

     The  Company's  Common Stock was listed on the Nasdaq Small Cap Market tier
of The Nasdaq  Market  under the symbol  "TSGI"  from May 10, 1996 to October 7,
1996. On October 7, 1996,  the  Company's  Common Stock was listed on the Nasdaq
National Market tier of The Nasdaq Market under the symbol "TSGI".  Prior to May
10, 1996, there was no public trading market for the Company's Common Stock.

     The high  and low  sales  prices  of the  Company's  Common  Stock  for the
quarterly  periods  during  the period  May 10,  1996 to March 28,  1997 were as
follows:

                                                                 High      Low
                                                                ------    -----
       Fiscal 1997
         First Quarter (May 10, 1996 through June 28, 1996)     12 3/4    9 3/8
         Second Quarter (ended September 27, 1996)              11 1/2    8 1/4
         Third Quarter (ended December 27, 1996)                11        6 7/8
         Fourth Quarter (ended March 28, 1997)                   7 7/8    4 1/4

     At March 28,  1997,  the  Company  had 15 common  stockholders  of  record.
However,  the Company believes that there were over 400 beneficial owners of its
Common Stock at March 28, 1997.

     The Company has never paid any cash  dividends on its Common Stock and does
not  currently  intend to pay cash  dividends  in the  foreseeable  future.  The
Company  currently  intends to retain its  earnings,  if any, for the  continued
growth of its business. Under the terms of a Loan and Security Agreement between
the Company and its bank,  the Company is prohibited  from paying cash dividends
or other distributions on capital stock, except stock distributions.

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


                                       20
<PAGE>

Item 6.  SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                     Predecessor                                         Company
                                       --------------------------------------------    --------------------------------------------
                                                                       Seven Months     Five Months
                                        Year Ended      Year Ended         Ended          Ended         Year Ended      Year Ended
                                          April 2,        April 1,      October 30,      March 31,       March 29,       March 28,
                                           1993            1994            1994            1995            1996            1997
                                       ------------    ------------    ------------    ------------    ------------    ------------
<S>                                    <C>             <C>             <C>             <C>             <C>             <C>         
Results of Operations
Net sales                              $ 30,535,968    $ 31,048,706    $ 11,108,653    $  9,161,359    $ 33,201,686    $ 33,471,918
Cost of goods sold                       24,083,319      25,761,831       9,176,134       8,226,245      26,082,055      26,638,622
General and administrative                3,333,996       3,476,932       1,742,324         850,069       2,204,915       2,391,164
 expenses
Marketing and selling expenses            1,865,134       1,748,814         366,464         371,757       1,290,349         881,324
Engineering, research and
  development expenses                    2,241,552       2,009,524         457,553         480,495       1,197,183       1,776,611
Restructuring charges (credits)                --         2,570,652        (534,092)           --              --            62,500
Litigation settlement                          --              --          (261,022)           --              --          (105,146)
Interest expense                            809,589         911,821         599,276         356,624         941,261         399,469
Other (income) expense                      200,875          54,557         (14,618)        (58,250)        (17,763)       (116,664)
Income (loss) before taxes               (1,998,497)     (5,485,425)       (423,366)     (1,065,581)      1,503,686       1,544,038
Income tax provision                           --              --              --              --          (326,315)       (533,379)
Net income (loss)                      $ (1,998,497)   $ (5,485,425)   $   (423,366)   $ (1,065,581)   $  1,177,371    $  1,010,659
Income (loss) per common and
  common equivalent share (1)(2)
     Primary                                                                           $      (0.30)   $       0.30    $       0.22
     Assuming full dilution                                                            $      (0.30)   $       0.30    $       0.22
Weighted average number of
  common and common equivalent
  shares outstanding
     Primary                                                                              3,541,778       3,870,889       4,780,263
     Assuming full dilution                                                               3,541,778       3,870,889       4,780,263
Financial Position
Current assets                         $ 14,213,270    $  9,742,477    $  7,579,857    $  8,551,369    $ 12,741,489    $ 14,865,472
Total assets                             18,868,906      13,421,291      10,397,376      15,669,648      19,633,764      19,772,382
Borrowings under revolving
  credit agreement                        6,727,726       5,352,040       1,660,965         970,197            --         3,810,961
Current maturities under
  long-term debt and capital
  lease obligations (3)                     827,198       1,283,792         877,557         813,917         118,444            --
Current liabilities                      12,942,935      13,006,714       8,190,910       6,856,802       8,347,509       6,644,652
Working capital (deficit)                 1,270,335      (3,264,237)       (611,053)      1,694,567       4,393,980       8,220,820
Long-term debt and capital
  lease obligations (4)                   2,068,287         957,104       3,627,596       3,532,867       3,414,586            --
Long-term borrowings under
  revolving credit agreement (5)               --              --              --              --         1,093,735            --
Notes payable to stockholders (3)(4)           --              --           400,000       2,800,000       2,800,000            --
Other liabilities                              --           862,517            --           375,000         378,198            --
Total liabilities                        15,011,222      14,826,335      12,218,506      13,564,669      16,034,028       6,644,652
Retained earnings (deficit)             (18,964,484)    (24,449,909)    (24,873,275)     (1,065,581)        111,790       1,122,449
Stockholders' equity (deficit)         $  3,857,684    $ (1,405,044)   $ (1,821,130)   $  2,104,979    $  3,599,736    $ 13,127,730

</TABLE>

(1)  Assuming the  Acquisition  had occurred on April 2, 1994, the Company's and
     the  Predecessor's  net loss for the year ended  March 31,  1995 would have
     approximated  $1,599,000 and the net loss per common and common  equivalent
     share  outstanding  (primary and assuming  full  dilution)  would have been
     ($.45).

(2)  Income  (loss)  per common and  common  equivalent  share and the  weighted
     average number of common and common equivalent  shares  outstanding are not
     presented  for periods  prior to the five months ended March 31, 1995 since
     such data is not meaningful for periods prior to the Acquisition on October
     31, 1994.

(3)  Subordinated  notes  payable to  stockholders  of $400,000  were retired in
     connection  with the  Acquisition.  These notes were  classified as current
     maturities  under long-term debt and capital lease  obligations at April 1,
     1994.

(4)  Indebtedness  under a bank term note in the  amount of  $2,200,000,  a bank
     term note in the amount of $309,524 and notes  payable to  stockholders  of
     $2,800,000 were repaid from the proceeds from the Company's  initial public
     offering of securities in May 1996.

(5)  Indebtedness  under the  revolving  credit  agreement  was repaid  from the
     proceeds from the Company's  initial  public  offering of securities in May
     1996.   Accordingly,   such  indebtedness  is  classified  as  a  long-term
     obligation at March 29, 1996.

     The selected financial data and related footnotes set forth above should be
read in  connection  with Item 7 --  "Management's  Discussion  and  Analysis of
Financial   Condition  and  Results  of  Operations"  and  Item  8 -- "Financial
Statements and Supplementary Data."


                                       21
<PAGE>

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

Overview

     Fiscal 1997 and fiscal 1996 operating  performance  reflects the successful
outcome of  initiatives  and plans set in motion during the later part of fiscal
1994 and  throughout  fiscal  1995 to turn  around  the  business,  to return to
profitability,  and to improve the Company's  financial condition and liquidity.
These initiatives included a change in senior management, a restructuring of the
organization,  and raising additional  capital and financing.  The restructuring
was also directed at reducing  operating costs and expenses and increasing sales
and gross profit margins. In addition, the Company refocused its engineering and
product  development  activities to resolve certain  technical  product problems
experienced  prior  to the  restructuring  and to  develop  new  smart  payphone
products that would  position the Company to capture a significant  share of the
market for the technological upgrade of the installed base of payphones owned by
the RBOCs.

     This discussion contains certain forward looking statements  concerning the
Company's  operations,   economic  performance  and  financial  condition.  Such
statements are subject to various risks and uncertainties.  Actual results could
differ  materially from those currently  anticipated due to a number of factors,
including those identified herein.

Background - The Acquisition

     On October 31, 1994, TSG  Acquisition  Corp., a wholly-owned  subsidiary of
Wexford Partners Fund, L.P. ("Wexford"), acquired all of the outstanding capital
stock of the Company  pursuant to an Agreement  and Plan of Merger dated October
11, 1994 between  Wexford,  TSG Acquisition  Corp., the Company and the majority
holders of the Company's  capital stock (the  "Acquisition").  The consideration
paid  by  TSG  Acquisition  Corp.  aggregated  $3,500,000  including  contingent
consideration  of $329,709,  consisting  of cash of $230,117 and a  subordinated
note of the Company in the  principal  amount of  $99,592,  placed in escrow and
distributed   to  former   stockholders   in  September   1995.   The  aggregate
consideration  consisted of $3,004,000 to acquire the outstanding  capital stock
of the Company and $496,000 to retire a $400,000  subordinated master promissory
note payable to former  stockholders and related accrued interest and preference
fees of $96,000.  Aggregate cash payments to former stockholders,  including the
contingent   consideration  and  the  retirement  of  the  subordinated   master
promissory note,  accrued interest and preference fees of $496,000,  amounted to
$3,222,090.  Consideration  of $277,910 was withheld from amounts paid to former
stockholders to pay certain liabilities of the Company.

     The  Acquisition was accounted for using the purchase method of accounting.
Accordingly, the aggregate purchase price of $3,170,291, exclusive of contingent
consideration,  was pushed down and allocated to the net assets  acquired  based
upon their fair values. The excess of the purchase price over the estimated fair
value of the net assets  acquired of $3,853,877  was recorded as goodwill.  Upon
distribution  of the escrow  consideration  in  September  1995,  the  aggregate
purchase price was increased to $3,500,000,  which increased the excess purchase
price over the  estimated  fair value of net assets  acquired  and  recorded  as
goodwill  by  $329,709.  Prior to the  Acquisition,  the  Company  is  sometimes
referred to as the "Predecessor."

     In conjunction with the Acquisition,  TSG Acquisition Corp. was merged into
the  Company.  The  outstanding  shares  of the  Company's  capital  stock  were
cancelled and the outstanding  shares of capital stock of TSG Acquisition  Corp.
were exchanged for one share of the Company's common stock,  $.05 par value (the
"merger  share").  In  addition,  on October 31, 1994,  the Company  amended its
Certificate of  Incorporation  to reflect  authorized  capital  consisting of 10
million shares of common stock, $.01 par value (the `Common Stock),  and 100,000
shares of preferred stock, $100 par value.  Further, the Company entered into an
investment agreement with Wexford, Acor S.A. ("Acor") and Firlane Business Corp.
("Firlane"),  referred to herein  collectively as the  "investors."  Pursuant to
that investment agreement, the Company issued 3.5 million shares of Common Stock
in exchange for the merger share.  Also, the Company  borrowed $2.8 million from
Wexford and 


                                       22
<PAGE>

Acor and issued 10% interest  bearing  subordinated  promissory notes in respect
thereof due November 1, 1999 (the "Affiliate Notes") to such persons.

     The  accompanying  analysis  compares the combined results of operations of
the Company and the Predecessor for the fiscal year ended March 31, 1995 and the
Predecessor  for the fiscal year ended April 1, 1994,  the results of operations
of the Company for the fiscal year ended March 29, 1996 and the combined results
of operations of the Predecessor and the Company for the fiscal year ended March
31, 1995 and the  results of the  Company  for the fiscal  years ended March 28,
1997 and March 29, 1996.

     Because of the Acquisition,  certain financial  information described below
is not  comparable  in all  respects.  In  addition,  comparability  is affected
because of the following purchase accounting  adjustments made by the Company on
October 31, 1994: (i) a net decrease in  inventories of $44,734  consisting of a
reduction  of $491,397  attributable  to a change in the method used to estimate
the amount of manufacturing  overhead  included in inventories to a method based
on labor factors, not on a combination of labor and material factors,  offset by
an increase in the basis of inventories  of $446,664 to reflect their  estimated
net realizable value; (ii) an increase in the basis of property and equipment of
$382,733  to reflect  their  estimated  fair  value;  (iii) an  increase in debt
obligations  of  $106,275  to  reflect  present  values  of  amounts  to be paid
determined at current interest rates; (iv) a net increase in accrued liabilities
of $124,859 to reflect the acquisition  expenses of TSG Acquisition  Corp. to be
paid by the Company,  offset by a reduction of accrued  interest and  preference
fees of $96,000 retired in connection with the  Acquisition;  (v) a reduction in
accrued  restructuring  charges  of  $202,910  retired  in  connection  with the
Acquisition;  (vi) a  reduction  of notes  payable to  stockholders  of $400,000
retired in connection with the Acquisition; (vii) a net increase in other assets
of  $429,728  consisting  of  an  increase  in  identifiable  intangible  assets
(consisting of product software,  patents,  customer  contracts,  and unpatented
technology)  of $584,095 to reflect  their  estimated  fair values,  offset by a
reduction in goodwill and deferred debt issuance  expenses of $154,367  recorded
by  the  Predecessor;  and  (viii)  an  increase  in  goodwill  related  to  the
Acquisition  of  $3,853,877.  The principal  impacts of the purchase  accounting
adjustments  on the Company's  results of  operations  for the five months ended
March  31,  1995  consisted  of a slight  increase  in  depreciation  due to the
increase in the basis of  property  and  equipment  and their  estimated  useful
lives, an increase in amortization expense of approximately  $100,000 due to the
net increase in the basis of intangible assets,  including  goodwill,  and their
estimated  useful lives,  and an increase in cost of goods sold of approximately
$235,000 due to the revaluation of inventories. The change in the method used to
estimate the amount of  manufacturing  overhead  included in inventories did not
have a significant  effect on the Company's  results of operations  for the five
months ended March 31, 1995.

     During  the fiscal  years  ended  March 29,  1996 and March 28,  1997,  the
Company has reduced  goodwill by  approximately  $653,000 in the aggregate  with
respect to the realization of acquired deferred tax assets.

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



                                       23
<PAGE>

Results of Operations

Year Ended March 28, 1997 Compared to the Year Ended March 29, 1996

     The following table shows certain line items in the Company's  consolidated
statements of  operations  for the years ended March 28, 1997 and March 29, 1996
that are discussed below together with the change expressed as a percentage.

                                    Year Ended       Year Ended     Percentage
                                     March 28,        March 29,      Increase
                                       1997             1996         (Decrease)
                                   ------------     ------------    -----------
Sales                              $ 33,471,918     $ 33,201,686           1% 
Cost of goods sold                   26,638,622       26,082,055           2%
General and 
   administrative expenses            2,391,164        2,204,915           8%
Marketing and selling expenses          881,324        1,290,349         -32%
Engineering, research and
  development expenses                1,776,611        1,197,183          48%
Restructuring charges                    62,500             --           -- 
Litigation settlement                  (105,146)            --           -- 
Interest expense                        399,469          941,261         -58%
Other income                            116,664           17,763         557%
Income tax expense                      553,379          326,315          70%
                                                                              
     Overview.  The  Company's  operations  for the year  ended  March 28,  1997
reflect a slow down in sales  during  the last six  months of the year which the
Company  attributes  to several  factors as  explained  below,  an  increase  in
engineering,  research  and  development  spending of  $579,428  directed at the
development of a new wireline smart payphone  product for the RBOC,  independent
and international  markets,  a gain on the settlement of litigation of $105,146,
restructuring  charges of $62,500,  lower  interest  expense as a result of debt
repayments  from proceeds of an initial public  offering and higher income taxes
due to limitations on utilization of net operating loss carryforwards.

     Sales.  The increase in sales during fiscal 1997 as compared to fiscal 1996
is primarily  related to volume  fluctuations.  Sales of smart payphone products
and components  decreased by approximately  $.6 million (3%) to $21.2 million in
fiscal 1997 as compared  to $21.8  million in fiscal  1996,  and  accounted  for
approximately 63% of sales during fiscal 1997 as compared to 66% of sales during
fiscal 1996. Sales related to refurbishment,  repair and conversion services and
related  products  during fiscal 1997  increased by  approximately  $1.2 million
(11%) to $11.8  million  as  compared  to $10.6  million  in  fiscal  1996,  and
accounted  for 35% of sales as  compared  to 32% in fiscal  1996.  Export  sales
consisting  primarily  of wireless  products  during  fiscal  1997  approximated
$461,000 as compared to approximately $856,000 during fiscal 1996.

     The Company  believes  that the reduction in smart product sales volume was
attributable  to several key factors,  including  the  uncertainties  created by
merger  activities among the Company's RBOC customers,  the efforts of the RBOCs
to comply with the requirements of the Telecommunications Act of 1996 during the
last six months of the Company's  fiscal year, and related budget  implications.
Notwithstanding,  sales from  refurbishment,  repair and conversion services and
related  products  increased  as a result of  additional  volume from one of the
Company's  customers  that  has not  begun a smart  product  upgrade  conversion
program.  Export sales  activities  during  fiscal 1997 did not generate  volume
comparable  to fiscal  1996, a trend the Company  expects to reverse  during the
coming year.

     The Company believes,  but cannot assure, that the decline in smart product
sales volume during the last six months of fiscal 1997,  which is believed to be
attributable to efforts of the RBOCs to comply with the


                                       24
<PAGE>

Telecommunications  Act of 1996,  represents  a short term  trend,  and that its
sales  will be  favorably  affected  by the  implications  of the new law during
fiscal 1998 and beyond.

     During  fiscal  1997,  the  Company  entered  into  a  non-exclusive  sales
agreement,  effective  July 1, 1996,  to provide its Gemini smart  payphones and
processors,  CoinNet payphone management system and other payphone components to
NYNEX for a period of five years.  Sales of smart payphone  products  during the
year ended March 28,  1997 were  primarily  attributable  to  shipments  under a
former sales agreement  between the Company and NYNEX executed in December 1995.
This sales  agreement  expired  during the third  quarter  of fiscal  1997,  and
although the Company entered into the new contract,  no significant  orders were
received until February 1997,  which the Company believes was due to the factors
enumerated above. During the year ended March 29, 1996, a significant portion of
the  Company's  sales were  attributable  to  shipments  under the former  NYNEX
agreement as well as a sales agreement between the Company and Southwestern Bell
Telephone   Company  ("SWB")  executed  in  December  1994.  SWB  had  purchased
approximately  65% of the  committed  volume under the agreement as of March 29,
1996. However,  sales to SWB under the 1994 contract were not significant during
the Company's 1997 fiscal year, a condition the Company believes is attributable
to a change in deployment  strategies of SWB. In June 1997, the Company  entered
into an agreement  with SWB that  supersedes  and  terminates  the December 1994
agreement. Under the new agreement, the Company agreed to reduce SWB's remaining
purchase  commitment to approximately  $3 million from  approximately $8 million
under the former  agreement  and,  among other things,  upgrade  SWB's  payphone
management  system. In return,  SWB made a $250,000 cash payment to the Company,
terminated  the  Company's  obligation  to pay  royalties  on sales  of  GemStar
processors to other  customers and terminated the Company's  obligation to repay
$375,000  received  from the sale of product  software  under the December  1994
agreement.  SWB also agreed to make additional cash payments of $250,000 on July
2, 1997,  $100,000 on  September  1, 1997,  $150,000  on  December  31, 1997 and
$250,000 on March 31, 1998 to the Company  subject to the  Company's  compliance
with the  terms and  conditions  of the  agreement,  including  conditions  with
respect to performance, service and repair. See Item 1 -- "Business -- Sales and
Markets" for a discussion of the Company's  dependence on significant  customers
and  contractual  relationships.  Also, see "Liquidity and Capital  Resources --
Operating Trends and Uncertainties," below.

     Cost of Goods Sold.  The  increase in cost of  products  sold is  primarily
attributable  to the increase in sales,  the increase in the percentage of sales
related to  refurbishment,  repair and conversion  services and related products
and certain sales price reductions.  Incremental costs of approximately $350,000
incurred in connection  with the closure of one of the  Company's  manufacturing
facilities and the consolidation of service operations were offset substantially
by gains of  approximately  $273,000  from changes in  estimates  of  contingent
liability  obligations  recorded in connection with the Acquisition.  Production
costs as a percentage of sales  increased to  approximately  80% during the year
ended March 28, 1997 as compared to 79% during the year ended March 29, 1996 due
to these factors.

     General  and   Administrative   Expenses.   The  increase  in  general  and
administrative  expenses is primarily  related to incremental costs and expenses
incurred as a public  reporting  entity after the  consummation of the Company's
initial public offering in May 1996.

     Marketing  and Selling  Expenses.  The decrease in marketing and selling is
primarily attributable to the expiration of a smart product royalty agreement on
June 30, 1996 and the related decrease in royalty expense.

     Engineering,  Research and Development Expenses. Engineering,  research and
development  expenses  increased  primarily  due to an expansion of  engineering
resources and product  development  activities.  The Company began to expand its
engineering  resources  during  the first  quarter  of  fiscal  1997 in order to
facilitate  smart  product  development  activities  and the  implementation  of
lower-cost  manufacturing  methodologies.  During the year ended March 28, 1997,
the Company capitalized  approximately $422,000 of software development costs in
connection with the development of its new smart payphone processor.


                                       25
<PAGE>

     Litigation  Settlement.  Pursuant  to the terms of a  settlement  agreement
dated July 3, 1996,  a suit filed  against the  Company by a former  supplier to
collect  approximately   $400,000  of  unpaid  obligations  was  dismissed  with
prejudice. As a result of the settlement agreement,  the Company realized a gain
of $105,146  representing the difference between the unpaid obligations recorded
in the Company's accounts and the aggregate settlement payments.

     Interest Expense.  The decrease in interest expense is primarily due to the
repayment of outstanding bank and stockholder  debt obligations  during May 1996
from proceeds of the Company's  initial  public  offering.  See  "Liquidity  and
Capital Resources -- Cash Flows From Financing Activities," below.

     Restructuring  Charges.   During  August  1996,  the  Company  initiated  a
facilities  consolidation plan intended to augment its on-going productivity and
quality improvement programs. The consolidation plan provided for the closure of
the  Company's  Kentucky  manufacturing  facility,  the closure of the Company's
Georgia corporate office facility,  the  consolidation of repair,  refurbishment
and conversion  service  operations into the Company's Virginia facility and the
consolidation of corporate activities and product assembly operations into a new
Georgia   facility.   In  connection  with  this  plan,  the  Company   recorded
restructuring  charges of $62,500  during the year ended March 28,  1997.  These
restructuring  charges  consisted of severance  obligations and estimated losses
related  to the  abandonment  of  assets  in  connection  with  the  closure  of
facilities.

     Other Income.  The Company assigned the capital lease obligation related to
its former Kentucky  facility to an unaffiliated  third party,  and recorded the
retirement of the  outstanding  capital lease  obligation and the disposition of
the property  during the fiscal year ended March 28, 1997.  In  connection  with
this  transaction,  the  Company  realized  a gain of $44,169  representing  the
difference between the outstanding lease obligation ($933,510) plus the proceeds
received  ($50,000)  and the net book  value  of the  property  ($939,341).  The
increase in other income during the year ended March 28, 1997 as compared to the
year  ended  March  29,  1996 is  primarily  attributable  to the gain  from the
disposition of the facility and an increase in income related to the sublease of
a portion of property leased by the Company.

     Income Tax Expense.  The increase in income tax expense is primarily due to
a  reduction  in  tax  benefits  from   utilization   of  net   operating   loss
carryforwards.  Benefits  of net  operating  loss  carryforwards  used to offset
current  tax  expense  amounted  to $71,995  during  fiscal  1997 as compared to
$334,985  during fiscal 1996.  Deferred tax benefits of $492,110 were recognized
during the year ended  March 28,  1997 as  compared  to $50,544  during the year
ended  March 29,  1996.  However,  deferred  tax  benefits  related to  acquired
deferred tax assets aggregating  $442,070 were applied to goodwill during fiscal
1997 as compared to $211,193 during fiscal 1996.

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



                                       26
<PAGE>

Year Ended March 29, 1996 Compared to the Year Ended March 31, 1995

     The following table shows certain line items in the Company's  consolidated
statement of  operations  for the year ended March 29, 1996 and in the Company's
and Predecessor's  consolidated statement of operations for the year ended March
31, 1995 that are discussed below and that changed significantly between the two
periods indicated together with the change expressed as a percentage.

                                           Year Ended     Year Ended  Percentage
                                            March 29,     March 31,    Increase
                                              1996           1995     (Decrease)
                                          ------------  ------------  ----------
  
   Sales                                  $ 33,201,686  $ 20,270,012       64%
   Cost of goods sold                       26,082,055    17,402,379       50%
   General and administrative expenses       2,204,915     2,592,393      -15%
   Marketing and selling expenses            1,290,349       738,221       75%
   Engineering, research and development
     expenses                                1,197,183       938,048       28%
   Restructuring credits                          --         534,092     -100%
   Litigation settlement                          --         261,022     -100%
   Income tax expense                          326,315          --        --
  
     Overview. The Company's results for the year ended March 29, 1996 reflect a
significant  increase in sales volume, an increase in operating  expenses and an
income tax provision of $326,315 on pre-tax  profits of $1.5 million as compared
to the previous  year during which the Company  reported a loss of $1.5 million.
The results of the  Predecessor  during the seven months ended  October 30, 1994
includes a gain from the  recognition  of a litigation  settlement  of $261,022,
restructuring  credits of $534,092 and  acquisition  expenses of  $166,000.  The
results of  operations  of the Company for the five months  ended March 31, 1995
include the effects of the Acquisition  consisting  primarily of amortization of
intangible  assets of  approximately  $100,000  and an increase in cost of goods
sold of  approximately  $226,000.  The results of the Company during fiscal 1996
include the effects of the Acquisition  consisting  primarily of amortization of
intangible assets,  including  goodwill,  of $253,000 and an increase in cost of
goods sold of approximately $221,000.

     Sales.  Sales of smart payphone  products and components during fiscal 1996
approximated  $21.8  million as compared to  approximately  $6.6 million  during
fiscal 1995.  Sales  attributable to refurbishment  and conversion  services and
related  payphone  components  approximated  $10.6 million during fiscal 1996 as
compared to  approximately  $12.3 million during fiscal 1995.  Sales of wireless
payphone   products  and  components   consisting   primarily  of  export  sales
approximated  $856,000  during  fiscal 1996 as compared  to  approximately  $1.4
million  during  fiscal  1995.  The  $15.2  million  increase  in sales of smart
payphone  products and components  during fiscal 1996 as compared to fiscal 1995
was primarily  attributable to an increase in sales volume of GemStar  products,
Gemini  products and  electronic  locks under sales  agreements  entered into in
December 1994 and December 1995. Sales increases attributable to GemStar, Gemini
and  electronic  lock  products  were offset by a reduction  in sales  volume of
Inmate  products,  which the Company  believes is primarily  attributable to the
saturation  of the  inmate  institution  market.  The 14%  decline in sales from
repair,  refurbishment and conversion  services and related payphone  components
during  fiscal 1996 as compared to fiscal 1995 was  primarily due to a reduction
in volume that the Company believes was attributable to  implementation of smart
product conversion  programs by certain customers,  as well as competition.  The
decline in the Company's  wireless  product sales during fiscal 1996 as compared
to fiscal 1995 was primarily due to a decrease in export volume to Mexico, which
the Company  believes was  attributable  to the  devaluation of the Mexican peso
during fiscal 1995.

     Cost of Products  Sold.  The increase in cost of products sold is primarily
attributable  to the 64%  increase  in sales  during  fiscal 1996 as compared to
fiscal 1995.  Production  costs as a percentage of sales


                                       27
<PAGE>

declined to 79% during  fiscal  1996 as compared to 86% during  fiscal 1995 as a
result of the  increase in volume.  In  addition,  during the five months  ended
March 31,  1995,  the  Company  accrued  damages of $200,000  attributable  to a
product   recall   initiated   in  April   1995  (see   "Operating   Trends  and
Uncertainties," below). Purchase adjustments from the revaluation of inventories
in connection  with the  Acquisition  had the impact of increasing cost of goods
sold by $226,000  and  $221,000  during the five months ended March 31, 1995 and
year ended March 29, 1996, respectively.

     General   and   Administrative   Expenses.   The  decline  in  general  and
administrative  expenses is primarily related to cost reductions associated with
a restructuring  initiated during the latter part of fiscal 1994 and expenses of
$166,000  incurred by the Predecessor  during the seven months ended October 30,
1994 in  connection  with the  Acquisition.  Amortization  of goodwill and other
intangible  assets  recorded in  connection  with the  Acquisition  approximated
$253,000  during fiscal 1996 as compared to  approximately  $100,000  during the
five months ended March 31, 1995.

     Marketing  and Selling  Expenses.  The  increase in  marketing  and selling
expenses is primarily  due to royalties on sales of GemStar and Gemini  products
incurred  under an asset  purchase  agreement  dated  January 11,  1991,  and an
elimination of royalties  during the first six months of fiscal 1995 pursuant to
a November 9, 1994 amendment to the royalty provisions of that agreement.

     Engineering,  Research and Development Expenses. Engineering,  research and
development  expenses  increased  primarily  due to an expansion of  engineering
resources  and product  development  activities,  which had been reduced  during
fiscal 1995 as a result of the restructuring  initiated during the later part of
fiscal 1994.

     Restructuring  Credits.  During the five months ended March 31,  1995,  the
Company settled severance  obligations under employment  contracts terminated in
fiscal 1994 and  negotiated  the  termination  of certain  non-cancelable  lease
obligations   with  respect  to  facilities   closed  in  connection   with  the
restructuring  initiated  at the end of fiscal  1994.  The  severance  and lease
obligations  were settled on terms more favorable than estimated during the year
ended April 1, 1994, which resulted in the recognition of restructuring  credits
of $248,684 and  $274,659,  respectively,  during the seven months ended October
30, 1994. Restructuring credits recognized during the seven months ended October
30, 1994 aggregated $534,092.

     Litigation Settlement.  During the seven months ended October 30, 1994, the
Company  settled  litigation  against a supplier  to recover  costs and  damages
attributable  to defective  components  supplied to the Company,  and realized a
gain of approximately $261,000, net of legal fees of $56,000.

     Income Tax  Expense.  During the year ended  March 29,  1996,  the  Company
generated a taxable profit as compared to a net loss during the year ended March
31, 1995.  Benefits of net operating loss  carryforwards  used to offset current
tax expense  during  fiscal 1996  aggregated  $334,985.  Deferred  tax  benefits
recognized  during  fiscal  1996 of $50,544  were offset by benefits of acquired
deferred  tax assets  aggregating  $211,193  that were used to reduce  goodwill.
There was no tax  provision  during  fiscal 1995 as a result of the reported net
loss.

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


                                       28
<PAGE>

Year Ended March 31, 1995 Compared to the Year Ended April 1, 1994

     The  following  table shows  certain  line items in the  Company's  and the
Predecessor's  consolidated statement of operations for the year ended March 31,
1995 and in the Predecessor's  consolidated statement of operations for the year
ended  April 1, 1994 that are  discussed  below and that  changed  significantly
between  the two  periods  indicated  together  with the change  expressed  as a
percentage.

                                           Year Ended    Year Ended   Percentage
                                            March 31,     April 1,     Increase
                                              1995          1994      (Decrease)
                                          ------------  ------------  ----------
 
  Sales                                   $ 20,270,012  $ 31,048,706     -35%
  Cost of goods sold                        17,402,379    25,761,831     -32%
  General and administrative expenses        2,592,393     3,476,932     -25%
  Marketing and selling expenses               738,221     1,748,814     -58%
  Engineering, research and development
    expenses                                   938,048     2,009,524     -53%
  Restructuring charges (credits)            (534,092)     2,570,652     121%
  Litigation settlement                        261,022          --        --

     Overview.  The results of the Company  and  Predecessor  for the year ended
March  31,  1995  reflect a  significant  decrease  in sales  and a  significant
decrease in  operating  expenses  from  restructuring  activities  at the end of
fiscal  1994.  The results of the  Predecessor  for the year ended April 1, 1994
reflect  restructuring  charges of  $2,570,652.  The results of the  Predecessor
during the seven  months  ended  October 30, 1994  include  the  recognition  of
restructuring  credits and the gain from recognition of a litigation  settlement
of $534,092 and $261,022,  respectively,  and expenses of approximately $166,000
incurred in connection with the  Acquisition.  The results of the Company during
the five months ended March 31, 1995 included the  recognition of product recall
damages of $200,000 and the effects of the Acquisition  consisting  primarily of
an increase in cost of goods sold of approximately  $235,000 and amortization of
intangible assets, including goodwill, of approximately $100,000.

     Sales.  Sales of smart payphone  products and components during fiscal 1995
approximated  $6.6 million as compared to $9.0 million during fiscal 1994. Sales
from  refurbishment  and  conversion  services and related  payphone  components
approximated $12.3 million during fiscal 1995 versus $21.2 million during fiscal
1994. Sales of wireless payphone products and components consisting primarily of
export sales  approximated $1.4 million in fiscal 1995 versus $833,000 in fiscal
1994. The 27% decline in sales of smart payphone products and components and the
42% decline in sales from  refurbishment  and  conversion  services  and related
payphone components resulted primarily from a decrease in the volume of business
due to the termination of a sales agreement for a first generation smart product
and the non-renewal of a refurbishment  sales agreement  between the Company and
one of the RBOCs during the latter part of fiscal 1994. The volume reductions in
fiscal 1995 resulting from the termination  and non-renewal of these  agreements
were offset somewhat by sales under the terms of a sales  agreement  between the
Company and SWB executed in December 1994. Sales under this agreement during the
five months ended March 31, 1995 approximated $2.6 million.  The increase in the
Company's  wireless  product  sales in fiscal 1995 as compared to fiscal 1994 is
attributable to an increase in export volume.  However, during the third quarter
of fiscal 1995,  the  devaluation  of the Mexican peso had an adverse  impact on
export sales to one of the Company's primary foreign customers.

     Cost of Products  Sold.  The decrease in cost of products sold is primarily
attributable  to a 35% decrease in sales,  which was offset by a net increase in
production costs during fiscal 1995.  Higher production costs as a percentage of
sales,  damages of $200,000  attributable to a product recall initiated in April
1995 (see "Operating  Trends and  Uncertainties,"  below) and the effects of the
Acquisition  consisting  primarily  of an  increase  in  cost


                                       29
<PAGE>

of goods sold of approximately $235,000 for the five months ended March 31, 1995
offset   decreases  in   provisions   for  obsolete  and  excess   inventory  of
approximately $758,000 and warranty expense of approximately $347,000 related to
reserves established in fiscal 1994.

     General and  Administrative  Expenses.  In connection  with a restructuring
initiated at the end of fiscal 1994, the Company closed one of its manufacturing
facilities  and three  satellite  office  locations  and relocated its corporate
headquarters  from  Pennsylvania  to  Georgia.   The  decrease  in  general  and
administrative  expenses  is  primarily  attributable  the  restructuring.  Cost
reductions attributable to the fiscal 1994 restructuring were offset somewhat by
Acquisition  expenses of  approximately  $166,000  during the seven months ended
October 30, 1994 and amortization  expense of approximately  $100,000 during the
five months ended March 31, 1995.

     Marketing  and Selling  Expenses.  The  reduction in marketing  and selling
expenses is  attributable to personnel and other  operating  expense  reductions
resulting   from  the  fiscal  1994   restructuring   and  the   curtailment  of
participation  at trade shows during fiscal 1995. In addition,  royalty  expense
during  fiscal  1995  declined  by  approximately  $188,000  as a  result  of an
amendment to the royalty provisions of an asset purchase agreement dated January
11, 1991 that eliminated royalty  obligations for the six months ended September
30, 1994.

     Engineering,   Research  and   Development   Expenses.   The  reduction  in
engineering,  research and development expenses is attributable to personnel and
other operating expense reductions  resulting from the fiscal 1994 restructuring
and the refocus of research and development  activities  towards  development of
smart payphone products.

     Litigation Settlement.  During the seven months ended October 30, 1994, the
Company  settled  litigation  against a supplier  to recover  costs and  damages
attributable  to defective  components  supplied to the Company,  and realized a
gain of approximately $261,000, net of legal fees of $56,000.

Liquidity and Capital Resources

Initial Public Offering

     During May 1996,  the  Company  completed  an initial  public  offering  of
1,150,000  Units,  each  Unit  consisting  of one  share of  Common  Stock and a
redeemable  warrant,  at a price  of  $9.00  per  Unit  for  gross  proceeds  of
$10,350,000. In connection with the offering, the Company issued warrants to the
underwriter  to  purchase  100,000  shares of  Common  Stock  (the  "Underwriter
Warrants") for gross proceeds of $10. Net proceeds received by the Company as of
March 28, 1997,  after  underwriting  discounts and expenses of  $1,231,897  and
other  expenses of  $824,953,  aggregated  $8,293,160.  At March 29,  1996,  the
Company had incurred and deferred  offering  expenses of $338,372.  Accordingly,
net proceeds from the Company's  initial public  offering  during the year ended
March 28, 1997 aggregated $8,631,532.

     The proceeds of the offering,  net of underwriting  discounts and expenses,
were  initially  used to  repay  then  outstanding  indebtedness  consisting  of
subordinated notes payable to stockholders of $2.8 million and bank indebtedness
aggregating  $6,318,113  (see "Cash Flows From  Financing  Activities,"  below).
Indebtedness under a loan agreement between the Company and its bank repaid with
the net  proceeds  consisted  of a $2.2 million term note due November 30, 1997,
$309,524  outstanding  under a  $650,000  term note due  November  30,  1997 and
indebtedness under a revolving credit agreement of $3,808,589.

The Loan Agreement

     At March 29,  1996,  the  Company  was able to borrow up to a maximum of $9
million under term and installment  notes and a revolving credit agreement under
the terms of a Loan and Security  Agreement (the "Loan  Agreement")  between the
Company and its bank.  Indebtedness  under the Loan  Agreement at March 29, 1996
included  $2,525,000  outstanding under term and installment notes,  including a
$2.2 million term note due November 30, 1997, and $1,093,735  outstanding  under
the revolving credit agreement.


                                       30
<PAGE>

     At March 28,  1997,  the  Company  was able to borrow up to a maximum of $9
million under the revolving  credit agreement of which $3,810,961 had been drawn
down on that date.

     At March 29, 1996 and March 28, 1997,  outstanding  indebtedness  under the
Loan  Agreement bore interest at a variable rate per annum equal to 1.5% above a
base rate quoted by Citibank, N.A. The interest rate was reduced from 2% above a
base rate quoted by Citibank,  N.A. on March 1, 1996. The base rate at March 28,
1997 and March 29,  1996 was 8.5% and 8.25%  per  annum,  respectively.  Amounts
borrowed under the Loan Agreement are secured by substantially all assets of the
Company, including accounts receivable,  inventories and property and equipment.
The Loan Agreement  expires on November 30, 1997, and is renewable  annually for
one-year periods unless terminated by the bank upon an occurrence of an event of
default or by the Company upon at least 90 days notice.

     The Loan  Agreement  contains  conditions  and  covenants  that prohibit or
restrict the Company from engaging in certain  transactions  without the consent
of the  bank,  including  merging  or  consolidating,  payment  of  subordinated
stockholder  debt  obligations,   declaration  or  payment  of  dividends,   and
disposition of assets, among others.  Additionally,  the Loan Agreement requires
the Company to comply with specific  financial  covenants,  including  covenants
with respect to cash flow, working capital and net worth. Noncompliance with any
of these  conditions and covenants or the occurrence of an event of default,  if
not waived or  corrected,  could  accelerate  the  maturity of the  indebtedness
outstanding  under the Loan  Agreement.  Although the Company was in  compliance
with the covenants set forth in the Loan  Agreement at March 28, 1997,  there is
no  assurance  that the Company will be able to remain in  compliance  with such
covenants in the future.

     The Company used the net proceeds of its initial  public  offering to repay
outstanding  indebtedness  under  the Loan  Agreement  in order  to  reduce  its
interest expense.  The Company intends to use the financing  available under the
Loan Agreement to finance its on-going  working  capital  needs.  If an event of
default under the existing working capital facility were to occur,  however, the
Company's ability in this regard could be curtailed.  In such event, the Company
would  seek  alternative  financing  sources,  but  there is no  assurance  that
alternative  financing  sources  would be available on  commercially  reasonable
terms,  or at all.  Further,  the Loan  Agreement  expires on November  30, 1997
unless it is renewed in  accordance  with its terms.  The  Company is  presently
discussing  renewal  options  with  its bank and is  seeking  other  refinancing
sources.  Although  the  Company  believes  that it  will  either  negotiate  an
acceptable  renewal or  refinancing  agreement,  there is no assurance  that its
efforts will be  successful.  The Company's  liquidity  would be materially  and
adversely  affected  if it is unable to renew or  refinance  is  present  credit
facility.

     The Company borrows funds to finance  increases in accounts  receivable and
inventories  and  decreases  in bank  overdrafts,  accounts  payable and accrued
liability  obligations to the extent that such requirements exceed cash provided
by operations,  if any. The Company also uses the financing  available under the
revolving credit agreement to fund operations, investing activities and payments
on long-term debt when necessary.  The Company measures its liquidity based upon
the amount of funds that the Company is able to borrow under the Loan Agreement,
which varies based upon  operating  performance  and the value of current assets
and liabilities.

Cash Flows From Financing Activities

     During the seven months prior to the  Acquisition  ended  October 30, 1994,
the Company generally maintained its outstanding  borrowings under the revolving
credit  agreement at the maximum amount  permitted.  Financing  available to the
Company  during this  period was not  sufficient  to fund the  working  capital,
capital  expenditure  and debt  service  requirements  of the  Company,  and the
Company was unable to meet its accrued  liability  and supplier  obligations  as
they became due. In April 1994,  amounts  borrowed  under the  revolving  credit
agreement  between  the  Company  and  its  bank  exceeded  the  maximum  amount
permitted.  However,  the Company and its bank entered  into an  amendment  that
provided  for an  over-advance  of  $300,000  that was repaid by May 31, 1994 in
accordance with the terms of the amendment.


                                       31
<PAGE>

     During the seven months ended October 30, 1994,  the Company was in default
of  the  terms  of  unsecured   promissory  notes,  with  outstanding   balances
aggregating  $425,536  at April 1,  1994,  as a result  of its  failure  to make
certain royalty payments. However, on November 9, 1994, the Company entered into
an amendment  agreement which brought the Company into compliance with the terms
of the note agreements.  The Company executed a non-interest  bearing promissory
note payable in nineteen equal monthly  installments in the principal  amount of
$206,595  representing  unpaid  royalties as of October 30, 1994.  This note was
repaid during the year ended March 28, 1997.

     In June 1994, the Company borrowed $400,000 from its preferred stockholders
and issued a master  subordinated  promissory  note  payable  on demand  bearing
interest at a rate of 10% per annum. Under the terms of the master  subordinated
promissory note, a loan preference fee in an escalating amount which, when added
to accruing interest, would equal 5% of the outstanding principal for each month
the note was  outstanding  became  immediately  due and payable upon a change in
ownership of the Company.  In connection with the Acquisition,  the subordinated
master promissory note together with accrued interest and preference fees in the
amount of $96,000 were retired.

     Concurrently with the issuance of the subordinated  master promissory note,
the Company and its bank entered into an amendment to the Loan  Agreement  and a
$500,000 installment note obligation with a then outstanding balance of $62,500.
The Company  borrowed  $402,500 and executed an amended  installment note in the
amount of $465,000 payable in eighteen  monthly  installments of $25,000 and one
final  installment of $15,000.  This note was repaid during the year ended March
29, 1996.

     Pursuant  to the  October 31, 1994  Investment  Agreement  entered  into in
connection with the Acquisition,  the Company borrowed $2.8 million from Wexford
and Acor and issued  10%  interest  bearing  subordinated  promissory  notes due
November 1, 1999. The Company issued a 10% interest bearing subordinated note to
Wexford in the  principal  amount of  $2,361,082  dated  October 31,  1994.  The
Company issued 10% interest bearing subordinated promissory notes to Acor in the
principal amount of $208,216.73 dated October 31, 1994, $99,591.93 dated October
31, 1994,  $83,497.82  dated November 10, 1994 and $47,611.52 dated December 23,
1994.

     Concurrently with the Acquisition, the Loan Agreement was amended, and $2.2
million of debt  outstanding  under the revolving credit agreement was converted
into a term note payable on November 30, 1997.  However,  proceeds of $2,569,298
from the subordinated  promissory notes dated October 31, 1994 issued to Wexford
and Acor  were used to  retire  debt  outstanding  under  the  revolving  credit
agreement,  and after such repayment,  the initial principal balance outstanding
under the $2.2  million  term note on October 31, 1994  amounted to  $1,291,667.
Between  October 31, 1994 and March 31, 1995,  the Company  borrowed the balance
available  under the $2.2 million term note of  $908,333,  and also  re-borrowed
$970,196 under its revolving credit agreement.

     Net payments of indebtedness under the Company's revolving credit agreement
during the seven months  ended  October 31, 1994 and five months ended March 31,
1995 amounted to $1,491,074 and $1,599,102, respectively. Net proceeds under the
revolving  credit  agreement  during the year ended March 29,  1996  amounted to
$123,538. Net proceeds under the Company's revolving credit agreement during the
year ended  March 28,  1997  amounted  to  $2,717,226.  Net  proceeds  under the
revolving  credit  agreement  during the year ended March 28,  1997  reflect the
repayment of  $3,808,589  of  indebtedness  from the  proceeds of the  Company's
initial pubic offering.

     During the year ended March 28, 1997, the Company repaid, from the proceeds
of  the  Company's   initial  public  offering,   $2.8  million  of  outstanding
indebtedness under the 10% interest bearing subordinated promissory notes issued
to Wexford and Acor.


                                       32
<PAGE>

     Principal  payments on other  long-term debt and capital lease  obligations
during the seven months ended October 30, 1994, five months ended March 31, 1995
and year ended  March 29, 1996  amounted to  $459,084,  $482,307  and  $813,754,
respectively.  Principal  payments on other  long-term  debt and  capital  lease
obligations  during  the  year  ended  March  28,  1997  aggregated  $2,599,521,
including  repayment  of the $2.2  million  term note due  November 30, 1997 and
repayment of $309,524  outstanding  under a $650,000  term note due November 30,
1997 from the  proceeds of the  Company's  initial  public  offering.  Principal
payments on other long-term debt and capital lease  obligations  during the year
ended March 28, 1997,  excluding the repayments of term note  indebtedness  from
the  proceeds of the  offering,  amounted to $89,997.  The decrease in principal
payments  (exclusive of  repayments  made from proceeds of the offering) for the
year  ended  March 28,  1997 as  compared  to the year ended  March 29,  1996 is
attributable  to debt maturing  during fiscal 1997, the repayments made from the
proceeds of the  offering and the  assignment  of the capital  lease  obligation
related to the  Company's  Kentucky  facility  to an  unrelated  third  party in
November 1996.

     The Company has also  established a cash  management  program with its bank
under which the Company  funds drafts as they clear the bank.  Accordingly,  the
Company maintains bank overdrafts  representing  outstanding drafts and utilizes
the cash  management  account  as a source  of  funding.  Bank  overdrafts  vary
according to many factors,  including the volume of business,  and the timing of
purchases  and  disbursements.  During the seven months ended  October 30, 1994,
five months  ended March 31, 1995 and year ended March 29, 1996,  the  Company's
bank  overdrafts  increased by $323,633,  $120,714 and  $501,761,  respectively.
During the year ended March 28, 1997, the Company's bank overdrafts decreased by
$759,751.

     In June  1996,  the  Company  issued  40,000  shares  of  common  stock for
aggregate  proceeds of $160,000  upon the exercise of  outstanding  common stock
purchase  warrants issued in May 1995. See "Capital  Commitments and Liquidity,"
below.  During the year ended March 28, 1997, the Company issued 5,000 shares of
common  stock upon the  exercise  of  incentive  stock  options at an  aggregate
exercise  price of $5,000,  and  issued  6,760  shares of common  stock upon the
exercise of rights granted under the Company's 1995 Employee Stock Purchase Plan
for an aggregate purchase price of $51,714.

Cash Flows From Operating Activities

     During the seven  months  ended  October 30,  1994,  the Company  generated
$914,820 of cash from  operating  activities.  The Company used $99,688 of cash,
net of non-cash charges and credits of $323,678, to fund operating losses during
the seven  months  ended  October 30, 1994.  Because of  recurring  losses,  the
Company's cash resources during the seven months ended October 30, 1994 were not
sufficient  to fund  working  capital,  capital  expenditure  and  debt  service
requirements,  and the Company  was unable to meet all of its accrued  liability
and supplier  obligations as they became due.  However,  the Company was able to
generate cash from reductions in accounts receivable and inventories of $577,671
and $1,387,946,  respectively,  and prepaid expenses of $66,940 during the seven
months ended October 30, 1994.  The cash  provided  from these asset  reductions
enabled the Company to begin efforts to decrease its past due  obligations,  and
during the seven  months ended  October 30,  1994,  $965,672 of cash was used to
reduce accounts payable, accrued liabilities and accrued restructuring charges.

     During the five months ended March 31, 1995, the Company used $1,597,674 of
cash to fund operating activities. Cash used to fund operating losses during the
five months ended March 31, 1995 amounted to $358,182,  net of non-cash  charges
and credits of $707,399. Also, because of an increase in the volume of business,
the Company used  $329,469  and  $764,211 of cash to fund  increases in accounts
receivable and inventories, respectively, during the five months ended March 31,
1995.  As a  result  of  the  investor  financing  received  in  connection  the
Acquisition and an increase in deferred revenue which provided  $375,000 in cash
(see  "Capital  Commitments  and  Liquidity,"  below),  the  Company was able to
further pay down its past due liability  obligations,  and used $618,352 of cash
to reduce its accounts payable,  accrued  liabilities and accrued  restructuring
charges during the five months ended March 31, 1995.


                                       33
<PAGE>

     During  the year  ended  March 29,  1996,  the  Company  generated  cash of
$194,390  from  operating  activities.   Cash  provided  by  operations,   after
adjustments  related to non-cash  charges of  $1,583,659,  during the year ended
March 29,  1996,  amounted  to  $2,761,030.  Also,  although  the  Company  paid
remaining  undisputed  past due  liability  obligations,  a net  increase in the
Company's  supplier and accrued  liability  obligations,  income taxes  payable,
deferred revenue and accrued  restructuring  charges provided cash of $2,600,034
during fiscal 1996.  The Company used  $4,634,615 in cash used to fund increases
in  accounts   receivable  and   inventories   of  $1,206,385  and   $3,428,230,
respectively.  In  addition,  the  Company  expended  $474,095  of  cash to fund
increases in other assets  including the acquisition of a patent license and the
expenses of the Company's  initial public  offering  during the year ended March
29,  1996.  The  increases  in  accounts  receivable,  inventories  and  current
liability  obligations  during  the year  ended  March 29,  1996 were  primarily
related to the increase in the volume of business as compared to fiscal 1995.

     Cash used to fund operating activities during the year ended March 28, 1997
amounted to  $4,995,192.  During the year ended March 28,  1997,  the  Company's
operations  generated  $2,613,011 in cash, after adjustments related to non-cash
charges  and  credits  of  $1,602,352.  In  addition,  a  decrease  in  accounts
receivable  caused by sales  fluctuations  provided cash of $631,595  during the
year ended  March 28,  1997.  The  Company  used  $2,484,664  in cash to fund an
increase in  inventories  during the year ended March 28, 1997.  This  inventory
increase was related to the production of electronic  locks and GemStar products
under contractual  agreements (see "Capital  Commitments and Liquidity," below),
the final  production  run of Gemini  printed  circuit board  assemblies to meet
anticipated  sales  requirements  until the planned release of the Company's new
smart payphone processor and a slow-down of orders during the latter part of the
year (see "Results of Operations,"  above). The Company used $418,404 of cash to
fund  changes in prepaid  expenses  and other  assets  consisting  primarily  of
capitalized software development expenses. In addition,  cash used for decreases
in accounts  payable of  $3,983,739,  income taxes payable of $39,659,  deferred
revenue of $541,245 and accrued  liabilities,  including  accrued  restructuring
charges, of $771,399 aggregated $5,336,042 during the year ended March 28, 1997.
The  decrease in accounts  payable is related to the  slow-down in sales and the
Company's  efforts  to reduce  contracted  manufacturing  volume  and  inventory
balances during the latter part of fiscal 1997.  During fiscal 1997, the Company
satisfied its delivery  requirements  with respect to revenues deferred at March
29, 1996 and deferred  revenue  decreased  accordingly.  The decrease in accrued
liability  obligations  is primarily  attributable  to the expiration of a smart
product  royalty  agreement  and the payment of  remaining  royalty  obligations
during  fiscal 1997 and a decrease in accrued  interest due to the  repayment of
debt obligations.

Capital Commitments and Liquidity

     The  Company  has not  entered  into any  significant  commitments  for the
purchase of capital assets. However, the Company intends to purchase and install
information  systems and capital  equipment,  including  printed  circuit  board
assembly equipment and other manufacturing  equipment,  to advance its prototype
manufacturing and product testing capabilities during the next year at a cost of
approximately  $800,000.  The Company  believes,  based on its current plans and
assumptions relating to its operations,  that its sources of capital,  including
capital  available under its revolving credit line and cash flow from operations
will be adequate to satisfy its anticipated  cash needs,  including  anticipated
capital expenditures, for at least the next year. However, in the event that the
Company's  plans  or the  basis  for  its  assumptions  change  or  prove  to be
inaccurate,  or cash flow and  sources of capital  prove to be  insufficient  to
provide for the Company's cash requirements (due to unanticipated expenses, loss
of sales revenues,  operating  difficulties or otherwise),  the Company would be
required  to  seek  additional  financing.  In such an  event,  there  can be no
assurance  that  additional  financing  will  be  available  to the  Company  on
commercially reasonable terms, or at all.

     Extension of credit to customers  and  inventory  purchases  represent  the
principal working capital requirements of the Company.  Significant increases in
accounts  receivable and inventory  balances could have an adverse effect on the
Company's  liquidity.  The  level of  inventory  maintained  by the  Company  is
dependent on a number of factors,  including delivery requirements of customers,
availability  and  lead-time  of  components  and the  ability of the Company to
estimate and plan the volume of its business.  The Company  markets a wide


                                       34
<PAGE>

range of services  and  products  and the  requirements  of its  customers  vary
significantly  from period to period.  Accordingly,  inventory balances may vary
significantly.

     In  October  1994,  the  Company  entered  into  a  contract  manufacturing
agreement  that  provides  for the  production  of its  GemStar  smart  payphone
processors.  The Company  committed to purchase $12.2 million of product over an
eighteen-month period beginning in December 1994. In addition, in November 1994,
the  Company  entered  into a dealer  agreement  that  committed  the Company to
purchase  approximately  $3.5 million of electronic lock devices over a two-year
period. The Company initially  scheduled  purchases under these agreements based
on anticipated  quantities required to meet its sales commitments.  At March 28,
1997, the Company had acquired the majority of committed  purchase  volume under
these purchase  agreements.  However,  as a result of a decline in sales to SWB,
the Company's inventories related to these agreements increased by approximately
$2 million during the year ended March 28, 1997.

     The revolving credit agreement  between the Company and its bank limits the
outstanding   indebtedness  secured  by  eligible  inventory  to  $3.1  million.
Accordingly,  the increase in inventory together with a decrease in sales during
the last  six  months  of  fiscal  1997 has  adversely  affected  the  Company's
liquidity under the revolving  credit  agreement.  The ability of the Company to
improve its  liquidity  during the next year is  dependent on the level of smart
payphone product orders and the extent of the related  inventory  reduction,  if
any.

     In December 1994, the Company entered into a sales agreement with SWB under
which SWB  committed  to purchase  $21.3  million of GemStar  smart  processors,
electronic  locks and other components over a three-year  period.  In connection
with this agreement, the Company sold the rights to certain product software for
an aggregate purchase price of $500,000.  The Company received back an exclusive
irrevocable  perpetual  right to sub-license the software in connection with the
sale of related  products.  In return,  the Company  agreed to pay  royalties on
sales of licensed  products to other  customers.  At March 28, 1997, the Company
was not  obligated  and had not paid any  royalties  under  the  agreement.  The
Company was obligated to repay,  three years from the date of sale, a portion of
the purchase  price up to a maximum  amount of  $375,000,  which is reflected as
deferred revenue in the Company's consolidated financial statements at March 29,
1996 and March 28,  1997.  However,  in June 1997,  the Company  entered into an
agreement with SWB that  superseded and terminated the December 1994  agreement.
Under the new agreement,  the Company agreed to reduce SWB's remaining  purchase
commitment to approximately  $3 million from  approximately $8 million under the
former  agreement  and, among other things,  upgrade SWB's  payphone  management
system. In return,  SWB made a $250,000 cash payment to the Company,  terminated
the Company's obligation to pay royalties on sales of licensed products to other
customers and  terminated the Company's  obligation to repay  $375,000  received
from the sale of product  software under the December 1994  agreement.  SWB also
agreed to make additional cash payments of $250,000 on July 2, 1997, $100,000 on
September 1, 1997,  $150,000 on December 31, 1997 and $250,000 on March 31, 1998
to the Company subject to the Company's compliance with the terms and conditions
of the agreement, including conditions with respect to performance,  service and
repair.  SWB has the right to cancel the agreement  upon default by the Company.
Therefore,  there is no assurance  that the Company will receive the  additional
payments  or that its will ship the  products  set forth in the  agreement.  The
Company believes that it will be able to market inventory quantities of products
manufactured for supply under the former agreement, and presently estimates that
the value of these  inventories  at March 28, 1997 is not  impaired in an amount
that exceeds amounts received under the new agreement.

     During  October  1994,  the Company,  its bank and a contract  manufacturer
entered into an escrow  agreement  as security for the payment of the  Company's
obligations to the contract manufacturer. In May 1995, the Company issued common
stock purchase  warrants that provided the contract  manufacturer with the right
to purchase  40,000 shares of the Common Stock at a price of $4.00 per share for
a period of five years in return for  extension  of credit of $1.5  million  and
45-day payment terms to the Company.  This agreement had a significant favorable
impact on the Company's liquidity. However, if the Company defaults with respect
to the payment terms, the Company will be required to utilize the escrow account
previously  established,  which could have a significant  adverse  effect on the
Company's liquidity.


                                       35
<PAGE>

Operating Trends and Uncertainties

     Dependence  on Customers  and  Contractual  Relationships.  During the past
three years,  four of the RBOCs have accounted for the majority of the Company's
sales.  The  Company  anticipates  that it will  continue  to derive most of its
revenues from such customers,  and other regional telephone  companies,  for the
foreseeable future. The loss of any one RBOC customer or a significant reduction
in sales volume from these customers would have a material adverse effect on the
Company's  business.  The Company's  prospects for continued  profitability  are
largely  dependent upon the RBOCs  upgrading the  technological  capabilities of
their  installed  base of payphones,  and  utilizing the Company's  products and
services for such upgrade conversion programs. Also, the Company's prospects and
the ability of the  Company to maintain a  profitable  level of  operations  are
dependent  upon its  ability  to  secure  contract  awards  from the  RBOCs.  In
addition,  the  Company's  prospects  for growth are  dependent  upon the market
acceptance and success of its smart payphone products, as well as development of
smart products containing additional advanced features. If the Company is unable
to attract the  interest  of the RBOCs to deploy the  Company's  smart  payphone
products, the Company's sales revenues,  business and prospects for growth would
be  adversely  affected.  Further,  the  Company's  ability to  maintain  and/or
increase  its sales is  dependent  upon its ability to compete for and  maintain
satisfactory  relationships  with the RBOCs,  particularly  those RBOCs that are
presently  significant  customers  of  the  Company.  Prior  to a  restructuring
instituted in 1994, the Company experienced difficulties with a first generation
smart payphone product,  which  difficulties  subsequently  were remedied.  Such
difficulties,  however,  resulted  in the  termination  of a  contract  for such
product with one of the Company's then significant RBOC customers.  There can be
no assurances that similar difficulties will not occur in the future.

     In June 1997, a December 1994 sales  agreement  between the Company and SWB
was  terminated  and  superseded by a new agreement  (see Item 1 -- "Business --
Sales and  Markets").  Under the new agreement,  SWB's  purchase  commitment was
reduced from approximately $8 million to $3 million.  However, SWB has the right
to cancel the  agreement  upon a default by the  Company of any of the terms and
conditions contained in the new agreement.

     The  assessment  of penalties  and/or  damages  under the  Company's  sales
contracts  could  have a  material  adverse  effect on the  Company's  operating
results and liquidity. In April 1995, the Company initiated a recall of products
due to contamination  introduced into the manufacturing process by the Company's
contract   manufacturer.   Although  the  Company's  contract  manufacturer  was
responsible for the repair or replacement of the recalled  product,  the Company
incurred  liquidated  damages  under the terms of the sales  agreement  with its
customer in the amount of $200,000.

     Sales Prices.  The  Company's  agreements  with its contract  manufacturers
generally provide that the Company will bear certain cost increases  incurred by
the manufacturer.  Accordingly,  the Company's manufacturing costs may fluctuate
based on costs  incurred by its  contract  manufacturers  and such  fluctuations
could have a material  and  adverse  impact on  earnings.  The  Company's  sales
agreements with customers generally have fixed product prices with limited price
escalation provisions. Consequently, there is a risk that the Company may not be
able to increase  sales prices when  product  costs  increase.  In the event the
Company's costs increase  without a  corresponding  price increase or orders are
lost due to price  increases,  the  Company's  profitability  would be adversely
affected. The Company encounters  substantial  competition with respect to smart
payphone  contract  awards by the RBOCs and this  competition  is  beginning  to
result in price  reductions.  The  Company  reduced its prices to NYNEX upon the
execution of a November 1996 sales agreement based on the planned release of its
new lower cost smart processor  during the fourth quarter of fiscal 1997.  Until
the Company releases its new smart processor and depletes  present  inventories,
the Company will  experience a reduction in gross profit margins with respect to
smart product sales to NYNEX,  and such  reduction  will be material.  Any other
price  reductions in response to  competition  will also result in reduced gross
profit  margins  unless the  Company is able to  achieve  reductions  in product
costs.


                                       36
<PAGE>

     Seasonality. The Company's sales are generally stronger during periods when
weather does not interfere with the  maintenance  and  installation  of payphone
equipment by the Company's customers, and may be adversely impacted near the end
of the  calendar  year by the budget  short  falls of  customers.  However,  the
Company may also receive large  year-end  orders from its customers for shipment
in December depending upon their budget positions. In the event the Company does
not receive any significant end of year orders for its smart payphone  products,
its third quarter sales may decline significantly in relation to other quarters.

     Sources of Supply and  Dependence  on Contract  Manufacturers.  The Company
generally  assembles its smart  payphone  products from  assemblies  produced by
certain  manufacturers under contractual  arrangements.  To the extent that such
manufacturers  encounter  difficulties in their production  processes that delay
shipment  to the  Company or that  affect the  quality of items  supplied to the
Company,  the Company's  ability to perform its sales agreements or otherwise to
meet supply schedules with its customers can be adversely affected. In the event
that contract manufacturers delay shipments or supply defective materials to the
Company,  and such  delays or  defects  are  material,  the  Company's  customer
relations  could  deteriorate  and its  sales  and  operating  results  could be
materially and adversely affected.

     As a percentage of revenues, the majority of the Company's products contain
components or assemblies  that are purchased  from single  sources.  The Company
believes that there are alternative sources of supply for most of the components
and assemblies  currently  purchased from those sources.  Most of the components
and assemblies used by the Company for which there are not immediately available
alternative  sources  of supply  are  provided  to the  Company  under  standard
purchase  arrangements.  In addition,  suppliers of certain electronic parts and
components  to the Company and its  contract  manufacturers  occasionally  place
their  customers on allocation for those parts.  If a shortage or termination of
the supply of any one or more of such  components or  assemblies  were to occur,
the Company's  business  could be materially  and  adversely  affected.  In such
event, the Company would have to incur the costs associated with redesigning its
products to include  available  components  or  assemblies  or otherwise  obtain
adequate  substitutes,  and those costs could be material.  Also,  any delays in
redesigning products or obtaining  substitute  components could adversely affect
the Company's business.

     Telecommunication  Act. On February 8, 1996, the President  signed into law
the  Telecommunications  Act of 1996 (the  "Telecommunications  Act"),  the most
comprehensive   reform  of  communications   law  since  the  enactment  of  the
Communications Act of 1934. As a result of the  Telecommunications  Act of 1996,
the RBOCs  will be  permitted  to  manufacture  and  provide  telecommunications
equipment  and  to  manufacture   customer   premises   equipment  when  certain
competitive conditions have been met. It is possible that one or more RBOCs will
decide to manufacture  payphone  products,  which would increase the competition
faced by the Company and could  decrease  demand for the  Company's  products by
such RBOCs.  Notwithstanding,  the Company believes that deregulation  generally
will benefit the Company.  However,  there can be no assurance  that the Company
will benefit  from  deregulation  or that it will not be  adversely  affected by
deregulation.

     Net Operating Loss Carryforwards. As of March 28, 1997, the Company had net
operating  loss  carryforwards  for income tax  purposes  of  approximately  $14
million to offset  future  taxable  income.  Under  Section 382 of the  Internal
Revenue  Code of  1986,  as  amended,  the  utilization  of net  operating  loss
carryforwards is limited after an ownership  change,  as defined in such Section
382,  to an  annual  amount  equal  to  the  value  of  the  loss  corporation's
outstanding stock immediately before the date of the ownership change multiplied
by the  federal  long-term  tax-exempt  rate in  effect  during  the  month  the
ownership change occurred. Such an ownership change occurred on October 31, 1994
and could occur in the future.  As a result,  the Company  will be subject to an
annual  limitation  on the  use of its net  operating  losses  of  approximately
$210,000.  This limitation only affects net operating  losses incurred up to the
ownership  change and does not reduce the total amount of net  operating  losses
which may be taken,  but  limits the  amount  which may be used in a  particular
year. Therefore, in the event the Company maintains profitable operations,  such
limitation  would have the effect of increasing  the Company's tax liability and
reducing net income and available  cash resources if the taxable income during a
year  exceeded the  allowable  loss carried  forward to that year.  In addition,
because


                                       37
<PAGE>

of such limitations,  the Company will be unable to use a significant portion of
its net operating loss carryforwards.

Selected Quarterly Data

     The  following  sets forth a summary of selected  statements  of operations
data  (unaudited)  for the  quarters  ended June 30, 1995,  September  29, 1995,
December 29, 1995 and March 29, 1996:

                                             Quarter Ended
                        --------------------------------------------------------
                          June 30,    September 29,   December 29,    March 29,
                            1995          1995            1995           1996
                        -----------    -----------    -----------    -----------
Net sales               $ 6,354,145    $ 7,737,680    $ 9,585,664    $ 9,524,197
Net income (loss)       $  (230,658)   $   236,104    $   654,957    $   516,968

     The  following  sets forth a summary of selected  statements  of operations
data  (unaudited)  for the  quarters  ended June 28, 1996,  September  27, 1996,
December 27, 1996 and March 28, 1997:

                                             Quarter Ended
                        --------------------------------------------------------
                          June 28,    September 27,   December 27,    March 28,
                            1996           1996           1996           1997
                        -----------    -----------    -----------    -----------
Net sales               $12,078,496    $10,061,718    $ 5,651,655    $ 5,680,049
Net income (loss)       $   585,080    $   385,389    $    27,145    $    13,045

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



                                       38
<PAGE>

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                                                                            Page

Independent Auditors' Report                                                 40

Consolidated Financial Statements:

  Consolidated Balance Sheets as of March 29, 1996 and March 28, 1997        41

  Consolidated Statements of Operations for the seven months ended 
   October 30, 1994, five months ended March 31, 1995
   and years ended March 29, 1996 and March 28, 1997                         42

  Consolidated Statements of Cash Flows for the seven months ended 
   October 30, 1994, five months ended March 31, 1995
   and years ended March 29, 1996 and March 28, 1997                         43

  Consolidated Statements of Changes in Stockholders' Equity (Deficit) 
   for the seven months ended October 30, 1994, five months ended
   March 31, 1995 and years ended March 29, 1996 and March 28, 1997          44

  Notes to Consolidated Financial Statements                                 45

Financial Statement Schedule:

  Schedule II--Valuation and Qualifying Accounts                             89

   All other  schedules are omitted  because they are not required or are
   not applicable,  or the required information is shown in the financial
   statements or notes thereto.

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

        None

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


                                       39
<PAGE>

                          INDEPENDENT AUDITORS' REPORT

Stockholders
Technology Service Group, Inc.

     We have audited the accompanying  consolidated balance sheets of Technology
Service Group,  Inc. and subsidiary as of March 28, 1997 and March 29, 1996, and
the  related  consolidated   statements  of  operations,   stockholders'  equity
(deficit), and cash flows for the years ended March 28, 1997 and March 29, 1996,
five months ended March 31, 1995,  and the seven months ended  October 30, 1994.
Our audits also included the financial statement schedule listed in the Index at
Item 8. These  financial  statements  and financial  statement  schedule are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on the financial  statements and financial  statement  schedule 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,  such consolidated  financial statements present fairly, in
all material respects,  the financial position of Technology Service Group, Inc.
and  subsidiary  at March 28,  1997 and March 29,  1996 and the results of their
operations and their cash flows for the years ended March 28, 1997 and March 29,
1996,  the five months ended March 31, 1995,  and the seven months ended October
30, 1994 in conformity with generally accepted accounting  principles.  Also, in
our opinion,  such financial statement schedule,  when considered in relation to
the basic consolidated financial statements taken as a whole, presents fairly in
all material respects the information set forth therein.

DELOITTE & TOUCHE LLP
Atlanta, Georgia
May 23, 1997
(June 9, 1997 as to the last
paragraph of Note 14)



                                       40
<PAGE>

                         TECHNOLOGY SERVICE GROUP, INC.
                           CONSOLIDATED BALANCE SHEETS

                                                      March 29,      March 28,
                                                        1996           1997
                                                    ------------   ------------
ASSETS
Current assets:
  Cash                                              $     19,787   $     67,880
  Accounts receivable, less allowance for 
      doubtful accounts of $216,000 and $147,000       3,866,372      3,234,777
  Inventories                                          8,658,669     10,879,180
  Deferred income taxes                                   50,544        542,654
  Prepaid expenses and other current assets              146,117        140,981
                                                    ------------   ------------
        Total current assets                          12,741,489     14,865,472
Property and equipment, net                            2,198,625        847,443
Other assets                                           4,693,650      4,059,467
                                                    ============   ============
                                                    $ 19,633,764   $ 19,772,382
                                                    ============   ============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Bank overdraft                                    $  1,002,403   $    242,652
  Borrowings under revolving credit agreement               --        3,810,961
  Current maturities under long-term debt and
       capital lease obligations                         118,444           --
  Accounts payable                                     5,030,945      1,047,206
  Income taxes payable                                   165,666        126,007
  Deferred revenue                                       541,245        375,000
  Accrued liabilities                                  1,472,379      1,015,032
  Accrued restructuring charges                           16,427         27,794
                                                    ------------   ------------
        Total current liabilities                      8,347,509      6,644,652
Borrowings under revolving credit agreement            1,093,735           --
Long-term debt and capital lease obligations           3,414,586           --
Notes payable to stockholders                          2,800,000           --
Deferred revenue                                         375,000           --
Other liabilities                                          3,198           --
                                                    ------------   ------------
                                                      16,034,028      6,644,652
                                                    ------------   ------------
Commitments and contingencies                               --             --
Stockholders' equity:
  Preferred stock, $100 par value, 100,000 
      authorized, none issued or outstanding                --             --
  Common stock, $.01 par value, 10,000,000 
      shares authorized, 3,500,000 and 
      4,701,760 shares issued and outstanding             35,000         47,018
  Capital in excess of par value                       3,465,000     11,962,856
  Retained earnings                                      111,790      1,122,449
  Cumulative translation adjustment                      (12,054)        (4,593)
                                                    ------------   ------------
        Total stockholders' equity                     3,599,736     13,127,730
                                                    ------------   ------------
                                                    $ 19,633,764   $ 19,772,382
                                                    ============   ============

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


                                       41
<PAGE>

                         TECHNOLOGY SERVICE GROUP, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                             Predecessor                        Company                     
                                            ------------       --------------------------------------------
                                            Seven Months        Five Months
                                               Ended              Ended         Year Ended      Year Ended
                                            October 30,          March 31,       March 29,       March 28,
                                               1994                1995            1996            1997
                                           ------------        ------------    ------------    ------------
<S>                                        <C>                 <C>             <C>             <C>         
Net sales                                  $ 11,108,653        $  9,161,359    $ 33,201,686    $ 33,471,918
                                           ------------        ------------    ------------    ------------
Costs and expenses:                                           
    Cost of goods sold                        9,176,134           8,226,245      26,082,055      26,638,622
    General and administrative expenses       1,742,324             850,069       2,204,915       2,391,164
    Marketing and selling expenses              366,464             371,757       1,290,349         881,324
    Engineering, research and                                 
        development expenses                    457,553             480,495       1,197,183       1,776,611
    Restructuring charges (credits)            (534,092)               --              --            62,500
    Litigation settlement                      (261,022)               --              --          (105,146)
    Interest expense                            599,276             356,624         941,261         399,469
    Other income                                (14,618)            (58,250)        (17,763)       (116,664)
                                           ------------        ------------    ------------    ------------
                                             11,532,019          10,226,940      31,698,000      31,927,880
                                           ------------        ------------    ------------    ------------
Income (loss) before income tax                               
    expense                                    (423,366)         (1,065,581)      1,503,686       1,544,038
Income tax expense                                 --                  --          (326,315)       (533,379)
                                           ------------        ------------    ------------    ------------
Net income (loss)                          $   (423,366)       $ (1,065,581)   $  1,177,371    $  1,010,659
                                           ============        ============    ============    ============
Income (loss) per common and                                  
   common equivalent share:                                   
      Primary                                                  $      (0.30)   $       0.30    $       0.22
                                                               ============    ============    ============
      Assuming full dilution                                   $      (0.30)   $       0.30    $       0.22
                                                               ============    ============    ============
Weighted average number of common and                         
   common equivalent shares outstanding:                      
      Primary                                                     3,541,778       3,870,889       4,780,263
                                                               ============    ============    ============
      Assuming full dilution                                      3,541,778       3,870,889       4,780,263
                                                               ============    ============    ============
                                                              
</TABLE>

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


                                       42
<PAGE>

                         TECHNOLOGY SERVICE GROUP, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                               Predecessor                       Company                     
                                               ------------      -----------------------------------------
                                               Seven Months      Five Months
                                                  Ended            Ended        Year Ended     Year Ended
                                                October 30,       March 31,      March 29,      March 28,
                                                   1994              1995           1996           1997
                                               -----------       -----------    -----------    -----------
<S>                                            <C>               <C>            <C>            <C>        
Cash flows from operating activities                           
  Net income (loss)                            $  (423,366)      $(1,065,581)   $ 1,177,371    $ 1,010,659
  Adjustments to reconcile net income (loss)                   
    to net cash provided by (used for)                         
    operating activities                                       
      Depreciation and amortization                647,717           407,892      1,060,655      1,072,210
      Loss (gain) on sale of assets                 18,397             4,936           --          (47,325)
      Restructuring charges (credits)             (534,092)             --             --           62,500
      Provisions for inventory losses and                      
        warranty expense                           164,534           298,038        352,256        565,007
      Provision for uncollectible accounts                     
        receivable                                  27,122            (3,467)        10,099           --
      Provision for deferred tax expense                       
        (benefits)                                    --                --          160,649        (50,040)
      Changes in certain assets and                            
        liabilities, net of effects of                         
        acquisition                                            
        (Increase) decrease in accounts                        
          receivable                               577,671          (329,469)    (1,206,385)       631,595
        (Increase) decrease in inventories       1,387,946          (764,211)    (3,428,230)    (2,484,664)
        (Increase) decrease in prepaid                         
          expenses and other current assets         66,940            90,778        (56,923)         5,136
        (Increase) decrease in other assets          3,358             6,501       (474,095)      (423,540)
        (Decrease) increase in accounts                        
          payable                                 (981,786)         (172,369)     2,071,856     (3,983,739)
        (Decrease) increase in income taxes                    
          payable                                     --                --          165,666        (39,659)
        (Decrease) increase in deferred                        
          revenue                                     --             375,000        541,245       (541,245)
        (Decrease) increase in accrued                         
          liabilities                              458,058          (299,310)      (104,843)      (761,399)
        (Decrease) in accrued restructuring                    
          charges                                 (441,944)         (146,673)       (73,890)       (10,000)
        Other                                      (55,735)              261         (1,041)          (688)
                                               -----------       -----------    -----------    -----------
        Net cash provided by (used for)                        
          operating activities                     914,820        (1,597,674)       194,390     (4,995,192)
                                               -----------       -----------    -----------    -----------
Cash flows from investing activities                           
  Capital expenditures                             (21,481)          (59,956)      (251,724)      (421,965)
  Proceeds from sale of assets                      12,001              --             --           59,050
                                               -----------       -----------    -----------    -----------
        Net cash used for investing                            
          activities                                (9,480)          (59,956)      (251,724)      (362,915)
                                               -----------       -----------    -----------    -----------
Cash flows from financing activities                           
  Net proceeds (payments) under                                
    revolving credit agreement                  (1,491,074)       (1,599,102)       123,538      2,717,226
  Proceeds from initial public offering, net                   
    of offering expenses                              --                --             --        8,631,532
  Proceeds from exercise of stock options                      
    and warrants                                      --                --             --          216,714
  Proceeds from notes payable to banks             402,500           908,333           --             --
  Proceeds from notes payable                                  
    to stockholders                                400,000         2,800,000           --             --
  Payments on notes payable to stockholders           --                --             --       (2,800,000)
  Principal payments on long-term                              
    debt and capital lease obligations            (459,084)         (482,307)      (813,754)    (2,599,521)
  Increase (decrease) in bank overdraft            323,633           120,714        501,761       (759,751)
                                               -----------       -----------    -----------    -----------
        Net cash provided by (used for)                        
          financing activities                    (824,025)        1,747,638       (188,455)     5,406,200
                                               -----------       -----------    -----------    -----------
Increase (decrease) in cash                         81,315            90,008       (245,789)        48,093
Cash, beginning of period                           94,253           175,568        265,576         19,787
                                               ===========       ===========    ===========    ===========
Cash, end of period                            $   175,568       $   265,576    $    19,787    $    67,880
                                               ===========       ===========    ===========    ===========
</TABLE>                                                       

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


                                       43
<PAGE>

                         TECHNOLOGY SERVICE GROUP, INC.
      CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
                                 Series E       Series C        Series B        Series A    
                                Preferred      Preferred       Preferred        Preferred   
                                  Stock          Stock           Stock           Stock      
                              ------------    ------------    ------------    ------------  
<S>                           <C>             <C>                   <C>             <C>     
Predecessor
Balance at April 1, 1994      $     30,000    $    234,066          30,000          30,667  
Net loss for the period                                                                     
Foreign currency
    translation adjustment                                                                  
                              ============    ============    ============    ============  
Balance at October 30, 1994         30,000    $    234,066    $     30,000    $     30,667  
                              ============    ============    ============    ============  
Company
Balance at October 30, 1994   $     30,000    $    234,066    $     30,000    $     30,667  
Business combination               (30,000)       (234,066)        (30,000)        (30,667)
Net loss for the period                                                                     
Foreign currency
  translation adjustment                                                                    
                              ------------    ------------    ------------    ------------  
Balance at March 31, 1995             --              --              --              --    
Business combination -
  distribution of escrow
  consideration                                                                             
Net income for the year                                                                     
Foreign currency
  translation adjustment                                                                    
                              ------------    ------------    ------------    ------------  
Balance at March 29, 1996     $       --      $       --      $       --      $       --    
Net income for the year                                                                     
Issuance of 1,150,000
  shares in initial public
  offering, net of offering
  expenses                                                                                  
Issuance of 40,000 shares                                                                   
  upon exercise of common                                                                   
  stock purchase warrants                                                                   
Issuance of 5,000 shares                                                                    
  upon exercise of common                                                                   
  stock options                                                                             
Issuance of 6,760 shares                                                                    
  under 1995 Employee                                                                       
  Stock Purchase Plan                                                                       
Foreign currency                                                                            
  translation adjustment                                                                    
                              ============    ============    ============    ============  
Balance at March 28, 1997     $       --      $       --      $       --      $       --    
                              ============    ============    ============    ============  

<CAPTION>

                                  Common         Common                                                                   
                                  Stock          Stock        Capital in      Retained       Cumulative                  
                                $.05 Par       $.01 Par       Excess of       Earnings      Translation                  
                                  Value          Value        Par Value      (Deficit)       Adjustment        Total     
                              ------------   ------------    ------------   ------------    ------------    ------------ 
<S>                               <C>           <C>           <C>           <C>                  <C>       <C>          
Predecessor                                                                                                              
Balance at April 1, 1994            21,882           --        22,651,826    (24,449,909)         46,424    $ (1,405,044)
Net loss for the period                                                         (423,366)                       (423,366)
Foreign currency                                                                                                         
    translation adjustment                                                                         7,280           7,280 
                              ============   ============    ============   ============    ============    ============ 
Balance at October 30, 1994   $     21,882   $       --        22,651,826    (24,873,275)   $     53,704      (1,821,130)
                              ============   ============    ============   ============    ============    ============ 
Company                                                                                                                  
Balance at October 30, 1994   $     21,882   $       --      $ 22,651,826    (24,873,275)   $     53,704    $ (1,821,130)
Business combination               (21,882)       35,000      (19,516,535)    24,873,275         (53,704)      4,991,421      
Net loss for the period                                                       (1,065,581)                     (1,065,581)    
Foreign currency                                                                                                         
  translation adjustment                                                                             269             269 
                              ------------   ------------    ------------   ------------    ------------    ------------ 
Balance at March 31, 1995             --           35,000       3,135,291     (1,065,581)            269       2,104,979 
Business combination -                                                                                                   
  distribution of escrow                                                                                                 
  consideration                                                   329,709                                        329,709 
Net income for the year                                                        1,177,371                       1,177,371 
Foreign currency                                                                                                         
  translation adjustment                                                                         (12,323)        (12,323)
                              ------------   ------------    ------------   ------------    ------------    ------------ 
Balance at March 29, 1996     $       --     $     35,000    $  3,465,000   $    111,790    $    (12,054)   $  3,599,736 
Net income for the year                                                        1,010,659                       1,010,659 
Issuance of 1,150,000                                                                                                    
  shares in initial public                                                                                               
  offering, net of offering                                                                                              
  expenses                                         11,500       8,281,660                                      8,293,160 
Issuance of 40,000 shares                                                                                                
  upon exercise of common                                                                                                
  stock purchase warrants                             400         159,600                                        160,000 
Issuance of 5,000 shares                                                                                                 
  upon exercise of common                                                                                                
  stock options                                        50           4,950                                          5,000 
Issuance of 6,760 shares                                                                                                 
  under 1995 Employee                                                                                                    
  Stock Purchase Plan                                  68          51,646                                         51,714 
Foreign currency                                                                                                         
  translation adjustment                                                                           7,461           7,461 
                              ============   ============    ============   ============    ============    ============ 
Balance at March 28, 1997     $       --     $     47,018    $ 11,962,856   $  1,122,449    $     (4,593)   $ 13,127,730 
                              ============   ============    ============   ============    ============    ============ 
</TABLE>

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


                                       44
<PAGE>

                         TECHNOLOGY SERVICE GROUP, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   THE COMPANY

     Technology  Service Group,  Inc. (the  "Company") was  incorporated  in the
State of  Delaware in 1975.  The Company  designs,  develops,  manufactures  and
markets public communication products including  microprocessor-based  ("smart")
wireline and wireless  payphone systems,  electronic  wireline payphone products
and related payphone components. The Company also provides payphone and payphone
component  repair,   refurbishment   and  upgrade   conversion   services.   The
accompanying   financial  statements  include  the  accounts  of  the  Company's
wholly-owned subsidiary, International Service Technologies, Inc. ("IST"), which
has a foreign division located in Taiwan.

2.   ACQUISITION

     On  October  31,  1994,  TSG  Acquisition  Corp.  ("TSG  Acquisition"),   a
non-operating   corporation   wholly-owned   by  Wexford   Partners  Fund,  L.P.
("Wexford"),  acquired  all of the  outstanding  capital  stock  of the  Company
pursuant to an Agreement and Plan of Merger dated October 11, 1994 (the "Plan of
Merger") between Wexford, TSG Acquisition,  the Company and the majority holders
of the Company's  capital stock (the  "Acquisition").  TSG  Acquisition  paid an
aggregate  of $3.5  million in cash  pursuant  to the Plan of Merger,  including
$329,709  of   contingent   consideration   that  was  placed  in  escrow.   The
consideration  consisted of $3,004,000 to acquire the outstanding  capital stock
of the Company and $496,000 to retire a subordinated  master  promissory note of
$400,000  payable  to former  stockholders  and  related  accrued  interest  and
preference fees of $96,000.  Cash payments to former stockholders on October 31,
1994  aggregated   $2,991,973   after  deducting   $277,910  to  retire  certain
obligations of the Company and $230,117 placed in escrow.  Consideration  placed
in escrow of $329,709  consisting of cash of $230,117 and a subordinated note of
the Company payable to one of the former stockholders in the principal amount of
$99,592 was distributed to former stockholders in September 1995 upon compliance
with indemnification provisions set forth in the Plan of Merger.

     In conjunction  with the  Acquisition,  TSG Acquisition was merged into the
Company,  which was then wholly-owned by Wexford.  The outstanding shares of the
Company's  capital  stock and rights to purchase the  Company's  capital  stock,
including  preferred  stock  purchase  warrants,  at  October  31,  1994 and the
Company's  Incentive Stock Option Plan were cancelled and the outstanding shares
of  capital  stock  of TSG  Acquisition  were  exchanged  for one  share  of the
Company's  common  stock,  $.05 par value (the "merger  share").  The Company is
sometimes referred to as the "Predecessor" for periods prior to the Acquisition.

     In  addition,  the  Company  entered  into  an  Investment  Agreement  (the
"Investment  Agreement") with Wexford and certain former investors (collectively
the  "investors").  The Company issued 3.5 million shares of common stock,  $.01
par value,  in exchange for the merger share held by Wexford.  Also, the Company
borrowed  $2.8  million  from the  investors  and  issued 10%  interest  bearing
subordinated promissory notes due November 1, 1999 (see Note 7).

     The  Acquisition  has been  accounted  for  using  the  purchase  method of
accounting.  Accordingly,  the aggregate purchase price of $3,170,291 (excluding
contingent   consideration)   was  pushed  down  and  allocated  to  assets  and
liabilities  of the  Company as of October  31,  1994 (the date of  acquisition)
based upon their  estimated  fair values.  The excess of the purchase price over
the fair value of the net assets acquired of $3,853,877 was recorded as goodwill
(see Note 6). The increase in the aggregate purchase price and goodwill upon the
distribution of escrow consideration of $329,709 was recognized in the Company's
financial statements during the year ended March 29, 1996.


                                       45
<PAGE>

     A summary of the book value of the assets and liabilities of the Company as
compared to their  estimated  fair value  reflected in the  Company's  financial
statements as of the date of acquisition is set forth below.

                                                        Book         Estimated
                                                       Value         Fair Value
                                                    -----------     -----------

Cash                                                $   175,568     $   175,568
Accounts receivable                                   2,337,150       2,337,150
Inventories                                           4,887,167       4,842,433
Prepaid expenses and other current assets               179,972         179,972
Property and equipment                                2,601,801       2,984,574
Other assets                                            215,718         645,447
Bank overdraft                                         (379,928)       (379,928)
Borrowings under revolving credit agreement          (1,660,965)     (1,660,965)
Current maturities under long-term debt
    and capital lease obligations                      (877,557)       (888,392)
Accounts payable                                     (3,133,058)     (3,133,058)
Accrued expenses                                     (1,624,180)     (1,749,039)
Accrued restructuring charges                          (515,222)       (312,312)
Notes payable to stockholders                          (400,000)           --
Long-term debt and capital lease obligations         (3,627,596)     (3,725,036)
                                                    -----------     -----------
Net assets acquired                                  (1,821,130)       (683,586)
Excess of purchase price over net
    assets acquired                                        --         3,853,877
                                                    ===========     ===========
                                                    $(1,821,130)    $ 3,170,291
                                                    ===========     ===========

     The accompanying  financial statements at March 29, 1996 and March 28, 1997
and for the five months  ended March 31, 1995 and years ended March 29, 1996 and
March 28, 1997 reflect the effects of the Acquisition.  Assuming the Acquisition
had occurred on April 2, 1994, the Company's and the  Predecessor's net loss for
the year ended March 31, 1995 including  proforma  adjustments for depreciation,
interest  and  amortization  of assets to give  effect to the  accounting  bases
recognized  in recording  the  Acquisition  would have  approximated  $1,599,000
(unaudited),  or a loss  of $.45  per  share  (unaudited),  as  compared  to the
reported  loss of  $1,488,947  ($423,366  for the seven months ended October 30,
1994 and  $1,065,581  for the five months  ended March 31,  1995).  The proforma
adjustments  include an  increase  in the  amortization  of  goodwill  and other
intangible assets of approximately  $140,000  (unaudited) due to the increase in
the basis of intangible  assets and their estimated  useful lives, a decrease in
depreciation  of  approximately  $24,000  (unaudited)  due to an increase in the
basis of property and equipment and their estimated  useful lives and a decrease
in interest  expense of approximately  $6,000  (unaudited) due to revaluation of
capital lease  obligations,  the  financing  received from the investors and the
repayment of indebtedness under the Company's revolving credit agreement.


                                       46
<PAGE>

3.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     A summary of the significant accounting policies followed by the Company is
set forth below:

Fiscal Year

     The Company  operates on a fiscal year ending the Friday  nearest  March 31
resulting  in  a  52/53  week  year.  The  accompanying  consolidated  financial
statements  include the audited financial  statements of the Predecessor for the
seven months (30 weeks) ended  October 30, 1994 and the Company,  subsequent  to
the  Acquisition,  for the five months (22 weeks) ended March 31, 1995 and years
(52 weeks) ended March 29, 1996 and March 28, 1997.

Consolidation

     All significant intercompany balances and transactions have been eliminated
in consolidation.

Translation of Foreign Currency

     The financial  position and results of operations of the Company's  foreign
division are measured using local currency as the  functional  currency.  Assets
and  liabilities of the Company's  foreign  division are translated  into United
States  dollars  at the  applicable  exchange  rate in  effect at the end of the
period.  Income statement  accounts are translated at the average rate in effect
over the  period.  Translation  adjustments  arising  from the use of  differing
exchange rates from period to period are accumulated in a separate  component of
stockholders'   equity.   Gains  and  losses  resulting  from  foreign  currency
transactions  are  included in income in the period in which these  transactions
occur.  The effects of foreign currency  translation on the Company's  financial
position and results of operations are not  significant.  Also, the  operations,
assets and liabilities of the Company's foreign division are not significant.

Cash

     The Company's cash balances serve as collateral under a loan agreement (see
Note 7) and, accordingly, are restricted.

Inventories

     Inventories  are stated at the lower of cost or market.  Cost is determined
based upon the  first-in,  first-out  ("FIFO")  method or standard  cost,  which
approximates cost on a FIFO basis.

     Reserves to provide for  potential  losses due to  obsolescence  and excess
quantities are established in the period in which such losses occur.

Property and Equipment

     Property and equipment is recorded at cost less  accumulated  depreciation.
Depreciation  is computed using the  straight-line  method over the  established
useful lives of the assets as follows:

                                             Predecessor             Company
                                             -----------            ---------

Building and building improvements              30 years             30 years
Machinery and equipment                       2-10 years            2-5 years
Furniture and fixtures                        2-10 years            2-3 years
Leasehold improvements                        5-15 years              5 years


                                       47
<PAGE>

     Additions,  improvements and  expenditures  that  significantly  extend the
useful  life  of  an  asset  are  capitalized.   Expenditures  for  repairs  and
maintenance  are charged to operations  as incurred.  When assets are retired or
disposed of, the cost and accumulated  depreciation  thereon are eliminated from
the accounts, and any gains or losses are included in income.

Revenue Recognition

     Sales and  related  costs are  recorded  by the  Company  upon  shipment of
products.  Deferred  revenue  consists of  prepayments  from  customers  and the
refundable  portion of proceeds received from the sale of software (see Note 14)
which is classified according to the terms of the repayment obligation. Deferred
revenue is  recognized  as earned  upon  shipment of products or pursuant to the
terms of the sales contract.

Engineering, Research, and Development Costs

     Costs and expenses incurred for the purpose of product research, design and
development  are charged to  operations as incurred.  Engineering,  research and
development  costs consist primarily of costs associated with development of new
products and manufacturing  processes.  The Company  capitalizes as other assets
certain product software  development costs once  technological  feasibility has
been  achieved.  Commencing  upon  initial  product  release,  these  costs  are
amortized based on the  straight-line  method over the estimated  useful life of
the product,  which is generally five years.  Capitalized  software  development
costs are reported at the lower of cost, net of accumulated amortization, or net
realizable  value (see Note 6).  Software  development  costs  incurred prior to
achieving  technological  feasibility  are charged to research  and  development
expense as incurred.

Stock-Based Compensation

     In October 1995, the Financial  Accounting Standards Board issued Statement
of  Financial   Accounting   Standards  No.  123,   Accounting  for  Stock-Based
Compensation  ("SFAS  123").  SFAS 123,  which is  effective  for  fiscal  years
beginning  after  December  15,  1995,  defines  a fair  value  based  method of
accounting  for  compensation  cost related to stock  options and other forms of
stock-based  compensation  plans.  This  statement  gives  entities  a choice of
recognizing related  compensation costs by adopting the new fair value method or
to continue to measure compensation using the intrinsic value approach contained
in Accounting  Principles Board Opinion 25 ("APB 25"), the former  standard.  If
the former standard for measurement is elected,  SFAS 123 requires  supplemental
disclosure  to show the  effects  of using  the new  measurement  criteria.  The
Company has elected to continue to apply the former  standards  contained in APB
25, and as a result,  the Company adopted the pro forma disclosure  requirements
of SFAS 123 during the year ended  March 28,  1997 (see Note 9). APB 25 requires
compensation  expense for stock-based  compensation plans to be recognized based
on the difference,  if any,  between the per-share market value of the stock and
the option exercise price on the measurement  date, which is generally the grant
date. The Company has not recognized  any  compensation  expense with respect to
stock  options  granted  under  the  Company's  plans  in  accordance  with  the
requirements of APB 25.

Fair Value of Financial Instruments and Concentration of Credit Risk

     The  estimated  fair  value of the  Company's  cash,  accounts  receivable,
accounts payable and outstanding indebtedness  approximates the carrying amounts
due principally to their short  maturities.  Accounts  receivable  represent the
primary  financial   instrument  which  potentially   subjects  the  Company  to
concentrations  of credit risk.  The Company  does not require its  customers to
provide collateral with respect to amounts owed, but periodically  evaluates the
credit of its  customers  (see Note 14). The  allowance  for  non-collection  of
accounts  receivable is estimated based upon the expected  collectibility of all
accounts receivable.

Goodwill

     The  excess of the  purchase  price  over the fair  value of the  Company's
assets and  liabilities  at the date of the  Acquisition  is being  amortized to
operations on a  straight-line  basis over a period of 35 years. At each balance
sheet date,  the Company  evaluates the  realizability  of goodwill based on its
expectations  of future


                                       48
<PAGE>

nondiscounted  cash flows.  Based on the  Company's  most recent  analysis,  the
Company  believes that no material  impairment  of goodwill  exists at March 28,
1997.

Income Taxes

     Income tax expense  (benefit) is based upon income  (loss)  recognized  for
financial  statement purposes and includes the effects of temporary  differences
between such income  (loss) and that  recognized  for tax purposes in accordance
with Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting
for Income  Taxes."  SFAS 109  requires  recognition  of deferred tax assets and
liabilities  for the expected  future tax  consequences of events that have been
included in the financial statements or tax returns.  Using the enacted tax rate
in  effect  for the year in which  the  differences  are  expected  to  reverse,
deferred tax assets and  liabilities  are determined  based upon the differences
between  the  financial  reporting  basis and income tax basis of the assets and
liabilities (see Note 10). A valuation allowance is established for deferred tax
assets to the extent realization thereof is not assured.

Income (Loss) Per Common and Common Equivalent Share

     Income  (loss) per common and common  equivalent  share for the five months
ended  March 31,  1995 and years  ended  March  29,  1996 and March 28,  1997 is
computed  on the basis of the  weighted  average  number of common and  dilutive
common equivalent shares  outstanding  during the period,  except as required by
Accounting  Principles Board Opinion No. 15, Earnings per Share, all outstanding
options and warrants  during the year ended March 28, 1997 have been included in
the  calculation  in accordance  with the modified  treasury  stock method,  and
except as  required by  Securities  and  Exchange  Commission  Staff  Accounting
Bulletin  ("SECSAB")  Topic 4:D, stock issued and stock options  covering 89,000
shares of common  stock  granted  during the 12 months  prior to a May 10,  1996
initial public  offering (see Note 9) at prices below the public  offering price
have been included in the  calculation of weighted  average number of common and
common  equivalent  shares  outstanding  as if they were  outstanding  as of the
beginning of the period. Also, as a result of the Acquisition, income (loss) per
share is not presented for periods prior to the five months ended March 31, 1995
in accordance with SECSAB Topic 1:B2.

     In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"). SFAS
128 requires disclosure of basic earnings per share based on income available to
common stockholders and the weighted average number of common shares outstanding
during the period,  and diluted  earnings per share based on income available to
common  stockholders  and the  weighted  average  number of common and  dilutive
potential common shares  outstanding during the period. The adoption of SFAS 128
is required  for fiscal  years  ending  after  December  15,  1997,  and earlier
adoption is not  permitted.  Had the Company  adopted  SFAS 128 during the years
ended March 29, 1996 and March 28, 1997, basic earnings per share on a pro forma
basis  would  have  been  $.34 and $.22 per  share,  respectively,  and  diluted
earnings per share on a pro forma basis would have been $.30 and $.21 per share,
respectively.

     Also, in February 1997,  the Financial  Accounting  Standards  Board issued
Statement of Financial  Accounting  Standards No. 129, Disclosure of Information
about Capital Structure ("SFAS 129"). SFAS 129 requires a Company to explain the
privileges  and  rights of its  various  outstanding  securities,  the number of
shares issued upon conversion,  exercise or satisfaction of required  conditions
during  the  most  recent  annual  fiscal  period,  liquidation  preferences  of
preferred stock and other matters with respect to preferred stock.  Although the
statement is effective for periods ending after December 15, 1997, the Company's
financial statement disclosures are in compliance with SFAS 129.

Use of Estimates

     The  preparation  of financial  statements  in  conformity  with  generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that  affect the  reported  amounts of assets and  liabilities  


                                       49
<PAGE>

and disclosure of contingent assets and liabilities at the date of the financial
statements  and the  reported  amounts  of  revenues  and  expenses  during  the
reporting period. Actual results could differ from those estimates.

4.   INVENTORIES

     Inventories  at  March  29,  1996  and  March  28,  1997  consisted  of the
following:
 
                                                 March 29,           March 28,
                                                   1996                1997
                                               ------------        ------------
     
     Raw materials                             $  7,403,532        $  6,153,808
     Work-in-process                              1,207,080           2,117,668
     Finished goods                               1,654,252           4,036,191
                                               ------------        ------------
                                                 10,264,864          12,307,667
     Reserve for potential losses                (1,606,195)         (1,428,487)
                                               ------------        ------------
                                               $  8,658,669        $ 10,879,180
                                               ============        ============
 
     Substantially  all  inventories  are pledged to secure  notes  payable (see
Note 7).

5.   PROPERTY AND EQUIPMENT

     Property and  equipment  at March 29, 1996 and March 28, 1997  consisted of
the following:
     
                                                   March 29,         March 28,
                                                     1996              1997
                                                  -----------       -----------
     Land                                         $   120,633       $      --
     Building and building improvements               877,187              --
     Machinery and equipment                        2,009,159         2,287,656
     Furniture and fixtures                           119,879           111,057
     Leasehold improvements                           151,116           167,784
                                                  -----------       -----------
                                                    3,277,974         2,566,497
     Accumulated depreciation                      (1,079,349)       (1,719,054)
                                                  -----------       -----------
                                                  $ 2,198,625       $   847,443
                                                  ===========       ===========

     Substantially all property and equipment is pledged to secure notes payable
(see Note 7).

     Depreciation  expense for the seven months ended  October 30, 1994 and five
months  ended March 31, 1995  aggregated  $454,911 and  $308,047,  respectively.
Depreciation  expense  for the years  ended  March 29,  1996 and March 28,  1997
aggregated $784,039 and $794,928, respectively.

     Assets  under  capital   leases  are   capitalized   using  interest  rates
appropriate  at the  date of  purchase  or at the  inception  of the  lease,  as
applicable.  The  following is a summary of the  Company's  assets under capital
leases which are included in property and equipment at March 29, 1996:

     Land                                                      $   120,633
     Building and building improvements                            877,187
     Machinery and equipment                                        60,445
                                                               -----------
                                                                 1,058,265
     Accumulated depreciation                                      (70,762)
                                                               -----------
                                                               $   987,503
                                                               ===========


                                       50
<PAGE>

     During the year ended  March 28,  1997,  the  Company  closed a one hundred
thousand square foot  manufacturing  facility  located in Paducah,  Kentucky and
assigned  its  capital  lease   obligation  to  an  unaffiliated   third  party.
Accordingly,  the Company  recorded the  retirement of the  outstanding  capital
lease obligation and the disposition of the property during the year ended March
28, 1997. In connection with this  transaction,  the Company  realized a gain of
$44,169  representing  the difference  between the outstanding  lease obligation
($933,510)  plus the proceeds  received  ($50,000) and the net book value of the
property ($939,341).

6.   OTHER ASSETS

     Other  assets at March 29,  1996 and March  28,  1997,  net of  accumulated
amortization of $375,481 and $652,762, respectively, consisted of the following:

                                                        March 29,    March 28,
                                                          1996         1997
                                                       ----------   ----------
     Excess of purchase price over fair value of net
         assets acquired, net of accumulated
         amortization of $169,336 and $278,247         $3,803,057   $3,252,076
     Product software, net of accumulated
         amortization of $66,300 and $113,100             167,700      542,593
     Patents, net of accumulated amortization
         of $46,453 and $79,243                           117,499       84,709
     Customer contracts, net of accumulated
         amortization of $55,103 and $93,999               71,309       32,413
     Unpatented technology, net of accumulated
         amortization of $15,622 and $26,649               44,109       33,082
     Patent license, net of accumulated
         amortization of $22,667 and $61,524              110,333       71,476
     Deferred initial public offering expenses            338,372
     Deposits                                              40,500       40,342
     Other                                                    771        2,776
                                                       ----------   ----------
                                                       $4,693,650   $4,059,467
                                                       ==========   ==========

     The excess of the purchase price over the fair value of net assets acquired
in  connection  with  the  Acquisition,   including  the  escrow   consideration
distributed  during the year ended March 29, 1996,  aggregated  $4,183,586.  Tax
benefits of acquired  deferred tax assets of $211,193  and  $442,070  during the
years  ended  March 29,  1996 and March 28,  1997,  respectively,  were  applied
against the excess purchase price (see Note 10).

     Other  intangible  assets  recorded  in  connection  with  the  Acquisition
consisted  of  product  software  of  $234,000,  patents of  $163,952,  customer
contracts of $126,412 and  unpatented  technology  of $59,731.  These assets are
being amortized over estimated  useful lives ranging from less than two years to
five  years,  and  are  reported  at the  lower  of  cost,  net  of  accumulated
amortization, or net realizable value.

     During the year ended  March 28,  1997,  the Company  capitalized  software
development  costs  of  $421,693  in  connection  with  the  development  of new
products. Software development costs during the five months ended March 31, 1995
and year ended March 29, 1996 were not significant.

     Amortization  expense for the seven  months ended  October 30,  1994,  five
months  ended  March 31,  1995 and years ended March 29, 1996 and March 28, 1997
amounted to $192,806, $99,845, $276,616 and $277,282, respectively.


                                       51
<PAGE>

7.   BORROWINGS UNDER REVOLVING CREDIT AGREEMENT,  LONG-TERM DEBT, CAPITAL LEASE
     OBLIGATIONS AND NOTES PAYABLE TO STOCKHOLDERS

Borrowings Under Revolving Credit Agreement

     At March 29,  1996,  the  Company  was able to borrow up to a maximum of $9
million under term and installment  notes and a revolving credit agreement under
the terms of a Loan and Security  Agreement (the "Loan  Agreement")  between the
Company and its bank.  Indebtedness  under the Loan  Agreement at March 29, 1996
included $2,525,000  outstanding under term and installment notes and $1,093,735
outstanding under the revolving credit agreement.

     At March 28,  1997,  the  Company  was able to borrow up to a maximum of $9
million under the revolving credit agreement. At March 28, 1997, the Company had
outstanding debt of $3,810,961 under the revolving credit agreement.

     Amounts borrowed under the Loan Agreement are secured by substantially  all
assets of the Company including  accounts  receivable,  inventories and property
and equipment. The borrowing limit under the revolving credit agreement is based
upon specified  percentages  applied to the value of  collateral,  consisting of
accounts  receivable  and  inventories  (less amounts  outstanding  under a $2.2
million  term note at March 29,  1996),  and varies  based  upon  changes in the
collateral  value.  Interest  is payable  monthly  based upon the greater of the
actual  outstanding  debt  balances  or $4 million at a variable  rate per annum
equal to 1.5% above a base rate  quoted by  Citibank  (8.25%  March 29, 1996 and
8.50% at March 28, 1997). The Loan Agreement is renewable  annually for one year
periods unless  terminated by the bank upon an occurrence of an event of default
or by the Company  upon at least 90 days  notice.  The Company has agreed to pay
termination  fees of up to 2% of the average  monthly  borrowings or the minimum
loan  amount ($4  million),  whichever  is  greater,  if the Loan  Agreement  is
terminated on the date other than an anniversary date.

     The Loan  Agreement  contains  conditions  and  covenants  that  prevent or
restrict the Company from engaging in certain  transactions  without the consent
of the  bank,  including  merging  or  consolidating,  payment  of  subordinated
stockholder   debt   obligations,   declaration  or  payment  of  dividends  and
disposition of assets, among others.  Additionally,  the Loan Agreement requires
the Company to comply with specific  financial  covenants,  including  covenants
with respect to cash flow, working capital and net worth. Noncompliance with any
of these  conditions  and  covenants  or the  occurrence  of any other  event of
default,  if not waived or  corrected,  could  accelerate  the  maturity  of the
borrowings  outstanding under the Loan Agreement.  The Company was in compliance
with the covenants and  conditions  contained in the Loan Agreement at March 29,
1996 and March 28, 1997.

     Pursuant to an  amendment to the Loan  Agreement on October 31, 1994,  $2.2
million of debt  outstanding  under the revolving credit agreement was converted
into a term note payable on November 30, 1997. In addition, the term of the Loan
Agreement was extended from May 31, 1995 to November 30, 1997,  and the interest
rate on amounts  borrowed  under the terms of the Loan  Agreement was reduced by
 .75%.  Proceeds of $2,569,298  pursuant to subordinated  promissory  notes dated
October  31, 1994 issued to  stockholders  were used to retire debt  outstanding
under  the  revolving  credit  agreement.  After  such  repayment,  the  initial
principal  balance  outstanding  under the $2.2 million term note on October 31,
1994 amounted to  $1,291,667.  Between  October 31, 1994 and March 31, 1995, the
Company  borrowed  the balance  available  under the $2.2  million  term note of
$908,333.

     Pursuant to a June 9, 1994 amendment to the Loan  Agreement,  the aggregate
principal  obligation  under an installment  note was decreased from $500,000 to
$465,000,  and the Company borrowed an additional $402,500.  The expiration date
of the Loan  Agreement and the due date of the term and  installment  notes were
extended from February 28, 1995 to May 31, 1995. The monthly  principal  payment
under the installment note was increased from $20,833 to $25,000.  This note was
repaid during the year ended March 29, 1996.


                                       52
<PAGE>

     In May 1996,  the Company  completed an initial  public  offering of equity
securities  (see  Note 9). A  portion  of the  proceeds  of the  initial  public
offering were used to repay the Company's then  outstanding  indebtedness  under
the  Loan  Agreement.   Accordingly,   the  Company  classified   $1,093,735  of
indebtedness  outstanding  under the  revolving  credit  facility as a long-term
obligation at March 29, 1996.

Long-Term Debt and Capital Lease Obligations

     Long-term  debt and  capital  lease  obligations  payable at March 29, 1996
consisted of the following:

     Loan and Security Agreement
       $2.2 million secured term note, principal
         balance due November 30, 1997                         $ 2,200,000
       $650,000 secured term note, principal
         payable in sixty equal monthly
         installments of $7,738, with remaining
         principal balance due November 30, 1997                   325,000
     Unsecured non-interest bearing promissory
      note, payable in nineteen equal monthly
      installments of $10,873                                       32,620
     Obligations under capital leases                              975,410
                                                               -----------
                                                                 3,533,030
     Less - current maturities                                    (118,444)
                                                               -----------
                                                               $ 3,414,586
                                                               ===========

     At March 31, 1995,  the Company had  outstanding  indebtedness  of $203,077
pursuant  to  10%  interest  bearing  promissory  notes  payable  to  a  company
affiliated  with  certain  officers and  employees  of the Company.  Outstanding
indebtedness under these promissory notes was paid in full during the year ended
March 29,  1996.  Interest  paid  pursuant to these notes during the years ended
March 31, 1995 and March 29, 1996 aggregated  $48,934 and $9,424,  respectively.
On November 9, 1994, the Company executed a non-interest bearing promissory note
in the principal amount of $206,595 representing unpaid royalties at October 31,
1994 due to the company  affiliated  with certain of the Company's  officers and
employees.  The note, payable in nineteen equal monthly  installments of $10,873
commencing on December 11, 1994, had an outstanding  balance of $32,620 at March
29, 1996. This note was paid in full during the year ended March 28, 1997.

     In May 1996,  the Company  completed an initial  public  offering of equity
securities  (see  Note 9). A  portion  of the  proceeds  of the  initial  public
offering were used to repay the Company's then  outstanding  indebtedness  under
the Loan Agreement. Accordingly, the Company classified indebtedness outstanding
under the $2.2 million term note and $309,524 of indebtedness  then  outstanding
under the $650,000 term note as long-term obligations at March 29, 1996.

     During the year ended  March 28,  1997,  the Company  assigned  its capital
lease   obligation   with  respect  to  a  one  hundred   thousand  square  foot
manufacturing  facility  located in Paducah,  Kentucky to an unaffiliated  third
party.  Accordingly,  the Company  recorded the  retirement of the capital lease
obligation with a then  outstanding  balance of $933,510 (see Note 5) during the
year ended March 28, 1997.

Notes Payable to Stockholders

     On  June  9,  1994,  the  Company  borrowed  $400,000  from  its  preferred
stockholders and issued a subordinated  master promissory note payable on demand
bearing  interest at a rate of 10% per annum.  This note,  accrued  interest and
preference  fees,  which when added to accruing  interest  would equal 5% of the
outstanding  principal  amount  for each  month  that the note was  outstanding,
became due upon the Acquisition. Accordingly, the subordinated master promissory
note,  together  with  accrued  interest  and  preference  fees from the date of
issuance aggregating $96,000, were retired on October 31, 1994.


                                       53
<PAGE>

     On October 31, 1994, the Company entered into an Investment  Agreement with
the investors. Under the terms of the Investment Agreement, the Company borrowed
$2.8 million from the  investors  and issued 10% interest  bearing  subordinated
promissory notes due November 1, 1999. During the year ended March 28, 1997, the
Company repaid the subordinated  promissory notes with a portion of the proceeds
from its initial public offering (see Note 9). Interest  accrued under the terms
of the subordinated  promissory notes was payable semi-annually beginning May 1,
1995. During the years ended March 29, 1996 and March 28, 1997, the Company paid
interest  with  respect to the  subordinated  notes of  $279,847  and  $151,890,
respectively.  At March  29,  1996,  interest  accrued  under  the  terms of the
subordinated promissory notes aggregated $116,603.

8.   ACCRUED LIABILITIES

     Accrued  liabilities  at March 29, 1996 and March 28, 1997 consisted of the
following:

                                                      March 29,    March 28,
                                                        1996         1997
                                                     ----------   ----------
     Workers' compensation and employee group
         insurance                                   $  117,546   $  103,830
     Salaries, wages and related employee benefits
         and taxes                                      339,481      255,410
     Interest                                           149,674       31,792
     Royalties                                          273,169          233
     Warranty expense                                   209,500      366,916
     Sales and use taxes                                 24,651        7,060
     Professional fees                                   99,136       90,673
     Environmental costs                                 12,948          625
     Property taxes                                      20,840       29,674
     Bonuses                                             74,790       62,104
     Other                                              150,644       66,715
                                                     ----------   ----------
                                                     $1,472,379   $1,015,032
                                                     ==========   ==========

9.   STOCKHOLDERS' EQUITY

Preferred Stock

     The  Company is  authorized,  under its  Certificate  of  Incorporation  as
amended on October 31, 1994, to issue up to 100,000  shares of preferred  stock,
$100 par value,  in one or more series or other  designations  determined by the
Board  of  Directors  ("Board")  of the  Company.  The  Board is  authorized  to
determine,  as to any particular series of preferred stock: the dividend rights,
including annual dividend rates and whether the dividends shall be cumulative or
non-cumulative; redemption provisions; per-share liquidation preferences; voting
powers; conversion terms; and any other rights or preferences.  No dividends may
be paid or declared on the Company's common stock or on any other class of stock
ranking junior to the preferred  stock,  nor shall any shares of common stock or
any other class of stock  ranking  junior to the  preferred  stock be purchased,
retired or otherwise  acquired by the Company  unless all dividends  accrued and
payable on  preferred  shares and all amounts  required to retire the  preferred
shares have been paid out of assets  legally  available  for the payment of such
obligations.

     At March 28, 1997,  no preferred  stock had been issued,  nor has the Board
designated any series of preferred  stock for issuance or determined any related
rights or preferences.

     In connection  with the  Acquisition,  the then  outstanding  shares of the
Company's  Series A,  Series  B,  Series C and  Series E  preferred  stock  were
cancelled.  The Series A, Series B,  Series C and Series E  preferred  stock had
per-share  liquidation  preferences  of $15, $5, $2.50 and $2.50,  respectively,
plus declared and unpaid 


                                       54
<PAGE>

dividends.  The aggregate liquidation preference of the preferred stock in order
of priority were as follows: Series E - $750,000; Series C - $5,851,650;  Series
B - $1,500,000;  and Series A - $4,600,020.  The shares of preferred  stock were
convertible  into an equal number of shares of common stock,  subject to certain
anti-dilution  provisions.  Shares of Series A,  Series B and Series C preferred
stock were  convertible  into voting common stock.  Shares of Series E preferred
stock were  convertible  into  non-voting  common stock.  Series A, Series B and
Series C  preferred  shares had voting  rights  equal to the number of shares of
common stock which would have been  received upon  conversion to common  shares.
The Series E preferred stock had no voting rights.

     The Company  could not,  without the consent of stipulated  percentages  of
holders of the  applicable  series of preferred  stock,  authorize or create any
class or series of capital stock  ranking,  either as to payment of dividends or
distribution of assets,  prior to or on a parity with such series of convertible
preferred  stock or alter or change the  powers,  preferences  or rights of such
series of  convertible  preferred  stock.  Further,  the Company  could not sell
shares  of  capital  stock  ranking,  either  as  to  payment  of  dividends  or
distribution  of  assets,  prior  to or on  parity  with  those  of  convertible
preferred  stock at prices less than the conversion  prices or convertible  into
common stock at prices less than the conversion prices of convertible  preferred
stock without such consent(s).

Common Stock

     The  Company is  authorized,  under its  Certificate  of  Incorporation  as
amended on October 31, 1994, to issue up to  10,000,000  shares of common stock,
$.01 par value. As described in Note 1, the Company issued 3.5 million shares of
common stock on October 31, 1994 in  accordance  with the terms of an Investment
Agreement between the Company, Wexford and certain former investors.

     Holders of voting  common  stock are  entitled to one vote per share on all
matters to be voted on by the stockholders. No dividends may be paid or declared
on the  Company's  common  stock  until all  dividends  accrued  and  payable on
preferred shares outstanding have been paid.

     In connection  with the  Acquisition,  the then  outstanding  shares of the
Company's common stock were cancelled. Prior to the Acquisition, the Company was
authorized to issue 11,100,000 shares of common stock, $.05 par value.

Initial Public Offering and Common Stock Purchase Warrants

     In May 1996, the Company  completed an initial public offering of 1,150,000
units (the "Units"),  each Unit  consisting of one share of common stock and one
redeemable warrant ("Redeemable Warrant") at a price of $9.00 per Unit for gross
proceeds of  $10,350,000.  In connection  with the offering,  the Company issued
warrants to the  underwriters  to purchase  100,000  shares of common stock (the
"Underwriter  Warrants") for gross proceeds of $10. Net proceeds received by the
Company,  after  underwriting  discounts  and expenses of  $1,231,897  and other
expenses of $824,953, amounted to $8,293,160. At March 29, 1996, the Company had
incurred,  and  deferred  as  other  assets,   offering  expenses  of  $338,372.
Accordingly,  net  proceeds  during the year ended  March 28,  1997  amounted to
$8,631,532.

     Two Redeemable Warrants entitle the holder thereof to purchase one share of
common  stock at an exercise  price of $11.00 per share.  Unless the  Redeemable
Warrants  are  redeemed,  the  Redeemable  Warrants may be exercised at any time
beginning on May 10, 1996 and ending May 9, 1999,  at which time the  Redeemable
Warrants will expire.  Beginning on February 10, 1997, the  Redeemable  Warrants
are redeemable by the Company at its option, as a whole and not in part, at $.05
per  Redeemable  Warrant on 30 days' prior  written  notice,  provided  that the
average closing price of the common stock equals or exceeds $12.00 per share for
20  consecutive  trading  days ending  within five days prior to the date of the
notice of redemption. The Redeemable Warrants will be entitled to the benefit of
adjustments  in the  exercise  price and in the number of shares of common stock
deliverable  upon the exercise  thereof upon the  occurrence of certain  events,
including a stock dividend, stock split or similar reorganization.


                                       55
<PAGE>

     The Underwriter Warrants are initially exercisable at a price of $10.80 per
share of common stock. The Underwriter Warrants contain anti-dilution provisions
providing  for  adjustments  of the number of warrants and exercise  price under
certain  circumstances.  The  Underwriter  Warrants grant to the holders thereof
certain rights of registration  of the securities  issuable upon exercise of the
Underwriter  Warrants.  The  Underwriter  Warrants  may be exercised at any time
beginning on May 10, 1997 and ending May 9, 2001, at which time the  Underwriter
Warrants will expire.

     As of October 31, 1994, the Company had outstanding warrants to purchase an
aggregate of 312,000 shares of Series C preferred  stock at a price of $2.50 per
share.  These  warrants were  cancelled upon  consummation  of the  Acquisition.
Generally,  the warrants were exercisable for five-year periods beginning either
on the  issuance  date or one year  thereafter,  and  expired on  various  dates
through March 31, 1996.

     On May 23,  1995,  the  Company  issued a  warrant  to one of its  contract
manufacturers  to purchase  40,000 shares of common stock,  $.01 par value, at a
price of $4.00 per share in return for the  extension  of credit under the terms
of a manufacturing  agreement between the Company and the contract manufacturer.
On June 17, 1996, the warrant was exercised and the Company issued 40,000 shares
of common stock for aggregate proceeds of $160,000.

Stock Options

     On November 1, 1994,  the  Company's  Board of  Directors  adopted the 1994
Omnibus  Stock Plan (the "Stock  Plan").  The Stock Plan provides the Board or a
committee of the Board with the  authority to grant to officers and employees of
the Company  incentive  stock options  within the meaning of Section 422A of the
Internal  Revenue  Code and to  grant  to  directors,  officers,  employees  and
consultants  of the Company  non-qualified  stock options and  restricted  stock
which do not qualify as incentive stock options.  An aggregate of 635,000 shares
of the  Company's  common stock may be issued under the Stock Plan.  The maximum
number of  shares  with  respect  to which  options  may be  granted  to any one
employee may not exceed 300,000 shares.  The Board's  authority to grant options
under the Stock Plan expires on November 1, 2004. The Stock Plan is administered
by a Stock Plans Committee consisting of members appointed by the Board.

     The Board has the  authority to  determine  option  periods,  the number of
shares of common  stock  subject to  options  granted  and such other  terms and
conditions  under  which  options  may be  exercised.  The  Board  also  has the
authority  to  determine  at which  times  options  or  restricted  stock may be
granted,  the purchase price of restricted stock,  whether an option shall be an
incentive stock option or a non-qualified  option,  whether restrictions such as
repurchase  rights are to be imposed on shares subject to options and restricted
stock,  and the  nature of such  restrictions.  The  per-share  option  price of
incentive  stock options granted under the Stock Plan shall not be less than the
per-share fair market value, as determined by the Board, of the Company's common
stock  as of the date of  grant,  or 110% of the  per-share  market  value  with
respect to incentive  stock options  granted to employees  owning 10% or more of
the total combined  voting power of all classes of the Company's  stock.  Option
periods  shall not exceed ten years from the date options are  granted,  or five
years with respect to incentive stock options to employees owning 10% or more of
the total voting power of all classes of the Company's  stock.  Options  granted
under the Stock Plan generally expire 60 days after termination of employment or
at the end of the option period stipulated by the Board in the option agreement,
whichever is earlier.

     The Board has the authority to accelerate the date of exercise of an option
or any installment thereof, unless, in the case of incentive stock options, such
acceleration would violate the annual vesting  limitations  contained in Section
422(d) of the Internal  Revenue  Code.  The exercise  prices of options  granted
under  the  Stock  Plan  are  subject  to  adjustment   upon  any   subdivision,
combination, merger, splits, split-up, liquidation, or the like, to reflect such
subdivision, combination or exchange. The number of shares of common stock to be
received  upon  exercise of options  granted under the Stock Plan are subject to
adjustment upon  declarations  of stock dividends  between the date of grant and
the date of  exercise  of options.  Also,  the number of shares of 


                                       56
<PAGE>

common stock  reserved for issuance  under the Stock Plan shall be adjusted upon
the occurrence of such events.

     The Board may grant  restricted  stock  under the Stock Plan  pursuant to a
restricted stock agreement.  The Board has the authority to determine the number
of shares of common stock to be issued and to the extent,  if any, to which they
shall be issued in exchange for cash and/or other  consideration.  Shares issued
pursuant to restricted stock may not be sold, transferred, pledged, or otherwise
disposed  of,  except by the laws of descent and  distribution,  or as otherwise
determined  by the Board for a period as  determined  by the Board from the date
the  restricted  stock is  granted.  The  Company  has the  right to  repurchase
restricted  stock at such price as determined by the Board on the date of grant.
The repurchase  rights are  exercisable on such terms as determined by the Board
upon the  termination  of  services of the grantee  prior to  expiration  of the
restriction on transfer of the shares, failure of the grantee to pay the Company
income taxes required to be withheld in respect of the restricted stock or under
such other circumstances as the Board may determine.

     The  following  table  summarizes  the status and changes in stock  options
outstanding  under the Stock Plan for the five  months  ended March 31, 1995 and
years ended March 29, 1996 and March 28, 1997:

<TABLE>
<CAPTION>
                                                                                  Weighted
                                                Incentive          Option          Average
                                                  Stock             Price         Exercise
                                                 Options            Range          Price
                                                ---------      ---------------    --------
<S>                                              <C>                <C>             <C>  
     Outstanding at October 31, 1994                --                --             --
     Options granted                             357,000            $1.00           $1.00
                                                 -------
     Outstanding at March 31, 1995               357,000            $1.00           $1.00
     Options granted                              89,000        $1.00 - $5.00       $4.78
     Options cancelled                           (11,750)           $1.00           $1.00
                                                 -------
     Outstanding at March 29, 1996               434,250        $1.00 - $5.00       $1.77
     Options granted                             191,250       $8.00 - $10.781      $9.23
     Options exercised                            (5,000)           $1.00           $1.00
     Options cancelled                           (78,500)       $1.00 - $9.50       $7.74
                                                 -------
     Outstanding at March 28, 1997               542,000       $1.00 - $10.781      $3.55
                                                 =======
     Options Exercisable at March 31, 1995        89,250            $1.00           $1.00
                                                 =======
     Options Exercisable at March 29, 1996       196,750        $1.00 - $5.00       $1.43
                                                 =======
     Options Exercisable at March 28, 1997       327,563       $1.00 - $10.781      $2.35
                                                 =======
</TABLE>

     Options  granted  and  outstanding  under  the  Stock  Plan  are  generally
exercisable in four equal annual installments beginning on the date of grant. At
March 28, 1997, outstanding options under the Stock Plan have a weighted average
remaining  contractual life of 8.17 years. At March 29, 1996 and March 28, 1997,
635,000 and 630,000 shares,  respectively,  were reserved for issuance under the
Stock Plan.

     On May 10, 1995,  the Board of Directors  approved the adoption of the 1995
Employee Stock Purchase Plan (the "Employee  Plan").  The Employee Plan provides
the Board of Directors with the authority to grant to the Company's officers and
employees  the right to purchase up to 100,000  shares of common stock at 85% of
the public market  price.  However,  the Employee Plan did not become  effective
until the  Company's  initial  public  offering.  The rights  granted  under the
Employee Plan are  exercisable for an offering period as determined by the Board
of  Directors,  which may not exceed 27 months.  No  employee  may be granted an
option under which the  employee's  right to purchase  shares under the Employee
Plan first  become  exercisable  at a rate in excess of  $25,000 in fair  market
value  (determined at the date of grant) in any calendar year. Also, an employee
may not  allocate in excess of 10% of his or her  compensation  for  purchase of
stock  under the  Employee  Plan  during any  offering  period.  The Stock Plans
Committee of the Board of Directors  administers the Employee Plan. The Employee
Plan was approved by the  stockholders  of the Company on December 26, 1995.  At
March 29, 1996


                                       57
<PAGE>

and March 28, 1997,  100,000 and 93,240  shares of common  stock,  respectively,
were reserved for issuance under the Employee Plan.

     During the first  offering  period ending  November 15, 1996,  6,760 shares
were  purchased by  employees  at a price of $7.65 per share.  During the second
offering which commenced January 13, 1997 (and which will end on July 11, 1997),
5,930 shares are subject to purchase  under the Employee  Plan based on the base
compensation  of  participates  and the per-share  market price of the Company's
common stock on January 13, 1997. The actual number of shares that may be issued
will vary based  upon  compensation  of the  participants  during  the  offering
period,  the per-share  market value of the  Company's  common stock on July 11,
1997, and the number of participates who have not withdrawn by the July 11, 1997
end date.

     On May 10, 1995, the Board  approved the adoption of the 1995  Non-Employee
Director Stock Option Plan (the "Director Plan"). The Director Plan provides for
the grant to  directors  who are not  employees  of the  Company  of  options to
purchase up to 100,000 shares of common stock. The Director Plan is administered
by the Stock  Plans  Committee  consisting  of members  appointed  by the Board.
Pursuant to the Director  Plan,  each  non-employee  director was  automatically
granted a  non-qualified  option to purchase  10,000 shares of common stock upon
the  consummation  of the  Company's  initial  public  offering on May 10, 1996.
Thereafter,  on September 1 of each year, each non-employee  director receives a
non-qualified  option to purchase 3,000 shares of common stock. Any non-employee
director who is first  appointed or elected after the Company's  initial  public
offering will receive a  non-qualified  stock option to purchase 3,000 shares of
common  stock upon such  appointment  or election  and an  additional  option to
purchase 3,000 shares of common stock on each  anniversary of the date of his or
her  election,  provided  that  he or  she is  then  serving  as a  non-employee
director.  Options  granted upon  consummation  of the Company's  initial public
offering  became  exercisable  six months from the date the offering.  All other
options  become  exercisable  on the  anniversary  of the date of grant.  Option
periods  shall not exceed ten years from the date options are  granted.  Options
granted under the Director Plan have an exercise price equal to the market value
per share of the common stock on the date of grant.  Options  granted expire 180
days  after the date a director  ceases to serve as a director  or 10 years from
the grant date,  whichever is earlier.  Vesting is accelerated in the event of a
change of control of the Company.

     On May 10,  1996,  options to purchase  30,000  shares of common stock were
automatically  granted to  non-employee  directors at an exercise price of $8.50
per share.  On May 17,  1996,  options to purchase  3,000 shares of common stock
were granted at an exercise price of $10.781 to a non-employee  director elected
to the Board on that date.  On  September  1, 1996,  options to  purchase  9,000
shares of common stock were automatically  granted to non-employee  directors at
an exercise price of $10.812 per share.  On March 14, 1997,  options to purchase
3,000  shares of common  stock were  granted at an exercise  price of $5.00 to a
non-employee  director  elected  to the Board on that  date.  At March 28,  1997
options to purchase 45,000 shares of common stock at a weighted-average exercise
price of $8.88 per share  were  outstanding  under the  Director  Plan.  Options
granted under the Director  Plan to purchase  30,000 shares of common stock at a
weighted-average exercise price of $8.50 per share were exercisable at March 28,
1997.

     At March  28,  1997,  outstanding  options  under  the  Director  Plan have
exercise  prices  ranging  between  $5.00 and  $10.812  per share and a weighted
average  remaining  contractual  life of 9.23 years.  The  Company has  reserved
100,000 shares of common stock for issuance under the Director Plan at March 29,
1996 and March 28, 1997.


                                       58
<PAGE>

     The following table summarizes  information about stock options outstanding
under the Stock Plan and Director Plan at March 28, 1997:

                         Options Outstanding                Options Exercisable
                --------------------------------------    ----------------------
                                Weighted
                                Average      Weighted                   Weighted
   Exercise                    Remaining      Average                    Average
    Price          Number     Contractual    Exercise        Number     Exercise
   or Range     Outstanding   Life (years)     Price      Exercisable     Price
 ------------   -----------   ------------   ---------    -----------   --------
    $1.00         337,250         7.45         $1.00         254,500      $1.00
    $5.00          83,000         8.89         $5.00          40,000      $5.00
    $8.50          30,000         9.11         $8.50          30,000      $8.50
    $9.50         123,500         9.31         $9.50          32,750      $9.50
$10.78-$10.81      13,250         9.33        $10.80             313     $10.78
    Total         587,000         8.17         $3.96         357,563      $2.86

     On October 31, 1994 upon  consummation  of the  Acquisition,  the Company's
Incentive  Stock  Option  Plan (the  "Plan")  adopted by the Board of  Directors
effective  June 1, 1992 was  cancelled.  The Plan  provided  the Board  with the
authority to grant to key  employees of the Company  incentive  stock options to
purchase  up to a maximum  of  300,000  shares of the  Company's  common  stock.
Options  granted  under the Plan were  intended to  constitute  incentive  stock
options  within the meaning of Section 422A of the Internal  Revenue  Code.  The
Board had the  authority to determine  option  periods,  the number of shares of
common  stock  subject to options  granted and such other  terms and  conditions
under which  options may be  exercised.  Options  granted under the Plan were to
expire  upon  termination  of  employment  or at the  end of the  option  period
stipulated by the Board in the option agreement, whichever was earlier. The Plan
specifically  limited the aggregate  fair market value of options which could be
exercised  by an  employee in any one  calendar  year to  $100,000.  The Board's
authority  to grant  options  under the Plan was to expire on May 31,  2002.  On
August 4, 1994,  the Board of Directors  authorized  management to grant options
covering 253,500 shares of common stock to employees. However, as of the date of
cancellation of the Plan, no options had been granted.

Stock Option Compensation

     The  Company  has  adopted  the  disclosure-only  provisions  of SFAS  123.
Accordingly,  no  compensation  cost has been  recognized  for stock options and
purchase  rights  granted  under  the  Company's  plans in  accordance  with the
requirements  of APB 25. Had  compensation  cost  related to stock  options  and
purchase rights granted under the Company's  plans been recognized  based on the
fair value of awards on the grant dates  consistent  with SFAS 123,  the Company
would have  recorded  compensation  expense of $54,972 and  $613,447  during the
years ended March 29, 1996 and March 28, 1997.


                                       59
<PAGE>

     The fair value of each option or right granted  under the  Company's  stock
option  and  purchase  plans  is  estimated  on the  date  of  grant  using  the
Black-Scholes option pricing model. The significant weighted-average assumptions
used during the years  ended  March 29, 1996 and March 28, 1997 to estimate  the
fair  values  of  options  and  rights  granted  under the  Company's  plans are
summarized in the following table.

                                           Year Ended         Year Ended
                                            March 29,          March 28,
                                              1996               1997
                                           ----------         ----------
     Stock Plan:
       Expected volaltility                    74.80%            72.30%
       Expected life                         3.5 years         3.5 years
       Risk-free interest rate                  5.22%             6.35%
       Expected dividend yield                  None              None
     Director Plan:
       Expected volaltility                     --               76.00%
       Expected life                            --             2.67 years
       Risk-free interest rate                  --                6.30%
       Expected dividend                        --                None
     Employee Plan:
       Expected volaltility                     --               76.90%
       Expected life                            --             .5 years
       Risk-free interest rate                  --                5.32%
       Expected dividend                        --                None
     
     Based on these assumptions,  the weighted-average fair value of each option
and right granted  under the Company's  plans for the years ended March 29, 1996
and  March  28,   1997   amounted   to  $2.63  and  $4.70,   respectively.   The
weighted-average  fair value of each option  granted under the Stock Plan during
the years  ended  March  29,  1996 and  March  28,  1997 was  $2.63  and  $5.04,
respectively.  The weighted-average  fair value of each option granted under the
Director   Plan  during  the  year  ended   March  28,   1997  was  $4.53.   The
weighted-average  fair value of each  purchase  right granted under the Employee
Plan during the year ended March 28, 1997 was $1.91.

     A  comparison  of the  Company's  net  income  and net  income per share as
reported and on a pro forma basis had  compensation  cost been recorded based on
the fair  value at the grant  dates for  options  and rights  granted  under the
Company's  plans in accordance  with SFAS 123 for the years ended March 29, 1996
and March 28, 1997 is set forth below:

                                                 Year Ended        Year Ended
                                                  March 29,          March 28,
                                                    1996               1997
                                                 -----------        ----------
Net income                       As reported     $ 1,177,371        $1,010,659
                                 Pro Forma       $ 1,143,618        $  634,924

Net income per share - primary   As reported     $      0.30        $     0.22
                                 Pro Forma       $      0.30        $     0.14

Net income per share - assuming 
  full dilution                  As reported     $      0.30        $     0.22
                                 Pro Forma       $      0.30        $     0.14



                                       60
<PAGE>

Common Stock Reserved

     Common stock reserved for issuance  pursuant to the Company's  stock option
and purchase plans and  outstanding  common stock warrants at March 29, 1996 and
March 28, 1997 is summarized as follows:


                                                   March 29,      March 28,
                                                     1996           1997
                                                   ---------      ---------
     Stock Option and Purchase Plans                 835,000        823,240
     Redeemable Warrants                                --          575,000
     Underwriter Warrants                               --          100,000
     Common Stock Purchase Warrants                   40,000           --
                                                   ---------      ---------
                                                     875,000      1,498,240
                                                   =========      =========

10.  INCOME TAXES

     There was no income  tax  expense  (benefit)  for the  seven  months  ended
October 30, 1994 and five months  ended March 31,  1995.  Income tax expense for
the years ended March 29, 1996 and March 28, 1997 is summarized as follows:

                                                   Year Ended    Year Ended
                                                    March 29,     March 28,
                                                      1996          1997
                                                   ---------     ---------
     Current tax expense:
         Federal                                   $ 101,615     $ 564,265
         State                                        64,051        19,154
                                                   ---------     ---------
         Total current                               165,666       583,419
                                                   ---------     ---------
     Deferred tax (benefit) expense:
         Federal                                     150,019       (52,969)
         State                                        10,630         2,929
                                                   ---------     ---------
         Total deferred                              160,649       (50,040)
                                                   ---------     ---------
                                                   $ 326,315     $ 533,379
                                                   =========     =========

     Income tax expense  differs from the amount of income taxes  determined  by
applying the applicable U.S.  statutory federal income tax rate to income (loss)
before income taxes as a result of the following:

                           Seven Months    Five Months     Year         Year
                               Ended          Ended        Ended        Ended
                            October 30,     March 31,    March 29,    March 28,
                               1994           1995         1996         1997
                             ---------      ---------    ---------    ---------
Statutory U.S. tax rates     $(143,944)     $(362,298)   $ 511,253      524,973
State taxes, net                  --             --         47,181       12,642
Non-deductible expenses         15,479         41,177      102,866       58,375
Losses for which no tax                   
  benefit was provided         128,465        321,121         --
Utilization of loss                       
  carryforwards                   --             --       (334,985)     (71,995)
Other                             --             --           --          9,384
                             ---------      ---------    ---------    ---------
Effective tax rates          $    --        $    --      $ 326,315    $ 533,379
                             =========      =========    =========    =========
                                        

                                       61
<PAGE>

         Deferred tax assets and liabilities arising from temporary  differences
at March 29, 1996 and March 28, 1997 are comprised of the following:

                                                      March 29,      March 28,
                                                        1996           1997
                                                    -----------    -----------
   Deferred tax assets:
       Net operating loss carryforwards             $ 6,596,897    $ 5,410,844
       Inventories                                      900,258        907,415
       Accrued liabilities                              165,816        205,234
       Accrued restructuring charges                      6,365         10,770
       Deferred revenue                                 145,313        145,313
       Accounts receivable                               83,528         56,947
       Depreciation                                        --           51,345
       Long-term debt                                    35,976           --
                                                    -----------    -----------
           Total deferred tax assets                  7,934,153      6,787,868
                                                    -----------    -----------
   Deferred tax liabilities:
       Other assets                                     (72,128)       (45,136)
       Property and equipment                           (59,116)       (65,125)
       Depreciation                                     (87,083)          --  
                                                    -----------    -----------
         Total deferred tax liabilities                (218,327)      (110,261)
                                                    -----------    -----------
   Excess of deferred tax assets over liabilities     7,715,826      6,677,607
   Valuation allowance                               (7,665,282)    (6,134,953)
                                                    ===========    ===========
   Net deferred tax assets                          $    50,544    $   542,654
                                                    ===========    ===========

     The  valuation  allowance  for deferred tax assets  during the seven months
ended  October  30,  1994 and five months  ended  March 31,  1995  increased  by
$1,388,060.  The  valuation  allowance  for deferred tax assets during the years
ended March 29, 1996 and March 28, 1997 decreased by $1,406,634 and  $1,530,329,
respectively.  A full valuation  allowance was maintained through March 31, 1995
because of the uncertainty of realization of deferred tax assets.

     Income taxes currently payable for the years ended March 29, 1996 and March
28,  1997 were  reduced by  $454,868  and  $71,995,  respectively,  through  the
utilization  of net operating loss  carryforwards.  During the years ended March
29, 1996 and March 28, 1997,  the Company  reduced the  valuation  allowance and
recorded  tax  benefits  of $50,544 and  $492,110,  respectively.  Deferred  tax
benefits from utilization of net operating loss  carryforwards and reductions in
the  valuation  allowance  of $211,193  and  $442,070  were  allocated to reduce
goodwill during the years ended March 29, 1996 and March 28, 1997, respectively.

     As of March 28, 1997, the Company has tax net operating loss  carryforwards
available to reduce future taxable income of  approximately  $14 million,  which
expire from 1998  through  2010.  The  utilization  of such net  operating  loss
carryforwards   and   realization  of  tax  benefits  in  future  years  depends
predominantly upon the recognition of taxable income.  Further,  the utilization
of these  carryforwards  is  subject  to annual  limitations  as a result of the
change in  ownership  of the Company (as  described in Note 2) as defined in the
Internal  Revenue  Code.  The  limitation  approximates  $210,000  annually  and
represents the value of the Company's capital stock immediately  before the date
of the ownership change multiplied by the federal  long-term  tax-exempt rate in
effect during the month the ownership change occurred.  This limitation does not
reduce the total amount of net operating  losses which may be taken,  but rather
substantially limits the amount which may be used during a particular year. As a
result,  the  Company  will be unable to use a  significant  portion  of its net
operating loss carryforwards.


                                       62
<PAGE>

11. RESTRUCTURING CHARGES AND CREDITS

     As a result of the Acquisition and additional  financing  described in Note
2, the Company was able to settle certain severance obligations under terminated
employment  contracts and negotiate the  termination  of certain  non-cancelable
lease  obligations  with  respect  to  facilities  closed in  connection  with a
restructuring initiated in fiscal 1994. The severance and lease obligations were
settled on terms more favorable than previously estimated, which resulted in the
recognition  of  restructuring  credits of $248,684 and $274,659,  respectively,
during the seven months ended October 30, 1994. In addition, the Company revised
its estimate of certain other  severance  obligations,  and recorded  additional
restructuring  credits of $10,749.  Accordingly,  during the seven  months ended
October 30, 1994, the Company realized net restructuring credits of $534,092.

     During the year ended March 28, 1997, the Company initiated a consolidation
plan  intended  to augment its  on-going  productivity  and quality  improvement
programs.  The  consolidation  plan  provided  for the closure of the  Company's
Kentucky manufacturing  facility, the closure of the Company's Georgia corporate
office  facility,  the  consolidation  of repair,  refurbishment  and conversion
service operations into the Company's Virginia facility and the consolidation of
corporate  activities  and  product  assembly  operations  into  a  new  Georgia
facility.  In  connection  with this plan,  the Company  recorded  restructuring
charges of $62,500  during the year ended March 28,  1997.  These  restructuring
charges  consist of severance  obligations  and losses related to abandonment of
assets.  Relocation  expenses and other incremental costs incurred in connection
with the consolidation and charged to operations during the year ended March 28,
1997 approximated $350,000.

12. PROFIT SHARING RETIREMENT PLAN

     On January 1, 1995,  the  Company  adopted a 401(k)  retirement  and profit
sharing plan. Eligible employees of the Company who are 21 years of age with one
or more  years of  service  and who are not  covered  by  collective  bargaining
agreements may elect to  participate in the plan.  Employees who elect to become
participants  in the plan may contribute up to 15% of their  compensation to the
plan up to a maximum  dollar  limit  established  by law.  The  Company may also
contribute   to  the  plan  at  the   discretion  of  the  Board  of  Directors.
Contributions   by  the  Company   may   consist  of   matching   contributions,
discretionary  profit  sharing  contributions  and other special  contributions.
During the five  months  ended March 31, 1995 and years ended March 29, 1996 and
March 28, 1997, the Company  accrued  profit  sharing and retirement  expense of
$2,455,  $15,650 and $26,808,  respectively,  pursuant to discretionary matching
contributions  authorized by the Board of Directors.  Contributions  to the plan
funded by the  Company  during the years ended March 29, 1996 and March 28, 1997
amounted to $14,415 and $26,416, respectively. Participants are 100% vested with
respect  to their  compensation  contributions  to the plan.  Vesting in Company
discretionary  contributions  begins  at 20%  after  one  year  of  service  and
increases by 20% annually each year until full (100%) vesting upon five years of
service.  The plan pays retirement  benefits based on the  participant's  vested
account  balance.   Benefit   distributions  are  generally   available  upon  a
participant's death, disability or retirement. Participants generally qualify to
receive  retirement  benefits  upon  reaching  the  age  of 65.  Early  retirees
generally  qualify  for  benefits  provided  they have  reached  age 55 and have
completed 5 years of service with the Company. Benefits are payable in lump sums
equal to 100% of the participant's account balance.


                                       63
<PAGE>

13. SUPPLEMENTAL CASH FLOW INFORMATION

     Supplemental  cash flow  information for the seven months ended October 30,
1994,  five  months  ended  March  31,  1995,   excluding  the  effects  of  the
Acquisition,  and years ended March 29, 1996 and March 28, 1997  consists of the
following:

                                    Seven
                                    Months    Five Months    Year        Year
                                    Ended       Ended       Ended       Ended
                                  October 30,  March 31,   March 29,   March 28,
                                     1994        1995        1996        1997
                                     ----        ----        ----        ----
Interest paid                      $457,019    $225,860    $966,153    $516,489
Income taxes paid                      --          --          --       624,644
Non-cash activities:                                                    
 Deferred offering expenses                                            
  charged against proceeds of                                         
  initial public offering              --          --          --       338,372
 Fixed assets acquired under                                           
  capital leases                     33,753       9,069        --          --
 Retirement of capital lease                                           
  obligation and write-off                                            
  of related property                  --          --          --       933,510
 Write-off of property and                                             
  equipment against accrued                                           
  restructuring charges             185,777        --          --        41,133
 Write-off of property and                                             
  equipment against                                                   
  impairment reserve                117,807        --          --          --
 Other current assets                                                  
  acquired by assumption                                              
  of debt obligations               165,102        --       131,594        --
 Accrued liabilities converted                                         
  to notes payable                     --       206,595        --          --
 Write-off of inventory                                                
  against accrued                                                     
  restructuring charges              70,229        --          --          --
 Write-off of other                                                    
  assets against accrued                                              
  restructuring charges                --        15,323        --          --
 Write-off of property and                                             
  equipment against                                                   
  accounts payable                     --          --         1,600        --
 Increase in goodwill                                                  
  from distribution of                                                
  escrow consideration                 --          --       329,709        --
 Tax benefits applied to                                               
  goodwill                             --          --       211,193     442,070
                                                                      
                                                               
                                       64
<PAGE>

14. COMMITMENTS AND CONTINGENT LIABILITIES

Operating Leases

     Minimum  future  rental  payments at March 28,  1997 under  non-cancellable
operating  leases with an initial term of more than one year are  summarized  as
follows:


1998                                                 $331,158
1999                                                  220,902
2000                                                  213,001
2001                                                  210,079
2002                                                  210,079
                                                 ------------
                                                    1,185,219
Less sublease rentals                                 (28,790)
                                                 ------------
                                                 $  1,156,429
                                                 ============

     Rental expense approximated $257,000 for the seven months ended October 30,
1994,  $176,000  for the five months  ended  March 31,  1995,  $376,000,  net of
sublease  income of  approximately  $18,000,  for year ended  March 29, 1996 and
$323,000,  net of sublease income of approximately  $45,000,  for the year ended
March 28, 1997.

Litigation, Disputes and Environmental Matters

     During the seven  months  ended  October  30,  1994,  the  Company  settled
litigation  against a supplier  to recover  costs and  damages  attributable  to
defective  components supplied to the Company,  and realized a gain of $261,000,
net of legal fees of $56,000.

     Pursuant to the terms of a settlement  agreement  and mutual  release dated
July 3, 1996, a suit filed  against the Company by a former  supplier to collect
approximately $400,000 of unpaid obligations was dismissed with prejudice. Under
the terms of the settlement  agreement,  the Company paid $180,000 and agreed to
pay an  additional  $112,500  in  six  equal  monthly  installments  of  $18,750
commencing  on August 15, 1996.  As a result of the  settlement  agreement,  the
Company realized a gain of $105,146  representing the difference  between unpaid
obligations recorded in the Company's accounts and aggregate settlement payments
set forth in the  settlement  agreement.  The gain is reflected in the Company's
results of operations for the year ended March 28, 1997.

     The  Company  has  been  involved  in a  dispute  with  a  former  contract
manufacturer since 1994 with respect to inventories acquired by the manufacturer
for the Company's programs,  which approximate $l million, unpaid obligations of
the Company of approximately  $265,000,  and other matters  including an alleged
claim of lost profits by the contract  manufacturer  of  approximately  $916,000
related to the Company's minimum contract purchase  commitment.  The Company has
alleged that the contract manufacturer  breached the agreement,  is obligated to
pay unpaid obligations to the Company of approximately $125,000 and is obligated
to the Company for lost  business  and expenses due to the delivery of defective
products and the termination of a significant sales agreement.  Neither party is
presently pursuing the dispute. There is no assurance, however, that the dispute
will not be pursued or escalate  into  litigation.  Should the dispute  escalate
into  litigation,  the  Company  intends  to defend  and  pursue  its  positions
vigorously.  In the opinion of management,  the ultimate  outcome of this matter
will not have a  material  impact on the  Company's  financial  position  or its
results of operations.

     The Company is a potentially  responsible party with respect to undertaking
response  actions at a facility  for the  treatment,  storage  and  disposal  of
hazardous  substances  operated  by an  unaffiliated  party.  In the  opinion of
management,  the ultimate outcome of this  environmental  action will not have a
material  impact  on  the  Company's   financial  position  or  its  results  of
operations.


                                       65
<PAGE>

Significant Customers

     The Company's  primary  customers  consist of the regional  bell  telephone
companies. During the seven months ended October 30, 1994, three of the regional
bell  telephone  companies  accounted  for  33%,  23% and  11% of the  Company's
consolidated  sales.  During the five months ended March 31,  1995,  four of the
regional  bell  telephone  companies  accounted for 34%, 23%, 11% and 10% of the
Company's consolidated sales. During the year ended March 29, 1996, three of the
regional  bell  telephone  companies  accounted  for  47%,  17%  and  24% of the
Company's consolidated sales. During the year ended March 28, 1997, three of the
regional  bell  telephone  companies  accounted  for  14%,  16%  and  60% of the
Company's  consolidated  sales.  Accounts receivable at March 29, 1996 and March
28, 1997  consists  primarily  of amounts due from the regional  bell  telephone
companies.

Royalty and License Agreements

     Pursuant  to the  terms  of an asset  purchase  agreement  entered  into on
January 11, 1991, the Company agreed to pay royalties  equal to 3.5% of sales of
microprocessor-based  components to a company  affiliated with certain  officers
and employees of the Company. On November 9, 1994, the royalty provisions of the
purchase  agreement were amended to eliminate  royalties for the period April 2,
1994 to September 30, 1994. In return,  the term of the royalty  obligation  was
extended  from  December 31, 1995 to June 30, 1996.  Royalty  expense under this
agreement  amounted to $3,900  during the seven months  ended  October 30, 1994,
$93,578  during the five months ended March 31, 1995,  $563,750  during the year
ended March 29, 1996 and $196,144 during the year ended March 28, 1997.

     The Company has  entered  into a patent  license  agreement  providing  the
Company  with the  exclusive  world-wide  rights to certain  algorithm  software
covered by a patent  application.  The Company is  obligated to pay license fees
aggregating  $200,000  at a rate of  $50,000  annually  over a four year  period
commencing on the date the patent is issued. Further, the agreement provides for
the  payment of  royalties  on products  incorporating  the  licensed  software.
Minimum  royalties  payable  upon  issuance  of the patent  will  range  between
$125,000 and $500,000  annually  during the life of the patent.  The term of the
license  agreement will correspond to the expiration date of the patent upon its
issuance. As of March 28, 1997, the patent has not been issued. Accordingly, the
Company has not recorded the contingent liability in the accompanying  financial
statements. Further, as of March 28, 1997, the Company has not sold any products
incorporating  the licensed  software or incurred any royalty  obligations under
the agreement.

     In December 1994, the Company sold the rights to certain  product  software
for an aggregate  purchase price of $500,000.  The Company received an exclusive
irrevocable  perpetual  right to sublicense the software in connection  with the
sale of  products  to other  customers.  In return,  the  Company  agreed to pay
royalties  equal to the  greater of 4.44% of sales or $10 per unit  sold.  As of
March 28, 1997, the Company has not sold any products incorporating the licensed
software to other  customers  or  incurred  any  royalty  obligations  under the
agreement The Company was  obligated to repay,  three years from the date of the
contract,  a portion of the  purchase  price up to a maximum  amount of $375,000
depending upon the amount of aggregate royalties paid pursuant to the agreement.
However,  in May 1997, the Company entered into an agreement that terminated the
Company's royalty and repayment obligations.

Employment Contracts

     On October 31, 1994, the Company  entered into an employment  contract with
one of its executives that provides for minimum annual  compensation of $147,200
through December 31, 1996 and $160,000 from January 1, 1997 through December 31,
1997. The contract provides for compensation  increases at the discretion of the
Board of  Directors,  additional  compensation  in the form of bonuses  based on
performance,  benefits  equal  to those  provided  to  other  executives  of the
Company,  reimbursement  of  business  expenses,  travel  and  temporary  living
expenses  and options to purchase  shares of the  Company's  common  stock.  The
agreement  provides for annual  renewals  subsequent to December 31, 1997 at the
option of the Company.  Termination  by the Company  


                                       66
<PAGE>

without cause  entitles the executive to receive his current salary and benefits
for the remaining term of the agreement or for a period of six months, whichever
is greater.  The agreement  may be  terminated  by the  executive  upon 120 days
notice effective on December 31, 1997 or thereafter.

     On October  31,  1994,  the  Company  entered  into an  agreement  with the
Chairman of the Board of Directors that provides for minimum annual compensation
of $60,000  through  December 31, 1997.  The agreement  provides for  additional
compensation  based on  services  performed  not to  exceed  $2,500  per  month,
benefits  equal  to  those   provided  to  other   executives  of  the  Company,
reimbursement  of  business  expenses  and  options  to  purchase  shares of the
Company's  common stock.  Termination by the Company  without cause entitles the
Chairman to receive his current  salary and benefits for the  remaining  term of
the agreement or for a period of six months, whichever is greater. The agreement
may be  terminated  by the  Chairman  upon  90 days  written  notice.  Prior  to
execution  of  the  Chairman's  Agreement,   the  Chairman  provided  consulting
services, as President of Atlantic Management  Associates,  Inc., to the Company
during the seven months ended October 30, 1994 similar to those  provided  under
the  Chairman's  Agreement.  In addition,  Atlantic  Management  Services,  Inc.
assisted the Company and its  stockholders  in their  efforts to attract a buyer
for the equity of the Company, and received a success fee in connection with the
Acquisition  of $75,000  representing  compensation  for such  services.  During
fiscal 1995, the Company paid Atlantic Management  Associates,  Inc. $43,000 for
consulting services, excluding expenses of $7,386, rendered prior to the date of
the Chairman's Agreement.  During fiscal 1995, the Company paid the Chairman and
Atlantic Management Associates,  Inc. $30,231, excluding expenses of $9,419, for
services rendered under the terms of the Chairman's  Agreement.  During the year
ended March 29, 1996,  the Company  paid the  Chairman  and Atlantic  Management
Associates,  Inc. $66,000, excluding reimbursed expenses of $9,007, for services
rendered  under the terms of the  Chairman's  Agreement.  During  the year ended
March  28,  1997,  the  Company  paid  the  Chairman  and  Atlantic   Management
Associates, Inc. $69,000, excluding reimbursed expenses of $11,003, for services
rendered under the terms of the Chairman's Agreement.

Purchase and Sales Commitments

     At March 28, 1997, the Company has outstanding  purchase order  commitments
to purchase  approximately $5.5 million of  microprocessor-based  products under
the terms of a  manufacturing  agreement  entered into in October  1994.  Upon a
termination  of the  agreement  by the  Company,  the  Company is  obligated  to
purchase  inventories held by the  manufacturer and pay vendor  cancellation and
restocking charges, and a reasonable profit thereon. In addition, the Company is
obligated  to pay a  cancellation  penalty of up to  $500,000  if it cancels its
purchase  obligation  or a  substantial  portion  thereof.  The  amount  of  the
cancellation  penalty, if any, will vary depending upon quantities  purchased by
the Company.

     In June 1997,  the Company  entered into an agreement  that  supersedes and
terminates a December 1994 sales agreement. Under the new agreement, the Company
agreed to reduce the customers  remaining  purchase  commitment of certain smart
processors and other components to  approximately $3 million from  approximately
$8 million  under the former  agreement  and,  among other  things,  upgrade the
customer's  payphone  management system. In return, the customer made a $250,000
cash  payment  to  the  Company,  terminated  the  Company's  obligation  to pay
royalties on sales of certain  products to other  customers and  terminated  the
Company's obligation to repay $375,000 received from the sale of certain product
software  under the December  1994  agreement.  The customer also agreed to make
additional  cash payments of $250,000 on July 2, 1997,  $100,000 on September 1,
1997,  $150,000  on  December  31,  1997 and  $250,000  on March 31, 1998 to the
Company subject to the Company's compliance with the terms and conditions of the
agreement, including conditions with respect to product performance, service and
repair.  The customer has the right to cancel the agreement  upon default by the
Company.  Therefore,  there is no  assurance  that the Company  will receive the
additional  payments  or that  its  will  ship  the  products  set  forth in the
agreement.


                                       67
<PAGE>

                                    PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The  following  sets forth the name and age of each  director and executive
officer of the Company,  his positions and offices with the Company,  his period
of service  with the Company and his business  experience  for at least the past
five years, and with respect to directors,  their present  principal  occupation
and other directorships held in public companies.

Directors

     Directors  are  elected  to  serve  for a  one-year  term and  until  their
successors are elected and qualified. The Bylaws of the Company provide that the
number  of  directors  shall be  determined  from  time to time by the  Board of
Directors or the  stockholders of the Company,  but that there shall be at least
one  director.  Directors  of the Company who were serving as such at the end of
the 1997 fiscal year are as follows:

Name                                       Age                    Director Since

David R. A. Steadman, Chairman             60                          1994
D. Thomas Abbott                           43                          1996
Vincent C. Bisceglia                       42                          1994
Charles E. Davidson                        44                          1994
Mark L. Plaumann                           41                          1997
Olivier Roussel                            50                          1986

     David  R.  A.  Steadman.  Mr.  Steadman  has  been  President  of  Atlantic
Management  Associates,  Inc., a management services firm, since 1988. From 1990
to 1994, Mr. Steadman served as President and Chief Executive Officer of Integra
-- A Hotel and Restaurant Company,  and from 1987 to 1988, as Chairman and Chief
Executive Officer of GCA Corporation,  a manufacturer of automated semiconductor
capital  equipment.  From 1980 to 1987,  Mr.  Steadman  was a Vice  President of
Raytheon  Company,  a defense  electronics  manufacturer,  and served in various
management  positions,  most  recently  as  President  of  its  venture  capital
division.  Mr.  Steadman  is  Chairman  of the  Board  of  Directors  of  Wahlco
Environmental  Systems,  Inc.,  a  manufacturer  of  environmental  conditioning
systems.  He is also a  director  of Aavid  Thermal  Technologies,  Inc.,  which
manufactures  thermal  management  products  and  produces  computational  fluid
dynamics  software;  Kurzweil Applied  Intelligence,  Inc., a voice  recognition
software company; and Vitronics Corporation,  a manufacturer of reflow soldering
ovens. Mr. Steadman was elected  Chairman of the Board of Directors  pursuant to
an employment  agreement described under the heading  "Employment  Contracts and
Termination  of Employment  and  Change-in-Control  Arrangements"  in Item 11 --
"Executive Compensation."

     Thomas Abbott.  Mr. Abbott has been Chairman of MeesPierson  Holdings Inc.,
the United States  operation of a Dutch merchant bank,  since 1995. From 1993 to
1995, Mr. Abbott was Chairman and Chief Executive Officer of Savin  Corporation,
an office products  company,  and from 1989 to 1993, he was President of Harvest
Group,  Inc., a private  investment  firm.  From 1976 to 1988,  Mr.  Abbott held
various executive positions with Bankers Trust Company. Mr. Abbott is a director
of International  Mezzanine  Investment N.V.,  Precise Holdings Inc., and Coffee
Tree Limited.


                                       68
<PAGE>

     Vincent  C.  Bisceglia.  Mr.  Bisceglia  has  served as a  director  and as
President and Chief Executive  Officer of the Company since February 1994. Prior
to  that he  served  the  Company  as a  consultant  and in  various  management
positions.  From 1982 to 1986,  Mr.  Bisceglia was Executive  Vice  President of
Transaction Management,  Inc., a manufacturer of point-of-sale systems, and from
1978 to 1982, he held senior marketing positions with National Semiconductor-DTS
and Siemens-Nixdorf Computer Corporation.

     Charles E.  Davidson.  Mr.  Davidson has served as Chairman of the Board of
Wexford Capital  Corporation,  which served as the investment manager to several
private  investment  funds,  including Wexford Partners Fund, L.P., the majority
stockholder  of the  Company.  Since  January 1,  1995,  Mr.  Davidson  has been
Chairman of Wexford  Management LLC, a private  investment  management  company,
which now serves as the investment  manager to Wexford  Partners Fund, L.P. From
1984 to 1994, Mr. Davidson was a partner of Steinhardt Partners, L.P., a private
investment  firm, and from 1977 to 1984,  Mr.  Davidson was employed by Goldman,
Sachs & Co.,  serving as Vice President of corporate bond trading.  Mr. Davidson
is  Chairman  of the  Board of DLB Oil & Gas,  Resurgence  Properties  Inc.  and
Presidio Capital Corp. and is a director of Wahlco Environmental  Systems, Inc.,
a manufacturer of environmental conditioning systems.

     Mark L. Plaumann.  Mr. Plaumann has been a Senior Vice President of Wexford
Management LLC ("Wexford  Management") since January 1996 and since March 1995 a
director  and/or  Vice  President  of the  general  partner  of  various  public
partnerships managed by Wexford Management.  Mr. Plaumann joined the predecessor
entities  of Wexford  Management  in  February  1995.  Prior to joining  Wexford
Management,  Mr. Plaumann was a Managing  Director of Alvarez & Marsal,  Inc., a
crisis  management  consulting firm, from 1990 to 1995, and from 1985 to 1990 he
was with  American  Healthcare  Management,  Inc.,  an  owner  and  operator  of
hospitals,  where he served in a variety of  capacities,  most  recently  as its
President.  Prior  to that he was with  Ernst & Young  LLP in its  auditing  and
consulting  divisions  for eleven  years.  Mr.  Plaumann is a director of Wahlco
Environmental  Systems,  Inc.,  a  manufacturer  of  environmental  conditioning
systems.

     Olivier Roussel.  Mr. Roussel has been Chairman and President of Acor S.A.,
a private  investment  company,  since  1975.  From 1974 to 1977,  he was a Vice
President  of  Nobel-Bozel  and from  1977 to 1982 he was an  Assistant  General
Manager of Heli-Union.  Mr. Roussel was a Director of Roussel-Uclaf from 1975 to
1982 and  Chairman of Eminence  S.A.  from 1987 to 1990.  He is Chief  Operating
Officer and a Director of Vacsyn S.A., a biotechnology  company,  and a director
of Bollore Technologies, a public company listed on the Paris Stock Exchange.

Executive Officers

     Executive  Officers are elected by the Board of  Directors  and serve until
they resign or are removed by the Board.  The Company's  executive  officers who
served as such during fiscal 1997 are as follows:

Name                     Age               Positions and Offices

David R. A. Steadman     60       Chairman of the Board of Directors
Vincent C. Bisceglia     42       President and Chief Executive Officer, 
                                  Director
M. Winton Schriner       50       Executive Vice President, Operations
Darold R. Bartusek       50       Senior Vice President, Sales and Marketing
William H. Thompson      44       Vice President, Finance, Chief Financial 
                                  Officer and Secretary
Allen W. Vogl            49       Vice President, Engineering

     The business  experience  of Messrs.  Steadman  and  Bisceglia is set forth
above under the listing of directors of the Company.


                                       69
<PAGE>

     M. Winton Schriner.  Mr. Schriner has served as Executive Vice President of
Operations  since  July  1996.  From  August  1994 to April  1996,  he served as
Director of Contract  Manufacturing.  From 1991 to 1993, Mr. Schriner served the
Company in various capacities  including Vice President of Operations,  Director
of Marketing and Director of Engineering.  Prior to joining the Company in 1991,
he was at  BellSouth  Telecommunications  Company  for a  period  of 12 years in
various management  capacities with duties ranging from public communications to
strategic planning and executive  support.  He holds a B.S. degree in Industrial
Education and an M.S. degree in Vocational Rehabilitation from the University of
Wisconsin.

     Darold R.  Bartusek.  Mr.  Bartusek has served as Senior Vice  President of
Sales and Marketing  since November 1996 and from February 1994 to April 1996 he
was Vice  President  of Sales and  Marketing.  From 1991 to February  1994,  Mr.
Bartusek  served the Company in various  capacities  including Vice President of
Worldwide  Sales and Vice President and General  Manager of the Company's  Smart
Product Business.  From August 1989 to January 1991, Mr. Bartusek served as Vice
President of Marketing of the Public Communication Systems Division of Executone
Information  Systems,  Inc., a supplier of smart payphone systems.  From 1973 to
1988,  Mr.  Bartusek  served GTE  Communication  Systems  Corporation in various
capacities   including  Director  of  Public   Communications  and  Director  of
Advertising and Sales Promotion. Mr. Bartusek holds a B.B.A. degree from Mankato
State University.

     William H. Thompson.  Mr. Thompson has served as Vice President of Finance,
Chief  Financial  Officer and Secretary of the Company since February 1994. From
1990 to 1994,  he was Vice  President of Finance.  Prior to joining the Company,
Mr.  Thompson was Controller  and Vice  President of Finance of Cardiac  Control
Systems, Inc., a publicly-held medical device manufacturer, from May 1983 to May
1988 and Executive  Vice  President of  Operations  and Finance from May 1988 to
June 1990. From June 1974 to May 1983, he held various positions,  most recently
as Audit Manager,  with Price Waterhouse LLP, certified public accountants.  Mr.
Thompson is a certified  public  accountant  in the State of Florida and holds a
B.S. degree in accountancy from Florida State University.

     Allen W. Vogl. Mr. Vogl has served as Vice  President of Engineering  since
February 1994 and before that, he served the Company in various capacities since
1981,  including  Vice  President of  Engineering,  Executive Vice President and
Chief Scientist.  From 1972 to 1981, he was employed in various  engineering and
research and development capacities by Harris Corporation and Storage Technology
Corporation.

Section 16(a) Beneficial Ownership Reporting Compliance

     Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and directors,  and persons who own more than 10% of a registered class
of the Company's equity securities ("Insiders") to file reports of ownership and
certain changes in ownership with the Securities and Exchange  Commission and to
furnish the Company  with copies of those  reports.  Based solely on a review of
Forms 3 and 4 and  amendments  thereto  during the most recent fiscal year ended
March 28, 1997 and Forms 5 and amendments  thereto furnished to the Company with
respect to the fiscal year ended March 28, 1997 and any written  representations
by Insiders that no Form 5 is required,  Messrs.  Abbott,  Bartusek,  Bisceglia,
Davidson,  Roussel,  Schriner,  Steadman,  Thompson  and Vogl as well as Wexford
Partners Fund, L.P. each filed late his Form 3, "Initial Statement of Beneficial
Ownership of  Securities"  (required as a result of the  Company's  registration
statement  relating to its initial public offering becoming effective on May 10,
1996.)

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


                                       70


<PAGE>

Item 11. EXECUTIVE COMPENSATION

     This item contains information about compensation, stock options grants and
employment   arrangements  and  other  information  concerning  certain  of  the
executive officers of the Company.

Summary Compensation Table

     The  following  table  sets forth the  compensation  the  Company  paid for
services  rendered during the fiscal years ended March 28, 1997,  March 29, 1996
and March 31, 1995 by the Chief Executive Officer and the four other most highly
compensated  executive  officers  of the  Company  whose  compensation  exceeded
$100,000 in fiscal 1997 and who were serving at the end of the 1997 fiscal year.

<TABLE>
<CAPTION>

                                                                                       Long Term Compensation
                                                Annual Compensation                           Awards
                                    --------------------------------------------    ------------------------------
                                                                    Other Annual     Securities
                                                                      Compen-        Underlying        All Other
                                     Fiscal   Salary*     Bonus      sation (1)       Options        Compensation
Name and Principal Position           Year      ($)        ($)          ($)             (#)              ($)

<S>                                   <C>     <C>        <C>          <C>             <C>               <C>    
Vincent C. Bisceglia (1)              1997    150,055    71,438       30,729             --             7,760 (2)
President & Chief Executive           1996    147,200       --        26,915             --             5,932
Officer                               1995    121,970    52,500       37,405            150,000         4,088

M. Winton Schriner                    1997    114,154       --           --             25,000          6,794 (3)
Executive Vice President,             1996     80,000       --           --             15,000          5,638
Operations                            1995     32,000       --           --             15,000          1,766

Darold R. Bartusek                    1997    104,000       --           --             25,000          7,390 (4)
Senior Vice President, Sales &        1996    104,000       --           --             15,000          6,282
Marketing                             1995    99,600     17,500          --             15,000          5,754

William H. Thompson (1)               1997    114,567       --           --             15,000          7,429 (5)
Vice President, Finance, Chief        1996    107,536       --           --             10,000          6,063
Financial Officer, Secretary          1995    102,986    35,000       40,147            30,000          6,029
                                                                                      
Allen W. Vogl (1)                     1997    110,455       --        28,492               --           7,037 (6)
Vice President, Engineering           1996    108,400       --        31,824            15,000          6,456
                                      1995    103,814    35,000       38,269            15,000          6,110
</TABLE>
-------------
*    Includes commissions.

(1)  Other  Compensation  with respect to Mr.  Bisceglia and Mr. Vogl represents
     the  estimated  incremental  costs to the  Company  of  reimbursements  and
     payments  of  their  travel  expenses  to and from the  Company  and  their
     respective  residences and temporary living  expenses,  and with respect to
     Mr. Thompson, represents reimbursement of relocation expenses.

(2)  Of this  amount,  $198  represents  the taxable  portion of group term life
     insurance provided by the Company;  $3,279 represents  premiums paid by the
     Company  for  split-dollar  universal  life  insurance;  $2,284  represents
     premiums paid by the Company for long-term disability insurance; and $1,999
     represents  contributions  made by the Company to the 401(k) Profit Sharing
     Retirement Plan for the account of the executive.


                                       71
<PAGE>

(3)  Of this  amount,  $403  represents  the taxable  portion of group term life
     insurance provided by the Company;  $3,713 represents  premiums paid by the
     Company  for  split-dollar  universal  life  insurance;  $2,234  represents
     premiums paid by the Company for long-term disability  insurance;  and $444
     represents  contributions  made by the Company to the 401(k) Profit Sharing
     Retirement Plan for the account of the executive.

(4)  Of this  amount,  $311  represents  the taxable  portion of group term life
     insurance provided by the Company;  $3,494 represents  premiums paid by the
     Company  for  split-dollar  universal  life  insurance;  $2,503  represents
     premiums paid by the Company for long-term disability insurance; and $1,082
     represents  contributions  made by the Company to the 401(k) Profit Sharing
     Retirement Plan for the account of the executive.

(5)  Of this  amount,  $139  represents  the taxable  portion of group term life
     insurance provided by the Company;  $3,725 represents  premiums paid by the
     Company  for  split-dollar  universal  life  insurance;  $2,418  represents
     premiums paid by the Company for long-term disability insurance; and $1,147
     represents  contributions  made by the Company to the 401(k) Profit Sharing
     Retirement Plan for the account of the executive.

(6)  Of this  amount,  $214  represents  the taxable  portion of group term life
     insurance provided by the Company;  $3,581 represents  premiums paid by the
     Company  for  split-dollar  universal  life  insurance;  $2,773  represents
     premiums paid by the Company for long-term disability  insurance;  and $469
     represents  contributions  made by the Company to the 401(k) Profit Sharing
     Retirement Plan for the account of the executive.

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


                                       72
<PAGE>

Option Grants in the Last Fiscal Year

         The  following  table sets forth  certain  information  with respect to
options to purchase shares of common stock of the Company  ("Common Stock") that
were granted to each of the Company's  executive  officers  named in the Summary
Compensation Table, above, during the fiscal year ended March 28, 1997.

<TABLE>
<CAPTION>
                                                                                           Potential Realizable
                                                                                          Value at Assumed Annual
                                                                                           Rates of Stock Price
                                                                                             Appreciation for
                                                 Individual Grants                            Option Term (2)
                              -------------------------------------------------------     ------------------------
                              Number of    Percent of Total
                              Securities  Options Granted to   Exercise
                              Underlying     Employees in       Price      Expiration         5%          10%
 Name                          Options     Fiscal Year 1997      ($)          Date            ($)         ($)

<S>                             <C>               <C>            <C>        <C>             <C>         <C>    
 Vincent C. Bisceglia            None              --             --           --             --           --
 M. Winton Schriner (1)         25,000            13%            9.50       07/23/06        149,362     378,513
 Darold R. Bartusek (1)         25,000            13%            9.50       07/23/06        149,362     378,513
 William H. Thompson (1)        15,000            8%             9.50       07/23/06        89,617      227,108
 Allen W. Vogl                   None              --             --           --             --           --
</TABLE>
-------------
(1)  These  options  were  granted at an  exercise  price equal to the per share
     market  value of the Common  Stock on the grant date and vest in four equal
     annual  installments on the grant date and the first three anniversaries of
     the grant date. In the event of a change in control of the Company,  50% of
     the shares not then exercisable will become fully exercisable.

(2)  The  potential  realizable  value  is  calculated  based on the term of the
     option (ten years) at its date of grant.  It is calculated by assuming that
     the stock price on the date of grant  appreciates  at the indicated  annual
     rate compounded  annually for the entire term of the option;  however,  the
     optionee  will not actually  realize any benefit from the option unless the
     market value of the Company's stock price in fact increases over the option
     price.

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


                                       73
<PAGE>

Aggregated  Option  Exercises in the Last Fiscal Year and Fiscal Year-End Option
Values

     The following table sets forth for each of the Company's executive officers
named in the Summary  Compensation Table, above,  certain information  regarding
exercises of stock options during the fiscal year ended March 28, 1997 and stock
options held at that date.  The "Value of  Unexercised  In-the-Money  Options at
Fiscal  Year End" is based on the  difference  between  the market  price of the
Common  Stock  subject to the option on March 28, 1997 ($5.25 per share) and the
option exercise  (purchase)  price per share.  During fiscal 1997, there were no
option  exercises  by  any of  the  executive  officers  named  in  the  Summary
Compensation Table, above.

<TABLE>
<CAPTION>
                              Number of Securities Underlying Unexercised       Value of Unexercised In-the-Money
                                      Options at Fiscal Year End                   Options at Fiscal Year End
                                                 (#)                                          ($) 
                            ------------------------------------------------ ----------------------------------------
Name                              Exercisable            Unexercisable            Exercisable       Unexercisable

<S>                                 <C>                     <C>                     <C>                <C>    
Vincent C. Bisceglia                112,500                 37,500                  478,125            159,375
M. Winton Schriner                   25,000                 30,000                  49,687              17,812
Darold R. Bartusek                   25,000                 30,000                  49,687              17,812
William H. Thompson                  31,250                 23,750                  96,875              33,125
Allen W. Vogl                        18,750                 11,250                  49,687              17,812
</TABLE>

Employment  Contracts  and  Termination  of  Employment  and   Change-in-Control
Arrangements

     Mr.  Bisceglia.  On October 31, 1994, the Company and Mr. Bisceglia entered
into an  employment  agreement  that expires on December  31,  1997,  subject to
certain early termination provisions and automatic renewal provisions.  Pursuant
to the  agreement,  Mr.  Bisceglia  serves as the President and Chief  Executive
Officer  and as a director  of the  Company  and is paid an annual  salary of at
least $147,200.  His base salary is subject to annual review for merit and other
increases at the  discretion of the Board of Directors as of January 1, 1996 and
each year thereafter,  and as a result of such reviews,  Mr.  Bisceglia's annual
salary was increased to $160,000 per year on January 1, 1997.

     Pursuant to the terms of the  agreement,  Mr.  Bisceglia is entitled to the
same  benefits made  available to the other senior  executives of the Company on
the same terms and conditions as such  executives.  The agreement  provides that
the Company will reimburse and/or pay on Mr. Bisceglia's behalf up to $4,000 per
month of temporary living expenses, including travel to and from the Company and
Mr. Bisceglia's residence, until the Company requires Mr. Bisceglia to relocate,
at the Company's expense. Mr. Bisceglia is also entitled to receive an incentive
bonus for each fiscal year during the term of the  agreement  equal to 2% of the
operating  profits  of  the  Company,   defined  as  net  income  before  taxes,
amortization  and  depreciation,   interest,   gains  and  losses  arising  from
revaluation  of assets,  and charges or  allocations  by a parent or  affiliated
company  except to the extent that such charges are for expenses  that  directly
relate to the operations of the Company.

     Mr.  Bisceglia  was also  granted  pursuant to the  agreement  an option to
purchase  150,000 shares of Common Stock at an exercise price of $1.00 per share
under the Company's  1994 Omnibus Stock Plan.  The shares  subject to the option
become exercisable in four equal annual  installments  commencing on the date of
grant. In the event the Company's majority  shareholder,  Wexford Partners Fund,
L.P., ceases to own at least 51% of the Company's  outstanding voting stock, the
option  becomes  exercisable in full. The option expires ten years from the date
of  grant,  unless  earlier  terminated  upon  termination  of  Mr.  Bisceglia's
employment for cause or upon Mr. Bisceglia's resignation. The agreement contains
provisions that require the Company, at the option of Mr. Bisceglia, to purchase
unexercised  option  shares at market  value if Mr.  Bisceglia's  employment  is


                                       74
<PAGE>

terminated  by the Company for reasons other than cause.  Otherwise,  the option
remains in effect until its expiration date.

     If the agreement is terminated by the Company without cause,  Mr. Bisceglia
is  entitled  to  receive  the  amount of  compensation  and  benefits  he would
otherwise  have  received  for the  remaining  term of the  agreement or for six
months,  whichever period is longer. The agreement is automatically  renewed for
additional  one-year  periods unless the Company provides Mr. Bisceglia 180 days
notice of non-renewal or Mr. Bisceglia provides the Company with 120 days notice
of termination on December 31, 1997, or on any date thereafter.

     Pursuant to the agreement, Mr. Bisceglia is indemnified by the Company with
respect to claims made against him as a director,  officer,  and/or  employee of
the Company or any subsidiary of the Company to the fullest extent  permitted by
the  Company's  Certificate  of  Incorporation,  its  by-laws  and  the  General
Corporation Law of the State of Delaware.

     Mr.  Steadman.  Mr.  Steadman is  employed  by the  Company  pursuant to an
agreement  dated  October 31, 1994 at the rate of $5,000 per month plus $500 per
day for each day spent on Company  business  outside of the New England area (in
which Mr.  Steadman's  office is located),  but not to exceed  $7,500 in any one
month. Pursuant to the agreement,  Mr. Steadman is elected Chairman of the Board
of Directors and in that capacity  renders advice to the Board and management on
business,  operational  and  financial  matters.  Mr.  Steadman  is  entitled to
participate in employee benefit plans made available to other senior  executives
of the Company.  The agreement also provided for the grant to Mr. Steadman of an
option to purchase  50,000 shares of Common Stock at an exercise  price of $1.00
per  share.  The  option  has  substantially  the  same  terms  as  those of Mr.
Bisceglia's option, described above.

     Other  Officers.  Effective  July 1,  1996,  the  Company  adopted a policy
regarding  all  officers of the Company,  which is  described  under the heading
"Report  of the  Compensation  Committee  on  Executive  Compensation  --  Other
Executive Officers," below.

Notwithstanding  anything  to the  contrary  set  forth in any of the  Company's
filings under the Securities Act of 1933, as amended, or the Securities Exchange
Act of 1934, as amended,  that might incorporate future filings,  including this
Annual  Report on Form  10-K in whole or in part,  the  following  report of the
Compensation  Committee,  and the  Performance  Graph  shall not be deemed to be
incorporated by reference into any such filings.

Report of the Compensation Committee on Executive Compensation

     This report has been prepared by the Compensation Committee of the Board of
Directors of the Company and addresses the Company's  compensation policies with
respect to the Chief Executive Officer and executive  officers of the Company in
general for the fiscal year ended March 28, 1997. Except for Mr. Steadman,  each
member of the Committee is a non-employee director. Mr. Steadman's  compensation
is based on his employment agreement, described above, which was approved by the
Board of Directors in November 1994.

Compensation Policy

     The overall intent of the Committee in respect of executive  officers is to
establish levels of compensation that provide appropriate incentives in order to
command high levels of individual  performance and thereby increase the value of
the Company to its stockholders, and that are sufficiently competitive to retain
and  attract  the skills  required  for the  success  and  profitability  of the
Company.  The principal  components of executive  compensation are salary, bonus
and stock options.


                                       75
<PAGE>

Chief Executive Officer's Compensation

     The Chief Executive  Officer's  compensation  for fiscal 1997 is based on a
written  employment  agreement  that was negotiated and entered into between him
and the  Company  in  October  1994 and is  described  above  under the  heading
"Employment  Contracts  and  Termination  of  Employment  and  Change-in-Control
Arrangements."  The salary in the agreement was  determined to be appropriate by
the members of the Committee at the time the agreement was entered into based on
the  financial  and legal  difficulties  that the Company had  experienced;  the
expertise and  responsibility  that the position  requires;  the Chief Executive
Officer's  experience with the Company in other  capacities;  and the subjective
judgement of members of a reasonable  compensation level. The increase in salary
granted  by  the  Committee  in  January  1997  was  based  on  Mr.  Bisceglia's
performance  during  fiscal  1997 and  that of the  Company  as a whole  and the
subjective judgement of Committee members of a reasonable raise.

Other Executive Officers

     Officers'  Policy.  Effective  July 1, 1996,  the Company  adopted a policy
regarding all officers of the Company to acknowledge that they have extra duties
and  responsibilities and that they are held to a higher standard of performance
than  employees  generally.   The  policy  provides,  among  other  things,  for
Company-paid  life  insurance for each officer in the amount of two and one-half
times base salary; long term disability insurance coverage; the establishment of
an annual pool of funds from the Company's  operating profits for the payment of
bonuses;  severance benefits in the event the officer's employment is terminated
without cause consisting of a minimum of continued payment of two months' salary
and a maximum of four months' salary,  plus the continuation of Company benefits
during the period of continued salary payment;  and the acceleration of one-half
of the officer's  unvested option shares in the event of a sale of substantially
all of the assets of the Company or a person or entity acquires more than 51% of
the outstanding  voting stock of the Company.  The policy also provides the same
level of indemnity as for Mr. Bisceglia, described above.

     Salary. During fiscal 1997, the salary of each executive officer other than
the salary of the  Chairman and the Chief  Executive  Officer  (described  above
under the heading  "Employment  Contracts  and  Termination  of  Employment  and
Change-in-Control  Arrangements") was based on the level of his prior salary and
on the subjective judgement of members of the Committee as to what constitutes a
compensation  level that is fair and  calculated  to retain the executive in the
Company's employ. In the case of one executive officer,  his salary increase was
also based on a promotion to a new position with increased responsibilities.

     Bonuses. In July 1996 pursuant to the Officers' Policy described above, the
Compensation  Committee  adopted a bonus plan for the 1997 fiscal year  covering
officers which also covers key employees of the Company other than those covered
under a sales bonus plan of the Company.  Bonuses  under the plan are to be paid
out of a pool of funds  equal to 15% of the net income of the Company (i) before
taxes and before the payment of any bonuses paid  outside of the plan,  (such as
to the Chief Executive  Officer  pursuant to his employment  agreement) and (ii)
after deducting an amount equal to 15% of stockholders'  equity.  The allocation
of  the  fund  to  individual  officers  and  key  employees  is  based  on  the
recommendations  to  the  Compensation  Committee  of  the  Chairman  and  Chief
Executive  Officer.  The decision of the Compensation  Committee is final and is
based the recommendations it receives and the subjective judgement of members of
the Committee.

     Mr.  Bartusek's  incentive  bonus  compensation as Senior Vice President of
Sales and Marketing is based on the difference  between the Company's  quarterly
revenues in fiscal 1996 and the corresponding quarterly revenues in fiscal 1997.
If 1997 quarterly  revenues meet a minimum target  established for each quarter,
he is paid a percentage  of the  difference.  The plan was based on the budgeted
revenues  for fiscal  1997 and the  subjective  judgement  of the members of the
Committee  as to the  appropriate  level of  incentive  payment if the  budgeted
minimum quarterly revenues are achieved.  Payment of the incentive  compensation
is made only after the Company's year-end audit has been completed.


                                       76
<PAGE>

     Stock  Options.  Stock options are granted by the Stock Plans  Committee of
the Board of Directors.  The Stock Plans Committee believes that stock ownership
by executive  officers is important in aligning  management's and  stockholders'
interests  in the  enhancement  of  stockholder  value over the long  term.  For
options  granted  during fiscal 1997, the exercise price was equal to the market
price of the Common Stock on the date of grant.  The stock option grants made to
the  executive  officers  in  fiscal  1997  were  made  based on the  subjective
judgement of the  Committee  members of the  appropriate  recognition  for their
services to the Company during the 1997 fiscal year and prior years.

Compliance  with Internal  Revenue Code Section  162(m).  Section  162(m) of the
Internal  Revenue Code (enacted in 1993) generally  disallows a tax deduction to
public  companies for  compensation  over $1 million paid to its chief executive
officer and its four other most highly  compensated  executives.  The  Company's
compensation  payable to any one executive officer  (including  potential income
from  outstanding  stock  options) is currently and for the  foreseeable  future
unlikely to reach that  threshold.  Qualifying,  performance-based  compensation
will not be subject to the deduction limit if certain  requirements are met. The
Committee  currently  intends to  structure  stock  option  grants to  executive
officers in a manner that complies with the  performance-based  requirements  of
the statute.

The Compensation Committee:   Charles E. Davidson
                              Mark L. Plaumann
                              David R. A. Steadman

Stock Plans Committee:        Charles E. Davidson
                              Mark L. Plaumann

Directors' Compensation

     Directors  who are  employees of the Company  receive no  compensation,  as
such,  for services as members of the Board.  Directors who are not employees of
the Company receive no cash  compensation  for their services as directors.  Mr.
Steadman,  who is an employee of the Company receives  compensation as such. See
"Compensation  Committee  Interlocks  and  Insider  Participation,"  below.  All
directors are reimbursed for their  out-of-pocket  business expenses incurred in
attending Board meetings and for performing any other services for the Company.

     Non-employee directors of the Company receive "formula" stock option grants
under the Company's  1995  Non-Employee  Director  Stock Option Plan approved by
stockholders on May 10, 1995.  Each  non-employee  director  serving on the date
that the Company's  initial  registration  statement  became  effective (May 10,
1996) was  automatically  granted an option to purchase  10,000 shares of Common
Stock (the "Initial  Grants") that became fully exercisable six months after the
grant  date.   After  the  Initial  Grants,   each   non-employee   director  is
automatically  granted an  additional  option to purchase  3,000  shares on each
anniversary of September 1, 1996 so long as he is then serving as a non-employee
director.  Each  non-employee  director first elected to the Board after May 10,
1996  automatically  receives an option to purchase 3,000 shares of Common Stock
on the date of his or her election  and, so long as he or she is then serving as
a non-employee director, an additional option to purchase 3,000 shares of Common
Stock on each  anniversary  of that date. All options under the Plan are granted
at an exercise  price per share  equal to the market  value of a share of Common
Stock on the date of grant.  Except for the Initial Grants,  all options vest in
full on the first anniversary of the grant date.

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


                                       77
<PAGE>

Compensation Committee Interlocks and Insider Participation

     Decisions  concerning  executive  compensation  (other  than  that  of  the
Chairman)  are made by the  Compensation  Committee  of the Board of  Directors,
which  currently  consists  of Messrs.  Davidson,  Plaumann  and  Steadman.  Mr.
Steadman is Chairman of the Board of  Directors  and an employee of the Company;
Messrs.  Davidson and Plaumann are neither officers nor employees of the Company
or any of its  subsidiaries.  During  fiscal 1997,  no executive  officer of the
Company  served as a director or member of a  compensation  committee of another
entity with which any director of the Company had any relationship as a director
or officer, except that Mr. Steadman is Chairman of the Board of Directors and a
member of the Compensation  Committee of Wahlco Environmental  Systems,  Inc. of
which Mr. Plaumann is a director and former President.

     Mr. Steadman was elected Chairman of the Board of Directors and is employed
by the Company  pursuant to an employment  agreement that is described under the
heading    "Employment    Contracts   and    Termination   of   Employment   and
Change-in-Control  Arrangements,"  above. In fiscal 1997, Mr. Steadman  received
compensation  of $69,000,  plus the  reimbursement  of $11,003 of  out-of-pocket
expenses  incurred in  rendering  services to the Company and was also granted a
stock option to purchase 15,000 shares of Common Stock at $5.00 per share.

     Pursuant  to an  acquisition  in  January  1991 of the assets of the Public
Communication  Systems Division of Executone  Information Systems, Inc. ("PCS"),
the Company was  obligated to pay OAB,  Inc.  royalties of 3.5% of the Company's
sales of microprocessor-based components through June 30, 1996. Mr. Bartusek and
certain  other  employees  of the  Company,  who  were  employees  of  PCS,  are
stockholders of OAB.  Royalty  payments under this agreement  during fiscal 1997
through the June 30, 1996 expiration date were approximately $420,100 (including
payments  of accrued  royalties  at March 29,  1996 and debt  payments  on notes
issued  in  respect  of  accrued  royalties),  of which  Mr.  Bartusek  received
approximately $80,000.

     Wexford  Partners  Fund,  L.P. and Acor S.A.  are parties to an  Investment
Agreement pursuant to which they acquired $2,361,082 and $438,918, respectively,
of 10%  subordinated  notes of the Company in 1994.  In May,  1996,  the Company
repaid the  principal  balances of these notes in full --  $2,361,082 to Wexford
and  $438,918,  to Acor.  Interest  paid on the notes to Wexford and Acor during
fiscal 1997 was $128,081 and $23,810, respectively.

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


                                       78
<PAGE>

Performance Graph

     The following graph assumes an investment of $100 on May 10, 1996 (the date
the Common Stock was first  registered under Section 12 of the Exchange Act) and
compares yearly changes thereafter  (through March 28, 1997) in the market price
of the Common Stock with (i) the Nasdaq Market Index for U.S. Companies (a broad
market index) and (ii) the Nasdaq Telecommunications Index, a published industry
index.

     The  performance  of the  indices  is  shown  on a total  return  (dividend
reinvestment)  basis;  however,  the Company paid no dividends during the period
shown.  The graph lines merely  connect the  beginning  and end of the measuring
periods and do not reflect fluctuations between those dates.

 [The following table was represented by a line graph in the printed material]

                                                       May 10,     March 28,
                                                        1996         1997
                                                  
 Technology Service Group, Inc.                       $ 100.00     $ 54.70
 Nasdaq Market Index for U.S. Companies                 100.00       98.20
 Nasdaq Telecommunications Index                        100.00       84.93
                                     

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


                                       79
<PAGE>

Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL HOLDERS AND MANAGEMENT

     The following tables sets forth certain  information  regarding  beneficial
ownership of the  outstanding  common stock of the Company  ("Common  Stock") at
June 1, 1997 by (i) each person  known by the Company to own  beneficially  more
than 5% of the Common Stock;  (ii) each of the  directors of the Company;  (iii)
the executive  officers named in the Summary  Compensation  Table, in Item 11 --
"Executive  Compensation"  and (iv) all directors  and  executive  officers as a
group. The numbers and percentages  assume for each person or group listed,  the
exercise of all warrants and stock options held by such person or group that are
exercisable  within 60 days of June 1, 1997, in accordance with Rule 13d-3(d)(1)
of the  Securities  Exchange Act of 1934,  but not the exercise of such warrants
and stock options owned by any other  person.  Except as otherwise  indicated in
the footnotes,  the Company  believes that the  beneficial  owners of the Common
Stock listed below,  based on  information  furnished by such owners,  have sole
investment  and voting power with respect to the shares of Common Stock shown as
beneficially owned by them.

Security Ownership of Certain Beneficial Holders

Name and Address                    Number of Shares
of Beneficial Owner                  of Common Stock        Percentage of Class

Wexford Partners Fund, L.P.             2,444,286                 52.0%
411 West Putnam Avenue
Greenwich, CT 06830

Acor S.A.                                 454,386                  9.7%
17 Rue du Colisee
Paris, France 75008

Firlane Business Corp.                    235,028                  5.0%
Box 202
1211 Geneva 12, Switzerland

A.T.T. IV, NV                             549,450 (1)             11.6%
c/o Applied Communications
Technologies, Inc.
20 William Street
Wellesley, MA 02181

-----------------
(1)  Of these  shares,  183,150  shares are  subject to  purchase  at $11.00 per
     share,  (i) 142,857 shares from Wexford  Partners Fund,  L.P.;  (ii) 26,557
     shares from Acor S.A.; and (iii) 13,736 shares from Firlane  Business Corp.
     If the options  were  exercised in full,  Wexford  would  beneficially  own
     2,301,429 shares (49%); Acor would  beneficially own 427,829 shares (9.1%);
     and Firlane  would  beneficially  own 221,292  shares  (4.7%) of the Common
     Stock.

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


                                       80
<PAGE>

Security Ownership of Management
                                          Shares
Name of Beneficial Owner            Beneficially Owned       Percentage of Class

D. Thomas Abbott                            3,000 (1)                 *

Vincent C. Bisceglia                      114,154 (2)               2.4%

Charles E. Davidson                     2,454,286 (3)              52.0%

Mark L. Plaumann                        2,444,286 (4)              52.0%

Olivier Roussel                           464,386 (5)               9.9%

David R. A. Steadman                       45,407 (6)                 *

Darold R. Bartusek                         31,956 (7)                 *

M. Winton Schriner                         31,250 (7)                 *

William H. Thompson                        35,331 (8)                 *

Allen W. Vogl                              19,000 (9)                 *

All Directors and Executive
Officers as a Group (10 Persons)         3,198,720 /10              64.0%

--------------
*    Represents holdings of less than one percent.

(1)  These shares are  purchasable  within 60 days of June 1, 1997 under a stock
     option at $10.71 per share.

(2)  Of these shares,  112,500 shares are purchasable  within 60 days of June 1,
     1997 under a stock option at $1.00 per share.

(3)  These shares include 10,000 shares that are  purchasable  within 60 days of
     June 1, 1997 under a stock option at $8.50 per share and  2,444,286  shares
     that are owned by Wexford  Partners Fund, L.P., of which Mr. Davidson is an
     affiliate.  Mr. Davidson disclaims beneficial ownership of the shares owned
     by Wexford Partners Fund, L.P.

(4)  These  shares  are  owned by  Wexford  Partners  Fund,  L.P.,  of which Mr.
     Plaumann is an affiliate.  Mr. Plaumann disclaims  beneficial  ownership of
     these shares.

(5)  These shares include 10,000 shares that are  purchasable  within 60 days of
     June 1, 1997  under a stock  option at $8.50 per share and  454,386  shares
     that  are  owned by Acor  S.A.,  of  which  Mr.  Roussel  is  Chairman  and
     President.  Mr. Roussel disclaims  beneficial ownership of the shares owned
     by Acor S.A..

(6)  These shares include 45,000 shares that are  purchasable  within 60 days of
     June 1, 1997 under stock options at prices  ranging from $1.00 to $5.00 per
     share.


                                       81
<PAGE>

(7)  These shares include 31,250 shares that are  purchasable  within 60 days of
     June 1, 1997 under stock options at prices  ranging from $1.00 to $9.50 per
     share.

(8)  These shares include 35,000 shares that are  purchasable  within 60 days of
     June 1, 1997 under stock options at prices  ranging from $1.00 to $9.50 per
     share.

(9)  These shares include 18,750 shares that are  purchasable  within 60 days of
     June 1, 1997 under stock options at prices  ranging from $1.00 to $5.00 per
     share,  and 50 shares that are  purchasable  within 60 days of June 1, 1997
     under redeemable warrants at a price of $11.00 per share.

(10) These shares include  2,444,286  shares that are owned by Wexford  Partners
     Fund, L.P., (as to which Messrs.  Davidson and Plaumann disclaim beneficial
     ownership);  454,386  shares  that are owned by Acor S.A.  (as to which Mr.
     Roussel  disclaims  beneficial  ownership);  and  296,750  shares  that are
     purchasable  within 60 days of June 1, 1997 under  stock  options at prices
     ranging from $1.00 to $10.71 per share.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Reference  is  made  to  "Compensation  of  Directors"  and   "Compensation
Committee  Interlocks  and  Insider   Participation"  in  Item  11--  "Executive
Compensation," above.

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


                                       82
<PAGE>

                                     PART IV

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

(a)  List of Documents filed as part of this Report.

     (1)  Financial  Statements -- See the index to the financial  statements in
          Item 8 at page 39.

     (2)  Financial  Statement  Schedules -- See  the  index  to  the  financial
          statement schedules in Item 8 at page 39.

     (3)  Exhibits --

Exhibit No.                        Description of Exhibit
-----------                        ----------------------
3 (i)              Certificate of  Incorporation  (incorporated  by reference to
                   Exhibit  3  (i)  to  Amendment  No.  1  to  the  Registrant's
                   Registration  Statement,  No. 33-80695,  on Form S-1 filed on
                   March 1, 1996).

3 (ii)             By-laws  (incorporated  by  reference  to  Exhibit  3 (ii) to
                   Amendment No. 1 to the Registrant's  Registration  Statement,
                   No. 33-80695, on Form S-1 filed on March 1, 1996).

4.1(a)             Warrant  Agreement  (incorporated by reference to Exhibit 4.1
                   to  Amendment   No.  2  to  the   Registrant's   Registration
                   Statement,  No.  33-80695,  on Form S-1  filed  on March  29,
                   1996).

4.1(b)             Form of  Redeemable  Warrant  (incorporated  by  reference to
                   Exhibit  4.1(a)  to  Amendment  No.  3  to  the  Registrant's
                   Registration  Statement,  No. 33-80695,  on Form S-1 filed on
                   April 29, 1996).

4.2                Representative's   Warrant   Agreement   including   form  of
                   Representative's   Warrant   (incorporated  by  reference  to
                   Exhibit  4.2  to   Amendment   No.  2  to  the   Registrant's
                   Registration  Statement,  No. 33-80695,  on Form S-1 filed on
                   March 29, 1996).

4.3                Form of Common Stock  Certificate  (incorporated by reference
                   to  Exhibit  4.3  to  Amendment  No.  3 to  the  Registrant's
                   Registration  Statement,  No. 33-80695,  on Form S-1 filed on
                   April 29, 1996).

10.1               Loan and Security Agreement between Barclays Business Credit,
                   Inc. and International Teleservice Corporation dated February
                   23,  1990  (incorporated  by  reference  to  Exhibit  10.1 to
                   Amendment No. 1 to the Registrant's  Registration  Statement,
                   No. 33-80695, on Form S-1 filed
                   on March 1, 1996).


                                       83
<PAGE>

10.2               Continuing   Guaranty  Agreement  between  Barclays  Business
                   Credit, Inc. and International  Teleservice Corporation dated
                   February 23, 1990  (incorporated by reference to Exhibit 10.2
                   to  Amendment   No.  1  to  the   Registrant's   Registration
                   Statement, No. 33-80695, on Form S-1 filed on March 1, 1996).

10.3               First  Amendment  to  Loan  and  Security  Agreement  between
                   Barclays Business Credit, Inc. and International  Teleservice
                   Corporation dated January 11, 1991 (incorporated by reference
                   to  Exhibit  10.3  to  Amendment  No.  1 to the  Registrant's
                   Registration  Statement,  No. 33-80695,  on Form S-1 filed on
                   March 1, 1996).

10.4               Second  Amendment  to Loan  and  Security  Agreement  between
                   Barclays Business Credit,  Inc. and Technology Service Group,
                   Inc. dated June 9, 1994 (incorporated by reference to Exhibit
                   10.4 to  Amendment  No.  1 to the  Registrant's  Registration
                   Statement, No. 33-80695, on Form S-1 filed on March 1, 1996).

10.5               Third  Amendment  to  Loan  and  Security  Agreement  between
                   Barclays Business Credit,  Inc. and Technology Service Group,
                   Inc. dated July 8, 1994 (incorporated by reference to Exhibit
                   10.5 to  Amendment  No.  1 to the  Registrant's  Registration
                   Statement, No. 33-80695, on Form S-1 filed on March 1, 1996).

10.6               Fourth  Amendment  to Loan  and  Security  Agreement  between
                   Barclays Business Credit,  Inc. and Technology Service Group,
                   Inc.  dated  October 31, 1994  (incorporated  by reference to
                   Exhibit  10.6  to  Amendment   No.  1  to  the   Registrant's
                   Registration  Statement,  No. 33-80695,  on Form S-1 filed on
                   March 1, 1996).

10.7**             Manufacturing  Services  Agreement  TSG-1O94JLR dated October
                   21, 1994 by and between  Technology  Service Group,  Inc. and
                   Avex Electronics  Inc.  (incorporated by reference to Exhibit
                   10.8 to  Amendment  No.  3 to the  Registrant's  Registration
                   Statement,  No.  33-80695,  on Form S-1  filed  on April  29,
                   1996).

10.8               Fifth  Amendment  to  Loan  and  Security  Agreement  between
                   Barclays Business Credit,  Inc. and Technology Service Group,
                   Inc. dated as of April 22, 1996 (incorporated by reference to
                   Exhibit  10.9  to  Amendment   No.  3  to  the   Registrant's
                   Registration  Statement,  No. 33-80695,  on Form S-1 filed on
                   April 29, 1996).

10.9**             Amendment  002  to  the  Manufacturing   Services   Agreement
                   TSG-1O49JLR dated October 21, 1994 by and between  Technology
                   Service Group,  Inc. and Avex Electronics Inc.  (incorporated
                   by  reference  to  Exhibit  10.10 to  Amendment  No. 3 to the
                   Registrant's  Registration  Statement,  No. 33-80695, on Form
                   S-1 filed on April 29, 1996).


                                       84
<PAGE>

10.10              Manufacturing  Rights  Agreement  dated  September  16,  1991
                   between  Newco,  Inc.  (Commtek  Industries,  Inc.),  Dynacom
                   Corporation  and  International  Service  Technologies,  Inc.
                   (incorporated  by reference to Exhibit 10.11 to Amendment No.
                   1 to the Registrant's  Registration Statement,  No. 33-80695,
                   on Form S-1 filed on March 1, 1996).

10.11              Lease Agreement between Telematics Products, Inc. and William
                   M. Johnson dated July 14, 1988  (incorporated by reference to
                   Exhibit  10.13  to  Amendment  No.  1  to  the   Registrant's
                   Registration  Statement,  No. 33-80695,  on Form S-1 filed on
                   March 1, 1996).

10.12              Assignment of Lease between  Executone  Information  Systems,
                   Inc. and Technology Service  Enterprises,  Inc. dated January
                   11,  1991  (incorporated  by  reference  to Exhibit  10.14 to
                   Amendment No. 1 to the Registrant's  Registration  Statement,
                   No. 33-80695, on Form S-1 filed on March 1, 1996).

10.13              First  Amendment  to  Lease  Agreement  between  Mansell  400
                   Associates,  L.P. and Technology  Service  Group,  Inc. dated
                   February 1993  (incorporated by reference to Exhibit 10.15 to
                   Amendment No. 1 to the Registrant's  Registration  Statement,
                   No. 33-80695, on Form S-1 filed on March 1, 1996).

10.14              Lease between  Steroben  Associates and Comdial  TeleServices
                   Corporation  dated August 1, 1986  (incorporated by reference
                   to  Exhibit  10.16 to  Amendment  No.  1 to the  Registrant's
                   Registration  Statement,  No. 33-80695,  on Form S-1 filed on
                   March 1, 1996).

10.15**            Dealer Agreement between Control Module,  Inc. and Technology
                   Service Group, Inc. dated November 18, 1994  (incorporated by
                   reference  to  Exhibit  10.17  to  Amendment  No.  3  to  the
                   Registrant's  Registration  Statement,  No. 33-80695, on Form
                   S-1 filed on April 29, 1996).

10.16*             Employment  Agreement between  Technology Service Group, Inc.
                   and Vincent C. Bisceglia dated October 31, 1994 (incorporated
                   by  reference  to  Exhibit  10.18 to  Amendment  No. 1 to the
                   Registrant's  Registration  Statement,  No. 33-80695, on Form
                   S-1 filed on March 1, 1996).

10.17*             Chairman's  Agreement between  Technology Service Group, Inc.
                   and David R.A. Steadman dated October 31, 1994  (incorporated
                   by  reference  to  Exhibit  10.19 to  Amendment  No. 1 to the
                   Registrant's  Registration  Statement,  No. 33-80695, on Form
                   S-1 filed on March 1, 1996).

10.18**            Patent  License  Agreement   (incorporated  by  reference  to
                   Exhibit  10.21  to  Amendment  No.  3  to  the   Registrant's
                   Registration  Statement,  No. 33-80695,  on Form S-1 filed on
                   April 29, 1996).


                                       85
<PAGE>

10.19              Warrant Agreement between  Technology Service Group, Inc. and
                   Avex  Electronics  Inc. dated May 23, 1995  (incorporated  by
                   reference  to  Exhibit  10.22  to  Amendment  No.  1  to  the
                   Registrant's  Registration  Statement,  No. 33-80695, on Form
                   S-1 filed on March 1, 1996).

10.20*             Employee  Incentive Stock Option Agreement between Technology
                   Service Group,  Inc. and Vincent C. Bisceglia  dated November
                   1,  1994  (incorporated  by  reference  to  Exhibit  10.23 to
                   Amendment No. 1 to the Registrant's  Registration  Statement,
                   No. 33-80695, on Form S-1 filed on March 1, 1996).

10.21*             Incentive Stock Option Agreement between  Technology  Service
                   Group,  Inc. and David R.A.  Steadman  dated November 1, 1994
                   (incorporated  by reference to Exhibit 10.24 to Amendment No.
                   1 to the Registrant's  Registration Statement,  No. 33-80695,
                   on Form S-1 filed on March 1, 1996).

10.22*             Form of Employee  Incentive Stock Option  Agreement under the
                   1994 Omnibus Stock Plan of  Technology  Service  Group,  Inc.
                   (incorporated  by reference to Exhibit 10.25 to Amendment No.
                   1 to the Registrant's  Registration Statement,  No. 33-80695,
                   on Form S-1 filed on March 1, 1996).

10.23              Agreement   and  Plan  of  Merger   among   Wexford   Capital
                   Corporation, TSG Acquisition Corporation,  Technology Service
                   Group,  Inc. and certain  shareholders of Technology  Service
                   Group, Inc. dated October 11, 1994 (incorporated by reference
                   to  Exhibit  10.26 to  Amendment  No.  1 to the  Registrant's
                   Registration  Statement,  No. 33-80695,  on Form S-1 filed on
                   March 1, 1996).

10.24              Amendment  dated  October 31, 1994 to  Agreement  and Plan of
                   Merger among Wexford  Capital  Corporation,  TSG  Acquisition
                   Corporation,  Technology  Service  Group,  Inc.  and  certain
                   shareholders of Technology  Service Group, Inc. dated October
                   11,  1994  (incorporated  by  reference  to Exhibit  10.27 to
                   Amendment No. 1 to the Registrant's  Registration  Statement,
                   No. 33-80695, on Form S-1 filed on March 1, 1996).

10.25              Subordination  Agreement  between  Technology  Service Group,
                   Inc.,  Wexford  Partners Fund,  L.P., Acor, S.A. and Barclays
                   Business Credit, Inc. dated October 31, 1994 (incorporated by
                   reference  to  Exhibit  10.29  to  Amendment  No.  1  to  the
                   Registrant's  Registration  Statement,  No. 33-80695, on Form
                   S-1 filed on March 1, 1996).

10.26              Investment  Agreement between Technology Service Group, Inc.,
                   Wexford  Partners Fund, L.P., Acor, S.A. and Firlane Business
                   Corp.  dated October 31, 1994  (incorporated  by reference to
                   Exhibit  10.30  to  Amendment  No.  1  to  the   Registrant's
                   Registration  Statement,  No. 33-80695,  on Form S-1 filed on
                   March 1, 1996).


                                       86
<PAGE>

10.27              Amended and Restated Stockholders' Agreement among Technology
                   Service Group, Inc., Wexford Partners Fund, L.P., Acor, S.A.,
                   Firlane Business Corp. and A.T.T.  IV, N.V.  (incorporated by
                   reference to Exhibit 10.31(b) to the  Registrant's  Form 10-K
                   Annual Report for the year ended March 29, 1996).

10.28**            Contract No. XO8895D between  Technology  Service Group, Inc.
                   and NYNEX  (incorporated  by  reference  to Exhibit  10.37 to
                   Amendment No. 3 to the Registrant's  Registration  Statement,
                   No. 33-80695, on Form S-1 filed on April 29, 1996).

10.29**            Contract No. C5262CO between  Technology  Service Group, Inc.
                   and  Southwestern  Bell Telephone  Company  (incorporated  by
                   reference  to  Exhibit  10.38  to  Amendment  No.  3  to  the
                   Registrant's  Registration  Statement,  No. 33-80695, on Form
                   S-1 filed on April 29, 1996).

10.30*             1994 Omnibus Stock Plan (incorporated by reference to Exhibit
                   10.45 to  Amendment  No. 1 to the  Registrant's  Registration
                   Statement, No. 33-80695, on Form S-1 filed on March 1, 1996).

10.31              1995 Employee Stock Purchase Plan  (incorporated by reference
                   to  Exhibit  10.46 to  Amendment  No.  1 to the  Registrant's
                   Registration  Statement,  No. 33-80695,  on Form S-1 filed on
                   March 1, 1996).

10.32*             1995 Non-Employee Director Stock Option Plan (incorporated by
                   reference  to  Exhibit  10.47  to  Amendment  No.  1  to  the
                   Registrant's  Registration  Statement,  No. 33-80695, on Form
                   S-1 filed on March 1, 1996).

10.33***           Lease Agreement  between  Technology  Service Group, Inc. and
                   McDonald  Windward  Partners II,  L.L.C.  dated  November 12,
                   1996.

10.34***           Letter Agreement between  Technology  Service Group, Inc. and
                   Mr. James Lacy dated  September 18, 1996,  amendment  thereto
                   and  Assignment  and  Assumption of Real Estate Lease between
                   Technology Service Group, Inc., Mr. James Lacy and G.P.E.D.C.
                   dated November 6, 1996.

10.35***           Lease Extension  Agreement  Between  Steroben  Associates and
                   Technology Service Group, Inc. dated August 1, 1996.


                                       87
<PAGE>

10.36***           Contract No. D08E20H44  between  Southwestern  Bell Telephone
                   Company and  Technology  Service  Group,  Inc.  dated June 9,
                   1997.

11.***             Statement re computation of per share earnings.

21.                Subsidiaries    of    Registrant:    International    Service
                   Technologies, Inc. (a Delaware corporation).

27.                Financial Data Schedule (Edgar Filing only).

      *    Management compensation contracts and plans.

      **   Registrant has received confidential treatment of  a portion of  this
           Exhibit, which portion has been separately filed with the Commission.

      ***  Filed herewith.

(b)  Reports on Form 8-K

     No  reports  on Form 8-K were  filed by the  Registrant  during  the fourth
     quarter of the fiscal year ended March 28, 1997.


                                       88
<PAGE>

SCHEDULE II

                        VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                                                                  Additions
                                                      ----------------------------------
                                          Balance at  Charged to       Charged to                           Balance at
                                          Beginning   Costs and          Other             Deductions-         End
Description                              of Period    Expenses      Accounts-Describe       Describe        of Period
-----------                              ---------    --------      -----------------       --------        ---------
<S>                                      <C>           <C>             <C>      <C>      <C>       <C>    <C>       
Seven Months Ended October 30, 1994
  Allowance for doubtful accounts        $  278,590    $ 27,122        $ 70,000 (3)      $(102,494)(1)    $  273,218
                                                                                                
  Reserve for obsolete and slow moving                              
    inventory                             1,643,774     223,064         (19,275)(4)        (10,653)(2)     1,836,910
                                                                    
  Reserve for impairment of property                                
    and equipment                           253,084                      (1,375)(6)       (117,807)(5)       133,902
                                                                    
Five Months Ended March 31, 1995                                    
  Allowance for doubtful accounts           273,218     (3,467)                            (68,305)(1)       201,446
                                                                    
  Reserve for obsolete and slow moving                              
    inventory                             1,836,910      80,130         (58,498)(4)        (92,343)(2)     1,766,199
                                                                    
  Reserve for impairment of property                                
    and equipment                           133,902                                       (133,902)(7)       --
                                                                    
Year Ended March 29, 1996                                           
  Allowance for doubtful accounts           201,446      10,099                              4,014 (1)       215,559
                                                                    
  Reserve for obsolete and slow moving                              
    inventory                             1,766,199     408,694         (57,511)(4)       (511,187)(2)     1,606,195
                                                                    
Year Ended March 28, 1997                                           
  Allowance for doubtful accounts           215,559                     (70,000)(3)          1,401 (1)       146,960
                                                                    
  Reserve for obsolete and slow moving                              
    inventory                            $1,606,195    $264,151                          ($441,859)(2)    $1,428,487
</TABLE>
                                                                  
--------------------
(1)  Write-off of uncollected accounts and recoveries.

(2)  Write-off of obsolete inventory, net of recoveries.

(3)  Charges  and  credits  to cost of  goods  sold  with  respect  to  accounts
     receivable and accounts payable offsets.  

(4)  Credits  to cost  of  goods  sold  with  respect  to net  realizable  value
     reserves.

(5)  Write-off of assets included in reserve for impairment.

(6)  Restructuring charges (credits).

(7)  Purchase accounting adjustment.


                                       89
<PAGE>

                                   SIGNATURES

     Pursuant  to the  requirements  of  Section  13 or 15(d) of the  Securities
Exchange  Act of 1934,  the  Company has duly caused this Report to be signed on
its behalf by the undersigned thereunto duly authorized,  on the 9th day of June
1997.

                                      TECHNOLOGY SERVICE GROUP, INC.

                                      By:  /s/ Vincent C. Bisceglia
                                           --------------------------
                                           Vincent C. Bisceglia
                                           President & Chief Executive Officer

     KNOW  ALL MEN BY THESE  PRESENTS,  that  each  individual  whose  signature
appears below constitutes and appoints each of Vincent C. Bisceglia,  William H.
Thompson  and  Roger M.  Barzun  jointly  and  severally  his  true  and  lawful
attorneys-in-fact  and agent with full powers of substitution for him and in his
name,  place  and  stead  in any and  all  capacities  to  sign  on his  behalf,
individually  and in  each  capacity  stated  below  and to  file  any  and  all
amendments to this Annual Report on Form 10-K with the  Securities  and Exchange
Commission,  granting  unto said  attorneys-in-fact  and agents and each of them
full  power  and  authority  to do and  perform  each and  every  act and  thing
requisite  and  necessary  to be done in and about the  premises  as fully as he
might or could do in  person,  hereby  ratifying  and  confirming  all that said
attorneys-in-fact and agents, or any of them, or their substitute or substitutes
may lawfully do or cause to be done by virtue thereof.

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

           Signature              Title                                Date
           ---------              -----                                ----

By: /s/ Vincent C. Bisceglia      President & Chief                  June 9,1997
   ---------------------------    Executive Officer, Director
        Vincent C. Bisceglia     

By: /s/ William H. Thompson       Vice President, Finance           June 9, 1997
   ---------------------------    Chief Financial Officer
        William H. Thompson       Secretary (principal financial
                                  and accounting officer)          

By: /s/ David R.A. Steadman       Director and Chairman             June 9, 1997
   ---------------------------    of the Board
        David R.A. Steadman       

By: /s/ Charles E. Davidson       Director                          June 9, 1997
   ---------------------------
        Charles E. Davidson

By: /s/ Mark L. Plaumann          Director                          June 9, 1997
   ---------------------------
        Mark L. Plaumann

By: /s/ Olivier Roussel           Director                          June 4, 1997
   ---------------------------
        Olivier Roussel

By: /s/ D. Thomas Abbott          Director                          June 9, 1997
   ---------------------------
        D. Thomas Abbott


                                       90

<PAGE>

                                  EXHIBIT INDEX

Exhibit No.               Description of Exhibit                         At Page
-----------               ----------------------                         -------
3(i)      Certificate of Incorporation (incorporated by reference
          to Exhibit 3 (i) to Amendment No. 1 to the Registrant's
          Registration Statement, No. 33-80695, on Form S-1 filed
          on March 1, 1996).

3 (ii)    By-laws (incorporated by reference to Exhibit 3 (ii) to
          Amendment  No.  1  to  the  Registrant's   Registration
          Statement,  No. 33-80695, on Form S-1 filed on March 1,
          1996).

4.1(a)    Warrant Agreement (incorporated by reference to Exhibit
          4.1 to Amendment No. 2 to the Registrant's Registration
          Statement, No. 33-80695, on Form S-1 filed on March 29,
          1996).

4.1(b)    Form of Redeemable  Warrant  (incorporated by reference
          to   Exhibit   4.1(a)  to   Amendment   No.  3  to  the
          Registrant's  Registration Statement,  No. 33-80695, on
          Form S-1 filed on April 29, 1996).

4.2       Representative's  Warrant  Agreement  including form of
          Representative's  Warrant (incorporated by reference to
          Exhibit  4.2 to  Amendment  No.  2 to the  Registrant's
          Registration Statement, No. 33-80695, on Form S-1 filed
          on March 29, 1996).

4.3       Form  of  Common  Stock  Certificate  (incorporated  by
          reference  to  Exhibit  4.3 to  Amendment  No. 3 to the
          Registrant's  Registration Statement,  No. 33-80695, on
          Form S-1 filed on April 29, 1996).

10.1      Loan and Security  Agreement  between Barclays Business
          Credit, Inc. and International  Teleservice Corporation
          dated February 23, 1990  (incorporated  by reference to
          Exhibit  10.1 to  Amendment  No. 1 to the  Registrant's
          Registration Statement, No. 33-80695, on Form S-1 filed
          on March 1, 1996).

10.2      Continuing Guaranty Agreement between Barclays Business
          Credit, Inc. and International  Teleservice Corporation
          dated February 23, 1990  (incorporated  by reference to
          Exhibit  10.2 to  Amendment  No. 1 to the  Registrant's
          Registration Statement, No. 33-80695, on Form S-1 filed
          on March 1, 1996).

10.3      First Amendment to Loan and Security  Agreement between
          Barclays   Business  Credit,   Inc.  and  International
          Teleservice   Corporation   dated   January   11,  1991
          (incorporated by reference to Exhibit 10.3 to Amendment
          No. 1 to the Registrant's  Registration Statement,  No.
          33-80695, on Form S-1 filed on March 1, 1996).

10.4      Second Amendment to Loan and Security Agreement between
          Barclays Business Credit,  Inc. and Technology  Service
          Group,  Inc.  dated  June  9,  1994   (incorporated  by
          reference  to Exhibit  10.4 to  Amendment  No. 1 to the
          Registrant's  Registration Statement,  No. 33-80695, on
          Form S-1 filed on March 1, 1996).


                               91
<PAGE>

                                                                         At Page
                                                                         -------
10.5      Third Amendment to Loan and Security  Agreement between
          Barclays Business Credit,  Inc. and Technology  Service
          Group,  Inc.  dated  July  8,  1994   (incorporated  by
          reference  to Exhibit  10.5 to  Amendment  No. 1 to the
          Registrant's  Registration Statement,  No. 33-80695, on
          Form S-1 filed on March 1, 1996).

10.6      Fourth Amendment to Loan and Security Agreement between
          Barclays Business Credit,  Inc. and Technology  Service
          Group,  Inc.  dated October 31, 1994  (incorporated  by
          reference  to Exhibit  10.6 to  Amendment  No. 1 to the
          Registrant's  Registration Statement,  No. 33-80695, on
          Form S-1 filed on March 1, 1996).

10.7**    Manufacturing   Services  Agreement  TSG-1O94JLR  dated
          October  21,  1994 by and  between  Technology  Service
          Group, Inc. and Avex Electronics Inc.  (incorporated by
          reference  to Exhibit  10.8 to  Amendment  No. 3 to the
          Registrant's  Registration Statement,  No. 33-80695, on
          Form S-1 filed on April 29, 1996).

10.8      Fifth Amendment to Loan and Security  Agreement between
          Barclays Business Credit,  Inc. and Technology  Service
          Group, Inc. dated as of April 22, 1996 (incorporated by
          reference  to Exhibit  10.9 to  Amendment  No. 3 to the
          Registrant's  Registration Statement,  No. 33-80695, on
          Form S-1 filed on April 29, 1996).

10.9**    Amendment 002 to the Manufacturing  Services  Agreement
          TSG-1O49JLR  dated  October  21,  1994  by and  between
          Technology  Service  Group,  Inc. and Avex  Electronics
          Inc.  (incorporated  by reference  to Exhibit  10.10 to
          Amendment  No.  3  to  the  Registrant's   Registration
          Statement, No. 33-80695, on Form S-1 filed on April 29,
          1996).

10.10     Manufacturing Rights Agreement dated September 16, 1991
          between Newco, Inc. (Commtek Industries, Inc.), Dynacom
          Corporation  and  International  Service  Technologies,
          Inc.  (incorporated  by reference  to Exhibit  10.11 to
          Amendment  No.  1  to  the  Registrant's   Registration
          Statement,  No. 33-80695, on Form S-1 filed on March 1,
          1996).

10.11     Lease Agreement between Telematics  Products,  Inc. and
          William M. Johnson dated July 14, 1988 (incorporated by
          reference to Exhibit  10.13 to  Amendment  No. 1 to the
          Registrant's  Registration Statement,  No. 33-80695, on
          Form S-1 filed on March 1, 1996).

10.12     Assignment  of  Lease  between  Executone   Information
          Systems, Inc. and Technology Service Enterprises,  Inc.
          dated  January 11, 1991  (incorporated  by reference to
          Exhibit  10.14 to Amendment  No. 1 to the  Registrant's
          Registration Statement, No. 33-80695, on Form S-1 filed
          on March 1, 1996).


                               92
<PAGE>

                                                                         At Page
                                                                         -------
10.13     First Amendment to Lease Agreement  between Mansell 400
          Associates,  L.P. and Technology  Service  Group,  Inc.
          dated  February  1993  (incorporated  by  reference  to
          Exhibit  10.15 to Amendment  No. 1 to the  Registrant's
          Registration Statement, No. 33-80695, on Form S-1 filed
          on March 1, 1996).

10.14     Lease   between   Steroben   Associates   and   Comdial
          TeleServices   Corporation   dated   August   1,   1986
          (incorporated   by  reference   to  Exhibit   10.16  to
          Amendment  No.  1  to  the  Registrant's   Registration
          Statement,  No. 33-80695, on Form S-1 filed on March 1,
          1996).

10.15**   Dealer  Agreement  between  Control  Module,  Inc.  and
          Technology  Service Group, Inc. dated November 18, 1994
          (incorporated   by  reference   to  Exhibit   10.17  to
          Amendment  No.  3  to  the  Registrant's   Registration
          Statement, No. 33-80695, on Form S-1 filed on April 29,
          1996).

10.16*    Employment  Agreement between Technology Service Group,
          Inc. and Vincent C.  Bisceglia  dated  October 31, 1994
          (incorporated   by  reference   to  Exhibit   10.18  to
          Amendment  No.  1  to  the  Registrant's   Registration
          Statement,  No. 33-80695, on Form S-1 filed on March 1,
          1996).

10.17*    Chairman's  Agreement between Technology Service Group,
          Inc.  and David R.A.  Steadman  dated  October 31, 1994
          (incorporated   by  reference   to  Exhibit   10.19  to
          Amendment  No.  1  to  the  Registrant's   Registration
          Statement,  No. 33-80695, on Form S-1 filed on March 1,
          1996).

10.18**   Patent License Agreement  (incorporated by reference to
          Exhibit  10.21 to Amendment  No. 3 to the  Registrant's
          Registration Statement, No. 33-80695 on Form S-1, filed
          on April 29, 1996).

10.19     Warrant  Agreement  between  Technology  Service Group,
          Inc.  and Avex  Electronics  Inc.  dated  May 23,  1995
          (incorporated   by  reference   to  Exhibit   10.22  to
          Amendment  No.  1  to  the  Registrant's   Registration
          Statement,  No. 33-80695, on Form S-1 filed on March 1,
          1996).

10.20*    Employee   Incentive  Stock  Option  Agreement  between
          Technology Service Group, Inc. and Vincent C. Bisceglia
          dated  November 1, 1994  (incorporated  by reference to
          Exhibit  10.23 to Amendment  No. 1 to the  Registrant's
          Registration Statement, No. 33-80695, on Form S-1 filed
          on March 1, 1996).

10.21*    Incentive  Stock Option  Agreement  between  Technology
          Service  Group,  Inc.  and David  R.A.  Steadman  dated
          November 1, 1994  (incorporated by reference to Exhibit
          10.24  to   Amendment   No.   1  to  the   Registrant's
          Registration Statement, No. 33-80695, on Form S-1 filed
          on March 1, 1996).


                               93
<PAGE>

                                                                         At Page
                                                                         -------
10.22*    Form of Employee Incentive Stock Option Agreement under
          the  1994  Omnibus  Stock  Plan of  Technology  Service
          Group, Inc. (incorporated by reference to Exhibit 10.25
          to  Amendment  No. 1 to the  Registrant's  Registration
          Statement,  No. 33-80695, on Form S-1 filed on March 1,
          1996).

10.23     Agreement  and Plan of  Merger  among  Wexford  Capital
          Corporation,  TSG Acquisition  Corporation,  Technology
          Service  Group,   Inc.  and  certain   shareholders  of
          Technology  Service Group,  Inc. dated October 11, 1994
          (incorporated   by  reference   to  Exhibit   10.26  to
          Amendment  No.  1  to  the  Registrant's   Registration
          Statement,  No. 33-80695, on Form S-1 filed on March 1,
          1996).

10.24     Amendment  dated October 31, 1994 to Agreement and Plan
          of  Merger  among  Wexford  Capital  Corporation,   TSG
          Acquisition Corporation, Technology Service Group, Inc.
          and certain  shareholders of Technology  Service Group,
          Inc. dated October 11, 1994  (incorporated by reference
          to Exhibit 10.27 to Amendment No. 1 to the Registrant's
          Registration Statement, No. 33-80695, on Form S-1 filed
          on March 1, 1996).

10.25     Subordination   Agreement  between  Technology  Service
          Group,  Inc.,  Wexford  Partners Fund, L.P., Acor, S.A.
          and Barclays  Business  Credit,  Inc. dated October 31,
          1994  (incorporated  by reference  to Exhibit  10.29 to
          Amendment  No.  1  to  the  Registrant's   Registration
          Statement,  No. 33-80695, on Form S-1 filed on March 1,
          1996).

10.26     Investment  Agreement between Technology Service Group,
          Inc.,  Wexford  Partners  Fund,  L.P.,  Acor,  S.A. and
          Firlane   Business   Corp.   dated   October  31,  1994
          (incorporated   by  reference   to  Exhibit   10.30  to
          Amendment  No.  1  to  the  Registrant's   Registration
          Statement,  No. 33-80695, on Form S-1 filed on March 1,
          1996).

10.27     Amended  and  Restated  Stockholders'  Agreement  among
          Technology  Service Group, Inc., Wexford Partners Fund,
          L.P., Acor, S.A., Firlane Business Corp. and A.T.T. IV,
          N.V. (incorporated by reference to Exhibit 10.31 (b) of
          Registrant's Form 10-K Annual Report for the year ended
          March 29,1996).

10.28**   Contract No. XO8895D between  Technology Service Group,
          Inc.  and NYNEX  (incorporated  by reference to Exhibit
          10.37  to   Amendment   No.   3  to  the   Registrant's
          Registration Statement, No. 33-80695, on Form S-1 filed
          on April 29, 1996).

10.29**   Contract No. C5262CO between  Technology Service Group,
          Inc.   and   Southwestern    Bell   Telephone   Company
          (incorporated   by  reference   to  Exhibit   10.38  to
          Amendment  No.  3  to  the  Registrant's   Registration
          Statement, No. 33-80695, on Form S-1 filed on April 29,
          1996).


                               94
<PAGE>

                                                                         At Page
                                                                         -------
10.30*    1994 Omnibus Stock Plan  (incorporated  by reference to
          Exhibit  10.45 to Amendment  No. 1 to the  Registrant's
          Registration Statement, No. 33-80695, on Form S-1 filed
          on March 1, 1996).

10.31     1995  Employee  Stock  Purchase Plan  (incorporated  by
          reference to Exhibit  10.46 to  Amendment  No. 1 to the
          Registrant's  Registration Statement,  No. 33-80695, on
          Form S-1 filed on March 1, 1996).

10.32*    1995   Non-Employee    Director   Stock   Option   Plan
          (incorporated   by  reference   to  Exhibit   10.47  to
          Amendment  No.  1  to  the  Registrant's   Registration
          Statement,  No. 33-80695, on Form S-1 filed on March 1,
          1996).

10.33***  Lease Agreement between  Technology Service Group, Inc.             96
          and  McDonald  Windward   Partners  II,  L.L.C.   dated
          November 12, 1996.

10.34***  Letter Agreement between Technology Service Group, Inc.            109
          and Mr. James Lacy dated September 18, 1996,  amendment
          thereto and  Assignment  and  Assumption of Real Estate
          Lease between Technology Service Group, Inc., Mr. James
          Lacy and G.P.E.D.C. dated November 6, 1996.

10.35***  Lease Extension  Agreement Between Steroben  Associates            124
          and Technology Service Group, Inc. dated August 1, 1996.

10.36***  Contract  No.  D08E20H44   between   Southwestern  Bell            126
          Telephone Company and  Technology  Service  Group, Inc. 
          dated June 9, 1997.

11.***    Statement re computation of per share earnings.                    179

21.       Subsidiaries  of  Registrant:   International   Service            
          Technologies, Inc. (a Delaware corporation).

27.       Financial Data Schedule (Edgar Filing only).                       180

*    Management compensation contracts and plans.
**   Registrant  has  received  confidential  treatment  of a  portion  of  this
     Exhibit, which portion has been separately filed with the Commission.
***  Filed herewith.


                               95