UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

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

     For the fiscal year ended May 31, 1998

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

                          Commission File No.: 0-25592

                             PERIPHONICS CORPORATION
             (Exact name of registrant as specified in its charter)

      Delaware                                          11-2699509
(State or other jurisdiction of                         (I.R.S. Employer
incorporation or organization)                          Identification No.)

               4000 Veterans Memorial Highway, Bohemia, N.Y. 11716
               (Address of principal executive offices) (Zip Code)

     Registrant's telephone number, including area code: (516) 468-9000

     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)

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

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

     The  aggregate  market  value of the  12,299,464  of Common  Stock  held by
non-affiliates of the Company as of August 25, 1998 is $78,409,083.

     The number of shares  outstanding  of each of the  registrant's  classes of
common equity as of August 25, 1998 is as follows:

             Class of Common Equity              Number of Shares
                 Common Stock                       13,519,305
                par value $.01

     The  information  required by Part III of this Form 10-K is incorporated by
reference from the Registrant's  definitive proxy statement to be filed with the
Commission on or before September 28, 1998.


<PAGE>


                                     PART I

     Item 1. BUSINESS

     General

     Periphonics  Corporation  (the  "Company") was originally  incorporated  in
Delaware in December  1969.  On January 31, 1983,  the Company was dissolved and
operated as a division of Gilbarco,  Inc., a  wholly-owned  subsidiary  of Exxon
Corporation. On July 26, 1984, the Company was reincorporated in Delaware and in
1986, 4000 VMH Corp., a company owned by persons who were then senior executives
of the Company,  purchased  all of the  outstanding  Common Stock of the Company
from Exxon  Corporation.  In March 1995, the Company completed an initial public
offering  ("IPO") of its Common  Stock.  Effective  upon the closing of the IPO,
4000 VMH Corp. was merged with and into the Company.

     The  Company  develops,  markets and  supports  products  and  professional
services for Computer  Telephony  Integration  ("CTI") and for Telecom  Enhanced
Network Services using  technologies  such as interactive voice response ("IVR")
speech  input,  messaging,  fax and web  browsers.  The  Company's  products and
services  automate  call  transaction  processing,  increase  call-center  agent
productivity, and often can create new revenue streams for its customers.

     The Company is a leading  supplier of  mid-to-large  scale call  processing
systems - systems  handling  hundreds to  thousands  of  simultaneous  telephone
calls.  Systems have been  installed in more than 50  countries.  The  Company's
staff of 866 employees (May 1998) serves customers from  Periphonics  offices in
Canada, Germany, Hong Kong, Mexico, Singapore, the United Kingdom and the United
States.

     The Market

     The Company's  products and services  represent an important element in the
telecommunications   and  data  processing   infrastructure   of  many  customer
service-oriented  organizations.   Typical  systems  enable  callers  to  use  a
touch-tone  telephone or speech input to access information in an organization's
computer  database  and to receive  that  information  verbally via high quality
digitally-stored  or  synthesized  speech or via facsimile.  In addition,  these
systems enable  customers to execute  certain  transactions  on-line without the
intervention of customer service  personnel.  As a result,  these systems permit
businesses  and other  organizations  in both the public and private  sectors to
better utilize the  capabilities  of their  telephone and computer  systems,  to
provide new revenue generating  services,  to increase the productivity of their
customer support staff, and to offer more services to customers in less time and
at lower  cost.  These  systems are used for a variety of  transaction  specific
applications  including  accessing data regarding bank, mutual fund or brokerage
accounts; checking the status of insurance claims or tax filings; obtaining loan
or credit card  balances  and/or rates;  registering  for college  courses;  and
retrieving descriptions of particular products or services.

     The  Company's  products  constitute a  specialized  segment of the overall
voice   processing/call   processing   market,   which   also   includes   voice
messaging/voice  mail  systems,  automated  attendant  systems,  automated  call
distribution  systems  and  outbound  predictive  dialing  systems.  The Company
believes  that the  increased  use of  these  systems  has  been due to  several
factors,  including  industry-wide  improvements  in  product  features,  public
acceptance of automated  systems to obtain  information or execute  transactions
and competitive  pressures on organizations to offer improved  customer services
at lower costs.

<PAGE>  

   International   sales  constitute  an  important  element  of  Periphonics'
business,  and Periphonics believes that international  markets will continue to
offer  attractive  growth  potential.  See  Note  11 of  Notes  to  Consolidated
Financial  Statements for  information  concerning  the Company's  operations by
geographic area.

     Principal Markets, Customers and Applications

     Periphonics has manufactured and delivered systems to customers in the U.S.
and in more than 50 other countries.  Based on its installed  customer base, the
Company  believes  it is a leading  supplier of mid-size  and  large-scale  call
processing  systems.  In each of fiscal 1996,  1997 and 1998, no single customer
accounted for as much as 10% of the Company's  total  revenues.  In fiscal 1998,
the Company's top ten customers (two of which were new customers)  accounted for
approximately  26% of total  revenues.  Four of  these  top ten  customers  were
telecommunications companies, four of them were financial services companies and
two were  transportation  customers.  The  Company's  system  sales to customers
outside the U.S.  contributed  approximately 37% of total system sales in fiscal
1998.

     Although the Company's vertical market focus includes additional industries
such as  government,  higher  education,  healthcare  services,  transportation,
electric and water utilities and distribution companies, it expects that it will
continue  to  derive  a   substantial   percentage  of  its  system  sales  from
telecommunications and financial services businesses.  Accordingly,  unfavorable
economic conditions or factors that relate to these industries, particularly any
such conditions  that might result in reductions in capital  expenditures by the
Company's  target  customers,  could  have  a  material  adverse  affect  on the
Company's results of operations.

     Product Technology

     The Company's  products  generally consist of the following major elements:
(i) an  application  processor  platform  with  one  or  more  SPARC-based  RISC
processors;  (ii) a  Company-designed  voice subsystem that contains one or more
telephony  interface boards,  voice storage,  and optionally one or more Digital
Signal Processing (DSP) modules, (iii)  Company-designed  transaction processing
software modules and (iv) optional application development tools.

     The main  attributes of the products'  architecture  include its internally
distributed  client/server processing structure and function specific processing
via dedicated microprocessors. The major advantage of this approach is two fold:
first,  it allows for more  effective  system  implementation  by tailoring each
function as required;  second,  it allows for incorporation of new technology in
each  function as it becomes  available,  which is beneficial  since  technology
relating to  different  functions  improves at  different  rates over time.  The
result  of  the  architecture  is  a  system  that  can  be  tailored  for  many
configurations  and adapted to newer  technologies  in telephony and transaction
processing.  By  maintaining  an  unmodified  UNIX kernel and standard UNIX file
system,   the  Company's   system   software   delivers  an  open  and  scalable
client/server  implementation  which can be easily migrated to new UNIX versions
or to other hardware platforms.  The architecture has been designed to provide a
systems platform that supports capacity growth and technological  evolution with
modular upgrades.

<PAGE>

     The  products,  like those of  several  other  competitors  (such as Lucent
Technologies,  formerly part of AT&T, IBM and  InterVoice),  utilize  internally
developed  telephony  interfaces  and  speech  processing  modules.  Many  other
competitors rely on telephony  interface and other modules  purchased from third
party component suppliers (such as Dialogic Corporation or Natural Microsystems,
Inc.).  The  Company  believes  that  designing  its own  telephone  and  speech
processing  modules  gives it an advantage in evolving and upgrading its systems
in a logical and compatible manner, thus preserving the customer's investment in
the system over a longer period of time.

     The Company's VPS Series products offer a wide range of telephone interface
and data connectivity  options. The telephone interface options supported by the
system include standard digital (including ISDN support for countries  including
the United States, Canada and Germany) and analog connections to public switched
networks  and to a variety of PBX/ACD  systems  from  vendors  including  Lucent
Technologies,  Northern Telecom,  Rolm/Siemens,  Rockwell, Aspect, NEC, Fujitsu,
Hitachi,  Ericsson and Alcatel.  The data connectivity  options supported by the
system  include  interfaces  for  mainframe-based  legacy  systems  as  well  as
LAN-based  systems.  These  interfaces  can support a variety of  databases  and
Application Programming Interfaces ("APIs").

     Products

     The  Company's  products  include a family  of  scalable  call  transaction
processing  systems,  called the VPS Series,  which can be configured  for small
(8-24  ports),  mid-size  (24 to  120  ports),  or  large  scale  installations,
including a network of multiple  systems to handle thousands of telephone ports.
The Company also  develops and sells systems and software  application  products
for Computer Telephony Integration (CTI) as part of the CallSPONSOR(TM)  product
suite. In addition, the Company develops and sells software application products
and  application   development   tools  that  provide   customers  with  various
administrative,  systems management and application development capabilities for
their systems.

     All of the products share an open, flexible, modular architecture,  and the
same system software which allows application  software developed for any system
to operate  across the  Company's  entire  range of system  configurations.  The
Company provides  periodic software upgrades for its systems to deliver enhanced
features and maintenance updates. The current VPS Series system software release
version is 5.3 and has been available  since February  1998.  Periphonics'  call
processing systems are listed below:

     VPS/is.  This model provides enhanced  client/server  capabilities within a
UNIX Software  architecture  that features parallel  functional  processing with
flexible scalability. The VPS/is system is designed to handle applications, even
at peak loads,  and  accommodates  new feature and performance  upgrades through
incremental enhancements.

     VPS/mcp.  This model provides higher density systems that are optimized for
high volume  calling  services.  The system and  application  software for these
models are fully compatible with VPS/is systems.

<PAGE>

     Depending   on  system   configuration,   optional   features   and  custom
programming,  prices for the  Company's  systems can range from less than $1,000
per port to more than $4,000 per port, and  individual  systems can be purchased
for as little as $18,000 to more than $1 million.

     Periphonics  provides a number of optional  features to enhance its systems
capabilities.  Most of these optional  features are configured as  shared-system
resources and are utilized  only when needed,  thus  providing a  cost-effective
implementation  that is scalable to the  capacity  needs.  Each of the  optional
features  is  available  for  use on  each of the  VPS  Series  products,  where
appropriate. These features include:

     Basic Speech Recognition Devices.  This option offers recognition of spoken
numbers and control words by callers along with standard  touch-tone  input.  In
addition,  some versions of this option can recognize individual spoken words or
continuous numbers or multilingual speech.

     Large Vocabulary  Recognition (LVR) Devices. This option offers recognition
of hundreds to thousands of spoken words along with standard  touch-tone  input.
In  addition,   recognition  results  can  be  combined  with  natural  language
processing  to allow a very simple and  intuitive  caller  interface  for a wide
range of automated interactive services.

     Caller  Message  Recording.  This option allows the system to record spoken
information such as names and addresses from callers and link it with touch-tone
information  from the same caller and with data  retrieved  from a host computer
for later transcription by the system operator.

     Message Transfer Server.  This option offers centralized speech storage and
retrieval for a cluster of systems.  It includes a highly available and scalable
configuration  with  fault-tolerant  disk storage (using RAID) and redundant LAN
based message storage and playback.

     Facsimile  Interface.  This  option  allows  the  system to provide a paper
response,  such as a  confirmation  letter or account  statement,  via facsimile
transmission,  as part of an interactive  transaction.  The VPS Series digitally
stores graphical fax images, which are dynamically combined with caller-supplied
information  and host  database  information  and  transmitted  to the  caller's
facsimile machine under application control.

     Text-to-Speech.  This option allows VPS Series  products to convert textual
data obtained from a database into synthesized speech.

     PeriWeb. A software option that permits  Periphonics'  systems to support a
user's web browser in order to  accomplish  World Wide  Web-based  transactions;
instead of a voice  greeting,  the  response  is provided  via a dynamic  visual
hypertext display.

     Periphonics also develops, markets and supports CTI Products including:

     CallSPONSOR(TM)  A CTI server  product that  integrates one or more PBX/ACD
systems,  IVR  systems  and  desktop  applications  to enable a more  productive
environment for call center agents.  CallSPONSOR(TM) provides call/data tracking
and  delivery  of  simultaneous  voice  and data  ("screen  pop")  to the  agent
desktops.

     CallView.  A CTI desktop  client  software  product  that  interfaces  with
CallSPONSOR(TM)  and enables  integration  with other  desktop  applications  to
provide seamless call transfers and software based control of PBX/ACD  telephone
functions.

     Periphonics  also  develops,  markets  and  supports  products  for Telecom
Enhanced Network Services including:

     Periphonics  Calling Card  Platform  ("PCCP").  This  application  software
product includes a replicated  Oracle database and a wide range of configuration
options that are activated through easily set parameters.  It is scalable over a
wide range of sizes - from sizes  suitable for small  countries as well as large
countries.

     Voice Activated Dialing ("VAD"). This application software product includes
speaker dependent recognition technology that is combined with a highly adaptive
application  to meet the needs of telecom  service  providers in a wide range of
configuration.

     Common Channel Signaling Service ("CCSS").  This option allows a cluster of
systems to  interface to a switching  network via SS7 or C7 signaling  protocol.
These  protocols  are used by network  service  providers  to  connect  enhanced
service  equipment with more  flexibility.  The CCSS includes a highly available
and scalable configuration with redundant servers.

<PAGE>

     Periphonics also develops,  markets and supports optional system management
and application software development tools including:

     PeriView.   A  network   management   system  that   facilitates   control,
administration  and monitoring of multiple VPS/is systems from designated common
points in the network.

     PeriProducer.   An  icon-based   visual  software   development  tool  that
application  developers  can  utilize  to  construct  full-function   production
applications  for VPS Series systems without the need for extensive  programming
experience or the use of conventional computer languages.

     PeriStudio. A tool that allows users to create, manage, and edit vocabulary
elements for VPS Series systems.  PeriStudio  employs a graphical user interface
with point-and-click  operation.  PeriStudio also supports file interchange with
Microsoft Windows, Apple and Sun Microsystems speech file formats.

     Product Development

     Recent product development efforts have resulted in the introduction of new
speech recognition  features,  new CTI features to increase agent  productivity,
Periphonics  Calling Card Platform and VAD  applications.  The Company's present
product  development  activities include  integration of new features for speech
recognition  and other voice  processing  functions;  development  of additional
graphical  management  tools;  interfaces to  additional  computer and telephone
systems;  additional  application  software  products;  and cost reducing design
enhancements.

     The  Company's  research and  development  ("R&D")  management  is customer
oriented and regularly interacts with its major customers.  The Company monitors
applicable  industry  technology  developments,   including  proposals  for  new
standards  from industry  groups (such as TSAPI and TAPI) as part of its product
development efforts to provide state-of-the-art systems and related features.

     During fiscal 1996,  1997 and 1998,  the Company spent $7.9 million,  $10.7
million and $15.1 million,  respectively,  on R&D. The Company  anticipates that
R&D expenditures will continue to represent a significant expense to the Company
on an ongoing basis.

     Customer Application Programming Services

     Implementing an IVR, LVR or CTI project usually  requires the creation of a
script,  recording and digitizing the appropriate words and phrases, and writing
custom  application  software  for the  system  that  links the  script  and the
telephone  network  interface and provides  access to the  appropriate  database
information.  Periphonics has established customer project implementation groups
that provides customer-specific  programming and project management services for
turnkey projects based in the United States (Bohemia,  New York, and Pleasanton,
California), Mexico, the United Kingdom, Germany and Singapore.

     The Company licenses its application  software  development  tools to those
customers  who  prefer to carry out this  implementation  work  themselves,  and
provides software support, detailed documentation,  and a comprehensive hands-on
training program to such customers.

     Support Services and Maintenance

     The  Company  has  established  its own  call-center  facility  located  in
Bohemia, on Long Island, to provide 24-hour direct support to its customers. The
Company's  technical  support  specialists  can access a  customer's  system via
dial-up modem access and utilize  various remote  diagnostic and trace functions
which are built into the Company's systems.  In addition,  the technical support
staff also assists the Company's  field service staff in resolving  installation
and maintenance issues relating to the Company's  products.  Field service staff
are based at many locations around the United States, Canada, Mexico, the United
Kingdom,  Germany,  Singapore and Hong Kong.  Technical support  specialists are
based in the  United  States  (Bohemia,  New York and  Pleasanton,  California),
Mexico, the United Kingdom, Germany, Singapore and Hong Kong.

<PAGE>

     In certain  instances,  technical support and maintenance for international
customers is provided by the Company's distributors.

     Periphonics'  products  and  services  are sold  with  limited  warranties,
generally  for 60 days.  After the  expiration  of the  warranty,  customers may
purchase a renewable 12-month maintenance contract.  Under these contracts,  the
Company agrees to provide upgrades of standard system  software,  on-site repair
or  replacement  of system  hardware  that does not perform in  accordance  with
specifications, and telephone consultation.

     Sales and Marketing

     The Company's sales,  marketing and pre-sales  technical  support personnel
are located in 17 cities in the United States and in Canada, the United Kingdom,
Germany,  Hong Kong, Mexico and Singapore.  The Company also has agreements with
VARs and OEMs who purchase the  Company's  systems for  integration  into larger
systems as well as with local distributors and independent sales representatives
in a number of overseas markets.

     The  Company's  marketing  and sales  efforts  also  utilize  direct  mail,
participation  in numerous trade shows,  an active  telemarketing  program,  and
trade publication advertising.

     The following  table  illustrates  the respective  amounts of the Company's
total revenues contributed by U.S. and international based customers:

<TABLE>
<CAPTION>

                                            For Fiscal Year Ending May 31
                                               (dollars in thousands)

                                        1996                       1997                        1998
                                    --------------             ----------------          ---------------
<S>                            <C>              <C>       <C>           <C>            <C>          <C>

U.S. customers                 $60,561          68.1%     $  74,864       67.3%       $  78,964       67.3%
International customers        $28,242          31.9%     $  36,380       32.7%       $  38,335       32.7%
                               -------          -----     ---------     -------       ---------     -------
Total revenues                 $88,803         100.0%     $ 111,244      100.0%        $117,229      100.0%
--------------                 =======         ======     =========     =======       =========      ======
</TABLE>

     Manufacturing

     The  Company's  manufacturing   activities,   which  consist  primarily  of
production planning,  purchasing,  module assembly and testing,  system assembly
and quality assurance,  are conducted at its Bohemia, New York facility and, for
European, Middle Eastern and African sales, at its facility in Camberley, U.K.

<PAGE>

     Risk Factors

     Variability of Quarterly Results; Limited Backlog

     The Company's  quarterly operating results have fluctuated and may continue
to  fluctuate as a result of a variety of factors,  including  the length of the
sales cycle,  the timing of orders from and  shipments to  customers,  delays in
development  and customer  acceptance of custom software  applications,  product
development expenses,  new product introductions or announcements by the Company
or its competitors,  levels of market acceptance for new products and the hiring
and  training  of  additional  staff  as well as  general  economic  conditions.
Historically,  the size  and  timing  of the  Company's  revenues  transactions,
including  international  revenues,  have varied  substantially  from quarter to
quarter with a substantial  percentage of orders and deliveries occurring in the
final weeks of a quarter, and the Company expects such variations to continue in
future periods.  The Company is typically able to deliver systems within 60 days
of receipt of the order and therefore,  does not customarily  have a significant
long-term  backlog.  Because a significant  portion of the Company's overhead is
fixed in the short-term,  the Company's  results of operations have been and may
continue  to be  materially  adversely  affected  if  revenues  fall  below  the
Company's expectations.  Generally, the Company's inventory of computer hardware
is  determined by the Company's  forecasts of sales during  future  periods.  If
management's   forecasts   of  product   sales  and  product  mix  prove  to  be
substantially  inaccurate,  the  Company  may not have the  necessary  inventory
available  to  deliver  systems  in a timely  manner  which may have a  material
adverse effect on the Company's results of operations during such period.

     Risk of Rapid Technological Change and New Product Introduction

     The  market  for  the  Company's  products  and  professional  services  is
characterized  by rapid  continual  technological  change  and  improvements  in
hardware and software  technology and in the features and  capabilities of these
systems.  The Company's future success depends upon its ability to introduce new
products and to add new features and  enhancements to its existing  systems that
keep pace with  technological  and market  developments,  and that  address  the
increasingly  sophisticated  and demanding  needs of its customers.  In order to
remain  competitive,  the  Company  expects to  continue  to expend  significant
resources  for research  and  development.  There can be no  assurance  that the
Company will be  successful  in  developing  and  marketing,  on a timely basis,
product   modifications   or  enhancements  or  new  products  that  respond  to
technological  advances  by others,  or that such new or  enhanced  products  or
features will adequately and competitively address the needs of the marketplace.
In addition,  there can be no assurances that the Company will properly estimate
costs  under  fixed price  contracts  in  developing  application  software  and
otherwise tailoring its systems to customer-specific requests.

     A portion of sales of the Company's  call  processing  systems  depend,  in
part,  upon  customers'  belief that the Company's UNIX and  RISC-based  systems
offer more  performance,  features and benefits than PC-based systems offered by
certain of the  Company's  competitors.  As PC hardware and  operating  software
become more powerful,  however,  the capabilities of PC-based systems are likely
to  increase  and  may  become  increasingly  competitive  alternatives  to  the
Company's products in mid-size and large scale installations.

     The Company's  software  products,  like software programs  generally,  may
contain  undetected  errors  or bugs when  introduced,  or as new  versions  are
released. While the Company's current products have not experienced post-release
software errors that have had a significant  financial or operational  impact on
the Company,  there can be no assurance that such problems will not occur in the
future,  particularly as the Company's  systems  continue to become more complex
and  sophisticated.  Such  defective  software may result in loss of or delay in
market  acceptance  of the  Company's  products,  warranty  liability or product
recalls.

<PAGE>

     Highly Competitive Market Environment

     The market for the Company's products and professional services in the U.S.
and  internationally  is highly  competitive  and competition may intensify from
existing suppliers and new market entrants. Certain of the Company's competitors
have substantially greater financial,  technical,  marketing and sales resources
than the Company. There can be no assurance that the Company's present or future
competitors will not exert increased  competitive  pressures on the Company.  In
particular,  the Company may in the future  experience  pricing pressures as the
markets in which it competes  mature,  as new technologies are introduced or for
other reasons,  and such price  competition could adversely affect the Company's
market share and results of operations.

     In addition,  many  suppliers of voice mail systems and  telecommunications
systems have added IVR capabilities to some of their product offerings and offer
IVR systems as a component  or add-on of an overall  sale of a voice mail system
or a  telecommunications  switch.  As  internet-based  systems are  enhanced for
transaction  processing  applications,  they may provide an alternative means of
allowing customers to interact with computer-based information, thereby reducing
the need for IVR.  Although  the  Company  believes  it has  certain  marketing,
technical and other  advantages over many of its  competitors,  maintaining such
advantages  will  require  continued   investment  by  the  Company  in  product
innovation and development, as well as in sales, marketing and customer support.
There can be no assurance  that the Company will be  successful in such efforts.
If the Company is unable to  maintain  such  advantages,  it may have a material
adverse effect on the Company's results of operations.

     Periphonics' principal competitors in the U.S. include Brite Voice Systems,
Inc.,  Edify,  Inc.,  InterVoice  and  Syntellect,  Inc.,  whose  businesses are
substantially  focused on sales of  interactive  call  processing  systems,  and
large, diversified companies such as Lucent Technologies,  and IBM for whom such
systems  are a small  portion of their  overall  business.  In certain  specific
vertical  markets,  such as higher  education  or  employee-benefit  information
systems,  the  Company  faces  specialized  competition  from one or two smaller
companies.

     In international markets,  Periphonics faces competition primarily from its
U.S. competitors and some locally based companies. Periphonics believes that the
principal   competitive   factors  are  supplier  and  product   reputation  and
reliability,  system features,  customer service, price and the effectiveness of
marketing and sales  efforts.  The Company  believes that it competes  favorably
with  respect  to  each of  these  factors  although  certain  of the  Company's
competitors  have  considerably  greater  financial,  technical  and  sales  and
marketing resources than the Company,

<PAGE>

     International Sales

     System revenues to customers  outside the U.S.  accounted for approximately
36%,  37%, and 38% of the  Company's  total system  revenues in the fiscal years
ended May 31, 1996,  1997 and 1998,  respectively.  System revenues to customers
outside the United States,  as a percentage of the Company's  overall  revenues,
may  fluctuate on a quarterly  basis,  and the  percentage of such revenues in a
particular  quarter  are  not  indicative  of the  percentage  of  international
revenues at the end of the fiscal year.

     The  Company's  international  business  is  subject  to a number of risks,
including  compliance  with special  national  telecommunications  standards and
regulatory  requirements,  export regulations,  currency exchange rates, tariffs
and other  barriers,  difficulties in staffing and managing  foreign  subsidiary
operations, potentially adverse tax consequences, longer payment cycles, greater
difficulty  in  accounts  receivable   collections  and  specialized   inventory
requirements  applicable  to  particular  foreign  countries.  There  can  be no
assurance  that these  factors will not have an adverse  impact on the Company's
future  international  revenues  or  operating  results.  The  Company  does not
currently engage in international  currency hedging transactions.  To the extent
the  Company is unable to match  revenue  received  in foreign  currencies  with
expenses  paid in the  same  currency,  it is  exposed  to  possible  losses  on
international currency transactions.

     Dependence on Suppliers

     Most of the  components  and  parts  used  in the  Company's  products  are
available  from more than one supplier.  Certain  components  that are purchased
from one source can  generally  be  replaced  with  parts  available  from other
sources, after some re-engineering or design changes.

     In certain instances,  despite the availability of multiple supply sources,
the Company elects to procure  certain  components or parts from a single source
to  maintain  quality  control or to  develop a  strategic  relationship  with a
supplier.  Although the Company has entered into long-term supply contracts with
certain of its vendors,  the Company has no assurance that  components and parts
will be available as required,  or that prices of such components and parts will
not increase.  In certain  instances the  manufacture of components  used by the
Company in its products has been  discontinued  by suppliers and the Company has
been required to seek functionally similar substitutes or substantially increase
its  inventories of these  discontinued  components for its future use. To date,
when  components  have become  unavailable,  the Company has been able to obtain
either  sufficient  inventory  for  its own use or  other  functionally  similar
substitutes  and  to  accomplish  any  necessary  redesign  without  a  material
interruption  in  production,  although there can be no assurance that this will
remain the case in the future.  If the Company  were to  experience  significant
delays,  interruptions,  discontinuations or reductions in the supply of certain
components  and  parts  purchased  from  suppliers,  the  Company's  results  of
operations could be materially adversely affected.

<PAGE>

     Limited Protection of Proprietary Technology

     The Company's  success is heavily  dependent upon its proprietary  software
technology. The Company has no patents; it relies on a combination of copyright,
and trade secret laws, employee and third-party  non-disclosure  agreements, and
license agreements to protect its proprietary software technology.  Nonetheless,
there can be no  assurance  that the steps  taken by the  Company to protect its
proprietary rights will be adequate to prevent  misappropriation  of such rights
or that other parties will not independently develop functionally  equivalent or
superior   software   technology.   The  Company  from  time  to  time  receives
correspondence  alleging  that its products  may infringe  patents held by other
parties  (refer to Item 3., Legal  Proceedings).  The Company  believes that its
products and other proprietary  rights do not infringe the proprietary rights of
other parties.  There can be no assurance,  however, that other parties will not
assert  infringement claims against the Company or that any such claims will not
require the Company to enter into license  arrangements  or result in protracted
and costly litigation,  regardless of the merits of such claims.  There also can
be no  assurance  that the Company  will be able to obtain  licenses to disputed
technology  or  that  such  licenses,  if  available,   would  be  available  on
commercially reasonable terms. The Company is aware that certain segments of the
voice processing industry,  particularly voice mail/voice messaging systems, are
affected by active and costly litigation.  There can be no assurance that as the
Company's interactive transaction processing systems evolve and provide features
which  extend their uses and  capabilities,  possibly to include  certain  voice
mail/voice messaging and/or additional  internet-related  features,  the Company
will not become involved in, or otherwise be affected by,  litigation  which may
or may not be meritorious.

     Dependence on Key Personnel

     The Company's  success  during the  foreseeable  future will depend largely
upon the continued services of its executive officers,  each of whom has entered
into an  employment  agreement  with  the  Company.  Each  employment  agreement
contains  non-competition  covenants that extend for a period of up to two years
following  termination  of  employment.  The Company  does not have key-man life
insurance on its executive officers.  The Company's success also depends in part
on its ability to attract and retain qualified  managerial,  technical and sales
and marketing personnel in a timely fashion. The Company's results of operations
could be  materially  adversely  affected if the Company were unable to attract,
hire, assimilate and train these personnel in a timely manner.

     Anti-Takeover Provisions and Rights Plan

     Certain "anti-takeover" provisions of the Delaware General Corporation Law,
among other matters,  restrict the ability of certain  stockholders  to effect a
merger or business  combination or obtain  control of the Company.  In addition,
the Company's By-Laws provide for a classified Board of Directors with staggered
three-year  terms.  The Company has an authorized  class of 1,000,000  shares of
Preferred Stock, which may be issued by the Board of Directors on such terms and
with such rights,  preferences  and  designations  as the Board of Directors may
determine, without further stockholder action. Issuance of such Preferred Stock,
depending upon the rights,  preferences and designations  thereof,  may have the
effect of delaying,  deferring or preventing a change in control of the Company.
On July 15, 1996,  the Board of Directors of the Company  approved a Rights Plan
designed  to  protect  stockholders  in the event of an  unsolicited  attempt to
acquire  the  Company,  including a gradual  accumulation  of shares in the open
market,  a partial or two-tier tender offer that does not treat all stockholders
equally, and other takeover tactics which the Board of Directors believes may be
abusive and not in the best interests of stockholders. The implementation of the
Rights  Plan  increases  the  Board  of  Directors'  power  in the  event  of an
unsolicited  proposal  by  giving  the  Board  of  Directors  more  time and the
opportunity to evaluate an offer and exercise its good faith  business  judgment
to take  appropriate  steps to protect  and  advance  stockholder  interests  by
negotiating   with  the  bidder,   auctioning   the  Company,   implementing   a
recapitalization  or  restructuring  designed as an alternative to the offer, or
taking other action.

<PAGE>

     Potential Volatility of Stock Price

     The market price of the shares of the Company's  Common Stock may be highly
volatile.  Factors such as  fluctuations  in the Company's  quarterly  operating
results,  announcements of technological  innovations or new commercial products
by the Company or its  competitors,  and  conditions in the markets in which the
Company and its customers  compete may have a  significant  effect on the market
price and marketability of the Common Stock.  Prices for many technology company
stocks,  including  the Common Stock,  may  fluctuate  widely as a result of the
factors  cited  above  or for  reasons  that  are not  directly  related  to the
operating performance of such companies, including general fluctuations in stock
prices and  changes in  earnings  estimates  or  recommendations  by  securities
analysts.  Refer to item 5 "Market  for Common  Equity and  Related  Stockholder
Matters", on page 15.

     Employees

     As of May 31, 1998,  Periphonics  employed 866 persons.  Approximately  130
employees  are  located  outside the U.S.  None of the  Company's  employees  is
covered by collective  bargaining  agreements.  The Company considers  relations
with its employees in general to be excellent.

     Disclosures Regarding Forward Looking Statements

     This report on Form 10-K includes  "forward-looking  statements" within the
meaning of Section 27A of the  Securities  Act of 1933, as amended,  and Section
21E of the Securities  Exchange Act of 1934, as amended.  All  statements  other
than statements of historical  facts included in this Form 10-K  including,  but
not  limited  to,  statements   contained  in  this  "Business,"   "Management's
Discussion  and  Analysis"  and "Notes to  Consolidated  Financial  Statements,"
located elsewhere herein regarding the Company's  financial  position,  business
strategy,  plans  and  objectives  of  management  of  the  Company  for  future
operations,  and industry conditions, are forward-looking  statements.  Although
the Company  believes that the  expectations  reflected in such  forward-looking
statements are reasonable,  it can give no assurance that such expectations will
prove correct.

     Item 2. Properties

     The Company's corporate  headquarters and manufacturing facility is located
in  Bohemia,  New York,  a New York City  suburb.  This  facility  consists of a
Company-owned  65,000 square-foot building located on a 3.9 acre site and 89,000
square  feet  leased in two  nearby  buildings.  The  headquarters  contain  the
Company's manufacturing, development, service and administration departments, as
well  as  a  professional-quality   recording  studio.  The  Company  also  owns
approximately  3.4 acres of vacant land for future  development  adjacent to its
headquarters.  The  Company  believes  that  suitable  additional  space will be
available in the area as needed in the future on commercially reasonable terms.

     In addition,  the Company has leased offices for professional  services and
technical  support  staff in  Pleasanton,  CA (11,000  sq.  ft) and in  Laurence
Harbor, NJ (8,700 sq. ft).

     The  Company  has leased  regional  sales  offices in  Atlanta,  Charlotte,
Chicago,  Dallas,  Denver,  Grand  Rapids,  Los Angeles,  Minneapolis,  Ontario,
Phoenix, Providence, San Francisco, Seattle, Tampa, Toronto and Washington D.C.

     The  Company's  European  headquarters  in  Camberley,  U.K. is housed in a
17,000  square-foot  leased  space in two adjacent  buildings.  The Company also
leases a maintenance  support office of  approximately  1,500 square feet nearby
Manchester,  England.  Sales,  professional services and technical support staff
operates out of leased offices in Germany, Hong Kong, Mexico and Singapore.

<PAGE>
     Item 3. Legal Proceedings

     On July 7,  1998  Lucent  Technologies,  Inc.  filed a patent  infringement
action in the United States District Court for the District of Delaware alleging
that Periphonics  infringed some nine patents of Lucent  Technologies,  Inc. The
Company  believes  the claims  contained  in the lawsuit  are without  merit and
intends to defend the  lawsuit  vigorously.  The  Company is involved in certain
other legal matters in the normal course of business.  The Company's  management
does not believe that  resolution of these matters will have a material  adverse
effect on the Company's consolidated financial statements.


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

     None


<PAGE>



                                     PART II

     Item 5. Market for Common Equity and Related Stockholder Matters

     (a) The  Company's  Common  Stock,  par value $.01 per share  (the  "Common
Stock"),  trades on the NASDAQ Stock Market under the symbol PERI. The following
table sets forth for each period  indicated the high and low closing  prices for
the  Common  Stock for the  period  March 31,  1995,  the date of the  Company's
initial public offering, through May 31, 1998, as reported by NASDAQ:

<TABLE>
<CAPTION>

                                                                                    Sales Prices
                                                                              ------------   -------
                                                                               High            Low
                                                                              ------------   -------
<S>                                                                           <C>            <C>

                       Fiscal 1995

Quarter Ended May 31, 1995 ................................................    8 5/8          7 3/8

                       Fiscal 1996

Quarter Ended August 31, 1995 .............................................   12 1/4          7 3/8
Quarter Ended November 30, 1995 ...........................................   14 3/4         11 3/4
Quarter Ended February 29, 1996 ...........................................   13 7/8         10 1/2
Quarter Ended May 31, 1996 ................................................   18             10 3/8

                       Fiscal 1997

Quarter Ended August 31, 1996 .............................................   20 1/8         12 7/8
Quarter Ended November 30, 1996 ...........................................   21             17 1/4
Quarter Ended February 28, 1997 ...........................................   34 3/4         11 1/4
Quarter Ended May 31, 1997 ................................................   19 1/2         11


                       Fiscal 1998

Quarter Ended August 31, 1997 .............................................   22 1/4         12 3/4
Quarter Ended November 30, 1997 ...........................................   14 1/2          8 5/8
Quarter Ended February 28, 1998 ...........................................   12 3/4          7 13/16
Quarter Ended May 31, 1998 ................................................   14 1/8          9 15/16


</TABLE>


     The foregoing  over-the-counter  market quotations  represent  inter-dealer
prices,  without  retail  mark-up,  markdown or commission and may not represent
actual transactions.

     Prices for the shares have been  adjusted to reflect a two for one split of
the  Company's  Common Stock  effected as a stock  dividend  paid on October 31,
1996.

     (b) The number of recordholders of the Common Stock as of August 25 1998 is
approximately  503. The Company believes that there are a substantially  greater
number of beneficial owners of shares of its Common Stock.

     (c) The Company  does not  anticipate  paying cash  dividends on its Common
Stock in the  foreseeable  future.  The  payment  of  dividends  is  within  the
discretion of the Board of Directors and will be dependent,  among other things,
upon  earnings,   capital  requirements,   financing  agreement  covenants,  the
financial condition of the Company and applicable law.

<PAGE>

     Item 6. Selected Financial Data

     The following  selected  consolidated  financial data as of and for each of
the five fiscal years in the period ended May 31, 1998 has been derived from the
consolidated  financial  statements  of the Company,  which have been audited by
Deloitte & Touche LLP, independent auditors, whose report as of May 31, 1998 and
1997,  and for each of the  three  years in the  period  ended  May 31,  1998 is
included  elsewhere herein. The selected  consolidated  financial data should be
read in  conjunction  with and is  qualified  in its  entirety by the  Company's
consolidated financial statements, related notes and other financial information
included elsewhere herein.

<TABLE>
<CAPTION>

                                                                     Fiscal Year Ended May 31,
                                                         (in thousands except share and per share data)

                                                          1994     1995 (1)     1996      1997      1998
                                                          ----      ----        ----      ----      ----
<S>                                                    <C>       <C>          <C>       <C>        <C>   


System revenues..................................      $41,192    $51,747    $71,800    $86,144    $87,618
Maintenance revenues.............................       10,293     13,030     17,003     25,100     29,681
                                                        ------     ------     ------     ------     ------
Total revenues...................................       51,485     64,777     88,803    111,244    117,299
                                                        ------     ------     ------    -------    -------
Cost of system revenues..........................       18,653     23,686     32,798     38,858     43,437
Cost of maintenance revenues.....................        7,748      8,387     10,956     14,924     16,988
                                                        ------     ------     ------     ------     ------
Total cost of revenues...........................       26,401     32,073     43,754     53,782     60,425
                                                        ------     ------     ------     ------     ------
Gross profit.....................................       25,084     32,704     45,049     57,462     56,874
                                                        ------     ------     ------     ------     ------
Selling, general and  administrative.............       15,249     18,749     22,587     27,737     36,111
Research and development.........................        4,961      5,831      7,933     10,698     15,068
Non-recurring, noncash compensation charge (1)...         -         1,250        -          -          -
                                                        ------     ------     ------     ------     ------
  Total operating expenses.......................       20,210     25,830     30,520     38,435     51,179
                                                       -------     ------     ------     ------     ------
Earnings from operations.........................        4,874      6,874     14,529     19,027      5,695
                                                       -------     ------     ------     ------     ------
Interest expense.................................         (936)      (992)       -          -          -
Interest and other income........................          159        170        885      1,242      1,272
Foreign exchange (loss) gain.....................         (464)        88       (345)       (49)     (547)
                                                       -------     ------     ------     ------     ------
  Total other expenses...........................       (1,241)      (734)       540      1,193        725
                                                       -------     ------     ------     ------     ------
Earnings before provision for income
 taxes and cumulative effect of
 change in accounting principle .................        3,633      6,140     15,069     20,220      6,420
Provision for income taxes.......................        1,599      2,956      5,854      7,583      1,990
                                                       -------     ------     ------     ------      -----
Earnings before cumulative effect
 of change in accounting principle ..............        2,034      3,184      9,215     12,637      4,430


Cumulative effect of change
 in accounting principle (2) ....................           83       -          -           -         -
                                                       -------    -------     ------     ------     ------
Net earnings.....................................     $  1,951    $ 3,184    $ 9,215    $12,637     $4,430
                                                      ========    =======    =======    =======     ======
Per share date: (3) .............................
 Basic earnings..................................     $   0.26    $  0.39    $  0.71    $  0.93    $  0.32
                                                      ========    =======    =======    =======    =======
 Diluted earnings................................     $   0.21    $  0.33    $  0.70    $  0.90    $  0.32
                                                      ========    =======    =======    =======    =======
Weighted average shares: ........................     
                                                      
 Basic...........................................        7,500      8,270     12,890     13,641     13,765
                                                      ========    =======     ======    =======    =======
 Diluted.........................................        9,238      9,778     13,258     14,020     13,947
                                                      ========    =======     ======     ======    =======

<PAGE>
                                                       
                                                        1994       1995       1996         1997       1998
                                                        ----       ----       ----         ----       ----           
                                                                             
Balance Sheet Data:
Working capital...................................     $13,837   $27,550     $48,476     $55,200     $58,083
Total assets......................................      33,714    47,722      75,103      93,583     100,607
Total debt........................................      10,032       -            -          -           -
Redeemable cumulative convertible preferred stock
issued by subsidiary .............................       1,215     1,215          -          -           -
Redeemable cumulative convertible preferred stock.       4,500       -            -          -           -
Common stockholders' equity.......................       6,289    33,576      58,781      72,208      77,860

</TABLE>


     (1) On  February  1,  1995,  the  Company  accelerated  the  vesting of all
outstanding  stock options under its 1986 Incentive Stock Option Plan (the "1986
Plan"),  thereby  allowing all such options to be fully vested at such date. The
Company also  relinquished its right to repurchase  shares obtained by employees
under the 1986 Plan. As a result, the Company recorded a non-recurring,  noncash
compensation charge of approximately $1.25 million, or $0.13 per share.

     (2) During fiscal 1994,  the Company  changed its method of accounting  for
income taxes to conform to Statement of Financial Accounting Standards No. 109.

     (3) In the third quarter of the fiscal 1998, the Company adopted  Statement
of Financial Accounting Standards No. 128 "Earnings Per Share". Basic income per
share is determined  using the weighted average number of shares of common stock
outstanding  during each period.  Diluted  income per share further  assumes the
issuance of common shares for all diluted securities including stock options.

     Item 7. Management's Discussion and Analysis

     Overview

     Disclosures Regarding Forward Looking Statements

     This report on Form 10-K includes  "forward-looking  statements" within the
meaning of Section 27A of the  Securities  Act of 1933, as amended,  and Section
21E of the Securities  Exchange Act of 1934, as amended.  All  statements  other
than statements of historical  facts included in this Form 10-K  including,  but
not  limited to,  statements  contained  in this  "Management's  Discussion  and
Analysis," "Business" and "Notes to Consolidated  Financial Statements," located
elsewhere herein regarding the Company's financial position,  business strategy,
plans and  objectives of management  of the Company for future  operations,  and
industry  conditions,  are  forward-looking  statements.  Although  the  Company
believes that the expectations reflected in such forward-looking  statements are
reasonable, it can give no assurance that such expectations will prove correct.


<PAGE>


     Management's Discussion and Analysis

     The  Company  develops,  markets and  supports  products  and  professional
services for Computer  Telephony  Integration  ("CTI") and for Telecom  Enhanced
Network Services using  technologies such as interactive voice response ("IVR"),
speech  input,  messaging,  fax and web  browsers.  The  Company's  products and
services  automate  call  transaction  processing,  increase  call-center  agent
productivity, and often can create new revenue streams for its customers.

     Historically,  the size and timing of system sales transactions have varied
substantially  from quarter to quarter,  and the Company expects such variations
to continue  into the future.  Because a  significant  portion of the  Company's
overhead is fixed in the short-term,  the Company's results of operations may be
adversely  affected  if  revenues  fall below the  Company's  expectations.  The
Company is typically  able to deliver a system  within 60 days of receipt of the
order and, therefore does not customarily have a significant long-term backlog.

     Results of Operations

     The following table sets forth,  for the periods  indicated,  certain items
from  the  Company's  consolidated  statements  of  earnings,   expressed  as  a
percentage of total revenues,  and the percentage change in the dollar amount of
such items compared to the prior comparable period.

<TABLE>
<CAPTION>

                                                 Percentage of Total Revenues              Percentage Increase (Decrease)

                                                                                        Fiscal 1997         Fiscal 1998
                                                  Fiscal Year Ended May 31,             Over Fiscal         Over Fiscal    
                                       ------------ ----------------- --------------- ----------------- ---------------
                                           1996           1997            1998            1996                1997
                                       ------------ ----------------- --------------- ----------------- ---------------
<S>                                      <C>           <C>               <C>                 <C>                  <C>  

Statement of Earnings Data:
System revenues                           80.9%           77.4%           74.7%              20.2%                1.7%
Maintenance revenues                      19.1            22.6            25.3               47.6                18.3
                                       ------------- ---------------- --------------
   Total revenues                         100.0          100.0           100.0               25.3                 5.4
                                       ------------- ---------------- --------------
Cost of system revenues                   36.9            34.9            37.0               18.5                11.8
Cost of maintenance revenues              12.4            13.4            14.5               36.2                13.8
                                       ------------- ---------------- --------------
  Total cost of revenues                  49.3            48.3            51.5               22.9                12.4
                                       ------------- ---------------- --------------
Gross profit                              50.7            51.7            48.5               27.6                (1.0)
Selling, general and administrative       25.4            24.9            30.8               22.8                30.0
Research and development                   8.9             9.6            12.8               34.9                40.8
                                       ------------- ---------------- --------------
Earnings from operations                  16.4            17.1             4.9               31.0               (70.1)
Other income (expense), net                0.6             1.1             0.6              120.9               (39.2)
                                       ------------- ---------------- --------------
Earnings before provisions for
   income taxes and cumulative
   effect of  change in accounting        17.0            18.2             5.5               34.2               (68.2)
   principal
Provision for income taxes                 6.6             6.8             1.7               29.5               (73.8)
                                       ------------- ----------------  -------------
                                       
 Earnings before cumulative effect
   of change in accounting principle      10.4%           11.4%            3.8%              37.1%              (64.9%)
                                       ============= ================  =============
</TABLE>

<PAGE>
                         
     Fiscal Years Ended May 31, 1997 and 1998

     Total  Revenues.  Total  revenues  for the fiscal  year ended May 31,  1998
increased  5.4% to $117.3  million  compared with $111.2 million in fiscal 1997.
System revenues for the year increased 1.7% to $87.6 million compared with $86.1
million in fiscal 1997.  System  revenues of the Company's  newest  products and
features,  including Large Vocabulary Speech Recognition (LVR),  CallSPONSOR(TM)
call center CTI application suite,  Periphonics Calling Card Platform (PCCP) and
the PeriWeb internet interface feature,  continued to grow substantially  during
1998. These new products generated $13.3 million or 15% of total system revenues
during the year,  compared  with $5.9 million or 7% of total system  revenues in
fiscal 1997. Maintenance revenues increased 18.3% to $29.7 million compared with
$25.1  million  in the prior  fiscal  year  primarily  due to the  growth in the
maintenance base.

     Domestic system revenues for fiscal 1998 remained  relatively  unchanged at
$54.4 million compared with $54.6 million in fiscal 1997.  Domestic  maintenance
revenues for fiscal 1998  increased  21.0% to $24.6 million  compared with $20.3
million in fiscal 1997. International revenues for fiscal 1998 increased 5.4% to
$38.3 million or 32.7% of total revenues compared with $36.4 million or 32.7% in
fiscal 1997. Revenues from Europe, the Middle East and Africa increased 38.4% to
$15.7 million  offsetting  lower  revenues from the Pacific Rim and the Americas
(excluding U.S.) which declined 8.4% to $12.5 million and 11.4% to $10.1 million
respectively compared with the prior year.

     Gross Profit.  The Company's gross profit for the year was $56.9 million or
48.5% of total revenues,  compared with $57.5 million or 51.7% of total revenues
in the prior year. Gross profit on system revenues  decreased by $3.1 million to
$44.2  million or 50.4% of system  revenues in fiscal 1998 from $47.3 million or
54.9% of systems  revenues in the prior  year.  The lower  gross  profit  margin
primarily  reflects product mix,  including a higher  percentage of lower margin
custom  programming  revenue  and  the  continued   investments  in  application
development  resources to pursue  growth  opportunities  in all  markets.  Gross
profit on  maintenance  revenues  increased by $2.5 million to $12.7  million in
fiscal  1998 or 42.8% of  maintenance  revenue  from  $10.2  million or 40.5% of
maintenance revenue in the prior fiscal year.

     Selling,  General  and  Administrative   Expenses.   Selling,  general  and
administrative  ("SG&A") expenses for fiscal 1998 were $36.1 million or 30.8% of
total  revenues  compared with $27.7  million or 24.9% of total  revenues in the
prior year.  The  increased  expense  level can be  attributed  primarily to the
Company's  expansion of its sales and marketing efforts designed to increase its
market penetration and market share on a global basis.

     Research  and  Development  Expenses.   Research  and  development  ("R&D")
expenses,  primarily  for new products and  features,  increased  40.8% to $15.1
million or 12.8% of total revenues  compared with $10.7 million or 9.6% of total
revenues  in fiscal  1997.  The  increase in the dollar  amount of research  and
development  expense  reflects  the  continued  expansion of the  Company's  R&D
efforts to broaden the scope of its product offerings in order to address growth
opportunities  in the  market  place.  The R&D staff  increased  to 171 from 128
between  May 31,  1998 and 1997.  R&D  expenses  are  charged to  operations  as
incurred,  and no software development costs have been capitalized.  The Company
expects such  expenditures  to remain at  approximately  13% of total  revenues,
though it may fluctuate from quarter to quarter.

<PAGE>

     Other  Income  (Expense).  Other  income was $0.7  million  for fiscal 1998
compared  with $1.2 million in fiscal  1997.  Interest and other income was $1.3
million for fiscal  1998  compared  with $1.2  million in fiscal  1997.  Foreign
exchange gain (loss) increased to a loss of $0.5 million in fiscal 1998 compared
with no gain or (loss) in the prior year.

     Income  Taxes.   Variations  in  the  customary  relationship  between  the
provision for income taxes and the statutory income tax rate during the past two
years  primarily  result from the  utilization of research and  development  tax
credits, state and local income taxes and exempt income of the Company's foreign
sales corporation. The Company's effective income tax rates were 31.0% and 37.5%
for fiscal 1998 and fiscal 1997, respectively.

     Foreign  Operations.  The Company's  European  subsidiary  had an operating
profit of $0.6 million  during fiscal 1998 compared with an operating  profit of
$0.4 million during fiscal 1997 (see Note 11 of notes to consolidated  financial
statements).  Transfers  from the  Company's  North  American  operations to its
European  subsidiary are accounted for at cost,  plus a reasonable  profit.  The
cost of revenues for the Company's European  subsidiary  includes  approximately
$0.8  million  and $0.6  million  of  intercompany  gross  profit  earned by the
Company's North American  operations on system sales by the European  subsidiary
to third parties during both fiscal 1998 and fiscal 1997, respectively.

     Fiscal Years Ended May 31, 1996 and 1997

     Total Revenues.  Total revenues  increased by 25.3%,  from $88.8 million in
fiscal 1996 to $111.2  million in fiscal  1997.  System  revenues  increased  by
20.0%,  from $71.8 million in fiscal 1996 to $86.1  million in fiscal 1997.  The
increase in system  revenues was due to an 18.6%  increase in domestic  revenues
and a 22.4% increase in international revenues primarily due to continued growth
in new and upgraded  system  requirements.  The increase in system  revenues was
primarily due to increases in unit sales volume.  Maintenance revenues increased
by 47.6%,  from $17.0  million in fiscal 1996 to $25.1  million in fiscal  1997,
primarily  due to the addition of units to the  maintenance  base, as well as an
increase in installation revenues.

     Gross Profit.  The Company's  gross profit  increased by $12.4 million from
$45.0 million in fiscal 1996 to $57.5 million in fiscal 1997.  Gross profit as a
percentage  of total  revenues  increased  from 50.7% in fiscal 1996 to 51.7% in
fiscal 1997.  Gross profit on system  revenues  increased  by $8.3  million,  or
21.2%,  from $39.0 million in fiscal 1996 to $47.3 million in fiscal 1997. Gross
margin on system revenues increased from 54.3% in fiscal 1996 to 54.9% in fiscal
1997. Gross profit on maintenance  revenues increased by $4.1 million, or 68.3%,
from $6.0 million in fiscal 1996 to $10.2  million in fiscal 1997.  Gross margin
on  maintenance  revenues  was 35.6% and  40.5% in fiscal  years  1996 and 1997,
respectively.

     Selling,  General  and  Administrative   Expenses.   Selling,  general  and
administrative ("SG&A") expenses were $22.6 million and $27.7 million for fiscal
1996 and 1997, respectively, or 25.4% and 24.9% of total revenues, respectively.
The  increase in the dollar  amount of the SG&A  expenses was  primarily  due to
expansion  of the  sales  effort in both  domestic  and  international  markets,
increased sales  commissions due to higher revenues and increases in expenses to
support the increased level of sales. SG&A expenses decreased as a percentage of
total revenues due to the Company's  ability to leverage  certain fixed expenses
over its growing revenue base.

<PAGE>

     Research  and  Development  Expenses.   Research  and  development  ("R&D")
expenses  were  $7.9  million  and  $10.7  million  for  fiscal  1996 and  1997,
respectively, or 8.9% and 9.6% of total revenues,  respectively. The increase in
the dollar  amount of research and  development  expense  reflects the continued
expansion of the Company's R&D staff which increased from 101 to 128 between May
31, 1996 and 1997.  R&D expenses  are charged to  operations  as  incurred,  and
software  development costs have not been capitalized.  The Company expects such
expenditures to continue to increase,  although such expenses as a percentage of
total revenues may vary from period to period.

     Other  Income  (Expense).  Other income was $1.2 million for fiscal 1997 as
compared to $0.5  million in fiscal 1996.  Interest  income was $0.9 million and
$1.2 million in fiscal 1996 and fiscal 1997, respectively. Foreign exchange gain
(loss) decreased from a loss of $0.4 million in fiscal 1996 to no loss in fiscal
1997.

     Income  Taxes.   Variations  in  the  customary  relationship  between  the
provision for income taxes and the statutory income tax rate during the past two
years  primarily  resulted from the  utilization of research and development tax
credits, state and local income taxes and exempt income of the Company's foreign
sales corporation. The Company's effective income tax rates were 38.8% and 37.5%
for fiscal 1996 and fiscal 1997, respectively.

     Foreign  Operations.  The Company's  European  subsidiary  had an operating
profit of $0.4 million during fiscal 1997 as compared to an operating  profit of
$0.8 million during fiscal 1996 (see Note 11 of notes to consolidated  financial
statements).  The  decline in  profitability  was  primarily  due to lower gross
margins  on  system   revenues  and  higher  SG&A   expenses   associated   with
infrastructure growth. Transfers from the Company's North American operations to
its European subsidiary are accounted for at cost, plus a reasonable profit. The
cost of revenues for the Company's European  subsidiary  includes  approximately
$0.6 million of intercompany gross profit earned by the Company's North American
operations on system revenues by the European subsidiary to third parties during
both fiscal 1996 and fiscal 1997, respectively.

     Liquidity and Capital Resources

     The Company's  principal cash  requirement to date has been to fund working
capital and  capital  expenditures  in order to support the growth of  revenues.
Historically,  the Company has primarily financed this requirement  through cash
flow  from  operations  and bank  borrowings  and two  Public  Offerings  of the
Company's  Common Stock in 1995, which resulted in an aggregate of $41.1 million
of net proceeds to the Company. Cash flow from operations was $9.6 million, $7.3
million and $7.2 million in fiscal 1996, 1997 and 1998, respectively. At May 31,
1998, the Company had working capital of $58.1 million,  including $25.8 million
of cash and cash equivalents,  and short-term  investments.  The Company expects
its working capital needs to increase along with planned future revenue growth.

     At May 31, 1998,  current  assets  increased by $4.4 million  while current
liabilities  increased  by $1.5  million as  compared to May 31,  1997.  Current
assets increased principally as a result of increases in accounts receivable and
inventories due to higher operating levels.

     The  average  days'  sales  outstanding  (calculated  by  dividing  the net
accounts  receivable at the balance sheet date) were  approximately 83 days, 111
days and 107 days at May 31, 1996, 1997 and 1998, respectively.

<PAGE>

     In November 1997, the Company increased its line of credit to $15.0 million
with interest  charged at the prime rate. The line of credit expires on November
30, 1998. As of May 31, 1998,  the Company had no borrowings  under this line of
credit.

     The Company made capital expenditures totalling $5.9 million, $10.3 million
and $7.7 million during fiscal 1996, 1997 and 1998, respectively.

     The  Company  believes  that its  existing  sources of working  capital and
borrowings  available  under its revolving  line of credit will be sufficient to
fund its operations and capital expenditures for at least 12 months.

     Year 2000 Compliance

     The Year 2000 issue exists because many computer  systems and  applications
use  two-digit  date  fields to  designate a year.  As the  century  date change
occurs, date sensitive systems may not be able to recognize the year 2000 or may
do so  incorrectly  as the year 1900.  This  inability  to recognize or properly
interpret the year 2000 may result in the incorrect  processing of financial and
operational information.

     The Company has  initiated  a program to upgrade its  internal  information
systems to address any year 2000  compliance  issues.  This  program  includes a
focus on internal  policies,  methods and tools, as well as  coordination  with
customers  and  suppliers.  The  Company  expects  its Year 2000  program to be
completed on a timely  basis.  However,  there is no assurance  that the Company
will  identify  and  resolve any and all Year 2000  compliance  issues with its
information  systems in a timely manner,  that the expenses associated with such
efforts  will not be  significant,  or that such issues will not have a material
adverse  effect on the  Company's  business,  operating  results  and  financial
condition.

     The Company  has made a thorough  review and  testing of its  products  and
believes  that its  current  products  are Year 2000  compliant.  The  Company's
assessment of its current  products is partially  dependent upon the accuracy of
representations  concerning Year 2000 compliance made by its suppliers,  such as
Sun and Microsoft,  among others.  Many of the Company's customers are, however,
using earlier  versions of the  Company's  products,  which may not be Year 2000
compliant.  The Company  has  initiated  programs  to  proactively  notify such
customers  of the risks  associated  with using these  products  and to actively
encourage such customers to migrate to the Company's current products.

     In addition,  the  Company's  products are  generally  integrated  within a
customer's  enterprise system,  which may involve products and systems developed
by other vendors.  A customer may mistakenly  believe that Year 2000  compliance
problems with its enterprise system are attributable to products provided by the
Company.  The Company may, in the future be subject to claims based on Year 2000
compliance  issues related to a customer's  enterprise  system or other products
provided by third parties,  custom  modifications to the Company's products made
by third  parties,  or issues  arising  from the  integration  of the  Company's
products  with  other  products.  The  Company  has  not  been  involved  in any
proceeding  involving  its  products or services  in  connection  with Year 2000
compliance,  however,  there is no  assurance  that the Company will not, in the
future,  be  required to defend its  products  or  services in such  proceedings
against claims of Year 2000 compliance  issues,  and any resulting  liability of
the Company for damages  could have a material  adverse  effect on the Company's
business, operating results and financial condition.

     Recent Financial Accounting Standards Board Statements

     Recent  pronouncements of the Financial Accounting Standards Board ("FASB")
which  are not  required  to be  adopted  at this  date  include,  Statement  of
Financial  Accounting  Standards  No.  131,  "Disclosures  about  Segments of an
Enterprise  and  Related  Information  ("SFAS  131"),   Statement  of  Financial
Accounting Standards No. 130, "Reporting  Comprehensive Income" ("SFAS 130") and
Statement of Financial  Accounting  Standards No. 132,  "Employers'  Disclosures
about Pensions and Other  Postretirement  Benefits" ("SFAS 132"). SFAS 131, SFAS
130 and SFAS 132 are effective  for fiscal years  beginning  after  December 15,
1997.  The adoption of these  pronouncements  is not expected to have a material
impact on the Company's consolidated financial statements.

<PAGE>

     In October of 1997, the  Accounting  Standards  Executive  Committee of the
American  Institute of Certified Public Accountants issued Statement of Position
97-2  "Software  Revenue  Recognition"  ("SOP 97-2").  This  statement  provides
guidance on applying  generally  accepted  accounting  principles in recognizing
revenues  on software  transactions.  This  Statement  supercedes  Statement  of
Position 91-1 "Software  Revenue  Recognition".  This Statement is effective for
transactions entered into in fiscal years beginning after December 15, 1997.

     Based upon Periphonics' reading and interpretation of SOP 97-2, the Company
believes that the  implementation  of SOP 97-2 will not have a material  adverse
affect on  expected  revenues  or  earnings.  However,  detailed  implementation
guidelines  for this  standard  have  not yet been  issued.  Once  issued,  such
detailed  guidance could lead to unanticipated  changes in the Company's current
revenue  accounting  practices  and material  adverse  changes in the  Company's
reported revenues and earnings. In the event implementation guidance is contrary
to the Company's revenue  accounting  practices,  the Company believes it may be
possible to change its current  business  practices to comply with this guidance
and  avoid any  material  adverse  effect on  reported  revenues  and  earnings.
However, there can be no assurance this will be the case.

     Foreign Currency Transaction

     The Company does not currently  engage in  international  currency  hedging
transactions to mitigate its foreign currency exposure.  Included in the foreign
exchange gain (loss) are unrealized  foreign exchange gains and losses resulting
from  the  currency   remeasurement  of  the  financial  statements   (primarily
inventories,   accounts   receivable  and  intercompany  debt)  of  the  foreign
subsidiaries  of the  Company  into U.S.  dollars.  To the extent the Company is
unable to match revenue received in foreign currencies with expenses paid in the
same  currency,  it is  exposed to  possible  losses on  international  currency
transactions.

     Inflation

     In the opinion of  management,  inflation has not had a material  effect on
the operations of the Company.

     Forward Looking Statements

     The Private Securities Litigation Reform Act of 1995 provides a safe harbor
for   certain   forward-looking   statements.   The   Annual   Report   contains
forward-looking  statements that reflect the Company's current news with respect
to future  events and  financial  performance,  including,  without  limitation,
statements containing the words "believes," "anticipates," "expects," "intends,"
"should,"  "seeks to" and similar words.  These  forward-looking  statements are
subject to certain risks and  uncertainties  which could cause actual results to
differ  materially from  historical  results or those  anticipated.  Readers are
cautioned not to place undue reliance on these forward-looking  statements.  The
Company   undertakes   no   obligation   to   publicly   update  or  revise  any
forward-looking  statements,  whether  as a result  of new  information,  future
events or otherwise.

<PAGE>

     Item 8. Consolidated Financial Statements

     The information is contained on Pages F-1 through F-17 hereof.

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

     None.


<PAGE>


                                     PART IV

     Item 14. Exhibits, Financial Statement Schedule and reports on Form 8-K

<TABLE>
<CAPTION>

(a)(1)   CONSOLIDATED FINANCIAL STATEMENTS                                                          PAGE(S)
<S>                                                                                                   <C>   

Index to Consolidated Financial Statements..........................................................F-1

Independent Auditors' Report........................................................................F-2


Consolidated Balance Sheets as of May 31, 1998 and 1997.............................................F-3


Consolidated Statements of Earnings for the years ended
  May 31, 1998, 1997 and 1996.......................................................................F-4


Consolidated Statements of Stockholders' Equity for the years
  Ended May 31, 1998, 1997 and 1996.................................................................F-5


Consolidated Statements of Cash Flows for the years ended
  May 31, 1998, 1997 and 1996.......................................................................F-6


Notes to Consolidated Financial Statements....................................................F-7 - F-17


(a)(2)  FINANCIAL STATEMENT SCHEDULE

Schedule II - Valuation and Qualifying Accounts.....................................................S-1

</TABLE>

<PAGE>

(a)(3)  EXHIBITS


 *3.1         Form of Amended and Restated Certificate of Incorporation
 *3.2         Form of Amended and Restated By-Laws
 *4.1         Form of Common Stock Certificate
*10.1         1986 Incentive Stock Option Plan
*10.2         1995 Stock Option Plan
*10.3         1995 Non-Employee Director Stock Option Plan
*10.13        Performance Incentive Plan
*22.1         List of Subsidiaries
 23           Consent of Deloitte & Touche LLP
 27           Financial Data Schedule


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

     *Incorporated  by reference to the Registrant's  Registration  Statement on
Form S-1, Registration Number 33-89294.


     (b)(1) REPORTS ON FORM 8-K

     The Registrant did not file any reports on Form 8-K during the last quarter
of its fiscal year ended May 31, 1998.



<PAGE>


                                   SIGNATURES

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

                                              PERIPHONICS CORPORATION
                                                           Registrant

                                        By:   /s/Peter J. Cohen
                                              -----------------------------
                                              Peter J. Cohen, President

Dated:  August 31, 1998

     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.

<TABLE>
<CAPTION>

             Signature                                        Title                                  Date
<S>                                     <C>                                                   <C>  

/s/Peter J. Cohen                      Chairman of the Board, President and Chief               August 31, 1998
---------------------                  Executive Officer (Principal Operating Officer)
Peter J. Cohen

/s/Richard A. Daniels                  Senior Vice President, Treasurer and Director            August 31, 1998
---------------------
Richard A. Daniels

/s/Kevin J. O'Brien                    Chief Financial Officer, Vice President-Finance          August 31, 1998
--------------------                   and Administration (Principal Accounting and
Kevin J. O'Brien                       Financial Officer), Secretary and Director

/s/Jayandra Patel                      Sr. Vice President-Product Development, Assistant        August 31, 1998
--------------------
Jayandra Patel                         Treasurer and Director

/s/Edward H. Blum                      Director                                                 August 31, 1998
--------------------
Edward H. Blum

/s/Peter Breitstone                    Director                                                 August 31, 1998
--------------------
Peter Breitstone

</TABLE>

<PAGE>
                                                         
                    PERIPHONICS CORPORATION AND SUBSIDIARIES

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>


                                                                                                         Page
<S>                                                                                                      <C>  

Independent Auditors' Report                                                                               F-2

Consolidated Balance Sheets as of May 31, 1998 and 1997                                                    F-3

Consolidated Statements of Earnings for the years
  ended May 31, 1998, 1997 and 1996                                                                        F-4

Consolidated Statements of Stockholders' Equity for
  the years ended May 31, 1998, 1997 and 1996                                                              F-5

Consolidated Statements of Cash Flows for the years
  ended May 31, 1998, 1997 and 1996                                                                        F-6

Notes to Consolidated Financial Statements                                                             F-7 - F-17


Schedule II - Valuation and Qualifying Accounts                                                            S-1
</TABLE>


<PAGE>












INDEPENDENT AUDITORS' REPORT


To the Board of Directors and Stockholders of
Periphonics Corporation
Bohemia, New York

     We have audited the accompanying consolidated balance sheets of Periphonics
Corporation  and  subsidiaries  as of May 31,  l998 and  1997,  and the  related
consolidated  statements  of earnings,  stockholders'  equity and cash flows for
each of the three  years in the  period  ended May 31,  1998.  Our  audits  also
included the financial  statement  schedule  listed in the Index at item 14(a)2.
These consolidated financial statements and financial statement schedule are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these  consolidated  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 Periphonics  Corporation and
subsidiaries  as of May 31, 1998 and 1997,  and the results of their  operations
and their  cash flows for each of the three  years in the  period  ended May 31,
1998 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


Jericho, New York
July 14, 1998

<PAGE>

                    PERIPHONICS CORPORATION AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
                (In thousands, except share and per share data)

<TABLE>
<CAPTION>


                                                                                               May 31,
                                                                                  ----------------------------
ASSETS                                                                               1998                 1997
------                                                                            ----------           -------
<S>                                                                              <C>                   <C>   

CURRENT ASSETS:
   Cash and cash equivalents                                                       $14,810             $25,092
   Short-term investments                                                           11,033                -
   Accounts receivable, less allowance for doubtful accounts
     of $1,266 and $1,000, respectively (Note 3)                                    37,721              35,735
   Inventories (Note 4)                                                             14,066              12,858
   Deferred income taxes (Note 8)                                                    1,687               1,357
   Prepaid expenses and other current assets                                         1,367               1,211
                                                                                  --------             -------
                  Total Current Assets                                              80,684              76,253

PROPERTY, PLANT AND EQUIPMENT, net
   (Note 5)                                                                         19,498              16,952

OTHER ASSETS                                                                           425                 378
                                                                                  --------             -------

                                                                                  $100,607             $93,583
                                                                                  ========             =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
   Accounts payable                                                                $ 8,273             $ 5,928
   Accrued expenses and other current liabilities (Note 6)                          14,328              15,125
                                                                                  --------             -------
                  Total Current Liabilities                                         22,601              21,053

DEFERRED INCOME TAXES (Note 8)                                                         146                 322
                                                                                  --------             -------
                                                                                    22,747              21,375
                                                                                  --------             -------

COMMITMENTS AND CONTINGENCIES
   (Notes 7 and 10)

STOCKHOLDERS' EQUITY (Notes 9 and 10):
   Preferred stock, par value $.01 per share, 1,000,000
     shares authorized, none issued                                                  -                   -
   Common stock, par value $.0l per share; authorized:  30,000,000
     shares, outstanding:  13,843,305 and 13,693,758 shares, respectively              138                 137
   Additional paid-in capital                                                       43,780              42,559
   Retained earnings                                                                33,942              29,512
                                                                                  --------             -------
                                                                                    77,860              72,208
                                                                                  --------             -------
                                                                                  $100,607             $93,583
                                                                                  ========             =======

</TABLE>


     See notes to consolidated financial statements.


<PAGE>


                    PERIPHONICS CORPORATION AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF EARNINGS
                                 (In thousands)
<TABLE>
<CAPTION>




                                                                                     Year Ended May 31,
                                                                           1998          l997          1996
                                                                        --------       ---------    ---------
<S>                                                                     <C>            <C>           <C>   

System revenues                                                         $  87,618     $  86,144     $  71,800
Maintenance revenues                                                       29,681        25,100        17,003
                                                                        ---------     ---------     ---------
     Total revenues                                                       117,299       111,244        88,803
                                                                        ---------     ---------     ---------

Cost of system revenues                                                    43,437        38,858        32,798
Cost of maintenance revenues                                               16,988        14,924        10,956
                                                                        ---------     ---------     ---------
     Cost of revenues                                                      60,425        53,782        43,754
                                                                        ---------     ---------     ---------

Gross profit                                                               56,874        57,462        45,049
                                                                        ---------     ---------     ---------

Operating expenses:
  Selling, general and administrative (Note 9)                             36,111        27,737        22,587
  Research and development                                                 15,068        10,698         7,933
                                                                        ---------     ---------     ---------

                                                                           51,179        38,435        30,520
                                                                        ---------     ---------     ---------

Earnings from operations                                                    5,695        19,027        14,529
                                                                        ---------     ---------     ---------

Other income (expense):
  Interest and other income                                                 1,272         1,242           885
  Foreign exchange loss                                                      (547)          (49)         (345)
                                                                        ---------     ---------     ---------
                                                                              725         1,193           540
                                                                        ---------     ---------     ---------
Earnings before provision for income taxes                                  6,420        20,220        15,069

Provision for income taxes (Note 8)                                         1,990         7,583         5,854
                                                                        ---------     ---------     ---------

Net earnings                                                            $   4,430     $  12,637     $   9,215
                                                                        =========     =========     =========

Per share data (Note 12):
  Basic earnings                                                        $   0.32      $    0.93     $    0.71
                                                                        ========      =========     =========

  Diluted earnings                                                      $   0.32      $    0.90     $    0.70
                                                                        ========      =========     =========


Weighted average shares (Note 12):
  Basic                                                                    13,765        13,641        12,890
                                                                        =========     =========     =========

  Diluted                                                                  13,947        14,020        13,258
                                                                        =========     =========     =========

</TABLE>





     See notes to consolidated financial statements.

<PAGE>


                    PERIPHONICS CORPORATION AND SUBSIDIARIES

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                       (In thousands, except share data)

<TABLE>
<CAPTION>

                                                                    Additional                           Total
                                              Common Stock            Paid-In       Retained         Stockholders'
                                          Shares        Amount        Capital       Earnings            Equity
                                          ------        ------       ---------      --------         ------------
<S>                                      <C>            <C>         <C>             <C>                <C> 


BALANCE, June 1, 1995                    12,050,000       $120        $25,796         $  7,660       $  33,576

Net earnings                                  -             -           -                9,215           9,215

Secondary public offering of
  common stock (Note 1)                   1,200,000         12         13,947             -             13,959

Exercise of stock options and
  stock issued under employee
  stock purchase plan (Note 9)              269,914          4            442            -                 446

Tax benefit relating to
  employee stock options                      -             -             370            -                 370

Conversion of preferred stock
  held by subsidiary (Note 9)                78,250         -           1,215            -               1,215
                                       ------------       ----        -------         --------       ---------

BALANCE, May 31, 1996                    13,598,164        136         41,770           16,875          58,781

Net earnings                                  -             -           -               12,637          12,637

Exercise of stock options and
  stock issued under employee
  stock purchase plan (Note 9)               95,594          1            622            -                 623

Tax benefit relating to
  employee stock options                      -             -             167            -                 167
                                       ------------       ----        -------         --------       ---------

BALANCE, May 31, 1997                    13,693,758        137         42,559           29,512          72,208

Net earnings                                  -             -             -              4,430           4,430

Exercise of stock options and
  stock issued under employee
  stock purchase plan (Note 9)              149,547          1          1,175            -               1,176

Tax benefit relating to
  employee stock options                      -             -              46            -                  46
                                       ------------       ----        -------         -------        ---------

BALANCE, May 31, 1998                    13,843,305       $138        $43,780         $ 33,942       $  77,860
                                       ============       ====        =======         ========       =========


</TABLE>




     See notes to consolidated financial statements.


<PAGE>


                    PERIPHONICS CORPORATION AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)

<TABLE>
<CAPTION>

                                                                                        Year Ended May 31,
                                                                                   1998         1997       1996
                                                                                   ----         ----       ----
<S>                                                                              <C>          <C>          <C>  

CASH FLOWS FROM OPERATING ACTIVITIES:
  Net earnings                                                                  $  4,430     $ 12,637    $ 9,215
  Adjustments to reconcile net earnings to net cash
    and cash equivalents provided by operating activities:
    Depreciation and amortization                                                  5,128        3,725      2,867
    Provision for losses on accounts receivable                                      266          110        140
    Provision for inventory reserves                                                 449          418        450
    Deferred income taxes                                                           (506)        (183)      (323)
    Changes in operating assets and liabilities:
      Increase in accounts receivable                                             (2,252)     (12,016)    (1,892)
      Increase in inventories                                                     (1,657)      (2,179)    (4,104)
      Increase in prepaid expenses and other current assets                         (156)        (276)       (20)
      Increase in other assets                                                       (68)         (90)       (76)
      Increase in accounts payable and accrued expenses and
        other current liabilities                                                  1,548        5,140      3,364
                                                                                --------     --------    -------
         Net cash and cash equivalents provided by
            operating activities                                                   7,182        7,286      9,621
                                                                                --------     --------    -------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property, plant and equipment, net                                 (7,653)     (10,251)    (5,882)
  Purchases of short-term investments                                            (21,723)      (6,283)    (8,603)
  Proceeds from the sale of short term investments                                10,690       14,886      -
                                                                                --------     --------    -------

         Net cash and cash equivalents used in
           investing activities                                                  (18,686)      (1,648)   (14,485)
                                                                                --------     ---------   -------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from public offering of common stock                                      -            -       13,959
  Proceeds from stock options exercised including related
    tax benefits                                                                   1,222          790        816
                                                                                --------     --------    -------

         Net cash and cash equivalents provided
            by financing activities                                                1,222          790     14,775
                                                                                --------     --------    -------

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                             (10,282)       6,428      9,911

CASH AND CASH EQUIVALENTS, beginning of year                                      25,092       18,664      8,753
                                                                                --------     --------    -------

CASH AND CASH EQUIVALENTS, end of year                                          $ 14,810     $ 25,092    $18,664
                                                                                ========      =======    =======

SUPPLEMENTAL DISCLOSURES OF CASH
  FLOW INFORMATION:
    Cash paid during the year for:
    Income taxes                                                                $  3,976     $  5,211    $ 6,079
                                                                                ========     ========    =======


</TABLE>

     See notes to consolidated financial statements.


<PAGE>


                    PERIPHONICS CORPORATION AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                    YEARS ENDED MAY 31, 1998, 1997 AND 1996
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

     1. DESCRIPTION OF BUSINESS AND SECONDARY STOCK OFFERING

     Periphonics Corporation and subsidiaries (the "Company") develops,  markets
and  supports  products  and  professional   services  for  Computer   Telephony
Integration ("CTI") and for Telecom Enhanced Network Services using technologies
such as interactive voice response ("IVR"), speech input, messaging, fax and web
browsers.  The Company's  products and services  automate  call and  transaction
processing,  increase  call  center  agent  productivity,  and often  create new
revenue streams for its customers.

     On November 17, 1995, the Company  consummated a secondary  public offering
of common stock (the  "Secondary  Offering").  In the  Secondary  Offering,  the
Company  sold  1,200,000  shares of common stock and selling  stockholders  sold
1,310,000  shares of common  stock at $12.75  per  share.  The  Company  did not
receive  any of the  proceeds  from the  sale of  common  stock  by the  selling
stockholders.   Net  proceeds  of  approximately   $13,959  (after  underwriting
discounts  of $876 and offering  expenses of $465) were  received by the Company
and are to be used for general  corporate  purposes,  including working capital,
facilities  expansion,  and possible  acquisitions of businesses,  products,  or
technologies complementary to the Company's business.

     On November 22,  1995,  the  underwriters  exercised  their  over-allotment
option to purchase an additional  376,500 shares from the selling  shareholders.
The Company did not receive any of the proceeds.

     Amounts of shares and per share  amounts in this note have been adjusted to
reflect the stock split (See Note 9c).

     2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     a. Principles of  consolidation  - The  consolidated  financial  statements
include  the  accounts  of  Periphonics   Corporation  and   subsidiaries.   All
significant  intercompany  balances and  transactions  have been  eliminated  in
consolidation.

     b. Revenue  recognition - Sales of standard  products are  recognized  when
products are shipped.  Sales of custom  software  (either as a portion of system
orders or as add-on orders) are recognized  upon customer  acceptance.  For both
standard  products  and custom  software,  sales are  recorded  only after it is
determined  that  the  Company  has no  significant  remaining  obligations  and
collectibility  of the  resulting  receivable is probable.  Maintenance  revenue
(including postcontract customer support) and other revenues (including revenues
relating  to  insignificant  obligations  at the time  sales are  recorded)  are
recognized  ratably  over  applicable  contractual  periods  or  as  service  is
performed.

     Standard  products and custom  software  are sold with limited  warranties,
generally for 60 days. Warranty expense for the fiscal years ended May 31, 1998,
1997 and 1996 was not material.

     In October of 1997, the  Accounting  Standards  Executive  Committee of the
American  Institute of Certified Public Accountants issued Statement of Position
97-2 Software Revenue Recognition ("SOP 97-2"). This statement provides guidance
on applying generally accepted accounting  principles in recognizing revenues on
software  transactions.  This  Statement  supercedes  Statement of Position 91-1
Software Revenue Recognition and is applicable for transactions  entered into in
fiscal years  beginning after December 15, 1997. This Statement has been adopted
by the Company  effective June 1, 1998 and management  does not anticipate  that
the  implementation  of the  guidance set forth in SOP 97-2 will have a material
impact on its current revenue recognition policies.

<PAGE>

     c.  Inventories  - Inventories  are valued at the lower of cost  (first-in,
first-out  method) or market.  Reserves are established to record provisions for
excess and  obsolete  inventories  in the period in which it becomes  reasonably
evident that the product is not salable or the market value is less than cost.

     d.  Cash  and  cash  equivalents  - The  Company  considers  all  cash  and
investments  with  original  maturity  dates  of  three  months  or  less  to be
components of cash and cash equivalents.

     e.  Investments  - The  Company  follows the  provisions  of  Statement  of
Financial  Accounting  Standards No. 115, "Accounting For Certain Investments In
Debt  and  Equity  Securities."  At May  31,  1998,  the  Company's  investments
consisted  of U.S.  Government  and Agency  bonds with  original  maturities  of
greater than three months and remaining  maturities of less than one year.  Such
debt securities are classified as  held-to-maturity  because the Company has the
positive   intent   and   ability   to  hold  the   investments   to   maturity.
Held-to-maturity   investments  are  stated  at  amortized  cost,  adjusted  for
amortization of premiums and accretion of discounts.

     f. Property,  plant and equipment - Property, plant and equipment is stated
at cost less accumulated  depreciation  and is depreciated on the  straight-line
method over the estimated useful lives of related assets. Leasehold improvements
are  amortized  over the life of the lease or the  estimated  life of the asset,
whichever is less.

     g. Software  development  costs - The development of new software  products
and   enhancements   to  existing   products  are  expensed  as  incurred  until
technological feasibility has been established.  After technological feasibility
is  established,  any additional  costs would be capitalized in accordance  with
Statement of Financial  Accounting Standards No. 86, "Accounting for the Cost of
Computer  Software  to Be Sold,  Leased  or  Otherwise  Marketed."  To date,  no
internal  software  development  costs  have  been  capitalized  as the  Company
believes  its  current  process for  developing  this  software  is  essentially
completed concurrently with the establishment of technological feasibility.

     h.  Impairment  of  Long-Lived  Assets - In  accordance  with  Statement of
Financial  Accounting  Standards  No.  121  ("SFAS  121"),  "Accounting  for the
Impairment of Long-Lived  Assets and for  Long-Lived  Assets to Be Disposed Of,"
the  Company  reviews  its  long-lived  assets,  including  property,  plant and
equipment,   identifiable   intangibles  and  software   development  costs  for
impairment  whenever  events  or  changes  in  circumstances  indicate  that the
carrying  amounts  of the  assets  may not be fully  recoverable.  To  determine
recoverability of its long-lived  assets,  the Company evaluates the probability
that future undiscounted net cash flows, without interest charges,  will be less
than the carrying  amount of the assets.  Impairment  is measured at fair value.
SFAS 121 had no effect on the Company's consolidated financial statements.

     i. Foreign currency  translation - The functional currency of the Company's
foreign subsidiaries is the US dollar. Therefore,  assets and liabilities of the
foreign   subsidiaries  are  remeasured  using  a  combination  of  current  and
historical  rates.  Income and expense  accounts are remeasured  primarily using
average rates in effect during the year.  Unrealized  foreign exchange gains and
losses  resulting from the  remeasurement  of these entities are included in the
results of operations.  The Company does not currently  engage in  international
currency hedging transactions.

     j.  Income  taxes - The Company  follows the  provisions  of  Statement  of
Financial  Accounting  Standards No. 109,  "Accounting  for Income Taxes" ("SFAS
109") which requires  recognition of deferred tax assets and liabilities for the
expected  future  tax  consequences  of events  that have been  included  in the
Company's financial statements or tax returns.  Under this method,  deferred tax
assets and  liabilities  are  determined  based on the  differences  between the
financial  accounting and tax bases of assets and liabilities  using enacted tax
rates in effect for the year in which the  differences  are expected to reverse.
Tax credits are accounted for under the flow-through method.

     k.  Earnings  per share - The Company has adopted  Statement  of  Financial
Accounting  Standards No. 128,  "Earnings  Per Share"  ("SFAS No.  128"),  which
requires dual  presentation of basic and diluted  earnings per share on the face
of the  income  statement.  Basic  earnings  per share is based on the  weighted
average number of shares of common stock outstanding during the period.  Diluted
earnings per share is based on the weighted  average  number of shares of common
stock and common stock equivalents (options and warrants) outstanding during the
period, computed in accordance with the treasury stock method.

<PAGE>

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

     m. Fair Value of  Financial  Instruments  - Financial  instruments  consist
primarily of  investments in cash  equivalents,  short-term  investments,  trade
accounts  receivable,  and accounts payable.  At May 31, 1998 and 1997, the fair
value of the Company's financial instruments approximated the carrying value.

     n. Stock-based  Compensation - The Company accounts for stock-based  awards
to employees  using the intrinsic  value method in  accordance  with APB No. 25,
"Accounting for Stock Issued to Employees" ("APB 25").

     3. ACCOUNTS RECEIVABLE

                                                 1998              1997
                                                 ----              ----
     Billed                                  $  23,957         $  27,003
     Unbilled                                   13,764             8,732
                                             ---------         ---------
                                            $   37,721        $   35,735
                                             =========         =========

     Unbilled  receivables  primarily  relate  to  sales  recorded  on  standard
products which have been shipped,  but have not yet been finally accepted by the
customer. The Company has no significant remaining obligations relating to these
unbilled receivables and collectibility is probable (see Note 2b). Substantially
all unbilled  receivables as of May 31, 1997 were collected  during fiscal 1998.
All unbilled receivables as of May 31, 1998 are expected to be collected in less
than one year.


4.   INVENTORIES

                                                 1998             1997
                                                -----            -----
     Raw materials                         $    8,528        $   7,624
     Work-in-process                            5,538            5,234
                                                -----        ---------
                                           $   14,066        $  12,858
                                           ==========        =========

5.   PROPERTY, PLANT AND EQUIPMENT, net

<TABLE>
<CAPTION>

                                                                 Useful Lives         1998              1997
                                                                 ------------         ----              ----
                                                                  (in years)
<S>                                                             <C>                  <C>              <C>  


     Land                                                                        $    906           $    906
     Building, building improvements and
           leasehold improvements                                    3-40               7,156            5,446
     Machinery, equipment, furniture and fixtures                    3-10              25,674           20,093
     Customer service equipment                                        5                7,157            6,796
                                                                                   ----------       ----------
                                                                                       40,893           33,241
     Less accumulated depreciation                                                     21,395           16,289
                                                                                   ----------       ----------
                                                                                   $   19,498       $   16,952
                                                                                   ==========       ==========
</TABLE>

<PAGE>

     Depreciation expense relating to property,  plant and equipment amounted to
approximately  $5,107,  $3,702 and $2,833 for the years ended May 31, 1998, 1997
and 1996, respectively.

     6. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

<TABLE>
<CAPTION>

                                                                                      1998              1997
                                                                                      ----              ----
<S>                                                                                 <C>                 <C>   

     Customer advance payments                                                     $    7,611       $   6,173
     Accrued payroll, commissions, bonuses,
       fringe benefits and payroll taxes                                                2,661           4,211
     Income taxes payable                                                               1,337           2,864
     Other accrued expenses                                                             2,719           1,877
                                                                                   ----------       ---------
                                                                                   $   14,328       $  15,125
                                                                                   ==========       =========
</TABLE>


     7. LINE OF CREDIT

     In November 1997,  the Company  increased its unsecured line of credit from
$8M to $15M.  There were no  borrowings  against  such line of credit at May 31,
1998 or 1997.  Any  borrowings  on this line of credit will bear interest at the
prime rate (8.50  percent at May 31, 1998) or the LIBOR rate plus 1.25  percent.
The line of credit expires on November 30, 1998.

     8. INCOME TAXES

     The provision for income taxes consists of the following:
<TABLE>
<CAPTION>

                                                                     1998             1997              1996
                                                                     ----             ----              ----
<S>                                                               <C>               <C>                 <C>
     Current:
       Federal                                                    $  1,809          $  5,880           $ 4,574
       State and local                                                 596             1,827             1,596
       Foreign                                                          45                59                 7
                                                                  --------          --------           -------

                                                                     2,450             7,766             6,177
                                                                  --------          --------           -------
     Deferred:
       Federal                                                        (368)             (136)             (240)
       State and local                                                 (92)              (47)              (83)
                                                                  --------          --------           -------
                                                                      (460)             (183)             (323)
                                                                  --------          --------           -------

              Total                                               $  1,990          $  7,583           $ 5,854
                                                                  ========          ========           =======


     The  difference  between the  statutory  Federal tax rate and the Company's
effective tax rate is as follows (as a percentage of pretax earnings):

                                                                       1998             1997              1996
                                                                       ----             ----              ----
     Statutory Federal income tax rate                                34.0%            34.0%              34.0%
     State and local income taxes (net of Federal tax benefit)          6.1              5.8               6.6
     Exempt income of foreign sales corporation                        (1.0)            (1.4)             (1.8)
     Research and development tax credits                             (11.6)            (1.9)              -
     Other                                                              3.5                              1.0 -
                                                                      ------           ------            ------

     Effective tax rate                                                31.0%            37.5%             38.8%
                                                                      =====            =====             =====

</TABLE>

<PAGE>


     At May 31, 1998,  1997 and 1996,  the  deferred tax assets and  liabilities
consisted of:
<TABLE>
<CAPTION>

                                            1998                          1997                     1996
                                ----------------------------     ----------------------   -----------------------
                                     Net             Net             Net         Net          Net        Net
                                   Current        Long-term        Current    Long-term     Current   Long-term
                                  Deferred        Deferred        Deferred    Deferred     Deferred   Deferred
                                     Tax             Tax             Tax         Tax          Tax        Tax
                                   Assets        Liabilities       Assets    Liabilities    Assets    Liabilities
                                   -------        --------       ---------      -----      -------    ---------
<S>                              <C>             <C>              <C>        <C>          <C>         <C>

     Accounts receivable          $  467          $ -            $   397      $  -        $   310       $-
     Inventories                     751            -                710         -            691        -
     State tax credit
       carryforwards                  32            -                 32         -             32        -
     Unrealized foreign
       exchange losses               391            -                218         -            228        -
     Property, plant, and
       equipment                    -                156            -           332            -         419
     Other                            53             (10)             53        (10)           67        (10)
     Net operating loss carry-
       forwards of foreign
       subsidiaries                  100            -                366         -            404        -
                                  ------          ------         -------      -------     -------       -----
                                   1,794             146           1,776        322         1,732        409
         Less valuation allowance    107            -                419         -            471        -
                                  ------          ------         -------      -------     --------     ------
     Total                        $1,687          $  146         $ 1,357      $   322     $ 1,261     $  409
                                  ======          ======         =======      =======     =======      ======

</TABLE>

     The  valuation  allowance  decreased by  approximately  $312 and $52 during
     fiscal  1998  and  1997,  respectively,   primarily  as  a  result  of  the
     utilization of net operating loss carryforwards of foreign subsidiaries.

     9. STOCKHOLDERS' EQUITY

     a. Stock  option  plans - The l986  Incentive  Stock Option Plan (the "1986
Plan")  allowed  for the  issuance of options to  purchase  1,000,000  shares of
common stock by  employees.  Options were issued at an exercise  price which was
calculated utilizing a formula based upon the book value of the Company's common
stock at the date of grant (the  "Formula  Price").  Options under the 1986 Plan
are  exercisable in 25 percent  increments  beginning one year after the date of
grant and expire up to ten years after the date of grant.  While the Company was
privately held, it maintained the right, under certain conditions, to repurchase
shares obtained by employees under the 1986 Plan at the Formula Price calculated
at the date of repurchase.  As of the date of the Company's public offering, the
Company no longer has the right to repurchase  such shares.  The Company's Board
of Directors  (the "Board") has  determined not to make further grants under the
1986 Plan and to make any future  grants  from the 1995 Stock  Option  Plan (the
"1995 Plan").

     Currently,  the Company  maintains two stock option plans pursuant to which
an aggregate of approximately 2,400,000 shares of common stock may be granted.

     The 1995 Plan has  2,200,000  shares of common stock  reserved for issuance
upon the exercise of options  designated as either [i]  incentive  stock options
("ISOs") under the Internal Revenue Code, or [ii]  non-qualified  options.  ISOs
may be granted  under the 1995 Plan to  employees  and  officers of the Company.
Non-qualified  options may be granted to consultants,  directors (whether or not
they are employees),  employees or officers of the Company. Each option vests in
four annual  installments  of 25 percent  each on the first,  second,  third and
fourth  anniversary of the date of grant.  Options granted under the 1995 Option
Plan may not be  granted  at a price  less  than the  fair  market  value of the
Company's common stock on the date of grant (or 110 percent of fair market value
in the case of persons  holding  10  percent or more of the voting  stock of the
Company)  and expire not more than ten years from the date of grant  (five years
in the case of ISOs granted to persons  holding 10 percent or more of the voting
stock of the Company).

<PAGE>

<TABLE>
<CAPTION>

                                                                                               Weighted
                                                  Shares              Option Price           Average Price
<S>                                             <C>                <C>                      <C>       

         Balance, June 1, 1995                      594,000        $  0.75 - $  7.00         $      3.12

         Options granted                            218,000        $  8.53 - $14.13          $     10.54
         Options exercised                         (257,000)       $  0.75 - $ 7.00          $      1.19
         Options canceled                           (30,000)       $  7.00 - $12.00          $      9.92
                                               ------------        ----------------          -----------

         Balance, May 31, 1996                      525,000        $  0.75 - $14.13          $      6.76

         Options granted                            241,000        $ 11.50 - $31.00          $     16.47
         Options exercised                          (77,800)       $  0.75 - $10.13          $      4.97
         Options canceled                           (24,000)       $  7.00 - $15.50          $     13.79
                                               ------------        ----------------          -----------

         Balance, May 31, 1997                      664,200        $  1.00 - $31.00          $     10.23

         Options granted                            279,000        $  8.75 - $20.50          $     12.80
         Options exercised                          (46,000)       $  1.00 - $15.50          $      3.41
         Options canceled                           (24,500)       $  8.75 - $15.50          $     12.10
                                               ------------        ----------------          -----------

         Balance, May 31, 1998                      872,700        $  1.68 - $31.00          $     11.44
                                               ============        ================          ===========

         Options exercisable at
           May 31, 1996                             192,750        $   .75 - $  7.00         $      2.80
                                                    =======        ==================        ===========
           May 31, 1997                             200,700        $  1.00 - $14.13$         $      4.57
                                                    =======        ==================        ===========
           May 31, 1998                             302,200        $  1.68 - $31.00$         $      8.25
                                                    =======        ==================        ===========
</TABLE>
<TABLE>
<CAPTION>


                                                     Options Outstanding              Options Exercisable
                                               Weighted Avg.      Weighted                         Weighted
                                                  Remaining        Average                          Average
                                 Number          Contractual       Exercise         Number          Exercise
         Exercise Prices     Outstanding          Life (yrs)         Price        Exercisable         Price
         ---------------     -----------       -----------------  ------------    -----------      --------
<S>       <C>                 <C>                <C>                <C>            <C>             <C>

               $  1.68             75,000           5.00           $   1.68             75,000       $   1.68
               $  7.00            153,500           1.83           $   7.00            105,500       $   7.00
          $  8.53 - $10.13        137,200           2.34           $   9.96             52,200       $  10.00
           $11.00 - $13.06        276,000           4.07           $  12.72             13,000       $  12.06
           $14.00 - $15.50        185,000           3.17           $  15.17             46,750       $  15.14
           $17.06 - $20.50         22,000           3.50           $  18.05              3,750       $  17.86
           $26.25 - $31.00         24,000           3.65           $  29.19              6,000       $  29.19
                              -----------                                          -----------

                                  872,700                                              302,200
                              ===========                                          ===========
</TABLE>


     There are 1,336,500 shares available for future grant under the 1995 plan.

<PAGE>

     In February  1995,  the Board  adopted  and the  stockholders  approved,  a
Non-Employee  Director Stock Option Plan (the "Directors  Plan").  The Directors
Plan has 200,000  shares of common stock reserved for issuance from which grants
of  non-qualified  stock  options  covering  15,000  shares and 10,000 shares of
common stock are automatically  made on the election of a non-employee  Director
to the Board and the date of each  annual  meeting  of  shareholders  to certain
non-employee  Directors of the Company,  respectively.  The exercise price under
each option is the fair market value of the  Company's  common stock on the date
of grant. Each option has a five-year term and vests in four annual installments
of 25 percent each on the first,  second,  third and fourth  anniversary  of the
date of grant.  The non-vested  portion of an option  terminates if the Director
ceases to be a member of the Board.
<TABLE>
<CAPTION>
                                                                                            Weighted
                                                   Shares             Price Range            Average Price
<S>                                             <C>                 <C>                 <C>

         Balance, June 1, 1995                      -              $      -                       -
         Options granted                               50,000      $ 8.88 - $13.25            $     10.63
                                                 ------------      ---------------            -----------
         Balance, May 31, 1996                         50,000      $ 8.88 - $13.25            $     10.63
         Options granted                               20,000          $19.25                 $     19.25
         Options exercised                             (3,750)         $ 8.88                 $      8.88
                                                 ------------      -------------------       ------------

         Balance, May 31, 1997                         66,250      $ 8.88 - $ 19.25          $      13.33
         Options granted                               20,000           $9.50                $       9.50
         Options exercised                             -           $      -                  $        -
                                                 ------------      -------------------       ------------

         Balance, May 31, 1998                         86,250      $ 8.88 - $ 19.25          $      12.44
                                                 ============      ===================       ============

         Options exercisable at:
           May 31, 1996                                -            $     -                  $       -
                                                 ============      =================         ============
           May 31, 1997                                 8,750      $ 8.88 - $13.25           $     11.38
                                                 ============      =================         ============
           May 31, 1998                                26,250      $ 8.88 - $19.25           $     12.52
                                                 ============      =================         ============
</TABLE>

<TABLE>
<CAPTION>



                                                     Options Outstanding              Options Exercisable
                                               Weighted Avg.      Weighted                         Weighted
                                                  Remaining        Average                          Average
                                Number           Contractual       Exercise         Number          Exercise
         Exercise Prices     Outstanding          Life (yrs)         Price        Exercisable         Price
<S>                          <C>                <C>               <C>             <C>               <C> 


              $  8.88             26,250             2.07           $ 8.88            11,250          $ 8.88
              $  9.50             20,000             4.45           $ 9.50              -                -
               $13.25             20,000             2.41           $13.25            10,000          $13.25
               $19.25             20,000             3.44           $19.25             5,000          $19.25
                              ----------                                           ---------

                                  86,250                                              26,250
                              ==========                                           =========
</TABLE>


     There are 110,000  shares  available  for future grants under the Directors
Plan. No options have been canceled under this plan.


     b. Additional  Stock Plan Information - As discussed in Note 2, the Company
continues to account for its stock-based awards using the intrinsic value method
in  accordance  with APB 25 and its  related  interpretations.  Accordingly,  no
compensation  expense  has  been  recognized  in the  financial  statements  for
employee stock arrangements.

<PAGE> 

     Statement  of  Financial  Accounting  Standards  No. 123,  "Accounting  for
Stock-Based Compensation," ("SFAS 123") requires the disclosure of pro forma net
income and earnings  per share had the Company  adopted the fair value method as
of the beginning of fiscal 1996.  Under SFAS 123, the fair value of  stock-based
awards to employees is calculated through the use of option pricing models, even
though such models were developed to estimate the fair value of freely tradable,
fully transferable  options without vesting  restrictions,  which  significantly
differ from the  Company's  stock  options  awards.  These  models also  require
subjective  assumptions,  including  future stock price  volatility and expected
time to exercise,  which greatly  affect the  calculated  values.  The Company's
calculations  were made using the  Black-Scholes  option  pricing model with the
following  weighted  average  assumptions:  expected life,  1.25 years following
vesting;  stock volatility,  73 percent in 1998 and 78 percent in 1997 and 1996,
risk free  interest rate of 5.5 peecent in 1998 and 6.0 percent in 1997 and 1996
and no dividends during the expected term. The Company's  calculations are based
on a multiple option  valuation  approach and forfeitures are recognized as they
occur. The impact of outstanding  non-vested stock options granted prior to June
1, 1995 has been excluded from the pro forma calculation; accordingly, pro forma
adjustments are not indicative of future period pro forma adjustments,  when the
calculation will apply to all applicable stock options.

<TABLE>
<CAPTION>


                                                                            Fiscal Year Ended May 31,
                                                                     1998             1997              1996
                                                                     ----             ----              ----
<S>                                                               <C>             <C>                  <C>   

         Net income:
           As reported                                            $  4,430          $ 12,637           $ 9,215
           Pro forma                                              $  3,238          $ 11,872           $ 8,927
         Basic earnings per share:
           As reported                                            $   0.32          $   0.93           $  0.71
           Pro forma                                              $   0.24          $   0.87           $  0.69
         Diluted earnings per share:
           As reported                                            $   0.32          $   0.90           $  0.70
           Pro forma                                              $   0.23          $   0.85           $  0.67
</TABLE>


     c. Stock Split and Changes in  Authorized  Capital - On September 20, 1996,
the Board of Directors approved a two-for-one split of its common stock effected
as a stock dividend on October 31, 1996 to  shareholders  of record at the close
of  business  on  October  15,  1996.  All  historical  share and per share data
appearing in the consolidated  financial  statements and notes thereto have been
retroactively adjusted for the stock split, unless otherwise noted.

     Also, on September 20, 1996, the Board of Directors determined it advisable
to amend the Company's  Certificate of  Incorporation  to increase the number of
authorized shares of Common Stock from 15,000,000  shares to 30,000,000  shares.
The proposed amendment to the Amended and Restated  Certificate of Incorporation
was submitted for shareholder  approval.  Shareholder  approval was announced on
November 8, 1996 at the 1996 Annual Meeting of Stockholders.

     d.  Employee  Stock  Purchase  Plan - During 1996,  the Company  adopted an
Employee  Stock  Purchase Plan to provide  eligible  employees an opportunity to
purchase  shares of its  common  stock  through  payroll  deductions  during two
offering  periods,  December 1 through  May 31 and June 1 through  November  30.
During 1998, the Company revised the offering periods to October 1 through March
31 and April 1 to September 30. The purchase  price is an amount equal to 85% of
the fair market value of a share of common stock on the first or last day of the
offering period, whichever is lower. The aggregate number of shares purchased by
an employee may not exceed a number of shares  determined by dividing $12,500 by
the fair market value of a share of the Company's  common stock on the first day
of the offering  period.  The stock  purchase plan expires on August 10, 2005. A
total of 400,000 shares are available for purchase  under the plan.  103,609 and
14,744 shares were issued under the plan during fiscal years 1998 and 1997 at an
average price of $9.84 and $14.24, respectively.

<PAGE>

     e. Stock Purchase  Rights - In July 1996, the Company adopted a Stockholder
Rights Plan (the "Plan") and declared a dividend  distribution  of one preferred
share  purchase  right (the  "Right") at the rate of one Right for each share of
common  stock  held as of the close of  business  on July 31,  1996.  Each Right
entitles the holder to purchase from the Company one one-hundredth of a share of
Series A Junior  Participating  Preferred Stock, par value $0.01 per share, at a
price of $100 per one  one-hundredth  of a preferred  share.  The Rights are not
exercisable  until certain  events occur,  as defined in the Plan, and expire on
July 31, 2006. The Rights are also redeemable,  under certain circumstances,  by
the Board of Directors at a pric of $0.01 per Right.

     f. Preferred  Stock Issued By Subsidiary - The Company had preferred  stock
issued by a subsidiary  of the Company,  which  consisted of 900,000  authorized
shares,  625,999 shares of which were issued in conjunction with the purchase of
certain assets of Autophon U.K. in July 1990. This preferred stock was stated at
$1,215 based upon the fair market value of the assets  acquired.  The  preferred
stock was convertible  into either common stock of Periphonics  Voice Processing
Systems  Limited (a subsidiary of the Company) at a ratio of 1,000 to 1, or into
78,250 shares of common stock of the Company  through the exercise of a warrant.
Effective May 31, 1996, the holder of this preferred stock exercised the warrant
to convert such shares into 78,250 shares of common stock of the Company.



     10. COMMITMENTS AND CONTINGENCIES

     a. Deferred  compensation  plan - The Company  maintains a 40l(k)  deferred
compensation  plan for all employees meeting certain service  requirements.  The
Company has made no matching contribution to amounts deferred by employees.  The
Company pays the administrative costs of the plan.

     b. Employment contracts - The Company had entered into employment contracts
with seven officers expiring through December 31, 1996. These agreements allowed
for  aggregate  annual  base  compensation  of $1,698 as well as  bonuses  based
primarily  on the profit  growth of the  Company,  as  defined in the  Company's
performance incentive plan. On March 30, 1995, the Company terminated certain of
the employment  contracts and replaced them with revised contracts.  The revised
contracts  terminate  on May 31,  2001  and  allow  for  aggregate  annual  base
compensation  consistent with the previous  agreements as well as annual bonuses
to be determined in accordance with the provisions of the Company's  performance
incentive plan. In addition,  these revised employment  contracts  automatically
self renew for consecutive  two-year terms unless at least one year prior to the
expiration of the existing term either party gives notice of cancellation.

     c. Stock  repurchase  agreements - The Company has agreements  with certain
stockholders of the Company. The agreements require the Company to maintain life
insurance  on the  life of each of the  specified  stockholders  in  amounts  as
defined in the  agreement  and grant the estate of a deceased  stockholder a put
option  which  would  require  the  Company to redeem a portion of the shares of
common  stock  owned by the  estate.  The  maximum  number of such  shares to be
redeemed shall be determined by dividing the fair market value of a share on the
date of death into the net life insurance  proceeds received by the Company upon
the death of such deceased stockholder.

     d. Legal matters - On July 7, 1998, Lucent  Technologies,  Inc.  ("Lucent")
filed a patent  infringement  action in the United States District Court for the
District of Delaware  alleging that the Company  infringed  some nine patents of
Lucent.  The  Company  believes  that the claims  contained  in the  lawsuit are
without  merit and  intends to defend the  lawsuit  vigorously.  The  Company is
involved in certain other legal  matters in the normal course of business.  The
company's  management  does not believe that  resolution  of these matters will
have a  materially  adverse  effect  on  the  Company's  consolidated  financial
statements.

<PAGE>

     The Company is involved in certain other legal matters in the normal course
of business.  The Company's management does not believe that resolution of these
other  matters  will  have  a  materially   adverse   effect  on  the  Company's
consolidated financial statements.

     e. Concentration of industry and credit risk - The Company grants credit to
geographically  diversified  customers primarily in the  telecommunications  and
financial services industry. The Company is broadening its vertical market focus
to  include  additional   industries  such  as  government,   higher  education,
healthcare   services,   transportation,   electric  and  water   utilities  and
distribution  companies.  No one customer  accounted for more than 10 percent of
total revenues during fiscal 1998, 1997 and 1996.

     f. Lease  agreements  - The Company has entered into  operating  leases for
certain  facilities,  automobiles  and office  equipment.  Future minimum annual
lease payments under noncancellable operating leases are:

           Year Ending May 31,
                    1999                                         $    2,904
                    2000                                              2,294
                    2001                                              1,936
                    2002                                              1,696
                    2003                                                983
                 Thereafter                                           2,745
                                                                     ------
                                                                 $   12,558

     Rental expense was $2,860, $2,003 and $1,045 during the years ended May 31,
1998, 1997 and 1996, respectively.

     11. OPERATIONS BY GEOGRAPHIC AREA

<TABLE>
<CAPTION>
                                                                                     Year Ended May 31,
                                                                           1998            1997            1996
                                                                           ----            ----            ----
<S>                                                                      <C>            <C>               <C> 

     System Revenues and Maintenance Revenues:
     Sales to unaffiliated customers from:
       North America                                                     $ 101,590      $  99,895        $  79,997
       Europe                                                               15,709         11,349            8,806
                                                                         ---------      ---------        ---------
     Total revenues to unaffiliated customers                              117,299        111,244           88,803
                                                                         ---------      ---------        ---------
     Transfers between geographic areas from:
       North America                                                         4,167          3,815            3,665
       Europe                                                                    -          -                -
                                                                         ---------      ---------        ---------
     Total transfers between geographic areas                                4,167          3,815            3,665
                                                                         ---------      ---------        ---------
     Eliminations                                                           (4,167)        (3,815)          (3,665)
                                                                         ---------      ---------        ---------
     Total revenues                                                      $ 117,299      $ 111,244        $  88,803
                                                                         =========      =========        =========
     Earnings from Operations:
       North America                                                     $   5,030      $  18,686        $  13,696
       Europe                                                                  625            428              840
       Eliminations                                                             40            (87)              (7)
                                                                         ---------      ---------        ---------
     Total earnings from operations                                      $   5,695      $  19,027        $  14,529
                                                                         =========      =========        =========
     Identifiable Assets:
       North America                                                     $ 109,057      $  99,038        $  78,393
       Europe                                                               13,919         10,279            8,051
       Eliminations                                                        (22,369)       (15,734)         (11,341)
                                                                         ---------      ---------        ---------
     Total identifiable assets                                           $ 100,607      $  93,583        $  75,103
                                                                         =========      =========        =========

</TABLE>

<PAGE>

     The activities of the Company's Mexican  operation,  which are not material
for separate disclosure, are included in North America.

     Transfers  between  geographic  areas  are  accounted  for at cost,  plus a
reasonable  profit.  European cost of revenues for the years ended May 31, 1998,
1997 and 1996  includes  approximately  $769,  $589 and $565,  respectively,  of
intercompany  gross profit  earned by North America on system sales by Europe to
third parties.

     Total  revenues to customers  outside the U.S.  were  $38,335,  $36,380 and
$28,242 for the years ended May 31, 1998, 1997, and 1996, respectively.

     Export sales from the Company's  United States  operations to  unaffiliated
customers were as follows:

<TABLE>
<CAPTION>
                                                                     Year Ended May 31,
                                                          1998              1997             1996
                                                     -------------     -------------    ---------
<S>                                                    <C>              <C>              <C>    


         Pacific Rim                                 $      12,477       $  13,532        $  15,907
         The Americas (excluding the
           United States)                                   10,149          11,499            2,836
                                                     -------------       ---------        ---------
         Total                                       $      22,626       $  25,031        $  18,743
                                                     =============       =========        =========

</TABLE>

     12. RECONCILIATION OF BASIC EARNINGS PER SHARE

     In  accordance  with SFAS No.  128,  basic  earnings  per common  share are
computed  based on the  weighted-average  number  of common  shares  outstanding
during each period.  Diluted earnings per common share are computed based on the
weighted-average  number of common shares, after giving effect to diluted common
stock equivalents outstanding during each period. The following table provides a
reconciliation between basic and diluted earnings per share:

<TABLE>
<CAPTION>

                                                                          Fiscal Year Ended May 31,
                                                                  (In thousands, except per share amounts)
                                               1998                                1997                              1996
                                    --------------------------         ----------------------------      ---------------------------
                                                         Per                                  Per                               Per
                                    Income    Shares    Share          Income     Shares    Share        Income     Shares     Share
                                    ------    ------    -----          ------     ------    -----        ------     ------     -----
<S>                                 <C>      <C>       <C>            <C>         <C>       <C>          <C>        <C>        <C>

  Basic EPS:
   Income available to common
    stockholders                  $4,430   13,765    $   0.32        $12,637    13,641     $  0.93      $9,215    12,890    $  0.71
   Effect of dilutive securities:
    Options/warrants                 -        182         -              -         379       (0.03)        -        368       (0.01)
                                    -----    ------    -------         ------     ------   -------      ------     -----     ------

   Diluted EPS:
    Income available to common
      stockholders plus assumed
      exercises                    $4,430   $13,947   $   0.32        $12,637    14,020     $  0.90      $9,215    13,258    $  0.70
                                   ======   =======    =======        =======    ======     =======      ======    ======    =======
</TABLE>


<PAGE>


                                                                 SCHEDULE II


                    PERIPHONICS CORPORATION AND SUBSIDIARIES

                SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                                 (In thousands)


<TABLE>
<CAPTION>


       COLUMN A                         COLUMN B                 COLUMN C                  COLUMN D       COLUMN E
       --------                         --------                 --------                  --------       --------
<S>                                      <C>                    <C>                      <C>               <C>    
                                                                Additions
                                                                ---------
                                                                        Charged to
                                       Balance at        Charged to       Other                            Balance
                                        beginning         Cost and      Accounts -       Deductions -     at end of
     Descriptions                       of Period         Expenses       describe           describe       Period
     ------------                        --------         --------      ---------         ----------       -------

Year ended May 31, 1998:
  Allowance for doubtful accounts        $ 1,000            $266           $ -               $ -            $ 1,266
                                         =======            ====           ====              =====          =======
  Reserve for excess and
    obsolete inventory                   $ 1,150            $449           $ -               $(367)(1)      $ 1,232
                                         =======            ====           ====              =====          =======


Year ended May 31, 1997:
  Allowance for doubtful accounts        $   890            $110           $ -              $-             $ 1,000
                                         =======            ====           ===              =====          =======
  Reserve for excess and
    obsolete inventory                   $ 1,100            $418           $ -              $(368)(1)      $ 1,150
                                         =======            ====           ===              =====          =======


Year ended May 31, 1996:
  Allowance for doubtful accounts        $   750            $140           $ -              $-             $   890
                                         =======            ====           ===              =====          =======
  Reserve for excess and
    obsolete inventory                   $   950            $450           $ -              $(300)(1)      $ 1,100
                                         =======            ====           ===              =====          =======


</TABLE>



     (1) Amounts written off or disposed of.










                                                            S-1