SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

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

For the Fiscal Year Ended December 31, 1997       Commission File Number 0-26912
                          -----------------                              -------

                             VODAVI TECHNOLOGY, INC.
--------------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)

              DELAWARE                                        86-0789350
----------------------------------------               -------------------------
   (State or other jurisdiction of                         (I.R.S. Employer
          incorporation or                                Identification No.)
            organization)

     8300 EAST RAINTREE DRIVE
        SCOTTSDALE, ARIZONA                                     85260
----------------------------------------               -------------------------
(Address of principal executive offices)                     (Zip Code)

                                 (602) 443-6000
               --------------------------------------------------
               Registrant's telephone number, including area code

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

           Securities registered pursuant to Section 12(g) of the Act:
                          Common Stock, $.001 par value

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 ]

Issuer's revenue for its most recent fiscal year:  $47,674,751

At March 23, 1998, there were  outstanding  4,342,238 shares of the registrant's
Common Stock,  $.001 par value.  The aggregate market value of Common Stock held
by nonaffiliates of the registrant (2,740,208 shares) based on the closing price
of the Common Stock as reported on the Nasdaq National Market on March 23, 1998,
was $10,618,306.  For purposes of this computation,  all officers, directors and
10%  beneficial  owners of the  registrant  are  deemed to be  affiliates.  Such
determination should not be deemed an admission that such officers, directors or
10% beneficial owners are, in fact, affiliates of the registrant.

Documents  incorporated by reference:  Portions of the  registrant's  definitive
Proxy Statement for the 1998 Annual Meeting of Stockholders  are incorporated by
reference into Part III of this Report.
<PAGE>
                             VODAVI TECHNOLOGY, INC.

                           ANNUAL REPORT ON FORM 10-K

                       FISCAL YEAR ENDED DECEMBER 31, 1997

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
PART I                                                                                 Page
                                                                                       ----
<S>      <C>      <C>      <C>                                                          <C>
         ITEM     1.       BUSINESS...................................................    1
         ITEM     2.       PROPERTIES.................................................   22
         ITEM     3.       LEGAL PROCEEDINGS..........................................   22
         ITEM     4.       SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........   22

PART II
         ITEM     5.       MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
                             RELATED STOCKHOLDER MATTERS..............................   23
         ITEM     6.       SELECTED CONSOLIDATED FINANCIAL DATA.......................   24
         ITEM     7.       MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                             CONDITION AND RESULTS OF OPERATIONS......................   25
         ITEM     7A.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
                           MARKET RISK................................................   27
         ITEM     8.       FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................   28
         ITEM     9.       CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                             ACCOUNTING AND FINANCIAL DISCLOSURE......................   28
PART III
         ITEM     10.      DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.........   28
         ITEM     11.      EXECUTIVE COMPENSATION.....................................   28
         ITEM     12.      SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
                             AND MANAGEMENT...........................................   28
         ITEM     13.      CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............   28

PART IV
         ITEM     14.      EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
                             ON FORM 8-K..............................................   29

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

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS............................................  F-1
</TABLE>
                                        i
<PAGE>
                                     PART I

ITEM 1.           BUSINESS

                                  INTRODUCTION

         The Company designs,  develops,  markets, and supports a broad range of
communication   products,   including   telephone   systems,   commercial  grade
telephones,  voice processing products,  and  computer-telephony  products for a
wide  variety  of  business   applications.   The  Company's  telephone  systems
incorporate sophisticated features, such as automatic call distribution, and its
voice processing products include interactive voice response systems,  automated
attendant,  and voice and fax mail.  The Company's  computer-telephony  products
allow users to combine the  functionality  of telephones  and desktop  computers
through   applications   such  as  integrated  PC   telephones,   desktop  video
conferencing systems, call accounting systems,  Unified messaging,  and Internet
messaging.  The Company  markets its products  primarily in the United States as
well as in  foreign  countries  through a  distribution  network  consisting  of
wholesale distributors, direct dealers, and its own sales personnel.

         The Company's  business  strategy  includes (i) expanding the Company's
historical   business  of  supplying  telephone  systems  and  commercial  grade
telephones;  (ii)  emphasizing its new voice  processing and  computer-telephony
integration products for use in connection with telephone systems supplied by it
and by others;  (iii)  pursuing its strategic  relationship  with LG Electronics
Inc. ("LGE"), a member of the multi-billion  dollar,  Korean-based LG Group with
which  management  has had a  long-term  relationship;  and (iv)  expanding  its
technological expertise through business acquisitions,  license arrangements and
other strategic  relationships,  and increased internal research and development
efforts in order to enhance  existing  products,  introduce  new  products,  and
expand product lines.

         Unless the context indicates otherwise, all references to the "Company"
refer  to  Vodavi  Technology,  Inc.,  its  predecessors  and its  subsidiaries,
including Vodavi Communications  Systems,  Inc. ("VCS"),  Enhanced Systems, Inc.
("Enhanced"),   and  Arizona  Repair  Services,  Inc.  ("ARSI").  The  Company's
corporate  headquarters  are located at 8300 East  Raintree  Drive,  Scottsdale,
Arizona 85260, and its telephone number is (602) 443-6000.

                                    BUSINESS

Industry Overview

         Virtually every business today relies upon its business  communications
system  as  an  essential  tool  to  speed  and  enhance  the  effectiveness  of
communications  among  employees,  customers,  and vendors;  to contact decision
makers  regardless of their  location;  to increase  employee  productivity;  to
provide better customer  service;  and to reduce operating  costs.  Many factors
have  stimulated  the  growth  of  the  telecommunications  industry,  including
successive  technological  developments  that have resulted in enhanced features
and  services,  advances in telephone and computer  hardware and  software,  and
regulatory  changes.  These  factors have resulted in continual  development  of
full-featured  business  communications  systems  designed for use by small- and
medium-sized businesses and offered at affordable prices.

         Accelerated   technological  advances  in  recent  years  have  enabled
telecommunications  system providers to develop sophisticated systems that offer
a wide  variety of  applications  in  addition  to  traditional  call  switching
functions.  Businesses  of all sizes now  demand  affordable  telecommunications
systems that provide the  capacity  for (i) voice and text  processing  systems,
which   automate  call   answering,   provide  voice  mail  and  automated  call
distribution  functions,  and provide the capacity to manage facsimile messages;
(ii)  interactive  voice  response,  which enables  businesses to provide a wide
range  of  additional  services  at  lower  cost  by  providing  access  to  the
organization's   computer  system  from  any  touchtone  telephone;   and  (iii)
computer-telephony   integration,   which  greatly   enhances   efficiency   and
productivity by providing  access to and control of telephone  system  functions
from
                                        1
<PAGE>
individual  computer terminals.  Recent  developments in wireless  technologies,
computer-telephony  integration  technologies,  and desktop  video  conferencing
technologies represent significant  opportunities for sales of new product lines
and features to further increase employee  mobility and efficiency.  The Company
also  believes  that  international  sales of  telecommunications  systems  that
include  productivity  enhancing  features  will increase  substantially  in the
future as cultural  resistance to functions  such as voicemail  and  interactive
voice response declines.

Products

         The Company currently designs, develops,  markets, and supports a broad
range of (i)  telephony  products,  which  include  digital and  electronic  key
telephone  systems  and  commercial  grade  telephones;  (ii)  voice  processing
products,  including  interactive voice response systems,  automated  attendant,
automatic   call   distribution,   voice   mail   and  fax   mail;   and   (iii)
computer-telephony  products, including Windows-based application products (such
as PC telephones  and  attendant  consoles),  local area network  ("LAN") to PBX
connection packages,  unified messaging systems, Internet messaging systems, and
desktop video conferencing systems.

Key Telephone Systems

         Sales of key  telephone  systems  represented  approximately  70.0% and
72.4% of the  Company's  revenue  during  1996  and  1997,  respectively.  A key
telephone system consists primarily of a sophisticated switching unit located at
the user's place of business, along with the individual telephone sets and other
devices, such as facsimile machines or modems, located at individual "stations."
Telephone  systems are designed to accommodate  the number of "ports" (the total
number of incoming  lines,  or "trunks,"  and  stations)  required to handle the
communications  needs of businesses of varying sizes.  The switching unit routes
calls on one or more incoming  trunks from the local or long distance  telephone
company central office  equipment to the appropriate  station located within the
business.  The  switching  unit also routes  calls from one  station  within the
business to other stations  within the business or out to the telephone  company
central office for switching to other local or long distance telephone numbers.

         The Company currently  markets various lines of key telephone  systems,
under its STARPLUS and infinite brand names, for businesses  requiring as few as
two  incoming  trunks  and four  stations  up to 96 trunks and 252  stations  (a
348-port  system).  The Company sells the STARPLUS line through large  wholesale
distributors  known as "Supply  Houses" and the infinite line through  telephone
sales  and  installation  companies  known  as  "Direct  Dealers."  See  Item 1,
"Business - Sales, Marketing,  and Distribution." Each of the infinite telephone
systems  incorporates  the  base  platform  and  software  of the  corresponding
STARPLUS system,  with certain  modifications  that  differentiate  the infinite
system from the STARPLUS system in function and cosmetic appearance.

         The  Company  supplies  several  models  of  key  telephone  sets  with
progressive  features for use in conjunction with each of its telephone systems,
including   a   model   with  PC   Interface   for  use   with   the   Company's
computer-telephony  integration  products.  Many of the  feature  buttons on the
Company's key telephones are  user-programmable to enable users to custom-tailor
their telephone systems for maximum efficiency in specific applications.

         The Company  markets  both fully  digital and  electronic  (analog) key
telephone systems and related products.  The Company's digital telephone systems
employ a digital architecture in order to provide digital voice transmission and
system  control,  while the  Company's  electronic  telephone  systems  employ a
microprocessor-based   architecture   and  solid  state   switching   for  voice
transmission and system control. Most of the Company's telephone systems feature
flexible  software  combined with modular  hardware and card slot design,  which
allow  cost-effective  system  customization  and expansion to meet the needs of
individual  users.  The Company's  telephone  systems are fully  compatible with
industry-standard  commercial grade telephones and contain an extensive array of
standard  features  that  add  sophistication  generally  found  only in  larger
telephone  systems.  The Company  designs its key  telephone  systems to readily
permit  expansion  or  customization  for  specific  business   applications  by
installation of a variety
                                        2
<PAGE>
of voice  processing or  computer-telephony  integration  products.  See Item 1,
"Business  - Products  - Voice  Processing  Products"  and Item 1,  "Business  -
Products - Computer-Telephony Integration Products."

         The  Company's  digital  systems  enable  customers  to  upgrade  their
telephone systems as their businesses grow and as technology  advances by adding
or replacing  components in stages without replacing their entire systems.  As a
result,  it is  generally  more  economical  for the end users to  expand  their
STARPLUS  or  infinite  systems  than to switch  to a  competitor's  system.  In
addition,  the wireless  telephone  systems currently offered by the Company are
designed to be incorporated with the Company's digital systems without requiring
significant  modification to existing  equipment.  The Company believes that the
economy and  flexibility  provided to its customers by this  migration  strategy
offers a competitive advantage to the Company.

Commercial Grade Telephones

         The  Company  markets  several  lines of  commercial  grade  telephones
through  Supply Houses for ultimate  sale to home office or business  users that
require  a  business  telephone  with  multiple  features;   for  use  with  PBX
installations  in hotels,  motels,  and resorts;  and for use with electronic or
digital  key  systems,   PBX  systems,   or  telephone  company  central  office
("Centrex")  switching  systems when the customer  prefers  telephone  sets that
provide multiple  features.  Sales of commercial  grade  telephones  represented
approximately  17.7% and 15.7% of the  Company's  revenue  during 1996 and 1997,
respectively.  All of the Company's  commercial  grade  telephones meet industry
standards for commercial  telephone units and may be used with telephone systems
sold by the Company or by  competing  manufacturers.  The  Company's  commercial
grade telephones offer a myriad of features, functions, and designs ranging from
simple,  traditionally  styled desk and wall-mounted  telephones to programmable
telephones with  contemporary  styling.  The Company's more advanced  commercial
grade telephones  contain a central processing unit,  built-in memory,  built-in
data jacks, built-in speakerphones, and the capability to utilize custom calling
features provided by local telephone companies.

Voice Processing Products

         Voice  processing  includes  functions  designed to reduce  labor costs
while providing  faster,  more efficient  routing of incoming calls and speeding
and  simplifying  message  delivery and storage.  The Company  designs its voice
processing  products to integrate with telephone  systems sold by the Company as
well as competing  manufacturers  and  frequently  markets its voice  processing
products   independently  of  its  telephone  systems.  The  Company,   however,
cultivates  the expansion of its existing base of telephone  systems by offering
voice  processing  products  that  differentiate  its products from those of its
competitors and that provide a value-added  basis for increased sales and profit
margins.

Automated Attendant; Voice Mail and Fax Mail Systems; Internet Fax Delivery

         The Company's  telephone systems include an "automated  attendant" that
routes incoming calls  automatically to the intended person or department during
and  after  business  hours by  instructing  the  caller  to press on his or her
touch-tone telephone the numbers of the recipient's  extension or the letters of
the recipient's  name,  which provides  front-end  automated call processing for
small key  telephone  systems and PBX systems that support  standard  commercial
telephones. Automated attendant features ensure that each caller has the ability
to contact the  intended  person and enable the  business to eliminate or reduce
operators or  attendants  or to assign other  responsibilities  to attendants or
operators  when not  answering  calls.  The  business  user also can program the
system so that callers always have the option of speaking with an operator.

         Voice mail  enables  callers to leave  detailed  messages  and  permits
recipients to retrieve  messages when they return to their offices or by dialing
into the system from remote telephones.  Each voice mailbox can be customized to
the individual user's needs. Voice messages can be stored,  replayed,  saved, or
erased as desired by the user. The menu routing functions included in certain of
the Company's voice mail systems enable business users to
                                        3
<PAGE>
program the systems to create custom,  multi-level  menus that permit callers to
automatically access  organizational  departments or product,  service, or event
information by dialing menu choices.

         During  1997,  the  Company  introduced  a new line of  self-contained,
Microsoft Corp.  ("Microsoft")  Windows-based  voice processing systems designed
for small- to medium-sized  organizations.  These competitively  priced systems,
which work in conjunction with key telephone systems sold by the Company as well
as  other  manufacturers,  can be  expanded  from two  ports up to eight  ports,
feature a full  range of  automated  attendant  and voice  mail  functions,  and
include a serial port for  administration  via the user's laptop PC. The Company
believes that the  functionality,  ease of installation and use, and competitive
pricing of these  products will result in a higher  percentage of sales of these
voice  processing  systems  in  conjunction  with  sales  of the  Company's  key
telephone systems than the Company experienced with its previous DOS-based voice
mail products.

         The Company's Windows NT-based messaging systems, which provide 8 to 24
port  capacities,  combine  traditional  voice  mail  functions  with  facsimile
messaging  capabilities  ("fax  mail") as well as the ability to share  messages
with other voice  messaging  systems over the  Internet.  Fax mail  provides the
ability to receive,  store, retrieve, and forward facsimile messages in the same
manner that voice mail handles  voice  messages.  The  Company's fax mail system
digitizes and stores facsimile messages and notifies the user that messages have
been received.  The user can retrieve and print the  facsimiles  from his or her
office or remote  locations  (such as a hotel  room) and can also  instruct  the
system  to  forward  facsimiles  to other  recipients.  "Fax-on-demand"  enables
callers to access information stored by a business,  such as sales and marketing
brochures, technical specifications, and pricing data, and request the system to
transmit the desired information to the caller's facsimile machine.

         The  new  Windows  NT-based  system  also  utilizes   Company-developed
extensions to existing  Internet e-mail protocols to enable voice messages to be
transported over the Internet or other electronic fields for efficient, low-cost
information exchange between remote systems. In addition,  the Company's Windows
NT-based Internet fax delivery systems connect the user's telephone and computer
to enable the user to transmit  facsimile  messages or documents to conventional
facsimile machines via the Internet. These systems provide ease of use and avoid
problems  associated  with  e-mail   attachments,   mismatched  data  encryption
techniques,  or private or switched  network costs.  The Company's  Internet fax
delivery  systems  provide  spoken  prompts  that  guide  the user  through  the
transmission  process and also  transmit  delivery  confirmations  to the user's
mailbox.  As a result,  a business  with  multiple  offices can extend its voice
messaging  system so as to permit  employees in  different  locations to create,
receive,  answer, or forward voice and facsimile  messages via the Internet more
quickly,  efficiently, and economically than traditional long-distance telephone
calls.

Interactive Voice Response

         The Company's  interactive  voice response  ("IVR") system connects the
business user's  telephone system to the user's host computer in order to permit
the use of any  touchtone  telephone  to  access  and store  information  in the
business's  database.  This interactive  connectivity permits callers to conduct
transactions,  such  as  placing  orders,  checking  inventory,  tracking  order
shipments,  or querying account information,  from any touchtone telephone.  IVR
converts  callers'  touchtone  key presses into data for storage on the computer
system  and  uses  synthesized  human  speech  to give the  caller  instructions
regarding  how  to  access  the  database  and  to  communicate   the  requested
information  to the caller.  The open  architecture  design of the Company's IVR
system provides unlimited scalability by permitting users to increase the number
of ports or voice  storage  capacity  simply by  plugging in more voice cards or
disk drives and by linking  multiple  devices into networks to create  virtually
unlimited  configurations.  Users may enhance  the system by adding  independent
off-the-shelf  software  modules that can be  seamlessly  integrated  to provide
additional   features,   such   as   call   routing,   voice   messaging,    fax
store-and-forward, and audiotext.
                                        4
<PAGE>
Automatic Call Distribution

         The Company  markets its ACD System  Software  ("ACD") and PC-based ACD
Reporting Package for use with digital key telephone systems. The automatic call
distribution  functions  provided by ACD enable  businesses that receive a large
volume of customer calls (such as catalog sales  operations) to manage  incoming
calls  efficiently by directly  routing them to the proper person or group.  ACD
reduces the number of abandoned  calls by reducing the number of calls placed on
hold and by minimizing the length of time that calls are kept on hold.  When all
group member  telephones  are busy,  ACD plays a custom  "hold"  message for the
caller and connects the call to the first available  person or sales agent.  ACD
saves  employee time by eliminating  the necessity of continually  answering and
transferring  calls  to  the  same  groups.  ACD  enables  agents  with  display
telephones  to see the number of calls waiting in queue as well as the length of
the  longest  waiting  call in order to speed  call  handling  at times of heavy
calling  activity.  The PC-based ACD Reporting Package component of ACD provides
real-time  information and comprehensive  historical reports on calling activity
for review by management.

Computer-Telephony Integration Products

         The  Company   designs,   develops,   and  markets   computer-telephony
integration  ("CTI")  products that combine the  communications  technologies of
business   telephone  systems  with  the  information   storage  and  processing
capabilities of personal  computers.  The Company's CTI products utilize an open
system  architecture  to  integrate  computers  and  telephone  systems  into  a
user-friendly  information  storage,  processing,  and transmitting  device. The
Company  believes that developing  more  value-added  CTI  applications  for its
telephone  systems will enhance the appeal of its product lines and enable it to
sell more key telephone systems,  full-featured  telephones,  and other software
packages and add-on peripheral  products.  The Company markets CTI products that
enable a user to (i) utilize the Internet to access voice, facsimile, and e-mail
messages  via personal  computer;  (ii)  incorporate  telephone  functions  with
computer  software  to speed call  handling  and permit the user to  personalize
telephone  functions;  (iii) identify  incoming  callers and immediately  access
computer files  relating to the caller;  (iv) connect  Windows-based  local area
networks to the user's  telephone  system;  and (v)  quickly  and  inexpensively
access and analyze call accounting information.

CTI Software Products

         The Company's CTI product lines include software  applications designed
to operate in conjunction with Microsoft's Windows operating systems software in
order to unite  personal  computers and telephones to help business users better
manage their  communications and information  systems. The Company's current CTI
product lines provide the choice of either (i) a CTI module that connects one of
the  Company's  digital  telephones  to the  user's PC, or (ii) a CTI board that
slides  into the  user's  PC and  replaces  the  traditional  desktop  telephone
altogether.  The second option  includes  either a handset or headset that plugs
into the  computer  terminal  for use in  private  conversations.  After the CTI
module or board is installed,  the Company's CTI software incorporates the fixed
and flexible  feature buttons of the Company's  digital  telephones (such as the
dial pad,  call status  display,  directory  window,  and dial display) onto the
computer screen. The user can then access all telephone  features,  place calls,
and process  incoming calls from the computer,  or, if a CTI module is used, the
desktop  telephone.  For instance,  the user can click on the directory  icon to
access the  desired  telephone  directory,  type in the name of the person to be
called,  and click on the "dial out" icon to  automatically  dial the  telephone
number. The system also permits the user to answer incoming calls without having
to exit a Windows  application.  In addition,  the Company's CTI products enable
users to customize and enhance message handling efficiency by using programmable
feature buttons to create user-specific functions, such as conference calling or
speed dial  numbers;  permit users to access voice mail and activate  voice mail
options,  such as fast-forward,  rewind, or delete by using the mouse,  computer
keyboard,  or telephone keypad; and permit users to create multiple  directories
with up to 1,000 names in each directory.
                                        5
<PAGE>
Unified Messaging

         The Company's unified messaging system utilizes Microsoft's  "Exchange"
technology to enable users to access e-mail, voice mail, facsimiles,  and paging
messages  in a single  session at a  personal  computer.  The system  displays a
listing of all of the user's messages and enables the user to access and control
all of his or her messages with a click of the computer mouse.

Desktop Video Conferencing

         The  Company  recently  introduced  a  full-featured  Windows  95-based
desktop ISDN video conferencing system that is designed to enable users to place
and  receive  video  calls  with  ease.  The  system   features  a  full  duplex
speakerphone with echo cancellation and  "picture-in-picture"  to show both ends
of the call.  Users can assemble  video  conferences  with up to five parties by
using  an  external  video  conferencing   service.  The  system  also  supports
application  sharing and permits all parties on the call to  collaborate in data
sharing.

New Product Development

         The Company engages in an on-going  program to develop  enhancements to
its  existing  product  lines and to  develop  new  products  that  address  the
increasing demands of business organizations for low-cost productivity enhancing
communications  tools. The Company  believes that continuous  development of new
products and features will be necessary to enable it to offer telephony systems,
voice processing  products,  computer-telephony  products,  and related business
communications  products  that will be in greatest  demand and that will provide
the best  opportunities  for  growth  and  profitability  of the  Company  on an
on-going basis.  Since 1994, the Company has developed and released  several new
products  and  product  lines,  including  a new line of digital  key  telephone
systems  introduced in 1997. This new digital product line utilizes hardware and
software  technologies  developed by the Company in conjunction  with LGE. These
new technologies  replace certain digital technologies for which the Company has
licenses with a third party for use in certain of its other digital products.

         The Company currently is focusing its new product  development  efforts
on developing  and refining  enhancements  that will deliver  greater  features,
sophistication,  functionality,  and value to its current product offerings. For
example,  the Company  currently is developing  digital voice mail  integration,
ISDN capabilities for its key telephone systems,  new ACD reporting packages,  a
wireless  key  telephone  adjunct  for its digital key  telephone  systems,  and
additional  enhancements to its Windows NT-based voice messaging systems and its
IVR systems.  The Company may from time to time enter into  strategic  alliances
with third parties related to the development of new products, product lines, or
product features. For example,  during 1997 the Company entered into a strategic
alliance to market a wireless  key  telephone  system that can be connected to a
business's existing telephone system without the need for special wiring or that
can operate as a stand-alone key system with desktop and mobile telephone units.
The mobile units offer a full array of features similar to those provided by the
Company's  traditional key telephone systems,  but permit the user to roam up to
100 feet from stationary digital cell units that can be positioned  throughout a
business's office, warehouse, or factory.

Sales, Marketing, and Distribution

         The Company  currently markets its products in all 50 states and Puerto
Rico through a  distribution  network  consisting  primarily of large  wholesale
distributors  known as "Supply  Houses"  and  telephone  sales and  installation
companies  known as "Direct  Dealers."  The Company  also  maintains an in-house
sales  staff  that  makes  direct  sales of  certain  of its  products  to large
commercial  organizations and public access  providers,  such as local telephone
companies and cellular telephone system providers.  The Company also markets its
products on a private label basis to original equipment  manufacturers ("OEMs").
The Company  derived  approximately  80.2%,  10.3% and 4.4% of its total revenue
from sales to Supply Houses, Direct Dealers, and OEMs, respectively, in 1997.
                                        6
<PAGE>
Supply Houses (Wholesale Distributors)

         The Company designs and markets its STARPLUS brand of products for sale
through Supply Houses. The Supply Houses resell the Company's products primarily
to small local interconnect companies and independent telephone companies, which
in turn resell the Company's  products to end users,  install the systems at the
end users'  businesses,  and provide service and technical support following the
sale. The Company  provides ongoing training to Supply House employees to enable
them  to sell  more  effectively  the  Company's  products  and to  provide  the
interconnects and independent  telephone companies with technical  assistance in
installation, maintenance, and customer support.

         The Company  believes that sales through  Supply Houses offers  several
advantages, including (i) established distribution systems and access to a large
number of customer accounts;  (ii) maintenance of customer credit facilities and
an  established  inventory of the Company's  products;  (iii) prompt  payment of
receivables;  (iv)  reduced  needs  for  direct  training  by the  Company;  (v)
effective   promotion  of  the   Company's   products  at  trade   shows;   (vi)
geographically  dispersed sales forces that can reach customers more effectively
than the Company would otherwise be able to do; (vii) lower support and carrying
costs compared with the costs  associated with direct sales to a large number of
Direct  Dealers;  and (viii) the absence of conflict with the Company's sales to
medium and larger interconnects through Direct Dealers.

         The Company  recently  introduced  its  STARPLUS  TRIAD line of digital
telephone  systems for sale through  Supply Houses to authorized  TRIAD dealers.
The TRIAD  product  line  includes  a full array of  digital  telephone  systems
ranging from 18 to 348 ports,  as well as voice  messaging,  ACD, CTI, and other
digital products similar to the Company's infinite line of digital products. The
authorized  dealers must commit to minimum  purchases of TRIAD or other STARPLUS
products  and will be  required  to be trained  and  certified  through a formal
product and sales  training  program  conducted by the Company.  In return,  the
Company will  provide the  authorized  TRIAD  dealers  with  preferential  order
fulfillment,  marketing,  sales,  and  product  support  services.  The  Company
currently is enrolling  dealers and anticipates  that  commercial  deliveries of
TRIAD products will commence during the second or third quarter of fiscal 1998.

         Supply  Houses that  currently  resell the Company's  products  include
Graybar  Electric Co.,  Inc.  ("Graybar"),  Alltel  Supply,  Inc.,  Sprint/North
Supply,  Anixter  Brothers,  Inc.,  G.T.E.  Supply Co., Famous Telephone Supply,
Power & Telephone Supply Company, Inc., and Ingram Micro, Inc. Graybar accounted
for 44% and 40% of sales during 1996 and 1997, respectively. The Company's sales
and  marketing  personnel  stimulate  demand for its  products  with the smaller
interconnects  and independent  telephone  companies that purchase the Company's
products from Graybar,  Alltel Supply, Inc., and other Supply Houses and install
these products at the end users' premises.  These  interconnects and independent
telephone companies provide the "pull through" demand for the Company's products
from Graybar and other Supply Houses.  As a result,  the Company believes that a
decrease in purchases  by Graybar or other Supply  Houses would result in only a
temporary  adverse  effect on the  Company's  operations  if  interconnects  and
independent  telephone companies would continue to demand the Company's products
from other Supply Houses,  which in turn would  increase their  purchases of the
Company's products.

Direct Dealers

         The  Company  developed  its  infinite  line of  telephone  systems and
related  products for sales to Direct  Dealers.  These Direct Dealers are medium
and large  interconnect  companies or local  dealers  that resell the  Company's
products  directly  to end  users.  The  Company  believes  that  the  principal
advantages  of this  distribution  channel are higher  gross  margins on product
sales,  greater  visibility of the Company's  product lines,  and the ability to
exert additional control over factors such as pricing of the Company's products.
Sales to Direct Dealers, however,  generally involve longer credit terms for the
Company,  the  necessity to provide  increased  direct  marketing  and technical
support,  and  additional  costs  associated  with  developing  and training the
independent  commissioned  sales staff of the various  Direct  Dealers to enable
them to solicit purchases of the Company's products. The
                                        7
<PAGE>
Company  has  increased  the  number of Direct  Dealers  that sell its  infinite
products from 15 at December 31, 1992 to  approximately  85 at December 31, 1997
and continues to seek additional Direct Dealers for its infinite products.

OEMs

         In May 1997,  the  Company  entered  into an  agreement  with  Paradygm
Communications,   Inc.   ("Paradygm")  to  distribute  the  Company's   384-port
hotel/motel  switching  system under the Paradygm brand name. Under the terms of
the agreement, Paradygm is responsible for the sales and marketing of the switch
to a group  of  Paradygm  dealers,  which  in turn  market  the  product  to the
hospitality industry.

         In August 1997,  the Company  entered  into an  agreement  with Fujitsu
Business  Communication  Systems,  Inc.  ("Fujitsu")  to sell  its  digital  key
telephone  systems  under the  Fujitsu  brand  name to the  existing  dealers of
Fujitsu's other  telecommunications  products. Under the terms of the agreement,
Fujitsu is  responsible  for the sales and  marketing  of these  products to its
dealers, which in turn market to end users.

In-house Sales Staff

         The Company  maintains an in-house  sales staff that makes direct sales
of certain of its products to large  commercial  organizations  and governmental
agencies in the United  States and foreign  countries.  The  Company's  in-house
sales  force also  develops  relationships  with  value-added  resellers,  which
purchase  certain of the  Company's  products  as a base  platform,  enhance the
platform with specialized software that they have developed, and then resell the
combined systems.

International Sales

         To date, sales of the Company's  products in foreign countries have not
represented  a  significant  portion  of the  Company's  revenue.  The  Company,
however,  believes  that sales of its  telephone  systems and other  products in
international  markets  may  increase in the future as  cultural  resistance  to
features  such as  voice  mail  and  interactive  voice  response  declines,  as
touchtone  technologies and cellular telephone service become more available and
other installed  communications  infrastructures are improved, and as regulatory
differences  between  countries are  eliminated.  All of the Company's  sales in
foreign countries are denominated in United States dollars.

Research and Development; Strategic Alliances with LGE and Other Companies

         The Company  believes that the continued  development  of software that
distinguishes the functions and features of the Company's products from those of
its  competitors  represents  a critical  factor in  determining  the  Company's
ongoing success. The Company's  engineering staff consists of highly trained and
experienced  software  professionals  who focus on providing and supporting high
quality, user-friendly business communications systems and related products. The
availability  of in-house  software  and systems  development  expertise  at the
Company's  facilities  in Arizona and Georgia  provides the Company with product
control,  permits  faster  turnaround  and  reaction  time  to  changing  market
conditions, and provides a solid base of maintenance and support services to end
users. The Company utilizes product and market  development groups that interact
with  customers in order to  anticipate  and respond to customer  needs  through
development of new product programs and enhancement of existing product lines.

         The Company  conducts  joint  development  activities  with LGE for the
design and  development of hardware  incorporated  into certain of the Company's
existing or planned  telephone  system and commercial  grade  telephone  product
lines.  Under its joint  development  projects  with LGE,  the Company  provides
market  analysis,  product  management,  functional and  performance  standards,
software   development,   quality   control  program   development,   sales  and
distribution,  and  customer  service and support,  while LGE provides  hardware
research,  design and development,  development of components such as integrated
circuits and semiconductor chips, and manufacturing
                                        8
<PAGE>
and production engineering.  Generally, LGE contributes the ongoing research and
development  costs for the product  hardware in return for an arrangement  under
which LGE produces the finished goods developed under the alliance.  See Item 1,
"Business - Manufacturing" and "Special Considerations - Dependence on LGE." The
Company  has  successfully  engaged  in such  projects  with LGE in the past and
believes  that it will  continue  to have  access  to  LGE's  advanced  hardware
research and development  capabilities as the Company develops new product lines
in such areas as digital key telephone systems, digital PBX systems, large-scale
integrated  circuits,  multi-layer  printed  circuit  boards,  and surface mount
technologies.

         The Company also enhances its software  development  expertise  through
acquisitions of or licensing  arrangements  and other  strategic  alliances with
independent  third-party  developers.  The Company has active strategic alliance
relationships  with other  companies  that possess  expertise in automatic  call
distribution,   small  digital  key  telephone  systems,  and  digital  wireless
technologies.  The Company intends to pursue  additional  opportunities to enter
into strategic alliances with other companies that possess established expertise
in  specific  technologies  in order to  co-develop  proprietary  products or to
acquire such companies in order to develop new products internally.

Manufacturing

         The  Company  obtains  its  key  telephone  systems  and  full-featured
commercial  grade  telephones  under  manufacturing  arrangements  with  various
third-party manufacturers, including LGE. The Company owns a significant portion
of the  tooling  used  by  the  third-party  manufacturers  to  manufacture  its
products. The Company's agreements with the third-party  manufacturers generally
require the  manufacturers  to produce the Company's  products  according to the
Company's  technical  specifications,  to perform quality  control  functions or
otherwise meet the Company's quality standards for manufacturing, and to test or
inspect  the  products  prior  to  shipment.   Pursuant  to  the   manufacturing
agreements,  the  manufacturers  provide the Company  with  warranties  that the
products are free of defects in material and  workmanship.  The agreements  also
require the manufacturers to repair or replace, at their expense,  products that
fail to conform  with the  warranties  within  specified  periods.  The  Company
performs  final  assembly,  systems  integration,  and testing of certain of its
automated call distribution,  voice mail, automated attendant, interactive voice
response, and computer-telephony integration products at its Arizona and Georgia
facilities.

         The Company  obtains  certain of its electronic  telephone  systems and
certain of its  digital  telephones  from LGE,  which owns the rights to produce
such equipment. LGE owns approximately 18.7% of the Company's outstanding Common
Stock. Pursuant to an agreement with LGE (the "LGE Agreement"),  LGE granted the
Company the right to distribute and sell throughout the United States and Canada
products  covered by the agreement that LGE manufactures in South Korea. The LGE
Agreement  expired on April 12,  1997.  The Company  continues  to purchase  the
products  that  it  previously  purchased  pursuant  to the LGE  Agreement  on a
purchase order basis.  The Company  currently is engaged in discussions with LGE
regarding entering into a new manufacturing  agreement for the products that the
Company  obtains from LGE. See Item 1, "Special  Considerations  - Dependence on
LGE"  and  "Special  Considerations  -  Control  by  Management;   Stockholders'
Agreement; Conflicts of Interest."

         The Company  obtains  certain of its electronic  telephone  systems and
most  of  its  commercial  grade  telephones  and  replacement  parts  for  such
telephones  from LG Srithai,  Ltd.  ("LGST"),  a joint  venture  between LGE and
Srithai Group, a Thailand-based entity.  Pursuant to an agreement with LGST (the
"LGST  Agreement"),  LGST granted the Company the right to  distribute  and sell
throughout  the United States and Canada such products  manufactured  by LGST in
Thailand.  The LGST Agreement prohibits the Company from purchasing the products
covered by the LGST Agreement from any other manufacturer during the term of the
agreement,  which  expires  on April 12,  1998.  The LGST  Agreement  will renew
automatically for successive  one-year terms unless either party provides notice
to the other of its intent to cancel the  agreement  at least three months prior
to the end of the then-current term. The Company makes all purchases pursuant to
the  LGST   Agreement  on  a  purchase   order  basis.   See  Item  1,  "Special
Considerations  - Dependence  on LGE" and "Special  Considerations  - Control by
Management; Stockholders' Agreement; Conflicts of Interest."
                                        9
<PAGE>
         The Company  currently  obtains  certain of its  digital key  telephone
systems  and  related  digital  products  from  Wong's   Electronics  Co.,  Ltd.
("Wongs"),  a Hong Kong  company,  pursuant  to an  agreement  with  Wong's (the
"Wong's  Agreement").  The Wong's  Agreement  will remain in effect until either
party  gives  the  other  party  at  least  three  months'   advance  notice  of
termination. The Company makes all purchases pursuant to the Wong's Agreement on
a purchase order basis.  Executone Information Systems, Inc.  ("Executone") owns
certain rights to the products that the Company purchases pursuant to the Wong's
Agreement  and licenses to the Company the right to use  Executone's  technology
incorporated  into such products.  See Item 1, "Business - Patents,  Trademarks,
and Licenses."

         The Company also obtains  certain of its digital key telephone  systems
from Tecom Co.,  Ltd.,  ("Tecom")  a Republic of China  company.  Pursuant to an
agreement  with Tecom (the  "Tecom  Agreement"),  Tecom  granted the Company the
exclusive right to sell and distribute throughout all of North and South America
such products  manufactured  by Tecom.  The initial term of the Tecom  Agreement
expires in June 1999, at which time the agreement will  automatically  renew and
continue  until  either  party  gives  the  other  party not less than 120 days'
advance notice of termination.  The Company makes all purchases  pursuant to the
Tecom  Agreement on a purchase  order basis.  The Tecom  Agreement  requires the
Company  to use its  best  efforts  to  purchase  from  Tecom  products  with an
aggregate minimum purchase price of $4.25 million during 1998. In the event that
the Company fails to purchase at least 75% of such purchase  obligations,  Tecom
has the right to either designate the Company as a non-exclusive  distributor of
the products  purchased under the Tecom Agreement or increase the prices of such
products by up to 5%.

         The  countries  in  which   certain  of  the  Company's   products  are
manufactured  have been subject to natural  disasters and civil  disturbances in
the past.  These  circumstances  could  affect the  Company's  ability to obtain
certain of its products from its overseas manufacturers.  Except for a fire that
interrupted production at one plant in China during late 1993 and the first part
of 1994,  the Company  has not  experienced  any  significant  interruptions  of
shipments  to  date.  The   termination  of  any  of  the  agreements  with  its
manufacturers  or the  inability of the Company to obtain  products  pursuant to
such  agreements,  even for a  relatively  short  period of time,  could  have a
material adverse effect on the Company's operations.  In addition, the countries
in which certain of the Company's products are manufactured have been subject to
recent economic problems. To date, such economic difficulties have not adversely
impacted the Company's  ability to obtain its products or the prices the Company
pays  for  its  products.  There  can  be  no  assurance,   however,  that  such
difficulties  will not impact the  Company in the future.  See Item 1,  "Special
Considerations  - Dependence on Third Parties for  Manufacturing;  International
Manufacturing Sources."

Quality Control

         The  Company  recognizes  that  product  quality  and  reliability  are
critical factors in  distinguishing  its products from those of its competitors.
The Company designs its products to include components meeting specified quality
standards in order to ensure reliable performance. The Company also requires its
third-party  manufacturers to comply with specified quality standards  regarding
materials and assembly methods used in manufacturing the Company's products. See
Item 1,  "Business  -  Manufacturing."  In  addition,  the  Company  maintains a
rigorous  quality  assurance  program designed to ensure that the manufacture of
its  products  conforms  with  specified  standards  and to  detect  substandard
products before shipment.  The Company  inspects  products as they arrive at its
warehouse in Arizona.

Support Services

         The Company provides limited warranties against defective materials and
workmanship  on each of the  products  that it sells.  The  Company  provides  a
complete  support  service  for all of its  products  by  maintaining  a 24-hour
toll-free  telephone  number that system users or their service  representatives
can  contact  for  trouble  shooting  and  diagnostic  assistance.  The  Company
maintains an operating  set-up of each of its telephone  systems,  key telephone
units, and peripheral systems at its headquarters facility, supported by a staff
of technicians trained to handle service assistance calls. When a customer calls
with a question relating to performance malfunctions or an
                                       10
<PAGE>
operational  system question,  the Company's  personnel attempt to replicate any
problem the customer is encountering, diagnose the cause, and provide a solution
to the customer via telephone. If the Company's technicians cannot determine the
cause of the malfunction  over the telephone,  the Company  dispatches a service
representative to the customer's place of business in order to locate the source
of the problem and take corrective measures.

         The Company also operates a repair  facility  that performs  repairs on
certain of the Company's  products.  The Company believes that operating its own
repair center  provides it with savings on repair  expenses as well as increased
customer  satisfaction as a result of faster turn-around time,  improved quality
of repairs, and reduced need for repeat repairs.

Competition

         Markets for  communications  products are  extremely  competitive.  The
Company currently competes  principally on the basis of the technical innovation
and performance of its telephone systems, commercial grade telephones, and other
products,  including their ease of installation and use, reliability,  cost, and
the  technical  support both before and after sales to end users.  The Company's
competitors  in the sale of telephone  systems and telephones  include  Comdial,
Nitsuko, Panasonic Communications & Systems Co., Lucent Technologies,  Inc., NEC
Corp., Nortel, and Toshiba Information  Systems,  Inc. Competitors in the supply
of voice processing  systems include Active Voice  Corporation and Applied Voice
Technology  as well as PBX and key  system  telephone  manufacturers  that offer
integrated  voice  processing  systems  of their own  design  and under  various
original equipment manufacturer agreements. Competition in the interactive voice
response market includes Brite Voice Systems, Intellivoice Communications, Inc.,
and Glenayre.  In the computer  telephony market, the Company competes with many
of the same  companies  indicated  above as well as large  software  development
companies, including Microsoft Corp., Lotus Development Corporation, and Novell,
Inc. Most of the Company's  competitors  are large  companies  that have greater
name recognition and greater  financial,  technical,  marketing,  manufacturing,
distribution,   and  personnel   resources   than  the  Company.   The  revenue,
profitability, and success of the Company depends substantially upon its ability
to  compete  with other  providers  of  telephone  systems  and other  telephony
products. No assurance can be given that the Company will continue to be able to
successfully compete with such organizations.

         Certain of the  Company's  product  lines  compete  with  products  and
services  provided by the regional Bell  operating  companies,  ("RBOCs")  which
offer key telephone systems and commercial grade telephones  produced by several
of the competitors named above as well as Centrex systems that provide automatic
call  distribution  facilities  and features  through  equipment  located in the
telephone company's central switching offices.  The RBOCs from time to time have
proposed the modification or repeal of statutes and regulations, which currently
prohibit them from conducting telephone equipment  manufacturing  activities and
from  providing  certain  other  services  that may  directly  compete  with the
Company's  product lines.  There can be no assurance that such  regulations will
remain in effect or unchanged  indefinitely.  Any modification or repeal of such
regulations  that would permit the RBOCs to compete with the Company by directly
or indirectly  manufacturing  or  distributing  telephone  systems and equipment
and/or "bundling" telephone equipment sales with other calling services provided
by the RBOCs may have a  material  adverse  effect  on the  Company's  operating
results.

Patents, Trademarks, and Licenses

         As of December 31, 1997,  the Company owned six United  States  patents
expiring  on various  dates  beginning  in 2000 and ending in 2008.  The Company
intends to continue to seek patents on its inventions used in its products.  The
process  of  seeking  patent   protection  can  be  expensive  and  can  consume
significant  management  resources.   The  Company  believes  that  its  patents
strengthen  its  negotiating  position with respect to future  disputes that may
arise regarding its technology. However, the Company believes that its continued
success  depends  primarily  on such  factors  as the  technological  skills and
innovative abilities of its personnel rather than on its
                                       11
<PAGE>
patents.  There can be no  assurance  that  patents  will issue from  pending or
future  applications or that any patents that are issued will provide meaningful
protection or other commercial advantage to the Company.

         The Company owns a number of  registered  and  unregistered  trademarks
that it considers  to be an important  factor in  marketing  its  products.  The
Company's  ability to compete  may be  enhanced  by its  ability to protect  its
proprietary  information,  including  the issuance of patents,  copyrights,  and
trademarks.  The  Company  also has  taken  steps  to  protect  its  proprietary
information  through a "trade secrets"  program that includes copy protection of
its  software  programs  and  obtaining  confidentiality   agreements  with  its
employees.  There  can be no  assurance,  however,  that  such  efforts  will be
effective  to prevent  misappropriation,  reverse  engineering,  or  independent
development of the Company's proprietary  information by its competitors.  While
no intellectual  property right of the Company has been  invalidated or declared
unenforceable,  there can be no assurance that such rights will be upheld in the
future.  Accordingly,  the  Company  believes  that,  due to the  rapid  pace of
technological  change in the  telecommunications  industry,  the  technical  and
creative skills of its engineers and other personnel will be extremely important
in determining the Company's future technological success.

         Pursuant to an agreement with Executone (the "License Agreement"),  the
Company possesses a non- exclusive license to use Executone's technology related
to certain of the Company's  digital  telephone  systems.  The License Agreement
prohibits  the Company  from  modifying  the  technology  so that the  Company's
telephone systems can be used with Executone's  products.  The License Agreement
requires  Executone  to provide  certain  technical  support  necessary  for the
Company to utilize  the  technology  covered by the  agreement.  Pursuant to the
License Agreement,  the Company purchases all of the proprietary  components for
its digital  telephone systems at Executone's cost plus 5%, and the Company pays
Executone a royalty fee of 5.3% of the manufactured  cost of all of its products
that utilize the  technology  covered by the  agreement.  The License  Agreement
expires in 2014.

         The telecommunications industry is characterized by rapid technological
development and frequent  introduction of new products and features. In order to
remain  competitive,  the  Company  and other  telecommunications  manufacturers
continually  find it  necessary to develop  products  and features  that provide
functions similar to those of other industry participants, often with incomplete
knowledge of whether patent or copyright protection may have been applied for or
obtained by other parties.  As a result,  the Company receives notices from time
to time  alleging  possible  infringement  of  patents  and  other  intellectual
property  rights of others.  To date, the Company has been able to  successfully
defend such claims or to negotiate  settlements  to such claims on terms that it
believes to be favorable.  In the future,  however,  the defense of such claims,
fees paid in  settlement  of such claims,  or costs  associated  with  licensing
rights to use the  intellectual  property  of others or to  develop  alternative
technology may have a material adverse impact on the Company's operations.

Government Regulation

         The United States government from time to time has imposed anti-dumping
duties on certain telephone products manufactured in certain of the countries in
which the Company's  products are  manufactured.  There can be no assurance that
similar  duties  will  not be  imposed  in the  future  on  telephone  products,
including  the  Company's  products,  manufactured  in these  or  other  foreign
countries.  The imposition of such additional  duties on the Company's  products
could  have a  material  adverse  effect  on the  Company's  operating  results.
Legislation  enacted in the United States during 1997 will phase out duties that
the Company pays for products  manufactured in certain other of the countries in
which the Company's  products are  manufactured.  Provided that those  countries
remain qualified under the legislation, duties on products manufactured in those
countries will be phased out through 2000.  There can be no assurance,  however,
that the  countries  that  currently  qualify for the  phase-out  of duties will
remain  qualified or that duties will not be levied on products  manufactured in
those countries in the future.

Employees

         As of December 31, 1997,  the Company  employed a total of 173 persons,
consisting  of 169  full-time  employees  and four  part-time  employees  at its
facilities in Scottsdale, Arizona and Norcross, Georgia. This number
                                       12
<PAGE>
includes  36  persons  in  engineering  and  product  development,  77 in sales,
marketing and technical support, 14 in warehouse and distribution  functions, 19
in equipment repair, and 27 in administration,  including  executive  personnel.
The Company  considers its relationship  with its employees to be good, and none
of its employees  currently are represented by a union in collective  bargaining
with the Company.

         Various third-party  manufacturers provide the personnel engaged in the
manufacture  and assembly of the  Company's  products in South Korea,  Thailand,
Malaysia,  Hong Kong,  Republic  of China,  and the  People's  Republic of China
pursuant to the agreements between the Company and the respective manufacturers.

Executive Officers

         The  following  table sets  forth  information  concerning  each of the
executive officers of the Company:

<TABLE>
<CAPTION>
          Name                  Age                      Position
          ----                  ---                      --------

<S>                              <C>      <C>
William J. Hinz...........       52       Chairman of the Board
Glenn R. Fitchet..........       50       President, Chief Executive Officer, and Director
Gregory K. Roeper.........       37       Executive Vice President - Finance,
                                          Administration, and Operations; Chief Financial
                                            Officer; Secretary; and Treasurer
Mark D. Fife..............       30       Executive Vice President - Sales, Marketing, and
                                            Support
</TABLE>

         William  J. Hinz has  served as  Chairman  of the Board of the  Company
since October 1997 and as a director of the Company  since April 1997.  Mr. Hinz
has  served  as  Executive  Vice  President  of  Operations  and a  director  of
Stolper-Fabralloy  Company, a precision aerospace engine component manufacturer,
since March 1996.  Mr. Hinz was Vice  President  of Global  Repair and  Overhaul
Operations for AlliedSignal  Aerospace  Company from June 1994 until March 1996.
During this period,  Mr. Hinz also was  responsible  for  aerospace  aftermarket
merger and  acquisition  activity.  Mr.  Hinz  served as  President  of European
Operations for AlliedSignal Aerospace Company from December 1991 until June 1994
and served in various other manufacturing management positions with AlliedSignal
Aerospace Company from 1968 to 1991.

         Glenn R. Fitchet has served as President  and a director of the Company
since April 1994 and as Chief  Executive  Officer of the Company since May 1996.
Mr.  Fitchet was Vice  President and General  Manager of the Vodavi  Division of
Executone  from  January  1990 until  April  1994.  Mr.  Fitchet  served as Vice
President  Marketing and Manufacturing of Executone from July 1988 until January
1990 and as Vice President of Vodavi Technology  Corporation from September 1984
to July 1988.  Mr.  Fitchet also served as Vice  President - Sales and Marketing
for Valcom, Inc. from December 1981 to August 1984 and as National Sales Manager
for Siemens Information Systems from July 1976 until December 1981.

         Gregory K. Roeper has served as the Company's  Executive Vice President
- Finance, Administration,  and Operations, since December 1997; as Secretary of
the Company since October 1997; and as Chief Financial  Officer and Treasurer of
the Company  since  November  1994.  Mr.  Roeper  served as the  Company's  Vice
President Finance from November 1994 until December 1997. From 1982 to 1994, Mr.
Roeper was employed by Arthur  Andersen LLP, most recently as a Senior  Manager.
Mr. Roeper is a Certified Public Accountant in the state of Arizona.

         Mark D.  Fife has  served  as a Vice  President  of the  Company  since
February 1998 and as Executive  Vice President - Sales,  Marketing,  and Support
since March 1998. From February 1997 to June 1997, Mr. Fife served as President,
Chief Executive Officer, and a director of Evergreen Internet,  Inc., a provider
of turnkey Internet
                                       13
<PAGE>
electronic commerce  applications for businesses.  From February 1991 to January
1997, Mr. Fife Served in various executive  capacities with Insight  Enterprise,
Inc., most recently as Senior Vice President - Strategic Alliances.

History of the Company

         The Company was  incorporated  in Delaware on March 10, 1994.  On April
11, 1994, the Company acquired the operating assets of the Vodavi Communications
Systems  Division (the "Vodavi  Division") of Executone.  The Company's  current
management   team  includes   individuals   who  conducted  the  operations  and
development of the Vodavi Division and its predecessor since 1983.

         In July 1995, the Company,  through its wholly owned subsidiary,  ARSI,
acquired  from an  affiliate of LGE certain of the assets and  liabilities  of a
telecommunications equipment repair business located in Scottsdale, Arizona.

         In October 1995,  Enhanced merged with a wholly owned subsidiary of the
Company.  Enhanced  develops and markets  voice  processing,  interactive  voice
response, desktop video conferencing,  and call accounting software products for
small, medium, and large businesses,  universities, and government organizations
in the United States and internationally.


                             SPECIAL CONSIDERATIONS

Certain Factors Affecting Operating Results

         The  Company's  operating  results are  affected  by a wide  variety of
factors  that  could  adversely  impact its net sales and  profitability.  These
factors,  many of which are  beyond  the  control of the  Company,  include  the
Company's  ability to identify  market  segments  that have  significant  growth
potential and to  successfully  market its products and services to those market
segments; its ability to maintain the product design and production capabilities
necessary to design and produce  innovative  and  desirable  product  lines on a
timely and cost-effective  basis; the Company's success in maintaining  customer
satisfaction   with  its  products;   market   acceptance  of  new  products  or
technological  innovations;  the  Company's  ability to  establish  and maintain
strong and long-lasting relationships with the wholesale distributors and direct
dealers that distribute its products;  the Company's  success in encouraging its
distributors and dealers to promote the Company's products ahead of those of its
competitors; the level and timing of orders placed by customers that the Company
can complete in a quarter;  customer order patterns and seasonality;  changes in
product mix; the  performance and  reliability of the telephone  systems,  voice
processing systems, and computer-telephony products designed and marketed by the
Company;  the life  cycles of its  products;  the ability of the Company and its
third-party   manufacturers  to  produce  the  Company's  products  and  product
components in an efficient,  timely,  and high-quality  manner; the availability
and cost of raw materials,  equipment,  and supplies; the timing of expenditures
in  anticipation of orders;  the cyclical nature of the businesses,  industries,
and markets served by the Company;  technological  changes;  the introduction of
new products by competitors; and competition and competitive pressures on prices
which, among other things, may decrease gross margins.

         The  Company's  ability to increase its design  capacity and enter into
manufacturing  arrangements  in  order  to meet  customer  demand  and  maintain
satisfactory  delivery  schedules  will be an important  factor in its long-term
prospects.  A  slowdown  in demand  for the  Company's  products  as a result of
economic  or  other  conditions  in  markets  served  by the  Company  or  other
broad-based factors would adversely affect the Company's operating results.

Dependence  on Third  Parties  for  Manufacturing;  International  Manufacturing
Sources

         The Company depends upon third parties to manufacture its key telephone
systems and commercial grade  telephones.  Although the Company owns most of the
equipment,  tools,  dies, and molds utilized in the manufacturing  process,  the
Company has limited control over the manufacturing processes. As a result, any
                                       14
<PAGE>
difficulties encountered by the third-party manufacturers that result in product
defects,  production delays, cost overruns,  or inability to fulfill orders on a
timely basis could have a material adverse effect on the Company.

         The Company  currently  obtains  certain of its products  under various
manufacturing  arrangements  with  third-party  manufacturers  in  South  Korea,
Thailand,  Malaysia,  Hong Kong, Republic of China, and the People's Republic of
China. See Item 1, "Business - Manufacturing"  for a description of the material
terms  of  certain  of  these  arrangements.   The  Company's  reliance  on  the
third-party   manufacturers  to  provide   personnel  and  facilities  in  these
countries,  the Company's  maintenance of equipment and inventories  abroad, and
the potential imposition of quota limitations on imported goods from certain Far
East countries expose it to certain economic and political risks,  including the
business and financial  condition of the  third-party  manufacturers;  political
uncertainty;  the  possibility of  expropriation,  supply  disruption,  currency
controls,  and  exchange  fluctuations;  and changes in tax laws,  tariffs,  and
freight rates.  Although the current economic situation in Asia has not resulted
in any adverse changes in the prices that the Company pays for its products,  an
extended  period  of  financial   pressure  on  overseas   markets  or  currency
devaluations  that  result in a  financial  setback  to the  Company's  overseas
manufacturers could have an adverse impact on the Company's  operations.  Except
for a fire that  interrupted  production  at one plant in China during late 1993
and the first part of 1994,  the Company  has not  experienced  any  significant
interruptions to date in obtaining its products from third-party  manufacturers.
The Company  believes that production of its product lines overseas  enables the
Company to obtain  these items on a cost basis that  enhances the ability of the
Company to market them profitably.

         The Company  purchased  approximately  $17.9 million and $18.8 million,
respectively,  of key telephone systems and commercial grade telephones from LGE
and LGST, an affiliate of LGE, during 1996 and 1997, constituting  approximately
69.6% and 63.5%, respectively,  of total purchases of such products during these
periods.  See Item 1, "Business - Manufacturing"  and "Special  Considerations -
Control by Management; Stockholders' Agreement; Conflicts of Interest." Although
the Company  currently  is engaged in  discussions  with LGE to enter into a new
agreement  with respect to purchases from LGE, there can be no assurance that it
will be able to secure long-term manufacturing  arrangements for the products it
currently obtains from LGE. The Company's operations would be adversely affected
if it lost its relationship  with any of its current  suppliers or if any of its
current suppliers'  operations or overseas or air transportation  were disrupted
or terminated  even for a relatively  short period of time. The Company does not
maintain  an  inventory  of  sufficient  size  to  provide  protection  for  any
significant  period against an interruption  of supply,  particularly if it were
required  to locate and  utilize  alternative  sources of  supply.  The  Company
currently maintains a $5.2 million insurance policy to cover lost revenue in the
event of certain interruptions in purchases from its overseas manufacturers.

Dependence on LGE

         The  Company  depends  on LGE,  which owns  approximately  18.7% of the
Company's  outstanding Common Stock, for the supply of key telephone systems and
commercial  grade  telephones  as well as on  LGE's  engineering,  hardware  and
circuit  development,  and manufacturing  capabilities.  See Item 1, "Business -
Manufacturing"   and   "Special   Considerations   -  Control   by   Management;
Stockholders'  Agreement;  Conflicts of  Interest."  Except for certain  product
supply agreements,  LGE has no commitments to support the business or operations
of the Company.

Competition

         The business in which the Company engages is intensely  competitive and
has been characterized by price erosion, rapid technological change, and foreign
competition.   The  Company  competes  with  major  domestic  and  international
companies,  many of which have  greater  market  recognition  and  substantially
greater financial, technical, marketing,  distribution, and other resources than
the  Company  possesses.  Principal  competitors  include  Comdial  Corporation,
Nitsuko, Panasonic Communications & Systems Co., Lucent Technologies,  Inc., NEC
Corp.,  Nortel,  Toshiba  Information  Systems,  Inc., Active Voice Corporation,
Applied Voice Technology,  and Brite Voice Systems. The Company anticipates that
major computer software development companies,  including Microsoft Corp., Lotus
Development   Corporation,   and  Novell,   Inc.,   may  enter  the  market  for
computer-based telephone
                                       15
<PAGE>
products.  Emerging  companies  also may  increase  their  participation  in the
telephone systems and peripherals markets.

         The ability of the Company to compete  successfully depends on a number
of  factors  both  within  and  outside  its  control,  including  the  quality,
performance,  reliability,  features, ease of use, pricing, and diversity of its
product lines; the quality of its customer services;  its ability to address the
needs of its customers; its success in designing and manufacturing new products,
including those  implementing  new  technologies;  the  availability of adequate
sources of raw materials,  finished components, and other supplies at acceptable
prices;  its  efficiency of  production;  the rate at which end users upgrade or
expand their existing telephone systems, applications, and services; new product
introductions by the Company's  competitors;  the number, nature, and success of
its competitors in a given market;  and general market and economic  conditions.
The  Company  currently  competes  principally  on the  basis  of the  technical
innovation  and  performance  of  its  telephone   systems,   commercial   grade
telephones,   voice  processing  products,  and   computer-telephony   products,
including their ease of use,  reliability,  cost, timely introduction,  delivery
schedules,  and after-sale service and technical support.  There is no assurance
that the Company will continue to be able to compete successfully in the future.
See Item 1, "Business - Competition."

Dependence on New Products and Technologies

         The Company operates in an industry that is increasingly  characterized
by fast-changing technology. As a result, the Company will be required to expend
substantial  funds  for and  commit  significant  resources  to the  conduct  of
continuing product  development,  including research and development  activities
and the engagement of additional engineering and other technical personnel.  Any
failure by the Company to  anticipate  or respond  adequately  to  technological
developments, customer requirements, or new design and production techniques, or
any  significant  delays in product  development or  introduction,  could have a
material adverse effect on the Company's operations.

         The  Company's  future  operating  results will depend to a significant
extent  on  its  ability  to  identify,  develop,  and  market  enhancements  or
improvements to existing product lines as well as to introduce new product lines
that  compare  favorably  on the  basis  of  time  to  introduction,  cost,  and
performance  with the product lines offered by  competitors.  The success of new
product  lines  depends on various  factors,  including  proper  market  segment
selection, utilization of advances in technology,  innovative development of new
product concepts, timely completion and delivery of new product lines, efficient
and cost-effective  features, and market acceptance of its products.  Because of
the  complexity  of the  design  and  manufacturing  processes  required  by the
Company's  products,  the  Company  may  experience  delays from time to time in
completing the design and manufacture of improvements to existing  product lines
or the introduction of new product lines. In addition, there can be no assurance
that  any new  product  lines  will  receive  or  maintain  customer  or  market
acceptance.  If the Company were unable to design and implement  enhancements to
existing product lines or introduce new products on a timely and  cost-effective
basis, its future  operating  results would be adversely  affected.  See Item 1,
"Business - Products."

         Complex  software  programs,  such as those developed by the Company or
other  software   sources  and   incorporated   into  the  Company's   products,
occasionally  contain errors that are discovered only after the product has been
installed  and  used  by many  different  customers  in a  variety  of  business
operations.  Although  the Company  conducts  extensive  testing of the software
programs  included in its products,  there can be no assurance  that the Company
will successfully  detect and eliminate all such errors in its products prior to
shipment.  Significant  programming  errors in product  software  could  require
substantial design  modifications that may create delays in product introduction
and  shipment  and that  could  result in an  adverse  impact  on the  Company's
goodwill as well as on its operating results.
                                       16
<PAGE>
Reliance on Independent Distribution Network

         The Company  currently  markets  its  products  through a  distribution
network  consisting  primarily of large wholesale  distributors known as "Supply
Houses"  and  telephone  sales  and  installation  companies  known  as  "Direct
Dealers."  Supply Houses  generally  maintain  inventories  in amounts that they
consider  sufficient to fill anticipated  orders for at least a two-month period
of time. A decline in the volume of sales made by Supply Houses,  however, could
result in  inventory  levels that exceed  anticipated  sales,  which could delay
purchases  of  additional  products  from the Company  until the Supply  Houses'
inventories reach re-ordering levels. Direct Dealers generally stock inventories
only in quantities deemed sufficient to fill anticipated short-term orders. As a
result,  orders  generally can be cancelled and volume levels changed or delayed
on short notice to the Company. The timely replacement of cancelled, delayed, or
reduced orders cannot be assured.

         The Company depends upon  independent  Supply Houses and Direct Dealers
to sell its  products to end users,  to perform  installation  services,  and to
perform  service and support  functions after the sale.  Other telephone  system
manufacturers  compete intensely for the attention of the same Supply Houses and
Direct  Dealers,  most of which carry  products  that compete  directly with the
Company's  products.  There can be no assurance that the Company will be able to
maintain favorable  relationships with the Supply Houses and Direct Dealers that
currently carry its product lines in order to encourage them to promote and sell
its  products  instead of those of its  competitors  or that the Company will be
able to develop such relationships  with additional  distributors and dealers in
the future. See "Business - Sales, Marketing, and Distribution."

         Graybar accounted for 44% and 40%,  respectively,  of sales during 1995
and 1996. Accounts receivable from Graybar comprised  approximately 36% of total
accounts receivable at December 31, 1997.

Patents, Licenses, and Intellectual Property Claims

         The Company's  success  depends in part upon its ability to protect its
proprietary  technology.  The  Company  relies on a  combination  of  copyright,
trademark,   and  trade  secret  laws,   nondisclosure   and  other  contractual
agreements, and technical measures to protect its proprietary technology.  There
can be no  assurance  that  the  steps  taken  by the  Company  to  protect  its
proprietary rights will be adequate to protect  misappropriation  of such rights
or that third  parties will not  independently  develop  equivalent  or superior
technology.  In addition,  the Company has acquired  certain  patents and patent
licenses  and  intends  to  continue  to  seek  patents  on its  inventions  and
manufacturing  processes.  The process of seeking patent  protection can be long
and expensive, and there can be no assurance that patents will issue from future
applications or that the Company's  existing patents or any new patents that are
issued will be of sufficient scope or strength to provide meaningful  protection
or any commercial advantage to the Company. The Company may be subject to or may
initiate interference proceedings in the U.S. Patent and Trademark Office, which
can demand significant financial and management resources.  As is typical in the
telecommunications  industry, the Company from time to time has received, and in
the future may receive, communications alleging possible infringement of patents
or other intellectual property rights of others. Based on industry practice, the
Company  believes that in most cases it could obtain any  necessary  licenses or
other rights on  commercially  reasonable  terms,  but no assurance can be given
that licenses would be available on acceptable  terms, that litigation would not
ensue,  or that  damages  for any  past  infringements  would  not be  assessed.
Litigation, which could result in substantial cost to and diversion of effort by
the Company, may be necessary to enforce patents or other intellectual  property
rights of the Company or to defend the Company against  claimed  infringement of
the rights of others.  The failure to obtain necessary  licenses or other rights
or litigation  arising out of infringement  claims could have a material adverse
effect  on the  Company.  See  Item 1,  "Business  -  Patents,  Trademarks,  and
Licenses."

Management of Growth

         The Company's  ability to manage its growth  effectively  in the future
will require it to enhance its operational,  financial,  and management systems;
to expand its facilities and equipment; and to successfully hire,
                                       17
<PAGE>
train,  and motivate  additional  employees,  including the technical  personnel
necessary to design the software used in the Company's telephone systems,  voice
processing  products,  and  computer-telephony  products,  and to integrate  new
software systems with evolving hardware technologies. The failure of the Company
to manage its growth on a effective  basis could have a material  adverse effect
on the Company's operations.

         The Company may be required to increase  staffing and other expenses as
well as its capital  expenditures  in order to meet the demand for its  products
and  services.  Customers,  however,  generally  do not commit to firm  purchase
orders for more than a short time in advance. The Company's  profitability would
be adversely  affected if the Company increases its expenditures in anticipation
of future orders that do not  materialize.  The  development  of new products or
product  enhancements  or  unexpected  customer  orders also may  require  rapid
increases in design and  production  services  that place  excessive  short-term
burdens on the Company's resources.

The Telecommunications Industry; Cyclicity and Capital Requirements

         The  telecommunications  industry has experienced economic downturns at
various times,  characterized by diminished product demand,  accelerated erosion
of average selling prices, and production  overcapacity.  The Company has sought
to reduce its  exposure to industry  downturns by  targeting  its product  lines
towards  small to  medium-sized  businesses,  which the  Company  believes  will
sustain  continued  growth in the near and long  term,  resulting  in a steadily
increasing  demand  for  enhanced  and  upgraded  telephone  systems  and  voice
processing   products.   However,   the  Company  may   experience   substantial
period-to-period  fluctuations  in future  operating  results because of general
industry  conditions or events  occurring in the general  economy.  In addition,
although  the  Company  has  not   experienced   significant   quarterly   sales
fluctuations  in the  past,  the size  and  timing  of  sales  of its new  voice
processing and computer-telephony  products may be expected to vary from quarter
to quarter to a greater extent.  The expanding  importance of these new products
could  result in  significant  variations  in the  Company's  overall  operating
results on a quarterly basis.

         To remain  competitive,  the Company must continue to make  significant
investments in research and development,  equipment, and facilities. As a result
of the increase in fixed costs and operating  expenses  related to these capital
expenditures,  the Company's  operating results may be adversely affected if its
net sales do not  increase  sufficiently  to offset  the  increased  costs.  The
Company  from  time to time may seek  additional  equity  or debt  financing  to
provide  for the  capital  expenditures  required  to  maintain  or  expand  the
Company's design and production facilities and equipment.  The timing and amount
of any such capital  requirements cannot be predicted at this time. There can be
no assurance that any such financing will be available or, if available, will be
available  on  terms  satisfactory  to the  Company.  If such  financing  is not
available  on  satisfactory  terms,  the  Company  may be unable  to expand  its
business or develop new products at the rate desired and its  operating  results
may be adversely affected.  Debt financing increases expenses and must be repaid
regardless of operating  results.  Equity  financing  could result in additional
dilution to existing  stockholders.  See Item 7,  "Management's  Discussion  and
Analysis of  Financial  Condition  and  Results of  Operations  - Liquidity  and
Capital Resources."

Shortage of Raw Materials and Supplies

         The  principal  raw  materials  and  components  used in producing  the
Company's  products  consist of  semiconductor  components,  unfinished  printed
circuit  boards,  molded plastic parts,  metals,  and packaging  materials.  The
third-party  manufacturers of the Company's products acquire these raw materials
primarily from Asian sources,  which indirectly  subjects the Company to certain
risks,   including  supply   interruptions  and  currency  price   fluctuations.
Purchasers  of  these  materials,  including  the  Company  and its  third-party
manufacturers,  experience  difficulties  from  time to time in  obtaining  such
materials. The suppliers of these materials currently are adequately meeting the
requirements of the Company.  The Company also believes that there are alternate
suppliers for most of these materials.

         Voice processing boards that are used in certain of the Company's voice
processing and interactive voice response products  currently are available from
a limited number of sources. The Company currently purchases most
                                       18
<PAGE>
of its  requirements  for voice  processing  boards from  Dialogic on a purchase
order basis. The Company's ability to deliver certain of its product lines could
be  adversely  affected if it is unable to obtain voice  processing  boards from
Dialogic  at any time that  alternative  sources of similar  components  are not
readily available.

Dependence on Management and Other Key Personnel

         The Company's  development  and  operations to date have been,  and its
proposed  operations  will be,  substantially  dependent  upon the  efforts  and
abilities of its senior management and technical personnel. The Company does not
have  employment  agreements  with any of its executive  officers.  The Company,
however,  maintains  agreements  with each of its  officers and  employees  that
prohibit such persons from disclosing  confidential  information  obtained while
employed with the Company.  The loss of existing key personnel or the failure to
recruit and retain  necessary  additional  personnel would adversely  affect the
Company's business prospects. There can be no assurance that the Company will be
able to  retain  its  current  personnel  or to  attract  and  retain  necessary
additional  personnel.  The Company's  internal  growth and the expansion of its
product  lines will  require  additional  expertise  in such  areas as  software
development,  operational management,  and marketing.  Such growth and expansion
activities  will  increase  further the demand on the  Company's  resources  and
require  the  addition  of new  personnel  and  the  development  of  additional
expertise  by  existing  personnel.  The  failure of the  Company to attract and
retain  personnel  with the requisite  expertise or to develop  internally  such
expertise could adversely  affect the prospects for the Company's  success.  The
Company  currently  maintains key person insurance in the amount of $1.0 million
covering  Glenn R. Fitchet,  its  President.  See Item 1,  "Business - Executive
Officers."

Year 2000 Compliance

         Many currently  installed  computer  systems and software  products are
coded to accept  only  two-digit  entries  to  represent  years in the date code
field.  Computer systems and products that do not accept four-digit year entries
will need to be upgraded or replaced to accept four-digit entries to distinguish
years  beginning  with 2000 from prior years.  The Company has initiated but has
not completed an internal  system  assessment to determine  whether its existing
software programs are "Year 2000" compliant. The Company currently is evaluating
its entire  internal  computer  system  with  respect  to a proposed  program to
upgrade its  existing  hardware  and  software or to install  new  hardware  and
software  systems  intended  to  improve  the  content,  quality,  and  flow  of
information  within the  Company as well as to address any Year 2000 issues that
may exist.  Although the Company has not  completed  the  evaluation of its Year
2000  compliance  issues and is not able to quantify the costs that it may incur
in order to eliminate any Year 2000 issues that may exist, the Company currently
does not believe that the total cost to the Company of addressing  its Year 2000
compliance issues will have a material adverse effect on the Company's financial
condition or results of operations.  The Company  currently is developing a plan
to evaluate  the Year 2000 issue as it relates to computer  systems  operated by
third parties,  including suppliers and financial  institutions,  with which the
Company's systems interface. Any failure of the Company's computer system or the
systems of third  parties to timely  achieve Year 2000  compliance  could have a
material  adverse effect on the Company's  business,  financial  condition,  and
operating results.

         The Company also is in the process of identifying which of its existing
products are not Year 2000  compliant and to determine  which,  if any, of those
products it intends to modify or upgrade in order to become Year 2000 compliant.
The Company  believes  that it will be able to pass along to its  customers  the
cost of upgrading installed products that are no longer covered by the Company's
product warranties.

Control by Management; Stockholders' Agreement; Conflicts of Interest

         The  directors,   executive  officers,  and  certain  other  management
personnel of the Company and their  affiliates  own  approximately  36.9% of the
outstanding shares of Common Stock,  including  approximately 18.7% owned by LGE
(excluding  shares  issuable  to  such  persons  upon  exercise  of  outstanding
options).  The Company,  LGE, Glenn R. Fitchet,  Steven A. Sherman,  and certain
other stockholders of the Company are parties to a stockholders'  agreement (the
"Stockholders' Agreement"). At any time that the Company issues shares of its
                                       19
<PAGE>
Common  Stock in an amount  representing  1% or more of its  outstanding  Common
Stock,  the  Stockholders'  Agreement  gives LGE the right to purchase  from the
Company  a  sufficient  number of shares  as may be  required  to enable  LGE to
maintain the  percentage  of ownership of Common Stock that existed  immediately
prior to such issuance.  The  Stockholders'  Agreement also requires Mr. Fitchet
and Mr.  Sherman to vote their  shares of Common  Stock to elect as directors of
the Company that number of persons designated by LGE that comprises a percentage
of the Board of  Directors  equal to LGE's then  percentage  of ownership of the
Company's  Common  Stock,  provided  that so long as LGE  owns 8% or more of the
Company's outstanding Common Stock, Messrs.  Fitchet and Sherman will vote their
shares to the elect at least one designee of LGE as a director.

         The Company obtains a substantial  portion of the hardware  utilized in
its  telephone  systems and  commercial  grade  telephones  from LGE and obtains
certain of its electronic  telephone  systems and most of its  commercial  grade
telephone and  replacement  parts for such telephones from LGST, an affiliate of
LGE.  See  Item  1,  "Business  Manufacturing"  and  "Special  Considerations  -
Dependence on LGE." As a result of LGE's ownership  interest in the Company,  an
inherent  conflict of interest exists in  establishing  the volume and terms and
conditions of such purchases. In order to mitigate such conflicts, all decisions
with  respect to such  purchases  will be made by  officers  of the  Company and
reviewed by directors of the Company who have no relationship with LGE.

Possible Volatility of Stock Price

         The  trading  price  of  the  Company's  Common  Stock  in  the  public
securities market could be subject to wide fluctuations in response to quarterly
variations  in operating  results of the Company or its  competitors,  actual or
anticipated   announcements   of   technological   innovations  or  new  product
developments by the Company or its competitors,  changes in analysts'  estimates
of the Company's  financial  performance,  developments  or disputes  concerning
proprietary  rights,  regulatory  developments,   general  industry  conditions,
worldwide economic and financial  conditions,  and other events and factors. The
trading  volume  of the  Company's  Common  Stock  has been  limited,  which may
increase  the  volatility  of the  market  price for such  stock or  reduce  the
liquidity of an  investment  in shares of the  Company's  Common  Stock.  During
certain  periods,  the stock markets have  experienced  extreme price and volume
fluctuations.  In particular,  prices for many technology stocks often fluctuate
widely,  frequently for reasons  unrelated to the operating  performance of such
companies.  These broad  market  fluctuations  and other  factors may  adversely
affect the market price of the Company's Common Stock.

Rights to Acquire Shares

         A total of  850,000  shares of Common  Stock  have  been  reserved  for
issuance  upon  exercise  of options  granted or which may be granted  under the
Company's  stock option plan.  Options to acquire 816,900 shares of Common Stock
at  a  weighted  average  exercise  price  of  $4.80  per  share  currently  are
outstanding  under the stock option plan.  In addition,  the Company sold to the
underwriter of its initial public offering  warrants to purchase  133,333 shares
of Common Stock.  The warrants have an exercise price per share of $7.20 and are
exercisable  until October 2000.  During the terms of such options and warrants,
the holders  thereof will have the opportunity to profit from an increase in the
market price of the Common Stock. The existence of such options and warrants may
adversely affect the terms on which the Company can obtain additional financing,
and the holders of such options and  warrants  can be expected to exercise  such
options or warrants at a time when the Company, in all likelihood, would be able
to obtain  additional  capital by offering  shares of its Common  Stock on terms
more  favorable  to the  Company  than those  provided  by the  exercise of such
options or warrants.

Shares Eligible for Future Sale

         Sales of substantial amounts of Common Stock in the public market could
adversely affect prevailing market prices and could impair the Company's ability
to raise  capital  through  the  sale of its  equity  securities.  Approximately
2,114,800  shares  of  Common  Stock,  including  shares  held by the  Company's
directors,  executive officers,  and LGE, currently are eligible for sale in the
public market, subject to compliance with the requirements of Rule 144 under the
Securities Act of 1933, as amended (the  "Securities  Act").  Shares issued upon
the exercise
                                       20
<PAGE>
of stock options issued under the Company's  Stock Option Plan generally will be
eligible for sale in the public  market.  The Company also has the  authority to
issue  additional  shares of Common  Stock and  shares of one or more  series of
preferred stock. The issuance of such shares could result in the dilution of the
voting power of the currently  outstanding shares of Common Stock and could have
a dilutive effect on earnings per share.

Change in Control Provisions

         The  Company's  Amended  Certificate  of  Incorporation  (the  "Amended
Certificate") and Bylaws and the Delaware General Corporation Law (the "Delaware
GCL") contain  provisions  that may have the effect of making more  difficult or
delaying  attempts by others to obtain  control of the Company,  even when these
attempts may be in the best interests of stockholders.

         The Company is subject to the provisions of Section 203 of the Delaware
GCL. In general,  this statute  prohibits a publicly held  Delaware  corporation
from engaging, under certain circumstances,  in a "business combination" with an
"interested  stockholder"  for a period  of three  years  after  the date of the
transaction in which the person becomes an interested stockholder, unless either
(i) prior to the date at which the stockholder became an interested stockholder,
the  Board  of  Directors  approved  either  the  business  combination  or  the
transaction  in which the person  becomes an interested  stockholder,  (ii) upon
consummation of the  transaction in which the stockholder  becomes an interested
stockholder,  the stockholder owned at least 95% of the outstanding voting stock
of the corporation  (excluding shares held by directors who are officers or held
in certain employee stock plans), or (iii) the business  combination is approved
by the Board of Directors and by two-thirds of the  outstanding  voting stock of
the  corporation  (excluding  shares held by the  interested  stockholder)  at a
meeting  of  stockholders  held on or  subsequent  to the  date of the  business
combination.  An  "interested  stockholder"  is a  person  that,  together  with
affiliates and associates, owns (or at any time within the prior three years did
own) 15% or more of the  corporation's  voting  stock.  Section  203  defines  a
"business combination" to include, without limitation, mergers,  consolidations,
stock sales and asset based transactions,  and other transactions resulting in a
financial benefit to the interested stockholder.

         The Company's Amended  Certificate and Bylaws contain a number of other
provisions  relating to corporate  governance and to the rights of stockholders.
These  provisions  include (a) the  authority  of the Board of Directors to fill
vacancies on the Board of Directors; (b) the authority of the Board of Directors
to issue  preferred  stock in series with such voting rights and other powers as
the Board of Directors may determine;  and (c) the  requirement  that any of the
following  actions be  approved by the  affirmative  vote of  two-thirds  of the
directors  then in office:  (1) a public  offering of the  capital  stock of the
Company;  (2) the merger  with or the  acquisition  of another  business  or the
acquisition of a significant  amount of the assets of another business;  (3) the
sale of a  significant  amount of the  assets of the  Company;  (4) the  Company
entering into contracts with  stockholders or directors of the Company;  (5) the
assumption or acquisition  by the Company of debt in excess of  $1,000,000;  and
(6) any amendment of the Amended  Certificate of Incorporation and Bylaws of the
Company or VCS.

Lack of Dividends

         The Company has never paid any cash  dividends  on its Common Stock and
does  not  anticipate  that it will pay  dividends  in the  foreseeable  future.
Instead,  the Company intends to retain any earnings to provide funds for use in
its business.  Furthermore,  the terms of the revolving line of credit  facility
between VCS and GE Capital  prohibit  VCS from paying  dividends  to the Company
without the consent of General Electric Capital Corporation ("GE Capital"). This
restriction  could limit the  Company's  ability to pay dividends in the future.
There  currently are no  restrictions  that would prohibit  Enhanced from paying
dividends to the Company.

Cautionary Statement Regarding Forward-Looking Statements

         Certain  statements and information  contained in this Report under the
headings "Business," "Special  Considerations," and "Management's Discussion and
Analysis of Financial Condition and Results of Operations"
                                       21
<PAGE>
concerning future,  proposed, and anticipated activities of the Company, certain
trends  with  respect  to the  Company's  revenue,  operating  results,  capital
resources,  and  liquidity  or with  respect to the markets in which the Company
competes or the  telecommunications  industry in general,  and other  statements
contained in this Report  regarding  matters that are not  historical  facts are
forward-looking  statements,  as such term is  defined  in the  Securities  Act.
Forward-looking   statements,   by  their  very   nature,   include   risks  and
uncertainties,  many of which are beyond  the  Company's  control.  Accordingly,
actual  results may  differ,  perhaps  materially,  from those  expressed  in or
implied by such  forward-looking  statements.  Factors  that could cause  actual
results to differ materially  include those discussed  elsewhere under this Item
1, "Special Considerations."

ITEM 2.           PROPERTIES

         The Company leases, for a term expiring in December 2001, approximately
60,000  square  feet  of  space  in  Scottsdale,  Arizona,  where  it  maintains
engineering and design laboratories,  a sound engineering  laboratory,  software
development  facilities,  testing laboratories,  product development facilities,
customer service support  facilities,  an employee training facility,  warehouse
and distribution  areas,  sales and marketing  offices,  and  administrative and
executive offices.  The Company also leases  approximately 16,200 square feet of
space in Norcross,  Georgia,  for a term  expiring in August  2002.  The Company
maintains software development facilities,  engineering and design laboratories,
product  development  facilities,   product  assembly  and  testing  facilities,
warehouse and  distribution  areas,  and sales,  marketing,  and  administrative
offices at this  location.  The  Company  leases,  for a term ending in December
2004, approximately 19,500 square feet of space in Scottsdale,  Arizona, for its
telecommunications   equipment  repair  operations.  The  Company  believes  its
facilities are adequate for its reasonably anticipated needs.

ITEM 3.           LEGAL PROCEEDINGS

         On September 20, 1996, the Company and Enhanced filed a lawsuit against
Michael Mittel and Fereydoun Taslimi, former officers and directors of Enhanced,
in the United  States  District  Court for the District of Arizona.  The lawsuit
subsequently  was  transferred  to the  Northern  District of  Georgia,  Atlanta
Division (No.  1-98-CV-18- CAM). The lawsuit alleges,  among other things,  that
Messrs.  Mittel and Taslimi  violated  federal and Arizona  securities  laws and
engaged in fraudulent activities in connection with the Company's acquisition of
Enhanced  in  1995;  breached  certain  terms  of  their  respective  employment
contracts with Enhanced;  and converted  certain  corporate  assets of Enhanced,
breached  their  fiduciary  duties  to  Enhanced,  and  misappropriated  certain
corporate  opportunities  for their own  benefit.  The Company and  Enhanced are
seeking compensatory and punitive damages against Messrs. Mittel and Taslimi. On
September  24, 1996,  Messrs.  Mittel and Taslimi  filed a lawsuit in the United
States  District Court for the Northern  District of Georgia,  Atlanta  Division
(No.  196-CV-2563),  against the Company and Enhanced.  The lawsuit alleges that
Enhanced  breached  Messrs.   Mittel's  and  Taslimi's   respective   employment
agreements  by  terminating  their  employment.  Messrs.  Mittel and Taslimi are
seeking damages in an amount to be determined at trial, plus costs and attorneys
fees.  The parties  have not yet  commenced  discovery  in either  lawsuit.  The
Company intends to proceed with its lawsuit  against Messrs.  Mittel and Taslimi
and is  vigorously  defending  the lawsuit filed by them against the Company and
Enhanced.

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

         Not applicable
                                       22
<PAGE>
                                     PART II

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

         The  Company's  Common  Stock has been  quoted in the  Nasdaq  National
Market under the symbol "VTEK" since October 6, 1995.  The following  table sets
forth the high and low closing sales prices of the Company's Common Stock on the
Nasdaq National Market for the periods indicated.

<TABLE>
<CAPTION>
                                                                         High        Low
                                                                         ----        ---

<S>                                                                      <C>        <C>
1995:
    Fourth quarter (from October 6, 1995 to December 31, 1995)...        $7.50      $5.25

1996:
    First quarter................................................        $7.38      $5.25
    Second quarter...............................................         8.88       5.88
    Third quarter................................................         8.13       5.25
    Fourth quarter...............................................         5.88       2.88

1997:
    First quarter................................................        $4.75      $3.30
    Second quarter...............................................         5.38       2.63
    Third quarter................................................         5.50       4.13
    Fourth quarter...............................................         6.00       4.13

1998:
    First quarter (through March 23, 1998).......................        $4.50      $3.25
</TABLE>

         On March 23,  1998,  the closing  sales  price of the Common  Stock was
$3.88 per  share.  As of March 23,  1998,  there  were 33  holders of record and
approximately 700 beneficial owners of the Company's Common Stock.
                                       23
<PAGE>
ITEM 6.           SELECTED CONSOLIDATED FINANCIAL DATA

         The following table summarizes certain selected consolidated  financial
data of the Company and its  predecessor,  the Vodavi  Division.  The results of
operations  for the  three  months  ended  March  31,  1994 are not  necessarily
indicative  of the results of  operations  for a full fiscal year.  The selected
financial  information provided below should be read in conjunction with Item 7,
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations" and the Consolidated Financial Statements of the Company and related
notes thereto. No dividends were paid during the periods presented.

               (in thousands, except share and per share amounts)

<TABLE>
<CAPTION>
                                  Vodavi Division(1)                                   The Company
                              -------------------------   ---------------------------------------------------------------------
                                                          Period From
                                                Three      Inception
                                               Months    (Aug. 3, 1993)
                              Year Ended        Ended       through
                              December 31,    March 31,   December 31,                   Year Ended December 31,
                              -----------     ---------   -----------    ------------------------------------------------------
                                  1993          1994          1993           1994(2)       1995          1996           1997
                                  ----          ----          ----           -------       ----          ----           ----
<S>                           <C>           <C>           <C>            <C>           <C>           <C>            <C>
Operating Data:
Revenue ...................   $    31,571   $     8,587   $      --      $    29,140   $    39,601   $    46,154    $    47,675
Gross margin ..............         8,172         2,418          --            8,613        12,404        15,312         15,667
Operating expenses ........         6,591         1,872             7          6,291        10,399        13,749         13,828
Asset impairment and
  restructuring charges ...          --            --            --             --            --           4,805            819
Operating income (loss)  ..         1,581           546            (7)         2,322         2,055        (3,242)         1,020
Interest & other expenses .            11          --               6            576         1,130           840            663
Pretax income (loss) ......         1,570           546           (13)         1,746           875        (4,082)           357
Income taxes ..............          --            --            --              693           417           327            142
Net income (loss) .........         1,570           546           (13)         1,053           458        (4,409)           215
Net income (loss) per
    share, diluted.........           N/A           N/A   $     (0.02)   $      0.55   $      0.17   $     (1.02)   $      0.05
Weighted average shares
    outstanding, diluted...           N/A           N/A       849,999      1,917,346     2,769,434     4,342,238      4,342,238
</TABLE>

<TABLE>
<CAPTION>
                                 As of         As of
                              December 31,   March 31,                              As of December 31,
                              -----------   -----------   ---------------------------------------------------------------------
                                  1993          1994          1993           1994          1995          1996           1997
                                  ----          ----          ----           ----          ----          ----           ----
<S>                           <C>           <C>           <C>            <C>           <C>           <C>            <C>
Balance Sheet Data:
Assets:
  Current assets ..........   $    10,544   $    12,034   $       130    $    14,122   $    17,719   $    16,591    $    19,507
  Property and
     equipment ............           397           452          --              635         1,731         2,465          2,616
  Goodwill ................          --            --            --            2,833         7,089         2,547          2,395
  Other ...................          --            --             280            357           931           815          1,146
                              -----------   -----------   -----------    -----------   -----------   -----------    -----------
                              $    10,941   $    12,486   $       410    $    17,947   $    27,470   $    22,418    $    25,664
                              ===========   ===========   ===========    ===========   ===========   ===========    ===========
Liabilities:
  Current liabilities .....   $     2,390   $     3,128   $       406    $     5,316   $     5,706   $     7,292    $     7,115
  Long-term debt ..........          --            --            --            8,574         7,884         5,588          8,752
  Other long-term
     obligations ..........          --            --            --             --              69           137            182
  Due to parent ...........         2,444         2,705          --             --            --            --             --
                              -----------   -----------   -----------    -----------   -----------   -----------    -----------
Total liabilities .........         4,834         5,833           406         13,890        13,660        13,017         16,049
Stockholders' equity ......         6,107         6,653             4          4,057        13,810         9,401          9,615
                              -----------   -----------   -----------    -----------   -----------   -----------    -----------
                              $    10,941   $    12,486   $       410    $    17,947   $    27,470   $    22,418    $    25,664
                              ===========   ===========   ===========    ===========   ===========   ===========    ===========
</TABLE>

------------------
(1)  Prior to the acquisition by the Company,  the Vodavi Division operated as a
     separate division within a publicly held company.  See Item 1, "Business --
     History of the Company." As a result, share information is not applicable.
(2)  Excludes the results of operations of the Vodavi Division prior to April 1,
     1994, the effective date of the acquisition.
                                       24
<PAGE>
ITEM 7.           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                  CONDITION AND RESULTS OF OPERATIONS

Results of Operations

Annual Results

         The following table summarizes the operating results of the Company for
the periods  indicated.  The table and the  discussion  below  should be read in
conjunction with the Consolidated  Financial Statements and Notes thereto, which
appear elsewhere in this Report.

<TABLE>
<CAPTION>
                                                                  Years ended December 31,
                                                ------------------------------------------------------------
                                                       1995                 1996                  1997
                                                -----------------    -----------------     -----------------
                                                                 (Dollar amounts in thousands)
                                                    $         %          $         %           $         %
                                                --------    -----    --------    -----     --------    -----
<S>                                             <C>         <C>      <C>         <C>       <C>         <C>
Revenue .....................................   $ 39,601    100.0%   $ 46,154    100.0%    $ 47,675    100.0%
Cost of goods sold ..........................     27,197     68.7%     30,842     66.8%      32,008     67.1%
                                                --------    -----    --------    -----     --------    -----
  Gross margin ..............................     12,404     31.3%     15,312     33.2%      15,667     32.9%
Operating expenses:
  Engineering and product
    development .............................      1,942      4.9%      2,161      4.7%       2,101      4.4%
  Selling, general, and administrative ......      8,457     21.3%     11,588     25.1%      11,727     24.6%
  Asset impairment and restructuring charges        --       --         4,805     10.4%         819      1.7%
                                                --------    -----    --------    -----     --------    -----
Operating income (loss) .....................      2,005      5.1%     (3,242)    (7.0)%      1,020      2.1%
Other income (expense), net .................     (1,130)     2.9%       (840)     1.8%        (663)    (1.4)%
                                                --------    -----    --------    -----     --------    -----
Pretax income (loss) ........................        875      2.2%     (4,082)    (8.8)%        357      0.7%
Income tax expense ..........................        417      1.0%        327      0.7%         142      0.3%
                                                --------    -----    --------    -----     --------    -----
Net income (loss) ...........................   $    458      1.2%   $ (4,409)    (9.5)%   $    215      0.5%
                                                ========    =====    ========    =====     ========    =====
</TABLE>

Revenue

         Revenue in 1997 was  approximately  $47.7 million,  an increase of $1.5
million, or 3.2%, over 1996 revenue of approximately $46.2 million. The increase
in 1997 can be attributed to the addition of two OEM accounts,  which  accounted
for  approximately  $1.7  million of the  increased  revenue.  Revenue  from the
Company's other channels declined approximately $200,000. The Company attributes
this decline to delays in the  introduction  of new products in 1997 as a result
of an emphasis  on  securing  the OEM  contracts.  In an effort to reverse  this
trend, the Company began adding to its outside sales force in the fourth quarter
of 1997 and began a series of programs  late in the year  designed to  stimulate
growth.

         Revenue in 1996 increased  approximately  $6.6 million,  or 16.5%, over
revenue of  approximately  $39.6  million in 1995.  The  increase in 1996 can be
attributed to the  annualized  impact of the 1995  acquisitions  of Enhanced and
ARSI as well as new product introductions and the addition of new customers.

Cost of Goods Sold

         Gross margins  decreased to  approximately  32.9% of revenue in 1997 as
compared with 33.2% in 1996.  The decline can be attributed to the lower margins
earned on the Company's OEM contracts as well as the impact of certain discounts
included in the  programs  discussed  above,  which are  designed  to  stimulate
growth.  The Company  expects that margins will continue to be lower in the near
term while these programs continue.

         The increase in gross  margins in 1996 as compared to 1995 reflects the
impact of the  acquisition of Enhanced,  which sells  products at  significantly
higher margins than other products sold by the Company.
                                       25
<PAGE>
Engineering and Product Development

         Expenditures  related to engineering and product  development  remained
relatively stable at approximately $2.1 million,  $2.2 million, and $1.9 million
in 1997, 1996, and 1995, respectively.

Selling, General and Administrative Expenses

         Selling,    general   and   administrative   ("SG&A")   expenses   were
approximately $11.7 million in 1997, an increase of approximately  $100,000,  or
1.0%, over SG&A expenses in 1996 of approximately $11.6 million. As a percentage
of revenue,  SG&A  expenses  declined to 24.6% in 1997 as compared with 25.1% in
1996. The  recognition of the impairment  loss related to Enhanced in the fourth
quarter of 1996, as described  below,  resulted in the  elimination  of goodwill
amortization of approximately $460,000 annually. After considering the impact of
this, SG&A expenses  increased  approximately  $480,000 in 1997,  primarily as a
result of additional personnel in sales and marketing functions.

         SG&A expenses increased  approximately $3.1 million in 1996 as compared
with 1995. As a percentage of revenue,  SG&A expenses increased to 25.1% in 1996
as compared to 21.3% in 1995.  This increase can be attributed  primarily to the
annualized impact of the acquisitions of Enhanced and ARSI  (approximately  $1.9
million of the increase) as well as increased  sales and marketing  expenses and
increased costs associated with being a publicly traded company.

Asset Impairment and Restructuring Charges

         In the  fourth  quarter  of 1997,  the  Company  began  implementing  a
restructuring  plan  designed to increase the  Company's  focus and  competitive
position  in the  industry.  As part of this plan,  the  Company  determined  to
implement  certain  personnel  reductions as well as to cancel  certain  product
lines.  The  Company has  recorded a charge of  $820,000  in the fourth  quarter
related to severance  charges for the personnel  reductions as well as the costs
associated with the abandonment of the various products.

         In 1996, the Company recorded a $4.2 million write-down of the goodwill
associated  with the  acquisition  of Enhanced in accordance  with  Statement of
Financial  Accounting  Standard  No.  121,  Accounting  for  the  Impairment  of
Long-Lived Assets and for Assets to be Disposed Of. The Company  determined that
the write-down  was  appropriate  after  evaluating the impact of several events
that  occurred  in the  latter  part of 1996,  including  communications  from a
customer that  purchase  levels to which the customer had  previously  committed
would not be met. The  write-down  of the goodwill of Enhanced  will result in a
reduction of goodwill amortization of approximately  $460,000 annually. In 1996,
the  Company  also  accrued  approximately  $600,000 in  restructuring  reserves
related to the  operations  of Enhanced.  These  reserves  included the costs of
relocating  new management to Atlanta,  Georgia,  costs related to the Company's
lawsuit  against the former owners of Enhanced,  costs related to the settlement
of an outstanding  legal matter,  and other  expenses  related to the management
change.

Other Income (Expense), Net

         Other income  (expense),  net consists  primarily of interest  expense.
Interest expense was  approximately  $663,000,  $840,000,  and $1.1 million,  in
1997, 1996, and 1995,  respectively.  The $177,000 reduction in interest expense
in 1997 is  attributable  to the lower interest rate obtained in connection with
the renewal of the Company's operating line of credit with GE Capital.  See Item
7, "Management's  Discussion and Analysis of Financial  Condition and Results of
Operations  - Liquidity  and  Capital  Resources."  The  $260,000  reduction  in
interest  expense in 1996 can be  attributed  to a reduction in  borrowings as a
result of improved asset management in 1996.
                                       26
<PAGE>
Income Taxes

         The  effective  rate of the  Company's  income tax provision was 31.6%,
(8.0)%, and 47.7% in 1997, 1996, and 1995, respectively. The Company's effective
tax rate in 1997 was  favorably  impacted by the  utilization  of a research and
development tax credit. The Company's effective tax rate in 1996 was impacted by
the asset  impairment  and  restructuring  charges  taken in 1996,  as described
above.  The  write-down  of the  goodwill  associated  with the  acquisition  of
Enhanced was not deductible, impacting the effective rate for 1996. In 1995, the
non-deductibility  of the goodwill  amortization  resulted in an increase in the
effective rate.

Liquidity and Capital Resources

         The Company's cash and cash equivalents were approximately  $634,000 at
December 31, 1997. The Company's  cash accounts are swept  regularly and applied
against  the  Company's  operating  line of  credit,  as  described  below.  The
Company's  borrowings against its available operating line of credit at December
31, 1997 were  approximately  $8.6  million,  which  represents  a $3.2  million
increase from its  borrowings of $5.4 million at December 31, 1996. The increase
is attributed to the increase in current  assets of  approximately  $2.9 million
over the same period. At December 31, 1997, the Company had  approximately  $2.0
million available to it under its operating line of credit.

         The  Company  has a $12.0  million  revolving  line of  credit  with GE
Capital.  In the second quarter of 1997, the Company extended the line of credit
through April 2000. The terms of the extension lowered the interest rate to 2.5%
over the 30-day  commercial  paper rate,  which  resulted in a borrowing rate of
8.35% at December 31, 1997. Available borrowings under the line of credit depend
upon  the  accounts  receivable  and  inventories  of VCS  and  are  secured  by
substantially all of the Company's  assets.  The line of credit contains certain
financial  covenants that are customary for similar  credit  facilities and also
prohibits  VCS from paying  dividends  to the Company  without the consent of GE
Capital.  See Item 1, "Special  Considerations - Lack of Dividends." At December
31, 1997, the Company was in compliance  with all of the covenants.  An increase
in the  Company's  borrowings  under the line of credit in 1998,  along with the
associated  increase in the current assets,  has caused the Company to violate a
financial  covenant  from time to time  subsequent  to year end. The Company has
secured a waiver of these violations and an amendment to the financial  covenant
through  April 30,  1998.  The  amendment  is  intended to enable the Company to
remain in compliance  with the covenant.  In addition,  the Company is exploring
increasing the line of credit from $12.0 million to $15.0 million.

         The Company has entered  into several  capital  lease  agreements  with
interest rates ranging from 9% to 13%. These agreements  generally have terms of
24 months.

         The Company has no significant  outstanding  commitments other than its
existing  lease  agreements  and  commitments  under various  supply and royalty
agreements, as described in the Notes to the Consolidated Financial Statements.

         The Company  believes  that its working  capital and credit  facilities
will be sufficient to finance its internal  growth for the  foreseeable  future.
Although  the  Company  currently  has no  acquisition  targets,  it  intends to
continue to explore acquisition  opportunities as they arise and may be required
to seek additional financing in the future to meet such opportunities.

ITEM 7A.          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         Not applicable.
                                       27
<PAGE>
ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

         Reference is made to the financial statements,  the report thereon, and
the  notes  thereto  commencing  at page  F-1 of this  Report,  which  financial
statements, report, and notes are incorporated by reference.

ITEM 9.           CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                  ACCOUNTING AND FINANCIAL DISCLOSURE

         Not applicable


                                    PART III

ITEM 10.          DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The  information  required by this Item  relating to  directors  of the
Company is incorporated herein by reference to the definitive Proxy Statement to
be filed pursuant to Regulation  14A of the Securities  Exchange Act of 1934, as
amended  (the  "Exchange   Act")  for  the  Company's  1998  Annual  Meeting  of
Stockholders.  The  information  required  by this Item  relating  to  executive
officers of the Company is included in Item 1, "Business Executive Officers."

ITEM 11.          EXECUTIVE COMPENSATION

         The  information  required  by this  Item  is  incorporated  herein  by
reference to the definitive  Proxy  Statement to be filed pursuant to Regulation
14A of the Exchange Act for the Company's 1998 Annual Meeting of Stockholders.

ITEM 12.          SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                  MANAGEMENT

         The  information  required  by this  Item  is  incorporated  herein  by
reference to the definitive  Proxy  Statement to be filed pursuant to Regulation
14A of the Exchange Act for the Company's 1998 Annual Meeting of Stockholders.

ITEM 13.          CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The  information  required  by this  Item  is  incorporated  herein  by
reference to the definitive  Proxy  Statement to be filed pursuant to Regulation
14A of the Exchange Act for the Company's 1998 Annual Meeting of Stockholders.
                                       28
<PAGE>
                                     PART IV

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

(a)      Financial Statements and Financial Statement Schedules

         (1)     Financial  Statements  are listed in the Index to  Consolidated
                 Financial Statements on page F-1 of this Report.

         (2)     No Financial  Statement  Schedules  are  included  because such
                 schedules  are not  applicable,  are not  required,  or because
                 required information is included in the consolidated  financial
                 statements or notes thereto.

(b)      Reports on Form 8-K.

         Not applicable.

(c) Exhibits

<TABLE>
<CAPTION>
Exhibit
Number                                      Exhibit
------                                      -------

<S>        <C>
3.1        Amended Certificate of Incorporation of the Registrant(l)
3.2        Amended and Restated Bylaws of the Registrant(l)
4.1        Form of Certificate representing shares of Common Stock, par value $.001 per share(1)
4.2        Form of Underwriter's Warrant(l)
10.1       Credit Agreement dated as of April 11, 1994 between Vodavi Communications Systems, Inc. and General
           Electric Capital Corporation(l)
10.2       Security Agreement dated as of April 11, 1994 between Vodavi Communications Systems, Inc. and
           General Electric Capital Corporation(l)
10.3       Stock Pledge and Security Agreement dated as of April 11, 1994 between the Registrant and General
           Electric Capital Corporation(l)
10.7       Patent Collateral Assignment Agreement dated as of April 11, 1994 between V Technology Acquisition
           Corp. and General Electric Capital Corporation(l)
10.8       Trademark Security Agreement dated as of April 11, 1994 between V Technology Acquisition Corp. and
           General Electric Capital Corporation(l)
10.9       Vodavi Technology, Inc. Second Amended and Restated 1994 Stock Option Plan
10.10      Stockholders' Agreement among the Registrant, V Technology Holdings Corp., GoldStar
           Telecommunication Co., Ltd., The Sherman Group, The Opportunity Fund, Steven A. Sherman, and
           Glenn R. Fitchet, dated March 28, 1994, and Amendment Agreement dated April 5, 1995(1)
10.11      Escrow Agreement dated as of March 28, 1994 between the Registrant, GoldStar Telecommunication Co.,
           Ltd., Steven Sherman, Glenn R. Fitchet and STKK Service Company, as Escrow Agent(l)
10.12      Vodavi Key System Agreement dated April 4, 1994 between GoldStar Telecommunication Co., Ltd., and
           Vodavi Communication Systems, a division of Executone Information Systems, Inc.(l)
10.13      Vodavi Single Line Telephone Agreement dated April 4,1994 between Srithai GoldStar Co., Ltd., and
           Vodavi Communication Systems, Inc., a division of Executone Information Systems, Inc.(l)
10.13A     Vodavi Single Line Telephone Agreement Extension dated April 4, 1997 between Vodavi Communications
           Systems, Inc. and L.G. Srithai Electronics Co., Ltd.(2)
10.14      License Agreement dated as of March 31, 1994 between Executone Information Systems, Inc. and V
           Technology Acquisition Corp.(l)
</TABLE>
                                       29
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number                                      Exhibit
------                                      -------

<S>        <C>
10.15      Assignment and Assumption Agreement dated April 11, 1994 between Executone Information Systems,
           Inc. and V Technology Acquisition Corp.(l)
10.16      Supply Agreement dated December 1, 1994 between NovAtel Communications Ltd., and Vodavi
           Communications Systems, Inc.(l)
10.19      OEM Agreement dated as of June 19, 1995, between Tecom Co., Ltd. and Vodavi Communications
           Systems, Inc.(3)
10.20      Agreement dated June 14, 1995 between Wong's Electronics Co., Ltd. and Vodavi Communications
           Systems, Inc.(3)
10.21      Master Lease Agreement dated May 31, 1996, between Matrix Funding Corporation and Vodavi
           Communications Systems, Inc.(4)
10.22      Master Lease Agreement dated October 7, 1996, between Matrix Funding Corporation and Vodavi
           Communications Systems, Inc.(5)
10.23      Amended and Restated Credit Agreement dated as of April 11, 1994 between Vodavi Communications
           Systems, Inc. and General Electric Capital Corporation, as Amended and Restated as of June 11, 1997(2)
10.24      First Amendment to Stock Pledge and Security Agreement dated as of June 11, 1997, between Vodavi
           Technology, Inc. and General Electric Capital Corporation(2)
10.25      Security Agreement dated as of June 11, 1997 between Enhanced Systems, Inc. and General Electric
           Capital Corporation(2)
10.26      Security Agreement dated as of June 11, 1997 between Arizona Repair Services, Inc. and General Electric
           Capital Corporation(2)
10.27      Guaranty Agreement dated as of June 11, 1997, by and among Arizona Repair Services, Inc., Enhanced
           Systems, Inc., and General Electric Capital Corporation(2)
10.28      Trademark Security Agreement, dated as of June 11, 1997, by and between Vodavi Communications
           Systems, Inc. and General Electric Capital Corporation(2)
10.29      Trademark Security Agreement dated as of June 11, 1997, by and between Enhanced Systems, Inc. and
           General Electric Capital Corporation(2)
10.30      Strategic Alliance Agreement dated May 22, 1997 between Vodavi Communications Systems, Inc. and
           Paradygm Communications, Inc.(2)
10.31      OEM Agreement dated August 15, 1997 between Vodavi Communications Systems, Inc. and Fujitsu
           Business Communication Systems, Inc.(6)
10.32      OEM  Purchase  Agreement  dated as of April 11, 1997,  between  Santa
           Barbara Connected Systems Corporation and Enhanced Systems, Inc.
10.33      Consulting Agreement dated as of December 5, 1997 between Vodavi Technology, Inc. and Steven A.
           Sherman
21         List of Subsidiaries(7)
23.1       Consent of Arthur Andersen LLP
27.1       Financial Data Schedule
27.2       Restated Financial Data Schedule
</TABLE>

---------------------
(1)  Incorporated  by  reference  to  Registration  Statement  on Form  S-1 (No.
     33-95926) and amendments thereto which became effective on October 6, 1995.
(2)  Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the quarter ended June 30, 1997, as filed on August 11, 1997.
(3)  Incorporated  by reference to the  Registrant's  Annual Report on Form 10-K
     for the fiscal year ended December 31, 1995, as filed on April 1, 1996.
(4)  Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the quarter ended June 30, 1996, as filed on August 14, 1996.
(5)  Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the quarter ended September 30, 1996, as filed on November 14, 1996.
                                       30
<PAGE>
(6)  Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the quarter ended September 30, 1997, as filed on November 14, 1997.
(7)  Incorporated  by reference to the  Registrant's  Annual Report on Form 10-K
     for the fiscal year ended December 31, 1996, as filed on March 28, 1997.
                                       31
<PAGE>
                                   SIGNATURES

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

                             VODAVI TECHNOLOGY, INC.

Date March 27, 1998          By:  /s/ Glenn R. Fitchet
                                ------------------------------------------------
                                Glenn R. Fitchet
                                President, Chief Executive Officer, and Director

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


<TABLE>
<CAPTION>
          Signature                                Title                            Date
          ---------                                -----                            ----


<S>                                  <C>                                        <C>
   /s/  WILLIAM J. HINZ              Chairman of the Board                      March 27, 1998
-------------------------------
        William J. Hinz


   /s/  GLENN R. FITCHET             President, Chief Executive Officer,        March 27, 1998
-------------------------------      and Director
        Glenn R. Fitchet


   /s/  GREGORY K. ROEPER            Vice President - Finance,                  March 27, 1998
-------------------------------      Administration, and Operations;
        Gregory K. Roeper            Chief Financial Officer; Secretary;
                                     and Treasurer (Principal Financial
                                     and Accounting Officer)



                                     Director                                   _____ __, 1998
-------------------------------
        Nam K. Woo


   /s/  STEVEN A. SHERMAN            Director                                   March 27, 1998
-------------------------------
        Steven A. Sherman


   /s/  GILBERT H. ENGELS            Director                                   March 27, 1998
-------------------------------
        Gilbert H. Engels


   /s/  STEPHEN A MCCONNELL          Director                                   March 27, 1998
-------------------------------
        Stephen A McConnell
</TABLE>
                                       32
<PAGE>
                             VODAVI TECHNOLOGY, INC.


                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS






                                                                            Page

Report of Independent Public Accountants ---------------------------------- F-2

Consolidated Balance Sheets as of December 31, 1996 and 1997 -------------- F-3

Consolidated Statements of Operations for the Years Ended
   December 31, 1995, 1996, and 1997 -------------------------------------- F-4

Consolidated Statements of Changes in Stockholders' Equity for
   the Years Ended December 31, 1995, 1996, and 1997 ---------------------- F-5

Consolidated Statements of Cash Flows for the Years Ended
   December 31, 1995, 1996, and 1997 -------------------------------------- F-6

Notes to Consolidated Financial Statements -------------------------------- F-7
                                      F-1
<PAGE>
                              ARTHUR ANDERSEN LLP



                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To Vodavi Technology, Inc.:


We  have  audited  the  accompanying   consolidated  balance  sheets  of  VODAVI
TECHNOLOGY,  INC. (a Delaware  corporation)  and subsidiaries as of December 31,
1996 and 1997, and the related consolidated statements of operations, changes in
stockholders'  equity and cash  flows for each of the three  years in the period
ended  December  31,  1997.  These  consolidated  financial  statements  are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

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

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


                                                  ARTHUR ANDERSEN LLP

Phoenix, Arizona,
   February 13, 1998.
                                      F-2
<PAGE>
                             VODAVI TECHNOLOGY, INC.


                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                         December 31,
                                                                                ----------------------------
                                                                                    1996            1997
                                                                                ------------    ------------
<S>                                                                             <C>             <C>
                                                   ASSETS

CURRENT ASSETS:
   Cash and cash equivalents                                                    $  1,151,713    $    634,255
   Accounts receivable, net of allowances of
     $234,000 in 1996 and $250,000 in 1997                                         7,789,832       9,681,545
   Inventories, net                                                                7,229,325       8,286,173
   Prepaid expenses and other                                                        420,455         905,451
                                                                                ------------    ------------

                  Total current assets                                            16,591,325      19,507,424

PROPERTY AND EQUIPMENT, net                                                        2,465,214       2,616,320

GOODWILL, net                                                                      2,546,465       2,394,990

OTHER LONG-TERM ASSETS, net                                                          814,620       1,145,308
                                                                                ------------    ------------

                                                                                $ 22,417,624    $ 25,664,042
                                                                                ============    ============

                                    LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
   Current portion of long-term debt                                            $    258,000    $    378,931
   Payable to related parties                                                      2,291,581       1,621,547
   Accounts payable                                                                2,172,042       2,698,362
   Accrued liabilities                                                             2,276,467       2,416,218
   Accrued income taxes                                                              293,840            --
                                                                                ------------    ------------

                  Total current liabilities                                        7,291,930       7,115,058
                                                                                ------------    ------------

LONG-TERM DEBT, net                                                                5,588,209       8,752,367
                                                                                ------------    ------------

OTHER LONG-TERM OBLIGATIONS                                                          137,060         181,247
                                                                                ------------    ------------

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY:
   Preferred stock, $.001 par value, 1,000,000 shares
     authorized, no shares issued                                                       --              --
   Common stock, $.001 par value, 10,000,000 shares
     authorized; 4,342,238 shares issued and outstanding                               4,342           4,342
   Additional paid-in capital                                                     12,307,739      12,307,739
   Retained earnings (deficit)                                                    (2,911,656)     (2,696,711)
                                                                                ------------    ------------

                                                                                   9,400,425       9,615,370
                                                                                ------------    ------------

                                                                                $ 22,417,624    $ 25,664,042
                                                                                ============    ============
</TABLE>

   The accompanying notes are an integral part of these consolidated balance
                                    sheets.
                                      F-3
<PAGE>
                             VODAVI TECHNOLOGY, INC.


                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                     Years Ended December 31,
                                           -------------------------------------------
                                               1995           1996            1997
                                           ------------   ------------    ------------
<S>                                        <C>            <C>             <C>
REVENUE, net                               $ 39,600,726   $ 46,154,174    $ 47,674,751

COSTS OF GOODS SOLD (including
  products acquired from related parties
  (LGE) of $15.6 million, $17.8 million,
  and $17.8 million, respectively)           27,196,571     30,842,422      32,007,992
                                           ------------   ------------    ------------

                  Gross margin               12,404,155     15,311,752      15,666,759

OPERATING EXPENSES:
   Engineering and product development        1,941,503      2,161,306       2,100,682
   Selling, general and administrative        8,457,641     11,587,971      11,726,902
   Asset impairment and restructuring
     charges (Note 2)                              --        4,804,717         819,389
                                           ------------   ------------    ------------

OPERATING INCOME (LOSS)                       2,005,011     (3,242,242)      1,019,786

INTEREST EXPENSE                              1,129,604        840,830         662,828
                                           ------------   ------------    ------------

INCOME (LOSS) BEFORE INCOME TAXES               875,407     (4,083,072)        356,958

PROVISION FOR INCOME TAXES                      417,599        326,691         142,013
                                           ------------   ------------    ------------

NET INCOME (LOSS)                          $    457,808   $ (4,409,763)   $    214,945
                                           ============   ============    ============

BASIC EARNINGS (LOSS) PER SHARE            $       0.17   $      (1.02)   $        .05
                                           ============   ============    ============

DILUTED EARNINGS (LOSS) PER SHARE          $       0.17   $      (1.02)   $        .05
                                           ============   ============    ============

WEIGHTED AVERAGE SHARES
   OUTSTANDING - BASIC                        2,690,267      4,342,238       4,342,238
                                           ============   ============    ============

WEIGHTED AVERAGE SHARES
   OUTSTANDING - DILUTED                      2,769,434      4,342,238       4,342,238
                                           ============   ============    ============
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                      F-4
<PAGE>
                             VODAVI TECHNOLOGY, INC.


           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                       Common Stock
                               ---------------------------    Additional      Retained
                                                  Par          Paid-in        Earnings
                                  Shares         Value         Capital        (Deficit)          Total
                               ------------   ------------   ------------    ------------    ------------

<S>                               <C>         <C>            <C>             <C>             <C>
BALANCE, December 31, 1994        1,999,993   $      2,000   $  3,015,000    $  1,040,299    $  4,057,299
     Warrant conversion             187,500            187           (187)           --              --
     Initial public offering      1,488,083          1,488      7,293,593            --         7,295,081
     Issuance of shares to
       acquire Enhanced             666,662            667      1,999,333            --         2,000,000
     Net income                        --             --             --           457,808         457,808
                               ------------   ------------   ------------    ------------    ------------

BALANCE, December 31, 1995        4,342,238          4,342     12,307,739       1,498,107      13,810,188
     Net loss                          --             --             --        (4,409,763)     (4,409,763)
                               ------------   ------------   ------------    ------------    ------------

BALANCE, December 31, 1996        4,342,238          4,342     12,307,739      (2,911,656)      9,400,425
     Net income                        --             --             --           214,945         214,945
                               ------------   ------------   ------------    ------------    ------------

BALANCE, December 31, 1997        4,342,238   $      4,342   $ 12,307,739    $ (2,696,711)   $  9,615,370
                               ============   ============   ============    ============    ============
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                      F-5
<PAGE>
                             VODAVI TECHNOLOGY, INC.


                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                        Years Ended December 31,
                                                                              --------------------------------------------
                                                                                  1995            1996             1997
                                                                              ------------    ------------    ------------
<S>                                                                           <C>             <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income (loss)                                                          $    457,808    $ (4,409,763)   $    214,945
   Adjustments to reconcile net income (loss) to net cash
     (used in) provided by operating activities:
       Depreciation and amortization                                               561,048         903,735         750,400
       Asset impairment                                                               --         4,174,717         407,776
       Rent levelization                                                            68,813          68,246          44,187
       Loss on retirement of fixed assets                                             --            63,081            --
   Changes in working capital, net of assets and liabilities
     acquired in business combinations:
       Accounts receivable                                                         326,370      (1,310,669)     (1,943,753)
       Inventories                                                              (2,305,470)      1,302,059      (1,137,315)
       Prepaid expenses and other                                                 (377,344)        380,878        (351,853)
       Other long-term assets                                                     (156,742)         36,615        (450,926)
       Accounts payable and payables to related parties                            648,547         838,935        (143,714)
       Accrued liabilities                                                        (183,170)        619,003         227,831
       Accrued income taxes                                                       (109,023)        (77,223)       (426,983)
                                                                              ------------    ------------    ------------
                  Net cash flows (used in) provided by operating activities     (1,069,163)      2,589,614      (2,809,405)
                                                                              ------------    ------------    ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Cash paid to acquire assets through business combinations                    (2,351,524)           --              --
   Accrued acquisition costs paid                                                 (309,932)       (217,894)        (36,040)
   Cash paid to acquire fixed assets                                            (1,185,328)       (556,664)       (577,030)
                                                                              ------------    ------------    ------------
                  Net cash flows used in investing activities                   (3,846,784)       (774,558)       (613,070)
                                                                              ------------    ------------    ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from the sale of common stock                                        8,928,598            --              --
   Equity offering costs paid                                                   (1,633,517)           --              --
   Repayment of notes payable                                                   (1,200,000)           --              --
   Financing costs paid                                                               --              --           (77,301)
   Payments on capital leases                                                         --          (109,760)       (259,282)
   Borrowings on revolving credit facility                                      41,127,236      41,369,367      48,488,925
   Payments on revolving credit facility                                       (41,816,582)    (43,867,070)    (45,247,325)
                                                                              ------------    ------------    ------------
                  Net cash flows provided by (used in) financing activities      5,405,735      (2,607,463)      2,905,017
                                                                              ------------    ------------    ------------

CHANGE IN CASH AND CASH EQUIVALENTS                                                489,788        (792,407)       (517,458)

CASH AND CASH EQUIVALENTS, beginning of period                                   1,454,332       1,944,120       1,151,713
                                                                              ------------    ------------    ------------
CASH AND CASH EQUIVALENTS, end of period                                      $  1,944,120    $  1,151,713    $    634,255
                                                                              ============    ============    ============
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                      F-6
<PAGE>
                             VODAVI TECHNOLOGY, INC.


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



(1)   NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT
      ACCOUNTING POLICIES:

         Nature of Business

Vodavi  Technology,  Inc.  (VTI),  a Delaware  corporation,  designs,  develops,
markets, and supports a broad range of  telecommunications  systems,  commercial
grade telephones,  computer-telephony  products,  and voice processing products,
including  voice mail,  fax mail,  Internet  messaging,  and  interactive  voice
response systems for a wide variety of commercial applications.

         Principles of Consolidation

The consolidated financial statements include the accounts of VTI and its wholly
owned subsidiaries  Vodavi  Communication  Systems,  Inc. (VCS),  Arizona Repair
Services,  Inc. (ARSI), and Enhanced Systems, Inc. (Enhanced) (together referred
to as the Company). All material intercompany  transactions have been eliminated
in consolidation.

         Use of Estimates

The preparation of financial  statements in conformity  with generally  accepted
accounting  principles  requires the Company's  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  revenue  and  expenses  during  the
reporting period. Actual results could differ from those estimates.

         Cash and Cash Equivalents

Cash and cash equivalents include funds on hand and short-term investments.

         Inventory

Inventories  are  stated at the lower of cost  (first-in,  first-out  method) or
market.
                                      F-7
<PAGE>
         Property and Equipment

Property and equipment are recorded at cost.  Depreciation is computed using the
straight-line  method.  Property  and  equipment  and the related  useful  lives
consist of the following as of December 31, 1996 and 1997, respectively:

<TABLE>
<CAPTION>
                                              Useful Life
                   Type of Asset                in Years       1996             1997
         -----------------------------------  -----------   ---------        ---------

<S>                                               <C>      <C>              <C>
         Office and computer equipment               5     $  671,869       $1,030,354
         Furniture and fixtures                     10        219,063          255,089
         Tooling and manufacturing equipment       5-8      1,060,387        1,506,761
         Assets under capital lease               5-12        574,982          741,226
         Property and equipment in progress         -         502,976          128,702
                                                            ---------        ---------
                                                            3,029,277        3,662,132
         Less:  Accumulated depreciation                     (564,063)      (1,045,812)
                                                            ---------        ---------

                                                           $2,465,214       $2,616,320
                                                            =========        =========
</TABLE>

Property and equipment in progress relates to assets under development that have
not yet been placed in service.

         Goodwill

Goodwill  represents  the cost in excess of the estimated fair value of tangible
assets  acquired  in  business  combinations  and  is  being  amortized  on  the
straight-line method over the estimated life of the asset.

         Income Taxes

The Company  utilizes the liability method of accounting for income taxes as set
forth in Statement of Financial  Accounting Standards 109, Accounting for Income
Taxes.  Under the liability  method,  deferred  taxes are provided  based on the
temporary differences between the financial reporting basis and the tax basis of
the Company's assets and liabilities.

         Revenue Recognition

Revenue,  net of an allowance for product returns, is generally  recognized upon
shipment  to the  customer.  When  the  Company  has an  installation  or  other
significant  obligation,  revenue is recognized upon installation or substantial
completion  of the  Company's  obligation.  Revenue  from  extended  maintenance
contracts is recognized over the lives of the respective contracts.

         Earnings Per Share

In February 1997, the Financial  Accounting  Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings Per Share (SFAS No. 128), which
supersedes  Accounting  Principles  Board  (APB)  Opinion  No. 15, the  previous
authoritative  guidance.  SFAS No. 128 replaces the  calculation  of primary and
fully diluted  earnings per share (EPS) with basic and diluted EPS. SFAS No. 128
is effective for financial statements for both interim and
                                      F-8
<PAGE>
annual periods  presented  after  December 15, 1997, and as a result,  all prior
period  EPS data  presented  has been  restated.  Basic EPS for the years  ended
December 31, 1995,  1996 and 1997 were  determined by dividing net income by the
weighted  average  number of common  shares  outstanding.  The weighted  average
number of common  shares  outstanding  excludes  all common  stock  equivalents.
Diluted EPS for the years ended December 31, 1995, 1996 and 1997 were determined
by  dividing  net  income by the  weighted  average  number of common and common
equivalent shares outstanding.  The weighted average number of common and common
equivalent shares for the year ended December 31, 1995,  assumes the exercise of
all  outstanding  options and the  corresponding  repurchase of shares using the
treasury  stock method.  No common  equivalent  shares were included in weighted
average  common and common  equivalent  shares for the years ended  December 31,
1996 and 1997.

         Fair Value of Financial Instruments

The following disclosure of the estimated fair value of financial instruments is
made in accordance with the  requirements  of Statement of Financial  Accounting
Standards No. 107,  Disclosures About Fair Value of Financial  Instruments.  The
estimated fair value amounts have been determined by the Company at December 31,
1997, using available market information.  Considerable  judgment is required in
interpreting  market data to develop the  estimates of fair value.  Accordingly,
the  estimates  may not be  indicative  of the amounts  that the  Company  could
realize in a current market exchange.  The use of different  market  assumptions
and valuation  methodologies  could have a material effect on the estimated fair
value amounts.

The carrying value of cash and cash equivalents,  accounts receivable,  accounts
payable, payable to related party, accrued liabilities, and the revolving credit
facility  approximate  fair  values due to the  short-term  maturities  of these
instruments.

         New Statements of Financial Accounting Standards

In June 1997,  the  Financial  Accounting  Standards  Board issued  Statement of
Financial Accounting Standards No. 130, Reporting Comprehensive Income (SFAS No.
130).  SFAS  No.  130  establishes   standards  for  reporting  and  display  of
comprehensive income and its components  (revenue,  gains, and losses) in a full
set of  general-purpose  financial  statements.  SFAS No. 130 requires  that all
items  that  are  required  to  be  recognized  under  accounting  standards  as
components of comprehensive  income be reported in a financial statement that is
displayed with the same prominence as other financial statements.

This statement is effective for fiscal years  beginning after December 15, 1997.
For comparative  purposes,  reclassification of financial statements for earlier
periods  is  required.  The  adoption  of SFAS No.  130 will not have a material
impact on the Company's financial statements.

In June 1997,  the  Financial  Accounting  Standards  Board issued  Statement of
Financial  Accounting  Standard  No.  131,  Disclosures  About  Segments  of  an
Enterprise  and  Related  Information  (SFAS No.  131),  which  supersedes  FASB
Statement No. 14, Financial Reporting for Segments of a Business Enterprise, but
retains  the  requirement  to report  information  about major  customers.  This
statement  establishes  standards for the way that public  business  enterprises
report information about operating  segments in annual financial  statements and
requires that those
                                      F-9
<PAGE>
enterprises  report selected  information  about  operating  segments in interim
financial  reports issued to  shareholders.  It also  establishes  standards for
related  disclosures  about products and services,  geographic  areas, and major
customers.

This statement is effective for financial statements for periods beginning after
December 15, 1997. In the initial year of application,  comparative  information
for  earlier  years is to be  restated.  This  statement  need not be applied to
interim  financial  statements  in the  initial  year  of its  application,  but
comparative  information  for interim periods in the initial year of application
is to be reported in financial statements for interim periods in the second year
of application.

(2)   ASSET IMPAIRMENTS AND RESTRUCTURING CHARGE:

The  Financial  Accounting  Standards  Board has issued  Statement  of Financial
Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets
and for  Long-Lived  Assets to Be Disposed Of (SFAS No. 121),  which the Company
adopted in 1996.  SFAS No. 121 requires that  long-lived  assets be reviewed for
impairment whenever events or circumstances indicate that the carrying amount of
the assets may not be recoverable.  If the sum of the expected future cash flows
(undiscounted and without interest charges) from an asset to be held and used in
operations is less than the carrying value of the asset, an impairment loss must
be recognized in the amount of the difference between the carrying value and the
fair  value.  Assets to be  disposed  of must be valued at the lower of carrying
value or fair value less costs to sell.

During 1996,  certain  events  occurred that required the Company to re-evaluate
the  realizability  of goodwill  recorded in connection  with the acquisition of
Enhanced.  As a result of the impact of these events on the projected cash flows
of Enhanced, the Company concluded that the goodwill was impaired and recorded a
$4.2 million impairment loss.

During 1997, the Company recorded a restructuring charge that included a reserve
for severance payments and the write off of various assets following a review of
product  strategies,  which resulted in the  discontinuance  of certain  product
lines.

(3)   BUSINESS COMBINATIONS:

In July 1995,  ARSI  acquired  certain  operating  assets of  Goldstar  Products
Company, Ltd. (GPC), an affiliate of LGE. The operations acquired consisted of a
repair facility utilized by GPC to repair telecommunications equipment primarily
sold  by  VCS.  The  purchase  price  was  $440,000,   including   other  direct
acquisition-related  costs. The acquisition was accounted for under the purchase
method. The purchase price was allocated as follows:

                 Current assets                  $ 80,000
                 Fixed assets                      90,000
                 Goodwill                         270,000
                                                 --------

                                                 $440,000
                                                 ========
                                      F-10
<PAGE>
Concurrently  with the Company's  initial public offering (IPO) in October 1995,
Enhanced,  a Norcross,  Georgia-based  provider of voice processing  technology,
merged with a wholly owned  subsidiary of the Company.  The total purchase price
of   Enhanced   was   approximately    $5,250,000,    including   other   direct
acquisition-related  costs, and consisted of $3,000,000 in cash and the issuance
of 666,662 restricted shares of VTI Common Stock.

The  acquisition  of Enhanced was accounted for under the purchase  method.  The
purchase price of Enhanced was allocated as follows:

           Net current assets                        $  500,000
           Long-term assets                             250,000
           Goodwill                                   4,500,000
                                                     ----------

                                                     $5,250,000
                                                     ==========

The following table presents the unaudited  pro-forma  results of operations for
the year ended December 31, 1995, assuming the transactions  described above had
taken place as of January 1, 1994:

           Revenue                                  $41,938,000
           Net income                                   272,000
           Net income per share - diluted                   .08

(4)   LONG-TERM DEBT:

Long-term debt consists of the following as of December 31, 1996 and 1997:

                                                  1996           1997
                                               ----------     ----------

         Revolving credit facility             $5,386,623     $8,628,227
         Capital lease obligations                459,586        503,071
                                               ----------     ----------
                                                5,846,209      9,131,298
         Less: Current portion                    258,000        378,931
                                               ----------     ----------

                                               $5,588,209     $8,752,367
                                               ==========     ==========

The Company maintains a $12.0 million revolving credit facility with a financial
institution.  Borrowings  under the  facility,  which are based on inventory and
accounts receivable,  carry interest payable monthly at a variable rate based on
commercial  paper plus  4-1/2% in 1996 and 2-1/2% in 1997  (10.45%  and 8.03% at
December 31, 1996 and 1997, respectively).  The credit facility expires in April
2000 and is secured by substantially all of the Company's assets.

The credit agreement contains certain financial covenants that are customary for
similar  credit   facilities   and  also   prohibits  the  Company's   operating
subsidiaries  from paying  dividends  to the Company  without the consent of the
financial institution.  At December 31, 1997, the Company was in compliance with
all of the  covenants.  Subsequent  to year end, the Company was in violation of
one  financial  covenant;  however,  a waiver was  obtained  from the  financial
institution.
                                      F-11
<PAGE>
The Company has entered into several  capital  lease  agreements  with  interest
rates  ranging  from 9% to 13%.  These  agreements  generally  have  terms of 24
months.

(5)   COMMITMENTS AND CONTINGENCIES:

         Legal Matters

The  Company  is  currently  involved  in a lawsuit  with the  former  owners of
Enhanced,  who were  dismissed from their  positions as executive  management of
Enhanced in the third quarter of 1996. In September  1996,  the Company sued the
former  owners  alleging  securities  fraud,  fraudulent  activities,  breach of
employment agreements, breach of fiduciary duties, and other charges. The former
owners  countersued the Company  claiming the Company  breached their employment
agreements  and  owes  them  approximately  $500,000.  The  Company  intends  to
vigorously  pursue its action and defend against the countersuit.  In connection
with the  fourth  quarter of 1996  charges  for the asset  impairment  and other
restructuring  charges,  the Company reserved  approximately  $250,000 to pursue
this matter.

         Operating Leases

The Company has entered into  long-term  lease  agreements for all of its office
and warehouse facilities.  Minimum payments under the Company's lease agreements
are as follows:

                                                       Total
                                                    -----------

         1998                                       $ 1,090,731
         1999                                         1,120,707
         2000                                         1,160,679
         2001                                         1,201,335
         2002                                           311,745
         Thereafter                                     174,720

Rent  expense  is  recognized  on a  straight-line  basis and was  approximately
$825,000,  $1,115,000,  and  $1,107,000  for the years ended  December 31, 1995,
1996, and 1997,  respectively.  The difference between rent expensed and paid is
included in other long-term obligations.

         Royalties

VCS acquires certain  proprietary  components from a third party under the terms
of a license  agreement.  Under the terms of the agreement,  VCS will pay a 5.3%
royalty over the  manufactured  cost of all products  utilizing the  proprietary
components.  Total royalties  related to this agreement were $492,000,  $502,000
and $449,000 in 1995, 1996, and 1997, respectively.

         Supply Agreements

VCS has entered  into  various  supply  agreements  with its vendors to purchase
products  through  1999.  Minimum  required  purchases  in 1998 and  1999  total
approximately $9.75 million and $5.5 million, respectively.
                                      F-12
<PAGE>
         401(k) Profit Sharing Plan

In April  1994,  the Company  adopted a profit  sharing  plan (the 401(k)  Plan)
pursuant to Section 401(k) of the Internal Revenue Code of 1986. The 401(k) Plan
covers   substantially   all  full-time   employees  who  meet  the  eligibility
requirements and provides for a discretionary profit sharing contribution by the
Company and an  employee  elective  contribution  with a  discretionary  Company
matching provision. The Company expensed discretionary contributions pursuant to
the 401(k) Plan in the amounts of approximately  $40,000,  $67,500,  and $75,000
for the years ended December 31, 1995, 1996, and 1997, respectively.

(6)   STOCKHOLDERS' EQUITY:

         Warrants

In connection  with the private sale of Common Stock in April 1994,  the Company
issued  warrants to acquire an  additional  1,125,000  shares of Common Stock at
$4.00 per share.  In September  1995,  the Company  issued 187,500 shares of its
Common Stock in a cashless exchange for these warrants.

In  connection  with the IPO,  the Company sold to its  underwriter  warrants to
purchase up to 133,333 shares of its Common Stock at a price of $7.20 per share.
The warrants are exercisable  during a four-year period from October 12, 1996 to
October 12, 2000.

         Vodavi Technology, Inc. 1994 Stock Option Plan

The Vodavi  Technology,  Inc.  1994 Stock  Option Plan (the  Plan),  as amended,
provides for the  granting of options to purchase up to 850,000  shares of VTI's
Common  Stock.  Under the Plan,  options may be issued to key  personnel  of the
Company. The options issued may be incentive stock options or nonqualified stock
options.  If any option  terminates or expires  without having been exercised in
full,  stock not  issued  under such  option  will  again be  available  for the
purposes of the Plan.

To the extent that granted  options are incentive  stock options,  the terms and
conditions  of  those  options  must  be  consistent   with  the   qualification
requirements  set forth in Section 422 of the Internal Revenue Code of 1986. The
maximum  number of shares of Common Stock with  respect to which  options can be
granted to any one employee, including officers, during the term of the plan may
not exceed 50% of the shares of Common Stock covered by the Plan.

The  expiration  date,  maximum  number  of  shares  purchasable,  and the other
provisions of the options are  established at the time of grant.  Options may be
granted for terms of up to ten years and become  exercisable  in whole or in one
or more installments at such time as may be determined by the plan administrator
upon grant of the options.  The exercise prices of options are determined by the
plan administrator, but may not be less than 100% (110% if the option is granted
to a stockholder  who at the time the option is granted owns stock  representing
more than ten percent of the total  combined  voting power of all classes of VTI
stock) of the fair market value of the Common Stock at the time of the grant.
                                      F-13
<PAGE>
The following summarizes activity under the plan for the years ended:

<TABLE>
<CAPTION>
                                   December 31, 1995          December 31, 1996        December 31, 1997
                                -----------------------     ---------------------    ----------------------
                                               Weighted                  Weighted                  Weighted
                                               Average                   Average                   Average
                                  Number       Exercise       Number     Exercise      Number      Exercise
                                of Shares       Price       of Shares     Price      of Shares      Price
                                ---------      -------      ---------    -------     ---------     --------
<S>                               <C>          <C>            <C>        <C>           <C>         <C>
Options outstanding at
   beginning of period:           240,000      $  4.00        237,500    $  4.00       498,500     $   5.08
     Granted                           -                      295,000       6.07       380,600         4.45
     Canceled                      (2,500)        4.00        (34,000)      6.00       (62,200)        5.13
     Exercised                         -                           -                        -            -
                                ---------      -------      ---------    -------     ---------     --------

Options outstanding
   at end of period               237,500      $  4.00        498,500    $  5.08       816,900     $   4.80
                                =========      =======      =========    =======     =========     ========

Options available
   for grant                       75,000                     351,500                   33,200
                                =========                   =========                =========

Exercisable at end
   of period                       59,375      $  4.00        118,750    $  4.00       178,125     $   4.00
                                =========      =======      =========    =======     =========     ========

Weighted average fair
   value of options granted           N/A                     $  2.69                  $  2.93
                                =========                   =========                =========
</TABLE>

The Company has elected to account for its stock-based  compensation plans under
Accounting  Principles  Board  Opinion No. 25,  Accounting  for Stock  Issued to
Employees (APB Opinion No. 25). Accordingly,  no compensation cost is recognized
in the  accompanying  financial  statements  for  stock-based  employee  awards.
Entities  electing to remain with the accounting in APB Opinion No. 25 must make
pro forma disclosures of net income and earnings per share, as if the fair value
based  method  of  accounting  defined  in  Statement  of  Financial  Accounting
Standards No. 123,  Accounting for Stock-Based  Compensation  (SFAS No. 123) had
been applied. The Company has computed,  for pro forma disclosure purposes,  the
value of all  options  granted  during  1996 and 1997,  using the  Black-Scholes
option pricing model with the following weighted average assumptions:

                                                     Year Ended
                                                    December 31,
                                                --------------------
                                                 1996          1997
                                                ------        ------
         Risk free interest rate                 5.47%         6.16%
         Expected dividend yield                    -             -
         Expected lives in years                   5             5
         Expected volatility                    47.86%        62.47%
                                      F-14
<PAGE>
If the Company had accounted for its stock-based  compensation plan using a fair
value based method of accounting,  the Company's net loss and earnings per share
would have been reported as follows:

                                                    Year Ended
                                                   December 31,
                                              ---------------------
                                                 1996        1997
                                              ----------  ---------
                                              (in thousands, except
                                                per share amounts)
         Net loss:
           Pro forma                           $(4,607)     $(150)
         Earnings per share:
           Pro forma - Basic                   $ (1.06)     $(.03)
           Pro forma - Diluted                   (1.06)      (.03)

(7)   MAJOR CUSTOMERS:

The  Company's  sales efforts have been  concentrated  on major supply houses as
well as a dealer network.  During 1995,  1996, and 1997,  sales to the Company's
largest   customer   accounted  for  45%,  44%,  and  40%  of  total   revenues,
respectively.

Accounts  receivable  from  this  supply  house  comprise  44% and 36% of  total
accounts receivable at December 31, 1996 and 1997, respectively.  Generally, the
Company does not require collateral from its customers. The Company believes its
credit evaluation procedures substantially reduce its credit risk.

(8)   INCOME TAXES:

The Company  files a  consolidated  federal  income tax  return.  The income tax
provision is comprised of the following:

                                        1995           1996          1997
                                     ----------     ----------    ----------

           Current                   $  531,488     $  311,490    $  202,753
           Deferred                    (113,889)        15,201       (60,740)
                                     ----------     ----------    ----------

                                     $  417,599     $  326,691    $  142,013
                                     ==========     ==========    ==========
                                      F-15
<PAGE>
The  Company  provides  for  deferred  income  taxes  resulting  from  temporary
differences  between  amounts  reported for financial  accounting and income tax
purposes.  The  components of the net deferred  income tax asset at December 31,
1996 and 1997, were as follows:

                                                    1996           1997
                                                 ---------      ---------
         Deferred tax assets:
           Inventory and receivable reserves     $ 180,139      $ 238,902
           UNICAP adjustment                       120,096        109,629
           Other accruals                          344,791        463,722
                                                 ---------      ---------

                                                   645,026        812,253
                                                 ---------      ---------
         Deferred tax liabilities:
           Depreciation differences                (38,901)      (179,433)
           Amortization differences                (86,882)       (53,027)
                                                 ---------      ---------

                                                  (125,783)      (232,460)
                                                 ---------      ---------

         Net long-term deferred tax asset        $ 519,243      $ 579,793
                                                 =========      =========

The net long-term  deferred tax asset is included in other  long-term  assets in
the accompanying consolidated balance sheet.

Reconciliation of the federal income tax rate to the Company's  effective income
tax rate is as follows:

                                           1995       1996       1997
                                           ----       ----       ----

         Federal statutory tax rate        34.0%      34.0%      34.0%
         State taxes, net                   4.7        4.6        4.6
         Non-deductible expenses and
           other permanent differences      9.0      (46.6)      (7.0)
                                           ----       ----       ----

                                           47.7%      (8.0)%     31.6%
                                           ====       ====       ====

The  Company's  effective  income tax rate for 1995 and 1996 was impacted by the
acquisition of Enhanced and the subsequent  asset  impairment and  restructuring
charges  recognized in 1996,  as the goodwill  generated by the  acquisition  is
non-deductible. The Company's effective income tax rate for 1997 was impacted by
the filing of a research and  development tax credit for current and prior years
which will generate a refund in 1998.

(9)   RELATED PARTIES TRANSACTIONS:

LG Electronics Inc. (LGE), the Company's principal supplier,  owns approximately
19.0% of the  Company's  outstanding  Common Stock at December 31, 1997.  During
1995, 1996, and 1997, the Company purchased  approximately $17.4 million,  $17.9
million,  and $18.8  million  of key  telephone  systems  and  commercial  grade
telephones from LGE.
                                      F-16
<PAGE>
(10)  SUPPLEMENTAL CASH FLOW INFORMATION:

Cash paid for interest  and income taxes for the years ended  December 31, 1995,
1996, and 1997, is as follows:

                                           1995         1996       1997
                                       -----------   ---------  ---------

         Interest paid                 $ 1,130,000   $ 840,000  $ 663,000
         Income taxes paid             $   435,000   $  22,000  $ 630,000

The following information relates to business combinations made by the Company.

<TABLE>
<CAPTION>
                                                 1995             1996            1997
                                             -----------      -----------     -----------

<S>                                          <C>              <C>             <C>
         Fair value of assets acquired       $ 5,690,000      $       --      $       --
         Value of stock issued                (2,000,000)             --              --
         Cash paid, net of cash acquired      (2,351,524)             --              --
                                             -----------      -----------     -----------

         Liabilities assumed or incurred     $ 1,338,476      $       --      $       --
                                             ===========      ===========     ===========
</TABLE>

During  the years  ended  December  31,  1996 and  1997,  the  Company  acquired
approximately  $575,000  and $303,000 of property and  equipment  using  capital
leases.
                                      F-17