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, 1998       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 organization)                              Identification No.)



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

                                 (480) 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. [ ]

At March 26, 1999, 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 (2,982,208 shares) based on the closing price
of the Common Stock as reported on the Nasdaq National Market on March 26, 1999,
was $8,201,072.  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 1999 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, 1998

                                TABLE OF CONTENTS

                                                                            PAGE
                                                                            ----
PART I

   ITEM 1.   BUSINESS ......................................................  1
   ITEM 2.   PROPERTIES .................................................... 21
   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..... 29
   ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA..................... 29
   ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
               AND FINANCIAL DISCLOSURE..................................... 29

PART III

   ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............. 29
   ITEM 11.  EXECUTIVE COMPENSATION......................................... 29
   ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
               MANAGEMENT................................................... 29
   ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................. 29

PART IV

   ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
               FORM 8-K..................................................... 30

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

                 STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

         THE  STATEMENTS  CONTAINED  IN THIS  REPORT  ON FORM  10-K THAT ARE NOT
PURELY  HISTORICAL  ARE  FORWARDING-LOOKING  STATEMENTS  WITHIN  THE  MEANING OF
APPLICABLE  SECURITIES  LAWS.   FORWARD-LOOKING  STATEMENTS  INCLUDE  STATEMENTS
REGARDING THE COMPANY'S "EXPECTATIONS," "ANTICIPATION," "INTENTIONS," "BELIEFS,"
OR "STRATEGIES"  REGARDING THE FUTURE.  FORWARD-LOOKING  STATEMENTS ALSO INCLUDE
STATEMENTS  REGARDING  REVENUE,  MARGINS,  EXPENSES,  AND EARNINGS  ANALYSIS FOR
FISCAL  1999 AND  THEREAFTER;  TECHNOLOGICAL  DEVELOPMENTS;  FUTURE  PRODUCTS OR
PRODUCT DEVELOPMENT;  THE COMPANY'S PRODUCT AND DISTRIBUTION CHANNEL DEVELOPMENT
STRATEGIES;  POTENTIAL  ACQUISITIONS  OR  STRATEGIC  ALLIANCES;  THE  SUCCESS OF
PARTICULAR  PRODUCT OR MARKETING  PROGRAMS;  AND LIQUIDITY AND ANTICIPATED  CASH
NEEDS AND AVAILABILITY.  ALL FORWARD-LOOKING  STATEMENTS INCLUDED IN THIS REPORT
ARE BASED ON INFORMATION  AVAILABLE TO THE COMPANY AS OF THE FILING DATE OF THIS
REPORT, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING
STATEMENTS.  THE  COMPANY'S  ACTUAL  RESULTS  COULD DIFFER  MATERIALLY  FROM THE
FORWARD-LOOKING STATEMENTS. AMONG THE FACTORS THAT COULD CAUSE RESULTS TO DIFFER
MATERIALLY ARE THE FACTORS DISCUSSED IN ITEM 1, "SPECIAL CONSIDERATIONS."

                                      -i-
<PAGE>
                                     PART I

ITEM 1.  BUSINESS
                                  INTRODUCTION

         The Company designs,  develops,  markets, and supports a broad range of
business  telecommunications  solutions,  including digital  telephone  systems,
voice processing systems, 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 their telephone system with their computer systems. 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
core business of supplying telephone systems, commercial grade telephones, voice
processing systems, and  computer-telephony  integration ("CTI") products;  (ii)
focusing on the integration of existing and newly developed  products to provide
complete  industry  standards-based  business  communications  solutions  to its
customers;  (iii)  pursuing its  strategic  relationship  with LG  Information &
Communications,   Ltd.   ("LGIC"),   a  member  of  the  multi-billion   dollar,
Korean-based  LG Group with which the Company has had a long-term  relationship;
and (iv) expanding its technological expertise and distribution channels through
business acquisitions,  license arrangements and other strategic  relationships,
and  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.  The
Company's  corporate  headquarters  are  located  at 8300 East  Raintree  Drive,
Scottsdale,  Arizona 85260.  Effective  April 1, 1999,  the Company's  telephone
number is (480) 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, emphasis
on the use of communications systems to provide cost-effective customer service,
development of the Internet as an alternative to traditional telephone networks,
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  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 a business to provide its customers
with automated  access to the business'  database via telephone or the Internet;
and (iii) computer-telephony  integration, which greatly enhances efficiency and
productivity  by  integrating  businesses'  voice  and data  networks.  Wireless
technologies,  computer-telephony integration, expanded use of the Internet, and
other innovations represent  significant  opportunities for sales of new product
lines and applications to further increase employee mobility and efficiency. The
Company also believes that

                                       1
<PAGE>
international sales of voice processing products will increase  substantially in
the  future as demand for  features  such as voice  mail and  interactive  voice
response increases.

         The following table summarizes the most recent  published  estimates of
market revenue between 1998 and 2004,  compound annual market growth rates,  and
average prices for each business communications product category listed.
<TABLE>
<CAPTION>
                                                          COMPOUND          AVERAGE
                              1998           2004          ANNUAL          PRICE PER
  PRODUCT SEGMENT           REVENUE(1)    REVENUE(1)     GROWTH RATE     STATION OR PORT
  ---------------           ----------    -----------    -----------     ---------------
<S>                          <C>           <C>            <C>           <C>             
Key Telephone Systems        $2,150.0      $2,720.0          4.1%                $   410
Voice Messaging                 783.4       3,670.0         14.4         $1,000 - $6,000
Interactive Voice Response      835.8       2,091.3         16.2         $1,320 - $3,730
Wireless PBX/Key                                                                        
  Telephone Systems             202.1       1,340.0         38.8                  $1,135
Server/PC-Based PBX              38.8       1,412.0         88.2         $  200 - $1,100
Internet Protocol Telephony     244.8       3,158.5(2)     132.0                  $1,055
</TABLE>
----------
(1) Dollars in millions
(2) Represents projected market revenue for 2002.

PRODUCTS

         The Company currently designs, develops,  markets, and supports a broad
range of (i) telephony products,  which include digital and analog 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 unified messaging systems;  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, and Internet messaging systems.

KEY TELEPHONE SYSTEMS

         Sales of key  telephone  systems  represented  approximately  72.4% and
74.7% of the  Company's  revenue  during  1997  and  1998,  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."
The Company supplies several models of key telephone sets,  several of which are
CTI compatible,  with  progressive  features for use in conjunction with each of
its key telephone systems.

         The Company currently  markets various lines of key telephone  systems,
under its STARPLUS and INFINITE brand names, for businesses  requiring as few as
three  incoming  lines and eight  stations  up to 144 lines and 250  stations (a
384-port  system).  The Company sells the STARPLUS line through large  wholesale
distributors  and the INFINITE  line through  telephone  sales and  installation
companies known as "direct  dealers." See Item 1, "Business - Sales,  Marketing,
and  Distribution."  The INFINITE brand telephone  systems  incorporate the base
platform and software of the STARPLUS Triad key telephone systems, which enables
the Company to leverage its research and development,  support,  and operational
resources.

         The Company  markets both digital and 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  analog  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

                                       2
<PAGE>
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  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.  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  models of  commercial  grade  telephones
through wholesale  distributors for use with analog or digital key systems,  PBX
systems,  or telephone  company central office  ("Centrex")  switching  systems.
Businesses,  school  districts,  and  the  hospitality  industry  represent  the
principal  purchasers of the Company's  commercial  grade  telephones.  Sales of
commercial grade telephones  accounted for approximately  15.7% and 11.9% of the
Company's  revenue  during  1997 and 1998,  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  improve  customer
service and 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  digitally  integrated  voice  processing  systems  for its
STARPLUS  Triad  and  INFINITE  product  lines to  differentiate  them  from its
competitors' products and to provide a value-added basis for increased sales and
profit margins.

         VOICE MAIL SYSTEMS

         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 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.

         In addition to its larger voice processing systems, the Company markets
a line of self-contained, competitively priced voice processing systems designed
for  small-  to  medium-sized  organizations.   These  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. As a result  of the  increased
functionality,  ease of installation  and use, and competitive  pricing of these
systems,  total sales of the Company's voice processing  systems  increased from
7.5% of the Company's revenue in 1997 to 11.6% of revenue in 1998.

                                       3
<PAGE>
         ADVANCED MESSAGING PLATFORM

         The Company's  Microsoft(R)  Windows NT-based messaging systems,  which
provide 4 to 48 port  capacities,  combine 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 Windows NT-based system also utilizes  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.

         The  Company's  Windows  NT-based  system  also  utilizes  Microsoft(R)
Exchange  technology to provide unified  messaging.  Unified  messaging  enables
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.

         INTERACTIVE VOICE RESPONSE

         The Company's  interactive  voice response  ("IVR") system connects the
business's  telephone  system to its host computer in order to permit the use of
any  telephone  to  access  and  store  certain  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  telephone.  IVR uses voice prompts to
communicate  the steps required to enable the caller to input  information to or
retrieve  information  from the database and to  communicate  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,   web-based  IVR,  speech
recognition, and text-to-speech capabilities.

         AUTOMATIC CALL DISTRIBUTION

         The Company markets its automatic call  distribution  systems  software
("ACD")  and a PC-based  ACD  reporting  package  for use with its  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

                                       4
<PAGE>
the  longest  waiting  call in order to speed  call  handling  at times of heavy
calling  activity.   The  PC-based  ACD  reporting  package  provides  real-time
statistics  and  comprehensive   reports  on  calling  activity  for  review  by
management.

COMPUTER-TELEPHONY INTEGRATION PRODUCTS

         The Company designs, develops, and markets CTI products that utilize an
open   architecture  to  integrate   computer  and  telephone   systems  into  a
user-friendly information storage,  processing, and system. 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.

         The Company's CTI product lines include software  applications designed
to operate in conjunction with  Microsoft(R)  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.

NEW PRODUCT DEVELOPMENT

         The Company  engages in an ongoing  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 ongoing
basis.  Since 1994,  the Company has  developed  and  introduced  several new or
enhanced  products and product lines,  including new ACD reporting  packages,  a
wireless key telephone adjunct for its digital key telephone systems, additional
enhancements  to its  Windows  NT-based  voice  messaging  systems  and  its IVR
systems, and a new line of digital key telephone systems.

         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,  a
new line of commercial grade telephones,  and an Internet telephony gateway.  In
addition,  the  Company is  focusing  research  and  development  efforts on the
integration  of  existing  and newly  developed  products  to  provide  complete
industry

                                       5
<PAGE>
standards-based  business communications solutions to its customers. The Company
from time to time enters into strategic  alliances with third parties related to
the development of new products, product lines, or product features. See Item 1,
"Business - Research and  Development;  Strategic  Alliances with LGIC and Other
Companies."

SALES, MARKETING, AND DISTRIBUTION

         The Company  currently  markets its products in all 50 states and, to a
limited  extent,  internationally  through  a  distribution  network  consisting
primarily of large wholesale  distributors  and telephone sales and installation
companies  known as "direct  dealers."  The Company  also  maintains an in-house
sales  staff that makes  direct  sales of its IVR  products to  businesses.  The
Company in the past has and in the future may market its  products  on a private
label basis to original equipment  manufacturers  ("OEMs").  The Company derived
approximately  80.3%,  15.8%,  2.5% and 1.0% of its total  revenue  in 1998 from
sales to distributors,  direct dealers, IVR customers,  and OEMs,  respectively.
The following  diagram  illustrates the distribution  channels for the Company's
product lines.

                                     VODAVI

                       INFINITE
      STARPLUS       DIGITAL SYSTEMS     IVR            INTERNATIONAL(1)
      --------       ---------------     ---            -------------
         |                  |             |                   |
         |                  |             |             International
    Distributor             |             |              Distributor
         |                  |             |                   |
         |                  |             |                   |
    Interconnect          Dealer          |                 Dealer
         |                  |             |                   |
         |                  |             |                   |
      End User           End User      End User            End User

----------
(1)      The  Company  currently  only  sells  certain  of its voice  processing
         products in international markets.

         WHOLESALE DISTRIBUTORS

         The Company designs and markets its STARPLUS brand of products for sale
through wholesale  distributors.  The distributors 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 support and training to enable
distributors 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  distributors  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)  availability  of
products in over 600 locations  throughout the United  States;  (iv) security of
receivables;  (v)  reduced  needs  for  direct  training  by the  Company;  (vi)
effective   promotion  of  the   Company's   products  at  trade  shows;   (vii)
geographically  dispersed sales forces that can reach customers more effectively
than the Company  would  otherwise be able to do; and (viii)  lower  support and
carrying costs compared with the costs  associated  with direct sales to a large
number of direct dealers.

                                       6
<PAGE>
         During 1998, the Company  introduced its STARPLUS Triad line of digital
telephone  systems  for  sale  through  distributors  to  a  limited  number  of
authorized  Triad  dealers.  The Triad  product  line  includes  a full array of
digital  telephone systems ranging from three lines and eight stations up to 384
ports,  as well as voice  messaging,  ACD,  CTI,  wireless,  and other  products
similar to the Company's INFINITE line of products.  The authorized dealers must
commit to minimum  purchases  of Triad or other  STARPLUS  products  and must be
trained  and  certified  through a formal  product  and sales  training  program
conducted by the Company. The Company provides the authorized Triad dealers with
order fulfillment, marketing, sales, and product support services.

         Distributors  that  currently  resell the  Company's  products  include
Graybar  Electric Co.,  Inc.  ("Graybar"),  Alltel  Supply,  Inc.,  Sprint/North
Supply,  Famous Telephone Supply, ADI, Target, Power & Telephone Supply Company,
GTE Supply Co., Catalyst, Anixter Brothers, Inc., and Capitol. Graybar accounted
for 40% and 39% of sales during 1997 and 1998, 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 and other  distributors  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  distributors.  As a result,  the  Company  believes  that a  decrease  in
purchases  by Graybar or other  distributors  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
distributors,  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  include  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 Company has increased the number of direct dealers that
sell its INFINITE  products from 15 at December 31, 1992 to approximately 100 at
December  31,  1998 and  continues  to seek  additional  direct  dealers for its
INFINITE products.

         IN-HOUSE SALES STAFF

         The Company  maintains an in-house  sales staff that makes direct sales
of  its  IVR  products.   The  Company's  in-house  sales  force  also  develops
relationships with strategic  partners,  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 voice processing  products in international
markets may increase in the future as demand for features such as voice mail and
interactive  voice response  increases,  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 U.S. dollars.

RESEARCH AND DEVELOPMENT; STRATEGIC ALLIANCES WITH LGIC 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

                                       7
<PAGE>
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 LGIC 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 LGIC,  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 LGIC provides  hardware
research,  design and development,  development of components such as integrated
circuits and semiconductor chips, and manufacturing and production  engineering.
Generally,  LGIC contributes the ongoing research and development  costs for the
product  hardware in return for an  arrangement  under which LGIC  produces  the
finished  goods  developed  under the  alliance.  To the extent that the Company
develops new hardware in conjunction with LGIC or another  development  partner,
the development  partner  typically retains ownership rights to the new hardware
and the Company retains the right to sell products  incorporating  that hardware
throughout  North America.  See Item 1, "Business -  Manufacturing"  and Item 1,
"Special  Considerations  - The Company Relies on LGIC as a Strategic  Partner."
The Company has successfully  engaged in such projects with LGIC in the past and
believes  that it will  continue  to have  access  to LGIC's  advanced  hardware
research and development capabilities as the Company develops new product lines.

         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,  computer  telephony,  and
Internet telephony. The Company believes that its strategic alliances with other
companies  enables the Company to develop products and bring them to market more
quickly and at a lower cost than it would be able to achieve by  developing  the
products internally.  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, full-featured commercial
grade   telephones,   and  certain  of  its  voice   processing   systems  under
manufacturing  arrangements with various  third-party  manufacturers,  including
LGIC.  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  digital  telephone  systems  and
certain of its commercial  grade  telephones from LGIC, which owns the rights to
produce such equipment.  The Company purchases products  manufactured by LGIC in
Korea on a purchase order basis. LGIC owns approximately  18.7% of the Company's
outstanding  Common  Stock.  See Item 1, "Special  Considerations  - The Company
Relies on LGIC as a Strategic

                                       8
<PAGE>
Partner" and "Special  Considerations - Certain  Conflicts of Interest May Arise
as a Result of LGIC's Ownership Interest in the Company."

         The Company obtains certain of its analog telephone systems and most of
its commercial grade  telephones and replacement  parts for such telephones from
LG Srithai,  Ltd.  ("LGST"),  a joint venture  between LGIC 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. The LGST Agreement renews 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  - The Company  Relies on LGIC as a
Strategic  Partner" and "Special  Considerations - Certain Conflicts of Interest
May Arise as a Result of LGIC's Ownership Interest in the Company."

         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  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
economic problems at times in the past. 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   -  The   Company   Depends  on  Third   Parties  for
Manufacturing"  and Item 1,  "Special  Considerations  - The Company Faces Risks
Associated with 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

                                       9
<PAGE>
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 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  performs  repairs on certain of its  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  Lucent
Technologies,   Inc.,  Nortel,   Toshiba  Information  Systems,   Inc.,  Comdial
Corporation,  Panasonic  Communications  & Systems Co.,  Nitsuko,  and NEC Corp.
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  Intervoice  Communications,  Inc.,
Edify Corp., Periphonics,  Syntellect,  and Brite Voice Systems. In the computer
telephony market, the Company competes with many of the same companies indicated
above.  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. 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 revenue,  profitability,  and success of the Company  depends  substantially
upon its ability to compete with other providers of telephone  systems and other
telephony  products.  The Company cannot provide assurance that it will continue
to be able to successfully compete with such organizations.

PATENTS, TRADEMARKS, AND LICENSES

         As of December 31, 1998,  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

                                       10
<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 March 26,  1999,  the  Company  employed a total of 164  persons,
consisting  of 160  full-time  employees  and four  part-time  employees  at its
facilities in Scottsdale, Arizona and Norcross, Georgia. This number includes 33
persons in  engineering  and product  development,  79 in sales,  marketing  and
technical

                                       11
<PAGE>
support, 18 in warehouse and distribution functions, 15 in equipment repair, and
19 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,
Taiwan,  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:

            NAME             AGE                POSITION
            ----             ---                --------

William J. Hinz..........    53    Chairman of the Board
Gregory K. Roeper........    38    President, Chief Operating Officer, Chief
                                     Financial Officer, Secretary, and Treasurer

         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.  Since
March 1996,  Mr. Hinz has served as Executive Vice President of Operations and a
director of  Stolper-Fabralloy  Company, a precision  aerospace engine component
manufacturer  that is a  subsidiary  of Triumph  Group,  Inc.,  a publicly  held
company.  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.

         GREGORY K. ROEPER has served as the Company's  President since December
1998;  as Chief  Operating  Officer since June 1998; 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 Executive Vice President
- Finance, Administration, and Operations from December 1997 until December 1998
and as 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.

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 Vodavi Division and
its  predecessor  had engaged in the design,  development,  and marketing of key
telephone systems, commercial grade telephones, and related products since 1983.
In July 1995,  the Company  acquired  from an  affiliate  of LGIC certain of the
assets and liabilities of a telecommunications equipment repair business located
in Scottsdale,  Arizona.  In October 1995,  Vodavi-CT,  Inc.  (formerly Enhanced
Systems,  Inc.)  ("Vodavi-CT")  merged  with a wholly  owned  subsidiary  of the
Company.  Vodavi-CT  develops and markets voice  processing,  interactive  voice
response,  and call accounting  software products for small,  medium,  and large
businesses,  universities, and government organizations in the United States and
internationally.

                                       12
<PAGE>
                             SPECIAL CONSIDERATIONS

         INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS,  IN ADDITION
TO THOSE DISCUSSED  ELSEWHERE IN THIS REPORT,  IN EVALUATING THE COMPANY AND ITS
BUSINESS.

A VARIETY OF FACTORS MAY AFFECT OPERATING RESULTS

         A wide variety of factors  affect the Company's  operating  results and
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;

         +    the  Company's   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 availability and terms of adequate financing;

         +    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.

                                       13
<PAGE>
THE COMPANY DEPENDS ON THIRD PARTIES FOR MANUFACTURING

         The Company  depends upon third  parties to  manufacture  its products.
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, certain difficulties could have a material
adverse  effect on the Company,  including any  difficulties  encountered by the
third-party manufacturers that result in

         +    product defects,

         +    production delays,

         +    cost overruns, or

         +    the inability to fulfill orders on a timely basis.

The Company's operations would be adversely affected if the Company were to lose
its relationship with any of its suppliers,  if any of its suppliers' operations
were interrupted or terminated,  or if overseas or air  transportation  services
were disrupted 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.

THE COMPANY FACES RISKS ASSOCIATED WITH INTERNATIONAL MANUFACTURING SOURCES

         The Company  currently  obtains  certain of its products  under various
manufacturing  arrangements  with  third-party  manufacturers  in  South  Korea,
Thailand,  Taiwan,  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 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'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
following:

         +    the  business   and   financial   condition  of  the   third-party
              manufacturers;

         +    political and economic conditions abroad;

         +    the  possibility of  expropriation,  supply  disruption,  currency
              controls, and exchange fluctuations; and

         +    changes in tax laws, tariffs, and freight rates.

Although the economic  situation in Asia in recent years 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 RELIES ON LGIC AS A STRATEGIC PARTNER

         During 1998, LG Electrontics,  Inc. ("LGE")  transferred certain of its
assets  related to  business  communications  systems to LGIC.  The  Company now
relies on LGIC to supply  certain key  telephone  systems and  commercial  grade
telephones as well as on LGIC's engineering,  hardware and circuit  development,
and manufacturing capabilities.  The Company now purchases a significant portion
of its key telephone systems and commercial grade telephones from LGIC and LGST,
an affiliate of LGIC.  During 1997, the Company  purchased $18.8 million of such
products from LGE and LGST, constituting  approximately 63.5% of total purchases
during 1997.  During 1998, the Company  purchased  $16.3 million of product from
LGIC, LGE, and LGST, constituting

                                       14
<PAGE>
approximately  60% of total  purchases of such products during 1998. See Item 1,
"Business  -  Manufacturing"  and  Item 1,  "Special  Considerations  -  Certain
Conflicts of Interest May Arise as a Result of LGIC's Ownership  Interest in the
Company." The Company  currently  obtains products from LGIC on a purchase order
basis and  cannot  provide  assurance  that it will be able to secure  long-term
manufacturing arrangements for the products it currently obtains from LGIC. LGIC
has no formal commitments to support the business or operations of the Company.

THE COMPANY FACES RISKS ASSOCIATED WITH COMPETITION

         The Company engages in an intensely  competitive business that has been
characterized  by  price  erosion,   rapid  technological  change,  and  foreign
competition.   The  Company  competes  with  major  domestic  and  international
companies. Many of the Company's competitors have greater market recognition and
substantially greater financial, technical,  marketing,  distribution, and other
resources than the Company possesses. Emerging companies also may increase their
participation  in the  telephone  systems  and  peripherals  markets.  Principal
competitors include


   + Lucent Technologies, Inc.                 + Active Voice Corporation
   + Nortel                                    + Applied Voice Technology
   + Toshiba Information Systems, Inc.         + Intervoice Communications, Inc.
   + Comdial Corporation                       + Edify Corp.
   + Panasonic Communications & Systems Co.    + Periphonics
   + Nitsuko                                   + Syntellect
   + NEC Corp.                                 + Brite Voice Systems

         The ability of the Company to compete  successfully depends on a number
of factors both within and outside its control, including the following:

         +    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.  The Company may not
continue to be able to compete successfully in the future.

THE COMPANY DEPENDS 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

                                       15
<PAGE>
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,  customers or markets may
not accept new product lines. The failure of the Company to design and implement
enhancements  to  existing  product  lines  or the  failure  of the  Company  to
introduce  new  products on a timely and  cost-effective  basis would  adversely
affect the Company's future operating results.

         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,  the Company may not 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.

THE COMPANY RELIES ON AN INDEPENDENT DISTRIBUTION NETWORK

         The Company  currently  markets  its  products  through a  distribution
network consisting primarily of large wholesale distributors and telephone sales
and installation  companies known as "direct  dealers."  Distributors  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 distributors,  however, could result in inventory levels
that  exceed  anticipated  sales,  which  could delay  purchases  of  additional
products from the Company until the distributors'  inventories reach re-ordering
levels.  Direct dealers  generally stock  inventories only in quantities  deemed
sufficient to fill anticipated short-term orders. As a result,  distributors and
direct  dealers  generally  cancel  orders and delay or change  volume levels on
short notice to the Company.

         The Company depends upon independent distributors 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 distributors and
direct  dealers,  most of which carry  products  that compete  directly with the
Company's  products.   The  Company  may  not  be  able  to  maintain  favorable
relationships  with the distributors 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. In addition, the Company may not be able to
develop  such  relationships  with  additional  distributors  and dealers in the
future. See Item 1, "Business - Sales, Marketing, and Distribution."

         Graybar  accounted for 40% of sales during 1997 and 39% of sales during
1998.  Accounts  receivable from Graybar  comprised  approximately  32% of total
accounts receivable at December 31, 1998.

THE COMPANY FACES RISKS  ASSOCIATED  WITH PATENTS,  LICENSES,  AND  INTELLECTUAL
PROPERTY

         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

                                       16
<PAGE>
contractual  agreements,  and  technical  measures  to protect  its  proprietary
technology.  The Company has acquired  certain  patents and patent  licenses and
intends  to  continue  to  seek  patents  on its  inventions  and  manufacturing
processes.  The Company faces risks associated with its  intellectual  property,
including the following:

         +    the steps taken by the Company to protect its  proprietary  rights
              may be inadequate to protect misappropriation of such rights;

         +    third  parties may  independently  develop  equivalent or superior
              technology;

         +    the  process  of  seeking  patent   protection  can  be  long  and
              expensive, and patents may not issue from future applications;

         +    existing  patents or any new patents that are issued may not 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;

         +    the Company may commence  litigation  to enforce  patents or other
              intellectual  property  rights,  or to defend the Company  against
              claimed  infringement of the rights of others,  which could result
              in substantial cost to and diversion of effort by the Company.

         As is typical in the telecommunications industry, the Company from time
to time has  received,  and in the future may receive,  allegations  of 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. In the
event that a third party alleges that the Company is infringing its rights,  the
Company may not be able to obtain licenses on commercially reasonable terms from
the third party, if at all, or the third party may commence  litigation  against
the  Company.  The failure to obtain  necessary  licenses or other rights or the
occurrence  of  litigation  arising  out of such  claims  could  materially  and
adversely affect the Company, its result of operations, or prospects.

THE COMPANY MUST BE ABLE TO MANAGE ITS GROWTH

         The failure of the Company to manage its growth in an effective  manner
could have a material adverse effect on the Company's operations.  The Company's
ability to manage its growth effectively in the future will require it to

         +    enhance its operational, financial, and management systems;

         +    expand its facilities and equipment;

         +    successfully  hire,  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

         +    integrate   new   software   systems   with   evolving    hardware
              technologies.

         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.  Any  increase  in the  Company's
expenditures  in  anticipation  of future  orders  would  adversely  affect  the
Company's  profitability if those orders 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.  Such increases in
design  and  production  services  place  excessive  short-term  burdens  on the
Company's resources.

THE TELECOMMUNICATIONS INDUSTRY IS CYCLICAL

         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

                                       17
<PAGE>
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 vary from quarter to quarter to a
greater extent in future periods. The expanding importance of these new products
could  result in  significant  variations  in the  Company's  overall  operating
results on a quarterly basis.

THE COMPANY MUST FINANCE THE  EXPANSION OF ITS BUSINESS AND THE  DEVELOPMENT  OF
NEW PRODUCTS

         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,  any failure of the Company to increase net sales  sufficiently to
offset the increased costs may adversely affect the Company's operating results.
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 Company cannot
predict the timing and amount of any such capital  requirements.  Such financing
may  not  be  available  or,  if  available,  may  not  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,  from time to time  experience  difficulties  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 of its
requirements  for voice  processing  boards from  Dialogic  on a purchase  order
basis.  The  failure  of the  Company to obtain  voice  processing  boards  from
Dialogic  at any time that  alternative  sources of similar  components  are not
readily  available  could  adversely  affect  the  Company's  ability to deliver
certain of its product lines.

THE COMPANY DEPENDS 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

                                       18
<PAGE>
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.  The Company cannot provide assurance
that it will be able to retain its current  personnel or that it will be able 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.

YEAR 2000 COMPLIANCE

         Many currently installed computer systems and software products may not
function  properly when processing  transactions that include dates on and after
January 1, 2000.  The Company  has  completed  its  assessment  of its  existing
products and has modified or upgraded those products to be 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.  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  evaluating  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.  See Item 7,
"Management's  Discussion  and Analysis of Financial  Conditions  and Results of
Operations - Year 2000 Compliance."

CERTAIN CONFLICTS OF INTEREST MAY ARISE AS A RESULT OF LGIC'S OWNERSHIP INTEREST
IN THE COMPANY

         LGIC  owns  approximately  18.7% of the  Company's  outstanding  Common
Stock. The Company obtains certain of its digital  telephone systems and certain
of its commercial  grade  telephones from LGIC and obtains certain of its analog
telephone  systems and most of its commercial  grade  telephone and  replacement
parts for such telephones from LGST, an affiliate of LGIC. See Item 1, "Business
- Manufacturing"  and "Special  Considerations - The Company Relies on LGIC as a
Strategic  Partner." As a result of LGIC's  indirect  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 LGIC.

         The Company,  LGIC, and certain other  stockholders  of the Company are
parties to a stockholders' agreement. At any time that the Company issues shares
of its  Common  Stock in an amount  representing  1% or more of its  outstanding
Common Stock, the stockholders'  agreement gives LGIC the right to purchase from
the Company a  sufficient  number of shares as may be required to enable LGIC to
maintain the  percentage  of ownership of Common Stock that existed  immediately
prior to such  issuance.  The  stockholders'  agreement  also requires  Glenn R.
Fitchet and Steven A. Sherman,  former officers and directors of the Company, to
vote their  shares of Common  Stock to elect as  directors  of the Company  that
number of persons designated by LGIC that comprises a percentage of the Board of
Directors equal to LGIC's then  percentage of ownership of the Company's  Common
Stock,  provided  that  so  long  as  LGIC  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 LGIC as a director.

                                       19
<PAGE>
THE COMPANY'S STOCK PRICE MAY BE VOLATILE

         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 that may be granted  under the
Company's stock option plan and other options granted to consultants. Options to
acquire 197,200 shares of Common Stock at a weighted  average  exercise price of
$4.85 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.  Those  warrants have an
exercise  price per share of $7.20 and are  exercisable  until  October 2000. In
February  1999,  the Company  issued to an investor  relations  firm warrants to
acquire an aggregate of 122,500  shares of Common  Stock.  Those  warrants  have
exercise prices ranging from $4.00 to $6.50 per share and are exercisable  until
February  2004.  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
1,715,000  shares  of  Common  Stock,  including  1,360,030  shares  held by the
Company's  directors,  executive officers,  and LGIC, currently are eligible for
sale in the public market,  subject to compliance with the  requirements of Rule
144 under the securities laws.  Shares issued upon the exercise of stock options
granted 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  dilute  the  voting  power of the
currently  outstanding  shares of Common  Stock and could  dilute  earnings  per
share.

                                       20
<PAGE>
CHANGE IN CONTROL PROVISIONS

         The Company is subject to provisions under Delaware  corporate law that
would  require  the  Company  to  obtain  certain  approvals  from the  Board of
Directors or stockholders in order to engage in a business  combination  with an
interested  stockholder  under  certain  circumstances.  The  Company's  Amended
Certificate  of  Incorporation  and  Bylaws  also  contain  a  number  of  other
provisions  relating to corporate  governance and to the rights of stockholders.
These provisions

         +    authorize the Board of Directors to fill vacancies on the Board of
              Directors;

         +    authorize  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

         +    require the  affirmative  vote of two-thirds of the directors then
              in office to approve:

              -- a public offering of the capital stock of the Company;
              -- the merger with or the  acquisition of another  business or the
                 acquisition  of a  significant  amount of the assets of another
                 business;
              -- the sale of a significant amount of the assets of the Company;
              -- the  Company  entering  into  contracts  with  stockholders  or
                 directors of the Company;
              -- the  assumption or acquisition by the Company of debt in excess
                 of $1.0 million; and
              -- any amendment of the Amended  Certificate of Incorporation  and
                 Bylaws of the  Company or its wholly  owned  subsidiary  Vodavi
                 Communications Systems, Inc.

These  provisions in the Company's  Amended  Certificate  of  Incorporation  and
Bylaws and Delaware  corporate law 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 DOES NOT PAY CASH 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 Vodavi  Communications  Systems,  Inc., a wholly owned subsidiary of the
Company ("VCS") and General Electric Capital Corporation ("GE Capital") prohibit
VCS from paying dividends to the Company without the consent of GE Capital. This
restriction could limit the Company's ability to pay dividends in the future.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

         Certain statements and information  contained in this Report 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  laws.  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

                                       21
<PAGE>
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  Vodavi-CT  filed a lawsuit
against Michael Mittel and Fereydoun  Taslimi,  former officers and directors of
Vodavi-CT,  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
Vodavi-CT  in  1995;  breached  certain  terms of  their  respective  employment
contracts with Vodavi-CT;  and converted  certain corporate assets of Vodavi-CT,
breached  their  fiduciary  duties to  Vodavi-CT,  and  misappropriated  certain
corporate  opportunities  for their own benefit.  The Company and  Vodavi-CT 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 Vodavi-CT.  The lawsuit alleges that
Vodavi-CT  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 commenced discovery in the lawsuits. In January 1999, the
parties  filed  motions for summary  judgment  with respect to portions of their
respective  claims.  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 Vodavi-CT.

         On November 9, 1998,  Paradygm  Communications,  Inc.  ("Paradygm") and
R.C.  Patel  ("Patel")  filed a lawsuit  against  VCS in the  Superior  Court of
Gwinnett County, Georgia (Case No. 98-A-8744-6).  The complaint alleges that VCS
(i) breached its strategic  alliance  agreement  with  Paradygm,  as well as its
warranty of product fitness under the strategic alliance agreement;  (ii) failed
to provide  reasonable  technical  and sales  training  assistance to Paradygm's
employees  to  support  Paradygm  in its  efforts  to sell  products  under  the
agreement;  and  (iii)  engaged  in  conduct  that  constitutes  intentional  or
negligent  misrepresentation.  The complaint  requests  compensatory,  punitive,
incidental,  and  consequential  damages,  attorneys'  fees, plus any additional
relief. VCS answered the complaint denying the foregoing allegations,  asserting
that the complaint fails to state a claim and, for various  reasons,  the relief
sought by  Paradygm  and  Patel is  barred.  VCS also has  filed a  counterclaim
against Paradygm  alleging that Paradygm  breached the agreement  because of its
failure  to meet its  payment  obligations  to VCS.  The  counterclaim  requests
amounts  due  pursuant  to  the  strategic  alliance  agreement,  the  costs  of
litigation,  and reasonable  attorneys'  fees. The Company intends to vigorously
defend this lawsuit.

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.

                                                              HIGH       LOW
                                                              ----       ---
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...................................        $4.50      $3.25
     Second quarter..................................         3.97       2.75
     Third quarter...................................         3.25       1.75
     Fourth quarter..................................         3.50       1.81

1999:
     First quarter (through March 26, 1999)..........        $3.63      $2.38


         On March 26,  1999,  the closing  sales  price of the Common  Stock was
$2.75 per  share.  As of March 26,  1999,  there  were 31  holders of record and
approximately 640 beneficial owners of the Company's Common Stock.

         The Company has not  declared or paid any cash  dividends on its Common
Stock  and  does  not  intend  to  declare  or pay  any  cash  dividends  in the
foreseeable  future. In addition,  the Company's credit facility with GE Capital
restricts the Company's ability to pay cash dividends.

                                       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.

<TABLE>
<CAPTION>
                                       (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

                               VODAVI
                             DIVISION(1)
                             -----------                         THE COMPANY
                            THREE MONTHS    -----------------------------------------------------
                           ENDED MARCH 31,                  YEAR ENDED DECEMBER 31,
                           --------------   -------------------------------------------------------
OPERATING DATA:                 1994        1994(2)       1995        1996        1997      1998
                                ----        -------       ----        ----        ----      ----
<S>                            <C>          <C>         <C>         <C>         <C>        <C>
Revenue....................... $8,587       $29,140     $39,601     $46,154     $47,675    $47,983
Gross margin..................  2,418         8,613      12,404      15,312      15,667     15,858
Operating expenses............  1,872         6,291      10,399      13,749      13,828     14,414
Asset impairment and
   restructuring charges......     --            --          --       4,805         819         --
Operating income (loss).......    546         2,322       2,055      (3,242)      1,020      1,444
Interest & other expenses.....     --           576       1,130         840         663        791
Pretax income (loss)..........    546         1,746         875      (4,082)        357        653
Income taxes..................     --           693         417         327         142       (331)
Net income (loss).............    546         1,053         458      (4,409)        215        984
Net income (loss) per share,
   diluted....................    N/A         $0.55       $0.17      $(1.02)      $0.05      $0.23
Weighted average shares
   outstanding, diluted.......    N/A     1,917,346   2,769,434   4,342,238   4,342,238  4,342,238


                              AS OF MARCH 31,               AS OF DECEMBER 31,
                              --------------  -----------------------------------------------
BALANCE SHEET DATA:               1994          1994     1995       1996      1997     1998
                                  ----          ----     ----       ----      ----     ----
<S>                            <C>          <C>       <C>       <C>       <C>     <C>
Assets:                          
 Current assets................  $12,034      $14,122   $17,719   $16,591   $19,507   $16,766
 Property and equipment........      452          635     1,731     2,465     2,616     2,663
 Goodwill......................       --        2,833     7,089     2,547     2,395     2,244
 Other.........................       --          357       931       815     1,146     1,169
                                 -------      -------   -------   -------   -------   -------
                                 $12,486      $17,947   $27,470   $22,418   $25,664   $22,842
                                 =======      =======   =======   =======   =======   =======
Liabilities:                                                                                 
 Current liabilities...........   $3,128       $5,316    $5,706    $7,292    $7,115    $4,333
 Long-term debt................       --        8,574     7,884     5,588     8,752     7,711
 Other long-term obligations...       --           --        69       137       182       199
 Due to parent.................    2,705           --        --        --        --        --
                                 -------      -------   -------   -------   -------   -------
Total liabilities..............    5,833       13,890    13,660    13,017    16,049    12,243
Stockholders' equity...........    6,653        4,057    13,810     9,401     9,615    10,599
                                 -------      -------   -------   -------   -------   -------
                                 $12,486      $17,947   $27,470   $22,418   $25,664   $22,842
                                 =======      =======   =======   =======   =======   =======
</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 that
appear elsewhere in this Report.
<TABLE>
<CAPTION>
                                                    YEARS ENDED DECEMBER 31,
                                -----------------------------------------------------------
                                      1996                  1997                  1998
                                ----------------      ----------------     ----------------
                                                (DOLLAR AMOUNTS IN THOUSANDS)
                                   $         %           $         %          $         %
                                -------    -----      -------    -----     -------    -----
<S>                             <C>        <C>        <C>        <C>       <C>        <C>
Revenue ....................    $46,154    100.0%     $47,675    100.0%    $47,983    100.0%
Cost of goods sold .........     30,842     66.8%      32,008     67.1%     32,125     67.0%
                                -------    -----      -------    -----     -------    -----
   Gross margin ............     15,312     33.2%      15,667     32.9%     15,858     33.0%
Operating expenses:
Engineering and product
   development .............      2,161      4.7%       2,101      4.4%      1,616      3.4%
Selling, general, and
   administrative ..........     11,588     25.1%      11,727     24.6%     12,798     26.7%
Asset impairment and
     restructuring charges..      4,805     10.4%         819      1.7%         --      0%
                                -------    -----      -------    -----     -------    -----
Operating income (loss) ....     (3,242)    (7.0)%      1,020      2.2%      1,444      2.9%
Other income (expense), net        (840)     1.8%        (663)    (1.4)%      (791)    (1.6)%
                                -------    -----      -------    -----     -------    -----
Pretax income (loss) .......     (4,082)    (8.8)%        357      0.8%        653      1.3%
Income tax expense (benefit)        327      0.7%         142      0.3%       (331)    (0.7)%
                                -------    -----      -------    -----     -------    -----
Net income (loss) ..........    $(4,409)    (9.5)%    $   215      0.5%    $   984      2.0%
                                =======    =====      =======    =====     =======    =====
</TABLE>

REVENUE

         Revenue in 1998  increased  slightly to $48.0  million  over revenue of
approximately  $47.7 million in 1997. Sales of key telephone  products increased
by  approximately  $1.3  million  over  1997 and  sales of  voice  mail  systems
increased by  approximately  $2.0 million over sales of those  products in 1997.
These sales increases were offset,  however,  by an  approximately  $1.8 million
decrease in sales of  commercial  grade  telephones  and an  approximately  $1.6
million  decrease in sales to OEMs. The Company intends to continue  emphasizing
sales of its newer product lines, such as its new voice mail systems, which were
well-received  in 1998. The Company also is taking steps to slow the decrease in
sales of its current line of commercial  grade telephones and plans to introduce
a new line of commercial grade telephones in 1999.

         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.

                                       25
<PAGE>
COST OF GOODS SOLD

         Gross  margins  increased  slightly  to  33.0%  of  revenue  in 1998 as
compared with 32.9% in 1997.  Although sales of higher-margin voice mail systems
increased  substantially  during 1998, overall gross margins remained relatively
constant  as a result of  increased  rebates  provided  primarily  to  wholesale
distributors  and  the  interconnects  to  which  those  distributors  sell  the
Company's  products.  The Company  provided  the  increased  rebates in order to
stimulate "pull through" demand for its products.

         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.

ENGINEERING AND PRODUCT DEVELOPMENT

         Expenditures  related to engineering and product development  decreased
to  approximately  $1.6  million in 1998 as compared  with $2.1 million and $2.2
million in 1997 and 1996, respectively.  This decrease is due to the elimination
of several  engineering and products  development  positions within the Company.
The Company  believes the  elimination of these positions will have no effect on
new product development.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

         Selling,  general and  administrative  ("SG&A")  expenses  increased to
approximately $12.8 million in 1998 as compared with $11.7 million in 1997. As a
percentage of revenue, SG&A expenses increased to 26.7% in 1998 as compared with
24.6% in 1997.  This  increase  can be  attributed  primarily  to an increase in
personnel in sales and marketing functions.

         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 Vodavi-CT 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.

ASSET IMPAIRMENT AND RESTRUCTURING CHARGES

         In 1996, the Company recorded a $4.2 million write-down of the goodwill
associated  with the  acquisition  of Vodavi-CT 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  Vodavi-CT  resulted 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 Vodavi-CT.  These  reserves  included the costs of
relocating  new management to Atlanta,  Georgia;  costs related to the Company's
lawsuit against the former owners of Vodavi-CT;  costs related to the settlement
of an outstanding  legal matter;  and other  expenses  related to the management
change.

         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.  At December 31, 1997,
approximately  $700,000 was  included in accrued  liabilities  as  restructuring
reserves on the Company's balance sheet.

                                       26
<PAGE>
         During 1998,  approximately  $412,000 and $196,000 was charged  against
the reserve for severance payments and legal fees,  respectively.  The remaining
restructuring  reserve balance  included in accrued  liabilities at December 31,
1998, was approximately $92,000, which relates to legal fees.

OTHER INCOME (EXPENSE), NET

         Other income  (expense),  net consists  primarily of interest  expense.
Interest expense was approximately  $791,000,  $663,000,  and $840,000, in 1998,
1997, and 1996, respectively.  The $128,000 increase in interest expense in 1998
can be attributed  to an increase in borrowings as a result of increased  levels
of inventory and receivables. 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."

INCOME TAXES

         The effective  rate of the Company's  income tax provision was (50.7)%,
31.6%, and (8.0)%,  in 1998, 1997, and 1996  respectively.  The Company utilized
research  and  development  tax  credits of  approximately  $509,000 in 1998 and
approximately  $100,000 in 1997, which favorably impacted the effective tax rate
in each of those years. 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
Vodavi-CT was not deductible, which also impacted the effective rate for 1996.

LIQUIDITY AND CAPITAL RESOURCES

         The Company had  approximately  $796,000 in cash at December  31, 1998.
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,  1998 were
approximately  $7.7  million,  which  represents  a $900,000  decrease  from its
borrowings  of $8.6 million at December 31, 1997.  The decrease is attributed to
the  increase in current  assets of  approximately  $2.7  million  over the same
period.  At December  31,  1998,  the Company had total  availability  under its
operating line of credit of approximately  $2.0 million,  with $200,000 reserved
for standby  letters of credit and $1.25 million  reserved for  maintaining  the
minimum availability covenant, resulting in net availability of $550,000.

         The  Company  has a $12.0  million  revolving  line of  credit  with GE
Capital that extends  through  April 2000.  Borrowings  under the line of credit
bear interest at 2.5% over the 30-day commercial paper rate, which resulted in a
borrowing rate of 7.8% at December 31, 1998. 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.  At December 31, 1998,  the Company was in compliance
with all of the covenants.

         The Company has several  capital lease  agreements  with interest rates
ranging from 9% to 13%. These  agreements  generally have terms of 24 months and
provide  the  Company  with the option to purchase  the leased  equipment  for a
nominal amount at the end of the lease term.

         The Company has no significant  outstanding  commitments other than its
existing  lease  agreements  and  commitments  under  a  royalty  agreement,  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 may explore
acquisition  opportunities  as they arise and may be required to seek additional
financing in the future to meet such opportunities.

                                       27
<PAGE>
INTERNATIONAL MANUFACTURING SOURCES

         The Company  currently  obtains  certain of its products  under various
manufacturing  arrangements  with  third-party  manufacturers in Asia. As of the
date of this  Report,  the Company  does not believe  that the current  economic
situation in Asia will have any adverse impact on the Company's operations.

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 yet  completed  an  internal  system  assessment  to  determine  whether its
existing computer hardware and software systems are "Year 2000" compliant.

         The Company currently is evaluating its entire internal computer system
and has  engaged a  third-party  consultant  in  connection  with the upgrade of
certain of its existing  financial and accounting  systems,  including  software
related to order entry,  inventory management,  materials planning, and accounts
payable and  receivable.  These  upgrades  are  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.  As of the filing  date of this  Report,  these
projects are  approximately 75 to 85% complete.  The Company  currently plans to
test the  upgrades to this system in May 1999.  The Company  estimates  that the
cost of these upgrades will be approximately $25,000.

         The Company has been advised  that  certain of the computer  processing
platforms and networks and certain  software systems used in connection with its
operations, other than the financial and accounting systems described above, may
not be Year 2000  compliant.  The Company  currently is assessing  the extent of
such  non-compliance  and intends to develop a program to brings  those  systems
into Year 2000  compliance  during  calendar  1999.  A failure  of its  computer
systems as a result of Year 2000 issues could have a material  adverse effect on
the Company's operations.

         A significant portion of the Company's business  communications systems
products is manufactured by third parties in Asia. The Company has initiated but
has not yet completed an assessment of the Year 2000 risks  associated  with the
inability of those  manufacturers to bring their production  processes and other
computer-based  systems  into Year 2000  compliance.  Because the  manufacturing
processes  utilized  do not rely  upon  date-related  information,  the  Company
currently  believes that a failure on the part of its overseas  manufacturers to
bring their processes and equipment into Year 2000 compliance does not represent
a material  risk to the  Company's  ability to obtain its  products  on a timely
basis.

         Certain of the Company's  products  contain  software and hardware that
perform  functions  based  upon  date-related   information.   The  Company  has
identified  those of its existing  products that are not Year 2000 compliant and
has completed  development of upgrades or  modifications  to those products that
will enable them to process Year 2000 dates without malfunctioning.  The Company
believes  that it will be able to pass along to its  customers  costs related to
upgrading installed products that are no longer covered by the Company's product
warranties.  The  Company  also  believes  that the costs  related to  upgrading
installed  products that remain under the Company's product  warranties would be
relatively  insignificant.  To date,  the  Company  has  incurred  approximately
$15,000  in  costs  associated  with the  development  of Year  2000  compliance
upgrades.  The inability of the Company to develop and provide on a timely basis
product  modifications  that may be required could result in a material  adverse
effect on the Company, including increased warranty costs, customer satisfaction
issues, and potential litigation.

         The Company is unable to fully assess the impact of the Year 2000 issue
as of the filing date of this Report.  The Company  currently is evaluating  the
Year 2000 issue as it relates to computer  systems  operated by all of the third
parties,   including   manufacturers,   suppliers,   customers,   and  financial
institutions,  with which the Company's  systems  interface.  The 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

                                       28
<PAGE>
condition,  and  operating  results.  As of the filing date of this Report,  the
Company has not  formulated  a  contingency  plan with  respect to the Year 2000
compliance issues described above.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         Not applicable.

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  1999  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 1999 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 1999 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 1999 Annual Meeting of Stockholders.

                                       29
<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

EXHIBIT
NUMBER                             EXHIBIT
------                             -------
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) 
10.2     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(8)
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)
10.15    Assignment  and  Assumption  Agreement  dated  April 11,  1994  between
         Executone  Information  Systems,  Inc.  and  V  Technology  Acquisition
         Corp.(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)

                                       30
<PAGE>
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.(8)
10.33    Consulting  Agreement  dated as of  December  5,  1997  between  Vodavi
         Technology, Inc. and Steven A. Sherman(8)
21       List of Subsidiaries
23.1     Consent of Arthur Andersen LLP
27.1     Financial Data Schedule

----------
(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.
(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.
(8)  Incorporated  by reference to the  Registrant's  Annual Report on Form 10-K
     for the fiscal year ended December 31, 1997, as filed on March 31, 1998 and
     as amended on Form 10-K/A filed on April 30, 1998.

                                       31
<PAGE>
                                   SIGNATURES

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

                                           VODAVI TECHNOLOGY, INC.


Date:  March 30, 1998                      By:  /s/ William J. Hinz
                                              ----------------------------------
                                               William J. Hinz
                                               Chairman of the Board

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

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

/s/ William J. Hinz          Chairman of the Board (Principal     March 30, 1999
---------------------------  Executive Officer)
William J. Hinz


/s/ Gregory K. Roeper        President, Chief Operating           March 30, 1999
---------------------------  Officer, Chief Financial Officer,
Gregory K. Roeper            Secretary, and Treasurer
                             (Principal Accounting Officer)


/s/ Nam K. Woo               Director                             March 30, 1999
---------------------------
Nam K. Woo


                             Director                             March __, 1999
---------------------------
Gilbert H. Engels


/s/ Stephen A Mcconnell      Director                             March 30, 1999
---------------------------
Stephen A McConnell


/s/ Emmett E. Mitchell       Director                             March 30, 1999
---------------------------
Emmett E. Mitchell


                                       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, 1997 and 1998 ...........   F-3

Consolidated Statements of Operations for the Years Ended
   December 31, 1996, 1997, and 1998 ...................................   F-4

Consolidated Statements of Changes in Stockholders' Equity for
   the Years Ended December 31, 1996, 1997, and 1998 ...................   F-5

Consolidated Statements of Cash Flows for the Years Ended
   December 31, 1996, 1997, and 1998 ...................................   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,
1997 and 1998, 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,  1998.  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,  1997  and  1998  and the  results  of  their
operations  and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.


                                                  /s/ ARTHUR ANDERSEN LLP


Phoenix, Arizona,
   January 29, 1999.

                                      F-2
<PAGE>
                             VODAVI TECHNOLOGY, INC.

                           CONSOLIDATED BALANCE SHEETS

                                                            December 31,
                                                     --------------------------
                                                         1997           1998
                                                     -----------    -----------
                                     ASSETS
CURRENT ASSETS:
 Cash                                                $   634,255    $   795,731
 Accounts receivable, net of allowances
  of $250,000 in 1997 and $674,000 in 1998             9,681,545      8,887,884
 Inventories, net                                      8,286,173      6,385,460
 Prepaid expenses and other                              905,451        696,835
                                                     -----------    -----------
      Total current assets                            19,507,424     16,765,910

PROPERTY AND EQUIPMENT, net                            2,616,320      2,662,979

GOODWILL, net                                          2,394,990      2,243,514

OTHER LONG-TERM ASSETS, net                            1,145,308      1,169,664
                                                     -----------    -----------
                                                     $25,664,042    $22,842,067
                                                     ===========    ===========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
 Current portion of long-term debt                   $   378,931    $   124,141
 Payable to related parties                            1,621,547         34,221
 Accounts payable                                      2,698,362      2,320,844
 Accrued liabilities                                   2,416,218      1,853,921
                                                     -----------    -----------
      Total current liabilities                        7,115,058      4,333,127
                                                     -----------    -----------

LONG-TERM DEBT, net                                    8,752,367      7,711,471
                                                     -----------    -----------
OTHER LONG-TERM OBLIGATIONS                              181,247        198,685
                                                     -----------    -----------
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
 Accumulated deficit                                  (2,696,711)    (1,713,297)
                                                     -----------    -----------
                                                       9,615,370     10,598,784

                                                     $25,664,042    $22,842,067
                                                     ===========    ===========

              The accompanying notes are an integral part of these
                          consolidated balance sheets.

                                      F-3
<PAGE>
                             VODAVI TECHNOLOGY, INC.

                      CONSOLIDATED STATEMENTS OF OPERATIONS


                                               Years Ended December 31,
                                        ---------------------------------------
                                            1996         1997          1998
                                        -----------   -----------   -----------

REVENUE, net                            $46,154,174   $47,674,751   $47,983,344

COSTS OF GOODS SOLD (including
 products acquired from related parties
 (LGIC) of $17.8 million, $17.8 million,
 and $18.0 million, respectively)        30,842,422    32,007,992    32,124,508
                                        -----------   -----------   -----------

      Gross margin                       15,311,752    15,666,759    15,858,836

OPERATING EXPENSES:
 Engineering and product development      2,161,306     2,100,682     1,616,134
 Selling, general and administrative     11,587,971    11,726,902    12,798,609
 Asset impairment and restructuring
   charges (Note 2)                       4,804,717       819,389            --
                                        -----------   -----------   -----------

OPERATING INCOME (LOSS)                  (3,242,242)    1,019,786     1,444,093

INTEREST EXPENSE                            840,830       662,828       791,362
                                        -----------   -----------   -----------

INCOME (LOSS) BEFORE INCOME TAXES        (4,083,072)      356,958       652,731

PROVISION (BENEFIT) FOR INCOME TAXES        326,691       142,013      (330,683)
                                        -----------   -----------   -----------

NET INCOME (LOSS)                       $(4,409,763)  $   214,945   $   983,414
                                        ===========   ===========   ===========

BASIC EARNINGS (LOSS) PER SHARE         $     (1.02)  $       .05   $       .23
                                        ===========   ===========   ===========

DILUTED EARNINGS (LOSS) PER SHARE       $     (1.02)  $       .05   $       .23
                                        ===========   ===========   ===========
WEIGHTED AVERAGE SHARES
   OUTSTANDING - BASIC                    4,342,238     4,342,238     4,342,238
                                        ===========   ===========   ===========
WEIGHTED AVERAGE SHARES
   OUTSTANDING - DILUTED                  4,342,238     4,342,238     4,342,238
                                        ===========   ===========   ===========

              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                     Retained
                              -------------------    Additional     Earnings
                                            Par       Paid-in     (Accumulated
                                Shares     Value      Capital       Deficit)        Total
                                ------     -----      -------       --------        -----
<S>                          <C>          <C>      <C>           <C>            <C>
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
  Net income                         --        --            --       983,414        983,414
                              ---------    ------   -----------   -----------    -----------
BALANCE, December 31, 1998    4,342,238    $4,342   $12,307,739   $(1,713,297)   $10,598,784
                              =========    ======   ===========   ===========    ===========
</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,
                                                    ---------------------------------------------
                                                         1996            1997            1998
                                                     ------------    ------------    ------------
<S>                                                  <C>              <C>              <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
 Net income (loss)                                   $ (4,409,763)   $    214,945    $    983,414
 Adjustments to reconcile net income (loss) to net
  cash (used in) provided by operating activities:
   Depreciation and amortization                          903,735         750,400         765,394
   Asset impairment                                     4,174,717         407,776              --
   Rent levelization                                       68,246          44,187          17,441
   Loss on retirement of fixed assets                      63,081              --              --
 Changes in working capital:
   Accounts receivable                                 (1,310,669)     (1,943,753)        793,661
   Inventories                                          1,302,059      (1,137,315)      1,900,713
   Prepaid expenses and other                             380,878        (351,853)        208,616
   Other long-term assets                                  36,615        (450,926)        (56,134)
   Accounts payable and payables to related
     parties                                              838,935        (143,714)     (1,964,844)
   Accrued liabilities                                    619,003         227,831        (562,297)
   Accrued income taxes                                   (77,223)       (426,983)             --
                                                     ------------    ------------    ------------
      Net cash flows provided by (used in)
       operating activities                             2,589,614      (2,809,405)      2,085,964
                                                     ------------    ------------    ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
 Accrued acquisition costs paid                          (217,894)        (36,040)             --
 Cash paid to acquire property and equipment             (556,664)       (577,030)       (628,802)
                                                     ------------    ------------    ------------
      Net cash flows used in investing
       activities                                        (774,558)       (613,070)       (628,802)
                                                     ------------    ------------    ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
   Financing costs paid                                        --         (77,301)             --
   Payments on capital leases                            (109,760)       (259,282)       (378,065)
   Borrowings on revolving credit facility             41,369,367      48,488,925      47,712,453
   Payments on revolving credit facility              (43,867,070)    (45,247,325)    (48,630,074)
                                                     ------------    ------------    ------------
      Net cash flows (used in) provided by
       financing activities                            (2,607,463)      2,905,017      (1,295,686)
                                                     ------------    ------------    ------------

CHANGE IN CASH                                           (792,407)       (517,458)        161,476

CASH, beginning of period                               1,944,120       1,151,713         634,255
                                                     ------------    ------------    ------------

CASH, end of period                                  $  1,151,713    $    634,255    $    795,731
                                                     ============    ============    ============
</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.  (the  Company),  a  Delaware  corporation,   designs,
develops,  markets,  and  supports a broad range of business  telecommunications
solutions,  including digital telephone systems,  voice processing systems,  and
computer-telephony products for a wide variety of business applications.

     PRINCIPLES OF CONSOLIDATION

The consolidated  financial  statements  include the accounts of the Company and
its wholly owned subsidiaries Vodavi Communication  Systems, Inc. (VCS), Arizona
Repair Services, Inc. (ARSI) and Vodavi-CT, Inc. (Vodavi-CT),  formerly known as
Enhanced Systems,  Inc. (together referred to as the Company).  ARSI merged with
VCS on December  31,  1998.  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.

     INVENTORIES

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, 1997 and 1998, respectively:

                                      Useful Life
         Type of Asset                 in Years        1997            1998
         -------------                 --------        ----            ----

Office and computer equipment               5      $ 1,030,354    $ 1,443,562
Furniture and fixtures                     10          255,089        338,779
Tooling and manufacturing equipment       5-8        1,506,761      1,724,553
Assets under capital lease               5-12          741,226        741,226
Property and equipment in progress         --          128,702         42,814
                                                   -----------    -----------
                                                     3,662,132      4,290,934
Less:  Accumulated depreciation                     (1,045,812)    (1,627,955)
                                                   -----------    -----------
                                                   $ 2,616,320    $ 2,662,979
                                                   ===========    ===========

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 (SFAS) No. 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 SFAS No. 128,
EARNINGS PER SHARE, 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 annual periods presented after December 15, 1997, and as a

                                      F-8
<PAGE>
result, all prior period EPS data presented has been restated. Basic EPS for the
years ended December 31, 1996,  1997 and 1998,  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, 1996,  1997 and 1998,
were determined by dividing net income by the weighted  average number of common
and common  equivalent  shares  outstanding.  No common  equivalent  shares were
included in weighted average common and common equivalent shares for each of the
three years ended December 31, 1998.

     FAIR VALUE OF FINANCIAL INSTRUMENTS

The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of SFAS No. 107, DISCLOSURES ABOUT FAIR
VALUE OF  FINANCIAL  INSTRUMENTS.  The  estimated  fair value  amounts have been
determined  by  the  Company  at  December  31,  1998,  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, accounts  receivable,  accounts payable,  payable to
related  parties,  accrued  liabilities,   and  the  revolving  credit  facility
approximate fair values due to the short-term maturities of these instruments.

     RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

Effective  January 1, 1998, the Company adopted SFAS No. 131,  DISCLOSURES ABOUT
SEGMENTS OF AND ENTERPRISE AND RELATED  INFORMATION,  which established  revised
standards  for the  reporting of financial  and  descriptive  information  about
operating segments in financial statements.

The Company has determined  that it has one reportable  operating  segment.  The
Company has three  operating  segments  which are managed based on the Company's
product  categories,  key  telephone  systems,  voice  processing  systems,  and
computer-telephony   products.   The  Company's  voice  processing  systems  and
computer-telephony  products categories do not meet the reportable thresholds of
SFAS No. 131.

As a result of the foregoing,  the Company has determined that it is appropriate
to present one reportable  segment consistent with the guidance in SFAS No. 131.
Accordingly,  the Company has not presented separate  financial  information for
each  of  its  operating  segments  as  the  Company's   consolidated  financial
statements present its one reportable segment.

(2) ASSET IMPAIRMENT AND RESTRUCTURING CHARGES:

The Financial Accounting Standards Board has issued SFAS No. 121, ACCOUNTING FOR
THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF,
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

                                      F-9
<PAGE>
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
Vodavi-CT. As a result of the impact of these events on the projected cash flows
of Vodavi-CT,  the Company concluded that the goodwill was impaired and recorded
a $4.2 million impairment loss.

During  1997,  the  Company  recorded a  restructuring  charge of  approximately
$820,000  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.  At December 31, 1997,  approximately
$700,000 in  restructuring  reserves is included in accrued  liabilities  on the
accompanying balance sheet.

During 1998, approximately $412,000 and $196,000 was charged against the reserve
for severance payments and legal fees, respectively. The remaining restructuring
reserve  balance in accrued  liabilities  relating to legal fees at December 31,
1998 was approximately $92,000.

(3) LONG-TERM DEBT:

Long-term debt consists of the following as of December 31, 1997 and 1998:

                                                 1997             1998
                                              ----------       ----------
       Revolving credit facility              $8,628,227       $7,710,606
       Capital lease obligations                 503,071          125,006
                                              ----------       ----------
                                               9,131,298        7,835,612
       Less: Current portion                     (378,93)        (124,141)
                                              ----------       ----------
                                              $8,752,367       $7,711,471
                                              ==========       ==========

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 2 1/2%  (8.03% and 7.80% at  December  31, 1997 and 1998,
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, 1998, the Company was in compliance with
all of the covenants.

During 1996 and 1997, the Company entered into several capital lease  agreements
with interest  rates ranging from 9% to 13%.  These  agreements  generally  have
terms of 24 months  and  provide  the  Company  with an option to  purchase  the
equipment for a nominal amount at the end of the lease term.

                                      F-10
<PAGE>
(4) COMMITMENTS AND CONTINGENCIES:

     LEGAL MATTERS

The  Company  is  currently  involved  in a lawsuit  with the  former  owners of
Vodavi-CT,  who were dismissed from their  positions as executive  management of
Vodavi-CT 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 for legal
fees to pursue this matter. The reserve balance in accrued  liabilities  related
to legal fees at December 31, 1998 was approximately $92,000.

The Company is also  involved in a lawsuit with a former OEM  alleging  that VCS
breached a strategic  alliance to provide  certain key telephone  systems to the
OEM.  The  former  OEM  is  seeking  compensatory,   punitive,  incidental,  and
consequential  damages  related  to the  lawsuit.  The  Company  has  denied the
allegations  and is  aggressively  defending  itself.  The  Company  has filed a
counterclaim  against the former OEM for breaching  the  strategic  alliance for
failure to pay for  services  rendered.  Although the outcome of this lawsuit is
still uncertain,  the Company has increased its allowance for doubtful  accounts
to reflect the added uncertainty  associated with the collectibility of accounts
receivable related to this OEM.

     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
                                                    -----
             1999                                $1,120,707
             2000                                 1,160,679
             2001                                 1,201,335
             2002                                   311,745
             2003                                   174,720
             Thereafter                             174,720

Rent  expense  is  recognized  on a  straight-line  basis and was  approximately
$1,115,000,  $1,107,000,  and  $1,107,000 for the years ended December 31, 1996,
1997, and 1998,  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  approximately
$502,000, $449,000, and $264,000 in 1996, 1997, and 1998, respectively.

                                      F-11
<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  $67,500,  $75,000,  and $70,000
for the years ended December 31, 1996, 1997, and 1998, respectively.

(5) STOCKHOLDERS' EQUITY:

     WARRANTS

In  connection  with  its  initial  public  offering,  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 the
Company'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 the
Company's stock) of the fair market value of the Common Stock at the time of the
grant.

                                      F-12
<PAGE>
The following summarizes activity under the Plan for the years ended:
<TABLE>
<CAPTION>
                          December 31, 1996     December 31, 1997      December 31, 1998
                         -------------------  --------------------   ---------------------
                                     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:     237,500     $4.00     498,500     $5.08       816,900    $4.80
  Granted                 295,000      6.07     380,600      4.45       157,500     3.90
  Canceled                (34,000)     6.00     (62,200)     5.13      (382,000)    4.42
  Exercised                    --                    --                      --       --
                         --------    ------    --------    -------    ---------   ------
Options outstanding
   at end of period       498,500     $5.08     816,900     $4.80       592,400    $4.88
                         ========     =====    ========     =====     =========    =====
Options available
 for grant                351,500                33,200                 257,600
                         ========              ========               =========
Exercisable at end
 of period                118,750     $4.00     178,125     $4.00       197,200    $4.85
                         ========     =====    ========     =====     =========    =====
Weighted average fair
 value of options
 granted                 $  2.69               $   2.93               $    2.43
                         =======               ========               =========
</TABLE>

The Company has elected to account for its stock-based  compensation plans under
APB Opinion No. 25,  ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES.  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 SFAS No.
123, ACCOUNTING FOR STOCK-BASED  COMPENSATION had been applied.  The Company has
computed,  for pro forma disclosure  purposes,  the value of all options granted
during 1996, 1997, and 1998, using the  Black-Scholes  option pricing model with
the following weighted average assumptions:

                                                 Year Ended December 31,
                                          ----------------------------------
                                          1996            1997          1998
                                          ----            ----          ----

         Risk free interest rate          5.47%           6.16%         5.50%
         Expected dividend yield            --              --            --
         Expected lives in years             5               5             5
         Expected volatility             47.86%          62.47%        70.09%

                                      F-13
<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          1998
                                         ----            ----          ----
                                      (in thousands, except per share amounts)
    Net income (loss):
      Pro forma                         $(4,607)        $(150)        $ 798
    Earnings (loss) per share:
      Pro forma - Basic                 $ (1.06)        $(.03)        $ .18
      Pro forma - Diluted                 (1.06)         (.03)          .18

(6) MAJOR CUSTOMERS:

The  Company's   sales  efforts  have  been   concentrated  on  major  wholesale
distributors  as well as a direct dealer network.  During 1996,  1997, and 1998,
sales to the Company's  largest  distributor  accounted for 44%, 40%, and 39% of
total revenues, respectively.

Accounts receivable from this distributor comprise 36% and 32% of total accounts
receivable at December 31, 1997 and 1998,  respectively.  Generally, the Company
does not require collateral from its customers.  The Company believes its credit
evaluation procedures substantially reduce its credit risk.

(7) INCOME TAXES:

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

                            1996             1997              1998
                            ----             ----              ----
      Current             $311,490         $202,753        $(167,449)
      Deferred              15,201          (60,740)        (163,234)
                          --------         --------        ---------

                          $326,691         $142,013        $(330,683)
                          ========         ========        =========

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,
1997 and 1998, were as follows:

                                                   1997               1998
                                                 ---------          ---------
   Deferred tax assets:
     Inventory and receivable reserves           $ 238,902         $  374,844
     UNICAP adjustment                             109,629             87,483
     Other accruals                                463,722            256,153
     Research and development credit                    -             325,632
                                                 ---------         ----------
                                                 $ 812,253         $1,044,112
                                                 =========         ==========

                                      F-14
<PAGE>
                                                    1997               1998
                                                 ---------          ---------
         Deferred tax liabilities:
           Depreciation differences               (179,433)          (264,113)
           Amortization differences                (53,027)           (37,100)
                                                 ---------          ---------
                                                  (232,460)          (301,213)
                                                 ---------          ---------
         Net long-term deferred tax asset        $ 579,793          $ 742,899
                                                 =========          =========

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:

                                                 1996         1997        1998
                                                 ----         ----        ----
      Federal statutory tax rate                 34.0%        34.0%       34.0%
      State taxes, net                            4.6          4.6         4.6
      Research and development tax credits        -          (10.8)      (93.4)
      Non-deductible expenses and
        other permanent differences             (46.6)         3.8         4.1
                                                -----        -----       -----

                                                 (8.0)%       31.6%      (50.7)%
                                                =====        =====       =====

In 1996,  the Company  recognized an asset  impairment  charge  associated  with
goodwill recorded in connection with the acquisition of Vodavi-CT.  The goodwill
generated by the acquisition was non-deductible,  and its impairment impacts the
Company's effective income tax rate in 1996.

In 1997, the Company recorded approximately $100,000 in research and development
tax credits made available through filing amended tax returns for prior years.

In 1998, the Company  finalized its research and development tax credit analysis
and identified  approximately  $509,000 in available tax credits.  Approximately
$183,000 in research and development tax credits was utilized through carrybacks
to prior years' and application to the current year's tax returns.  In addition,
a deferred tax asset of approximately  $326,000 was recorded. The realization of
this deferred tax asset is dependent on future income. The Company believes that
operating  income will more likely than not be  sufficient to fully realize this
deferred tax asset during the carryforward period.

(8) RELATED PARTIES TRANSACTIONS:

LG  Information  and  Communications,   Ltd.  (LGIC),  the  Company's  principal
supplier, owned approximately 18.7% of the Company's outstanding Common Stock at
December 31, 1998. The Company  purchased  approximately  $17.9  million,  $18.8
million,  and $16.3  million  of key  telephone  systems  and  commercial  grade
telephones  from LGIC and an  affiliate  of LGIC during  1996,  1997,  and 1998,
respectively.

                                      F-15
<PAGE>
(9) SUPPLEMENTAL CASH FLOW INFORMATION:

Cash paid for interest  and income taxes for the years ended  December 31, 1996,
1997, and 1998 were approximately as follows:

                                    1996           1997           1998
                                    ----           ----           ----
         Interest paid            $840,000       $663,000       $791,000
         Income taxes paid        $ 22,000       $630,000       $ 58,000


                                      F-16