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, 1996       Commission File Number 0-26912
                          -----------------                              -------

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

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

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

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

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

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

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

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

At March 24, 1997, 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 (2,733,708 shares) based on the closing price
of the Common Stock as reported on the Nasdaq National Market on March 24, 1997,
was $9,567,978.  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 1997 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, 1996

                                TABLE OF CONTENTS
<TABLE>
PART I                                                                                                         Page
                                                                                                               ----
<S>      <C>     <C>                                                                                             <C>
         ITEM     1.       BUSINESS...........................................................................    1
         ITEM     2.       PROPERTIES.........................................................................   24
         ITEM     3.       LEGAL PROCEEDINGS..................................................................   24
         ITEM     4.       SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................   25

PART II
         ITEM     5.       MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
                             RELATED STOCKHOLDER MATTERS......................................................   26
         ITEM     6.       SELECTED CONSOLIDATED FINANCIAL DATA...............................................   27
         ITEM     7.       MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                             CONDITION AND RESULTS OF OPERATIONS..............................................   28
         ITEM     8.       FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................................   31
         ITEM     9.       CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                             ACCOUNTING AND FINANCIAL DISCLOSURE..............................................   31
PART III
         ITEM     10.      DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................................   31
         ITEM     11.      EXECUTIVE COMPENSATION.............................................................   31
         ITEM     12.      SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
                             AND MANAGEMENT...................................................................   31
         ITEM     13.      CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.....................................   31

PART IV
         ITEM     14.      EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
                             ON FORM 8-K......................................................................   32

SIGNATURES....................................................................................................   34
</TABLE>
                                        i
<PAGE>
                                     PART I

ITEM 1. BUSINESS

                                  INTRODUCTION

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

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

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

                                    BUSINESS

Industry Overview

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

         Since the late 1980s, the  telecommunications  industry has undergone a
significant  transition from products based on proprietary hardware and software
systems to more  flexible  open  architecture  based  products.  The use of open
architecture  systems has enabled  product  developers to combine  technological
advances  created by third-party  developers  with  standardized  or proprietary
hardware,  operating systems,  and software in order to reduce development time,
lower product cost, and expand product  functionality.  The availability of open
architecture  based platforms and flexible,  user-programmable  software modules
has made affordably priced,  full-featured  communications  systems available to
small businesses with limited resources as well as to larger, more established
                                        1
<PAGE>
organizations  and has prompted  users to replace older systems and equipment or
to enhance their  existing  systems  after the  introduction  of newer  designs,
technologies, and features.

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

Products

         The Company currently designs, develops,  markets, and supports a broad
range of (i)  telephony  products,  which  include  digital and  electronic  key
telephone  systems  and  commercial  grade  telephones;  (ii)  voice  processing
products,  including  interactive voice response systems,  automated  attendant,
automatic call distribution,  voice mail and fax mail, and an advanced telephony
software development language; and (iii) computer-telephony  products, including
Windows-based   application  products  (such  as  PC  telephones  and  attendant
consoles),  local area  network  ("LAN")  to PBX  connection  packages,  unified
messaging servers utilizing the Internet,  call accounting systems,  and desktop
video  conferencing  systems.  The Company currently is developing a new line of
digital  communications  systems  and  wireless  digital  telephone  systems for
introduction   in   1997.   The   Company   also   is   developing    additional
computer-telephone  integration programs,  voice activated command products, and
unified messaging systems.

Key Telephone Systems

         Sales of key  telephone  systems  represented  approximately  72.4% and
70.0% of the  Company's  revenue  during  1995  and  1996,  respectively.  A key
telephone system consists primarily of a sophisticated switching unit located at
the user's place of business, along with the individual telephone sets and other
devices, such as facsimile machines or modems, located at individual "stations."
Telephone  systems are designed to accommodate  the number of "ports" (the total
number of incoming  lines,  or "trunks,"  and  stations)  required to handle the
communications  needs of businesses of varying sizes.  The switching unit routes
calls on one or more incoming  trunks from the local or long distance  telephone
company central office  equipment to the appropriate  station located within the
business.  The  switching  unit also routes  calls from one  station  within the
business to other stations  within the business or out to the telephone  company
central office for switching to other local or long distance telephone numbers.

         The Company currently  markets various lines of key telephone  systems,
under its STARPLUS and infinite brand names, for businesses  requiring as few as
two  incoming  trunks  and four  stations  up to 96 trunks and 120  stations  (a
216-port  system).  The Company sells the STARPLUS line through large  wholesale
distributors  known as "Supply  Houses" and the infinite line through  telephone
sales  and  installation  companies  known  as  "Direct  Dealers."  See  Item 1,
"Business - Sales, Marketing,  and Distribution." Each of the infinite telephone
systems  incorporates  the  base  platform  and  software  of the  corresponding
STARPLUS system,  with certain  modifications  that  differentiate  the infinite
system from the STARPLUS system in function and cosmetic appearance.
                                        2
<PAGE>
         The  Company  supplies  several  models  of  key  telephone  sets  with
progressive  features for use in conjunction with each of its telephone systems,
including  a model  with PC  Interface  for use  with  the  Company's  computer-
telephony integration products. Many of the feature buttons on the Company's key
telephones  are   user-programmable  to  enable  users  to  custom-tailor  their
telephone systems for maximum efficiency in specific applications.

         The Company  markets  both fully  digital and  electronic  (analog) key
telephone systems and related products.  The Company's digital telephone systems
employ a digital architecture in order to provide digital voice transmission and
system  control,  while the  Company's  electronic  telephone  systems  employ a
microprocessor-based   architecture   and  solid  state   switching   for  voice
transmission and system control. Most of the Company's telephone systems feature
flexible  software  combined with modular  hardware and card slot design,  which
allow  cost-effective  system  customization  and expansion to meet the needs of
individual  users.  The Company's  telephone  systems are fully  compatible with
industry-standard  commercial grade telephones and contain an extensive array of
standard  features  that  add  sophistication  generally  found  only in  larger
telephone  systems.  The Company  designs its key  telephone  systems to readily
permit  expansion  or  customization  for  specific  business   applications  by
installation of a variety 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  intends to take  advantage of the expected  replacement of
the entire  installed  base of  electronic  telephone  equipment  as digital and
wireless  systems become better defined,  more cost  effective,  and more widely
accepted.  The  digital  technology  incorporated  into  the  Company's  digital
telephone  systems  provides clearer voice  reproduction and a  state-of-the-art
interface to data  applications  that enables better data  compression  and more
accurate  data  transmission  than can be provided by  electronic  systems.  The
Company  also  believes  that the  growing  acceptance  and  utilization  of the
Integrated  Services  Digital Network  ("ISDN"),  which provides the capacity to
simultaneously  transmit  voice,  data,  and  video  information  over  the same
telephone,  will significantly stimulate sales of digital telephone systems that
include  high-speed data  transmission and other  technology  necessary to fully
implement ISDN capabilities.

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

Commercial Grade Telephones

         The  Company  markets  several  lines of  commercial  grade  telephones
through  Supply  Houses and Direct  Dealers for ultimate  sale to home office or
business users that require a business telephone with multiple features; for use
with  PBX  installations  in  hotels,  motels,  and  resorts;  and for use  with
electronic or digital key systems,  PBX systems,  or telephone  company  central
office  ("Centrex")  switching  systems when the customer prefers telephone sets
that provide multiple features. Sales of commercial grade telephones represented
approximately  17.7% of the Company's  revenue during each of 1995 and 1996. 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.
                                        3
<PAGE>
Voice Processing Products

         Voice  processing  includes  functions  designed to reduce  labor costs
while providing  faster,  more efficient  routing of incoming calls and speeding
and simplifying  message delivery and storage.  A caller  communicates  with the
system by pressing appropriate keys on a touchtone telephone or by giving spoken
commands.  The  system  listens  for this  input and then  makes an  appropriate
response.   The  Company's  voice  processing  systems  also  provide  extensive
reporting  capabilities,  including data used to analyze mailbox usage or caller
routing  patterns.  The  flexible  design  of these  systems  permits  operating
personnel  to access  system  programming  and  administration  functions  via a
keyboard and monitor or from remote locations via touchtone telephone.

         The  Company   designs  its  voice   processing   systems  by  using  a
microprocessor-based  open architecture  platform,  which enables the Company to
significantly enhance product development by utilizing standardized hardware and
operating  systems  software and by supplementing  its own software  development
expertise with  additional  software  systems  developed in conjunction  with or
acquired through licensing arrangements with independent third-party developers.
The Company packages this platform with increasingly  sophisticated combinations
of  software  application  modules  in order to  create  several  lines of voice
processing  products  that offer a wide array of  features  designed to meet the
needs of  business  organizations  depending  upon  the size of their  telephone
systems and required  complexity of voice  processing  functions.  The Company's
voice processing  platforms utilize a modular software  application  design that
permits  users  to  configure  their  systems  to  meet  current  needs  and  to
accommodate system growth as their businesses expand.

         The Company  designs its voice  processing  products to integrate  with
telephone  systems  sold by the Company as well as competing  manufacturers  and
frequently markets its voice processing products  independently of its telephone
systems. The Company, however,  cultivates the expansion of its existing base of
telephone systems by offering voice processing  products that  differentiate its
products from those of its competitors and that provide a value-added  basis for
increased  sales and profit  margins.  The  Company  also  markets  an  advanced
software development  language,  which enables independent  developers to create
custom telephony applications.

Interactive Voice Response

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

Voice Mail and Fax Mail Systems

         The Company's  traditional  DOS-based voice mail systems  automatically
route unanswered calls to a preprogrammed  destination or the recipient's  voice
mailbox.  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
                                        4
<PAGE>
that  permit  callers to  automatically  access  organizational  departments  or
product, service, or event information by dialing menu choices.

         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-command"  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 Company's Microsoft Corp.  ("Microsoft") Windows NT-based messaging
systems combine traditional voice and facsimile messaging  capabilities with the
ability to share messages with other voice messaging  systems over the Internet.
The new system utilizes Company developed extensions to existing Internet e-mail
protocols to enable voice messages to be transported  over the Internet or other
electronic fields for efficient,  low-cost  information  exchange between remote
systems.  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. In addition,  by adding the Company's new Unified Messaging server, users
may retrieve voice, facsimile,  paging, e-mail, or Internet mail messages from a
consolidated  desktop  computer  screen.  See Item 1,  "Business  -  Products  -
Computer-Telephony Integration Products."

Automatic Call Distribution

         The Company markets its ACD System  Software and ACD Reporting  Package
(the "ACD  System") for use with digital key  telephone  systems.  The automatic
call  distribution  functions  provided by the ACD System 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.  The ACD System 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,  the ACD System
plays a custom "hold"  message for the caller and connects the call to the first
available  person  or  sales  agent.  The  ACD  System  saves  employee  time by
eliminating the necessity of continually answering and transferring calls to the
same groups.  The ACD System enables  agents with display  telephones to see the
number of calls  waiting in queue as well as the length of the  longest  waiting
call in order to speed call handling at times of heavy calling activity. The ACD
Reporting Package component of the ACD System provides real-time information and
comprehensive historical reports on calling activity for review by management.

Automated Attendant

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

Computer-Telephony Integration Products

         The  Company   designs,   develops,   and  markets   computer-telephony
integration  ("CTI")  products that combine the  communications  technologies of
business telephone systems with the information storage and processing
                                        5
<PAGE>
capabilities of personal  computers.  The Company's CTI products utilize an open
system  architecture  to  integrate  computers  and  telephone  systems  into  a
user-friendly  information  storage,  processing,  and transmitting  device. The
Company  believes that developing  more  value-added  CTI  applications  for its
telephone  systems will enhance the appeal of its product lines and enable it to
sell more key telephone systems,  full-featured  telephones,  and other software
packages and add-on peripheral  products.  The Company markets CTI products that
enable a user to (i) utilize the Internet to access voice, facsimile, and e-mail
messages  via personal  computer;  (ii)  incorporate  telephone  functions  with
computer  software  to speed call  handling  and permit the user to  personalize
telephone  functions;  (iii) identify  incoming  callers and immediately  access
computer files  relating to the caller;  (iv) connect  Windows-based  local area
networks to the user's  telephone  system;  and (v)  quickly  and  inexpensively
access and  analyze  call  accounting  information.  The  Company  has  recently
incorporated  an  application  provider  interface  into its  digital  telephone
systems  that  will  be  compatible  with  Microsoft's   Telephony   Application
Programming Interface.

PC Phone

         The  Company's PC Phone product  lines  include  software  applications
designed to operate in conjunction with Microsoft's  Windows  operating  systems
software in order to unite  personal  computers and  telephones to help business
users better manage their  communications and information  systems. The PC Phone
package  includes  the PC Phone  software,  which is ready to be loaded onto the
computer workstation, and a PC Interface Telephone, which is a digital telephone
keyset with RS-232C serial port for connection to the user's computer.  PC Phone
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 either the telephone or
the computer.  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.

         PC Phone  enables  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.  PC Phone also
permits  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. PC Phone permits users to create multiple  directories with up
to 1,000 names in each directory.  PC Phone also provides connections to readily
available  personal   information   managers  and  contact  management  software
packages, such as "ACT!," "TeleMagic," and "Gold Mine."

Incoming Caller ID

         The Company's  Incoming  Caller ID product  lines provide  system users
with instant  identification  of the caller's name and telephone number prior to
answering the incoming call.  When connected to the business's  computer  system
via the Company's PC Phone products,  the Incoming Caller ID systems  facilitate
instant access to customer database information, such as account activity notes,
prior purchases, or billing and payment history, which the system's "Screen Pop"
feature  displays  at the user's  personal  computer  screen  before the call is
answered.  Other Incoming  Caller ID features permit faster transfer of calls to
the appropriate system user, simplify the process of returning  unanswered calls
by enabling the user to scroll  through the table of  unanswered  calls shown on
the telephone display and press the speed dial button on the highlighted  number
to return the call, and record  incoming  caller  information,  including  name,
telephone  number,  time and date of call, call duration,  and the number of the
station that answered the call.

Callsort Pro for Windows

         The  Company's  Callsort  Pro for Windows  ("Callsort")  combines  call
accounting  software  with a graphical  interface  designed  to enable  business
managers  quickly  and  inexpensively  to access  and  analyze  call  accounting
information.  Reports  generated by Callsort  enable  business users to allocate
expenses  by  department  or  project,  bill  customers  for calls made on their
behalf, evaluate productivity of individual employees, verify telephone bills,
                                        6
<PAGE>
and identify  long-distance  call  abusers.  Callsort  seamlessly  blends a call
collecting and pricing software module, a system management software module, and
a reporting  software  module to form a single  application  that may be used in
conjunction with stand-alone computers or local area networks. Telephony systems
managers can program  Callsort to control the  collection  and  distribution  of
system information and to grant or restrict access to specific data according to
the user's telephone extension, department, account, or other criteria. Callsort
provides  over 30  predefined  report  formats that can be accessed and executed
from any  Windows-based  PC on the network and also  enables  users to customize
reports  by  selecting  from  various  combinations  of  selection  and  sorting
criteria.  In addition,  users can create and save their own reporting  formats.
Callsort  includes a hotel  module,  which  enables  hotels and motels to charge
guests automatically for local and long-distance calls made from their rooms.

Unified Messaging

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

Internet Fax Delivery

         The Company's  Windows  NT-based  Internet fax delivery systems provide
the  ability  to send and  receive  facsimile  messages  via the  Internet.  The
Company's  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.

Desktop Video Conferencing

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

New Product Development

         The Company engages in an on-going  program to develop  enhancements to
its  existing  product  lines and to  develop  new  products  that  address  the
increasing demands of business organizations for low-cost productivity enhancing
communications  tools. The Company  believes that continuous  development of new
products and features will be necessary to enable it to offer telephony systems,
voice processing  products,  computer-telephony  products,  and related business
communications  products  that will be in greatest  demand and that will provide
the best  opportunities  for  growth  and  profitability  of the  Company  on an
on-going basis.

Digital Communications Systems

         In conjunction with LGE, the Company currently is developing a new line
of  digital  communications  systems,  which will  support up to 384 ports.  The
Company  anticipates that the line will be ready for  distribution  beginning in
mid-1997.  Upon  introduction of the line, the Company will compete for sales of
the approximately 3.6 million stations  currently sold annually to the 50 to 400
station  market  segment,   which  will   significantly   expand  the  Company's
addressable  market for  telephone  systems  and related  products.  The Company
intends to target its systems towards the small-installation  segment of the PBX
market, with particular emphasis on key vertical market
                                        7
<PAGE>
segments,  such  as  hotels  and  motels,   educational  institutions,   service
organizations, and general business organizations.

         The  Company is  designing  its new  digital  systems  to  combine  the
sophistication  and high-end  capabilities  of traditional  PBX systems with the
ease of use of key telephone systems that are integrated for both voice and data
applications.  The systems  will be fully  modular and will  utilize a universal
slot orientation capable of supporting a wide variety of terminals,  trunks, and
data interfaces.  In addition to the new digital systems' productivity enhancing
features  and  capabilities,  the Company  anticipates  that the larger  digital
communications  systems will provide  users of the  Company's  products with the
ability to expand their telephone systems beyond the capacities of the Company's
current telephone  systems,  while retaining their installed base of STARPLUS or
infinite  telephone  sets,  voice  processing  systems,  and computer  telephony
products. The Company currently is developing  enhancements to its platform that
will provide support for multi-cell, multi-user wireless communications systems,
computer-telephony  integration  products,  ISDN functions,  and voice activated
commands.

Wireless Telephone Systems

         The  Company and  NovAtel  Wireless,  Inc.  ("NovAtel")  currently  are
jointly developing a single cell,  multi-user  wireless telephone system for use
with smaller telephone systems and a multi-cell,  multi-user wireless system for
use with the  Company's  digital  communications  systems and PBX  systems.  The
low-powered, lightweight, portable wireless telephone handset units are designed
to operate as a stand-alone  telephone system or to work in conjunction with all
industry-standard  telephone  systems marketed by the Company or its competitors
and will  incorporate  multiple key system  feature  buttons in order to provide
access to many of the  system  features  currently  provided  by such  telephone
systems.  The  Company's  wireless  telephone  systems will use a 900  megahertz
digital  spread-spectrum  frequency hopping technology.  The Company anticipates
that the  handsets  will  operate  at a range of up to 200 feet from a  wireless
transmitting station.

         Benefits of the  Company's  wireless  telephone  systems  will  include
greater mobility,  reduced need for external paging equipment,  reduced need for
voice mail, and reduced  secretary  workload as well as ease of installation and
lower initial  installation  costs  resulting from the  elimination of wiring to
individual  stations.  The Company believes that its wireless  telephone systems
will provide increased  productivity in business situations in which managers or
employees  spend a large  portion  of their  time  away  from a fixed  office or
telephone location,  such as sales clerks working on the floor of a large retail
store,   order  processing  clerks  in  warehouse   operations,   or  production
supervisors  inspecting a large manufacturing plant. The Company currently plans
to introduce its first wireless communication products in 1997.

         Under the  agreement  between the Company  and NovAtel  (the  "Wireless
Agreement"),  the Company and NovAtel  share product  development  costs and the
Company pays the costs associated with obtaining necessary government approvals.
NovAtel has granted the Company the exclusive right to market and distribute the
wireless  telephone  systems  in the  United  States and  Canada.  The  Wireless
Agreement  requires the Company to purchase  from NovAtel,  on a purchase  order
basis,  minimum  quantities of wireless  base units and  handsets.  The Wireless
Agreement establishes the minimum purchase obligations for the first year of the
agreement  and  gives  NovAtel  the  right to  change  the  Company's  exclusive
distribution  right to a  non-exclusive  right in the event that the Company and
NovAtel are unable to agree upon the Company's minimum purchase  obligations for
subsequent years. The Wireless  Agreement will expire five years after the first
delivery  of  wireless  telephone  products  ordered by the  Company.  Steven A.
Sherman,  the Company's  Chairman of the Board, is the Chairman of the Board and
President  and a  significant  shareholder  of  NovAtel.  See  Item 1,  "Special
Considerations - Control by Management;  Stockholders'  Agreement;  Conflicts of
Interest."
                                        8
<PAGE>
CTI Development Programs

         The  Company  currently  is  developing  products  to  embrace  the new
Telephony   Application   Programming   Interface  ("TAPI")   computer-telephony
integration standard.  TAPI is a programming interface that works in conjunction
with software standards  developed by Microsoft to enable  third-party  software
developers  to  design  CTI  software  that  permits  computer  applications  to
communicate  with  telephone  systems  without  being  written for a  particular
telephone system vendor's hardware.

Sales, Marketing, and Distribution

         The Company  currently markets its products in all 50 states and Puerto
Rico through a  distribution  network  consisting  primarily of large  wholesale
distributors  known as "Supply  Houses"  and  telephone  sales and  installation
companies  known as "Direct  Dealers."  The Company  also  maintains an in-house
sales  staff  that  makes  direct  sales of  certain  of its  products  to large
commercial  organizations and public access  providers,  such as local telephone
companies  and  cellular  telephone  system  providers.  From time to time,  the
Company  may also  market its  products  on a private  label  basis to  original
equipment  manufacturers  ("OEMs").  The Company derived approximately 81.5% and
12.1% of its total  revenue  from sales to Supply  Houses  and  Direct  Dealers,
respectively, in 1996.

Supply Houses (Wholesale Distributors)

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

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

         Supply  Houses that  currently  resell the Company's  products  include
Graybar Electric Co., Inc. ("Graybar"),  Sprint/North Supply,  Anixter Brothers,
Inc.,  G.T.E.  Supply Co., Famous  Telephone  Supply,  Power & Telephone  Supply
Company, Inc., Alltel Supply, Inc., Ademco Distribution, Inc., and Ingram Micro,
Inc.  Graybar  accounted  for  45%  and  44% of  sales  during  1995  and  1996,
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,  Sprint/North  Supply,  and
other Supply Houses and install these products at the end users' premises. These
interconnects  and independent  telephone  companies  provide the "pull through"
demand for the  Company's  products from Graybar and other Supply  Houses.  As a
result,  the Company  believes  that a decrease in purchases by Graybar or other
Supply Houses would result in only a temporary  adverse  effect on the Company's
operations if interconnects and independent  telephone  companies would continue
to demand the Company's  products from other Supply Houses,  which in turn would
increase their purchases of the Company's products.
                                        9
<PAGE>
Direct Dealers

         The  Company  developed  its  infinite  line of  telephone  systems and
related  products for sales to Direct  Dealers.  These Direct Dealers are medium
and large  interconnect  companies or local  dealers  that resell the  Company's
products  directly  to end  users.  The  Company  believes  that  the  principal
advantages  of this  distribution  channel are higher  gross  margins on product
sales,  greater  visibility of the Company's  product lines,  and the ability to
exert additional control over factors such as pricing of the Company's products.
Sales to Direct Dealers, however,  generally involve longer credit terms for the
Company,  the  necessity to provide  increased  direct  marketing  and technical
support,  and  additional  costs  associated  with  developing  and training the
independent  commissioned  sales staff of the various  Direct  Dealers to enable
them to solicit purchases of the Company's  products.  The Company has increased
the number of Direct Dealers that sell its infinite products from 15 at December
31,  1992 to  approximately  77 at  December  31,  1996  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 certain of its products to large  commercial  organizations  and governmental
agencies in the United  States and foreign  countries.  The  Company's  in-house
sales  force also  develops  relationships  with  value-added  resellers,  which
purchase  certain of the  Company's  products  as a base  platform,  enhance the
platform with specialized software that they have developed, and then resell the
combined systems.

International Sales

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

Research and Development; Strategic Alliances with LGE and Other Companies

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

         The Company  conducts  joint  development  activities  with LGE for the
design and  development of hardware  incorporated  into certain of the Company's
existing or planned  telephone  system and commercial  grade  telephone  product
lines.  Under its joint  development  projects  with LGE,  the Company  provides
market  analysis,  product  management,  functional and  performance  standards,
software   development,   quality   control  program   development,   sales  and
distribution,  and  customer  service and support,  while LGE provides  hardware
research,  design and development,  development of components such as integrated
circuits and semiconductor chips, and manufacturing and production  engineering.
Generally,  LGE contributes the ongoing  research and development  costs for the
product  hardware  in return for an  arrangement  under which LGE  produces  the
finished goods developed under the
                                       10
<PAGE>
alliance.  See Item 1, "Business - Manufacturing" and "Special  Considerations -
Dependence on LGE." The Company has  successfully  engaged in such projects with
LGE in the past and  believes  that it will  continue  to have  access  to LGE's
advanced hardware research and development  capabilities as the Company develops
new  product  lines  in such  areas  as  wireless  communications,  digital  key
telephone  systems,  digital  PBX  systems,   large-scale  integrated  circuits,
multi-layer printed circuit boards, and surface mount technologies.

         The Company also enhances its software  development  expertise  through
acquisitions of or licensing  arrangements  and other  strategic  alliances with
independent  third-party  developers.  The Company and NovAtel are parties to an
agreement  to  jointly  develop  wireless  communications  systems.  See Item 1,
"Business - Products - New Product  Development"  and "Special  Considerations -
Control by  Management;  Stockholders'  Agreement;  Conflicts of Interest."  The
acquisition  of Enhanced has provided  the Company  with  significant  technical
resources   related  to  speech   recognition,   interactive   voice   response,
computer-telephony  integration,  and voice mail systems. The Company has active
strategic alliance  relationships with other companies that possess expertise in
automatic call distribution,  small digital key telephone  systems,  and digital
wireless technologies. The Company intends to pursue additional opportunities to
enter into  strategic  alliances with other  companies that possess  established
expertise in specific  technologies in order to co-develop  proprietary products
or to acquire such companies in order to develop new products internally.

Manufacturing

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

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

         The Company  obtains  certain of its electronic  telephone  systems and
most  of  its  commercial  grade  telephones  and  replacement  parts  for  such
telephones  from LG Srithai,  Ltd.  ("LGST"),  a joint  venture  between LGE and
Srithai Group, a Thailand-based entity.  Pursuant to an agreement with LGST (the
"LGST  Agreement"),  LGST granted the Company the right to  distribute  and sell
throughout  the United States and Canada such products  manufactured  by LGST in
Thailand.  The LGST Agreement prohibits the Company from purchasing the products
covered by the LGST Agreement from any other manufacturer during the term of the
agreement,  which expires on April 12, 1997. The Company currently is engaged in
discussions with LGST regarding extending the current agreement or entering into
a new  manufacturing  agreement for the products  that the Company  obtains from
LGST.
                                       11
<PAGE>
The Company  makes all  purchases  pursuant to the LGST  Agreement on a purchase
order  basis.  See Item 1,  "Special  Considerations  -  Dependence  on LGE" and
"Special  Considerations  -  Control  by  Management;  Stockholders'  Agreement;
Conflicts of Interest."

         The Company  currently  obtains  certain of its  digital key  telephone
systems  and  related  digital  products  from  Wong's   Electronics  Co.,  Ltd.
("Wongs"),  a Hong Kong  company,  pursuant  to an  agreement  with  Wong's (the
"Wong's  Agreement").  The Wong's  Agreement  will remain in effect until either
party  gives  the  other  party  at  least  three  months'   advance  notice  of
termination. The Company makes all purchases pursuant to the Wong's Agreement on
a purchase order basis.  Executone Information Systems, Inc.  ("Executone") owns
certain rights to the products that the Company purchases pursuant to the Wong's
Agreement  and licenses to the Company the right to use  Executone's  technology
incorporated  into such products.  See Item 1, "Business - Patents,  Trademarks,
and Licenses."

         The Company also obtains  certain of its digital key telephone  systems
from Tecom Co.,  Ltd.,  ("Tecom")  a Republic of China  company.  Pursuant to an
agreement  with Tecom (the  "Tecom  Agreement"),  Tecom  granted the Company the
exclusive right to sell and distribute throughout all of North and South America
such products  manufactured  by Tecom.  The initial term of the Tecom  Agreement
expires in June 1999, at which time the agreement will  automatically  renew and
continue  until  either  party  gives  the  other  party not less than 120 days'
advance notice of termination.  The Company makes all purchases  pursuant to the
Tecom  Agreement on a purchase  order basis.  The Tecom  Agreement  requires the
Company  to use its  best  efforts  to  purchase  from  Tecom  products  with an
aggregate  minimum  purchase price of $3.5 million and $4.25 million during 1997
and 1998, respectively. In the event that the Company fails to purchase at least
75% of such purchase  obligations,  Tecom has the right to either  designate the
Company as a non-exclusive distributor of the products purchased under the Tecom
Agreement or increase the prices of such products by up to 5%.

         The  countries  in  which   certain  of  the  Company's   products  are
manufactured  have been subject to natural  disasters and civil  disturbances in
the past.  These  circumstances  could  affect the  Company's  ability to obtain
certain of its products from its overseas manufacturers.  Except for a fire that
interrupted production at one plant in China during late 1993 and the first part
of 1994,  the Company  has not  experienced  any  significant  interruptions  of
shipments  to  date.  The   termination  of  any  of  the  agreements  with  its
manufacturers  or the  inability of the Company to obtain  products  pursuant to
such  agreements,  even for a  relatively  short  period of time,  could  have a
material  adverse  effect  on the  Company's  operations.  See Item 1,  "Special
Considerations  - Dependence on Third Parties for  Manufacturing;  International
Manufacturing Sources."

Quality Control

         The  Company  recognizes  that  product  quality  and  reliability  are
critical factors in  distinguishing  its products from those of its competitors.
The Company designs its products to include components meeting specified quality
standards in order to ensure reliable performance. The Company also requires its
third-party  manufacturers to comply with specified quality standards  regarding
materials and assembly methods used in manufacturing the Company's products. See
Item 1,  "Business  -  Manufacturing."  In  addition,  the  Company  maintains a
rigorous  quality  assurance  program designed to ensure that the manufacture of
its  products  conforms  with  specified  standards  and to  detect  substandard
products before shipment.  As part of this program, the Company maintains,  on a
full-time or part-time  basis,  personnel at the factories in which its products
are  manufactured.  These  quality  assurance  personnel  inspect  incoming  raw
materials  and  components,  audit  in-process  controls at the  factories,  and
participate  in finished  goods  acceptance  inspections.  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
                                       12
<PAGE>
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 operates a repair  facility  that performs  repairs on
the  Company's  telephone  systems,  commercial  grade  telephones,  and related
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 key telephone  systems,  commercial grade  telephones,  and
other communications  products are extremely competitive.  The Company currently
competes principally on the basis of the technical innovation and performance of
its  telephone  systems,   commercial  grade  telephones,  and  other  products,
including  their  ease of  installation  and  use,  reliability,  cost,  and the
technical  support  both  before  and after  sales to end users.  The  Company's
competitors  in the sale of telephone  systems and telephones  include  Comdial,
Nitsuko,  Panasonic  Communications  &  Systems  Co.,  and  Toshiba  Information
Systems,  Inc.  Competitors in the supply of voice  processing  systems  include
Active Voice  Corporation  and Applied  Voice  Technology as well as PBX and key
system telephone manufacturers that offer integrated voice processing systems of
their own design and under various original equipment  manufacturer  agreements.
Competition  in the  interactive  voice  response  market  includes  Brite Voice
Systems,  Intellivoice  Communications,  Inc.,  and  Glenayre.  In the  computer
telephony market, the Company competes with many of the same companies indicated
above as well as  large  software  development  companies,  including  Microsoft
Corp.,  Lotus Development  Corporation,  and Novell,  Inc. Most of the Company's
competitors are large  companies that have greater name  recognition and greater
financial,  technical,  marketing,  manufacturing,  distribution,  and personnel
resources  than the  Company.  The  revenue,  profitability,  and success of the
Company depends  substantially  upon its ability to compete with other providers
of telephone  systems and other  telephony  products.  No assurance can be given
that the Company will  continue to be able to  successfully  complete  with such
organizations.

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

Patents, Trademarks, and Licenses

         As of December 31, 1996,  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
                                       13
<PAGE>
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 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  acquired the  registered and  unregistered  trademarks for
"STARPLUS,"  "First  Class,"  and  "infinite"  from  Executone  as  part  of the
acquisition  of the assets of the Company  from  Executone  in April  1994.  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 STARPLUS and infinite  digital  telephone  systems.  Under the
License  Agreement,  the Company has granted to Executone a  cross-license  that
enables  Executone  to utilize  improvements  that the Company  develops for the
technology covered by the License Agreement. 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  STARPLUS  and
infinite 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 on March 30,  2014,  but  automatically  renews for a 20-year
period unless either party gives written  notice of  termination  within 60 days
prior to March 30, 2014. The Company and Executone in the past have disputed the
extent to which the License  Agreement  applies to products  sold by the Company
and the amount of the royalty fee that the Company must pay to Executone.

         In December 1996, the Company entered into an agreement with Syntellect
Technology  Corp.  ("Syntellect")  under  which  the  Company  may make and sell
products utilizing  Syntellect's  portfolio of approximately 20 patents, so long
as the Company obtains  certain  components used in those products from Dialogic
Corporation,  which has a license  agreement for the technology  incorporated in
those products. See Item 2, "Legal Proceedings."

         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.
                                       14
<PAGE>
Government Regulation

         In recent years, the United States government 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.

         The wireless telephone systems currently being developed by the Company
will be subject to extensive regulation by the Federal Communications  Committee
("FCC") and government agencies of foreign countries. Such regulations have been
designed,  among other things,  to allocate the radio  frequency  spectrum among
different types of users, avoid interference among users of radio equipment, and
permit  interconnection  of equipment.  As a result, the Company must design its
wireless  telephone  systems so as to comply with such  regulations  in order to
obtain governmental  approvals necessary to permit it to market these systems in
the  United  States  and  other  countries.  Furthermore,  the FCC  and  foreign
regulatory  agencies  continually  are  adopting  new or changed  standards  and
regulations  governing  wireless   communications   products.   Changed  or  new
regulations  may  require  the  Company  to modify  its  then-existing  wireless
telephone  products or to develop new products that will comply with regulations
then  in  effect.  To  the  extent  that  foreign  countries  maintain  wireless
communications standards and regulations that are different from those in effect
in the United  States,  the  Company  may be  required  to modify  its  wireless
telephone systems in order to market such systems in those countries.  Delays in
obtaining  governmental  approvals  or the  inability  to design  or modify  its
wireless  telephone  systems  to  meet  governmental  regulations  could  have a
material  adverse  effect on the  Company's  operating  results  related  to its
proposed wireless telephone systems.

Employees

         As of December 31, 1996,  the Company  employed a total of 160 persons,
consisting of 159 full-time employees and 1 part-time employee at its facilities
in Scottsdale, Arizona and Norcross, Georgia. This number includes 33 persons in
engineering  and  product  development,  68 in sales,  marketing  and  technical
support, 14 in warehouse and distribution functions, 20 in equipment repair, and
25 in administration,  including executive personnel.  The Company considers its
relationship with its employees to be good, and none of its employees  currently
are represented by a union in collective bargaining with the Company.

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

Executive Officers

         The  following  table sets  forth  information  concerning  each of the
executive officers of the Company:
<TABLE>
<CAPTION>
                  Name                               Age                                  Position
                  ----                               ---                                  --------

<S>                                                  <C>           <C>                                
Steven A. Sherman........................            51            Chairman of the Board
Glenn R. Fitchet.........................            49            President, Chief Executive Officer, and Director
Kent R. Burgess..........................            50            Senior Vice President -- Operations and
                                                                     Secretary; President of Enhanced Systems, Inc.
Gregory K. Roeper........................            36            Vice President -- Finance, Chief Financial
                                                                     Officer, and Treasurer
Larry L. Steinmetz.......................            40            President of Vodavi Communications Systems,
                                                                     Inc.
</TABLE>
                                       15
<PAGE>
         Steven A.  Sherman  has served as  Chairman of the Board of the Company
since March 1994.  Mr. Sherman has served as Chairman of the Board and President
of NovAtel  Wireless,  Inc.  since  August  1996.  Mr.  Sherman  has served as a
director  of Main  Street and Main  Incorporated  ("Main  Street"),  the world's
largest franchisee of TGI Friday's  restaurants,  since June 1990, and served as
Chairman  of the Board of Main  Street  from June 1990 to August 1996 and as the
Chief  Executive  Officer of Main Street from June 1990 until January 1996.  Mr.
Sherman is a principal of the Sherman Capital Group,  L.L.C., a merchant banking
organization which he founded in July 1988. Mr. Sherman was a founder and served
as the Chairman of the Board of Vodavi Technology Corporation,  a predecessor of
the  Company,  from 1983  until  his  resignation  in July 1988 and  served as a
director of Executone from July 1988 until his  resignation in January 1990. Mr.
Sherman also currently serves as a director of  GlobalCenter,  Inc., a privately
held Internet services provider.

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

         Kent R. Burgess has served as Senior Vice  President -  Operations  and
Secretary of the Company  since April 1994 and as  President  of Enhanced  since
September  1996.  Mr.  Burgess  served  as  Senior  Vice  President  -  Business
Operations for Main Street and Main  Incorporated from November 1992 until March
1994.  Mr.  Burgess  served as Vice  President - Production  of  Executone  from
December  1989  to  November   1992,   with   responsibilities   for  materials,
manufacturing, quality assurance, distribution, and warehousing. Mr. Burgess was
Executive Vice President of Vodavi Technology Corporation prior to the formation
of Executone.

         Gregory  K.  Roeper  has  served as Vice  President  -  Finance,  Chief
Financial  Officer,  and Treasurer of the Company since November 1994. 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.

         Larry L.  Steinmetz has served as President of VCS since July 1996. Mr.
Steinmetz  served as Vice  President  - Sales of VCS from July 1995 to June 1996
and served as Vice President - Distribution Sales of VCS from April 1994 to June
1995. Mr. Steinmetz was Director of Distribution Sales of the Vodavi Division of
Executone from July 1988 to April 1994, Director of Distribution Sales of Vodavi
Technology  Corporation  from April 1987 until July 1988, and National  Accounts
Manager of Vodavi  Technology  Corporation  from November 1983 until April 1987.
Mr.  Steinmetz also served as Director of Sales,  Eastern Region,  of Inter-Tel,
Incorporated  from 1982 until November 1983 and held various sales and marketing
positions for Sprint United Telephone from 1979 until 1982.

History of the Company

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

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

         In October 1995,  Enhanced merged with a wholly owned subsidiary of the
Company.  Enhanced  develops and markets  voice  processing,  interactive  voice
response, desktop video conferencing,  and call accounting software products for
small, medium, and large businesses,  universities, and government organizations
in the United States 
                                       16
<PAGE>
and  internationally.  The  Company  issued to the  shareholders  of Enhanced an
aggregate  of 666,662  shares of Common  Stock and $3.0 million in cash upon the
consummation of the merger.

                             SPECIAL CONSIDERATIONS

Certain Factors Affecting Operating Results

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

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

Dependence  on Third  Parties  for  Manufacturing;  International  Manufacturing
Sources

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

         The Company  currently  obtains  certain of its products  under various
manufacturing  arrangements  with  third-party  manufacturers  in  South  Korea,
Thailand,  Malaysia,  Hong Kong, Republic of China, and the Peoples' Republic of
China. See Item 1, "Business - Manufacturing"  for a description of the material
terms  of  certain  of  these  arrangements.   The  Company's  reliance  on  the
third-party   manufacturers  to  provide   personnel  and  facilities  in  these
countries,  the Company's  maintenance of equipment and inventories  abroad, and
the potential imposition of quota limitations on imported goods from certain Far
East countries expose it to certain economic and political risks,  including the
business and financial  condition of the  third-party  manufacturers;  political
uncertainty;  the  possibility of  expropriation,  supply  disruption,  currency
controls,  and  exchange  fluctuations;  and changes in tax laws,  tariffs,  and
freight  rates.  Except for a fire that  interrupted  production at one plant in
China  during  late  1993  and the  first  part of  1994,  the  Company  has not
experienced any significant interruptions to date in obtaining its products from
third-party  manufacturers.  The Company believes that production of its product
lines  overseas  enables the Company to obtain  these items on a cost basis that
enhances the ability of the Company to market them profitably.
                                       17
<PAGE>
         The Company  purchased  approximately  $17.4 million and $17.9 million,
respectively,  of key telephone systems and commercial grade telephones from LGE
and LGST, an affiliate of LGE, during fiscal 1995 and fiscal 1996,  constituting
approximately 68.0% and 69.6%, respectively, of total purchases of such products
during these  periods.  The Company made such  purchases  pursuant to agreements
that expire in April 1997. See Item 1, "Business -  Manufacturing"  and "Special
Considerations - Control by Management;  Stockholders'  Agreement;  Conflicts of
Interest." Although the Company currently is engaged in discussions with LGE and
LGST to extend the current agreements or to enter into new agreements, there can
be no  assurance  that  it  will  be  able  to  secure  long-term  manufacturing
arrangements  for the  products  it  currently  obtains  from LGE and LGST.  The
Company's  operations  would be adversely  affected if it lost its  relationship
with any of its current suppliers or if any of its current suppliers' operations
or  overseas or air  transportation  were  disrupted  or  terminated  even for a
relatively  short period of time.  The Company does not maintain an inventory of
sufficient  size to provide  protection  for any  significant  period against an
interruption  of supply,  particularly if it were required to locate and utilize
alternative sources of supply.

Dependence on LGE

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

Competition

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

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

Dependence on New Products and Technologies

         The Company operates in an industry that is increasingly  characterized
by fast-changing technology. As a result, the Company will be required to expend
substantial  funds  for and  commit  significant  resources  to the  conduct  of
continuing product  development,  including research and development  activities
and the engagement of
                                       18
<PAGE>
additional engineering and other technical personnel. Any failure by the Company
to anticipate  or respond  adequately to  technological  developments,  customer
requirements, or new design and production techniques, or any significant delays
in product development or introduction,  could have a material adverse effect on
the Company's operations.

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

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

Reliance on Independent Distribution Network

         The Company  currently  markets  its  products  through a  distribution
network  consisting  primarily of large wholesale  distributors known as "Supply
Houses"  and  telephone  sales  and  installation  companies  known  as  "Direct
Dealers." Supply Houses and Direct Dealers  generally stock  inventories only in
quantities deemed sufficient to fill anticipated short-term orders. As a result,
orders  generally can be cancelled and volume levels changed or delayed on short
notice to the Company. The timely replacement of cancelled,  delayed, or reduced
orders cannot be assured.

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

         Graybar accounted for 45% and 44%,  respectively,  of sales during 1995
and 1996. Accounts receivable from Graybar comprised  approximately 44% of total
accounts receivable at December 31, 1996.

Patents, Licenses, and Intellectual Property Claims

         The Company's  success  depends in part upon its ability to protect its
proprietary  technology.  The  Company  relies on a  combination  of  copyright,
trademark, and trade secret laws, nondisclosure and other contractual
                                       19
<PAGE>
agreements, and technical measures to protect its proprietary technology.  There
can be no  assurance  that  the  steps  taken  by the  Company  to  protect  its
proprietary rights will be adequate to protect  misappropriation  of such rights
or that third  parties will not  independently  develop  equivalent  or superior
technology.  In addition,  the Company has acquired  certain  patents and patent
licenses  and  intends  to  continue  to  seek  patents  on its  inventions  and
manufacturing  processes.  The process of seeking patent  protection can be long
and expensive, and there can be no assurance that patents will issue from future
applications or that the Company's  existing patents or any new patents that are
issued will be of sufficient scope or strength to provide meaningful  protection
or any commercial advantage to the Company. The Company may be subject to or may
initiate interference proceedings in the U.S. Patent and Trademark Office, which
can demand significant financial and management resources.  As is typical in the
telecommunications  industry, the Company from time to time has received, and in
the future may receive, communications alleging possible infringement of patents
or  other   intellectual   property  rights  of  others.   See  Item  3,  "Legal
Proceedings."  Based on industry  practice,  the Company  believes  that in most
cases it could obtain any  necessary  licenses or other  rights on  commercially
reasonable terms, but no assurance can be given that licenses would be available
on acceptable  terms,  that litigation  would not ensue, or that damages for any
past  infringements  would not be  assessed.  Litigation,  which could result in
substantial cost to and diversion of effort by the Company,  may be necessary to
enforce  patents  or other  intellectual  property  rights of the  Company or to
defend the Company  against claimed  infringement  of the rights of others.  The
failure to obtain necessary  licenses or other rights or litigation  arising out
of infringement claims could have a material adverse effect on the Company.  See
Item 1, "Business - Patents, Trademarks, and Licenses."

Management of Growth

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

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

The Telecommunications Industry; Cyclicity and Capital Requirements

         The  telecommunications  industry has experienced economic downturns at
various times,  characterized by diminished product demand,  accelerated erosion
of average selling prices, and production  overcapacity.  The Company has sought
to reduce its  exposure to industry  downturns by  targeting  its product  lines
towards  small to  medium-sized  businesses,  which the  Company  believes  will
sustain  continued  growth in the near and long  term,  resulting  in a steadily
increasing  demand  for  enhanced  and  upgraded  telephone  systems  and  voice
processing   products.   However,   the  Company  may   experience   substantial
period-to-period  fluctuations  in future  operating  results because of general
industry  conditions or events  occurring in the general  economy.  In addition,
although  the  Company  has  not   experienced   significant   quarterly   sales
fluctuations  in the  past,  the size  and  timing  of  sales  of its new  voice
processing and computer-telephony  products may be expected to vary from quarter
to quarter to a greater extent.  The expanding  importance of these new products
could  result in  significant  variations  in the  Company's  overall  operating
results on a quarterly basis.
                                       20
<PAGE>
         To remain  competitive,  the Company must continue to make  significant
investments in research and development,  equipment, and facilities. As a result
of the increase in fixed costs and operating  expenses  related to these capital
expenditures,  the Company's  operating results may be adversely affected if its
net sales do not  increase  sufficiently  to offset  the  increased  costs.  The
Company  from  time to time may seek  additional  equity  or debt  financing  to
provide  for the  capital  expenditures  required  to  maintain  or  expand  the
Company's design and production facilities and equipment.  The timing and amount
of any such capital  requirements cannot be predicted at this time. There can be
no assurance that any such financing will be available or, if available, will be
available  on  terms  satisfactory  to the  Company.  If such  financing  is not
available  on  satisfactory  terms,  the  Company  may be unable  to expand  its
business or develop new products at the rate desired and its  operating  results
may be adversely affected.  Debt financing increases expenses and must be repaid
regardless of operating  results.  Equity  financing  could result in additional
dilution to existing  stockholders.  See Item 7,  "Management's  Discussion  and
Analysis of  Financial  Condition  and  Results of  Operations  - Liquidity  and
Capital Resources."

Shortage of Raw Materials and Supplies

         The  principal  raw  materials  and  components  used in producing  the
Company's  products  consist of  semiconductor  components,  unfinished  printed
circuit  boards,  molded plastic parts,  metals,  and packaging  materials.  The
third-party  manufacturers of the Company's products acquire these raw materials
primarily from Asian sources,  which indirectly  subjects the Company to certain
risks,   including  supply   interruptions  and  currency  price   fluctuations.
Purchasers  of  these  materials,  including  the  Company  and its  third-party
manufacturers,  experience  difficulties  from  time to time in  obtaining  such
materials. The suppliers of these materials currently are adequately meeting the
requirements of the Company.  The Company also believes that there are alternate
sources of supplies 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. Furthermore,  the Company's license agreement with Syntellect permits the
Company  to  make  and  sell  products  utilizing   Syntellect's   portfolio  of
approximately 20 patents, so long as the Company obtains certain components used
in  those  products  from  Dialogic,  which  has a  license  agreement  for  the
technology  incorporated in those products. See Item 2, "Legal Proceedings." The
Company's  ability to deliver  certain of its product  lines could be  adversely
affected if it is unable to obtain voice processing  boards from Dialogic at any
time that alternative sources of similar components are not readily available.

Dependence on Management and Other Key Personnel

         The Company's  development  and  operations to date have been,  and its
proposed  operations  will be,  substantially  dependent  upon the  efforts  and
abilities of its senior management and technical personnel. The Company does not
have employment agreements with any of its executive officers other than Kent R.
Burgess, the President of Enhanced. The Company,  however,  maintains agreements
with  each of its  officers  and  employees  that  prohibit  such  persons  from
disclosing  confidential  information  obtained while employed with the Company.
The loss of  existing  key  personnel  or the  failure  to  recruit  and  retain
necessary  additional  personnel would adversely  affect the Company's  business
prospects. There can be no assurance that the Company will be able to retain its
current personnel or to attract and retain necessary additional  personnel.  The
Company's  internal  growth and the  expansion of its product lines will require
additional  expertise  in  such  areas  as  software  development,   operational
management,  and marketing.  Such growth and expansion  activities will increase
further the demand on the  Company's  resources  and require the addition of new
personnel and the  development of additional  expertise by existing   personnel.
The failure of the Company to attract and retain  personnel  with the  requisite
expertise or to develop  internally such expertise  could  adversely  affect the
prospects for the Company's success.  The Company currently maintains key person
insurance  in the  amount  of  $1.0  million  covering  Glenn  R.  Fitchet,  its
President.  The terms of the revolving line of credit  facility  between VCS and
General Electric Capital Corporation ("GE
                                       21
<PAGE>
Capital")  currently  require  that  Steven  Sherman  or  a  successor  that  is
acceptable to GE Capital must serve as Chairman of the Board of VCS. See Item 1,
"Business - Executive Officers."

Control by Management; Stockholders' Agreement; Conflicts of Interest

         The  directors,   executive  officers,  and  certain  other  management
personnel of the Company and their  affiliates  own  approximately  38.5% of the
outstanding shares of Common Stock,  including  approximately 18.7% owned by LGE
(excluding  shares  issuable  to  such  persons  upon  exercise  of  outstanding
options).  The Company,  LGE, Steven A. Sherman,  Glenn R. Fitchet,  and certain
other stockholders of the Company are parties to a stockholders'  agreement (the
"Stockholders'  Agreement").  At any time that the Company  issues shares of its
Common  Stock in an amount  representing  1% or more of its  outstanding  Common
Stock,  the  Stockholders'  Agreement  gives LGE the right to purchase  from the
Company  a  sufficient  number of shares  as may be  required  to enable  LGE to
maintain the  percentage  of ownership of Common Stock that existed  immediately
prior to such issuance.  The  Stockholders'  Agreement also requires Mr. Sherman
and Mr.  Fitchet to vote their  shares of Common  Stock to elect as directors of
the Company that number of persons designated by LGE that comprises a percentage
of the Board of  Directors  equal to LGE's then  percentage  of ownership of the
Company's  Common  Stock,  provided  that so long as LGE  owns 8% or more of the
Company's outstanding Common Stock, Messrs.  Sherman and Fitchet will vote their
shares to the elect at least one designee of LGE as a director.

         The Company obtains a substantial  portion of the hardware  utilized in
its  telephone  systems and  commercial  grade  telephones  from LGE and obtains
certain of its electronic  telephone  systems and most of its  commercial  grade
telephone and  replacement  parts for such telephones from LGST, an affiliate of
LGE. The terms of the Company's  manufacturing  agreement  with LGST require the
Company to purchase  $5.5 million of product from LGST during 1997.  See Item 1,
"Business - Manufacturing" and "Special  Considerations - Dependence on LGE." As
a result of LGE's  ownership  interest in the Company,  an inherent  conflict of
interest  exists in  establishing  the volume and terms and  conditions  of such
purchases.  In order to mitigate such  conflicts,  all decisions with respect to
such purchases will be made by officers of the Company and reviewed by directors
of the Company who have no relationship with LGE.

         Steven A. Sherman, the Company's Chairman of the Board, is the Chairman
of the Board and President and a significant  shareholder of NovAtel, with which
the Company has an agreement to develop wireless telephone systems.  See Item 1,
"Business - New Product Development - Wireless Telephone Systems."

Possible Volatility of Stock Price

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

Rights to Acquire Shares

         A total of  850,000  shares of Common  Stock  have  been  reserved  for
issuance  upon  exercise  of options  granted or which may be granted  under the
Company's  stock option plan.  Options to acquire 648,500 shares of Common Stock
at  a  weighted  average  exercise  price  of  $4.83  per  share  currently  are
outstanding under the stock
                                       22
<PAGE>
option plan.  In addition,  the Company sold to the  underwriter  of its initial
public  offering  warrants  to  purchase  133,333  shares of Common  Stock.  The
warrants  have an exercise  price per share of $7.20 and are  exercisable  until
October 2000. During the terms of such options and warrants, the holders thereof
will have the  opportunity to profit from an increase in the market price of the
Common Stock.  The  existence of such options and warrants may adversely  affect
the terms on which the Company can obtain additional financing,  and the holders
of such  options  and  warrants  can be expected  to  exercise  such  options or
warrants at a time when the Company, in all likelihood,  would be able to obtain
additional  capital  by  offering  shares  of its  Common  Stock on  terms  more
favorable to the Company than those  provided by the exercise of such options or
warrants.

Shares Eligible for Future Sale

         Sales of Common  Stock in the  public  market  could  adversely  affect
prevailing  market  prices.  Approximately  1,817,000  shares  of  Common  Stock
currently are eligible for sale in the public market, subject to compliance with
the  requirements  of Rule 144 under the Securities Act of 1933, as amended (the
"Securities  Act").  As a result of recent  changes to Rule 144,  an  additional
854,162  shares of Common Stock will become  eligible for sale  pursuant to Rule
144 in April 1997. Shares issued upon the exercise of stock options issued under
the  Company's  Stock  Option Plan  generally  will be eligible  for sale in the
public market.  The Company also has the authority to issue additional shares of
Common Stock and shares of one or more series of preferred  stock.  The issuance
of such shares could result in the dilution of the voting power of the currently
outstanding  shares of Common Stock and could have a dilutive effect on earnings
per share.

Change in Control Provisions

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

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

         The Company's Amended  Certificate and Bylaws contain a number of other
provisions  relating to corporate  governance and to the rights of stockholders.
These  provisions  include (a) the  authority  of the Board of Directors to fill
vacancies on the Board of Directors; (b) the authority of the Board of Directors
to issue  preferred  stock in series with such voting rights and other powers as
the Board of Directors may determine;  and (c) the  requirement  that any of the
following  actions be  approved by the  affirmative  vote of  two-thirds  of the
directors  then in office:  (1) a public  offering of the  capital  stock of the
Company;  (2) the merger  with or the  acquisition  of another  business  or the
acquisition of a significant  amount of the assets of another business;  (3) the
sale of a  significant  amount of the  assets of the  Company;  (4) the  Company
entering into contracts with stockholders or directors of the Company;
                                       23
<PAGE>
(5)  the  assumption  or  acquisition  by the  Company  of  debt  in  excess  of
$1,000,000;  and (6) any amendment of the Amended  Certificate of  Incorporation
and Bylaws of the Company or VCS.

Lack of Dividends

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

Cautionary Statement Regarding Forward-Looking Statements

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

ITEM 2.           PROPERTIES

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

ITEM 3.           LEGAL PROCEEDINGS

         In March 1996,  Syntellect  Technology Corp.  ("Syntellect") filed suit
against  the  Company,  Enhanced,  and an  unaffiliated  third  party,  alleging
infringement of six United States patents held by Syntellect.  In December 1996,
the Company reached an agreement with  Syntellect  under which it obtained (i) a
full  release of all claims  that formed the basis for the  lawsuit,  and (ii) a
license  to  make  and  sell  products  utilizing   Syntellect's   portfolio  of
approximately  20 patents,  including  patents  that were not the subject of the
lawsuit,  so  long as the  Company  obtains  certain  components  used in  those
products  from  a  third-party  supplier  that  has  a  license  agreement  with
Syntellect for that technology. See Item 1, "Business - Patents, Trademarks, and
Licenses."

         On September 20, 1996,  the Company and Enhanced filed a lawsuit in the
United  States  District  Court for the District of Arizona (No. CIV 96-2184 PHX
SMM) against Michael Mittel and Fereydoun Taslimi, former
                                       24
<PAGE>
officers and  directors of Enhanced.  The lawsuit  alleges,  among other things,
that Messrs. Mittel and Taslimi violated federal and Arizona securities laws and
engaged in fraudulent activities in connection with the Company's acquisition of
Enhanced  in  1995;  breached  certain  terms  of  their  respective  employment
contracts  with  Enhanced;  and  breached  their  fiduciary  duties to Enhanced,
including  converting certain corporate assets of Enhanced and  misappropriating
certain corporate  opportunities for their own benefit. The Company and Enhanced
are  seeking  compensatory  and  punitive  damages  against  Messrs.  Mittel and
Taslimi.

         On September  24, 1996,  Messrs.  Mittel and Taslimi filed a lawsuit in
the United States District Court for the Northern  District of Georgia,  Atlanta
Division  (No.  196-CV-2563),  against  the Company  and  Enhanced.  The lawsuit
alleges  that  Enhanced  breached  Messrs.  Mittel's  and  Taslimi's  respective
employment  agreements by terminating their  employment.  The Company intends to
proceed with its lawsuit  against  Messrs.  Mittel and Taslimi and to vigorously
defend the lawsuit filed by them against the Company and Enhanced.

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

         Not applicable
                                       25
<PAGE>
                                     PART II

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

         The  Company's  Common  Stock has been  quoted in the  Nasdaq  National
Market under the symbol "VTEK" since October 6, 1995.  The following  table sets
forth the high and low closing sales prices of the Company's Common Stock on the
Nasdaq National Market for the periods indicated.
<TABLE>
<CAPTION>
                                                                                       High                   Low
                                                                                       ----                   ---
<S>                                                                                 <C>                     <C>   
1995:
    Fourth quarter (from October 6, 1995 to December 31, 1995)..............        $ 7.50                  $ 5.25

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

1997:
    First quarter (through March 24, 1997)..................................        $ 5.00                  $ 3.50
</TABLE>


         On March 24,  1997,  the closing  sales  price of the Common  Stock was
$3.50 per  share.  As of March 24,  1997,  there  were 42  holders of record and
approximately 660 beneficial owners of the Company's Common Stock.
                                       26
<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>
                                     Vodavi Division(1)                                 The Company
                           -------------------------------------       --------------------------------------------
                                                                        Period From
                                                         Three           Inception
                                                        Months        (Aug. 3, 1993)
                                                         Ended            through
                           Year Ended December 31,     March 31,       December 31,         Year Ended December 31,
                           -----------------------     ---------       ------------         -----------------------
                             1992         1993           1994              1993           1994(2)    1995     1996
                             ----         ----           ----              ----           -------    ----     ----
                                                        (In thousands, except share data)
<S>                         <C>           <C>            <C>            <C>               <C>     <C>       <C>     
Operating Data:
Revenue.................    $26,556       $31,571        $8,587         $     --          $29,140 $  39,601 $ 46,154
Gross margin............      6,812         8,172         2,418               --            8,613    12,404   15,312
Operating expenses......      6,071         6,591         1,872                7            6,291    10,399   13,749
Asset impairment and
  restructuring charges.         --            --            --               --               --        --    4,805(3)
Operating income (loss).        741         1,581           546               (7)           2,322     2,055   (3,242)
Interest & other expenses        47            11            --                6              576     1,130      840
Pretax income (loss)....        694         1,570           546             (13)            1,746       875   (4,082)
Income taxes............         --            --            --               --              693       417      327
Net income (loss).......        694         1,570           546             (13)            1,053       458   (4,409)
Net income (loss) per share     N/A           N/A           N/A        $  (0.02)         $   0.55 $    0.17 $  (1.02)
Weighted average
  shares outstanding....        N/A           N/A           N/A          849,999        1,917,346 2,769,434 4,342,238
<CAPTION>
                             As of December 31,       As of March 31,               As of December 31,
                         ------------------------     --------------- ----------------------------------------------
                             1992         1993           1994              1993           1994      1995      1996
                             ----         ----           ----              ----           ----      ----      ----
Balance Sheet Data:
Assets:
  Current assets........    $10,953       $10,544       $12,034             $130          $14,122   $17,719  $16,591
  Property and
     equipment..........        424           397           452               --              635     1,731    2,465
  Goodwill..............         --            --            --               --            2,833     7,089    2,547
  Other.................         --            --            --              280              357       931      815
                          ---------     ---------     ---------            -----         --------  -------- --------
                            $11,377       $10,941       $12,486             $410          $17,947   $27,470  $22,418
                            =======       =======       =======             ====          =======   =======  =======
Liabilities:
  Current liabilities...     $2,800        $2,390        $3,128             $406           $5,316    $5,776   $7,240
  Long-term debt........         --            --            --               --            8,574     7,884    5,588
  Other long-term
     obligations........         --            --            --               --               --        69      189
  Due to parent.........      4,040         2,444         2,705               --               --        --       --
                            -------       -------       -------            -----         --------  -------- --------
Total liabilities.......      6,840         4,834         5,833              406           13,890    13,660   13,017
Stockholders' equity....      4,537         6,107         6,653                4            4,057    13,810    9,401
                            -------       -------       -------            -----          -------   -------  -------
                            $11,377       $10,941       $12,486             $410          $17,947   $27,470  $22,418
                            =======       =======       =======             ====          =======   =======  -------
</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.

(3)  Represents a $4.8 million charge to write down goodwill associated with the
     acquisition  of  Enhanced  and  to  set up restructuring charges related to
     Enhanced. See  Item 7,  "Managements  Discussion  and Analysis of Financial
     Condition  and Results of Operations."
                                       27
<PAGE>
ITEM 7. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

Basis of Presentation

         In April 1994, the Company acquired  substantially all of the operating
assets of the Vodavi Division.  See Item 1, "Business - History of the Company."
The  acquisition  was accounted for using the purchase  method of accounting for
business combinations. Prior to the acquisition, the Vodavi Division operated as
a separate division within a publicly held company,  with stand-alone  financial
results.

Results of Operations

Annual Results

         The following table summarizes the operating results of the Company for
the periods  indicated.  The table and the  discussion  below  should be read in
conjunction with the Consolidated  Financial Statements and Notes thereto, which
appear elsewhere in this Report.
<TABLE>
<CAPTION>
                                                                              Years ended December 31,
                                                ---------------------------------------------------------------------------------
                                                    1994 - Pro Forma(1)                1995                         1996
                                                --------------------------   -------------------------   ------------------------
                                                                           (Dollar amounts in thousands)
                                                        $             %             $             %              $          %
                                                     -------        -----        -------        -----         -------     ----- 
<S>                                                  <C>            <C>          <C>            <C>           <C>         <C>   
Revenue......................................        $37,727        100.0%       $39,601        100.0%        $46,154     100.0%
Cost of goods sold...........................         26,696         70.8%        27,197         68.7%         30,842      66.8%
                                                      ------        -----         ------        -----          ------     -----
  Gross margin...............................         11,031         29.2%        12,404         31.3%         15,312      33.2%
Operating expenses
  Engineering and product
    development..............................          1,834          4.9%         1,942          4.9%          2,161       4.7%
  Selling, general, and administrative.......          6,410         17.0%         8,457         21.3%         11,588      25.1%
  Asset impairment and restructuring charges.            ---           ---           ---           ---          4,805      10.4%
                                                    --------        ------       -------        ------         ------     -----
Operating income (loss)......................          2,787          7.3%         2,005          5.1%        (3,242)      (7.0)%
Other income (expense), net..................          (766)          2.0%       (1,130)          2.9%          (840)       1.8%
                                                    -------        ------        ------         -----        --------    ------
Pretax income (loss).........................          2,021          5.3%           875          2.2%        (4,082)      (8.8)%
Income tax expense...........................            798          2.1%           417          1.0%            327       0.7%
                                                     -------       ------        -------        -----         -------    ------
Net income (loss)............................        $ 1,223          3.2%      $    458          1.2%       $(4,409)      (9.5)%
                                                     =======       ======       ========        =====        =======     =======
</TABLE>

(1) Includes the pro forma results of the Vodavi  Division for the first quarter
    of 1994.

Revenue

         Revenue was  approximately  $46.2  million in 1996, an increase of $6.6
million, or 16.7%, over 1995 revenue of approximately $39.6 million.  Revenue in
1995 increased  approximately $1.9 million,  or 5.0%, over pro forma revenue for
1994 of approximately  $37.7 million.  The increase in 1996 can be attributed to
the annualized  impact of the 1995  acquisitions of Enhanced and ARSI as well as
new product  introductions  and the addition of new  customers.  The increase in
1995 can be attributed to the  acquisitions of ARSI and Enhanced  (approximately
$900,000) as well as increased sales of the Company's digital telephone systems.

Cost of Goods Sold

         Gross margins  increased to  approximately  33.2% of revenue in 1996 as
compared with 31.3% and 29.2% in 1995 and 1994, respectively. The improvement in
1996 reflects the October 1995  acquisition  of Enhanced,  which sells  products
with significantly higher gross margins than other products sold by the Company.
The increased  margins also reflect the Company's  ongoing efforts to reduce the
costs of products  obtained  from its  contract  manufacturers  as well as price
increases implemented during the periods presented.
                                       28
<PAGE>
Engineering and Product Development

         Expenditures  related to engineering and product  development  remained
relatively stable at approximately $2.2 million,  $1.9 million, and $1.8 million
in 1996, 1995, and 1994, respectively.

Selling, General and Administrative Expenses

         Selling,  general and administrative  expenses were approximately $11.6
million,  $8.5 million, and $6.4 million in 1996, 1995, and 1994,  respectively.
The $3.1 million, or 36.5%,  increase in 1996 can be attributed primarily to the
annualized impact of the 1995  acquisitions of Enhanced and ARSI  (approximately
$1.9 million of the increase) as well as increased sales and marketing  expenses
and increased costs associated with being a publicly traded company.

         The increase in 1995 of  approximately  $2.1 million,  or 32.8%, can be
attributed to numerous factors,  including the acquisitions of ARSI and Enhanced
(approximately  $600,000 of the  increase)  and the  expansion of the  Company's
infrastructure  in order to accommodate  the separation of the operations of the
Vodavi  Division from the  operations of Executone and for  anticipated  growth.
Such increases  included an increase in facilities  expense related to the lease
entered into in January 1995, which significantly  increased the space available
to the Company after  Executone  vacated the premises at the end of 1994, and an
increase in personnel of  approximately  40%,  primarily for warehouse,  quality
assurance,   systems  integration,   marketing,  human  resources,  and  finance
functions, all of which were previously shared with Executone.

Asset Impairment and Restructuring Charges

         In 1996, the Company recorded a $4.2 million write-down of the goodwill
associated  with the  acquisition  of Enhanced in accordance  with  Statement of
Financial  Accounting  Standard  No.  121,  Accounting  for  the  Impairment  of
Long-Lived Assets and for Assets to be Disposed Of. The Company  determined that
the write-down  was  appropriate  after  evaluating the impact of several events
that  occurred  in the  latter  part of 1996,  including  communications  from a
customer that  purchase  levels to which the customer had  previously  committed
would not be met. The  write-down  of the goodwill of Enhanced  will result in a
reduction of goodwill amortization of approximately $460,000 annually.

         The  Company  also  accrued  approximately  $600,000  in  restructuring
reserves  related to the  operations of Enhanced.  These  reserves  included the
costs of relocating  new  management to Atlanta,  costs related to the Company's
lawsuit  against the former owners of Enhanced,  costs related to the settlement
of an outstanding  legal matter,  and other  expenses  related to the management
change.

Other Income (Expense), Net

         Other income (expense),  net consists  principally of interest expense.
Interest expense was  approximately  $840,000,  $1.1 million,  and $766,000,  in
1996, 1995, and 1994, respectively. The $289,000, or 25.6%, decrease in 1996 can
be attributed  primarily to the reduction in debt as a result of improved  asset
management.  The increase in 1995  reflects  the  additional  borrowings  by the
Company in 1995 to finance increased inventory levels and capital  expenditures.
The increase also reflects  higher  interest  rates in 1995 as compared to 1994.
The Company  believes  that the trend  towards  reduced  interest  expense  will
continue during 1997,  primarily as a result of the new terms under its extended
credit  facility  with GE  Capital.  See Item 7,  "Management's  Discussion  and
Analysis of  Financial  Condition  and  Results of  Operations  - Liquidity  and
Capital Resources."
                                       29
<PAGE>
Income Taxes

         The effective  rate of the  Company's  income tax provision was (8.0)%,
47.7%, and 39.5% in 1996, 1995, and 1994,  respectively.  The effective tax rate
for the Company has been significantly  impacted by the purchase of Enhanced and
the subsequent charges taken related to Enhanced.  The goodwill generated by the
acquisition  was  non-deductible.  This was the primary  cause of the  increased
effective rate in 1995 as compared with 1994. The asset impairment and a portion
of the restructuring charges in 1996 were also non-deductible, thus resulting in
the negative  effective  rate for 1996.  The Company  expects that the effective
rate in the future will be in the 40-42% range.

Liquidity and Capital Resources

         The Company's cash and cash equivalents were approximately $1.2 million
at December 31, 1996.  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, 1996 were  approximately  $5.4  million,  which  represents  a $2.5  million
reduction  from its  borrowings  of $7.9  million  at  December  31,  1995.  The
reduction is  attributed  to several  factors,  including  cash  generated  from
operations,  improved  asset  management,  and  utilization of capital leases to
finance  capital  expenditures,  as described  below.  At December 31, 1996, the
Company had approximately  $4.0 million available to it under its operating line
of credit.

         The Company  maintains a $12.0 million revolving line of credit with GE
Capital.  The line of credit  extends  through  April  1997 and bears  interest,
payable  monthly,  at 4.5% over the 30-day  commercial paper rate, or a total of
10.45% at December  31, 1996.  The Company has recently  reached an agreement in
principal to extend the facility  through April 2000. The terms of the extension
will lower the interest rate to 2.5% over the 30-day commercial paper rate, or a
total of 8.45% at December 31, 1996. Advances under the line of credit are based
upon  the  accounts  receivable  and  inventories  of VCS  and  are  secured  by
substantially  all of the assets and all of capital  stock of VCS. The revolving
line of  credit  contains  covenants  that  are  customary  for  similar  credit
facilities and also prohibits VCS from paying  dividends to the Company  without
the  consent  of GE  Capital.  See  Item 1,  "Special  Considerations  - Lack of
Dividends."  At December 31, 1996, the Company was in violation of two financial
covenants  contained in the original  agreement.  The Company  anticipates  that
these  covenants  will be eliminated  when its line of credit with GE Capital is
extended.

         In 1996,  the  Company  entered  into  leasing  facilities  in order to
finance  capital  expenditures.  The  facilities  provide the Company with up to
$800,000 at rates tied to Treasury  notes  (approximately  9.0% at December  31,
1996). As of December 31, 1996, the Company had utilized  approximately $435,000
of these facilities and had commitments outstanding for an additional $200,000.

         As of December 31, 1996, the Company had commitments in connection with
its new product developments.  Such commitments aggregate approximately $300,000
and are payable through  December 31, 1997. The commitments  include payments to
NovAtel in connection with the development of the Company's wireless product and
payments to develop new tooling for its existing and future digital products.

         The Company  believes  that its working  capital and credit  facilities
will be sufficient to finance its internal  growth for the  foreseeable  future.
Although  the  Company  currently  has no  acquisition  targets,  it  intends to
continue to explore acquisition  opportunities as they arise and may be required
to seek additional financing in the future to meet such opportunities.
                                       30
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

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

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

         Not applicable


                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The  information  required by this Item  relating to  directors  of the
Company is incorporated herein by reference to the definitive Proxy Statement to
be filed pursuant to Regulation  14A of the Securities  Exchange Act of 1934, as
amended  (the  "Exchange   Act")  for  the  Company's  1997  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 1997 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 1997 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 1997 Annual Meeting of Stockholders.
                                       31
<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.

         On October 15,  1996,  the Company  filed a Current  Report on Form 8-K
         dated September 20, 1996,  reporting the election of Kent R. Burgess as
         the  President  and a director of  Enhanced,  the removal of the former
         President and Vice President of Enhanced,  and certain lawsuits between
         the Company and Enhanced on the one hand and the former  President  and
         Vice President of Enhanced on the other.

(c) Exhibits
<TABLE>
<CAPTION>
Exhibit
Number                                      Exhibit
------                                      -------
<S>        <C>                                          
2.1        Asset Purchase Agreement dated as of November 5, 1993 among V Technology Acquisition Corp.,
           Executone Information Systems, Inc., and Vodavi, Inc., with Amendment dated February 18, 1994(1)
2.2        Agreement and Plan of Reorganization dated as of May 9,1995 among the Registrant, VOD, Inc.,
           Enhanced Systems, Inc., Michael Mittel, Fereydoun Taslimi, Nahid Taslimi, Scott Kelly, and Earl
           Alexander, with letter amendment dated May 22, 1995(1)
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) 
9          Voting Trust Agreement dated as of May 9, 1995 among Enhanced Systems, Inc., Michael Mittel, 
           Fereydoun Taslimi, Nahid Taslimi, Scott Kelly, Earl Alexander, and Glenn R. Fitchet(1)
10.1       Credit Agreement dated as of April 11, 1994 between Vodavi Communications Systems, Inc. and General
           Electric Capital Corporation(l)
10.2       Security Agreement dated as of April 11, 1994 between Vodavi Communications Systems, Inc. and
           General Electric Capital Corporation(l)
10.3       Stock Pledge and Security Agreement dated as of April 11, 1994 between the Registrant and General
           Electric Capital Corporation(l)
10.7       Patent Collateral Assignment Agreement dated as of April 11, 1994 between V Technology Acquisition
           Corp. and General Electric Capital Corporation(l)
10.8       Trademark Security Agreement dated as of April 11, 1994 between V Technology Acquisition Corp. and
           General Electric Capital Corporation(l)
10.9       Vodavi Technology, Inc. Amended and Restated 1994 Stock Option Plan(2)
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)
</TABLE>
                                       32
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number                                      Exhibit
------                                      -------
<S>        <C>                                          
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)
10.14      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)
10.16      Supply Agreement dated December 1, 1994 between NovAtel Communications Ltd., and Vodavi
           Communications Systems, Inc.(l)
10.17      Escrow Agreement dated as of May 9, 1995 among the Registrant, VOD, Inc., Michael Mittel,
           Fereydoun Taslimi, Nahid Taslimi, Scott Kelly, Earl Alexander, Glenn R. Fitchet, Enhanced Systems,
           Inc., and Arizona Escrow & Financial Corporation.(l)
10.18      Asset Purchase Agreement dated June 30, 1995 among the Registrant, Arizona Repair Services, Inc.,
           Goldstar Products Company, Ltd., and LG Electronics, U.S.A., Inc.(l)
10.19      OEM Agreement dated as of June 19, 1995, between Tecom Co., Ltd. and Vodavi Communications
           Systems, Inc.(3)
10.20      Agreement dated June 14, 1995 between Wong's Electronics Co., Ltd. and Vodavi Communications
           Systems, Inc.(3)
10.21      Master Lease Agreement dated May 31, 1996, between Matrix Funding Corporation and Vodavi
           Communications Systems, Inc.(2)
10.22      Master Lease Agreement dated October 7, 1996, between Matrix Funding Corporation and Vodavi
           Communications Systems, Inc.(4)
11         Computation of Per Share Earnings
21         List of Subsidiaries
23.1       Consent of Arthur Andersen LLP
27         Financial Data Schedule
</TABLE>
---------------------

(1)  Incorporated  by  reference  to  Registration  Statement  on Form  S-1 (No.
     33-95926) and amendments thereto which became effective on October 6, 1995.
(2)  Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the quarter ended June 30, 1996, as filed on August 14, 1996.
(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 September 30, 1996, as filed on November 14, 1996. 
                                       33
<PAGE>
                                   SIGNATURES

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

                                        VODAVI TECHNOLOGY, INC.

Date March 28, 1997                     By:  /s/ Glenn R. Fitchet
                                           ----------------------
                                           Glenn R. Fitchet
                                           President

     Pursuant to the requirements of the Securities Act of 1934, this report has
been signed below by the following  persons on behalf of the  registrant  and in
the capacities and on the date indicated.
<TABLE>
<CAPTION>
                Signature                                   Title                                      Date
                ---------                                   -----                                      ----


<S>                                        <C>                                                    <C>
         /s/  STEVEN A. SHERMAN            Chairman of the Board                                  March 28, 1997
----------------------------------------
            Steven A. Sherman


          /s/  GLENN R. FITCHET            President and Director                                 March 28, 1997
----------------------------------------
            Glenn R. Fitchet


         /s/  GREGORY K. ROEPER            Vice President --- Finance, Chief                      March 28, 1997
----------------------------------------
            Gregory K. Roeper              Financial Officer (Principal
                                           Financial and Accounting Officer)


                                           Director                                               March __, 1996
----------------------------------------
               Nam K. Woo


         /s/  GILBERT H. ENGELS            Director                                               March 28, 1997
----------------------------------------
            Gilbert H. Engels


        /s/  STEPHEN A MCCONNELL           Director                                               March 28, 1997
----------------------------------------
           Stephen A McConnell
</TABLE>
<PAGE>
                             VODAVI TECHNOLOGY, INC.


                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS






                                                                           Page

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

Consolidated Balance Sheets as of December 31, 1995 and 1996 ------------- F-3

Consolidated Statements of Operations for the Years Ended
   December 31, 1994, 1995, and 1996 ------------------------------------- F-4

Consolidated Statements of Changes in Stockholders' Equity for
   the Years Ended December 31, 1994, 1995, and 1996 --------------------- F-5

Consolidated Statements of Cash Flows for the Years Ended
   December 31, 1994, 1995, and 1996 ------------------------------------- F-6

Notes to Consolidated Financial Statements ------------------------------- F-7
                                      F-1
<PAGE>
                    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,
1995 and 1996, 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,  1996.  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,  1995  and  1996,  and the  results  of their
operations  and cash  flows  for each of the  three  years in the  period  ended
December 31, 1996, in conformity with generally accepted accounting principles.


                                                             ARTHUR ANDERSEN LLP

Phoenix, Arizona,
   January 31, 1997.
                                       F-2
<PAGE>


                             VODAVI TECHNOLOGY, INC.


                           CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
                                                                     December 31,
                                                             ---------------------------
                                                                  1995          1996
                                                             ------------   ------------
<S>                                                          <C>            <C>         
                                     ASSETS

CURRENT ASSETS:
   Cash and cash equivalents                                 $  1,944,120   $  1,151,713
   Accounts receivable, net of allowances of
     $163,000 in 1995 and $234,000 in 1996                      6,427,123      7,789,832
   Inventories, net                                             8,546,384      7,229,325
   Prepaid expenses and other                                     801,333        420,455
                                                             ------------   ------------

                  Total current assets                         17,718,960     16,591,325

PROPERTY AND EQUIPMENT, net                                     1,730,514      2,465,214

GOODWILL, net                                                   7,089,140      2,546,465

OTHER LONG-TERM ASSETS, net                                       931,367        814,620
                                                             ------------   ------------

                                                             $ 27,469,981   $ 22,417,624
                                                             ============   ============

                      LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
   Current portion of long-term debt                         $       --     $    258,000
   Payable to related parties                                   1,646,656      2,291,581
   Accounts payable                                             1,978,032      2,172,042
   Accrued liabilities                                          1,710,903      2,224,427
   Accrued income taxes                                           371,063        293,840
                                                             ------------   ------------

                  Total current liabilities                     5,706,654      7,239,890
                                                             ------------   ------------

LONG-TERM DEBT                                                  7,884,326      5,588,209
                                                             ------------   ------------

OTHER LONG-TERM OBLIGATIONS                                        68,813        189,100
                                                             ------------   ------------

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY:
   Preferred stock, $.001 par value, 1,000,000 shares
   authorized, no shares issued                                      --             --
   Common stock, $.001 par value, 10,000,000 shares
     authorized; 4,342,238 shares issued
     and outstanding                                                4,342          4,342
   Additional paid-in capital                                  12,307,739     12,307,739
   Retained earnings (deficit)                                  1,498,107     (2,911,656)
                                                             ------------   ------------

                                                               13,810,188      9,400,425
                                                             ------------   ------------

                                                             $ 27,469,981   $ 22,417,624
                                                             ============   ============
</TABLE>
              The accompanying notes are an integral part of these
                          consolidated balance sheets.
                                      F-3
<PAGE>
                             VODAVI TECHNOLOGY, INC.


                      CONSOLIDATED STATEMENTS OF OPERATIONS



<TABLE>
<CAPTION>
                                                                           Years Ended December 31,
                                                            ----------------------------------------------------
                                                                 1994                1995              1996
                                                            ---------------     ---------------  ---------------
<S>                                                         <C>                 <C>              <C>            
REVENUES, net                                               $    29,139,730     $    39,600,726  $    46,154,174

COSTS OF GOODS SOLD (including  
  products  acquired from related parties 
  (LGE) of $12.1 million, $15.6 million,
  and $17.8 million, respectively                                20,526,701          27,196,571       30,842,422
                                                            ---------------     ---------------  ---------------

                  Gross margin                                    8,613,029          12,404,155       15,311,752

OPERATING EXPENSES:
   Engineering and product development                            1,375,850           1,941,503        2,161,306
   Selling, general and administrative                            4,915,409           8,457,641       11,587,971
   Asset impairment and restructuring
     charges (Notes 1 and 4)                                             -                   -         4,804,717
                                                            ---------------     ---------------  ---------------

OPERATING INCOME (LOSS)                                           2,321,770           2,005,011       (3,242,242)

INTEREST EXPENSE                                                    575,952           1,129,604          840,830
                                                            ---------------     ---------------  ---------------

INCOME (LOSS) BEFORE INCOME TAXES                                 1,745,818             875,407       (4,083,072)

PROVISION FOR INCOME TAXES                                          692,725             417,599          326,691
                                                            ---------------     ---------------  ---------------

NET INCOME (LOSS)                                           $     1,053,093     $       457,808  $    (4,409,763)
                                                            ===============     ===============  ===============

NET INCOME (LOSS) PER SHARE                                        $   0.55            $   0.17          $ (1.02)
                                                                   ========            ========          =======

WEIGHTED AVERAGE SHARES
   OUTSTANDING                                                    1,917,346           2,769,434        4,342,238
                                                            ===============     ===============  ===============
</TABLE>
              The accompanying notes are an integral part of these
                       consolidated financial statements.
                                      F-4
<PAGE>
                             VODAVI TECHNOLOGY, INC.


           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY



<TABLE>
<CAPTION>
                                               Common Stock           
                                        -------------------------     Additional        Retained
                                                           Par          Paid-in         Earnings
                                            Shares         Value        Capital         (Deficit)        Total
                                        ------------   ----------    -------------  --------------  --------------
<S>                                     <C>            <C>           <C>            <C>             <C>           
BALANCE, December 31, 1993                   849,999   $      850    $      16,150  $      (12,794) $        4,206

     Private sale of shares                1,033,994        1,034        2,563,966              -        2,565,000
     Issuance of shares to
       repay related party
       indebtedness                          116,000          116          434,884              -          435,000
     Net income                                   -            -                -        1,053,093       1,053,093
                                        ------------   ----------    -------------  --------------  --------------

BALANCE, December 31, 1994                 1,999,993        2,000        3,015,000       1,040,299       4,057,299

     Warrant conversion                      187,500          187             (187)             -               -
     Initial public offering               1,488,083        1,488        7,293,593              -        7,295,081
     Issuance of shares to
       acquire Enhanced                      666,662          667        1,999,333              -        2,000,000
     Net income                                   -            -                -          457,808         457,808
                                        ------------   ----------    -------------  --------------  --------------

BALANCE, December 31, 1995                 4,342,238        4,342       12,307,739       1,498,107      13,810,188

     Net loss                                     -            -                -       (4,409,763)     (4,409,763)
                                        ------------   ----------    -------------  --------------  --------------

BALANCE, December 31, 1996                 4,342,238   $    4,342    $  12,307,739  $   (2,911,656) $    9,400,425
                                        ============   ==========    =============  ==============  ==============
</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,
                                                                                   --------------------------------------------
                                                                                       1994             1995           1996
                                                                                   ------------    ------------    ------------
<S>                                                                                <C>             <C>             <C>          
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income (loss)                                                               $  1,053,093    $    457,808    $ (4,409,763)
   Adjustments to reconcile net income (loss) to net cash provided
     by operating activities:
       Depreciation and amortization                                                    287,423         561,048         903,741
       Asset impairment                                                                    --              --         4,174,717
       Rent levelization                                                                   --            68,813          68,246
       Loss on retirement of fixed assets                                                 2,796            --            63,081
       Changes in working  capital,  net of assets and  liabilities  acquired
          in business combinations:
           Accounts receivable                                                          404,831         326,370      (1,310,669)
           Inventories                                                                 (920,352)     (2,305,470)      1,302,059
           Prepaid expenses and other                                                  (367,552)       (377,344)        380,878
           Other long-term assets                                                      (141,919)       (156,742)         36,615
           Accounts payable and payables to related parties                              32,709         648,547         838,935
           Accrued liabilities                                                          815,452        (183,170)        619,003
           Accrued income taxes                                                            --          (109,023)        (77,223)
                                                                                   ------------    ------------    ------------

                  Net cash flows provided by (used in) operating activities           1,166,481      (1,069,163)      2,589,620
                                                                                   ------------    ------------    ------------


CASH FLOWS FROM INVESTING ACTIVITIES:
   Cash paid to acquire assets through business combinations                         (9,583,427)     (2,351,524)           --
   Accrued acquisition costs paid                                                      (943,956)       (309,932)       (217,894)
   Cash paid to acquire fixed assets                                                   (313,515)     (1,185,328)       (556,664)
                                                                                   ------------    ------------    ------------

                  Net cash flows used in investing activities                       (10,840,898)     (3,846,784)       (774,558)
                                                                                   ------------    ------------    ------------


CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from the sale of common stock                                             2,565,000       8,928,598            --
   Equity offering costs paid                                                              --        (1,633,517)           --
   Borrowings from related parties                                                       35,000            --              --
   Financing costs paid                                                                (175,000)           --              --
   Repayment of notes payable                                                              --        (1,200,000)           --
   Payments on capital leases                                                              --              --          (109,760)
   Borrowings on revolving credit facility                                           37,798,136      41,127,236      41,369,367
   Payments on revolving credit facility                                            (29,224,464)    (41,816,582)    (43,867,070)
                                                                                   ------------    ------------    ------------

                  Net cash flows provided by (used in) financing activities          10,998,672       5,405,735      (2,607,463)
                                                                                   ------------    ------------    ------------

CHANGES IN CASH AND CASH EQUIVALENTS                                                  1,324,255         489,788        (792,407)

CASH AND CASH EQUIVALENTS, beginning of period                                          130,077       1,454,332       1,944,120
                                                                                   ------------    ------------    ------------

CASH AND CASH EQUIVALENTS, end of period                                           $  1,454,332    $  1,944,120    $  1,151,713
                                                                                   ============    ============    ============
</TABLE>
                 The accompanying notes are an integral part of
                    these consolidated financial statements.
                                      F-6
<PAGE>
                             VODAVI TECHNOLOGY, INC.


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





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

         Nature of Business

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

         Principles of Consolidation

The consolidated financial statements include the accounts of VTI and its wholly
owned subsidiaries  Vodavi  Communication  Systems,  Inc. (VCS),  Arizona Repair
Services,  Inc. (ARSI), and Enhanced Systems, Inc. (Enhanced) (together referred
to  as  the  Company)  for  the  periods  indicated  in  Note  2.  All  material
intercompany transactions have been eliminated in consolidation.

         Use of Estimates

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

         Cash and Cash Equivalents

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

         Inventory

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

Property and equipment are recorded at cost.  Depreciation is computed using the
straight-line  method.  Property  and  equipment  and the related  useful  lives
consist of the following as of December 31, 1995 and 1996, respectively:

<TABLE>
<CAPTION>
                                                      Useful Life
                         Type of Asset                 in Years             1995              1996
-------------------------------------------------   ---------------     -------------    -------------
<S>                                                    <C>            <C>              <C>          
         Office and computer equipment                      5           $     439,628    $     671,869
         Furniture and fixtures                            10                 232,310          219,063
         Tooling and manufacturing equipment              5-8                 613,080        1,060,387
         Assets under capital lease                      5-12                      -           574,982
         Construction in progress                          -                  758,422          502,976
                                                                        -------------    -------------
                                                                            2,043,440        3,029,277
         Less:  Accumulated depreciation                                     (312,926)        (564,063)
                                                                        -------------    -------------

                                                                        $   1,730,514    $   2,465,214
                                                                        =============    =============
</TABLE>
Construction  in  progress  relates to the  manufacture  of new tooling and test
fixtures.

         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.

During 1996, the Company  adopted  Statement of Financial  Accounting  Standards
121,  Accounting  for the  Impairment  of Long-Lived  Assets and For  Long-Lived
Assets to be Disposed Of, which requires that long-lived  assets be reviewed for
impairment whenever events or circumstances indicate that the carrying amount of
the asset may not be recoverable.

During 1996,  certain events  occurred which required the Company to re-evaluate
the realizability of the goodwill recorded in connection with the acquisition of
Enhanced.  One of  the  events  involved  a  significant  customer  of  Enhanced
informing  the Company that a previously  communicated  level of purchases  from
Enhanced  would  not be met.  As a result  of the  impact  of this  event on the
projected  cash flows of Enhanced,  the Company  concluded that the goodwill was
impaired and recorded a $4.2 million impairment loss.

         Income Taxes

The Company  utilizes the liability method of accounting for income taxes as set
forth in Statement of Financial  Accounting Standards 109, Accounting for Income
Taxes.  Under the liability  method,  deferred  taxes are provided  based on the
temporary differences between the financial reporting basis and the tax basis of
the Company's assets and liabilities.
                                      F-8
<PAGE>
         Revenue Recognition

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

         Net Income (Loss) Per Share

Net  income  per share for the years  ended  December  31,  1994 and 1995,  were
determined by dividing net income by the weighted  average  number of common and
common  equivalent  shares  outstanding.  The weighted  average number of common
equivalent  shares for the year ended December 31, 1994,  assumes the conversion
of the warrants described in Note 5 and the exercise of all outstanding  options
and the  corresponding  repurchase of shares using the treasury  stock method on
April 1, 1994, the date of the  acquisition of VCS. The weighted  average number
of common  equivalent  shares for the year ended December 31, 1995,  assumes the
conversion  of  the  warrants  described  in  Note  5 and  the  exercise  of all
outstanding options and the corresponding repurchase of shares and retirement of
debt using the treasury stock method on January 1, 1995.

Net loss per share for the year ended  December  31,  1996,  was  determined  by
dividing  the  net  loss  by  the  weighted  average  number  of  common  shares
outstanding. Common stock equivalents were not included as the effect would have
been anti-dilutive.

Fully  diluted  earnings per share are not  presented as the effect would not be
materially different.

         Fair Value of Financial Instruments

The following disclosure of the estimated fair value of financial instruments is
made in accordance with the  requirements  of Statement of Financial  Accounting
Standards No. 107,  Disclosures About Fair Value of Financial  Instruments.  The
estimated fair value amounts have been determined by the Company at December 31,
1996, using available market information.  Considerable  judgment is required in
interpreting  market data to develop the  estimates of fair value.  Accordingly,
the  estimates  presented  below may not be  indicative  of the amounts that the
Company could realize in a current market exchange.  The use of different market
assumptions  and  valuation  methodologies  could have a material  effect on the
estimated fair value amounts.

The carrying value of cash and cash equivalents,  accounts receivable,  accounts
payable, payable to related party, accrued liabilities, and the revolving credit
facility  approximate  fair  values due to the  short-term  maturities  of these
instruments.
                                      F-9
<PAGE>
(2)   BUSINESS COMBINATIONS:

In April 1994,  VCS acquired the  operating  assets of the Vodavi  Communication
Systems Division (the Vodavi Division) of Executone  Information  Systems,  Inc.
(Executone).  The acquisition was accounted for under the purchase  method.  The
purchase price of the Vodavi  Division was  approximately  $12.0 million and was
allocated as follows:

                  Net current assets                  $     8,600,000
                  Fixed assets                                400,000
                  Goodwill                                  3,000,000
                                                      ---------------

                                                      $    12,000,000
                                                      ===============

The accompanying financial statements include the results of the Vodavi Division
since April 1, 1994.

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

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

                                                      $   440,000
                                                      ===========

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

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

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

                                                      $   5,250,000
                                                      =============
                                      F-10
<PAGE>
The following table presents the unaudited  pro-forma  results of operations for
the years ended December 31, 1994 and 1995, assuming the transactions  described
above had taken place as of January 1, 1994:

                                                  1994                1995
                                            ----------------    ---------------

                  Revenue                   $  40,929,000       $  41,938,000
                  Net income                    1,398,000             272,000
                  Net income per share               0.33                 .06

(3)   LONG-TERM DEBT:

Long-term debt consists of the following as of December 31, 1995 and 1996:

                                                 1995                1996
                                            -------------       -------------

           Revolving credit facility        $   7,884,326       $   5,386,623
           Capital lease obligations                   -              459,586
                                            -------------       -------------
                                                7,884,326           5,846,209
           Less: Current portion                       -              258,000
                                            -------------       -------------

                                            $   7,884,326       $   5,588,209
                                            =============       =============

The Company  has a $12.0  million  revolving  credit  facility  with a financial
institution,  which expires in April 1997. Borrowings under the facility,  which
are based on inventory and accounts  receivable,  carry interest payable monthly
at a variable rate based on commercial  paper plus 4-1/2%  (10.31% and 10.45% at
December  31, 1995 and 1996,  respectively).  The credit  facility is secured by
substantially all of the assets and all of the common stock of VCS.

The credit agreement contains certain financial covenants relative to net worth,
cash flow,  capital  expenditures,  and other ratios.  At December 31, 1996, the
Company  was not in  compliance  with two of such  covenants.  The  Company  has
recently  negotiated a  three-year  extension  of this  facility.  Under the new
terms,  the  Company  will pay  interest  monthly  at a  variable  rate based on
commercial  paper plus 2-1/2% (8.45% at December 31, 1996).  The extension  also
eliminates  certain fees and eliminates certain financial  covenants,  including
the two  covenants  with which the Company was not in compliance at December 31,
1996.

The Company has entered into several  capital  lease  agreements  with  interest
rates  ranging  from 7.5% to 9%.  These  agreements  generally  have terms of 24
months.
                                      F-11
<PAGE>
(4)   COMMITMENTS AND CONTINGENCIES:

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

                  1997                                   $      1,061,403
                  1998                                          1,090,731
                  1999                                          1,120,707
                  2000                                          1,160,679
                  2001                                          1,201,335
                  Thereafter                                      486,465

Rent  expense  is  recognized  on a  straight-line  basis and was  approximately
$315,000,  $825,000, and $1,115,000 for the years ended December 31, 1994, 1995,
and 1996,  respectively.  For the year ended  December  31,  1994,  the  Company
operated in facilities shared with Executone.

         Royalties

VCS acquires certain proprietary  components from Executone under the terms of a
20-year 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 to Executone were $250,000,  $492,000, and $502,000
in 1994, 1995, and 1996, respectively.

         Supply Agreements

VCS has entered  into  various  supply  agreements  with its vendors to purchase
products  through  1998.  Minimum  required  purchases  in 1997 and  1998  total
approximately $11.5 million and $4.3 million, respectively.

         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  $26,000,  $40,000,  and $67,500
for the years ended December 31, 1994, 1995, and 1996, respectively.

         Legal Matters

The  Company  is  currently  involved  in a lawsuit  with the  former  owners of
Enhanced,  who were  dismissed from their  positions as executive  management of
Enhanced in the third quarter of 1996. In September  1996,  the Company sued the
former  owners  alleging  securities  fraud,  fraudulent  activities,  breach of
employment agreements, breach of fiduciary duties, and other 
                                      F-12
<PAGE>
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  charges for the asset  impairment and other
restructuring  charges,  the Company reserved  approximately  $250,000 to pursue
this matter.

(5)   STOCKHOLDERS' EQUITY:

         Warrants

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

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

         Vodavi Technology, Inc. Stock Option Plan

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

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

The  expiration  date,  maximum  number  of  shares  purchasable,  and the other
provisions of the options are  established at the time of grant.  Options may be
granted for terms of up to ten years and become  exercisable  in whole or in one
or more installments at such time as may be determined by the plan administrator
upon grant of the options.  The exercise prices of options are determined by the
plan administrator, but may not be less than 100% (110% if the option is granted
to a stockholder  who at the time the option is granted owns stock  representing
more than ten percent of the total  combined  voting power of all classes of VTI
stock) of the fair market value of the common stock at the time of the grant.
                                      F-13
<PAGE>
The following summarizes the activity for the Plan:
<TABLE>
<CAPTION>
                                   December 31, 1994          December 31, 1995         December 31, 1996
                               ------------------------   ------------------------  ------------------------
                                              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:                -       $ 4.00       240,000      $  4.00       237,500     $  4.00
     Granted                      240,000                        -                     295,000     $  6.07
     Canceled                          -                     (2,500)     $  4.00       (34,000)    $  6.00
     Exercised                         -                         -                          -
                                ---------                  --------                  --------

Options outstanding
   at end of period               240,000      $ 4.00       237,500      $  4.00       498,500     $  5.08
                                =========                  ========                  =========

Options available
   for grant                       72,500                    75,000                    351,500
                                =========                  ========                  =========

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

Weighted average fair
   value of options granted                                   N/A                    $ 2.69
                                                           ======                    ======
</TABLE>
Of the  498,500  options  outstanding  at December  31,  1996,  237,500  have an
exercise price of $4.00 and a weighted  average  remaining  contractual  life of
eight years. Of these options,  118,750 are exercisable.  The remaining  261,000
options have exercise  prices between $6.00 and $7.00,  with a weighted  average
exercise price of $6.07 and a weighted  average  remaining  contractual  life of
nine years. None of these options are exercisable at December 31, 1996.

The  Company  accounts  for the Plan under APB  Opinion  No. 25,  under which no
compensation  cost has been recognized.  Had  compensation  cost for these plans
been  determined  consistent with FASB Statement No. 123, the Company's 1996 pro
forma net loss and pro forma loss per share would have been $4,607,000 and $1.06
per share, respectively. There were no options granted in 1995.

The fair value of each option  grant is estimated on the date of grant using the
Black-Scholes   option  pricing  model  with  the  following   weighted  average
assumptions used for grants in 1996: risk-free interest rates of 5.47%; expected
dividend  yields of zero;  expected  lives at 5 years;  expected  volatility  of
47.86%.

In February 1997, the Company's Board of Directors granted an additional 150,000
options at an exercise price of $4.00 per share.

(6)   MAJOR CUSTOMERS:

The  Company's  sales efforts have been  concentrated  on major supply houses as
well as a dealer network.  During 1994,  1995, and 1996,  sales to the Company's
largest   customer   accounted  for  49%,  45%,  and  44%  of  total   revenues,
respectively.
                                      F-14
<PAGE>
Accounts  receivable  from  this  supply  house  comprise  46% and 44% of  total
accounts receivable at December 31, 1995 and 1996, 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 is comprised of the following:

                                1994             1995              1996
                           -------------     -------------    -------------

           Current         $     816,376     $     531,448    $     311,490
           Deferred             (123,651)         (113,889)          15,201
                           -------------     -------------    -------------

                           $     692,725     $     417,599    $     326,691
                           =============     =============    =============

The  Company  provides  for  deferred  income  taxes  resulting  from  temporary
differences  between  amounts  reported for financial  accounting and income tax
purposes.  The components of net deferred  income tax asset at December 31, 1995
and 1996, were as follows:

                                                    1995             1996
                                               -------------    -------------
         Deferred tax assets:
           Inventory and receivable reserves   $     133,945    $     180,139
           UNICAP adjustment                         232,083          120,096
           Other accruals                            311,778          344,791
                                               -------------    -------------

                                                     677,806          645,026
                                               -------------    -------------
         Deferred tax liabilities:
           Depreciation differences                  (25,276)         (38,901)
           Amortization differences                  (25,075)         (86,882)
                                               -------------    -------------

                                                     (50,351)        (125,783)
                                               -------------    -------------
         Net long-term deferred tax asset      $     627,455    $     519,243
                                               =============    =============

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:

                                                   1994       1995       1996
                                                  ------     ------     ------

              Federal statutory tax rate           34.0%      34.0%      34.0%
              State taxes, net                      4.2        4.7        4.6
              Non-deductible expenses               1.7        9.0      (46.6)
              Utilization of NOLC reversal of
                valuation reserve                   (.3)       --         --
                                                  ------     ------     ------

                                                   39.6%      47.7%      (8.0)%
                                                  ======     ======     ======
                                           F-15
<PAGE>
The Copmany's  effective income tax rate has been impacted by the acquisition of
Enhanced  and  the  subsequent  asset  impairment  and   restructuring   charges
recognized  in  1996,  as  the  goodwill   generated  by  the   acquisition   is
non-deductible.

(8)   RELATED PARTIES TRANSACTIONS:

LG Electronics Inc. (LGE), the Company's principal supplier,  owns approximately
19.0% of the  Company's  outstanding  Common Stock at December 31, 1996.  During
1994, 1995, and 1996, the Company purchased  approximately $12.7 million,  $17.4
million,  and $17.9  million  of key  telephone  systems  and  commercial  grade
telephones from LGE.

During 1994 and 1995,  LGE  provided  the Company  with a $3.5  million  line of
credit for use in inventory purchases.  During 1995, VCS utilized  approximately
$2.5 million of this line.  The Company  utilized a portion of the proceeds from
the IPO to repay the line of credit in full, along with  approximately  $175,000
in interest, in October 1995.

(9)   SUPPLEMENTAL CASH FLOW INFORMATION:

Cash paid for interest  and income taxes for the years ended  December 31, 1994,
1995, and 1996, is as follows:
<TABLE>
<CAPTION>
                                                                   1994             1995              1996
                                                              -------------     -------------    -------------

<S>                                                           <C>               <C>              <C>          
         Interest paid                                        $     892,000     $   1,130,000    $     840,000
         Income taxes paid                                    $     642,000     $     435,000    $      22,000

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

                                                                   1994            1995               1996
                                                              -------------   ---------------   --------------

         Fair value of assets acquired                       $   15,124,000   $     5,690,000   $            -
         Value of stock issued                                           -         (2,000,000)               -
         Cash paid, net of cash acquired                         (3,000,000)       (2,351,524)               -
                                                             --------------   ---------------   --------------

         Liabilities assumed or incurred                     $   12,114,000   $     1,338,476   $            -
                                                             ==============   ===============   ==============
</TABLE>
During the year ended  December 31,  1996,  the Company  acquired  approximately
$575,000 of property and equipment using capital leases.
                                      F-16