SECURITIES AND EXCHANGE COMMISSION
                             Washington, D. C. 20549

                                   FORM 10-KSB

                   ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                   For the fiscal year ended December 31, 1997
                         Commission file number 0-27052



                             DIGITAL DICTATION, INC.

                        Incorporated in State of Delaware
                            8230 Old Courthouse Road
                             Vienna, Virginia, 22182
                           Telephone : (703) 848-2830
                  I.R.S. Employer Identification No. 52-1451022


Securities registered pursuant to Section 12(b) of the Act:

              Title of                     Name of each exchange on
             each class                        which registered
            ------------                   ------------------------
                None                                 None

Securities registered pursuant to Section 12(g) of the Act:

                          Common Stock, $.01 par value


Check  whether the Issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding  twelve 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 ninety days.
                                 YES [X] NO [ ]


Check if there is no disclosure of delinquent  filers in response to Item 405 of
Regulation S-B in this form, and no disclosure will 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-KSB or any  amendment to
this Form 10-KSB.
                                     [X]

Revenues for the year ended December 31, 1997 were $10,025,895.

The number of shares  outstanding of the Issuer's $.01 par value Common Stock as
of January 1, 1998 was  6,281,612.  The  aggregate  market value of voting stock
held by non-affiliates of the Registrant as of January 1, 1998 was approximately
$674,012.

                       Documents Incorporated by Reference
                                      None.

Transitional Small Business Disclosure Format:   YES  [X]   NO  [ ]


<PAGE>



                                                       

                                     PART I


ITEM 1 - DESCRIPTION OF BUSINESS


                                   The Company

Digital  Dictation,  Inc.  ("DDI",  or the "Company"),  a Delaware  corporation,
provides  electronic medical  information  processing  services to institutional
health care providers,  including  hospitals and emergency  medicine  facilities
located in various  parts of the country.  The Company's  business  involves the
transcription  of medical  reports which have been  dictated by  physicians  and
other medical  professionals,  into computer readable form and/or hard copy. The
Company's  emphasis is on the management and control of the entire dictation and
transcription process for its clients.

Management  believes  that DDI is one of the few firms in its industry  that has
successfully  created a  centralized,  automated  transcription  service able to
serve a  national  client  base  from a single  location.  DDI has  developed  a
proprietary  in-hospital  transcription  processing system that provides totally
automated processing of all incoming  transcriptions  through an electronic link
with the  Company's  centralized  processing  system in its Virginia  Operations
Center  in  Vienna,   Virginia.   The  Company  utilizes  high  caliber  medical
transcriptionists,  working from their homes  throughout  the  country,  who are
connected to the Virginia Operations Center via computer modem.



                       Incorporation and Operating History

The Company was organized as a Virginia  corporation,  originally under the name
Kabrumer Transcriptions,  Inc., in April 1989 and, in May 1989, acquired certain
assets from Kabrumer Transcriptions  ("Kabrumer"),  a proprietorship operating a
traditional local medical  transcription  business serving the Washington,  D.C.
market and,  through a second  office,  the Pittsburgh  market.  The name of the
corporation was changed to Digital Dictation,  Inc. in October 1989. Digital has
since  operated under the trade names "digital  dictation,  inc." and "ddi".  In
October 1995, the Company underwent a merger and reorganization, following which
it became a reporting company under Section 15(d) of the Securities Exchange Act
of 1934 (the "Exchange  Act") through the filing of a Registration  Statement on
Form 10-SB with the Securities and Exchange Commission.  (See  "Recapitalization
of the Company".)

The  Company  has  developed  and refined an  operating  concept of  centralized
management  of remote  transcription  and  developed an  integrated  information
processing and dictation control system to support that operating concept. These
technological advances, combined with a specific and stated corporate philosophy
of  achieving  total  client   satisfaction   through  a  focus  on  operational
excellence,  have  enabled DDI to achieve a four-year  record of 38% average per
year  revenue  growth,  although  there can be no  assurances  that such  annual
revenue growth rates will be sustained.

The Company  presently  serves  major  hospitals  located in  Washington,  D.C.,
Virginia,  California,  Pennsylvania,  Washington  State, New Jersey,  Maryland,
Ohio, New York, Michigan, Florida, and Illinois. Representative client hospitals
include  Sutter  Roseville  Hospital in  Sacramento,  California,  Michael Reese
Hospital  and  Medical  Center  in  Chicago,   St.  Francis  Medical  Center  in
Pittsburgh,  State  University  of New York  (SUNY)  Health  Sciences  Center in
Syracuse, New York, the National Naval Medical Center in Bethesda, Maryland, and
Mary Washington Hospital in Fredericksburg, Virginia.



<PAGE>


                                    Business

The Company's  business involves the transcription of medical reports which have
been  dictated by  physicians  and other  medical  professionals,  into computer
readable  form and/or hard copy.  DDI's  services are utilized by  institutional
health care providers to replace in-house medical transcription  functions.  The
Company's  clients are limited to acute care  hospitals and related  facilities.
The Company  does not provide  transcription  services to  individual  physician
practices.

Medical  transcription  is generally not an elective  function within the health
care industry;  that is, the  documentation,  insurance,  billing and compliance
regulations  within the  industry  require  that  medical  reports be  prepared.
Virtually  all such  reports are  dictated  and  transcribed,  with only a small
percentage hand-written.  The medical transcription process,  however, is highly
specialized  and  requires  the use of skilled and  experienced  personnel.  The
ability to retain  qualified  medical  transcriptionists  is one of the critical
success factors for a company in this industry.

Management  believes  that DDI is one of the few firms in its industry  that has
successfully created a centralized,  automated  transcription  service,  able to
serve a national client base from a single central location. The Company retains
high caliber  medical  transcriptionists,  many of whom hold the  designation of
Certified  Medical  Transcriptionist  (CMT) from the  American  Association  for
Medical  Transcription.   All  of  DDI's   transcriptionists,   referred  to  as
independent  medical   transcriptionists   ("IMT's"),   work  from  their  homes
throughout the country, and are supported by a centralized transcription control
and management system located at the Company's Virginia Operations Center.

DDI has developed a proprietary in-hospital transcription processing system that
is electronically linked with the Company's centralized processing system in its
Virginia  Operations Center.  This in-hospital system provides totally automated
processing  of all incoming  transcriptions,  enabling the hospital to eliminate
clerical  positions  formerly  assigned to  transcription  processing.  Dictated
reports are transcribed, edited, transmitted to hospitals, printed, up-loaded to
mainframe-based hospital information systems and faxed to physicians,  all under
computer control, around the clock.

The Company  has refined its  operating  concept of  centralized  management  of
remote  transcription  and has developed a proprietary,  integrated  information
processing and dictation control system to support that operating  concept.  The
Company's  emphasis is on the management and control of the entire dictation and
transcription  process  for its  clients.  As such,  its  services  are  limited
exclusively to full contract  (outsourced)  transcription.  Unlike most firms in
the  industry,  the Company  does not accept  contracts  for fill-in or overflow
transcription.

The Company generally enters into written contracts with its clients pursuant to
which the Company  provides medical  transcription  services for a fixed fee per
line of transcription or per transcribed report.  These contracts vary in length
from one to four years,  with the majority of contracts  containing an automatic
annual  renewal  clause  with a price  increase  generally  in the amount of the
consumer  price  index.  Most of the  Company's  contracts  enable the client to
terminate the contract at any time without cause by providing sixty days advance
written notice.

Management   has  evaluated   opportunities   to  expand  the  Company   through
acquisitions,  to expand its service offerings to include overflow transcription
services, to diversify its client base to serve physicians' offices, and to sell
or license its  technology to other  companies.  Management  strongly  believes,
however,  that the growth and profitability of the Company can best be optimized
by continuing to focus on DDI's core business,  which has produced  growth rates
in excess of 38% per year for more than four  years'  running,  and  resist  the
temptation to diversify into other areas.
<PAGE>




                            The Transcription Process

Physicians are able to dictate relevant  patient  information into the Company's
recording  units  via  telephone  from  anywhere  in the  continental  U.S.  The
Company's  proprietary  software then enables its IMT's located  anywhere in the
country to dial into the DDI digital  dictation  systems and transfer  dictation
directly onto a personal computer  equipped with a DDI-provided  voice card. The
IMT transcribes the dictated material into prescribed document format.

All  transcribed  material is subject to review by one of the  Company's  senior
transcriptionists,    who   function   as   company    transcription    editors.
Transcriptionists  are  required  to "flag" any word or phrase for which they do
not  understand  the  meaning.  All such  "flagged"  reports are  electronically
transmitted  to one of the editors prior to  transmission  to the hospital.  The
editor then listens to the report and corrects or validates all of the "flagged"
words or phrases.  The corrected  report is returned to DDI for  transmission to
the hospital;  a copy of the  corrections  is sent to the  transcriptionist  via
internal company e-mail.


                    Market for Medical Transcription Services

The primary users of medical transcription services include hospitals,  clinics,
emergency  medicine  facilities,   radiology  facilities  and  HMO's.   Industry
estimates  are that such  users  spend  approximately  $6  billion  per year for
medical  transcription  services  with  approximately  $1  billion of such total
expenditures  going to outside medical  transcription  service companies and the
remainder  representing  expenditures by users on in-house personnel.  As health
care reform  continues to force medical  institutions  to become more efficient,
management  believes  that  the  transition  from  in-house,  employee-performed
transcription to the use of outside medical transcription firms will accelerate.


                           Competition/Market Dynamics

Management believes that the medical transcription services industry is a large,
rapidly-growing and highly fragmented service industry. Industry estimates place
the number of small transcription  companies to be as high as 1,500.  Management
also believes that this industry is in the beginning stages of a transition from
a  clerical-based,  local cottage industry to a  technology-driven,  information
processing environment,  which may result in substantial consolidation among the
market  participants  who are  generally  ill-equipped  and poorly  organized to
operate successfully in such an environment.

The companies which comprise the outside medical transcription services industry
are believed by management to include the following: (1) MRC Group (a roll-up of
Medifax/Secrephone,  Dictation West and Medical Records  Corp.),  with estimated
annual revenue of  approximately  $100 million,  (2) MedQuist,  Inc., a publicly
held company,  with 1996 annual revenue of $80 million,  (3) approximately eight
national and regional firms,  including the Company,  each with estimated annual
revenues  of from $5 million  to $25  million;  and (4) as many as 1,500  small,
local companies,  most of them privately held, with annual revenues of less than
$5 million and mostly below $1 million.

To  the   Company's   knowledge,   the  smaller   transcription   firms  utilize
transcriptionists  who work in one  office  and  provide  medical  transcription
services to the local medical  institutions.  Although computers may be used for
the word  processing  function,  the fundamental  process remains  paper-driven.
Transcribed  reports are either  printed in the local  office and  delivered  by
courier or printed on-site at the hospital using a remote printer.

<PAGE>



Management believes that the larger transcription firms continue to embrace this
operating  model  as  well.  Although  these  companies  are  considered  to  be
"national"  firms,  their method of doing  business is through a number of small
offices  located  throughout  the  country.  Each  office  operates  as a  local
transcription  company,  managed by a  transcriptionist  and servicing the local
institutions  with  locally-based  transcriptionists  in a highly  decentralized
operating  environment,  with little  technical  or  management  sophistication.
Management  believes that this structure inhibits the ability of these companies
to achieve  significant  economies of scale and also restricts  their ability to
achieve any real level of operational control over the business.

Management  believes  that  as  a  result  of  these  limitations,  the  medical
transcription service industry is characterized by an extraordinarily high level
of customer  dissatisfaction,  although management is not aware of the existence
of published  industry  statistics to that effect.  The Company also understands
that many medical  institutions using outside  transcription  firms change their
vendors every two or three years,  indicating a general dissatisfaction with the
services provided by the industry. In the opinion of management,  the reputation
of the  industry  for user  dissatisfaction  is the primary  factor  slowing the
transition from in-house transcription to the use of outside services.

Another  factor  impacting on the market  development  is the  evolving  need by
medical  institutions  to eliminate  paper-based  systems in favor of electronic
medical records.  Currently,  an important  component of a medical record is the
transcribed  document.  Management believes that the participants in the medical
transcription  services industry have failed to effectively address the need for
electronic  interface  between the  transcription  systems and the institutional
patient care computer systems.

For these reasons, the Company believes that the medical transcription  services
industry, in its present condition,  is unable to meet the needs of its customer
base. The transcription services industry is  transcription-driven,  technically
unsophisticated   and  locally   oriented,   while  its  customers  are  seeking
information-driven,  technically sophisticated services which are not limited by
geographic  boundaries.  Management  believes  that  this gap  creates  enormous
opportunities  for the companies such as DDI that are culturally and technically
prepared to meet the rapidly-evolving  requirements of the health care industry.
Indeed,  during the last two years,  at least two,  and  possibly  more  venture
capital-backed  companies have evolved and are developing  business models along
the lines of ddi's network.

                              Proprietary Software

     All of the Company's  applications  software has been developed in-house by
its  employees,  and the rights to such  software  are held  exclusively  by the
Company.  All software is protected by copyrights through notices that appear on
the computer screen.  The Company neither sells nor licenses its software to any
other  person or firm,  nor does it have any plans to do so in the  future.  DDI
considers its proprietary  software to be an essential element in its ability to
achieve and maintain a competitive advantage. Moreover, Management believes, the
use of this software is highly integrated with the  organizational  structure of
the Company, thereby enhancing its operational value to the Company.

                             The Company's Strategy

The fundamental  strategy of the Company is to serve the  institutional  medical
transcription market faster and better than any other firm in the industry.  The
three essential components of this strategy are as follows:
|X|  to  utilize  systems   engineering  and  computer  and   telecommunications
     technology to automate the entire transcription  management process; 
|X|  to continue to retain one of the most highly skilled groups of IMT's in the
     industry; and
|X|  to develop an organizational culture that continually strives to exceed the
     service  expectations  of  clients.  
<PAGE>




The technology  component of the DDI strategy is focused on continuing to create
and improve a centralized  transcription  management and processing  system. The
Company's  centralized  transcription  processing  system enables DDI to serve a
national client base efficiently with  transcriptionists  located throughout the
country from a single operations center,  while maintaining control of each step
of the transcription  process. It does not appear there is a cost advantage over
traditional  one-office  medical  transcription  businesses,  or combinations of
several local offices into national networks of local businesses.  However,  the
Company believes it obtains several  non-cost  advantages.  For example,  DDI is
able to develop interfaces to download and upload information from each client's
health  information  and  administrative  system,  and be able to use a standard
interface to the DDI side while  competitors  using many  different  systems and
technologies  throughout  their national network may be discouraged by having to
invent each interface  independently.  Similarly,  centralization permits DDI to
manage the  consistency of the quality of its services  delivered to all clients
more easily than if it were to have to manage each  location  individual  office
location  separately  

The transcription component of the Company's strategy recognizes that the IMT is
the  producer of the product  provided  to the  clients,  and that DDI cannot be
successful  without a  productive  and loyal  network  of IMT's.  The  Company's
strategy is to acknowledge dependence upon this group of people and to establish
an environment  that not only rewards them  financially  for their efforts,  but
also  provides  them with respect for their skills and  talents,  technical  and
personal support for their transcription  activities and on-going expressions of
gratitude  and  appreciation  for their  efforts  on behalf  of the  Company.  A
tangible  example of these efforts  includes  IMT's  participate  in the Company
Stock Option Plan.

The service component of the Company's  strategy is to impress the client with a
high-quality  level of service,  so  superior  that it  engenders a  significant
degree of client loyalty.  In part, the service component of the strategy relies
on the fact that DDI is not limited in its  geographic  recruitment  for quality
IMTs by the location of its clients. This means that all transcription resources
are  collectively  available  to service all  clients  instead of pools of local
transcriptionists  each available only to specific local clients.  This helps to
insure that  transcription  services are  available  twenty-four  hours per day,
seven days a week,  without  regard to  vacation  schedules,  holidays,  weather
interruptions  and the like which impact upon local firms dependent upon smaller
numbers of IMTs in a limited  geographic  area.  This focus on customer  service
will continue to be the  cornerstone of DDI, for it is the essential  element of
the success of the Company.

The three  components  of the DDI strategy  are linked  together to form a basic
operating  approach to the business.  Through its commitment to technology,  DDI
utilizes  machines to handle the  transactional  processes in a  controlled  and
dependable  manner and at a lower cost, to support the  effective  production of
transcribed  documents  by a  national  transcription  network,  and  to  permit
operations personnel to focus on dealing with the non-transactional needs of the
customers. The strategy of maintaining a high quality group of transcriptionists
based upon the  principles of respect and  appreciation,  as well as competitive
compensation,   enables   DDI  to  continue  to  attract  and  retain  the  best
transcriptionists  and to  continue  to enlarge the network to meet the needs of
the growing client base.

In an industry characterized,  as management believes, by unreliable transaction
processing and non-responsive  customer service, the DDI strategy is intended to
differentiate  the  Company  from all of its  competitors  in a manner that will
support the continuing  acquisition of new clients and the on-going retention of
the existing client base.

<PAGE>




                        Marketing Plans And Sales Service

Having  solidified  its  central  operating  concept  and refined its methods of
recruiting  and  training  IMT's,  the  Company  is  prepared  to launch a major
marketing  offensive,  aimed at exposing and educating  potential clients to the
benefits that can be realized from a technology-based,  quality-focused company.
This marketing plan will capitalize on the Company's excellent reputation in the
industry and will utilize the  willingness of existing  clients to testify as to
the Company's  high level of service.  The Company's  marketing to date has been
conducted primarily by senior management.

The  Company  intends  to  continue  the  same  aggressive   sales  service
techniques that have contributed to its substantial previous growth.

                      Effects of Governmental Regulations

The Company is aware of the current  political  climate with respect to proposed
health care reform  legislation.  While no major  national  legislation  to that
effect has yet been enacted, management believes that, in general, future health
care reform  legislation which prompts health care providers to reduce operating
costs to remain  competitive  should  increase  the  demand  for  DDI's  medical
transcription services.



             Effects of Year 2000 (Y2K) Millenium Date-Change Issues

The Company has conducted a survey of the hardware and software  currently being
used in the business  and has audited how the  software  was created,  either as
software  created by DDI or hardware and software  purchased from vendors.  With
respect to the software  created by the Company,  the tools used to create these
programs  are Y2K  compliant.  Furthermore,  where  changes to the  systems  are
necessary, DDI has current and accurate copies of the source code, and there has
been virtually no turnover in the staff that developed  these internal  systems,
so there is a current  knowledge  base of the  smallest  details of the  systems
developed.  The  software  and  hardware  developed by vendors and used in DDI's
business  are mostly  compliant or have  patches  available  from the vendors to
solve  the  problems  for at  least  two  decades into the twenty-first century.
Nevertheless, the Company is not currently free of Y2K problems, for the patches
have not all been  installed,  adequate  testing to confirm  that no  unintended
consequences  will result have not been conducted,  and interfaces with hospital
systems have not been investigated.

             Discussion of Operating Results and Financial Condition

Revenues

Reference is made to the Company's  audited  financial  statements for the years
ended December 31, 1997 and 1996 presented in Part F/S of this report.

The Company has reported  average  annual  growth in revenues over the past four
fiscal  years  of  38%.  DDI  focuses  on  securing   long-term   contracts  for
full-service  (outsourced) medical  transcription  services rather than overflow
services from medical institutions. As a result, each client contract produces a
fairly consistent stream of revenue paid on a weekly basis.  Annual revenues for
the current and preceding four fiscal years were as follows:

                                   For the year ended December 31,
                        1997        1996        1995        1994        1993
                        ----        ----        ----        ----        ----
    Revenues        $10,025,895  $6,936,730  $5,057,585  $3,838,076  $2,754,897

<PAGE>




Total revenue from all contracts each week (the "run rate") is management's  key
indicator of current  financial  performance.  The  acquisition  of a new client
results in an immediate  positive  impact on the weekly run rate,  as revenue is
increased by the full weekly amount of the new contract.  At the same time,  the
Company has been able to maintain its existing  client base.  As of December 31,
1997,  the  Company's  weekly  "run  rate" had  grown to in excess of  $215,000,
compared  to a rate of  approximately  $140,000  as of December  31,  1996.  The
year-to-year "run rate" increase is approximately  fifty-four  percent (54%). As
DDI continues to expand its market  nationally  and exploit its  technology  and
client  support,  management  anticipates  the  ability to  continue to increase
annual revenue in line with historic trends, although there can be no assurances
that such annual revenue growth rates will be sustained.

Financial condition

At December 31, 1997,  the Company held cash and  equivalents  of  approximately
$2,500, along with net trade receivables of approximately $1,710,000.

As necessary  to finance its growth  rate,  the Company may draw upon a $500,000
line of credit obtained during 1997 which remains  available through December 3,
2002, subject to annual reviews. The Company expects to renew its line of credit
beyond  that  date.  Borrowings  against  the  line  of  credit,  which  totaled
approximately  $132,000 as of December 31, 1997, bear interest at prime plus one
per cent per annum and are secured by all the assets of the Company.  Given that
the Company will continue to grow at a rate in excess of its net profit  margin,
the  Company  will be  required  to draw  against  its line of credit or acquire
additional equity funding.  Management further believes that projected increases
in future  revenues  will be  sufficient  to fund the  associated  increases  in
operating costs of the Company.  Net cash flow from operations was approximately
$1,147,000 in 1997 and $465,000 in 1996.

Results of operations

Revenues  increased  by 45%  from  1996 to 1997,  and by 37% from  1995 to 1996.
Approximately  2% of the  increase in revenues in both  periods was due to price
increases to current customers; the remainder is due primarily to net additional
hospitals being taken on as clients.  Throughout this period,  DDI has continued
to provide  the same basic  level of service at the same  general  price  level,
subject to adjustment  for CPI increases,  to all of its clients,  both existing
and new.  During 1997,  DDI was  successful  in obtaining  new clients that were
larger in size than the  historical  average of the "run rate" for its  existing
clients.  This resulted in favorable  changes in operating  margin, as described
below.

Cost of services,  which includes all costs related to the IMT's,  and telephone
and associated equipment  depreciation,  represented 63.8% of revenue in 1997 as
compared to 64.7% in the prior year.  Costs of services are  generally  directly
related to revenue and it is expected  that such costs will continue at the rate
of  approximately  two-thirds  of  total  revenue.  The  decrease  of  .9%  as a
percentage  of  revenue   compared  to  1996  was  due  primarily  to  spreading
partially-fixed costs, such as depreciation, over a larger value of revenues. As
the  Company  continues  to  expand  nationally  by  obtaining   contracts  with
institutions located outside the local telephone calling area, and because these
new clients  are larger in size and require  more  sophisticated  services,  the
amount of telecommunications  services used by the Company will continue to grow
as a percentage of revenue.  However,  the Company  instituted a major  internal
software  development  project  during  1997 to convert  its  telecommunications
facilities  from  variable  cost  (based on minutes of usage) to fixed cost of a
virtual  private  network.   If  this  conversion  of  facilities  and  software
development is successful,  and the Company  continues to increase its revenues,
it will  result in future  increases  in margin as a result of  spreading  fixed
costs over a larger base of revenues.
<PAGE>




General and  administrative  ("G&A") expenses consist  primarily of salaries and
benefits  of  all  technical,   marketing,   operations   and  client   support,
administrative  and  executive   personnel,   occupancy  costs,   marketing  and
promotional costs, recruiting and other administrative expenses. G&A expenses as
a  percentage  of revenue  increased to 25.9% of revenue in 1997 versus 24.7% of
revenue in 1996. There were two primary reasons for the increase, and one reason
the increase was not greater than it otherwise  would have been. The reasons for
the increase are: a) each addition of a new hospital  client results in one-time
expenses for  marketing,  sales  service,  systems and  procedures  set-up,  and
commission  expenses related to securing the hospital as a client and assuring a
smooth and  successful  cut-over of services to DDI, and b) recruiting  expenses
and  salaries to increase  the size and  capability  of the  Company's  software
systems  staff.  These  expenses  are  estimated to represent an increase in G&A
expense  from 1996 to 1997 of 3.0% of  revenue.  During  1997,  DDI  initiated a
comprehensive  re-engineering of its telecommunications  platforms and software.
The project has not been  completed,  and some  systems  development  salary and
other  expense has been  deferred  until the project is completed  and placed in
service. The capitalized project costs, if expensed in 1997 would have increased
G&A by 1.7% of  revenue.  There were no such costs in 1996.  All other  expenses
amounted  to a decrease  of .1% of revenue  and were due to  spreading  of fixed
expenses over a larger amount of revenue.

Operating  income  increased by 41% from $729,800 in 1996 to $1,029,503 in 1997.
As  a  percentage  of  revenue,   the  operating  margin  was  10.5%  and  10.3%
respectively in the two years.

Interest  expense  decreased from $39,187 in 1996 to $23,169 in 1997,  primarily
reflecting  decreased  borrowing against the Company's line of credit to finance
accounts receivable balances.

                         Employees and Transcriptionists

As of December 31, 1997, the Company had twenty-eight full-time employees in its
principal  business office in Vienna,  Virginia and its Western Regional Office.
None of the Company's  employees is  represented  by a labor  organization.  The
Company  has never  experienced  a strike or work  stoppage,  and  believes  its
relations with its employees are good.

DDI presently has arrangements  with more than 275 home-based  transcriptionists
who are  either  CMT-certified  or are  financially  incented  by DDI to  become
certified.  Transcriptionists work from their homes, setting their own hours any
time  during  the day or night.  The  transcriptionists  are paid  bi-weekly  in
accordance  with the  amount of  transcription  they  produce,  as opposed to an
hourly rate. The Company has independent  contractor  agreements with all of the
transcriptionists  which specify the quality and delivery  requirements  and set
forth the method and rate for payment. The agreements with the transcriptionists
have no  specified  duration  and may be  terminated  by either  party,  without
notice, for any reason. The Company, however, has enjoyed productive,  long-term
relationships  with the  majority of its  transcriptionists  who have  continued
their  association  with the Company well beyond the completion of the sixty- to
ninety-day transition period from the date they began working with the Company.

ITEM 2 - DESCRIPTION OF PROPERTY

The Company's  principal  executive  offices and its Virginia  Operations Center
occupy  approximately 4200 square feet of the first floor of 8230 Old Courthouse
Road, Vienna, Virginia, 22182. This facility, which is comprised of two separate
spaces first  occupied by the Company in August 1991 and October  1996, is being
leased under two agreements through August 1999 and October 1999,  respectively.
The Company has equipped this facility with computer,  dictation,  telephone and
administrative equipment necessary to support the operation. Management believes
that all of the Company's property is adequately covered by insurance.
<PAGE>




ITEM 3 - DIRECTORS AND EXECUTIVE OFFICERS

Directors of the Company do not receive fees for their  services,  but the Board
of Directors  may in the future  determine to pay  directors'  fees.  Directors,
however,  are eligible to receive  stock option  grants and are  reimbursed  for
expenses  related to their  activities  as  directors.  Executive  officers  are
appointed and serve at the discretion of the Board of Directors.

The names, ages, dates terms as directors expire, and principal  occupations and
employment of the directors and executive  officers of the Company are set forth
below.


                                        Term as
                                       director
               Name               Age   expires             Position
 -------------------------------- --- ----------  ----------------------------
 Mr. Richard D. Cameron            52    1998     Chief Executive Officer, 
                                                  President and Director
 Mr. Bert I. Helfinstein           64    1998     Director
 Mr. Charles C. McGettigan         52    1998     Director
 Mr. Myron A. ("Mike") Wick III    53    1998     Director

Mr. Richard D. Cameron served as the principal  operating manager of the Company
from May 1989 through June 27, 1995, and has served as Chief Executive  Officer,
President and a director  since that date.  From 1985 to 1988 Mr. Cameron served
as President and Chief  Executive  Officer of PRAXIS Group,  Inc.,  the computer
services subsidiary of FPL Group, Inc., a New York Stock Exchange company. Prior
to 1985 Mr.  Cameron  held a  variety  of  positions  in the  computer  services
industry.

Mr. Bert I.  Helfinstein  has served as a director  of the  Company  since March
1996.  From 1985 until 1989 Mr.  Helfinstein  was  President and Chairman of the
Board of Entre Computer  Centers,  Inc., a franchiser of retail computer stores.
From 1989 until 1992 he was President and Chairman of the Board of Viteq,  Inc.,
a manufacturer of computer peripheral equipment.  Since 1993 Mr. Helfinstein has
served as Chairman of the Board of Campus Tech. Inc., a PC software distribution
company.

Mr. Charles C. McGettigan has served as a director of the Corporation since June
1995.  He was a founding  partner in 1991 and is a general  partner of Proactive
Investment Managers,  L.P. In 1988 Mr. McGettigan co-founded McGettigan,  Wick &
Co.,  Inc.,  an investment  banking firm.  From 1984 to 1988 he was a Principal,
Corporate Finance, of Hambrecht & Quist, Inc. Prior to that Mr. McGettigan was a
Senior Vice President of Dillon, Read & Co. Inc. Mr. McGettigan currently serves
on  the  Boards  of  Directors  of  I-Flow  Corporation,   Modtech,   Inc.,  PMR
Corporation,  Sonex  Research,  Inc.,  Phoenix  Network,  Inc,  Tanknology - NDE
Corporation, Vie de France Corporation, Wray Tech Instruments,  Inc., and Onsite
Energy, Inc., of which he is the Chairman.

Mr. Myron A. ("Mike") Wick III has served as a director of the  Corporation
since June 1995. He was a founding  partner in 1991 and is a general  partner of
Proactive Investment Managers, L.P. In 1988 Mr. Wick co-founded McGettigan, Wick
& Co.,  Inc., an investment  banking firm.  From 1985 to 1988 Mr. Wick was Chief
Operating   Officer  of  California   Biotechnology,   Inc.  in  Mountain  View,
California.  Mr. Wick currently  serves on the Boards of Directors of Children's
Discovery Centers of America, Inc., Modtech, Inc., Tanknology - NDE Corporation,
and serves as the Chairman of the Board of Directors of Sonex Research, Inc. and
Wray Tech Instruments, Inc.
<PAGE>




Mr. Gerald H. Gruber,  a certified  public  accountant,  became  Executive  Vice
President and Chief  Financial  Officer  beginning on April 8, 1997. Mr. Gruber,
60, was formerly  Controller  at James Martin  Company,  a software  engineering
consulting  firm,  from 1993 to 1997.  Prior to that,  from 1988 to 1993, he was
Executive Vice President of PracSys  Corporation,  a financial services company.
Mr. Gruber served as Executive  Vice  President and Chief  Financial  Officer of
PRAXIS Group,  Inc., the computer services  subsidiary of FPL Group, Inc., a New
York Stock Exchange company.

Pursuant to the Shareholders' Agreement, Mr. Cameron and Proactive are obligated
to vote their shares of Common  Stock to  constitute a Board of Directors of the
Company consisting of five members,  appointed as follows:  Mr. Cameron himself,
two  individuals  appointed  by Mr.  Cameron and two  individuals  appointed  by
Proactive. To date, Mr. Cameron has appointed only one of the two directors, Mr.
Helfinstein, while Mr. McGettigan and Mr. Wick were appointed by Proactive.


ITEM 4 - REMUNERATION OF DIRECTORS AND OFFICERS

The Chief Executive Officer is the Company's president,  Mr. Richard D. Cameron,
who was  compensated at an annual rate of $165,000 in 1997. The Company does not
have an employment  agreement  with Mr.  Cameron,  and his employment and annual
salary are subject to annual review by the Board of  Directors.  On December 11,
1997 the Board of Directors increased Mr. Cameron's salary to $200,000 annually.
In addition,  Mr.  Cameron is provided with a company car and  customary  health
benefits,  and is entitled to receive annual cash  performance  bonuses equal to
25% of any year-to-year increase in pre-tax profits that exceeds 30%. The amount
of such bonus earned by Mr. Cameron for 1997 was $36,000.

In  March  1996  the  Board  of  Directors  authorized  the  establishment  of a
non-qualified  stock  option  plan  for  its  full-time  employees,   directors,
transcriptionists  and  consultants  (the  "Option  Plan")  and  reserved  up to
1,300,000 shares of the Company's common stock for issuance upon the exercise of
options granted under this plan. The right to purchase shares under the existing
Option Plan  typically  vest over a four-year  period  beginning on the option's
date of grant.  Stock  options must be  exercised  within ten years from date of
grant. Options have been issued at fair market value. On September 11, 1997, the
Board of  Directors  approved  an  additional  300,000  shares of  common  stock
reserved under the same terms as described above.


ITEM 5 - SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN SECURITY HOLDERS

As of December 31, 1997,  there were 6,281,612 shares of DDI Common Stock issued
and  outstanding.  The  following  table  sets  forth as of  December  31,  1997
information  relating  to  beneficial  ownership  by each of the  directors  and
executive  officers of the Company,  the directors and executive officers of the
Company  as a  group,  and any  other  persons  known by the  Company  to be the
beneficial  owner  of  more  than  ten  percent  of  the  currently  issued  and
outstanding common stock of the Company.  Unless otherwise noted, all shares are
beneficially  owned and sole voting and investment  power is held by the persons
named.

<PAGE>




                                        Total Shares
         Name and Address (1)       Beneficially Owned (2)      % Of Class (2)
--------------------------------   ------------------------     --------------
Mr. Richard D. Cameron             3,156,738 (3) (4) (5)              50.21%
Mr. Bert I. Helfinstein               26,000 (5)                        .40%
Mr. Charles C. McGettigan          1,859,630 (4) (5) (6)              29.58%
Mr. Myron A. ("Mike") Wick III     1,839,630 (4) (5) (6)              29.26%
Mr. Gerald H. Gruber                  95,000 (7)                       1.49%

All directors and officers as a 
group (five persons)               5,136,368                          79.54%

Proactive Partners, L.P.
50 Osgood Place
San Francisco, CA 94133            1,814,630 (8)                      28.98%

Lagunitas Partners, L.P.
50 Osgood Place
San Francisco, CA 94133            2,714,268 (8)                      43.34%

Gruber & McBaine International
50 Osgood Place
San Francisco, CA 94133            1,919,630 (8)                      30.65%
-------------------------------------------------------------------------------

(1)  The  business  address  for  each  Officer  and/or  Director  is  8230  Old
     Courthouse Road, Vienna, VA 22182.
(2)  The term "shares  beneficially  owned"  encompasses  those shares which the
     reporting  person  currently  owns,  or has the  right  to  acquire  or the
     obligation  to  sell  within  the  next  sixty  days,  either  directly  or
     indirectly.  The percentage of beneficial  ownership of a reporting  person
     assumes the exercise of all such rights held by the reporting person and is
     computed  by  increasing  the  total  number  of  shares  of  Common  Stock
     outstanding by the number of shares  issuable to the reporting  person upon
     the exercise of such  rights.  Shares  which the  reporting  person has the
     right to acquire are not deemed to be outstanding,  however,  for computing
     the percentage of beneficial ownership of any other reporting person.
(3)  Includes  30,000  shares owned by Mr. Cameron's  daughter and 72,203 shares
     owned by Mr.  Cameron's wife. 
(4)  Includes  153,035  shares  which may be  acquired by Mr.  Cameron  upon the
     exercise of currently exercisable options to purchase shares from Proactive
     at a price of $1.44 per share.  Because  this  agreement  relates to shares
     which have  already  been issued by the  Corporation,  the exercise of such
     rights  will  not  result  in an  increase  in  the  total  number  of  the
     Corporation's  outstanding  shares for purposes of computing the percentage
     of beneficial ownership of the reporting persons. The right to exercise the
     options on these shares expires October 30, 1998.
(5)  Includes  25,000 shares which may be acquired from  authorized but unissued
     shares of the Corporation,  and therefore will result in an increase in the
     total  number of the  Corporation's  outstanding  shares  for  purposes  of
     computing the percentage of beneficial  ownership of the reporting  person.
     The option  price of the shares is $.76 per share and the option has a term
     of ten years.
(6)  Represents shares owned directly by Proactive Partners,  L.P., which shares
     could be deemed to be  beneficially  owned by both Mr.  McGettigan  and Mr.
     Wick, who are general partners of Proactive Investment Managers, L.P. , the
     general partner of Proactive  Partners,  L.P.  Messrs.  McGettigan and Wick
     exercise shared voting and investment control with respect to such shares.
<PAGE>




(7)  Includes  95,000 shares which may be acquired from  authorized but unissued
     shares of the Corporation,  and therefore will result in an increase in the
     total  number of the  Corporation's  outstanding  shares  for  purposes  of
     computing the percentage of beneficial  ownership of the reporting  person.
     The option  price of the shares is $1.50 and the  option  expires  June 25,
     1998.
(8)  Messrs.  Gruber and McBaine are general  partners of  Proactive  Investment
     Managers,   L.P.,   Lagunitas   Partners,   L.P.,   and  Gruber  &  McBaine
     International,  and  accordingly  all  of the  shares  owned  by  Proactive
     Partners, L.P., Lagunitas Partners, L.P. and Gruber & McBaine International
     could be  deemed  to be  beneficially  owned by both  Mr.  McBaine  and Mr.
     Gruber.  Messrs.  McBaine and Gruber  exercise shared voting and investment
     power with respect to such shares.  Proactive Partners, L.P. owns 1,967,665
     shares directly and is indirectly attributed to have granted 153,035 shares
     pursuant to the Agreement  described in (4).  Lagunitas owns 899,638 shares
     directly, 1,967,665 shares indirectly through Proactive Partners, L.P., and
     is indirectly  attributed to have granted options requiring sale of 153,035
     shares  pursuant  to the  Agreement  described  in (4).  Gruber  &  McBaine
     International  owns 105,000 shares directly,  1,967,665  shares  indirectly
     through  Proactive  Partners,  L.P.,  and is indirectly  attributed to have
     granted options  requiring sale of 153,035 shares pursuant to the Agreement
     described in (4).



In connection with Proactive's  purchase of Mr. Cameron's shares in Digital, Mr.
Cameron was initially  granted  options to purchase up to 459,105  shares of DDI
Common Stock now held by Proactive. The right to purchase 153,035 shares expired
unexercised. The remaining 306,070 options are exercisable as follows:

                                                  Exercise        Number of
                       Period exercisable          price            shares
  ------------------------------------------     ----------       ----------
  October 31, 1997 through October 30, 1998         $2.16           153,035
  October 31, 1998 through October 30, 1999         $2.88           153,035



ITEM 6 - INTEREST OF MANAGEMENT AND OTHERS IN CERTAIN TRANSACTIONS

None.


<PAGE>



                                     PART II


ITEM 1 - MARKET FOR  COMMON STOCK AND RELATED STOCKHOLDER MATTERS

The  authorized  capital stock of the Company  consists of 20,000,000  shares of
common stock,  $.01 par value (the "Common Stock").  There were 6,281,612 shares
of Common  Stock  issued  and  outstanding  as of  December  31,  1997,  held by
approximately 428 holders of record. The shares for approximately 370 additional
beneficial  owners are held of record (in "street  name") by  brokers,  dealers,
banks,  and other entities  holding such securities of record in nominee name or
otherwise  or as a  participant  in a clearing  agency  registered  pursuant  to
Section 17A of the Securities Exchange Act of 1934 (the "Exchange Act").

The Common Stock trades in the over-the-counter market on the OTC Bulletin Board
service under the symbol  "DGDT".  The OTC Bulletin  Board is an electronic  and
screen-based   quotation   medium,   operated  and  regulated  by  the  National
Association of Securities  Dealers,  Inc. Quotation  information on OTC Bulletin
Board stocks is available on stockbrokers' desktop terminals.

A total of 337,006 shares,  or 5.4%, of the Common Stock  currently  outstanding
are tradeable in the  over-the-counter  market.  The remaining  5,944,606 of the
outstanding  shares of Common  Stock  issued to Mr.  Cameron  and  Proactive  in
connection  with the Merger are  considered  "restricted  shares" and may not be
resold  currently in public  distribution  except in compliance  with applicable
registration requirements or exemptions therefrom. In addition, these shares are
subject  to the terms of the  Shareholders'  Agreement  with  respect to certain
matters  related to the  composition  of the  Company's  Board of Directors  and
certain employee-related matters.

The Board of Directors  currently has no plans or understandings  with regard to
the payment of any cash dividends in the foreseeable  future.  Holders of Common
Stock are entitled to receive dividends when, as and if declared by the Board of
Directors of the Company out of funds legally available  therefor.  In the event
of the  liquidation,  dissolution  or winding up of the affairs of the  Company,
holders of Common  Stock are  entitled to receive  ratably the net assets of the
Company available for distribution to holders of Common Stock. Holders of Common
Stock have no cumulative voting,  preemptive,  subscription,  redemption sinking
fund or  conversion  rights.  Each  share of Common  Stock  entitles  the holder
thereof to one vote on all matters submitted to a vote of the stockholders.


ITEM 2 - LEGAL PROCEEDINGS

As of the date of this report,  management is not aware of any legal proceedings
pending against the Company.


ITEM 3 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS

The Company has had no disagreements with its current  independent  accountants,
Hozik & Charin, on any matter of accounting principles or practices or financial
statement  disclosure.  Hozik &  Charin  have  been  the  Company's  independent
accountants since 1993.


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

The only matters  submitted to a vote of security  holders  during 1997 were the
election of directors and ratification of the Company's independent accountants.



<PAGE>




ITEM 5 - COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

Under federal  securities laws, upon the December 23, 1995  effectiveness of its
Registration  Statement  on Form 10-SB filed with the  Securities  and  Exchange
Commission  (SEC),  the  Company's  directors,  officers,  and any other persons
holding  more than 10% of the  Company's  common  stock were  required to report
their initial ownership of the Company's common stock, and are now also required
to report any subsequent changes in that ownership, to the SEC. Such persons are
also  required to furnish the Company  with copies of all such reports that they
file.  To the best of the Company's  knowledge,  based solely on a review of the
copies of such reports furnished to the Company and written representations that
no other  reports  were  required,  all of those filing  requirements  have been
satisfied.


ITEM 6 - REPORTS ON FORM 8-K

Not applicable.



                                    PART F/S


FINANCIAL STATEMENTS

Index to financial statements presented on pages 15 to 28:

     Report of independent auditors Financial statements:
         Balance  sheets as of December 31, 1997 and 1996  Statements  of income
         for  the  years  ended  December  31,  1997  and  1996   Statements  of
         stockholders'  equity for the years  ended  December  31, 1997 and 1996
         Statements of cash flows for the years ended December 31, 1997 and 1996
         Notes to financial statements



<PAGE>

















                             DIGITAL DICTATION, INC.

                          AUDITED FINANCIAL STATEMENTS

                     Years Ended December 31, 1997 and 1996



<PAGE>










INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders
Digital Dictation, Inc.
Vienna, Virginia

We have audited the accompanying balance sheets of Digital Dictation, Inc. as of
December 31, 1997 and 1996, and the related statements of income,  stockholders'
equity and cash flows for the years then ended.  These financial  statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these 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 Digital Dictation,  Inc. as of
December 31, 1997 and 1996, and the results of its operations and its cash flows
for the years  then  ended in  conformity  with  generally  accepted  accounting
principles.






McLean, Virginia
January 26, 1998



<PAGE>




                             DIGITAL DICTATION, INC.
                                 BALANCE SHEETS

                                                         December 31,          
                  ASSETS - Note 5                   1997              1996
                                               --------------    --------------
Current assets
    Cash and cash equivalents                  $       2,530     $       88,815
    Accounts receivable (net of $40,000 
     allowance for doubtful accounts at 
     December 31, 1997) - Note 3                   1,709,503          1,156,841
    Employee receivables                               7,605              2,762
    Prepaid expenses and other                        22,898             28,702
                                               --------------     --------------
        Total current assets                       1,742,536          1,277,120

Property and equipment, net - Notes 4 and 8        1,546,079            879,983
                                               --------------     --------------

Total assets                                   $   3,288,615      $   2,157,103
                                               ==============     ==============

    LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities
    Borrowings under line of credit - Note 5   $     132,318      $     329,029
    Accounts payable                                 313,113            151,485
    Accrued payroll and payroll taxes                325,894            115,060
    Current income taxes payable - Note 6            405,575             27,000
    Current portion of long-term debt - Note 7         6,547              5,931
    Current portion of capital lease 
     obligations - Notes 8 and 14                     24,314             33,218
    Current deferred income taxes - Note 6            41,000            351,000
                                               --------------     --------------
        Total current liabilities                  1,248,761          1,012,723

Long-term debt, non current portion - Note 7             576              7,127
Capital lease obligations, non current 
 portion - Notes 8 and 14                                                23,846
Non current deferred income taxes - Note 6           339,000             69,000

Commitments - Note 14

Stockholders' equity
    Common stock, par value $.01 per share,  
     20,000,000 shares authorized, 6,281,612 
     and 6,257,480 shares issued and outstanding 
     at December 31, 1997 and 1996, respectively      62,816             62,575
    Additional paid-in capital                       610,900            571,496
    Retained earnings                              1,026,562            410,336
                                               --------------     --------------
        Total stockholders' equity                 1,700,278          1,044,407

Total liabilities and stockholders' equity     $   3,288,615       $  2,157,103
                                               ==============      =============

                 See accompanying notes to financial statements
<PAGE>







                             DIGITAL DICTATION, INC.
                              STATEMENTS OF INCOME


                                                Years ended December 31,
                                        --------------------------------------
                                            1997                       1996
                                      ---------------            ---------------
Revenues                              $   10,025,895             $    6,936,730
Cost of services                           6,398,276                  4,490,239
                                       --------------             --------------
        Gross profit                       3,627,619                  2,446,491
General and administrative expenses        2,598,116                  1,716,691
                                       --------------             --------------
        Operating income                   1,029,503                    729,800

Other income (expense)
    Interest and other income                  2,892                      2,054
    Interest expense                         (23,169)                   (39,187)
                                       --------------             --------------
                                             (20,277)                   (37,133)
                                       --------------             --------------
        Income before income taxes         1,009,226                    692,667

Income taxes - Note 6                        393,000                    253,000
                                       --------------             --------------

        Net income                     $     616,226              $     439,667
                                       ==============             ==============


Basic earnings per share - Note 13     $         .10              $         .07
                                       ==============             ==============

Diluted earnings per share - Note 13   $         .09              $         .07
                                       ==============             ==============






















                 See accompanying notes to financial statements
<PAGE>




                             DIGITAL DICTATION, INC.
                       STATEMENTS OF STOCKHOLDERS' EQUITY



                                    Years ended December 31, 1996 and 1997
                              -------------------------------------------------
                                            Additional   Retained     Total
                                Common        Paid-in    Earnings  Stockholders'
                                 Stock        Capital    (deficit)    Equity
                               ---------    ---------    ---------    ---------
Balance at January 1, 1996    $   62,575   $  571,496   $  (29,331)  $  604,740

 Net income                                                439,667      439,667
                              -----------  -----------  -----------  -----------

Balance at December 31, 1996      62,575      571,496      410,336    1,044,407

 Issue of Common Stock - Employee
  Stock Purchase Plan 
  (18,733 shares)                    187       31,659                    31,846
 Issue of Common Stock upon
  exercise of Stock Options
  (5,399 shares)                      54        7,745                     7,799
 Net income                                                616,226      616,226
                              -----------  -----------  -----------  -----------

Balance at December 31, 1997  $   62,816   $  610,900   $  026,562   $1,700,278
                              ===========  ===========  ===========  ===========



























                 See accompanying notes to financial statements
<PAGE>




                             DIGITAL DICTATION, INC.
                            STATEMENTS OF CASH FLOWS

                                                     Years ended December 31,
                                                      1997             1996
                                                  ------------     ------------
Cash flows from operating activities
 Net income                                      $    616,226      $    439,667
 Charges to operations not affecting cash:
        Depreciation and amortization                 371,209           282,132
        Provision for doubtful accounts                40,000
        Net deferred income tax provision             (40,000)          218,000
 Changes in operating assets and liabilities:
        Accounts receivable                          (592,662)         (442,635)
        Employee receivables                           (4,843)           20,262
        Prepaid expenses and other                      5,804            (4,122)
        Accounts payable                              161,628           (60,858)
        Accrued payroll and payroll taxes             210,834           (14,040)
        Current income taxes payable                  378,575            27,000
                                                 -------------     -------------

 Net cash provided by operating activities          1,146,771           465,406
                                                 -------------     -------------

Cash flows from investing activities
    Additions to property and equipment            (1,037,305)         (316,486)
                                                 -------------     -------------

    Net cash used by investing activities          (1,037,305)         (316,486)
                                                 -------------     -------------

Cash flows from financing activities
  Borrowings under line of credit                    (196,711)           64,282
  Proceeds from long-term debt                                           18,000
  Issue of Common Stock - Employee Stock 
   Purchase Plan                                       31,846
  Issue of Common Stock -- Stock Option Plan            7,799
  Dividends paid to former stockholder                                  (44,791)
  Principal payments on long-term debt                 (5,935)          (61,332)
  Principal payments on capital lease obligations     (32,750)          (68,798)
                                                 -------------     -------------

    Net cash used by financing activities            (195,751)          (92,639)
                                                 -------------     -------------

 Increase (decrease) in cash and cash equivalents     (86,285)           56,281

 Cash and cash equivalents at beginning of year        88,815            32,534
                                                 -------------     -------------

 Cash and cash equivalents at end of year        $      2,530      $     88,815
                                                 =============     =============






                 See accompanying notes to financial statements
<PAGE>




                             DIGITAL DICTATION, INC.
                          NOTES TO FINANCIAL STATEMENTS
                           December 31, 1997 and 1996


NOTE 1 - ORGANIZATION

Digital  Dictation,  Inc. (the "Company" or "DDI")  provides  transcription
services for various  medical  facilities.  The Company is  incorporated  in the
state of Delaware and commenced operations during 1989.

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates:  The  preparation of financial  statements in conformity  with
generally accepted  accounting  principles requires management to make estimates
that affect  certain  reported  amounts  and  disclosures.  Accordingly,  actual
results could differ from those estimates.

Revenue Recognition:  Revenue for transcription services is recognized when
the services are provided.

Property and Equipment: Property and equipment is stated at cost or, in the case
of equipment acquired under capital leases, at the present value of future lease
payments, less accumulated  depreciation and amortization.  Internally developed
software costs of $170,596  incurred in 1997 have been capitalized in accordance
with an AICPA exposure draft dated December 17, 1996 of a Statement of Position,
"Accounting  for the  Costs of  Computer  Software  Developed  or  Obtained  for
Internal Use." These costs include  $141,989 of salaries and fringe benefits for
software  developers and $28,607 of  telecommunications  and outside  consultant
costs.  Repair and  maintenance  expenditures  are charged to  operations in the
period  incurred.  Depreciation  is computed  under the straight line method for
financial  reporting  purposes and accelerated  methods for income tax purposes.
Equipment,  furniture,  fixtures,  automobile,  and leasehold  improvements  are
depreciated over five to seven years.  Purchased software is amortized using the
straight  line method over five years.  Internally  developed  software  will be
amortized over five years when the system is placed in operation.

Income Taxes: The Company accounts for income taxes in accordance with Statement
of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes."
Deferred taxes are provided on a liability  method  whereby  deferred tax assets
are recognized for deductible  temporary  differences and operating loss and tax
credit  carryforwards  and deferred tax  liabilities  are recognized for taxable
temporary  differences.  Temporary  differences are the differences  between the
reported  amounts of assets and  liabilities  and their tax bases.  Deferred tax
assets are reduced by a valuation  allowance when, in the opinion of management,
it is more likely than not that some  portion or all of the  deferred tax assets
will not be realized.  Deferred tax assets and  liabilities are adjusted for the
effects of changes in tax laws and rates on the date of enactment.

Cash and Cash  Equivalents:  The Company  considers all highly liquid securities
purchased with a maturity of three months or less to be cash equivalents.

Net Income Per Share: The Company has adopted Statement of Financial  Accounting
Standards  (SFAS) No.  128,  "Earnings  Per Share" as of  December  31, 1997 and
restated  1996  earnings  per share.  Earnings  per common share is based on the
weighted average shares outstanding during the year. Diluted earnings per common
share gives effect to all dilutive  potential common shares  outstanding  during
the year.

Stock Options: The  Company applies APB Opinion 25 and related  Interpretations
in accounting for its stock option plans.
<PAGE>




NOTE 3 - CONCENTRATION OF CREDIT RISK

The  Company  provides  services  on credit to its  clients,  which are  medical
facilities  located  throughout the United States.  The Company performs ongoing
credit evaluation of its clients and requires no collateral. The Company has had
minimal credit losses on its accounts  receivable and the allowance for doubtful
accounts  is  considered  adequate  at  December  31,  1997.  No  allowance  was
considered necessary at December 31, 1996.

NOTE 4 - PROPERTY AND EQUIPMENT, NET

Property and equipment consists of the following:

                                                         December 31,
                                                 1997                  1996
                                             ------------          ------------
    Dictation and other equipment           $   2,480,673         $   1,706,294
    Furniture and fixtures                         94,157                84,069
    Leasehold improvements                         64,671                55,083
    Automobile                                     23,400                23,400
    Software                                      255,981                44,850
                                            --------------        --------------
                                                2,918,882             1,913,696

    Accumulated depreciation and amortization  (1,372,803)           (1,033,713)
                                            --------------        --------------

                                            $   1,546,079         $     879,983
                                            ==============        ==============

NOTE 5 - BORROWINGS UNDER LINE OF CREDIT

The Company has a $500,000 revolving line of credit with Crestar Bank subject to
annual  reviews and expires  December 3, 2002.  This replaces a $450,000 line of
credit with Merrill Lynch Business Financial Services,  Inc as of June 30, 1997.
Borrowings under these lines of credit at December 31, 1997 and 1996 amounted to
$132,318 and $329,029,  respectively.  Interest is payable at prime plus one per
cent per annum (9.5% at December 31, 1997). The line of credit is secured by all
assets of the Company.

Borrowings  under this line of credit are solely for working  capital  purposes.
The related  loan and  security  agreement  requires the Company to, among other
things,  submit annual reviewed  financial  statements within 120 days after the
end of each fiscal year, and unaudited  interim  financial  statements within 20
days  after the end of each  month.  The  Company  is in  compliance  with these
reporting covenants.

NOTE 6 - INCOME TAXES

The Company is taxed as a C corporation.  Effective  January 1, 1997 the Company
converted  from the cash method to the accrual  method of reporting  for Federal
income tax purposes.  The cumulative  difference  between cash and accrual basis
tax reporting as of December 31, 1996 is $935,961. One quarter of this amount is
required to be included in the Company's  taxable income during each of the four
years 1997 to 2000.

The provision (benefit) for income taxes  for the year  ended December 31, 1997
and  December  31, 1996  consists of the following:

<PAGE>




NOTE 6 - INCOME TAXES  (CONTINUED)

                                                  1997                 1996
                                             --------------       --------------
   Current tax expense
       Federal                               $     364,000        $      27,000
       State                                        69,000                8,000
                                             --------------       --------------
                                                   433,000               35,000
                                             --------------       --------------

   Deferred tax expense (benefit)
       Federal                                     (34,000)             183,000
       State                                        (6,000)              35,000
                                             --------------       --------------
                                                   (40,000)             218,000
                                             --------------       --------------
   Total                                     $     393,000        $     253,000
                                             ==============       ==============

Components  of net deferred tax assets and  liabilities  as of December 31, 1997
and 1996 are as follows:

                                                  1997                 1996
                                             --------------       --------------
   Deferred tax liabilities:
       Accounts receivable                   $                    $     440,000
       Prepaid expenses                                                   2,000
       Prepaid income taxes                                               6,000
       Property and equipment                      161,000               69,000
       Cash to accrual                             267,000
                                             --------------       --------------
         Total deferred tax liabilities            428,000              517,000
   Deferred tax assets:
       Accounts receivable allowance                15,000
       Moving reserve                               19,000
       Accounts payable                                                  53,000
       Accrued payroll                              14,000               44,000
                                             --------------       --------------
          Total deferred tax assets                 48,000               97,000
                                             --------------       --------------
       Less valuation allowance                       -                    -
                                             --------------       --------------
   Net deferred tax assets                          48,000               97,000
                                             --------------       --------------
   Net deferred tax liabilities as of 
    December 31, 1997 and 1996 (including 
    $41,000 and $351,000, respectively, 
    classified as current)                   $     380,000        $     420,000
                                             ==============       ==============


<PAGE>





NOTE 6 - INCOME TAXES  (CONTINUED)

Income tax expense for the years ended December 31, 1997 and 1996, respectively,
differ from the Federal statutory rate as follows:

                                                     Years ended December 31,
                                                     1997                1996
                                                  ---------           ---------
  Statutory Federal income tax rate                  34.0%                34.0%
  Effect of graduated rates                                               (1.5)
  State income taxes, net of Federal tax benefit      4.0                  4.0
  Other                                               0.6                  0.0
                                                  ---------           ---------
                                                     38.6%                36.5%
                                                  =========           =========


NOTE 7 - LONG-TERM DEBT

Long-term debt consists of the following:
                                                           December 31,
                                                      1997              1996
                                                  -----------       -----------
    Automobile installment loan, 10% interest
       due December 1998                        $       7,123     $      13,058
    Less current portion                               (6,547)           (5,931)
                                                --------------    --------------

                                                $         576     $       7,127
                                                ==============    ==============


NOTE 8 - CAPITAL LEASES

The Company leases various  equipment  under long-term  contracts.  Property and
equipment includes the following amounts for leases that have been capitalized:

                                                            December 31,
                                                     1997              1996
                                                  -----------       -----------
    Dictation and other equipment               $     104,515     $     104,515
    Allowance for depreciation                        (58,204)          (37,301)
                                                --------------    --------------

                                                $      46,311     $      67,214
                                                ==============    ==============

Depreciation  of these  assets,  computed by the straight  line method over five
years, is included in depreciation expense.



<PAGE>




NOTE 9 - FIXED STOCK OPTION PLANS

At December 31, 1997 and 1996, the Company has a stock-based  compensation plan,
which is  described  below.  The  Company  applies  APB  Opinion 25 and  related
Interpretations  in accounting for its plan.  Accordingly,  no compensation cost
has been  recognized  for its fixed option plan. Had  compensation  cost for the
Company's stock-based  compensation plan been determined based on the fair value
at the grant dates for awards  under those plans  consistent  with the method of
SFAS No. 123, Accounting for Stock Based Compensation,  the Company's net income
and  earnings  per share (EPS) for 1997 and 1996 would have been  reduced to the
pro forma amounts indicated below:

                                                1997                  1996
                                           ---------------       ---------------
         Net income as reported            $      616,226         $     439,667
         Pro forma                         $      563,226         $     408,667

         Basic EPS as reported             $          .10         $         .07
         Pro forma                         $          .09         $         .07

         Diluted EPS as reported           $          .09         $         .07
         Pro forma                         $          .08         $         .07


The effect of  applying  SFAS No.123 is not likely to be  representative  of the
effects on reported net income for future years due, among other things,  to the
effects of vesting.

In March  1996,  the  Board  of  Directors  authorized  the  establishment  of a
non-qualified  stock  option plan for its  directors,  full-time  employees  and
consultants  (the Plan) and reserved  1,300,000  shares of the Company's  common
stock for issuance  upon the  exercise of options  granted  under this Plan.  In
September, 1997, the Board of Directors approved reserving an additional 300,000
shares of the  Company's  common stock for issuance upon the exercise of options
granted under this Plan. All options  granted to date under the Plan are granted
at fair market value as of the date of the grant, and have a maximum term of ten
years.

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:

                                                1997                  1996
                                              --------             ---------
         Expected volatility                    60%                   60%
         Risk-free interest rate               5.4%                  6.3%
         Expected lives                       4 years               5 years
         Dividend yield                         -                     -


<PAGE>




NOTE 9 - FIXED STOCK OPTION PLANS (CONTINUED)

A summary of the status of the  Company's  stock option plans as of December 31,
1997 and 1996, and changes during the year, is presented below:

                                     1997                       1996
                          --------------------------  --------------------------
                                          Weighted                   Weighted
   Fixed options             Shares    Average Price    Shares     Average Price
   -------------------    -----------   -----------   -----------   -----------
  Outstanding at 
     beginning of year       936,346       $ 0.76           -               -
  Granted                    549,925         1.50        936,796         $ 0.76
  Exercised                   (5,399)        1.44           -               -
  Forfeited                 (110,423)         .79           (450)          0.75
                          -----------                 -----------
  Outstanding end of year  1,370,449         1.06        936,346         $ 0.76
                          ===========                 ===========

  Options exercisable 
     at end of year          352,421                         -

  Weighted-average fair value
     of options granted 
     during the year      $     0.48                   $     0.23
                          ===========                  ===========

The following table summarizes information about fixed stock options outstanding
at December 31, 1997:

                       Options Outstanding               Options Exercisable
               -------------------------------------   ------------------------
                   Number       Weighted-   Weighted-     Number     Weighted-
  Range of     Outstanding at    Average     Average   Exercisable    Average
  Exercise      December 31,    Remaining    Exercise  December 31,  Exercise
   Prices          1997       Contract Life   Price       1997         Price
-------------  ------------   -------------  --------  ----------   ---------- 
$ .75 - $1.00    1,020,975     8.45 years     $  .77     257,421     $  .77
$1.01 - $1.75      166,122     4.33 years       1.50      95,000       1.50
$1.76 - $2.50      183,352     9.83 years       2.27
                ----------                              -------- 
                 1,370,449     8.13 years     $ 1.06     352,421     $  .97
                ==========                              ========

NOTE 10 - EMPLOYEE BENEFITS

During 1996, the Company established a 401(k) plan for its employees.  This plan
is funded jointly by employee and employer contributions.  Employees are allowed
to contribute up to 15% of their salary  subject to an overall  limitation.  The
Company contributes 20% of the amount contributed by employees, limited to 5% of
the employee's  salary.  Employer  contributions to this plan for the year ended
December 31, 1997 and 1996 totaled $7,801 and $3,314 respectively.

In December  1996,  the Board of Directors  approved an Employee  Stock Purchase
Plan and reserved  150,000 shares of the Company's common stock. The Company has
issued 18,733 shares under the Plan as of December 31, 1997.

In March 1997,  the Board of  Directors  authorized  establishing  a Section 125
Cafeteria Plan for the Company's employees.


<PAGE>




NOTE 11 - CASH FLOW INFORMATION

Non cash investing and financing activities excluded from the statements of cash
flows consist of property and equipment  acquired under capital leases  totaling
$104,390 for the year ended  December 31, 1996.  Net cash  provided by operating
activities includes interest payments of $23,169 and $39,187 for the years ended
December 31, 1997 and 1996,  respectively.  The Company made income tax payments
of $35,425 and $25,000 during 1997 and 1996 respectively.

NOTE 12 - MAJOR CUSTOMERS

The Company has no customer  exceeding 10% of total  revenues for the year ended
December 31, 1997.  Revenues from several  contracts with the U.S. Naval and two
Veterans Administration hospitals aggregated approximately $928,000 for the year
ended  December 31, 1996.  Revenues  exceeding  10% of total  revenues  from one
nonprofit  hospital group aggregated  approximately  $867,000 for the year ended
December 31, 1996.  Revenues exceeding 10% of total revenues from one for-profit
hospital group aggregated approximately $750,000 for the year ended December 31,
1996.

NOTE 13 -  EARNINGS PER SHARE DISCLOSURE
                                     Income            Shares       Per Share
                                   (Numerator)    (Denominator)       Amount
                                   -----------     -----------     -----------
For Year Ended December 31, 1997
--------------------------------
Basic earnings per share
  Income available to common 
   stockholders                    $   616,266      6,259,765        $    .10

Effect of Dilutive Securities
  Stock options                                       568,018
                                   -----------     -----------      -----------

Diluted earnings per share
  Income available to common stockholders, 
   including assumed conversions   $   616,266      6,827,783        $    .09
                                   ===========     ==========        ==========


For Year Ended December 31, 1996
--------------------------------
Basic earnings per share
  Income available to common
   stockholders                    $   439,667       6,257,480       $    .07

Effect of Dilutive Securities
  Stock options                                         95,188
Diluted earnings per share
  Income available to common stockholders, 
   including assumed conversions   $   439,667       6,352,668       $    .07
                                   ===========      ==========       ==========

Options to purchase  183,550  shares of common stock at $2.25 to $2.38 per share
were outstanding  during October to December,  1997 but were not included in the
computation of diluted EPS because the options'  exercise price was greater than
the average  market price of the common shares.  The options,  which expire from
October to December, 2007, were still outstanding at the end of 1997.


<PAGE>




NOTE 14 - COMMITMENTS

The Company rents office space under two agreements  that expire August 31, 1999
and October 31,  1999.  DDI leases an  automobile  under a three year  operating
lease  through July 1998 at a cost of $461 per month.  The Company also leases a
copier under a three year  operating  lease  through March 18, 2000 at a cost of
$554 per month.

The  future  minimum  lease  payments  under  capital  leases  (see  Note 8) and
non-cancelable  operating leases for office space, equipment,  and automobile as
of December 31, 1997 are as follows:

                                 Capital             Operating
                                 Leases               Leases           Total
Year Ending December 31,
         1998                 $    25,448        $     101,693      $   127,141
         1999                        -                  72,845           72,845
         2000                        -                   1,661            1,661
                              ------------       --------------      -----------
Total minimum lease payments       25,448        $     176,199       $  201,647
                                                 ==============      ===========

Amount representing interest       (1,134)

Present value of net minimum
 lease payments               $    24,314
                              ============

Rent expense under  operating  leases for the years  ended December 31, 1997 and
1996 totaled $96,356 and $65,827, respectively.















<PAGE>




                                    PART III


EXHIBITS LIST


      None


<PAGE>


                                                         SIGNATURES


In  accordance  with  Section 13 or 15(d) of the Exchange  Act,  the  Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.


                                                     DIGITAL DICTATION, INC.


February _, 1998               By:      /s/ Richard D. Cameron
                                        ----------------------
                                        Richard D. Cameron
                                        Principal Executive Officer

February 4, 1998               By:      /s/ Gerald H. Gruber
                                        ----------------------
                                        Gerald H. Gruber
                                        Principal Financial and Accounting 
                                        Officer


In  accordance  with the Exchange  Act, this report has been signed below by the
following  persons on behalf of the  Registrant and in the capacities and on the
dates indicated.


February __, 1998                       /s/ Myron A. Wick III
                                        -------------------------
                                        Myron A. Wick III
                                        Chairman of the Board of Directors


February __, 1998                       /s/ Charles C. McGettigan
                                        --------------------------
                                        Charles C. McGettigan
                                        Director


February 4, 1998                       /s/ Bert I. Helfinstein
                                        --------------------------
                                        Bert I. Helfinstein
                                        Director


The Registrant  will furnish its  shareholders  with copies of its annual report
and proxy statement after the date of this report.