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, 1996
                         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, 1996 were $6,936,730.

     The number of shares  outstanding  of the  Issuer's  $.01 par value  Common
Stock as of March 31, 1997 was 6,257,480.  The aggregate  market value of voting
stock  held  by  non-affiliates  of the  Registrant  as of  March  31,  1997  is
approximately $156,437.


                       Documents Incorporated by Reference

                                      None.

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

                                        1

<PAGE>


                                     PART I


ITEM 1 - DESCRIPTION OF BUSINESS


                                   The Company

Digital  Dictation,  Inc.  ("DDI",  or the "Company"),  a Delaware  corporation,
provides medical transcription  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 five-year  record of 31% average per
year  revenue  growth,  although  there can be no  assurances  that such  annual
revenue growth rates will be sustained.

The Company  presently serves  twenty-eight  major hospitals,  five of which are
located in Washington,  D.C.,  five in Virginia,  four in  California,  three in
Pennsylvania,  two each in New Jersey,  Maryland  and Ohio,  and one each in New
York, Michigan,  Florida, Illinois, and Washington State. These 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.



                                        2

<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, although no client has ever exercised this clause.

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  and resist the  temptation  to
diversify into other areas.



                                        3

<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 document format.

All transcribed material is subject to review by one of the Company's ten 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 $60 million,  (3) approximately eight
national and regional firms,  including the Company,  each with estimated annual
revenues  of from $5 million  to $15  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.

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.

                                        4

<PAGE>

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.


                              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. Management believes, however, that
the use of  this  software  is so  highly  integrated  with  the  organizational
structure of the Company  that the software  alone would be of little value to a
competing firm.


                             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:

  o  to  utilize  systems   engineering  and  computer  and   telecommunications
     technology to automate the entire  transcription  management  process;

  o  to continue to retain one of the most highly skilled groups of IMT's in the
     industry;  and

  o  to develop an organizational culture that continually strives to exceed the
     service expectations of clients.

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 and while gaining a cost advantage over competing
firms operating from local offices.

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.

                                        5

<PAGE>

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. 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 stategy 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.


                                 Marketing Plans

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 hired one regional  manager in
California 1995 and expects to hire an additional  regional manager for the East
Coast in April of 1997 to provide new business development and additional client
support.  The Company's marketing to date has been conducted primarily by senior
management.


                       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.



                                        6

<PAGE>

             Discussion of Operating Results and Financial Condition

Reference is made to the Company's  audited  financial  statements for the years
ended December 31, 1996 and 1995 presented in Part F/S of this report.

The Company has reported  average  annual  growth in revenues over the past five
fiscal  years  of  31%.  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 preceding five fiscal years were as follows:


                               For the year ended December 31,
                -------------------------------------------------------------
                1996           1995          1994          1993          1992
                ----           ----          ----          ----          ----

Revenues    $6,936,730     $5,057,585    $3,838,076    $2,745,897    $2,354,043


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.  Since  January 1,
1990,  the Company has added  twenty-eight  new clients to its original  base of
five,  while losing only five clients:  two small facilities whose revenues were
too  small  to  continue  to  serve  profitably,  an  emergency  facility  whose
transcription  needs were taken over by its parent hospital,  a VA hospital that
was merged into another larger hospital,  and an HMO that was sold by its parent
company  to a  competing  facility.  This  record of adding  new  clients  while
maintaining  existing  client  loyalty has  resulted  in a stable and  generally
predictable  annual revenue growth rate. This client base currently stands at 28
clients with five additional clients with signed contracts awaiting installation
in the next ninety days.

As of March 31, 1997, the Company's  weekly "run rate" had grown to in excess of
$165,000,  with signed  contracts  representing  an additional  $20,000 per week
awaiting  installation.  This run rate indicates that annual revenue for 1997 in
excess of $9 million is likely. 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, 1996,  the Company held cash and  equivalents  of  approximately
$89,000, along with trade receivables of approximately $1,157,000.

As necessary  to finance its growth  rate,  the Company may draw upon a $450,000
line of credit  obtained  during 1995 which remains  available  through June 30,
1997.  The  Company  expects  to renew  its line of  credit  beyond  that  date.
Borrowings against the line of credit, which totalled  approximately $329,000 as
of December 31, 1996, 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. In addition to being  collateralized by the assets of the Company,  the
line of credit is  personally  guaranteed  by  Richard  Cameron,  the  Company's
President.  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 $465,869 in 1996 and $599,690
in 1995.


                                        7

<PAGE>

Results of operations

Revenues  increased  by 37%  from  1995 to 1996,  and by 32% from  1994 to 1995.
Approximately  2% of the  increase in revenues in both  periods was due to price
increases to current  customers;  the  remainder is due  primarily to additional
hospitals  being taken on as  clients,  without any  reduction  in the  existing
client base. 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. At the close of fiscal
year 1993, DDI was providing services to 15 health care institutions,  18 at the
close of 1994, 22 at the close of 1995 and 26 at the close of 1996.

Cost of services,  which includes all costs related to the IMT's,  and telephone
and associated equipment  depreciation,  represented 64.7% of revenue in 1996 as
compared to 68.0% 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  3.3% as a
percentage of revenue  compared to 1995 was due primarily to improved control of
telephone  costs.  As the Company  continues to expand  nationally  by obtaining
contracts with  institutions  located outside the local telephone  calling area,
the amount of  telecommunications  services used by the Company will continue to
grow. However, the Company's new,  multi-year,  volume discount agreement with a
national long distance  vendor has resulted in  improvements in the overall cost
of telecommunications.

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,  and  other  administrative  expenses.  G&A  expenses  as  a
percentage  of revenue  remained  relatively  consistent in both years (24.7% of
revenue in 1996 versus 25.4% of revenue in 1995).

Interest expense  increased from $25,121 in 1995 to $39,187 in 1996,  reflecting
increased  borrowing  against  the  Company's  line of credit to finance  larger
average accounts receivable balances resulting from increased revenue.


                         Employees and Transcriptionists

As of March 31, 1997,  the Company had  twenty-two  full-time  employees and two
part-time  employees in its principal  executive offices and Virginia Operations
Center.  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 200 home-based  transcriptionists
who  are  either   CMT-certified  or  in  the  process  of  becoming  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  subcontract  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.


                         Recapitalization of the Company

On June 27,  1995,  Mr.  Richard D.  Cameron,  the current  President  and Chief
Executive  Officer of the Company,  acquired  all of the issued and  outstanding
common stock of DDI (the "Digital  Stock") from his former wife Ms.  Jennifer B.
Cameron in connection  with the  termination  of their  marriage and incident to
their divorce  settlement.  Mr. Cameron's  payments under the divorce settlement
were financed  through a loan,  secured by 50% of the Digital Stock  acquired by
Mr. Cameron,  from Proactive  Partners,  L.P., a California limited  partnership
(together with its affiliates and/or designees referred to as "Proactive") under
an arrangement by which Proactive  ultimately would acquire from Mr. Cameron 50%
of the  Digital  Stock for  $2,265,000.  (See  Item 5 -  Security  Ownership  of
Management and Certain Security Holders.)


                                        8

<PAGE>

The  general  partner  of  Proactive  Partners,  L.P.  is  Proactive  Investment
Managers, L.P., two of whose general partners, Mr. Charles C. McGettigan and Mr.
Myron A. ("Mike") Wick, III,  became  directors of Digital on June 27, 1995. Mr.
Cameron,   Proactive  and  Digital  executed  a  Shareholders'   Agreement  (the
"Shareholders' Agreement") governing issues such as the composition of the board
of directors  (See Item 3 - Directors  and  Executive  Officers.),  employee and
officer compensation (See Item 4 - Remuneration of Directors and Officers.), and
stock  options  (See Item 5 -  Security  Ownership  of  Management  and  Certain
Security Holders.).

Effective as of October 10, 1995, the Company was merged (the "Merger") with and
into SonoChem, Inc. ("SonoChem"),  with SonoChem being the corporation surviving
the Merger while it was the business of the Company that continued. SonoChem, an
inactive  Delaware  corporation with no assets or liabilities,  was organized in
June 1985 as a subsidiary of Sonex Research,  Inc., a Maryland corporation.  All
of the 312,874 shares of SonoChem's common stock issued and outstanding prior to
the Merger had been registered previously under the Exchange Act. Mr. McGettigan
and Mr. Wick are also directors of Sonex Research,  Inc. In addition,  Proactive
is the  largest  shareholder  of Sonex by  virtue  of  holdings  of  convertible
preferred stock and common stock purchase warrants.

The Merger was  effected  through  the  issuance  and  exchange  by  SonoChem of
5,944,606  additional  shares of its  common  stock for 100% of the  issued  and
outstanding  shares of Digital stock.  As a result of this issuance and exchange
of  shares,  immediately  following  the  Merger,  the  holders  of  100% of the
pre-Merger issued and outstanding  shares of Digital stock became the holders of
95% of the  issued  and  outstanding  shares  of common  stock of the  surviving
corporation. In connection with the Merger, the surviving corporation's name was
changed  from  SonoChem,  Inc.  to Digital  Dictation,  Inc.  In  addition,  the
pre-Merger officers and directors of Digital Dictation,  Inc. became the initial
officers and directors of the corporation surviving the Merger.

Because  it is the  business  of the  Company  that  survived  the  Merger,  for
financial reporting purposes the Merger was treated as a recapitalization of the
Company in the position of acquirer in a reverse merger.  The terms "Company" or
"DDI" are used in this report to refer to both the  post-Merger  and  pre-Merger
corporations known as Digital Dictation, Inc.



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.



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.


                                        9

<PAGE>

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

Richard D. Cameron             52     1997    Chief Executive Officer, President
                                                  and Director
Bert I. Helfinstein            63     1997    Director
Charles C. McGettigan          52     1997    Director
Myron A. ("Mike") Wick, III    53     1997    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 franchisor 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 Company since June 27,
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 Company,  Modtech, Inc., PMR Company, Sonex
Research, Inc., and Onsite Energy, Inc., of which he is the Chairman.

Mr. Myron A. ("Mike")  Wick,  III, has served as a director of the Company since
June 27,  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., NDE Environmental,  Phoenix
Network, Inc., and WrayTech Instruments, Inc., and serves as the Chairman of the
Board of Directors for Sonex Research, Inc. and Stat-Tech International Company.

The  Company  has  recently  hired Mr.  Gerald H.  Gruber,  a  certified  public
accountant,  to serve as Executive  Vice President and Chief  Financial  Officer
beginning on April 8, 1997.  Mr.  Gruber,  59, 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.


                                       10

<PAGE>

ITEM 4 - REMUNERATION OF DIRECTORS AND OFFICERS

The only  executive  officer  is the  Company's  president  and chief  executive
officer,  Mr.  Richard D.  Cameron,  who was  compensated  at an annual  rate of
$150,000 in 1996.  The Company does not have an  employment  agreement  with Mr.
Cameron; however, pursuant to the Shareholders' Agreement, the Company agreed to
continue to employ Mr.  Cameron as its president at an annual salary of $165,000
through December 31, 1997. Mr. Cameron's employment and annual salary after that
date will  continue to be subject to an annual review by the Board of Directors.
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 1996 was $73,000.

In  March  1996  the  Board  of  Directors  authorized  the  establishment  of a
non-qualified  stock  option plan for its  full-time  employees  (the  "Employee
Plan") and  reserved  up to 800,000  shares of the  Company's  common  stock for
issuance upon the exercise of options  granted under this plan.  Consultants  to
the Company are also eligible to receive options  pursuant to the Employee Plan.
The options granted to date to eligible  individuals vest at the rate of 25% per
year,  beginning one year after the date of grant, and have a term of ten years.
As of December 31, 1996, the Company had granted  options to purchase a total of
636,346 shares at exercise  prices between $0.75 and $1.00 per share. No portion
of these outstanding options had become exercisable as of that date.

Also in March 1996 the Board of  Directors  authorized  the  establishment  of a
non-qualified  stock option plan for its  directors  (the  "Director  Plan") and
reserved up to 500,000  shares of the  Company's  common stock for issuance upon
the exercise of options  granted  under this plan.  Initial  grants were made of
options to purchase  75,000 shares of common stock to each of the Company's four
directors.  These options vest at the rate of one-third  per year  beginning one
year after the date of grant, have an exercise price of $.76 per share, and have
a term of ten years.  There have been no further  grants of options to directors
since  these  initial  grants,  and no  portion  of  these  options  had  become
exercisable as of December 31, 1996.



ITEM 5 - SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN SECURITY HOLDERS

As of March 31, 1997, there were 6,257,480 shares of DDI Common Stock issued and
outstanding.  The  following  table sets forth as of March 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.



                                       11

<PAGE>

                              Shares     Shares    Rights to  Total shares    %
                              owned      owned      acquire   beneficially   of
    Name and address (1)     directly  indirectly   shares(2)    owned(3)  class
    --------------------     --------  ----------   ---------    --------  -----

Richard D. Cameron          2,952,703       -       178,035(4)  3,130,738   48.7
Bert I. Helfinstein              -          -        25,000(6)     25,000    0.4
Charles C. McGettigan          20,000  2,972,303(5)  25,000(6)  2,992,303   47.8
Myron A. ("Mike") Wick, III      -     2,972,303(5)  25,000(6)  2,972,303   47.5

All directors and officers,
 as a group (four persons)  2,972,703  2,972,303(5) 100,000(6)  6,045,006   95.1

Proactive
 50 Osgood Place
 San Francisco, CA  94133   2,972,303       -                   2,972,303   47.5
-----------------------------
    (1) The  business  address for each  director is 8230 Old  Courthouse  Road,
        Vienna, VA, 22182.
    (2) Represents  rights to  acquire  shares  which are  already  outstanding;
        accordingly,  the exercise of such rights will not result in an increase
        in the total of  outstanding  shares for  computing  the  percentage  of
        beneficial ownership of the reporting person exercising such rights.
    (3) The term "shares  beneficially owned" encompasses those shares which the
        reporting  person currently owns, or has the right to acquire 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.
    (4) Includes  153,035  shares  which may be  acquired  upon the  exercise of
        currently  exercisable  options to purchase  shares from Proactive at an
        exercise  price of $1.44 per share (See the table  below.) and currently
        exercisable  options to  purchase  25,000  shares from the Company at an
        exercise price of $.76 per share
    (5) Represents  shares owned  directly by  Proactive,  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., which is
        the general  partner of  Proactive.  Both  individuals  exercise  shared
        voting and investment power with respect to such shares.
    (6) Represents  shares which may be acquired  upon the exercise of currently
        exercisable  options to purchase  shares from the Company at an exercise
        price of $.76 per share.


In connection with Proactive's  purchase of Mr. Cameron's shares in Digital (See
Item 1 - Business - "Recapitalization of the Company"),  Mr. Cameron was granted
options  to  purchase  up to  459,105  shares  of DDI  Common  Stock now held by
Proactive, exercisable as follows:

                                                  Exercise       Number of
          Period exercisable                        price         shares
          ------------------                        -----         ------

   Currently, through October 30, 1997              $1.44         153,035
   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.

                                       12

<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 6,257,480 shares
of Common Stock issued and outstanding as of March 31, 1997, held by 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 312,874  shares,  or 5%, of the Common Stock  currently  outstanding,
representing the ownership interest of the stockholders of SonoChem  immediately
prior to the Merger (See Part I, Item 1, "Recapitalization of the Company".) 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  (See Item 1 - Business -
"Recapitalization  of the Company") 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  matter  submitted  to a vote of security  holders  during 1996 was the
election of directors.




                                       13

<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, 1996 and 1995

         Statements  of income for the years ended December 31, 1996 and 1995

         Statements of stockholders'  equity for the period from January 1, 1995
         through December 31, 1996

         Statements of cash flows for the years ended December 31, 1996 and 1995

         Notes to financial statements


                                       14

<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, 1996 and 1995, 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, 1996 and 1995, and the results of its operations and its cash flows
for the years  then  ended in  conformity  with  generally  accepted  accounting
principles.




HOZIK & CHARIN

McLean, Virginia
February 15, 1997

                                       15

<PAGE>

                             DIGITAL DICTATION, INC.
                                 BALANCE SHEETS

                                                            December 31,
                                                         -------------------
                                                         1996           1995
        ASSETS - Note 5                                  ----           ----

Current assets
 Cash and cash equivalents                            $   88,815    $   32,534
 Accounts receivable - Note 3                          1,156,841       714,206
 Employee receivables                                      2,762        23,024
 Prepaid expenses and other                               28,702        24,580
                                                      ----------    ----------
     Total current assets                              1,277,120       794,344

Property and equipment, net - Notes 4 and 8              879,983       845,629
                                                      ----------    ----------

     Total assets                                     $2,157,103    $1,639,973
                                                      ==========    ==========


    LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities
 Borrowings under line of credit - Note 5             $  329,029    $  264,747
 Accounts payable                                        151,485       212,343
 Accrued payroll and payroll taxes                       115,060       129,100
 Dividends payable - Note 11                                            44,791
 Current income taxes payable - Note 10                   27,000
 Current portion of long-term debt - Note 7                5,931        56,390
 Current portion of capital lease
   obligations - Notes 8 and 9                            33,218        68,798
 Current deferred income taxes - Note 10                 351,000       152,000
                                                      ----------    ----------
     Total current liabilities                         1,012,723       928,169

Long-term debt, non current portion - Note 7               7,127

Capital lease obligations, non current
   portion - Notes 8 and 9                                23,846        57,064

Non current deferred income taxes - Note 10               69,000        50,000

Commitments - Note 9

Stockholders' equity
 Common stock, par value $.01 per share,
   20,000,000 shares authorized, 6,257,480
   shares issued and outstanding                          62,575        62,575
 Additional paid-in capital                              571,496       571,496
 Retained earnings (deficit)                             410,336       (29,331)
                                                      ----------    ----------
    Total stockholders' equity                         1,044,407       604,740
                                                      ----------    ----------


    Total liabilities and stockholders' equity        $2,157,103    $1,639,973
                                                      ==========    ==========


                 See accompanying notes to financial statements.

                                       16

<PAGE>

                             DIGITAL DICTATION, INC.
                              STATEMENTS OF INCOME


                                                     Years ended December 31,
                                                     ------------------------
                                                      1996              1995
                                                      ----              ----

Revenues                                           $6,936,730        $5,057,585

Cost of services                                    4,490,239         3,442,698
                                                   ----------        ----------

 Gross profit                                       2,446,491         1,614,887

General and administrative expenses                 1,716,691         1,284,084
                                                   ----------        ----------

    Operating income                                  729,800           330,803

Other income (expense)
 Interest and other income                              2,054               735
 Interest expense                                     (39,187)          (25,121)
                                                   ----------        ----------
                                                      (37,133)          (24,386)
                                                   ----------        ----------

    Income before income taxes                        692,667           306,417

Income taxes (benefit) - Note 10                      253,000           (18,000)
                                                   ----------        ----------

                                                      439,667           324,417

Income tax adjustment for change in
 tax status - Note 10                                                  (220,000)
                                                   ----------        ----------

    Net income                                     $  439,667        $  104,417
                                                   ==========        ==========


Net income per share                                     $.07
                                                         ====

Weighted average shares outstanding                 6,257,480
                                                    =========


Pro forma data (Unaudited) - Notes 2 and 10

 Income before income taxes, as reported                            $  306,417
 Pro forma provision for income tax                                    112,000
                                                                    ----------
 Pro forma net income                                               $  194,417
                                                                    ==========

 Pro forma net income per share                                           $.03
                                                                          ====

 Weighted average shares outstanding                                 6,257,480
                                                                     =========

                 See accompanying notes to financial statements.

                                       17

<PAGE>

                             DIGITAL DICTATION, INC.
                       STATEMENTS OF STOCKHOLDERS' EQUITY

                     Years ended December 31, 1995 and 1996



                                           Additional   Retained       Total
                                  Common    Paid-in     Earnings   Stockholders'
                                  Stock     Capital     (deficit)      Equity
                                  -----     -------     ---------      ------

Balance at January 1, 1995       $62,575    $354,492    $411,621    $  828,688

Merger costs                                 (51,572)                  (51,572)
Dividends paid to former
  stockholder                                           (232,002)     (232,002)
Dividends payable                                        (44,791)      (44,791)
Constructive dividend - Note 11              268,576    (268,576)
Net income                                               104,417       104,417
                                 -------    --------    --------    ----------
Balance at December 31, 1995      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
                                 =======    ========    ========    ==========






                 See accompanying notes to financial statements.

                                       18

<PAGE>

                             DIGITAL DICTATION, INC.
                            STATEMENTS OF CASH FLOWS

                                                    Years ended December 31,
                                                   -------------------------
                                                      1996            1995
                                                      ----            ----
Cash flows from operating activities
  Net income                                         $439,667       $104,417
  Charges to operations not affecting cash:
      Depreciation and amortization                   282,132        247,551
      Net deferred income tax provision               218,000        202,000
      Loss on disposal of property and equipment          463
  Changes in operating assets and liabilities:
      Accounts receivable                            (442,635)       (90,110)
      Employee receivables                             20,262        (11,469)
      Due from stockholder                                             7,463
      Prepaid expenses and other                       (4,122)       (21,036)
      Accounts payable                                (60,858)       125,332
      Accrued payroll and payroll taxes               (14,040)
      Current income taxes payable                     27,000         35,542
                                                     --------       --------
  Net cash provided by operating activities           465,869        599,690

Cash flows from investing activities
  Additions to property and equipment                (316,949)      (408,952)
                                                     --------       --------
  Net cash used by investing activities              (316,949)      (408,952)
                                                     --------       --------
Cash flows from financing activities
  Borrowings under line of credit                      64,282        264,747
  Proceeds from long-term debt                         18,000
  Merger costs charged to additional paid-in capital                 (51,572)
  Dividends paid to former stockholder                (44,791)      (232,002)
  Principal payments on long-term debt                (61,332)       (55,386)
  Principal payments on capital lease obligations     (68,798)       (85,713)
                                                     --------       --------
  Net cash used by financing activities               (92,639)      (159,926)
                                                     --------       --------
Increase in cash and cash equivalents                  56,281         30,812

Cash and cash equivalents at beginning of year         32,534          1,722
                                                     --------       --------

Cash and cash equivalents at end of year             $ 88,815       $ 32,534
                                                     ========       ========



                 See accompanying notes to financial statements.

                                       19

<PAGE>

                             DIGITAL DICTATION, INC.
                          NOTES TO FINANCIAL STATEMENTS

                           December 31, 1996 and 1995


NOTE 1 - ORGANIZATION, CHANGE IN OWNERSHIP AND MERGER

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.


Change in Ownership:
--------------------

In June,  1995 Mr.  Richard D. Cameron,  now the  President and Chief  Executive
Officer of DDI,  acquired  all of the issued  and  outstanding  shares of common
stock of the Company. In connection therewith,  Mr. Cameron obtained a loan from
Proactive  Partners,  L.P.,  a  California  limited  partnership  ("Proactive"),
pursuant to a Note Purchase Agreement and Promissory Note. The terms of the Note
provided for, among other things,  payment  through the transfer to Proactive of
50% of Mr.  Cameron's  shares of DDI in connection with a merger of DDI with and
into a public shell company.


Merger:
-------

On October 10, 1995, the Company was acquired by SonoChem, Inc. ("SonoChem"), an
inactive public corporation,  in a non-taxable  reverse acquisition  pursuant to
Section  368(a) of the  Internal  Revenue  Code of 1986 and Plan of Merger dated
September  15,  1995.   SonoChem  acquired  all  of  the  Company's  issued  and
outstanding  shares  of  common  stock  in  exchange  for  5,944,606  shares  of
SonoChem's  $.01 par  value  common  stock.  As a result of this  issuance,  the
previous  holders of the Company's common stock became the holders of 95% of the
issued and outstanding  shares of SonoChem.  Concurrent  with this  transaction,
SonoChem's name was changed to Digital Dictation, Inc.

For  financial  reporting  purposes,  this  transaction  has been  treated  as a
recapitalization of the Company, with the Company in the position of acquirer in
a reverse acquisition.  The historical financial statements prior to October 10,
1995 are those of the Company.  Pro forma information is not presented because a
business  combination  did not  occur.  The  recapitalization  of the  Company's
authorized,  issued and  outstanding  common  stock has been  given  retroactive
effect in the accompanying financial statements.


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.  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.  Software is
amortized using the straight line method over five years.

                                       20

<PAGE>

Income Taxes:
-------------

     For  periods  through  October  9,  1995,  the  Company  was  taxed as an S
corporation.  Accordingly,  federal  and state  income  taxes were the  personal
responsibility  of the  stockholder,  and no  provision  for  income  taxes  was
necessary.  Effective October 10, 1995, as a result of the reverse  acquisition,
the Company is taxed as a C corporation.

Effective   October  10,  1995,  the  Company  adopted  Statement  of  Financial
Accounting  Standards (SFAS) No. 109,  "Accounting for Income Taxes". Under SFAS
No. 109,  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:
---------------------

Net income  per share is based on the  weighted  average  of shares  outstanding
during 1996.


Pro Forma Net Income Per Share:
-------------------------------

Pro  forma  net  income  per share is based on the  weighted  average  of shares
outstanding during 1995 after giving effect to the recapitalization discussed in
Note 1.


Stock Options:
--------------

The Company applies APB Opinion 25 and related Interpretations in accounting for
its stock option plans.


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 no allowance for doubtful
accounts is considered necessary at December 31, 1996 and 1995.



                                       21

<PAGE>

NOTE 4 - PROPERTY AND EQUIPMENT, NET

Property and equipment consists of the following:

                                                       December 31,
                                                    ------------------
                                                    1996          1995
                                                    ----          ----

    Dictation and other equipment                $1,706,294    $1,479,526
    Furniture and fixtures                           84,069        65,860
    Leasehold improvements                           55,083        44,343
    Automobile                                       23,400        23,400
    Software                                         44,850        45,894
                                                 ----------    ----------
                                                  1,913,696     1,659,023

    Accumulated depreciation and amortization    (1,033,713)     (813,394)
                                                 ----------    ----------

                                                 $  879,983    $  845,629
                                                 ==========    ==========


NOTE 5 - BORROWINGS UNDER LINE OF CREDIT

The Company has a $450,000 line of credit with Merrill Lynch Business  Financial
Services, Inc. which expires June 30, 1997. Borrowings under this line of credit
at December 31, 1996 and 1995 amounted to $329,029 and  $264,747,  respectively.
Interest is payable at prime plus one per cent per annum  (9.2% at December  31,
1996). 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 submit  annual
reviewed financial statements within 120 days after the end of each fiscal year,
and unaudited interim financial  statements within 45 days after the end of each
fiscal quarter. The Company is in compliance with these reporting covenants.


NOTE 6 - TRANSACTIONS WITH RELATED PARTY

During  May 1996  Mr.  Cameron  repaid,  on  behalf  of the  Company,  unsecured
installment notes,  totaling $36,035 (See Note 7). The balance was repaid to Mr.
Cameron in installments through December 1996 including interest totaling $1,037
calculated  at 10% annum.  This  repayment  is on the same terms as the original
notes.



                                       22

<PAGE>

NOTE 7 - LONG-TERM DEBT

Long-term debt consists of the following:

                                                       December 31,
                                                    ------------------
                                                    1996          1995
                                                    ----          ----

    Automobile installment loan, 10% interest
      due December 1998                          $ 13,058      $   -
    Unsecured installment notes, 10% interest,
      due December 1996, prepaid in May 1996
      (See Note 6)                                               56,390
                                                 --------      --------
                                                   13,058        56,390

    Less current portion                           (5,931)      (56,390)
                                                 --------      --------

                                                 $  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,
                                                    ------------------
                                                    1996          1995
                                                    ----          ----

    Dictation and other equipment                $104,515      $464,303
    Allowance for depreciation                    (37,301)      277,085)
                                                 --------      --------

                                                 $ 67,214      $187,218
                                                 ========      ========

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


NOTE 9 -  COMMITMENTS

The Company rents office space under two agreements which 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  November 1998 at a cost of
$175 per month.


                                       23

<PAGE>

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, 1996 are as follows:

                                        Capital    Operating
                                        Leases      Leases      Total
                                        ------      ------      -----
Year Ending December 31,
  1997                                 $ 37,913    $ 98,067    $135,980
  1998                                   24,980      93,452     118,432
  1999                                               64,365      64,365
                                       --------    --------    --------
  Total minimum lease payments           62,893    $255,884    $318,777
                                                   ========    ========

  Amount representing interest           (5,829)
                                       --------
  Present value of net minimum
    lease payments (including
    $33,218 classified as current)     $ 57,064
                                       ========

Rent expense under  operating  leases for the years ended  December 31, 1996 and
1995 totaled $65,827 and $50,364, respectively.


NOTE 10 - INCOME TAXES AND CHANGES IN TAX STATUS

As a result of the reverse acquisition  described in Note 1, on October 10, 1995
the Company's income tax status changed. Effective October 10, 1995, the Company
is  required  to pay income  taxes on its  earnings,  including  deferred  taxes
existing at the time that the S corporation status was terminated.

The components of the deferred tax expense (benefit) for the year ended December
31, 1996 and the period from  October 10, 1995 to December  31, 1995  consist of
the following:

                                                   1996          1995
                                                   ----          ----
  Current tax expense
      Federal                                    $ 27,000
      State                                         8,000
                                                 --------
                                                   35,000
                                                 --------

  Deferred tax expense (benefit)
      Federal                                    $183,000     $(15,000)
      State                                        35,000       (3,000)
                                                 --------     --------
                                                  218,000      (18,000)
                                                 --------     --------

  Total                                          $253,000     $(18,000)
                                                 ========     ========



                                       24

<PAGE>

Components  of the  Company's  net  deferred  tax assets and  liabilities  as of
December 31, 1996 and 1995 are as follows:
                                                    1996          1995
                                                    ----          ----
  Deferred tax assets:
      Accounts payable                            $ 53,000    $ 50,000
      Accrued payroll                               44,000      41,000
      Net operating loss carry forward                          28,000
                                                  --------    --------
      Total deferred tax assets                     97,000     119,000
                                                  --------    --------
  Deferred tax liabilities:
      Accounts receivable                          440,000     270,000
      Prepaid expenses                               2,000       1,000
      Prepaid income taxes                           6,000
      Property and equipment                        69,000      50,000
                                                  --------    --------
      Total deferred tax liabilities               517,000     321,000
                                                  --------    --------

  Net deferred tax liabilities                     420,000     202,000

  Less valuation allowance                            -           -
                                                  --------    --------
  Net deferred tax liabilities as of
      December 31, 1996 and 1995 (including
      $351,000 and $152,000, respectively
      classified as current)                      $420,000    $202,000
                                                  ========    ========


The unaudited pro forma  adjustment to reflect income taxes in the  accompanying
statement of income is for  information  purposes  only and has been  calculated
based on the estimated effective tax rate in 1995, assuming the Company had been
subject to corporate income tax.

Income tax expense and pro forma income tax expense for the years ended December
31,  1996 and 1995,  respectively,  differ from the  Federal  statutory  rate as
follows:

                                                       December 31,
                                                    ------------------
                                                    1996          1995
                                                    ----          ----
 Statutory Federal income tax rate                  34.0%         34.0%
 Effect of graduated rates                          (1.5)         (1.4)
 State income taxes, net of Federal tax benefit      4.0           4.0
                                                    ----          ----
                                                    36.5%         36.6%
                                                    ====          ====


NOTE 11 - DIVIDENDS

On October 9, 1995,  the Company's S corporation  election  terminated.  At that
time the  retained  earnings  balance  representing  undistributed  earnings  of
$268,576  was  reclassified  as  additional  paid-in  capital as a  constructive
distribution to the stockholder followed by a contribution by the stockholder to
the capital of the Company.  The dividend  payable of $44,791 as of December 31,
1995  represents  the income tax  liability of the S  corporation  stockholder's
proportionate  share of the  undistributed  taxable  earnings through October 9,
1995.

                                       25

<PAGE>

NOTE 12 - FIXED STOCK OPTION PLANS

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

                                      Net income           EPS
                                      ----------           ---
         As reported                   $439,667           $.07

         Pro forma                     $408,667           $.07

The effect of applying FASB statement 123 is not likely to be  representative of
the  effects on  reported  net income  for  future  years due to the  effects of
vesting.

In March  1996,  the  Board  of  Directors  authorized  the  establishment  of a
non-qualified stock option plan for its full-time employees and consultants (the
"Employee  Plan") and reserved  800,000 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  Employee  Plan  vest at the rate of 25% per  year,
beginning one year after the date of grant, and have a term of ten years.

Also in March 1996,  the Board of Directors  authorized the  establishment  of a
non-qualified  stock option plan for its  directors  (the  "Director  Plan") and
reserved  500,000  shares of the  Company's  common stock for issuance  upon the
exercise of options granted under this plan. Initial grants were made of options
to  purchase  75,000  shares  of  common  stock  to each of the  Company's  four
directors.  These options vest at the rate of one-third  per year  beginning one
year after the date of grant, have an exercise price of $.76 per share, and have
a 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  used  for  grants  in  1996:  expected  volatility  of 60  percent;
risk-free interest rate of 6.2 percent for the Employee Plan and 6.3 percent for
the Director Plan; expected lives of 5 years for the Employee Plan options and 7
years for the Director Plan options; no dividends are anticipated.

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

                                                           Weighted-Average
 Fixed options                                Shares        Exercise Price
 -------------                                ------        --------------

 Granted                                      936,796            $.76
 Forfeited                                       (450)            .75
                                              -------            ----
 Outstanding at end of year                   936,346            $.76
                                              =======            ====

 Weighted-average fair value of
     options granted during the year             $.23
                                                 ====

                                       26

<PAGE>

No options were exercisable at December 31, 1996. The following table summarizes
information about fixed stock options outstanding at December 31, 1996:

  Range of              Number          Weighted-Average        Weighted-
  Exercise          Outstanding at          Remaining            Average
   Price           December 31, 1996    Contractual Life     Exercise Price
   -----           -----------------    ----------------     --------------

 $.75 - $.76           931,600              9.3 years            $ .76
    $1.00                4,746              9.9 years             1.00
                       -------

                       936,346              9.3 years
                       =======


NOTE 13 - 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, 1996 totaled $3,314.


NOTE 14 - 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, 1997.  Net cash  provided by operating
activities includes interest payments of $39,187 and $25,121 for the years ended
December 31, 1996 and 1995, respectively.  The Company made a $25,000 income tax
payment during 1996.


NOTE 15 - MAJOR CUSTOMERS

Revenues  from  several   contracts   with  the  U.S.  Naval  and  two  Veterans
Administration  hospitals aggregated approximately $928,000 and $896,000 for the
years ended December 31, 1996 and 1995, respectively.  Revenues exceeding 10% of
total  revenues from one  non-profit  hospital  group  aggregated  approximately
$867,000  and  $506,000  for  the  years  ended  December  31,  1996  and  1995,
respectively.  Revenues  exceeding  10% of total  revenues  from one  for-profit
hospital group aggregated approximately $750,000 for the year ended December 31,
1996.

                                       27

<PAGE>


                                    PART III


EXHIBITS LIST


2.1  Amended and Restated  Certificate of Incorporation  of SonoChem,  Inc. (now
     known as Digital Dictation, Inc.) (1)

2.2  Amended and Restated Bylaws of Digital  Dictation,  Inc.  (f/k/a  SonoChem,
     Inc.) (1)

3    Specimen Certificate for Shares of DDI Common Stock (1)

5    Digital Dictation, Inc. Shareholders' Agreement (1)

12   Agreement  and  Plan  of  Merger  By and  Among  Digital  Dictation,  Inc.,
     SonoChem, Inc. and Principal SonoChem Stockholders (1)

27   Financial Data Schedule



(1) Filed previously with the Company's  Registration Statement #0-27052 on Form
10-SB filed with the Securities and Exchange Commission on October 23, 1995.

                                       28

<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.


April 9, 1997             By:        /s/  Richard D. Cameron
                               -----------------------------------
                               Richard D. Cameron
                               Principal Executive Officer, 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.


April 9, 1997                       /s/   Myron A. Wick, III
                               -----------------------------------
                               Myron A. Wick, III
                               Chairman of the Board of Directors


April 9, 1997                       /s/   Charles C. McGettigan
                               -----------------------------------
                              Charles C. McGettigan
                              Director


April 9, 1997                       /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.

                                       29

<PAGE>