SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                    ---------
                                   FORM 10-KSB
  (Mark One)

  |X|    ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT
         OF 1934: For the fiscal year ended FEBRUARY 28, 1997


  | |    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE
         ACT OF 1934: For the transition period from ---------- to ----------

                         Commission file number 0-24426
                                                -------

                               C-PHONE CORPORATION
                 ----------------------------------------------
                 (Name of small business issuer in its charter)


                    NEW YORK                                   06-1170506
         -------------------------------                 -------------------
         (State or other jurisdiction of                 (I.R.S. employer
         incorporation or organization)                  identification No.)


         6714 NETHERLANDS DRIVE, WILMINGTON, NORTH CAROLINA            28405
         --------------------------------------------------           --------
               (Address of principal executive offices)              (Zip Code)

                    Issuer's telephone number: (910) 395-6100
                                               --------------

       Securities registered under Section 12(b) of the Exchange Act: NONE

         Securities registered under Section 12(g) of the Exchange Act:

                          COMMON STOCK, $.01 PAR VALUE
                          ----------------------------
                                (Title of class)

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

         Check if there is no  disclosure  of  delinquent  filers in response to
Item 405 of  Regulation  S-B contained 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. [ ]

         State issuer's revenues for its most recent fiscal year: $2,042,878

         State  the  aggregate   market  value  of  the  voting  stock  held  by
non-affiliates  computed by  reference to the price at which the stock was sold,
or the average bid and asked prices of such stock, as of a specified date within
the past 60 days:

                  Approximately  $36,710,000,  based on the last  published sale
                  price ($9-1/8) on The Nasdaq National Market on May 20, 1997.

         State the number of shares  outstanding of each of the issuer's classes
of common equity, as of the latest practicable date:

                  As of May 20, 1997 - 5,202,786 shares.

         Documents   Incorporated   by  Reference:   Portions  of  the  issuer's
definitive  proxy  statement to be mailed to shareholders in connection with the
issuer's 1997 Annual Meeting are incorporated by reference into Part III of this
Annual Report on Form 10-KSB.

        Transitional Small Business Disclosure Format (check one) Yes [ ] No [X]
<PAGE>
                                TABLE OF CONTENTS
<TABLE>
<CAPTION>

<S>      <C>                                                                      <C>
ITEM NO.                                                                          PAGE
--------                                                                          ----

Glossary.........................................................................  ii

PART I

         1.    Description of Business...........................................   2

         2.    Description of Property...........................................  18

         3.    Legal Proceedings.................................................  19

         4.    Submission of Matters to a Vote of Security Holders...............  19

PART II

         5.    Market for Common Equity and Related Stockholder Matters..........  19

         6.    Management's Discussion and Analysis or Plan of Operations........  20

         7.    Financial Statements..............................................  26

         8.    Changes In and Disagreements With Accountants on Accounting
               and Financial Disclosure..........................................  44

PART III

         9.    Directors, Executive Officers, Promoters and Control Persons;
               Compliance with Section 16(a) of the Exchange Act.................  44

         10.   Executive Compensation............................................  44

         11.   Security Ownership of Certain Beneficial Owners and Management....  44

         12.   Certain Relationships and Related Transactions....................  44

         13.   Exhibits and Reports on Form 8-K..................................  44

         Signatures..............................................................  48
</TABLE>

                                       i

<PAGE>
                                    GLOSSARY

Algorithm:                          A step-by-step problem solving procedure.

Analog telephone lines:             Standard telephone lines in use in most home
                                    (also  known as POTS  (plain  old  telephone
                                    lines)).

Asynchronous:                       Lacking  in  synchronization.  A  method  of
                                    transmitting  data over a network.  The time
                                    interval   between   characters  may  be  of
                                    varying   lengths.   A   video   signal   is
                                    asynchronous  when its timing  differs  from
                                    that of the system reference signal.

ATM:                                Asynchronous transfer mode - A developmental
                                    high-speed,    high-bandwidth,     low-delay
                                    transport  technology,   integrating  voice,
                                    video and data.

Bandwidth:                          The amount of data a medium can  transmit in
                                    a given  amount  of time.  The  greater  the
                                    bandwidth,  the  faster  the  rate  of  data
                                    transmission.

bps:                                Bits per second - A unit of  measurement  of
                                    the speed of data transmission.

Broadband:                          Networks  having  bandwidths   significantly
                                    greater than that found in regular telephone
                                    networks.  Broadband  systems are capable of
                                    transmitting   a  vast   quantity   of  data
                                    simultaneously,   and   usually   depend  on
                                    coaxial    or    fiber-optic    cable    for
                                    transmissions.

CCD:                                Charged    coupled   device   -   CCDs   are
                                    specialized  semi-conductors,  consist of an
                                    array  of  hundreds  of  thousands  of light
                                    sensitive  photo-diodes,  and  are  used  in
                                    cameras as an optical scanning mechanism.

Codec:                              Compression/decompression hardware providing
                                    digital  compression  and  decompression  of
                                    analog  video  signals  so that  they can be
                                    efficiently transmitted.

Compression:                        Reducing   the  size  of  a  data   file  by
                                    eliminating unnecessary information, such as
                                    blanks and repeating or redundant characters
                                    or    information.     Compressing     video
                                    information  also  can  be  accomplished  by
                                    sending  fewer frames per second or reducing
                                    the quality (by displaying  the  information
                                    in a smaller window).

Digital telephone lines:            Telephone lines, such as ISDN, T-1, Switched
                                    56,  Frame Relay and Sonet,  which  transmit
                                    data in a digital  format through the use of
                                    codecs and  compression  algorithms.  Use of
                                    digital  telephone  service  may require the
                                    installation of special wiring.

DVC:                                Desktop video  conferencing,  also sometimes
                                    called PC-based video conferencing.

Ethernet:                           A  protocol  for  medium  and  higher  speed
                                    transmission of data over a LAN.

fps:                                Frames per second.

Frame Relay:                        Packet   data   protocol   with  less  error
                                    correction  to speed up  communication  over
                                    high quality connections.

                                       ii
<PAGE>
H.320                               The industry standard for video conferencing
                                    over digital telephone lines.

H.323                               The industry standard for video conferencing
                                    on a LAN.

H.324                               The industry standard for video conferencing
                                    over analog telephone lines using a modem.

Intranet:                           A private Internet.

Internet:                           A network of computer  networks using TCP/IP
                                    protocol.

ISDN:                               Integrated  Services Digital Network - A set
                                    of protocol  and  interface  standards  that
                                    effectively provide 3 separate,  integrated,
                                    transmission  channels.  ISDN is expected to
                                    replace current telephone lines.

Kilobits:                           A  thousand  bits;  a measure of the rate of
                                    data transmission.

LAN:                                Local  Area  Network  - A  private  computer
                                    network   connecting   work-stations,   file
                                    servers,  printers  and other  devices  in a
                                    local  area,   such  as  within  an  office,
                                    building  or  campus  using  coaxial  cable,
                                    twisted  pair  or  multimode  fiber.  A  LAN
                                    permits  the  sharing of  resources  and the
                                    exchange     of     information      between
                                    work-stations.

MCU:                                Multipoint  control  unit  - A  device  that
                                    bridges  together  multiple  inputs  so that
                                    more than two parties can  participate  in a
                                    video conference.

Modem:                              A device for converting  digital  signals to
                                    analog  signals,  and vice versa,  typically
                                    used to connect  digital devices with analog
                                    telephone lines.

Multimedia:                         A  combination  of multiple  digitized  data
                                    types:   text,   sound,   computer-generated
                                    graphics  and  animations,  photographs  and
                                    video.

Multipoint:                         A  communications   configuration  in  which
                                    several terminals or stations are connected.

Network:                            A group of devices  (such as  work-stations,
                                    telephones, file servers, etc.) connected by
                                    a communications facility.

NTSC:                               The standard for scanning television signals
                                    in the US, Canada and Korea.

Packet:                             A sequence of digitized  information that is
                                    transmitted as a unit.

PAL:                                The standard for scanning television signals
                                    in most of Europe and Japan.

PBX:                                Private   branch   exchange  -  A  telephone
                                    switch,   usually  located  on  the  users's
                                    premises,   connected   to   the   telephone
                                    network,  but  operated by the users.  A PBX
                                    provides  pooled  access  to a number of the
                                    user's inside  telephone  lines of a smaller
                                    number of outside telephone lines.

PC:                                 Personal computer.

POTS:                               Plain old telephone  service -  Conventional
                                    analog  telephone  lines using  twisted-pair
                                    copper wire.

                                       iii

<PAGE>

Protocol:                           A set of rules  for data  communications;  a
                                    set of rules and procedures for establishing
                                    and controlling the exchange of data between
                                    computers.

Roll-About System:                  A mobile  video  conferencing  system  which
                                    allows the video  conferencing  equipment to
                                    be moved between rooms.

Sonet:                              Synchronous  optical  network - An interface
                                    standard  for  transmitting  data over fiber
                                    optic lines.

Switched 56:                        A switched digital  telephone  service which
                                    permits  users to transmit up to 56,000 bits
                                    of digital information per second.

T-1:                                A    point-to-point    high-speed    digital
                                    telephone transmission service.

TCP/IP:                             Transmission    Control    Protocol/Internet
                                    Protocol  - the  protocol  used  for  packet
                                    oriented   communication  between  networked
                                    computers.

Token Ring:                         A protocol for transmitting data over a LAN.

Unshielded twisted pair:            Standard  building wiring  currently used to
                                    transmit   voice    (telephone)   and   data
                                    throughout an office or building.

WAN:                                Wide  Area  Network  -  A  computer  network
                                    covering a  geographic  area  larger  than a
                                    campus, generally linking multiple LANs.

Whiteboard:                         A shared  document  session which offers the
                                    capability   of  two  or   more   users   to
                                    simultaneously view and modify the document.

World Wide Web:                     A very large  collection of linked  Internet
                                    servers using a standard linking and display
                                    language.

                                       iv

<PAGE>

                                     PART I

ITEM 1.  DESCRIPTION OF BUSINESS
         -----------------------

GENERAL

         C-Phone Corporation (the "Company") has been, and is, primarily engaged
in the  engineering,  manufacturing  and  marketing of a line of PC-based  video
conferencing  systems.  Since the second half of its fiscal year ended  February
28, 1997 ("Fiscal 1997"),  the Company has been engaged in contractual  software
development  related to its PC-based video  conferencing  systems.  In addition,
during Fiscal 1997, the Company  engaged in the  engineering of a TV-based video
conferencing  system,  which was  introduced  in  January  1997.  The  Company's
PC-based video  conferencing  systems,  which communicate over digital networks,
are marketed  under the name  C-Phone(R)  . The  Company's  recently  introduced
TV-based video conferencing system or "video phone", which operates over regular
analog  telephone  lines using a standard  television set, is marketed under the
name C-Phone Home(TM).

         Since 1993, the Company has invested  significant  resources in product
development,  engineering  and marketing  activities for its video  conferencing
systems and related products. As a result of these activities and the low volume
of sales during the initial  commercialization  of C-Phone, the Company incurred
significant  losses  during the three fiscal  years ended  February 28, 1997 and
expects that it will incur  significant  losses  during its current  fiscal year
ending February 28, 1998. The Company  anticipates that it will continue to make
significant   expenditures   for  product   development  and  marketing  in  the
foreseeable future.

         The Company was  incorporated in New York in 1986 under the name Target
Tuning,  Inc., as a  manufacturer  of promotional  radios.  In 1990, the Company
developed  data/fax  modems  under the name  "TWINCOM"  and  changed its name to
Target  Technologies,  Inc. In early 1993, because of continued price pressures,
shrinking margins and for competitive  reasons,  the Company shifted its primary
focus from modems to the  development  of C-Phone;  and,  during the fiscal year
ended February 28, 1995, the Company phased out its modem product line as it was
no longer  profitable.  In August 1996,  in order to more  closely  identify the
Company  with  its  C-Phone  product  line,  and to  eliminate  confusion  among
investors, the Company changed its name to C-Phone Corporation.

         In August 1994, the Company  completed an initial public  offering (the
"1994 Public  Offering") of 2,000,000 shares of its common stock, par value $.01
per share ("Common Stock"), at a price of $7.00 per share, pursuant to which the
Company received net proceeds of approximately  $12,288,000.  In connection with
the  1994  Public  Offering,  the  Company  issued  to  Josephthal  Lyon  & Ross
Incorporated  ("JLR"),  the  representative of the  underwriters,  warrants (the
"1994 Warrants") to purchase 200,000 shares of Common Stock, at a price of $8.40
per share  exercisable  through  August  18,  1998.  See Item 6 -  "Management's
Discussion  and  Analysis or Plan of  Operations"  and Notes 6 and 7 of Notes to
Financial Statements included in Item 7 - "Financial Statements."

RECENT DEVELOPMENTS

         During the week of March 31,  1997,  the  Company  completed  a private
placement (the "1997 Placement"),  through JLR as the placement agent,  pursuant
to which the Company  issued an aggregate of 833,667 shares of Common Stock (the
"Original  Shares") to the participants (the "Investors") in the 1997 Placement.
Accompanying  each  of  the  Original  Shares  was  the  right,   under  certain
circumstances,  to receive  additional shares of Common Stock in accordance with
the terms of a  "contingent  value right" (the  "Rights").  The Company sold the
Original  Shares and Rights at a price of $6.00 per Original  Share and received
net proceeds of approximately  $4,370,000 (after payment of fees and expenses of
approximately $632,000).

         The Investors  have the right to register,  under the Securities Act of
1933 (the "1933  Act"),  the  Original  Shares  and the  shares of Common  Stock
issuable upon exercise of the Rights. In accordance with

                                        2

<PAGE>
the terms of such registration  right, the Company prepared at its expense,  and
filed on April 16, 1997 with the Securities and Exchange Commission (the "SEC"),
a registration  statement on Form S-3 (the  "Registration  Statement") under the
1933 Act covering the Original Shares and the maximum number of shares of Common
Stock  issuable upon  exercise of the Rights.  The Company has agreed to use its
reasonable  best  efforts  to  (i)  have  the  Registration  Statement  declared
effective by the SEC, and (ii) maintain the Registration  Statement  current for
the  lesser  of one year  after  the date  that the  Registration  Statement  is
declared effective (the "Effective  Date"), or until the securities  included in
the  Registration  Statement have been sold  thereunder.  In connection with the
1997 Placement, Daniel Flohr, Chairman, President and Chief Executive Officer of
the Company,  delivered to JLR, as escrow agent for the Investors,  an aggregate
of 250,000 of his own shares of Common Stock, which shares will be forfeited, at
the rate of 1,000  shares a day,  if the  Effective  Date  does not  occur on or
before July 19, 1997;  and, in the event that the Effective  Date does not occur
on or before October 17, 1997, the remaining escrowed shares will be forfeited.

         In accordance with the rules of The Nasdaq National Market,  upon which
the Common  Stock is listed  and  traded,  the  Company  is  required  to obtain
shareholder  approval  prior to the issuance of any shares of Common  Stock,  in
excess of  approximately  870,000 shares of Common Stock,  issued or issuable to
the Investors in connection with the 1997 Placement. The Company has agreed with
the  Investors  to include a proposal for approval of the issuance of the shares
of Common Stock  issuable upon exercise of the Rights on the agenda for its 1997
Annual Meeting of Shareholders, currently scheduled for early August.

         The Rights are  automatically  exercised at the time,  and from time to
time,  as the Original  Shares are first  publicly  sold through a broker dealer
after the  Effective  Date,  and expire one year after the Effective  Date.  The
terms of the  Rights  provide  that,  upon the first  such sale of any  Original
Shares  at a price of less than  $8.00 per  share,  the  seller of the  Original
Shares will  automatically  receive,  for each such  Original  Share  sold,  and
without the payment of any additional  consideration,  such additional number of
shares of Common Stock as equals (i) $8.00 divided by the Adjusted Price,  minus
(ii) one;  where the  Adjusted  Price will equal the  greater of (x) the average
closing bid price per share of Common  Stock on The Nasdaq  National  Market for
the ten trading  days  immediately  preceding  the date of sale of the  Original
Shares, or (y) $2.00.

         In  consideration  for JLR's  services as  placement  agent in the 1997
Placement,  the  Company  (i) paid  JLR a fee of  $450,180  (or 9% of the  gross
proceeds  received  by the  Company  in the  1997  Placement),  (ii)  agreed  to
reimburse JLR for its out-of-pocket  expenses (not to exceed $25,000), and (iii)
issued to an  affiliate of JLR,  warrants  (the "1997  Warrants")  to acquire an
aggregate of 150,000  shares of Common  Stock at an exercise  price of $9.60 per
share (120% of the closing bid price for the Common Stock on The Nasdaq National
Market on the trading  day  immediately  prior to the first  closing of the 1997
Placement).  The 1997  Warrants  expire 90 days after the  Effective  Date.  The
shares of Common Stock  issuable upon exercise of the 1994 Warrants and the 1997
Warrants have been included in the Registration Statement.

VIDEO CONFERENCING

INDUSTRY BACKGROUND

                  Video conferencing was introduced in the late 1970s with video
conferencing rooms located in office parks or office buildings. These rooms were
outfitted  with  expensive  video  conferencing   equipment   requiring  trained
operators.  Using special leased digital  telephone  lines,  these systems could
only conference with other compatible facilities. While early video conferencing
rooms  cost  between  $200,000  and  $400,000,  technological  improvements  and
increased production volumes have lowered the present total cost of a room-based
corporate video conferencing system to between $50,000 and $90,000, with certain
lower-cost,  lesser-function  systems selling below $20,000.  Video conferencing
rooms are  typically  used by large  corporations  primarily  for  intra-company
communications  between  distant  locations,  although  within the past  several
years,  telecommunication  companies,  as an  adjunct to their  other  services,
hotels offering business conference  facilities and other third parties in major
metropolitan   areas  have  made  video  conference  room  facilities   publicly
available,  at an hourly fee of several hundred  dollars.  The Company  believes
that there are

                                        3
<PAGE>
in excess of 25,000 installed video  conference  rooms  worldwide,  but that the
high  costs  of  video  conferencing  rooms,  the  logistical   difficulties  in
scheduling their  simultaneous  availability and the need for trained  operators
have limited their growth.

         During the last several years, mobile video conferencing systems, known
as "roll-about"  systems, have become available at prices generally ranging from
$15,000 to $30,000,  which allow the video  conferencing  equipment  to be moved
between  locations.  In addition,  desk-top video  conferencing  ("DVC") systems
using a  personal  computer  ("PC")  have been  developed,  some of which  offer
advantages over video conferencing rooms and "roll-about"  systems. A DVC system
improves productivity by offering the ease of operation of a telephone, avoiding
the  need  for  special   scheduling,   and  allowing  the  video   conferencing
participants  to share  software  applications.  In  addition,  a DVC  system is
substantially  less expensive  than a video  conferencing  room or  "roll-about"
system,  with a system price,  excluding  the cost of the PC, of typically  less
than  $5,000,  with  prices of  certain  available  systems  as low as $1,200 to
$2,000.  The Company believes that the DVC market is expanding and the number of
DVC systems  will  increase  similar to the manner in which  PC-based  operating
systems  increased the overall market for computer  systems and increased  their
market share relative to main frame based computer systems. However, and despite
this belief, the DVC market has not yet achieved substantial market acceptance.

         The Company believes that DVC systems facilitate  external and internal
communications   and  allow  users  at   different   locations  to  combine  the
effectiveness  of  face-to-face  meetings with the convenience of the telephone,
without the need for trained operators. In addition, DVC also can improve worker
productivity  and reduce or eliminate  travel costs,  accelerate the exchange of
information and leverage the use of limited resources. The Company believes that
applications  of video  conferencing  systems  will  continue to expand as users
become increasingly  dependent on immediate access to data and other information
to remain competitive.

         Historically,  video  conferencing  systems have used digital telephone
lines to interconnect users. In order to transmit a real-time video image over a
digital  telephone  line, the  electronic  video and  accompanying  audio signal
(which,  in its  original  form,  may contain  over 130 million bits of data per
second) must first be "digitized"  and then reduced or  "compressed"  to fit the
capacity  of the digital  telephone  line.  The video  signal is  compressed  by
eliminating  data,  which  typically  causes the  quality of the video  image to
degrade.   After  transmission,   the  video  image  is  then  reconstructed  or
"decompressed."  The quality of the reconstructed image is a function of (i) the
sophistication of the compression algorithm (which determines the information to
be  eliminated),  (ii) the  amount  (expressed  as bits per second  ("bps"))  of
real-time data which can be transmitted  over the digital  telephone line, (iii)
the power,  speed and  sophistication  of the codec (which  ranges in price from
$1,000  to  $25,000,  unless  a  lower  quality  codec  is  built  in to  the pc
processor), and (iv) the relative amount of audio accompanying the video signal.
As compression  algorithms  continue to be refined,  video and audio quality are
expected  to  improve.   With  the  recent   adoption  of  standards  for  video
conferencing over a LAN, the increased power and speed of PCs, the increased and
wider-spread  availability of digital telephone  services (such as ISDN) and the
decreased charges for such services by the telecommunications  service provider,
as well as the slowly  decreasing  prices for DVC systems,  the Company believes
that use of PC-based video  conferencing  systems will increase,  although there
can be no  assurance  of how  long a  period  of time  will be  needed  for such
increase to occur.

         Presently,  most DVC  systems  employ  one of three  methods to connect
users to each other digital telephone lines,  cross point switches or a PC-based
LAN:

                  DIGITAL  TELEPHONE LINES. Most DVC systems in use are PC-based
         and operate over digital  telephone  lines,  although  some systems are
         TV-based.  These  systems  require  a codec and  other  hardware  to be
         installed  in each PC (or the  set-top  box,  in the case of a TV-based
         systems) and one or more separate dedicated telephone lines for each PC
         or TV. Video conferencing conducted from this type of system requires a
         toll call to be placed over the digital  telephone  line, even when the
         video  conferencing  is within the same  office.  These  systems do not
         allow sharing of in-bound and

                                        4
<PAGE>
         out-bound telephone lines, call transfer,  multi-party  connections and
         other features  common to a typical  office phone system.  In addition,
         these systems may use up to three of the PC's expansion slots.

                  CROSS  POINT  SWITCHES.  Some DVC systems  connect  users with
         shielded  or  unshielded  twisted  pair wire and  utilize  cross  point
         switching  hardware  similar to a standard  internal  PBX phone  system
         arrangement. These systems, which may cost in excess of $5,000 per user
         (excluding the cost of the additional equipment necessary to connect to
         off-site  systems),  provide high quality video, but are limited in the
         number of users that they can  accommodate  and may require  additional
         wiring.

                  PC-BASED  LAN.  Other  DVC  systems  connect   individual  PCs
         together  using a LAN. Most of these systems have attempted to transmit
         the video  and  audio as  compressed  digital  information  in the same
         packet  format  that  other  data is  transmitted.  However,  LAN based
         networks  can  transmit  only a finite  capacity of data within a given
         period and the  transmission  of even a single  continuous  video image
         uses a substantial portion of this capacity. As a result, these systems
         currently tend to have a debilitating  effect on the performance of the
         LAN and the PC and limit the number of simultaneous calls. In addition,
         these systems have small picture size and less than television  quality
         image.  Certain major  telecommunications  companies,  including Lucent
         Technologies,  are  currently  working on LAN based systems which would
         offer improved picture size and quality, but require networking systems
         using technologies that have not yet been widely deployed. By contrast,
         other LAN-based systems, such as the Company's C-Phone system, transmit
         the video and audio  information in a different  format and outside the
         bandwidth  conventionally  used to transmit data packets;  as a result,
         such systems do not degrade the performance of the LAN or PC.

         During the past several  years,  AT&T and MCI, as well as several other
companies,  have  unsuccessfully  introduced  proprietary  consumer video phones
which  operate  over  standard  analog  telephone  lines.   These  video  phones
transmitted a low resolution  video image at a rate of between  one-half and ten
frames per second  ("fps"),  as compared to television  which  delivers a higher
resolution video image at 30 fps. In addition, the video image was small and not
completely  synchronized  with the  audio  portion  of the  transmission.  Other
companies,  such as Creative Labs Inc.,  also have introduced  PC-based  systems
which can operate over analog telephone lines. With the widespread  availability
of modems which permit the  transmission of data over analog  telephone lines at
rates of up to 33,600 bits of data per second, as well as the recent adoption of
the H.324 standard for video  conferencing over analog telephone lines,  several
companies, including the Company, have announced or introduced products to allow
video conferencing using modems over analog telephone lines. While these systems
operate at a  significantly  lower video frame rates (ranging up to 15 fps under
ideal conditions) and often without fully synchronized  audio, such products are
designed to appeal to non-commercial  home users and small  businesses,  and are
less expensive to own and operate than video  conferencing  products requiring a
digital  telephone  line.  During the past two years, a number of companies have
introduced  products which,  when connected to a PC, allow video telephone calls
to be made through  analog  telephone  lines over the internet.  Although  video
conferencing  over the internet may eliminate long distance  telephone  charges,
the fps  rate is less  than  with a  direct  telephone  connection,  the lack of
industry  standards  requires  the use by the parties of  comparable  equipment,
portions of the conference may be "lost" in the  transmission  and delays in the
receipt of the transmission may occur. As a result,  the Company does not expect
that internet video  conferencing  will materially  affect the market for direct
video conferencing over analog telephone lines.

INDUSTRY STANDARDS

         Historically,  a factor that  limited the growth of video  conferencing
was the lack of uniform protocols so that proprietary video conferencing systems
could only  communicate  with similar  systems of the same  manufacturer.  Video
conferencing  has  become  more  widespread  as a  result  of the  emergence  of
international  industry standards  designed to allow video conferencing  systems
manufactured by different vendors to be compatible.

                                        5
<PAGE>

         The Company's  business video  conferencing  systems are designed to be
compatible  with all standard and  proprietary  protocols by connecting with the
appropriate codec as a network peripheral.  As a result, a C-Phone user, calling
outside a LAN, may connect to any other video conferencing system, provided that
the systems have compatible codecs.

         In  1990,   the   Telecommunication   Standardization   Sector  of  the
International  Telecommunication  Union  ("ITU"),  a United Nations agency which
develops  international  standards for  telecommunications  equipment,  formally
adopted the H.320 standard for video conferencing,  which includes standards for
video and audio  transmission  and data transfers.  While other protocols exist,
H.320 has achieved the most widespread  acceptance,  and has been adopted by the
Company and substantially all of its competitors.

         The ITU  formally  adopted  the H.324  standard in March 1996 for video
conferencing  over analog telephone lines. The Company believes that adoption of
the H.324  standard  will permit a broad  acceptance of analog  telephone  video
conferencing using products such as C-Phone Home. C-Phone Home has been designed
to be compatible with other H.324 compatible equipment.

         The ITU formally  adopted the H.323 standard in November 1996 for video
conferencing  over a LAN.  Although the Company  believes  that  adoption of the
H.323  standard  may lead to wider  use of video  conferencing  over a LAN,  the
quality of such video conferencing will not be as high as with C-Phone and it is
uncertain as to whether  managers of LAN systems will find the increased  amount
of LAN traffic acceptable to their systems.

THE COMPANY'S STRATEGY

BUSINESS PRODUCTS

         The Company  believes that  PC-based  systems can expand the market for
video  conferencing and that the Company can gain commercial  advantage by being
among the few vendors to offer a high-quality PC-based video conferencing system
specifically  designed for a customer's needs and which provides  long-term cost
effectiveness.  However,  the historical  cost, as well as the  un-scalable  and
inflexible  nature of video  conferencing  systems,  combined  with the negative
impact of PC-based  systems when used on a LAN have limited  market  acceptance,
and there can be no assurance that PC-based systems generally,  or the Company's
C-Phone system particularly, will gain widespread market acceptance.

         Although a number of the Company's competitors are capable of wide area
connectivity over ISDN digital phone lines, the Company believes that C-Phone is
one of a few available systems that also operates over a variety of switched and
dedicated  digital phone  services,  and should easily  accommodate  new digital
phone  services  as they  come  into  being.  The  Company  believes  that  this
"broadband-ready"  feature is an  important  element to make C-Phone a long-term
solution,  which should not become  obsolete as new broadband  telecommunication
services become available. The Company's C-Phone video conferencing products are
used in traditional video conferencing room systems, in small group "roll-about"
units and as PC-based DVC systems.  Users of a C-Phone system can participate in
real-time, high quality video phone calls to other people within their building,
as well as to  anyone  with a  standards  based  compatible  video  conferencing
system, anywhere else in the world.

         The C-Phone  system is modeled on a typical  office  (PBX) phone system
providing  features and functions such as call screening,  call transfer,  hold,
caller ID, free calling  within the facility and shared  access to outside phone
lines.  C-Phone video quality  within a building,  campus or  metropolitan  area
network is based on the NTSC TV quality standard in the US, Canada and Korea and
the PAL TV quality standard in Europe and Japan. C-Phone calls made over outside
digital telephone lines are based on the H.320 video conferencing  standard. The
C-Phone  system  operates over a wide variety of digital phone  services such as
Basic and Primary Rate ISDN, T-1, Switched 56, Frame Relay and Sonet.

                                        6
<PAGE>
         The  C-Phone  system   currently   operates   under  the   Microsoft(R)
Windows(TM)  operating  system and is  compatible  with  Ethernet and Token Ring
network operating systems running a variety of network protocols  including IPX,
TCP/IP and  netBios(R).  Together,  these network  operating  systems  presently
account  for the  majority of the  installed  base of PC  networks.  The C-Phone
system  is  designed  to  operate  with the ease and full  functionality  of the
typical office telephone network,  while permitting other simultaneous unimpeded
uses of the LAN and PC.

         The C-Phone system,  when operating on a LAN, must be interconnected by
coaxial cable,  Category 4 or 5 unshielded  twisted wire, or a fiber optic line,
which  wiring is not always  available  in  existing  LANs,  and there can be no
assurance  that  customers  will be  willing,  where  necessary,  to install any
requisite  internal  wiring in order to permit the C-Phone  system to  function.
When functioning over presently available switched digital telephone lines (such
as ISDN), the C-Phone system uses the industry standard H.320 protocols, thereby
offering picture quality equal to or exceeding that of other presently available
video conferencing systems.

         Since the C-Phone system allows digital  telephone lines and peripheral
devices,  such as  codecs,  to be shared  resources,  it has an  operating  cost
advantage  compared to PC-based  systems  that  require  each PC to have its own
codec and  digital  telephone  line.  The  Company  believes  that this  design,
combined with the Company's  pricing of its C-Phone  systems,  makes the C-Phone
system one of the more affordable systems currently available.

         The Company believes that the success of DVC systems will be contingent
upon greater market acceptance of PC-based video conferencing  systems which, in
turn,  will  depend,  in part,  on the  ability of such  systems to deliver  the
following elements that C-Phone technology offers:

                  TELEVISION  QUALITY VIDEO WITH FULLY  SYNCHRONIZED  AUDIO. The
         C-Phone system permits two or more persons using PCs linked by a LAN to
         engage in real-time,  full-color,  television-quality  video calls with
         fully synchronized  audio. The video image of the participants  appears
         on  the  computer   monitor,   and  the  audio  is  produced  from  the
         camera/speaker/microphone  unit  mounted  on the  monitor  or through a
         conventional  telephone handset.  Within the LAN, C-Phone's video image
         is  displayed  at a rate of 30 fps  regardless  of image size.  C-Phone
         users also can call  outside of their LAN to other  C-Phones,  PC-based
         systems or video conferencing rooms, with picture quality equal to that
         of  other  presently  available  video  conferencing   systems,   which
         typically offer less than television quality picture,  depending on the
         type of codec and the type and number of digital telephone lines used.

                  LOW PRICE PER USER. The Company  presently markets three basic
         C-Phone  systems  that  are  priced  at the low to mid  price  range of
         existing  similar  systems.  In  addition,  the C-Phone  system  treats
         digital  telephone  lines and codecs  (which are needed by the  C-Phone
         system to connect  outside  the LAN),  as shared  network  peripherals,
         similar to a file server or laser printer,  which allow a number of PCs
         to share  the same  resources,  thereby  providing  an  operating  cost
         advantage  compared  to systems  that  require  each PC to have its own
         digital  telephone  lines and  codec.  See "The  Company's  Products  -
         BUSINESS PRODUCTS" and "Marketing and Sales - BUSINESS PRODUCTS."

                  NO  DEGRADATION OF PC OR LAN  PERFORMANCE.  The C-Phone system
         operates in a manner that does not degrade the  performance  of the LAN
         or the PC,  regardless  of the  number of users or  simultaneous  video
         phone calls taking place.

                  CAPACITY TO HANDLE NUMEROUS  SIMULTANEOUS  CALLS.  The C-Phone
         system  operates  much  like a PBX phone  system  in a  typical  office
         environment.  The current  C-Phone LAN system can  accommodate up to 64
         simultaneous  video phone lines in a LAN work group,  either as two-way
         calls,  one-way broadcasts or, using the Company's optional  multipoint
         control unit ("MCU"), multi-party conference calls. Additional capacity
         can be achieved as LAN work groups are connected to work

                                        7
<PAGE>

         groups in other LANs. Through its broadcast and conferencing modes, the
         C-Phone  system  permits all users to actively  participate in a single
         conference.

                  STANDARD  COMMUNICATION   PROTOCOLS.  The  C-Phone  system  is
         designed  to be  compatible  with all  PC-based  codecs,  whether  they
         contain  standard or  proprietary  protocols,  provided  that the codec
         manufacturer  provides  the  requisite  developmental  software.  As  a
         result,  a C-Phone user  calling  outside the LAN is able to connect to
         any  other  video  conferencing  system,   provided  the  systems  have
         compatible codecs. See "Video Conferencing - INDUSTRY STANDARDS."

                  MULTIPOINT CAPABILITIES. A C-Phone optional feature includes a
         MCU,  in which  up to 4 users  (which  may be  expanded  to  additional
         users),  whether within a LAN or connected by digital  telephone lines,
         may  be  simultaneously   displayed  on  the  PC  monitor,   with  each
         participant actively participating in the video call.

                  EASE OF  OPERATION  WITH  FULL  TELEPHONE  FUNCTIONALITY.  The
         C-Phone   system  is  designed  to  operate  with  the  ease  and  full
         functionality of the typical office PBX telephone network.  The C-Phone
         system features,  among other things, call transferring,  call waiting,
         caller ID, hold,  conferencing  and a "vanity  mode" for a user to view
         his or her own video image before going on-line or at any time during a
         video call.  The C-Phone  system  also  operates as an audio  answering
         machine and includes a photo- based phone directory.

HOME PRODUCTS

         The Company's C-Phone Home is a consumer oriented TV-based,  "set-top",
video phone which allows users to make video phone calls using their  television
set and their analog telephone line.

         The Company believes that a commercial consumer market for C-Phone Home
exists involving users such as grandparents and their grandchildren, parents and
their children away at school,  working  parents and their children in day care,
divorced or separated parents and their young children,  and families with aging
relatives.  However,  the Company has no reliable data to assure that there will
be significant  market acceptance of TV-based video phones,  and there can be no
assurance that C-Phone Home will gain sufficient  market  acceptance to generate
significant  commercial  sales.  Previous efforts to sell video phones by larger
better known companies than the Company have been unsuccessful.

         The  Company  believes  that  the  success  of  C-Phone  Home  will  be
contingent upon its ability to deliver the following elements:

                   QUALITY  OF  VIDEO  WITH THE  FEEL OF A  TELEPHONE.  Previous
         efforts to sell video phones by other companies have been unsuccessful.
         This has been due, in part, to the inability of such systems to deliver
         video data at the rate of greater than between  one-half to ten fps and
         to the  inability of such systems to emulate a normal  telephone  call,
         primarily  as the result of lower  audio  quality  associated  with the
         phone line's  limited  bandwidth  which must be shared with video data.
         Currently, C-Phone Home is capable of delivering video data at rates of
         up to 16 fps under ideal  circumstances.  Many  factors,  taken  either
         singularly or together,  will lower the video frame rate. These include
         non-  optimal  conditions  on the  analog  phone  line  to  the  user's
         premises,  the  presence  of noise on the  phone  line and  substantial
         movement in the video being  transmitted,  especially when transmitting
         in a high  resolution  mode.  In the instance  when any or all of these
         factors  are  present,  frame rate may be reduced to as low as one fps.
         The Company  believes  that most users of C-Phone Home will prefer full
         screen, highest resolution mode, when frame rates are typically four to
         eight fps. At these frame rates, there is not enough motion in the lips
         of the users for video and audio  synchronization to be necessary,  and
         C-Phone Home  transmits  the audio with as little  processing  delay as
         possible  in  an  attempt  to  make  the  users  feel  as if  they  are
         participating in a regular phone call. In other conditions,  where over
         ten to twelve  fps are  transmitted,  lip  synchronization  may be more
         desirable and may

                                        8
<PAGE>
         result in as much as a one-half second delay in the audio transmission.
         Such a delay  may not be  deemed  acceptable  by  consumers  and,  as a
         result,  there can be no  assurance  that the  Company  will be able to
         achieve a  satisfactory  level of consumer  acceptance  of C-Phone Home
         within a reasonable period of time, if at all. See "Marketing and Sales
         - HOME PRODUCTS."

                  EASE OF USE.  C-Phone  Home,  which is  operated by a wireless
         remote control containing a microphone unit, operates with any standard
         television set. A video phone call can be dialed or answered by pushing
         one or two  buttons  on the  hand-held  remote  control.  In  addition,
         C-Phone Home offers easy-to-use  on-screen  instructions and text menus
         to operate and configure the system. See "The Company's Products - HOME
         PRODUCTS."

                  REASONABLE  COST.  The suggested list price of C-Phone Home is
         $995.95,  which will enable the Company to recapture its full costs and
         a per unit profit.  The Company  recognizes  that such price may be too
         high for  C-Phone  Home to  penetrate  the home  market.  The  Company,
         therefor,  has  arranged for its  resellers to offer  C-Phone Home at a
         suggested    list   price   of   $349.95   when    purchased   with   a
         telecommunications  service contract offered by the Company, which will
         enable the Company to obtain a profit from  monthly  subscription  fees
         and the resale of long-distance  telephone usage, similar to the method
         by which most cellular  telephones are sold.  However,  there can be no
         assurance that such marketing strategy will enable C-Phone Home to gain
         widespread  consumer  acceptance.  See  "Marketing  and  Sales  -  HOME
         PRODUCTS."

                  COMPATIBILITY.  C-Phone  Home  uses  H.324  standards  and  is
         designed to be compatible  with other systems using such standard.  See
         "Video Conferencing - INDUSTRY STANDARDS."

THE COMPANY'S PRODUCTS

BUSINESS PRODUCTS

         The Company  currently  has six core  products  in its C-Phone  product
line. The Company's  principal core products consist of the PC-based C-Phone LAN
system,  the C-Phone  C-Station  system and the C-Phone  RollAbout  system.  The
Company also offers a substantial  number of additional  components and features
which complement its core products.

                  THE  C-PHONE  LAN  SYSTEM.   The  C-Phone  LAN  system  allows
         networked  PC users to engage in  real-time,  full color,  full screen,
         television quality video conferencing.  The C-Phone LAN system consists
         of three main hardware components (a camera/speaker/microphone  ("CSM")
         unit, an external  network video interface  module and a host interface
         card), as well as a handset and proprietary  system  software.  The CSM
         unit rests on top of the PC monitor  and is designed so that the camera
         projects out over the monitor to just above the screen,  minimizing the
         face-to-lens  divergence  angle  and  thereby  giving  the  sense  of a
         face-to-face  conversation.  The video interface  module links together
         the CSM, the circuit board  controller  and the network and handles the
         video protocols and switching.  The host interface card,  which has its
         own  processor,  contains a  proprietary  configuration  of  circuitry,
         components and firmware and is installed within the PC. The C-Phone LAN
         system has a suggested list price of $1,995.

                  THE C-PHONE  C-STATION  SYSTEM.  The C-Phone  C-Station system
         allows  a  stand-alone  PC  user  running  Microsoft's(R)   Windows(TM)
         operating  software  to  engage  in  video  conferencing  over  digital
         telephone lines. The C-Phone C-Station system consists of the CSM unit,
         an external video interface  module,  a host interface card and a codec
         (which will vary based on the type and speed of the  digital  telephone
         line),  as well as a  handset  and  proprietary  system  software.  The
         C-Phone C-Station system has a suggested list price ranging from $2,495
         to $7,995, depending on the specific features included.

                                        9
<PAGE>

                  THE C-PHONE ROLLABOUT SYSTEM.  The C-Phone RollAbout system is
         a  self-contained  moveable  group  video  conferencing  system,  which
         currently  includes  a 32"  high-resolution  monitor  and a PC  and  is
         available in either a LAN or WAN  configuration.  The LAN configuration
         connects to a LAN and can share codecs and digital  telephone lines for
         video  conferencing  outside  of the LAN.  The WAN  configuration  is a
         stand-alone unit and contains hardware similar to that contained in the
         C-Phone C-Station system.  The C-Phone RollAbout system has a suggested
         list price  ranging  from $9,995 to $19,995,  depending on the specific
         features included.

                  WAN  SERVER.  The WAN Server  allows  those  C-Phone  PC-based
         systems  which do not  contain  a built in  codec to  connect  to other
         C-Phone systems outside of the LAN or other video conferencing  systems
         over telephone  lines providing  digital  services such as ISDN, T-1 or
         Switched  56. The WAN  Server is  comprised  of one or more  codecs and
         appropriate   interfaces  to  digital   telephone   lines.  See  "Video
         Conferencing - INDUSTRY STANDARDS."

                  MULTIPOINT  CONTROL  UNIT.  The MCU allows  multiple  parties,
         whether  within a LAN or  connected  by  digital  telephone  lines,  to
         participate in a video conference call and be simultaneously  displayed
         on the PC monitor. Each MCU displays four simultaneous videos on the PC
         monitor  and has the  capability,  by  interconnecting  five  MCUs,  to
         conference up to 16 users.

                  C-LINK.   C-Link  allows  a  C-Phone  PC-based  system  to  be
         connected to other video sources,  such as a video camera, VCR or cable
         or  broadcast   television.   Possible  uses  can  include  a  VCR  for
         transmitting training films,  television for viewing news and financial
         programming and a video camera for recording meetings and surveillance.

         The Company has  developed  and markets its own codec and ISDN adaptor.
The Company also offers products in configurations for coaxial cable, unshielded
twisted  pair wire,  network and fiber  optic  links.  Other  devices in various
stages of planning or  development  by the Company  include  equipment  to allow
various LAN work groups  within a building  or campus to be  interconnected  and
interfaces  which will  allow a C-Phone  system to accept  telephone  calls from
conventional telephones.

         From time to time in  response to  customer  requests,  the Company has
developed  specialized  software  applications  for use as  enhancements  to its
C-Phone  business  products.  During  Fiscal  1997,  the  Company  had  software
development  revenue of approximately  $150,000,  substantially all of which was
derived from software development for Mirage Resorts, Inc.

HOME PRODUCTS

         The Company's home product line currently  consists of a single product
- C-Phone Home, a TV-based  video phone,  which allows a user to engage in video
conferencing  over an analog  telephone line using a standard  television set or
monitor.  C-Phone Home consists of a "set-top"  box, a remote  control and an AC
power adapter. The set-top box, which weighs less than five pounds,  connects to
the television's RF or audio and video inputs and includes a color camera, modem
(to connect to the telephone line), codec and proprietary  software.  The remote
control contains a built-in wireless full-duplex microphone and allows the users
to make,  answer or end a call and otherwise  configure and operate C-Phone Home
through  the touch of a  button.  C-Phone  Home has a  suggested  list  price of
$995.95 when sold through independent consumer electronic retailers. The Company
also has  arranged for C-Phone Home to be sold at a lower price and to be resold
by  retailers  at a  suggested  list  price of  $349.95  when  purchased  with a
telecommunications  services  contract  offered by the  Company.  The  Company's
telecommunications  services contracts are for various terms, the shortest being
for 12 months, and require the payment of monthly access charges which aggregate
at least $239.40  during the life of the contract.  In addition,  such contracts
require the payment of per minute  interconnect  usage fees, the amount of which
depends upon the monthly usage. See "Marketing and Sales - HOME PRODUCTS."

                                       10
<PAGE>
MARKETING AND SALES

BUSINESS PRODUCTS

         The Company developed its initial C-Phone video conferencing product in
1993, and has developed a number of enhancements since such time.  However,  the
market for PC-based video  conferencing  has not matured as rapidly as expected.
In order to  expedite  the  commercial  introduction  of its video  conferencing
products,  the Company's initial sales and marketing  strategy was to attempt to
form alliances with strategic partners,  primarily nationally  recognized system
integrators,   resellers,   telecommunication  service  companies  and  original
equipment  manufacturers,  to assist the Company in identifying,  developing and
exploiting specific  high-volume market applications which would incorporate the
Company's video  conferencing  products into larger  information  management and
communication  systems.  Although  the  Company has entered  into  several  such
alliances,  none of such alliances  have yet resulted in significant  commercial
sales and there can be no  assurance  that  significant  commercial  sales  will
result  from the  Company's  relationship  with any of its  strategic  partners.
During 1996,  the Company  reoriented  the  emphasis of its sales and  marketing
strategy  and  focused  on  sales  to  regional  resellers,   including  systems
integrators, telephone system dealers and audio/visual specialists, and selected
large  potential   customers  with  needs  for  customized  video   conferencing
capabilities.  During Fiscal 1997, U.S.  resellers  accounted for  approximately
64.9% of the  Company's  net  sales  of  C-Phone  products,  which  were  resold
primarily to the U.S.  Department of Defense and other Federal,  state and local
governments or governmental agencies,  hospitals and educational facilities,  as
well as to  corporate  users.  During  Fiscal 1997,  approximately  18.9% of the
Company's net sales of C-Phone  products  were sold  directly by the Company,  a
significant portion of which were sales to Mirage Resorts, Inc. See "Competition
- BUSINESS PRODUCTS." The Company's video conferencing revenues since commercial
introduction  in 1994 through  February 28, 1997 have  aggregated  approximately
$4,165,000.

         The  Company  provides  marketing  support  to  its  resellers  by  (i)
participation  with its resellers in selected  trade shows,  particularly  those
directed to the video conferencing,  teleconferencing  and computer  industries,
(ii)  developing  and  distributing  marketing  literature at trade shows and in
response to potential  customer  inquiries,  (iii)  developing  and  maintaining
public relations and targeted  advertising programs to increase awareness of the
Company and the C-Phone product line, (iv) offering training to resellers' sales
staffs, (v) supporting  resellers' end-user  demonstrations,  and (vi) providing
resellers with the names of potential  customers who have contacted the Company.
Technical  support consists of providing  resellers with assistance in designing
and configuring  applications for specific  business  solutions.  In addition to
management,  the Company has 12 full-time  employees  dedicated to marketing and
sales of its business products.

         A significant  portion of the Company's recent  revenues,  all of which
have related to the Company's business products, have been dependent on sales to
a limited  number of  customers.  During  Fiscal 1997,  net revenues from Mirage
Resorts,  Inc. and C-Phone  Europe NV/SA (the  Company's  European  distributor)
constituted 14.3% and 10.3%, respectively, of the Company's net revenues. During
Fiscal 1996, net revenues from TRW, Inc. and Venisoft Computer  Solutions,  Inc.
(a U. S. reseller) constituted 10.5% and 10.3%,  respectively,  of the Company's
net revenues.  Although the Company requires its non North American distributors
to purchase a minimum  annual  amount of products  to maintain  their  exclusive
distributorships,  the Company does not have written  agreements with any of its
customers  which  require  the  purchase of any  minimum  quantities  of C-Phone
products and, therefore,  such customers could reduce or curtail their purchases
at any time.  Therefore,  a  substantial  reduction in orders from the Company's
C-Phone  customers or the inability to attract  orders from new customers  would
have a material adverse effect on the Company's current business.

         During  Fiscal  1997 and  Fiscal  1996,  the  Company's  revenues  from
non-U.S. sales of video conferencing products aggregated approximately 15.0% and
16.2%, respectively,  of net revenues, which revenues were derived from sales to
its European distributor and resellers in Canada,  Europe and southeastern Asia.
As a result,  a  reduction  in the  volume  of  non-U.S.  trade or any  material
restrictions on such trade could

                                       11
<PAGE>
have a material  adverse  impact on the Company's  revenues from business  video
conferencing  products.  The  Company  sells  to its  European  distributor  and
Canadian reseller on credit terms and usually makes its other foreign sales on a
prepaid basis due to the difficulty in collecting  foreign accounts  receivable;
and any change in such policy which may be occasioned by the potential of larger
orders from  foreign  customers  could  expose the Company to  increased  credit
risks.  Foreign sales are  denominated in U.S.  dollars and the Company does not
incur any foreign  currency risks;  however,  fluctuations in currency  exchange
rates could cause the Company's business video  conferencing  products to become
relatively  more  expensive  to  foreign  customers,  which  could  result  in a
reduction in foreign sales or profitability of any such sales.

HOME PRODUCTS

         The Company introduced C-Phone Home, as a production prototype,  at the
January 1997 Consumer Electronics Show in Las Vegas, Nevada. At the time of such
introduction,  the Company had engaged in only preliminary marketing for C-Phone
Home and had not obtained any orders for consumer  resale.  Based upon perceived
enthusiasm from the trade for C-Phone Home, the Company determined that a viable
market for the product  existed,  and that its marketing  strategy  should be to
make  initial  sales  of C-  Phone  Home  through  one or  more  large  consumer
electronics retail chains,  assuming that the Company could convince such chains
that C-Phone Home was a credible product deserving retail store display space.

         The  Company  has   appointed   a  national   network  of   independent
manufacturer's  representative  organizations  to act as the Company's  national
field sales force for C-Phone  Home,  and  recently  hired a full-time  National
Sales Director to manage such effort. The Company also has retained the services
of a consultant  to assist in the  marketing of C-Phone Home to larger  consumer
electronic retail chains.

         In  March  1997,  Nobody  Beats  The Wiz,  Inc.  (the  "Wiz"),  a large
northeastern U.S.  consumer  electronics  retail chain,  agreed to carry C-Phone
Home in its  stores.  Shipments  to the Wiz began in April  1997,  the Wiz first
announced  availability of C-Phone Home in its weekly sales circular distributed
the weekend of May 9 and, as of May 15, dealer display  demonstration units have
been installed in 57 of the Wiz stores. The Company has no long-term arrangement
with the Wiz, which  purchases  C-Phone Home through  regular  purchase  orders.
Since  March  1997,  the Company has  entered  into  arrangements  with  several
additional  consumer  electronics  retailers to carry C-Phone Home, has received
initial  stocking  orders from such retailers and is actively  negotiating  with
other retailers.

         The Company has had only limited  prior  experience  in  marketing  and
selling its products to consumer electronic retailers, some of whom have special
problems,  such as inadequate working capital, which may affect their ability to
timely pay for their  purchases  from the Company and may require the Company to
grant extended credit terms. Such retailers typically require that their vendors
pay  advertising  expense  prior to  consumer  resale and payment to the vendor.
Furthermore,  and  irrespective of the contracted  payment terms negotiated with
such retailers, such retailers generally do not pay for their merchandise unless
and until such  merchandise  "sells through" to the consumer,  thereby  creating
higher payment risks.

         C-Phone Home is sold to consumer  electronic  retailers for resale at a
suggested list price of $995.95.  The Company  recognizes that such price may be
too high for C-Phone Home to penetrate  the mass consumer  market.  The Company,
therefore, has determined to also sell C-Phone Home in the same manner that most
cellular  telephones are sold, by offering retailers the opportunity to purchase
and resell  C-Phone Home at a suggested list price of $349.95 when purchased and
resold with  telecommunications  services offered  directly by the Company.  The
Company  anticipates that substantially all of its initial sales of C-Phone Home
to consumer electronic  retailers will be made under the latter purchase option.
See "The Company's Products - HOME PRODUCTS."

         The  Company's  ability  to provide  inter-exchange  telecommunications
services is  dependent,  among other  things,  upon the  Company  maintaining  a
suitable arrangement with one or more long distance  telecommunications services
companies, which will enable the Company to purchase telecommunications

                                       12

<PAGE>
services for resale to third parties.  The Company's current  telecommunications
services arrangement is with MCI  Telecommunications  Corporation ("MCI"), which
provides  telecommunications services for resale to a large number of companies.
Pursuant to its investment customer arrangement with MCI, which expires in March
1998 unless  terminated  earlier,  the Company has  deposited a letter of credit
with MCI to cover its  anticipated  monthly  charges and is required to increase
such letter of credit if it appears  that such  monthly  charges will exceed the
amount  of the  letter  of  credit.  The  Company  has  been  advised  that  its
arrangement  with MCI is MCI's  normal  arrangement  for  customers  such as the
Company,  except that the arrangement offers the Company a credit against future
MCI  services  if  the  Company  applies,  and  is  approved,  for  an  upgraded
minimum-term  arrangement  with  MCI.  There  are  a  number  of  long  distance
telecommunications  services companies which provide telecommunications services
for resale and the Company  believes that, if its current  arrangement  with MCI
expires without being renewed or is terminated, or the Company determines not to
continue its  relationship  with MCI, the Company could replace its MCI services
with similar services offered by another services provider.

         As a condition to reselling  intra-state,  interstate and international
telecommunications  services,  the Company is  required  to obtain and  maintain
certain  approvals from the Federal  Communications  Commission  (the "FCC") and
from certain State regulatory authorities, and to comply with various applicable
regulatory provisions imposed by such authorities.  See "Government Regulation."
The Company has  obtained  FCC  approval to provide  inter-state  long  distance
telecommunications  services;  however,  due to the timing of obtaining  certain
State  approvals,  the Company will be unable to initially offer  inter-exchange
telecommunications  services  for making  intra-state  video phone calls  within
certain  States  until it has applied for and  received  appropriate  regulatory
approvals  from such  States.  As of May 15,  1997,  the  Company  has  obtained
appropriate  regulatory approval from ten States and has applications pending or
in the process of being  prepared for filing in a number of  additional  States,
and the Company does not believe that such limitation  should have a significant
effect on its ability to sell C-Phone Home.

         Until  such  time,  if  at  all,  as  the  Company  attains  sufficient
manufacturing volume or can utilize less costly components in the manufacture of
C-Phone Home to enable the Company to reduce its manufactured  cost, the Company
may not be able to sell sufficient  quantities of C-Phone Home for such sales to
be profitable.  To the extent that the consumer  electronic  retail chains which
purchase  C-Phone Home  purchase the product for resale with  telecommunications
services, the Company's initially required monthly telecommunications access fee
will not be  sufficient  for the Company to recoup the  remainder of its current
manufactured  cost.  Unless the  purchasers  of C-Phone  Home,  who purchase the
product with telecommunications  services, renew their initial subscriptions for
telecommunications  services or purchase a material  amount of  telephone  usage
from the Company, of which there can be no assurance, the Company will be unable
to  recoup  from  such  sales all of its  manufacturing  costs  and its  related
expenditures for development and marketing of C-Phone Home.

         The Company has limited sales, marketing and distribution experience in
retail consumer goods.  The introduction of C-Phone Home requires certain sales,
marketing  and  distribution  capabilities,  some of which the Company  does not
currently  possess,  and there can be no assurance that the Company will be able
to  establish  and  retain  a sales  and  marketing  capability  which  would be
successful  in gaining  market  acceptance  for  C-Phone  Home.  The  Company is
devoting a material portion of its available resources for the commercialization
of C-Phone Home,  and failure of the Company to establish  the necessary  sales,
marketing and distribution network for C-Phone Home will have a material adverse
effect on the Company's financial condition.

GENERAL

         The Company's success will depend, in part, upon its ability to provide
its customers, either directly or through others, technical support and customer
service  for its  products.  The Company  presently  provides  support  services
directly for its U.S. customers, but relies on its foreign strategic partners to
supply support services outside of the United States. If the Company's  business
expands, of which there can be no

                                       13
<PAGE>
certainty,  there can be no assurance  that the Company can continue to directly
provide such services to its U.S. customers, in which event it would be required
to negotiate  third-party  support services on acceptable  terms, of which there
can be no  assurance.  Failure to provide  such  support  services  would have a
material adverse effect on the Company.

MANUFACTURING

         The   Company's   products  are   comprised   primarily  of  components
manufactured  on  a  batch  basis  by  the  Company,  sub-assemblies  and  parts
manufactured to the Company's  specifications by third parties and certain other
"off the shelf" electronic  components  purchased from third parties. To date, a
substantial  portion  of the  Company's  manufacturing,  as  well  as the  final
assembly,  testing and  packaging  of all of its  products is  performed  at the
Company's facility in Wilmington, North Carolina.

         The Company relies on a variety of small and large  manufacturers  that
supply a wide variety of off-the-shelf  semiconductor  integrated  circuit chips
and specialized  electronic  components,  several of which manufacturers are the
sole source of supply. The Company also relies on third party  manufacturers and
assemblers to manufacture  and/or assemble certain components and sub-assemblies
for the Company's  products that are built to the Company's  specifications  and
which require  fabrication  equipment  the Company does not  presently  possess.
Further,  the  Company  relies  on third  party  manufacturers  for  specialized
sub-assemblies, including the charged coupled device color camera presently used
by the  Company  which,  although  not  built  to  Company  specifications,  are
manufactured   outside  of  the  United  States  and  are   inventoried  by  the
manufacturers in limited  quantities.  While the Company believes that all these
components could be obtained  elsewhere if needed or that the Company's products
could be redesigned  to use  alternative  components,  no assurance can be given
that other  sources of supply would be available  without  significant  delay or
increased cost, and the use of alternative  available  components  could require
re-engineering  by the Company of portions of its  products,  which could impose
additional cost and significant delay on the Company.

         In addition, the Company's reliance on third parties to manufacture and
sub-assemble  certain  components involve  significant risks,  including reduced
control  over   delivery   schedules,   the  inability  to  ship  product  under
"just-in-time" arrangements and quality assurance.  Furthermore,  certain of the
Company's  manufacturers,  sub-assemblers and suppliers,  including suppliers of
components made outside the United States,  may require the Company to make firm
scheduling and delivery  commitments and deliver secure financing  arrangements,
such as letters of credit,  as a condition to fulfillment  of their  contractual
obligations to the Company.  Failure to obtain an adequate  supply of components
and  required  sub-assembler  services  on a timely  basis would have a material
adverse effect on the Company.  As a result, the Company anticipates that, if it
is  successful  in  the  commercialization  of  its  products,  so  that  larger
quantities  of its  products  can be sold,  the  Company  will  become even more
dependent  on a timely  supply of purchased  inventory,  and will be required to
devote significant capital to its inventory. The Company currently does not have
the  significant  financial  resources  necessary  to fully  fund such  level of
commercialization. See Item 6 - "Management's Discussion and Analysis or Plan of
Operations - Liquidity and Capital Resources."

         While the Company has been  manufacturing  certain  video  conferencing
components  since 1994,  sales volume to date has kept  production at relatively
low and inefficient levels. In order to be profitable,  the Company must be able
to  manufacture  its products at acceptable  costs and there can be no assurance
that the Company will be able to make the transition to higher production volume
successfully  or within  acceptable  profit  margins.  As the  Company  only has
limited experience in manufacturing  commercial quantities of its products,  and
anticipates  heavy reliance on third party contract  manufacturers if demand for
its products  increase,  there can be no assurance that unforeseen  technical or
other  difficulties will not arise which could interfere with the development or
manufacture of its products,  or prevent,  or create delays in, marketing of its
products.

                                       14
<PAGE>

COMPETITION

GENERAL

         The technology  underlying  video  conferencing  products is subject to
rapid change,  including potential introduction of new products and technologies
which may have a material adverse impact on the Company's products.  The Company
needs to maintain an on-going research,  development and engineering program and
its success,  if any,  will depend in part on its ability to respond  quickly to
technological  advances by developing and  introducing new products or features.
There can be no assurance  that the Company will have the  financial  ability to
maintain an appropriate on-going research,  development and engineering program,
and if it has such  ability  whether  the  Company  will be able to foresee  and
respond to  technological  advances in a timely manner,  if at all. In addition,
even though the open architecture of the Company's  products allow components to
be replaced as new  technologies  develop,  there can be no  assurance  that the
development  of  technologies  and products by  competitors  will not render the
Company's products non-competitive or obsolete.

BUSINESS PRODUCTS

         Video   conferencing   products  have  received  only  limited   market
acceptance and penetration. A number of the companies which now compete with the
Company,  or which are  expected to offer  products  that may  compete  with the
Company's   products,   are  more  established,   benefit  from  greater  market
recognition with national marketing  programs,  and have  significantly  greater
financial,  technological,  manufacturing,  and  marketing  resources  than  the
Company. The Company's  competitors for its business video conferencing products
include video conferencing companies and major telecommunications and electronic
companies such as British Telecom,  BT Visual Images L.L.C.,  Compression  Labs,
Inc., Corel Corp., Creative Labs Inc., Intel Corp.,  PictureTel  Corporation and
VTEL Corporation.  In addition, numerous other companies have announced PC-based
video  conferencing  systems and this  number is  expected to increase  rapidly.
Intel Corp., a major computer chip manufacturer, has recently commenced shipment
of  chips  with  telephony  applications  with the  intention  of  making  video
conferencing a standard part of the PC computing  environment.  Several computer
manufacturers,  such as Compaq Computer Corp and Packard Bell have  incorporated
video conferencing  features into their equipment.  Several telephone  companies
have entered into strategic  alliances with one or more  manufacturers  of video
conferencing  equipment to increase the usage of their digital  telephone lines,
which in turn, if they are successful,  will increase their competitive image in
the  marketplace  for video  conferencing  products.  Furthermore,  as  expected
advances  in data  compression  and higher  speed LANs are  achieved,  new video
conferencing  products  utilizing these advances will compete with the Company's
products. As a result of the Company's limited marketing resources,  the Company
has been  utilizing  regional  resellers,  supported by the  Company's  internal
marketing  staff, as the Company's  marketing arm. Such regional  resellers have
not had the broad marketing  contacts,  national sales support and resources and
internal  backup  support to enable the Company to penetrate  the base of larger
potential broad-based multiple-location users of video conferencing who have not
yet  integrated  video  conferencing  into their  organizations.  The Company is
continuing to try to define its niche in the video conferencing  marketplace for
its  products,  and there can be no  assurance  that the Company will be able to
compete successfully in the business video conferencing market.

         The Company  believes  that the  principal  competitive  factors in the
current   business  video   conferencing   market  are  perceived   quality  and
availability of national sales and follow-up support services, quality of video,
price,  effect  on  the  PC  and  LAN  capacity,   compatibility  with  standard
communication protocols,  multipoint conferencing  capabilities and ease of use.
The Company's  marketing  efforts have emphasized the Company's ability to offer
customized and scalable video conferencing products,  with picture quality equal
to or  greater  than  competing  products  and priced at the low to mid range of
similar systems.

                                       15
<PAGE>

HOME PRODUCTS

         To date,  video  conferencing  over analog telephone lines has received
very limited market acceptance. As a result of recent technological advances and
the adoption of the H.324  standards for video  telephony over analog  telephone
lines, consumer video phones are being developed by a number of companies,  some
of which are more established,  benefit from greater market recognition and have
significantly  greater  financial,  technological,  manufacturing  and marketing
resources  than the  Company.  The Company  expects  that  C-Phone Home may face
substantial  competition from many well-known  established suppliers of consumer
electronic   products,   which  may  include   Compression  Labs,  Inc.,  Lucent
Technologies,  PictureTel  Corporation,  Philips Electronics N.V. and Sony Corp.
Many of these potential  competitors sell television and telephone products into
which they may integrate  video phone systems,  thereby  eliminating the need to
purchase a separate video phone system.  Additionally,  as discussed  above, the
recent  introduction  by Intel Corp. of chips with telephony  applications  have
enabled computer  manufacturers to incorporate video conferencing  features into
their equipment, which features may include video phone capabilities. 8x8, Inc.,
a manufacturer of integrated  video  compression  semiconductors  and associated
software, from whom the Company previously had purchased integrated circuits for
the  Company's  video  conferencing  products and C-Phone  Home,  has  commenced
production and sale of the first product in an announced planned family of video
phones,  which  product is intended  to  directly  compete  with  C-Phone  Home.
Additionally, 8x8, Inc. has licensed its video phone technology to U.S. Robotics
Access  Corporation  and Kyushu  Matsushita  Electric Co., Ltd., and the Company
anticipates  that such  companies  also may announce  competing  products.  As a
result,  and even though the Company  believes  that it is the first  company to
bring to market a  consumer-acceptable  TV-based  video  phone,  there can be no
assurance  that the Company  will be able to compete  successfully  in the video
phone market.

         The Company  believes  that the  principal  competitive  factors in the
TV-based  video  phone  market  will be  quality  of  video  and  audio,  price,
compatibility with standard  communication  protocols,  ease of use, strength of
distribution  channels,  ability  to timely  fulfill  order  requests,  customer
support, reliability and brand-name recognition. The Company's initial marketing
efforts for C-Phone Home have  emphasized  the Company being one of the first to
offer a  product  for home use which is easy to use and has  acceptable  picture
quality.

PATENTS AND OTHER INTELLECTUAL PROPERTY

         The Company has four United  States  patents  (one of which is a design
patent) and has pending five United States patent  applications  and one foreign
patent application,  all of which relate to technology incorporated in its video
conferencing  products  and  the  design  of  various  related  components.  The
inventions  which are the subject of these patent and patent  applications  were
created  jointly by Daniel Flohr and certain other  employees of, or consultants
to, the  Company  and,  in each case,  all rights to such  inventions  have been
assigned to the Company.

         Patents  and patent  applications  involve  complex  legal and  factual
issues.  Moreover,  the  technology  applicable  to the  Company's  products  is
developing  rapidly.  A number of companies have filed applications for, or have
been issued, patents relating to products or technology that are similar to some
of the products or technology being developed or used by the Company.  The scope
and validity of these  patents,  the extent to which the Company may be required
to obtain licenses thereunder or under other proprietary rights and the cost and
availability  of  licenses,  are  unknown.  There can be no  assurance  that the
Company's  patent  applications  will result in patents being issued or that, if
issued,  the  patents  will afford  protection  against  competitors  developing
similar or related  technologies.  Although  the  earliest  patent  owned by the
Company was granted in 1995,  and patents  generally have a seventeen year life,
due to rapidly developing  technology the Company  contemplates that alternative
technological  solutions  will be  devised to  accomplish  the  purposes  of its
patents substantially before the Company's patents expire, but that such patents
may offer  short-term  protection from third parties.  There can be no assurance
that other parties have not applied for,

                                       16
<PAGE>
or will not obtain,  patents  under which the Company would need to be granted a
license or around which the Company would be forced to redesign its products.

         The Company seeks to protect its intellectual property rights through a
combination of trade secret,  nondisclosure and other contractual  arrangements,
and patent,  copyright and trademark  laws.  The Company  generally  enters into
confidentiality    agreements   with   its   employees,    consultants,    sales
representatives  and  certain  potential  customers  and  limits  access  to and
distribution of its proprietary information.  However, there can be no assurance
that these actions will be adequate to deter  misappropriation  of the Company's
proprietary  information,  that the Company will be able to detect  unauthorized
use of its intellectual property rights, or that the Company can afford the high
cost required to enforce, through litigation,  its intellectual property rights.
Moreover,   any  such  litigation  could  result  in  substantial  diversion  of
managerial  time and  resources,  which  could  be  better  and more  fruitfully
utilized on other  activities.  Furthermore,  there can be no  assurance  that a
claim that the  Company's  services  and products  infringe on the  intellectual
property rights of others will not be asserted  successfully against the Company
in the future.

         In 1995, the U.S.  Patent and Trademark  Office (the "PTO")  registered
the  "C-Phone"  trademark  to the  Company.  In 1996,  in order to more  closely
identify the Company with its  products,  all of which utilize the C-Phone name,
and in an attempt to eliminate  confusion among  investors,  the Company changed
its name to C-Phone Corporation.  In August 1996, the Company was advised by the
PTO that a former  registered  owner of the  C-Phone  trademark  (which  the PTO
canceled  in 1993 for  failure  to  submit a  required  affidavit),  had filed a
petition to cancel the  Company's  registration,  alleging that the PTO canceled
the prior registration "inadvertently". The former owner had used, and continues
to use, the C-Phone  name for marine  telephone  products,  and may have certain
"common law" rights to continued  use of the name. A proceeding  with respect to
the matter is pending  before the PTO's  Trademark  Trial and Appeal Board,  who
will  determine  whether the  conflicting  use by the Company is so  confusingly
similar  that a  registration  should  not have  been  granted  to the  Company.
Discussions to resolve the matter by a mutual  co-existence  agreement have been
initiated;  however, there can be no assurance that such discussions will result
in a successful  resolution.  If the matter is not resolved  between the parties
and the Company is not  successful in the current PTO  proceedings,  the Company
may need to change the identifying  name on its products,  may determine that it
is  appropriate to change its corporate name and may be subject to damages if it
could be shown that the  Company had  infringed  the former  owner's  common law
rights. Any change in the use by the Company of the C-Phone name would result in
a loss of good will and  identification  which the  Company  has been  promoting
since 1993, and could have a temporary adverse impact on the Company's marketing
plans.

GOVERNMENT REGULATION

         The  Company's  products  must comply  with  certain  requirements  and
specifications   set  forth  in  regulations   adopted  by  the  FCC  regulating
electromagnetic radiation and the connection of terminal equipment to the public
switched telephone network. These regulations,  among other things, require that
the Company's  products be in compliance with such regulations as a prerequisite
to marketing them.  Although the Company's  products are currently in compliance
with such  regulations,  if the Company  redesigns  or  otherwise  modifies  its
products, or if current regulations or industry standards are revised, there can
be no  assurance  as to when,  if ever,  the  Company's  redesigned  or modified
products will be in compliance  with  applicable  governmental  regulations  and
evolving industry standards.  In addition,  the Company must comply with certain
similar  requirements  of  various  foreign  government  agencies  to effect its
foreign  sales.  The Company's  foreign  distributors,  as part of the Company's
distribution  agreements,  are  responsible  for ensuring  compliance  with, and
obtaining any necessary permits from, such foreign government agencies.

         The Company, in marketing C-Phone Home, is offering consumer electronic
retail  chains the option to purchase  the  product,  at a reduced  price,  when
purchased  with  telecommunications   services.  As  a  condition  to  reselling
intra-state and interstate  telecommunications services, the Company is required
to obtain and maintain  certain  approvals  from the FCC and from various  State
regulatory  authorities,  and  to  comply  with  various  applicable  regulatory
provisions imposed by such authorities, noncompliance with which could

                                       17
<PAGE>
subject  the  Company to  possible  forfeitures,  damages  and other  sanctions.
Various applicable regulatory provisions include,  among other things,  approval
as a  non-dominant  long  distance  carrier,  requirements  for the  filing  and
following of tariffs and that  equipment  and service  offerings be separate and
distinct and prohibitions against unjust,  unreasonable or discriminatory rates,
against  preferences  and against  the making of direct or  indirect  rebates of
amounts  paid for tariffed  services.  Although  the Company  believes  that its
offering of inter-exchange  telecommunications services complies with applicable
regulatory requirements,  there can be no assurance that the Company will obtain
and retain all required regulatory approvals, that all of such approvals will be
obtained timely or that a regulatory  authority may not impose  conditions which
the Company may not be able to fulfill.  Furthermore,  there can be no assurance
that compliance with the requirements  imposed by any regulatory authority would
not require  modifications  to the Company's  business plan for C- Phone Home or
that  regulatory  requirements  will not change in such a way as will materially
adversely affect the Company's business operations. The Company has obtained FCC
approval to resell inter-state  telecommunications services; however, due to the
timing of  obtaining  certain  State  approvals,  the Company  will be unable to
initially   offer   inter-exchange   telecommunications   services   for  making
intra-state video phone calls within certain States until it has applied for and
received  appropriate  regulatory approvals from such States. See "Marketing and
Sales - "HOME PRODUCTS."

EMPLOYEES

         As of May 15, 1997,  the Company  employed 66 persons (all of whom were
full-time employees),  including 18 manufacturing and distribution employees, 17
product development and engineering employees, 13 sales and marketing employees,
8 management and administrative employees and 10 technical support employees. As
the Company  proceeds with full scale  production and marketing of its products,
it will need to increase  substantially  the number of its employees,  and there
can be no assurance  that the Company will be able to do so in a timely  manner,
if at all. The Company considers that its  relationships  with its employees are
good.


ITEM 2.  DESCRIPTION OF PROPERTY
         -----------------------

         The Company  conducts all of its operations from its 14,420 square foot
Wilmington,  North  Carolina  facility,  approximately  17% of which is used for
engineering,  approximately  23% of  which is used  for  administration  and the
balance of which is used for production, inventory, shipping and receiving.

         The  Company  leases  its  facility,  which  was  built  in 1993 to the
Company's  specifications,  from its two principal  executive  officers,  Daniel
Flohr and Tina  Jacobs,  pursuant  to a triple net lease  pursuant  to which the
Company is responsible for all costs and expenses,  including  applicable taxes,
relating to the facility.  The current lease for the facility  expires April 30,
1999 and has a three-year  renewal  option at a renewal rent no greater than the
fair market value of the rented space at the beginning of the renewal term.  The
current base annual rent for the facility is $75,360,  which was no greater than
the fair market rental for the facility at the commencement of the current term.
Mr.  Flohr and Ms.  Jacobs allow the Company to use  approximately  9,000 square
feet of a 1.4 acre adjacent tract of land owned by them (the  "Adjacent  Tract")
as a parking area for the Company's  employees and customers,  in  consideration
for which the Company provides minimal  maintenance of the parking area and pays
$330 per year of real estate  taxes on the tract of land.  The Company  believes
that the terms and  conditions of the lease are no less favorable to the Company
than those available from unaffiliated third parties.

         The Company's  present facility is being fully utilized.  Mr. Flohr and
Ms.  Jacobs have  offered to construct  an  additional  building on the Adjacent
Tract  to  the  Company's  specifications  and  to  lease  such  building,  when
constructed,  to the  Company  on terms  similar  to the lease  for the  present
facility,  including  at a rental  no  greater  than  fair  market  value at the
commencement  of the lease term.  Plans for the  additional  facility  are being
discussed.

                                       18
<PAGE>

         See Note 12 of  Notes  to  Financial  Statements  included  in Item 7 -
"Financial Statements."

ITEM 3.  LEGAL PROCEEDINGS
         -----------------

         The  Company  is  involved  in  various  legal  proceedings  which  are
incidental to the conduct of its business. None of such proceedings are expected
to have a material adverse effect on the Company's financial position or results
of operations;  however,  see Item 1. -  "Description  of Business - Patents and
Other Intellectual Property."

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

         No matter was submitted to a vote of securities  holders of the Company
during the fiscal quarter ended February 28, 1997.

                                     PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
         --------------------------------------------------------

         The Common Stock is traded on The Nasdaq National Market under
the symbol "CFON." The following table sets forth the high and low closing sales
price for each  quarterly  period since March 1, 1995 for the Common  Stock,  as
reported by The Nasdaq Stock Market, Inc.

<TABLE>
<CAPTION>
         FISCAL 1996                                               HIGH            LOW
         -----------                                               ----            ---
<S>      <C>                                                       <C>              <C>

         1st Quarter (quarter ended May 31, 1995)                  8-1/4            7
         2nd Quarter (quarter ended August 31, 1995)               9                6-1/4
         3rd Quarter (quarter ended November 30, 1995)             8-1/4            5-5/8
         4th Quarter (quarter ended February 29, 1996)             8-1/4            5-1/4

         FISCAL 1997                                               HIGH            LOW

         1st Quarter (quarter ended May 31, 1996)                  8-1/4            6
         2nd Quarter (quarter ended August 31, 1996)               6-3/8            2-3/8
         3rd Quarter (quarter ended November 30, 1996)             6-1/16           2-3/8
         4th Quarter (quarter ended February 28, 1997)            16-1/4            3-1/8
</TABLE>

         As of May 22,  1997,  there  were 323  holders  of record of the Common
Stock,  including  CEDE & Co and four other  institutional  holders  who held an
aggregate  of 3,102,892  shares of Common  Stock as nominees for an  undisclosed
number of beneficial  holders.  The Company  estimates  that it has in excess of
2,000 beneficial holders.

         The  Company  has never paid any  dividends  and,  for the  foreseeable
future, the Company expects to retain earnings, if any, to finance the expansion
and development of its business.  Any future payment of dividends will be within
the  discretion of the Company's  Board of Directors,  which may be deemed to be
controlled by the Company's principal shareholders, and will depend, among other
factors,  on the  earnings,  capital  requirements  and  operating and financial
condition of the Company.

                                       19
<PAGE>

ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
         ----------------------------------------------------------

OVERVIEW

         Since 1993, the Company has been primarily  engaged in the engineering,
manufacturing  and marketing of C-Phone,  a line of PC-based video  conferencing
systems.  During  Fiscal 1997,  the Company  commenced  third-party  contractual
software  development  related to its PC-based  video  conferencing  systems and
substantially completed development of C-Phone Home, a TV-based video phone. See
"Financial Condition".

         In August 1994, the Company  completed its initial  public  offering of
2,000,000 shares of Common Stock,  pursuant to which it received net proceeds of
approximately  $12,288,000,  of which approximately  $1,947,000 was used for the
repayment of indebtedness and accrued interest thereon.

         During the week of March 31,  1997,  the  Company  completed  a private
placement of 833,667  shares of Common Stock,  subject to the  issuance,  for no
further  consideration,  of up to 2,500,001  additional  shares of Common Stock,
pursuant to which it received net proceeds of approximately $4,370,000. See Item
1 - "Description of Business - Recent  Developments." The Company expects to use
such proceeds for sales and marketing of C-Phone Home, the continued development
of additional C-Phone products and features and related products,  for sales and
marketing  of  C-Phone,  and  working  capital,  including  funding  anticipated
increases in inventories and receivables.

         The  Company  commenced   operations  in  1986  as  a  manufacturer  of
promotional  radios  and,  in 1990,  developed  data/fax  modems  under the name
"TWINCOM".  In early  1993,  because of  continued  price  pressures,  shrinking
margins and for competitive  reasons, the Company shifted its primary focus from
modems to the  development of C-Phone and, during the fiscal year ended February
28,  1995,  the Company  phased out its modem  product  line as it was no longer
profitable.  Since 1993,  the  Company has  invested  significant  resources  in
product  development,  engineering  and  marketing  activities  for  C-Phone and
related  products.  As a result of these activities and the low volume of sales,
the Company has incurred  significant losses during the three fiscal years ended
February  28,  1997.  The  Company  expects  to  continue  to  make  significant
expenditures for product development and marketing in the foreseeable future.

         This Annual Report on Form 10-KSB  contains,  in addition to historical
information,  certain forward-looking  statements that involve significant risks
and  uncertainties.  Such  forward-looking  statements are based on management's
belief as well as assumptions made by, and information  currently  available to,
management  pursuant to the "safe harbor"  provisions of the Private  Securities
Litigation  Reform  Act of 1995.  The  Company's  actual  results  could  differ
materially from those expressed in or implied by the forward-looking  statements
contained  herein.  Factors that could cause or contribute  to such  differences
include,  but are not limited to, those  discussed in Item 1 -  "Description  of
Business", in "Liquidity and Capital Resources" in this Item 6, and elsewhere in
this Annual  Report on Form 10-KSB.  The Company  undertakes  no  obligation  to
release publicly the result of any revisions to these forward looking statements
that may be made to  reflect  events  or  circumstances  after  the date of this
Annual Report on Form 10-KSB or to reflect the occurrence of other unanticipated
events.

RESULTS OF OPERATIONS

FISCAL 1997 AS COMPARED TO FISCAL 1996

         REVENUES.  Revenues  increased  14% to  $2,042,878  in Fiscal 1997 from
$1,786,115  in Fiscal 1996.  The revenues for Fiscal 1997  included  $150,000 of
software development revenue related to software developed by the Company at two
customers'  requests for use with C-Phone  products and  $1,890,213  of sales of
C-Phone products,  while the revenues for Fiscal 1996 consisted only of sales of
C-Phone  products.  As a result,  net sales of C-Phone products  increased 6% in
Fiscal 1997 as compared to Fiscal 1996. The Company

                                       20
<PAGE>

believes that such minimal  increase was primarily  related to a change in sales
and marketing  personnel.  While the Company hired a new Vice President of Sales
and  Marketing  in  September  1996 and  replaced  several  sales and  marketing
personnel in November 1996, appropriate indoctrination, integration and training
of such persons and the required  lead-time  for such persons to generate  sales
was not sufficient to produce significant tangible results during Fiscal 1997.

         COST OF  REVENUE.  Cost of revenue  consists  of cost of goods sold and
cost of software  development  and other  revenue.  Cost of goods sold  includes
labor,  materials  and other  manufacturing  costs (such as salaries,  supplies,
leasing costs,  depreciation  related to production  operations and write-off of
obsolete inventory). Cost of software development and other revenue includes the
allocation  of  salaries  and  benefits  of  personnel  and the cost of  outside
services  directly  related to such revenue.  Cost of goods sold increased 5% to
$1,629,287  (86% of net sales) in Fiscal 1997 from $1,556,353 (87% of net sales)
in Fiscal  1996.  The  increase  in cost of goods sold and the  decrease  in the
percentage of cost of goods sold to net sales were both primarily related to the
moderate  increase in sales. The cost of software  development and other revenue
($81,079) was 53% of the related revenue;  the Company had no similar revenue in
Fiscal 1996.

         GROSS PROFIT.  Gross profit  increased to $332,512 (16% of revenues) in
Fiscal 1997 from  $229,762  (13% of revenues)  in Fiscal 1996.  The gross profit
produced  from sales of goods was $260,926 (14% of net sales) in Fiscal 1997, as
compared  to  $229,762  (13% of net  sales) in  Fiscal  1996.  The gross  profit
percentage related to software development and other revenue was $71,586 (47% of
such  revenue) in Fiscal  1997;  the  Company  did not have any such  revenue in
Fiscal 1996. The increase in gross profit and gross profit percentage related to
sales was directly related to the increase in sales.

         SELLING,    GENERAL   AND   ADMINISTRATIVE.    Selling,   general   and
administrative  expenses  decreased 33% to  $2,454,337  (or 120% of revenues) in
Fiscal 1997 from  $3,662,679  (or 205% of revenues) in Fiscal 1996.  The primary
reason for the decrease was a 50% reduction in selling and marketing expenses to
approximately  $1,125,000 in Fiscal 1997 from approximately $2,230,000 in Fiscal
1996, of which  approximately  $1,200,000  was directly  related to a nationwide
advertising and marketing  campaign which ran for most of the three months ended
May 31,  1995 ("1st  Quarter  96").  While the  Company's  trade  show  expenses
decreased to approximately  $230,000 in Fiscal 1997 from approximately  $425,000
in Fiscal 1996 as a result of the Company's  decision not to  participate in the
1996 Las Vegas Comdex trade show,  this decrease was mostly offset by additional
marketing  expenses related to the initial  marketing launch of C-Phone Home. In
additional,  general  and  administrative  expenses  increased  as a  result  of
increased  personnel costs resulting from additional  customer support personnel
and a reallocation of duties of certain personnel from research, development and
engineering.  The Company  expects  that it will  continue to incur  substantial
selling,  general and administrative expenses for Fiscal 1998 as a result of the
commercialization of C-Phone Home.

         RESEARCH,  DEVELOPMENT  AND  ENGINEERING.   Research,  development  and
engineering  expenses decreased 8% to $1,016,293 (50% of revenue) in Fiscal 1997
from  $1,102,737 (62% of revenue) in Fiscal 1996. The decrease was primarily the
result of the  reallocation of  approximately  $76,000 of certain  personnel and
benefit  costs to the cost of  software  development  revenue  and a decrease in
personnel costs  resulting from a partial change in duties of certain  personnel
to selling,  general and  administrative.  Without the reallocation of personnel
costs  to cost  software  development,  research,  development  and  engineering
expenses for Fiscal 1997 would be approximately the same amount as such expenses
for Fiscal 1996,  as the majority of these  allocated  costs were for  permanent
personnel.  All of these costs were charged to  operations  as incurred and were
funded by the Company's cash reserves. The Company expects to continue to invest
significant  resources during the foreseeable future in new product  development
and engineering.

         OPERATING  LOSS.  As a  result  of the  factors  discussed  above,  the
Company's  operating  loss  decreased  31% to  $3,138,118  in  Fiscal  1997 from
$4,535,654 in Fiscal 1996.

                                       21
<PAGE>

         INTEREST. Interest income decreased 65% to $132,405 in Fiscal 1997 from
$378,932 in Fiscal  1996 as a result of  decreased  investments,  as the Company
utilized  the net  proceeds  of the  1994  Public  Offering  for the  continuing
development and commercialization of C-Phone products.

         INCOME TAXES.  The Company's losses for Fiscal 1997 and Fiscal 1996 may
be utilized as an offset against future earnings, although there is no assurance
that future operations will produce taxable earnings.

FISCAL 1996 AS COMPARED TO FISCAL 1995

         REVENUES.  Revenues  increased  89% to  $1,786,115  in Fiscal 1996 from
$945,035 in Fiscal 1995.  All revenues in Fiscal 1996 were from sales of C-Phone
products compared to revenues of $338,121 from C-Phone sales during Fiscal 1995.
The balance of revenues in Fiscal 1995  ($606,914)  were from sales of the modem
product line phased out during Fiscal 1995.

         COST OF REVENUE.  Cost of revenue  consists of cost of goods sold. Cost
of goods sold includes labor,  materials and other  manufacturing costs (such as
salaries,  supplies,  leasing costs and depreciation costs related to production
operations).  Cost of goods sold increased 40% to $1,556,353 in Fiscal 1996 from
$1,110,642  in Fiscal  1995.  All of the costs of goods sold in Fiscal 1996 were
related to the C-Phone  product line while 27%  ($297,679) of the costs of goods
sold in Fiscal 1995 were related to C-Phone and 73%  ($812,963)  were related to
the modem product line.

         GROSS  PROFIT  (LOSS).  Gross  profit  increased  to  $229,762  (13% of
revenues)  for Fiscal 1996 from a gross loss of $165,607  (18% of revenues)  for
Fiscal  1995.  The gross  loss for  Fiscal  1995 was  primarily  the result of a
$97,491  write-down  of inventory  related to the phase out of the modem product
line.

         SELLING,    GENERAL   AND   ADMINISTRATIVE.    Selling,   general   and
administrative  expenses  increased  122% to  $3,662,679  (205% of  revenues) in
Fiscal  1996  from  $1,649,336  (175% of  revenues)  in Fiscal  1995.  Decreased
expenses  from the phase out of the modem  product line were more than offset by
the increased marketing and other expenses related to the  commercialization  of
C-Phone.  Selling and marketing expenses included  approximately  $1,174,000 for
advertising,  approximately $563,000 for trade shows, approximately $352,000 for
salaries and benefits for  marketing  personnel and  approximately  $141,000 for
brochures,  materials  and  mailing  costs.  Of  these  expenses,  approximately
$1,200,000  was  directly  related to a  nationwide  advertising  and  marketing
campaign  that ran for most of the  first  quarter  of  Fiscal  1996.  While the
Company does not anticipate continuing  advertising  expenditures at such level,
it  does  expect   that  it  will  incur   substantial   selling,   general  and
administrative expenses during the fiscal year ending February 28, 1997 ("Fiscal
1997") as a result of the continuing  commercialization  of the C-Phone  product
line. In addition,  the Company's bad debt expense  increased to $164,554 (9% of
revenues)  in  Fiscal  1996 from  $54,856  (6% of  revenues)  for  Fiscal  1995,
primarily  as a result of the change in the  Company's  business  from modems to
C-Phone,  resulting  in a  change  in the  type  and  mix of  customers  for the
Company's products during C-Phone's initial introductory phase combined with the
increase in sales volume in Fiscal 1996 over Fiscal 1995. See Item 1 - "Business
- Video Conferencing - MARKETING AND SALES."

         RESEARCH,  DEVELOPMENT  AND  ENGINEERING.   Research,  development  and
engineering  expenses  increased 35% to  $1,102,737  (62% of revenues) in Fiscal
1996 from  $814,413  (86% of revenues) in Fiscal  1995,  due to the  engineering
effort to continue the development of C-Phone and to add C-Phone  products.  The
Company's research,  development and engineering  expenses for C-Phone in Fiscal
1996 consisted primarily of salaries and benefit costs for engineering personnel
of approximately  $819,000,  parts and supplies of approximately  $122,000,  and
outside consulting  services of approximately  $65,000.  All of these costs were
charged  to  operations  as  incurred  and were  funded  by the  Company's  cash
reserves. The Company expects to continue to invest significant resources during
the foreseeable future in new product development and engineering.

                                       22
<PAGE>

         OPERATING  LOSS.  As a  result  of the  factors  discussed  above,  the
Company's  operating  loss  increased  73% to  $4,535,654  in  Fiscal  1996 from
$2,629,356 in Fiscal 1995.

         INTEREST.  Interest  expense in Fiscal  1996 was $4,614 as  compared to
$1,116,237 in Fiscal 1995. This decrease was due to the repayment in Fiscal 1995
of the 7% Notes from the net  proceeds  of the 1994  Public  Offering.  Interest
income increased to $378,932 in Fiscal 1996 from $275,068 in Fiscal 1995, due to
higher average  levels of investments as a result of the proceeds  received from
the 1994 Public Offering.

         INCOME TAXES. The Company's losses in Fiscal 1996 may be utilized as an
offset  against  future  taxable  earnings,  although there is no assurance that
future operations will produce taxable earnings.

LIQUIDITY AND CAPITAL RESOURCES

         The Company has financed its recent  operations  primarily  through the
1994 Public Offering, which raised net proceeds of approximately $12,288,000 and
the 1997 Placement, which raised net proceeds of approximately $4,370,000 during
the week of March 31, 1997.

         At February 28, 1997, the Company had working  capital of $2,318,766 (a
decline from  $5,334,175  at February  29,  1996) and cash and cash  equivalents
(including  short-term  investments) of $1,398,049 (as compared to $4,279,223 at
February 29, 1996).  The Company's  invested  funds consist  primarily of United
States  Treasury  Bills and  obligations of United States  government  agencies.
During Fiscal 1997,  operating activities used $2,812,517 of net cash, primarily
to fund operating  activities,  investing  activities provided $2,348,536 of net
cash,  primarily  from  maturities  of  short-term  investments,  and  financing
activities  provided  $9,210 of net  cash.  Due to the  technical  nature of the
Company's business and the anticipated  expansion of its C-Phone technology into
new applications, management expects to continue to expend significant resources
for  continued  development  and  engineering  as well as selling and  marketing
expenses.

         The Company believes that its current working  capital,  which includes
the net proceeds from the 1997 Placement,  together with anticipated  funds from
operations,  will be sufficient to meet the Company's  projected operating needs
and capital  expenditures,  including the initial  commercialization  of C-Phone
Home,  through the end of the  Company's  fiscal year ending  February  28, 1998
("Fiscal 1998"). However, if C-Phone Home gains any market acceptance,  of which
there can be no assurance,  the Company's  pricing  strategy (as discussed above
under Item 1 -  "Description  of Business - Marketing and Sales"),  and the very
substantial  investment  which  would  then  be  required  by  the  Company  for
manufacturing,  inventory  build-up and  marketing  expenditures  related to the
commercialization   of  C-Phone  Home,  would  require  the  Company  to  obtain
additional  working  capital by the third  fiscal  quarter of Fiscal  1998.  The
Company has  commenced  the  planning  process to raise such funds.  The Company
anticipates that such funds should be available  through a private  placement of
(i) its debt  securities,  (ii) authorized,  but unissued,  shares of its Common
Stock, or (iii) its debt securities which would be convertible into such shares;
and if and when still further funds are needed, that such funds may be available
through a possible public offering of its  authorized,  but unissued,  shares of
Common  Stock.  There can be no assurance  that  additional  funds needed by the
Company will be available  when needed or, if available,  that the terms of such
fundings will be favorable or acceptable to the Company.


         Assuming  acceptance  of C-Phone Home by the  marketplace,  the Company
anticipates that it may take in excess of two years to obtain positive cash flow
from the Company's anticipated operations,  during which time the Company may be
required  to obtain  still more  financing.  If the  Company is unable to timely
obtain any of its required funds, its C-Phone Home marketing strategy may not be
attainable  and its business  could be  materially  adversely  affected.  Unless
adequate income from sales of C-Phone Home is attained, the timing or receipt of
which cannot be predicted,  the Company may require additional cash resources to
finance receivables and for development of alternative products. There can be no
assurance  that  additional  funds needed by the Company will be available  when
needed or, if  available,  that the terms of such  fundings will be favorable or
acceptable to the Company.

                                       23
<PAGE>
         In connection  with the 1994 Public  Offering,  the Company  issued the
1994 Warrants to JLR pursuant to a  Representative's  Warrant  Agreement.  On or
about January 13, 1997,  the Company  received from the holders of a majority of
the 1994  Warrants,  most of whom are officers of JLR, a request to register the
shares of Common Stock issuable upon exercise of the 1994 Warrants. Although the
Company  filed  a  registration  statement  with  the  Securities  and  Exchange
Commission to register such shares on April 16, 1997,  the Company's  failure to
file such a  registration  statement  within 45 days after  January 13, 1997 may
give the  holders of a majority  of the 1994  Warrants  the right to require the
Company to repurchase  the 1994 Warrants for an aggregate of up to $1,370,000 at
any  time  prior  to the  sale of a  majority  of such  shares  pursuant  to the
prospectus included in such registration statement. If such holders successfully
assert such right,  the Company may not have the financial  ability to make such
payment;  and, in the event that such right is  successfully  asserted at a time
when the Company has the financial  ability to make such  payment,  such payment
could  materially  adversely  affect the Company's  financial  condition and may
deplete  all of  its  necessary  cash  resources  for  the  continuation  of its
operations. The possible existence of this repurchase right, and the possibility
of its  exercise,  will  increase  the  difficulty  of the  Company  raising its
required additional working capital on terms acceptable to the Company.

         The  development  during Fiscal 1997, and the recent  introduction,  of
C-Phone Home has placed a significant strain on the Company's limited personnel,
management  and other  resources.  The  Company's  ability  to manage any future
growth effectively will require it to continue to attract,  train,  motivate and
manage its employees  successfully  and to continue to improve its  operational,
financial and management  systems.  The Company's failure to effectively  manage
its growth could have a material  adverse  effect on the Company's  business and
operating results.

         The  Company  leases  its  facility  and has  financed a portion of its
manufacturing  equipment expenditures through capital leases. As of February 28,
1997, the Company had no material commitments for capital expenditures.

         At February 28, 1997,  the Company  estimates that it had available net
operating loss  carryforwards of approximately  $10,233,000 for Federal purposes
and net economic  loss  carryforwards  of  approximately  $10,482,000  for state
purposes, which may be used to reduce future taxable income, if any. The Federal
carryforwards  will  expire  starting in 2009 and the state  carryforwards  will
expire starting in 1999.

         The Company believes that,  during the past three years,  inflation has
not had a  significant  impact  on the  Company's  sales or  operating  results.
Certain  of  the  components  and  sub-assemblies  used  by the  Company  in its
products,  such  as  the  CCD  color  camera  presently  used  in  C-Phone,  are
manufactured  outside of the United States and represents a material  portion of
the unit cost of the  Company's  basic  products.  Although  the Company has not
experienced  any  significant  price increases to date as a result of changes in
foreign currency rates,  there can be no assurance that, in the future,  changes
in foreign  currency  rates will not  affect the cost of its  foreign  purchased
components  and   sub-assemblies.   See  Item  1  "Description   of  Business  -
Manufacturing."

         The Company's  foreign sales are  denominated  in U.S.  dollars and the
Company does not incur any foreign  currency  risks;  however,  fluctuations  in
currency exchange rates could cause the Company's  products to become relatively
more  expensive  to foreign  customers,  which would  result in a  reduction  in
foreign sales or the profitability of any of such sales.

NEW ACCOUNTING PRONOUNCEMENTS

         In February 1997, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial  Accounting  Standards ("SFAS") No. 128, "Earnings
Per  Share".  SFAS No.  128 is  designed  to  improve  the  earnings  per  share
information  provided  in  financial  statements  by  simplifying  the  existing
computational  guidelines,  revising the disclosure  requirements and increasing
comparability of earnings per

                                       24

<PAGE>
share data on an international basis. The pronouncement is effective for periods
ending after December 15, 1997 and is not expected to have a material  impact on
the Company's financial statements.

         In  October  1995,  the FASB  issued  SFAS  No.  123,  "Accounting  and
Disclosure of  Stock-Based  Compensation".  SFAS No. 123 introduces a fair-value
based method of accounting for stock-based  compensation,  and  encourages,  but
does not  require,  companies to  recognize  compensation  expense for grants of
stock,  stock options and other equity  instruments to employees  based on their
estimated fair market value on the date of grant.  SFAS No. 123 is effective for
fiscal years  beginning  after December 15, 1995. The Company will not adopt the
new fair value accounting rules provided under SFAS No. 123, except for the fair
value of options granted to consultants as required under the provisions of SFAS
No.  123.  As a result,  SFAS No. 123 will not have any effect on the  Company's
financial  statements,   except  for  the  fair  value  of  options  granted  to
consultants.

                                       25

<PAGE>

ITEM 7.   FINANCIAL STATEMENTS
          --------------------
                                                                      PAGE
                                                                      ----
TABLE OF CONTENTS
-----------------

Report of Independent Accountants                                     28

Balance Sheets as of February 28, 1997 and February 29, 1996          29

Statements of Operations for the years ended
  February 28, 1997, February 29, 1996 and February 28, 1995          30

Statements of Shareholders' Equity for the years ended
  February 28, 1997, February 29, 1996 and February 28, 1995          31

Statements of Cash Flows for the years ended
  February 28, 1997, February 29, 1996 and February 28, 1995          32

Notes to Financial Statements                                         33

                                       26

<PAGE>
                        REPORT OF INDEPENDENT ACCOUNTANTS



To the Board of Directors and 
Shareholders of C-Phone Corporation:


We have audited the  accompanying  balance  sheets of C-Phone  Corporation as of
February  28,  1997  and  February  29,  1996,  and the  related  statements  of
operations,  shareholders'  equity and cash flows for each of the three years in
the  period  ended  February  28,  1997.  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 C-Phone  Corporation  as of
February 28, 1997 and February 29, 1996,  and the results of its  operations and
its cash flows for each of the three  years in the  period  ended  February  28,
1997, in conformity with generally accepted accounting principles.




Coopers & Lybrand L.L.P.

Raleigh, North Carolina
May 8, 1997


                                       27
<PAGE>
                               C-PHONE CORPORATION

                                 BALANCE SHEETS

                     FEBRUARY 28, 1997 AND FEBRUARY 29, 1996
<TABLE>
<CAPTION>
                                     ASSETS                                            1997                    1996
                                                                                       ----                    ----

Current assets:
<S>                                                                                    <C>                     <C>         
  Cash and cash equivalents                                                            $  1,398,049            $  1,852,820
  Short-term investments                                                                         --               2,426,403
  Accounts receivable, net of allowance for doubtful
    accounts of $120,000 and $170,000 at February
    28, 1997 and February 29, 1996, respectively                                            422,042                 398,004
  Inventories                                                                             1,341,931               1,061,496
  Prepaid expenses and other current assets                                                  82,066                 123,915
                                                                                -------------------     -------------------
          Total current assets                                                            3,244,088               5,862,638

Property and equipment, net                                                                 251,913                 308,248
                                                                                -------------------     -------------------

Other assets                                                                                154,246                  67,320
                                                                                -------------------     -------------------

          Total assets                                                                 $  3,650,247            $  6,238,206
                                                                                ===================     ===================

                      LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
  Accounts payable, trade                                                              $    587,877           $     289,362
  Accrued expenses                                                                          325,938                 222,998
  Current obligations under capital leases                                                   11,507                  16,103
                                                                                -------------------     -------------------
          Total current liabilities                                                         925,322                 528,463

Long-term obligations under capital leases                                                       --                  11,507
                                                                                -------------------     -------------------
          Total liabilities                                                                 925,322                 539,970
                                                                                -------------------     -------------------

Commitments and Contingencies (Notes 12 and 14)

Shareholders' equity:
  Common stock,  $.01 par value;  10,000,000  shares  authorized;
  4,355,393 and 4,347,293 shares issued and outstanding at February
  28, 1997 and February 29, 1996, respectively                                               43,554                  43,473
  Paid-in capital                                                                        13,530,208              13,495,376
  Accumulated deficit                                                                   (10,848,837)             (7,840,613)
                                                                                -------------------     -------------------
          Total shareholders' equity                                                      2,724,925               5,698,236
                                                                                -------------------     -------------------

          Total liabilities and shareholders' equity                                   $  3,650,247            $  6,238,206
                                                                                ===================     ===================
</TABLE>

    The accompanying notes are an integral part of the financial statements.

                                       28
<PAGE>
                               C-PHONE CORPORATION

                            STATEMENTS OF OPERATIONS

                     FOR THE YEARS ENDED FEBRUARY 28, 1997,
                     FEBRUARY 29, 1996 AND FEBRUARY 28, 1995

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

Net sales                                                          $ 1,890,213         $  1,786,115          $    945,035
Software development and
  other revenue                                                        152,665                   --                    --
                                                             -----------------    -----------------    ------------------

     Total revenue                                                   2,042,878            1,786,115               945,035
                                                             -----------------    -----------------    ------------------

Cost of goods sold                                                   1,629,287            1,556,353             1,110,642
Cost of software development and
  other revenue                                                         81,079                   --                    --
                                                             -----------------    -----------------    ------------------

     Total cost of revenue                                           1,710,366            1,556,353             1,110,642
                                                             -----------------    -----------------    ------------------

     Gross profit (loss)                                               332,512              229,762              (165,607)
                                                             -----------------    -----------------    ------------------

Operating expenses:
  Selling, general and administrative                                2,454,337            3,662,679             1,649,336
  Research, development and engineering                              1,016,293            1,102,737               814,413
                                                             -----------------    -----------------    ------------------

     Total operating expenses                                        3,470,630            4,765,416             2,463,749
                                                             -----------------    -----------------    ------------------

     Operating loss                                                 (3,138,118)          (4,535,654)           (2,629,356)

Interest expense (including amortization 
  of original issue discount and deferred
  financing costs totalling $1,043,050
  in 1995) (Note 6)                                                     (2,511)              (4,614)           (1,116,237)

Interest income                                                        132,405              378,932               275,068
                                                             -----------------    -----------------    ------------------

     Net loss                                                      $(3,008,224)         $(4,161,336)          $(3,470,525)
                                                             =================    =================    ==================

Per-share data:
     Net loss per share                                            $     (0.69)         $     (0.96)          $     (1.03)
                                                             =================    =================    ==================

Weighted average number of common
  shares and common share
  equivalents outstanding                                            4,347,968            4,347,293             3,366,497
                                                             =================    =================    ==================
</TABLE>

    The accompanying notes are an integral part of the financial statements.

                                       29

<PAGE>

                               C-PHONE CORPORATION

                       STAT MENTS OF SHAREHOLDERS' EQUITY

                     FOR THE YEARS ENDED FEBRUARY 28, 1997,
                     FEBRUARY 29, 1996 AND FEBRUARY 28, 1995

<TABLE>
<CAPTION>
                                                                                                                           TOTAL
                                                          COMMON STOCK                               ACCUMULATED       SHAREHOLDERS'
                                                    SHARES         AMOUNT        PAID-IN CAPITAL       DEFICIT            EQUITY
                                                    ------         ------        ---------------     -----------       -------------

<S>                                                 <C>            <C>             <C>              <C>                 <C>        
Balance, February 28, 1994                          2,185,559      $ 21,856        $   501,605      $  (208,752)        $   314,709

Issuance of common stock as
  part of bridge financing, net
  of placement costs of $124,036                      146,281         1,463            617,704                              619,167

Issuance of common stock as a
  result of initial public offering                 2,000,000        20,000         12,268,051                           12,288,051

Issuance of additional  shares of
  common stock as a part of the 
  bridge financing due to the
  initial public offering price
  per share                                            15,504           155            108,373                              108,528

Purchase of fractional shares                             (51)           (1)              (357)                                (358)

Net loss                                                                                             (3,470,525)         (3,470,525)
                                      -----------------------   -----------   ----------------   ---------------    ---------------

Balance, February 28, 1995                          4,347,293        43,473         13,495,376       (3,679,277)          9,859,572

Net loss                                                                                             (4,161,336)         (4,161,336)
                                      -----------------------   -----------   ----------------   ---------------    ---------------

Balance, February 29, 1996                          4,347,293        43,473         13,495,376       (7,840,613)          5,698,236

Exercise of employee stock
  options                                               8,100            81             25,232                               25,313

Expense of stock options
  granted to consultant                                                                  9,600                                9,600

Net loss                                                                                             (3,008,224)         (3,008,224)
                                      -----------------------   -----------   ----------------   ---------------    ---------------

Balance, February 28, 1997                          4,355,393      $ 43,554       $ 13,530,208    $ (10,848,837)        $ 2,724,925
                                      =======================   ===========   ================   ===============    ===============
</TABLE>

    The accompanying notes are an integral part of the financial statements.

                                       30

<PAGE>
                               C-PHONE CORPORATION

                            STATEMENTS OF CASH FLOWS

                     FOR THE YEARS ENDED FEBRUARY 28, 1997,
                     FEBRUARY 29, 1996 AND FEBRUARY 28, 1995
<TABLE>
<CAPTION>
                                                                      1997            1996             1995
                                                                      ----            ----             ----
<S>                                                              <C>             <C>             <C>          
Cash flows from operating activities:
  Net loss                                                       $ (3,008,224)   $ (4,161,336)   $ (3,470,525)
  Adjustments to reconcile net loss to net
   cash used in operating activities:
      Depreciation and amortization                                   134,202         182,803         191,282
      Amortization of deferred financing costs and
        original issue discount                                          --              --         1,043,050
      Provision for inventory obsolescence                               --            70,227          97,491
      Provision for doubtful accounts                                  90,831         164,554          54,856
      Compensation expense of stock options                             9,600            --              --
      Changes in operating assets and liabilities:
        Restricted cash                                                  --              --            18,625
        Accounts receivable                                          (114,879)       (391,124)        (99,534)
        Inventories                                                  (280,435)       (535,997)       (178,065)
        Customer deposits                                                --              --           (31,880)
        Prepaid expenses and other current assets                      41,849         145,740        (253,730)
        Other assets                                                  (86,926)        (64,318)          9,472
        Accounts payable                                              298,515        (191,229)       (346,567)
        Accrued expenses                                              102,940          42,249         159,011
        Income taxes payable                                             --              --           233,283
                                                                 ------------    ------------    ------------
          Net cash used in operating activities                    (2,812,517)     (4,738,431)     (2,573,231)
                                                                 ------------    ------------    ------------

Cash flows from investing activities:
  Equipment purchases                                                 (77,867)        (92,334)       (325,789)
  Purchases of short-term investments                              (1,647,371)     (8,319,464)     (7,775,522)
  Maturities of short-term investments                              4,073,774       9,763,943       3,904,640
  Repayment of note receivable from shareholders                         --              --            71,463
                                                                 ------------    ------------    ------------
          Net cash provided by (used in) investing activities       2,348,536       1,352,145      (4,125,208)
                                                                 ------------    ------------    ------------

Cash flows from financing activities:
  Proceeds from exercise of stock options                              25,313            --              --
  Proceeds from debt and equity private placement                        --              --         1,583,395
  Proceeds from public issuance of common stock                          --              --        12,288,051
  Payment of note payable, bank                                          --              --           (41,671)
  Payment of note payable, debt private placement                        --              --        (1,898,750)
  Payment of capital lease obligations                                (16,103)        (21,999)        (27,408)
  Payments of note payable to shareholder                                --              --           (90,590)
  Purchase of fractional shares of common stock                          --              --              (358)
  Proceeds from prepayment of private placement fees                     --              --            59,415
                                                                 ------------    ------------    ------------
          Net cash provided by (used in) financing activities           9,210         (21,999)     11,872,084
                                                                 ------------    ------------    ------------

          Net increase (decrease) in cash and cash equivalents       (454,771)     (3,408,285)      5,173,645

Cash and cash equivalents, beginning of year                        1,852,820       5,261,105          87,460
                                                                 ------------    ------------    ------------

Cash and cash equivalents, end of year                           $  1,398,049    $  1,852,820    $  5,261,105
                                                                 ============    ============    ============

Supplemental disclosure of cash flow information:

  Interest paid                                                  $      2,511    $      4,614    $     73,187
                                                                 ============    ============    ============

  Income taxes paid                                              $       --      $       --      $       --
                                                                 ============    ============    ============
</TABLE>

    The accompanying notes are an integral part of the financial statements.

                                       31
<PAGE>
                               C-PHONE CORPORATION

                          NOTES TO FINANCIAL STATEMENTS

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

1.      NATURE OF BUSINESS

        C-Phone Corporation (the "Company") was incorporated in the State of New
        York on March 28, 1986.  The Company has been  primarily  engaged in the
        engineering,  manufacturing and marketing of C-Phone, a line of PC-based
        video conferencing systems. During the year ended February 28, 1997, the
        Company has engaged in contractual  software  development related to its
        PC-based  video  conferencing  systems.  In  addition,  the  Company has
        recently  completed   development  of  C-Phone  Home(TM),  a  television
        "set-top" box video system which allows video telephone calls to be made
        over  regular  telephone  lines  using a standard  television  set.  The
        Company phased out its data/fax modem product line during the year ended
        February 28, 1995.

2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
        -----------------------------------------------------------

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

        CASH AND CASH EQUIVALENTS
        -------------------------

        Cash and cash  equivalents  includes all cash balances and highly liquid
        investments  with a  maturity  of three  months or less from the date of
        purchase.

        SHORT-TERM INVESTMENTS
        ----------------------

        Short-term investments include highly liquid investments with a maturity
        of more than  three  months  and not more than one year from the date of
        purchase.

        CONCENTRATION OF CREDIT RISK
        ----------------------------

        Concentrations  of credit  risk that  arise from  financial  instruments
        exist for  groups of  counterparties  when  they have  similar  economic
        characteristics  that would  cause  their  ability  to meet  contractual
        obligations  to be  similarly  affected  by changes in economic or other
        conditions.

        Significant customers and concentrations of credit risk are discussed in
        Note 13. As discussed in Note 3, the Company  maintains its cash in bank
        deposit accounts which, at times, may exceed federally insured limits.

        FAIR VALUE OF FINANCIAL INSTRUMENTS
        -----------------------------------

        The carrying value of the Company's financial instruments, which consist
        of cash and cash  equivalents at February 28, 1997 and February 29, 1996
        and short-term  investments at February 29, 1996,  approximates the fair
        value because of the short maturities of these instruments.

        INVENTORIES
        -----------

        Inventories  are  valued at the  lower of cost or market on a  first-in,
        first-out basis.

                                       32

<PAGE>

                               C-PHONE CORPORATION

                          NOTES TO FINANCIAL STATEMENTS

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


2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  (Continued)

        PROPERTY AND EQUIPMENT
        ----------------------

        Property and equipment is stated at cost and is  depreciated,  including
        equipment under capital leases, by the  double-declining-balance  method
        over the estimated useful lives of the assets, which range from three to
        seven years.  Leasehold  improvements  are amortized  over the estimated
        useful  life of the  asset.  Major  tooling  costs are  capitalized  and
        amortized  over the expected life of the tooling or the expected life of
        the related product,  whichever is less. Expenditures for minor tooling,
        maintenance and repairs are charged to expense as incurred.

        Significant  expenditures  for betterments and renewals are capitalized.
        The cost and related accumulated  depreciation of property and equipment
        are removed from the accounts upon retirement or other disposition,  and
        any gain or loss is reflected in operations.

        The Company assesses the impairment of its long-lived assets,  including
        property,  plant and equipment,  whenever  economic events or changes in
        circumstances  indicate that the carrying value of the assets may not be
        recoverable.  Long-lived  assets are  considered to be impaired when the
        sum of the  expected  future  operating  cash  flows,  undiscounted  and
        without  interest  charges,  is less  than the  carrying  values  of the
        related assets.

        INCOME TAXES
        ------------

        The Company  provides for income taxes in accordance  with  Statement of
        Financial Accounting Standards No. 109 ("SFAS No. 109"), "Accounting for
        Income  Taxes".  SFAS No. 109  requires  that all deferred tax asset and
        liability balances be determined by application to temporary differences
        of the tax rate expected to be in effect when taxes will become  payable
        or receivable.  Temporary  differences are  differences  between the tax
        basis of assets  and  liabilities  and  their  reported  amounts  in the
        financial  statements that will result in taxable or deductible  amounts
        in future years. The Company's  temporary  differences consist primarily
        of  depreciation,   allowance  for  doubtful  accounts   receivable  and
        inventory valuation reserves.

        REVENUE RECOGNITION
        -------------------

        Product revenues are recognized when the product is shipped,  collection
        of the  purchase  price is probable  and the Company has no  significant
        further  obligation to the  customer.  Software  development  revenue is
        recognized  under  the  completed  contract  method  when  the  software
        development is completed or substantially completed.  Costs of remaining
        insignificant  Company  obligations,  if any,  are  accrued  as costs of
        revenue at the time of revenue recognition.

        WARRANTY
        --------

        The Company  generally  provides a one-year  warranty  on its  products.
        Estimated  warranty  expenses  are  accrued and charged to cost of goods
        sold when the related revenues are recognized.

        RESEARCH AND DEVELOPMENT COSTS
        ------------------------------

        Research and development expenditures are charged to expense in the year
        incurred.

                                       33
<PAGE>

                               C-PHONE CORPORATION

                          NOTES TO FINANCIAL STATEMENTS

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


2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  (Continued)

        DEFERRED FINANCING COSTS AND ORIGINAL ISSUE DISCOUNT
        ----------------------------------------------------

        In  March  1994,  the  Company  completed  a  private  placement  of the
        Company's  common stock and extendable  one-year  promissory notes (Note
        6). The  portion of the costs of the  private  placement  related to the
        promissory notes and the original issue discount related to the issuance
        of common stock were amortized over the term of the notes.  As the notes
        were repaid on August 26, 1994 in conjunction with the Company's initial
        public offering of stock (Note 7), all of the deferred finance costs and
        original issue  discount were  amortized  during the year ended February
        28, 1995 ("Fiscal 1995").

        NET LOSS PER SHARE
        ------------------

        Per-share  data has been  computed on the basis of the weighted  average
        number of shares of common stock  outstanding  during the year  adjusted
        for the August  1994  stock  split of one  additional  share for each 30
        shares of common  stock.  Common  stock  options  and  warrants  are not
        included  for the years  ended  February  28, 1997  ("Fiscal  1997") and
        February 29, 1996 ("Fiscal 1996") as they would be anti-dilutive.

        Pursuant  to  Securities  and  Exchange   Commission   Staff  Accounting
        Bulletins,  common  stock and common stock  options and warrants  issued
        during the twelve months  immediately  preceding the initial filing date
        of the public offering have been included in the calculations as if they
        were  outstanding  for all periods  presented  (using the Treasury Stock
        Method and the initial public offering price).

        In February  1997,  the  Financial  Accounting  Standards  Board  issued
        Statement of Financial  Accounting  Standards  No. 128 ("SFAS No. 128"),
        "Earnings  Per Share".  SFAS No. 128 is designed to improve the earnings
        per share  information  provided in financial  statements by simplifying
        the  existing   computational   guidelines,   revising  the   disclosure
        requirements and increasing  comparability of earnings per share data on
        an  international  basis.  This  pronouncement  is effective for periods
        ending after  December 15, 1997,  and is not expected to have a material
        impact on the Company's financial statements.

        ACCOUNTING FOR STOCK OPTIONS
        ----------------------------

         As permitted by Statement  of Financial  Accounting  Standards  No. 123
         ("SFAS  No.  123"),  "Accounting  for Stock  Based  Compensation",  the
         Company applies Accounting Principals Board Opinion No. 25, "Accounting
         for  Stock  Issued  to  Employees"  and  related   interpretations   in
         accounting for the 1994 Stock Option Plan (the "Plan"). Accordingly, no
         compensation  cost has been  recognized  for options  granted under the
         Plan except for $9,600  related to the fair value of services  received
         in exchange for options granted to a consultant.  However,  the Company
         has  disclosed in Note 9 the pro forma  effects had  compensation  cost
         been  determined  based on the fair  value of the  options at the grant
         date.

        RECLASSIFICATIONS
        -----------------

        Certain amounts in the Fiscal 1996 and Fiscal 1995 financial  statements
        have been reclassified to conform to the Fiscal 1997 presentation, which
        had no effect on previously reported net loss or shareholders' equity.

                                       34

<PAGE>
                               C-PHONE CORPORATION

                          NOTES TO FINANCIAL STATEMENTS

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


3.      CASH AND SHORT-TERM INVESTMENTS

        The  Company  places a  portion  of its cash and cash  equivalents  with
        various financial institutions. At times, such cash and cash equivalents
        may be in excess of the FDIC insurance limits. At February 28, 1997, the
        Company's cash equivalents  consisted primarily of discount notes issued
        by the United  States  Treasury or United  States  government  agencies.
        These  investments  all  mature  in less  than 90 days  from the date of
        purchase and it is the Company's  intention to hold them until maturity.
        The aggregate fair value of these investments approximated the amortized
        cost at February 28, 1997.

4.      INVENTORIES

        Inventories  consist of the  following at February 28, 1997 and February
29, 1996:
<TABLE>
<CAPTION>
                                                                              1997                         1996
                                                                              ----                         ----

<S>                                                                     <C>                         <C>        
        Raw materials                                                   $  985,914                  $   765,784
        Work in process                                                    304,839                      162,127
        Finished goods                                                      51,178                      133,585
                                                              --------------------         --------------------

                                                                        $1,341,931                   $1,061,496
                                                              ====================         ====================
</TABLE>

        All of the above  inventories  are C-Phone  related.  All data/fax modem
        inventory was liquidated, written off, or fully reserved in Fiscal 1995.

5.      PROPERTY AND EQUIPMENT

        Property and equipment consist of the following at February 28, 1997 and
February 29, 1996:
<TABLE>
<CAPTION>
                                                                     1997                      1996
                                                                     ----                      ----

<S>                                                                   <C>                       <C>       
        Machinery and equipment                                       $  965,711                $  897,448
        Furniture and fixtures                                            49,084                    45,851
        Leasehold improvements                                            71,895                    69,743
                                                              ------------------        ------------------

                                                                       1,086,690                 1,013,042
        Less accumulated depreciation
          and amortization                                               834,777                   704,794
                                                              ------------------        ------------------

                                                                      $  251,913                $  308,248
                                                              ==================        ==================
</TABLE>

         Depreciation  and  amortization  expense  was  $134,202,  $182,803  and
         $191,282 for Fiscal 1997, Fiscal 1996 and Fiscal 1995, respectively.

6.      BRIDGE FINANCING

        In March 1994,  the Company  issued 38 units (the "Units") of extendable
        one-year  promissory notes and common stock in a private  placement (the
        "Bridge  Financing").  Each  unit  consisted  of  a  $50,000  extendable
        one-year  7%  promissory  note ("7%  Notes")  with  interest  payable at
        maturity and 3,875

                                       35

<PAGE>
                               C-PHONE CORPORATION

                          NOTES TO FINANCIAL STATEMENTS

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

6.      BRIDGE FINANCING   (Continued)

        shares of common stock,  which was subject to adjustment  depending upon
        the  terms  of  certain  additional  financing.   The  Company  received
        $1,583,395  in cash  from  the  Bridge  Financing,  net of  $316,605  in
        expenses.  In August 1994, the Company repurchased  one-quarter (1/4) of
        one Unit for $11,250.  The 7% Notes were collateralized by substantially
        all of the Company's  assets and restricted the payment of dividends and
        the incurrence of additional indebtedness.

        As required  under their  terms,  the 7% Notes were repaid on August 26,
        1994 after completion of the Company's initial public offering (Note 7).
        At that time, the number of shares of common stock included in each Unit
        was  adjusted to 4,286  shares to provide for a value of $30,000,  based
        upon the  initial  public  offering  price of $7.00  per share of common
        stock.

        The original  issue  discount on the 7% Notes of $743,203,  representing
        the value  assigned by  management  to the shares of common stock issued
        with each Unit, and deferred financing fees of $191,319, net of $124,036
        of  expenses  related  to the  issuance  of the common  stock,  totaling
        $934,522,  was  amortized  over  the  term  of the 7%  Notes.  Upon  the
        repayment  of the 7% Notes,  an  additional  $108,528 of original  issue
        discount was  expensed,  based upon the value of the  additional  shares
        issued to the Unit holders as a result of the initial public offering.

7.      INITIAL PUBLIC OFFERING

        On August 26, 1994, the Company  completed the sale of 2,000,000  shares
        of  common  stock at an  initial  offering  price of  $7.00  per  share,
        resulting in net proceeds to the Company of  $12,288,051  after expenses
        of the offering totalling $1,711,949. The Company used $1,946,923 of the
        proceeds  to repay  principal  ($1,887,500)  of,  and  accrued  interest
        ($59,423) on, the 7% Notes (Note 6).

8.      SHAREHOLDERS' EQUITY

        In August  1994,  the Company  effected a stock split of one  additional
        share  for each 30  shares of common  stock.  All  numbers  of shares of
        common  stock and the per share  amounts in the  accompanying  financial
        statements   have   been   retroactively   adjusted   to   reflect   the
        aforementioned stock splits.

        In connection with the initial public  offering,  the Company granted to
        the managing  underwriter  warrants to purchase 200,000 shares of common
        stock at $8.40 per share.  The  warrants  may be  exercised  at any time
        until expiration on August 18, 1999.

        During  Fiscal  1997,  the Company  granted to a  consultant a five-year
        option to purchase  25,000  shares of common  stock at a price of $3.375
        per share (the market  price of the common  stock on the date of grant).
        The right to exercise certain of the shares subject to the option may be
        forfeited if the Company  terminates the consultant during the first six
        months of a one-year  consulting  agreement.  The option was  granted in
        partial payment for services to be rendered by the consultant  under the
        agreement,  which  services  the Company  has valued at $38,400.  During
        Fiscal  1997,  $9,600 of this  amount  was  expensed  and,  as a result,
        paid-in capital was increased by such amount.

                                       36

<PAGE>

                               C-PHONE CORPORATION

                          NOTES TO FINANCIAL STATEMENTS

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


9.      STOCK OPTION PLAN

        In connection with the initial public  offering,  the Board of Directors
        of the Company, subject to shareholder approval, adopted the Plan, which
        provides for the grant of options to officers, directors,  employees and
        consultants.   Options  may  be  either   incentive   stock  options  or
        non-qualified  stock options,  except that only employees may be granted
        incentive stock options.  In addition,  the Plan provided for a one-time
        grant to each  outside  director  of  non-qualified  options to purchase
        5,000  shares of common stock when such a director  initially  joins the
        Board.  The Board of  Directors  has  granted  additional  non-qualified
        options to the outside directors as part of their annual compensation.

        The  maximum  number of shares of common  stock  with  respect  to which
        options  may be  granted  under  the  Plan is  500,000  shares.  Options
        generally  vest over a period of three  years.  The  maximum  term of an
        option is ten years.  The Plan will  terminate  in August  2004,  though
        options granted prior to termination may expire after that date.

        Had  compensation  cost for the Plan been  determined  based on the fair
        value at the grant dates for awards under the Plan,  excluding the grant
        to the consultant discussed in Note 8 above,  consistent with the method
        of SFAS No.  123,  the  Company's  net loss and net loss per share would
        have increased to the pro forma amounts indicated below:
<TABLE>
<CAPTION>

                                                1997                            1996
                                     ---------------------------       ----------------------
                                         AS             PRO               AS             PRO
                                      REPORTED         FORMA           REPORTED         FORMA
                                      --------         -----           --------         -----
<S>                                    <C>            <C>               <C>            <C>   

        Net loss (in thousands)        $3,008         $3,108            $4,161         $4,191
        Net loss per share             $ 0.69         $ 0.71            $ 0.96         $ 0.96
</TABLE>


        The fair value of each option  grant is  estimated  on the date of grant
        using  the Black  Scholes  option-  pricing  method  with the  following
        weighted average  assumptions used for grants. The weighted average fair
        value of options  granted  during  Fiscal 1997 and Fiscal 1996 was $2.85
        and $3.51 per share, respectively.

                                          1997                       1996
                                          ----                       ----
        Dividend yield                      0%                         0%
        Expected volatility             138.8%                      43.3%
        Risk-free interest rate          6.25%                      6.25%
        Expected lives, in years            5                          5


                                       37

<PAGE>
                               C-PHONE CORPORATION

                          NOTES TO FINANCIAL STATEMENTS

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

9.      STOCK OPTION PLAN   (Continued)

        A summary of the status of the Plan at February  28,  1997 and  February
        29, 1996 and the changes during the years then ended is presented below:
<TABLE>
<CAPTION>

                                                          1997                                    1996
                                            ---------------------------------        ------------------------------
                                                                   WEIGHTED                               WEIGHTED
                                               SHARES               AVERAGE              SHARES           AVERAGE
                                             UNDERLYING            EXERCISE            UNDERLYING         EXERCISE
                                               OPTIONS               PRICE              OPTIONS            PRICE
                                            -------------         -----------        -------------      -----------
<S>                                               <C>                 <C>                  <C>              <C>  

        Outstanding at beginning of year          116,500             $7.34                106,950          $7.13
        Granted                                   189,150              3.18                 47,050           7.45
        Exercised                                  (8,100)             3.13                      0            -- 
        Forfeited                                 (22,350)             6.39                (37,500)          7.03
                                            -------------                            -------------

        Outstanding at end of year                275,200             $4.66                116,500          $7.34
                                            =============         =========          =============      =========

        Exercisable at end of year                 85,967             $6.01                 30,583          $7.21
                                            =============         =========          =============      =========
</TABLE>

        The following table summarizes information about stock options under the
Plan at February 28, 1997:
<TABLE>
<CAPTION>
                                      OPTIONS OUTSTANDING                            OPTIONS EXERCISABLE
                      ----------------------------------------------------   -----------------------------------

                                              WEIGHTED
                                              AVERAGE          WEIGHTED                             WEIGHTED
                                             REMAINING          AVERAGE                              AVERAGE
     RANGE OF              NUMBER           CONTRACTUAL        EXERCISE           NUMBER            EXERCISE
  EXERCISE PRICE         OUTSTANDING            LIFE             PRICE          EXERCISABLE           PRICE
-------------------   -----------------  ------------------  -------------   -----------------   ---------------
<C>     <C>                <C>                <C>                <C>              <C>                 <C>  

$2.38 - $3.38              170,900            4.6 years          $3.07            26,100              $3.18
$6.75 - $7.50              104,300            2.9 years          $7.23            59,867              $7.23
                      -----------------                                      ----------------

                           275,200                                                85,967
                      =================                                      ================
</TABLE>


10.     RELATED  PARTY  TRANSACTIONS

        In September  1994,  the Company repaid a note payable to a shareholder.
        The note was a demand note with  interest at a rate of 8% per annum.  In
        connection with this note, the Company  recognized  interest  expense of
        approximately $3,700 in Fiscal 1995.

        In March 1994,  the Company  received a repayment in full of a loan made
        in  February  1993  to two of  its  executive  officers,  who  are  also
        directors of the Company,  in the original principal amount of $126,575.
        Interest on the  outstanding  balance  accrued at a rate of 8% per annum
        and was collateralized by the shareholders' common stock in the Company.
        The Company  recognized  interest  income of $132 during  Fiscal 1995 on
        this loan.

        The Company leases its office,  manufacturing  and warehouse  space from
        two of its  executive  officers  who also are  directors  of the Company
        (Note 12).

                                       38
<PAGE>

                               C-PHONE CORPORATION

                          NOTES TO FINANCIAL STATEMENTS

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


11.     OBLIGATIONS UNDER CAPITAL  LEASES

        The Company leases certain  manufacturing  equipment,  with an aggregate
        cost of $68,674 and accumulated  depreciation of $66,413 at February 28,
        1997 and an aggregate cost of $76,008 and  accumulated  depreciation  of
        $65,559 at February 29, 1996.

        Obligations  under  the  capital  leases  consist  of the  following  at
February 28, 1997 and February 29, 1996:
<TABLE>
<CAPTION>

                                                             1997                      1996
                                                             ----                      ----
<S>                                                             <C>                       <C>

Capital leases payable in monthly  installments of 
  $1,506 and $1,682 for Fiscal 1997 and 1996,
  respectively, including interest, collateralized
  by manufacturing equipment having a net book 
  value of $2,261 at February 28, 1997 and $10,449 
  at February 29, 1996                                         $11,507                   $27,610
Less current maturities                                         11,507                    16,103
                                                      ------------------        ------------------

                                                               $   --                    $11,507
                                                      ==================        ==================
</TABLE>

        The following is a schedule of future  minimum lease  payments under the
        capital lease at February 28, 1997:

        Fiscal year ending February 28, 1998                          $12,046

        Less amounts representing interest                                539
                                                              -----------------

        Present value of future minimum lease payments                $11,507
                                                              =================


12.     COMMITMENTS

         The Company leases office,  manufacturing  and warehouse space totaling
         approximately 14,420 square feet from two of its executive officers who
         also are  directors of the  Company.  The initial term of the lease was
         for three years  commencing on May 1, 1993 with monthly rental payments
         of $5,000.  The Company  exercised its option to renew for a three year
         period ending April 30, 1999 and, according to the terms of the option,
         the monthly  rental  payments were  increased  beginning May 1, 1996 to
         $6,280. Under the lease, the Company is required to pay all real estate
         taxes and  maintenance  costs,  and  maintain  property  and  liability
         insurance on the leased property.

        The Company,  at its option,  may extend the lease term to April 2002 by
        exercising the remaining  three-year  renewal option and, in that event,
        the monthly  rental payment would be adjusted to the then current market
        rate, as defined, of similar space at the time of renewal.


                                       39

<PAGE>

                               C-PHONE CORPORATION

                          NOTES TO FINANCIAL STATEMENTS

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

12.     COMMITMENTS   (Continued)

        The  future  minimum   aggregate  lease  payments  under   noncancelable
        operating leases are as follows at February 28, 1997:

        FISCAL YEAR ENDING FEBRUARY 28,

        1998                                                         $  75,360
        1999                                                            75,360
        2000                                                            12,560
                                                               -----------------

                                                                      $163,280
                                                               =================

        Rent  expense was $72,800,  $60,000 and $60,000 in Fiscal  1997,  Fiscal
        1996, and Fiscal 1995, respectively.

13.     SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK

        At February 28, 1997 and February 29, 1996, the Company had  outstanding
        trade accounts  receivable from 33 and 51 customers,  respectively.  The
        Company  monitors  the  granting  of  credit to all its  customers  and,
        generally, no collateral is required.

        In each of Fiscal  1997,  Fiscal  1996 and Fiscal  1995,  there were net
        revenues  from two  major  customers  that  exceeded  10% of  total  net
        revenues. Net revenues from these customers were as follows:

<TABLE>
<CAPTION>
                                                 NET REVENUES
                        -------------------------------------------------------------

                               1997                  1996                  1995
                               ----                  ----                  ----
<S>                             <C>                    <C>                    <C>    

        Customer A                     --                     --            $ 402,802
        Customer B              $  31,678              $ 187,119              108,980
        Customer C                291,710                     --                   --
        Customer D                  5,864                184,063                   --
        Customer E                211,224                 58,325                   --
                        -----------------     ------------------    -----------------

                                $ 540,476              $ 429,507            $ 511,782
                        =================     ==================    =================
</TABLE>

                                       40

<PAGE>

                               C-PHONE CORPORATION

                          NOTES TO FINANCIAL STATEMENTS

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


13.     SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK   (Continued)

        Accounts receivable from these customers were as follows at February 28,
        1997 and February 29, 1996:

                                           ACCOUNTS RECEIVABLE
                            --------------------------------------------

                                   1997                       1996
                                   ----                       ----

        Customer A                          --                        --
        Customer B                     $17,417                 $  57,375
        Customer C                      30,066                        --
        Customer D                          --                    63,769
        Customer E                      51,938                    22,670
                            ------------------         -----------------

                                       $99,421                  $143,814
                            ==================         =================



        Customer A in the tables above was a purchaser of the Company's data/fax
        modems,  which product line was phased out during Fiscal 1995. Customers
        B, C, D and E are purchasers of the Company's C-Phone product line.

        Sales to customers located outside of North America, principally Europe,
        comprised approximately $294,000,  $103,000 and $556,000 of net revenues
        during Fiscal 1997, 1996 and 1995, respectively.  The Company's sales of
        C-Phone  related  products  during  Fiscal  1995 were  $245,206 in North
        America and $92,915 in Europe.  All sales in Fiscal 1996 and Fiscal 1997
        were sales of C-Phone related products.

14.     CONTINGENCIES

        The  Company  is  involved  in  various  legal   proceedings  which  are
        incidental to the conduct of its business. Although the final resolution
        of these matters cannot be determined,  it is management's  opinion that
        the final  outcome of these  matters  will not have a  material  adverse
        effect on the Company's financial position or results of operations.

15.     INCOME TAXES

        The components of the net deferred tax asset were as follows at February
        28, 1997 and February 29, 1996:
<TABLE>
<CAPTION>
                                                              1997                     1996
                                                     ------------------         ---------------
<S>                                                         <C>                    <C>         

        Net operating loss carryforwards                    $ 4,034,541            $  2,885,553
        Alternative minimum tax credit carryforwards              5,924                   5,924
        Allowance for doubtful accounts                          46,938                  66,496
        Research and development tax credit                     118,550                 102,186
        Other                                                   164,302                  97,870
        Valuation allowance                                  (4,370,255)             (3,158,029)
                                                     ------------------         ---------------

        Net deferred tax asset                              $        --            $         --
                                                     ==================         ===============
</TABLE>

                                       41

<PAGE>

                               C-PHONE CORPORATION

                          NOTES TO FINANCIAL STATEMENTS

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


15.     INCOME TAXES   (Continued)

        The Company provides a valuation  allowance for deferred tax assets that
        are not expected to be realized.  Due to the recent net losses  incurred
        by the  Company,  a valuation  allowance  has been  established  for all
        deferred tax assets.

        Reconciliation of differences between  the statutory U.S. Federal income
        tax rate and the Company's effective tax rate follows:

<TABLE>
<CAPTION>

                                                                1997                  1996                1995
                                                          -------------         -------------        -----------
<S>                                                               <C>                  <C>                 <C>  

        Federal statutory income tax rate                         (34)%                (34)%               (34)%
        State income taxes, net of federal benefit                 (5)                  (7)                 (2)
        Valuation allowance increase                               39                   41                  37
        Research and development tax credit                        --                   --                  (1)
                                                          -------------         -------------        -----------

                                                                   0%                    0%                  0%
                                                          =============         =============        ===========
</TABLE>


        The net  operating  loss  carryforwards  for Federal tax  purposes as of
        February 28, 1997 are estimated to be $10,233,000. The net economic loss
        carryforwards  for  state  tax  purposes  as of  February  28,  1997 are
        estimated   to  be   $10,482,000.   The  Federal  net   operating   loss
        carryforwards  expire in 2009  through  2012 and the state net  economic
        loss carryforwards  expire in 1999 through 2002. The equity transactions
        in Fiscal 1995 (Notes 6 and 7) resulted in a change in  ownership  which
        limits the  utilization  of  $1,658,436  of the  Company's  Federal  net
        operating  loss  carryforwards  to an  annual  amount  determined  under
        Section 382 of the  Internal  Revenue Code of 1986,  as amended.  As the
        Company  incurred  losses  during Fiscal 1995,  Fiscal 1996,  and Fiscal
        1997,  the unused annual  limitations  for such periods will be added to
        the annual limitation for Fiscal 1998.

16.     SUBSEQUENT EVENT

        During  the week of March 31,  1997,  the  Company  completed  a private
        placement  (the  "1997  Placement"),  through  Josephthal  Lyon  &  Ross
        Incorporated  ("JLR"),  as the  placement  agent,  pursuant to which the
        Company  issued an  aggregate  of  833,667  shares of common  stock (the
        "Original  Shares") to the  participants  (the  "Investors") in the 1997
        Placement. Accompanying each of the Original Shares was the right, under
        certain  circumstances,  to receive additional shares of common stock in
        accordance with the terms of a "contingent  value right" (the "Rights").
        The Company sold the Original  Shares and Rights at a price of $6.00 per
        Original  Share and received  net proceeds of  approximately  $4,370,000
        (net of fees and expenses of approximately $632,000).

        The Rights are  automatically  exercised  at the time,  and from time to
        time as, the Original  Shares are first  publicly  sold through a broker
        dealer  after  the  effective  date  (the   "Effective   Date")  of  the
        Registration  Statement  on Form  S-3  filed  by the  Company  with  the
        Securities  and  Exchange  Commission  on April 16,  1997  covering  the
        Original  Shares  and the  maximum  number of  shares  of  common  stock
        issuable  upon  exercise  of the  Rights,  and expire one year after the
        Effective  Date.  The terms of the Rights  provide that,  upon the first
        such  sale of any  Original  Shares  at a price of less  than  $8.00 per
        share, the seller of the Original Shares will automatically receive, for
        each such Original

                                       42

<PAGE>

                               C-PHONE CORPORATION

                          NOTES TO FINANCIAL STATEMENTS

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

 16.    SUBSEQUENT EVENT   (Continued)

        Share sold,  and without  the payment of any  additional  consideration,
        such  additional  number of shares of common  stock as equals  (i) $8.00
        divided by the Adjusted Price,  minus (ii) one; where the Adjusted Price
        will equal the greater of (x) the average closing bid price per share of
        common  stock on The Nasdaq  National  Market for the ten  trading  days
        immediately  preceding the date of sale of the Original  Shares,  or (y)
        $2.00.

        In  consideration  for JLR's  services  as  placement  agent in the 1997
        Placement,  the  Company  (i) paid JLR a fee of  $450,180  (or 9% of the
        gross  proceeds  received  by the Company in the 1997  Placement),  (ii)
        agreed to reimburse  JLR for its  out-of-pocket  expenses (not to exceed
        $25,000),  and (iii) issued to an affiliate of JLR,  warrants (the "1997
        Warrants") to acquire an aggregate of 150,000  shares of common stock at
        an exercise  price of $9.60 per share (120% of the closing bid price for
        the  common  stock on The  Nasdaq  National  Market on the  trading  day
        immediately prior to the first closing of the 1997 Placement).  The 1997
        Warrants  expire 90 days after the Effective  Date. The shares of common
        stock  issuable upon exercise of the 1994 Warrants and the 1997 Warrants
        have been included in the Registration Statement.

        The pro forma  balances  as of  February  28,  1997,  assuming  the 1997
        Placement had been  completed as of such date,  would have  reflected an
        increase  in cash and  cash  equivalents  and  shareholders'  equity  of
        $4,370,000.

                                       43

<PAGE>


ITEM 8.  CHANGES  IN  AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
         FINANCIAL DISCLOSURE
         -----------------------------------------------------------------------

         Coopers & Lybrand L.L.P.,  independent  accountants,  currently is, and
for more than the  Company's  last two  fiscal  years has  been,  the  Company's
independent  auditors.  Since the beginning of such two fiscal year period,  (i)
Coopers & Lybrand L.L.P. has not expressed reliance, in its audit report, on the
audit  services  of any  other  accounting  firm,  and (ii)  there  have been no
reported  disagreements  between the Company and Coopers & Lybrand L.L.P. on any
matter of accounting principles or practices,  financial statement disclosure or
auditing scope or procedure.

                                    PART III

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
         COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
         ------------------------------------------------------------

         The  information  required for this Item 9 is incorporated by reference
from the Company's  definitive  proxy  statement to be filed with the Securities
and Exchange Commission (the "Commission")  pursuant to Regulation 14A under the
Securities Exchange Act of 1934 ("Regulation 14A") within 120 days after the end
of the Company's fiscal year covered by this Annual Report on Form 10-KSB.

ITEM 10. EXECUTIVE COMPENSATION.
         ----------------------

         The information  required for this Item 10 is incorporated by reference
from the Company's  definitive  proxy  statement to be filed with the Commission
pursuant to Regulation 14A within 120 days after the end of the Company's fiscal
year covered by this Annual Report on Form 10-KSB.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
         --------------------------------------------------------------

         The information  required for this Item 11 is incorporated by reference
from the Company's  definitive  proxy  statement to be filed with the Commission
pursuant to Regulation 14A within 120 days after the end of the Company's fiscal
year covered by this Annual Report on Form 10-KSB.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
         ----------------------------------------------

         The information  required for this Item 12 is incorporated by reference
from the Company's  definitive  proxy  statement to be filed with the Commission
pursuant to Regulation 14A within 120 days after the end of the Company's fiscal
year covered by this Annual Report on Form 10-KSB.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
         --------------------------------

(a)  EXHIBITS.
     --------

   3.    Articles of incorporation and by-laws.

         3(i)     (a)      Restated Certificate of Incorporation of the Company,
                           as filed with the  Secretary of State of the State of
                           New York on February 24, 1994(1)

                  (b)      Certificate    of   Amendment   to   Certificate   of
                           Incorporation,  as filed with the  Secretary of State
                           of the State of New York on August 9, 1996(5)

         3(ii)    By-laws of the Company, as currently in effect(1)

                                       44
<PAGE>

   4.    Instruments   defining  the  rights  of  security  holders,   including
         indentures.

         4.1      Form of certificate representing shares of the Common Stock(2)

         4.2      Warrant Agreement,  dated August 20, 1994, between the Company
                  and Josephthal  Lyon & Ross  Incorporated  and form of Warrant
                  Certificate(2)

         4.3      Placement  Agent  Warrant  Agreement,  dated  March 31,  1997,
                  between the Company and  Josephthal  Lyon & Ross  Incorporated
                  and form of Warrant Certificate(6)

   9.    Voting trust agreement and amendments - None.

  10.    Material contracts.

         10.1     (a)      Lease,  dated May 1, 1993,  between  the  Company and
                           Daniel Flohr and Tina Jacobs(1)

                  (b)      Addendum,  dated as of May 1, 1996,  to  Indenture of
                           Lease,  between the Company and Daniel Flohr and Tina
                           Jacobs(4)

         10.2     (a)      Employment  Agreement,  dated as of  March  1,  1994,
                           between the Company and Daniel Flohr, as amended(3)

                  (b)      Amendment No. 2 to Employment Agreement,  dated as of
                           March  1,  1996,   between  the  Company  and  Daniel
                           Flohr(4)

         10.3     (a)      Employment  Agreement,  dated as of  March  1,  1994,
                           between the Company and Tina Jacobs, as amended(3)

                  (b)      Amendment No. 2 to Employment Agreement,  dated as of
                           March 1, 1996, between the Company and Tina Jacobs(4)

         10.4     Employment  Agreement,  dated as of December 30, 1993, between
                  the Company and Stuart Ross(1)

         10.5     Employment Agreement, dated as of August 15, 1996, between the
                  Company and David DeSimone

         10.6     C-Phone  Corporation  Amended and  Restated  1994 Stock Option
                  Plan and form of Option Agreement(4)

         10.7     Exclusive  Marketing and Distribution  Agreement,  dated as of
                  October 1, 1995 between the Company and C-Phone  Europe NV/SA,
                  as amended(4)

         10.8     Standard Form of Reseller Agreement(4)

         10.9     (a)      Placement  Agent  Agreement,  dated  March 31,  1997,
                           between  the  Company  and  Josephthal  Lyon  &  Ross
                           Incorporated(6)

                  (b)      Form of Securities  Purchase  Agreement,  dated March
                           31,  1997,  between the  Company and each  subscriber
                           party thereto,  with terms of Contingent Value Rights
                           granted thereby attached thereto(6)

                                       45
<PAGE>
                  (c)      Form of Registration  Rights  Agreement,  dated March
                           31,  1997,  between the  Company and each  subscriber
                           party thereto(6)

                  (d)      Stock Pledge Agreement, dated March 31, 1997, between
                           Daniel Flohr and Josephthal Lyon & Ross Incorporated,
                           as agent(6)

  11.    Statement re  computation  of per share  earnings - Not required  since
         such computation can be clearly  determined from the material contained
         in this report on Form 10-KSB.

  13.    Annual report to security  holders for the last fiscal year,  Form 10-Q
         or 10-QSB or quarterly report to security  holders,  if incorporated by
         reference in the filing - Not applicable.

  16.    Letter on change in certifying accountant - Not applicable.

  18.    Letter on change in accounting principles - Not applicable.

  21.    Subsidiaries of the small business issuer - None.

  22.    Published  report  regarding  matters  submitted  to vote  of  security
         holders - Not applicable.

  23.    Consent of experts and counsel

         23.1     Consent of Coopers & Lybrand L.L.P.

  24.    Power of attorney - Not applicable.

  27.    Financial Data Schedule

  28.    Information from reports  furnished to state  regulatory  authorities -
         Not applicable.

  99.    Additional Exhibits -  Not applicable.

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

  (1)    Incorporated  by reference to an Exhibit filed as part of the Company's
         Registration  Statement on Form S-1 (the "S-1 Registration  Statement")
         (Registration No. 33-80280), filed on June 14, 1994.

  (2)    Incorporated  by reference to an Exhibit filed as part of Amendment No.
         2 to the S-1 Registration Statement, filed on August 11, 1994.

  (3)    Incorporated  by reference to an Exhibit filed as part of Amendment No.
         1 to the S-1 Registration Statement, filed on July 21, 1994.

  (4)    Incorporated  by reference to an Exhibit filed as part of the Company's
         Annual  Report on Form  10-KSB for the fiscal year ended  February  29,
         1996.

  (5)    Incorporated  by reference to an Exhibit filed as part of the Company's
         Quarterly Report on Form 10-QSB for the fiscal quarter ended August 30,
         1996.

  (6)    Incorporated  by reference to an Exhibit filed as part of the Company's
         Current Report on Form 8-K, dated April 1, 1997.

                                       46

<PAGE>

(b) REPORTS ON FORM 8-K. No Reports on Form 8-K were filed by the Company during
the  fiscal  quarter  ended  February  28,  1997;  although a report on Form 8-K
(responding to Item 5 - "Other Events") was filed by the Company in April 1997.

                                       47

<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.

Dated: May 28, 1997

                               C-PHONE CORPORATION


                              By:  /s/ DANIEL P. FLOHR
                                  -----------------------------------
                                       Daniel P. Flohr, President and
                                       Chief Executive 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:

Dated:
May 28, 1997                       /s/ DANIEL P. FLOHR
                                  -----------------------------------
                                       Daniel P. Flohr
                                       President, Chief Executive Officer and 
                                       Director
                                      (Principal Executive Officer)


May 28, 1997                       /s/ TINA L. JACOBS
                                  -----------------------------------
                                       Tina L. Jacobs
                                       Director


May 28, 1997                       /s/ SEYMOUR L. GARTENBERG
                                  -----------------------------------
                                       Seymour L. Gartenberg
                                       Director


May 28, 1997                       /s/ E. HENRY MIZE
                                  -----------------------------------
                                       E. Henry Mize
                                       Director


May 28, 1997                       /s/ DONALD S. MCCOY
                                  -----------------------------------
                                       Donald S. McCoy
                                       Director


May 28, 1997                       /s/ STUART E. ROSS
                                  -----------------------------------
                                       Stuart E. Ross
                                       Director


May 28, 1997                       /s/ PAUL H. ALBRITTON
                                  -----------------------------------
                                       Paul H. Albritton
                                       Vice President and
                                       Chief Financial Officer
                                      (Principal Financial and 
                                       Accounting Officer)


                                       48