EXHIBIT 13

         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                              RESULTS OF OPERATIONS


General
The Company  develops and markets  proprietary  music  technology  products that
enhance  music  learning  and  composition,   increase   productivity  and  make
practicing and performing  music fun. On December 31, 1992, the Company acquired
Coda Company, a partnership with an established music notation software business
and a reputation for producing quality music technology  products.  Coda Company
also had established  distribution  relationships and an existing infrastructure
with product development, sales, marketing and administrative capabilities.

Following  the  acquisition,  the primary  business of the Company  consisted of
enhancing,  marketing  and  selling  Finale  products  while  developing  Vivace
products.  In June 1994,  the first test  markets  of the  Vivace  product  were
launched. After receiving an encouraging response from music educators and music
students,  the Company began the process of building a dealer network in January
1995.  The  Company  anticipates  that  revenues  from the Vivace  product  will
increase as the dealer network expands and gains experience, as well as with the
introduction of stronger and more focused marketing  efforts by the Company.  In
the  spring of 1996,  the  Company  released  new  configurations  of the Vivace
product at lower suggested  retail prices together with upgraded  features which
now  include  an  application  for  vocalists.  With a  long-term  objective  of
penetrating  the amateur music making  market,  the Company  intends to continue
adapting its product to technologies with lower cost and to expand the amount of
repertoire available for use with the Vivace product.

The Company has  incurred  losses from  operations  since  inception  and has an
accumulated deficit of $8,455,977 as of December 31, 1996. In November 1996, the
Company reduced its headcount by 17 positions to align fixed operating  expenses
with current revenues.

Results of operations
For the year ended  December  31, 1996  compared to the year ended  December 31,
1995- 

Net  Revenues.  Revenues for 1996 were  $565,900  higher than revenues for
1995.  This total  increase  reflects a 99% increase in revenues from the Vivace
Intelligent Accompaniment product, offset by a 10% decrease in revenues from the
Finale music notation product.

Vivace  product  revenues  in 1996  included  the  sale of  approximately  2,000
application   systems  (modular  systems,   soundcard   products,   or  software
applications) compared to 700 application sales in 1995. The unit increase had a
lower  percentage  impact  on  revenue  due to price  reductions.  In  addition,
approximately  26,000 repertoire  cartridges were sold in 1996 compared to 4,500
repertoire cartridges sold in 1995.




<PAGE>



The  decrease  in music  notation  product  sales  resulted  from  the  delay in
releasing  the Finale 3.7  upgrade.  This delay  impacted  sales to the academic
market and pushed sales of upgrades into 1997.

Gross profit.  The 1996 gross profit  percentage of 66% compared  unfavorably to
the 1995 gross profit  percentage  of 76%.  The  decrease in gross  profits from
$3,737,053  in 1995 to  $3,626,593  in 1996 is  attributable  to the decrease in
sales of the higher margin music  notation  product,  a reduction in pricing for
the Vivace  application and the impact of introductory  promotional  pricing for
the Vivace product.

Sales and marketing expenses. Sales and marketing expenses of $2,652,620 in 1996
increased $270,753 or 11% compared to 1995. This increase is due to the addition
of personnel and travel costs  associated  with  expanding  distribution  of the
Vivace product. The Company had approximately 100 dealers for its Vivace product
as of December 31, 1996, compared to 40 dealers as of December 31, 1995.

Product development expenses.  The Company expensed product development costs of
$1,306,570 in 1996 and capitalized  costs incurred in repertoire  development of
$476,921.  This compares to a total of $1,382,051  incurred for  repertoire  and
product   development  in  1995.  The  increased  total  investment  in  product
development is due to the Company's  decision to accelerate  the  development of
lower cost technologies for the Vivace  application and to broaden the amount of
repertoire available.

General and  administrative  expenses.  General and  administrative  expenses of
$1,549,281  in 1996 were $129,365  less than the amount  incurred in 1995.  This
decrease is primarily attributable to lower compensation costs.

Interest  income,  net. The Company had net interest  income of $110,832 in 1996
compared to $55,090 in 1995. The increased  income results from the availability
of proceeds from the Company's  initial public offering for a full year in 1996.
The  offering  proceeds  were  received in July,  1995,  so the company only had
interest earnings for a portion of the year in 1995.

Net loss.  The net loss of  $1,771,046  for 1996 exceeds the loss of  $1,650,421
incurred in 1995.  This increase in the loss is  attributable  to the changes in
revenues and costs described above.



<PAGE>

Income Taxes

In accordance with Section 382 of the Internal  Revenue Code of 1986, as amended
(the "Code"),  a change in ownership of greater than 50% of the Company within a
three-year  period results in an annual  limitation on the Company's  ability to
utilize its net operating loss ("NOL") carryforward which accrued during the tax
periods prior to the change in ownership.  As of December 31, 1996,  the Company
had an NOL  carryforward of  approximately  $4,800,000 which begins to expire in
2005.  The  amount of the  Company's  taxable  income  that may be  offset  with
pre-ownership  change net operating loss  carryforwards  is limited  annually to
approximately $1,000,000.


Liquidity and Capital Resources

In July 1995, the Company  received net proceeds of $5,891,725  from the initial
public offering of 1,135,000  shares of its common stock. The proceeds were used
to repay  subordinated  debt and accrued interest totaling  $1,262,592,  and the
remainder was invested in short-term securities.

The  Company  has a $500,000  line of credit  with a bank which has been used to
finance its  working  capital  requirements.  The  borrowings  under the line of
credit bear interest at 1% over the bank's reference rate and are collateralized
by all of the accounts  receivable,  inventory  and general  intangibles  of the
Company.  Among other  requirements,  the loan agreement requires the Company to
maintain  minimum  levels of tangible  net worth,  as defined in the  agreement.
While  the  agreement  is in  effect,  the  Company  may  not  incur  additional
indebtedness, liquidate or merge the Company, pay dividends or acquire any other
entity without the prior approval of the lender.  Further,  a 25% or more change
in ownership of the Company constitutes an event of default under the agreement.
As of December 31, 1996,  there were no borrowings  under the line of credit and
the Company was in compliance with all terms of the agreement, as amended.

Net cash used in operating  activities totaled $1,925,381 in 1996 and $1,516,423
in 1995.  In  addition,  the Company made capital  expenditures  for  furniture,
equipment and fixtures of $344,477 in 1996 and $189,601 in 1995.

The Company  anticipates  that capital  expenditures  for 1997 will  approximate
$150,000.  Management  believes  existing  cash and proceeds from line of credit
borrowings,  together  with funds  generated  from the sale of products  will be
sufficient  to fund its capital  expenditure,  product  development  and working
capital  requirements  though 1997.  However,  additional  capital may be sought
through a new line of credit  with a bank,  asset  based  lending or the sale of
equity.  No  assurance  can be given  that such  capital  will be  available  or
available on terms favorable to the Company.  The sale of equity interests would
dilute the ownership of current  shareholders.  If  additional  equity funds are
obtained,  the Company will  accelerate the development of repertoire and expand
marketing efforts to reach the student and consumer markets for its products.



<PAGE>


Future Results

The Company  cautions  investors  that actual  results of future  operations may
differ from those  anticipated in forward looking  statements due to a number of
factors  including  market  acceptance of the  Company's  Vivace  products,  the
potential  need for  additional  capital,  the need for  additional  product and
repertoire  development work,  dependence on sales to schools and key customers,
fluctuations in operating  results,  competition,  dependence on suppliers,  and
dependence on proprietary  technology.  For a more complete  description of such
factors, see "Cautionary  Statements " under Item I of the Company's Form 10-KSB
for the year ended December 31, 1996.


Common Stock Price Ranges

The  Company's  Common  Stock trades on The Nasdaq  SmallCap  Market tier of The
Nasdaq Stock Market under the symbol:  COMT. The following  table sets forth the
quarterly  high and low  trade  prices  from  June  29,  1995  (the  date of the
Company's initial public offering) to December 31, 1996:

<TABLE>
<CAPTION>

                                        1995                                               1996
                   ----------------------------------------------     -----------------------------------------------
     Quarter                 High                    Low                           High                     Low
     -------                 ----
<S>                          <C>                    <C>                            <C>                     <C>    
First                                                                              $5.25                   $3.00
Second                       $6.00                  $6.00                           5.50                    4.00
Third                         6.75                   6.00                           5.50                    3.50
Fourth                        6.88                   4.38                           3.94                    1.50

</TABLE>


As of December 31, 1996, there were  approximately 170 shareholders of record of
the  Company's  Common  Stock.  In  addition,  the  Company  estimates  that  an
additional  1,450  shareholders  own stock held for their  accounts at brokerage
firms and financial  institutions.  The Company has never paid cash dividends on
any of its securities.  The Company currently intends to retain any earnings for
use in its  operations  and does not  anticipate  paying cash  dividends  in the
foreseeable future.


<PAGE>



                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS




To Coda Music Technology, Inc.:
We have audited the accompanying  balance sheets of Coda Music Technology,  Inc.
(a  Minnesota  corporation)  as of December  31, 1996 and 1995,  and the related
statements of operations, shareholders' equity and cash flows for the years then
ended.  These  financial  statements  are the  responsibility  of the  Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements  based on our audits.  We  conducted  our audits in  accordance  with
generally accepted auditing standards.  Those standards require that we plan and
perform the audit to obtain  reasonable  assurance  about  whether the financial
statements are free of material misstatement.  An audit includes examining, on a
test basis,  evidence  supporting  the amounts and  disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable  basis for our opinion.  In our  opinion,  the  financial  statements
referred to above  present  fairly,  in all  material  respects,  the  financial
position of Coda Music  Technology,  Inc. as of December 31, 1996 and 1995,  and
the results of its  operations  and its cash flows for the years then ended,  in
conformity with generally accepted accounting principles.


                                             /s/ ARTHUR ANDERSEN LLP



Minneapolis, Minnesota,
   February 14, 1997





<PAGE>

<TABLE>
<CAPTION>


                                            CODA MUSIC TECHNOLOGY, INC.

                                                  Balance Sheets

                                                 As of December 31


                                                                                         1996                  1995
<S>                                                                                     <C>                   <C>
ASSETS
CURRENT ASSETS:
   Cash and cash equivalents                                                            $ 1,174,293           $ 2,499,476
   Short-term investments                                                                         -             1,460,798
   Accounts receivable, less allowance of $25,000 and $20,000                               596,946               405,528
   Inventories                                                                              983,375               563,741
   Prepaid royalties                                                                        118,470                91,117
   Other current assets                                                                      53,102               124,676

               Total current assets                                                       2,926,186             5,145,336
                                                                                        -----------            ----------
EQUIPMENT, FURNITURE AND FIXTURES, less accumulated
   depreciation of $671,791 and $669,918                                                    494,811               466,592

REPERTOIRE DEVELOPMENT COSTS, net of accumulated
   amortization of $48,298                                                                  476,921                     -

OTHER ASSETS                                                                                183,916                93,526
                                                                                        -----------            ----------
                                                                                        $ 4,081,834           $ 5,705,454
                                                                                        ===========            ==========

   LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
   Accounts payable                                                                     $   366,271           $   343,392
   Accrued expenses                                                                         516,146               582,398
   Deferred revenue                                                                         201,927               122,692
                                                                                        -----------            ----------
               Total current liabilities                                                  1,084,344             1,048,482
                                                                                        -----------            ----------
COMMITMENTS AND CONTINGENCIES (Note 6)

SHAREHOLDERS' EQUITY (Note 4):
   Common Stock, without par value, 15,000,000 shares
      authorized; 4,327,035 and 4,261,288 issued and outstanding                         11,453,467            11,341,903
   Accumulated deficit                                                                   (8,455,977)           (6,684,931)
                                                                                        -----------            ----------
               Total shareholders' equity                                                 2,997,490             4,656,972
                                                                                        -----------            ----------
                                                                                        $ 4,081,834           $ 5,705,454
                                                                                        ===========            ==========
</TABLE>

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




<PAGE>


                                            CODA MUSIC TECHNOLOGY, INC.

                                              Statements of Operations

                                          For the Years Ended December 31

<TABLE>
<CAPTION>

                                                                                          1996            1995
<S>                                                                                   <C>               <C>  

NET REVENUES                                                                          $ 5,500,158       $ 4,934,258

COST OF SALES                                                                           1,873,565         1,197,205
                                                                                        ---------         ---------
GROSS PROFIT                                                                            3,626,593         3,737,053
                                                                                        ---------         ---------
OPERATING EXPENSES:
   Sales and marketing                                                                  2,652,620         2,381,867
   Product development                                                                  1,306,570         1,382,051
   General and administrative                                                           1,549,281         1,678,646
                                                                                        ---------         ---------
               Total operating expenses                                                 5,508,471         5,442,564
                                                                                        ---------         ---------
LOSS FROM OPERATIONS                                                                   (1,881,878)       (1,705,511)

INTEREST INCOME, net                                                                      110,832            55,090
                                                                                        ---------         ---------
               Net loss                                                               $(1,771,046)      $(1,650,421)
                                                                                        =========         =========

WEIGHTED AVERAGE COMMON AND COMMON
   EQUIVALENT SHARES OUTSTANDING (Note 2)                                               4,300,411         3,767,967
                                                                                        =========         =========
NET LOSS PER COMMON AND COMMON EQUIVALENT
   SHARE (Note 2)                                                                     $      (.41)      $      (.44)
                                                                                        ==========        =========

</TABLE>

        The accompanying notes are an integral part of these statements.





<PAGE>



                           CODA MUSIC TECHNOLOGY, INC.

                       Statements of Shareholders' Equity

                        For the Years Ended December 31


<TABLE>
<CAPTION>


                                                   Convertible Preferred Stock        Common Stock      Accumulated
                                                        Shares      Amount         Shares     Amount      Deficit      Total

<S>                                                  <C>          <C>           <C>         <C>          <C>          <C>
BALANCE, December 31, 1994                            4,916,500   $5,008,993     1,320,052  $   425,185  $(5,034,510) $  399,668
   Conversion of Convertible Preferred Stock
      to Common Stock (Note 4)                       (4,916,500)  (5,008,993)    4,916,500    5,008,993            -           -
   Effects of 1-for-2 reverse stock split (Note 4)            -            -    (3,118,264)           -            -           -
   Sale of Common Stock, net of offering costs                -            -     1,135,000    5,891,725            -   5,891,725
   Exercise of stock warrants                                 -            -         8,000       16,000            -      16,000
   Net loss                                                   -            -             -            -   (1,650,421) (1,650,421)
                                                      ---------    ---------     ---------    ---------    ---------   ---------
BALANCE, December 31, 1995                                    -            -     4,261,288   11,341,903   (6,684,931)  4,656,972
   Stock options exercised                                    -            -        65,747      111,564            -     111,564
   Net loss                                                   -            -             -            -   (1,771,046) (1,771,046)
                                                      ---------    ---------     ---------   ----------    ---------   ---------
BALANCE, December 31, 1996                                    -   $        -     4,327,035  $11,453,467  $(8,455,977) $2,997,490
                                                      =========    =========     =========   ==========    =========   =========

</TABLE>


        The accompanying notes are an integral part of these statements.





<PAGE>

                                            CODA MUSIC TECHNOLOGY, INC.

                                             Statements of Cash Flows

                                           For the Years Ended December 31

<TABLE>
<CAPTION>

                                                                                           1996                   1995
<S>                                                                                     <C>                   <C>    
OPERATING ACTIVITIES:
   Net loss                                                                             $(1,771,046)          $(1,650,421)
   Adjustments to reconcile net loss to net cash used in
      operating activities-
         Depreciation and amortization                                                      372,796               274,611
         Change in current assets and liabilities:
            Accounts receivable                                                            (191,418)               49,924
            Inventories                                                                    (419,634)              (27,633)
            Prepaid royalties                                                               (27,353)               (9,492)
            Other current assets                                                             71,574               (39,979)
            Accounts payable                                                                 26,717              (285,490)
            Accrued expenses                                                                (66,252)              149,365
            Deferred revenue                                                                 79,235                22,692
                                                                                          ---------             ---------       
               Net cash used in operating activities                                     (1,925,381)           (1,516,423)
                                                                                          ---------             ---------
INVESTING ACTIVITIES:
   Purchases of equipment, furniture and fixtures                                          (344,477)             (189,601)
   Capitalized repertoire development cost                                                 (525,219)                    -
   Change in other assets                                                                   (98,630)              (93,526)
                                                                                          ---------             ---------
               Net cash used in investing activities                                       (968,326)             (283,127)
                                                                                          ---------             ---------
FINANCING ACTIVITIES:
   Proceeds from initial public offering, net of offering costs                                   -             5,891,725
   Proceeds from subordinated debt                                                                -               700,000
   Repayment of subordinated debt                                                                 -            (1,200,000)
   Sale (purchase) of short-term investments                                              1,460,798            (1,460,798)
   Proceeds from stock options and warrants exercised                                       111,564                16,000
   Repayment of short-term borrowings                                                             -              (300,000)
   Repayment of long-term debt                                                               (3,838)              (32,628)
                                                                                          ---------             ---------
               Net cash provided by financing activities                                  1,568,524             3,614,299
                                                                                          ---------             ---------
NET INCREASE (DECREASE) IN CASH AND
   CASH EQUIVALENTS                                                                      (1,325,183)            1,814,749

CASH AND CASH EQUIVALENTS, beginning of year                                              2,499,476               684,727
                                                                                          ---------             ---------
CASH AND CASH EQUIVALENTS, end of year                                                  $ 1,174,293           $ 2,499,476
                                                                                          =========             =========
</TABLE>

        The accompanying notes are an integral part of these statements.





<PAGE>

                           CODA MUSIC TECHNOLOGY, INC.

                          Notes to Financial Statements

                           December 31, 1996 and 1995


1.   Organization and Nature of Business:

Coda Music Technology, Inc. (the Company) develops and markets proprietary music
technology  products  that  enhance  music  learning and  composition,  increase
productivity  and make  practicing  and  performing  music  fun.  The  Company's
innovative products provide easy-to-use,  efficient  alternatives to traditional
practice,  education and  composition  techniques.  The  Company's  products are
marketed primarily in North America,  Japan and Europe.  International  revenues
represented 20% and 21% of 1996 and 1995 revenues, respectively. 

The  Company  was  organized  in November  1990 under the name  Vivace,  Inc. On
December 31, 1992, the Company  acquired Coda Company and  subsequently  changed
Vivace, Inc.'s name to Coda Music Technology, Inc. The acquisition was accounted
for  using  the  purchase  method  of  accounting,  and  the  acquired  software
technology was amortized  over the two-year  period ended December 31, 1994. 

The Company has incurred  losses since inception and at December 31, 1996 had an
accumulated  deficit  of  $8,455,977,  which  includes  amortization  expense of
software acquired of $2,309,036.  Management believes cash equivalents, its line
of credit and funds  generated  from the sale of products  will be sufficient to
meet operating requirements in 1997.

2.   Summary of Significant Accounting Policies:

Cash Equivalents and Short-Term Investments

Cash equivalents consist of money market instruments with original maturities of
90 days or less.  Short-term  investments  consist of U. S. Treasury  securities
with original  maturities  of 12 months or less which are not cash  equivalents.
Cash  equivalents  and  short-term  investments  are  recorded  at  cost,  which
approximates  fair  value.  All  short-term  investments  are  considered  to be
available for sale.

Inventories

Inventories  are stated at the lower of first-in,  first-out  cost or market and
consist of finished products and components.

Equipment, Furniture and Fixtures

Equipment,  furniture and fixtures are stated at cost and are depreciated  using
the straight-line method over their estimated useful lives of two to five years.
Repairs and maintenance are charged to expense as incurred.

Repertoire Development Costs

Effective January 1, 1996, the Company began to capitalize the costs incurred in
the  development  of repertoire  software  since sales  history  related to such
software  had been  established.  In  accordance  with  Statement  of  Financial
Accounting Standards (SFAS) No. 86, "Accounting for the Costs of Computer



<PAGE>


Software to Be Sold, Leased, or Otherwise Marketed," the Company has capitalized
$525,219 of costs incurred in the  development  of  repertoire.  These costs are
amortized using the straight-line  method over the economic lives of the assets,
not to exceed five years,  beginning when the repertoire  products are released.
Other  product   development  costs  associated  with  development  of  software
applications  are charged to expense since the costs incurred  between the point
the technological feasibility of these products is established and the time when
such  products  are   available  for  general   release  to  customers  has  not
historically been significant.

Patents and Trademarks

The  Company  capitalizes  the  costs  associated  with  obtaining  patents  and
trademarks.  These costs are being amortized over the estimated  useful lives of
the assets, not to exceed 20 years.

Revenue Recognition

Revenues and related cost of sales are recorded at the time of shipment.  In the
event that  software  upgrade  rights are  granted  to  customers  at no charge,
associated revenues are deferred until shipment of the upgrade. Costs related to
insignificant obligations, which include telephone support, are accrued.

Income Taxes

The Company  accounts  for income  taxes  using the  liability  method,  whereby
deferred  taxes are based on the  estimated  future tax  effects of  differences
between the financial  statement and tax bases of assets and liabilities,  given
the provisions of enacted tax laws.

Net Loss Per Common and Common Equivalent Share

Net loss per common and common  equivalent  share was  computed by dividing  net
loss by the weighted  average number of shares of Common Stock, and common stock
equivalents  have been excluded from the calculation as their inclusion would be
antidilutive.  For the  computation of common and common  equivalent  shares for
1995, the Convertible Preferred Stock issued during the 12-month period prior to
the initial public offering of Common Stock, at prices below the offering price,
is  included  in  the  calculation  as if it was  outstanding  for  all  periods
presented using the treasury stock method.

Use of Estimates

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

3.   Debt:

Line of Credit

The Company has a $500,000 line-of-credit agreement that expires on February 14,
1998.  There were no  borrowings  outstanding  as of December 31, 1996 and 1995.
Borrowings  under  the  agreement  are  limited  to  75%  of  eligible  accounts
receivable plus 25% of eligible inventories, as defined, bear interest at the



<PAGE>


bank's  reference  rate  (8.25%  as of  December  31,  1996)  plus  1%  and  are
collateralized  by all of  the  accounts  receivable,  inventories  and  general
intangibles  of the Company.  The loan  agreement  supporting the line of credit
requires the Company to maintain  certain  levels of tangible  net worth.  While
this agreement is in effect, the Company may not incur additional  indebtedness,
liquidate  or merge the  Company,  pay  dividends  or acquire  any other  entity
without  the prior  approval  of the  lender.  Further,  a 25% or more change in
ownership of the Company constitutes an event of default under the agreement. At
December  31, 1996,  the Company was in  compliance  with all  covenants of this
agreement, as amended.

4.   Shareholders' Equity:

Authorized Shares

The Company's  Restated  Articles of  Incorporation  authorized  the issuance of
30,000,000  shares of no par value capital  stock.  Of such  authorized  shares,
15,000,000 have been designated as common shares and 15,000,000 are undesignated
as of December 31, 1996.

Initial Public Offering of Common Stock and Recapitalization

During June and July 1995, the Company  completed an initial public  offering of
its Common Stock  through the  issuance of 1,135,000  shares of Common Stock for
net proceeds of $5,891,725. In conjunction with the initial public offering, the
Company's  Convertible  Preferred Stock  outstanding was converted into an equal
number of shares of Common Stock on a  share-for-share  basis. In addition,  the
Company  effected a 1-for-2 reverse stock split.  All per share  information has
been restated to reflect the reverse stock split.

Stock Options

The Company has a stock option plan  pursuant to which options for up to 775,000
shares  of its  Common  Stock  may be issued  to key  employees,  directors  and
officers of the  Company.  The options vest over periods of up to five years and
are granted at prices  which must be at least equal to the fair market  value of
the Common Stock at the date of grant. The Company has also granted nonqualified
stock options to key  employees,  directors  and  investors of the Company.  The
options  vest over  periods of up to four years and have been  granted at prices
which were  equal to the fair  market  value of the Common  Stock at the date of
grant.





<PAGE>

The following summarizes stock issued under the Company's stock option plans.
                                                                     Weighted
                                                                      Average
                                                     Outstanding       Price

Balance at December 31, 1994                           533,598          $1.98
   Granted                                              91,501           4.77
   Canceled                                           (136,520)          2.15
                                                       -------          -----
Balance at December 31, 1995                           488,579           2.44
   Granted                                             266,000           3.17
   Exercised                                           (65,747)          1.70
   Canceled                                           (116,296)          2.08
                                                       -------          -----
Balance at December 31, 1996                           572,536          $2.94
                                                       =======          =====
Exercisable at December 31, 1996                       308,653          $2.57
                                                       =======          =====

The Company accounts for stock options under Accounting Principles Board Opinion
No. 25, under which no compensation  cost has been recognized.  Had compensation
cost for these options been determined consistent with SFAS No. 123, "Accounting
for Stock-Based  Compensation,"  the net loss and loss per share would have been
increased to the following pro forma amounts:
                                                      1996            1995

Net loss                 As reported             $(1,771,046)     $(1,650,421)
                         Pro forma                (2,195,037)      (1,826,745)
Net loss per share       As reported                    (.41)            (.44)
                         Pro forma                      (.51)            (.48)


All options  outstanding at December 31, 1996 were granted with exercise  prices
equal to the fair  market  value of the Common  Stock at the date of grant.  The
Company's Common Stock price at December 31, 1996 was $1.95,  which is below the
exercise price of all options issued during 1996 and 1995. However, for purposes
of  calculating  the above  required  disclosure,  the fair value of each option
grant is estimated on the date of grant using the  Black-Scholes  option pricing
model with the following  weighted  average  assumptions used for grants in 1996
and 1995, respectively: risk-free interest rates of 5.21% and 6.51%, no expected
dividend yield, expected lives of seven years and expected volatility of 53% and
22%. The weighted average fair value of options granted during 1996 and 1995 was
$1.92 and $1.99, respectively. Options issued during 1995 and 1996, which remain
outstanding  at December  31, 1996,  have an exercise  price  between  $2.40 and
$6.00,  a  weighted  average  exercise  price of $3.66  and a  weighted  average
remaining contractual life of 5.9 years.

Warrants

In  connection  with  certain  financing  transactions,  the  Company has issued
warrants to purchase  381,584 shares of Common Stock at prices between $2.00 and
$7.20 per share,  exercisable  over periods of five to seven years from the date
of grant. Warrants outstanding at December 31, 1996 totaled 373,334.



<PAGE>


5.  Income Taxes:

For income tax reporting purposes, net operating loss carryforwards approximated
$4,821,000  as of  December  31,  1996 and begin to expire in 2005.  A valuation
allowance  equal to the full amount of the related  deferred  tax asset has been
established  due to the  uncertainty of its  realization.  Certain  restrictions
under the Tax Reform Act of 1986,  caused by the change in  ownership  resulting
from sales of Common Stock,  limit annual  utilization of the net operating loss
carryforwards.  The amount of the  Company's  taxable  income that may be offset
with preownership change net operating loss carryforwards is limited annually to
approximately $1,000,000.

6.   Commitments and Contingencies:

Operating Leases

The  Company  leases  office and  warehouse  space and certain  equipment  under
operating  leases through 1998. The future minimum lease payments as of December
31, 1996 under these leases are $102,000 in 1997 and $6,000 in 1998.

Licensing and Exclusivity Agreements

The  Company has  entered  into  license/exclusivity  agreements  which  require
payments  based on sales of its  products  or,  in some  cases,  annual  minimum
payments. Minimum royalties pursuant to an agreement with a significant licensor
are as follows:

1997                                                           $  100,000
1998                                                              200,000
1999                                                              300,000
2000                                                              300,000
2001 and thereafter                                             1,350,000


Royalty expense,  including amounts related to the agreement  referred to above,
totaled  $217,018  and  $123,734 in the years ended  December 31, 1996 and 1995,
respectively,  and  are  reflected  as a  component  of  cost  of  sales  in the
accompanying statements of operations.

Employment Agreements

Effective January 1, 1996, the Company entered into an employment agreement with
an officer which  requires the Company to pay the officer one year's base salary
of $150,000 plus medical insurance premiums, in the event of termination.

401(k) Savings Plan

The Company has  established a 401(k)  savings plan for the benefit of qualified
employees.  Under the plan,  qualified employees may elect to defer up to 15% of
their  compensation,  subject  to a maximum  limit  determined  by the  Internal
Revenue Service.  The Company, at the discretion of the board of directors,  may
elect to make additional contributions. The Company has made no contributions to
the plan as of December 31, 1996.

7.  Related-Party Transactions:

Management Fee

The  Company  paid  management  fees  totaling  $24,000  during the years  ended
December 31, 1996 and 1995 to an affiliate of a director for management services
provided to the Company.