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.

The Company  acquired  the Finale  product on December 31, 1992 and enhanced and
marketed this product while developing Vivace(R) accompaniment products. In June
1994,  the first test markets of the Vivace product were launched with a modular
system product at a suggested retail price of $2,295. In the spring of 1996, the
Company  released new  configurations  of the Vivace product at lower  suggested
retail  prices  together  with  upgraded  features  which  included  support for
vocalists.  The Company  announced in July 1997 the  introduction  of a software
version of the product with a suggested  retail  price of $199 and  repositioned
the product as a complete practice system, the Vivace Practice  Studio(TM).  The
Company began shipping this new product in the fourth quarter of 1997.

To date, the Company's marketing efforts have been primarily directed toward the
retail music dealer  channel,  with a long-term  objective  of  penetrating  the
amateur musician market.  As the Company adapts its product to technologies with
lower cost and  continues  to expand  the  amount  and styles of  accompaniments
available for use with the Vivace product, the Company's  distribution  channels
will change.  The Company  cannot predict the time it will take to establish new
methods of distribution  which will more effectively  reach the student and home
markets.

The Company has  incurred  losses from  operations  since  inception  and has an
accumulated deficit of $9,968,214 as of December 31, 1997.

Results of operations

For the year ended  December  31, 1997  compared to the year ended  December 31,
1996-Net  revenues.  Revenues  for 1997 were $62,947  higher than  revenues for
1996.  This total  increase  reflects a 20% increase in revenues from the Finale
music  notation  product,  offset by a 35% decrease in revenues  from the Vivace
Intelligent  Accompaniment(R)  product.  The increase in Finale revenue  results
from a change in the timing of the release of product  upgrades between years as
well as an increase  in the price of the Finale for  Macintosh  upgrade  between
years. As the Company transitioned the Vivace Intelligent  Accompaniment product
to its new software version,  Vivace revenues  decreased 35% due to transitional
price  decreases  implemented  in July 1997,  stock  balancing  and unit  volume
changes.  The Company sold 2,600 Vivace applications in 197, a 30% increase over
the number of units sold  during  1996.  The  number of  application  cartridges
declined  from 26,000  units in 1996 to 19,000 units in 1997.  This  decrease is
primarily  related to the  termination  of the soundcard  promotion  opportunity
whereby  customers  purchasing  $995 of application  cartridges  received a free
soundcard  unit.  Vivace product  revenues in 1997 included the sale of 1,527 of
the new Vivace  Practice  Studio  application  released in the fourth quarter of
1997.

<PAGE>

Gross  profit.  The 6% increase  in gross  profit  between  years  reflects  the
favorable mix of sales related to the higher margin music notation product line.
The 1997 gross profit  percentage  of 69%  compares  favorably to the 1996 gross
profit  percentage of 66%. The 1997 gross profit amount is net of  approximately
$180,000  charged  to  obsolescence  expense  attributable  to the change in the
products during the year.

Sales  and  marketing  expenses.  Sales and  marketing  expenses  of  $2,330,241
decreased  $322,379 or 12% compared to 1996.  The  principal  components of this
decrease  include  approximately  $245,000  related to lower personnel costs and
$280,000  related to decreased  travel and attendance at trade shows,  offset by
approximately$205,000 increase in the design and duplication costs incurred with
the introduction of the Vivace Practice Studio product and Finale upgrade.

Product development expenses.  The Company expensed product development costs of
$1,555,660  in 1997,  an  increase  of $249,090  or19% over 1996  expenses.  The
increase  includes  approximately$121,000  related to increased  amortization of
software  translation  costs and $130,000  related to increased  amortization of
capitalized repertoire development costs.

General and  administrative  expenses.  General and  administrative  expenses of
$1,589,968 in 1997 were $40,687 or 2% greater than the amount incurred in 1996.

Interest  income,  net. The Company had net  interest  income of $98,438 in 1997
compared to $110,832 in 1996.

Net loss. The net loss of $1,512,237 for 1997 is favorable  compared to the loss
of $1,771,046 incurred in 1996. This decrease in the loss is attributable to the
changes in revenues and costs described above.

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, 1997,  the Company
had an NOL  carryforward  of  approximately  $8,600,00,  of which  $7,300,000 is
currently  available to offset future taxable income. The carryforwards begin 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 May 1997,  the Company  received net proceeds of $2,259,105  from the private
placement  of  1,872,697  shares of its Common  Stock and  warrants  to purchase
additional shares. The proceeds were invested in short-term securities.

<PAGE>

The Company has a $500,000  line of credit with a bank  available to finance its
working  capital  requirements.  The  borrowings  under the line of  credit  are
limited to 75% of eligible accounts receivable plus 25% of eligible inventories,
as  defined,  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, 1997, 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 $742,604 in 1997 and $1,925,381 in
1996.  In  addition,  the  Company  made  capital  expenditures  for  furniture,
equipment and fixtures of $158,792 in 1997 and $344,477 in 1997.

The Company  anticipates  that capital  expenditures  for 1998 will  approximate
$120,000.  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 1998.

Year 2000 Issue

The  software  products  which  the  Company  markets  and  sells do not use any
reference to dates that will require  modification  to recognize the  four-digit
year 2000. The Company's internal business systems will require  modification to
recognize  this date;  however,  such  modification  will be  handled  through a
routine  upgrade  to  existing  software,  and the cost of such  upgrade  is not
expected to be material.

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,
distribution and sales level issues,the  potential need for additional  capital,
the need for additional product and repertoire development work, 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, 1997.

<PAGE>

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 for the years ending  December 31, 1997 and
1996:

                     1997                            1996
Quarter            High          Low                High                Low
-------            -------------------------------------------------------------
First              $2.38       $1.63               $5.25              $3.00
Second              2.50        1.13                5.50               4.00
Third               1.81        1.13                5.50               3.50
Fourth              1.25         .75                3.94               1.50







As of December 31, 1997, there were  approximately 150 shareholders of record of
the  Company's  Common  Stock.  In  addition,  the  Company  estimates  that  an
additional  1,500  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.  The  company's  current bank line of credit  prohibits the
payment of dividends without prior approval of the lender.

<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, 1997 and 1996,  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, 1997 and 1996,  and
the results of its  operations  and its cash flows for the years then ended,  in
conformity with generally accepted accounting principles.


                                                          ARTHUR ANDERSEN LLP



Minneapolis, Minnesota,
   February 20, 1998



<PAGE>



                           CODA MUSIC TECHNOLOGY, INC.
                                 Balance Sheets
                                As of December 31

<TABLE>
<CAPTION>

                                                                                       1997                1996
                                   ASSETS                                     -----------------      --------------

<S>                                                                                <C>                 <C>   
CURRENT ASSETS:
   Cash and cash equivalents                                                        $ 1,233,454         $ 1,174,293
   Short-term investments                                                               979,000                   -
   Accounts receivable, less allowance of $25,000                                       477,960             596,946
   Inventories                                                                          616,696             983,375
   Other current assets                                                                  93,200              53,102
                                                                              -----------------      --------------
               Total current assets                                                   3,400,310           2,807,716
EQUIPMENT, FURNITURE AND FIXTURES, less accumulated depreciation of
   $891,209 and $671,791                                                                370,105             494,811

REPERTOIRE DEVELOPMENT COSTS, net of accumulated amortization of $226,611
   and $48,298                                                                          591,445             476,921

PREPAID ROYALTIES                                                                       181,105             118,470

OTHER ASSETS                                                                             88,279             183,916
                                                                              -----------------      --------------
                                                                                    $ 4,631,244         $ 4,081,834
                                                                              =================      ==============

                    LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
   Accounts payable                                                                  $  294,398          $  366,271
   Accrued expenses                                                                     389,885             516,146
   Deferred revenue                                                                     202,603             201,927
                                                                              -----------------      --------------
               Total current liabilities                                                886,886           1,084,344
                                                                              -----------------      --------------
COMMITMENTS AND CONTINGENCIES (Note 6)

SHAREHOLDERS' EQUITY (Note 4):
   Common Stock, without par value, 15,000,000 shares authorized; 6,199,732
      and 4,327,035 issued and outstanding                                           13,712,572          11,453,467
   Accumulated deficit                                                               (9,968,214)         (8,455,977)
                                                                              -----------------      -------------- 
               Total shareholders' equity                                             3,744,358           2,997,490
                                                                              -----------------      --------------
                                                                                    $ 4,631,244         $ 4,081,834
                                                                              =================      ==============
</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>


                                                                                          1997               1996
                                                                                  -----------------------------------
<S>                                                                                   <C>                <C>    
NET REVENUES                                                                          $ 5,563,105        $ 5,500,158

COST OF SALES                                                                           1,697,911          1,873,565
                                                                                  ---------------      -------------
GROSS PROFIT                                                                            3,865,194          3,626,593
                                                                                  ---------------      -------------
OPERATING EXPENSES:
   Sales and marketing                                                                  2,330,241          2,652,620
   Product development                                                                  1,555,660          1,306,570
   General and administrative                                                           1,589,968          1,549,281
                                                                                  ---------------      -------------
               Total operating expenses                                                 5,475,869          5,508,471
                                                                                  ---------------      -------------
LOSS FROM OPERATIONS                                                                   (1,610,675)        (1,881,878)
                                   
INTEREST INCOME, net                                                                       98,438            110,832
                                                                                  ---------------      -------------
               Net loss                                                               $(1,512,237)       $(1,771,046)
                                                                                  ===============      =============

WEIGHTED AVERAGE COMMON  SHARES OUTSTANDING
  (Note 2)                                                                              5,435,261          4,300,411
                                                                                  ===============      =============
BASIC AND DILUTED NET LOSS PER COMMON SHARE 
  (Note 2)                                                                            $     (.28)        $     (.41)
                                                                                  ==============       ============

</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>


                                                                    Common Stock                   Accumulated
                                                                Shares            Amount             Deficit              Total
                                                               ---------         -----------       ------------       -----------
<S>                                                            <C>                <C>              <C>                 <C>    
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
   Sale of Common Stock, net of offering costs                 1,872,697           2,259,105                  -         2,259,105
   Net loss                                                            -                   -         (1,512,237)       (1,512,237)
                                                               ---------         -----------        -----------       -----------
BALANCE, December 31, 1997                                     6,199,732         $13,712,572        $(9,968,214)       $3,744,358
                                                               =========         ===========        ===========       ===========

</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>


                                                                                       1997                 1996
                                                                                ----------------         ------------
<S>                                                                                  <C>                 <C>   
OPERATING ACTIVITIES:
   Net loss                                                                          $(1,512,237)        $(1,771,046)
   Adjustments to reconcile net loss to net cash used in operating
      activities-
         Depreciation and amortization                                                   584,159             372,796
         Change in current assets and liabilities:
            Accounts receivable                                                          118,986            (191,418)
            Inventories                                                                  366,679            (419,634)
            Prepaid royalties                                                            (62,635)            (27,353)
            Other current assets                                                         (40,098)             71,574
            Accounts payable                                                             (71,873)             26,717
            Accrued expenses                                                            (126,261)            (66,252)
            Deferred revenue                                                                 676              79,235
                                                                                ----------------         -----------
               Net cash used in operating activities                                    (742,604)         (1,925,381)
                                                                                ----------------         -----------
INVESTING ACTIVITIES:
   Purchases of equipment, furniture and fixtures                                       (158,792)           (344,477)
   Capitalized repertoire development cost                                              (292,837)           (525,219)
   Patent expenditures                                                                   (26,711)            (98,630)
                                                                                ----------------         -----------
               Net cash used in investing activities                                    (478,340)           (968,326)
                                                                                ----------------         -----------
FINANCING ACTIVITIES:
   Proceeds from private placement of Common Stock, net of offering costs              2,259,105                   -
   Sale (purchase) of short-term investments                                            (979,000)          1,460,798
   Proceeds from stock options and warrants exercised                                          -             111,564
   Repayment of long-term debt                                                                 -              (3,838)
                                                                                ----------------         -----------
               Net cash provided by financing activities                               1,280,105           1,568,524
                                                                                ----------------         -----------
NET INCREASE (DECREASE) IN CASH AND
   CASH EQUIVALENTS                                                                       59,161          (1,325,183)
                                                                                        
CASH AND CASH EQUIVALENTS, beginning of year                                           1,174,293           2,499,476
                                                                                ----------------         -----------
CASH AND CASH EQUIVALENTS, end of year                                                 1,233,454           1,174,293
SHORT-TERM INVESTMENTS, end of year                                                      979,000                   -
                                                                                ----------------         -----------
Total cash equivalents and short-term investments, end of year                       $ 2,212,454         $ 1,174,293
                                                                                ================         ===========

</TABLE>

        The accompanying notes are an integral part of these statements.


<PAGE>


                           CODA MUSIC TECHNOLOGY, INC.
                          Notes to Financial Statements
                           December 31, 1997 and 1996

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 has incurred losses
since  inception  and at  December  31,  1997  had  an  accumulated  deficit  of
$9,968,214.  Management  believes  that  cash and cash  equivalents,  short-term
investments,  its line of credit and funds  generated  from the sale of products
will be  sufficient  to meet  operating  requirements  in 1998.  

2.  Summary  of Significant Accounting Policies:

Cash and 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.  Unrealized  gains or losses were immaterial at December 31,
1997. 

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

The Company  capitalizes  the costs  incurred in the  development  of repertoire
software in accordance with Statement of Financial  Accounting  Standards (SFAS)
No. 86,  "Accounting for the Costs of Computer  Software to Be Sold,  Leased, or
Otherwise  Marketed."  The Company has  capitalized  $818,056 and $525,219 as of
December 31, 1997 and 1996,  respectively,  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.  The Company  periodically  evaluates whether
events and  circumstances  have occurred that indicate the remaining  balance of
repertoire  development costs may not be recoverable.  Other product development
costs  associated  with  development  of  software  applications  are charged to
expense  since the costs  incurred  between the point in time 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.

<PAGE>

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 Share

Basic and diluted net loss per common was  computed by dividing  the net loss by
the weighted  average number of shares of Common Stock.  In accordance  with the
requirements  of  Financial  Accounting  Standard  No.  128 , which the  company
adopted as of December 31, 1997,  common stock  equivalents  have been  excluded
from the calculation as their inclusion would be antidilutive.  

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,
1999.  There were no  borrowings  outstanding  as of December 31, 1997 and 1996.
Borrowings  under  the  agreement  are  limited  to  75%  of  eligible  accounts
receivable plus 25% of eligible  inventories,  as defined,  bear interest at the
bank's  reference  rate  (8.5%  as  of  December  31,  1997)  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, 1997,  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, 1997.

<PAGE>

Private Placement of Common Stock

On May 29, 1997,  the Company  sold an  aggregate of 1,872,697  shares of Common
Stock and issued  warrants to  purchase,  at $2.00 per share,  an  aggregate  of
936,357  shares  of Common  Stock.  The net  proceeds  of the  offering  totaled
$2,259,105.

Stock Options

The Company has a stock option plan  pursuant to which options for up to 975,000
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. In 1997, the Company repriced certain stock options previously granted to
the fair market value at the date of repricing.  The following  summarizes stock
issued under the Company's stock option plans.

<TABLE>
<CAPTION>


                                                               Weighted
                                                                Average
                                                               Exercise
                                               Outstanding       Price
                                              ------------     ---------
<S>                                            <C>              <C>  
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
   Granted                                       599,500         1.35
   Canceled                                     (422,416)        3.17
                                               ---------       ------
Balance at December 31, 1997                     749,620        $1.56
                                               =========       ======
Exercisable at December 31, 1997                 395,957        $1.76
                                               =========       ======

</TABLE>


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:

<TABLE>
<CAPTION>


                                                   1997               1996
                                               ------------        -----------
<S>                          <C>               <C>                <C>    
Net loss                     As reported       $(1,512,237)       $(1,771,046)
                             Pro forma          (1,764,810)        (2,195,037)
Basic and fully diluted 
   net loss per share        As reported              (.28)              (.41)
                             Pro forma                (.32)              (.51)

</TABLE>


All options  outstanding at December 31, 1997 were granted with exercise  prices
greater  than or equal to the fair market  value of the Common Stock at the date
of grant. The Company's Common Stock price at December 31, 1997 was $1.00, which
is less than or equal to the exercise  price of all options  issued  during 1997
and 1996.  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


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assumptions used for grants in 1997 and 1996,  respectively:  risk-free interest
rates of 5.78 and 5.21,  no expected  dividend  yield,  expected  lives of seven
years and expected volatility of 34% and 53%. The weighted average fair value of
options granted during 1997 and 1996 was $.42 and $1.92,  respectively.  Options
issued during 1996 and 1997, which remain outstanding at December 31, 1997, have
an exercise price between $1.00 and $4.50, a weighted  average exercise price of
$1.38 and a weighted average remaining contractual life of 5.9 years. 

Warrants

In  connection  with  certain  financing   transactions  including  the  private
placement of Common Stock in 1997,  the Company has issued  warrants to purchase
1,317,941  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, 1997 totaled 1,309,691. 

5. Income Taxes:

For income tax reporting purposes, net operating loss carryforwards approximated
$8,600,000,  of which  $7,300,000  million is currently  available to offset the
Company's  future  taxable income as of December 31, 1997.  These  carryforwards
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 2000. Lease expense during 1997 totaled  $118,676.  The
future  minimum  lease  payments as of December  31, 1997 under these leases are
$128,600 in 1998, $126,400 in 1999 and $114,200 in 2000.

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 related to a significant licensor are as follows:

              1998                                     $  200,000
              1999                                        300,000
              2000                                        300,000
              2001                                        300,000
              2002 and thereafter                       1,050,000

Royalty expense,  including amounts related to the agreement  referred to above,
totaled  $190,649  and  $217,018 in the years ended  December 31, 1997 and 1996,
respectively,  and  are  reflected  as a  component  of  cost  of  sales  in the
accompanying statements of operations.

Employment Agreement

The Company has an  employment  agreement  with an officer  which  requires  the
Company to pay the  officer one year's  base  salary of  $157,500  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 made no contributions to the
plan in 1997 or 1996.

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7.   Management Fee:

The  Company  paid  management  fees  totaling  $24,000  during the years  ended
December 31, 1997 and 1996 to an affiliate of a director for management services
provided to the Company.