<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
                               ________________

                                   FORM 10-K

                       FOR ANNUAL AND TRANSITION REPORTS
                    PURSUANT TO SECTIONS 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
(Mark One)

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 1998

                                       OR

[   ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
     SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________

                         Commission File Number ______

                                 EVERCOM, INC.
--------------------------------------------------------------------------------
            (Exact Name of Registrant as Specified in Its Charter)

                                        
           Delaware                                    75-2680266
-------------------------------------------------------------------------------
(State or Other Jurisdiction of                  (I.R.S. Employer
Incorporation or Organization)                   Identification Number)


           8201 Tristar Drive
             Irving, Texas                                   75063
-----------------------------------------------   -----------------------------
(Address of Principal Executive Offices)                  (Zip Code)


      Registrant's telephone number, including area code --    972/988-3737
                                                            -------------------
      
Securities registered pursuant to Section 12(b) of the Act:


        Title of Each Class           Name of Each Exchange on Which Registered
-----------------------------------   -----------------------------------------
     11 % Series B Senior Notes                    Not Applicable
         Due June 30, 2007

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


                                     None
-------------------------------------------------------------------------------
                               (Title of Class)

     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 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 
                                              ---    ---
<PAGE>
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not 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-K or any amendment to this
Form 10-K. [   ] Not Applicable.

                                       2
<PAGE>
 
     As of December 31, 1998, the market value for the voting and non-voting
common equity held by non-affiliates of the registrant was $0.

     As of March 15, 1999, 15,933 shares of Class A common stock, par value
$0.01 per share, were issued and outstanding, and 400 shares of Class B common
stock, par value $0.01 per share, were issued and outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

     Exhibits to the following documents filed with the Securities and Exchange
Commission have been incorporated by reference in Part IV of this Annual Report
on Form 10-K:

1.  Registration Statement on Form S-4 (File No. 333-33639);

2.  Quarterly Report on Form 10-Q, dated as of August 14, 1998;

3.  Quarterly Report on Form 10-Q, dated as of November 16, 1998; and

4.  Quarterly Report on Form 10-Q/A, dated as of November 18, 1998.

                                       3
<PAGE>
 
                                 EVERCOM, INC.
                               Table of Contents
                                Form 10-K Report
                               December 31, 1998
<TABLE> 
<CAPTION> 
Part I                                                                                                         Page 
------
<S>              <C>                                                                                          <C> 
 
  Item 1.        Business......................................................................................  5
 
  Item 2.        Properties....................................................................................  13
 
  Item 3.        Legal Proceedings.............................................................................  13
 
  Item 4.        Submission of Matters to a Vote of Security Holders...........................................  13
 
Part II
-------
 
  Item 5.        Market for Registrant's Common Equity and Related Stockholder Matters.........................  14
 
  Item 6.        Selected Financial Data.......................................................................  15
 
  Item 7.        Management's Discussion and Analysis of Financial Condition
                 and Results of Operations.....................................................................  17
 
  Item 7A.       Quantitative and Qualitative Disclosures About Market Risk....................................  26
 
  Item 8.        Financial Statements and Supplementary Data...................................................  27
 
  Item 9.        Changes in and Disagreements with Accountants on Accounting
                 and Financial Disclosure......................................................................  84
 
Part III
--------
 
  Item 10.       Directors and Executive Officers of the Registrant............................................  85
 
  Item 11.       Executive Compensation........................................................................  87
 
  Item 12.       Security Ownership of Certain Beneficial Owners and Management................................  91
 
  Item 13.       Certain Relationships and Related Transactions................................................  92
 
Part IV
--------
 
  Item 14.       Exhibits, Financial Statement Schedules, and Reports on Form 8-K..............................  94
 
   Signatures..................................................................................................  98
</TABLE>

                                       4
<PAGE>
 
                                     PART I
                                     ------
                                        
ITEM 1.    BUSINESS

General

        Evercom, Inc. (the "Company") is the largest independent provider of
collect, prepaid, and debit calling services to local, county, state, and
private correctional facilities in the U.S. As of December 31, 1998, the Company
served 2,073 correctional facilities in 43 states.

        The Company's inmate telecommunications business consists of owning,
operating, servicing, and maintaining a system of automated operator switches
and telephones located in correctional facilities. Generally, inmates may make
only collect, prepaid, and debit calls from correctional facilities, which
generates revenue per phone line in excess of industry averages for a typical
business phone line. The Company generally enters into multi-year agreements
with correctional facilities pursuant to which the Company serves as exclusive
provider of telecommunications services to inmates within the facility. In
exchange for the exclusive service rights, the Company pays a percentage of its
revenues from each correctional facility to that facility as a commission.
Typically, the Company installs and retains ownership of the telephones and
related equipment.

        Significant costs typically associated with providing telecommunication
services to correctional facilities include uncollectible accounts, network, and
billing expenses. The Company has developed an integrated call management and
billing system to help control these expenses. This system limits inmates to
collect, prepaid, or debit calls; validates and evaluates the payment history
and account status of each number dialed; confirms that the destination number
has not been blocked; and processes call records for billing through a third
party. To facilitate billing, the Company has entered into 29 separate
agreements with regional bell operating companies ("RBOCs") and local exchange
carriers ("LECs"), allowing the Company to bill directly through the RBOCs and
LECs rather than utilizing third party billing services. Management believes
that direct billing arrangements expedite the billing and collections process
and increases collectibility.

        The Company uses its experience in billing, collection, and control of
uncollectible accounts to offer specialized billing and collection services to
other inmate telecommunications service providers.  In May 1998, the Company
entered into a contract with a major RBOC, under which the Company performs all 
of the validation, billing, and collection services for the RBOC's inmate calls,
and began processing call traffic under the contract. Under the terms of the
contract, the Company receives call traffic from 428 facilities. In addition,
the Company offers call processing services for a major interexchange carrier
("IXC"). The Company continues to pursue additional opportunities to market
these services to RBOCs, LECs, IXCs, and other inmate telecommunications
providers.

        The Company was formed in December 1996 to consummate the acquisitions
of AmeriTel Pay Phones, Inc. ("AmeriTel") and Talton Telecommunications
Corporation and its subsidiary ("Talton Telecommunications"). The Company was
formed by Engles Urso Follmer ("EUF") Talton, an affiliate of Engles Urso
Follmer Capital Corporation ("EUFCC"), a private investment banking and
consulting firm. In addition to the acquisition of its predecessors, AmeriTel
and Talton Telecommunications, the Company also acquired the operations of Tri-
T, Inc. ("Tataka") on April 2, 1997, Security Telecom Corporation ("STC") on
June 27, 1997, Correctional Communications Corporation ("CCC") on July 31, 1997,
the inmate payphone division of Communications Central, Inc. ("InVision") on
October 6, 1997, the inmate payphone division of North American InTeleCom
("NAI") on December 1, 1997, the inmate payphone division of Peoples Telephone
Company ("PTC") on December 18, 1997, the inmate payphone division of ILD
Teleservices, Inc. ("ILD") on January 1, 1998, MOG Communications, Inc. ("MOG")
on February 1, 1998, and Saratoga Telephone Co. Inc. ("Saratoga") on July 1,
1998 (collectively, the "Acquisitions").

Special Note Regarding Forward-Looking Information

        Certain statements in this Annual Report on Form 10-K constitute
forward-looking statements. These forward-looking statements are all statements
that are not statements of historical fact or that might otherwise be considered
opinion, belief, or projection. These forward-looking statements involve known
and unknown risks, uncertainties, and other factors that may cause the actual
results, levels of activity, performance, or achievements of the Company, or
industry results, to be materially different from any future results,
levels of activity, performance, or achievements expressed or implied by such
forward-looking statements. The risks, uncertainties, and other factors to which
forward-statements are subject include, among others, those set

                                       5
<PAGE>
 
forth under the caption "Risk Factors" in the Prospectus of the Company dated
September 10, 1998, which is available from the Company, from the Securities and
Exchange Commission at prescribed rates, and at the web-site www.sec.gov. Such
factors include, without limitation, the following: competitors with greater
resources; risks associated with uncollectible accounts; risks associated with
anticipated growth; risks associated with market growth stagnating or declining;
risks related to potential Year 2000 problems; lack of patents and possible
infringements; technological change and new services; control by principal
shareholders; changes in the telecommunications industry; availability of key
personnel; and changes in, or the failure to comply with, governmental
regulations. All subsequent written or oral forward-looking statements
attributable to the Company or persons acting on its behalf are expressly
qualified in their entirety by such factors.

        In some cases, forward-looking statements can be identified by
terminology such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential," or "continue" or the negative
of such terms or other comparable terminology. Although the Company believes
that the assumptions and expectations reflected in such forward-looking
statements are reasonable, as a result of the foregoing and other factors, no
assurance can be given as to future results, levels of activity, performance, or
achievements, and neither the Company nor any other person assumes
responsibility for the accuracy and completeness of such forward-looking
statements. All forward-looking statements included in this Annual Report on
Form 10-K are based on information available to the Company on the date hereof,
and the Company is under no duty to update any of the forward-looking statements
after the date hereof.

Industry Overview

        The U.S. has one of the highest incarceration rates of any country in
the world. According to U.S. Department of Justice statistics, the number of
inmates incarcerated in federal and state prisons and in city and county
correctional facilities increased from approximately 1.1 million at June 30,
1990 to approximately 1.8 million at June 30, 1998. Of this total, approximately
two-thirds were housed in state and federal prisons, with the remainder in city
and county facilities. The statistics also reflect that the number of inmates
incarcerated in the U.S. increased by 4.4% between June 1997 and June 1998.

        The inmate telecommunications industry places unique demands on
telecommunications systems and service providers.  Security and public safety
concerns associated with inmate telephone use require that correctional
facilities use call processor technology, which allows the facilities to control
inmate access to certain telephone numbers and to monitor inmate telephone
activity.  In addition, concerns regarding fraud and the called parties' failure
to pay for inmate collect calls require systems and procedures unique to this
industry.

        Inmate telephones in the U.S. are operated by a large and diverse group
of service providers. Large telecommunications companies such as RBOCs, other
LECs, and IXCs such as AT&T Corp. ("AT&T"), MCI WorldCom, and Sprint Corporation
provide inmate telecommunications in addition to other services. In addition,
independent public pay telephone and inmate telephone companies also focus on
this market segment. The Company estimates that, as of December 31, 1998, the
inmate telecommunications market represented approximately $1.6 billion in gross
revenues annually.

        Companies compete for the right to serve as the exclusive provider of
inmate calling services within a particular correctional facility. Most city or
county correctional facilities (typically fewer than 250 beds) award contracts
on a facility-by-facility basis, while most state prison systems award contracts
on a system-wide basis. Generally, contracts are awarded pursuant to a
competitive bidding process.

        The Company targets the corrections industry by tracking when the
telecommunications contracts for significant inmate facilities in the U.S. are
up for bid.  The Company monitors which federal, state, county, and city
contracts are coming up for renewal and how much revenue is expected to be
generated by each of those contracts.

                                       6
<PAGE>
 
Operations

     Contracts

        The Company has contracts to provide inmate telecommunications services
on an exclusive basis to correctional facilities ranging in size from small,
municipal jails to large, state-operated facilities, as well as other types of
confinement facilities, including juvenile detention centers, private
correctional facilities, and halfway houses. The Company's contracts have multi-
year terms, and typically contain renewal options. The Company's contracts
generally provide for automatic renewal unless terminated by written notice a
specified period of time before the end of a contract term.

     Marketing and Customer Service

        The Company has historically focused its marketing efforts on local and
county correctional facilities.  Local and county facilities house inmates for
shorter durations than federal and state prisons and generally have higher
inmate call volumes.  The Company's competitors in bidding for contracts to
serve local and county correctional facilities are usually small, regionally
focused independent providers.  For larger local and county correctional
facility contracts, the Company may also compete with the local RBOC.  In August
1998, the Company, in a relationship with Public Communications Services, Inc.
("PCS"), was awarded the federal contract for 14 Immigration and Naturalization
Service ("INS") facilities, representing approximately 6,640 beds.

        The Company seeks new contracts by participating in competitive bidding
processes and by negotiating directly with correctional facilities. The Company
markets its inmate telecommunications services through a sales staff largely
made up of former law enforcement officials and others with experience in the
corrections and telecommunications industries who understand the specialized
needs of correctional facilities. The Company's marketing strategy emphasizes
the knowledge, experience, and reputation of the Company in the inmate
telecommunications industry, its high level of service, and the additional
specialized products and services offered by the Company to its correctional
facility customers. In addition to conducting in-person sales calls on the
operators of correctional facilities, the Company participates in trade shows
and is active in local law enforcement associations.

        The Company provides and installs the inmate telephone system in each
correctional facility at no cost to the operator of the facility and generally
performs all maintenance activities.  The Company utilizes a geographically
dispersed staff of field service technicians and independent telecommunications
services contractors, which allows the Company to respond quickly (typically
within 24 hours) to service interruptions. In addition, the Company has the
ability to make some repairs remotely through electronic communication with the
installed equipment without the need of an on-site service call.

     Products and Services

        The Company has developed its products and services to meet the needs of
the inmate telecommunications market. The Company offers the following products
and services as part of its core inmate telecommunications business:

     .  Inmate Collect Call Services. The Company provides collect call services
        on an exclusive basis to its inmate facility customers during the term
        of the facility's contract. The majority of calls made by inmates from
        correctional facilities are collect calls, with the balance of the calls
        being prepaid and debit card calls. The Company's collect call revenues
        comprise a majority of the Company's total revenues.

     .  Prepaid and Debit Card Services. The Company also provides both prepaid
        and debit card services to inmates and called parties. The Company sells
        debit cards to correctional facilities at a discount to their face
        value, which facilities in turn sell the cards at face value to inmates
        at those facilities. Prepaid call services allow the recipient of an
        inmate call to pay in advance for collect calls placed to the recipient,
        while debit card services allow inmates to pay in advance for telephone
        calls placed by that inmate. Both prepaid and debit card services have
        no associated uncollectible account expenses and minimal billing and
        collection costs. The Company's prepaid and debit card services revenues
        comprise a small percentage of the Company's revenues, but these
        revenues are expected to increase as a percentage of total revenue.

                                       7
<PAGE>
 
     .  Billing Services. The Company uses its experience in billing and
        collections and management of uncollectible accounts to offer
        specialized billing and collection services for other inmate
        telecommunications service providers. The Company is pursuing
        opportunities to market these services to RBOCs, LECs, IXCs, and other
        inmate telecommunications providers. In May 1998, the Company entered
        into a contract with a major RBOC, under which the Company performs
        all of the validation, billing, and collection services for the RBOC's
        inmate calls, and began processing call traffic under this contract.
        Under the terms of the agreement, the Company acquires at a discount the
        related accounts receivable from the RBOC for the calls that the Company
        processes. When the receivables are purchased, the Company accepts
        responsibility for all validation, uncollectible accounts, billing and
        collections costs, with no recourse to the RBOC. However, under the
        terms of the agreement, all purchased receivables must be processed and
        validated through the Company's call management and billing system. The
        Company's revenues from this service equal the difference between the
        face value of the receivables purchased and the amount it pays the RBOC
        for the discounted accounts receivable. The contract term is three years
        and has no minimum volume commitment.

     .  Additional Value Added Services. The Company offers value added services
        on a customized, facility by facility basis. These services include the
        use of the Company's computer-based specialized law enforcement
        management system ("LEMS"), which includes jail management, victim
        notification, and prisoner profile software packages. LEMS is a key
        selling point for the Company to potential customers and will also be
        marketed to its existing customers. The Company also offers jail
        training services that include Company-sponsored training seminars for
        jail personnel on a variety of topics, including safety and fraud
        detection.

     Billing Arrangements

        The Company uses direct and third party billing agreements to bill and
collect phone charges. Under direct billing agreements with LECs, the LEC
includes collect call charges for the Company's services on the local telephone
bill sent to the called party. The Company generally receives payment from the
LEC for such calls 30 to 60 days after the end of the month in which the call is
submitted to the LEC for billing. The payment received by the Company is net of
a service fee, write-offs of uncollectible accounts, and an estimated reserve
for future uncollectible accounts.

        Unlike many smaller independent service providers with lower
telecommunications traffic, the Company has been able to enter into direct
billing agreements in most of its markets because of the Company's high market
penetration.  The Company's increased telecommunications traffic has enabled the
Company to enter into 29 direct billing arrangements that enabled the Company to
direct bill approximately 89% of its operating revenues in December 1998.
Management believes that direct billing agreements expedite the billing and
collection process and increase collectibility.  

        In the absence of a direct billing arrangement, the Company bills and
collects its fees through a third-party billing and collection clearinghouse
that in turn has a billing and collection agreement with the LEC. When the
Company employs a third-party billing and collection clearinghouse, the account
proceeds are forwarded by the various LECs to the clearinghouse, which then
forwards the proceeds to the Company, less a processing fee that varies from 2%
to 3% of billed revenues. The Company also has a central billing office that
receives all call records and then enters them into the Company's call activity
data base.

        The Company's specialized call management and billing system integrates
its direct billing arrangements with LECs with its call blocking, validation,
and customer inquiry procedures. Through the use of this system, the Company
believes that it has incurred lower levels of expenses associated with
uncollectible accounts than its competitors. This system has also provided the
Company with the opportunity to market its billing and collection services to
third parties. In May 1998 the Company entered into a contract with a major
RBOC, under which the Company performs all of the validation, billing, and
collection services for inmate call records supplied by the RBOC. In addition,
the Company provides call processing services for a major IXC. The Company
intends to pursue opportunities to market these systems to third parties such as
RBOCs, LECs, IXCs, and other inmate telecommunication providers.

                                       8
<PAGE>
 
     Systems

        The Company currently utilizes a call management and billing system that
consists of purchased and internally developed software applications on
specialized equipment.  This system limits inmates to collect, prepay, or debit
calls, validates and verifies the payment history and account status of each
number dialed for billing purposes, and confirms that the destination number has
not been blocked.  The Company also installs its internally developed call
management system ("CAM") within new facilities that require special features
such as call monitoring and recording capability.
 
        The Company's database of telephone numbers and call activity provides
valuable data to assist the Company in reducing unbillable and uncollectible
accounts and allows the Company to provide extensive call activity reports to
correctional facilities and enforcement authorities.  These include reports of
frequently called numbers, calls of longer than normal duration, and calls by
more than one inmate to the same number, which can assist law enforcement
authorities in connection with ongoing investigations.  

Other Operations

        The Company owns, operates, services, and maintains a system of
microprocessor controlled public pay telephones that are ancillary to its inmate
telecommunications business, and occasionally installs public pay telephones as
an accommodation to, or pursuant to a contract requirement imposed by, its
correctional facility customers.

Competition

        In the inmate telecommunications business, the Company competes with
numerous independent providers of inmate telephone systems, RBOCs, LECs, and
IXCs. Many of the Company's competitors are larger and better capitalized with
significantly greater financial resources than the Company. The Company believes
that the principal competitive factors in the inmate telecommunications industry
are (i) rates of commissions paid to the correctional facilities; (ii) system
features and functionality; (iii) system reliability and service; (iv) the
ability to customize inmate call processing systems to the specific needs of the
particular correctional facility; and (v) relationships with correctional
facilities.

        Inmate telephones in the U.S. are operated by a large and diverse group
of service providers. Large telecommunications companies such as RBOCs, other
LECs, and IXCs such as AT&T, MCI WorldCom, and Sprint Corporation provide inmate
telecommunications in addition to other services. In addition, independent
public pay telephone and inmate telephone companies also focus on this market
segment.

Regulation

        The inmate telephone industry is regulated at the federal level by the
Federal Communications Commission (the "FCC") and at the state level by the
public utility commissions of the various states. In addition, from time to
time, legislation may be enacted by Congress or the various state legislatures
that affects the telecommunications industry generally and the inmate telephone
industry specifically. Court decisions interpreting applicable laws and
regulations may also have a significant effect on the inmate telephone industry.
Changes in existing laws and regulations, as well as the adoption of new laws
and regulations applicable to the activities of the Company or other
telecommunications business, could have a material adverse effect on the
Company.

     Federal Regulation

        Prior to 1996, the federal government's role in the regulation of the
inmate telephone industry was limited. The enactment of the Telecommunications
Act of 1996 (the "Telecom Act"), however, marked a significant change in the
scope of

                                       9
<PAGE>
 
federal regulation of inmate telephone service. Section 276 of the Telecom Act
directed the FCC to implement rules to overhaul the regulation of the provision
of pay telephone service, which Congress defined to include the provision of
inmate telephone service.

        Before adoption of the Telecom Act, LECs generally included inmate
telephone operations as part of their regulated local exchange telephone company
operations. This allowed the LECs to pool revenue and expenses from their
monopoly local exchange operations with revenue and expenses from their inmate
telephone operations. This commingling of operations made possible the
subsidization of the LECs' inmate operations through other regulated revenues.
The LECs were also able to shift certain costs from their inmate operations to
their local exchange monopoly accounts. In particular, the LECs were able to
pool the bad debt from their inmate operations with their other bad debt.
Because inmate telephone providers act as their own carrier, they bear the risk
of fraudulent calling and uncollectible calls and other bad debt. Bad debt is
substantially higher in the inmate telephone industry than in other segments of
the telecommunications industry. The LECs' practice of pooling bad debt shifts
the high costs of bad debt from inmate telephone operations to the expense
accounts of other LEC operations, presenting a vehicle for the cross-
subsidization of the LECs' inmate operations, which, in turn, has allowed the
LECs to offer commissions to correctional facilities that are significantly
higher than those that independent inmate telephone providers can offer.

        Section 276 directed the FCC to adopt regulations to end the LECs'
subsidization of their inmate telephone operations from regulated revenues.
Congress also directed the FCC to ensure that the LECs could not discriminate in
favor of their own operations to the competitive detriment of independent inmate
telephone providers.  Finally, Congress required the FCC to ensure that all
inmate telephone providers were fairly compensated for "each and every" call
made from their telephones.

        To carry out its Congressional mandate, the FCC adopted regulations
requiring all LECs to transfer their inmate telephone operations from their
regulated accounts to the LECs' unregulated accounts no later than April 15,
1997. While the FCC's rules implementing Section 276 are designed to eliminate
cross-subsidization and cost-shifting, there are significant questions regarding
their ultimate effect. For example, it is unclear whether the FCC's rules will
fully prevent the shifting of bad debt from inmate operations to the LECs'
regulated accounts. Since the bad debt arises from the charges for collect
calls, which have traditionally been regulated carrier activities, the FCC has
not yet finally resolved exactly how the bad debt from inmate operations will be
allocated between regulated and unregulated accounts.

        The FCC also addressed the one-time transfer of existing inmate
telephone operation assets from the LECs' regulated accounts to the unregulated
accounts established for inmate telephone operations. The FCC ordered the
transfer of those assets at their net book value rather than at their fair
market value. The inmate telecommunications industry had argued to the FCC that
the transfer should be accomplished at the assets' fair market value, including
the value of the contracts between the LECs' inmate operations and correctional
facilities. The net book value of those assets is much lower than their fair
market value. As a result of the below market valuation of the assets, the LECs'
inmate telephone operations may be able to post nominally higher returns on
their assets than they would otherwise be able to and hence relieve operating
pressures for returns on assets. This also could result in a competitive
advantage for the LECs with respect to access to capital markets compared with
the Company and other independent inmate telephone providers.

        To eliminate discrimination, the FCC required, among other things, that
the LECs' inmate telephone operations take any tariffed services from its
regulated operations at the tariffed rate for the service, rather than the
actual cost of the service. Before the Telecom Act, the LECs' inmate operations
were able to take these services at some variant of their underlying costs
without regard to the tariffed rate being charged to independent providers.
Under the Telecom Act, the LECs' inmate operations must take tariffed services
on an arm's length basis, at tariffed rates that are subject to regulatory
approval. Further, the rates for the tariffed services offered to both the LECs'
inmate telephone operations and independent inmate telephone providers must be
developed on a consistent basis. The test that the FCC has mandated for the
pricing of services to both independent inmate telephone providers and the LECs'
own inmate operations will require a reexamination of existing rates and may
lead to a rate reduction for services in some instances, while it is also
possible that the rate reexamination may result in some rate increases. In
either event, the requirement for a consistent methodology for developing rates
should substantially reduce LEC opportunities for unfavorable rate
discrimination against independent inmate telephone providers like the Company.

        The FCC did allow the LECs to offer certain non-tariffed services, for
example, repair and installation services, to the LECs' inmate operations on a
cost-sharing basis, which could result in some cost advantage to the LECs'
inmate operations.  The LECs are free to price these services at full market
rates to independent inmate

                                       10
<PAGE>
 
telephone providers. Independent inmate telephone providers are not, however,
dependent on the LEC for these services, as they are with telephone lines;
independent inmate telephone providers can provide services like repair and
installation with their own staff or contractors.

        To ensure "fair compensation" for inmate telephone providers, the FCC
held that it was not required to prescribe compensation for collect calls
because inmate providers act as their own carriers and collect the revenue from
those calls directly from called parties. The inmate telephone industry had
argued to the FCC, however, that because of state-mandated ceilings on the rates
for intrastate collect calls, inmate telephone providers could not recover
adequate revenue for those calls, and accordingly, had sought an "inmate system
compensation charge" in addition to the charges collected for carrying the call.
See "--State Regulation."

        Because of continuing restrictions stemming from the 1984 divestiture of
the RBOCs by AT&T, the RBOCs are not able to carry long distance traffic. Prior
to the Telecom Act, the RBOCs were also precluded from choosing a long distance
carrier for calls originating from facilities where the RBOCs provided the
inmate telephone service and receiving commission revenue from that carrier.
Instead, carriers were selected by, and paid commissions directly to, the
individual correctional facilities being served by RBOCs.

        Pursuant to the Telecom Act, the FCC decided that the RBOCs would be
allowed to choose their own carrier for their traffic from a given correctional
facility. As a result, the RBOCs may gain the ability to negotiate higher
commission rates to be paid to them from their contracted carrier by aggregating
traffic from several facilities into a single contract with the carrier.

        Many aspects of the FCC's rules implementing Section 276 are currently
the subject of further proceedings by the FCC. In particular, two important
issues are back before the FCC as the result of a court challenge in which the
FCC voluntarily sought, and the court granted, a remand to the FCC for further
proceedings. The first of those issues is the FCC's decision not to prescribe
compensation for inmate collect calls. If the FCC ultimately decides to
prescribe compensation, the Company could potentially benefit from the ability
to collect additional revenue. It is not possible to predict whether the FCC
will prescribe compensation and the degree to which the Company could benefit,
if at all, would depend on the exact compensation scheme ultimately prescribed
by the FCC for inmate collect calls.

        The second important issue before the FCC on remand is the FCC's
decision to include only inmate telephone equipment and not the collect calling
service itself in the inmate telephone services that the RBOCs must provide on a
nonregulated basis. As a result of this ruling, the RBOCs have to some extent
remained able to subsidize and discriminate in favor of their inmate calling
operations. In particular, so long as the RBOCs can continue to define their
inmate collect calling service as part of their regulated operations, they may
be commingling that bad debt with bad debt from other services. It cannot be
predicted how the FCC will rule on this issue on remand. However, if the FCC
reverses its stance and defines nonregulated inmate calling services to include
inmate collect calls, the Company could potentially benefit from a reduction in
the ability of its RBOC competitors to subsidize and discriminate in favor of
their inmate operations.

        Because of the further proceedings pending before the FCC, the ultimate
effects of the rule changes mandated by the Telecom Act are uncertain.  In
particular, the extent to which the FCC's rules designed to eliminate
subsidization and discrimination by the LECs prove to be effective will
significantly affect the level of competition faced by the Company in the inmate
telecommunications market.

        Apart from its proceedings to implement the Telecom Act, the FCC also
adopted new regulations for interstate calls requiring inmate telephone service
providers to announce to called parties, before the called party incurs any
charges, that rate quotes may be obtained by dialing no more than two digits or
remaining on the line. The Company must come into compliance with these new
rules by October 1, 1999. The Company's existing systems already have the
capability to perform this function. These new regulations could result in an
increase in the Company's costs by slightly increasing the non-billable network
hold time for interstate collect calls. Also, since the Company may comply with
the new federal requirement by implementing rate disclosure on all calls,
including intrastate calls, the new regulations may lead to slight increases in
the costs for all inmate collect calls carried by the Company. In addition, the
announcement of rate quotes may lead to called parties refusing to accept calls.
The exact effect of the new regulations is difficult to predict as it will
depend in large part on how frequently called parties opt to receive a rate
quote.

        Significantly, the FCC adopted the rate disclosure option in lieu of the
so-called "Billed Party Preference" proposal that had been pending before the
FCC for several years. Under that plan, inmate telephone service providers would
have been required to send their interstate inmate collect calls to the called
party's pre-subscribed carrier, thereby bypassing the

                                       11
<PAGE>
 
opportunity for the inmate telephone service provider to receive revenue from
the calls. The Company believes that the rate quote regulations adopted by the
Commission are a preferable alternative to Billed Party Preference, which would
potentially have had a much more adverse effect on the Company's business.

     State Regulation

        The most significant state involvement in the regulation of inmate
telephone service is the limit on the maximum rates that can be charged for
intrastate collect calls set by most states, referred to as "rate ceilings."
Since collect calls are generally the only kind of calls that can be made by
inmates in correctional facilities, the state-imposed rate ceilings on those
calls can have a significant effect on the Company's business.

        In many states, the rate ceilings on inmate collect calls within the
originating LEC's service area are tied to the rates charged by the LEC and
subject to state regulatory approval.  Thus, where the LEC chooses not to raise
its rates, independent inmate telephone providers are precluded from raising
theirs.  Prior to the passage of the Telecom Act, the LECs had less incentive to
raise their rates than independent inmate telephone providers because the LECs
were able to subsidize their inmate telephone operations and discriminate in
their favor, as described above.  See "--Federal Regulation."  It is possible
that as a result of the FCC's new rules designed to eliminate such subsidies,
some LECs may choose to file with their state commissions to raise their rates
for inmate collect calls.  If this occurs, the Company and other independent
inmate telephone providers could also raise their rates.  It is difficult to
predict the extent to which the LECs will raise their rates.

        For calls going outside the originating LEC's service area, there may be
state rate ceilings tied to the rates of the largest IXCs. In some cases, these
rate ceilings can also make sufficient cost recovery difficult. In general, the
cost recovery problems that arise from rate ceilings tied to IXC rates are not
as severe as the difficulties created by rate ceilings tied to LEC rates.

        In its rulemaking implementing the Telecom Act, the FCC declined to
address these state rate ceilings. The FCC ruled that inmate telephone providers
must first seek relief from the state rate ceilings at the state level. The
outcome of any such proceedings at the state level, if undertaken, is uncertain.
Further, it is uncertain whether the FCC would intervene or if so, how, in the
event a state failed to provide relief. This issue is part of the currently
pending FCC remand proceeding.

        In addition to imposing rate caps, the states regulate other aspects of
the inmate calling industry. While the degree of regulatory oversight varies
significantly from state to state, state regulations generally establish minimum
technical and operating standards to ensure that public interest considerations
are met. Among other things, most states have established rules that govern
registration requirements, notice to called parties of the identity of the
service provider in the form of postings or verbal announcements, and
requirements for rate quotes upon request. In some jurisdictions, in order for
the Company to operate its inmate telephones and public pay telephones, it is
necessary to become certificated and to file tariffs with the appropriate state
regulatory authority.

Tradenames

        The Company has two registered trademarks, Security Telecom
Corporation(R) and STC(R) and has developed or acquired a number of additional
unregistered tradenames that it uses in its business. Although the use of these
trademarks and tradenames has created goodwill in certain markets, management
does not believe that the loss of these trademarks and tradenames would have a
material adverse effect on the Company's operations. The Company also has a
registration application pending for the tradename Evercom and certain
derivatives thereof.

Environmental

        The Company is subject to certain federal, state, and local
environmental regulations. Management does not expect environmental compliance
to have a material effect on the Company's capital expenditures, earnings, or
competitive position in the foreseeable future.

Employees

        As of December 31, 1998, the Company had approximately 316 employees.

                                       12
<PAGE>
 
ITEM 2.    PROPERTIES

        The Company's principal executive offices are located in, and a portion
of its operations are conducted from, leased premises located at 8201 Tristar
Drive, Irving, Texas 75063. The Company also has three additional regional
facilities from which it conducts its operations located in Selma, Alabama;
Louisville, Kentucky; and Lee's Summit, Missouri, all of which are leased.

ITEM 3.    LEGAL PROCEEDINGS

        The Company is from time to time a party to legal proceedings that arise
in the ordinary course of business. Management does not believe that the
resolution of any threatened or pending legal proceedings will have a material
adverse effect on the Company.

        The Company was unsuccessful in obtaining a Federal Bureau of Prisons
contract, and has appealed the award. There can be no assurances that the
Company will be successful in appealing this award.

        None of the Company's internally developed call processing technology 
has been patented. Accordingly, such technology and intellectual property rights
could infringe on other parties' intellectual property rights and could be 
contested or challenged. The Company has received notice from two parties that 
certain features of the Company's call processing technology may infringe upon 
such parties' patents. Should the Company's call processor or any material 
feature thereof be determined to violate applicable patents, the Company would 
be required to cease using these features or to obtain appropriate licenses for 
the use of such technology.

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

        At the Company's annual meeting held on June 24, 1998, the following
matters were voted upon:

1.  Name change of the Company from "Talton Holdings, Inc." to "Evercom, Inc."

          Votes for: 14,010    Votes Against:     0  Did Not Vote:     1,790

2.  Approval of the Company's 1998 Stock Option Plan.

          Votes for: 14,010    Votes Against:     0  Did Not Vote:     1,790

                                       13
<PAGE>
 
                                    PART II
                                    -------
                                        
ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

        There is currently no established public trading market for the
Registrant's issued and outstanding capital stock.

        As of December 31, 1998, there were forty-eight holders of the Company's
Class A common stock (the "Common Stock") and four holders of the Company's
Class B common stock (the "Class B Common Stock").

        There have been no cash dividends declared on the Common Stock from the
period January 1, 1996 through December 31, 1998. The Indenture (the
"Indenture") governing the Company's Series A and Series B Senior Notes Due 2007
and the Company's senior credit facility, as amended and restated (the "Senior
Credit Facility") contain certain restrictive covenants that are likely to
materially limit the future payment of dividends on the Common Stock. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

        The following table sets forth information with respect to all
securities sold by the Company for the Company's last fiscal year that were not
registered under the Securities Act of 1933, as amended, (the "Securities Act").
All securities sold and not registered were sold in transactions not involving a
public offering under Section 4(2) of the Securities Act. 

<TABLE>
<CAPTION>
SECURITIES SOLD   DATE        PERSON ACQUIRING      AMOUNT          CONSIDERATION             USE OF PROCEEDS      TERMS OF
                                 SECURITIES                                                                      CONVERSION OF
                                                                                                                    EXERCISE
--------------------------------------------------------------------------------------------------------------------------------
<S>               <C>       <C>                     <C>             <C>                       <C>              <C>
Convertible       02/18/98  former shareholders     158-1/3 shares  additional consideration  Acquisition      $6,000.00 strike
Note                        of MOG                                  for asset acquisition     of Business      price per share
                            Communications, Inc.
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>

                                       14
<PAGE>
 
ITEM 6.   SELECTED FINANCIAL DATA - (in thousands)

     Effective December 1, 1996, the Company became the holding company for the
operations of AmeriTel and Talton Telecommunications.  The Company accounted for
these acquisitions using the purchase method of accounting.  Accordingly, the
Company's consolidated financial statements included the operations of AmeriTel
and Talton Telecommunications only for periods after December 1, 1996.

     The following selected consolidated financial data of the Company for each
of the two years ended December 31, 1998 and the one month ended December 31,
1996, and the selected combined financial data of the Company's predecessors for
the years ended December 31, 1994 and 1995 and for the eleven months ended
November 30, 1996, have been derived from the Company's and its predecessors'
audited financial statements.

     The selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements and the notes thereto
included elsewhere in this Form 10-K.

                                      15
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                         COMBINED PREDECESSORS                            THE COMPANY
                                             --------------------------------------------- -----------------------------------------

                                                                         ELEVEN MONTHS      ONE MONTH    
                                                                             ENDED            ENDED      
                                              YEARS ENDED DECEMBER 31,    NOVEMBER 30,     DECEMBER 31,   YEARS ENDED DECEMBER 31,
                                             -------------------------                                  ----------------------------
                                                1994          1995            1996             1996          1997          1998
                                             -----------  ------------   --------------    ------------ -------------   ------------

<S>                                           <C>            <C>         <C>               <C>            <C>            <C> 
Operating Data:                                                                                                        
Operating revenues                                $ 23,892    $ 40,326       $ 53,663         $ 5,506       $ 91,773     $ 225,293
Operating expenses:                                                                                                    
       Telecommunciation costs                      11,761      18,673         23,317           2,299         37,871        99,843
       Facility commissions                          3,901       9,595         13,962           1,455         25,724        71,206
       Field operations and maintenance              1,044       1,467          1,816             219          4,543         7,817
       Selling, general and administrative           2,571       4,089          3,921             372          8,540        17,661
       Depreciation and impairment                     965       1,359          1,538             111          2,219         6,692
       Amortization of intangibles                   1,392       1,605          1,746             741         14,243        26,339
       Restructuring and other charges                   -           -            684               -            400         1,743
                                                ----------- -----------    -----------    ------------   ------------   -----------
           Total operating expenses                 21,634      36,788         46,984           5,197         93,540       231,301
                                                ----------- -----------    -----------    ------------   ------------   -----------

Operating income (loss)                              2,258       3,538          6,679             309         (1,767)       (6,008)
Other (income) expenses:                                                                                               
       Interest expense, net                           745       1,360          1,469             612         11,138        19,638
       Other, net                                     (134)        (52)            27             (20)           (76)         (236)
                                                ----------- -----------    -----------    ------------   ------------   -----------
           Total other (income) expense                611       1,308          1,496             592         11,062        19,402
                                                ----------- -----------    -----------    ------------   ------------   -----------

Income (loss) before income taxes and                                                                                  
       extraordinary loss                            1,647       2,230          5,183            (283)       (12,829)      (25,410)
                                                                                                                       
Income tax (benefit) expense                           (11)        891          1,917             (23)          (642)          476
                                                ----------- -----------    -----------    ------------   ------------   -----------
Income (loss) before extraordinary                                                                                     
       loss                                          1,658       1,339          3,266            (260)       (12,187)      (25,886)
                                                                                                                       
Extraordinary loss                                       -           -             52               -          4,740             -
                                                ----------- -----------    -----------    ------------   ------------   -----------
                                                                                                                       
Net income (loss)                                  $ 1,658     $ 1,339        $ 3,214          $ (260)     $ (16,927)    $ (25,886)
                                                =========== ===========    ===========    ============   ============   ===========
                                                                                                                       
OTHER DATA:                                                                                                            
EBITDA (1)                                         $ 4,749     $ 6,554        $ 9,936         $ 1,181       $ 14,771      $ 27,259
Net cash provided (used) by operating                                                                                  
  activities                                         3,445       4,069          7,300          (1,419)         6,048         4,258
Net cash used in investing activities               (9,976)     (8,022)        (7,515)        (47,252)       (90,757)      (23,384)
Net cash provided (used) by financing                                                                                  
  activities                                         6,668       4,827           (547)         48,966         92,193        13,039
Capital expenditures (2)                             3,223       4,669          2,804             269          8,063        13,592
Ratio of earnings to fixed charges (3)                 3.0         2.5            4.2              --             --            --
Deficiency of earnings to fixed charges                 --          --             --           $ 283       $ 12,829      $ 25,410
                                                                                                                       
BALANCE SHEET DATE (AT END OF PERIOD)                                                                                  
Cash and cash equivalents                            $ 419     $ 1,293          $ 531           $ 294        $ 7,778       $ 1,692
Total assets                                        17,639      26,592         34,708          80,134        189,388       191,466
Total debt (including current                                                                                          
       maturities)                                  10,750      15,074         14,845          63,315        166,736       180,483
Total stockholders' equity (deficit)                 2,027       4,850          9,361           6,481        (10,020)      (36,113)
</TABLE> 

___________

(1)  For the purpose of this Form 10-K, EBITDA means income before interest,
     income taxes, depreciation, and amortization. Although EBITDA is not a 
     measure of performance calculated in accordance with generally accepted
     accounting principles, the Company has included information concerning
     EBITDA in this Form 10-K because it is commonly used by certain investors
     and analysts as a measure of a company's ability to service its debt
     obligations and is a component of the Company's debt compliance ratios.
     EBITDA should not be used as an alternative to, or be considered more
     meaningful than operating income, net income, or cash flow as an indicator
     of the Company's operating performance.

(2)  Capital expenditures include only amounts expended for purchases of
     property and equipment and the implementation of facilitiy contracts and
     excludes cash outflows for acquisitions.

(3)  Earnings are defined as earnings (loss) before income taxes from continuing
     operations and fixed charges. Fixed charges are defined as interest expense
     and a portion of rental expense representing the interest factor, which the
     Company estimates to be one-third of rental expense, and amortization of
     deferred financing expense. This calculation is a prescribed earnings
     coverage ratio intended to present the extent to which earnings are
     sufficient to cover fixed charges, as defined.

                                      16
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
          OF OPERATIONS

        The following discussion and analysis of the Company's financial
condition and results of operations should be read in conjunction with the
financial statements and the notes thereto contained elsewhere in this report.
Certain information contained in the discussion and analysis set forth below
includes forward-looking statements that involve risks and uncertainties. See
"Special Note Regarding Forward-Looking Information."

Overview

        The Company is the largest independent provider of collect, prepaid, and
debit calling services to local, county, state, and private correctional
facilities in the U.S. The Company derives substantially all of its revenues
from its operation of inmate telecommunications systems located in correctional
facilities in approximately 43 states. As of December 31, 1998, the Company
served 2,073 correctional facilities in 43 states.

        The Company derives substantially all of its revenues from its operation
of inmate telecommunications systems located in correctional facilities in 43
states. The Company's inmate telecommunications services consist of collect
call, prepaid, and debit card services. The Company enters into multi-year
agreements (generally three to five years) with the correctional facilities,
pursuant to which the Company serves as the exclusive provider of
telecommunications services to inmates within each facility. In exchange for the
exclusive service rights, the Company pays a percentage of its revenue from each
correctional facility as a commission to that facility. Typically, the Company
installs and retains ownership of the telephones and related equipment and
provides additional services to correctional facilities that are tailored to the
specialized needs of the corrections industry and to the requirements of the
individual correctional facility, such as call activity reporting and call
blocking. The Company also generates revenues from public pay telephones that
are ancillary to its inmate telephone business.

        The Company accumulates call activity data from its various
installations and bills its revenues related to this call activity through LECs
or through third-party billing services. In addition, the Company accrues the
related telecommunications costs for validating, transmitting, billing and
collection, and line and long-distance charges, along with commissions payable
to the facilities, and allowances for uncollectible accounts based on historical
experience.

        The Company's traditional inmate business consists of collect, prepaid,
and debit calling services provided to correctional facilities. In May 1998, the
Company began providing validation, billing, and collection services for the
inmate calls of a major RBOC. Under the terms of the agreement, the Company
acquires at a discount the related accounts receivable from the RBOC for the
calls that the Company processes. When the receivables are purchased, the
Company accepts responsibility for all validation, uncollectible accounts, and
billing and collections costs, with no recourse to the RBOC. However, under the
terms of the agreement, all purchased receivables must be processed and
validated through the Company's call management and billing system. The
Company's revenues from this service equal the difference between the face value
of the receivables purchased and the amount it pays the RBOC for the discounted
accounts receivable. Because the Company's revenues associated with this
contract represent only a percentage of the face value of the receivables
purchased, the associated uncollectible account expense and billing and
collection fees represent a much higher percentage of revenue as compared to the
Company's traditional inmate business. Consequently, the Company's
telecommunications costs represent a higher percentage of revenue under this
contract. There are minimal selling, general, and administrative ("SG&A") costs
associated with this contract. The contract term is three years and has no
minimum volume commitment. The Company pays no facility commissions under this
agreement.

        The Company's principal operating expenses consist of (i)
telecommunication costs; (ii) commissions paid to correctional facilities, which
are typically expressed as a percentage of either gross or net revenues, fixed
for the term of the agreements with the facilities, and in some cases are
subject to monthly minimum amounts; (iii) field operations and maintenance
costs, which consist primarily of field service on the Company's installed base
of inmate telephones; and (iv) SG&A costs.

        Telecommunication Costs.  The principal components of telecommunication
costs are long distance transmission costs, local access costs, third party
billing costs, and costs of uncollectible accounts.  Historically, long distance
costs have consisted of charges for minutes of use purchased from IXCs.  The
Company entered into an agreement to lease lines connecting urban areas
and correctional facilities in the state of North Carolina.  Given the Company's
relatively high level of traffic in North Carolina, management believes that
transmission via leased lines will be more economical than acquiring minutes of
use.  

                                       17 
<PAGE>
 
Local access charges consist of monthly line and usage charges paid to RBOCs and
other LECs for interconnection to the local network for local calls, which are
computed on a flat monthly charge plus, for certain LECs, and on a per message
or per minute usage rate based on the time and duration of the call. Third party
billing charges consist of payments to LECs and other billing service providers
for billing and collecting revenues from called parties. The Company believes
that it experiences faster payments and lower expenses associated with
uncollectible accounts when using direct billing than when using other billing
service providers. Expenses associated with uncollectible accounts are a
significant cost in providing inmate telecommunications services.

        Commissions. The Company pays a percentage of its revenue from each
facility to that facility as a commission. Commissions are generally set for the
duration of the Company's multi-year contract with the facility. Commission
rates are the principal basis of competition for obtaining and retaining
contracts. The Company's ability to offer increasingly attractive commission
rates to facilities depends on its ability to control its operating expenses.
Generally, contracts for larger facilities have higher commission rates, but
these higher commission rates are typically offset by lower network charges,
field maintenance, and SG&A expenses as a percentage of revenue. The commission
rates paid by the Company have increased in each period, from 23.8% in 1995 to
31.6% in 1998. This increase is due primarily to higher facility commissions on
contracts obtained by the Company through acquisitions, competition for larger
facilities, and increased commission rates on renewals. Commission rates are
expected to gradually increase as a percentage of revenues in the future. The
overall commission percentage to total revenues of 31.5% in 1998 includes the
effect of the billing and collection services provided under the Company's
agreement with a major RBOC, under which no commissions are paid.

        Field Operations and Maintenance. Field operations and maintenance
consist of maintenance costs associated with inmate phones and related
equipment. These costs are relatively small and more constant components of
operating expenses.

        Selling, General, and Administrative. SG&A expenses consist of corporate
overhead and selling expense. These costs are also relatively small and more
constant components of operating expenses. 

        Restructuring Costs. The Company is currently integrating its acquired
operations into its existing operations, which resulted in a restructuring
charge in September 1998 of $1.4 million. The restructuring charge was lowered
by $0.2 million in the fourth quarter, primarily due to the final determination
of the number of employees terminated, the unanticipated subletting of certain
facilities, and a refinement of expected legal and other costs.

        Company History. The Company became the holding company for the
operations of its predecessors, AmeriTel and Talton Telecommunications,
effective December 1, 1996. The Company also acquired the operations of Tataka
on April 2, 1997, STC on June 27, 1997, CCC on July 31, 1997, InVision on
October 6, 1997, NAI on December 1, 1997, PTC on December 18, 1997, ILD on
January 1, 1998, MOG on February 1, 1998, and Saratoga on July 1, 1998. Because
the Company's acquisitions of its predecessors have been accounted for using the
purchase method of accounting, the Company's results of operations reflect the
operations of AmeriTel and Talton Telecommunications only subsequent to December
1, 1996. In addition to the acquisitions of its predecessors, the Company has
also completed the Acquisitions, which have also been accounted for using the
purchase method of accounting, and the Company's results of operations therefore
reflect the operations of these companies only subsequent to the effective dates
of their respective acquisitions. Management believes that the growth of the
Company and its predecessors, AmeriTel and Talton Telecommunications, through
acquisitions makes meaningful period-to-period comparison of historical results
of operations difficult. Consequently, management believes that the investor is
presented with more meaningful information through discussion of the Company and
its predecessors on a combined basis, for the periods discussed below.

                                       18
<PAGE>
 
Results of Operations

        The following table sets forth, for the periods indicated, the combined
historical results of operations of the Company and AmeriTel and Talton
Telecommunications, without any adjustments to historical results to reflect
changes in depreciation and amortization resulting from purchase accounting
evaluations, as follows:

Year ended December 31, 1996...........   Combined results of operations of the
                                          predecessors, AmeriTel and Talton
                                          Telecommunications, for the eleven
                                          months ended November 30, 1996 and of
                                          the Company for the one month ended
                                          December 31, 1996

Years ended December 31, 1997 and 1998..  Consolidated results of operations of
                                          the Company for the periods

        These above described combined results of operations include the
results of operations of the acquired entities in the Company's results of
operations only for the periods subsequent to their acquisition dates.`


<TABLE>
<CAPTION>
                                                                     Years Ended December 31,
                                          -------------------------------------------------------------------------------
                                                   1996                      1997                         1998
                                          ----------------------  ---------------------------  --------------------------
<S>                                       <C>          <C>        <C>             <C>          <C>           <C>
                                                                      (Dollars in thousands)
Operating revenues  ......................    $59,169     100.0%       $ 91,773        100.0%     $225,293         100.0%
Operating expenses:
 Telecommunication costs  ................     25,616      43.3          37,871         41.3        99,843          44.3
 Facility commissions  ...................     15,417      26.1          25,724         28.0        71,206          31.6
 Field operations and maintenance  .......      2,035       3.4           4,543          5.0         7,817           3.5
 Selling, general, and administrative.....      4,293       7.3           8,540          9.3        17,661           7.8
 Depreciation and impairment..............      1,649       2.8           2,219          2.4         6,692           3.0
 Amortization of intangibles  ............      2,487       4.2          14,243         15.5        26,339          11.7
 Restructuring and other charges..........        684       1.2             400          0.4         1,743           0.8
                                              -------      ----        --------       ------      --------        ------
Total operating expenses  ................     52,181      88.3          93,540        101.9       231,301         102.7
                                              -------      ----        --------       ------      --------        ------
Operating income (loss)  .................      6,988      11.7          (1,767)        (1.9)       (6,008)         (2.7)
Other (income) expense:
 Interest expense, net  ..................      2,081       3.5          11,138         12.1        19,638           8.7
 Other, net  .............................          7      (0.0)            (76)         0.0          (236)         (0.1)
                                              -------      ----        --------       ------      --------        ------
Total other expense  .....................      2,088       3.5          11,062         12.1        19,402           8.6
                                              -------      ----        --------       ------      --------        ------
Income (loss) before income taxes and
 extraordinary loss  .....................      4,900       8.2         (12,829)       (14.0)      (25,410)        (11.3)

Income tax expense (benefit)  ............      1,894       3.2            (642)        (0.7)          476           0.2
                                              -------      ----        --------       ------      --------        ------
Income (loss) before extraordinary loss...      3,006       5.0         (12,187)       (13.3)      (25,886)        (11.5)
Extraordinary loss  ......................         52       0.1           4,740          5.1            --            --
                                              -------      ----        --------       ------      --------        ------
Net income (loss)  .......................    $ 2,954       4.9%       $(16,927)      (18.4)%     $(25,886)       (11.5)%
                                              =======      ====        ========       ======      ========        ======
EBITDA  ..................................    $11,117      18.8%       $ 14,771         16.1%     $ 27,259          12.1%
</TABLE>

Year Ended December 31, 1998 (Consolidated Results of Operations of the Company)
compared to year ended December 31, 1997 (Consolidated Results of Operations of
the Company)

        Operating Revenues. The Company's operating revenues increased by $133.5
million, or 145.5%, from $91.8 million for the year ended December 31, 1997 to
$225.3 million for the year ended December 31, 1998. The increase in operating
revenues was primarily due to acquisitions by the Company of CCC, InVision, and
PTC between July and December 1997 and of ILD, MOG and Saratoga in 1998. Since
its inception, the Company has acquired contracts for 1,888 facilities through
the Acquisitions and has added additional facilities by winning new contracts
for county, local, and state facilities. As of December 31, 1998 the Company
served 2,073 correctional facilities in 43 states. The Company's contract with
the State of Alabama was not renewed, and the Company estimates that this will
result in a reduction in revenue and EBITDA in fiscal year 1999 of $8.2 million
and $1.5 million, respectively, when compared to fiscal year 1998.


                                       19
<PAGE>
 
        Operating Expenses. Total operating expenses increased by $137.8
million, or 147.3%, from $93.5 million in 1997 to $231.3 million in 1998.
Operating expenses as a percentage of operating revenues increased by 0.8% from
101.9% for the year ended December 31, 1997 to 102.7% for the year ended
December 31, 1998. The increase in operating expenses as a percentage of
revenues is primarily due to factors discussed below.

        Telecommunication costs increased by $61.9 million, from $37.9 million
in 1997 to $99.8 million in 1998. Telecommunication costs represented 41.3% of
operating revenues in 1997 and 44.3% of operating revenues in 1998, an increase
of 3.0%. The percentage increase is due in part to higher levels of
uncollectible accounts associated with the Company's acquisitions subsequent to
June 30, 1997, which are located in geographic regions that exhibit higher
uncollectible rates. The percentage increase is also due to the increase in
competitive local exchange carrier ("CLEC") activity. These CLECs increased the
Company's unbillable expense, because in most cases the CLECs are unable to bill
the Company's traffic. The Company is responding to this problem by offering
prepaid services to these customers. The Company's overall telecommunications
costs as a percentage of revenues of 44.3% for 1998 include the effect of the
Company's billing and collection services provided to a major RBOC as discussed
in "General" in Item 2. These billing and collection services exhibit higher
telecommunication costs as a percentage of revenue than the Company's
traditional inmate business.

        Facility commissions increased by $45.5 million, from $25.7 million in
1997 to $71.2 million in 1998. Facility commissions represented 28.0% of
operating revenues in 1997 and 31.6 % in 1998, an increase of 3.6%. This
increase as a percentage of revenue is primarily due to increased facility
commissions under contracts obtained by the Company through acquisitions, the
competition in larger facilities, and increased commission rates on renewals.
Facility commissions are expected to gradually increase as a percentage of
revenue in the future. The overall commission percentage to total revenue of
31.6% in 1998 includes the effect of the billing and collection services
provided to a major RBOC as discussed in "General" in Item 2.

        Field operations and maintenance costs increased by $3.3 million, from
$4.5 million in 1997 to $7.8 million in 1998. Field operations and maintenance
costs represented 5.0% of operating revenues in 1997 and 3.5% of operating
revenues in 1998, a decrease of 1.5%. The dollar increase is primarily due to
costs associated with servicing the acquired facilities and the new contract
facilities. Field operations and maintenance costs as a percentage of revenue
was 3.3% for the fourth quarter 1998 compared to 3.4% for the third quarter
1998. This decrease is due to the integration activities completed by the
Company in the fourth quarter.

        SG&A costs increased by $9.2 million, from $8.5 million in 1997 to $17.7
million in 1998.  SG&A represented 9.3% of operating revenues in 1997 and 7.8%
of operating revenues in 1998, a decrease of 1.5%.  The dollar increase in SG&A
costs is primarily due to the increased infrastructure necessary to support the
Acquisitions.  SG&A costs as a percentage of revenue was 7.3% for the fourth
quarter 1998 compared to 8.0% for the third quarter 1998.  This percentage
decrease is mainly due to the integration activities completed by the Company in
the fourth quarter.

        Total depreciation and amortization costs increased by $16.5 million,
from $16.5 million in 1997 to $33.0 million in 1998. Depreciation and
amortization costs represented 17.9% of operating revenues in 1997 and 14.7% of
operating revenues in 1998, a decrease of 3.2%. The dollar increase is primarily
due to additional amortization expense associated with the inmate facility
contracts acquired in the Acquisitions. Amortization resulting from purchase
accounting of the Acquisitions is and will continue to be a substantial portion
of the Company's operating expenses.

        The Company integrated its acquired operations into its existing
operations, which resulted in a restructuring charge of $1.4 million in
September 1998. The restructuring charge was lowered by $0.2 million in the
fourth quarter, primarily due to the final determination of the number of
employees terminated, the unanticipated subletting of certain facilities, and a
refinement of expected legal and other costs. In December 1998, the Company
wrote-off approximately $0.5 million related to the postponement of the
Company's initial public offering.

        Other (Income) Expense.  Other (income) expense, consisting primarily of
interest expense, increased by $8.3 million from $11.1 million in 1997 to $19.4
million in 1998.  The increase was primarily due to interest expense associated
with the indebtedness incurred by the Company in connection with the
Acquisitions.

        Net Loss.  The Company's net loss increased by $9.0 million, from $16.9
million in 1997 to $25.9 million in 1998 as a result of the factors described
above.

        EBITDA. Earnings before interest, income taxes, depreciation and
amortization ("EBITDA") increased by $12.5 million from $14.8 million in 1997 to
$27.3 million in 1998. EBITDA as a percentage of operating revenues decreased
from 16.1% in 1997 to 12.1% in 1998 due to the factors described above. Although
EBITDA is not a measure of performance

                                       20
<PAGE>
 
calculated in accordance with generally accepted accounting principles, the
Company has included information concerning EBITDA in this Form 10-K because it
is commonly used by certain investors and analysts as a measure of a company's
ability to service its debt obligations and is a component of the Company's debt
compliance ratios. EBITDA should not be used as an alternative to, or be
considered more meaningful than, operating income, net income or cash flows as
an indicator of the Company's operating income. Several of the Company's
subsidiaries are subject to state income taxes. Consequently, the Company
accrues income tax expense even in a loss period.

Year Ended December 31, 1997 (Consolidated Results of Operations of the Company)
Compared to Year Ended December 31, 1996 (Combined Results of Operations of the
Company's Predecessors, AmeriTel And Talton Telecommunications, for the Eleven
Months Ended November 30, 1996 and of the Company for the One Month Ended
December 31, 1996)

        Operating Revenues.  The Company's operating revenues increased by $32.6
million, or 55.1%, from $59.2 million for the year ended December 31, 1996 to
$91.8 million for the year ended December 31, 1997.  The increase in operating
revenues was primarily due to acquisitions of the Company of STC, CCC, InVision,
NAI, and PTC during 1997, and new contract installations.  Specifically, the
Company acquired inmate telephone contracts at 128 facilities in 14 states from
STC; 23 facilities in 3 states from CCC; 568 facilities in 37 states from
InVision; 57 facilities in 5 states from NAI; and 82 facilities in 10 states
from PTC.

        Operating Expenses. Total operating expenses increased $41.3 million,
from $52.2 million in 1996 to $93.5 million in 1997. Operating expenses as a
percentage of operating revenues increased 13.6% from 88.3% for the year ended
December 31, 1996 to 101.9% for the year ended December 31, 1997. The increase
in operating expenses as a percentage of revenues is primarily due to the
factors discussed below.

        Telecommunication costs increased by $12.3 million, from $25.6 million
in 1996 to $37.9 million in 1997. Telecommunication costs represented 43.3% of
operating revenues in 1996 and 41.3% of operating revenues in 1997, a decrease
of 2.0%. The dollar increase is primarily due to the acquisitions by the Company
of STC, CCC, InVision, NAI, and PTC during 1997, and new contract installations.
The decrease as a percentage of operating revenues is primarily due to lower
billing and collection costs as a result of direct billing arrangements entered
into with various major LECs and lower relative costs for long distance as a
result of new long distance agreements.

        Facility commissions increased by $10.3 million, from $15.4 million in
1996 to $25.7 million in 1997. Facility commissions represented 26.1% of
operating revenues in 1996 and 28.0% of operating revenues in 1997, an increase
of 1.9%. The increase is primarily due to higher commission rates for certain
contracts associated with the Acquisitions, as well as higher commission
percentages paid as a result of periodic increases in percentages paid to
existing customers as contracts are renewed.

        Field operation and maintenance costs increased by $2.5 million, from
$2.0 million in 1996 to $4.5 million in 1996. Field operation and maintenance
costs represented 3.4% of operating revenues in 1996 and 5.0% of operating
revenues in 1997, an increase of 1.6%. The dollar increase is primarily due to
an increase in the costs associated with servicing acquired facilities.

        SG&A increased by $4.2 million, from $4.3 million in 1996 to $8.5
million in 1997. SG&A represented 7.3% of operating revenues in 1996 and 9.3% of
operating revenues in 1997, an increase of 2.0%. The increase in SG&A as a
percentage of operating revenues is primarily due to the increased
infrastructure necessary to support the Company's acquisitions and the Company's
more aggressive sales efforts. The Company's SG&A for 1997 was affected by the
significant acquisition activity during the period.

        Total depreciation and amortization costs increased by $12.4 million,
from $4.1 million in 1996 to $16.5 million in 1997. Depreciation and
amortization costs represented 7.0% of operating revenues in 1996 and 17.9% of
operating revenues in 1997, an increase of 10.9%. The dollar increase is
primarily due to additional amortization expense associated with the
acquisitions by the Company of inmate facility contracts, and the Acquisitions.

     The Company incurred an expense of $400,000 in 1997 related to external
costs associated with the Company's application for the Federal Board of Prisons
contract. The Company was unsuccessful in obtaining the contract. The contract
award has been appealed, however, the Company has expensed all costs associated
with the bid.

                                       21
<PAGE>
 
        The Company incurred a non-recurring expense of $684,000 in 1996 related
to $434,000 in bonuses paid by AmeriTel prior to its acquisition by the Company
and $250,000 paid by AmeriTel to settle a lawsuit. Such expense represented 1.2%
of operating revenues in 1996.

        Operating Income (Loss). The Company's operating income decreased by
$8.8 million, from $7.0 million in 1996 to an operating loss of $1.8 million in
1997 primarily as a result of increases in depreciation and amortization due to
the Acquisitions. Also, as a result of the depreciation and amortization, the
Company's operating income margin decreased from 11.7% in 1996 to an operating
loss of 1.9% in 1997.

        Other (Income) Expense.  Other (income) expense, consisting primarily of
interest expense, increased by $9.0 million from $2.1 million in 1996 to $11.1
million in 1997.  The increase was primarily due to interest expense associated
with indebtedness incurred by the Company in connection with acquisitions and
completion of the June 1997 offering (the "Notes Placement") of $115,000,000
principal amount 11% Senior Notes due 2007 (the "Senior Notes").

        Extraordinary Loss.  The Company incurred an extraordinary loss of $4.7
million in 1997 due to the write-off of the unamortized deferred loan costs and
the unamortized discount related to the senior subordinated notes originally
issued by Canadian Imperial Bank of Commerce ("CIBC"), which were repaid in
connection with the acquisitions of AmeriTel and Talton Telecommunications (the
"Senior Subordinated Notes") with the net proceeds the Notes Placement.  In
1996, one of the Company's predecessors incurred an extraordinary loss of
approximately $52,000 in conjunction with the extinguishment of debt.

        Net Income (Loss). The Company's net income decreased by $20.0 million,
from $3.0 million in 1996 to a net loss of $17.0 million in 1997 as a result of
the factors described above.

        EBITDA. EBITDA increased by $3.7 million from $11.1 million in 1996 to
$14.8 million in 1997. EBITDA as a percentage of operating revenues decreased
from 18.8% in 1996 to 16.1% in 1997 due to the factors described above.

Liquidity and Capital Resources

        The Company anticipates that its principal uses of liquidity will be to
provide working capital, meet debt service requirements, and to repay principal
under the Senior Credit Facility. The Company expects that its principal sources
of funds will be cash flow from operations and borrowings under the Senior
Credit Facility. The Company anticipates that its primary capital expenditures
will be for capital items required to implement new contracts entered into by
the Company and alternative network solutions, although the Company does not
have material commitments for capital expenditures. Management believes that
cash flow from operations (if any) and from the Senior Credit Facility will be
sufficient to fund the requirements of the Company for at least the next 12
months.

        In March 1999 the Company raised $5 million of equity from its existing
shareholders and warrant holders and/or their affiliates through the issuance of
5,000 investment units at a price of $1,000 per unit.  Each unit consists of one
share of newly authorized First Preferred Series A Stock and a warrant to
acquire one share of Common Stock for $1,000 per share.  The First Preferred
Series A Stock will be entitled to receive dividends at the applicable First
Preferred Series A Rate, payable quarterly commencing on April 1, 1999.  Such
dividends will be payable out of funds legally available therefor, are payable
only when, as, and if declared by the Board of Directors, are cumulative, and,
if undeclared or unpaid, shall bear interest at the applicable First Preferred
Series A Rate until paid.  The First Preferred Series A Rate will be 8% per
annum through March 31, 2001, 10% per annum from April 1, 2001 through June 30,
2001, and thereafter will increase by 0.5% for each additional three month
period up to a maximum of 16% per annum.  The First Preferred Series A Stock
ranks senior to all classes of the Company's common stock but ranks junior to
the Senior Preferred Stock of the Company (the "Senior Preferred Stock") with
respect to dividend rights and rights upon liquidation.  The warrants have a
strike price of $1,000 per share and will expire, if not sooner exercised, on
December 31, 2007.  As a result of the issuance of the First Preferred Series A
Stock and warrants, the Company was required to obtain a waiver from its Senior
Credit Facility group of lenders that waived the lenders' rights to the proceeds
raised by the Company from the issuance.

        In conjunction with the March 1999 equity offering, the preferred 
dividend rates on the original Senior Preferred Stock were modified to mirror 
the preferred dividend rates on the First Preferred Series A Stock.

        Also in March 1999 and in conjunction with the issuance of the First
Preferred Series A Stock and warrants, the Company amended and restated its
Senior Credit Facility. The amendment increased the Company's borrowing capacity
under the term loan facility of the Senior Credit Facility by $5.5 million,
which will bear interest at similar rates to the existing

                                       22
<PAGE>
 
borrowings under the Senior Credit Facility. The Company borrowed the additional
$5.5 million in March 1999 and concurrently repaid $5 million under the
revolving portion of the Senior Credit Facility.

        As of March 26, 1999, the Company had $13.5 million of available 
borrowing capacity under the Senior Credit Facility.

        The Company intends to evaluate additional acquisitions to expand its
base of installed inmate telephones and value added services and will continue
to evaluate possible acquisition candidates. There can be no assurance that the
Company will have sufficient available capital resources to realize its
acquisition strategy. Such future acquisitions, depending on their size and the
form of consideration, may require the Company to seek additional debt or equity
financing, or both.

        Net cash provided by operating activities was $4.3 million for the year
ended December 31, 1998, as compared to net cash provided by operating
activities of $6.0 million for the year ended December 31, 1997. Net cash
provided by operating activities was $5.9 million for the year ended December
31, 1996. Net cash provided by operating activities in 1998 declined from 1997
primarily due to working capital required to fund the Company's growth in its
traditional inmate business.

        Cash used in investing activities was $23.4 million for the year ended
December 31, 1998, as compared to $90.8 million for the year ended December 31,
1997.  Cash used in investing activities in 1998 consisted primarily of $7.0
million to fund the acquisitions of ILD, MOG and Saratoga, $4.7 million in
payments related to acquisitions made in 1997 and $13.6 million for new
business, contract renewals and infrastructure improvements.  Cash used in
investing activities in 1997 consisted primarily of cash outflows for
acquisitions.  Cash used in investing activities was $54.8 million in 1996,
consisting primarily of cash outflows for acquisitions.

        Cash provided by financing activities was $13.0 million for the year
ended December 31, 1998, as compared to $92.2 million in 1997. Cash provided by
financing activities in 1998 consisting primarily of new borrowings under the
Senior Credit Facility offset by $5.5 million of repayments of the term loan
portion of the Senior Credit Facility and $0.5 million of preferred dividends
paid. Cash provided by financing activities in 1997 consisted primarily of the
issuance of the Senior Notes, the borrowing of $50.5 million under the Senior
Credit Facility and offset by the repayment of amounts borrowed under the
Company's previous credit facility, the Senior Subordinated Notes, and
subordinated notes issued in connection with the acquisition of Talton
Telecommunications (the "Talton Notes"). Net cash provided by financing
activities was $48.4 million in 1996.

        The Senior Credit Facility consists of (a) a $55.0 million term loan
acquisition facility, (b) a $5.5 million additional term loan facility, and (c)
a $25.0 million revolving loan facility (which includes a $5.0 million letter of
credit facility). Scheduled principal payments under the term loan facilities
may not be reborrowed. Amounts borrowed under the Senior Credit Facility bear
interest, at the option of the Company, at either (i) the Base Rate (i.e., the
higher of CIBC's reference rate and the overnight federal funds rate plus 0.5%)
plus a margin that varies from 75 to 225 basis points, depending on the
Company's Total Debt to EBITDA Ratio (as defined in the Senior Credit Facility);
or (ii) the LIBO rate plus a margin that varies from 200 to 350 basis points,
depending on the Company's Total Debt to EBITDA Ratio.

        The Senior Credit Facility requires quarterly interest payments to be
made on base rate loans and periodic interest-only payments based on the
applicable interest period on LIBO rate loans, at least quarterly, in each case
until maturity. In addition, the Senior Credit Facility requires mandatory
prepayments out of the proceeds of certain equity or debt offerings, asset
dispositions, receipt of insurance proceeds not applied as provided in the
Senior Credit Facility, and receipts of funds from certain escrow accounts.
Scheduled principal payments on the term loan facility are approximately $9.7
million, $12.4 million, $13.8 million, and $13.8 million during the years ended
1999, 2000, 2001, and 2002, respectively. All outstanding principal and interest
under the Senior Credit Facility is due December 31, 2002. The Senior Credit
Facility is secured by substantially all the assets of the Company and its
subsidiaries.

        As of December 31, 1998, the Company had approximately $180.5 million of
long-term indebtedness outstanding, including (i) $115.0 million of the Senior
Notes outstanding at an interest rate of 11.0%, (ii) $64.0 million of
indebtedness under the Senior Credit Facility, and (iii) $1.5 million of other
indebtedness consisting primarily of deferred acquisitions costs and capital
leases. As of December 31, 1998, the Company had available borrowing capacity
under the revolving credit portion of its Senior Credit Facility of
approximately $8.5 million, subject to borrowing base limitations and certain
conditions.

        On June 30, 1998, the Company entered into an interest rate cap
agreement that has been designated as a hedge against the Company's variable
interest rate exposure on its loan under the Senior Credit Facility. At December
31, 1998, the interest

                                       23
<PAGE>
 
rate cap has an aggregate notional amount of $30.0 million, which matures in
June 2001, and caps interest on the LIBO rate portion of the term loan, up to
the aggregate notional amount, at 7.5%, plus the applicable LIBO rate margin.

        As of December 31, 1998 the Company was not in compliance with one of
its financial covenant ratios under the Senior Credit Facility and was
consequently required to obtain a waiver of default letter from its group of
lenders. This ratio, the fixed charge coverage ratio, which is a measure of the
Company's debt service, capital expenditures, and income tax obligations to its
free cash flow (as defined), was subsequently modified in the March 1999
amendment to the Senior Credit Facility. Based on this modification, the
Company is currently in compliance with its debt covenants and would have been
in compliance as of December 31, 1998.

        The Senior Credit Facility and the Indenture contain numerous
restrictive covenants including, among others, limitations on the ability of the
Company to incur additional indebtedness, to create liens and other
encumbrances, to make certain payments and investments, to sell or otherwise
dispose of assets, or to merge or consolidate with another entity. The Senior
Credit Facility also requires the Company to meet certain financial tests on a
consolidated basis, some of which may be more restrictive in future years. The
Company's failure to comply with its obligations under the Senior Credit
Facility, or in agreements relating to indebtedness incurred in the future,
could result in an event of default under such agreements, which could permit
acceleration of the related debt and acceleration of debt under other financing
arrangements that may contain cross-acceleration or cross-default provisions. In
addition, because interest under the Senior Credit Facility accrues at floating
rates, the Company remains subject to interest rate risk with respect to a
significant portion of its indebtedness.

Income Taxes

        Since the Company's acquisitions of AmeriTel, Talton Telecommunications,
MOG, and Saratoga were stock purchases, the Company was required to retain the
tax bases of AmeriTel, Talton Telecommunications, MOG, and Saratoga in the
assets acquired. As a result, the Company will not be entitled to a tax
deduction for the amortization of goodwill or the depreciation and amortization
of certain other tangible and intangible assets related to these acquisitions.
The Company has provided deferred income tax liabilities for differences in the
financial accounting and tax bases of its tangible and identifiable intangible
assets. However, in accordance with the requirements of Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," future
amortization of non-deductible goodwill will be treated as a permanent
difference in the Company's financial statements.

Accounting Pronouncements

        SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," was issued in June 1998, and requires recognition of all derivative
financial instruments as either assets or liabilities in consolidated balance
sheets at fair value and determines the method(s) of gain/loss recognition. SFAS
No. 133 is effective for fiscal years beginning after June 15, 1999. The Company
is currently evaluating the effect that it may have on the Company's
consolidated financial statements.

        In March 1998, the American Institute of Certified Public Accountants
("AICPA") released Statement of Position ("SOP") No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use."  SOP 98-1
requires the capitalization of certain expenditures for software that is
purchased or internally developed.  SOP No. 98-1 is effective for fiscal years
beginning after December 15, 1998.  The Company believes that the adoption of
this SOP will have no material effect on the financial position, results of
operations, or cash flows of the Company.

        In April 1998, the AICPA released SOP 98-5, "Reporting on the Costs of
Start-Up Activities." SOP 98-5 generally requires costs of start-up activities
to be expensed instead of being capitalized and amortized. SOP 98-5 is effective
for fiscal years beginning after December 15, 1998. The Company expects that the
adoption of this SOP will have no material effect on the financial position,
results of operations, or cash flows of the Company.

                                       24
<PAGE>
 
Information Systems And The Year 2000

        The following statements and all other statements made in this Annual
Report on Form 10-K with respect to the Company's Year 2000 processing
capabilities or readiness are "Year 2000 Readiness Disclosures" in conformance
with with the Year 2000 Information and Readiness Disclosure Act of 1998 (Public
Law 105-271, 112 Stat. 2386).

        Some computers, software, and other equipment include computer code in
which calendar year data is abbreviated to only two digits. As a result of this
design decision, some of these systems could fail to operate or fail to produce
correct results if "00" is interpreted to mean 1900, rather than 2000. These
problems are widely expected to increase in frequency and severity as the year
2000 approaches, and are commonly referred to as the "Year 2000 Problem."

        Assessment. The Year 2000 Problem affects computers, software, and other
equipment used, operated, or maintained by the Company. Accordingly, the Company
has organized a program team comprised of internal and external staff
responsible for monitoring the assessment and remediation status of the
Company's Year 2000 projects and reporting such status to the Company's
Executive Committee. This project team is currently assessing the potential
effect of, and costs of remediating, the Year 2000 Problem for the Company's
internal systems.

        For reporting purposes, the Company is using a methodology involving the
following six phases: Discovery, Assessment, Planning, Remediation, Testing, and
Implementation.  At December 31, 1998, the Discovery and Assessment phases were
substantially complete for all program areas.  The target completion date for
priority items by remaining steps are as follows: Planning - March 1999;
Remediation - May 1999; Testing - July 1999; and Implementation - August 1999.

        Internal Infrastructure. The Company believes that it has identified
most of the major computers, software applications, and related other equipment
used in connection with its internal operations that must be modified, upgraded,
or replaced in order to minimize the possibility of a material disruption to its
business from the Year 2000 Problem. The Company has commenced the process of
modifying, upgrading, and replacing major systems that have been assessed as
adversely affected, and expects to complete this process before the occurrence
of any material disruption of its business. However, there can be no assurance
in this regard.

        Systems Other than Information Technology Systems.  In addition to
computers and related systems, the operation of office and facilities equipment,
such as fax machines, photocopiers, telephone switches, security systems,
elevators, and other common devices may be affected by the Year 2000 Problem.
The Company is currently assessing the potential effect of, and costs of
remediating, the Year 2000 Problem on its office and facilities equipment.

        The Company estimates the total cost to the Company of completing any
required modifications, upgrades, or replacements of these internal systems to
be approximately $0.3 million, almost all of which the Company believes will be
incurred during 1999.  This estimate is being monitored and will be revised as
additional information becomes available.

        Based on the activities described above, the Company does not believe
that the Year 2000 Problem will have a material adverse effect on the Company's
business or results of operations. In addition, the Company has not deferred any
material information technology projects as a result of its Year 2000 Problem
activities.

        Customers and Suppliers. The Company has initiated communications with
its customers and third party suppliers of the major computers, software, and
other equipment used, operated, or maintained by the Company to identify and, to
the extent possible, resolve issues involving the Year 2000 Problem. However,
the Company has limited or no control over the actions of these customers and
third party suppliers. Thus, while the Company expects that it will be able to
resolve any significant Year 2000 Problems with these systems, there can be no
assurance that these customers and suppliers will resolve any or all Year 2000
Problems with these systems before the occurrence of a material disruption to
the business of the Company or any of its clients. Any failure of these third
parties to timely resolve Year 2000 Problems with their systems could have a
material adverse effect on the Company's business, financial condition, and
results of operations.

        Most Likely Consequences of Year 2000 Problem.  The Company expects to
identify and resolve all Year 2000 Problems that could have a material adverse
affect on its business operations.  However, management believes that it is not
possible to determine with complete certainty that all Year 2000 Problems
affecting the Company or its clients have been identified or corrected.  The
number of devices that could be affected and the interactions among these
devices are simply too numerous.  In addition, no one can accurately predict how
many Year 2000 Problem-related failures will occur or the severity, duration, or

                                       25
<PAGE>
 
financial consequences of these perhaps inevitable failures.  As a result,
management believes that the following consequences are possible:

     .  a significant number of operational inconveniences and inefficiencies
        for the Company and its clients that will divert management's time and
        attention and financial and human resources from ordinary business
        activities;

     .  a lesser number of serious systems failures that will require
        significant efforts by the Company or its clients to prevent or
        alleviate material business disruptions;

     .  several routine business disputes and claims for pricing adjustments or
        penalties by clients due to Year 2000 Problems, which will be resolved
        in the ordinary course of business; and

     .  a few serious business disputes alleging that the Company failed to
        comply with the terms of contracts or industry standards of performance,
        some of which could result in litigation or contract termination.

        Contingency Plans. The Company is currently developing contingency plans
to be implemented if its efforts to identify and correct Year 2000 Problems
affecting its internal systems are not effective. The Company expects to
complete its contingency plans by June 1999. Depending on the systems affected,
these plans could include accelerated replacement of affected equipment or
software; short- to medium-term use of backup sites, equipment, and software;
increased work hours for Company personnel; use of contract personnel to correct
on an accelerated schedule any Year 2000 Problems that arise or to provide
manual workarounds for information systems; and other similar approaches. If the
Company is required to implement any of these contingency plans, it could have a
material adverse effect on the Company's financial condition and results of
operations.

        Disclaimer.  The discussion of the Company's efforts, and management's
expectations, relating to Year 2000 compliance are forward-looking statements.
The Company's ability to achieve Year 2000 compliance, and the level of
incremental costs associated therewith, could be adversely impacted by, among
other things, the availability and cost of programming and testing resources,
vendors' ability to modify proprietary software, and unanticipated problems
identified in the ongoing compliance review.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

        The Company uses fixed and variable rate debt to partially finance
budgeted expenditures.  These agreements expose the Company to market risk
associated with changes in interest rates.  The Company does not hold or issues
derivative financial instruments for trading purposes.  On June 30, 1998, the
Company entered into an interest rate cap agreement that has been designated as
a hedge against the Company's variable interest rate risk exposure under the
Senior Credit Facility.  At December 31, 1998, the interest rate cap has an
aggregate national amount of $30.0 million, which matures in June 2001 and caps
interest on the LIBO rate portion of the term portion of the Senior Credit
Facility at 7.5%, plus the applicable LIBO rate margin.

        The following table presents the carrying and fair value of the
Company's debt along with average interest rates. Fair values are calculated as
the net present value of the expected cash flows of the financial instrument.

<TABLE>
<S>                <C>          <C>          <C>          <C>          <C>   <C>           <C>           <C>
Expected Maturity
Date.............                                                                                            Fair
                      1999         2000         2001         2002        2003   Thereafter    Total         Value
 
Variable Rate
 Debt (1)........  $9,657,729   $12,375,000  $13,750,000  $28,250,000                      $ 64,032,729  $ 64,032,729
 
 
Fixed Rate
Debt.............  $  950,000                                                $115,000,000  $115,950,000  $110,384,000
 
Average Interest
 Rate............           8%
 
</TABLE>
_________________
(1)  The average interest rate on variable debt is 9.74%

                                       26
<PAGE>
 
ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                  Index to Financial Statements and Schedules


                                                                            Page
                                                                            ----
Evercom, Inc.

     Report of Independent Certified Public Accountants...................... 29

     Consolidated Balance Sheets for December 31, 1997 and 1998.............. 30

     Consolidated Statements of Operations for the one month
          period ended December 31, 1996 and for each of the two
          years ended December 31, 1998...................................... 31

     Consolidated Statements of Stockholders' Equity (Deficit)
          for the one month period ended December 31, 1996 and
          for each of the two years ended December 31, 1998.................. 32

     Consolidated Statements of Cash Flows for the one month
          period ended December 31, 1996 and for each of the two
          years ended December 31, 1998...................................... 33

     Notes to Consolidated Financial Statements.............................. 34


Predecessors' Financial Statements

AmeriTel Pay Phones, Inc.

     Report of Independent Certified Public Accountants...................... 55

     Balance Sheet for November 30, 1996..................................... 56

     Statement of Income for the eleven months ended November 30,
          1996............................................................... 57

     Statement of Stockholders' Equity for the eleven months
          ended November 30, 1996............................................ 58

     Statement of Cash Flows for the eleven months ended
          November 30, 1996.................................................. 59

     Notes to Financial Statements........................................... 60

                                      27
<PAGE>
 
Talton Telecommunications Corporation

     Report of Independent Certified Public Accountants ..............  71
     
     Consolidated Balance Sheet for November 30, 1996.................. 72
     
     Consolidated Statement of Income for the eleven months
          ended November 30, 1996...................................... 73
          
     Consolidated Statement of Stockholders' Equity for the
          eleven months ended November 30, 1996........................ 74
     
     Consolidated Statement of Cash Flows for the eleven months
          ended November 30, 1996...................................... 75
     
     Notes to Consolidated Financial Statements........................ 76


SUPPLEMENTARY DATA:
------------------ 

     Consolidated Valuation and Qualifying Accounts for the one
          month period ended December 31, 1996 and for each of
          the two years ended December 31, 1998........................ 83




                                      28
<PAGE>
 
INDEPENDENT AUDITORS' REPORT


To the Board of Directors and
   Stockholders of Evercom, Inc.:

We have audited the accompanying consolidated balance sheets of Evercom, Inc.
and subsidiaries (the "Company") as of December 31, 1998 and 1997, and the
related consolidated statements of operations, stockholders' equity (deficit)
and cash flows for each of the two years in the period ended December 31, 1998
and for the one-month period from December 1, 1996 (date of acquisition) to
December 31, 1996. Our audits also included the financial statement schedule
listed in the Index at Item 8. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on the consolidated financial statements
and financial statement schedule 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, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of the Company as of
December 31, 1998 and 1997, and the results of their operations and their cash
flows for each of the two years in the period ended December 31, 1998 and the
one-month period ended December 31, 1996, in conformity with generally accepted
accounting principles. Also, in our opinion, such financial statement schedule,
when considered in relation to the basic consolidated financial statements taken
as a whole, presents fairly in all material respects the information set forth
therein.




DELOITTE & TOUCHE LLP
Dallas, Texas
March 25, 1999

                                      29
<PAGE>
 
                        EVERCOM, INC. AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS

<TABLE> 
<CAPTION> 
                                                                                                 DECEMBER 31,
                                                                                    ----------------------------------------
ASSETS                                                                                     1997                1998
                                                                                           ----                ----

<S>                                                                                 <C>                 <C> 
CURRENT ASSETS:
   Cash and cash equivalents                                                           $   7,777,996    $   1,691,762
   Accounts receivable                                                                    17,401,907       39,070,959
   Refundable income taxes                                                                   600,388          435,593
   Inventories                                                                             1,690,930        2,360,280
   Prepaid expenses and other current assets                                               2,309,661          392,448
   Deferred income tax assets                                                              1,059,752        1,442,122
                                                                                       -------------    -------------  
           Total current assets                                                           30,840,634       45,393,164

PROPERTY AND EQUIPMENT                                                                    24,007,039       29,485,944

INTANGIBLE AND OTHER ASSETS                                                              134,540,767      116,586,808
                                                                                       -------------    -------------  
TOTAL                                                                                  $ 189,388,440    $ 191,465,916
                                                                                       =============    =============  

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

CURRENT LIABILITIES:
   Accounts payable                                                                    $   6,933,874    $  21,856,484
   Accrued expenses                                                                       24,678,158       23,798,055
   Current portion of long-term debt                                                       5,545,363       10,607,729
                                                                                       -------------    -------------  

           Total current liabilities                                                      37,157,395       56,262,268

LONG-TERM DEBT                                                                           160,040,938      169,375,000

OTHER LONG-TERM LIABILITIES                                                                1,150,000          500,000

DEFERRED INCOME TAXES                                                                      1,059,752        1,442,122

COMMITMENTS AND CONTINGENCIES (See Notes)

STOCKHOLDERS' EQUITY (DEFICIT):
   Preferred stock, $.01 par value; 6,000 shares authorized; 5,925 shares issued and
      outstanding (cumulative liquidation value of $5,925,000)                                    59               59
   Common stock, $.01 par value; 50,000 shares authorized; 16,200 shares and
     16,333 shares issued and outstanding as of December 31, 1997, and
      December 31, 1998,  respectively                                                           162              163
   Additional paid-in capital                                                             22,036,963       21,829,562
   Accumulated deficit                                                                   (32,056,829)     (57,943,258)
                                                                                       -------------    -------------  

           Total stockholders' equity (deficit)                                          (10,019,645)     (36,113,474)
                                                                                       -------------    -------------  

TOTAL                                                                                  $ 189,388,440    $ 191,465,916
                                                                                       =============    =============  
</TABLE> 

See notes to consolidated financial statements.

                                      30
<PAGE>
 
                         EVERCOM INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE> 
<CAPTION> 
                                                          One Month 
                                                        Period Ended 
                                                        December 31,      Years Ended December 31,
                                                        ------------  -------------------------------
                                                            1996             1997            1998
<S>                                                   <C>              <C>              <C> 
OPERATING REVENUE                                     $   5,506,110    $  91,773,041    $ 225,292,986

OPERATING EXPENSES:
    Telecommunication costs                               2,298,712       37,871,217       99,842,779
    Facility commissions                                  1,455,375       25,723,997       71,205,505
    Field operations and maintenance                        218,895        4,542,757        7,817,165
    Selling, general and administrative                     372,341        8,540,629       17,661,406
    Depreciation and impairment                             110,803        2,218,694        6,691,954
    Amortization of intangibles                             741,032       14,243,332       26,338,961
    Restructure and other charges                                            399,817        1,743,290
                                                      -------------    -------------    -------------  

           Total operating expenses                       5,197,158       93,540,443      231,301,060
                                                      -------------    -------------    -------------  

OPERATING INCOME (LOSS)                                     308,952       (1,767,402)      (6,008,074)

OTHER (INCOME) EXPENSE:
    Interest expense, net                                   612,071       11,137,877       19,637,507
    Other (income), net                                     (20,490)         (76,392)        (235,623)
                                                      -------------    -------------    -------------  

           Total other (income) expense                     591,581       11,061,485       19,401,884
                                                      -------------    -------------    -------------  

LOSS BEFORE INCOME TAXES AND
   EXTRAORDINARY LOSS                                      (282,629)     (12,828,887)     (25,409,958)

INCOME TAX (BENEFIT) EXPENSE                                (22,502)        (641,670)         476,471
                                                      -------------    -------------    -------------  

LOSS BEFORE EXTRAORDINARY  ITEM                            (260,127)     (12,187,217)     (25,886,429)

EXTRAORDINARY LOSS ON DEBT EXTINGUISHMENT                                  4,739,757
                                                      -------------    -------------    -------------   
NET LOSS                                                   (260,127)     (16,926,974)     (25,886,429)
                                                                                                        
PREFERRED STOCK DIVIDENDS                                                    474,000          474,000
                                                      -------------    -------------    -------------   
NET LOSS APPLICABLE TO COMMON STOCK                   $    (260,127)   $ (17,400,974)   $ (26,360,429)
                                                      =============    =============    =============   
</TABLE> 

See notes to consolidated financial statements 

                                      31
<PAGE>
 
                        EVERCOM, INC. AND SUBSIDIARIES
 
           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
 
<TABLE> 
<CAPTION> 
                                                                                                       
                                           PREFERRED STOCK          COMMON STOCK       ADDITIONAL 
                                         --------------------  ----------------------   PAID-IN       ACCUMULATED 
                                           SHARES    AMOUNT    SHARES     AMOUNT         CAPITAL       (DEFICIT)         TOTAL
                                           ------    ------    ------  -------------  -------------  --------------  --------------
<S>                                        <C>       <C>       <C>     <C>            <C>            <C>             <C>
Issuance of Preferred Stock                 5,925       $59                            $ 5,924,941                    $  5,925,000
Issuance of Common Stock                                       15,300           $153    15,686,031                      15,686,184
Portion of Acquisition Cash             
    Payments to Continuing              
    Stockholders, Treated as a          
    Dividend                                                                                          $(14,869,728)    (14,869,728)
Net Loss                                                                                                  (260,127)       (260,127)
                                           ------    ------    ------  -------------   -----------   -------------    ------------
                                        
BALANCE, JANUARY 1, 1997                    5,925        59    15,300            153   $21,610,972     (15,129,855)      6,481,329
                                        
   Preferred dividends                                                                    (474,000)                       (474,000)
                                        
   Issuance of common stock                                       900              9       899,991                         900,000
                                        
   Net loss                                                                                            (16,926,974)    (16,926,974)
                                           ------    ------    ------  -------------  ------------   -------------    ------------
                                        
BALANCE, DECEMBER 31, 1997                  5,925        59    16,200            162    22,036,963     (32,056,829)    (10,019,645)
                                        
   Preferred dividends                                                                    (474,000)                       (474,000)
                                        
   Issuance of common stock                                       133              1       266,599                         266,600
                                                                                                       (25,886,429)    (25,886,429)
   Net loss                             
                                           ------    ------    ------  -------------  ------------   -------------   -------------
                                        
BALANCE, DECEMBER 31, 1998                  5,925       $59    16,333           $163   $21,829,562    $(57,943,258)   $(36,113,474)
                                           ======    ======    ======  =============   ===========   =============    ============
 
</TABLE>
 
See notes to consolidated financial statements.

                                      32
<PAGE>
 
                  EVERCOM, INCEVERCOM, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 

<TABLE> 
<CAPTION> 
                                                                           ONE MONTH 
                                                                          PERIOD ENDED 
                                                                           DECEMBER 31,       YEARS ENDED DECEMBER 31,
                                                                        ----------------  -------------------------------
                                                                              1996              1997          1998
<S>                                                                     <C>               <C>              <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net loss                                                             $  (260,127)      $(16,926,974)    $(25,886,429)
   Adjustments to reconcile net loss to net
    cash(used in) provided by operating activities:
      Depreciation and impairment                                            110,803          2,218,694        6,691,954
      Amortization of intangible assets, including deferred
       financing costs and bond discount                                     803,023         14,804,641       27,482,445
      Extraordinary loss on debt extinguishment                                               4,739,757
      Deferred income taxes                                                  160,512         (1,295,508)
      Changes in operating assets and liabilities, net
       of effects of acquisitions:
         Accounts receivable                                                  44,823         (6,974,425)     (22,232,694)
         Inventories                                                          12,013           (723,013)        (606,359)
         Prepaid expenses and other assets                                  (166,096)           (87,536)         134,130
         Accounts payable                                                 (1,010,795)         1,574,179       14,782,610
         Accrued expenses                                                   (718,313)         9,694,953        3,728,009
         Income taxes                                                       (394,963)          (976,546)         164,795
                                                                        ------------      -------------    -------------
 
           Net cash (used in) provided by operating activities            (1,419,120)         6,048,222        4,258,461
                                                                        ------------      -------------    -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
   (Increase) Decrease in restricted cash                                                    (1,919,312)       1,919,312
   Capital expenditures                                                     (268,801)        (8,062,724)     (13,591,974)
   Cash outflows for acquisitions                                        (46,983,442)       (80,775,395)     (11,711,061)
                                                                        ------------      -------------    -------------
 
           Net cash used in investing activities                         (47,252,243)       (90,757,431)     (23,383,723)
                                                                        ------------      -------------    -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from the issuance of debt                                     59,200,000        168,709,966       19,000,000
   Repayment of advances                                                                     (1,001,024)
   Repayment of debt                                                     (15,912,706)       (67,630,581)      (5,553,572)
   Payments of deferred financing costs                                   (3,804,121)        (7,885,650)
   Payments of preferred dividends                                                                              (474,000)
   Proceeds from the issuance of common and
    preferred stock, net of expenses                                       9,482,684                              66,600
                                                                        ------------      -------------    -------------
 
           Net cash provided by financing activities                      48,965,857         92,192,711       13,039,028
                                                                        ------------      -------------    -------------
 
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                             294,494          7,483,502       (6,086,234)
 
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                                  294,494        7,777,996
                                                                        ------------      -------------    -------------
 
CASH AND CASH EQUIVALENTS, END OF PERIOD                                $    294,494      $   7,777,996    $   1,691,762
                                                                        ============      =============    =============
SUPPLEMENTAL INFORMATION:
   Cash paid for interest                                               $    640,035      $   4,202,059    $  25,102,184
                                                                        ============      =============    =============
 
   Cash paid for income taxes                                           $    211,950      $   1,552,973    $     311,676
                                                                        ============      =============    =============
   Noncash transactions:
      Issuance of subordinate notes, preferred
       stock and common stock for acquisitions                          $ 16,043,000      $     900,000    $     950,000
                                                                        ============      =============    =============
 
      Dividends payable                                                 $                 $     474,000    $     474,000
                                                                        ============      =============    =============
 
      Amounts payable for acquisition costs                             $                 $   8,369,421    $
                                                                        ============      =============    =============
 
      Amounts payable for deferred financing costs                      $                 $     757,493    $
                                                                        ============      =============    =============
       Issuance of stock for forgiveness of
          acquisition liability                                         $                 $                $     200,000
                                                                        ============      =============    =============
       Reduction of stockholders' equity to reflect
        accrued continuing shareholder interests                        $ 14,869,728      $                $
                                                                        ============      =============    =============
</TABLE>
See notes to consolidated financial statements.

                                      33
<PAGE>
 
                        EVERCOM, INC. AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.    BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      BUSINESS - Evercom, Inc. (the "Company") owns, operates and maintains
      telephone systems under contracts with correctional facilities in 43
      states throughout the United States. The Company was incorporated on
      November 20, 1996, and effective December 1, 1996, acquired all of the
      outstanding equity interests of Talton Telecommunications Corporation and
      AmeriTel Pay Phones, Inc. The Company has grown through numerous
      subsequent acquisitions, as discussed in Note 2.

      The Company accumulates call activity from its various installations and
      bills its revenues related to this call activity through major local
      exchange carriers ("LECs") or through third-party billing services for
      smaller volume LECs, all of which are granted credit in the normal course
      of business with terms of between 30 and 60 days. The Company also
      provides validation, billing and collection services for the inmate calls
      of a major regional bell operating company. The Company performs ongoing
      credit evaluations of its customers and maintains allowances for
      unbillable and uncollectible losses based on historical experience.

      The Company operated in only one business segment as its operating
      activities are related to the operation and processing of collect, prepaid
      and debit calling services to local, county, state and private
      correctional facilities in the United States.

      PREPARATION OF FINANCIAL STATEMENTS - The preparation of financial
      statements in conformity with generally accepted accounting principles
      requires management to make estimates and assumptions, such as estimates
      of allowances and reserves for unbillable and uncollectible chargebacks
      that affect the reported amounts of assets and liabilities at the date of
      the financial statements and the reported amounts of revenues and expenses
      during the reporting period. Actual results could differ from those
      estimates.

      PRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial
      statements include the accounts of the Company and its wholly owned
      subsidiaries, Talton Telecommunications Corporation, Talton
      Telecommunications of Carolina, Inc., AmeriTel Pay Phones, Inc., Talton
      STC Inc., Talton InVision, Inc., MOG Communications, Inc., Saratoga
      Telephone Company, Inc., and One Source Telecommunications, Inc. All
      significant intercompany balances and transactions are eliminated in
      consolidation. Certain amounts have been reclassified to conform with the
      current year presentation.

      CASH AND CASH EQUIVALENTS - Cash and cash equivalents include cash on hand
      and investments with a remaining maturity at date of purchase of three
      months or less.

      ACCOUNTS RECEIVABLE - Trade accounts receivable represent amounts billed
      for calls placed through the Company's telephone systems to the various
      LECs or third-party billing services, net of advance payments received,
      and an allowance for unbillable and uncollectible calls, based on
      historical experience, for estimated chargebacks to be made by the LECs.
      Under account advance agreements with various third-party billing
      services, advance payments equal to a percentage of the outstanding billed
      receivables are remitted to the Company when calls are submitted to the
      third-party billing service, and the Company grants a lien to the
      third-party billing service on the related accounts 

                                      34
<PAGE>
 
      receivable for the advance. The remainder of the billed receivable is paid
      to the Company, net of the advance amount, after the third-party billing
      service has collected the amounts receivable from the respective LECs.
      Interest is charged on the advance payment at varying rates.

      INVENTORIES - Inventories are stated at the lower of cost, as determined
      primarily using the weighted average cost method, or market. Inventory is
      primarily composed of equipment for installation on new contracts and
      supplies and parts for the telephone systems serviced by the Company.

      PROPERTY AND EQUIPMENT - Property and equipment are stated at cost.
      Depreciation and amortization is provided on a straight-line basis over
      the estimated useful lives of the related assets. The following is a
      summary of useful lives for major categories of property and equipment.

<TABLE> 
<CAPTION> 
       ASSET                                                                           USEFUL LIFE
       <S>                                                                             <C> 
       Leasehold improvements                                                          Lesser of life or lease term
       Telephone system equipment                                                      3.5 to 7.5 years
       Vehicles                                                                        3 years
       Office equipment                                                                3 to 7 years
</TABLE> 

      Maintenance and repairs are expensed when incurred and major repairs that
      extend an asset's useful life are capitalized. When items are retired or
      disposed, the related carrying value and accumulated depreciation are
      removed from the respective accounts, and the net difference less any
      amount realized from the disposition is reflected in earnings.

      INTANGIBLE AND OTHER ASSETS - Intangible and other assets primarily
      include amounts allocated to acquired facility contracts, noncompete
      agreements, goodwill and other intangible assets, which are stated at
      cost, along with the long-term portion of customer advances, and the
      long-term portion of recoverable Universal Service Fund fees. Amortization
      of intangible assets is provided on a straight-line basis over the
      estimated useful lives of the related assets. The following is a summary
      of useful lives for major categories of intangible assets:

<TABLE> 
<CAPTION> 
       INTANGIBLE ASSET                                                                USEFUL LIFE
       <S>                                                                             <C> 
       Acquired facility contracts                                                     Contract term
       Noncompete agreements                                                           Agreement term
       Deferred loan costs                                                             Loan term
       Other assets and intangibles                                                    2 to 5 years
       Goodwill                                                                        20 years
</TABLE> 

      Acquired facility contracts consist primarily of costs allocated to
      locations acquired in acquisitions of facility contract rights from other
      service providers, along with signing bonuses paid to the facilities under
      new facility installations and other incremental direct costs paid to
      obtain the facility contracts.

      Other assets and intangibles include costs incurred to obtain direct
      billing agreements with LECs, and licensing fees to obtain state licenses
      to conduct business.

      The Company periodically assesses the net realizable value of its
      intangible assets, as well as all other long-term assets, by comparing the
      expected future net operating 

                                      35
<PAGE>
 
      cash flow, undiscounted and without interest charges, to the carrying
      amount of the underlying assets. The Company would evaluate a potential
      impairment if the recorded value of these assets exceeded the associated
      future net operating cash flows. Any potential impairment loss would be
      measured as the amount by which the carrying value exceeds the fair value
      of the asset. Fair value of assets would be measured by market value, if
      an active market exists, or by a forecast of expected future net operating
      cash flows, discounted at a rate commensurate with the risk involved. As
      discussed in footnote 4, the Company recorded an impairment loss on a
      portion of its telephone system equipment in 1998.

      INCOME TAXES - The Company accounts for income taxes using the liability
      method in accordance with the provisions of Statement of Financial
      Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes."
      Under this method, deferred tax assets and liabilities are provided for
      temporary differences between the financial statement and tax bases of the
      assets and liabilities using current tax rates.

      REVENUE RECOGNITION - Revenues related to collect, prepaid and debit
      calling services are recognized during the period in which the calls are
      made. In addition, during the same period, the Company accrues the related
      telecommunication costs for validating, transmitting, billing and
      collection, and line and long-distance charges, along with commissions
      payable to the facilities and allowances for unbillable and uncollectible
      calls, based on historical experience.

      Revenues related to the validation, billing and collection services
      provided to other entities are recognized in the period in which the calls
      are processed through the Company's system. During the same period, the
      Company accrues the related telecommunications costs for validating,
      transmitting, and billing and collection costs, along with allowances for
      unbillable and uncollectible calls, based on historical experience.

      FACILITY COMMISSIONS - Under the terms of the Company's telephone system
      contracts with correctional facilities, the Company pays commissions to
      these facilities generally based on call volume revenues that are accrued
      during the period the revenues are generated.

      COMPREHENSIVE INCOME - SFAS No. 130, "Reporting Comprehensive Income"
      became effective as of the first quarter of 1998. This statement requires
      companies to report and display comprehensive income and its components
      (revenues, expenses, gains and losses). Comprehensive income includes all
      changes in equity during a period except those resulting from investments
      by owners and distributions to owners. For the Company, comprehensive
      income is the same as the net loss reported in the statements of
      consolidated operations for each of the two years in the period ended
      December 31, 1998 and for the one-month period ended December 31, 1996,
      since there were no other items of comprehensive income for the periods
      presented.

      RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - SFAS No. 133, "Accounting for
      Derivative Instruments and Hedging Activities," was issued in June 1998,
      and requires recognition of all derivative financial instruments as either
      assets or liabilities in consolidated balance sheets at fair value and
      determines the method(s) of gain/loss recognition. SFAS No. 133 is
      effective for fiscal years beginning after June 15, 1999. The Company is
      currently evaluating the effect that the statement may have on the
      Company's consolidated financial statements.

      In March 1998, the American Institute of Certified Public Accountants
      ("AICPA") released Statement of Position ("SOP") No. 98-1, "Accounting for
      the Costs of Computer Software Developed or Obtained for Internal Use."
      SOP 98-1 requires the capitalization of certain expenditures for software
      that is purchased or internally developed. SOP No. 98-1 is effective for
      fiscal years beginning after 

                                      36
<PAGE>
 
      December 15, 1998. The Company believes that the adoption of this SOP will
      have no material effect on the financial position, results of operations,
      or cash flows of the Company.

      In April 1998, the AICPA released SOP 98-5, "Reporting on the Costs of
      Start-Up Activities." SOP 98-5 generally requires costs of start-up
      activities to be expensed instead of being capitalized and amortized. SOP
      98-5 is effective for fiscal years beginning after December 15, 1998. The
      Company believes that the adoption of this SOP will have no material
      effect on the financial position, results of operations or cash flows of
      the Company.

2.    ACQUISITIONS

      Effective December 1, 1996, the Company acquired all of the outstanding
      equity interests of Talton Telecommunications Corporation and AmeriTel Pay
      Phones, Inc. The aggregate net purchase price was approximately $47.9
      million, which was funded with the net proceeds from the issuance of
      common and preferred stock and the proceeds from the issuance of long-term
      debt.

      Since certain of the stockholders of the Company held ownership interests
      in Talton Telecommunications and AmeriTel Pay Phones, Inc., their
      continuing ownership interest in the Company has been accounted for at
      their prior historical basis, which has resulted in a reduction in
      stockholders' deficit of approximately $14.9 million and a corresponding
      reduction in the fair values assigned to tangible and identifiable
      intangible assets, in accordance with the provisions of Emerging Issue
      Task Force discussion No. 88-16, "Basis in Leveraged Buyout Transactions."

      Effective April 4, 1997, the Company acquired substantially all of the net
      assets of Tri-T, Inc. (d.b.a. Tataka) for cash of $0.8 million, which was
      funded primarily by borrowings under the Senior Credit Facility.

      Effective June 27, 1997, the Company acquired substantially all of the net
      assets of Security Telecom Corporation for cash of $9.9 million and
      issuance of 900 shares of the Company's Class A common stock. The Company
      financed the acquisition with a portion of the proceeds from the Senior
      Notes (as defined). Approximately $2.5 million of the purchase price was
      withheld at closing, pending certain regulatory approvals and final
      adjustments. In conjunction with the acquisition of Security Telecom
      Corporation, the Company entered into an agreement with an employee of
      Security Telecom Corporation giving the employee the right to receive cash
      of $200,000 or to purchase up to 100 shares of the Company's Class A
      common stock for $2,000 per share. The employee exercised this right in
      September 1998.

      Effective July 31, 1997, the Company acquired all of the net assets of
      Correctional Communications Corporation for a cash purchase price of $10.3
      million. Approximately $1.6 million of the purchase price is held in an
      escrow account pending resolution to certain consents and indemnities. The
      acquisition agreement also provides for contingent payment of up to $1.5
      million if certain financial performance benchmarks are achieved in the
      future. The $1.5 million contingency will be accounted for as an
      adjustment to the purchase price when the contingency is resolved. The
      Company financed the acquisition with a portion of the proceeds from the
      Senior Notes.

      Effective October 6, 1997, the Company entered into an agreement to
      purchase substantially all of the net assets of the inmate pay phone
      division of Communications Central Inc. for $40 million in cash and
      assumption of $2.0 million in liabilities subject to various adjustments
      as defined in the agreement and subject to a provision for working capital
      of approximately $1.2 million provided to the Company 

                                      37
<PAGE>
 
      pursuant to the purchase agreement. The Company financed the acquisition
      with the remaining proceeds from the Senior Notes and borrowings under the
      Senior Credit Facility.

      Effective December 1, 1997, the Company entered into an agreement to
      purchase substantially all of the net assets of the inmate pay phone
      division of North American InTeleCom, Inc. from TSC Communications for a
      cash purchase price of $6.5 million in cash, a deferred payment of $1.7
      million, and the assumption of certain liabilities approximating $0.7
      million. The Company funded the acquisition with borrowings under the
      Senior Credit Facility.

      Effective December 19, 1997, the Company entered into an agreement to
      purchase substantially all of the net assets of the inmate pay phone
      division of Peoples Telephone Company, Inc. for $10.6 million with the
      assumption of certain liabilities. The acquisition agreement also provides
      for additional contingent payments if certain financial results are
      obtained in the future. The additional payments will be accounted for as
      an adjustment to the purchase price when the contingency is resolved. The
      Company funded the acquisition with borrowings under the Senior Credit
      Facility.

      Effective January 1, 1998, the Company entered into an agreement to
      purchase substantially all of the net assets of the inmate pay phone
      division of ILD Teleservices, Inc. for a cash purchase price of $2.6
      million. The acquisition was funded with borrowings under the Senior
      Credit Facility.

      Effective February 1, 1998, the Company entered into an agreement to
      purchase MOG Communications, Inc. for a cash purchase price of $1.9
      million and a note of $950,000. The acquisition was funded with borrowings
      under the Senior Credit Facility.

      Effective July 1, 1998, the Company entered into an agreement to purchase
      Saratoga Telephone Company for a cash purchase price of $2.0 million. The
      acquisition was funded with borrowings under the Senior Credit Facility.

      The above acquisitions were accounted for using the purchase method of
      accounting as of their respective acquisition dates and, accordingly, only
      the results of operations of the acquired companies subsequent to their
      respective acquisition dates are included in the consolidated financial
      statements of the Company. At the acquisition date, the purchase price was
      allocated to assets acquired, including identifiable intangibles and
      liabilities assumed based on their fair market values. The excess of the
      total purchase prices over the fair value of the net assets acquired
      represents goodwill.

                                      38
<PAGE>
 
      In connection with the acquisitions, assets were acquired and liabilities
      were assumed as follows:

<TABLE> 
<CAPTION> 
                          Purchase Prices                            1997            1998     
                          ---------------                       ------------    ------------  
       <S>                                                      <C>             <C>           
       Net cash paid                                            $ 80,775,395    $  7,021,727  
       Amounts payable for acquisition costs                       8,369,421                  
       Subordinated notes, preferred stock and common stock                                   
          issued to sellers, net of expenses                         900,000         950,000  
                                                                ------------     -----------  
       Total net purchase prices, including professional fees     90,044,816       7,971,727  
                                                                                              
       Fair values of net assets acquired:                                                    
          Fair values of assets acquired                          53,131,563       3,828,315  
          Liabilities assumed                                     (3,297,973)       (416,780) 
                                                                ------------     -----------  
                                                                                              
       Total net assets acquired                                  49,833,590       3,411,535  
                                                                ------------     -----------  
       Goodwill                                                 $ 40,211,226    $  4,560,192  
                                                                ============     ===========   
</TABLE> 

      The following table presents unaudited pro forma results of operations of
      the Company for the one month ended December 31, 1996 and for the years
      ended December 31, 1997 and 1998, respectively, as if the acquisitions had
      occurred at the beginning of each respective period:

<TABLE> 
<CAPTION> 
                                                                                                               
                                                   ONE MONTH PERIOD                                          
                                                  ENDED DECEMBER 31,           YEARS ENDED DECEMBER 31,        
                                                  ------------------    -------------------------------------  
                                                         1996                  1997              1998          
                                                                                                               
       <S>                                        <C>                   <C>                    <C>             
       Operating revenues                             $ 15,613,199        $ 180,883,954        $ 226,779,019   
       Loss before extraordinary loss                    2,082,154           27,304,983           26,572,457   
       Net loss                                          2,082,154           32,044,740           26,572,457    
</TABLE> 

      The unaudited pro forma results of operations are not necessarily
      indicative of what the actual results of operations of the Company would
      have been had the acquisitions occurred at the beginning of the periods
      presented, nor do they purport to be indicative of the future results of
      operations of the Company.

                                      39
<PAGE>
 
3.    ACCOUNTS RECEIVABLE

      Accounts receivable consist of the following:

<TABLE> 
<CAPTION> 
                                                                                           December 31,
                                                                              --------------------------------------
                                                                                      1997            1998
       <S>                                                                    <C>                <C> 
       Trade accounts receivable, net of advance payments        
          received of $187,647 and $141,460 at                   
          December 31, 1997 and 1998, respectively                               $ 21,809,811    $ 42,308,582
       Advance commissions receivable                                                 272,921       2,020,020
       Receivables related to acquisitions                                            456,875         141,044
       Recoverable Universal Service Fund Fees - current portion                                    1,089,800
       Receivables from joint venture partner                                                         419,643
       Employees and other                                                            178,989         329,749
                                                                                 ------------    ------------ 

                                                                                   22,718,596      46,308,838
       Less allowance for unbillable and                         
          uncollectible chargebacks                                                (5,316,689)     (7,237,879)
                                                                                 ------------    ------------ 

                                                                                 $ 17,401,907    $ 39,070,959
                                                                                 ============    ============ 
</TABLE> 

      At December 31, 1997 and 1998, the Company had advanced commissions to
      certain facilities of $1,290,732 and $2,495,558, respectively, which are
      recoverable from such facilities as a reduction of earned commissions at
      specified monthly amounts. Amounts included in accounts receivable
      represent the estimated recoverable amounts during the next fiscal year
      with the remaining balance recorded in other assets.

      At December 31, 1998, the Company had remitted $1,511,688 more federal
      Universal Service Fund fees than it had collected from its
      telecommunications customers. Based on the Company's current recovery
      rate, $1,089,800 of this balance will be recovered in the next fiscal year
      and is included in accounts receivable with the remaining balance recorded
      in other assets.

                                      40
<PAGE>
 
4.    PROPERTY AND EQUIPMENT

      Property and equipment consist of the following:

<TABLE> 
<CAPTION>
                                                               December 31,                 
                                                  ------------------------------------      
                                                          1997            1998              
       <S>                                          <C>             <C>                     
       Leasehold improvements                       $    493,836    $    834,051            
       Telephone system equipment                     24,480,777      33,776,168            
       Vehicles                                          249,868         431,807            
       Office equipment                                1,075,751       2,419,992            
                                                    ------------    ------------ 

                                                      26,300,232      37,462,018            
                                                                                            
       Less accumulated depreciation                  (2,293,193)     (7,976,074)           
                                                    ------------    ------------            

                                                    $ 24,007,039    $ 29,485,944             
                                                    ============    ============ 
</TABLE> 


      DEPRECIATION AND IMPAIRMENT - Depreciation and impairment in 1997 and 1998
      includes depreciation expense of $2,218,694 and $5,996,816, respectively.
      Also included in depreciation and impairment in 1998 is an impairment loss
      of $695,138, representing the net book value of telephone system equipment
      that was removed from service.

5.    INTANGIBLE AND OTHER ASSETS

      Intangible and other assets consist of the following:

<TABLE> 
<CAPTION> 
                                                                                               December 31,              
                                                                               -------------------------------------------
                                                                                         1997              1998          
       <S>                                                                     <C>                  <C>                  
       Intangible and other assets:                                                                                      
          Acquired telephone contracts                                             $  59,064,429    $  63,835,844        
          Noncompete agreements                                                          403,611          568,611        
          Deferred loan costs                                                          8,299,067        8,299,067        
          Goodwill                                                                    79,970,642       84,530,834        
          Other intangibles                                                              526,385          694,493        
                                                                                   -------------    -------------  

                                                                                     148,264,134      157,928,849        
        Less accumulated amortization                                                (15,157,562)     (42,640,007)       
                                                                                   -------------    -------------

                                                                                     133,106,572      115,288,842        
                                                                                                                         
       Deposits                                                                          416,384          400,540        
       Recoverable Universal Service Fund  Fees - noncurrent portion                                      421,888
       Other assets - noncurrent portion                                                                                 
          of commission advances to facilities                                         1,017,811          475,538        
                                                                                   -------------    -------------  
                                                                                                                         
                                                                                   $ 134,540,767    $ 116,586,808         
                                                                                   =============    =============  
</TABLE> 

                                      41
<PAGE>
 
6.    ACCRUED EXPENSES

      Accrued expenses consist of the following:

<TABLE> 
<CAPTION> 
                                                                    December 31,                 
                                                        ---------------------------------        
                                                               1997          1998                
       <S>                                                 <C>           <C>                     
       Facility commissions                                $ 5,456,245   $ 8,007,248             
       Billing and collection fees                           1,148,171     1,804,790             
       Uncollectible call chargebacks                          990,135     5,267,345             
       Accrued acquisition and financing                                                         
          costs                                              8,599,778     3,941,666             
       Accrued interest                                      6,557,651       218,646             
       Accrued excise taxes payable                          1,166,003     2,072,856             
       Accrued dividends on preferred stock                    474,000       474,000             
       Accrued restructure costs                                             654,245
       Accrued payroll and bonuses                                           778,633
       Other                                                   286,175       578,626             
                                                           -----------   ----------- 

                                                           $24,678,158   $23,798,055              
                                                           ===========   =========== 
</TABLE> 

      The accrual for uncollectible call chargebacks represents a reserve for
      amounts collected from LECs that are expected to be charged back to the
      Company in future periods.

      The amount payable for acquisitions and financing costs includes a $2.3
      million holdback of the purchase price of Security Telecom Corporation
      (see Note 2), which will be paid to the sellers after resolution of
      certain indemnifications, and an $870,000 deferred payment relating to the
      North American InTeleCom acquisition.

                                      42
<PAGE>
 
7.    LONG-TERM DEBT

      The following is a summary of long-term debt:

<TABLE> 
<CAPTION> 
                                                                      DECEMBER 31,                          
                                                         -------------------------------------
                                                                1997            1998                
                                                                                                                               
       <S>                                                 <C>              <C> 
       Senior Notes                                        $ 115,000,000    $ 115,000,000                                      
       Senior Credit Facility                                                                                                  
          Revolving loan facility                              2,000,000       14,500,000                                      
          Term loan facility                                  48,500,000       49,500,000                                      
       Note payable (see Note 2), with interest of 8.0%,                                                                        
          due at maturity on February 19, 1999, and 
          subordinate to borrowings of the Senior                                                                
          Notes and Senior Credit Facility                                        950,000 
       Other                                                      86,301           32,729                                      
                                                           -------------    -------------   
                                                             165,586,301      179,982,729                                      
                                                                                                                               
       Less current portion of long-term debt                 (5,545,363)     (10,607,729)                                     
                                                           -------------    -------------

                                                           $ 160,040,938    $ 169,375,000                                       
                                                           =============    =============
</TABLE> 

      SENIOR NOTES - On June 27, 1997, the Company issued $115.0 million of 11%
      Senior Notes due 2007 (the "Senior Notes"). A portion of the proceeds of
      the issuance was used to repay substantially all of the Company's previous
      debt outstanding and to fund the purchase of Security Telecom Corporation.
      As a result of the repayment of the outstanding debt, and amendment of the
      Company's Senior Credit Facility, the Company incurred an extraordinary
      loss of $4.7 million resulting from the write-off of the unamortized
      deferred loan costs and the unamortized discount of the original senior
      subordinated notes.

      Interest on the Senior Notes is payable semiannually. All of the Company's
      subsidiaries (the "Subsidiary Guarantors") are fully, unconditionally, and
      jointly and severally liable for the Senior Notes. The Subsidiary
      Guarantors are wholly owned and constitute all of the Company's direct and
      indirect subsidiaries. The Company has not included separate financial
      statements of its subsidiaries because (a) the aggregate assets,
      liabilities, earnings and equity of such subsidiaries are substantially
      equivalent to the assets, liabilities, earnings and equity of the Company
      on a consolidated basis and (b) the Company believes that separate
      financial statements and other disclosures concerning subsidiaries are not
      material to investors.

                                      43
<PAGE>
 
      The Senior Notes are redeemable at the Company's option on or after June
      30, 2002. The Senior Notes are redeemable at the redemption prices
      (expressed as percentages of principal amount) set forth below plus
      accrued and unpaid interest:

<TABLE> 
<CAPTION> 
       YEAR                                                          PERCENTAGE
       <S>                                                           <C> 
       2002                                                           105.500%
       2003                                                           103.667%
       2004                                                           101.833%
       2005 and thereafter                                            100.000%
</TABLE> 

      At any time on or prior to June 30, 2000, the Company may redeem up to 30%
      of the Senior Notes originally issued at a redemption price of 111% of the
      principal amount, plus accrued and unpaid interest, with the proceeds of
      one or more Equity Offerings (as defined in the Senior Credit Facility).

      SENIOR CREDIT FACILITY - The Company amended and restated its Senior
      Credit Facility with a group of lenders in March 1999 in conjunction with
      the issuance of First Preferred Series A stock and warrants, as discussed
      in footnote 15. The amendment provides for an additional $5.5 million term
      loan facility that will bear interest at similar rates to borrowings under
      the Senior Credit Facility. The additional term loan facility matures on
      December 31, 2002.

      The Senior Credit Facility, as amended in March 1999, includes a $55
      million term loan acquisition facility, a $5.5 million additional term
      loan facility, and a $25.0 million revolving loan facility (which includes
      a $5 million letter of credit facility). Scheduled principal payments
      under the term loan facilities cannot be reborrowed. Under the terms of
      the Senior Credit Facility, the term loan acquisition facility is
      amortized on a quarterly basis over five years beginning September 30,
      1998, the additional term loan facility matures on December 31, 2002, and
      the revolving credit facility expires on December 31, 2002.

      Amounts outstanding under the Senior Credit Facility bear interest at a
      rate per annum equal to one of the following rates, at the Company's
      option: (i) a base rate equal to the higher of the Federal Funds rate plus
      50 basis points or the lead bank's reference rate plus a margin that
      varies from 75 to 225 basis points, depending on the Company's Total Debt
      to EBITDA Ratio (as defined in the Senior Credit Facility) or (ii) the
      London Interbank Offering Rate ("LIBOR") plus a margin that varies from
      200 to 350 basis points, based on the Company's Total Debt to EBITDA
      Ratio. The Company pays a commitment fee on unused amounts of the Senior
      Credit Facility at the rate of 50 basis points. The blended interest rate
      in effect at December 31, 1998, on the Senior Credit Facility was 9.74%.

      Interest is payable quarterly, and scheduled principal installments on the
      term loan acquisition facility is due in quarterly installments of
      $2,750,000 beginning September 30, 1998 through December 31, 1998,
      decreasing to $2,406,250 on March 31, 1999, and increasing to $3,093,750
      on March 31, 2000, and $3,437,500 on March 31, 2001, with the remaining
      unpaid balance due on December 31, 2002. The additional term loan facility
      is due on December 31, 2002. Both the revolving and the term loan
      facilities are collateralized by substantially all of the assets of the
      Company. 

      INTEREST RATE CAP AGREEMENT - On June 30, 1998, the Company entered into
      an interest rate cap agreement that has been designated as a hedge against
      the Company's variable interest rate exposure under the Company's Senior
      Credit Facility. At December 31, 1998, the interest rate cap has an

                                      44
<PAGE>
 
      aggregate notional amount of $30.0 million, which matures in June 2001,
      and caps interest on the LIBOR portion of the term loan at 7.5%, plus the
      applicable LIBOR margin.

      COVENANTS AND OTHER - The Senior Notes and the Senior Credit Facility
      contain financial and operating covenants requiring, among other items,
      the maintenance of certain financial ratios, including total debt to free
      cash flow (as defined in the Senior Credit Facility), senior secured debt
      to free cash flow and various other ratios of free cash flow to specified
      minimums. In addition, the Senior Credit Facility contains various
      covenants, which, among other things, limit the Company's ability to incur
      additional indebtedness, restrict the Company's ability to invest in and
      divest of assets, and restrict the Company's ability to pay dividends. As
      of December 31, 1998, the Company was not in compliance with one of its
      financial covenant ratios under the Senior Credit Facility and was
      consequently required to obtain a waiver of default letter from its group
      of lenders. The financial covenant ratio, the fixed charge coverage ratio,
      which is a measure of the Company's debt service, capital expenditures,
      and income tax obligations to its free cash flow, was subsequently
      modified in the March 1999 amendment to the Senior Credit Facility. Based
      on this modification, the Company is in compliance with its debt covenants
      and would have been in compliance as of December 31, 1998. In the event
      the Company fails to comply with the covenants and other restrictions, as
      specified, it could be in default under the Senior Notes and the Senior
      Credit Facility and substantially all of the Company's long-term
      maturities could be accelerated.

      As a result of the issuance of the First Preferred Series A Stock and
      warrants discussed in Note 15, the Company was required to obtain a waiver
      from its Senior Credit Facility group of lenders that waives the lenders'
      rights to the proceeds raised by the Company from the equity offering.

      At December 31, 1998, the scheduled maturities of long-term debt were as
follows:

<TABLE> 
      <S>                                                      <C> 
      1999                                                     $ 10,607,729
      2000                                                       12,375,000
      2001                                                       13,750,000
      2002                                                       28,250,000
      2003                                                                0
      Thereafter                                                115,000,000
                                                               ------------ 

                                                               $179,982,729
                                                               ============ 
</TABLE> 

                                      45
<PAGE>
 
8.    INCOME TAXES

      A summary of the income tax expense (benefit) is as follows:

<TABLE> 
<CAPTION> 
                                                                One-Month                                               
                                                              Period Ended                                              
                                                               December 31,         Years Ended December 31,            
                                                          --------------------   -------------------------------        
                                                                 1996                  1997            1998    
       <S>                                                <C>                    <C>              <C>           
       Current income tax provision:                                                                           
          Federal                                          $   (73,837)           $   228,461     $  (135,134) 
          State                                                (10,260)               425,377         611,605  
          Deferred income taxes                                 61,595             (1,295,508)                 
                                                           -----------            -----------     ----------- 

                                                           $   (22,502)           $  (641,670)    $   476,471   
                                                           ===========            ===========     ===========
</TABLE> 

      The income tax expense (benefit) differs from statutory rates primarily
      because of permanent differences related to a valuation allowance on
      deferred tax assets, nondeductible write-off of debt discount expense and
      nondeductible goodwill amortization. The following is a reconciliation of
      the income tax benefit reported in the statement of operations:

<TABLE> 
<CAPTION>                                                          
                                                                       One-Month                                       
                                                                     Period Ended                                      
                                                                      December 31,             December 31,            
                                                                   ----------------   ------------------------------   
                                                                        1996              1997             1998        
       <S>                                                        <C>                 <C>             <C>              
       Tax benefit at statutory rates                             $     (96,094)      $ (5,973,339)   $ (8,639,386)     
       Effect of state income taxes                                     (13,284)          (301,595)       (521,679)     
       Effect of nondeductible goodwill amortization                     86,876            675,910         759,953      
       Nondeductible write-off of debt discount                                            332,163                      
       Valuation allowance on deferred tax assets                                        4,674,920       8,588,395      
       Other                                                                               (49,729)        289,188       
                                                                  -------------       ------------    ------------      

                                                                  $     (22,502)      $   (641,670)   $    476,471       
                                                                  =============       ============    ============       
</TABLE> 

                                      46
<PAGE>
 
      The tax effects of temporary differences giving rise to deferred income
      tax assets and liabilities were:

<TABLE> 
<CAPTION>
                                                                                                           DECEMBER 31,             

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

                                                                                                  1997                      1998    

       <S>                                                                                  <C>                         <C>         

       Deferred income tax assets:                                                                                                  
          Reserves for unbillable and uncollectible chargebacks                              $  1,486,129              $  3,214,286 
          Other reserves                                                                          166,368                   689,786 
          Amortization of intangibles                                                           2,210,171                 8,191,148 
          Net operating loss carryforward                                                       1,872,004                 2,610,217 
          Valuation allowance                                                                  (4,674,920)              (13,263,315)
                                                                                             ------------              ------------ 

                                                                                                1,059,752                 1,442,122 

       Deferred income tax liability:                                                                                             

          Depreciation and amortization                                                        (1,059,752)               (1,442,122)
                                                                                             ------------              ------------ 
       Net deferred income tax asset (liability)                                             $         -               $        -   
                                                                                             ============              ============
</TABLE> 

      This net deferred income tax liability is classified in the consolidated
      balance sheet as follows:

<TABLE> 
<CAPTION> 
                                                                                                      December 31,               
                                                                                          -------------------------------------  
                                                                                               1997                   1997       
       <S>                                                                                 <C>                     <C>           
       Current asset                                                                       $ 1,059,752             $ 1,442,122   
       Noncurrent liability                                                                 (1,059,752)             (1,442,122)  
                                                                                           -------------           ------------   
                                                                                                                                 
                                                                                           $        -              $        -    
                                                                                           =============           ============   
</TABLE> 

      The Company has established a valuation allowance for deferred tax assets
      primarily as a result of operating and extraordinary losses. The Company
      was unable to determine that it is more likely than not that the deferred
      tax assets will be realized. The Company has accumulated a federal income
      tax net operating loss carryforward of approximately $7.7 million through
      December 31, 1998 of which $317,000 and $7.4 million will expire in 2017
      and 2018, respectively.

9.    STOCKHOLDERS' EQUITY

      COMMON STOCK - The authorized common stock of the Company includes 49,600
      shares of Class A common stock and 400 shares of Class B common stock.
      Holders of the shares of the Company's Class A and the Company's Class B
      common stock have identical rights and privileges except that holders of
      the Company's Class B common stock are entitled to four votes a share as
      compared to one vote per share for holders of the Company's Class A common
      stock.

      In September 1998, an employee exercised his option, received in
      connection with a previous acquisition, to purchase 100 shares of the
      Company's Class A common stock for $2,000 per share. Additionally, in
      November 1998, a former employee exercised options to purchase 33 shares
      of the Company's Class A common stock for $2,000 per share.

                                      47
<PAGE>
 
      Issued and outstanding shares of Class A common stock as of December 31,
      1997 and 1998, were 15,800 shares and 15,933 shares, respectively. Issued
      and outstanding shares of Class B common stock as of December 31, 1997 and
      1998, were 400 shares. The Class B common stock is convertible into four
      shares of Class A common stock upon the occurrence of a major event, as
      defined.

      SENIOR PREFERRED STOCK - In connection with the acquisitions of Talton
      Telecommunications Corporation and AmeriTel Pay Phones, Inc. as discussed
      in Note 2, the Company issued 5,925 shares of senior preferred stock to
      former stockholders of the acquired companies. The preferred stockholders
      have no voting rights and are entitled to receive cumulative dividends at
      the rate of $80 per share per annum, payable quarterly, when declared by
      the Board of Directors. In the event of any liquidation, dissolution or
      winding up of the Company (voluntary or involuntary), the holders of the
      preferred stock shall be entitled to receive a preference over common
      stockholders in any distribution of assets of the Company, equal to $1,000
      per share plus cumulative unpaid dividends. Upon the occurrence of a major
      event, which includes (i) a sale of all or substantially all the assets of
      the Company or (ii) a registered public offering of equity interests with
      gross proceeds of at least $20.0 million under the Securities Act of 1933,
      as amended, the Company is required to redeem the outstanding shares of
      preferred stock at a price equal to $1,000 a share plus cumulative unpaid
      dividends. Each holder of preferred stock is entitled to convert each
      preferred share into 0.08505 shares of Class A common stock, at the option
      of the holder, at any time after the date of issuance and on or prior to
      the occurrence of a major event, as defined.

      In addition to the senior preferred stock discussed above, the Company is
      authorized to issue up to 44,000 shares of junior preferred stock, of
      which no shares had been issued as of December 31, 1998.

      In March 1999, the Company issued 5,000 shares of newly authorized First
      Preferred Series A Stock as discussed in footnote 15.

      WARRANTS - At the acquisition date, the Company entered into a warrant
      agreement with certain of its senior subordinated note holders, which
      granted the note holders the right to purchase 1,085 shares of Class A
      common stock at an exercise price of $.01 a share, which was below the
      market value of the underlying shares at that date. Accordingly, as of
      December 31, 1996, approximately $1,085,500 of the proceeds of the senior
      subordinated note borrowings were allocated to these warrants and were
      recorded as additional paid-in capital. The $1,085,500, net of accumulated
      amortization, was written off in 1997 as part of the extraordinary loss on
      debt extinguishment upon the issuance of the Senior Notes and the related
      repayment of the outstanding balances under the previous Senior Credit
      Facility.

      At the acquisition date, the Company also entered into various warrant
      agreements with its other subordinated lenders along with its Class B
      common stockholders that granted such holders the right to purchase 6,230
      shares of Class A common stock of the Company upon terms established by
      the Board of Directors. In conjunction with the issuance of the Senior
      Notes, 1,059 of these warrants were terminated. The remaining 5,171
      warrants are exercisable in whole or part, at various dates through
      December 27, 2006, at warrant prices ranging from $1,000 to $3,000 a
      share.

      In March 1999, the Company issued 5,000 warrants giving the holders of
      each warrant the right to acquire one share of the Company's Class A
      common stock for $1,000 per share, as discussed in footnote 15.

      OPTIONS - In connection with certain employment agreements in 1997 and
      1998, the Company granted 691 and 896, respectively, options to acquire
      common stock at an exercise price equal to the fair market 

                                      48
<PAGE>
 
      value of such shares at the date of grant. The options vest ratably over
      the term of the employment agreements and expire ten years from the date
      of grant.


      On May 26, 1998, the Company's Board of Directors approved the Evercom,
      Inc. 1998 Stock Option Plan (the "Plan"). The Plan provides for the grant
      of options to purchase shares of Class A common stock to certain officers
      and employees. The Company granted 56 options to employees on June 30,
      1998. These options have a term of ten years, an exercise price equal to
      the fair market value of such shares at the date of grant and vest over
      five years.


      The following information summarize the shares subject to options:

<TABLE> 
<CAPTION> 

                                                             Number of Shares        Weighted Average Exercise
                                                                                          Price Per Share
                                                              1997         1998           1997            1998
                                                              ----         ----           ----            ----
        <S>                                              <C>         <C>             <C>                <C>  
        Options outstanding, beginning of year                             691                          $2,000
        Granted                                                691         952           2,000           2,000
        Exercised                                                         (33)                           2,000
        Cancelled                                                         (55)                           2,000
                                                         ---------   ---------
        Options outstanding, end of year                       691       1,555          $2,000          $2,000
                                                               ===       =====
        Options exercisable, end of year                       106         291
                                                                ==         ===
</TABLE> 

      The following table summarizes information about options outstanding at
      December 31, 1998:

<TABLE> 
<CAPTION> 
                                                                                              
                                                                   WEIGHTED AVERAGE REMAINING  WEIGHTED AVERAGE EXERCISE
            RANGE OF EXERCISE PRICE         NUMBER OUTSTANDING          CONTRACTUAL LIFE                 PRICE
            <S>                             <C>                    <C>                         <C> 
                     $2,000                       1,555                       9.92                       $2,000
</TABLE> 


      The Company applies the provisions of Accounting Principles Board Opinion
      No. 25, "Accounting for Stock Issued to Employees," and related
      interpretations in accounting for its options. Accordingly, no
      compensation cost has been recognized for such option grants. Had
      compensation cost for the

                                      49
<PAGE>
 
      Company's options been determined based upon the fair value at the grant
      dates for awards consistent with the method prescribed by the SFAS No.
      123, "Accounting for Stock-Based Compensation," the Company's pro forma
      net loss would have been as follows:

<TABLE> 
<CAPTION> 
                                                                                YEARS ENDED DECEBER 31,            
                                                                           -----------------------------------    
                                                                                  1997             1998           
            <S>                                                            <C>                    <C>             
            COMPENSATION COST DISCLOSURE                                                                          
                                                                                                                  
            Compensation Cost                                                       $ 207,000       $ 344,000     
                                                                                                                  
            Net Loss:                                                                                             
                  As reported                                                     (16,926,974)    (25,886,429)    
                  Pro forma                                                       (17,133,974)    (26,230,429)    
                                                                                                                  
            Stock option share data:                                                                              
                  Stock options granted during the period                                 691             952     
                  Weighted average option fair value (a)                                $ 900           $ 720      
</TABLE> 

          ________________

          (a) Calculated in accordance with the Black-Scholes option pricing
          model, using the following assumptions: expected volitility of 0%;
          expected dividend yield of 0%; expected option term of ten years and
          risk-free rate of return of 6.09% and 4.5% for the options granted in
          1997 and 1998, respectively.


10.   RELATED-PARTY TRANSACTIONS

      One of the Company's subsidiaries leased office space from a stockholder
      under a month-to-month lease with monthly rentals of $3,000. This lease
      expired on December 31, 1996. Subsequently, the Company entered into a new
      lease agreement with the stockholder, with monthly payments in 1997 and
      1998 of $9,083 and $9,812, respectively. The lease term extends through
      December 31, 2001, at which time the Company has an option to extend the
      lease for an additional five years.

      A stockholder of the Company earns a commission based on the net operating
      income, as defined by the commission agreement, generated from one of the
      Company's contracts. The Company paid $300,000 to this stockholder in
      accordance with this commission agreement during the year ended December
      31, 1998.

      In conjunction with the formation of the Company in 1996 and the
      consummation and original financing of the acquisitions of Talton
      Telecommunications Corporation and AmeriTel Pay Phones, Inc., the Company
      paid transaction fees and expenses of $1,670,000 to three companies
      affiliated with certain stockholders that have been capitalized in the
      acquisitions.

                                      50
<PAGE>
 
      The Company entered into a management services and consulting agreement
      with a company affiliated with certain stockholders, along with separate
      consulting agreements with four stockholders who are former employees of
      the acquired companies. These agreements require the payment of aggregate
      minimum annual consulting fees over the agreement life in the following
      amounts:

          1999                                                   $500,000
          2000                                                    200,000
          2001                                                    200,000
          2002                                                    100,000


      These agreements also provide for the reimbursement of direct expenses
      along with future payments for transaction consulting services. One of the
      agreements entitles an affiliate of certain stockholders to a 1% fee based
      on the gross acquisition price for any asset or stock acquisitions by the
      Company. This agreement, which expires in December 1999, limits the
      cumulative acquisition fees paid to this consultant to an amount not to
      exceed $1,250,000 over the life of the agreement. In 1997 and 1998, the
      Company paid $187,000 and $666,000, respectively, under the terms of this
      agreement and $591,250 and $0 were recorded as a liability at December 31,
      1997 and 1998, respectively. This agreement also provides for an
      additional payment upon the refinancing of certain senior subordinated
      notes outstanding. In conjunction with the offering of the Senior Notes,
      the Company paid $200,000 under the terms of this agreement.

      The management services and consulting agreement has a three-year term and
      is cancelable at either party's discretion, with all consulting fees under
      the remaining term of the agreement to be paid upon the date of
      termination. The remaining consulting agreements are cancelable only at
      the option of the consultants and expire over one- to five-year terms. In
      connection with these agreements, the Company paid $478,000 and $300,000
      during the years ended December 31, 1997 and 1998, respectively.

11.   BENEFIT PLAN

      The Company's subsidiaries sponsor 401(k) savings plans for the benefit of
      eligible full-time employees, which are qualified benefit plans in
      accordance with the Employee Retirement Income Security Act ("ERISA").
      Employees participating in the plan can generally make contributions to
      the plan of up to 15% of their compensation. The plans provide for
      discretionary matching contributions by the Company of up to 50% of an
      eligible employee's contribution. Total plan expenses were $3,517 for the
      one-month ended December 31, 1996, and $5,115 and $5,490 for the years
      ended December 31, 1997 and 1998, respectively.

                                      51
<PAGE>
 
12.   COMMITMENTS AND CONTINGENCIES

      OPERATING LEASES - The Company leases office furniture, office space and
      vehicles under various operating lease agreements. Rent expense under
      these operating lease agreements was $19,900 during the one-month ended
      December 31, 1996, and $496,967 and $919,085 during the year ended
      December 31, 1997 and 1998, respectively. Minimum future rental payments
      under noncancelable operating leases for each of the next five years and
      thereafter and in the aggregate are:

<TABLE> 
       <S>                                                                       <C> 
       Year ending December 31:
          1999                                                                   $    652,353 
          2000                                                                        458,571 
          2001                                                                        431,203 
          2002                                                                        329,238
          2003                                                                        311,350
          Thereafter                                                                1,317,250
                                                                                 ------------   
                                                                                              
                                                                                 $  3,499,965   
                                                                                 ============   
</TABLE> 

      MINIMUM COMMISSIONS - In the normal course of business, the Company pays
      commissions to correctional facilities generally based on call volume
      revenues. In certain situations, the Company will enter into a minimum
      commission guarantee with the correctional facility. The minimum guarantee
      is developed based on, among other things, an expected base level of call
      traffic. The Company's three-year contract with one of its customers
      provides for minimum annual commissions of approximately $10 million per
      year. Call traffic, and therefore revenues generated from the contract in
      the initial period of operation were substantially below initial
      projections. As a result of the shortfall, the Company and its customer
      have agreed to review the results for the initial period of operation,
      review the causes for the shortfall and negotiate the guaranteed
      commission amount. The Company has recorded a liability for the minimum
      commission based on its estimate of the most likely outcome of the
      negotiations. The maximum potential payment required under the original
      minimum commission guarantee at December 31, 1998 was approximately $2.9
      million. Under the terms of the contract, any minimum guarantee payment
      due is not required to be made until the year 2000. Management of the
      Company believes that the Company has adequately accrued for the
      commission liability as of December 31, 1998 and that the final negotiated
      commission payment will not have a material adverse effect on the
      consolidated financial position, results of operations, or cash flows of
      the Company.

      EMPLOYMENT AGREEMENTS - As of December 31, 1998, the Company had entered
      into employment agreements with certain key management personnel, which
      provided for minimum compensation levels and incentive bonuses along with
      provisions for termination of benefits in certain circumstances and for
      certain severance payments in the event of a change in control (as
      defined).

      LITIGATION - The Company is subject to various legal proceedings and
      claims that arise in the ordinary course of business operations. In the
      opinion of management, the amount of liability, if any, with respect to
      these actions would not materially affect the financial statements of the
      Company.

13.   FAIR VALUE OF FINANCIAL INSTRUMENTS

      Pursuant to SFAS No. 107, "Disclosure About Fair Value of Financial
      Instruments," the Company is required to disclose an estimate of the fair
      value of the Company's financial instruments. The Company believes that
      the carrying amounts of cash and cash equivalents, accounts receivable
      and accounts

                                      52
<PAGE>
 
   payable are a reasonable estimate of their fair value because of the short-
   term maturities of such instruments. In addition, because the interest rates
   on the amounts borrowed under the Senior Credit Facility are variable, their
   fair values approximate their carrying values.

   The fair value of the Senior Notes is based on their quoted market value. The
   following is a summary of the carrying value of the Company's debt
   instruments:

<TABLE>
<CAPTION>
                                                DECEMBER 31, 1997                                DECEMBER 31, 1998             
                                   ---------------------------------------------   ------------------------------------------
                                        HISTORICAL                                        HISTORICAL                           
                                      CARRYING VALUE             FAIR VALUE             CARRYING VALUE          FAIR VALUE     
                                                                                                                               
     <S>                              <C>                        <C>                    <C>                     <C>                 

     Senior Notes                     $115,000,000               $123,912,500             $115,000,000          $109,434,000
                                                                                                                            
     Senior Credit Agreement            50,500,000                 50,500,000               64,000,000            64,000,000 
</TABLE>

14. RESTRUCTURING AND OTHER COSTS

   RESTRUCTURING COSTS - During 1998, management authorized and committed to a
   plan of restructure.  The plan provides for the consolidation of certain
   operations, including the closing of a number of office locations and
   reducing the workforce by approximately 21 employees and certain management
   positions.  Based on the finalization of estimates included within the plan
   and the actual undertaking of certain actions in accordance with the plan,
   management made revisions to the original estimates during the fourth
   quarter.  The revisions primarily relate to the final determination of the
   number of employees terminated, which resulted in 19 terminations, the
   unexpected subletting of certain facilities, and a refinement of expected
   legal and other costs.  Although certain specific actions of the plan were
   modified, the overall plan for restructuring the Company is expected to be
   completed at a total cost of approximately $200,000 less than the original
   provision.

   Original restructuring reserves were established totaling $1.4 million, of
   which $200,000 was reversed in the fourth quarter.  Of the adjusted amount,
   $600,000 was reserved for severance and related costs, $200,000 for the
   office leases and $400,000 for legal and other costs.

   Major categories of the restructuring reserve and the amounts incurred are
   summarized below:

<TABLE>
<CAPTION>
                                                                          Amounts
                                                                         Charged to             Amounts    
                                                                         Earnings in          Incurred in 
                                                                            1998                 1998     
                                                                      ----------------       --------------
     <S>                                                              <C>                    <C>          
     Severance and related costs                                            $  614,678            $252,885
     Leased facilities                                                         217,902              68,449
     Legal and other costs                                                     379,685             236,685
                                                                            ----------            --------
                                                                            $1,212,265            $558,019
                                                                            ==========            ======== 
</TABLE>

   OFFERING COSTS - During 1998, the Company incurred $531,025 of external costs
   associated with a potential offering of equity securities.  Due to the
   postponement of the equity offering, these costs were expensed in 1998.

                                      53
<PAGE>
 
   FEDERAL BID COSTS - During 1997, the Company incurred $399,817 of external
   costs associated with a bid for the Federal Bureau of Prisons contract.  The
   Company was unsuccessful in obtaining the contract.  The contract award has
   been appealed; however, the Company has expensed all costs associated with
   the bid.

   EXTRAORDINARY LOSS- During 1997, as a result of the repayment of outstanding
   indebtedness and amendments of the Senior Credit Facility, the Company
   expensed approximately $4.7 million of debt issuance, legal and other costs
   associated with the extinguishment of the prior credit facilities. These
   amounts have been classified as an extraordinary loss in accordance with the
   provisions of SFAS No. 4, "Reporting Gains and Losses From the Extinguishment
   of Debt."

15. SUBSEQUENT EVENTS

   In March 1999, the Company raised $5 million of equity from its existing
   shareholders and warrant holders and/or their affiliates through the issuance
   of 5,000 investment units at $1,000 per unit. Each unit consists of one share
   of newly authorized First Preferred Series A Stock and a warrant to acquire
   one share of the Company's Class A common stock for $1,000 per share.

   The First Preferred Series A Stock will be entitled to receive dividends at
   the applicable First Preferred Series A Rate, payable quarterly commencing on
   April 1, 1999.  Such dividends will be payable out of funds legally available
   therefor, will be payable only when, as, and if declared by the Board of
   Directors, shall be cumulative, and, if undeclared or unpaid, shall bear
   interest at the applicable First Preferred Series A Rate until paid.  The
   First Preferred Series A Rate will be eight percent  per annum through March
   31, 2001, will be ten percent per annum from April 1, 2001 through June 30,
   2001 and thereafter will increase by 0.5% for each additional three month
   period up to a maximum of 16% per annum.  The First Preferred Series A Stock
   ranks senior to all classes of common stock but ranks junior to the Senior
   Preferred Stock of the Company with respect to dividend rights and rights
   upon liquidation.  The warrants have a strike price of $1,000 per share and
   will expire if not sooner exercised on December 31, 2007.

   In conjunction with the March 1999 equity offering, the preferred dividend
   rates on the original Senior Preferred Stock were modified to mirror the
   preferred dividend rates on the First Preferred Series A Stock.

   Also in March 1999, in conjunction with the issuance of the First Preferred
   Series A Stock and warrants, the Company amended and restated its Senior
   Credit Facility, as discussed further in footnote 7.  The amendment increased
   the Company's borrowing capacity under the term loan facility of the Senior
   Credit Facility by $5.5 million.


                                    ******

                                      54
<PAGE>
 
INDEPENDENT AUDITORS' REPORT


To the Stockholders of
 AmeriTel Pay Phones, Inc.:

We have audited the accompanying balance sheet of AmeriTel Pay Phones, Inc. (the
"Company") as of November 30, 1996, and the related statement of income,
stockholder's equity and cash flows for the eleven months 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 audit.

We conducted our audit 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 audit provides a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material
respects, the financial position of AmeriTel Pay Phones, Inc. as of November 30,
1996, and the results of its income and its cash flows for the eleven months
then ended, in conformity with generally accepted accounting principles.


DELOITTE & TOUCHE LLP
Dallas, Texas
April 4, 1997

                                      55
<PAGE>
 
                           AMERITEL PAY PHONES, INC.
 
                                 BALANCE SHEET

<TABLE> 
<CAPTION>
                                                                                                 NOVEMBER 30,
ASSETS                                                                                               1996
                                                                                            ----------------------
<S>                                                                                         <C>
CURRENT ASSETS:
   Cash and cash equivalents                                                                           $    80,664
   Accounts receivable                                                                                   5,546,304
   Stock subscriptions receivable                                                                        1,061,384
   Refundable income taxes                                                                                 342,986
   Inventories                                                                                             785,438
   Prepaid expenses                                                                                         34,646
   Deferred tax asset                                                                                      396,752
                                                                                                       -----------
 
           Total current assets                                                                          8,248,174
 
PROPERTY AND EQUIPMENT                                                                                   4,521,521
 
INTANGIBLE AND OTHER ASSETS                                                                             14,114,958
                                                                                                       -----------
 
TOTAL                                                                                                  $26,884,653
                                                                                                       ===========
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
CURRENT LIABILITIES:
   Accounts payable                                                                                    $ 1,429,916
   Accrued expenses                                                                                      3,289,957
   Current maturities of long-term debt                                                                  1,824,907
                                                                                                       -----------
 
           Total current liabilities                                                                     6,544,780
 
LONG-TERM DEBT                                                                                          13,019,811
 
DEFERRED INCOME TAXES                                                                                      425,689
 
COMMITMENTS AND CONTINGENCIES
 
STOCKHOLDERS' EQUITY:
   Preferred stock, $.01 par value, 500,000 shares authorized;
      244,800 shares issued and outstanding (liquidation value of
      $1,534,157 at November 30, 1996)                                                                       2,448
   Common stock, $.01 par value, 10,000,000 shares authorized;
      3,519,315 shares issued and outstanding as of
      November 30, 1996                                                                                     35,193
   Additional paid-in capital                                                                            3,704,863
   Retained earnings                                                                                     3,151,869
                                                                                                       -----------
 
           Total stockholders' equity                                                                    6,894,373
                                                                                                       -----------

TOTAL                                                                                                  $26,884,653
                                                                                                       ===========
</TABLE> 
 
See notes to financial statements.
 
                                      56
<PAGE>
 
                           AMERITEL PAY PHONES, INC.
 
                              STATEMENT OF INCOME

<TABLE> 
<CAPTION> 
                                                                                                 ELEVEN MONTHS
                                                                                                     ENDED
                                                                                                  NOVEMBER 30,
                                                                                                      1996
                                                                                            ------------------------
<S>                                                                                         <C>
OPERATING REVENUE                                                                                  $29,305,641
                                                                                                   
OPERATING EXPENSES:                                                                                
   Telecommunication costs                                                                          13,728,316
   Facility commissions                                                                              6,086,469
   Field operations and maintenance                                                                  1,166,063
   Selling, general and administrative                                                               2,281,177
   Depreciation                                                                                        536,264
   Amortization of intangibles                                                                       1,624,017
   Nonrecurring expenses                                                                               684,320
                                                                                                   -----------
                                                                                                   
           Total operating expenses                                                                 26,106,626
                                                                                                   -----------
                                                                                                   
OPERATING INCOME                                                                                     3,199,015
                                                                                                   
OTHER (INCOME) EXPENSE:                                                                            
   Interest income                                                                                     (20,816)
   Interest expense                                                                                  1,375,701
   Other, net                                                                                           38,881
                                                                                                   -----------
                                                                                                   
           Total other (income) expense                                                              1,393,766
                                                                                                   -----------

INCOME BEFORE INCOME TAXES AND                                                                     
   EXTRAORDINARY LOSS                                                                                1,805,249
                                                                                                   
INCOME TAXES                                                                                           693,001
                                                                                                   -----------
                                                                                                   
INCOME BEFORE EXTRAORDINARY LOSS                                                                     1,112,248
                                                                                                   
EXTRAORDINARY LOSS FROM EARLY                                                                      
   EXTINGUISHMENT OF DEBT                                                                               52,353
                                                                                                   -----------
                                                                                                   
NET INCOME                                                                                         $ 1,059,895
                                                                                                   ===========
</TABLE> 
 
See notes to financial statements.
 

                                      57
<PAGE>
 
                           AMERITEL PAY PHONES, INC.
 
                       STATEMENT OF STOCKHOLDERS' EQUITY
 
 
<TABLE> 
<CAPTION>                                                                                       
                                                 PREFERRED       COMMON STOCK        ADDITIONAL            
                                                            ----------------------    PAID-IN     RETAINED 
                                                   STOCK       SHARES      AMOUNT     CAPITAL     EARNINGS        TOTAL
                                                 ---------  ------------  --------  -----------  -----------   -----------
<S>                                              <C>        <C>           <C>       <C>          <C>           <C>           
BALANCE, JANUARY 1, 1996                            $2,448     3,233,854    32,338    2,292,548    2,209,682     4,537,016
 
   Issuance of common stock                                      285,461     2,855    1,412,315                  1,415,170
   Preferred stock dividends ($0.48 per share)                                                      (117,708)     (117,708)
   Net income                                                                                      1,059,895     1,059,895
                                                 ---------  ------------  --------  -----------  -----------   -----------
 
BALANCE, NOVEMBER 30, 1996                          $2,448     3,519,315   $35,193   $3,704,863   $3,151,869    $6,894,373
                                                 =========  ============  ========  ===========  ===========   ===========
</TABLE> 
 
See notes to financial statements.
 

                                      58
<PAGE>
 
                          AMERITEL  PAY PHONES, INC.
 
                            STATEMENT OF CASH FLOWS
 
<TABLE> 
<CAPTION> 
                                                                                                    ELEVEN
                                                                                                    MONTHS
                                                                                                     ENDED
                                                                                                 NOVEMBER 30,
                                                                                                     1996
                                                                                                     ----
<S>                                                                                              <C> 
CASH FLOWS FROM OPERATING ACTIVITIES:                                                            
   Net income                                                                                    $ 1,059,895
   Adjustments to reconcile net income to net cash provided by operating activities:             
      Extraordinary loss                                                                              52,353
      Depreciation and amortization                                                                2,160,281
      Deferred income taxes                                                                          (35,524)
      Changes in operating assets and liabilities:                                               
         Accounts receivable                                                                      (3,803,925)
         Inventory                                                                                   271,286
         Prepaid expenses                                                                             44,880
         Accounts payable                                                                          1,092,431
         Accrued expenses                                                                          1,460,005
         Income taxes                                                                                266,149
                                                                                                 -----------
                                                                                                 
           Net cash provided by operating activities                                               2,567,831
                                                                                                 -----------
                                                                                                 
CASH FLOWS FROM INVESTING ACTIVITIES:                                                            
   Capital expenditures                                                                           (1,516,236)
   Cash outflows for acquisition of facility contracts                                            (4,698,468)
                                                                                                 -----------
                                                                                                 
           Net cash used in investing activities                                                  (6,214,704)
                                                                                                 -----------
                                                                                                 
CASH FLOWS FROM FINANCING ACTIVITIES:                                                            
   Proceeds from long-term debt borrowings                                                         5,600,000
   Proceeds from issuance of common stock                                                             19,501
   Payments of long-term debt                                                                     (2,645,282)
   Dividends paid on common and preferred stock                                                     (137,708)
                                                                                                 -----------
                                                                                                 
           Net cash provided by financing activities                                               2,836,511
                                                                                                 -----------
                                                                                                 
DECREASE IN CASH AND CASH EQUIVALENTS                                                               (810,362)
                                                                                                 
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                                       891,026
                                                                                                 -----------
                                                                                                 
CASH AND CASH EQUIVALENTS, END OF PERIOD                                                         $    80,664
                                                                                                 ===========
                                                                                                 
SUPPLEMENTAL INFORMATION:                                                                        
   Cash paid for interest                                                                        $ 1,489,076
                                                                                                 ===========
                                                                                                 
   Cash paid for income tax                                                                      $   462,380
                                                                                                 ===========
                                                                                                 
   Noncash transactions:                                                                         
      Issuance of common stock upon exercise of stock options in exchange                        
         for stock subscriptions receivable, along with the related tax benefit                  $ 1,395,669
                                                                                                 ===========
                                                                                                 
      Amounts payable for acquisitions                                                           $   310,000
                                                                                                 ===========
</TABLE> 
 
See notes to financial statements.
 
                                      59
<PAGE>
 
                           AMERITEL PAY PHONES, INC.

                         NOTES TO FINANCIAL STATEMENTS

1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

   BUSINESS - AmeriTel Pay Phones, Inc. (the "Company"), which was incorporated
   on June 6, 1991, owns, operates and maintains telephone systems under
   contracts with correctional facilities in 30 states, with the majority of its
   installations in Missouri, Kansas, Iowa, Indiana, Minnesota and Nebraska.

   The Company accumulates call activity from its various installations and
   bills its revenues related to this call activity through major local exchange
   carriers ("LECs") or through third-party billing services, all of which are
   granted credit in the normal course of business with terms of between 30 and
   60 days. The Company performs ongoing credit evaluations of its customers and
   maintains allowances for unbillable and uncollectible losses based on
   historical experience.

   PREPARATION OF FINANCIAL STATEMENTS - The preparation of financial statements
   in conformity with generally accepted accounting principles requires
   management to make estimates and assumptions, such as estimates of allowances
   for unbillable and uncollectible chargebacks, that affect the reported
   amounts of assets and liabilities at the date of the financial statements and
   the reported amounts of revenues and expenses during the reporting period.
   Actual results could differ from those estimates.

   CASH AND CASH EQUIVALENTS - For purposes of the statement of cash flows, cash
   and cash equivalents include cash on hand and cash investments with a
   remaining maturity at the date of purchase of three months or less.

   ACCOUNTS RECEIVABLE - Trade accounts receivable represent amounts billed for
   calls placed through the Company's telephone systems to the various LECs or
   third-party billing services, net of advance payments received, and an
   allowance for unbillable and uncollectible calls based on historical
   experience for estimated chargebacks to be made by the LECs. Under account
   advance agreements with various third-party billing services, advance
   payments equal to a percentage of the outstanding billed receivables are
   remitted to the Company when calls are submitted to the third-party billing
   service, and the Company grants a lien to the third-party billing service on
   the related accounts receivable for the advance. The remainder of the billed
   receivable is paid to the Company, net of the advance amount, after the
   third-party billing service has collected the amounts receivable from the
   respective LECs. Interest is charged on the advance payment at varying rates.

   INVENTORIES - Inventories are stated at the lower of cost, as determined
   using the weighted average cost method, or market. Inventory is primarily
   composed of equipment available for installation on new contracts and
   supplies and parts for the telephone systems serviced by the Company.

                                      60
<PAGE>
 
   PROPERTY AND EQUIPMENT - Property and equipment are stated at cost.
   Depreciation and amortization is provided on a straight-line basis over the
   estimated useful lives of the related assets. The following is a summary of
   useful lives for major categories of property and equipment:

<TABLE>
<CAPTION>
     ASSET                                                                              USEFUL LIFE   
     <S>                                                                                <C>              
     Leasehold improvements                                                             Term of lease    
     Telephone system equipment                                                         7.5 to 10 years  
     Vehicles                                                                           5 years          
     Office equipment                                                                   3 to 7 years 
</TABLE>

   Maintenance and repairs are expensed when incurred, and major repairs that
   extend an asset's useful life are capitalized. When items are retired or
   disposed of, the related carrying value and accumulated depreciation are
   removed from the respective accounts, and the net difference less any amount
   realized from the disposition is reflected in earnings.

   INTANGIBLE AND OTHER ASSETS - Intangible and other assets primarily include
   amounts allocated to acquired facility contracts, noncompete agreements,
   goodwill and other intangible assets, which are stated at cost, along with
   the long-term portion of customer advances. Amortization of intangible assets
   is provided on a straight-line basis over the estimated useful lives of the
   related assets. The following is a summary of useful lives for major
   categories of intangible assets:

<TABLE>
<CAPTION>
     INTANGIBLE ASSET                                                                   USEFUL LIFE    
     <S>                                                                                <C>               
     Acquired facility contracts                                                        7.5 years         
     Noncompete agreements                                                              Agreement term    
     Deferred loan costs                                                                Loan term         
     Other intangibles                                                                  5 to 20 years     
     Goodwill                                                                           15 years           
</TABLE>

   Acquired facility contracts consist primarily of costs allocated to locations
   acquired in acquisitions of facility contract rights from other service
   providers, along with signing bonuses paid to the facilities under new
   facility installations and other incremental direct costs paid to obtain the
   facility contracts.

   Other intangibles include organizational costs and licensing fees to obtain
   state licenses to conduct business.

   The Company began in 1996 to periodically assess the net realizable value of
   its intangible assets, as well as all other assets, by comparing the expected
   future net operating cash flow, undiscounted and without interest charges, to
   the carrying amount of the underlying assets. The Company would evaluate a
   potential impairment if the recorded value of these assets exceeded the
   associated future net operating cash flows. Any potential impairment loss
   would be measured as the amount by which the carrying value exceeds the fair
   value of the asset. Fair value of assets would be measured by market value,
   if an active market exists, or by a forecast of expected future net operating
   cash flows, discounted at a rate commensurate with the risk involved.

   INCOME TAXES - The Company accounts for income taxes using the liability
   method in accordance with the provisions of Statement of Financial Accounting
   Standards ("SFAS") No. 109, "Accounting for Income Taxes." Under this method,
   deferred tax assets and liabilities are provided for temporary 

                                      61
<PAGE>
 
   differences between the financial statement and tax bases of the assets and
   liabilities using current tax rates.

   REVENUE RECOGNITION - Revenues are recognized during the period the calls are
   made. In addition, during the same period, the Company accrues the related
   telecommunication costs for validating, transmitting, billing and collection,
   and line and long distance charges, along with commissions payable to the
   facilities and allowances for unbillable and uncollectible calls, based on
   historical experience.

   FACILITY COMMISSIONS - Under the terms of the Company's telephone system
   contracts with correctional facilities, the Company pays commissions to these
   facilities generally based on call volume revenues, which are accrued during
   the period the revenues are generated.

   FINANCIAL INSTRUMENTS - The Company's financial instruments under SFAS No.
   107, "Disclosures About Fair Value of Financial Instruments," include cash
   and cash equivalents, accounts receivable, accounts payable and long-term
   debt. The Company believes that the carrying amounts of cash and cash
   equivalents, accounts receivable, accounts payable and long-term debt are a
   reasonable estimate of their fair value because of the short-term maturities
   of such instruments or, in the case of the revolving credit facility
   borrowings, because of the floating interest rates on such borrowings. In the
   case of the subordinated promissory notes to related parties, which bear a
   fixed interest rate, the Company believes that the current interest rates on
   these notes approximate the rates that could be currently negotiated with
   such related parties.

2. ACQUISITIONS

   During the eleven months ended November 30, 1996, the Company acquired
   facility contracts and the related facility equipment from various other
   independent inmate phone operators for purchase prices aggregating $5.0
   million.

   These acquisitions were each accounted for using the purchase method of
   accounting as of their respective acquisition dates, and accordingly, only
   the results of the operations of these facilities subsequent to their
   respective acquisition dates are included in the financial statements of the
   Company. At the acquisition dates, the purchase prices were allocated to the
   assets acquired, including telephone system equipment, facility contracts and
   other identifiable intangibles based on their fair market values.

                                      62
<PAGE>
 
   The excess of the total purchase prices over the fair values of the assets
   acquired represented goodwill. In connection with the acquisitions, assets
   were acquired, and liabilities were assumed as follows:

<TABLE>
<CAPTION>
                                                                                           ELEVEN MONTHS 
                                                                                               ENDED     
                                                                                           NOVEMBER 30,  
                                                                                               1996      
                                                                                          ---------------
     <S>                                                                                  <C>            
     Purchase prices:                                                                                    
        Net cash paid                                                                          $4,698,468
        Amounts payable to sellers                                                                310,000
                                                                                               ----------
                                                                                                         
     Total purchase price                                                                       5,008,468
                                                                                                         
     Estimated fair values of tangible and                                                               
        identifiable intangible assets acquired                                                 4,121,809
                                                                                               ----------
                                                                                                         
     Goodwill                                                                                  $  886,659
                                                                                               ========== 
</TABLE> 

   The following table presents unaudited pro forma results of operations of the
   Company for the eleven months ended November 30, 1996, as if the 1996
   acquisitions had occurred at the beginning of 1996:

<TABLE>
<CAPTION>
                                                                                                  1996      
                                                                                                  ----
                                                                                               (UNAUDITED)   
     <S>                                                                                       <C>
     Net sales                                                                                  $31,929,045
                                                                                                ===========
                                                                                                           
     Income before extraordinary loss                                                           $ 1,308,344
                                                                                                ===========
                                                                                                           
     Net income                                                                                 $ 1,255,991
                                                                                                =========== 
</TABLE>

   The unaudited pro forma results of operations are not necessarily indicative
   of what the actual results of operations of the Company would have been had
   the acquisitions occurred at the beginning of the year, nor do they purport
   to be indicative of the future results of operations of the Company.

   In connection with two of the acquisitions in 1996, the Company recorded
   amounts payable to the sellers of $310,000, the payment of which was
   contingent upon the fulfillment of certain stipulations that the Company
   believed were probable of being met. In the event that the stipulations were
   not met and the full balance was not paid by the Company, intangible assets
   previously recorded on these acquisitions would be reduced.

                                      63
<PAGE>
 
3. ACCOUNTS RECEIVABLE

   Accounts receivable consist of the following:

<TABLE>
<CAPTION>
                                                                                             NOVEMBER 30,  
                                                                                                 1996      
                                                                                                 ----
     <S>                                                                                     <C>            
     Trade accounts receivable                                                                 $6,895,904
     Advance commissions receivable                                                               353,378
     Employees and other                                                                           50,670
                                                                                               ----------
                                                                                                         
                                                                                                7,299,952
                                                                                                         
     Less advances on receivables                                                                (719,093)
     Less allowance for unbillable and uncollectible chargebacks                               (1,034,555)
                                                                                               ----------
                                                                                                         
                                                                                               $5,546,304
                                                                                               ========== 
</TABLE>

   At November 30, 1996, the Company had advanced commissions to certain
   facilities of $843,378, which are recoverable from such facilities as a
   reduction of earned commissions at specified monthly amounts. Amounts
   included in accounts receivable represent the estimated recoverable amounts
   during the next fiscal year with the remaining balance recorded in other
   assets.

4. PROPERTY AND EQUIPMENT

   Property and equipment consist of the following:

<TABLE>
<CAPTION>
                                                                                               NOVEMBER 30,  
                                                                                                  1996      
                                                                                                  ----      
     <S>                                                                                       <C>            
     Leasehold improvements                                                                    $   59,145
     Telephone system equipment                                                                 5,159,020
     Vehicles                                                                                     138,914
     Office equipment                                                                             334,543
                                                                                               ----------
                                                                                                         
                                                                                                5,691,622
                                                                                                         
     Less accumulated depreciation and amortization                                            (1,170,101)
                                                                                               ----------
                                                                                                         
                                                                                               $4,521,521
                                                                                               ========== 
</TABLE>

   Substantially all of the Company's property and equipment is collateral for
   the Company's long-term debt.

                                      64
<PAGE>
 
5. INTANGIBLE AND OTHER ASSETS

   Intangible and other assets consist of the following:

<TABLE>
<CAPTION>
                                                                                              NOVEMBER 30,    
                                                                                                  1996        
                                                                                                  ----         
     <S>                                                                                      <C>          
     Intangible assets:                                                                                    
       Acquired facility contracts                                                              $11,432,435
       Noncompete agreements                                                                        375,000
       Goodwill                                                                                   5,088,960
       Other intangibles                                                                            100,945
                                                                                                -----------
                                                                                                           
                                                                                                 16,997,340
                                                                                                           
     Less accumulated amortization                                                               (3,372,382)
                                                                                                -----------
                                                                                                           
     Total intangible assets                                                                     13,624,958
                                                                                                           
     Other assets - noncurrent portion of commission                                                       
        advances to facilities                                                                      490,000
                                                                                                -----------
                                                                                                           
                                                                                                $14,114,958
                                                                                                =========== 
</TABLE>

6. ACCRUED EXPENSES

   Accrued expenses consist of the following:

<TABLE>
<CAPTION>
                                                                                        NOVEMBER 30,   
                                                                                            1996       
                                                                                            ----     
     <S>                                                                                <C>         
     Billing and collection fees                                                          $  420,338
     Facility commissions                                                                    722,769
     Long-distance charges                                                                 1,399,180
     Recurring and special bonuses                                                           521,875
     Other                                                                                   225,795
                                                                                          ----------
                                                                                                    
                                                                                          $3,289,957
                                                                                          ========== 
</TABLE>

                                      65
<PAGE>
 
7. LONG-TERM DEBT

   Long-term debt consists of the following:

<TABLE>
<CAPTION>
                                                                                            NOVEMBER 30,    
                                                                                                1996       
                                                                                          -----------------
     <S>                                                                                  <C>              
     Revolving credit facility advances                                                         $12,600,000
                                                                                                           
     Subordinated promissory note payable to a related party, with                                         
        interest at 10%, due on December 31, 2001                                                   800,000
                                                                                                           
     Subordinated promissory notes payable to a related party, with                                        
        interest of 10%, payable in quarterly installments of                                              
        $106,472 until maturity on March 31, 2001, collateralized by                                       
        a security interest in certain facility equipment and contracts                           1,244,718
                                                                                                
                                                                                                           
     Amount payable in connection with a facility contract                                                 
        acquisition, due in February 1999                                                           200,000
                                                                                                -----------
                                                                                                           
                                                                                                 14,844,718
                                                                                                           
     Less current maturities of long-term debt                                                   (1,824,907)
                                                                                                -----------
                                                                                                           
                                                                                                $13,019,811
                                                                                                =========== 
</TABLE>

   The revolving credit facility is a $20,000,000 revolving credit facility with
   United Missouri Bank, N.A. and NBD Bank, with interest at a floating rate
   based on either prime or LIBOR options plus applicable basis points based on
   the Company's applicable coverage ratios. The outstanding balance at
   September 30, 1996, was converted into an installment note at that date, with
   the remaining balance of the revolving credit facility available until
   September 30, 1998. The installment note is payable in quarterly installments
   of $378,000 in 1997, increasing on an annual basis thereafter through
   September 30, 2001. The Company pays a commitment and facility fee of 0.5% on
   the average daily unused portion of the revolving credit facility. The
   revolving credit facility is collateralized by substantially all assets of
   the Company.

   Scheduled principal maturities on long-term debt for the five years
   subsequent to December 31, 1996, are as follows:

<TABLE>
     <S>                                                                                      <C>         
     1997                                                                                     $ 1,824,907
     1998                                                                                       2,374,490
     1999                                                                                       3,194,374
     2000                                                                                       3,122,947
     2001                                                                                       4,328,000
                                                                                              -----------
                                                                                                         
                                                                                              $14,844,718
                                                                                              =========== 
</TABLE>

   In conjunction with the sale of the Company, as discussed in Note 14, all of
   the outstanding debt was repaid.

                                      66
<PAGE>
 
8. INCOME TAXES

   The provision for income taxes for the eleven months ended November 30, 1996,
   is as follows:

<TABLE>
<CAPTION>
                                                                                                 1996      
                                                                                            ---------------
     <S>                                                                                    <C>           
     Current taxes payable:                                                                               
        Federal                                                                                   $609,228
        State                                                                                      119,297
     Deferred income taxes                                                                         (35,524)
                                                                                                  --------
                                                                                                          
                                                                                                  $693,001
                                                                                                  ======== 
</TABLE>

   The provision for income taxes differs from statutory rates primarily as a
   result of state income taxes and permanent differences. The following is a
   reconciliation of income taxes reported in the statement of operations:

<TABLE>
<CAPTION>
                                                                                                 1996      
                                                                                            ---------------
     <S>                                                                                    <C>           
     Tax at statutory rates                                                                       $613,785
     Effect of state income taxes                                                                  102,487
     Other                                                                                         (23,271)
                                                                                                  --------
                                                                                                          
                                                                                                  $693,001
                                                                                                  ======== 
</TABLE>

   The tax effects of temporary differences giving rise to deferred income tax
   asset and liabilities were:

<TABLE>
<CAPTION>
                                                                                             ELEVEN MONTHS  
                                                                                                 ENDED     
                                                                                              NOVEMBER 30, 
                                                                                                  1996     
                                                                                            ----------------
     <S>                                                                                    <C>            
     Deferred tax asset:                                                                                   
        Allowance for unbillable and uncollectible chargebacks                                    $ 396,752
                                                                                                           
     Deferred tax liabilities:                                                                             
        Depreciation and amortization                                                              (402,892)
        Other                                                                                       (22,797)
                                                                                                  ---------
                                                                                                           
                                                                                                   (425,689)
                                                                                                  ---------
                                                                                                           
     Net deferred income tax liability                                                            $ (28,937)
                                                                                                  ========= 
</TABLE>

                                      67
<PAGE>
 
   This net deferred income tax liability is classified in the balance sheet as
   follows:

<TABLE>
<CAPTION>
                                                                                               ELEVEN MONTHS  
                                                                                                   ENDED     
                                                                                                NOVEMBER 30, 
                                                                                                    1996     
                                                                                              ----------------
     <S>                                                                                      <C>            
     Current asset                                                                                  $ 396,752
     Noncurrent liability                                                                            (425,689)
                                                                                                    ---------
                                                                                                             
                                                                                                    $ (28,937)
                                                                                                    ========= 
</TABLE>

9. STOCKHOLDERS' EQUITY

   STOCK OPTIONS - On May 1, 1994, the Board of Directors of the Company adopted
   a stock option agreement for certain employees and consultants of the
   Company. On the same date, the Board of Directors granted options for 233,335
   shares of common stock at $.765 per share, the then-estimated fair market
   value per share of common stock of the Company that were exercisable at any
   time for a period of up to ten years from the date of grant.

   On December 19, 1994, the Board of Directors of the Company adopted the 1995
   Stock Option Plan (the "Plan") for the directors, officers and other key
   employees of the Company, effective for fiscal year 1995. The maximum number
   of shares that could be granted under the Plan was amended from 653,600
   shares to 446,248 shares on April 28, 1995. Under the provisions of the Plan,
   options were to be granted at an exercise price per share not less than the
   fair market value at the date of grant, as determined by the Compensation
   Committee (the "Committee"), and were to be exercisable on the date of grant.
   The Committee was also assigned responsibility for determining the term of
   each option, which in no event could exceed ten years from the date of grant.
   A total of 225,492 options were granted under the Plan during 1995 at a price
   of $4.59 per share, the then estimated fair market value per share of common
   stock of the Company.

   During 1996, no additional stock options were granted to employees, and
   employees exercised all remaining unexercised options prior to the sale of
   the Company, as discussed in Note 14. The following is a summary of changes
   in stock options during 1996:

<TABLE>
<CAPTION>
                                                                                                     EXERCISE       
                                                                                                     WEIGHTED       
                                                                                                     AVERAGE        
                                                                                    NUMBER OF         PRICE         
                                                                                      SHARES        PER SHARE        
     <S>                                                                         <C>                <C>       
     Outstanding at January 1, 1996                                                  285,461          3.790   
                                                                                                              
        Exercised during 1996                                                       (285,461)         3.790   
                                                                                  ----------                  
                                                                                                              
     Outstanding at November 30, 1996                                                      -                  
                                                                                  ==========                   
</TABLE>

   The Company applies APB Opinion No. 25 and related interpretations in
   accounting for its stock option plans, and accordingly, no compensation has
   been recognized since stock options granted under these plans were at
   exercise prices, which approximated market value at the grant date. Had the
   Company 

                                      68
<PAGE>
 
   implemented SFAS No. 123, "Accounting for Stock-Based Compensation" the
   implementation would not have affected the net income of the Company for the
   eleven months ending November 30, 1996, because no options were granted
   during the period and because options granted prior to 1996 were fully
   vested. 

   In connection with the issuance of shares of the Company's common stock for
   exercised options in 1996, the Company recognized, as increases in common
   stock and additional paid-in capital, the aggregate exercise price of
   $1,080,885, along with the tax benefits related to such options of $334,285.
   At November 30, 1996, the Company had recorded stock subscriptions receivable
   of $1,061,384 from certain employees for unpaid exercise proceeds, which were
   subsequently collected by the Company in December 1996.

   PREFERRED STOCK - The preferred stock accrues dividends at 8% for the one-
   year period ending on the first anniversary of the original issue date, 10%
   until the second anniversary date and 12% thereafter.  The preferred stock is
   convertible any time into 244,800 shares of common stock on an after-stock-
   conversion basis. During 1996, $137,708 of the cash dividends were paid on
   the preferred stock.

   In conjunction with the sale of the Company, as discussed in Note 14, all
   outstanding shares of preferred stock were redeemed.

10. RELATED PARTY TRANSACTIONS

   In addition to the related party notes payable discussed in Note 7 and the
   stock subscription receivables related to exercised stock options discussed
   in Note 9, during the eleven months ended November 30, 1996, the Company paid
   an affiliate of its majority stockholders a consulting fee of  $37,500 and
   incurred certain legal costs on behalf of its stockholders, which are
   recorded as accounts receivable from such stockholders.

11. BENEFIT PLAN

   The Company sponsors a 401(k) savings plan for the benefit of eligible full-
   time employees; this is a qualified benefit plan in accordance with the
   Employee Retirement Income Security Act ("ERISA"). The employees
   participating in the plan can generally make contributions to the plan of up
   to 15% of their compensation. The plan provides for discretionary matching
   contributions by the Company of up to 50% of an eligible employee's
   contribution. No significant contributions to this plan were made by the
   Company during 1996.

12. OTHER COSTS

   NONRECURRING COSTS - During 1996, the Company incurred costs of $250,000
   related to the settlement of a lawsuit related to a prior acquisition, along
   with special bonuses of $434,320 paid to key management at the date of the
   sale of the Company, as discussed in Note 14. These special bonuses were
   payable to key management upon the closing of the sale of the Company
   pursuant to a transaction bonus agreement with such employees, due and
   payable only upon the closing of the sale, a portion of which was
   attributable to the buyout of existing employment contracts with such
   employees.

                                      69
<PAGE>
 
   EXTRAORDINARY LOSS - In connection with the sale of the Company, all
   outstanding long-term debt was repaid, resulting in the expensing of existing
   unamortized debt issue costs of $52,353 (net of income tax benefit of
   $32,573). This loss has been classified as an extraordinary loss in
   accordance with the provisions of SFAS No. 4, "Reporting Gains and Losses
   From the Early Extinguishment of Debt."

13. COMMITMENTS AND CONTINGENCIES

   OPERATING LEASE - The Company leases office space under an operating lease
   agreement that expires on July 31, 1999. Rent expense under this and prior
   operating lease agreements was $61,050 during fiscal year 1996. The total
   remaining future minimum lease payments for the Company under the operating
   lease agreement are as follows:


<TABLE>
     <S>                                                                                         <C>           
     1997                                                                                        $ 66,600
     1998                                                                                          66,600
     1999                                                                                          38,850
                                                                                                 --------
                                                                                                         
                                                                                                 $172,050
                                                                                                 ======== 
</TABLE>

   CONTINGENCIES - The Company is subject to various legal proceedings and
   claims that arise in the ordinary course of business operations. In the
   opinion of management, the amount of liability, if any, with respect to these
   actions would not materially affect the financial position of the Company or
   its results of operations.

14. SUBSEQUENT SALE OF COMPANY

   On December 27, 1996, Talton Holdings, Inc. acquired all of the outstanding
   common stock of the Company in a purchase business combination effective
   December 1, 1996. In conjunction with this transaction, all of the
   outstanding debt of the Company was repaid and all of the outstanding
   preferred stock was redeemed.

                                    ******

                                      70
<PAGE>
 
INDEPENDENT AUDITORS' REPORT

To the Board of Directors and
 Stockholders of Talton Telecommunications Corporation:

We have audited the accompanying consolidated balance sheet of Talton
Telecommunications Corporation and subsidiary (the "Company") as of November 30,
1996, and the related consolidated statements of income, stockholders' equity
and cash flows for the eleven months then ended. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.

We conducted our audit 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 audit provides a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of Talton
Telecommunications Corporation and subsidiary as of November 30, 1996, and the
results of their income and their cash flows for the eleven months then ended,
in conformity with generally accepted accounting principles.

DELOITTE & TOUCHE LLP

Dallas, Texas
April 4, 1997

                                      71
<PAGE>
 
             TALTON TELECOMMUNICATIONS CORPORATION AND SUBSIDIARY
 
                          CONSOLIDATED BALANCE SHEET
 
<TABLE> 
<CAPTION> 
 
                                                                                                         NOVEMBER 30,
ASSETS                                                                                                       1996
                                                                                                       ----------------
<S>                                                                                                    <C>
CURRENT ASSETS:
   Cash and cash equivalents                                                                                 $  449,904
   Accounts receivable                                                                                        2,388,958
   Refundable income taxes
   Inventories                                                                                                  168,395
   Prepaid expenses                                                                                              55,788
   Deferred income tax asset                                                                                     54,400
                                                                                                             ----------
 
           Total current assets                                                                               3,117,445
 
PROPERTY AND EQUIPMENT                                                                                        4,119,147
 
INTANGIBLE AND OTHER ASSETS                                                                                     586,656
                                                                                                             ----------
 
TOTAL                                                                                                        $7,823,248
                                                                                                             ==========
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
CURRENT LIABILITIES:
   Accounts payable                                                                                          $  950,576
   Accrued expenses                                                                                           3,205,027
   Income taxes payable                                                                                         892,000
                                                                                                             ----------
           Total current liabilities                                                                          5,047,603
 
DEFERRED INCOME TAXES                                                                                           308,605
 
COMMITMENTS AND CONTINGENCIES
 
STOCKHOLDERS' EQUITY:
   Common stock, $1.00 par value; 5,000 shares authorized,
      issued and outstanding                                                                                      5,000
   Retained earnings                                                                                          2,462,040
                                                                                                             ----------
 
           Total stockholders' equity                                                                         2,467,040
                                                                                                             ----------
 
TOTAL                                                                                                        $7,823,248
                                                                                                             ==========
</TABLE>
 
See notes to consolidated financial statements.

                                      72
<PAGE>
 
             TALTON TELECOMMUNICATIONS CORPORATION AND SUBSIDIARY
 
                       CONSOLIDATED STATEMENT OF INCOME
 

<TABLE> 
<CAPTION> 
                                                                                        ELEVEN MONTHS  
                                                                                            ENDED      
                                                                                         NOVEMBER 30,  
                                                                                             1996      
                                                                                             ----       
                                                                                  
<S>                                                                                       <C> 
OPERATING REVENUE                                                                         $24,357,473
                                                                                  
OPERATING EXPENSES:                                                               
   Telecommunication costs                                                                  9,588,482
   Facility commissions                                                                     7,875,455
   Field operations and maintenance                                                           649,739
   Selling, general and administrative                                                      1,639,827
   Depreciation                                                                             1,001,982
   Amortization of intangibles                                                                122,180
                                                                                          -----------
                                                                                  
           Total operating expenses                                                        20,877,665
                                                                                          -----------
                                                                                  
OPERATING INCOME                                                                            3,479,808
                                                                                  
OTHER (INCOME) EXPENSE:                                                           
   Interest income                                                                            (55,268)
   Interest expense                                                                           169,789
   Other, net                                                                                 (12,321)
                                                                                          -----------
                                                                                  
           Total other (income) expense                                                       102,200
                                                                                          -----------
                                                                                  
INCOME BEFORE INCOME TAXES                                                                  3,377,608
                                                                                  
INCOME TAXES                                                                                1,223,989
                                                                                          -----------
                                                                                  
NET INCOME                                                                                $ 2,153,619
                                                                                          ===========
</TABLE>
 
See notes to consolidated financial statements.

                                      73
<PAGE>
 
             TALTON TELECOMMUNICATIONS CORPORATION AND SUBSIDIARY

                CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
 
<TABLE> 
<CAPTION> 
                                                                             COMMON STOCK                
                                                                          -----------------     RETAINED 
                                                                            SHARES  AMOUNT      EARNINGS         TOTAL
                                                                            ------  -------    -----------    -----------
<S>                                                                         <C>     <C>        <C>            <C>
BALANCE, JANUARY 1, 1996                                                     5,000   $5,000     $  308,421     $  313,421
 
   Net income for the eleven months ended November 30, 1996                                      2,153,619      2,153,619
                                                                            ------  -------     ----------     ----------
 
BALANCE, NOVEMBER 30, 1996                                                   5,000   $5,000     $2,462,040     $2,467,040
                                                                            ======  =======     ==========     ==========
</TABLE> 
 
See notes to consolidated financial statements.

                                      74
<PAGE>
 
             TALTON TELECOMMUNICATIONS CORPORATION AND SUBSIDIARY
 
                     CONSOLIDATED STATEMENT OF CASH FLOWS
 

<TABLE> 
<CAPTION> 
                                                                                                      ELEVEN MONTHS
                                                                                                          ENDED
                                                                                                       NOVEMBER 30,
                                                                                                           1996
                                                                                                           ----
<S>                                                                                                   <C> 
CASH FLOWS FROM OPERATING ACTIVITIES:                                                              
   Net income                                                                                           $ 2,153,619
   Adjustments to reconcile net income                                                             
      to net cash provided by operating activities:                                                
      Depreciation and amortization                                                                       1,124,162
      Deferred income taxes                                                                                 250,989
   Changes in operating assets and liabilities:                                                    
      Accounts receivable                                                                                  (180,563)
      Inventories                                                                                           142,233
      Prepaid expenses                                                                                      (55,788)
      Accounts payable                                                                                       14,007
      Accrued expenses                                                                                      (97,672)
      Income taxes payable                                                                                1,381,652
                                                                                                        -----------
                                                                                                   
            Net cash provided by operating activities                                                     4,732,639
                                                                                                        -----------
                                                                                                   
CASH FLOWS FROM INVESTING ACTIVITIES:                                                              
   Capital expenditures                                                                                  (1,287,703)
   Payments for intangible and other                                                                        (12,975)
                                                                                                        -----------
                                                                                                   
           Net cash used in investing activities                                                         (1,300,678)
                                                                                                        -----------
                                                                                                   
CASH FLOWS FROM FINANCING ACTIVITIES:                                                              
   Payments of long-term debt                                                                            (3,383,794)
                                                                                                        -----------
                                                                                                   
           Net cash used in financing activities                                                         (3,383,794)
                                                                                                        -----------
                                                                                                   
INCREASE IN CASH AND CASH EQUIVALENTS                                                                        48,167
                                                                                                   
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                                              401,737
                                                                                                        -----------
                                                                                                   
CASH AND CASH EQUIVALENTS, END OF PERIOD                                                                $   449,904
                                                                                                        ===========
                                                                                                   
SUPPLEMENTAL INFORMATION:                                                                          
   Interest paid                                                                                        $   172,578
                                                                                                        ===========
                                                                                                   
   Income taxes refunded                                                                                $  (408,652)
                                                                                                        ===========
</TABLE>
 
See notes to consolidated financial statements.

                                      75
<PAGE>
 
             TALTON TELECOMMUNICATIONS CORPORATION AND SUBSIDIARY

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

   BUSINESS - Talton Telecommunications Corporation (the "Company"), which was
   incorporated in 1973, owns, operates and maintains telephone systems under
   contracts with correctional facilities in Alabama, Mississippi, North
   Carolina and South Carolina. The Company also operates and maintains public
   pay telephone systems at various third-party property locations. The Company
   accumulates call activity from its various installations and bills its
   revenues related to this call activity through major local exchange carriers
   ("LECs") or through third-party billing services for smaller volume LECs, all
   of which are granted credit in the normal course of business with terms of
   between 30 and 60 days. The Company performs ongoing credit evaluations of
   its customers and maintains allowances for unbillable and uncollectible
   losses based on historical experience.

   PREPARATION OF FINANCIAL STATEMENTS - The preparation of financial statements
   in conformity with generally accepted accounting principles requires
   management to make estimates and assumptions, such as estimates of allowances
   and reserves for unbillable and uncollectible chargebacks, that affect the
   reported amounts of assets and liabilities at the date of the financial
   statements and the reported amounts of revenues and expenses during the
   reporting period. Actual results could differ from those estimates.

   PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include
   the accounts of the Company and its wholly owned subsidiary, Talton
   Telecommunications of Carolina, Inc. All significant intercompany balances
   and transactions are eliminated in consolidation.

   CASH AND CASH EQUIVALENTS - For purposes of the statement of cash flows, cash
   and cash equivalents includes cash on hand and cash investments with a
   remaining maturity at the date of purchase of three months or less.

   ACCOUNTS RECEIVABLE - Trade accounts receivable represents amounts billed for
   calls placed through the Company's telephone systems to the various LECs or
   third-party billing services, net of an allowance for unbillable and
   uncollectible calls, based on historical experience, for estimated
   chargebacks to be made by the LECs.

   INVENTORIES - Inventories are stated at the lower of cost, as determined
   using the first-in, first-out ("FIFO") method of valuation or market.
   Inventory is primarily composed of equipment available for installation on
   new contracts and supplies and parts for the telephone systems serviced by
   the Company.

                                      76
<PAGE>
 
   PROPERTY AND EQUIPMENT - Property and equipment is stated at cost.
   Depreciation and amortization is provided on a straight-line basis over the
   estimated useful lives of the related assets. The following is a summary of
   useful lives for major categories of property and equipment:

<TABLE>
<CAPTION>
     ASSET                                                                       USEFUL LIFE   
     <S>                                                                         <C>               
                                                                                                        
     Leasehold improvements                                                      15 to 39 years    
     Telephone system equipment                                                  5 to 6 years      
     Vehicles                                                                    5 years           
     Office equipment                                                            5 to 7 years       
</TABLE>

   Maintenance and repairs are expensed when incurred, and major repairs that
   extend an asset's useful life are capitalized. When items are retired or
   disposed of, the related carrying value and accumulated depreciation are
   removed from the respective accounts, and the net difference less any amount
   realized from the disposition is reflected in earnings.

   INTANGIBLE AND OTHER ASSETS - Intangible and other assets include amounts
   allocated to acquired facility contracts, noncompete agreements, goodwill and
   other intangible assets, which are stated at cost. Amortization of intangible
   assets is provided on a straight-line basis over the estimated useful lives
   of the related assets. The following is a summary of useful lives for major
   categories of intangible assets:

<TABLE>
<CAPTION>
     INTANGIBLE ASSET                                                            USEFUL LIFE    
     <S>                                                                         <C>                  
                                                                                                           
     Acquired facility contracts                                                 Contract term        
     Noncompete agreements                                                       Agreement term       
     Goodwill                                                                    15 years              
</TABLE>

   Acquired facility contracts consist primarily of costs allocated to locations
   acquired in acquisitions of facility contract rights from other service
   providers, along with other incremental direct costs paid to obtain the
   facility contracts.

   The Company periodically assesses the net realizable value of its intangible
   assets, as well as all other assets, by comparing the expected future net
   operating cash flows, undiscounted and without interest charges, to the
   carrying amount of the underlying assets. The Company would evaluate a
   potential impairment if the recorded value of these assets exceeded the
   associated future net operating cash flows. Any potential impairment loss
   would be measured as the amount by which the carrying value exceeds the fair
   value of the asset. Fair value of assets would be measured by market value,
   if an active market exists, or by a forecast of expected future net operating
   cash flows, discounted at a rate commensurate with the risk involved.

   INCOME TAXES - The Company accounts for income taxes using the liability
   method in accordance with the provisions of Statement of Financial Accounting
   Standards ("SFAS") No. 109, "Accounting for Income Taxes." Under this method,
   deferred tax assets and liabilities are provided for temporary differences
   between the financial statement and tax bases of the assets and liabilities
   using current tax rates.

   REVENUE RECOGNITION - Revenues are recognized during the period the calls are
   made. In addition, during the same period, the Company accrues the related
   telecommunication costs for validating, transmitting, billing and collection,
   and line and long distance charges, along with commissions payable to the
   facilities and allowances for unbillable and uncollectible calls, based on
   historical experience.

                                      77
<PAGE>
 
   FACILITY COMMISSIONS - Under the terms of the Company's telephone system
   contracts with correctional facilities, the Company pays commissions to these
   facilities generally based on call volume revenues that are accrued during
   the period the revenues are generated.

   FINANCIAL INSTRUMENTS - The Company's financial instruments under SFAS No.
   107, "Disclosures About Fair Value of Financial Instruments," include cash
   and cash equivalents, accounts receivable, accounts payable and long-term
   debt. The Company believes that the carrying amounts of cash and cash
   equivalents, accounts receivable, accounts payable and long-term debt are a
   reasonable estimate of their fair value because of the short-term maturities
   of such instruments or, in the case of long-term debt, because of the
   floating interest rates on such long-term debt.

2. ACCOUNTS RECEIVABLE

   Accounts receivable consist of the following:

<TABLE>
<CAPTION>
                                                                                            NOVEMBER 30,     
                                                                                                1996         
                                                                                          ----------------   
     <S>                                                                                  <C>                
     Trade accounts receivable                                                                 $2,390,864    
     Amounts due from shareholders                                                                154,894    
     Other                                                                                          3,200    
                                                                                               ----------    
                                                                                                             
                                                                                                2,548,958    
                                                                                                             
     Less allowance for unbillable and uncollectible                                                         
        chargebacks                                                                              (160,000)   
                                                                                               ----------    
                                                                                                             
                                                                                               $2,388,958    
                                                                                               ==========     
</TABLE>

3. PROPERTY AND EQUIPMENT

   Property and equipment consist of the following:

<TABLE>
<CAPTION>
                                                                                           NOVEMBER 30,  
                                                                                               1996      
                                                                                         -----------------
     <S>                                                                                 <C>             
     Leasehold improvements                                                                   $   449,116
     Telephone system equipment                                                                 7,425,582
     Vehicles                                                                                     246,611
     Office equipment                                                                             319,167
                                                                                              -----------
                                                                                                         
                                                                                                8,440,476
                                                                                                         
     Less accumulated depreciation and                                                                   
        amortization                                                                           (4,321,329)
                                                                                              -----------
                                                                                                         
                                                                                              $ 4,119,147
                                                                                              =========== 
</TABLE>

                                      78
<PAGE>
 
4. INTANGIBLE AND OTHER ASSETS

   Intangible and other assets consist of the following:


<TABLE>
<CAPTION>
                                                                                        NOVEMBER 30, 
                                                                                            1996     
                                                                                      ----------------
     <S>                                                                              <C>            
     Acquired facility contracts                                                          $ 1,562,906
     Noncompete agreement                                                                     250,000
     Goodwill                                                                                 455,704
     Other                                                                                     66,375
                                                                                          -----------
                                                                                                     
                                                                                            2,334,985
                                                                                                     
     Less accumulated amortization                                                         (1,748,329)
                                                                                          -----------
                                                                                                     
                                                                                          $   586,656
                                                                                          =========== 
</TABLE>

5. ACCRUED EXPENSES

   Accrued expenses consist of the following:

<TABLE>
<CAPTION>
                                                                                        NOVEMBER 30,  
                                                                                            1996      
                                                                                       ---------------
     <S>                                                                               <C>            
     Facility commissions                                                                   $1,317,000
     Uncollectible call chargebacks                                                            840,000
     Sales and excise taxes                                                                    702,838
     Payroll and benefits                                                                      145,295
     Other                                                                                     199,894
                                                                                            ----------
                                                                                                      
                                                                                            $3,205,027
                                                                                            ========== 
</TABLE>

   The accrual for uncollectible call chargebacks represents a reserve for
   amounts collected from the various LECs or third-party billing services
   that are expected to be charged back to the Company in future periods.

                                      79
<PAGE>
 
6. LONG-TERM DEBT

   All of the outstanding debt was repaid by the Company during 1996, there are
   no outstanding balances at November 30, 1996.

   The Company has a $750,000 line of credit arrangement with The Peoples Bank
   and Trust Company. The line had no outstanding balance at November 30, 1996.
   The line of credit bears interest at the prime rate, and is personally
   guaranteed by the majority stockholder.

7. INCOME TAXES

   The provision for income taxes for the eleven months ended November 30, 1996,
   are as follows:

<TABLE>
<CAPTION>
                                                                                                1996      
                                                                                           ---------------
     <S>                                                                                   <C>            
     Current taxes payable:                                                                               
        Federal                                                                                 $  901,000
        State                                                                                       72,000
        Deferred income taxes                                                                      250,989
                                                                                                ----------
                                                                                                          
                                                                                                $1,223,989
                                                                                                ========== 
</TABLE>

   The Company has provided income tax expense during the nine months ended
   September 30, 1996, using the effective tax rates for each of its taxing
   jurisdictions that have been allocated between current income taxes payable
   and deferred income taxes based on 1996 anticipated temporary differences.

   The provision for income taxes differs from statutory rates primarily as a
   result of state income taxes and permanent differences. The following is a
   reconciliation of income taxes reported in the consolidated statement of
   income:

<TABLE>
<CAPTION>
                                                                                               NOVEMBER 30, 
                                                                                                   1996     
                                                                                             ----------------
     <S>                                                                                     <C>            
     Tax at statutory rates                                                                       $1,148,387
     Effect of state income taxes                                                                     97,951
     Tax penalties and other                                                                         (22,349)
                                                                                                  ----------
                                                                                                            
                                                                                                  $1,223,989
                                                                                                  ========== 
</TABLE>

                                      80
<PAGE>
 
   The tax effects of temporary differences giving rise to deferred income tax
   asset and liabilities were:

<TABLE>
<CAPTION>
                                                                                               NOVEMBER 30, 
                                                                                                   1996     
                                                                                             ----------------
     <S>                                                                                     <C>            
     Deferred income tax assets:                                                                            
        Allowance for unbillable and uncollectible revenues                                        $  54,400
                                                                                                   ---------
                                                                                                      54,400
                                                                                                            
     Deferred income tax liabilities:                                                                       
        Depreciation and amortization                                                               (307,557)
        Other                                                                                         (1,048)
                                                                                                   ---------
                                                                                                            
                                                                                                    (308,605)
                                                                                                   ---------
                                                                                                            
     Net deferred income tax liability                                                             $(254,205)
                                                                                                   ========= 
</TABLE>

   This net deferred income tax liability is classified in the consolidated
   balance sheet as follows:

<TABLE>
<CAPTION>
                                                                                              NOVEMBER 30, 
                                                                                                  1996     
                                                                                            ----------------
     <S>                                                                                    <C>            
     Current asset                                                                                $  54,400
     Noncurrent liability                                                                          (308,605)
                                                                                                  ---------
                                                                                                           
                                                                                                  $(254,205)
                                                                                                  ========= 
</TABLE>

8. BENEFIT PLAN

   The Company sponsors a 401(k) savings plan for the benefit of eligible full-
   time employees that is a qualified benefit plan in accordance with the
   Employee Retirement Income Security Act ("ERISA"). The employees
   participating in the plan can generally make contributions to the plan of
   between 5% and 10% of their compensation. The plan provides for discretionary
   matching contributions by the Company of up to 50% of an eligible employee's
   contribution. Total plan expense was $32,820 for the eleven months ended
   November 30, 1996.

9. COMMITMENTS AND CONTINGENCIES

   The Company leases certain property and equipment used in its operations
   under operating lease agreements. Such leases, which are primarily for
   office furniture, office space and vehicles, have lease terms ranging from
   one to four years.

                                      81
<PAGE>
 
   Future minimum lease payments for years ending December 31 under
   noncancelable operating leases are summarized below:

<TABLE>
     <S>                                                                                         <C>           
     1996 (one month)                                                                            $ 10,848
     1997                                                                                          63,209
     1998                                                                                          30,187
     1999                                                                                             960
     2000                                                                                             720
                                                                                                 --------
                                                                                                         
                                                                                                 $105,924
                                                                                                 ======== 
</TABLE>

   Rent expense in connection with these leases totaled $107,158 for the eleven
   months ended November 30, 1996.

10. RELATED PARTY TRANSACTIONS

   The Company's majority and president has personally guaranteed three of the
   Company's operating leases, which have expiration dates ranging from March
   1997 to September 1998. Total payments under the guaranteed leases for the
   eleven months ended November 30, 1996, totaled $79,239.

   During 1996, the Company's stockholders incurred $154,894 of legal expenses,
   which were paid by the Company and are recorded as amounts due from
   stockholders in accounts receivable at November 30, 1996, pending
   reimbursement from such stockholders.

11. SUBSEQUENT SALE OF COMPANY

   On December 27, 1996, Talton Holdings, Inc. acquired all of the outstanding
   common stock of the Company in a purchase business combination effective
   December 1, 1996.


                                    ******

                                      82
<PAGE>
 
                                 EVERCOM, INC.
                                  SCHEDULE II
                CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
                     One Month Ended December 31, 1996 and
                    Years Ended December 31, 1997 and 1998
                                (In thousands)
<TABLE> 
<CAPTION> 
                                                                   Additions
                                                                   Charged to
                                                 Beginning         Costs and                          Ending
                  Description                     Balance           Expense         Deductions       Balance
     --------------------------------------- --------------------------------------------------------------------
<S>                                          <C>                   <C>              <C>              <C> 
1996
        Allowance for doubtful accounts                  1,195                653            (723)         1,125

1997
        Allowance for doubtful accounts                  1,125             17,257         (13,065)         5,317

1998
        Allowance for doubtful accounts                  5,317             35,670         (33,749)         7,238
</TABLE> 

                                      83
<PAGE>
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE

   None.

                                      84
<PAGE>
 
                                    PART III
                                    --------
                                        
ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

   The following table sets forth the names, ages, and positions of each of the
directors and officers of the Company as of December 31, 1998.

<TABLE>
<CAPTION>
                        Name                           Age                             Position
                        ----                         --------                          --------                                 
<S>                                                  <C>       <C>
Dennis L. Whipple..................................        55  Chief Executive Officer, Chairman, and Director
Donald B. Vaello...................................        52  Chief Operating Officer
Jeffrey D. Cushman.................................        37  Chief Financial Officer, Vice President, Secretary, and
                                                               Treasurer
Keith S. Kelson....................................        32  Vice President of Finance, Assistant Secretary, and
                                                               Assistant Treasurer
Todd W. Follmer (1)................................        39  Director
Gregg L. Engles....................................        41  Director
Richard H. Hochman (1)(3)..........................        53  Director
Jay R. Levine (2)(3)...............................        42  Director
Nina E. McLemore (2)...............................        53  Director
Bruce I. Raben (1).................................        45  Director
David A. Sachs (2).................................        39  Director
Roger K. Sallee (3)................................        50  Director
Julius E. Talton, Sr. (2)..........................        70  Director
Joseph P. Urso.....................................        44  Director
</TABLE>
_______________

(1)  Member of the Executive Committee.
(2)  Member of the Audit and Finance Committee
(3)  Member of the Compensation Committee

     Dennis L. Whipple.  Mr. Whipple became Chief Executive Officer, Vice
Chairman and a Director of the Company in September 1998. In November 1998, Mr.
Whipple became Chairman of the Company's Board of Directors. From June 1995
until March 1998, Mr. Whipple served as President of ALLTEL Communications, Inc.
Mr. Whipple served as Chief Executive Officer and President of Contel Cellular,
Inc. from 1991 through June 1995. Prior to joining Contel Cellular, Inc., Mr.
Whipple held various positions with GTE from 1971 through 1991, most recently as
Corporate Vice President of Marketing and Business Development.

     Donald B. Vaello.  Mr. Vaello became Chief Operating Officer of the Company
in June 1998.  From August 1994 until June 1998 Mr. Vaello served as Chairman
and Chief Operating Officer of North American Intelcom, a public communications
company that he formed in 1983 and sold in 1989 to Diamond Shamrock Refining and
Marketing, Inc.  After the sale to Diamond Shamrock Refining and Marketing,
Inc., Mr. Vaello served in various capacities with Diamond North American
Intelcom, most recently as President and Chief Operating Officer.

     Jeffrey D. Cushman.  Mr. Cushman became Chief Financial Officer of the
Company in November 1997. In addition, in  December 1997 Mr. Cushman was named
Vice President, Secretary, and Treasurer. From 1985 until October 1997, Mr.
Cushman served in various capacities with Electronic Data Systems Corporation
("EDS"), most recently as director of Business Development for EDS' Customer
Solutions Unit.

     Keith S. Kelson.  Mr. Kelson became Vice President of Finance of the
Company in April 1998 and became Assistant Secretary and Assistant Treasurer of
the Company in May 1998. From January 1995 until April 1998, Mr. Kelson served
in the accounting and auditing services division of Deloitte & Touche, LLP. From
May 1991 until January 1995, Mr. Kelson served as Accounting Manager for Viata
Corporation, a credit card processing company. Mr. Kelson is a certified public
accountant.

     Todd W. Follmer.  Mr. Follmer was elected to the Company's Board of
Directors in December 1996. Mr. Follmer served as the Chairman of the Company's
Board of Directors from June 1998 until November 1998, and as the Company's
Chief Executive Officer and President from June 1998 until September 1998. From
November 1997 until June 1998, Mr. Follmer served as Acting Chief Executive
Officer, and from December 1996 until June 1998, Mr. Follmer served as Vice
President, Assistant Secretary, and Assistant Treasurer. Mr. Follmer has been a
principal of EUFCC since January 1996. From January 1993 until December 1995,
Mr. Follmer

                                      85
<PAGE>
 
served as President of Gulf Capital Partners Inc., a merchant banking firm.

     Gregg L. Engles.  Mr. Engles was elected to the Company's Board of
Directors in December 1996. Mr. Engles has served as Chairman and has been a
principal of EUFCC since January 1996. Mr. Engles has served as Chairman of the
Board and Chief Executive Officer of Suiza Foods Corporation since October 1994.
Mr. Engles has also served in various senior management positions with certain
subsidiaries of Suiza Foods since 1988. In addition, Mr. Engles has served as
President of Kaminski Engles Capital Corporation ("KECC") since May 1988 and as
President of Engles Management Corporation ("EMC") since February 1993. KECC and
EMC are investment banking and consulting firms. Mr. Engles is a director of
Columbus Realty Trust.

     Richard H. Hochman.  Mr. Hochman was elected to the Company's Board of
Directors in December 1996.  Mr. Hochman has served as the Chairman of Regent
Capital Management Corp., a private investment firm, since January 1995.  From
1990 to December 1994, Mr. Hochman was a Managing Director of PaineWebber, Inc.,
an investment banking firm.  Mr. Hochman is a director of Cablevision Systems
Corporation and RABCO Enterprises.

     Jay R. Levine.  Mr. Levine was elected to the Company's Board of Directors
in December 1996. Since April 1997, Mr. Levine has served as a Managing Director
of CIBC Oppenheimer, an investment banking firm, and since May 1997 has managed
the CIBC Oppenheimer High Yield Merchant Banking Funds. From September 1996 to
May 1997, Mr. Levine served as President of PPMJ, Inc., a private consulting
firm. From 1990 until June 1996, Mr. Levine served as a senior executive in the
Morningside and Springfield Group, a private investment company. Mr. Levine is a
director of Aircraft Service International Group, Inc., Consolidated Advisers
Limited, L.L.C., Global Crossing, Ltd., and Heating Oil Partners, L.P.

     Nina E. McLemore.  Ms. McLemore was elected to the Company's Board of
Directors in December 1996.  Ms. McLemore has been the President of Regent
Capital Management Corp. since January 1995.  From 1990 until 1993, Ms. McLemore
served in various capacities with Liz Claiborne Accessories.

     Bruce I. Raben.  Mr. Raben was elected to the Company's Board of Directors
in December 1996. Since February 1996, Mr. Raben has served as a Managing
Director of CIBC Wood Gundy Securities Corp., an investment banking firm. From
March 1990 to February 1996, Mr. Raben served as a Managing Director of
Jefferies & Co., an investment banking firm. Mr. Raben is a director of GT
Parent Holdings, L.D.C., Terex Corporation, Optical Security, Inc., and Equity
Marketing, Inc.

     David A. Sachs.  Mr. Sachs was elected to the Company's Board of Directors
in December 1996. Since July 1994, Mr. Sachs has been a principal of Onyx
Partners, Inc., a merchant banking firm, and since October 1997 Mr. Sachs has
been a Managing Director of Ares Management, L.P., an investment management
firm. From October 1990 until June 1994, Mr. Sachs was employed at TMT-FW, Inc.,
an affiliate of Taylor & Co., a private investment management firm. Mr. Sachs is
a director of Terex Corporation.

     Roger K. Sallee.  Mr. Sallee was elected to the Company's Board of
Directors in December 1996. Mr. Sallee founded AmeriTel and served as its
President and Chief Executive Officer from July 1991 until December 1996.

     Joseph P. Urso.  Mr. Urso was elected to the Company's Board of Directors
in December 1996. Mr. Urso has served as President and has been a principal of
EUFCC since January 1996. Since March 1996, Mr. Urso has served as Chairman of
Interstate Engineering, a manufacturing firm located in California. Mr. Urso was
a shareholder of Stutzman & Bromberg, P.C. from January 1992 until June 1995.

     Julius E. Talton, Sr.  Mr. Talton was elected to the Company's Board in
December 1996.  From December 1996 until June 1998, Mr. Talton served as
Chairman of the Board and President of the Company.  Mr. Talton founded Talton
Telecommunications and served as its Chairman of the Board, President, and Chief
Executive Officer from 1973 until December 1996.  Mr. Talton served as President
of Talton Outdoor Advertising from 1976 until November 1996.  Mr. Talton is a
director of the People's Bank and Trust Company in Alabama.

     The Company's Certificate of Incorporation divides the Board of Directors
into two classes, the "Class A/B Directors" and the "Class B Directors," with
each class serving a one-year term. The size of the Board of Directors depends
on the aggregate percentage ownership of all outstanding Common Stock held by
Gregg L. Engles, Joseph P. Urso, Todd W. Follmer, 

                                      86
<PAGE>
 
and their respective affiliates (the "EUF Holders") and Onyx Talton Partners,
L.P. and Sachs Investment Partners and their respective affiliates (the "Onyx
Holders").

     The size of the Company's Board of Directors is currently eleven (11)
members, with the holders of Common Stock and Class B Common Stock entitled to
elect six Class A/B Directors and the holders of Class B Common Stock entitled
exclusively to elect five Class B Directors. The Class A/B Directors are Richard
H. Hochman, Jay R. Levine, Nina E. McLemore, Bruce I. Raben, Dennis L. Whipple,
and Julius E. Talton.  The Class B Directors are Gregg L. Engles, Todd W.
Follmer, David A. Sachs, Roger K. Sallee, and Joseph P. Urso.

     Each Class A/B Director is entitled, at all times, to one vote on any
matter voted on by the Board of Directors. The number of votes that each Class B
Director is entitled to on any matter voted on by the Board of Directors depends
on the aggregate percentage ownership of all outstanding Common Stock held by
the EUF Holders and the Onyx Holders. Each Class B Director is currently
entitled to a 0.6 director vote on any matter voted on by the Board of
Directors, resulting in the Class B Directors having an aggregate of three (3)
director votes as a class. As the EUF Holders' and the Onyx Holders' ownership
of the outstanding Common Stock decreases, the number of Class B Directors that
the EUF Holders have the right to designate, the aggregate number of votes held
by the remaining Class B Directors, and the size of the Company's Board of
Directors decrease (and the number of Class A/B Directors increases), all as set
forth in the Company's Certificate of Incorporation and the Shareholders
Agreement (as defined). Under the terms of the Certificate of Incorporation and
the Shareholders Agreement, the total number of votes on the Board of Directors
will remain at nine.

ITEM 11.  EXECUTIVE COMPENSATION

Summary Compensation Table

     The following table sets forth annual cash compensation paid or accrued by
the Company to the Company's Chief Executive Officer and its other Executive
Officers receiving total salary and bonus in excess of $100,000 for the fiscal
years ended December 31, 1998, 1997, and 1996.

<TABLE>
<CAPTION>
                                                                                    LONG-TERM
                                                  ANNUAL COMPENSATION              COMPENSATION
                                                                   OTHER ANNUAL       SHARES        ALL OTHER
                                                                   COMPENSATION     UNDERLYING    COMPENSATION
Name and Principal Position           YEAR  SALARY($)  BONUS($)       ($)(1)        OPTIONS (#)        ($)
---------------------------          
<S>                                   <C>   <C>        <C>       <C>               <C>            <C>
Dennis L. Whipple (2)                        
 Chief Executive Officer............  1998   95,577    75,000            0              500             0
                                      1997    ___       ___             ___             ___            ___
                                      1996    ___       ___             ___             ___            ___

Todd W. Follmer (3).................  1998      0         0              0               0              0
                                      1997      0         0              0               0              0
                                      1996      0         0              0               0              0 
                                                                                                          
Donald B. Vaello (4)                 
 Chief Operating Officer............  1998  106,153    80,000         18,749(5)         200             0
                                      1997    ___       ___             ___             ___            ___
                                      1996    ___       ___             ___             ___            ___
 
Jeffrey D. Cushman (6)
 Chief Financial Officer, Vice
 President, Secretary, and
 Treasurer..........................  1998  143,500    85,000            0              125             0
                                      1997   17,500    35,000            0               0              0
                                      1996    ___       ___             ___             ___            ___
</TABLE> 

                                      87
<PAGE>
 
<TABLE> 
<CAPTION> 
<S>                                   <C>   <C>        <C>       <C>               <C>            <C>
Keith S. Kelson (7)
 Vice President of Finance,                   
 Assistant Treasurer, and
 Assistant Secretary................  1998    68,205   40,000            0               50             0
                                      1997    ___       ___             ___             ___            ___
                                      1996    ___       ___             ___             ___            ___
</TABLE>
                                        
(1)  Unless otherwise indicated, the aggregate value of perquisites and other
     personal benefits does not exceed the lesser of $50,000 or 10% of the
     total annual salary and bonus report for the named executive officer.
(2)  Appointed effective September 7, 1998.
(3)  Mr. Follmer served as Chief Executive Officer of the Company from June 1998
     until September 1998.
(4)  Appointed effective June 26, 1998.
(5)  Consisted of payment of closing costs on sale of residence.
(6)  Appointed effective November 15, 1997.
(7)  Appointed effective April 27, 1998.

Option Grants

     During 1998, options to purchase an aggregate of 1,555 shares of Common
Stock at an exercise price of $2,000 per share were granted. The following table
provides information regarding stock options granted during 1998 to the Named
Executive Officers.


                           Option Grants During 1998

<TABLE>
<CAPTION>
                                                   Individual Grants

                                                     % of Total                            Potential Realizable
                                     Number of         Options                               Value at Assumed
                                     Securities      Granted to                           Annual Rates of Stock
                                 Underlying Options   Employees   Exercise                Price Appreciation for
                                     Granted (#)       During       Price    Expiration      Option Term (1)
<S>                              <C>                 <C>          <C>        <C>         <C>           <C>
Name                                                       1998   ($/Share)     Date               5%         10%
Dennis L. Whipple..............                500        32.15%    $2,000    9/10/2008      628,895   1,593,742              
Donald B. Vaello...............                200        12.86%    $2,000     1/1/2008      251,558     637,497                 
Todd W. Follmer................                  0           --         --           --           --          --
Jeffrey D. Cushman.............                125         8.04%    $2,000     1/1/2008      157,224     398,436                 
Keith S. Kelson................                 50         3.22%    $2,000     1/1/2008       62,889     159,374                
</TABLE>
_____________
(1)  The 5% and 10% assumed annual rates of compounded stock price appreciation
     are mandated by the rules of the Securities and Exchange Commission.  The
     actual value, if any, that an executive officer may realize will depend on
     the excess of the stock price over the exercise price on the date the
     option is exercised.  There is no assurance the value realized by an
     executive officer will be at or near the assumed 5% or 10% levels.

Aggregated Option Exercises in 1998 and Year-End Option Values

     During 1998, none of the Named Executive Officers exercised any options.

Employment Agreements and Other Arrangements

     Dennis L. Whipple joined the Company as Chief Executive Officer in
September 1998. The Company entered into a written employment agreement with Mr.
Whipple that has an initial term expiring on December 31, 2001, with successive
one-year renewals thereafter unless notice is given by either party not less
than 90 days immediately preceding the commencement of the renewal period. Mr.
Whipple receives an annual base salary of $300,000, and received a guaranteed
bonus of $75,000 for 1998. Mr. Whipple's target annual bonus is 100% of his base
salary and is earned upon the achievement of pre-determined performance
objectives. This bonus may actually be in excess of such amount, up to a maximum
of 200% of Mr. Whipple's base salary, in the event such objectives are exceeded.
Mr. Whipple is guaranteed a bonus in 1999 of at least $150,000. In addition, Mr.
Whipple received options to purchase 500 shares of Common Stock at a per share
price of $2,000. If Mr. Whipple is terminated by the Company without cause, the
employment agreement provides for a severance pay equal to the

                                      88
<PAGE>
 
cash compensation paid by the Company to Mr. Whipple in the year prior to the
year in which his employment is terminated or not extended. The employment
agreement contains non-competition provisions that cover the Company's existing
markets and expansion markets and that apply during the term of the agreement
and for a period of one year after the expiration or earlier termination of the
agreement.

     Donald B. Vaello joined the Company as Chief Operating Officer in June
1998.  The Company entered into a written employment agreement with Mr. Vaello
that has an initial term expiring on June 30, 2001, with successive one-year
renewals thereafter unless notice is given by either party not less than 90 days
immediately preceding the commencement of the renewal period.  Mr. Vaello
receives an annual base salary of $200,000, and a one-time guaranteed bonus of
$30,000, which was paid on or before December 31, 1998.  Mr. Vaello is also
eligible for an annual bonus generally equal to an additional amount up to 50%
of his base salary based upon achieving pre-determined performance objectives.
This bonus may be in excess of such amount in the event such objectives are
exceeded. In addition, Mr. Vaello received options to purchase 200 shares of
Common Stock at a price of $2,000 per share. The employment agreement provides
for a severance payment equal to one year's base salary if Mr. Vaello is
terminated by the Company without cause. The employment agreement also contains
non-competition provisions that cover the Company's existing markets and
expansion markets that apply during the term of the agreement and for a period
of one year after the expiration or earlier termination of the agreement.

     Jeffrey D. Cushman joined the Company as Chief Financial Officer in
November 1997. The Company entered into a written employment agreement with Mr.
Cushman that was amended in November 1998.  The agreement has an initial term
expiring on December 31, 1999, with successive one-year renewals thereafter
unless notice is given by either party not later than 90 days immediately
preceding the commencement of the renewal period.  Mr. Cushman receives an
annual base salary of $168,000 and a one-time guaranteed bonus of $85,000,
$35,000 of which was paid in June 1998, and the remaining $50,000 of which was
paid in February 1999. Mr. Cushman's target annual bonus is 50% of his base
salary and is earned upon the achievement of pre-determined performance
objectives. This bonus may actually be in excess of such amount, up to a maximum
of 100% of Mr. Cushman's base salary, in the event such objectives are exceeded.
In addition, Mr. Cushman received options to purchase 125 shares of Common
Stock at a price of $2,000 per share. If Mr. Cushman is terminated by the
Company without cause, the employment agreement provides for a severance payment
equal to the cash compensation paid by the Company to Mr. Cushman in the
calendar year prior to the calendar year in which his employment is terminated
or not extended. The employment agreement also contains non-competition
provisions that cover the Company's existing markets and expansion markets that
apply during the term of the agreement and for a period of one year after the
expiration or earlier termination of the agreement, provided that the one year
period shall be extended for an additional year in the event that Mr. Cushman,
rather than the Company, terminates the employment agreement.

     Keith S. Kelson joined the Company as Vice President of Finance in April
1998.  Mr. Kelson's offer letter specifies that Mr. Kelson receives a base
salary of $100,000 per year.  Mr. Kelson is eligible for an annual bonus
generally equal to an additional amount up to 40% of his base salary based upon
pre-determined performance objectives. This bonus may actually be in excess of
such amount in the event such objectives are exceeded. In addition, Mr. Kelson
received options to purchase 50 shares of Common Stock at an exercise price of
$2,000 per share. The offer letter provides for a severance payment equal to one
year's base salary if Mr. Kelson is terminated by the Company without cause.

Stock Option Plans

     The Company's 1998 Stock Option Plan (the "Stock Option Plan") has been
established to provide the officers and employees of the Company a strong
incentive to contribute to the success of the Company by granting them options
to acquire Common Stock.  The Stock Option Plan is administered by the
Compensation Committee for the Board of Directors.  The Compensation Committee
has the authority to determine the persons employed by the Company who are to be
granted options under the Stock Option Plan, the number of shares subject to
each option, the date of the grant of each option, the option exercise price,
whether the option granted is to be treated as an incentive stock option or a
non-statutory stock option, the vesting period, and such other determinations as
may be appropriate or necessary for the administration of the Stock Option Plan.

     Only employees of the Company may be granted options under the Stock Option
Plan.  The option exercise price of each option granted under the Stock Option
Plan may not be less than 100% of the fair market value of the Common Stock on
the date of grant.  In the event of a Change of Control (as defined in the Stock
Option Plan), options issued pursuant to the Stock Option Plan become
immediately exercisable for a period of 30 days following such event.  Any
options not exercised 

                                      89
<PAGE>
 
during the 30 day period are treated as if no Change in Control had occurred and
will be governed by the terms of their original grant.

     The Stock Option Plan may be abandoned or terminated by the Board of
Directors at any time.  Such abandonment or termination, however, will not alter
or impair any rights under any options granted prior to termination or
abandonment.  Unless previously terminated, the Stock Option Plan will expire on
January 1, 2008.

     The Company has reserved 2,000 shares of Common Stock for issuance pursuant
to the Stock Option Plan.  As of December 31, 1998, options to acquire 1,055
shares had been granted to the Company's employees.  The option exercise price
for each of these options is $2,000 per share.  These options generally provide
for a ratable vesting over a three to five year period commencing upon the
employee's initial employment with the Company.  The options generally expire,
if not previously exercised, upon the earlier of ten years following their date
of grant or three months following the option holder's termination of employment
with the Company.  If any options terminate or expire without having been
exercised, the shares not purchased under such options again are available for
issuance under the Stock Option Plan.

Limitation of Liability and Indemnification

     The Company's Certificate of Incorporation provides, consistent with the
provisions of the Delaware General Corporation Law ("DGCL"), that no director of
the Company will be personally liable to the Company or any of its stockholders
for monetary damages arising from the director's breach of fiduciary duty as a
director. This does not apply, however, with respect to any action for unlawful
payments of dividends, stock purchases, or redemptions, nor does it apply if the
director: (i) has breached his or her duty of loyalty to the Company and its
stockholders; (ii) does not act or, in failing to act, has not acted in good
faith; (iii) has acted in a manner involving intentional misconduct or a knowing
violation of law or, in failing to act, has acted in a manner involving
intentional misconduct or a knowing violation of law; or (iv) has derived an
improper personal benefit. The provisions of the Certificate of Incorporation
eliminating liability of directors for monetary damages do not affect the
standard of conduct to which directors must adhere, nor do such provisions
affect the availability of equitable relief. In addition, such limitations on
personal liability do not affect the availability of monetary damages under
claims based on federal law.

     The Company's bylaws provide for indemnification of its officers and
directors to the fullest extent permitted by the DGCL.

                                      90
<PAGE>
 
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The following table sets forth the beneficial ownership of the Company's
capital stock as of December 31, 1998 by (i) each stockholder known by the
Company to beneficially own more than 5% of any class of the Company's
outstanding capital stock; (ii) each director of the Company; (iii) each
executive officer named in the Summary Compensation Table; and (iv) all
executive officers and directors as a group.

<TABLE>
<CAPTION>
                                                                               SHARES BENEFICIALLY OWNED
                                                    --------------------------------------------------------------------------------

                                                   NUMBER OF             NUMBER OF                            NUMBER OF
                                                   SHARES OF             SHARES OF                 PERCENT    SHARES OF
                                                    CLASS A               CLASS B                 OF TOTAL     SENIOR
                                                    COMMON     PERCENT    COMMON    PERCENT OF     VOTING     REFERRED     PERCENT
NAME OF BENEFICIAL OWNER                             STOCK    OF CLASS     STOCK       CLASS      POWER(1)      STOCK    OF CLASS(2)

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

<S>                                                <C>        <C>        <C>        <C>          <C>          <C>        <C>
Dennis L. Whipple                                     --         --         --          --           --          --          --
Julius E. Talton(3)..............................    2,062.5     12.94%         --         -- %      11.8%      2,500.0      42.2%
Jeffrey D. Cushman...............................         --        --          --          --         --            --        --
Todd W. Follmer(4)...............................         --        --       100.0        25.0        2.3            --        --
Gregg L. Engles(4)...............................      150.0        *        100.0        25.0        3.1            --        --
Richard H. Hochman(5)............................    2,000.0      12.6          --          --       11.4            --        --
Jay R. Levine(6).................................    5,935.5        --          --          --         --            --        --
Nina E. McLemore(7)..............................    2,000.0      12.6          --          --       11.4            --        --
Bruce I. Raben(6)................................    5,935.5        --          --          --         --            --        --
David A. Sachs(8)................................      250.0       1.6        31.5         7.9        2.1            --        --
Roger K. Sallee..................................       22.0        *           --          --         *           61.7      1.04
Joseph P. Urso(4)................................         --        --       100.0        25.0        2.3            --        --
CIBC (9).........................................    5,935.5      37.2          --          --       33.8            --        --
Regent Capital Partners, L.P.(10)................    2,000.0      12.6          --          --       11.4            --        --
Onyx Talton Partners, L.P.(11)...................         --        --       100.0        25.0        2.3            --        --
Richard C. Green, Jr.............................      250.0       1.6          --          --        1.4         310.8      5.25
Robert K. Green..................................      250.0       1.6          --          --        1.4         310.8      5.25
William M. Ohland(12)............................      900.0       5.6          --          --        5.1            --        --
Donald B. Vaello.................................         --        --          --          --         --            --        --
Keith S. Kelson..................................         --        --          --          --         --            --        --
All executive officers and directors as a group     
 (14 persons)....................................    6,484.5      40.7       331.5        82.9      44.55       2,561.7     43.23
</TABLE>
________________
 
*    Less than 1.0%

(l)  In calculating the percent of total voting power, the voting power of
     shares of Common Stock (one vote per share) and Class B Common Stock (four
     votes per share) is aggregated. This calculation also assumes that no
     shares of Senior Preferred Stock are converted into shares of Common Stock.
(2)  Such percentages have been calculated in accordance with Section 13(d)(4)
     of the Securities Exchange Act of 1934, as amended.
(3)  The address for each of these stockholders is 720 Alabama Avenue, Selma,
     Alabama 36701.
(4)  The address for each of these stockholders is 3811 Turtle Creek Blvd.,
     Suite 1300, Dallas, Texas 75219
(5)  Includes 2,000 shares of Common Stock held by Regent Capital Partners. Mr.
     Hochman, who is the chairman of Regent Capital Management Corp., an
     affiliate of Regent Capital Partners, exercises voting and investment power
     with respect to such shares. Mr. Hochman's address is 505 Park Avenue, 17th
     Floor, New York, New York 10022.
(6)  Includes shares of Common Stock and warrants to acquire shares of Common
     Stock held by CIBC. Messrs. Levine and Raben are employees of an affiliate
     of CIBC. Such persons' address is 425 Lexington Ave., New York, New York
     10017. Messrs. Levine and Raben disclaim beneficial ownership of such
     shares.
(7)  Includes 2,000 shares of Common Stock held by Regent Capital Partners. Ms.
     McLemore, who is the president of Regent Capital Management Corp., an
     affiliate of Regent Capital Partners, exercises voting and investment power
     with respect to such shares. Ms. McLemore's address is 505 Park Avenue,
     17th Floor, New York, New York 10022.
(8)  Consists of 250 shares of Common Stock held by Sachs Investment Partners
     and 31.5 shares of Class B Common Stock held by Onyx Talton Partners, L.P.
     Mr. Sachs is a general partner of Sachs Investment Partners and a principal
     shareholder of Onyx Partners, Inc., the general partner of Onyx Talton
     Partners L.P. Mr. Sachs is a general partner of Sachs Partners, L.P. and
     exercises voting and investment power with respect to such shares. Mr.
     Sachs disclaims beneficial ownership of an additional 68.5 shares of Class
     B Common Stock held by Onyx Talton Partners, L.P. Mr. Sachs is a general
     partner of Sachs Investment Partners, L.P., and exercises voting and
     investment power with respect to such shares. Mr. Sachs disclaims
     beneficial ownership of an additional 68.5 shares of Class B Common Stock
     held by Onyx Talton Partners, L.P. Mr. Sachs address is 1999 Avenue of the
     Stars, Suite 1900, Los Angeles, California 90067.

                                      91
<PAGE>
 
(9)  Includes 1,085.5 shares of Common Stock subject to a warrant that is
     exercisable within 60 days. CIBC's address is 161 Bay Street, P.P. Box 500,
     M51258, Toronto, Canada. Jay R. Bloom, Andrew R. Heyes, and Dean C. Kehler,
     employees of an affiliate of CIBC, have the power to vote and dispose of
     the listed securities.
(10) Includes 500 shares of Common Stock held by Regent Capital Equity Partners,
     L.P., an affiliate of Regent Capital Partners. Regent Capital Partners'
     address is 505 Park Avenue, 17th Floor, New York, New York 10022.
(11) Onyx Talton Partners, L.P.'s address is 9595 Wilshire Blvd., Suite 700,
     Beverly Hills, California 90212.
(12) Consists of shares issued to STC as part of the purchase price in the STC
     Acquisition. Mr. Ohland owns all of the outstanding capital stock of STC.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Certain Relationships and Related Transactions

  Consulting and Strategic Services Agreement

     In connection with the acquisitions of AmeriTel and Talton
Telecommunications, the Company entered into a Consulting and Strategic Services
Agreement with EUF Talton, a limited partnership controlled by Messrs. Engles,
Urso, and Follmer, pursuant to which the Company will pay to EUF Talton an
annual consulting fee of $300,000 for an initial term of three years ending
December 27, 1999. Pursuant to this agreement, EUF Talton will provide
management consulting services relating to strategic and financial matters,
including acquisitions, business strategies, and financial planning.  In
addition, the Company has agreed to pay to EUF Talton an acquisition fee of 1%
of the gross acquisition price of any acquisitions of assets or stock by the
Company, up to an aggregate maximum of $1.25 million.

  Consulting and Employment Agreements

     In connection with the acquisitions of AmeriTel and Talton
Telecommunications, the Company entered into the agreements described below.
Each of the named persons was a former stockholder of AmeriTel or Talton
Telecommunications.

     The consulting agreement of Julius E. Talton (the "Talton Consulting
Agreement") provided that Mr. Talton would serve as a director of the Company
and perform such duties related to the business conducted by the Company as the
Board of Directors designated from time to time. The Talton Consulting Agreement
had an initial term of two years, with successive one-year renewal periods
thereafter unless earlier terminated by the Company or Mr. Talton.  In addition
to an aggregate of $10,000 payable in equal monthly installments to Mr. Talton
over the first twelve months of the agreement, the agreement provided that Mr.
Talton would receive payments of $86,000 and $96,000 for the first and second
years of the initial term, respectively, and $120,000 for each year thereafter
that the agreement remained in effect.  The Talton Consulting Agreement
contained a non-competition provision that applied during the term of the
agreement and applies for a period of two years after the expiration or earlier
termination of the agreement.  Mr. Talton ceased working for the Company
effective as of June 30, 1998 and the Talton Consulting Agreement was terminated
as of that date.  All fees due under the Talton Consulting Agreement were paid
on a prorated basis through June 30, 1998.  See "--Talton Agreement."

     Julius E. Talton, Jr.'s employment agreement (the "Talton Employment
Agreement") provided that Mr. Talton, Jr. would serve as an executive of the
Company, performing such duties and holding such positions as the Board of
Directors or senior management of the Company directed.  The Talton Employment
Agreement had an initial term of one year, with successive one-year renewal
periods thereafter unless earlier terminated by the Company or Mr. Talton, Jr.
In addition to an aggregate of $25,000 payable in equal monthly installments to
Mr. Talton, Jr. over the first twelve months of the agreement, the agreement
provided that Mr. Talton, Jr. would receive an annual base salary of $100,000, a
guaranteed bonus of $25,000 which was paid, in accordance with the agreement,
upon closing of the Notes Placement, and an incentive cash bonus of up to 37.5%
of base salary if certain performance goals established by the Board of
Directors were achieved.  The Talton Employment Agreement contained a non-
competition provision that will apply until June 2000.  Mr. Talton, Jr. also
received an option to purchase up to 247.5 shares of Common Stock at an exercise
price of $2,000 per share. Mr. Talton, Jr. ceased working for the Company
effective as of June 30, 1998 and the Talton Employment Agreement was terminated
as of that date.  All fees due under the Talton Employment Agreement were paid
on a prorated basis through June 30, 1998.  See "--Talton Agreement."

     The consulting agreement of James E. Lumpkin (the "Lumpkin Consulting
Agreement") provided that Mr. Lumpkin would serve, if requested, as a director
of the Company and would perform such duties related to the business conducted
by the Company as the chief executive officer or the Board of Directors
designated from time to time. The Lumpkin Consulting Agreement has an initial
term of two years, with successive one-year renewal periods thereafter unless
earlier terminated by the 

                                      92
<PAGE>
 
Company or Mr. Lumpkin. In addition to an aggregate of $10,000 payable in equal
monthly installments to Mr. Lumpkin over the first twelve months of the
agreement, the agreement provided that Mr. Lumpkin would receive $62,000 and
$72,000 for the first and second years of the initial term, respectively. Mr.
Lumpkin's consulting agreement contained a non-competition provision that will
apply until June 2000. Mr. Lumpkin ceased working for the Company effective as
of June 30, 1998 and the Lumpkin Consulting Agreement was terminated as of that
date. All fees due under such the Lumpkin Consulting Agreement were paid on a
prorated basis through June 30, 1998. See "--Talton Agreement."

     The consulting agreement of Roger K. Sallee provides that Mr. Sallee will
serve as a director of the Company and will perform such duties related to the
business conducted by the Company as the chief executive officer or the Board of
Directors may designate from time to time. The consulting agreement had an
initial term of one year, with successive one-year renewal periods thereafter
unless earlier terminated by the Company or Mr. Sallee. In addition to a lump
sum payment of $5,000 paid on the effective date of the agreement, Mr. Sallee
will receive an annual consulting fee of $30,000 for each year that the
agreement remains in effect. Mr. Sallee's consulting agreement contains non-
competition provisions covering the Company's existing markets and expansion
markets that apply during the term of the agreement and for a period of three
years and two years, respectively, after the expiration or earlier termination
of the agreement.

  Talton Agreement

     On July 1, 1998, the Company entered into an agreement with Julius E.
Talton, Julius E. Talton, Jr. and James Lumpkin (the "Talton Agreement"). The
Talton Agreement provided that each of the Talton Consulting Agreement, the
Talton Employment Agreement, and the Lumpkin Consulting Agreement was terminated
effective as of June 30, 1998. In accordance with the terms of the Talton
Agreement, Mr. Talton, Mr. Talton, Jr., and Mr. Lumpkin will provide consulting
services to the Company in relation to the Company's contract with a major RBOC.
The Talton Agreement has a term of one year, ending on June 30, 1999. Under the
terms of the Talton Agreement, Mr. Talton, Mr. Talton, Jr., and Mr. Lumpkin will
be paid 10% of the Profits (as defined in the Talton Agreement) between July 1,
1998 and December 31, 1998 and 5% of the Profits between January 1, 1999 and
June 30, 1999 from the Company's contract with a major RBOC.

  Lease Agreement

     In December 1996, Talton Telecommunications entered in a lease agreement
(the "Talton Lease") with Mr. Talton for office space located in Selma, Alabama.
The Talton Lease has a five-year term commencing January 1, 1997, with an option
to renew for an additional five-year term. Under the Talton Lease, Talton
Telecommunications will pay fixed annual rent of approximately $109,000,
$112,000, $90,000, $93,000, and $96,000, respectively, for the five years of the
initial term.

                                      93
<PAGE>
 
                                    PART IV
                                    -------
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

     (a)  (1) and (2)  The response to this portion of Item 14 is submitted as a
                       separate section of this report commencing on page 27.

     (a)  (3)          Exhibits.

<TABLE>
<CAPTION>
   Exhibit
     No.                                                    Description of Exhibit
     ---                                                    ----------------------
<S>             <C>
     2.1        Asset Purchase Agreement, dated as of August 21, 1997, among the Company, InVision Telecom, Inc., and
                Communications Central, Inc. (filed as Exhibit 2.1 to the Company's Registration Statement No. 333-33639 and
                incorporated herein by reference).
 
     2.2        Contribution Agreement, dated as of December 20, 1996, among the Company, Richard C. Green, Jr., Robert K.
                Green, T.R. Thompson, Roger K. Sallee, and certain other stockholders, and AmeriTel Pay Phones, Inc. (filed as
                Exhibit 2.2 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     2.3        Contribution Agreement, dated as of December 20, 1996, among the Company, Julius E. Talton, Julius E. Talton,
                Jr., and James E. Lumpkin (filed as Exhibit 2.3 to the Company's Registration Statement No. 333-33639 and
                incorporated herein by reference).
 
     2.4        Stock Acquisition Agreement, dated as of December 20, 1996, among the Company, Richard C. Green, Jr., Robert
                K. Green, T. R. Thompson, Roger K. Sallee, and certain other stockholders, and AmeriTel Pay Phones, Inc.
                (filed as Exhibit 2.4 to the Company's Registration Statement No. 333-33639 and incorporated herein by
                reference).
 
     2.5        Stock Acquisition Agreement, dated as of December 20, 1996, among the Company, Julius E. Talton, Julius E.
                Talton, Jr., James E. Lumpkin, Carrie T. Glover, Talton Telecommunications Corporation, and Talton
                Telecommunications of Carolina, Inc. (filed as Exhibit 2.5 to the Company's Registration Statement No.
                333-33639 and incorporated herein by reference).
 
     3.1        Certificate of Incorporation of the Company (filed as Exhibit 3.1 to the Company's Registration Statement No.
                333-33639 and incorporated herein by reference).
 
     3.2        Bylaws of the Company (filed as Exhibit 3.2 to the Company's Registration Statement No. 333-33639 and
                incorporated herein by reference).
 
     3.3        Certificate of Amendment to Restated Certificate of Incorporation of the Company, dated as of July 23, 1998
                (filed as Exhibit 3.3 to the Company's Quarterly Report on Form 10-Q, dated as of August 14, 1998, and
                incorporated herein by reference).
 
     4.1        Indenture, dated as of June 27, 1997, between the Company and U.S. Trust Company of Texas, N.A. (filed as
                Exhibit 4.1 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     4.2        Form of Note (contained in Indenture filed as Exhibit 4.2 to the Company's Registration Statement No.
                333-33639 and incorporated herein by reference).
 
     4.3        Form of Subsidiary Guaranty (contained in Indenture filed as Exhibit 4.3 to the Company's Registration
                Statement No. 333-33639 and incorporated herein by reference).
 
     4.4        Registration Rights Agreement, dated as of June 27, 1997, between the Company and the Initial Purchaser (filed
                as Exhibit 4.4 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     4.5        Registration Rights Agreement, dated as of December 27, 1996, by and among the Company and certain Holders
                named therein (filed as Exhibit 4.5 to the Company's Registration Statement No. 333-33639 and incorporated
                herein by reference).
</TABLE> 

                                      94
<PAGE>
 
<TABLE> 
<CAPTION> 
<S>             <C> 
     4.6        Shareholders Agreement, dated as of December 27, 1996, by and among the Company and certain Persons named
                therein (filed as Exhibit 4.6 to the Company's Registration Statement No. 333-33639 and incorporated herein by
                reference).
 
     4.7        Warrant Agreement, dated as of December 27, 1996, between the Company and CIBC Wood Gundy Ventures, Inc.
                (filed as Exhibit 4.7 to the Company's Registration Statement No. 333-33639 and incorporated herein by
                reference).
 
     4.8        Warrant Agreement, dated as of December 27, 1996, between the Company and Gregg L. Engles (filed as Exhibit
                4.8 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     4.9        Warrant Agreement, dated as of December 27, 1996, between the Company and Gregg L. Engles (filed as Exhibit
                4.9 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     4.10       Warrant Agreement, dated as of December 27, 1996, between the Company and Gregg L. Engles (filed as Exhibit
                4.10 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     4.11       Warrant Agreement, dated as of December 27, 1996, between the Company and Onyx Talton Partners, L.P. (filed as
                Exhibit 4.11 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     4.12       Warrant Agreement, dated as of December 27, 1996, between the Company and Onyx Talton Partners, L.P. (filed as
                Exhibit 4.12 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     4.13       Warrant Agreement, dated as of December 27, 1996, between the Company and Onyx Talton Partners, L.P. (filed as
                Exhibit 4.13 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     4.14       Warrant Agreement, dated as of December 27, 1996, between the Company and Joseph P. Urso (filed as Exhibit
                4.14 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
 
     4.15       Warrant Agreement, dated as of December 27, 1996, between the Company and Joseph P. Urso (filed as Exhibit
                4.15 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     4.16       Warrant Agreement, dated as of December 27, 1996, between the Company and Joseph P. Urso (filed as Exhibit
                4.16 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     4.17       Warrant Agreement, dated as of December 27, 1996, between the Company and Todd W. Follmer (filed as Exhibit
                4.17 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     4.18       Warrant Agreement, dated as of December 27, 1996, between the Company and Todd W. Follmer (filed as Exhibit
                4.18 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     4.19       Warrant Agreement, dated as of December 27, 1996, between the Company and Todd W. Follmer (filed as Exhibit
                4.19 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     10.1       Purchase Agreement dated as of June 27, 1997, between the Company and CIBC Wood Gundy Securities Corp. (filed
                as Exhibit 10.1 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     10.2       Amended and Restated Credit Agreement, dated as of July 30, 1997, among the Company, Canadian Imperial Bank of
                Commerce, CIBC Inc., and First Source Financial LLP (filed as Exhibit 10.2 to the Company's Registration
                Statement No. 333-33639 and incorporated herein by reference).
 
     10.3       Asset Purchase Agreement, dated as of May 9, 1997, among the Company, Security Telecom Corporation, and
</TABLE> 

                                      95
<PAGE>
 
<TABLE> 
<CAPTION> 
<S>             <C> 

                William H. Ohland (filed as Exhibit 10.3 to the Company's Registration Statement No. 333-33639 and
                incorporated herein by reference).
 
     10.4       First Amendment to Asset Purchase Agreement, dated as of June 21, 1997, among the Company, Security Telecom
                Corporation, and William H. Ohland (filed as Exhibit 10.4 to the Company's Registration Statement No.
                333-33639 and incorporated herein by reference).
 
     10.5       Consulting Agreement, dated as of December 27, 1966, between the Company and James E. Lumpkin (filed as
                Exhibit 10.6 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     10.6       Consulting Agreement, dated as of December 27, 1996, between the Company and Julius E. Talton (filed as
                Exhibit 10.7 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     10.7       Consulting and Strategic Services Agreement, dated as of December 27, 1996, between the Company and EUF
                Talton, L.P. (filed as Exhibit 10.8 to the Company's Registration Statement No. 333-33639 and incorporated
                herein by reference).
 
     10.8       Employment Agreement, dated as of December 27, 1996, between the Company and Julius E. Talton, Jr. (filed as
                Exhibit 10.9 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
     10.9       Employment Agreement, dated as of November 17, 1997, between the Company and Jeffrey D. Cushman (filed as
                Exhibit 10.12 to the Company's Registration Statement No. 333-33639 and incorporated herein by reference).
 
    10.10*      Employment Agreement, dated as of June 26, 1998, between the Company and Donald B. Vaello.
 
    10.11       Letter Agreement, dated as of April 17, 1998, between the Company and Keith S. Kelson (filed as Exhibit 10.1
                to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998 and incorporated
                herein by reference).
 
    10.12*      Employment Agreement, dated as of September 7, 1998, between the Company and Dennis L. Whipple.
 
    10.13*      First Amendment to Employment Agreement, dated as of October 21, 1998, between the Company and Jeffrey D.
                Cushman.
 
    10.14       Talton Agreement, dated as of July 1, 1998, among the Company, Talton Network Services, Inc., Julius E. Talton
                Sr., Julius E. Talton Jr., and James E. Lumpkin (filed as Exhibit 10.2 to the Company's Quarterly Report on
                Form 10-Q/A for the quarter ended September 30, 1998 and incorporated herein by reference).
 
    10.15*      Agreement, dated as of April 15, 1998, between the Company (doing business as Correctional Billing Services)
                and [Confidential information set forth here has been filed separately with the Securities and Exchange
                Commission under Rule 24b-2 under the Securities Exchange Act of 1934].
 
    12.1*       Computation of Ratio of Earnings to Fixed Charges.

    21.1*       Subsidiaries of the Company.
 
    27.1*       Financial Data Schedule
</TABLE>

                                      96
<PAGE>
 
__________________
*         Filed herewith.
 
     (b)  Reports on Form 8-K.

          (1)  On December 7, 1998, the Company filed a Form 8-K (pursuant to
               Item 5 of Form 8-K) regarding the Company's Board of Directors
               naming Dennis L. Whipple as Chief Executive Officer, Director,
               and Chairman of the Board.

     (c)  Exhibits -- The response to this portion of Item 14 is submitted as
          separate section of this report commencing on page 94.

     (d)  Financial Statement Schedules -- The response to this portion of Item
          14 is submitted as a separate section of this report on page 83.

     The agreements set forth above described the contents of certain exhibits
     thereunto that are not included.  Such exhibits will be furnished to the
     Commission upon request.

                                      97
<PAGE>
 
                                  SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                   EVERCOM, INC.


                                   By:  /s/  Dennis L. Whipple
                                        ----------------------
                                        Dennis L. Whipple
                                        Chief Executive Officer,
                                        Chairman, and Director

Date: March 26, 1999

   Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities indicated.

<TABLE>
<CAPTION>
                       Signature                                               Title                         Date
                       ---------                                               -----                         ----             
<S>                                                               <C>                                      <C> 
                /s/ Dennis L. Whipple                             Chief Executive Officer, Chairman,    March 26, 1999 
---------------------------------------------------------------    and Director 
                    Dennis L. Whipple
 
                                                                               
                /s/ Richard H. Hochman                                         Director                 March 26, 1999
---------------------------------------------------------------
                    Richard H. Hochman
 
                                                                               Director                 
---------------------------------------------------------------                
                     Nina E. McLemore

 
                /s/ Julius E. Talton, Sr.                                      Director                 March 26, 1999
---------------------------------------------------------------
                    Julius E. Talton, Sr.
 

                /s/ David A. Sachs                                             Director                 March 26, 1999
---------------------------------------------------------------                
                    David A. Sachs


                /s/  Todd W. Follmer                                           Director                 March 26, 1999
---------------------------------------------------------------
                     Todd W. Follmer
 

                /s/  Bruce I. Raben                                            Director                 March 26, 1999
---------------------------------------------------------------
                     Bruce I. Raben
 

                /s/  Roger K. Sallee                                           Director                 March 26, 1999
---------------------------------------------------------------
                     Roger K. Sallee
 

                /s/  Joseph P. Urso                                            Director                 March 26, 1999
---------------------------------------------------------------
                     Joseph P. Urso
 
                 /s/ Jay R. Levine                                             Director                 March 26, 1999
---------------------------------------------------------------
                     Jay R. Levine
 

                /s/  Gregg L. Engles                                           Director                 March 26, 1999
---------------------------------------------------------------
                     Gregg L. Engles

 
                /s/  Jeffrey D. Cushman                           Chief Financial Officer, Vice         March 26, 1999
---------------------------------------------------------------    President, Secretary and Treasurer
                     Jeffrey D. Cushman
</TABLE>

                                      98