UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                  FORM 10-KSB

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

                  For the fiscal year ended December 31, 1997

                         Commission file number 0-15938


                        FARMSTEAD TELEPHONE GROUP, INC.
                 (Name of small business issuer in its charter)


                Delaware                              06-1205743
    (State or other jurisdiction of      (IRS Employer Identification No.)
     incorporation or organization)


22 Prestige Park Circle, East Hartford, CT            06108-3728
 (Address of principal executive offices)             (Zip Code)


                   Issuer's telephone number: (860) 610-6000

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

         Title of each class           Name of Exchange on which registered
    -----------------------------      ------------------------------------

    Common Stock, $.001 par value             American Stock Exchange

Securities registered under Section 12(g) of the Exchange Act:   None

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

Check if there is no disclosure of delinquent filers in response to Item 
405 of Regulation S-B contained in this form, and no disclosure will be 
contained, to the best of registrant's knowledge, in definitive proxy or 
information statements incorporated by reference in Part III of this Form 
10-KSB or any amendment to this Form 10-KSB.    [ ]

State issuer's revenues for its most recent fiscal year:   $20,559,000

As of February 27, 1998, the aggregate market value of the Common Stock of 
the registrant held by non-affiliates, based upon the last sale price of 
the registrant's Common Stock on such date, was approximately $9,676,000.

As of February 27, 1998, the registrant had 3,262,329 shares of its $0.001 
par value Common Stock outstanding.

                     DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the Registrant's definitive proxy statement for the 
Annual Meeting of Stockholders to be held on June 18, 1998 are 
incorporated by reference in Items 9 through 13 of Part III of this Annual 
Report on Form 10-KSB.

Transitional Small Business Disclosure Format:   Yes  [ ]    No  [X]

<PAGE> 1

                      TABLE OF CONTENTS TO FORM 10-KSB

                                   PART I
<TABLE>
<CAPTION>
                                                                            Page
                                                                            ----
<S>        <C>                                                               <C>
Item 1.    Business                                                           3
Item 2.    Property                                                           7
Item 3.    Legal Proceedings                                                  7
Item 4.    Submission of Matters to a Vote of Security Holders                7

                                   PART II

Item 5.    Market for Common Equity and Related Stockholder Matters           7
Item 6.    Management's Discussion and Analysis of Financial Condition 
           and Results of Operations                                          8
Item 7.    Financial Statements                                              12
Item 8.    Changes in and Disagreements With Accountants on Accounting
           and Financial Disclosures                                         12

                                  PART III

Item 9.    Directors, Executive Officers, Promoters and Control Persons; 
           Compliance with Section 16(a) of the Exchange Act                 12
Item 10.   Executive Compensation                                            13
Item 11.   Security Ownership of Certain Beneficial Owners and Management    13
Item 12.   Certain Relationships and Related Transactions                    14
Item 13.   Exhibits and Reports on Form 8-K                                  14
          
SIGNATURES                                                                   15
INDEX TO EXHIBITS                                                            30
</TABLE>

<PAGE> 2

                         FORWARD-LOOKING STATEMENTS

      The Company's prospects are subject to certain uncertainties and 
risks. The discussions set forth below and elsewhere herein contain 
certain statements which are not historical facts and are considered 
forward-looking statements within the meaning of the Federal Securities 
laws. The Company's actual results could differ materially from those 
projected in the forward-looking statements as a result of, among other 
factors, general economic conditions and growth in the telecommunications 
industry, competitive factors and pricing pressures, changes in product 
mix, product demand, risk of dependence on third party suppliers, and 
other risk factors detailed in this report, described from time to time in 
the Company's other Securities and Exchange Commission filings, or 
discussed in the Company's press releases. In addition, other written or 
oral statements which constitute forward-looking statements may be made by 
or on behalf of the Company. All forward-looking statements included in 
this document are based upon information available to the Company on the 
date hereof. The Company undertakes no obligation to update publicly any 
forward-looking statements, whether as a result of new information, future 
events or otherwise.

                                   PART I

Item 1.  Business

General

      Farmstead Telephone Group, Inc. (the "Company") was incorporated in 
Delaware in 1986 and became a publicly held company in May 1987. The 
Company is located at 22 Prestige Park Circle, East Hartford, CT 06108, 
and its telephone number is (860) 610-6000. The Company is presently 
engaged in the Customer Premise Equipment ("CPE") segment of the 
telecommunications industry, principally as a secondary market reseller of 
used, remanufactured and/or refurbished Lucent Technologies, Inc. 
("Lucent") business telephone parts and systems, and as an authorized 
Lucent dealer and distributor of certain new telecommunications products. 
The Company also provides equipment repair and refurbishing, inventory 
management, and other related value-added services. The Company sells its 
products and services to both large and small end-user businesses, 
government agencies, and to other dealers and distributors. CPE refers to 
equipment which resides at the customer's premises.

      In January, 1994, the Company acquired certain operating assets of 
Cobotyx Corporation, Inc. ("CCI"), a designer, manufacturer and supplier 
of voice processing systems, and expanded its entry into this marketplace 
through the formation of a voice processing products division ("Cobotyx 
Division"). In December 1997, the Company began actively pursuing 
divesting itself of its Cobotyx voice processing products business. Assets 
expected to be sold during 1998 include inventories, fixed assets, all 
related technologies developed by the Company, tradenames, and other 
contract rights. The operations of the Cobotyx business unit through its 
disposal date are not expected to have a material negative impact on the 
Company's future operating results. For the years ended December 31, 1997 
and 1996, voice processing product revenues approximated $1,479,000 and 
$2,297,000, respectively.

      In February, 1996, the Company purchased from AT&T Systems Leasing 
Corporation, a subsidiary of AT&T Capital Corporation, certain assets of 
its discontinued Asset Recovery Center ("ARC"). The assets acquired 
consisted primarily of warehouse equipment, vehicles, computer and office 
equipment, and inventory. Prior to its closing in January 1996, the ARC 
primarily operated to service AT&T affiliates in the orderly disposition, 
by way of consignment sales arrangements, of excess, overstocked and end-
of-life telecommunications, computer and data transmission equipment. The 
Company concurrently formed a subsidiary corporation, Farmstead Asset 
Management Services, LLC ("FAMS"), and commenced a similar operation in 
Piscataway, New Jersey. Effective October 1, 1997, the Company sold all of 
its ownership interests in FAMS. For the years ended December 31, 1997 and 
1996, FAMS recorded revenues of $799,000 (through the date of sale) and 
$1,230,000, respectively.

<PAGE> 3

Products

      The Company sells used, remanufactured, refurbished and new 
telephone parts and systems manufactured by Lucent (See "Relationship with 
AT&T/Lucent Technologies" for further information on Lucent). These 
products are private switching systems, generally PBXs and key systems, 
located at the customers premises, that permit a number of local 
telephones or terminals to communicate with one another, with or without 
use of the public telephone network. Key systems are generally used by 
small businesses, and are characterized by telephones which have multiple 
buttons permitting the user to select outgoing or incoming telephone lines 
directly. PBXs are private telephone switching systems usually located on 
a customer's premises, with an attendant console, and are designed for use 
by larger businesses. A PBX normally has more memory capacity and 
therefore can provide more features and flexibility than a key system. The 
Company sells both telephone system parts and complete systems, however 
the Company's revenues are predominantly from the sale of parts. Parts 
sold primarily include both digital and analog telephone sets and circuit 
packs, and other system accessories such as headsets, consoles, 
speakerphones and paging systems.

      Lucent key systems sold by the Company, in both piece parts and 
complete systems, include: Merlin(R) and Merlin Legend(R), Spirit(R) and 
Partner(R). Lucent PBX equipment sold by the Company, primarily in parts, 
include: System 25, System 75, System 85, and Definity(R).

      Telephone equipment sales revenues accounted for approximately 93% 
of consolidated revenues from continuing operations in both 1997 and 1996, 
while service revenues comprised 7% of consolidated revenues from 
continuing operations in both years. Sales of PBX equipment and associated 
telephones and accessories comprised approximately 81% of telephone 
equipment sales in 1997 (88% in 1996), while key equipment parts and 
system sales comprised approximately 15% of telephone equipment sales in 
1997 (12% in 1996).

Relationship with AT&T/Lucent Technologies

      Prior to February 1, 1996, the business of Lucent was conducted as a 
part of the operations of AT&T Corp. ("AT&T"). On February 1, 1996, as a 
result of a decision to restructure the company, AT&T began the process of 
separating Lucent into a stand-alone company. AT&T completed an IPO of 
Lucent shares in April 1996 and the divestiture of Lucent was completed in 
October 1996 through the distribution of AT&T's shares in Lucent to AT&T 
shareholders. Lucent is comprised of the systems and technology units that 
were formerly part of AT&T. With 1997 revenues of $26.3 billion, Lucent is 
one of the world's leading designers, developers and manufacturers of 
telecommunications systems, software and products. Throughout this report, 
references to AT&T and Lucent will be referred to collectively as "Lucent 
Technologies", or "Lucent".

      Since 1985, Lucent has provided support to the secondary market by 
continuing to offer installation, maintenance, repair, reconditioning and 
certification services for its products purchased by end-users through 
equipment resellers. Equipment resellers such as the Company may also, 
with various restrictions, utilize Lucent documentation, technical 
information and software. Lucent also generally provides up to a one year 
warranty for products purchased from Lucent for resale. The installation 
and maintenance of Lucent equipment is generally provided by Lucent. The 
Company does, however, coordinate the installation scheduling directly with 
Lucent if requested to do so by its customer. The Company also has agreements 
with a number of installation and maintenance companies covering the New 
England and New York geographic areas who can also provide such services.

      The Company currently has dealer and distributor agreements in 
effect with Lucent, which have original terms ranging up to two years, and 
expire at various dates between July 1998 and January 1999, although they 
can generally be canceled upon 90 days notice. These agreements allow the 
Company to sell new key system products and certain PBX products in New 
England and New York state. In February 1998, the Company was selected by 
Lucent to be one of only two Authorized Remarketing Suppliers in a six 
month national trial program that allows 

<PAGE> 4

the Company, under a licensing agreement, to refurbish and resell used Lucent
business communications equipment. Under the terms of the trial agreement, 
the Company is authorized to buy back used Lucent business communications 
equipment from Lucent and from other sources, refurbish it to Lucent 
standards, and resell it nationally to end users as "certified" equipment for 
installation and full warranty by Lucent. The trial program expires August 
18, 1998. Based upon the outcome of this program, the Company may be 
afforded the opportunity to enter into a longer term agreement, however no 
assurances can be given that this program will be successful or that the 
Company will enter into an extended contract. Prior to entering into this 
trial program the Company was an "Authorized Distributor of Selected 
Lucent--Remanufactured Products" since 1991.

      The Company believes that its relationship with Lucent is 
satisfactory and has no indication that Lucent has any intention of 
canceling any of the existing agreements. The Company's business has not 
been adversely impacted by the divestiture of Lucent from AT&T, nor does 
the Company expect it to be. The Company could, however, be materially 
adversely affected should Lucent decide to no longer provide installation 
and maintenance services on used, remanufactured or refurbished products 
sold by resellers such as the Company, or should it cancel the Company's 
dealer and distributor agreements.

Marketing and Customers

      Telephone parts, systems and services are marketed through the 
Company's direct sales staff, and through a network of associate dealers, 
to over 1,700 business locations, with customers ranging from large, 
multi-location corporations, to small companies and home offices, and to 
equipment wholesalers, dealers, distributors and government agencies and 
municipalities. Approximately 77% (63% in 1996) of the Company's 1997 
telephone equipment sales and service revenues were to customers located 
in New England, New York, New Jersey and Pennsylvania. End-users accounted 
for approximately 89 % (95% in 1996) of telephone equipment revenues in 
1997, while sales to dealers and other resellers accounted for 
approximately 11% (5% in 1996).

      During the two years ended December 31, 1997, no single customer 
accounted for more than 10% of revenues from continuing operations, except 
for one company in the financial services industry, which accounted for 
approximately 11% in 1996. The Company's business is not considered 
seasonal.

      The Company has attempted over the last several years to market 
telecommunications equipment in the People's Republic of China ("PRC") to 
businesses, government agencies and local telephone service providers 
through its 50% owned affiliate, Beijing Antai Communication Equipment 
Company, Ltd. ("ATC") located in Beijing, PRC. These products included (i) 
used Lucent Dimension(R) PBX equipment, and (ii) central office equipment, 
consisting of proprietary Chinese system software, proprietary digital and 
analog interfaces, and a proprietary billing system, the combination of 
which enables the PBX equipment to be operated as a small central office 
(a telephone company facility where subscriber's lines are joined to 
switching equipment for connecting other subscribers to each other, 
locally and long distance). To date, sales of these products in China have 
been insignificant, and due to the emerging demand for more current 
technology products, the Company has abandoned pursuing sales of this 
product in China.

Customer Services

      The Company is committed to respond to its customers' service or 
project-oriented telecommunications needs. While each type of service is 
not material to the Company's operations as a whole, the Company believes 
they help differentiate the Company from its competitors, as well as 
contribute to longer lasting customer relationships and incremental sales. 
The Company provides the following services:

      Repair and Refurbishing: The Company performs fee-based repair and 
refurbishing services for its customers through its in-house facilities 
and use of subcontract repair shops. The in-house work includes cleaning, 
buffing and minor repairs. The Company outsources major repairs of circuit 
boards and digital telephone sets.

<PAGE> 5

      Inventory Management: The Company provides inventory storage, 
accounting, and distribution services, acting as a centralized depot for its
customers' idle telecommunications equipment.

      Other Services: The Company's technical staff currently provide 
engineering, configuration, technical "hot line" telephone support and 
limited on-site installation services. The Company rents out equipment on 
a month-to-month basis, servicing those customers that have temporary, 
short-term equipment needs. For customers in the television broadcast 
industry the Company provides telecommunications coordination services for 
broadcast sports and other events throughout the country.

      The Company's combined service revenues accounted for 7% of 
consolidated revenues from continuing operations in both 1997 and 1996. No 
individual service category accounted for more than 5% of consolidated 
revenues from continuing operations.

Competition

      The Company operates in a highly competitive marketplace. Telephone 
equipment product competitors currently include Lucent and other new 
equipment manufacturers such as Northern Telecom Ltd., other new equipment 
distributors, as well as other secondary market equipment resellers, of 
which the Company estimates there are over 100 nationwide. The Company 
believes that key competitive factors in this market are timeliness of 
delivery, service support, price and product reliability. The Company 
considers its working relationships with its customers to be an important 
and integral competitive factor. The Company anticipates intensified 
competition from larger companies having substantially greater technical, 
financial and marketing resources, as well as larger customer bases and 
name recognition than the Company. As the industry further develops CTI 
("Computer Telephony Integration"--the actual hardware and software that 
attaches to both telephone systems and computers) products, the Company 
anticipates that it will encounter a broader variety of competitors, 
including new entrants from related computer and communication industries.

Suppliers

      The Company obtains its telephone equipment parts for resale from a 
variety of sources, depending upon price and availability at the time of 
purchase. These sources include Lucent, its largest supplier, and other 
secondary market equipment dealers and distributors, leasing companies and 
end-users. In accordance with various distribution agreements with Lucent, 
the Company is required to purchase new products only from Lucent. The 
Company believes that if the various Lucent agreements were to be canceled 
or not renewed, it could obtain similar used or refurbished products from 
other suppliers, but would lose its ability to acquire new products for 
sale. The Company is not otherwise dependent upon any single supplier for 
used telephone equipment. The Company believes that product availability 
in the marketplace is presently sufficient to allow the Company to meet 
its customers' used equipment delivery requirements. See also 
"Relationship with AT&T/Lucent Technologies".

Patents, Licenses and Trademarks

      No patent or trademark is considered material to the Company's 
continuing operations. Pursuant to dealer/distribution agreements in 
effect with Lucent, the Company may utilize, during the term of these 
agreements, certain Lucent designated trademarks, insignia and symbols in 
the Company's advertising and promotion of Lucent products.

Research and Development

      Research and development is not material to the Company's continuing 
operations.

<PAGE> 6

Employees

      As of December 31, 1997, the Company had 80 employees, of which 77 
were employed on a full-time basis. Included are 7 full-time employees of 
the Cobotyx voice processing products division which is classified as a 
discontinued operation. The Company's employees are not represented by any 
organized labor union and are not covered by any collective bargaining 
agreements.

Item 2.  Property

      As of December 31, 1997, the Company operated in a 34,760 square 
foot building in East Hartford, CT, which is being leased pursuant to a 
five year lease which commenced February 1997. The lease agreement 
contains two three-year renewal options. The Company believes that its 
facilities are adequate for its present needs and suitable for their 
intended uses. If new or additional space is required, the Company 
believes that adequate facilities are available at competitive prices in 
the immediate areas of its current operations.

Item 3.  Legal Proceedings

      The Company is not a party to any pending material proceedings and 
no such proceedings are known to be contemplated by others.

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

      No matter was submitted to a vote of security holders in the fourth 
quarter of the fiscal year covered by this report.

                                   PART II

Item 5.  Market for Common Equity and Related Stockholder Matters

      Since September 12, 1996, the Company's securities have traded on 
the American Stock Exchange. Prior thereto the Company's securities traded 
on The Nasdaq SmallCap MarketSM ("Nasdaq") tier of The Nasdaq Stock 
MarketSM. . The Company's securities, their trading symbols and, in 
parentheses, the dates they began trading on the American Stock Exchange, 
are as follows: Common Stock--FTG (9/12/96); Redeemable Class A Common 
Stock Purchase Warrant--FTG.WS.A (11/29/96); Redeemable Class B Common 
Stock Purchase Warrant--FTG.WS.B (11/29/96); Warrant issued in the 
Company's 1987 initial public offering--FTG.WS (9/12/96).

      The following sets forth the range of quarterly high and low sales 
prices for the common stock, for the two years ended December 31, 1997 
(market prices and numbers of outstanding common shares for 1996 have been 
restated to give retroactive recognition to the 1-for-10 reverse stock 
split effected August 13, 1996):

<TABLE>
<CAPTION>
                                        1997              1996
              Common Stock:        --------------    --------------
              Quarter Ended        High      Low     High      Low
              -----------------    -----    -----    -----    -----

              <S>                  <C>      <C>      <C>      <C>
              March 31             $4.00    $2.75    $5.90    $1.90
              June 30               3.62     2.25     5.90     3.10
              September 30          2.56     1.69     5.00     3.10
              December 31           2.94     1.62     3.88     2.69
</TABLE>

      There were 3,262,329 common shares outstanding at December 31, 1997 
and 1996, respectively. There were 589 holders of record of the common 
stock as of December 31, 1997 representing approximately 4,500 beneficial 
stockholders. The Company has paid no dividends and does not expect to pay 
dividends in the foreseeable future as it intends to retain earnings to 
finance the growth of its operations. Pursuant to a Commercial Loan and

<PAGE> 7
 
Security Agreement with First Union National Bank, the Company is 
prohibited from declaring or paying any dividends or making any other 
distribution on any of the shares of its capital stock, without the prior 
consent of the lender.

Item 6.  Management's Discussion and Analysis of Financial Condition and 
         Results of Operations

      The following discussion and analysis should be read in conjunction 
with the financial statements and notes thereto contained in Item 7 of 
this Report.

Results of Operations

Net Loss

      The Company recorded a net loss $1,866,000 for the year ended 
December 31, 1997 as compared to net income of $882,000 for the year ended 
December 31, 1996. These results consisted of a loss from continuing 
operations of $600,000 for 1997 as compared to income from continuing 
operations of $1,206,000 for 1996, and a loss from discontinued operations 
of $1,266,000 for 1997 as compared to a loss from discontinued operations 
of $324,000 for 1996.

      Continuing Operations
      ---------------------

      The decline in the operating results from continuing operations from 
1996 to 1997 was attributable to several factors. In 1997, due to the 
unprofitable operations of the Company's foreign affiliates, ATC and 
TeleSolutions, the Company established a full valuation reserve against 
all associated assets, including inventory located overseas. The combined 
foreign affiliate losses and asset write-downs resulted in a one-time 
charge of $444,000. The Company recorded approximately $899,000 less 
income in 1997 from the AT&T coupon rebate program than it did in 1996, 
due to the expiration of this program in 1997. In addition, the Company's 
operating expenses increased as the Company increased its employment 
levels in connection with expanding its sales territory and product lines, 
and relocating to a larger facility.

      Discontinued Operations
      -----------------------

      In September 1997, due to declining revenues and resulting operating 
losses, the Company entered into negotiations with an employee of FAMS for 
the sale of the Company's interest in FAMS. The sale transaction was 
completed in December, effective October 1, 1997. FAMS, LLC, a newly formed 
New Jersey corporation (the "Buyer") acquired all of the Company's 
interest in FAMS for $40,000 in cash and a $360,000 10% Note, payable in 
60 monthly installments. The Note is secured by a $45,000 letter of credit 
and by all of the assets of FAMS. The Company has recorded a loss on 
disposal of FAMS of $208,000, consisting of $116,000 representing the 
excess of the book value of the net assets sold over the sales proceeds, 
and $92,000 of other costs and expenses of the sale. For the years ended 
December 31, 1997 and 1996, FAMS recorded revenues of $799,000 and 
$1,230,000, respectively. Prior to the effective date of sale, FAMS 
incurred an operating loss of approximately $578,000 in 1997, as compared 
with an operating loss of approximately $370,000 in 1996.

      In December 1997 the Company began actively pursuing divesting 
itself of its Cobotyx voice processing products business. Assets expected 
to be sold during 1998 include inventories, fixed assets, and certain 
other current assets which, as of December 31, 1997 aggregated 
approximately $560,000, plus all related technologies developed by the 
Company, tradenames, and other contract rights. The operations of this 
business through its disposal date are not expected to have a material 
negative impact on the Company's 1998 operating results, and the Company 
expects to sell these assets at book value. For the years ended December 
31, 1997 and 1996, voice processing product revenues approximated 
$1,479,000 and $2,297,000, respectively. The loss from operations was 
approximately $480,000 in 1997 as compared to income from operations of 
$46,000 in 1996.

<PAGE> 8

Discussion of the Results of Continuing Operations

Revenues

      Revenues from continuing operations for the year ended December 31, 
1997 were $20,559,000, an increase of $4,253,000 or 26% from the 
comparable 1996 period. The increase was attributable to sales of new 
products principally through the Company's associated dealers, increased 
end user secondary market equipment sales, and increased service revenues. 
Telephone equipment sales revenues accounted for approximately 93% of 
consolidated revenues in 1997 and in 1996, while service revenues 
comprised 7% of consolidated revenues in both years.

Gross Profit

      Gross profit from continuing operations for the year ended December 
31, 1997 was $5,099,000, an increase of $659,000 or 15% from the 
comparable 1996 period. The gross profit margin was 25% of revenues during 
1997, as compared to 27% of revenues for the comparable 1996 period. The 
decrease in gross profit margin was attributable principally to product 
sales mix as sales of new equipment to dealers, which yield lower profit 
margins than end user sales, increased over the prior year. The decrease 
in the gross profit margin from the prior year was also partly 
attributable to lower product purchase rebates earned in 1997 from the 
utilization of AT&T coupons.

Operating Expenses

      Selling, general and administrative ("SG&A") expenses from 
continuing operations for the year ended December 31, 1997 were 
$5,108,000, an increase of $1,558,000 or 44% over the comparable 1996 
period. SG&A expenses were 25% of revenues in 1997, compared with 22% for 
the comparable 1996 period. The increase in SG&A in 1997 was principally 
attributable to (i) higher average employment levels and associated 
compensation costs, as the Company increased its sales, marketing, 
customer and technical support staff, developed a network of associate 
dealers, and expanded its sales territories and product lines, and (ii) 
higher facility rental and occupancy costs, including increased 
depreciation expense from fixed assets purchased in connection with the 
Company's relocation to its larger headquarters in East Hartford, 
Connecticut.

Other Income and Expenses

      Other income from continuing operations for the year ended December 
31, 1997 was $100,000, as compared with $627,000 for the year ended 
December 31, 1996. Other income for 1997 consisted principally of interest 
earned on the Company's invested cash. Included in other income for 1996 
was $542,000 of rebates earned from AT&T on coupons tendered for 
redemption, net of coupon acquisition costs.

      Interest expense increased $47,000 or 30% in 1997 as compared with 
1996. The increase was attributable to higher average borrowings under the 
Company's revolving credit facility, and interest expense incurred under a 
capital lease entered into in 1997.

Year ended December 31, 1996 as compared to the year ended December 31, 1995

Revenues

      Revenues from continuing operations for the year ended December 31, 
1996 were $16,306,000, an increase of $4,151,000 or 34% from the 
comparable 1995 period. The increase was attributable to (i) higher end 
user sales of refurbished and Lucent--remanufactured products, (ii) sales 
of new Lucent equipment pursuant to various product dealer and distributor 
agreements entered into by the Company in 1996, and (iii) higher levels of 
provided services, including installations, event coordination and 
equipment repair and refurbishing. Provided services represented 7% of 
telephone equipment revenues in 1996 (3% in 1995). End user revenues 
accounted for 95% of total telephone equipment revenues in 1996 (86% in 
1995), while revenues from dealers and other equipment resellers accounted 
for 5% (14% in 1995).

<PAGE> 9

Gross Profit

      Gross profit from continuing operations for the year ended December 
31, 1996 was $4,440,000, an increase of $1,019,000 or 30% from the 
comparable 1995 period. The gross profit margin was 27% of revenues for 
1996 as compared to 28% of revenues for the comparable prior year period. 
For the year ended December 31, 1996, $459,000 of purchase rebates were 
credited to cost of sales, which had the effect of increasing the 
Company's gross profit margin to 28% from 24% otherwise realized. 
Excluding the effect of the rebates as described above, increased product 
acquisition costs on certain telephone system parts and higher labor and 
warehousing costs were the principal reasons for a lower overall gross 
profit margin from the prior year.

Operating Expenses

      Selling, general and administrative expenses from continuing 
operations ("SG&A") increased $347,000 or 11% in 1996 as compared with 
1995. SG&A was 22% of revenues in 1996 as compared with 26% in 1995. The 
increase in SG&A was attributable to increased sales compensation, 
personnel costs and other operating costs associated with the Company's 
increased business volume and number of employees.

Other Income and Expenses

      Other income from continuing operations increased $618,000 in 1996 
as compared with 1995. Included in other income for 1996 was $542,000 
related to rebates earned from AT&T on coupons tendered for redemption, 
net of coupon acquisition costs. The rebates are a result of coupons 
issued by AT&T in 1995 in settlement of a lawsuit, which are freely 
transferable and which can be used towards the cost of AT&T products and 
services purchased from May 1995 through June 1, 1997. In 1996 the Company 
began purchasing coupons at a discount to their $50 face value and 
redeeming them with AT&T for the full $50 face value. Accordingly, the 
Company recorded in other income the difference between the face value of 
the coupons and their acquisition cost. The Company continued to take 
advantage of the coupon redemption program through its June 1, 1997 
expiration date. See Note 3 to the consolidated financial statements 
included elsewhere herein.

      Interest expense increased $58,000 or 59% in 1996 as compared with 
1995. The increase was attributable to higher average borrowings under the 
Company's revolving credit facility, in order to support the Company's 
increased sales and operating levels. Average borrowings in 1996 were 
$1,406,000 as compared with $880,000 in 1995.

Liquidity and Capital Resources

      Working capital from continuing operations at December 31, 1997 was 
$6,440,000, an 8% decrease from $7,033,000 of working capital at December 
31, 1996. The working capital ratio at December 31, 1997 was approximately 
3 to 1 as compared to 2.6 to 1 at December 31, 1996. The increase in the 
working capital ratio was attributable to the reclassification to long-
term liabilities from current liabilities of the Company's borrowings 
under its revolving credit facility which, in May 1997, was replaced with 
a two year loan agreement. Excluding this reclassification, working 
capital otherwise declined in 1997 by approximately $2,496,000 principally 
due to the Company's 1997 net loss.

      Operating activities used $2,199,000 during the year ended December 
31, 1997, principally as a result of the Company's net loss, and a 34% 
increase in accounts receivable from December 31, 1996 due to increased 
fourth quarter sales over the prior year.

      Investing activities used $492,000 during the year ended December 
31, 1997, due to the purchase of office furniture and equipment, computer 
equipment, and leasehold improvements, principally in conjunction with the 
Company's relocation to a larger headquarters in East Hartford, 
Connecticut. In May 1997, the Company entered into a five year, 
noncancelable lease agreement to finance an additional $419,000 of office 
furniture and equipment, computer equipment, and leasehold improvements 
for like use. Under the lease agreement, which is being 

<PAGE> 10

accounted for as a capital lease, monthly lease payments are $9,589, with a
$1.00 buyout option at the end of the lease.

      Financing activities generated $632,000 during the year ended 
December 31, 1997, from advances under the Company's revolving credit 
facility.

      On June 6, 1997, the Company entered into a $2 million line of 
credit agreement with AT&T Commercial Finance Corporation which expires 
April 30, 1998. In December 1997, the credit agreement was acquired by 
Finova Capital Corporation ("Finova"). The credit line is used to finance 
the acquisition of inventory manufactured by Lucent, and borrowings are 
secured by all of the Company's inventories. Under the terms of this 
agreement, advances to finance products purchased directly from Lucent are 
repayable, interest-free, in either two or three equal monthly 
installments, depending upon the product purchased. Advances to finance 
Lucent products purchased from other vendors ("Other Eligible Inventory") 
are repayable in two equal monthly installments, bear interest at prime 
plus 1.5%, and are subject to a $500,000 borrowing limit. For products 
purchased directly from Lucent, the ratio of total collateral available to 
Finova (after deduction of any senior liens), to total Finova indebtedness 
must be at least 1.5 to 1. The ratio of Other Eligible Inventory to 
advances on Other Eligible Inventory must be at least 2 to 1. The Company 
is currently in compliance with these requirements. As of December 31, 
1997, outstanding borrowings under this credit arrangement were $889,000. 
The Company expects to either renew the Finova credit agreement for an 
additional term on or prior to its expiration date or to obtain a similar 
facility with a new lender, on terms not materially less favorable to the 
Company than its present terms.

      On May 30, 1997, the Company entered into a two year, $3.5 million 
revolving loan agreement with First Union Bank of Connecticut 
(subsequently renamed First Union National Bank, hereinafter referred to 
as "First Union"), modifying and replacing its previous one year, $2.5 
million agreement with First Union. Certain terms and conditions of this 
agreement were further modified in December 1997. Under the current 
agreement, borrowings are advanced at 75% of eligible accounts receivable, 
bear interest at First Union prime plus .5% (9% at December 31, 1997), and 
are secured by all of the Company's assets excluding inventories. The 
agreement requires the Company to maintain a minimum net worth of $5.3 
million, and to maintain certain debt to net worth and debt service 
coverage ratios. In addition, the agreement restricts fixed asset 
purchases and does not allow the payment of cash dividends without the 
consent of the lender. There is no requirement to maintain compensating 
balances under the agreement. The Company was in compliance with these 
covenants and loan requirements at December 31, 1997. As of December 31, 
1997, the unused portion of the credit facility was $1,803,000, of which 
approximately $1,050,000 was available under the borrowing formula. The 
average and highest amounts borrowed under these credit facilities during 
the year ended December 31, 1997 were approximately $1,714,000 and 
$2,282,000, respectively. Borrowings are dependent upon the continuing 
generation of collateral, subject to the credit limit. The weighted 
average interest rate on the Company's outstanding debt was 10.1 % for 
1997 and 10.6% for 1996. The carrying values of the Company's borrowings 
approximated their fair values at December 31, 1997 and 1996.

      The Company believes that it has sufficient capital resources, in 
the form of cash and availability under its credit facilities, to satisfy 
its present working capital requirements. Inflation has not been a 
significant factor in the Company's operations.

      The Company has been investigating the nature and extent of the work 
required to ensure that its systems are Year 2000 compliant. The Company's 
major systems consist principally of packaged software purchased from 
vendors who have represented that these systems are already Year 2000 
compliant or will soon be. Based upon currently available information, the 
Company believes that it will be able to manage its Year 2000 transition 
without any material costs or material adverse effects on its business 
operations.

<PAGE> 11

Item 7.  Financial Statements

      The following report and financial statements of the Company are 
contained on the pages indicated:

<TABLE>
<CAPTION>
                                                                        Page
                                                                        ----

      <S>                                                                <C>
      Report of Deloitte & Touche LLP                                    16
      Consolidated Balance Sheets--December 31, 1997 and 1996            17
      Consolidated Statements of Operations--Years Ended 
       December 31, 1997 and 1996                                        18
      Consolidated Statement of Changes in Stockholders' Equity
       --Years Ended December 31, 1997 and 1996                          19
      Consolidated Statements of Cash Flows--Years Ended 
       December 31, 1997 and 1996                                        20
      Notes to Consolidated Financial Statements                         21
</TABLE>

Item 8.  Changes in and Disagreements with Accountants on Accounting and 
         Financial Disclosure: None.

                                  PART III

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

      Incorporated by reference to the Company's proxy statement which the 
Company intends to file with the Securities and Exchange Commission within 
120 days after the close of its fiscal year.

                      Executive Officers of the Company
                     (Information as of January 1, 1998)

<TABLE>
<CAPTION>
                                 First Became
                                 An Executive
          Name             Age    Officer in                Position(s) Held
------------------------   ---   ------------   ---------------------------------------

<S>                         <C>      <C>        <C>
Directors:
----------
George J. Taylor, Jr. *     55       1984       Chairman of the Board, President, Chief
                                                Executive Officer

Robert G. LaVigne *         46       1988       Executive Vice President, Chief 
                                                Financial Officer, Secretary, Treasurer

Alexander E. Capo           47       1987       Vice President--Sales

Joseph A. Novak, Jr.        54       1993       Vice President--Operations

Neil R. Sullivan            46       1994       Vice President--Accounting & 
                                                Administration, Assistant Secretary

John G. Antonich            56       1996       Vice President & General Manager--
                                                Cobotyx Division

Robert L. Saelens           52       1997       Vice President--Marketing

<FN>
-------------------
<F*>   Member of the Board of Directors.
</FN>
</TABLE>

<PAGE> 12

      George J. Taylor, Jr., Chairman of the Board of Directors and Chief 
Executive Officer of the Company (including its predecessors) since 1984, 
and President since 1989. Member of the Compensation Committee of the 
Board of Directors (until February 4, 1998) President of Lease Solutions, 
Inc. (formerly Farmstead Leasing, Inc.), a business products and 
automobile leasing company, from 1981 to 1993. Vice President--Marketing 
and Sales for National Telephone Company from 1977 to 1981. Director of 
Beijing Antai Communication Equipment Company, Ltd. Mr. Taylor was one of 
the founders of the National Association of Telecommunication Dealers, has 
been a member of, or advisor to, its Board of Directors since its 
inception in 1986, and for two years served as its President and Chairman. 
Brother of Mr. Hugh M. Taylor, a Director of the Company.

      Robert G. LaVigne, Executive Vice President since July 1997. Chief 
Financial Officer, Corporate Secretary and Treasurer since 1988. Vice 
President--Finance & Administration from 1988 until July 1997. General 
Manager of the domestic telephone equipment division from January 1994 
until October 1994. Controller of Economy Electric Supply, Inc., a 
distributor of electrical supplies and fixtures, from 1985 to 1988. 
Corporate Controller of Hi-G, Inc., a manufacturer of electronic and 
electromechanical components, from 1982 to 1985. Certified Public 
Accountant. Director of ATC.

      Alexander E. Capo, Vice President--Sales since July 1997. Vice 
President--Sales & Marketing from 1987 until July 1997. Director of Sales 
for The Farmstead Group, Inc. from 1985 to 1987. Sales Manager for the 
National Telephone Company from 1972 to 1983.

      Joseph A. Novak, Jr., Vice President--Operations since 1993. 
General Manager of Farmstead Asset Management Services, LLC from 1996 to 
1997. Prior to 1990, he was employed by AT&T for 28 years, serving in 
various operational and sales management capacities. Vice General Manager 
and a Director of ATC.

      Neil R. Sullivan, Vice President--Accounting & Administration since 
July 1997. Vice President & General Manager of the domestic telephone 
equipment division from August 1996 to July 1997. Corporate Controller 
from October 1994 to August 1996. Assistant Secretary of the Company since 
1994. From 1981 to 1994 he was employed by Zero Corporation ("Zero"), a 
manufacturer of cabinets, cooling equipment and containers for the 
electronics industry. Mr. Sullivan was Controller of various divisions of 
Zero from 1981 to 1991, and was Vice President/General Manager of the 
Zero-East division from 1991 to 1994.

      John G. Antonich, Vice President & General Manager--Cobotyx voice 
processing products division since 1996. Director of Sales from 1993 to 
1996. Account Executive with Quodata, a software manufacturer, from 1991 
to 1993. Prior thereto, he had extensive sales, technical and managerial 
experience with Sperry Univac, Datapoint and Shared Technologies, Inc.

      Robert L. Saelens, Vice President--Marketing since June 1997. 
President of Saelens & Associates, a marketing consulting firm, from 1989 
to 1997. President of Baker, Bateson & Saelens, Inc., a marketing 
consulting firm, from 1982 to 1989. Prior thereto Mr. Saelens served for 
ten years in the Creative and Strategic planning departments of the J. 
Walter Thompson Corporation.

Item 10.  Executive Compensation

      Incorporated by reference to the Company's proxy statement which the 
Company intends to file with the Securities and Exchange Commission within 
120 days after the close of its fiscal year.

Item 11.  Security Ownership of Certain Beneficial Owners and Management

      Incorporated by reference to the Company's proxy statement which the 
Company intends to file with the Securities and Exchange Commission within 
120 days after the close of its fiscal year.

<PAGE> 13

Item 12.  Certain Relationships and Related Transactions

      Incorporated by reference to the Company's proxy statement which the 
Company intends to file with the Securities and Exchange Commission within 
120 days after the close of its fiscal year.

Item 13.  Exhibits and Reports on Form 8-K

Exhibits: See Index to Exhibits on page 30.

Reports on Form 8-K: The registrant did not file any reports on Form 8-K 
during the fourth quarter of 1997.

<PAGE> 14

                                 SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant 
caused this report to be signed on its behalf by the undersigned, 
thereunto duly authorized on March 17, 1998.


                                       FARMSTEAD TELEPHONE GROUP, INC.

                                       By: /s/ George J. Taylor, Jr.
                                           ----------------------------------
                                           George J. Taylor, Jr.
                                           Chairman of the Board, Chief
                                           Executive Officer and President

      In accordance with the Exchange Act, this report has been signed 
below by the following persons on behalf of the registrant and in the 
capacities and on the dates indicated as of March 17, 1998.

<TABLE>
<CAPTION>

          Signature                                        Title
--------------------------------     ------------------------------------------------

<S>                                  <C>
/s/ George J. Taylor, Jr             Chairman of the Board, Chief Executive Officer,
--------------------------------     and President (Principal Executive Officer)
George J. Taylor, Jr.

/s/ Robert G. LaVigne
--------------------------------     Executive Vice President, Chief Financial Officer,
Robert G. LaVigne                    Secretary and Director (Principal Financial and 
                                     Accounting Officer)


/s/ Harold L. Hansen                 Director
--------------------------------
Harold L. Hansen

/s/ Hugh M. Taylor                   Director 
--------------------------------
Hugh M. Taylor

/s/ Joseph J. Kelley                 Director 
--------------------------------
Joseph J. Kelley
</TABLE>

<PAGE> 15

                       REPORT OF DELOITTE & TOUCHE LLP


                        INDEPENDENT AUDITORS' REPORT


To the Board of Directors and Stockholders of
 Farmstead Telephone Group, Inc.
 East Hartford, Connecticut

We have audited the accompanying consolidated balance sheets of Farmstead 
Telephone Group, Inc. and subsidiaries (the "Company") as of December 31, 
1997 and 1996, and the related consolidated statements of operations, 
changes in stockholders' equity and cash flows for the years 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 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 consolidated financial 
statements are free of material misstatement. An audit includes examining, 
on a test basis, evidence supporting the amounts and disclosures in the 
consolidated 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 opinions.

In our opinion, such consolidated financial statements present fairly, in 
all material respects, the financial position of Farmstead Telephone 
Group, Inc. and subsidiaries as of December 31, 1997 and 1996, and the 
results of their operations and their cash flows for the years then ended 
in conformity with generally accepted accounting principles.


DELOITTE & TOUCHE LLP
March 3, 1998

<PAGE> 16

                       FARMSTEAD TELEPHONE GROUP, INC.

                         CONSOLIDATED BALANCE SHEETS
                         December 31, 1997 and 1996

<TABLE>
<CAPTION>

(In thousands, except number of shares)                       1997        1996
--------------------------------------------------------------------------------

                                   ASSETS

<S>                                                         <C>         <C>
Current assets:
  Cash and cash equivalents                                 $  1,102    $  3,161
  Accounts receivable, less allowance for doubtful 
   accounts of $579 in 1997 and $245 in 1996                   5,077       3,792
  Inventories                                                  2,583       3,111
  Net assets of discontinued operations (Note 7)                 560         848
  Other current assets                                           181         560
                                                            --------------------
      Total current assets                                     9,503      11,472
Property and equipment, net                                      935         186
Net assets of discontinued operations (Note 7)                     -         240
Investment in unconsolidated subsidiaries (Note 10)                -         117
Other assets                                                     391          59
                                                            --------------------
      Total assets                                          $ 10,829    $ 12,074
                                                            ====================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable                                          $  1,560    $  2,048
  Bank Borrowings (Note 6)                                         -       1,903
  Borrowings under inventory finance agreement (Note 6)          889           -
  Current portion of long-term debt                               69           -
  Accrued expenses and other current liabilities                 545         488
                                                            --------------------
      Total current liabilities                                3,063       4,439
Long-term debt                                                 1,997           -
                                                            --------------------
      Total liabilities                                        5,060       4,439
Commitments and contingencies (Note 11)
Stockholders' equity:
  Preferred stock, $0.001 par value; 2,000,000 shares
   authorized; zero shares issued and outstanding                  -           -
  Common stock, $0.001 par value; 30,000,000 shares 
   authorized; 3,262,329 shares issued and outstanding             3           3
  Additional paid-in capital                                  12,196      12,196
  Accumulated deficit                                         (6,430)     (4,564)
                                                            --------------------
      Total stockholders' equity                               5,769       7,635
                                                            --------------------
      Total liabilities and stockholders' equity            $ 10,829    $ 12,074
                                                            ====================
</TABLE>


        See accompanying notes to consolidated financial statements.

<PAGE> 17

                       FARMSTEAD TELEPHONE GROUP, INC.

                    CONSOLIDATED STATEMENTS OF OPERATIONS
                   Years Ended December 31, 1997 and 1996


<TABLE>
<CAPTION>

(In thousands, except per share amounts)                        1997        1996
----------------------------------------------------------------------------------

<S>                                                           <C>         <C>
Revenues                                                      $ 20,559    $ 16,306
Cost of revenues                                                15,460      11,866
                                                              --------------------
Gross profit                                                     5,099       4,440
Operating expenses:
  Selling, general and administrative                            5,108       3,550
  Research and development                                           -          11
                                                              --------------------
      Total operating expenses                                   5,108       3,561
                                                              --------------------
Operating income (loss)                                             (9)        879
Interest expense                                                   204         157
Equity in losses of unconsolidated subsidiaries (Note 10)           40         124
Write-down of investments in unconsolidated subsidiaries 
 (Note 10)                                                         404           -
Other income                                                      (100)       (627)
                                                              --------------------
Income (loss) from continuing operations before income
 taxes                                                            (557)      1,225
Provision for income taxes                                          43          19
                                                              --------------------
Income (loss) from continuing operations                          (600)      1,206
                                                              --------------------
Discontinued operations (Note 7):
  Loss from operations                                          (1,058)       (324)
  Loss on sale of discontinued operation                          (208)          -
                                                              --------------------
Loss from discontinued operations                               (1,266)       (324)
                                                              --------------------
Net income (loss)                                             $ (1,866)   $    882
                                                              ====================

Basic net income (loss) per common share:
  From continuing operations                                  $   (.18)   $    .49
  From discontinued operations                                    (.39)       (.13)
                                                              --------------------
Basic net income (loss) per common share                      $   (.57)   $    .36
                                                              ====================

Diluted net income (loss) per common share:
  From continuing operations                                  $   (.18)   $    .48
  From discontinued operations                                    (.39)       (.13)
                                                              --------------------
Diluted net income (loss) per common share                    $   (.57)   $    .35
                                                              ====================

Basic weighted average common shares outstanding (000's)         3,262       2,460
Dilutive effect of stock options                                     -          26
                                                              --------------------
Diluted weighted average common and common equivalent 
 shares outstanding (000's)                                      3,262       2,486
                                                              ====================
</TABLE>


        See accompanying notes to consolidated financial statements.

<PAGE> 18

                     CONSOLIDATED STATEMENTS OF CHANGES
                           IN STOCKHOLDERS' EQUITY
                   Years Ended December 31, 1997 and 1996


<TABLE>
<CAPTION>

                                    Common Stock       Additional
                                  -----------------     paid-in     Accumulated
(In thousands)                     Shares    Amount     capital       deficit      Total
------------------------------------------------------------------------------------------

<S>                               <C>         <C>       <C>          <S>          <C>
Balance at December 31, 1995       21,239     $  21     $  8,431     $ (5,446)    $  3,006
Stock options exercised                 5         -            1            -            1
Reverse stock split (Note 9)      (19,120)      (19)          19            -            -
Sale of Units (Note 9)              1,138         1        3,745            -        3,746
Net income                              -         -            -          882          882
                                  --------------------------------------------------------
Balance at December 31, 1996        3,262         3       12,196       (4,564)       7,635
Net loss                                -         -            -       (1,866)      (1,866)
                                  --------------------------------------------------------
Balance at December 31, 1997        3,262     $   3     $ 12,196     $ (6,430)    $  5,769
                                  ========================================================
</TABLE>


         See accompanying notes to consolidated financial statements.

<PAGE> 19

                       FARMSTEAD TELEPHONE GROUP, INC.

                    CONSOLIDATED STATEMENTS OF CASH FLOWS
                   Years Ended December 31, 1997 and 1996


<TABLE>
<CAPTION>

(In thousands)                                                     1997         1996
--------------------------------------------------------------------------------------

<S>                                                              <C>          <C>
Cash flows from operating activities:
  Net income (loss)                                              $ (1,866)    $    882
  Adjustments to reconcile net income (loss) to net cash 
   flows used by operating activities:
    Depreciation and amortization                                     308          160
    Equity in undistributed losses of unconsolidated  
     subsidiaries                                                      40          113
    Write-down of investments in unconsolidated subsidiaries           77            -
    Write-down of accounts receivable from unconsolidated
     subsidiary                                                       265            -
    Changes in operating assets and liabilities:
      Increase in accounts receivable                              (1,550)      (1,101)
      (Increase) decrease in inventories                              528       (1,590)
      Decrease in other assets                                        (32)        (377)
      Increase (decrease) in accounts payable, accrued 
       expenses and other current liabilities                        (431)       1,085
      (Increase) decrease in net assets of discontinued 
       operations                                                     462         (517)
                                                                 ---------------------
      Net cash used by operating activities                        (2,199)      (1,345)
                                                                 ---------------------
Cash flows from investing activities:
  Purchases of property and equipment                                (552)        (164)
  Purchases of redeemable coupons                                       -       (1,194)
  Redemptions of coupons                                               60        1,084
  Investment in unconsolidated subsidiaries                             -          (40)
                                                                 ---------------------
      Net cash used in investing activities                          (492)        (314)
                                                                 ---------------------
Cash flows from financing activities:
  Bank and inventory finance borrowings                               682          451
  Repayments of capital lease obligation                              (50)           -
  Proceeds from exercise of stock options and warrants                  -            1
  Proceeds from sales of Units and common stock, net                    -        3,746
                                                                 ---------------------
      Net cash provided by financing activities                       632        4,198
                                                                 ---------------------
Net increase (decrease) in cash and cash equivalents               (2,059)       2,539
Cash and cash equivalents at beginning of year                      3,161          622
                                                                 ---------------------
Cash and cash equivalents at end of year                         $  1,102     $  3,161
                                                                 =====================


Supplemental schedule of non-cash financing and investing 
 activities:
  Purchase of assets under capital lease obligation              $    419     $      -

Supplemental disclosure of cash flow information:
  Cash paid during the year for:
    Interest                                                     $    204     $    159
    Income taxes                                                       49           21
</TABLE>


         See accompanying notes to consolidated financial statements.

<PAGE> 20

                       FARMSTEAD TELEPHONE GROUP, INC.

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.  BUSINESS OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business Operations

      Farmstead Telephone Group, Inc. (the "Company") is presently engaged in
the Customer Premise Equipment ("CPE") segment of the telecommunications
industry, principally as a secondary market reseller of used, remanufactured
and/or refurbished Lucent Technologies, Inc. ("Lucent") business telephone
parts and systems, and as an authorized Lucent dealer and distributor of
certain new telephone system products. The Company also provides equipment
repair and refurbishing, inventory management, and other related value-added
services. The Company sells its products and services to corporate end users,
and to other dealers and distributors. CPE refers to equipment which resides at
the customer's premises. During the two years ended December 31, 1997, no
single customer accounted for more than 10% of revenues from continuing
operations, except for one company in the financial services industry, which
accounted for approximately 11% in 1996.

Principles of Consolidation

      The consolidated financial statements presented herein include the
accounts of the Company and all wholly-owned subsidiaries. Investments in
companies in which ownership interests range from 20-50% and which the Company
exercises significant influence but does not control, are accounted for under
the equity method. Under the equity method, the original investment is recorded
at cost and subsequently increased or decreased by the Company's share of the
subsidiary's undistributed earnings or losses. The investment is also reduced
by the amount of any deferred gross profits on sales to the subsidiary until
such time as the related goods are resold by the subsidiary. All material
intercompany transactions and balances have been eliminated.

Accounting Estimates

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

Revenue Recognition

      Revenues are recognized when a product is shipped or when a service is
performed.

Cash and Cash Equivalents

      The Company considers all highly liquid investments purchased with an 
initial maturity of three months or less to be cash equivalents.

Inventories

      Inventories are stated at the lower of cost or market. Cost is determined
on an average basis, which approximates the first-in, first-out method.

Property and Equipment

      Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the related assets
which range from three to ten years. Maintenance, repairs and minor renewals
are charged to operations as incurred.

Income Taxes

      The Company provides for income taxes under the asset and liability
method, under which deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial

<PAGE> 21

statement carrying amounts of existing assets and liabilities and their
respective tax basis. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date.

Net Income (Loss) Per Share

      In February 1997, Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" was issued, which became effective for periods ending
after December 15, 1997. This Statement has replaced the presentation of
primary and fully diluted earnings per share ("EPS") with a presentation of
basic EPS and diluted EPS. Basic EPS is computed by dividing net income (loss)
(the numerator) by the weighted average number of common shares outstanding
(the denominator) during the period. Diluted EPS is computed by increasing the
denominator by the weighted average number of additional shares that could have
been outstanding from securities convertible into common stock, such as stock
options and warrants, unless their effect on net income (loss) per share is
antidilutive. Earnings per share amounts presented for 1996 have been restated
for comparative purposes.

Reclassification

      Certain prior year amounts have been reclassified to conform with the
1997 presentation.

2.  CASH AND CASH EQUIVALENTS

      Cash and cash equivalents at December 31, 1997 includes investments in
money market funds consisting of high quality short term instruments,
principally U.S. Government and Agency issues and commercial paper.

3.  OTHER CURRENT ASSETS

      As part of a class action lawsuit settlement in 1995, AT&T was required
to issue approximately 4.2 million $50 face value coupons to the class action
members. The coupons are freely transferable and are redeemable against the
cost of certain specified AT&T telephone system products or maintenance
services sold by the Company during the period May 1, 1995 through June 1,
1997. In 1996, the Company began purchasing coupons in the marketplace at a
discount to their $50 face value and redeeming them with AT&T subject to a
maximum discount of 20% of the sales price up to a $2,500 maximum discount per
transaction. The Company's accounting policy is to record income in an amount
equal to the excess of the face value of the coupons redeemed over the
acquisition cost of the coupons, in the period in which it can calculate the
amount of rebate it has earned. During the year ended December 31, 1996, the
Company recorded $542,000 as other income from the redemption of coupons
applicable to prior year sales. Rebates earned on current year purchases are
recorded in cost of sales after the related products are sold, and amounted to
$54,000 and $411,000, respectively, for 1997 and 1996. Included in other
current assets at December 31, 1996 was $231,000 of rebates receivable,
representing cash due from the tendering of redeemable coupons. The rebate
program terminated in June 1997.

4.  PROPERTY AND EQUIPMENT, NET

      As of December 31, the components of property and equipment, net were as
follows (in thousands):

<TABLE>
<CAPTION>

                                                           1997       1996
                                                          -------    ------

      <S>                                                 <C>        <C>
      At cost:
                  
      Equipment                                           $   820    $  357
      Furniture and fixtures                                  102        76
      Leasehold improvements                                   78        45
      Leased equipment under capital lease                    419         -
                                                          -----------------
                                                            1,419       478
      Less accumulated depreciation and amortization         (484)     (292)
                                                          -----------------
      Property and equipment, net                         $   935    $  186
                                                          =================
</TABLE>

<PAGE> 22

      Leased equipment under capital lease at December 31, 1997 consists
principally of office furniture, equipment and computer equipment acquired in
connection with the Company's relocation to a larger operating facility. The
accumulated amortization of the leased equipment was $61,000 at December 31,
1997.

5.  ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

      As of December 31, the components of accrued expenses and other
liabilities were as follows (in thousands):

<TABLE>
<CAPTION>
                                                            1997     1996
                                                            -----    -----

      <S>                                                   <C>      <C>
      At cost:                
                  
      Salaries, commissions and benefits                    $ 480    $ 476
      Other                                                    65       12
                                                            --------------
      Accrued expenses and other current liabilities        $ 545    $ 488
                                                            ==============
</TABLE>

6.  DEBT OBLIGATIONS

      Inventory Financing Agreement:
      ------------------------------

      On June 6, 1997, the Company entered into a $2 million line of credit
agreement with AT&T Commercial Finance Corporation which expires April 30,
1998. In December 1997, the credit agreement was acquired by Finova Capital
Corporation ("Finova"). The credit line is used to finance the acquisition of
inventory manufactured by Lucent, and borrowings are secured by all of the
Company's inventories. Under the terms of this agreement, advances to finance
products purchased directly from Lucent are repayable, interest-free, in either
two or three equal monthly installments, depending upon the product purchased.
Advances to finance Lucent products purchased from other vendors ("Other
Eligible Inventory") are repayable in two equal monthly installments, bear
interest at prime plus 1.5%, and are subject to a $500,000 borrowing limit. For
products purchased directly from Lucent the ratio of total collateral available
to Finova (after deduction of any senior liens), to total Finova indebtedness
must be at least 1.5 to 1. The ratio of Other Eligible Inventory to advances on
Other Eligible Inventory must be at least 2 to 1. The Company is currently in
compliance with these requirements. As of December 31, 1997, outstanding
borrowings under this credit arrangement were $889,000. The Company expects to
either renew the Finova credit agreement for an additional term on or prior to
its expiration date or to obtain a similar facility with a new lender, on terms
not materially less favorable to the Company than its present terms.

      Long-term Debt:
      ---------------

      As of December 31, 1997, long-term debt obligations consisted of the
following (in thousands):

<TABLE>

             <S>                                       <C>
             Bank revolving credit agreement (a)       $ 1,697
             Obligation under capital lease (b)            369
                                                       -------
                                                         2,066
             Less current portion                          (69)
                                                       -------
             Long-term debt                            $ 1,997
                                                       =======
</TABLE>

      (a) On May 30, 1997, the Company entered into a two year, $3.5 million
revolving loan agreement with First Union Bank of Connecticut (subsequently
renamed First Union National Bank, hereinafter referred to as "First Union"),
modifying and replacing its previous one year, $2.5 million agreement with
First Union. Certain terms and conditions of this agreement were further
modified in December 1997. Under the current agreement, borrowings are advanced
at 75% of eligible accounts receivable, bear interest at First Union prime plus
 .5% (9% at December 31, 1997), and are secured by all of the Company's assets
excluding inventories. The agreement requires the Company to maintain a minimum
net worth of $5.3 million, and to maintain certain debt to net worth and debt
service coverage ratios. In addition, the agreement restricts fixed asset
purchases and does not allow the payment of cash dividends without the consent
of the lender. There is no requirement to maintain compensating balances under
the agreement. The Company was in compliance with these covenants and loan
requirements at December 

<PAGE> 23

31, 1997. As of December 31, 1997, the unused portion of the credit facility 
was $1,803,000, of which approximately $1,050,000 was available under the 
borrowing formula. The average and highest amounts borrowed under these credit 
facilities during the year ended December 31, 1997 were approximately 
$1,714,000 and $2,282,000, respectively. Borrowings are dependent upon the 
continuing generation of collateral, subject to the credit limit. The weighted 
average interest rate on the Company's outstanding debt was 10.1 % for
1997 and 10.6% for 1996. The carrying values of the Company's borrowings
approximated their fair values at December 31, 1997 and 1996.

      (b) In May 1997, the Company entered into a five year, noncancelable
lease agreement to finance $419,000 of office furniture, equipment and computer
equipment acquired in connection with the Company's relocation to a larger
operating facility. Monthly lease payments under the lease are $9,589, with a
$1.00 purchase option at the end of the lease. The effective interest rate on
the capitalized lease obligation is 13.29%. As of December 31, 1997 the future
minimum annual lease payments are as follows (in thousands):

<TABLE>

            <S>                                                 <C>
            Year ending December 31:
              1998                                              $ 115
              1999                                                115
              2000                                                115
              2001                                                115
              2002                                                 29
                                                                -----
            Total minimum lease payments                          489
            Less amount representing interest                    (120)
                                                                -----
            Present value of net minimum lease payments 
             under capital lease                                $ 369
                                                                =====
</TABLE>

7.  DISCONTINUED OPERATIONS

      FAMS
      ----

      In February, 1996, the Company purchased from AT&T Systems Leasing
Corporation, a subsidiary of AT&T Capital Corporation, certain assets of its
discontinued Asset Recovery Center ("ARC") for a purchase price of $250,000.
Prior to its closing in January 1996, the ARC primarily operated to service
AT&T affiliates in the orderly disposition, by way of consignment sales
arrangements, of excess, overstocked and end-of-life telecommunications,
computer and data transmission equipment. The assets acquired consisted
primarily of warehouse equipment, vehicles, computer and office equipment, and
inventory. The Company concurrently formed a subsidiary corporation, Farmstead
Asset Management Services, LLC ("FAMS"), which used the purchased assets in a
similar operation in Piscataway, New Jersey.

      In September 1997, due to declining revenues and resulting operating
losses, the Company entered into negotiations with an employee of FAMS for the
sale of the Company's interest in FAMS. The sale transaction was completed in
December, effective October 1,1997. FAMS, LLC, a newly formed New Jersey
corporation (the "Buyer") acquired all of the Company's interest in FAMS for
$40,000 in cash and a $360,000 10% Note, payable in 60 monthly installments.
The Note is secured by a $45,000 letter of credit and by all of the assets of
FAMS. The Company has recorded a loss on disposal of FAMS of $208,000,
consisting of $116,000 representing the excess of the book value of the net
assets sold over the sales proceeds, and $92,000 of other costs and expenses of
the sale. For the years ended December 31, 1997 and 1996, FAMS recorded
revenues of $799,000 and $1,230,000, respectively. Prior to the effective date
of sale, FAMS incurred an operating loss of approximately $578,000 in 1997, as
compared with an operating loss of approximately $370,000 in 1996.

      Voice Processing Products
      -------------------------

      In December 1997 the Company began actively pursuing divesting itself of
its Cobotyx voice processing products business. Assets expected to be sold
during 1998 include inventories, fixed assets, and certain other 

<PAGE> 24

current assets which, as of December 31, 1997 aggregated approximately 
$560,000, plus all related technologies developed by the Company, tradenames, 
and other contract rights. The operations of the Cobotyx business unit through 
its disposal date are not expected to have a material impact on the Company's 
operating results, and the Company expects to sell these assets at 
approximately book value. For the years ended December 31, 1997 and 1996, 
voice processing product revenues approximated $1,479,000 and $2,297,000, 
respectively. The Company's loss from the operations of its voice processing 
products business was approximately $480,000 in 1997 as compared to income of 
approximately $46,000 in 1996.

      The Company has restated prior year information contained in the
consolidated financial statements and notes thereto as a result of these
discontinued operations.

8.  STOCK OPTIONS

      The Company's 1992 Stock Option Plan ("1992 Plan") permits the granting
of options to employees, directors and consultants of the Company, which shall
be either incentive stock options as defined under Section 422 of the Internal
Revenue Code, or non-qualified options. Incentive stock options may be granted
at no less than market value at the time of granting, with a maximum term of
ten years except, for a 10% or more stockholder, the exercise price shall not
be less than 110% of market value, with a maximum term of five years. The
Company is authorized to grant options to acquire up to 3,500,000 shares of
common stock under the 1992 Plan, which expires in 2002.

      The Company's 1986 and 1987 Key Employees and Key Personnel Stock Option
Plans have expired, however options previously granted under these plans may
continue to be exercised in accordance with the terms of the individual grants.
Options currently granted under all plans expire on various dates through 2007.

      A summary of stock option transactions for each of the two years in the
period ended December 31, 1997 is as follows (the number of shares and option
prices for all periods prior to August, 1996 have been adjusted for the effects
of the 1-for-10 reverse stock split implemented on that date):

<TABLE>
<CAPTION>
                                                                             Weighted
                                                                             Average
                                               Number         Exercise       Exercise
                                              of Shares     Price Range       Price
                                              ---------    --------------    --------

<S>                                           <C>          <C>                <C>
Outstanding at December 31, 1995                300,441    $ 1.56 - 11.80     $ 4.25
  Granted                                       565,959      2.20 -  6.70       3.32
  Exercised                                        (500)             2.20       2.20
  Canceled or lapsed                            (44,250)     3.30 -  4.20       4.17
                                              --------------------------------------
Outstanding at December 31, 1996                821,650      1.56 - 11.80       3.69
  Granted                                     1,000,109      1.88 -  3.75       2.18
  Exercised                                           -                 -          -
  Canceled or lapsed                           (914,150)     2.13 - 10.00       3.58
                                              --------------------------------------
Outstanding at December 31, 1997                907,609    $ 1.56 - 11.80     $ 2.14
                                              ======================================

As of December 31, 1997:
  Exercisable                                    70,468    $ 1.56 - 11.80     $ 3.39
  Available for future grant                  2,612,333
</TABLE>

      The following table summarizes information about stock options
outstanding as of December 31, 1997:

<PAGE> 25

<TABLE>
<CAPTION>

                                Options Outstanding                       Options Exercisable
                   ----------------------------------------------    -----------------------------
                                  Weighted Avg.
                                    Remaining                
   Range of          Number        Contractual     Weighted Avg.       Number       Weighted Avg.
Exercise Prices    Outstanding    Life (Years)     Exercise Price    Exercisable    Exercise Price
---------------    -----------    -------------    --------------    -----------    --------------

 <S>                 <C>               <C>             <C>             <C>              <C>
 $1.56 -  2.00       875,259           9.5             $ 1.99          45,118           $ 1.83
 $2.01 -  5.00        16,000           5.0               3.73          13,000             3.79
 $5.01 - 11.80        16,350           6.0               8.33          12,350             8.66
</TABLE>

      Effective September 2, 1997, the Company issued replacement options to
all employees and directors who had outstanding options at that date with an
exercise price higher than $2.00 per share. The replacement options were issued
at $2.00 per share which represented the fair market value of the common stock
on the grant date. Approximately 847,000 options were cancelled and replaced
with these new grants.

      The Company applies Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its stock option plans. Accordingly, compensation cost for stock
options is recorded as the excess, if any, of the market price of the Company's
common stock at the date of grant over the exercise price of the option. Had
compensation cost for the Company's stock option plans been determined in
accordance with the methodology prescribed under Statement of Financial
Accounting Standards No. 123, "Accounting for Stock- Based Compensation", the
Company's net income (loss) and basic and diluted net income (loss) per share
would have approximated the pro forma amounts shown below for each of the years
ended December 31 (in thousands except per share data):

<TABLE>
<CAPTION>
                                                 1997                     1996
                                        ----------------------    ---------------------
                                           As                        As
                                        Reported     Pro forma    Reported    Pro forma
                                        ---------    ---------    --------    ---------

<S>                                     <C>          <C>           <C>          <C>
Net income (loss)                       $ (1,866)    $ (2,315)     $ 882        $ 418
Basic net income (loss) per share           (.57)        (.71)       .36          .17
Diluted net income (loss) per share         (.57)        (.71)       .35          .17
</TABLE>

      The fair value of options granted during 1997 was estimated on the date
of grant using the Black-Scholes option-pricing model with the following
weighted average assumptions: 5.37% (6.25% in 1996) risk-free interest rate, 
expected option lives of 5 years (3.4 years in 1996), expected volatility of 
80%, and no dividend yield.

9.  STOCKHOLDERS' EQUITY

      In 1986, 416,663 warrants were issued in conjunction with the formation
of the Company, each warrant entitling the holder to purchase one-half share of
common stock at a price of $2.00 per share, expiring April 30, 1992. In May
1987, the Company sold 3,313,630 units in its initial public offering, each
unit consisting of one share of common stock and a detachable unit warrant
(together with the warrants issued in 1986, hereinafter referred to as "Public
Warrants") entitling the holder to purchase one-half share of common stock at a
price of $2.00 per share, expiring April 30, 1992. Pursuant to the underwriting
agreement the Company issued to its underwriters options ("Underwriters
Options") to purchase 331,363 of the Company's units, exercisable at $1.68 per
unit through April 13, 1992.

      Since May 1987, the Company has periodically extended and modified both
the Public Warrants and the Underwriters Options. Currently, both are due to
expire on June 30, 2002. The Public Warrants are currently exercisable at $4.70
per share, and entitle the holder to acquire 1.06 shares of common stock for
each warrant tendered. They are subject to redemption by the Company on thirty
days written notice at a price of $.05 per warrant, if the bid price for the
common stock is $11.25 or higher per share for ten consecutive business days.
The Underwriters Options are exercisable at $7.50 per unit, entitling the
holder to acquire one share of common stock 

<PAGE> 26

and a warrant, exercisable at $4.70 per share, to purchase 1.06 shares of 
common stock. As of December 31, 1997, there were 183,579 Public Warrants 
outstanding.

      In September 1996, the Company completed a secondary offering of
1,000,000 Units, each Unit consisting of one share of Common Stock, one
Redeemable Class A Common Stock Purchase Warrant (the "Class A Warrants") and
one Redeemable Class B Common Stock Purchase Warrant (the "Class B Warrants",
and collectively with the Class A Warrants, the "Warrants") at an offer price
of $4.06 per Unit. The Units were first offered to stockholders of record as of
August 12, 1996 pursuant to a Rights Offering, which resulted in the sale of
80,512 Units. Upon completion of the Rights Offering, all of the remaining
919,488 Units were then sold through an underwritten offering. In October 1996
an additional 137,923 Units were sold to the Company's underwriter, pursuant to
the underwriter's over-allotment option provision. These transactions resulted
in proceeds of approximately $3,746,000, net of expenses.

      Prior to the commencement of the secondary offering, the Company
implemented a 1-for-10 reverse stock split which became effective August 13,
1996, and which had the effect of reducing the number of outstanding shares of
common stock prior to the commencement of the secondary offering from
21,243,676 to 2,124,406, and the number of outstanding warrants from 1,835,727
to 183,579. In this report, all per share amounts, numbers of shares, stock
options and market prices of the Company's common stock for periods prior to
the reverse split have been restated to give retroactive recognition to the
reverse stock split.

      Each Class A Warrant entitles the holder to purchase one share of Common
Stock at a price of $5.28 and each Class B Warrant entitles the holder to
purchase one share of Common Stock at a price of $6.09 at any time until August
12, 2001. The Warrants are redeemable by the Company at a redemption price of
$.10 per Warrant on thirty days' prior written notice, provided that the
reported closing price of the Common Stock equals or exceeds $6.09 for the
Class A Warrants and $6.90 for the Class B Warrants, for a period of twenty
consecutive trading days ending five days prior to the notice of redemption.

      In connection with the underwritten portion of the secondary offering,
the Underwriter received a warrant to purchase 89,948 Units at an exercise
price of $6.70, exercisable from September 17, 1997 until September 16, 2001.

10.  INVESTMENT IN UNCONSOLIDATED SUBSIDIARIES

      In May 1995, the Company completed the acquisition of a 50% interest in
Beijing Antai Communication Equipment Co., Ltd. ("ATC"), for a purchase price
of $100, plus a $390,000 capital contribution to ATC. ATC, located in Beijing,
Peoples Republic of China ("PRC"), was formed in October 1992 as a Joint
Venture Enterprise, and is also owned 50% by Beijing Aquatic Product Inc. ATC,
previously a distributor for the Company in the PRC, markets, assembles,
manufactures, installs and services the Company's telecommunications products
which have been developed for use in the PRC. These products include (i) used
Lucent PBX equipment, and (ii) central office equipment, consisting of
proprietary Chinese system software, proprietary digital and analog interfaces,
and a proprietary billing system, the combination of which enables the PBX
equipment to be operated as a small central office. ATC also distributes and
installs local telecommunications transmission systems and home and business
alarm systems, however their historical operations to date have been
insignificant, and no assurances can be given that the Company or ATC will be
successful in selling its products in the PRC. The acquisition costs exceeded
the underlying equity in the net assets of ATC by approximately $190,000 which
were being amortized on a pro rata basis over the remaining 17 year term of the
joint venture. In June 1997, due principally to fiscal year 1997 operating
losses at Beijing Antai Communication Equipment Co., LTD. ("ATC"), and a shift
in the Company's focus to domestic business development, the Company
established a full reserve against both the $77,000 balance of its investment
in, and its $265,000 accounts receivable from, ATC, which aggregated a $342,000
non-cash charge against earnings.

<PAGE> 27

      In June 1996, the Company and several Philippines investors formed
TeleSolutions, Inc., in which the Company invested $40,000 for a 40% ownership
interest. TeleSolutions was formed for the purpose of refurbishing, installing
and selling telecommunications equipment in the Republic of the Philippines. In
June 1997, the Company wrote off $52,000 of inventory located at TeleSolutions,
Inc., and accrued $10,000 of estimated closing costs for this operation.

      The following table shows the changes in the Company's investment in
unconsolidated subsidiaries during each of the years ended December 31
($000's):

<TABLE>
<CAPTION>
                                                              1997      1996
                                                             ------    ------

      <S>                                                    <C>       <C>
      Investment at beginning of year                        $ 117     $ 201
      Capital contribution, including other direct 
       acquisition costs                                         -        40
      Equity in unconsolidated subsidiary:
        Equity in net losses                                   (34)     (113)
        Amortization of excess of cost over equity 
         in net assets                                          (6)      (11)
        Write-down of investment balance                       (77)        -
                                                             ---------------
      Investment at end of year                              $   -     $ 117
                                                             ===============
</TABLE>

11.  LEASES AND OTHER COMMITMENTS AND CONTINGENCIES

      In November 1996, the Company entered into a five year lease, commencing
February 1997, for a 34,760 square foot building in East Hartford, CT. Under
the terms of the lease agreement, the minimum monthly rental will be $13,759
for the first two years, $14,483 for year three, and $15,207, for years four
and five. The lease agreement contains two three-year renewal options. In March
1997, the Company relocated substantially all of its Connecticut operations
into this facility. Rent expense from continuing operations was $197,000 in
1997 and $191,000 in 1996. Future minimum lease payments under noncancelable
operating leases at December 31, 1997 are as follows: $165,108 for 1998,
$172,348 for 1999, $181,036 for 2000, $182,484 for 2001, and $30,414 for 2002,
totaling $731,390.

      Effective January 1, 1998, the Company entered into a ten year employment
agreement with the Chief Executive Officer ("CEO"). The agreement provides for
five years of full-time employment (the "Active Period"), and five years of
limited employment (the "Limited Period") commencing January 1, 2003. During
the Active Period, a minimum annual base salary will be paid as follows:
$200,000 in 1998, $250,000 in 1999, and $300,000 for 2000 to 2003. During the
Limited Period, the CEO will be paid an annual amount equal to one-third of the
base salary rate in effect at the commencement of the Limited Period, as
consideration for up to fifty days of active service per year. The agreement
provides for an annual bonus of up to 50% of base salary during the term of the
agreement, an option to purchase up to 500,000 shares of common stock at the
fair market value on the date of grant, and $1,500,000 in life insurance for
the benefit of the CEO's named designee.

      The agreement provides for severance pay during the term should the
Company terminate the agreement without cause, or in the event of a change in
control of the Company, as defined. During the Active Period, severance pay
will equal three times (i) the amount of the then-current base pay, plus (ii)
the average bonus paid during the three most recent years. During the Limited
Period, severance pay will equal three times the total amount that would have
been due for the time remaining in the Limited Period. In addition, the Company
is obligated to provide supplemental retirement benefits, payable at age 65 to
80, in an amount equal to one-third of the CEO's average final three year
salary, currently estimated to be $100,000 per year. To fund this retirement
obligation and insurance benefit, the Company concurrently established a
Supplemental Executive Retirement Plan and purchased a split dollar variable
life insurance policy with a $50,000 annual 10 year premium.

<PAGE> 28

12.  INCOME TAXES

      Current income tax expense attributable to income from continuing
operations consisted of state tax expense of $24,000 and federal tax expense of
$19,000 in 1997, and state tax expense of $19,000 in 1996. There was no
deferred federal or state tax expense in either of those years.

      Income tax expense differed from the amounts computed by applying the
U.S. federal income tax rate of 34 percent to pretax income (loss) as a result
of the following (in thousands):

<TABLE>
<CAPTION>
                                                           1997       1996
                                                          -------    ------

<S>                                                       <C>        <C>
Computed "expected" tax expense (benefit)                 $ (634)    $  300
Increase (reduction) in income taxes resulting from:
  Amortization of goodwill                                     3          3
  State and local income taxes, net of federal income
   tax benefit                                                16         15
  Unutilized loss of foreign subsidiary                      133         43
  (Realized) unrealized benefit of operating loss 
   carryforwards                                             506       (350)
  Other                                                       19          8
                                                          -----------------
                                                          $   43     $   19
                                                          =================
</TABLE>

      The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and liabilities at December 31, 1997 and 1996
are as follows (in thousands):

<TABLE>
<CAPTION>
                                                                     1997        1996
                                                                   --------    --------

<S>                                                                <C>         <C>
Deferred tax assets
  Accounts receivable, principally due to allowance for 
   doubtful accounts                                               $    125    $    100
Inventories, principally due to additional costs inventoried 
 for tax purposes pursuant to the Tax Reform Act of 1986                139         142
Net operating loss and capital loss carryforwards                     1,133         855
Other                                                                     8         130
                                                                   --------------------
  Total gross deferred tax assets                                     1,405       1,227
  Less valuation allowance                                           (1,405)     (1,227)
                                                                   --------------------
  Net deferred tax assets                                          $      -    $      -
                                                                   ====================
Deferred tax liabilities                                           $      -    $      -
                                                                   ====================
</TABLE>

      The valuation allowance is considered necessary due to the Company's past
history of operating losses. Accordingly, net deferred tax assets have been
reduced to the amount which management believes is more likely than not to be
realized.

      The Company has net operating loss carryforwards for federal income tax
purposes of approximately $3,229,000. No federal income tax provision has been
made in the accompanying financial statements, except for alternative minimum 
taxes paid in 1997, because of the presence of net operating loss 
carryforwards. These carryforwards expire on various dates through 2012.

<PAGE> 29

INDEX TO EXHIBITS

      Registrant hereby incorporates by reference the following documents filed
as part of the S-18 Registration Statement of the Company's securities declared
effective on April 13, 1987 (File No. 3-9556B).

      3(a)    Certificate of Incorporation.

      3(b)    By-Laws.

      4(a)    Form of Unit Warrant.

      4(b)    Amended Form of Underwriter's Option.

      4(c)    1986 Key Employees and Key Personnel Stock Option Plan.

      4(d)    1987 Key Employees and Key Personnel Stock Option Plan.

      10(i)   Agreement between the Company and AT&T.

      Registrant hereby incorporates by reference the following exhibits filed
with the Registrant's Annual Report for the year ended December 31, 1988 on
Form 10-K:

      10.5    Amendment to the 1986 Key Employees and Key Personnel Stock
              Option plan previously filed as Exhibit No. 4(c) in the Form S-18
              Registration Statement of Farmstead Telephone Group, Inc.
              declared effective on April 3, 1987.

      10.6    Amendment to the 1987 Key Employees and Key Personnel Stock
              Option Plan previously filed as Exhibit No. 4(d) in the Form S-18
              Registration Statement of Farmstead Telephone Group, Inc.
              declared effective on April 13, 1987.

      Registrant hereby incorporates by reference the following exhibits filed
as part of the S-3 Registration Statement of the Company's securities declared
effective on July 3, 1991 (File No. 33-41442)

      4       Form of Private Placement Warrant

      Registrant hereby incorporates by reference the following exhibits filed
with the Registrant's Annual Report for the year ended December 31, 1991 on
Form 10-K:

      10.12   Certificate of Amendment of Certificate of Incorporation of
              Farmstead Telephone Group, Inc., dated July 10, 1991.

      Registrant hereby incorporates by reference the following exhibits filed
with the Form S-3 Registration Statement of the Company's securities declared
effective on October 29, 1992 (Registration No. 33-50432):

      4(a)    Resolutions adopted by Unanimous Written Consent of the Company's
              Board Of Directors dated as of July 9, 1992 amending terms of
              Warrants and Underwriter's Options.

      10(e)   Agreement dated June 25, 1992 between the Company and The Wall
              Street Group, Inc.

<PAGE> 30

      Registrant hereby incorporates by reference the following exhibit filed
with the Registrant's Annual Report on Form 10-K for the year ended December
31, 1992:

      4(e)    1992 Stock Option Plan.

      Registrant hereby incorporates by reference the following exhibits filed
as part of Form SB-2 , Amendment No. 1, dated January 21, 1995 (Registration
No. 33-87134):

      10.7    Stock Purchase Agreement between Farmstead Telephone Group, Inc.
              and DW International Ltd., dated December 31, 1994.

      Registrant hereby incorporates by reference the following exhibit filed
with the Registrant's Annual Report on Form 10-KSB for the year ended December
31, 1994:

      10.3    Summary compensation arrangements for Named Executive.

      Registrant hereby incorporates by reference the following exhibits filed
with the Registrant's Quarterly Report on Form 10-QSB for the quarter ended
June 30, 1995:

      10.2    Commercial Revolving Loan and Security Agreement dated June 5,
              1995, between Farmstead Telephone Group, Inc. and Affiliated
              Business Credit Corporation

      10.3    Contract for Beijing Antai Communication Equipment Company Ltd.,
              dated September 23, 1992

      Registrant hereby incorporates by reference the following exhibits filed
with the Registrant's Annual report on Form 10-KSB for the year ended December
31, 1995:

      10.1    Letter agreement dated March 11, 1996, amending the Commercial
              revolving Loan and Security Agreement dated June 5, 1995 between
              Farmstead Telephone Group, Inc. and Affiliated Business Credit
              Corporation

      Registrant hereby incorporates by reference the following exhibits filed
as part of SB-2 Registration Statement dated June 3, 1996 (Registration No.
333-5103):

      1.1     Form of Standby Underwriting Agreement.

      1.2     Form of Selected Dealers Agreement.

      4.2     Form of Underwriter's Warrant Agreement (including Form of
              Underwriter's Warrant).

      10.1    Form of Underwriter's Consulting Agreement.

      Registrant hereby incorporates by reference the following exhibits filed
as part of Amendment No. 1 to SB-2 Registration Statement dated July 22, 1996
(Registration No. 333-5103):

      10.2    Letter of Agreement dated June 3, 1996 between Farmstead
              Telephone Group, Inc. and Lucent Technologies, Inc.

      Registrant hereby incorporates by reference the following exhibits filed
as part of Amendment No. 2 to SB-2 Registration Statement dated July 22, 1996
(Registration No. 333-5103):

<PAGE> 31

      3(a)    Amendment of Certificate of Incorporation.

      4.1     Form of Warrant Certificate.

      4.3     Form of Warrant Agreement.

      4.4     Form of Unit Certificate.

      Registrant hereby incorporates by reference the following exhibits filed
with the Registrant's Quarterly Report on Form 10-QSB for the quarter ended
September 30, 1996:

      10.1    Agreement of Lease By and between Tolland Enterprises and
              Farmstead Telephone Group, Inc., dated November 5, 1996.

      Registrant hereby incorporates by reference the following exhibits filed
with the Registrant's Quarterly Report on Form 10-QSB for the quarter ended
June 30, 1997:

      10.1    Letter agreement dated as of May 30, 1997 by and among Farmstead
              Telephone Group, Inc. (the "Borrower"), Farmstead Asset
              Management Services, LLC (the "Guarantor") and First Union Bank
              of Connecticut (successor-in-interest to Affiliated Business
              Credit Corporation) (the "Lender"), amending the Commercial
              Revolving Loan and Security Agreement dated June 5, 1995, as
              amended, between Borrower and Lender.

      10.2    Third Amended and Restated Revolving Promissory Note, dated June
              6, 1997, in the amount of $3,500,000.

      10.3    Agreement for Wholesale Financing, dated June 6, 1997, and
              related letter agreement dated June 3, 1997.

      The following exhibits are filed herewith:

      10.1    Purchase and Sale Agreement, dated December 1, 1997 by and among
              Farmstead Telephone Group, Inc., FTG Venture Corporation, FAMS,
              LLC and Farmstead Asset Management Services, LLC.

      10.2    Letter agreement dated December 1, 1997 by and among Farmstead
              Telephone Group, Inc., FTG Venture Corporation, FAMS, LLC and
              Farmstead Asset Management Services, LLC, amending the Purchase
              and Sale Agreement.

      10.3    FAMS, LLC Promissory Note, dated December 1, 1997 in the
              principal amount of $360,000.

      10.4    Letter agreement dated as of December 1, 1997 by and among
              Farmstead Telephone Group, Inc. (the "Borrower"), Farmstead Asset
              Management Services, LLC (the "Guarantor") and First Union
              National Bank (successor-in-interest to Affiliated Business
              Credit Corporation), amending the Commercial Revolving Loan and
              Security Agreement dated June 5, 1995, and as amended May 30,
              1997.

      10.5    Employment Agreement dated as of January 1, 1998 between
              Farmstead Telephone Group, Inc. and George J. Taylor, Jr.

<PAGE> 32

      10.6    Supplemental Executive Retirement Plan, effective as of January
              1, 1998

      21.     Subsidiaries of Small Business Issuer

<PAGE> 33