CORTELCO SYSTEMS INC, S-1/A, 1999-08-10

CORTELCO SYSTEMS INC
S-1/A, 1999-08-10
TELEPHONE & TELEGRAPH APPARATUS

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<PAGE>

As filed with the Securities and Exchange Commission on August 10, 1999
Registration No. 333-77021
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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AMENDMENT NO. 4
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

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Cortelco Systems, Inc.
(Name of Registrant as specified in its charter)

Delaware 3661 62-1482176
(State or other (Primary Standard Industrial (I.R.S. Employer
jurisdiction of Classification Code) Identification No.)
incorporation or
organization)

4119 Willow Lake Blvd. Memphis, TN 38118 (901) 365-7774
(Address and telephone number of principal executive offices and principal
place of business)

J. Michael O'Dell
President and Chief Executive Officer
Cortelco Systems, Inc.
4119 Willow Lake Blvd.
Memphis, TN 38118
(901) 365-7774
(Name, address and telephone number of agent for service)

Copies to:
James C. Kitch, Esq. Alan Dean, Esq.
COOLEY GODWARD LLP DAVIS POLK & WARDWELL
Five Palo Alto Square 450 Lexington Avenue
3000 El Camino Real New York, NY 10017
Palo Alto, California 94036 (212) 450-4000
(650) 843-5000

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Approximate date of proposed sale to the public: As soon as practicable
after the registration statement becomes effective.
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If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, please check the following box. [_]

If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]

If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]

If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]

If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]

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CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
Proposed Maximum Proposed Maximum
Title of Securities to Amount to be Offering Price Per Aggregate Offering Amount of
be Registered Registered Share(1) Price(1) Registration fee(2)
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<S> <C> <C> <C> <C>
Common Stock, $.001 par
value.................. 3,680,000 $12.00 $44,160,000 $12,276
</TABLE>
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(1) Estimated solely for the purpose of calculating the amount of the
registration fee in accordance with Rule 457(a) under the Securities Act
of 1933.

(2) The fee has been previously paid.

The registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant
shall file a further amendment which specifically states that this
registration statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act of 1933, as amended, or until the
registration statement shall become effective on such date as the Securities
and Exchange Commission, acting pursuant to said Section 8(a), may determine.

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<PAGE>

++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this preliminary prospectus is not complete and may be +
+changed. These securities may not be sold until the registration statement +
+filed with the Securities and Exchange Commission is effective. This prelimi- +
+nary prospectus is not an offer to sell nor does it seek an offer to buy +
+these securities in any jurisdiction where the offer or sale is not permit- +
+ted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
Prospectus Subject To Completion,

Dated August 10, 1999

3,200,000 Shares

Common Stock

Cortelco Systems, Inc. is offering 2,380,000 shares of its common stock. The
selling stockholders are offering an additional 820,000 shares. We will not
receive any of the proceeds from the sale of shares by the selling
stockholders. This is our initial public offering and no public market
currently exists for our common stock. We estimate that the initial public
offering price will be between $10.00 and $12.00 per share.

We have filed an application to qualify our common stock for quotation on the
Nasdaq National Market under the symbol "CORT."

Investing in the common stock involves risks. See "Risk Factors" beginning on
page 4.

NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.

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<TABLE>
<CAPTION>
Proceeds to
Price to Underwriting Proceeds to Selling
Public Discounts Cortelco Stockholders
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<S> <C> <C> <C> <C>
Per Share $ $ $ $
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Total $ $ $ $
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</TABLE>

Cortelco has granted the underwriters the right to purchase up to an additional
109,464 shares of common stock to cover over-allotments and the selling
stockholders have granted the underwriters the right to purchase up to an
additional 370,536 shares of common stock to cover over-allotments.

J.P. Morgan & Co.

Needham & Company, Inc.

A.G. Edwards & Sons, Inc.

, 1999
<PAGE>

Table of Contents

<TABLE>
<CAPTION>
Page
<S> <C>
Prospectus Summary.................... 1
Risk Factors.......................... 4
Forward-Looking Statements............ 10
Company Background.................... 10
Use of Proceeds....................... 11
Dividend Policy....................... 11
Capitalization........................ 12
Dilution.............................. 13
Selected Pro Forma Consolidated
Financial Data....................... 14
Selected Consolidated Financial Data.. 15
Management's Discussion and Analysis
of Financial Condition and Results
of Operations........................ 16
</TABLE>
<TABLE>
<CAPTION>
Page
<S> <C>
Business............................ 24
Management.......................... 39
Principal and Selling Stockholders.. 47
Certain Transactions................ 49
Description of Capital Stock........ 51
Shares Eligible for Future Sale..... 53
Underwriting........................ 55
Legal Matters....................... 57
Experts............................. 57
Additional Information.............. 57
Index to Financial Statements....... F-1
</TABLE>

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In deciding whether to buy our common stock, you should rely only on the
information contained in this prospectus. To understand this offering fully,
you should read this entire prospectus carefully, including the financial
statements and notes. Individual sections of this prospectus, such as the
Prospectus Summary, are not complete and do not contain all of the information
that you should consider before investing in our common stock. We have not
authorized anyone to provide you with information different from that contained
in this prospectus. We are offering to sell, and seeking offers to buy, shares
of common stock only in jurisdictions where offers and sales are permitted. The
information contained in this prospectus is accurate only as of the date of
this prospectus, regardless of the time of delivery of this prospectus or of
any sale of the common stock.

Until , 1999, all dealers that buy, sell or trade our common stock, whether
or not participating in this offering, may be required to deliver a prospectus.
This is in addition to the dealers' obligation to deliver a prospectus when
acting as underwriters and with respect to their unsold allotments or
subscriptions.

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<PAGE>

Cortelco Provides Flexible Networked Systems for Voice, Video and Data
Communications

Automatic Call Distribution

In-building & Campus Centralized Voice
Wireless Functionality Processing & Unified
Messaging

Cortelco's Multi-Site
Networked Digital
Communications Platforms

Remote Agent & Internet Protocol
Telecommuter Services Services

Computer Telephony Circuit Switched Data
Integration
<PAGE>

Prospectus Summary

You should read the following summary together with the more detailed
information and financial statements and related notes appearing elsewhere in
this prospectus.

Cortelco Systems, Inc.

Our communications systems are based on two platforms, the Millennium and the
DSP Series. Both of our platforms support multi-site networking and other
advanced features such as dynamic call routing, interactive voice response,
voicemail and computer telephony integration. The Millennium is a full-function
routing and control system that primarily serves customers averaging
approximately 110 communications ports per installation. The Millennium also
includes automatic call distribution features. The DSP Series is primarily an
advanced automatic call distribution system that also includes a full-function
routing and control system. The DSP Series is typically used in installations
requiring advanced computer telephony integration applications such as those
used in sophisticated call centers. Both the Millennium and the DSP Series
interface with a variety of popular third-party products through standard
protocols.

Our integrated communications systems are flexible enough to meet the needs of
enterprises with small to medium-sized installations, yet are scalable enough
to accommodate these enterprises as they grow. Key elements of our strategy
include:

. targeting enterprises with small to medium-sized installations at one
or more locations

. providing customers with cost-effective, integrated solutions for
their voice communications requirements

. expanding both our direct sales force and our dealer network to more
aggressively pursue our target markets

. continuing to enhance our core product lines and develop new features
and applications that leverage our existing Millennium and DSP Series
platforms

As a result of these initiatives and a contract with the FAA accounting for
$9.9 million of revenues during the nine months ended April 30, 1999, our pro
forma revenues increased 50.2% from $25.6 million for the nine months ended
April 30, 1998 to $38.4 million for the nine months ended April 30, 1999. Pro
forma net income (loss) increased from $(1.2) million for the nine months ended
April 30, 1998 to $3.2 million for the nine months ended April 30, 1999.
Current development efforts address emerging market needs, such as unified
messaging, voice-over-Internet Protocol and Web-based virtual call center
capabilities.

In April 1999, we merged with Cortelco Systems Puerto Rico and acquired BCS
Technologies, Inc. We are a Delaware corporation with executive offices located
at 4119 Willow Lake Blvd., Memphis, Tennessee 38118 and our telephone number is
(901) 365-7774. Our Web site address is www.cortelcosystems.com. The
information on our Web site is not part of this prospectus.

1
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The Offering

<TABLE>
<S> <C>
Common stock offered by Cortelco............. 2,380,000 shares
Common stock offered by the selling
stockholders................................ 820,000 shares
Common stock outstanding after the offering.. 11,454,826 shares
Use of proceeds.............................. To repay debt and for working
capital and general corporate
purposes. See "Use of Proceeds."
Proposed Nasdaq National Market symbol....... CORT
</TABLE>

Unless otherwise indicated, the references to numbers and percentages of shares
of common stock in this prospectus assume that:

. the underwriters' over-allotment option is not exercised

. 1,463,206 shares of Series A convertible preferred stock shall, by its
terms, convert into 1,434,894 shares of common stock upon the closing of
this offering

All references to shares of common stock in this prospectus reflect the impact
of a 1-for-10 reverse split of the common stock effected in April 1999.

The information above excludes outstanding options to purchase up to 1,415,766
shares of common stock as of April 30, 1999 and 1,262,018 shares of common
stock reserved for future issuance under our 1999 Equity Incentive Plan and
1999 Employee Stock Purchase Plan.

2
<PAGE>

Summary Financial Data

The following table contains summary pro forma and historical financial data of
Cortelco. The summary pro forma financial data should be read together with our
Unaudited Pro Forma Consolidated Financial Information and related notes,
Cortelco's consolidated financial statements and related notes, BCS' financial
statements and related notes and "Management's Discussion and Analysis of
Financial Condition and Results of Operations." The summary historical
financial data should be read together with Cortelco's consolidated financial
statements and related notes and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."

The pro forma financial data in the table below reflects adjustments to the
historical financial statements of Cortelco that (1) reflect the purchase
method of accounting for the acquisition of BCS and (2) eliminate the results
of operations and related assets and liabilities not acquired from the merger
with Cortelco Systems Puerto Rico.

The as adjusted balance sheet data is adjusted to reflect the sale of 2,380,000
shares of common stock in this offering, the net proceeds from which are
estimated to be approximately $23.8 million after deducting underwriting
discounts and commissions and estimated offering expenses payable by Cortelco.
The as adjusted balance sheet data is also adjusted to reflect the intended
repayment of $4.9 million of senior and long-term subordinated debt from the
net proceeds of the offering.

In thousands, except per share data
<TABLE>
<CAPTION>
---------------------------------------------
Nine Months Ended
Year Ended ------------------------------
Consolidated Statement July 31, 1998 April 30, 1998 April 30, 1999
of Operations Data: ------------- -------------- --------------
<S> <C> <C> <C>
Pro Forma (unaudited)
Net revenues.................... $ 36,618 $ 25,577 $ 38,425
Gross profit.................... 16,945 11,727 19,910
Operating expenses.............. 15,909 12,057 14,458
Income (loss) from operations... 1,036 (330) 5,452
Net income (loss)............... $ (77) $ (1,240) $ 3,206
========== ========== ==========
Basic pro forma net income
(loss) per share............... $ (0.01) $ (0.15) $ 0.39
Diluted pro forma net income
(loss) per share............... $ (0.01) $ (0.15) $ 0.33
Weighted average shares
outstanding
Basic......................... 8,155 8,147 8,134
Diluted....................... 8,155 8,147 9,744
Historical
Net revenues.................... $ 30,172 $ 22,182 $ 27,173
Gross profit.................... 12,642 9,452 11,883
Operating expenses.............. 11,338 8,701 10,202
Income (loss) from operations... 1,304 751 1,681
Net income (loss)............... $ 316 $ (61) $ 898
========== ========== ==========
Basic net income (loss) per
share.......................... $ 0.08 $ (0.02) $ 0.22
Diluted net income (loss) per
share.......................... $ 0.07 $ (0.02) $ 0.16
Weighted average shares
outstanding
Basic......................... 3,918 3,910 4,159
Diluted....................... 5,353 3,910 5,769
</TABLE>

<TABLE>
<CAPTION>
----------------------
At April 30, 1999
----------------------
Actual As Adjusted
--------- -----------
<S> <C> <C>
Consolidated Balance Sheet
Data:
Cash and cash equivalents....... $ 1,774 $ 20,383
Working capital................. 4,849 26,335
Goodwill, net................... 11,266 11,266
Total assets.................... 34,003 51,990
Long term debt.................. 2,314 --
Common stock.................... 8 11
Total stockholders' equity...... 16,545 39,723
</TABLE>

3
<PAGE>

Risk Factors

This offering involves a high degree of risk. You should carefully consider the
risks and uncertainties described below and the other information in this
prospectus before deciding whether to invest in shares of our common stock.

Fluctuations in Our Quarterly Operating Results Could Adversely Affect the
Price of Our Common Stock

Our operating results are likely to fluctuate significantly from quarter to
quarter in the future due to a number of factors, many of which are beyond our
control. As a result, our operating results will likely not meet expectations
in some future quarters, which could have a material adverse effect on the
market price of our common stock. Factors that could affect our quarterly
operating results include the following:

. variations in the mix of products sold

. variations in the timing or size of orders from our customers

. completion of significant contracts such as the FAA contract

. delays or difficulties in introducing new products and/or in
implementing common applications across both our Millennium and DSP
Series platforms

. price decreases and other actions by our competitors

Quarterly operating results are also likely to fluctuate due to seasonal
factors that affect customers in some of our vertical markets. For example,
U.S. government customers typically make substantial purchases during the
quarter ended October 31, the last quarter of the government's fiscal year, and
these purchases decline significantly in the next quarter. Customers in other
vertical markets such as education and retail have also exhibited seasonal
buying patterns and do not purchase substantial amounts of equipment during the
quarter ended January 31. As a result, revenues in the quarter ended January 31
are often lower than in the previous quarter.

The uncertainty of our sales cycle also makes the timing of sales difficult to
predict and may cause fluctuations in our quarterly operating results. The
purchase of our products may involve a significant commitment of our customers'
personnel, financial and other resources to conduct technical evaluations, to
support installation and training and to fund purchases. As a result, our sales
cycles vary from one to six months for Millennium systems, which typically
range in price from $22,000 to $36,000 depending on the system configuration,
and from four to twelve months for DSP Series systems, which typically range in
price from $75,000 to $230,000 depending on the system configuration.
Additionally, our reliance on dealers and value added resellers to market our
products makes it even more difficult to predict the timing of sales because we
have little control over their selling efforts to end-user customers.

We generally recognize revenues on the date of shipment for Millennium systems,
but upon acceptance for DSP Series systems due to the customized nature of the
installation. Delays in shipment or acceptance due to late deliveries by our
contract manufacturers and other factors beyond our control could adversely
affect revenues in a quarter.

Our Recent Revenues Have Been Significantly Influenced by Our Contract with the
FAA and Our Revenues May Decline if We Are Unable to Replace the FAA Contract
with Additional Customer Contracts

Our recent revenues have been significantly influenced by one large customer,
the FAA. In June 1998, we began installing DSP Series systems in approximately
61 FAA sites. The FAA contract accounted

4
<PAGE>

for $9.9 million in revenues, or 25.9% of our pro forma revenues, for the nine
months ended April 30, 1999. We completed installations for the FAA contract in
June 1999. We cannot guarantee that we will be able to obtain sufficient
additional customer contracts to avoid a decline in revenues following the
completion of the FAA contract. Because of the significant contribution of the
FAA contract to our revenues during the nine months ended April 30, 1999, we
expect that our revenue growth in the next quarter will be less than the 50%
period over period growth seen for the last nine months ended April 30, 1999.

We Have a Limited Combined Operating History with BCS and Cortelco Systems
Puerto Rico and May Not Be Able to Realize Anticipated Operating Efficiencies

We have a limited combined operating history because we only recently acquired
BCS and merged with Cortelco Systems Puerto Rico. As a result, unanticipated
difficulties or delays may arise during the process of integrating our product
lines, our product development and sales and marketing efforts. Our operating
results may be adversely affected if we are not able to realize anticipated
operating efficiencies through the consolidation of certain administrative and
corporate functions and if we are not able to effectively integrate our
corporate cultures. See "Company Background."

We Have Many Established Competitors in the Communications Equipment Market and
We Cannot Assure You That We Will Be Able To Compete Effectively

The market for our products is highly competitive and subject to rapid
technological change. We expect competition to increase significantly in the
future. Our principal competitors in the voice communications equipment market
include Lucent Technologies, Mitel, NEC, Nortel Networks and Siemens. We also
compete with Aspect Telecommunications and Rockwell Electronic Commerce in the
call center market. As voice and data communications networks converge, data
equipment vendors such as Cisco Systems and 3Com may also compete in our
market. In addition, alliances and mergers between telecommunications and
computer companies may strengthen our competitors' positions or result in new
entrants into our market.

Many of our current and potential competitors have significantly greater
financial, technical, marketing, customer services and other resources, greater
name recognition and a larger installed customer base than we do. As a result,
our competitors may be able to respond to new or emerging technologies and
changes faster than we can. They may also be able to devote greater resources
to the development, promotion and sale of their products. Actions by our
competitors could result in price reductions, reduced margins and loss of
market share, any of which would have a material adverse effect on our
financial condition. We cannot assure you that we can compete successfully
against our competitors or that competitive pressures would not have a material
adverse effect on our operating results and financial condition.

We Have a Limited Direct Sales Force and Rely on Independent Dealers and Value
Added Resellers To Sell a Significant Percentage of Our Products

We have a limited direct sales force and rely on our dealers and value added
resellers to market our products. Authorized dealers and value added resellers
accounted for approximately 30% of our pro forma revenues in fiscal 1998.
Generally, our authorized dealers and value added resellers have no obligation
to sell our products and in many cases also offer our competitors' products.
Our authorized dealers and value added resellers could discontinue selling our
products at any time in favor of our competitors' products or for any other
reason. A reduction or loss of orders from our dealers and value added
resellers could have a material adverse effect on our operating results and
financial condition.

5
<PAGE>

If We Are Unable to Increase Our Sales Capability, We May Not Be Able to
Sustain or Grow Our Business

In order to increase sales, both domestically and internationally, we will need
to add to our direct sales force, expand existing distribution channels and
establish new distribution channels for our products. A failure to increase
existing or establish new distribution channels or hire personnel necessary to
develop and enhance such distribution channels could have a material adverse
effect on our operating results and financial condition. We have increased our
sales force by approximately 48% since April 30, 1998. We cannot assure you
that new sales personnel, dealers and value added resellers will be effective
at increasing sales or will achieve the same levels of productivity as our
existing sales resources. In addition, as we expand our distribution channels,
our direct sales force, dealers and value added resellers may compete with each
other for the same customers.

Our Product Platforms Must Integrate with Changing Protocols, Applications and
Third Party Technology to Remain Competitive

The markets for our products are characterized by rapid technological change,
evolving industry standards, changes in end-user customer requirements and
frequent new product introductions and enhancements. Our future success will
depend upon our ability to enhance our existing products and to develop and
introduce new products that will achieve market acceptance. A key feature of
our product platforms is their ability to integrate with most standard
protocols and transmission systems, computer telephony integration and
automatic call distribution applications and protocols, operating systems and
databases. In the event that our product platforms cannot be readily integrated
with third-party technology or newly developed technological advances which we
may fail to predict, we could be required to redesign our core product
platforms. In addition, the introduction or market acceptance of products
incorporating superior technologies or the emergence of alternative
technologies and new industry standards could also render our existing
products, as well as products currently under development, obsolete and
unmarketable. Redesigning any of our products may require significant
resources, and any failure to release new products or to enhance or redesign
our existing products in a timely manner could have a material adverse effect
on our operating results and financial condition.

Our Dependence on a Single Source of Supply for Some Electronic Components
Exposes Us to Supply Interruption

Our products are manufactured using components or subassemblies procured from
third-party suppliers. We receive some electronic components from a single
source. For example, we rely on Siemens to provide the digital signal
processors and associated chip sets for our Millennium and DSP Series products.
We rely on Natural Microsystems to supply the voice processors for our Cortelco
Voice Processing System and on CTP Systems to supply our Orbit Wireless
Communications handsets and base stations. Any interruption in the availability
of components from our key suppliers could adversely affect our ability to meet
our scheduled product deliveries. We also could experience difficulties in
identifying alternative sources or modifying product designs to use alternative
components. Resulting delays or reductions in product shipments could damage
customer relationships and adversely affect our operating results. Further, a
significant increase in the price of one or more third-party components or
subassemblies would have a material adverse effect on our gross profit and
operating results.

Our Dependence on Third-Party Contract Electronic Manufacturers Could Result in
Product Delivery Delays

We depend heavily upon the manufacturing capabilities of CMC Industries, Inc.
and Pensar Corporation, our primary contract electronic manufacturers. Our
ability to deliver products on a timely basis could be adversely affected by
any failure of CMC or Pensar to manufacture our products. In

6
<PAGE>

addition, we could have difficulty finding other manufacturers to build our
products. Resulting delays in manufacturing or shipping or an inability to meet
customer orders could adversely affect our customer relationships and our
operating results.

The Loss of the Principal Members of Our Management Team or Key Engineering
Personnel or the Inability to Attract and Retain Qualified Personnel Could Have
an Adverse Effect on Our Business

We are dependent on the principal members of our management team and key
members of our engineering staff. If we lose any of these persons, our
business, financial condition and operating results may be adversely affected.
Due to the specialized nature of our business, we are highly dependent on the
continued service of, and on the ability to attract and retain, qualified
engineering, sales, marketing and senior management personnel. Highly skilled
employees with the education and training that we require, especially qualified
service technicians and employees with significant experience and expertise in
computer telephony integration applications, are in high demand. If we are
unable to hire additional qualified personnel as needed, we may not be able to
grow our business effectively, adequately manage and complete our existing
sales commitments or bid for and execute additional sales opportunities.
Failure to attract and retain the qualified personnel necessary for the
development of our business could have a material adverse effect on our
operating results and financial condition.

We Face Many Risks in Expanding Our International Operations into the Caribbean
and Latin America

Sales outside of the United States and Puerto Rico accounted for approximately
2% of our total pro forma revenues for the nine months ended April 30, 1999 and
were made primarily through our dealer network. We expect to increase sales to
customers outside of the United States as we establish our distribution
channels in the Caribbean and Latin America. However, foreign markets for our
products may develop more slowly than currently anticipated. We may not be able
to successfully establish international distribution channels, or we may not be
able to hire the additional personnel necessary to support such distribution
channels. In addition, payment cycles with customers located outside the United
States are generally longer than those within the United States.

Our Products May Have Undetected Errors Leading to Product Returns or Claims of
Liability Which Could Adversely Affect Our Business

Our products, despite testing, may contain undetected errors or failures. The
occurrence of errors could result in product returns and other losses to us or
our customers. This occurrence also could result in the loss of, or delay in,
market acceptance of our products. In addition, any failure by our products to
properly perform could result in claims against us. Our purchase agreements
with our customers typically contain provisions designed to limit our exposure
to potential product liability claims. However, the limitation of liability
provisions contained in our purchase agreements may not be effective as a
result of federal, state or local laws or ordinances or unfavorable judicial
decisions in the United States or other countries. We maintain insurance to
protect against certain claims associated with the use of our products, but our
insurance coverage may not adequately cover all possible claims asserted
against us. In addition, even claims that ultimately are unsuccessful could
result in our expenditure of funds in litigation and management time and
resources.

We May Be Subject to Intellectual Property Litigation Which Could Result in
Substantial Cost and Divert Management from the Operation of the Business

As we grow and gain brand recognition, our products are more likely to be
subjected to infringement litigation. Responding to, defending against, or
bringing claims related to our intellectual property

7
<PAGE>

rights could result in substantial costs and diversion of management and
technical resources which could adversely affect our business, operating
results and financial condition. In addition, we rely on a combination of
patent, trademark, copyright and trade secret laws and contractual restrictions
to establish and protect our proprietary rights. These statutory and
contractual arrangements may not provide sufficient protection to prevent
misappropriation of our technology or to deter independent third-party
development of similar technologies. Such litigation could result in our
expenditure of funds and management time and resources.

Our Business May Be Disrupted if We Experience Year 2000 Problems in Our
Systems or Those of Our Key Suppliers, Manufacturers or Customers

We are heavily dependent upon the ability of our own computer or data-dependent
systems to correctly interpret century data. This includes, but is not limited
to, our systems in information, business, finance, operations and service. Any
failure or malfunctioning on the part of these or other systems could adversely
affect us in ways that are not currently known, discernible, quantifiable or
otherwise anticipated by us. We currently have only limited information on the
year 2000 compliance of our key suppliers, manufacturers and customers. Our
business and operating results could experience material adverse effects if our
key suppliers or manufacturers were to experience year 2000 issues that cause
them to delay production or shipment of key components or systems. In addition,
our operating results could experience material adverse effects if any of our
key customers encounter year 2000 issues that cause them to delay or cancel
substantial purchase orders or delivery of our product. For a discussion of our
year 2000 plans, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Year 2000 Compliance."

We Are Controlled by Our Principal Stockholders and Management Which May Limit
Your Ability to Influence Stockholder Matters

Upon completion of this offering, our executive officers, directors and
principal stockholders and their affiliates will own approximately 5,388,685
shares, or 47.0%, of the outstanding shares of common stock, or 5,061,786
shares, or 43.8%, if the underwriters' over-allotment option is exercised in
full. As a result, they will have the ability to effectively control us and
direct our affairs, including the election of directors and approval of
significant corporate transactions. This concentration of ownership also may
have the effect of delaying, deferring or preventing a change in control of our
company and may make some transactions more difficult or impossible without the
support of these stockholders. The interests of these stockholders may conflict
with those of other stockholders. We also have transactions with businesses in
which our principal stockholders maintain interests, such as CMC. We believe
that these transactions are conducted at an arm's length basis, but we cannot
assure you that these transactions would have the same terms if conducted with
an unrelated third-party.

Our Stock Previously Had No Active Public Market and Our Stock Price May Be
Volatile

Prior to this offering, there has been no public market for our common stock.
We have applied to list the common stock for trading on the Nasdaq National
Market. The initial public offering price will be determined by negotiations
among the underwriters, us and the selling stockholders and may not be
indicative of the market price for the common stock after this offering. We do
not know the extent to which investor interest will lead to the development of
a public market. Investors may not be able to resell the common stock at or
above the initial public offering price. Many factors could cause the market
price of the common stock after this offering to fluctuate substantially,
including future announcements concerning us or our competitors, variations in
operating results, loss of key

8
<PAGE>

customers, changes in pricing policies, or changes in earnings estimates by
analysts. General economic, political and market conditions may also have a
material adverse effect on the price of our common stock.

Certain Anti-Takeover Provisions in Our Charter Documents May Discourage Take-
Over Attempts and May Adversely Affect Our Stock Price

The board of directors has the authority to issue up to 10,000,000 shares of
preferred stock and to determine the preferences, rights and privileges of
those shares without any further vote or action by the stockholders. The rights
of the holders of common stock may be adversely affected by the rights of the
holders of any preferred stock that may be issued in the future. Certain
provisions of our certificate of incorporation and bylaws may make it more
difficult for a third-party to acquire control of us without the consent of our
board of directors, even if such changes were favored by a majority of the
stockholders. These include provisions that provide for a staggered board of
directors, prohibit stockholders from taking action by written consent and
restrict the ability of stockholders to call special meetings.

Significant Number of Shares Eligible for Future Sale May Decrease Our Stock
Price

Sales of substantial amounts of our common stock in the public market after
this offering, including shares issued upon the exercise of outstanding
options, or the perception that such sales could occur, could adversely affect
the market price of our common stock. These sales also might make it more
difficult for us to raise funds through future offerings of common stock.

Upon completion of this offering, we will have outstanding 11,454,826 shares of
common stock. All of the shares sold in this offering will be freely
transferable without restriction or further registration under the Securities
Act of 1933, except for shares purchased by our "affiliates," as defined in
Rule 144 under the Securities Act. The remaining 8,254,826 shares of common
stock that will be outstanding upon completion of this offering are "restricted
securities" as defined in Rule 144. These restricted securities may be sold in
the future without registration under the Securities Act to the extent
permitted under Rule 144, Rule 701, or another exemption under the Securities
Act. Cortelco, our officers, directors and stockholders holding approximately
8,927,323 shares of common stock will agree not to, without the prior written
consent of J.P. Morgan Securities Inc., directly or indirectly, sell, offer,
contract to sell, transfer the economic risk of ownership in, make any short
sale, pledge or otherwise dispose of any shares of common stock or any
securities convertible into, or exchangeable, or exercisable for, or any other
rights to purchase or acquire shares of common stock owned by them during the
180-day period commencing on the date of this prospectus.

Our Management Has Broad Discretion over the Offering Proceeds and May Use Them
in Ways That Our Stockholders May Not Deem Desirable

A significant portion of the net proceeds of the offering are not allocated for
specific uses. Our management has broad discretion over the use of the net
proceeds from this offering and may use them in ways that our stockholders may
not deem desirable. In addition, we cannot predict that the proceeds will be
invested to yield a significant return, if any. See "Use of Proceeds."

9
<PAGE>

Forward-Looking Statements

Statements contained in this prospectus may be forward-looking statements
concerning our operations, economic performance and financial condition.
Forward-looking statements are included, for example, in the discussions about:
the timing and availability of products under development; variations in
operating results; our strategy; year 2000 issues; and the market for voice
communications equipment. Those forward-looking statements involve risks and
uncertainties and actual results may differ materially from those expressed or
implied in those statements. Factors that could cause differences include, but
are not limited to, those discussed under "Risk Factors" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

Company Background

We were incorporated on July 23, 1991 as one of several corporations related
through common ownership that were formed to hold various telecommunications
equipment and other businesses that had been acquired primarily from Alcatel,
N.V. in 1990. In August 1993, we became a subsidiary of Cortelco Systems
Holding Corporation, a corporation formed to act as the holding company for the
telecommunications equipment businesses, while CMC Industries, Inc., a contract
electronic manufacturer, became a separate company. See "Business--
Manufacturing." In March 1997, our subsidiary in the automatic call
distribution products business was spun off to the Cortelco Systems Holding
Corporation stockholders, merged with Business Communications Systems, Inc.,
and renamed "BCS Technologies, Inc."

In April 1999:

. Cortelco Systems Holding Corporation distributed its shares of
Cortelco common stock in a spin-off transaction

. we merged with Cortelco Systems Puerto Rico, Inc., another subsidiary
of Cortelco Systems Holding Corporation, in exchange for 553,880
shares of our common stock

. we acquired BCS in exchange for 3,969,680 shares of our common stock

BCS and Cortelco Systems Puerto Rico are now wholly-owned subsidiaries of
Cortelco.

10
<PAGE>

Use of Proceeds

Our net proceeds from the sale of the 2,380,000 shares of common stock offered
by us are estimated to be approximately $23.8 million, or approximately $24.9
million if the underwriters exercise the over-allotment option in full, after
deducting underwriting discounts and commissions and estimated offering
expenses payable by us. We will not receive any proceeds from the sale of
common stock by the selling stockholders.

We currently intend to use our net proceeds from this offering:

. to fully repay a $2.3 million long-term subordinated note with
ChinaVest IV, L.P. that accrues interest at an 8.0% annual rate and
matures in July 2002

. to fully repay $2.6 million of senior debt under two credit facilities
with Foothill Capital, one of which accrues interest at a rate equal
to the prime rate plus 0.375% and matures in July 2001, and the other
of which accrues interest at a rate equal to the prime rate plus 1.25%
and matures in August 2001

. for working capital and general corporate purposes

We may also use some of the proceeds to acquire other companies, technologies
or products that complement our business, although we have not yet developed
any plans regarding these transactions. Pending use of the net proceeds as
described above, we intend to invest the net proceeds from this offering in
short-term, investment-grade securities.

Dividend Policy

We have declared cash dividends in the past in connection with intercompany
financing transactions with our parent company. See "Certain Transactions."
Cortelco currently anticipates that it will retain earnings to support
operations and finance the growth and development of its business and does not
anticipate declaring cash dividends for the foreseeable future. Future
dividends, if any, will be at the discretion of the board of directors, which
will base its decision on a number of factors, including our operating results
and financial requirements. The terms of our senior debt, which will be repaid
from the net proceeds of this offering, prohibit the declaration and payment of
dividends without the approval of the lender.

11
<PAGE>

Capitalization

The following table sets forth our capitalization as of April 30, 1999 on an
actual basis and on an adjusted basis after giving effect to our sale of
2,380,000 shares of common stock in this offering at an assumed public offering
price of $11.00 per share, after deducting underwriting discounts and
commissions, and estimated offering expenses and repayment of outstanding debt.
The capitalization on an actual basis excludes 1,415,766 shares of common stock
issuable upon exercise of options outstanding as of April 30, 1999 and
1,262,018 shares reserved as of April 30, 1999 for future issuance under our
1999 Equity Incentive Plan and 1999 Employee Stock Purchase Plan. This table
should be read in conjunction with our consolidated financial statements and
related notes appearing elsewhere in this prospectus and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

<TABLE>
<CAPTION>
----------------------
As of April 30, 1999
----------------------
Actual
Actual As Adjusted
Dollars in thousands, except share data --------- -----------
<S> <C> <C>
Long-term debt (excluding current portion)................. $ 2,314 $ --
Stockholders' equity (1):
Preferred stock, $.001 par value, 10,000,000 shares
authorized; 1,463,206 shares issued and outstanding,
actual; no shares issued and outstanding, as adjusted... 660 --
Common stock, $.001 par value, 50,000,000 shares
authorized; 7,639,932 shares issued and outstanding,
actual;
11,454,826 shares issued and outstanding, as adjusted... 8 11
Additional paid-in capital............................... 24,148 47,983
Note receivable from affiliate (former parent)........... (2,634) (2,634)
Retained earnings ....................................... (5,637) (5,637)
---------- ----------
Total stockholders' equity............................. 16,545 39,723
---------- ----------
Total capitalization................................... $ 18,859 $ 39,723
========== ==========
</TABLE>
- -------------------

(1) Upon the closing of this offering, the 1,463,206 shares of Series A
convertible preferred stock shall, by its terms, convert into 1,434,894 shares
of common stock.

12
<PAGE>

Dilution

Our net tangible book value at April 30, 1999 was approximately $4.3 million,
or $0.56 per share of common stock. Net tangible book value per share
represents the amount of total assets, less:

. goodwill and identifiable intangible assets

. total liabilities

. preferred stock

divided by the number of outstanding shares of common stock.

After giving effect to the sale of 2,380,000 shares of common stock offered to
new investors by Cortelco at an assumed initial public offering price of $11.00
per share, and after deducting underwriting discounts and commissions and
estimated offering expenses, our pro forma net tangible book value at April 30,
1999 would have been approximately $27.7 million, or $2.43 per share. This
represents an immediate increase in pro forma net tangible book value of $1.87
per share to existing stockholders and an immediate dilution in net tangible
book value of $8.57 per share to new investors. The following table illustrates
the per share dilution:

<TABLE>
<S> <C> <C>
Assumed initial public offering price per share................... $11.00
Net tangible book value per share as of April 30, 1999.......... $0.56
Pro forma increase in net tangible book value per share
attributable to new investors.................................. $1.87
-----
Pro forma net tangible book value per share after this offering... 2.43
------
Dilution per share to new investors............................... $ 8.57
======
</TABLE>

The following table summarizes on a pro forma basis as of April 30, 1999 the
differences between the existing stockholders and the new investors with
respect to the number of shares of common stock purchased from us, the total
consideration paid to us and the average price per share paid:

<TABLE>
<CAPTION>
------------------------------------------------------
Shares Purchased Total Consideration
------------------- -------------------- Average Price
Number Percent Amount Percent Per Share
---------- -------- ----------- -------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders
(1).................... 9,074,826 79.2% $ 6,273,000 19.3% $ 0.69
New investors........... 2,380,000 20.8 26,180,000 80.7 $11.00
---------- -------- ----------- --------
Total................. 11,454,826 100.0% $32,453,000 100.0%
========== ======== =========== ========
</TABLE>
- -------------------
(1) Excludes 1,415,766 shares of common stock issuable upon exercise of options
outstanding as of April 30, 1999 and 1,262,018 shares reserved as of April 30,
1999 for future issuance under our 1999 Equity Incentive Plan and 1999 Employee
Stock Purchase Plan.

13
<PAGE>

Selected Pro Forma Consolidated Financial Data

The following pro forma consolidated statement of operations data for the year
ended July 31, 1998 and the nine months ended April 30, 1998 and 1999 represent
the unaudited pro forma operating results as if the acquisition of BCS had
occurred as of August 1, 1997. The pro forma financial data reflects
adjustments to our consolidated financial statements that:

. reflect the purchase method of accounting for the acquisition of BCS

. eliminate the results of operations and related assets and liabilities
not acquired from the merger with Cortelco Systems Puerto Rico

The pro forma financial data does not purport to represent what our results of
operations actually would have been had the transactions occurred on the dates
indicated, or to project our results of operations at any future date or for
any future period. The following pro forma financial data should be read in
conjunction with Cortelco's consolidated financial statements and related
notes, BCS' financial statements and related notes and the Unaudited Pro Forma
Consolidated Financial Information and related notes, all of which are included
elsewhere in this prospectus, and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."

<TABLE>
<CAPTION>
---------------------------------------------
Nine Months Ended
Year Ended ------------------------------
In thousands, except per share July 31, 1998 April 30, 1998 April 30, 1999
data ------------- -------------- --------------
<S> <C> <C> <C>
Consolidated Statement of
Operations Data:
Net revenues................... $ 36,618 $ 25,577 $ 38,425
Cost of revenues............... 19,673 13,850 18,515
---------- ---------- ----------
Gross profit................. 16,945 11,727 19,910
Operating expenses:
Selling, general and
administrative............... 13,233 10,074 11,686
Research and development...... 2,111 1,559 2,348
Amortization of goodwill...... 565 424 424
---------- ---------- ----------
Total operating expenses..... 15,909 12,057 14,458
---------- ---------- ----------
Income (loss) from
operations.................. 1,036 (330) 5,452
Interest expense............... 499 394 308
Management fee expense, net.... 185 148 23
Equity in earnings of joint
venture....................... (66) (60) (7)
Other expenses, net............ 495 428 411
---------- ---------- ----------
Income (loss) before income
taxes....................... (77) (1,240) 4,717
Income tax expense............. -- -- 1,511
---------- ---------- ----------
Net income (loss)............ $ (77) $ (1,240) $ 3,206
========== ========== ==========
Basic pro forma net income
(loss) per share.............. $ (0.01) $ (0.15) $ 0.39
Diluted pro forma net income
(loss) per share.............. $ (0.01) $ (0.15) $ 0.33
Weighted average shares
outstanding (1):
Basic......................... 8,155 8,147 8,134
Diluted....................... 8,155 8,147 9,744
</TABLE>
- -------------------
(1) See notes to Unaudited Pro Forma Consolidated Financial Information for
determination of shares used in computing basic and diluted pro forma net
income (loss) per share.

14
<PAGE>

Selected Consolidated Financial Data

The selected consolidated financial data represent the results of Cortelco and
Cortelco Systems Puerto Rico and include the operating results of BCS beginning
April 12, 1999, the date on which BCS was acquired. The statement of operations
data set forth below for each of the fiscal years ended July 31, 1996, 1997 and
1998, and the selected balance sheet data at July 31, 1997 and 1998, are
derived from consolidated financial statements audited by Deloitte & Touche
LLP, independent auditors, whose reports appear elsewhere in this prospectus.
The consolidated balance sheet data at July 31, 1996 is derived from audited
financial statements not included in this prospectus. The statement of
operations data for the nine months ended April 30, 1998 and 1999 and the year
ended July 31, 1995 and the balance sheet data as of July 31, 1995 and April
30, 1999 are derived from unaudited financial statements. However, in the
opinion of management, the selected financial data for such periods include all
adjustments, which include only normal recurring adjustments, necessary for a
fair presentation of the data. This data should be read in conjunction with our
consolidated financial statements and notes thereto appearing elsewhere in this
prospectus and "Management Discussion and Analysis of Financial Condition and
Results of Operations." The results of operations for the nine months ended
April 30, 1999 are not necessarily indicative of the results to be expected for
the full year.
<TABLE>
<CAPTION>
-----------------------------------------------------------------
Nine Months Ended
Year Ended July 31, April 30,
------------------------------------------ ---------------------
In thousands, 1995 1996 1997 1998 1998 1999
except per share data --------- --------- --------- --------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Consolidated Statement of
Operations Data:
Net revenues........... $ 33,774 $ 38,518 $ 35,635 $ 30,172 $ 22,182 $ 27,173
Cost of revenues....... 24,228 26,501 24,312 17,530 12,730 15,290
--------- --------- --------- --------- --------- ----------
Gross profit......... 9,546 12,017 11,323 12,642 9,452 11,883
Operating expenses:
Selling, general and
administrative....... 7,235 7,853 10,103 9,931 7,663 8,649
Research and
development.......... 1,403 1,256 1,310 1,407 1,038 1,525
Amortization of
goodwill............. -- -- -- -- -- 28
--------- --------- --------- --------- --------- ----------
Total operating
expenses............ 8,638 9,109 11,413 11,338 8,701 10,202
--------- --------- --------- --------- --------- ----------
Income from
operations.......... 908 2,908 (90) 1,304 751 1,681
Interest expense....... 1,186 1,004 915 826 633 584
Management fee
expense, net.......... 134 178 406 185 148 23
Equity in earnings of
joint venture -- -- -- (66) (60) (7)
Other expenses
(income), net......... 83 (54) 272 43 91 102
--------- --------- --------- --------- --------- ----------
Income (loss) before
income taxes........ (495) 1,780 (1,683) 316 (61) 979
Income tax expense .... -- 702 -- -- -- 81
--------- --------- --------- --------- --------- ----------
Income (loss) from
continuing
operations.......... (495) 1,078 (1,683) 316 (61) 898
Discontinued
operations............ (958) (1,112) (515) -- -- --
--------- --------- --------- --------- --------- ----------
Net income (loss).... $ (1,453) $ (34) $ (2,198) $ 316 $ (61) 898
========= ========= ========= ========= ========= ==========
Basic net income (loss)
per share............. $ (0.38) $ (0.01) $ (0.57) $ 0.08 $ (0.02) $ 0.22
Diluted net income
(loss) per share...... $ (0.38) $ (0.01) $ (0.57) $ 0.07 $ (0.02) $ 0.16
Weighted average shares
outstanding (1)(2):
Basic................. 3,825 3,825 3,825 3,918 3,910 4,159
Diluted............... 3,825 3,825 3,825 5,353 3,910 5,769
<CAPTION>
-----------------------------------------------------------------
At July 31,
------------------------------------------ At April 30,
1995 1996 1997 1998 1999
In thousands --------- --------- --------- --------- ------------
<S> <C> <C> <C> <C> <C> <C>
Consolidated Balance
Sheet Data:
Cash and cash
equivalents........... $ 76 $ 183 $ 320 $ 103 $ 1,774
Working capital........ 4,159 5,824 3,964 1,820 4,849
Goodwill, net.......... -- -- -- -- 11,266
Total assets........... 19,369 21,104 17,699 16,430 34,003
Long term debt......... 2,903 2,751 5,621 6,400 2,314
Common stock........... 4 4 4 4 8
Total stockholders'
equity (deficit)...... 4,375 4,341 893 (1,391) 16,545
</TABLE>
- ------------------
(1) See note 19 to our consolidated financial statements for determination of
shares used in computing basic and diluted net income (loss) per share for the
years ended July 31, 1996, 1997 and 1998.
(2) See note 2 to our unaudited consolidated financial statements for
determination of shares used in computing basic and diluted net income (loss)
per share for the nine months ended April 30, 1998 and 1999.

15
<PAGE>

Management's Discussion and Analysis of
Financial Condition and Results of Operations

The following discussion of our results of operations and financial condition
should be read in conjunction with the consolidated financial statements and
related notes and other financial information included elsewhere in this
prospectus. This discussion contains forward-looking statements that involve
risks and uncertainties. Our actual results may be materially different from
those anticipated in these forward-looking statements as a result of certain
factors, including, but not limited to, those set forth under "Risk Factors"
and elsewhere in this prospectus.

Overview

Cortelco designs, develops and markets integrated enterprise communications
systems for small and medium-sized telephony installations in a range of
vertical markets such as education, retail, government agencies, emergency-911
services and catalog sales. Our operations are conducted through three business
units: Systems Business Operations, ACD Business Operations and Caribbean and
Latin American Operations. The Systems Business Operations unit primarily
focuses on the Millennium product line. The ACD Business Operations unit
primarily focuses on the DSP Series product line. The Caribbean and Latin
American Operations unit currently distributes the Millennium and DSP Series
systems and resells cellular airtime, cellular telephones and third-party voice
communications systems in Puerto Rico.

In April 1999, Cortelco merged with its sister company, Cortelco Systems Puerto
Rico, which became the Caribbean and Latin American Operations unit, and
acquired BCS, which became the ACD Business Operations unit. Prior to April
1999, our three business units shared substantial common ownership and prior to
March 1997 had been part of the same corporate family. Cortelco and Cortelco
Systems Puerto Rico had previously been subsidiaries of Cortelco Systems
Holding Corporation and were under common control. As a result, the merger of
Cortelco and Cortelco Systems Puerto Rico has been recorded for all periods
presented at historical costs and the financial statements are presented on a
consolidated basis for all historical periods. The acquisition of BCS has been
accounted for using the purchase method of accounting and goodwill in the
amount of $11.3 million was recorded in the BCS acquisition and is being
amortized over 20 years. BCS has been included in our consolidated financial
statements from April 12, 1999, the date on which it was acquired.

Our revenues are primarily derived from our sale of Millennium and DSP Series
systems, related systems products and services and the resale of cellular
airtime, cellular telephones and third-party voice communications systems in
Puerto Rico. Revenue is recognized upon shipment of product to our dealers and
end-user customers for Millennium systems and third-party systems, and upon
acceptance for DSP Series systems due to the customized nature of each
installation. In addition, our Caribbean and Latin American Operations unit
generates revenue from the resale of cellular airtime and cellular telephones
in Puerto Rico and recognizes these revenues when earned. Typical selling
prices range from $22,000 to $36,000 for Millennium systems and $75,000 to
$230,000 for DSP Series systems, depending on the system configuration. For the
nine months ended April 30, 1999, on a pro forma basis, we generated
approximately 42% of our revenue from the sale of Millennium products and
approximately 35% from the sale of DSP Series products. Pro forma revenues
increased 50.2% from $25.6 million for the nine months ended April 30, 1998 to
$38.4 million for the nine months ended April 30, 1999.

In the past several years, we have undergone some significant changes. In
fiscal 1994, we introduced a new digital platform, the Millennium, to replace
an older analog product, which was ultimately discontinued in fiscal 1998.
During fiscal 1996 and fiscal 1997, we sold a substantial number of

16
<PAGE>

Millennium systems to a single customer for installations in Southeast Asia.
This customer ceased placing new orders with us in 1997 due to general economic
instability in Southeast Asia, which resulted in a $3.0 million decrease in
purchases by this customer in fiscal 1998 as compared to fiscal 1997. Moreover,
in fiscal 1997, Cortelco Systems Puerto Rico redirected its marketing of
cellular airtime and cellular telephones to focus on higher quality customers,
mainly businesses, in order to minimize credit losses and increase margins.
This resulted in a reduction of Cortelco Systems Puerto Rico's revenues from
the resale of cellular airtime and cellular telephones from $9.8 million in
fiscal 1997 to $6.7 million in fiscal 1998. Beginning in the second quarter of
fiscal 1998, Cortelco, under the leadership of a new president, refocused its
overall marketing strategy and began to target markets for which the Millennium
system is particularly well-suited. Product development programs have been
directed to new software and other initiatives to strengthen the Millennium
product line and increase gross margins. We also increased our sales staff and
expanded our dealer and value added reseller network. As a result of these
changes and programs, Cortelco has become profitable and our operating results
have continued to improve in recent quarters.

Subsequent to the issuance of our financial statements for the year ended July
31, 1998, our management determined that certain costs related to the
acquisition of cellular airtime contracts that had been deferred should be
expensed as incurred. In addition, Cortelco changed its method of accounting
for its Longhai joint venture from full consolidation to the equity method. As
a result, the financial statements as of July 31, 1997 and 1998 and for each of
the three years in the period ended July 31, 1998 have been restated. See Note
21 to the consolidated financial statements. The financial information
contained in Management's Discussion and Analysis of Financial Condition and
Results of Operations herein reflects the impact of such restatement.

Pro Forma Net Revenues and Cost of Revenues

As a result of the recent acquisition of BCS, our historical financial
statements for past periods do not accurately reflect our current operations.
We have therefore included the net revenues and cost of revenues on a pro forma
basis for each of the seven quarters ended April 30, 1999 so that you can
better understand our business. The following table present the pro forma net
revenues and cost of revenues as if the acquisition of BCS had occurred as of
August 1, 1997. We believe that all necessary adjustments, consisting of only
normal recurring adjustments, have been included in the amounts stated below.
The pro forma net revenues and cost of revenues are presented for illustrative
purposes only and do not purport to represent what our net revenues and cost of
revenues actually would have been had the transactions occurred on the dates
indicated, or to project our net revenues and cost of revenues for any future
period. This data should be read in conjunction with the Unaudited Pro Forma
Consolidated Financial Information and the related notes, our consolidated
financial statements and the related notes and BCS' financial statements and
the related notes, all of which are included elsewhere in this prospectus.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------
Three Months Ended
-----------------------------------------------------------------------------
October 31, January 31, April 30, July 31, October 31, January 31, April 30,
1997 1998 1998 1998 1998 1999 1999
In thousands ----------- ----------- --------- -------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Consolidated Net
Revenues
and Cost of Revenues:
Net revenues............ $ 9,005 $ 8,105 $ 8,467 $ 11,041 $ 12,313 $ 11,558 $ 14,554
Cost of revenues........ 5,016 4,356 4,478 5,823 5,943 5,830 6,742
--------- --------- --------- --------- --------- --------- ---------
Gross profit........... $ 3,989 $ 3,749 $ 3,989 $ 5,218 $ 6,370 $ 5,728 $ 7,812
========= ========= ========= ========= ========= ========= =========
</TABLE>

Quarterly net revenues and cost of revenues, in particular the quarters ended
October 31 and January 31, are likely to fluctuate due to a number of factors,
including seasonal factors that affect

17
<PAGE>

customers in some of our vertical markets. For example, U.S. government
customers typically make substantial purchases during the quarter ended October
31, the last quarter of the government's fiscal year, and these purchases
decline significantly in the next quarter. Customers in other vertical markets
such as education and retail have also exhibited seasonal buying patterns and
do not purchase substantial amounts of equipment during the quarter ended
January 31. As a result, net revenues in the quarter ended January 31 are often
lower than in the previous quarter. The uncertainty of our sales cycle also
makes the timing of sales difficult to predict and may cause fluctuations in
our quarterly net revenues and cost of revenues. The purchase of our products
may involve a significant commitment of our customers' personnel, financial and
other resources to conduct technical evaluations, to support installation and
training and to fund purchases. As a result, our sales cycles vary from one to
six months for Millennium systems and from four to twelve months for the DSP
Series systems.

Revenues. Our revenues are primarily derived from the sales of Millennium and
DSP Series systems, related systems products and services and the resale of
cellular airtime, cellular telephones and third-party voice communications
systems in Puerto Rico. Our pro forma quarterly revenues have increased over
the prior year for the last three quarters ended April 30, 1999, due primarily
to the FAA contract, enhancements of our product line and expansion of our
sales force. Systems revenue from sales of third-party voice communications
systems in Puerto Rico generally account for approximately 5% to 10% of pro
forma total revenues in each quarter. Our pro forma cellular airtime and
cellular telephone revenues have generally decreased as a percentage of total
revenues since the quarter ended October 31, 1997, primarily due to our
limiting sales activities to higher quality customers, and were 8.8% of pro
forma revenues for the quarter ended April 30, 1999. Our pro forma revenues for
the quarters ended January 31, 1998 and 1999 have been influenced by seasonal
buying patterns in some of our vertical markets. Consequently, pro forma
revenues are lower in the quarters ended January 31 than in the quarters ended
October 31. Furthermore, our revenues were adversely affected in the first half
of fiscal 1998 due to a decrease in orders from our single largest customer due
to general economic instability in Southeast Asia and the unexpected loss of a
key sales executive. Pro forma revenues reflect purchases by the FAA of
$2.6 million, $2.6 million and $4.7 million for the last three quarters ended
April 30, 1999 under a contract that expired in June 1999. Although revenues
from the U.S. government will decline after June 1999 due to the completion of
installations under the FAA contract, we expect U.S. government agencies to
continue to account for a significant portion of our systems revenue.

Pro forma revenues increased 50.2% from $25.6 million for the nine months ended
April 30, 1998 to $38.4 million for the nine months ended April 30, 1999. The
increase was primarily due to $9.9 million in purchases of DSP Series systems
by the FAA and an increase in Millennium revenues of $2.0 million, partially
offset by a decrease in cellular revenues of $0.9 million. Millennium revenues
increased primarily due to the expansion of our sales force and the
introduction of new product features during the last year, while cellular
revenues decreased during the period due primarily to our decision to target
higher quality customers. For the nine months ended April 30, 1999, the FAA
accounted for 25.9% of our total pro forma revenues. As a result of the
completion of the FAA contract, we expect our revenue growth will slow during
the quarter ended July 31, 1999.

Cost of Revenues. Cost of revenues consists primarily of purchases from our
contract manufacturers and other suppliers and costs incurred for final
assembly, quality assurance and installation of our systems. Pro forma cost of
revenues increased in year over year comparative quarters due primarily to
higher revenues but decreased as a percentage of revenues due to a change in
product mix in favor of higher margin products, primarily DSP Series systems.
Lower cost of revenues in the quarters ended January 31, 1998 and 1999 were due
primarily to seasonal declines in revenues caused by our customers' purchasing
cycles.

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Historical Results of Operations of Cortelco and Cortelco Systems Puerto Rico

Cortelco Systems Puerto Rico was merged with Cortelco in April 1999 and has
been recorded for all periods presented at historical costs and the financial
statements are presented on a consolidated basis for all historical periods. We
acquired BCS on April 12, 1999 in a merger accounted for using the purchase
method of accounting. As a result, the historical results of operations for the
nine months ended April 30, 1998 and the fiscal years ended July 31, 1996, 1997
and 1998 represent the results of Cortelco Systems Puerto Rico and Cortelco and
include the operating results of BCS beginning on April 12, 1999.

Nine Months Ended April 30, 1998 and 1999

Revenues. Total revenues increased 22.5% from $22.2 million for the nine months
ended April 30, 1998 to $27.2 million for the nine months ended April 30, 1999.
The increase resulted primarily from increased systems sales in Puerto Rico of
$2.7 million, increased systems sales to the U.S. government of $1.7 million,
DSP Series revenues of $1.1 million subsequent to the April 12, 1999 merger
with BCS and increased sales of Cortelco Voice Processing Systems of
$0.8 million. These increases were partially offset by decreases in cellular
airtime and cellular telephone revenues in Puerto Rico of $0.9 million in an
effort to target higher quality customers.

Cost of Revenues and Gross Profit. Gross profit increased 25.7% from $9.5
million for the nine months ended April 30, 1998 to $11.9 million for the nine
months ended April 30, 1999. The increase in gross profit was due primarily to
$0.9 million in DSP Series gross profit in the current period, increased gross
profit for systems sales in Puerto Rico of $0.8 million, increased gross profit
for systems sales to the U.S. government of $0.6 million and increased gross
profit for the Cortelco Voice Processing Systems of $0.3 million. The gross
margin was 42.6% for the nine months ended April 30, 1998 and 43.7% for the
nine months ended April 30, 1999.

Operating Expenses. Operating expenses increased 17.3% from $8.7 million for
the nine months ended April 30, 1998 to $10.2 million for the nine months ended
April 30, 1999. The increase was due primarily to the hiring of additional
engineering and sales personnel during the period. Results for the nine months
ended April 30, 1999 include $0.5 million in operating expenses for the ACD
Business Operations unit that was established at the time of the merger with
BCS. Operating expenses decreased as a percentage of revenues from 39.2% for
the nine months ended April 30, 1998 to 37.5% for the nine months ended April
30, 1999.

Selling, General and Administrative. Selling, general and administrative
expenses consist primarily of salaries and benefit costs, advertising and trade
show related costs, and facilities and other overhead expenses incurred to
support the growth of our business. Selling, general and administrative
expenses increased from $7.7 million for the nine months ended April 30, 1998
to $8.6 million for the nine months ended April 30, 1999. The increased expense
was due primarily to the growth of the business and the hiring of additional
sales personnel. These expenses as a percentage of revenues decreased from
34.5% for the nine months ended April 30, 1998 to 31.7% for the nine months
ended April 30, 1999. We expect selling, general and administrative expenses to
increase as we invest in new sales and service personnel; however, we
anticipate that these expenses will decrease as a percentage of revenues in
future periods.

Research and Development. Research and development expenses consist primarily
of personnel and related expenses for our engineering staff and depreciation of
related equipment. Research and development expenses have generally increased
since the quarter ended October 31, 1997 due primarily to the hiring of
additional engineering personnel. Research and development expenses

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increased from $1.0 million for the nine months ended April 30, 1998 to $1.5
million for the nine months ended April 30, 1999. The increased expenses were
due primarily to the hiring of additional engineering personnel as well as
additional equipment purchases. These expenses as a percentage of revenues
increased from 4.7% for the nine months ended April 30, 1998 to 5.6% for the
nine months ended April 30, 1999. We expect research and development expenses
to continue to increase in dollars and as a percentage of revenues in future
periods as we hire additional engineers to support our new product initiatives.

Amortization of Goodwill. Cortelco recorded $11.3 million of goodwill related
to the acquisition of BCS in April 1999 and began amortizing the amount over a
20-year period on April 12, 1999.

Management Fee Expense, Net. Management fee expense consists primarily of net
administrative expenses incurred by or provided to our former parent company
related to administrative services.

Equity in Earnings of Joint Venture. Cortelco acquired a 55% interest in
Longhai Telecommunications Equipment Co., Ltd. in China in August 1997.
Cortelco does not currently anticipate investing in additional joint ventures
in China. See note 9 to our consolidated financial statements.

Income from Operations. Income from operations increased 123.8% from $0.8
million for the nine months ended April 30, 1998 to $1.7 million for the nine
months ended April 30, 1999. This was due primarily to a $2.7 million increase
in systems sales in Puerto Rico and $1.1 million of DSP revenues subsequent to
the merger with BCS on April 12, 1999. Gross profit increased primarily due to
the higher revenues of $5.0 million in the period and the mix of higher margin
products, including the DSP Series. While operating expenses on an absolute
basis for the nine months ended April 30, 1999 increased due primarily to the
hiring of additional sales and engineering personnel, operating growth was
slower than growth in revenues and gross profit for the period.

Years Ended July 31, 1996, 1997 and 1998

Revenues. Revenues were $38.5 million for fiscal 1996, $35.6 million for fiscal
1997 and $30.2 million for fiscal 1998. The decrease from fiscal 1996 to fiscal
1997 resulted primarily from a decrease of $2.0 million in revenues as we
phased out our older analog product and decreases of $0.4 million in cellular
airtime and cellular telephone revenues in Puerto Rico. The decrease from
fiscal 1997 to fiscal 1998 was due primarily to a $3.1 million decrease in
cellular airtime and cellular telephone revenues resulting from our decision to
target higher quality customers and a $3.0 million decrease in orders from our
single largest customer due to general economic instability in Southeast Asia.

Cost of Revenues and Gross Profit. Gross profit was $12.0 million for fiscal
1996, $11.3 million for fiscal 1997 and $12.6 million for fiscal 1998. The
decrease in gross profit from fiscal 1996 to fiscal 1997 was due primarily to
the decrease in revenues. The increase in gross profit from fiscal 1997 to
fiscal 1998 was due primarily to the increased sale of higher margin Millennium
products such as the Cortelco Voice Processing System. Gross margin was 31.2%
for fiscal 1996, 31.8% for fiscal 1997 and 41.9% for fiscal 1998.

Operating Expenses. Operating expenses were $9.1 million for fiscal 1996,
$11.4 million for fiscal 1997 and $11.3 million for fiscal 1998. Research and
development expenses increased during the periods due mainly to hiring of
additional engineering personnel, while selling, general and administrative
expenses decreased during fiscal 1998 due primarily to a decrease in
administrative expenses associated with the decreased cellular airtime and
cellular telephone sales during the year.

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Income (loss) from Operations. Income (loss) from operations decreased from
$2.9 million for fiscal 1996 to $(0.1) million for fiscal 1997 due primarily to
the $2.9 million decrease in revenues and the $2.3 million increase in
operating expenses for fiscal 1997. Operating expenses increased in fiscal 1997
due primarily to higher administrative costs associated with cellular airtime
and cellular telephone revenues in Puerto Rico and costs associated with
evaluating investment opportunities in China. Income (loss) from operations
increased from $(0.1) million for fiscal 1997 to $1.3 million for fiscal 1998
due primarily to the $1.3 million increase in gross profit that resulted from
the increased sales of higher margin products. Operating expenses were
essentially unchanged for fiscal 1998 as research and development costs
increased by $0.1 million, while increased systems sales expenses were
primarily offset by lower cellular airtime and cellular telephone
administrative costs resulting from our decision to target higher quality
customers.

Discontinued Operations. Discontinued operations represent the results of
operations of a former subsidiary of Cortelco that was spun off in March 1997
to the stockholders of our former parent, merged with Business Communications
Systems, Inc. and renamed "BCS Technologies, Inc." At the time of spin-off, the
subsidiary had experienced substantial net losses and our former parent decided
to concentrate its focus on realizing the Millennium's business potential.

Liquidity and Capital Resources

We have funded our operations primarily through cash generated from operations,
periodic borrowings under our existing credit facilities, a $3.0 million
subordinated convertible note financing and acquisition financing provided by
Alcatel in connection with the purchase of our business from Alcatel in 1990.

Net cash provided by operating activities was $1.6 million for fiscal 1996,
$1.1 million for fiscal 1997, $0.9 million for fiscal 1998, $1.2 million for
the nine months ended April 30, 1998 and $1.1 million for the nine months ended
April 30, 1999. Cash provided by operating activities in fiscal 1997 and fiscal
1998 primarily resulted from improved collection procedures implemented during
these years.

Net cash provided by (used in) investing activities was ($0.5) million for
fiscal 1996, ($0.9) million for fiscal 1997, ($0.2) million for fiscal 1998,
($0.5) million for the nine months ended April 30, 1998 and $2.8 million for
the nine months ended April 30, 1999. In each year, cash used in investing
activities was primarily attributable to purchases of equipment and, in fiscal
1997, to the purchase of $0.3 million of software applications for the
Millennium. The $2.8 million provided by investing activities for the nine
months ended April 30, 1999 was due primarily to the $3.1 million cash balance
of BCS on the date of the acquisition. To the extent that we continue to grow
our research and development activities and invest in new technologies in the
future, we expect net cash used in investing activities will increase.

Net cash used in financing activities was $1.1 million for fiscal 1996, $0.2
million for fiscal 1997, $0.9 million for fiscal 1998, $0.9 million for the
nine months ended April 30, 1998 and $2.3 million for the nine months ended
April 30, 1999. Cash used in financing activities in the year ended July 31,
1998 consisted primarily of a decrease in outstanding checks, repayments under
the revolving credit line and partial repayment of a note to our former parent
company, Cortelco Systems Holding Corporation. The primary source of cash from
financing activities in fiscal 1997 was a $3.0 million subordinated convertible
note financing. The net cash used in financing transactions for the nine months
ended April 30, 1999 was due primarily to the $2.0 million loan made to CSHC to
retire the acquisition financing provided by Alcatel. See "Certain
Transactions."

In July and August 1997, we entered into two credit facilities with Foothill
Capital which allow us to borrow up to an aggregate of $9.0 million based on
accounts receivable and inventory levels. As of

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April 30, 1999, there was $2.6 million outstanding under these credit
facilities which will be repaid using the net proceeds from this offering. See
note 11 to our consolidated financial statements.

We believe that the proceeds from this offering, together with available
funds, anticipated cash flows from operations and our line of credit, will
satisfy our projected working capital and capital expenditure requirements at
least through fiscal 2000. To the extent that we grow more rapidly than
expected in the future, we may need additional cash to finance our operating
and investing activities.

Recent Developments

Unaudited revenues for the fiscal quarter ending July 31, 1999 were
approximately $15.2 million. Unaudited earnings per share for the fiscal
quarter ending July 31, 1999 were approximately $0.11 per share on a diluted
basis. These amounts are preliminary and are subject to audit adjustments.

Year 2000 Compliance

The year 2000 issue is the result of computer programs written using two
digits rather than four to define the applicable year. Computer programs that
have such date-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.

We are heavily dependent upon the proper functioning of our own computer or
data-dependent systems. This includes, but is not limited to, our systems in
information, business, finance, operations and service. Any failure or
malfunctioning on the part of these or other systems could adversely affect us
in ways that are not currently known, discernible, quantifiable or otherwise
anticipated by us.

Our operations are also dependent on the year 2000 readiness of third parties
that do business with us. We are dependent on third-party suppliers of
infrastructure elements such as electric power and banking facilities. We do
not depend to any significant degree upon electronic transaction processing
with individual vendors for merchandise purchases, however, many of our
customers pay their invoices via electronic payment.

We have begun to evaluate those areas of our business that may be affected by
the year 2000 issue and have devised a plan to become year 2000 compliant in a
timely manner which includes:

. assessment of our own computer systems and the products we sell

. communications with all our key suppliers, manufacturers and customers
to determine the extent to which we are vulnerable to their failure to
remedy their own year 2000 issues

. correction, upgrade, replacement or retirement of our computer systems
which are affected by the year 2000 issue

. testing for and validation of our year 2000 compliance

. development of contingency plans to address situations that may result
if we are unable to achieve year 2000 compliance of our critical
operations

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Based on our assessment to date, we have determined that we will be required to
upgrade a portion of our software so that our computer systems will function
properly with respect to dates in the year 2000 and thereafter. We estimate
that our information systems will be year 2000 compliant by July 1999. We
estimate that costs associated with the upgrade of existing computer software
will be less than $75,000. Costs incurred and expensed in the nine months ended
April 30, 1999 were less than $30,000. These costs related entirely to
modifications of existing software and represented approximately 10% of our
information systems budget for information technology in the period. Of the
remaining portion of our estimated year 2000 costs, approximately $30,000 of
the costs will be incurred in the fiscal quarter ending July 31, 1999. We may
address non-critical year 2000 issues beyond the year 2000. There is no
assurance that total costs will not exceed our estimates.

We are in communications with key suppliers, manufacturers and customers to
determine the extent to which we will be vulnerable to such parties' failure to
remedy their own year 2000 issues. We currently have only limited information
on the year 2000 compliance of our key suppliers, manufacturers and customers.
Our business and results of operations could experience material adverse
effects if our key suppliers or manufacturers were to experience year 2000
issues that caused them to delay production or shipment of key components or
systems. In addition, our results of operations could be materially adversely
affected if any of our key customers encounter year 2000 issues that cause them
to delay or cancel substantial purchase orders or delivery of our product.

There can be no assurance that we will be able to upgrade any or all of our
major systems in accordance with our plan to address the year 2000 issue. In
addition, there can be no assurance that any such upgrades will effectively
address the year 2000 issue. If required upgrades are not completed or are
unsuccessful, there would be a material adverse impact on our operations.
Furthermore, there can be no guarantee that the systems of other companies on
which our own systems rely will be timely converted, or that a failure to
convert by another company, or a conversion that is incompatible with our
systems, would not have a material adverse effect on us. We intend to, but have
not yet established, a contingency plan detailing actions that will be taken in
the event that the assessment of the year 2000 issue is not successfully
completed on a timely basis. We believe that the worst case year 2000 scenario
would involve disruption in utilities, transportation, and banking facilities.

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Business

Cortelco designs, develops and markets integrated enterprise communications
systems for routing and controlling the voice, video and data communications of
businesses and other organizations. Our solutions are primarily designed for
enterprises with complex communications needs and small and medium-sized
telephony installations, typically between 25 to 500 communications ports. We
serve a range of vertical markets such as education, retail, government
agencies, emergency-911 services and catalog sales. Some of our customers have
multiple installations networked together and are as large as national retail
chains or multi-location branches of the U.S. government. Our customers include
Bell Atlantic, Budget Rent-A-Car, Circuit City, the FAA, PETsMART and U-Haul.
Our products are installed in over 7,100 locations worldwide. In addition to
selling our products, we also resell cellular airtime, cellular telephones and
third-party voice communications systems in Puerto Rico. Our products have won
numerous awards, including "Best of Show" awards at CT Expo in 1997 and 1998
and "Product of the Year" awards in 1997 and 1998 from Call Center magazine and
in 1999 from Call Center Solutions magazine. On a pro forma basis, our revenues
increased 50.2% from $25.6 million for the nine months ended April 30, 1998 to
$38.4 million for the nine months ended April 30, 1999.

Our communications systems are based on two platforms, the Millennium and the
DSP Series. Both platforms are based on flexible, modular hardware and software
architectures that are easy to configure. Our platforms support multi-site
networking and other advanced features such as dynamic call routing,
interactive voice response, voicemail and computer telephony integration. The
Millennium is a full-function routing and control system that primarily serves
customers averaging approximately 110 communications ports per installation and
addresses a broad range of voice, video and data communications requirements.
The Millennium also includes automatic call distribution features. The DSP
Series is primarily an advanced automatic call distribution system that also
includes a full-function routing and control system. The DSP Series is
typically used in installations requiring advanced computer telephony
integration applications such as those used in sophisticated call centers. The
architecture of our platforms is designed to permit easy configuration and
subsequent upgrading to meet changing customer needs. Customer desired features
can be incorporated through the installation of optional add-in cards and
software. Millennium systems can be connected over the public service telephone
network or private data networks and can support ISDN based systems such as
videoconferencing. Both the Millennium and the DSP Series interface with a
variety of popular third-party products through standard protocols.

We also offer other products to provide our customers with cost-effective,
integrated communications solutions. For example, the Cortelco Voice Processing
System offers integrated, multi-lingual voice and fax messaging services across
multiple networked locations. Our Illuminations software package enables self-
service access to databases, such as product pricing information or school
course registration options, using touch-tone telephones or the Internet. We
also offer software that organizes call center data into real-time,
customizable, graphical user interfaces and reports for agents and supervisors.

Industry Overview

According to Dataquest, the U.S. private branch exchange and call center
systems market will total $5.8 billion in 1999. Traditionally, the voice
switching requirements of large enterprises have been addressed by private
branch exchange equipment. Enterprises with smaller installations that have not
been able to justify the expense of private branch exchange equipment have
utilized key telephone systems that, while more economical, have limited
functionality and scalability. Technology advances and the demands of
increasingly sophisticated customers are driving changes in today's

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telecommunications equipment industry. Businesses and organizations have come
to rely on complex voice and data networks to meet mission critical needs.
Recent technology advances have resulted in the introduction of increasingly
sophisticated features and applications in enterprise communications systems
that extend beyond traditional voice switching. Enterprises of all sizes are
now demanding telecommunications systems with the latest features and
applications in order to meet their business objectives. These features include
dynamic call routing, computer telephony integration, support for the
convergence of voice and data networks, multi-site networking and mobile
workforce support.

Dynamic Call Routing

Advanced call routing capabilities have recently been introduced that
dynamically screen, distribute and queue incoming calls based on specific
caller information, such as the number dialed or the state from which the call
is made. The growing number of "1-800" and "1-900" mail order, e-commerce and
customer support centers, driven by a focus on customer service, is generating
increased demand for dynamic call routing capabilities. These capabilities,
originally available only in dedicated automatic call distribution systems for
large stand-alone call centers, are now available as optional features on
standard private branch exchange equipment, and are being used for more general
business applications in various departments, such as human resources and
customer support.

Computer Telephony Integration

Computer telephony integration is the combination of voice communications and
computing capabilities which link telephony equipment to voicemail servers,
telephone directories, customer information databases and PC applications.
Enterprises increasingly seek voice communications systems that can use
standard protocols to interface with numerous third-party computer
applications. Such integrated applications include interactive voice response,
call accounting and unified messaging. For example, computer telephony
integration applications can be used to personalize call handling based on a
customer database and other information provided from the business' data
network. When an incoming call is connected to the customer service agent,
pertinent information concerning the particular caller can be displayed on the
agent's monitor, enabling the agent to provide a prompt and informed response
to the customer.

Convergence of Voice and Data Networks

Advances in networking and computing technologies offer the prospect of
combining voice and data networks which until now have been built and operated
as separate networks. The ability to combine separate voice and data networks
into one converged network could improve functionality, reduce network
administration and provide cost savings. For example, the widespread
implementation of Internet Protocol-based data networks has led to the
development of voice-over-Internet Protocol technology that permits
transmission of voice communications over public or private Internet Protocol
networks. According to Dataquest, transmission of voice traffic over Internet
Protocol networks in smaller enterprises is projected to grow at a compound
annual growth rate of 313% to 18.8 billion minutes of use in 2000.

Multi-Site Networking

Enterprises are increasingly dependent on distributed voice and data networks
to support their operations across multiple locations. A networked voice
communications solution delivers voice communication functions across multiple
locations as an integrated system, thereby increasing productivity and user
convenience and reducing costs. For example, messaging can be centralized so
that voicemail, e-mail and faxes can be delivered seamlessly to all locations
across the network.

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Support for a Mobile Workforce

Today's work environment is characterized by the need for real-time
communications that support increasingly mobile workers. Employees need to have
access to, and be accessible through, the enterprise's communications network
to make informed decisions quickly, improve productivity and respond to
customer needs rapidly. Remote access capabilities also allow off-site workers
to access all functions of the enterprise's communications system as if they
were on-site.

Traditional voice communications systems were designed to provide a broad range
of capabilities, but were not designed to be readily adaptable. Implementing
new features and applications on these systems often requires substantial
development effort and the purchase of ancillary equipment. Further
customization may be necessary to meet the needs of a particular installation.
Given the expense of ancillary equipment and customized development and the
need to allocate development resources to support larger customers,
communications systems vendors have generally addressed the small to medium-
sized installation segment of the market with equipment that is often costly
and less flexible. Thus, while traditional private branch exchange systems have
been able to adapt to the changing needs of large installations, the complexity
of these systems has limited the ability of traditional vendors to provide
flexible and cost-effective communications solutions for small and medium-sized
installations.

The Cortelco Solution

Cortelco provides integrated communications systems flexible enough to meet the
immediate needs of enterprises with small to medium-sized installations, yet
scalable enough to accommodate these businesses and organizations as they grow.
Our systems are based on a general purpose bus architecture designed from the
outset to permit the dynamic addition and variation of inputs, outputs and
features through software and configuration of the system through add-in cards.
Our solution offers functionality previously not readily available or cost-
effective for small to medium-sized installations. Our communications platforms
provide advanced features at an affordable cost and without the need for
extensive specialized software and hardware or complex installation procedures.

The flexible architecture of our Millennium and DSP Series platforms is the
backbone for all of our products. Our comprehensive solutions are designed to
improve the productivity and efficiency of our customers by providing them with
a variety of communications capabilities, such as:

. advanced call routing allowing for dynamic distribution of incoming
voice, video and data traffic

. easy integration of voice communications and computing capabilities

. cost-effective multi-site networking

. advanced mobility features to provide in-building and campus wireless
communications and remote access by off-site workers

We believe that we have achieved significant advantages in the configurability
of and the ease of programming these capabilities and other new features
relative to many competitors. Our flexible core platforms and range of options
offer enterprises with small to medium-sized installations the combination of
features and functions that best suit their particular needs.

Strategy

Cortelco's objective is to provide comprehensive, cost-effective communications
systems for small and medium-sized installations in selected vertical markets.
Our strategy incorporates the following key elements:

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Target Small to Medium-Sized Installations

We target enterprises with small to medium-sized installations, typically 25 to
500 communications ports, at one or more locations and that may have complex
communications needs. We focus our sales efforts on selected vertical markets
in which we have identified needs that can be especially well served by our
systems and are characterized by enterprises with small to medium-sized
installations, complex communications needs and cost-sensitivity. Our current
targeted vertical markets include education, retail, government agencies,
emergency-911 services and catalog sales. The inherent flexibility and
configurability of our Millennium and DSP Series platforms make us uniquely
suited to meet the needs of our targeted customers.

Provide Cost-Effective, Integrated Customer Solutions

We provide customers with cost-effective, integrated solutions for their voice
communications requirements, including solutions to seamlessly integrate their
voice and data networks. We believe our customers prefer to purchase integrated
solutions from a single vendor due to convenience, consistency of service, ease
of upgrade and vendor accountability. We offer an integrated family of
communications products that interface with a wide range of third-party
products through industry standard protocols, enabling us and our dealers to
configure and deliver complete, customized voice communications systems that
meet the specific needs of each customer.

Expand Distribution Capabilities

We are expanding both our direct sales force and our dealer network to more
aggressively pursue our target markets. Since April 30, 1998, we have increased
our sales force by approximately 48% and we plan further increases over the
next year. We believe our use of indirect sales channels is especially
effective because our dealers often have experience in our targeted vertical
markets and because our flexible platforms enable them to sell, configure and
service advanced features with relatively little expertise. As of April 30,
1999, we had approximately 130 authorized dealers and value added resellers. We
are also expanding our geographic coverage by recruiting new dealers, value
added resellers and strategic partners in the United States, the Caribbean and
Latin America.

Develop New Product Capabilities

We intend to continue to enhance our core product line and develop new features
and applications that leverage our existing Millennium and DSP Series
platforms, address emerging market needs and increase gross margins. For
example, we recently introduced new features and applications such as circuit
switched data capabilities for data intensive applications and PC-based phone
control. We expect to introduce several additional product capabilities during
1999, including:

. integrated in-building and campus wireless capabilities which increase
the range and maximum number of users on the existing Orbit Wireless
Communications product and add desktop equivalent capabilities

. unified messaging which provides integrated access to voice, fax and
e-mail messages in a multi-site networked communications system

. Internet Protocol capabilities such as voice-over-Internet Protocol,
virtual private networks for voice and data applications and other
Internet-based applications

. Web-based virtual call center capabilities allowing agents and
supervisors located anywhere in the world to access their call centers
over the Internet

We are also developing our next generation automatic call distribution and
switching architecture to address the integration of emerging voice and data
communications technologies.

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Products and Services

Cortelco offers the Millennium and the DSP Series, two feature-rich
communications platforms targeted at specific market segments. Each platform
provides advanced features that are easy to program and cost-effective due to
an innovative modular hardware design and flexible software. Both platforms
support multi-site networking and advanced features such as dynamic call
routing, interactive voice response, voicemail and computer telephony
integration. Our platforms share a suite of applications and hardware,
including voice processing systems, an in-building and campus wireless
communications system, a number of advanced computer telephony integration
products and digital handsets. Both platforms also interface to a range of
popular third-party products through standard protocols. These two
communications systems allow us to provide an integrated communications
solution for our target markets.

We also sell a variety of other products for use with our platforms. Our
Caribbean and Latin American Operations unit sells communications systems and
products produced by Cortelco and resells cellular airtime, cellular telephones
and third-party voice communications systems in Puerto Rico.

The Millennium

The Millennium is a fully-featured private branch exchange with automatic call
distribution capabilities, primarily targeting enterprises with small to
medium-sized installations. It can be expanded in a modular manner from 32 to
1,024 communications ports and supports up to 100 automatic call distribution
agents. Customers can increase the number of ports and add new features and
applications through the simple installation of add-in cards and software.
Dynamic call routing and control functions are provided by an integrated system
controller running a real-time operating system. PC-based applications and
system features are accessed via a serial interface. The Millennium can be
networked with Cortelco platforms at other sites via a digital network
interface.

The following is a diagram of the functional architecture of the Millennium
platform.

[Millennium Network Diagram]

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We believe that the Millennium platform is well-suited to address the voice
switching needs of enterprises with small to medium-sized installations,
including schools and school districts, retail sales and service locations,
distribution centers, broadcast and extended health care facilities, government
agencies and small call centers. The key strengths of the Millennium are multi-
site networking, affordable automatic call distribution applications and server
capabilities.

Multi-Site Networking. Millennium systems can be connected across multiple
locations, creating a private communications network that operates as if all
sites were on a single system. Therefore, connected locations can share the
Millennium's flexible call routing capabilities and applications. For example,
networked Millennium systems employing our proprietary VoiceClusters technology
can share a single Cortelco Voice Processing System, simplifying system
management and ensuring answering and call routing consistency across
locations. Similarly, networked Millennium systems employing the recently
announced integrated Orbit Wireless Communications System at each location
enables use of the same wireless handset across all locations.

Affordable Automatic Call Distribution Applications. A standard feature of the
Millennium is automatic call distribution. The system's dynamic call routing
and report generation capabilities can be enhanced with an optional, real-time
automatic call distribution package that provides call center management data
collection and reporting capabilities for smaller call centers. The Millennium
RealTime Automatic Call Distributor received a "Product of the Year" award from
Call Center Solutions magazine in January 1999.

Server Capabilities. The Millennium can be used to perform a variety of server-
like functions. For example, the Millennium can be used as a protocol converter
between E1 trunks, communications links used primarily by European carriers,
and T1 trunks, communications links used primarily in North America. The
Millennium can also be used as a channel bank, a device which merges multiple
voice and data circuits into a single digital communications stream, or act as
the switch in a wireless local loop network. In addition, one Millennium system
at the hub can serve as the single entry point for T1, PRI (Primary Rate ISDN)
and dedicated fiber optic links for the entire enterprise.

- --------------------------------------------------------------------------------
KEY FEATURES OF THE MILLENNIUM
- --------------------------------------------------------------------------------

<TABLE>
<S> <C> <C>
Digital Switching Networking and Server Automatic Call Distribution
Architecture Capabilities

. 32 to 1,024 . ISDN Support . Extensive Call Routing
Communications Ports
. Multi-Site Networking . Real-Time Automatic Call
. Modular Upgrade Path Distribution Agent
. Circuit Switched Data Reporting
. Software-Based
Configuration . Personal . Supports up to 100
and Upgrades Communications Service Automatic Call
Access Distribution Agents
Telephony Features (typically between 20
. Fiber Remote and 50 agents)
. Integrated Voicemail Capability
Illuminations Applications
. Caller ID Support . Communications Suite
Protocol Conversion
. Auto Attendant Unified Messaging
. Channel Banking (available in late 1999)
. Interactive Voice
Response . Communications Hub

. PC Attendant Console . Integrated In-building
(Navigator) and Campus Wireless
(Add-In available in
. Computer Telephony 1999)
Integration Links
and Host Links . Voice-over-Internet
Protocol Gateway (Add-
In available in 1999)
</TABLE>

29
<PAGE>

The DSP Series

The DSP Series is a fully-featured automatic call distributor platform with
integrated private branch exchange capabilities, primarily targeting the call
center market and enterprises with larger installations. It can be expanded in
a modular manner from 8 to 3,500 communications ports and supports up to 1,000
automatic call distribution agents. Its call routing flexibility can support up
to 32,000 routes, each with 64 different steps. Customers can increase the
number of ports and add new features and applications through the simple
installation of add-in cards and software. Dynamic call routing and control
functions are provided by redundant Pentium PCs running a real-time Linux-based
operating system. PC-based applications and system features are accessed via an
integrated Ethernet LAN interface. The DSP Series can be networked with
Cortelco platforms at other sites via a digital network interface.

The following is a diagram of the functional architecture of the DSP Series
platform.

[DSP Series Network Diagram]

Our DSP Series is primarily designed for call centers across a broad range of
industries including financial services, utilities, catalog sales, service
bureaus and emergency-911 services. The DSP Series is designed to ensure
uninterrupted service by including redundant processing units and power
supplies and using a real-time Linux-based operating system. We believe the DSP
Series is one of the most powerful and economical systems available on a cost-
per-agent basis. The DSP Series won "Best of Show" awards at the 1997 and 1998
CT Expo and "Product of the Year" awards in 1997 and 1998 from Call Center
magazine and in 1999 from Call Center Solutions magazine.

The DSP Series provides the platform to handle, manage and improve all aspects
of call center management. Its advanced automatic call distribution
capabilities include real-time dynamic call routing, skill-based routing,
simultaneous queuing among multiple gates and multiple networked systems,
intelligent messages and caller identification number directed routing. The DSP
Series also provides a comprehensive, customizable report and display package
and can support computer

30
<PAGE>

telephony integration applications for both inbound and outbound call center
solutions. We currently offer the DSP1000 and DSP2000. The DSP2000 is an
updated version of the DSP1000 which provides an upgrade path to 3,500
communications ports and support for a greater number of call center agents.
The key strengths of the DSP Series are advanced automatic call distribution
capabilities, host computer telephony integration and PC Phone Control with
ActiveX.

Advanced Automatic Call Distribution Capabilities. The advanced automatic call
distribution capabilities of the DSP Series include:

. Home Agent--This feature allows an agent to call into the system from
a touch-tone phone, sign-on and conduct business as if he or she were
on-site. The home agent can perform all operations and enter all modes
as any other on-site agent. Supervisor displays, historical data
gathering and computer telephony integration applications work
identically for off-site and on-site agents. Additionally, the home
agent with a modem-connected PC can retrieve information from
enterprise databases.

. Automatic Agent Greetings (AgentVoice)--This feature allows an agent
to pre-record a number of different greetings that can be played based
upon a caller's identification number. The agent and the caller hear
the greeting simultaneously, providing a "whisper announce"
notification for the agent. Pre-recorded responses can be played on
demand to provide consistent, automated answers to frequently-asked
questions from callers. AgentVoice is particularly useful for high
volume call centers and service bureaus in which agents answer calls
for a variety of different businesses.

. Intelligent Announcement System--This feature enables our customers to
provide inbound callers with a number of customized interactive,
promotional, informational, holiday, after hours and delay messages.
In addition, it can provide the caller with real-time call statistics
such as estimated wait time, number of calls waiting and number of
agents available. Our customers can choose from a set of pre-recorded
voices or create a personalized message from a touch-tone phone or a
Microsoft Windows-based interface.

. Agent Call Back--This feature allows a call center agent with
automatic number identification capability to flag a call, enabling a
caller who calls back within a given period of time to be routed to
the agent who originally handled the call.

Host Computer Telephony Integration. The DSP Series offers an applications
link for direct, redundant TCP/IP communications to host computers using
10/100BaseT Ethernet, a standard data networking protocol. This link allows
data and commands to flow between the DSP Series and multiple host computers,
permitting a networked implementation of a variety of enhanced applications
such as screen synchronization, automated outbound dialing, automatic number
identification screening and call routing. The link uses a standard Computer
Supported Telecommunications Application ("CSTA") protocol which functions with
many commercially available computer telephony integration protocols such as
Novell TSAPI, IBM Call Path and Dialogic CT Connect applications. Unlike other
similar competitive offerings, no intermediate computers are required for the
CSTA interface.

PC Phone Control with ActiveX. PC Phone Control is a graphical user interface
for agents to access call center functions such as available/unavailable
status, group pickup, redial and multi-line support. The ActiveX component of
our PC Phone Control provides tools for developers of call center applications
to use a variety of programming languages, including C, C++, Borland Delphi,
Visual Basic and Java, to develop custom applications without the need to
understand complex computer telephony integration protocols. We have won
numerous awards for this product, including a "Best of Show" award at the 1998
CT Expo and a "Product of the Year" award in 1997 from Call Center magazine.

31
<PAGE>

KEY FEATURES OF THE DSP SERIES
- --------------------------------------------------------------------------------

<TABLE>
<S> <C> <C>
Digital Switching Redundant Embedded CSTA Advanced Automatic Call
Architecture Server Distribution

. 8 to 3,500 Networking and Server . Skill-based Routing
Communications Capabilities
Ports
. Caller-ID Support
. Modular Upgrade . Automatic Agent
Path . Multi-Site Networking Greeting (AgentVoice)

. Software-Based . Integrated In- . Intelligent Announcement
Configuration and building and Campus System
Upgrades Wireless (Add-In
available in 2000) . Agent Call Back
Telephony Features
. Voice-over-Internet . Agent Service Observation
. Voicemail (Add-In) Protocol Gateway
(Add-In available . Redundant Power
. ISDN Support in 1999) Supplies and
Processing Units
. Auto Attendant
Basic Automatic Call . Multi-Site, Networked
. Interactive Voice Distribution Automatic Call
Response Distribution Support

. Computer Telephony . Extensive Call . Advanced Call Center
Integration Links Routing Management Information
and Host Links System

Client Application . Real-Time Automatic
Computer Telephony Call Distribution
Integration Toolkit Agent Reporting . Supports up to 1,000
Automatic Call
Embedded SQL/ODBC . Remote/Home Agent Distribution Agents
Server (typically between 25
and 300 agents)

PC Phone Control with . Custom Automatic Call
ActiveX Distribution Display
</TABLE> Packages

Other Products

We also offer a variety of other products for use with both the Millennium and
DSP Series.

Voice Processing System. The Cortelco Voice Processing System manages voice
and fax messaging through integration of the telephone and messaging systems.
This system provides a full range of voice and fax messaging services across
networks running Microsoft NT, Novell NetWare, IBM OS/2 Warp and Artisoft
LANtastic. Our proprietary VoiceClusters technology links multiple Cortelco
Voice Processing System servers into a global messaging system, using existing
wide-area networks to exchange messages between systems. This capability
enables voice and fax message distribution to locations worldwide, improving
message access and reducing transmission costs and delivery time. The system
offers capabilities to support multiple languages simultaneously and language
preference can be programmed by system, group or individual users. The Cortelco
Voice Processing System is expandable from 4 to 48 ports and supports voicemail
applications for up to 3,000 mailboxes, the Millennium and DSP Series platforms
and many other voice communications platforms.

In-building Wireless Communications. Cortelco's Orbit Wireless Communications
System utilizes micro-cellular technology in the 1.92 to 1.93 gigahertz
frequency band to provide a private digital wireless voice/data communications
network within a building or campus. The system consists of a controller, base
stations and user handsets and can be used with our systems or with any third-
party private branch exchange or key telephone system. These system components
are purchased and licensed from a third-party supplier under an OEM purchase
agreement. We recently announced a Millennium Wireless Services Card of our own
design which we expect to make available during the third calendar quarter of
1999. This add-in card and software enables full desktop equivalent features on
the Orbit wireless handsets and significantly increases the range of the system
and number of users it can simultaneously support. We plan to provide a similar
add-in card for the DSP Series. The Orbit Wireless Communications System won a
"Best of Show" award at the 1998 CT Expo.

32
<PAGE>

Interactive Voice Response. Cortelco's Illuminations packages are Interactive
Voice Response and Web-enabled self-service information retrieval packages
customized for certain vertical markets. We released the first Illuminations
package, Illuminations for Education, in August 1998. Illuminations for
Education supports such common applications as automated course registration,
automated attendance validation and grade reporting. We are considering the
development of additional packages for the e-commerce, call center, broadcast
and retail markets.

PC-Based Attendant Console. The Navigator attendant console is a hardware and
software based answering and messaging package for use with our Millennium
system. The Navigator enhances an attendant's performance by presenting
appropriate answer phrases, associated company directories, current
availability status of individuals and other useful information with each
inbound call. Calls can be connected to desired parties, on- or off-site, with
a single keystroke or the click of a mouse. Messages can be taken for
unavailable parties or digital pagers can be dialed with preprogrammed callback
numbers displayed. The Navigator provides the attendant with the information
necessary to efficiently answer and process each call presented to the console.
The Navigator is particularly well-suited for multi-tenant applications. A new
version of this product, to be introduced in the third calendar quarter of
1999, provides the ability to integrate with popular e-mail packages such as
Microsoft Outlook. This product won a "Best of Show" award at the 1997 CT Expo.

Third-Party Products and Services in Puerto Rico

We resell cellular airtime, cellular telephones and third-party voice
communications systems in Puerto Rico. These third-party products include voice
communications systems from Hitachi and Lucent, sold under distributor
agreements for the Puerto Rico market. Cellular airtime services are resold
under agreements with CellularOne and GTE and cellular telephone equipment is
resold for a variety of equipment suppliers, including Ericsson, Motorola and
Nokia.

Customers

Cortelco's customers are typically enterprises with small to medium-sized
installations which often have complex communications needs. Many of these
customers are in selected vertical markets in which we have identified needs
that can be especially well served by our systems. These markets currently
include education, retail, government agencies, emergency-911 services and
catalog sales. Some of our customers have multiple installations networked
together and are as large as national retail chains, such as Circuit City and
U-Haul, or multi-location branches of the U.S. government, such as the FAA and
the U.S. Coast Guard.

For example, Circuit City, one of the nation's largest retailers of brand-name
consumer electronics equipment, has implemented our products in several hundred
stores throughout the United States. Circuit City's customer service centers
use the Millennium Real-Time Automatic Call Distributor package. The
Millennium's flexible call routing and automatic call distributor capabilities
and its easy installation, programming and setup were important factors for
Circuit City in choosing a Cortelco solution.

We have also sold over sixty DSP Series systems to the FAA for use in their
Automated Flight Service Stations. Whenever a general aviation pilot files a
flight plan, checks aviation weather or national airspace information, the call
is answered and routed through a DSP Series system. The DSP Series provides the
FAA with an automatic call distribution platform for applications such as
computer telephony integration, skill-based call routing and remote agents, as
well as full voice routing and control functionality.

33
<PAGE>

Our products have been installed for over 5,400 customers in over 7,100
locations. We believe the following list of customers is typical of our
customer base by virtue of the industries they represent and the types of
applications they implement using our products:

<TABLE>
<S> <C>
Retail Sales and Service Education
------------------------ ---------
Budget Rent-A-Car Celebration School (Disney partner)
Circuit City Pennsylvania State School Systems
Hartz Mountain St. Cloud, Minnesota School District
PETsMART Universidad Politechnica
U-Haul Washington University

Media/Entertainment General Business
------------------- ----------------
KQED Baxter Caribe
Los Angeles Dodgers Comair (Delta)
Penske Motorsports California Consolidated Freightways
Speedway Florida Power
Punch Productions Island Finance
Trinity Productions

Call Centers Government Agencies
------------ -------------------
Bell Atlantic (emergency-911) Federal Aviation Administration
Bell South (emergency-911) National Park Service
Bellco Federal Credit Union U.S. Coast Guard
Birkenstock Shoes U.S. Customs Service
California Highway Patrol U.S. Marshals Service
Current, Inc.
Resort Quest
</TABLE>

Sales and Marketing

For the fiscal year ended 1998, approximately 70% of our pro forma revenues
were generated by our direct distribution channels and approximately 30% of our
pro forma revenues were generated by our indirect distribution channels. We use
a direct sales force to market our Millennium systems to national accounts and
the federal government and for all DSP Series system sales. Approximately 130
authorized dealers and value added resellers sell, install and service our
Millennium systems. We directly install, maintain and support our DSP Series
systems. All of our sales in Puerto Rico are made through our direct sales
force. We also offer systems integration services and customized system
development. As of April 30, 1999, we had approximately 74 sales and marketing
personnel. We have increased the number of sales and marketing personnel by
approximately 48% since 1998 and anticipate further increases in the future.

Through our office in San Juan, Puerto Rico, our Caribbean and Latin American
Operations unit expects to develop a network of authorized dealers for sales
and service of the Millennium and DSP Series product lines in countries in the
Caribbean, Central America and the northern portion of South America.
Additionally, we expect to open an office in Santiago, Chile, which will
develop and manage a network of authorized dealers for sales and service in
Argentina, Bolivia, Chile, Equador and Peru.

Our marketing efforts focus on building brand awareness and increasing sales to
customers directly and through our dealer network and value added resellers. We
seek to educate customers in our targeted vertical markets about the benefits
of our flexible product platforms and integrated communications solutions and
the quality of our customer support and services.

34
<PAGE>

Research and Development

Our research and development efforts focus on enhancing our core product lines
and developing the next generation automatic call distribution and switching
architecture. We routinely conduct market research and solicit input from our
customers and a select set of dealers as an integral part of our product
planning. Current product initiatives include:

. Platform Extensions--Extend and enhance the capabilities of the
Millennium and DSP Series platforms. Examples include: unified
messaging support, enhanced integration of our Cortelco Voice
Processing System, an Orbit Wireless Services Card for the DSP Series
and 2-wire telephone support for the Millennium.

. Internet-Based Products--Integrate Internet capabilities into
traditional switched telephony applications. Examples include: voice-
over-Internet Protocol and Web-based virtual call center capabilities.

. Computer Telephony Integration Applications--Extend programming
interfaces, develop applications and certify third-party computer
telephony integration products for targeted vertical markets. Examples
include: TAPI standard computer telephony integration interface,
Illuminations packages for call centers and retail markets and
enhanced PC Phone Control with ActiveX.

. Next Generation Core Products--Establish design concepts and
architecture for new core products that will extend and enhance the
capabilities of our current Millennium and DSP Series products.
Consistent with our strategy, new core products will be based on an
open architecture, will support a broader set of industry standard
protocols than our current products and will more fully integrate
emerging voice and data technologies. Examples of the new technologies
and capabilities we are addressing include: a local area network
telephony gateway, an Internet Protocol-based dynamic call routing
server for voice and data, frame relay and asynchronous transfer mode
protocol support, and local area network-based Internet Protocol
telephones.

As of April 30, 1999, we had 32 employees engaged in research and development.
We have increased the total number of engineers by approximately 25% since
1998. We expect to continue to increase the number of our research and
development employees at a faster rate than other areas and to focus these
additional resources on our new product development initiatives. In particular,
we will expand our capability to design and develop new software features which
are based on industry standard network interfaces, such as asynchronous
transfer mode and frame relay, and industry standard operating systems, such as
Linux, Unix and Windows NT.

Manufacturing

We currently rely on two contract electronic manufacturers to produce the
Millennium, CMC Industries, Inc. in Corinth, Mississippi and Pensar Corporation
in Appleton, Wisconsin. Both contract manufacturers perform printed circuit
board assembly and soldering, in-circuit and functional testing and packaging.
We believe that CMC and Pensar have sufficient capacity and technical
capabilities to respond to foreseeable increases in customer demand and
advances in in-process technology. After final assembly by either manufacturer,
we inspect and perform quality assurance testing at our facility in Corinth,
Mississippi prior to shipment to our dealers or customers. Our contract with
CMC provides for the purchase of units through purchase orders with pricing to
be negotiated annually. The term of the contract is from August 1, 1998 through
July 31, 1999 with one year renewals upon written notice by Cortelco. We make
purchases from Pensar through purchase orders.

Due to the customized nature of call center installations, each DSP Series sys-
tem is custom-configured at our facility in Kennesaw, Georgia. We use various
contract electronic manufacturers to manufacture

35
<PAGE>

line cards, trunk cards and other DSP Series components and subassemblies. We
receive, inspect and test components and subassemblies at our Kennesaw facili-
ty. We then assemble and test each DSP Series system, configured in accordance
with the customer's order, and ship the product directly to the customer's
site.

We are dependent on certain key suppliers for a number of our product
components. For example, we rely on Siemens for our primary digital signal
processors and chip sets, Natural Microsystems to supply the voice processors
for our Cortelco Voice Processing System and CTP Systems for our Orbit wireless
handsets and base stations. Our contract electronic manufacturers use standard
components and subassemblies manufactured to our specifications. We make
purchases from these suppliers through purchase orders. Interruptions in the
availability of components from our key suppliers could result in delays or
reductions in product shipments, which could damage our customer relationships
and have an adverse effect on our operating results. We could also have
difficulties finding alternate suppliers or modifying product designs to use
alternative components.

Competition

Our principal competitors include Lucent Technologies, Mitel, NEC, Nortel
Networks and Siemens in the voice communications equipment market and Aspect
Telecommunications and Rockwell Electronic Commerce in the call center market.
We also compete with vendors in markets for our ancillary products, such as
voicemail, wireless communications and computer telephony integration
applications. As voice and data communications networks converge, data
equipment vendors such as Cisco Systems and 3Com may also compete in our
market. In addition, alliances and mergers between telecommunications and
computer companies may strengthen our competitors' positions or result in new
entrants into our market.

Many of our current and potential competitors have significantly greater
financial, technical, marketing, customer service and other resources, greater
name recognition and a larger installed customer base than we do. As a result,
our competitors may be able to respond to new or emerging technologies and
changes faster than we can. They may also be able to devote greater resources
to the development, promotion and sale of their products. Actions by our
competitors could result in price reductions, reduced margins and loss of
market share, any of which would have a material adverse effect on our
financial condition. There can be no assurance that we can compete successfully
against our competitors or that competitive pressures would not have a material
adverse effect on our financial condition and results of operations.

Intellectual Property

Cortelco relies on patent, trademark, copyright, trade secret protection and
confidentiality and license agreements with its employees, clients, partners
and others to protect its proprietary rights. We currently have 23 patents
issued in the United States and additional patents pending. There can be no
assurance that any patent applications now pending or hereafter filed by
Cortelco will result in patents being issued.

The patent position of technology companies involves complex legal and factual
questions and, therefore, their validity and enforceability cannot be predicted
with certainty. There can be no assurance that the steps taken by Cortelco to
protect its proprietary rights will be adequate or that third parties will not
infringe or misappropriate our patents, trade secrets, trademarks and similar
proprietary rights. Furthermore, there can be no assurance that others will not
independently develop similar technologies or duplicate any technology
developed by Cortelco.

A failure by Cortelco to protect its intellectual property could have a
material adverse effect on its business, financial condition and results of
operations. In addition, litigation may be necessary in the future to enforce
our intellectual property rights, protect our trade secrets or determine the
validity and

36
<PAGE>

scope of the proprietary rights of others. Such litigation could result in
substantial costs and diversion of management and technical resources, which
could have a material adverse effect on our business, financial condition and
results of operations.

"BCS Technologies," "DSP1000," "Millennium," "DSP2000," "Illuminations,"
"Navigator," "Orbit," "VoiceClusters" and the Cortelco logo are trademarks of
Cortelco.

Facilities

We currently lease the following facilities:

. Memphis, Tennessee--approximately 25,000 square feet of office space
for our corporate headquarters as well as administration, sales and
marketing, customer support and Millennium engineering departments

. Kennesaw, Georgia--approximately 23,000 square feet of office space
for our DSP Series engineering, manufacturing operations and quality
assurance departments

. San Juan, Puerto Rico--approximately 20,000 square feet of office
space for our Caribbean and Latin American Operations unit

. Corinth, Mississippi--approximately 11,000 square feet of warehouse
space for our Millennium manufacturing operations and quality
assurance departments

. Englewood, Colorado--approximately 7,000 square feet of office space
for ACD Business Operations unit sales and marketing and customer
support departments

. Guelph, Ontario, Canada--approximately 5,000 square feet of office
space for a software engineering group

We expect to relocate our headquarters to a larger facility in Memphis,
Tennessee in 2000. We believe that these facilities will be adequate to
accommodate our needs for the foreseeable future.

Employees

As of April 30, 1999, we employed approximately 243 people, including
approximately 74 in sales and marketing, approximately 32 in research and
development, approximately 75 in service, technical support and training,
approximately 24 in manufacturing operations and quality assurance and
approximately 38 in finance and administration. We also employ independent
contractors and other temporary employees. None of our employees is represented
by a labor union, and we consider our employee relations to be good.
Competition for qualified personnel in our industry is intense, particularly
for qualified service technicians and software engineers trained in computer
telephony integration and other technical staff. We believe that our future
success will depend in part on our ability to attract, hire and retain
qualified personnel.

Legal Proceedings

In the ordinary course of our business, we may from time to time be involved in
litigation with employees, customers and others. In 1997, Cellu-Tel, Inc. filed
an action against Cortelco Puerto Rico in Superior Court in San Juan, Puerto
Rico. The complaint essentially alleges that Cortelco Puerto Rico breached the
terms of its contract by terminating cellular activations. The complaint seeks
damages of approximately $854,430. We believe that this litigation is without
merit and will not have a material adverse effect on our business.

In July 1998, we were served with a complaint by CBC Distribution & Marketing,
Inc., alleging essentially that a Millennium system purchased by CBC failed to
function as represented. The

37
<PAGE>

complaint, which also named our dealer, Technicom Communications, Inc., and
CBC's insurance carrier as defendants, seeks actual damages of approximately
$1.5 million due to disruption of its fantasy football pool operations plus
punitive damages and attorneys' fees. CBC later amended the complaint to add
Sprint International Communications as a defendant. CBC's insurance carrier
also filed a cross-claim against us. CBC's claim against its insurance carrier
and the insurance carrier's cross-claim against us have since been voluntarily
dismissed. A trial date has been set for March 6, 2000. We believe that this
litigation is without merit and will not have a material adverse effect on our
business.

In addition, in November 1998, WSI, Inc., as debtor in possession in a chapter
XI bankruptcy proceeding, filed an action against Cortelco Puerto Rico,
Cortelco Systems Holding Corporation and David S. Lee, one of our directors, in
bankruptcy court. WSI is a distributor of telecommunications systems in Puerto
Rico. The complaint essentially alleges that the defendants misused
confidential information and otherwise engaged in unfair competition with WSI
by attempting to discredit WSI with Lucent Technologies, Inc. and WSI's
customers in Puerto Rico and to hire WSI employees. The complaint seeks damages
in excess of $15.0 million plus costs and attorneys' fees. We believe that this
litigation is without merit and will not have a material adverse effect on our
business.

38
<PAGE>

Management

Executive Officers and Directors

The executive officers and directors of Cortelco, and their ages as of April
30, 1999, are as follows:

<TABLE>
<CAPTION>
Name Age Position
- ------------------------ --- ------------------------------------------------------
<S> <C> <C>
J. Michael O'Dell....... 51 President, Chief Executive Officer and Director
Stephen N. Samp......... 34 Chief Financial Officer, Vice President of Finance and
Administration and Secretary
Robert R. Cash.......... 44 Vice President of Sales and Marketing
David M. Fredrick....... 46 Vice President/General Manager of ACD Business
Operations
Sergio R. Moren......... 54 Vice President/General Manager of Caribbean and Latin
American Operations
David S. Lee (1)........ 61 Chairman of the Board
Stephen R. Bowling (1)
(2).................... 56 Director
Robert P. Dilworth (2).. 57 Director
W. Frank King (1)....... 59 Director
Jenny Hsui Theleen (1)
(2).................... 46 Director
</TABLE>
- -------------------------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.

J. Michael O'Dell has served as Chief Executive Officer and a director of
Cortelco since April 1998 and as President since October 1997. He also served
as Chief Operating Officer of Cortelco from October 1997 to April 1998. From
May 1993 to October 1997, Mr. O'Dell held various management positions at VTEL
Corporation, a visual communications company, the most recent being Vice
President and General Manager for the Enterprise Systems Division. Prior to
VTEL, Mr. O'Dell served as Vice President, PC Products at Dell Computer
Corporation, a personal computer manufacturer, and in various management
capacities at IBM Corporation, a computer and electronics company. Mr. O'Dell
received an M.S. in computer science from the United States Naval Postgraduate
School and a B.S. from the United States Naval Academy in Annapolis, Maryland.

Stephen N. Samp has served as Chief Financial Officer, Vice President of
Finance and Administration and Secretary of Cortelco since March 1998. From
June 1995 to February 1998, Mr. Samp was Vice President, Controller and Chief
Accounting Officer at Guardsmark, Inc., a private security services firm. Mr.
Samp previously worked with Deloitte, Haskins & Sells, an accounting firm. From
August 1993 to May 1995, Mr. Samp attended the Wharton Graduate School of
Business at the University of Pennsylvania where he earned an M.B.A. Mr. Samp
received a B.S. in business administration from the Ohio State University.

Robert R. Cash has served as Vice President of Sales and Marketing for Cortelco
since March 1998. From June 1996 to March 1998, he was Senior Vice President at
Coherent Communications Systems Corporation, a telephone apparatus company.
From 1991 to 1994, Mr. Cash served as Vice President of Consumer Products and
Vice President and General Manager for the Wireless Terminal Strategic Business
Unit, a division of AT&T, a telecommunications company. He also has experience
as New Business Development Vice President, as well as Product Manager,
responsible for Key System Products at AT&T General Business Systems. Mr. Cash
received an M.B.A. from Rutgers University and a B.A. in accounting from
Lipscomb University.

39
<PAGE>

David M. Fredrick has served as Vice President/General Manager of ACD Business
Operations since April 1999. From 1988 until BCS was acquired by Cortelco in
April 1999, Mr. Fredrick served as President and a director of BCS and its
predecessor. Prior to BCS, Mr. Fredrick served as Vice President and Chief
Operating Officer of Big O Tire Dealers and a consultant for a healthcare
franchise company. Mr. Fredrick received an M.B.A. and a B.A. in business
administration from the University of Denver.

Sergio R. Moren has served as Vice President/General Manager of Caribbean and
Latin American Operations since April 1999. Mr. Moren joined Cortelco Systems
Puerto Rico in February 1998 and served as its President until it merged with
Cortelco in April 1999. He joined Cortelco from Integrated Technologies, a
contract manufacturer in the Dominican Republic, where he was Vice President
from January 1996 to February 1998. Mr. Moren has also held a number of
executive manufacturing and sales and marketing positions with various
companies, including ITT Industries, Inc. in Puerto Rico and Latin America,
where he last held the position of President and General Manager of ITT Qume
Caribe, Puerto Rico. Mr. Moren received a masters degree from Harvard
University's program for management development and a B.S. in electrical
engineering from Santa Maria University in Chile.

David S. Lee has served as the Chairman of Cortelco since 1991. Mr. Lee also
serves as a director of CMC Industries, Inc., a contract electronic
manufacturer; Centigram Communications Corporation, a communications management
system company; and Linear Technology Corporation, a semiconductor company. Mr.
Lee is a private investor and also serves as a Regent of the University of
California. Mr. Lee was the President and Chairman of Data Technology
Corporation from 1985 to 1988. Previously he served as Group Executive and
Chairman of the Business Information Systems Group of ITT Corporation, and
President of ITT Qume, formerly Qume Corporation. Mr. Lee co-founded Qume
Corporation in 1973 and served as Executive Vice President until the company
was acquired by ITT in 1978. Mr. Lee received an M.S. in mechanical engineering
from North Dakota State University. Mr. Lee received a B.S. in mechanical
engineering and an honorary doctorate of engineering from Montana State
University.

Stephen R. Bowling has served on the board of directors of Cortelco since
September 1993. From 1994 to October 1997, he was the President of Cortelco
and, from 1994 to April 1998, he was the Chief Executive Officer of Cortelco.
Mr. Bowling is a private investor and since September 1993, he has served as
President, Chief Executive Officer and a director of Cortelco Systems Holding
Corporation. From 1978 to 1984, Mr. Bowling held several executive positions
with Qume Corporation, a computer systems peripherals company, where his last
position was Executive Vice President and General Manager. Mr. Bowling received
an M.B.A. from Stanford University and a B.A. in economics from Williams
College.

Robert P. Dilworth has served on the board of directors of Cortelco since July
1998. He is presently serving as Senior Vice President of the Computer and
Consumer Products Group at VLSI Technology, Inc., a semiconductor manufacturer,
where he continues to serve as a director. Mr. Dilworth is also presently
serving as the Chairman of Metricom, Inc., a wireless data communications
company, and served as its President from 1987 to 1997, and its Chief Executive
Officer from 1987 to 1998. Mr. Dilworth is a director of Photonics Corporation,
a computer communications equipment company. Mr. Dilworth received a B.S. in
business administration from Los Angeles State University.

W. Frank King has served on the board of directors of Cortelco since September
1998. He is currently a private investor and a director of PSW Technologies,
Inc., a software integration consulting

40
<PAGE>

firm, where he served as President and Chief Executive Officer from 1992 to
1998. He currently serves on the boards of directors of Excalibur Technologies
Corporation, a software company; Auspex Systems Inc., a computer server
manufacturer; Best Software, Inc., an application software company; and Natural
Microsystems Corporation, a telecommunications company. Dr. King earned a Ph.D.
in electrical engineering from Princeton University, an M.S. in electrical
engineering from Stanford University and a B.S. in electrical engineering from
the University of Florida.

Jenny Hsui Theleen has served on the board of directors of Cortelco since July
1997. She is currently serving as the Chairman of CV Transportation Services,
an integrated transportation and distribution company. In 1984, Ms. Theleen co-
founded ChinaVest, a private equity investment firm, and presently serves as a
managing director. Ms. Theleen earned her post-graduate degree from L'Institut
d'Etudes Politiques in Paris, France, and a bachelor's degree from the
University of Singapore.

Committees of the Board of Directors

Our board of directors consists of six members, including our Chief Executive
Officer. In accordance with the terms of our certificate of incorporation, the
terms of office of the board of directors will be divided into three classes:
Class I, whose term will expire at the annual meeting of stockholders to be
held in 2000, Class II, whose term will expire at the annual meeting of
stockholders to be held in 2001, and Class III, whose term will expire at the
annual meeting of stockholders to be held in 2002. The Class I directors are
Stephen R. Bowling and Jenny Hsui Theleen, the Class II directors are Robert P.
Dilworth and David S. Lee, and the Class III directors are W. Frank King and J.
Michael O'Dell. At each annual meeting of stockholders after the initial
classification, the successors to directors whose terms will then expire will
be elected to serve from the time of election and qualification until the third
annual meeting following election. Any additional directorships resulting from
an increase in the number of directors will be distributed among the three
classes so that, as nearly as possible, each class will consist of one-third of
the directors.

Our board of directors has established an audit committee and a compensation
committee. The audit committee consists of independent directors Stephen R.
Bowling, Robert P. Dilworth and Jenny Hsui Theleen. The audit committee makes
recommendations to the board regarding the selection of independent auditors,
reviews the results and scope of the audit and other services provided by the
Cortelco's independent auditors, and reviews and evaluates Cortelco's audit and
control functions. The compensation committee consists of Stephen R. Bowling,
W. Frank King, David S. Lee and Jenny Hsui Theleen.

Director Compensation

Directors currently do not receive any cash compensation for services provided
as a board member but are reimbursed for out-of-pocket expenses they incur in
connection with attendance at board meetings. Pursuant to the 1997 Equity
Incentive Plan, Robert P. Dilworth and W. Frank King were each granted an
option to purchase 18,000 shares of common stock at an exercise price of $0.70
per share in July 1998 and September 1998, respectively, and an option to
purchase 17,027 shares of common stock at an exercise price of $6.50 per share
in December 1998. Directors are eligible to receive discretionary option grants
pursuant to the 1999 Equity Incentive Plan and employee directors will also be
eligible to participate in the 1999 Employee Stock Purchase Plan. See "--Stock
Incentive Plans."

Compensation Committee Interlocks and Insider Participation

In April 1998, our board of directors established a compensation committee. The
compensation committee is responsible for approving all compensation
arrangements for our officers and for

41
<PAGE>

administering our employee stock option and stock purchase plans. In the last
fiscal year, the compensation committee was composed of Stephen R. Bowling,
David S. Lee and Jenny Hsui Theleen. W. Frank King joined the compensation
committee in February 1999. Other than Stephen R. Bowling, who served as
Cortelco's President from 1994 to October 1997 and as Cortelco's Chief
Executive Officer from 1994 to April 1998, none of the members of the
compensation committee are, or have ever been, officers or employees of
Cortelco. Prior to the formation of the compensation committee, all decisions
regarding compensation arrangements for our officers were made by the board of
directors. See "Certain Transactions."

Executive Compensation

The following table sets forth certain information concerning the compensation
earned for the fiscal year ended July 31, 1998 for (a) Cortelco's Chief
Executive Officer and (b) each other executive officer of Cortelco whose total
salary and bonus exceeded $100,000 for services rendered to Cortelco and its
subsidiaries during the fiscal year 1998. For information regarding terms of
the stock options, see "--Stock Incentive Plans."

The annual compensation of each of Robert R. Cash, David M. Fredrick and Sergio
R. Moren exceeds $100,000. However, because all of the above individuals were
hired during fiscal year 1998 and their total compensation earned as of the end
of fiscal year 1998 did not exceed $100,000, they are not included in the
following table as named executive officers. J. Michael O'Dell joined Cortelco
as President and Chief Operating Officer in October 1997 and became the Chief
Executive Officer of Cortelco in April 1998. Stephen R. Bowling previously
served as President of Cortelco until October 1997 and Chief Executive Officer
until April 1998.

Summary Compensation Table

<TABLE>
<CAPTION>
---------------------------------------------
Long-Term
Annual Compensation Compensation
----------------------------- ------------
Securities
Other Annual Underlying
Name and Principal Position Salary Bonus Compensation Options
- --------------------------- -------- ------- ------------ ------------
<S> <C> <C> <C> <C>
J. Michael O'Dell................ $156,153 $25,000 $62,000(1) 85,000
Stephen R. Bowling............... 185,000 -- -- --
</TABLE>
- -------------------
(1) Represents reimbursement of relocation expenses.

Option Grants in Last Fiscal Year

The following table sets forth each grant of stock options made during the
fiscal year ended July 31, 1998 to each of the named executive officers.
Options generally vest at a rate of 12.5% beginning on the date six months
after the vesting commencement date and the remaining options vest in equal
installments on a monthly basis over a three and one-half year period
thereafter. These options have a term of 10 years.

The potential realizable value is calculated based on the term of the option at
the time of grant, which is 10 years. Stock price appreciation of 5% and 10% is
assumed pursuant to rules promulgated by the SEC and does not represent our
prediction of our stock price performance. The potential realizable value at 5%
and 10% appreciation is calculated by assuming that the exercise price on the
date of

42
<PAGE>

grant appreciates at the indicated rate for the entire term of the option and
that the option is exercised at the exercise price and sold on the last day of
its term at the appreciated price.
<TABLE>
<CAPTION>
--------------------------------------------------------------------------
Individual Grants
-------------------------------------------

Percentage Potential Realizable Value at
Number of of Total Assumed Annual Rates of
Securities Options Stock Price Appreciation for
Underlying Granted in Exercise Option Term
Options Fiscal Price Expiration ------------------------------
Name Granted 1998(1) Per Share Date 5% 10%
- ---- ---------- ---------- --------- ---------- -------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
J. Michael O'Dell....... 85,000 61.0% $ 1.00 10/15/07 $ 53,456 $ 135,468
</TABLE>

- -------------------
(1) Based on an aggregate of 139,311 shares subject to options granted to
employees of Cortelco under the 1997 Equity Incentive Plan in fiscal 1998,
including the named executive officers.

Aggregated Options Exercised in Fiscal 1998 and Year-End Option Values

The following table sets forth, for the named executive officers, the shares
acquired and the value realized on each exercise of stock options during the
year ended July 31, 1998, and the number and value of securities underlying
unexercised options held by the named executive officers at July 31, 1998.
Options generally vest at a rate of 12.5% on the date six months after the date
of grant and the remaining options vest in equal installments on a monthly
basis over a three and one-half year period thereafter. These options have a
term of 10 years. There was no public trading market for the common stock as of
April 30, 1999. Accordingly, the value of unexercised in-the-money options have
been calculated assuming the shares of common stock have a value of $11.00 per
share.

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------
Number of Securities Underlying Value of Unexercised
Shares Unexercised Options (1) In-The-Money Options
Acquired Value ---------------------------------- -------------------------
Name on Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- --------- --------------- ---------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
J. Michael O'Dell....... -- -- 15,938 69,062 $159,380 $690,620
Stephen R. Bowling...... -- -- 59,173 -- $591,730 --
</TABLE>

Stock Incentive Plans

1999 Equity Incentive Plan

In April 1999, our board of directors adopted, and the stockholders approved,
the 1999 Equity Incentive Plan. There is currently an aggregate of 2,000,000
shares of common stock authorized for issuance under the plan. The plan
provides for the grant of incentive stock options, as defined under the
Internal Revenue Code of 1986, as amended, to employees and nonstatutory stock
options, restricted stock purchase awards, stock bonuses and stock appreciation
rights to employees, directors and consultants of Cortelco and its affiliates.
The plan is administered by a committee appointed by the board of directors
which determines recipients and types of awards to be granted, including the
exercise price, the number of shares subject to the award, the vesting rate and
the exercisability of awards.

The terms of options granted under the plan may not exceed 10 years. The
exercise price is determined by the board of directors, provided that, the
exercise price for an incentive stock option cannot be less than 100% of the
fair market value of the common stock on the date of the option grant, and the
exercise price for a nonstatutory stock option cannot be less than 85% of the
fair market value of the common stock on the date of the option grant.
Generally, the optionee may not transfer a stock option other than by will or
the laws of descent or distribution unless the optionee holds a nonstatutory

43
<PAGE>

stock option that provides for transfer in the stock option agreement. However,
an optionee may designate a beneficiary who may exercise the option following
the optionee's death. An optionee whose service relationship with Cortelco or
any affiliate ceases for any reason may exercise vested options for the term
provided in the option agreement.

No incentive stock option may be granted to any person who, at the time of the
grant, owns, or is deemed to own, stock possessing more than 10% of the total
combined voting power of Cortelco or any affiliate of Cortelco, unless the
option exercise price is at least 110% of the fair market value of the stock
subject to the option on the date of grant and the term of the option does not
exceed five years from the date of grant. In addition, the aggregate fair
market value, determined at the time of grant, of the shares of common stock
with respect to which incentive stock options are exercisable for the first
time by an optionee during any calendar year, under all Cortelco stock plans
and its affiliates, may not exceed $100,000.

When Cortelco becomes subject to Section 162(m) of the Internal Revenue Code,
which denies a deduction to publicly held corporations for certain compensation
paid to specified employees in a taxable year to the extent that the
compensation exceeds $1,000,000, no person may be granted options under the
plan covering more than 500,000 shares of common stock in any calendar year.

Shares subject to stock awards that have expired or otherwise terminated
without having been exercised in full again become available for the grant of
awards under the plan. Restricted stock purchase awards granted under the plan
may be granted pursuant to a repurchase option in favor of Cortelco in
accordance with a vesting schedule and at a price determined by the board of
directors. Stock bonuses may be awarded in consideration of past services
without a purchase payment. Unless otherwise specified, rights under a stock
bonus or restricted stock bonus agreement generally may not be transferred
other than by will or the laws of descent and distribution during such period
as the stock awarded pursuant to such an agreement remains subject to the
agreement.

If there is any sale of substantially all of Cortelco's assets, any merger,
reverse merger or any consolidation in which Cortelco is not the surviving
corporation, or any acquisition by certain persons, entities or groups of 50%
or more of Cortelco's stock, all outstanding awards under the plan either will
be assumed or substituted by any surviving entity. If the surviving entity
determines not to assume or substitute such awards, the vesting provisions of
such stock awards will be accelerated and the awards terminated if not
exercised prior to the such transaction.

As of April 30, 1999, no stock bonuses or restricted stock awards had been
granted, options to purchase 987,982 shares of common stock were outstanding,
no options had been exercised and 1,012,018 shares remained available for
future grants pursuant to the plan. The plan will terminate in April 2009.

1997 Equity Incentive Plan

In April 1998, our board of directors and stockholders approved the 1997 Stock
Incentive Plan, which provides for the grant of incentive stock options,
nonqualified stock options and restricted stock awards to employees and
consultants. A maximum of 450,000 shares of common stock have been reserved for
issuance under the plan. In addition, the aggregate fair market value,
determined at the time of grant, of the shares of common stock with respect to
which incentive stock options are exercisable for the first time by an optionee
during any calendar year, under all stock plans of Cortelco and its affiliates,
may not exceed $100,000.

44
<PAGE>

The plan is administered by the board of directors, which has the authority to
determine which eligible individuals are to receive options or restricted stock
awards, the terms of such options or awards, the status of such options as
incentive or nonqualified stock options under the federal income tax laws,
including the number of shares, exercise or purchase prices and exercisability,
vesting schedule and the time, manner and form of payment upon exercise of an
option. The exercise price of options granted under the plan is determined by
the compensation committee. The options expire after a specified period that
may not exceed ten years or in the case of a stockholder holding greater than
10% of the voting power, five years. As of April 30, 1999, options to purchase
333,505 shares were outstanding, no options had been exercised, and 116,495
shares remained available for future grants pursuant to the plan. The plan will
terminate in April 2008. Our board of directors has determined that no further
options will be granted under the plan after the completion of this offering.

1997 Equity Incentive Plan of BCS Technologies, Inc.

In April 1999, in connection with the acquisition of BCS, we assumed the 1997
Stock Incentive Plan of BCS, which provides for the grant of incentive stock
options, nonqualified stock options and restricted stock awards to employees
and consultants. A maximum of 96,495 shares of our common stock have been
reserved for issuance under the plan. As of April 30, 1999, options to purchase
94,279 shares were outstanding, no options had been exercised, and 2,216 shares
remained available for future grants pursuant to the plan. The plan will
terminate in January 2007. Our board of directors has determined that no
further options will be granted under the plan after the completion of this
offering.

1999 Employee Stock Purchase Plan

In April 1999, our board of directors and stockholders approved the 1999
Employee Stock Purchase Plan, which enables eligible employees to acquire
shares of common stock through payroll deductions. The plan is intended to
qualify as an "employee stock purchase plan" under Section 423 of the Code. The
initial offering period will start on the date of this prospectus and end on
August 31, 2000, with purchase dates on February 29, 2000 and August 31, 2000,
unless otherwise determined by our board of directors. Each offering under the
plan after the initial offering will run for one year, unless otherwise
determined by the board of directors prior to the beginning of such offering.
During each offering period, an eligible employee may select a rate of payroll
deduction of up to 15% of compensation. The purchase price for the common stock
purchased under the plan is 85% of the lesser of the fair market value of the
shares on the first day or the purchase date. An aggregate of 250,000 shares of
common stock have been reserved for issuance under the plan.

Employment Agreement

With the exception of David M. Fredrick, Vice President/General Manager of ACD
Business Operations, none of our executive officers has an employment
agreement, and each of such executive officers serves at the discretion of our
board of directors. On April 12, 1999, Cortelco entered into an employment
agreement with Mr. Fredrick. Pursuant to the terms of such agreement, Mr.
Fredrick is to receive annual salary of $165,000 in 1999 and an annual salary
of $175,000 in 2000. Mr. Fredrick will receive an option to purchase 70,000
shares of common stock, 60,000 shares of which vest on January 2, 2001 and
10,000 shares of which vest on January 2, 2002.

45
<PAGE>

401(k) Plan

Effective July 15, 1990, as amended on October 1, 1995, our board of directors
adopted an employee savings and retirement plan covering certain of our
employees. Pursuant to the 401(k) plan, eligible employees may elect to reduce
their current compensation by up to the lesser of 16% of such compensation or
the statutorily prescribed annual limit ($10,000 in 1998) and have the amount
of such reduction contributed to the plan. Cortelco may make contributions
equal to 50% of the first 6% of the total of an employee's elective
contribution and/or their after-tax employee contribution up to a maximum of
$2,000 to the plan on behalf of eligible employees. Additionally, we may make
an additional non-matching contribution on a discretionary basis on behalf of
all eligible employees. The plan is intended to qualify under Section 401 of
the Internal Revenue Code so that contributions by employees or by Cortelco to
the plan, and income earned on the plan contributions, and so that
contributions by Cortelco, if any, will be deductible by us when made. The
trustee under the plan, at the direction of each participant, invests the plan
employee salary deferrals in selected investment options. We made monthly
contributions to the plan in fiscal 1998 and in the first three quarters of
fiscal 1999. We expect to continue to make monthly contributions at least
through fiscal 2000.

Limitation of Liability and Indemnification Matters

Our bylaws provide that we will indemnify our directors and executive officers
and may indemnify our other officers, employees and agents to the fullest
extent permitted by Delaware law. We are also empowered under our bylaws to
enter into indemnification contracts with our directors and executive officers
and to purchase insurance on behalf of any person we are required, or
permitted, to indemnify. Pursuant to this provision, we expect to enter into
indemnity agreements with each of our directors and executive officers.

In addition, our certificate of incorporation provides that, to the fullest
extent permitted by Delaware law, our directors will not be liable for monetary
damages for breach of the directors' fiduciary duty of care to us and our
stockholders. This provision in the certificate of incorporation does not
eliminate the duty of care, and in appropriate circumstances equitable remedies
such as an injunction or other forms of non-monetary relief would remain
available under Delaware law. Each director will continue to be subject to
liability for breach of the director's duty of loyalty to us, acts or omissions
not in good faith or involving intentional misconduct, knowing violations of
law, for any transaction from which the director derived an improper personal
benefit, improper transactions between the director and us and improper
distributions to stockholders and loans to directors and officers. This
provision also does not affect a director's responsibilities under any other
laws, such as the federal securities laws or state or federal environmental
laws.

We expect to enter into agreements with our directors and officers that require
us to indemnify such persons against expenses, judgments, fines, settlements
and other amounts actually and reasonably incurred (including expenses of a
derivative action) in connection with any proceeding, whether actual or
threatened, to which any such person may be made a party by reason of the fact
that such person is or was a director or officer of Cortelco or any of its
affiliated enterprises, provided such person acted in good faith and in a
manner such person reasonably believed to be in, or not opposed to, the best
interests of Cortelco and, with respect to any criminal proceeding, had no
reasonable cause to believe his or her conduct was unlawful. The
indemnification agreements also set forth certain procedures that will apply in
the event of a claim for indemnification thereunder.

46
<PAGE>

Principal and Selling Stockholders

The following table sets forth certain information with respect to the
beneficial ownership of Cortelco's outstanding common stock as of April 30,
1999 and as adjusted to reflect the sale of the common stock being offered
hereby by:

. each person (or group of affiliated persons) who is known by Cortelco
to own beneficially more than 5% of the common stock

. each of the named executive officers

. each of the directors

. all directors and executive officers of Cortelco as a group

. each of Cortelco's current stockholders who is expected to sell shares
in the offering

Unless otherwise specified, the address of the stockholder is the address of
Cortelco set forth in this prospectus.

Beneficial ownership is determined in accordance with the rules of the SEC and
generally means sole or shared power to vote or direct the voting or to dispose
or direct the disposition of any common stock. Except as indicated by footnote,
and subject to community property laws where applicable, the persons named in
the table below have sole voting and investment power with respect to all
shares of common stock shown as beneficially owned by them. The percentage of
beneficial ownership is based on 9,074,826 shares of common stock outstanding
as of April 30, 1999 and 11,454,826 shares of common stock outstanding after
completion of this offering assuming no exercise of the underwriters' over-
allotment option. If the underwriters' over-allotment option is exercised in
full, 11,564,290 shares of common stock will be outstanding after the
completion of this offering and the following stockholders will sell the
following additional number of shares: ChinaVest (181,818); Kevin Kormondy, a
BCS employee (30,000); Cortelco Systems Holding Corporation (22,727); CMC
Industries, Inc. (108,718); David M. Fredrick (13,636); and Frank Naso
(13,636).

<TABLE>
<CAPTION>
--------------------------------------------------------------
Beneficial Ownership Beneficial Ownership
Prior to Offering After Offering
---------------------- ----------------------
Number of Number of Number of
Beneficial Owner Shares Percent Shares Offered Shares Percent
- ---------------- ------------ --------- -------------- ------------ ---------
<S> <C> <C> <C> <C> <C>
David S. Lee (1)........ 3,551,119 39.1% -- 3,055,291 26.7%
ChinaVest and affiliated
entities (2)........... 1,888,457 20.8 -- 1,888,457 16.5
Cortelco Systems Holding
Corporation (3)........ 793,246 8.7 77,273 715,973 6.3
CMC Industries, Inc.
(4).................... 612,530 6.7 418,555 193,975 1.7
David M. Fredrick (5)... 636,518 7.0 121,750 438,862 3.8
Frank Naso (6).......... 616,445 6.8 121,751 418,788 3.7
J. Michael O'Dell (7)... 43,792 * -- 43,792 *
Jenny Hsui Theleen (8).. 1,888,457 20.8 -- 1,888,457 16.5
Stephen R. Bowling (9).. 860,406 9.4 -- 783,133 6.8
Robert P. Dilworth
(10)................... 6,253 * -- 6,253 *
W. Frank King (11)...... 5,128 * -- 5,128 *
All directors and
executive officers as
a group (10 persons)
(12).................... 6,210,127 67.5 121,750 5,516,643 47.6
Other selling
stockholders (13) ..... 151,812 1.7 80,671 71,141 *
</TABLE>
- -------------------
* Represents beneficial ownership of less than 1%.

47
<PAGE>

(1) Includes 2,145,343 shares held directly by David S. Lee, 793,246 shares
held by Cortelco Systems Holding Corporation and 612,530 shares held by
CMC prior to this offering. David S. Lee is both Chairman and a principal
stockholder of each of Cortelco Systems Holding Corporation and CMC. David
S. Lee disclaims beneficial ownership of the shares held by Cortelco
Systems Holding Corporation and the shares held by CMC.

(2) Consists entirely of 1,624,072 shares held by ChinaVest IV, L.P., 188,392
shares held by ChinaVest IV-A, L.P. and 75,992 shares held by ChinaVest
IV-B, L.P. (collectively, "ChinaVest"). The address for ChinaVest is 19/F
Dina House, 11 Duddell Street, Central, Hong Kong.
(3) The address for Cortelco Systems Holding Corporation is 1703 Sawyer Road,
Corinth, Mississippi.

(4) The address for CMC Industries, Inc. is 4950 Patrick Henry Drive, Santa
Clara, California. CMC was acquired by ACT Manufacturing Inc. on July 29,
1999.

(5) Includes 107,534 shares prior to this offering subject to purchase by
certain employees of BCS pursuant to options exercisable upon this
offering.

(6) Includes 107,533 shares prior to this offering subject to purchase by
certain BCS employees pursuant to options exercisable upon this offering.
Frank Naso is an employee of Cortelco and a former principal stockholder
of BCS.
(7) Consists entirely of 43,792 shares issuable upon the exercise of options
that will become exercisable within 60 days of April 30, 1999.
(8) Consists entirely of 1,888,457 shares held by ChinaVest. ChinaVest
Partners IV is a general partner of ChinaVest IV, L.P. and ChinaVest IV-A,
L.P. ChinaVest Management Ltd. is a general partner of ChinaVest IV-B,
L.P. Jenny Hsui Theleen is a general partner of ChinaVest Partners IV and
a stockholder of ChinaVest Management Ltd. Jenny Hsui Theleen disclaims
beneficial ownership of these shares except to the extent of her
proportional partnership interest therein.
(9) Includes 7,988 shares held directly by Stephen R. Bowling and 793,246
shares held by Cortelco Systems Holding Corporation prior to this offering
which includes 83,165 shares of common stock held by Cortelco Systems
Holding Corporation which are issuable to Stephen R. Bowling upon the
exercise of options to purchase shares of Cortelco Systems Holding
Corporation that will become exercisable within 60 days of April 30, 1999.
Also includes 59,172 shares issuable upon the exercise of options that
will become exercisable within 60 days of April 30, 1999. Stephen R.
Bowling is the President, Chief Executive Officer and a director of
Cortelco Systems Holding Corporation. Other than his option for 83,165
shares of common stock, Stephen R. Bowling disclaims beneficial ownership
of the shares held by Cortelco Systems Holding Corporation.
(10) Consists entirely of 6,253 shares issuable upon the exercise of options
that will become exercisable within 60 days of April 30, 1999.
(11) Consists entirely of 5,128 shares issuable upon the exercise of options
that will become exercisable within 60 days of April 30, 1999.
(12) Includes 126,045 shares issuable upon the exercise of options that will
become exercisable within 60 days of April 30, 1999.

(13) Consists entirely of 75,906 shares held by David M. Fredrick prior to this
offering and 75,906 shares held by Frank Naso prior to this offering, all
of which are subject to purchase by certain employees of BCS pursuant to
options exercisable upon this offering. These employees are Mary Ann
Alderman, Ed Barker, Michael Carothers, Jim Coker, Michael Countryman, Tom
Fiore, Dale Goulette, Robert Havens, Willie Humbert, Dave Kelly, Tom
McNeese, Keith Nansteel, John Nicholson, Wojciech Pawlowski, Barbara
Putnam, Gary Spears and Robert Van de Steeg.

48
<PAGE>

Certain Transactions

Prior to April 1999, Cortelco was a subsidiary of Cortelco Systems Holding
Corporation and from time to time engaged in intercompany transactions with its
parent and affiliates. See note 15 to our consolidated financial statements.
The Cortelco common stock held by our parent company was pledged to secure a
debt obligation in the amount of $3,600,000 as of December 31, 1998. In order
to release this stock from the pledge so that Cortelco Systems Holding
Corporation could distribute it to the holders of its capital stock and
facilitate the acquisition of BCS, an agreement was entered into with the
lender on February 25, 1999 to repay the remaining principal of this obligation
in several installments, the last of which was paid on May 28, 1999. We loaned
$2,600,000 at an interest rate equal to the prime rate plus 1.5% to Cortelco
Systems Holding Corporation to be used for these payments. We have also
declared dividends in the amount of $2,657,000, payable upon completion of this
offering, which will be applied to repay the principal of the loan to us.
Following release of the pledge, Cortelco Systems Holding Corporation
distributed a total of 2,856,944 shares of our common stock to its stockholders
in April 1999. In connection with this distribution, Cortelco Systems Holding
Corporation distributed: 1,137,364 shares of common stock to David S. Lee,
chairman of Cortelco; 612,530 shares to CMC Industries; and 4,667 shares to
Stephen R. Bowling, a director of Cortelco. David S. Lee is also Chairman and a
principal stockholder of Cortelco Systems Holding Corporation. Stephen
R. Bowling is also President, Chief Executive Officer and a director of
Cortelco Systems Holding Corporation. CMC Industries is affiliated with
Cortelco through common stock ownership.

Pursuant to a Convertible Note Purchase Agreement dated as of July 31, 1997, we
sold a convertible promissory note in the aggregate principal amount of
$3,000,000 to ChinaVest, a principal stockholder. The note matures on July 31,
2002 and accrues interest at the rate of 8.0%, payable on the maturity date or
sixty days following the date of conversion. On April 12, 1999, in accordance
with the terms of the note, ChinaVest converted $686,000 of outstanding
principal into 1,463,206 shares of Series A Convertible Preferred Stock. The
Series A Convertible Preferred Stock automatically converts into 1,434,894
shares of our common stock upon completion of this offering. The remaining
principal amount of $2,314,000, plus accrued interest, outstanding under the
note will be paid from the net proceeds of this offering. Jenny Hsui Theleen, a
director of Cortelco, is a managing director of ChinaVest.

In July 1997, we loaned Cortelco Systems Holding Corporation the principal
amount of $3,184,000. The note accrues interest at the rate of 8.0% per annum.
In April 1999, we repurchased 250,000 shares of our common stock from Cortelco
Systems Holding Corporation in exchange for the cancellation of $2,500,000 of
the principal amount of the note. The remaining principal amount of $684,000,
plus accrued interest, is due in November 2000.

In October 1997, we loaned J. Michael O'Dell, our Chief Executive Officer and a
director, the principal amount of $132,000 in connection with relocation
expenses. J. Michael O'Dell repaid $61,000 of principal on the note in October
1998. The balance is due in October 1999.

In April 1998, we sold a Millennium system to a public television station for
$210,000. The funding for the purchase was based on a directed donation from
David S. Lee through the Asia Cultural Teachings Corporation, a charitable
foundation. David S. Lee is the honorary president of Asia Cultural Teachings
Corporation.

In April 1998, David S. Lee loaned Cortelco the principal amount of $250,000,
payable on demand. The note was non-interest bearing and was repaid in full in
October 1998. In February 1999, we

49
<PAGE>

distributed a note receivable from David S. Lee in the amount of $250,000,
which had been recorded as an offset to stockholders equity, to Cortelco
Systems Holding Corporation as a dividend.

In April 1999, we declared and paid a stock dividend of 195,684 shares of
common stock.

In connection with the BCS acquisition, we issued 1,036,014 shares of our
common stock to David S. Lee, 636,518 shares to David M. Fredrick, 616,445
shares to Frank Naso, 453,562 shares to ChinaVest and 3,321 shares to Stephen
R. Bowling in exchange for their stockholdings in BCS. See "Company
Background." We also entered into employment agreements with David M. Fredrick
and Frank Naso. See "Management--Employment Agreements."

Since 1993, CMC Industries, Inc., a principal stockholder, has provided certain
manufacturing services on a non-exclusive basis. The current agreement with
CMC, dated as of August 1, 1998, expires on July 31, 1999, and is renewable
annually by Cortelco. David S. Lee is Chairman and a principal stockholder of
CMC. CMC was acquired by ACT Manufacturing Inc. on July 24, 1999.

We purchase single line phones from, and sell Millennium related products to,
Cortelco International, Inc., a wholly-owned subsidiary of Cortelco Systems
Holding Corporation. David S. Lee and Stephen R. Bowling are directors of
Cortelco International, Inc. In fiscal 1998, our purchases from Cortelco
International, Inc. totaled $85,000 and our sales totaled $188,000.

Cortelco believes that all of the transactions set forth above were made on
terms no less favorable to Cortelco than could have been otherwise obtained
from unaffiliated third parties. As a matter of policy, all future transactions
between Cortelco and any of its officers, directors or principal stockholders
will be approved by a majority of the board of directors, including a majority
of the independent and disinterested members of the board.

50
<PAGE>

Description of Capital Stock

The following description of our capital stock and provisions of our
certificate of incorporation and bylaws is a summary and is qualified in its
entirety by the provisions of our certificate of incorporation and bylaws,
which have been filed as exhibits to our registration statement, of which this
prospectus is a part.

Upon the closing of this offering, our authorized capital stock will consist of
50,000,000 shares of common stock, $.001 par value per share, and 10,000,000
shares of preferred stock, $.001 par value per share. As of April 30, 1999,
there were 9,074,826 shares of common stock outstanding held of record by
approximately 125 stockholders.

Common Stock

The holders of common stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders. The holders of
common stock are not entitled to cumulative voting rights with respect to the
election of directors, and as a consequence, minority stockholders will not be
able to elect directors on the basis of their votes alone. Subject to
preferences that may be applicable to any then outstanding shares of preferred
stock, holders of common stock are entitled to receive ratably such dividends
as may be declared by the board of directors out of funds legally available for
dividends. In the event of our liquidation, dissolution or winding up, holders
of the common stock are entitled to share ratably in all assets remaining after
payment of liabilities and the liquidation preference of the preferred stock,
if any, then outstanding. Holders of common stock have no preemptive rights and
no right to convert their common stock into any other securities. There are no
redemption or sinking fund provisions applicable to the common stock.

Preferred Stock

The board of directors has the authority, without further action by the
stockholders, to issue any undesignated shares of preferred stock in one or
more series and to fix the rights, preferences, privileges and restrictions of
any shares of preferred stock, including dividend rights, conversion rights,
voting rights, terms of redemption, liquidation preferences, sinking fund terms
and the number of shares constituting any series or the designation of such
series, without any further vote or action by stockholders. The issuance of
preferred stock could adversely affect the voting power of holders of common
stock and the likelihood that such holders will receive dividend payments and
payments upon liquidation and could have the effect of delaying, deferring or
preventing a change in control of Cortelco. We have no present plan to issue
any shares of preferred stock.

Registration Rights

After this offering, the holders of approximately 2,787,936 shares of common
stock will be entitled to rights to require the registration of such shares
under the Securities Act. If we propose to register any of our securities under
the Securities Act, either for our own account or for the account of other
security holders exercising registration rights, such holders are entitled to
notice of such registration and are entitled, subject to certain limitations,
to include their shares to be registered. The holders may also require us to
file a registration statement under the Securities Act with respect to their
shares, and we are required to use our best efforts to effect up to two such
registrations. Furthermore, the holders may require us to register their shares
on Form S-3 when we become eligible to use such form. Generally, we are
required to bear all registration and selling expenses incurred in connection
with any registrations except for underwriting discounts and commissions. These
rights are subject to conditions and limitations, including the right of the
underwriters of an offering to limit the number of shares included in such
registration.

51
<PAGE>

Delaware Anti-Takeover Law and Certain Charter Provisions

We are subject to the provisions of Section 203 of the Delaware General
Corporation Law, an anti-takeover law. In general, the statute prohibits a
publicly held Delaware corporation from engaging in a "business combination"
with an "interested stockholder" for a period of three years after the date of
the transaction in which the person became an interested stockholder, unless
the business combination is approved in a prescribed manner. For purposes of
Section 203, a "business combination" includes a merger, asset sale or other
transaction resulting in a financial benefit to the interested stockholder, and
an "interested stockholder" is a person who, together with affiliates and
associates, owns or within three years prior did own, 15% or more of the
corporation's voting stock.

Our certificate of incorporation, effective upon the closing of this offering,
also requires that:

. the terms of the board of directors will be staggered into three
classes

. any action required or permitted to be taken by stockholders of
Cortelco must be effected at a duly called annual or special meeting
of the stockholders and may not be effected by written consent

. the stocholders may amend our bylaws or adopt new bylaws only by the
affirmative vote of 66 2/3% of the outstanding voting securities

. special meetings of our stockholders may be called only by the board
of directors, the Chairman of the Board or the Chief Executive Officer

These provisions may have the effect of delaying, deferring or preventing a
change in control of Cortelco.

Transfer Agent and Registrar

American Securities Transfer and Trust has been appointed as the transfer agent
and registrar for our common stock. Its telephone number is (303) 298-5370.

52
<PAGE>

Shares Eligible for Future Sale

Prior to this offering, there has been no market for our common stock. Future
sales of substantial amounts of common stock in the public market could
adversely affect market prices prevailing from time to time. Furthermore, since
only a limited number of shares will be available for sale shortly after this
offering because of contractual and legal restrictions on resale described
below, sales of substantial amounts of common stock in the public market after
the restrictions lapse could adversely affect the prevailing market price and
our ability to raise equity capital in the future.

Upon completion of the offering, we will have 11,454,826 shares of common stock
outstanding, assuming no exercise of the underwriters' over-allotment option
and no exercise of outstanding options and warrants and based upon the number
of shares outstanding as of April 30, 1999. Of these shares, the 3,200,000
shares sold in this offering will be freely tradable without restriction or
further registration under the Securities Act, unless such shares are purchased
by our "affiliates," as that term is defined in Rule 144 under the Securities
Act. The remaining 8,254,826 shares held by existing stockholders, and any
shares purchased by affiliates in this offering, will be "restricted
securities" as that term is defined in Rule 144 under the Securities Act. Our
affiliates will hold 5,388,685 of the restricted shares. Restricted shares may
be sold in the public market only if registered or if they qualify for an
exemption from registration under Rules 144, 144(k) or 701 under the Securities
Act, which are summarized below.

Upon completion of this offering, the holders of 2,787,936 shares of common
stock, or their transferees, will be entitled to rights to require the
registration of such shares under the Securities Act. Registration of such
shares under the Securities Act would result in such shares becoming freely
tradable without restriction under the Securities Act, except for shares
purchased by our affiliates, immediately upon the effectiveness of such
registration. See "Description of Capital Stock--Registration Rights."

We, our officers, directors and stockholders holding approximately 8,927,323
shares of common stock will agree under written lock-up agreements not to,
without the prior written consent of J.P. Morgan Securities Inc., sell any
shares of common stock for 180 days after the date of this prospectus. See
"Underwriting."

In general, under Rule 144 as currently in effect, beginning 90 days after the
date of this prospectus, stockholders who have beneficially owned restricted
shares for at least one year will be entitled to sell in any three-month period
a number of shares that does not exceed the greater of one percent of the then
outstanding shares of our common stock or the average weekly trading volume of
our common stock in the Nasdaq National Market during the four calendar weeks
immediately preceding the date on which notice of the sale is filed with the
SEC. Sales pursuant to Rule 144 are subject to certain requirements relating to
manner of sale, notice and availability of current public information about
Cortelco. A person, or person whose shares may be aggregated, who is not deemed
to have been one of our affiliates at any time during the 90 days immediately
preceding the sale and who has beneficially owned restricted shares for at
least two years is entitled to sell such shares pursuant to Rule 144(k) without
regard to the limitations described above.

Any of our employees, directors or consultants who purchased, or was awarded
shares or options to purchase shares pursuant to a written compensatory plan or
contract is entitled to rely on the resale provisions of Rule 701 under the
Securities Act, which permits stockholders to sell their Rule 701 shares
without having to comply with Rule 144's holding period restrictions, in each
case commencing 90 days after the date of this prospectus. In addition, holders
who are not affiliates may sell Rule 701 shares without complying with the
public information, volume and notice provisions of Rule 144.

53
<PAGE>

We intend to file a registration statement under the Securities Act covering
shares of common stock reserved for issuance under our Stock Incentive Plans
and the Purchase Plan. Based on the number of options outstanding and options
and shares reserved for issuance at April 30, 1999, such registration statement
will cover approximately 2,677,784 shares. Such registration statement is
expected to be filed and to become effective as soon as practicable after the
date of this prospectus. Shares registered under such registration statement
will, subject to Rule 144 volume limitations applicable to affiliates, be
available for sale in the open market, unless such shares are subject to
vesting restrictions with Cortelco or the lock-up agreements described above.

54
<PAGE>

Underwriting

Subject to the terms and conditions contained in an underwriting agreement
dated , 1999, the underwriters named below, for whom J.P. Morgan
Securities Inc., Needham & Company, Inc. and A.G. Edwards & Sons, Inc. are
acting as representatives, have severally agreed to purchase, and we and the
selling stockholders have severally agreed to sell to them, an aggregate of
3,200,000 shares of common stock. We are selling 2,380,000 shares and the
selling stockholders are selling an aggregate of 820,000 shares. The number of
shares of common stock that each underwriter has agreed to purchase is set
forth opposite its name below.

<TABLE>
<CAPTION>
---------
Number of
Shares
---------
<S> <C>
J.P. Morgan Securities Inc......................................
Needham & Company, Inc..........................................
A.G. Edwards & Sons, Inc........................................
---------
Total........................................................... 3,200,000
=========
</TABLE>

The underwriters are offering the common stock subject to their acceptance of
the common stock and subject to prior sale. The underwriting agreement provides
that the obligations of the underwriters to purchase shares of common stock are
subject to the approval of certain legal matters by counsel and to certain
other conditions. If any of the shares of common stock are purchased by the
underwriters pursuant to the underwriting agreement, all of the shares, other
than the shares of common stock covered by the over-allotment option described
below, must be purchased.

The underwriters propose to offer the shares of common stock directly to the
public at the public offering price set forth on the cover page of this
prospectus and to dealers at such price less a concession not in excess of $
per share. The underwriters may allow, and such dealers may reallow, a
concession not in excess of $ per share to other dealers. After the initial
public offering of the common stock, the offering price and other selling terms
may be changed from time to time by the underwriters.

We and certain selling stockholders have granted to the underwriters an option
to purchase up to 480,000 additional shares of common stock on the same terms
and conditions solely to cover over-allotments. We have agreed to sell up to
109,464 additional shares and the selling stockholders have agreed to sell up
to 370,536 additional shares. The option may be exercised during the 30-day
period after the date of this prospectus. If the underwriters' option is
exercised in full, the total price to public would be $ , the total
underwriting discounts and commissions would be $ , and total proceeds to us
would be $ , before deducting $ in expenses.

We and the selling stockholders have agreed to indemnify the underwriters
against specified liabilities, including liabilities under the Securities Act,
and to contribute to payments that the underwriters may be required to make in
connection with such liabilities.

We, our officers, directors and stockholders holding an aggregate of 8,927,323
shares of common stock will agree not to, without the prior written consent of
J.P. Morgan Securities Inc., (1) offer, pledge, announce the intention to sell,
sell, contract to sell, sell any option or contract to purchase, purchase any
option or contract to sell, grant any option, right or warrant to purchase or
otherwise transfer or dispose of, directly or indirectly, any shares of common
stock or any securities of Cortelco which are substantially similar to the
common stock, including but not limited to any securities that are convertible
into or exercisable or exchangeable for, or that represent the right to receive
common stock

55
<PAGE>

or any such substantially similar securities or (2) enter into any swap,
option, future, forward or other agreement that transfers, in whole or in part,
any of the economic consequences of ownership of common stock or any securities
substantially similar to the common stock. We may, however, issue shares of
common stock upon the exercise of stock options that are currently outstanding,
and may grant additional options under our stock option plans, provided that,
without the prior written consent of J.P. Morgan Securities Inc., such
additional options shall not be exercisable during such period.

In connection with the offering, the underwriters may engage in transactions
that stabilize, maintain or otherwise affect the price of the common stock.
Specifically, the underwriters may over-allot the offering, creating a
syndicate short position. In addition, the underwriters may bid for, and
purchase, shares of common stock in the open market to cover syndicate short
positions or to stabilize the price of the common stock. Finally, the
underwriting syndicate may reclaim selling concessions allowed for distributing
the common stock in the offering, if the syndicate repurchases previously
distributed common stock in syndicate covering transactions, in stabilization
transactions or otherwise. Any of these activities may stabilize or maintain
the market price of the common stock above independent market levels. The
underwriters are not required to engage in these activities, and may end any of
these activities at any time.

Prior to this offering, there has been no public market for our common stock.
The initial public offering price for the shares of common stock offered in
this offering will be determined by negotiation among Cortelco, the selling
stockholders and the underwriters. Among the factors to be considered in
determining the initial public offering price are our revenues and earnings,
market valuations of other companies engaged in activities similar to ours,
estimates of our business potential and prospects, the present state of our
business operations, our management, the general condition of the securities
markets at the time of the offering and other factors deemed relevant. The
estimated initial public offering price range set forth on the cover of this
preliminary prospectus is subject to change as a result of market conditions
and other factors. There can be no assurance that an active trading market will
develop for our common stock or that our common stock will trade in the public
market at or above the initial public offering price.

56
<PAGE>

Legal Matters

The validity of the shares of common stock offered hereby will be passed upon
for Cortelco by Cooley Godward LLP, Palo Alto, California. Certain legal
matters in connection with this offering will be passed upon for the
underwriters by Davis Polk & Wardwell, New York, New York.

Experts

The consolidated financial statements of Cortelco Systems, Inc., (except for
Cortelco Puerto Rico Inc. for the year ended July 31, 1996) as of July 31, 1997
and 1998 and for each of the three years in the period ended July 31, 1998,
included in this prospectus and the related financial statements included
elsewhere in this registration statement have been audited by Deloitte & Touche
LLP, independent auditors, as stated in their reports appearing herein and
elsewhere in this registration statement. The 1996 financial statements of
Cortelco Puerto Rico, Inc. (consolidated with those of Cortelco) have been
audited by PricewaterhouseCoopers LLP, as stated in their report included
herein. The financial statements of Cortelco and its consolidated subsidiaries
are included in this prospectus in reliance upon the reports of Deloitte &
Touche LLP and are given based upon their authority as experts in accounting
and auditing.

The financial statements of Cortelco Puerto Rico, Inc., not separately
presented in this prospectus, have been audited by PricewaterhouseCoopers LLP,
independent accountants, whose report thereon appears herein. Such financial
statements, to the extent they have been included in the financial statements
of Cortelco Systems, Inc., have been so included in reliance on their report
given on the authority of said firm as experts in auditing and accounting.

The financial statements of BCS Technologies, Inc. as of July 31, 1997 and 1998
and for the year ended July 31, 1998 and the eleven months ended July 31, 1997
included in this prospectus have been audited by Brock and Company, CPA's,
P.C., independent auditors, as stated in their report appearing in this
prospectus and have been included in reliance upon the report of that firm
given upon their authority as experts in accounting and auditing.

Additional Information

A registration statement on Form S-1, relating to the common stock offered has
been filed by Cortelco with the SEC. This prospectus, which constitutes a part
of the registration statement, does not contain all of the information set
forth in the registration statement and the exhibits and schedules thereto.
Statements contained in this prospectus as to the contents of any contract or
other document referred to are not necessarily complete. If a contract of
document has been filed as an exhibit to the registration statement, we refer
you to the copy of such contract or other document that has been filed. Each
statement in this prospectus relating to a contract or document filed as an
exhibit is qualified in all respects by the filed exhibit. For further
information with respect to our company and the common stock offered by this
prospectus, we refer you to the registration statement, exhibits and schedules
that we have filed. A copy of the registration statement may be inspected by
anyone without charge at the public reference facilities maintained by the SEC
at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549, and copies
of material filed may be obtained from the SEC upon the payment of certain fees
prescribed by the SEC. The SEC also maintains a World Wide Web site that
contains registration statements, reports, proxy and information statements and
other information regarding registrants that file electronically. The address
of the site is www.sec.gov.

As a result of this offering, we will become subject to the information and
reporting requirements of the SEC and will be required to file periodic
reports, proxy statements and other information with the SEC. We intend to
furnish to our stockholders annual reports containing audited financial
statements and quarterly reports containing unaudited interim financial
information for the first three quarters of each fiscal year.

57
<PAGE>

Index to Financial Statements

<TABLE>
<CAPTION>
Page
----
<S> <C>
Cortelco Systems, Inc. and Subsidiaries:

Independent Auditors' Report.............................................. F-2

Report of Independent Accountants......................................... F-3

Consolidated Balance Sheets at July 31, 1997 and 1998..................... F-4

Consolidated Statements of Operations for the Years Ended July 31, 1996,
1997 and 1998............................................................ F-5

Consolidated Statements of Cash Flows for the Years Ended July 31, 1996,
1997 and 1998............................................................ F-6

Consolidated Statements of Stockholders' Equity (Deficit) for the Years
Ended July 31, 1996, 1997 and 1998....................................... F-7

Notes to Consolidated Financial Statements for the Years Ended July 31,
1996, 1997 and 1998...................................................... F-8

Consolidated Balance Sheets at July 31, 1998 (Unaudited) and April 30,
1999 (Unaudited)......................................................... F-22

Consolidated Statements of Operations for the Nine Months Ended April 30,
1998 (Unaudited) and 1999 (Unaudited).................................... F-23

Consolidated Statements of Cash Flows for the Nine Months Ended April 30,
1998 (Unaudited) and 1999 (Unaudited).................................... F-24

Notes to Consolidated Financial Statements for the Nine Months Ended April
30, 1998 (Unaudited) and 1999 (Unaudited)................................ F-25

BCS Technologies, Inc.:

Independent Auditors' Report.............................................. F-28

Balance Sheets at July 31, 1997 and 1998 and April 12, 1999 (Unaudited)... F-29

Statements of Operations for the Eleven Months Ended July 31, 1997, the
Year Ended July 31, 1998, the Nine Months Ended April 30, 1998
(Unaudited) and the Period from August 1, 1998 through April 12, 1999
(Unaudited).............................................................. F-30

Statements of Cash Flows for the Eleven Months Ended July 31, 1997, the
Year Ended July 31, 1998, the Nine Months Ended April 30, 1998
(Unaudited) and the Period from August 1, 1998 through April 12, 1999
(Unaudited).............................................................. F-31

Statements of Stockholders' Equity (Deficit) for the Eleven Months Ended
July 31, 1997, the Year Ended July 31, 1998 and the Period from August 1,
1998 through April 12, 1999 (Unaudited).................................. F-32

Notes to Financial Statements............................................. F-33

Unaudited Pro Forma Consolidated Financial Information:

Unaudited Pro Forma Consolidated Financial Information.................... F-40

Pro Forma Consolidated Balance Sheet at April 30, 1999 (Unaudited)........ F-41

Pro Forma Consolidated Statement of Operations for the Year Ended July 31,
1998 (Unaudited) ........................................................ F-42

Pro Forma Consolidated Statement of Operations for the Nine Months Ended
April 30, 1998 and 1999 (Unaudited) ..................................... F-43

Notes to Pro Forma Consolidated Financial Statements (Unaudited).......... F-44

</TABLE>

F-1
<PAGE>

Independent Auditors' Report

To the Board of Directors and Stockholders of Cortelco Systems, Inc.

We have audited the accompanying consolidated balance sheets of Cortelco
Systems, Inc. and subsidiaries (the "Company"), a 97% owned subsidiary of
Cortelco Systems Holding Corporation, as of July 31, 1997 and 1998 and the
related consolidated statements of operations, cash flows, and stockholders'
equity (deficit) for each of the three years in the period ended July 31, 1998.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits. We did not audit the statements of operations and cash flows of
Cortelco Puerto Rico, Inc. (a consolidated subsidiary) for the year ended July
31, 1996, which statements reflect total revenues constituting 39.7% of the
related consolidated total for that year. Those statements were audited by
other auditors whose report has been furnished to us and our opinion, insofar
as it relates to the amounts included for Cortelco Puerto Rico, Inc. for the
year ended July 31, 1996, is based solely on the report of such other auditors.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
presentation. We believe that our audits and the report of the other auditors
provide a reasonable basis for our opinion.

In our opinion, based on our audits and the report of other auditors, such
consolidated financial statements present fairly, in all material respects, the
financial position of Cortelco Systems, Inc. and its subsidiaries at July 31,
1997 and 1998 and the results of their operations and their cash flows for each
of the three years in the period ended July 31, 1998 in conformity with
generally accepted accounting principles.

As discussed in Note 21, the accompanying financial statements have been
restated.

Deloitte & Touche LLP

Memphis, Tennessee
April 9, 1999, except for Note 21, as to which the date is July 8, 1999

F-2
<PAGE>

Report of Independent Accountants

To the Board of Directors and
Stockholder of
Cortelco Puerto Rico, Inc.

In our opinion, the statements of income and of cash flows of Cortelco Puerto
Rico, Inc. for the year ended July 31, 1996 (not presented separately herein)
present fairly, in all material respects, the results of its operations and its
cash flows for the year ended July 31, 1996, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for the opinion expressed above. We have not
audited the financial statements of Cortelco Puerto Rico, Inc. for any period
subsequent to July 31, 1996.

As explained in Note 1 to the financial statements, the Company has restated
its previously issued financial statements to charge to income certain amounts
related to the acquisition of cellular airtime contracts and beeper services.
Those amounts had previously been deferred. As a result of the restatement, net
income for the year ended July 31, 1996, increased by $241,000 to $366,000.

/s/ PricewaterhouseCoopers LLP
PRICEWATERHOUSECOOPERS LLP

San Juan, Puerto Rico
September 17, 1996, except as to the
last paragraph of Note 1, which is as
of July 8, 1999

Stamp 1392003 of the P.R. Society of
Certified Public Accountants has been
Affixed to the file copy of this report

F-3
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Consolidated Balance Sheets (As Restated, See Note 21)
At July 31, 1997 and 1998

<TABLE>
<CAPTION>
--------------------
At July 31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Dollars in thousands
ASSETS:
Current assets:
Cash and cash equivalents.............................. $ 320 $ 103
Trade accounts receivable, net of allowance for
doubtful accounts of $3,090 and $1,880................ 8,295 6,630
Current portion of investment in sales-type leases..... 146 150
Inventories............................................ 5,849 5,631
Other current assets................................... 539 727
--------- ---------
Total current assets................................. 15,149 13,241
Certificate of deposit--restricted....................... 174 --
Property and equipment, net.............................. 1,322 1,250
Receivable from parent................................... 355 656
Receivable (payable) from affiliate...................... (172) 1
Other assets:
Investment in joint ventures........................... 67 138
Investment in sales-type leases, noncurrent............ 72 106
Intangible assets, net of accumulated amortization of
$0 and $4............................................. 315 327
Notes receivable from employees........................ -- 138
Deferred financing costs, net of accumulated
amortization of $0 and $91............................ 417 511
Other.................................................. -- 62
--------- ---------
Total other assets................................... 871 1,282
--------- ---------
Total assets......................................... $ 17,699 $ 16,430
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
Current liabilities:
Dividend payable....................................... $ -- $ 2,667
Checks outstanding..................................... 1,615 55
Note payable to related party.......................... -- 250
Current portion of long-term debt...................... 129 32
Notes payable under revolving line of credit........... 2,941 2,739
Trade accounts payable................................. 2,294 2,172
Accounts payable to CMC Industries, Inc................ 2,936 2,205
Accrued expenses and other............................. 1,270 1,301
--------- ---------
Total current liabilities............................ 11,185 11,421
Note payable to parent................................... 750 359
Long-term debt........................................... 4,871 6,041
Commitments and contingencies............................ -- --
Stockholders' equity (deficit):
Series A convertible preferred stock, $.001 par value,
(10,000,000 shares authorized, none outstanding)...... -- --
Common stock, $.001 par value (50,000,000 shares
authorized, 3,629,224 and 3,920,252 shares issued and
outstanding).......................................... 4 4
Additional paid-in capital............................. 9,217 8,324
Accumulated deficit.................................... (4,894) (6,535)
Note receivable from officer/director.................. (250) --
Note receivable from parent............................ (3,184) (3,184)
--------- ---------
Total stockholders' equity (deficit)................. 893 (1,391)
--------- ---------
Total liabilities and stockholders' equity........... $ 17,699 $ 16,430
========= =========
</TABLE>

See notes to consolidated financial statements.

F-4
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Consolidated Statements of Operations (As Restated, See Note 21)
Years Ended July 31, 1996, 1997 and 1998

<TABLE>
<CAPTION>
-------------------------------------
Year Ended July 31,
-------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Dollars in thousands, except per share
data
Net revenues........................... $ 38,518 $ 35,635 $ 30,172
Cost of revenues....................... 26,501 24,312 17,530
----------- ----------- -----------
Gross profit.......................... 12,017 11,323 12,642
Operating expenses:
Selling, general and administrative... 7,853 10,103 9,931
Research and development.............. 1,256 1,310 1,407
----------- ----------- -----------
Total operating expenses............. 9,109 11,413 11,338
----------- ----------- -----------
Income from operations................. 2,908 (90) 1,304
Interest expense....................... 1,004 915 826
Management fee expense, net............ 178 406 185
Equity in earnings of joint venture.... -- -- (66)
Other expense (income), net............ (54) 272 43
----------- ----------- -----------
Income (loss) from continuing
operations
before income taxes.................. 1,780 (1,683) 316
Income tax expense..................... 702 -- --
----------- ----------- -----------
Income (loss) from continuing
operations........................... 1,078 (1,683) 316
Discontinued operations--loss from
operations of Cortelco, Inc. (less
applicable income tax benefit of $702
in 1996).............................. (1,112) (515) --
----------- ----------- -----------
Net income (loss).................... $ (34) $ (2,198) $ 316
=========== =========== ===========
Net income (loss) per common share--
basic:
Income (loss) from continuing
operations........................... $ 0.28 $ (0.44) $ 0.08
Income (loss) from discontinued
operations........................... (0.29) (0.13) --
----------- ----------- -----------
Net loss per common share--basic:..... $ (0.01) $ (0.57) $ 0.08
=========== =========== ===========
Net income (loss) per common share--
diluted:
Income (loss) from continuing
operations........................... $ 0.28 $ (0.44) $ 0.07
Income (loss) from discontinued
operations........................... (0.29) (0.13) --
----------- ----------- -----------
Net income (loss) per common share--
diluted.............................. $ (0.01) $ (0.57) $ 0.07
=========== =========== ===========
</TABLE>

See notes to consolidated financial statements.

F-5
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (As Restated, See Note 21)
Years Ended July 31, 1996, 1997 and 1998

<TABLE>
<CAPTION>
---------------------------
Year Ended July 31,
---------------------------
1996 1997 1998
Dollars in thousands ------- --------- -------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................ $ (34) $ (2,198) $ 316
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation.................................... 474 368 326
Amortization of intangibles..................... -- -- 4
Provision for the allowance for doubtful
accounts....................................... 82 985 65
Loss from discontinued operations............... 1,814 515 --
Write-off of purchased software................. 108 -- --
Loss on sales of property and equipment......... -- -- 2
Equity in earnings of joint venture............. -- -- (66)
Changes in net assets and liabilities:
Trade accounts receivable...................... (1,508) 976 1,600
Investment in sales-type leases, net........... 793 424 (38)
Accounts receivable from/payable to
affiliates.................................... 814 (465) (474)
Inventories.................................... (779) 726 218
Other current assets........................... (98) 37 (188)
Trade accounts payable......................... (778) 606 (122)
Accounts payable to CMC Industries, Inc........ 511 (903) (731)
Accrued expenses and other..................... 250 78 31
------- --------- -------
Net cash provided by operating activities..... 1,649 1,149 943
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment.............. (472) (537) (256)
Purchase of patents, trademarks and software
technology...................................... -- (315) (15)
Maturities of certificates of deposit............ (5) (6) 174
Net repayments (advances) under notes receivable
from employees.................................. -- -- (138)
------- --------- -------
Net cash used in investing activities......... (477) (858) (235)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) under revolving line
of credit....................................... 850 (3,232) (202)
Increase (decrease) in checks outstanding........ -- 1,615 (1,560)
Repayments of long-term debt..................... (2,007) (1,120) 1,073
Proceeds from issuance of note payable to related
party........................................... -- -- 250
Proceeds from issuance of subordinated note...... 92 3,000 --
Repayment of note payable to parent company...... -- -- (391)
Debt issuance costs.............................. -- (417) (95)
------- --------- -------
Net cash used in financing activities......... (1,065) (154) (925)
------- --------- -------
Net increase (decrease) in cash and cash
equivalents...................................... 107 137 (217)
Cash and cash equivalents, beginning of year...... 76 183 320
------- --------- -------
Cash and cash equivalents, end of year............ $ 183 $ 320 $ 103
======= ========= =======
Supplemental cash flow information:
Interest paid.................................... $ 994 $ 923 $ 585
Income taxes paid................................ -- -- 86
Noncash activity:
1996 and 1997:
All noncash transactions, primarily transfers of assets to/from companies
affiliated through common ownership, are discussed in the accompanying
notes.
1998:
The Company issued 95,343 shares of common stock in exchange for a 55%
interest in a joint venture in mainland China (see Note 9).

Additionally, the Company entered into a barter transaction whereby they
exchanged inventory and installation services valued at approximately
$135,000 for advertising and promotional services.
</TABLE>

See notes to consolidated financial statements.

F-6
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Consolidated Statements of Stockholders' Equity (Deficit) (As Restated, See
Note 21)
Years Ended July 31, 1996, 1997 and 1998

<TABLE>
-----------------------------------------------------------------------------
<CAPTION>
Note
Common Stock Receivable From Total
---------------- Additional ----------------- Stockholders'
Paid- Accumulated Officer/ Equity
Shares Amount in Capital Deficit Director Parent (Deficit)
Dollars in thousands --------- ------ ---------- ----------- -------- ------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at July 31, 1995 3,629,224 $ 4 $ 9,217 $ (1,412) $ (250) $(3,184) $ 4,375
Net loss................ -- -- -- (34) -- -- (34)
--------- ---- -------- ---------- ------- ------- ---------
Balance at July 31, 1996 3,629,224 4 9,217 (1,446) (250) (3,184) 4,341
Distribution of
Cortelco, Inc.
common stock........... -- -- -- (1,250) -- -- (1,250)
Net loss................ -- -- -- (2,198) -- -- (2,198)
--------- ---- -------- ---------- ------- ------- ---------
Balance at July 31, 1997 3,629,224 4 9,217 (4,894) (250) (3,184) 893
Issuance of common stock
to acquire interest in
joint venture.......... 95,343 -- 67 -- -- -- 67
Net income.............. -- -- -- 316 -- -- 316
Stock dividend.......... 195,685 -- 1,957 (1,957) -- -- --
Dividend declaration
(CSI).................. -- -- (2,217) -- 250 -- (1,967)
Dividend declaration
(CSPR)................. -- -- (700) -- -- -- (700)
--------- ---- -------- ---------- ------- ------- ---------
Balance at July 31, 1998 3,920,252 $ 4 $ 8,324 $ (6,535) $ -- $(3,184) $ (1,391)
========= ==== ======== ========== ======= ======= =========
</TABLE>

See notes to consolidated financial statements.

F-7
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
Years Ended July 31, 1996, 1997 and 1998

1. Description of Business and Organization

Description of Business--Cortelco Systems, Inc. (the "Company" or "CSI")
designs, develops and markets integrated enterprise communications systems for
routing and controlling the voice, video and data communications of businesses
and other organizations. In addition to selling Millennium systems and related
systems products, Cortelco also resells cellular airtime, cellular telephones
and third-party voice communications systems in Puerto Rico.

Organization--Effective July 31, 1993, the telecommunications business of CMC
Industries, Inc. ("CMC") was spun-off to Cortelco Systems Holding Corporation
("CSHC", the parent company). From August 1, 1993 to July 31, 1995, CSHC
combined the operations of the Company (the "Systems" and "Automatic Call
Distributor" product lines) with the operations related to another product
line, single line telephones, and accounted for these product lines as a single
business unit.

Effective August 1, 1995, CSHC contributed the assets of the "Systems" and
"Automatic Call Distributor" product lines to the Company. The assets were
recorded at historical book value.

2. Basis of Presentation

Basis of Presentation--The Company was a 97% owned subsidiary of CSHC through
April 1999. The consolidated financial statements of CSI include the accounts
of its wholly-owned subsidiaries, Cortelco Puerto Rico, Inc. for all periods
presented and Cortelco, Inc. (the "Automatic Call Distributor" product line)
through March 31, 1997, at which time Cortelco, Inc. was spun-off to CSHC (see
Note 4). All significant intercompany balances have been eliminated.

The Company is also affiliated with the following entities through common
stockholder ownership:

Cortelco International, Inc. ("CII", subsidiary of CSHC)
Cortelco Puerto Rico, Inc. ("CPR", subsidiary of CSHC)
Cortelco Canada ("CC", subsidiary of CSHC)
BCS Technologies, Inc.
CMC Industries, Inc.

The Company also has two inactive subsidiaries, Cortelco Holding Corp. and CTC
Holding Corp.

In April 1999 a series of transactions occurred whereby CSHC distributed the
common stock of the Company to the CSHC stockholders and CPR formed a new
wholly-owned subsidiary in the Commonwealth of Puerto Rico, Cortelco Systems
Puerto Rico, Inc. ("CSPR"), in contemplation of a merger between the Company
and the newly formed subsidiary. Previous to the merger, CPR contributed
substantially all of the operations and certain assets and liabilities to the
newly formed CSPR. Cortelco Puerto Rico, Inc. retained certain real estate
assets and the related mortgage note payable. In April 1999, CPR transferred
all issued and outstanding stock of CSPR to CSHC, the Company issued 553,880
shares of common stock to CSHC in exchange for an 100% interest in CSPR and
CSPR assumed the CPR Credit Facility described in Note 11. The business
combination was between entities under common control, as CSHC owned 100% of
CSPR and 97% of the Company, therefore, the merger has been accounted for in a
manner similar to a pooling of interests and accordingly, all periods presented
in the accompanying financial statements reflect the results of operations on
an "as if pooled" basis. The common stock issued to effect the business
combination has been reflected as outstanding for all periods presented.

3. Summary of Significant Accounting Policies

Cash and Cash Equivalents--All highly liquid investments with a maturity of
three months or less are considered to be cash equivalents.

F-8
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements--(Continued)
Years Ended July 31, 1996, 1997 and 1998

The Company provides a centralized cash management function whereby all cash
receipts on customer accounts are processed through a lockbox arrangement and
swept daily to paydown the line of credit agreement discussed in Note 11. All
cash disbursements are handled through daily draws on the line of credit to
cover the Company's outstanding checks.

Inventories--Inventories are valued at the lower of cost or market. Cost is
determined by the last-in, first-out ("LIFO") method for approximately 81% of
the inventories at July 31, 1997 and 1998, respectively. The first-in, first-
out ("FIFO") method is principally used for the remainder.

Property and Equipment--Property and equipment are stated at cost. Depreciation
is provided using the straight-line method for financial reporting purposes and
accelerated method for income tax reporting purposes over the estimated useful
lives of the assets, generally five to thirty years.

Investments--Investments in affiliates and corporate joint ventures which
represent greater than a 20% equity interest but which the Company does not
exercise control are accounted for under the equity method. Investments
representing less than a 20% interest are carried at the lower of cost or net
realizable value.

Intangible Assets--Intangible assets primarily represent costs incurred to
acquire and/or establish patents, trademarks and software technology. These
costs are being amortized on a straight-line basis over the estimated useful
lives of the assets, generally five years. The amortization period begins with
the initial introduction of the underlying product to the market in order to
properly match revenue and expense. The Company reviews the carrying value of
intangible assets for impairment based on undiscounted cash flows whenever
events or changes in circumstances occur which might indicate that the carrying
amount might not be recoverable.

Deferred Financing Costs--Deferred financing costs represent costs associated
with the issuance of debt. These costs are being amortized using the effective
interest method over the life of the related debt issue.

Product Warranties--The Company provides the customer with a warranty from the
date of purchase. Estimated warranty obligations are recorded based on actual
claims experience.

Income Taxes--Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes. The
Company's results are included in the consolidated U.S. income tax return of
Cortelco Systems Holding Corporation. Income taxes are not provided on the
unremitted earnings of the Company's foreign subsidiaries and foreign joint
ventures since it is the Company's intention to continue to reinvest these
earnings.

Revenue Recognition--Revenues are recognized at the time products are shipped
or when title passes. Net sales is comprised of sales reduced by related sales
allowances. Revenues from cellular airtime are recognized when earned based on
cellular airtime contracts. The Company receives sales commissions on certain
transactions with the Puerto Rico Telephone Company. These commissions are
recorded as cellular airtime in the accompanying financial statements.

Allocation of Certain Shared Expenses--The accompanying financial statements
include the assets, liabilities, revenues and expenses specifically
identifiable with the Company as well as certain allocated expenses for
services provided by CSHC and CII. The costs have been allocated using formulas
including estimates of effort expended and sales and management believes the
allocation method to be reasonable. The financial statements may not
necessarily reflect the assets and liabilities and results of operations of the
Company had it been operated as a stand-alone entity. Management estimates that
the costs that would have been incurred on a stand alone basis would have
approximated $120,000, $390,000, and $100,000 for the years ended July 31,
1996, 1997, and 1998.

Medical Care and Disability Benefit Plans--The Company is self-insured with
respect to certain medical and disability benefits offered to substantially all
employees through participation in an insurance plan with an affiliated
company. These

F-9
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements--(Continued)
Years Ended July 31, 1996, 1997 and 1998

costs are charged against earnings in the period in which claims are incurred.
The Company does not provide benefits to retired employees.

Earnings Per Share--The Company follows Statement of Financial Accounting
Standard ("SFAS") No. 128, "Earnings Per Share," which requires disclosure of
basic and diluted earnings per share ("EPS"). Basic EPS is computed by dividing
income available to common stockholders by the weighted average number of
common shares outstanding during the year. Diluted EPS is similar to basic EPS
except that the weighted average number of common shares outstanding is
increased to include the number of additional common shares that would have
been outstanding if the potentially dilutive common shares, such as options,
had been issued.

Reverse Stock Split--On February 24, 1999, the Company's board of directors
authorized a 1 for 10 reverse stock split of its common and preferred stock
effective for stockholders of record on March 1, 1999. The Company's board of
directors also approved an amendment to the Company's certificate of
incorporation to decrease the authorized common and preferred shares to
50,000,000 and 10,000,000, respectively, and to increase the par value per
common share from $.0001 to $.001. Shares outstanding and all per share amounts
in the accompanying financial statements have been restated to give effect to
the reverse stock split.

Fair Value of Financial Instruments--The carrying amounts of financial
instruments such as cash, accounts receivable, accounts payable and the
outstanding borrowings under the revolving credit agreement approximate their
fair value due to the short term nature of the instruments. Additionally, the
carrying value of the Company's investment in the foreign joint venture
discussed in Note 9 approximates fair value. The fair value of the Company's
subordinated convertible debt approximates the carrying amount at July 31, 1998
based on available market information.

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

Reclassifications--Certain amounts in the 1997 financial statements have been
reclassified to conform with the 1998 presentation.

New Accounting Standards--In June 1997, the Financial Accounting Standards
Board ("FASB") issued SFAS 130, "Reporting Comprehensive Income," which
established standards for reporting and display of comprehensive income and its
components and requires a separate statement to report the components of
comprehensive income for each period reported. The provisions of this statement
are effective for fiscal years beginning after December 15, 1997. Management
believes this statement may require expanded disclosure in the Company's
financial statements.

In June 1998, FASB issued SFAS 133, "Accounting for Derivative Instruments and
Hedging," which established accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. The provisions of this statement are
effective for fiscal years beginning after June 15, 1999. Management has not
evaluated what impact, if any, the adoption of this statement will have on the
disclosures in the Company's financial statements.

F-10
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements--(Continued)
Years Ended July 31, 1996, 1997 and 1998

4. Discontinued Operations

Effective March 31, 1997 the Company distributed all of the outstanding common
stock of its subsidiary in the automatic call distribution business to the CSHC
stockholders. The net assets, results of operations and cash flows of Cortelco,
Inc. have been reported as discontinued operations in the accompanying
financial statements. Summarized financial information of the discontinued
operations is presented as follows:

<TABLE>
<CAPTION>
-------------------
Eight
Year Months
Ended Ended
July 31, March 31,
1996 1997
-------- ---------
<S> <C> <C>
Dollars in thousands
Net revenues.............................................. $ 6,063 $ 2,512
Cost of revenues.......................................... 4,631 1,321
-------- --------
Gross profit............................................. 1,432 1,191
Operating expenses........................................ 3,158 1,620
-------- --------
Loss from operations..................................... (1,726) (429)
Interest expense.......................................... 158 48
Other expense (income), net............................... (70) 38
-------- --------
Loss before income taxes................................. (1,814) (515)
Income tax benefit........................................ 702
-------- --------
Loss from discontinued operations....................... $ (1,112) $ (515)
======== ========
</TABLE>

As of the date of the spin-off, the net assets of the Company's subsidiary in
the automatic call distributor business totalled $1,250,000 and this amount was
charged against retained earnings in the accompanying 1997 balance sheet to
reflect the distribution of the subsidiary's stock.

5. Major Customers and Concentrations of Credit Risk

Financial instruments which potentially subject the Company to a concentration
of credit risk consist principally of cash, trade accounts receivable and notes
receivable. The Company maintains its cash balances with large regional or
national financial institutions and has not experienced losses. The Company's
products are sold principally to dealers, value added resellers, national
accounts and the U.S. government. Approximately 38% of the Company's revenues
are generated within the Commonwealth of Puerto Rico. The Company's credit risk
is limited principally to trade accounts receivable. The Company performs
ongoing credit evaluations of its customers and generally does not require
collateral. No additional risk beyond amounts provided for collection losses is
believed inherent in the Company's trade accounts receivable.

6. Inventories

Inventories consist of the following:

<TABLE>
<CAPTION>
------------------
1997 1998
-------- --------
<S> <C> <C>
Dollars in thousands
Raw materials and purchased components...................... $ 910 $ 819
Finished goods.............................................. 5,137 4,926
LIFO reserve................................................ (198) (114)
-------- --------
Total inventories......................................... $ 5,849 $ 5,631
======== ========
</TABLE>

In 1997, the liquidation of LIFO inventories decreased cost of revenues and
therefore decreased the net loss from continuing operations before taxes by
$200,000. In 1998, the liquidation of LIFO inventories decreased cost of
revenues and therefore increased the net income from continuing operations
before taxes by $84,000.

F-11
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements--(Continued)
Years Ended July 31, 1996, 1997 and 1998

7. Investment in Sales-Type Leases

The Company's net investment in sales-type lease contracts consists of:

<TABLE>
<CAPTION>
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Dollars in thousands
Future minimum lease contract receivables................ $ 255 $ 326
Less unearned interest income............................ (37) (70)
--------- ---------
Total investment in sales-type leases.................. 218 256
Less current portion..................................... (146) (150)
--------- ---------
Investment in sales-type leases, non-current........... $ 72 $ 106
========= =========
</TABLE>

Annual future minimum lease contract gross receivables under sales-type lease
contracts are as follows:

<TABLE>
<S> <C>
Dollars in thousands
1999................................................................. $ 150
2000................................................................. 67
2001................................................................. 58
2002................................................................. 44
2003 and thereafter.................................................. 7
---------
Total.............................................................. $ 326
=========
</TABLE>

8. Property and Equipment

Property and equipment consists of the following:

<TABLE>
<CAPTION>
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Dollars in thousands
Building improvements.................................... $ 900 $ 1,000
Machinery and equipment.................................. 744 869
Furniture and fixtures................................... 729 787
Automobiles.............................................. 25 25
Construction in progress................................. 42 10
--------- ---------
Total.................................................. 2,440 2,691
Less accumulated depreciation............................ (1,118) (1,441)
--------- ---------
Property and equipment, net............................ $ 1,322 $ 1,250
========= =========
</TABLE>

9. Investment in Joint Ventures

The Company has a $67,000 investment representing a 10% equity interest in a
Poland-based company (DTS/ZWUT) which will manufacture, sell and distribute
products designed and marketed by the Company. The Company accounts for its
interest in the joint venture at the lower of cost or net realizable value.

During 1996, the Company entered into an acquisition agreement with a Taiwanese
company ("Sea Union") whereby the Company has the option to acquire controlling
interests in several telecommunications joint ventures in mainland China over
an extended period of time in exchange for Company stock.

On August 11, 1997, the Company exercised its option to acquire an interest in
one of the joint ventures. The Company acquired a 55% interest in Heilongjiang
Longhai Telecommunication Equipment Co., Ltd. ("Longhai") in exchange for
95,343 shares of the Company's common stock valued at $67,000. Under the terms
of the joint venture agreement the Company does not have control over
significant operating decisions and therefore the Company does not consolidate
the joint venture's operating results.

F-12
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements--(Continued)
Years Ended July 31, 1996, 1997 and 1998

10. Accrued Expenses and Other

Accrued expenses and other consists of the following:

<TABLE>
<CAPTION>
-------------------
1997 1998
--------- ---------
<S> <C> <C>
Dollars in thousands
Employee compensation...................................... $ 128 $ 152
Commissions................................................ 96 85
Vacation................................................... 267 259
Warranty................................................... 340 250
Interest................................................... -- 263
Financing costs............................................ 195 --
Other...................................................... 244 292
--------- ---------
Total.................................................... $ 1,270 $ 1,301
========= =========
</TABLE>

11. Debt

Cortelco Systems, Inc. Revolving Credit Facility--On July 31, 1997, CSI entered
into a new loan and security agreement with Foothill Capital (the "CSI Credit
Facility") which provides for borrowings based upon an asset formula involving
eligible accounts receivable and inventories, up to a maximum of $7,500,000,
including letters of credit, and expires in July 2001. At July 31, 1998, CSI
had outstanding borrowings under this facility of $2,353,000. The Company had
no outstanding letters of credit at July 31, 1998. The borrowings are
collateralized by substantially all the assets of the Company. The CSI Credit
Facility provides for interest at the reference rate plus the margin in effect,
which fluctuates during the term of the CSI Credit Facility, based on the
Company's satisfaction of certain minimum income requirements. At July 31, 1998
the effective interest rate was 8.875% (prime rate of 8.5% plus a margin of
0.375%). The CSI Credit Facility also provides for an annual facility fee equal
to 0.125% of the maximum borrowing base and an annual unused line fee equal to
0.375% based upon the average unused portion of the available credit.

The CSI Credit Facility also contains covenants which, among other matters,
limit the ability of the Company to incur indebtedness; merge, consolidate or
acquire or sell assets; pay dividends; or redeem or exchange capital stock. At
July 31, 1998 the Company was not in compliance with certain covenants
contained in the CSI Credit Facility. On March 30, 1999, the Company received a
waiver related to the covenants previously in default. On April 8, 1999, the
CSI Credit Facility was amended to pledge the outstanding common stock of CSPR.

Cortelco Puerto Rico, Inc. ("CPR") Revolving Credit Facility--On August 29,
1997, CPR entered into a new revolving line of credit agreement with Foothill
Capital (the "CPR Credit Facility") under which CPR may borrow up to
$1,500,000. The agreement provides for interest at a variable rate plus 1.25%
(9.75% at July 31, 1998). The CPR Credit Facility contains various restrictive
covenants and is secured by liens on accounts receivable and inventories as
well as a pledge of CPR's stock. At July 31, 1998, CPR had outstanding
borrowings under this facility of $386,000.

The CPR Credit Facility contains covenants which, among other matters limit the
ability of CPR to incur indebtedness; merge, consolidate or acquire or sell
assets; pay dividends; or redeem or exchange capital stock. At July 31, 1998,
CPR was not in compliance with certain covenants contained in the CPR Credit
Facility. On March 30, 1999, CPR received a waiver related to the covenants
previously in default.

On April 8, 1999, in connection with the assumption of the CPR Credit Facility
by CSPR (see Note 2), the CPR Credit Facility was amended to include as an
event of default a failure by CSHC to pledge the outstanding stock of CII to
the lender on or before May 28, 1999, as contemplated by CII's credit facility
with the lender.

F-13
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements--(Continued)
Years Ended July 31, 1996, 1997 and 1998

Long-term debt consists of the following:

<TABLE>
<CAPTION>
--------------------
1997 1998
--------- ---------
Dollars in thousands
<S> <C> <C>
Subordinated note (1).................................... $ 3,000 $ 3,000
Note payable to bank by CPR (2).......................... 2,000 3,073
--------- ---------
Total.................................................. 5,000 6,073
Less amounts payable within one year..................... (129) (32)
--------- ---------
Long-term debt, less current portion................... $ 4,871 $ 6,041
========= =========
</TABLE>
- -------------------
(1) The outstanding balance of $3,000,000 represents borrowings under a
subordinated note agreement dated July 31, 1997 with ChinaVest IV, L.P. The
note matures on July 31, 2002 and is convertible into shares of the
Company's Series A Convertible Preferred Stock based on a conversion price
determined by a formula defined in the agreement, which is based on the
Company's audited net income for the fiscal year ended July 31, 1998. Based
on the conversion price formula, the holder can convert $686,000 of
principal to 1,463,206 shares of Series A Convertible Preferred Stock. The
holder has the option to convert the note at any time subsequent to July
31, 1998. The agreement provides for interest at the rate of 8% annually.
Upon conversion, the accrued interest on the principal amount converted by
the holder is payable within sixty days following the date of conversion.
The Company's Series A Convertible Preferred Stock has full voting rights
and is convertible into common shares at any time.
The agreement also contains covenants which, among other matters, limit the
ability of the Company to merge, consolidate, acquire, or sell assets. At
July 31, 1998, the Company was not in compliance with a covenant contained
in the agreement. On April 5, 1999, the Company received a waiver related to
the covenant previously in default. Additionally on April 5, 1999, the
holder of the subordinated note provided their consent to a series of
transactions, including the merger with CSPR and the reverse stock split
discussed in Note 1 and the repurchase of common stock from CSHC in partial
settlement of the outstanding note receivable (see Note 15).

(2) The outstanding balance at July 31, 1997 represents borrowings by CPR under
a term loan agreement bearing interest at an annual rate of 9.85%. On
August 29, 1997, the agreement was refinanced. The new agreement bears
interest at a fixed rate of 10% and is due in monthly installments of
principal and interest totalling $28,170 through September 1, 2002.
Subsequent to September 1, 2002, the remaining principal balance will be
negotiated for a period of five additional years. The agreement is
collateralized by certain property. The fair value of the term loan was
estimated by discounting future cash flows using rates currently available
for debt with similar terms and remaining maturities. The fair value was
estimated to be $3,318,000 at July 31, 1998.

The scheduled repayment of long-term debt is as follows:

<TABLE>
<CAPTION>
Dollars in thousands
<S> <C>
1999................................................................. $ 32
2000................................................................. 35
2001................................................................. 39
2002................................................................. 3,043
2003 and thereafter.................................................. 2,924
---------
Total................................................................ $ 6,073
=========
</TABLE>

F-14
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements--(Continued)
Years Ended July 31, 1996, 1997 and 1998

12. Lease Commitments

The Company leases its primary warehouse and office facilities, as well as
certain office equipment, under operating leases.

The following is a schedule of future minimum lease payments required under
operating leases that have remaining initial or remaining noncancellable lease
terms in excess of one year as of July 31, 1998:

<TABLE>
<S> <C>
Dollars in thousands
1999..................................................................... $ 443
2000..................................................................... 177
2001..................................................................... 174
2002..................................................................... 179
2003 and thereafter...................................................... 154
------
Total.................................................................... $1,127
======
</TABLE>

Rent expense for the years ended July 31, 1996, 1997, and 1998 totaled
$540,000, $526,000, and $446,000, respectively, which included $46,000,
$137,000, and $137,000, respectively, rent charged by CII for the sharing of
warehouse space.

13. Income Taxes

The Company's current taxable income has historically been included in the
consolidated income tax return of CSHC. There does not currently exist a tax
sharing agreement for allocating income taxes. The consolidated provision or
benefit is allocated proportionately between the subsidiaries of CSHC based on
the contribution of each company in the consolidated federal tax return as if
each company calculated its tax on a separate return basis.

The financial statements of the Company do not include a provision (benefit)
for income taxes for 1997 and 1998 due to cumulative net operating losses.

The components of income tax expense attributable to continuing operations for
1996 are as follows:

<TABLE>
<S> <C>
Dollars in thousands
Current:
Federal................................................................. $617
State................................................................... 85
----
Total current............................................................. 702
Deferred:
Federal................................................................. --
State................................................................... --
----
Total deferred............................................................ --
----
Total income tax expense.................................................. $702
====
</TABLE>

F-15
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements--(Continued)
Years Ended July 31, 1996, 1997 and 1998

A reconciliation between the income tax expense from continuing operations
recognized in the Company's consolidated statement of operations and the income
tax expense computed by applying the domestic federal statutory income tax rate
to income from continuing operations before income taxes is as follows:

<TABLE>
<CAPTION>
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Dollars in thousands
Income tax at statutory rate (35%)........... $ 623 $ (589) $ 111
State income taxes, net of federal benefit... 56 -- 13
Additional taxes on foreign income........... 5 (30)
Foreign earnings not repatriated............. -- -- (23)
Change in valuation allowance................ (5) 580 (169)
Other, net................................... 23 39 68
--------- --------- ---------
Total income tax expense................... $ 702 $ -- $ --
========= ========= =========
</TABLE>

Income taxes are not provided for the undistributed earnings of the foreign
joint venture as such earnings are intended to be permanently reinvested. Such
earnings would become taxable upon the sale or liquidation or upon the
remittance of dividends. Accumulated undistributed earnings on which U.S. taxes
have not been provided are approximately $66,000.

The deferred tax effects of the Company's principal temporary differences at
July 31, 1997 and 1998 are as follows:

<TABLE>
<CAPTION>
---------------------------------
Assets Liabilities Total
Dollars in thousands --------- ----------- ---------
1997
- ----
<S> <C> <C> <C>
Allowance for doubtful receivables......... $ 888 $ -- $ 888
Inventories................................ 444 (207) 237
Basis difference in property and
equipment................................. 184 -- 184
Accrued warranty costs..................... 54 -- 54
Accrued expenses and other................. 20 -- 20
Other...................................... 115 -- 115
Net operating loss carryforwards........... 255 -- 255
Minimum tax credits........................ 154 -- 154
Valuation allowance........................ (1,907) -- (1,907)
--------- ---------- ---------
Total deferred asset (liability)......... $ 207 $ (207) $ --
========= ========== =========
<CAPTION>
1998
- ----
<S> <C> <C> <C>
Allowance for doubtful receivables......... $ 574 $ -- $ 574
Inventories................................ 350 (78) 272
Basis difference in property and
equipment................................. 157 -- 157
Accrued warranty costs..................... 54 -- 54
Accrued expenses and other................. 47 -- 47
Other...................................... 88 -- 88
Net operating loss carryforwards........... 392 -- 392
Minimum tax credits........................ 154 -- 154
Valuation allowance........................ (1,738) -- (1,738)
--------- --------- ---------
Total deferred asset (liability)......... $ 78 $ (78) $ --
========= ========= =========
</TABLE>

At July 31, 1998 the Company's allocated portion of the consolidated net
operating loss carryforward is approximately $334,000, which expires at various
dates through 2013. During the year ended July 31, 1996, the Company utilized

F-16
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements--(Continued)
Years Ended July 31, 1996, 1997 and 1998

approximately $2,554,000 of net operating loss carryforwards. The provision for
income taxes for 1996 includes a benefit of approximately $893,900 related to
the utilization of these carryforwards.

14. Stock Options

During 1998, the Board of Directors approved the adoption of the 1997 Equity
Incentive Plan (the "Plan") which permits the granting of incentive stock
options, supplemental stock options, stock bonuses, and restricted stock
purchase agreements to officers, directors and key employees of the Company and
to non-employee consultants. At July 31, 1998, 250,000 shares of the Company's
common stock were reserved for issuance under the terms of the Plan. Incentive
stock options are granted only to employees and are issued at prices not less
than 100% of the fair market value of the stock at the date of grant. The
options vest over a four-year period and the term of any option shall not be
greater than ten years from the date of grant. Stock bonuses and restricted
stock purchase agreements are granted only to directors, officers, or employees
of or consultants to the Company and are issued at prices not less than 85% of
the fair market value of the stock at the date of grant. During 1998, 139,311
options were granted with exercise prices ranging from $.70 to $1.00 per share
and remain outstanding at July 31, 1998. No compensation expense related to
stock option grants was recorded during 1998 as the option exercise prices were
equal to or greater than fair market value on the date of grant.

The status of the Company's stock option plan is as follows:

<TABLE>
<CAPTION>
-------------------
Weighted
Average
Number Exercise
of Shares Price
--------- ---------
<S> <C> <C>
Granted.................................................... 139,311 $ 0.885
Exercised.................................................. -- N/A
Cancelled.................................................. -- N/A
--------- ---------
Outstanding at July 31, 1998............................... 139,311 $ 0.885
========= =========
Options exercisable at July 31, 1998....................... 7,904 $ 0.945
========= =========
</TABLE>

The options outstanding at July 31, 1998 are exercisable at prices ranging from
$.70 to $1.00 per share. The weighted average remaining contractual life of all
outstanding options was 9.81 years at July 31, 1998.

The Company accounts for stock-based compensation using the intrinsic value
method prescribed by Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," under which no compensation cost for stock
options is recognized for options granted at or above fair market value. Had
compensation expense been determined based upon fair values at the grant dates
in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation," the
Company's net income and earnings per share would not have been different as
the fair value of the options was determined to be zero on the applicable dates
of grant.

15. Related Parties

As discussed in Note 1, certain expenses reflected in the financial statements
include allocations of expenses from CSHC and CII. These allocations include:
insurance, computer maintenance, general warehousing expenses, and salesmen
expenses.

During 1997, CSHC incurred certain costs on behalf of CSHC's subsidiaries.
Management of CSHC allocated these costs proportionately among the subsidiaries
based on estimates of effort expended and sales. As a result, the Company
incurred management fee expense of $406,000 for the year ended July 31, 1997.

During 1998, certain costs were incurred by CSI on behalf of CSHC and the
consolidated group. The costs incurred by CSI related to certain administrative
functions, such as administration of insurance and benefit plans, handling of
legal and accounting matters, etc. As a result, CSI recognized management fee
income of $80,000 for the year ended July 31, 1998. During 1998, CPR received
various administrative services from CSHC and incurred management fee expense
of $265,000 for the year ended July 31, 1998.

F-17
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements--(Continued)
Years Ended July 31, 1996, 1997 and 1998

At July 31, 1997 and 1998, the Company's accounts include a receivable of
$355,000 and $656,000, respectively, due from CSHC. The amount in 1998 includes
an intercompany tax receivable of $86,000. Additionally, CPR has a non-interest
bearing demand note payable with CSHC. At July 31, 1997 and 1998, the balance
outstanding totaled $750,000 and $359,000, respectively. This note is
subordinate to the CPR revolving credit facility discussed in Note 11.

The Company also has a $3,184,000 note receivable from CSHC that has been
reflected as a reduction of stockholders' equity in the accompanying balance
sheets as of July 31, 1997 and 1998. The note matures on or before December 31,
2002, subject to CSHC's ability to repay the $3,600,000 note payable to
corporation discussed in Note 18.

During 1996, 1997, and 1998 the Company recognized sales to a company
affiliated through common stockholder ownership (CII) totalling $519,000,
$65,000, and $85,000, respectively. The Company also had inventory purchases
from this affiliate totalling $1,165,000, $692,000, and $188,000, respectively.
At July 31, 1997 and 1998, the Company's accounts include a $172,000 payable to
and a $1,000 receivable from CII, respectively.

The Company has a manufacturing services agreement with CMC (primary contract
electronic manufacturer), an affiliate through common stockholder ownership.
During 1996, 1997, and 1998 the Company purchased approximately $14,892,000,
$10,663,000, and $9,351,000, respectively, under the agreement. Additionally
the Company recognized sales to CMC during 1996, 1997, and 1998 of
approximately $767,000, $128,000, and $154,000, respectively, in component
parts. The agreement expired during 1997, however, subsequent to July 31, 1998
the Company renewed the agreement.

At July 31, 1998, the Company had a $250,000 non-interest bearing demand note
payable to a stockholder of CSHC. Subsequent to year-end, the note payable was
paid in full.

At July 31, 1997 and 1998, the Company's trade accounts receivable include
$124,000 and $95,000, respectively, due from a company affiliated through
common stockholder ownership (BCS Technologies, Inc.). Sales to this affiliate
totaled approximately $975,000, $392,000, and $353,000 during the years ended
July 31, 1996, 1997, and 1998, respectively.

16. Employee Savings Plan

Substantially all employees of the Company can participate in the Cortelco
International, Inc. Profit Sharing Plan, which is qualified under Section 401
of the Internal Revenue Code. Under the provisions of the plan, all
participants may contribute up to 16% of their compensation, subject to
limitations established by the Internal Revenue Service. The Company may
contribute a matching contribution of not less than 50% of the employee
contributions up to 6% of the employee's compensation. The Company may also
provide special discretionary contributions equal to a percentage of an
employee's annual compensation and/or an amount determined by management.
During 1996, 1997, and 1998 contributions allocated to the Company totaled
$115,000, $119,000, and $110,000, respectively.

17. Segment Information

In June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information," was issued effective for fiscal years beginning after
December 15, 1997. The statement allows, and the Company has chosen, the early
adoption of this statement for the year ended July 31, 1998.

The Company's reportable segments are communications systems and cellular
airtime services, each of which offers different products and services. Each
segment requires different technology and marketing strategies. The
communication systems solutions segment offers communications solutions that
address the voice, video, and data network switching requirements of small and
medium sized installations. The Company's cellular airtime services segment
offers cellular airtime and cellular telephones through CSPR.

F-18
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements--(Continued)
Years Ended July 31, 1996, 1997 and 1998

The accounting policies of the segments are those described in the summary of
significant accounting policies. Management evaluates performance based on
operating income.

<TABLE>
<CAPTION>
--------------------------------------
Cellular
Dollars in thousands Communications Airtime Consolidated
1996 Systems Services Total
- -------------------- -------------- --------- ------------
<S> <C> <C> <C>
Revenues................................ $ 28,334 $ 10,184 $ 38,518
Operating income........................ 2,634 274 2,908
Total assets............................ 14,616 3,001 17,617
Capital expenditures.................... 470 2 472
Depreciation and amortization........... 467 7 474
<CAPTION>
1997
- ----
<S> <C> <C> <C>
Revenues................................ $ 25,838 $ 9,797 $ 35,635
Operating income (loss)................. 311 (401) (90)
Total assets............................ 14,981 2,718 17,699
Capital expenditures.................... 370 167 537
Depreciation and amortization........... 354 14 368
<CAPTION>
1998
- ----
<S> <C> <C> <C>
Revenues................................ $ 23,464 $ 6,708 $ 30,172
Operating income........................ 755 549 1,304
Total assets............................ 14,699 1,731 16,430
Capital expenditures.................... 250 6 256
Depreciation and amortization........... 282 48 330
</TABLE>

Following is a reconciliation of profits from operating segments to income
before income taxes for the years ended July 31, 1996, 1997, and 1998:

<TABLE>
<CAPTION>
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Total income (loss) from operations for
reportable segments $ 2,908 $ (90) $ 1,304
Unallocated:
Interest expense............................. 1,004 915 826
Management fee expense, net.................. 178 406 185
Equity in earnings of joint venture.......... -- -- (66)
Other, net................................... (54) 272 43
--------- --------- ---------
Income (loss) from continuing operations
before income taxes....................... $ 1,780 $ (1,683) $ 316
========= ========= =========
</TABLE>

Financial information relating to the Company's revenues by geographic area was
as follows:

<TABLE>
<CAPTION>
-----------------------------
1996 1997 1998
Dollars in thousands --------- --------- ---------
<S> <C> <C> <C>
United States................................... $ 37,784 $ 34,994 $ 29,404
Central America................................. 161 324 256
Europe.......................................... 136 29 42
South America................................... 409 168 184
Saudi Arabia.................................... -- 119 128
South Africa.................................... -- -- 44
China........................................... 28 1 5
Taiwan.......................................... -- -- 109
--------- --------- ---------
Consolidated.................................. $ 38,518 $ 35,635 $ 30,172
========= ========= =========
</TABLE>

F-19
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements--(Continued)
Years Ended July 31, 1996, 1997 and 1998

18. Commitments and Contingencies

At July 31, 1998 the stock of the Company was pledged as collateral under a
$3,600,000 note payable from CSHC to a corporation. The note matured in
September 1998 and was secured by the outstanding common stock of the Company
and a personal guaranty of the single largest stockholder of CSHC. CSHC did not
make the scheduled payment due in September 1998. On February 25, 1999, CSHC
entered a consent agreement with the corporation whereby the stock of CSI was
released from the original pledge agreement in order to allow the CSI spin-off
discussed in Note 2. Additionally, the corporation agreed not to declare an
event of default. In exchange for the corporation's consent, CSHC remitted
$1,000,000 of the amount outstanding and agreed to a revised repayment
schedule. In connection with the transaction, CSHC's single largest stockholder
loaned CSHC $1,000,000.

The Company is involved in various matters of litigation, claims, and
assessments arising in the ordinary course of business. In the opinion of
management, the eventual disposition of these matters will not have a material
adverse effect on the financial statements.

19. Earnings Per Share

The computations of basic and diluted earnings per share for each year were as
follows:

<TABLE>
<CAPTION>
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Dollars in thousands, except per share data
Basic earnings per share:
Income (loss) from continuing operations...... $ 1,078 $ (1,683) $ 316
Income (loss) from discontinued operations.... (1,112) (515) --
--------- --------- ---------
Income (loss) available to common
shareholders............................... (34) (2,198) 316
Weighted average shares outstanding-basic..... 3,825 3,825 3,918
--------- --------- ---------
Basic earnings per share.................... $ (0.01) $ (0.57) $ 0.08
========= ========= =========
Diluted earnings per share:
Income:
Income (loss) available to common
shareholders............................... $ ( 34) $ (2,198) $ 316
Interest on 8% convertible subordinated
debt....................................... -- -- 55
--------- --------- ---------
Income (loss) available to common
shareholders.............................. (34) (2,198) 371
Weighted average shares:
Outstanding................................. 3,825 3,825 3,918
Assumed conversion of preferred stock....... -- -- 1,435
--------- --------- ---------
Weighted average shares outstanding-
diluted................................... 3,825 3,825 5,353
--------- --------- ---------
Diluted earnings per share................. $ (0.01) $ (0.57) $ 0.07
========= ========= =========
</TABLE>

Options to purchase 139,311 shares of common stock were outstanding at July 31,
1998 but were not included in the computation of the diluted earnings per share
because the options' exercise price was equal to or greater than the average
market price of the common shares. Additionally, at July 31, 1997 and 1998,
$686,000 of convertible subordinated debt was convertible into 1,463,206 shares
of convertible preferred stock which was convertible into 1,434,894 shares of
common stock. These potential common shares were excluded from the computation
of diluted earnings per share for 1997 because their inclusion would have had
an antidilutive effect on earnings per share.

20. Subsequent Events

On February 24, 1999, the Company's Board of Directors declared a dividend of
$2,216,514 payable to the stockholders (CSHC and Sea Union) of record on
February 26, 1999. Approximately $1,957,000 of the dividend declared is payable
upon certain events occurring in the future. The remaining amount of the
dividend declaration primarily relates to the distribution of the non-interest
bearing note receivable from an officer/director to CSHC. As the Company has a
retained deficit, the dividend is recorded as a return of capital. The dividend
has been reflected in the financial statements as if declared on July 31, 1998.

F-20
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements--(Continued)
Years Ended July 31, 1996, 1997 and 1998

On April 5, 1999, the Company's Board of Directors declared a stock dividend of
195,685 shares of the Company's common stock to stockholders of record on April
5, 1999. The dividend was charged to the accumulated deficit in the amount of
$1,956,850, which was based on the fair value of the Company's common stock as
determined by the Board of Directors. The stock dividend has been reflected in
the financial statements as if declared on July 31, 1998.

On April 5, 1999, the Company received 250,000 shares of its common stock from
CSHC in exchange for a $2,500,000 reduction of the outstanding note receivable
balance.

On April 8, 1999, previous to the merger discussed in Note 1, CSPR declared a
dividend of $700,000 payable to the stockholder (CSHC) of record on April 8,
1999, payable upon certain events occurring in the future. The dividend has
been reflected in the financial statements as if declared on July 31, 1998.

Subsequent to year-end, the Company entered into a letter of intent agreement
to merge with an affiliated company, BCS Technologies, Inc.

21.Restatement of Financial Statements

Subsequent to the issuance of the Company's financial statements for the year
ended July 31, 1998, the Company's management determined that certain costs
related to the acquisition of cellular airtime contracts that had been
deferred, should be expensed as incurred. In addition, the Company changed its
method of accounting for its Longhai joint venture from full consolidation to
the equity method. As a result, the accompanying financial statements as of
July 31, 1997 and 1998 and for each of the three years in the period ended July
31, 1998 have been restated from the amounts previously reported to properly
account for the transactions identified. A summary of the significant effects
of the restatement is as follows:

<TABLE>
<CAPTION>
------------------------- -------------------------
1997 1998
------------------------- -------------------------
As previously As As previously As
reported restated reported restated
Dollars in thousands, except per share data ------------- ---------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C>
At July 31:
Current portion of cellular telephone equipment
deferred acquisition costs, net................. $ 546 $ -- $ 269 $ --
Noncurrent portion of cellular telephone
equipment deferred acquisition costs, net....... 172 -- -- --
Accumulated deficit.............................. (4,176) (4,894) (6,266) (6,535)
Total Assets..................................... 18,417 17,699 17,835 16,430
Total Liabilities................................ 16,806 16,806 18,957 17,821
<CAPTION>
------------------------- ------------------------- -------------------------
1996 1997 1998
------------------------- ------------------------- -------------------------
As previously As As previously As As previously As
reported restated reported restated reported restated
------------- ---------- ------------- ---------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C>
For the year ended July
31:
Net revenues............ $ 38,518 $ 38,518 $ 35,635 $ 35,635 $ 30,949 $ 30,172
Net income (loss)....... (275) (34) (2,039) (2,198) (133) 316
Net income (loss) per
common share:
Basic................. $ (0.07) $ (0.01) $ (0.53) $ (0.57) $ (0.03) $ 0.08
Diluted............... $ (0.07) $ (0.01) $ (0.53) $ (0.57) $ (0.03) $ 0.07
</TABLE>

F-21
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Consolidated Balance Sheets (Unaudited)
At July 31, 1998 and April 30, 1999

<TABLE>
<CAPTION>
--------------------
At At April
July 31, 30,
1998 1999
--------- ---------
<S> <C> <C>
Dollars in thousands
ASSETS
Current assets:
Cash and cash equivalents............................... $ 103 $ 1,774
Trade accounts receivable, net of allowance for doubtful
accounts of $1,880 and $1,453.......................... 6,630 10,432
Current portion of investment in sales-type leases...... 150 70
Inventories............................................. 5,631 7,095
Other current assets.................................... 727 622
--------- ---------
Total current assets................................... 13,241 19,993
Property and equipment, net.............................. 1,250 1,052
Receivable (payable) from affiliate...................... 657 --
Other assets:
Investment in joint ventures............................ 138 145
Investment in sales-type leases, noncurrent............. 106 79
Intangible assets, net of accumulated amortization of $4
and $15................................................ 327 316
Notes receivable from employees......................... 138 90
Deferred financing costs, net of accumulated
amortization of $91 and $157........................... 511 246
Other assets............................................ 62 700
Deferred tax asset...................................... -- 116
Goodwill................................................ -- 11,266
--------- ---------
Total other assets..................................... 1,282 12,958
--------- ---------
Total assets........................................... $ 16,430 $ 34,003
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Dividends payable....................................... $ 2,667 $ 2,667
Short-term debt......................................... -- 16
Checks outstanding...................................... 55 --
Note payable to related party........................... 250 --
Payable to affiliate.................................... -- 79
Current portion of long-term debt....................... 32 --
Notes payable under revolving line of credit............ 2,739 2,552
Trade accounts payable.................................. 2,172 4,221
Accounts payable to CMC Industries, Inc................. 2,205 1,988
Accrued expenses and other.............................. 1,301 2,269
Income tax payable...................................... -- 1,352
--------- ---------
Total current liabilities.............................. 11,421 15,144
Note payable to parent................................... 359 --
Long-term debt........................................... 6,041 2,314
Commitments and contingencies............................ -- --
Stockholders' equity (deficit):
Series A convertible preferred stock, $.001 par value,
(10,000,000 shares authorized, 1,463,206 outstanding).. -- 660
Common stock, $.001 par value (50,000,000 shares
authorized,
3,920,252 and 7,639,932 shares issued and
outstanding)........................................... 4 8
Additional paid-in capital.............................. 8,324 24,148
Accumulated deficit..................................... (6,535) (5,637)
Note receivable from affiliate (former parent).......... (3,184) (2,634)
--------- ---------
Total stockholders' equity (deficit)................... (1,391) 16,545
--------- ---------
Total liabilities and stockholders' equity............. $ 16,430 $ 34,003
========= =========
</TABLE>

See notes to consolidated financial statements (unaudited).

F-22
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Consolidated Statements of Operations (Unaudited)
Nine Months Ended April 30, 1998 and 1999

<TABLE>
<CAPTION>
--------------------
Nine Months Ended
April 30,
--------------------
1998 1999
--------- ---------
<S> <C> <C>
Dollars in thousands, except per share data
Net revenues............................................. $ 22,182 $ 27,173
Cost of revenues......................................... 12,730 15,290
--------- ---------
Gross profit............................................ 9,452 11,883
Operating expenses:
Selling, general and administrative..................... 7,663 8,649
Research and development................................ 1,038 1,525
Amortization expense.................................... -- 28
--------- ---------
Total operating expenses............................... 8,701 10,202
--------- ---------
Income from operations................................... 751 1,681
Interest expense......................................... 633 584
Management fee expense (income), net..................... 148 23
Equity in earnings of joint venture...................... (60) (7)
Other expense (income), net.............................. 91 102
--------- ---------
Income (loss) before income taxes....................... (61) 979
Income tax expense....................................... -- 81
--------- ---------
Net income (loss) and comprehensive income (loss)....... $ (61) $ 898
========= =========
Net income (loss), per common share:
Basic................................................... $ (0.02) $ 0.22
Diluted................................................. $ (0.02) $ 0.16
</TABLE>

See notes to consolidated financial statements (unaudited).

F-23
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended April 30, 1998 and 1999

<TABLE>
<CAPTION>
--------------------
1998 1999
--------- ---------
<S> <C> <C>
Dollars in thousands
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)....................................... $ (61) $ 898
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization.......................... 237 171
Amortization of intangibles............................ 2 11
Provision for the allowance for doubtful accounts...... 194 196
Equity in earnings of joint venture.................... (60) (7)
Changes in net assets and liabilities, net of effect of
business acquisition:
Trade accounts receivable............................. 2,352 (1,594)
Investment in sales-type leases, net.................. (48) 107
Accounts receivable from/payable to affiliates........ (390) (87)
Inventories........................................... (1,010) 627
Other current assets.................................. 78 57
Deferred assets....................................... -- 9
Other assets.......................................... -- (638)
Trade accounts payable................................ (141) 1,417
Accounts payable to CMC Industries, Inc............... 35 (217)
Accrued expenses and other............................ 1 118
Income taxes payable.................................. -- 78
--------- ---------
Net cash provided by operating activities............ 1,189 1,146
CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash acquired from business acquisition............. -- 3,126
Purchases of property and equipment..................... (255) (325)
Purchase of patents, trademarks, and software
technology............................................. (239) --
Net repayments (advances) under notes receivable from
employees.............................................. (170) 48
Maturities of certificates of deposit................... 174 --
--------- ---------
Net cash provided by (used in) investing activities.. (490) 2,849
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments under revolving line of credit........... (162) (187)
Decrease in checks outstanding.......................... (1,615) (55)
Repayments of long-term debt............................ (2,051) (21)
Repayment of note payable to parent company............. (250) (100)
Repayment of note payable to related party.............. 250 (250)
Proceeds from term debt................................. 3,100 --
Debt issuance costs..................................... (127) 239
Loan to affiliate....................................... -- (1,950)
--------- ---------
Net cash used in financing activities................ (855) (2,324)
--------- ---------
Net increase (decrease) in cash and cash equivalents.... (156) 1,671
Cash and cash equivalents, beginning of period.......... 320 103
--------- ---------
Cash and cash equivalents, end of period................ $ 164 $ 1,774
========= =========
</TABLE>

See notes to consolidated financial statements (unaudited).

F-24
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)
Nine Months Ended April 30, 1998 and 1999

1. Financial Statement Presentation

The accompanying consolidated financial statements have been prepared by the
Company, without audit. It is management's opinion that these statements
include all adjustments, consisting of only normal recurring adjustments,
necessary to present fairly the financial position, results of operations, and
cash flows as of April 30, 1999 and for all periods presented. The results for
the nine months ended April 30, 1998 and 1999 are not necessarily indicative of
the results that may be expected for the full year.

Certain information and footnote disclosures normally included in annual
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. It is suggested that these
consolidated financial statements be read in conjunction with the consolidated
financial statements and notes thereto as of July 31, 1997 and 1998 and for
each of the three years in the period ended July 31, 1998.

In June 1997, the Financial Accounting Standards Board issued SFAS 130,
"Reporting Comprehensive Income," which established standards of reporting and
display of comprehensive income and its components and requires a separate
statement to report the components of comprehensive income for each period
reported. For the nine months ended April 30, 1998 and 1999 net income (loss)
equaled comprehensive income (loss).

2. Acquisition of BCS Technologies, Inc.

On April 12, 1999, the Company acquired BCS Technologies, Inc. ("BCS") in
exchange for 3,969,680 common shares. The purchase price was determined based
on the fair value of the BCS equity. The parties agreed to the merger in
November, 1998 and the purchase price was established as of November 30, 1998.
The acquisition was accounted for using the purchase method and the purchase
price of $16,840,000 was preliminarily allocated as follows:

<TABLE>
<S> <C>
Dollars in thousands
Current assets...................................................... $ 8,025
Fixed assets........................................................ 293
Goodwill............................................................ 11,294
Current liabilities assumed......................................... (2,772)
---------
Net assets acquired............................................... $ 16,840
=========
</TABLE>

The Company has not completed the determination of fair values and the
allocation of purchase price may change. The results of the acquired business
have been included in the consolidated financial statements since the
acquisition date. Goodwill is being amortized on a straight-line basis over
twenty years.

F-25
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)--(Continued)
Nine Months Ended April 30, 1998 and 1999

3. Earnings Per Share

The computations of basic and diluted earnings per share were as follows:

<TABLE>
<CAPTION>
----------------------------
Nine Months Ended April 30,
----------------------------
1998 1999
------------- -------------
<S> <C> <C>
Dollars in thousands, except per share data
Basic earnings per share:
Net income (loss)............................... $ (61) $ 898
Weighted average shares outstanding--basic...... 3,910 4,159
------------- -------------
Basic earnings per share...................... $ (0.02) $ 0.22
============= =============
Diluted earnings per share:
Income:
Net income (loss)............................... $ (61) $ 898
Interest on 8% convertible subordinated debt.... -- 38
------------- -------------
Income (loss) available to common
shareholders................................. (61) 936
Weighted average shares:
Outstanding..................................... 3,910 4,159
Assumed conversion of preferred stock........... -- 1,435
Dilutive effect of stock options................ -- 175
------------- -------------
Weighted average shares outstanding--diluted.. 3,910 5,769
------------- -------------
Diluted earnings per share.................... $ (0.02) $ 0.16
============= =============
</TABLE>

4. Inventories

Inventories consist of the following:

<TABLE>
<CAPTION>
----------------------------
July 31, April 30,
1998 1999
------------- -------------
<S> <C> <C>
Dollars in thousands
Raw materials and purchased components............ $ 819 $ 1,910
Finished goods.................................... 4,926 5,299
LIFO reserve...................................... (114) (114)
------------- -------------
Total inventories............................... $ 5,631 $ 7,095
============= =============
</TABLE>

5. Segment Information

<TABLE>
<CAPTION>
-------------------------------------------------
Cellular Automatic
Communication Airtime Call Consolidated
Systems Services Distribution Total
------------- --------- ------------ ------------
<S> <C> <C> <C> <C>
Dollars in thousands
Nine months ended April
30, 1998:
External revenue...... $ 16,964 $ 5,218 -- $ 22,182
Intersegment reserve.. -- -- -- --
Income from
operations........... 631 120 -- 751
Nine months ended April
30, 1999:
External revenue...... 22,250 3,838 $ 1,085 27,173
Intersegment reserve.. -- -- -- --
Income from
operations........... 598 606 477 1,681
</TABLE>

F-26
<PAGE>

Cortelco Systems, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)--(Continued)
Nine month periods ended April 30, 1998 and 1999

Following is a reconciliation of profits from operating segments to income
before income taxes for the nine month periods ended April 30, 1998 and 1999:

<TABLE>
<CAPTION>
--------------------
1998 1999
--------- ---------
<S> <C> <C>
Dollars in thousands
Total for reportable segments......................... $ 751 $ 1,681
Unallocated:
Interest expense.................................... 633 584
Management fee (income) expense..................... 148 23
Equity in earnings of joint venture................. (60) (7)
Other, net.......................................... 91 102
--------- ---------
Income (loss) before income taxes................. $ (61) $ 979
========= =========
</TABLE>

There have been no differences from the last annual financial statements in the
basis of measuring segment profit or loss. There have been no material changes
in the amount of assets for any operating segment since the last annual
financial statements, except for the acquisition of the automatic call
distribution business with total assets of approximately $19 million at April
30, 1999.

6. Changes In Stockholders' Equity

The following represents the changes in stockholders' equity for the nine
months ended April 30, 1999:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------
Note
Receivable
from
Preferred Stock Common Stock Additional Affiliate
------------------- -------------------- Paid in Accumulated (former Stockholders'
Dollars in thousands, Shares Amount Shares Amount Capital Deficit parent) Equity (Deficit)
except share data --------- --------- --------- --------- ---------- ----------- ---------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at July 31,
1998................... 3,920,252 $ 4 $ 8,324 $ (6,535) $ (3,184) $ (1,391)
Investment in BCS....... 3,969,680 4 16,796 16,800
Capital contribution
from parent............ 1,528 1,528
Conversion of debt to
preferred stock........ 1,463,206 $ 660 660
Shares in exchange for
note retirement........ (250,000) (2,500) 2,500
Loan to affiliate....... (1,950) (1,950)
Consolidated net
income................. 898 898
--------- --------- --------- --------- --------- --------- --------- ---------
Balance at April 30,
1999................... 1,463,206 $ 660 7,639,932 $ 8 $ 24,148 $ (5,637) $ (2,634) $ 16,545
========= ========= ========= ========= ========= ========= ========= =========
</TABLE>

7. Convertible Preferred Stock

In April 1999, the Company issued 1,463,206 shares of convertible preferred
stock in exchange for a reduction of $686,000 in subordinated notes payable.
The preferred stock is convertible into 1,434,894 common shares and carries
voting privileges equal to 1,434,894 common shares.

F-27
<PAGE>

Independent Auditors' Report

Board of Directors and Stockholders
BCS Technologies, Inc.
Englewood, Colorado

We have audited the accompanying balance sheets of BCS Technologies, Inc. as of
July 31, 1997 and 1998, and the related statements of operations, changes in
stockholders' equity and cash flows for the eleven months ended July 31, 1997
and the year ended July 31, 1998. These financial statements are the
responsibility of the Corporation's management. Our responsibility is to
express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of BCS Technologies, Inc. as of
July 31, 1997 and 1998, and the results of its operations and its cash flows
for the eleven months ended July 31, 1997 and the year ended July 31, 1998 in
conformity with generally accepted accounting principles.

Brock and Company, CPAs, P.C.
Certified Public Accountants

Littleton, Colorado
March 5, 1999

F-28
<PAGE>

BCS Technologies, Inc.

Balance Sheets

<TABLE>
<CAPTION>
-------------------------------
At July 31,
------------------ At April
1997 1998 12, 1999
------- --------- -----------
<S> <C> <C> <C>
Dollars in thousands (Unaudited)
ASSETS:
Current assets:
Cash and cash equivalents.................... $ 927 $ 406 $ 3,126
Accounts receivable--trade................... 865 2,073 2,404
Inventories.................................. 1,134 1,257 2,091
Prepaid expenses and other current assets.... 104 90 279
Deferred income tax asset.................... -- 69 125
------- --------- -----------
Total current assets........................ 3,030 3,895 8,025
Property and equipment, at cost:
Leasehold improvements....................... 16 20 23
Machinery and equipment...................... 420 496 564
Furniture and fixtures....................... 77 96 111
Computer software............................ 29 32 59
Vehicle...................................... 8 8 8
------- --------- -----------
Total property and equipment, at cost....... 550 652 765
Less accumulated depreciation................ (310) (396) (472)
------- --------- -----------
Net property and equipment.................. 240 256 293
------- --------- -----------
Total assets................................ $ 3,270 $ 4,151 $ 8,318
======= ========= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Short-term debt.............................. $ 102 $ 28 $ 16
Accounts payable............................. 202 328 632
Accounts payable--affiliates................. 137 183 --
Prepaid maintenance contracts................ 254 296 368
Income taxes payable--current................ 17 223 1,274
Accrued liabilities:
Compensation................................ 101 256 349
Warranty.................................... 70 55 45
Other....................................... 24 20 88
Current portion of capital lease
obligations................................. 5 -- --
------- --------- -----------
Total current liabilities................... 912 1,389 2,772

Stockholders' Equity:
Common stock, par value $.000001, 24,386,775
shares authorized, 23,814,706 shares issued
and outstanding in 1997 and 1998 and
23,602,242 shares issued in 1999............ -- -- --
Treasury stock, at cost...................... -- -- (157)
Additional paid-in capital................... 2,298 2,298 2,298
Retained earnings............................ 60 464 3,405
------- --------- -----------
Total stockholders' equity.................. 2,358 2,762 5,546
------- --------- -----------
Total liabilities and stockholders' equity.. $ 3,270 $ 4,151 $ 8,318
======= ========= ===========
</TABLE>

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

F-29
<PAGE>

BCS Technologies, Inc.

Statements of Operations

<TABLE>
<CAPTION>
----------------------------------------------------------
Period from
Eleven Months Year Nine Months August 1, 1998
Ended Ended Ended through
July 31, 1997 1998 April 30, 1998 April 12, 1999
-------------- ----------- --------------- --------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Dollars in thousands,
except per share data
Revenues................ $ 3,924 $ 6,799 $ 3,642 $ 12,239
Cost of revenues........ 1,538 2,465 1,363 4,197
---------- ----------- ----------- -----------
Gross profit........... 2,386 4,334 2,279 8,042
Operating expenses:
Selling, general and
administrative........ 1,810 3,095 2,256 2,898
Research and
development........... 235 704 521 823
---------- ----------- ----------- -----------
Total operating
expenses............. 2,045 3,799 2,777 3,721
---------- ----------- ----------- -----------
Income (loss) from
operations............. 341 535 (498) 4,321
Other Income:
Interest income........ 14 26 22 50
Gain on sale of
equipment............. 63 -- -- --
---------- ----------- ----------- -----------
Total other income.... 77 26 22 50
---------- ----------- ----------- -----------
Income (loss) before
income taxes........... 418 561 (476) 4,371
Income tax expense
(benefit).............. 17 157 -- 1,430
---------- ----------- ----------- -----------
Net income (loss)...... $ 401 $ 404 $ (476) $ 2,941
========== =========== =========== ===========
Pro forma information
(unaudited):
Net income before
income taxes.......... $ 418
Income tax expense..... 152
----------
Pro forma net income... $ 266
==========
Earnings (loss) per
common share:
Basic:.................
Net income (loss)..... $ 0.03 $ 0.02 $ (0.02) $ 0.12
Weighted average
number of common
shares............... 8,701,076 23,814,706 23,814,706 23,717,891
Diluted:...............
Net income (loss)..... $ 0.03 $ 0.02 $ (0.02) $ 0.12
Weighted average
number of common
shares............... 8,763,810 24,046,252 24,078,289 24,072,891
</TABLE>

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

F-30
<PAGE>

BCS Technologies, Inc.

Statements of Cash Flows
Increase (Decrease) in Cash and Cash Equivalents

<TABLE>
<CAPTION>
---------------------------------------------------------
Period from
Nine Months August 1, 1998
Eleven Months Year Ended Ended through April
Ended July 31, July 31, April 30, 12,
1997 1998 1998 1999
-------------- ---------- ----------- --------------
<S> <C> <C> <C> <C>
Dollars in thousands (Unaudited) (Unaudited)
CASH FLOWS FROM
OPERATING ACTIVITIES:
Net income (loss)...... $ 401 $ 404 $ (476) $ 2,941
Adjustments to
reconcile net income
(loss) to net cash
provided (used) by
operating activities:
Depreciation.......... 44 87 60 75
Gain on sale of
equipment............ (63) -- -- --
Increase (decrease)
from changes in assets
and liabilities, net
of effects from
acquisition:
Accounts receivable... 14 (1,208) 227 (331)
Inventories........... 134 (123) (74) (834)
Prepaid expenses and
other current as-
sets................. (1) 14 3 (189)
Deferred income tax
asset................ -- (69) -- (56)
Accounts payable...... (204) 126 (44) 304
Accounts payable--
affiliates........... 137 46 (103) (183)
Prepaid maintenance
contracts............ 74 42 25 72
Income taxes payable--
current.............. 17 206 (19) 1,051
Accrued liabilities... (99) 136 (23) 151
--------- --------- ----------- -----------
Net cash provided
(used) by operating
activities........... 454 (339) (424) 3,001
--------- --------- ---------- -----------
CASH FLOWS FROM
INVESTING ACTIVITIES:
Cash received from
acquisition........... 500 -- -- --
Proceeds from sale of
equipment............. 75 2 -- 1
Purchases of property
and equipment......... (73) (105) (82) (113)
--------- --------- ----------- -----------
Net cash provided
(used) by investing
activities........... 502 (103) (82) (112)
--------- --------- ----------- -----------
CASH FLOWS FROM
FINANCING ACTIVITIES:
Subchapter S dividend.. (412) -- -- --
Loan principal
payments.............. -- (79) (39) (12)
Proceeds from exercise
of stock options...... 19 -- -- --
Repurchase of common
stock................. -- -- -- (157)
--------- --------- ----------- -----------
Net cash used by
financing
activities........... (393) (79) (39) (169)
--------- --------- ----------- -----------
Net increase (decrease)
in cash and cash
equivalents............ 563 (521) (545) 2,720
Cash and cash
equivalents, beginning
of period............. 364 927 927 406
--------- --------- ----------- -----------
Cash and cash
equivalents, end of
period................ $ 927 $ 406 $ 382 $ 3,126
========= ========= =========== ===========
</TABLE>

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

F-31
<PAGE>

BCS Technologies, Inc.

Statements of Stockholders' Equity (Deficit)

<TABLE>
<CAPTION>
-----------------------------------------------------------------
Common Stock Treasury Stock Additional
------------------ ---------------- Paid-In Retained
Dollars in thousands, Shares Amount Shares Amount Capital Earnings Total
except share data ---------- ------ -------- ------ ---------- -------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, September 1,
1996................... 74,900 $ 51 -- $ -- $ -- $ 597 $ 648
---------- ------ -------- ------ -------- ------- ------
Dividends............... -- -- -- -- -- (460) (460)
Recapitalization of
common stock,
conversion Of
Subchapter S retained
earnings to additional
paid-in capital and
change in par value of
common stock........... 12,850,090 (51) -- -- 529 (478) --
Issuance of common stock
in connection with
merger................. 10,675,850 -- -- -- 1,750 -- 1,750
Exercise of common stock
purchase options....... 213,866 -- -- -- 19 -- 19
Net income for the
eleven months ended
July 31, 1997.......... -- -- -- -- -- 401 401
---------- ------ -------- ------ -------- ------- ------
Balance, July 31, 1997.. 23,814,706 -- -- -- 2,298 60 2,358
---------- ------ -------- ------ -------- ------- ------
Net income for the year
ended July 31, 1998.... -- -- -- -- -- 404 404
---------- ------ -------- ------ -------- ------- ------
Balance, July 31, 1998.. 23,814,706 -- -- -- 2,298 464 2,762
---------- ------ -------- ------ -------- ------- ------
Treasury stock purchased
(unaudited)............ (226,676) -- (226,676) (157) -- -- (157)
Net income for the
period August 1, 1998
to April 12, 1999
(unaudited)............ -- -- -- -- -- 2,941 2,941
---------- ------ -------- ------ -------- ------- ------
Balance, April 12, 1999
(unaudited)............ 23,588,030 $ -- (226,676) $ (157) $ 2,298 $ 3,405 $5,546
========== ====== ======== ====== ======== ======= ======
</TABLE>

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

F-32
<PAGE>

BCS Technologies, Inc.

Notes to Financial Statements
Year Ended July 31, 1998 and
Unaudited Nine Months ended April 30, 1998 and the period August 1, 1998
through April 12, 1999

1. Organization

Organization
Organization--BCS Technologies, Inc. is an organization formed by a series of
transactions between the following entities:

Cortelco Holding Corporation (CHC)
Cortelco Systems Holding Corporation (CSHC)
Cortelco, Inc. (CI)
Cortelco Systems, Inc. (CSI)
Business Communication Systems, Inc. (BCS)

CHC, CSHC, CI and CSI are all entities related through common stockholder
ownership. BCS was a closely held corporation not related to CHC, CSHC, CI and
CSI. The culmination of the series of transactions was a merger of BCS and CI
with BCS being the accounting acquirer. BCS then changed its name to BCS
Technologies, Inc. (the Company). The stockholders of BCS own 53% of the common
stock of the Company after the merger.

Before the merger of BCS and CI, CI was a wholly-owned subsidiary of CHC, which
was a wholly-owned subsidiary of CSI. CHC had no active operations. CSI was a
wholly-owned subsidiary of CSHC. At the time the merger agreement was signed,
CSHC owned 100% of CSI, which owned 100% of CI. Before the merger agreement was
signed, CSI owned 100% of CHC which owned 100% of CI. On March 27, 1997 CHC was
merged into CI. On April 1, 1997, CI was spun off by CSHC to its stockholders.
Immediately following the spin off of CI, on April 2, 1997, CI was merged into
BCS with BCS as the accounting acquirer. BCS changed its name to BCS
Technologies, Inc.

Description of Business
The Company was originally founded in 1985 and operates from offices in
Englewood, Colorado and a 23,000 square foot facility located in Georgia. The
Company is engaged in the development, sales, manufacturing and distribution of
electronic communication devices throughout the United States.

Business Activities
The Company is a corporation organized under the laws of the State of Delaware
for the purpose of the sale and servicing of electronic communication devices
throughout the United States.

2. Summary of Significant Accounting Policies

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

Cash and Cash Equivalents
For purposes of the statement of cash flows, the Company considers all highly
liquid investments purchased with a maturity of three months or less to be cash
equivalents. Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and temporary cash
investments. At times, cash balances held at financial institutions were in
excess of FDIC insurance limits. The Company limits the amount of credit
exposure to any one financial institution. The Company believes no significant
concentration of credit risk exists with respect to these cash investments.

Revenue Recognition
The Company recognizes revenues from system and product sales when title passes
to the customer. Revenues from prepaid maintenance contracts are recognized
ratably over the terms of the contracts. Revenues from the sales of systems
accounted for approximately 32%, 53%, 38%, and 78% for the eleven months ended
July 31, 1997, the year ended July 31, 1998, and the nine months ended April
30, 1998 and the period August 1, 1998 through April 12, 1999. The Company
generates the remainder of its revenue from parts sales and system maintenance.

Accounts Receivable
The Company charges off all known uncollectible accounts on a current basis. No
reserve for uncollectible accounts is required, as any accounts which are
considered doubtful are not considered material to the financial statements.

F-33
<PAGE>

BCS Technologies, Inc.

Notes to Financial Statements--(Continued)

Inventories
The Company uses the lower of first-in, first-out ("FIFO") cost or market in
valuing inventories.

Depreciation
The Company provides for depreciation of property and equipment using straight-
line and accelerated methods for financial and income tax reporting purposes
over the estimated useful lives of the assets, which is generally fifteen years
for leasehold improvements, five years for machinery and equipment, five to
seven years for furniture and fixtures and vehicles and three years for
computer software.

Product Warranties
The Company provides the customer with a warranty from the date of purchase.
Estimated warranty obligations are recorded based on actual claims experience.

Income Taxes
Income tax expense is based on reported income before income taxes. Deferred
income taxes reflect the temporary difference between assets and liabilities
recognized for financial reporting and such amounts recognized for tax purposes
which requires recognition of deferred income tax assets and liabilities.
Deferred income tax assets and liabilities are determined based on the
differences between the financial statement and tax basis of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. A valuation allowance is recognized if it
is anticipated that some or all of a deferred income tax asset may not be
realized.

Advertising
Advertising costs are charged to operations in the year incurred. The Company
expended $170,426 for the eleven months ended July 31, 1997, $117,912 for the
year ended July 31, 1998, and $91,077 for the nine months ended April 30, 1998
and $97,271 for the period August 1, 1998 through April 12, 1999.

Interim Financial Statements
The financial statements for the six months ended April 30, 1998 and the period
August 1, 1998 through April 12, 1999 are unaudited, but in the opinion of
management, include all adjustments necessary to fairly state the results
therein, such adjustments being of a normal, recurring nature. Operating
results for the period August 1, 1998 through April 12, 1999 are not
necessarily indicative of the results that may be expected for the fiscal year
ending July 31, 1999. All April 30, 1998 and April 12, 1999 data presented in
these footnotes is unaudited.

Stock Option Plans
The Company utilizes Statement of Financial Accounting Standards No. 123 (FAS
123), "Accounting for Stock-Based Compensation". The Statement defines a fair
value based method of accounting for stock options or similar equity
instrument. FAS 123 allows an entity to continue to measure compensation cost
for employee stock option plans using the intrinsic value based method of
accounting prescribed by Accounting Principles Board Opinion (APB) No. 25,
which was elected by the Company. Accordingly, the Company must make certain
pro forma disclosures as if the fair value based method had been applied.

Earnings (Loss) Per Common Share
Basic earnings per share is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for
the period. Dilutive earnings per share reflects the potential dilution that
could occur if dilutive securities, stock options, were exercised.

F-34
<PAGE>

BCS Technologies, Inc.

Notes to Financial Statements--(Continued)

3. Business Acquisition

On April 2, 1997, the Company acquired the net assets of Cortelco, Inc., which
had a fair value of $1,750,000, in exchange for 10,675,850 shares of common
stock. The acquisition was accounted for as a reverse acquisition using the
purchase method of accounting, and the results of CI's operations were included
in the Company's financial statements from the date of acquisition.

The Company acquired cash of $500,000, accounts receivable of $509,523,
inventory of $1,054,028, prepaid expenses of $70,185, property and equipment of
$183,333, and current liabilities of $567,069 in the purchase of Cortelco, Inc.

The following unaudited pro forma information presents the results of
operations as if the acquisition had occurred at September 1, 1996 and the
Company had revoked its subchapter S election on such date and was taxed as a
Subchapter C corporation for the entire period.
<TABLE>
<CAPTION>
------------
Eleven
months
ended
July 31,
Dollars in thousands, except per share data 1997
------------
<S> <C>
Net sales.......................................................... $ 5,761
Net income......................................................... 89
Earnings per common share:
Basic and diluted................................................ $ 0.00
</TABLE>

The unaudited pro forma information is not necessarily indicative of the
combined results that would have occurred had the acquisition been effected on
the assumed date, nor is it indicative of the results that may occur in the
future.

4. Inventories

Inventories consist of the following:

<TABLE>
<CAPTION>
-----------------------------
At
July 31,
Dollars in thousands ------------------- April 12,
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Raw materials and purchased components.......... $ 223 $ 225 $ 502
Finished goods.................................. 911 1,032 1,589
--------- --------- ---------
Total inventories............................. $ 1,134 $ 1,257 $ 2,091
========= ========= =========
</TABLE>

5. Short-Term Debt

Short-term debt consists of following:

<TABLE>
<CAPTION>
-----------------------------
At
July 31,
Dollars in thousands ------------------- April 12,
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Amount payable to affiliate--excess of net
worth of CI for the merger with BCS. To be
reduced by any uncollectible receivables, or
other items that would reduce the net worth of
CI at the date of merger...................... $ 54 $ 28 $ 16
Notes payable to stockholder, unsecured and due
on demand..................................... 48 -- --
--------- --------- ---------
Total.......................................... $ 102 $ 28 $ 16
========= ========= =========
</TABLE>

6. Capitalized Leases

The Company leased certain equipment under long term leases. During the year
ended July 31, 1998 the leases terminated and the Company purchased the
equipment for a nominal cost.

F-35
<PAGE>

BCS Technologies, Inc.

Notes to Financial Statements--(Continued)

7. Operating Leases and Rent Expense

The Company leases its office facilities in Englewood, Colorado and Dallas,
Texas under noncancellable lease agreements which expire in July 2001 and
December 1998, respectively. Additionally, the Company leases its primary
warehouse facility in Kennesaw, Georgia and certain office equipment under
noncancellable leases.

At July 31, 1998, future minimum lease payments required under the
noncancelable operating leases are as follows:

<TABLE>
<CAPTION>
Dollars in thousands
---------
Year Ending
July 31, Amount
- ----------- ---------
<S> <C>
1999................................................................. $ 178
2000................................................................. 100
2001................................................................. 98
---------
Total................................................................ $ 376
=========
</TABLE>

Rent expense under all operating leases in effect during the eleven months
ended July 31, 1997 was $148,246, during the year ended July 31, 1998 was
$308,164, during the nine months ended April 30, 1998 was $230,828 and during
the period August 1, 1998 through April 12, 1999 was $236,788.

8. Related Party Transactions

During the eleven months ended July 31, 1997, the year ended July 31, 1998, and
the nine months ended April 30, 1998 and the period August 1, 1998 through
April 12, 1999, the Company purchased inventory from affiliates totaling
$391,568, $353,023, $400,165, and $1,130,065, respectively.

During the year ended July 31, 1998 the Company, through a related party, was
awarded a GSA contract. The contract is invoiced through the related party who
remits the amount collected to the Company when received from the government.
At July 31, 1998 and April 12, 1999 the Company was due $856,259 and
$1,991,360, respectively, from the related party for amounts invoiced on the
contract. These amounts are included in trade accounts receivable at July 31,
1998 and April 12, 1999.

The Company's payable to affiliated companies' stockholders consists of:

<TABLE>
<CAPTION>
-----------------------------
July 31,
------------------- April 12,
1997 1998 1999
Dollars in thousands --------- --------- ---------
<S> <C> <C> <C>
Payable to CSHC................................. $ 16 $ 105 $ --
Payable to CSI.................................. 120 78 --
Payable to stockholders......................... 1 -- --
--------- --------- ---------
Net accounts payable--affiliates................ $ 137 $ 183 $ --
========= ========= =========
</TABLE>

9. Employee Savings Plan

Substantially all employees of the Company can participate in the Dean Witter
Reynolds, Inc. Savings Incentive Match Plan, which is qualified under Section
408(p) of the Internal Revenue Code. Under the provisions of the plan, all
participants may contribute the lesser of 100% of their compensation or $6,000.
The Company may contribute a matching contribution equal to the lesser of the
employee contributions or 3% of the employee's compensation. During the eleven
months ended July 31, 1997, the year ended July 31, 1998, and the nine months
ended April 30, 1998 and the period August 1, 1998 through April 12, 1999, the
Company contributed $7,265, $48,602, $26,350, and $56,458 to the plan,
respectively.

F-36
<PAGE>

BCS Technologies, Inc.

Notes to Financial Statements--(Continued)

10. Stock Option Plans

The Company currently has three stock option plans. Under the terms of the
first plan, certain employees may purchase common stock of the Company at
prices ranging from $.04 to $.34 per share. This plan is an exchange of options
in the pre-merger company for options in the merged company. The number of
options outstanding under this plan and the number of common shares reserved
for issuance upon the exercise of those options is 558,928.

The other two plans grant certain employees options to purchase common stock of
the Company held by two major stockholders for prices ranging from nominal
amounts to $.65 per share. These options are exercisable upon the achievement
of certain conditions or a lapse of ten years. The number of shares subject to
option under these plans are 1,355,306. The following is a summary of
transactions:

<TABLE>
<CAPTION>
--------------------
Weighted
Average
Exercise
Shares Price
--------- ---------
<S> <C> <C>
Outstanding, September 1, 1996
(None vested).......................................... 7,490 $ 8.01
Granted (weighted average of fair value of $0.03 per
share)................................................ 2,223,162 0.22
Canceled............................................... (174,964) 0.47
Exercised.............................................. (213,866) 0.09
---------
Outstanding, July 31, 1997 (402,072 vested at a weighted
average price
of $0.23 per share)..................................... 1,841,822 0.24
Canceled............................................... (83,144) 0.48
---------
Outstanding, July 31, 1998 (393,928 vested at a weighted
average price
of $0.23 per share)..................................... 1,758,678 0.23
Granted (weighted average fair value of $0.09 per
share)................................................ 290,000 0.37
Canceled............................................... (134,444) 0.0001
---------
Outstanding, April 12, 1999 (393,928 vested at a weighted
average price
of $0.13 per share)..................................... 1,914,234 $ 0.27
=========
</TABLE>

Additional information regarding options outstanding at January 31, 1999 is as
follows:

<TABLE>
<CAPTION>
-----------------------------------------------------
Options Outstanding Vested Options
--------------------------------- -----------------
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Price Outstanding Life Price Vested Price
- -------- ----------- ----------- --------- ------- ---------
<S> <C> <C> <C> <C> <C>
$0.0001.................. 480,306 7.9 $ 0.0001 -- $ --
0.04..................... 81,499 2.4 0.04 81,499 0.04
0.14..................... 293,637 2.4 0.14 293,637 0.14
0.25..................... 400,000 8.2 0.25 -- --
0.34..................... 183,792 8.6 0.34 18,792 0.34
0.65..................... 475,000 8.1 0.65 -- --
- ------------------------- --------- --------- --------- ------- ---------
$0.0001-$0.65 1,914,234 7.0 years $ 0.27 393,928 $ 0.13
========================= ========= ========= ========= ======= =========
</TABLE>

Additional Stock Plan Information.
Since the Company continues to account for its stock-based awards to employees
using the intrinsic value method in accordance with APB No. 25, FAS 123,
"Accounting for Stock-Based Compensation," requires the disclosure of pro forma
net income (loss) and earnings (loss) per share had the Company adopted the
fair value method as of the beginning of 1995. Under FAS 123, the fair value of
stock-based awards to employees is calculated through the use of option pricing
models, even though such models were developed to estimate the fair value of
freely tradable, fully transferable options

F-37
<PAGE>

BCS Technologies, Inc.

Notes to Financial Statements--(Continued)

without vesting restrictions, which significantly differ from the Company's
stock option awards. These models also require subjective assumptions,
including future stock price volatility and expected time to exercise, which
greatly affect the calculated values. The Company's fair value calculations on
stock-based awards under the stock plans were made using the Black-Scholes
option pricing model with the following weighted average assumptions: expected
life, 8 years from the date of grant in 1997 and 10 years from the date of
grant in 1999; stock volatility, 0% in 1997 and in 1999; risk-free interest
rate, 6.75% in 1997 and 5.0% in 1999 and no dividends during the expected term.
The Company's calculations are based on a single option award valuation
approach, and forfeitures are recognized as they occur. If the computed fair
values of the 1997 and 1999 awards had been amortized to expense over the
vesting period of the awards, the effect on pro forma net income (loss) would
have been insignificant.

11. Income Taxes

The provision for income taxes consists of the following:

<TABLE>
<CAPTION>
--------------------
At July
31,
--------------------
1997 1998
Dollars in thousands --------- ---------
<S> <C> <C>
Current:
Federal............................................... $ 13 $ 219
State................................................. 4 7
Deferred:
Federal............................................... (34) (23)
State................................................. (7) (5)
Valuation allowance................................... 41 (41)
--------- ---------
Total income tax expense................................ $ 17 $ 157
========= =========
</TABLE>

Income tax effects of deferred income tax assets are comprised of the following
future deductible amounts:

<TABLE>
<CAPTION>
--------------------
At July
31,
--------------------
1997 1998
Dollars in thousands --------- ---------
<S> <C> <C>
Allowance for warranties and sales returns................ $ 23 $ 19
Accrued compensated absences.............................. 18 27
Uniform inventory capitalization.......................... -- 23
--------- ---------
Subtotal.................................................. 41 69
Valuation allowance....................................... (41) --
--------- ---------
Net deferred income tax asset............................. $ -- $ 69
========= =========
</TABLE>

Prior to April 2, 1997, the Company had elected under Subchapter S of the
Internal Revenue Code to have its income taxed directly to its stockholders.
The 1997 provision for income taxes includes only the taxable income from April
2, 1997 through July 31, 1997. Pro forma net income and earnings per share have
been determined assuming the Company had been taxed under Subchapter C of the
Internal Revenue Code for federal and state purposes for 1997.

The following table reconciles the provision for income taxes at the U.S.
Statutory rate to that in the financial statements for 1998:

<TABLE>
<S> <C>
Income taxes at statutory rate........................................... 34.0%
State income taxes, net of federal benefit............................... 0.1
Uniform inventory capitalization......................................... 4.6
Change in valuation allowance and other.................................. (10.7)
-----
28.0%
=====
</TABLE>

F-38
<PAGE>

BCS Technologies, Inc.

Notes to Financial Statements--(Continued)

As a result of the merger, the Company has a net operating loss carryforward of
approximately $8,250,000 available to offset Georgia state income taxes. The
financial statements and disclosures do not include recognition of
approximately $495,000 of deferred income tax benefit due to the significant
uncertainty of its future realization.

12. Earnings (Loss) Per Common Share

Outstanding stock options to purchase 1,383,542, 1,364,750, 1,364,750 and
1,489,750 shares of common stock were not included in the computation of
diluted earnings (loss) per common share for the eleven months ended July 31,
1997, the year ended July 31, 1998, and the nine months ended April 30, 1998
and the period August 1, 1998 through April 12, 1999. The effect of including
the stock options would be antidilutive or the stock options were exercisable
from shares owned by existing stockholders.

A summary of the diluted weighted average number of common shares is as
follows:

<TABLE>
<CAPTION>
------------------------------------------------
Period
from
August 1,
Nine Months 1998
Eleven Months Year Ended Ended through
Ended July 31, July 31, April 30, April 12
1997 1998 1998 1999
-------------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Weighted average number of
common shares outstanding... 8,701,076 23,814,706 23,814,706 23,717,891
Dilutive effect of stock
options..................... 62,734 231,546 263,342 355,000
------------ ---------- ---------- ----------
Diluted weighted average
number of common shares
outstanding................. 8,763,810 24,046,252 24,078,048 24,072,891
============ ========== ========== ==========
</TABLE>

13. Major Customer

The Company had one major customer which accounted for 22% of revenues for the
year ended July 31, 1998, and 80% of revenues for the period August 1, 1998
through April 12, 1999.

14. Supplemental Cash Flow Information

The Company paid cash for income taxes totaling $17,000 during the year ended
July 31, 1998 and for the nine month period ended April 30, 1998. Cash totaling
$382,446 was paid for income taxes during the period August 1, 1998 through
Apri 12, 1999. No income taxes were paid during the eleven months ended July
31, 1997.

F-39
<PAGE>

Unaudited Pro Forma Consolidated Financial Information

The following pro forma consolidated statements of operations data for the year
ended July 31, 1998 and the nine month periods ended April 30, 1998 and 1999
present the unaudited pro forma operating results as if the acquisition of BCS
Technologies, Inc. had occurred as of August 1, 1997. The pro forma financial
data reflects adjustments to the historical financial statements of Cortelco
and BCS Technologies, Inc., that (1) reflect the purchase method of accounting
for the acquisition of BCS, and (2) eliminate the results of operations related
to assets and liabilities not acquired from the merger with Cortelco Systems
Puerto Rico.

The historical consolidated balance sheet at April 30, 1999 reflects the
acquisition of BCS and the merger with Cortelco Systems Puerto Rico in April
1999, therefore only pro forma offering adjustments are required to be
presented.

The pro forma, as adjusted, consolidated statement of operations data and the
pro forma balance sheet data gives effect to (1) the conversion of convertible
preferred stock into 1,434,894 shares of common stock upon the closing of this
offering, and (2) this offering and the uses of proceeds from this offering.

The pro forma financial data does not purport to represent what the company's
financial position or results of operations actually would have been had the
transactions occurred on the dates indicated, or to project the company's
financial position or results of operations at any future date or for any
future period. The following pro forma financial data should be read in
conjunction with the Company's consolidated financial statements and related
notes, BCS Technologies' financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" which is included elsewhere.

F-40
<PAGE>

Pro Forma Consolidated Balance Sheet
(Unaudited)
<TABLE>
<CAPTION>
-------------------------------------
At April 30, 1999
-------------------------------------
Actual
---------
Pro Forma
Offering
Adjustments Pro Forma
CSI (Note 3) As Adjusted
Dollars in thousands --------- ----------- -----------
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents............... $ 1,774 $ 23,800 (a) $ 20,383
(5,191)(b)
Trade accounts receivable............... 10,432 10,432
Inventories............................. 7,095 7,095
Other current assets.................... 692 692
Property and equipment, net............. 1,052 1,052
Other assets............................ 1,692 (622)(e) 1,070
Goodwill................................ 11,266 11,266
--------- --------- ----------
Total assets.......................... $ 34,003 $ 17,987 $ 51,990
========= ========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Dividends payable....................... $ 2,667 2,667
Current portion of long-term debt....... 16 16
Notes payable under revolving line-of-
credit................................. 2,552 (2,552)(b) --
Accounts payable........................ 4,221 4,221
Accrued expenses........................ 2,269 (325)(b) 1,944
Income tax payable...................... 1,352 1,352
Accounts payable to related parties..... 1,988 1,988
Payable to affiliate.................... 79 79
Long-term debt.......................... 2,314 (2,314)(b) --
Preferred stock......................... 660 (660)(c) --
Common shareholders' equity............. 15,885 23,800 (a) 39,723
660 (c)
(622)(e)
--------- --------- ---------
Total liabilities and stockholders'
equity............................... $ 34,003 $ 17,987 $ 51,990
========= ========== ==========
</TABLE>

See notes to pro forma consolidated financial statements (unaudited).

F-41
<PAGE>

Pro Forma Consolidated Statement of Operations Data

(Unaudited)

<TABLE>
<CAPTION>
----------------------------------------------------------------
Year Ended July 31, 1998
----------------------------------------------------------------
Pro Forma
Actual Pro Forma Offering
--------------- Adjustments Adjustments Pro Forma
Dollars in thousands, CSI BCS (Note 2) Pro Forma (Note 3) As Adjusted
except per share data ------- ------ ----------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net revenues............ $30,172 $6,799 $(353)(a) $36,618 $36,618
Cost of revenues........ 17,530 2,465 (322)(a) 19,673 19,673
------- ------ ----- ------- ---- -------
Gross profit........... 12,642 4,334 (31) 16,945 16,945
Operating expenses:
Selling, general and
administrative........ 9,931 3,095 304 (c) 13,233 13,233
(97)(e)
Research and
development........... 1,407 704 -- 2,111 2,111
Amortization of
goodwill.............. -- -- 565 (d) 565 565
------- ------ ----- ------- ---- -------
Total operating
expenses............ 11,338 3,799 772 15,909 15,909
------- ------ ----- ------- ---- -------
Income (loss) from
operations............. 1,304 535 (803) 1,036 1,036
Interest expense....... 826 -- (327)(f) 499 (499)(d) --
Management fee
expense, net.......... 185 -- -- 185 185
Equity in earnings of
joint venture......... (66) -- -- (66) (66)
Other expense
(income), net......... 43 (26) 478 (b) 495 495
------- ------ ----- ------- ---- -------
Income (loss) from
continuing operations
before income taxes ... 316 561 (954) (77) 499 422
Income tax expense
(benefit)............. -- 157 (157)(g) -- 143 (f) 143
------- ------ ----- ------- ---- -------
Net income (loss)...... $ 316 $ 404 $(797) $ (77) 356 $ 279
======= ====== ===== ======= ==== =======
Net income (loss) per
common share:
Basic.................. $ 0.08 $ (0.01) $ 0.02
Diluted................ $ 0.07 $ (0.01) $ 0.02
</TABLE>

See notes to pro forma consolidated financial statements (unaudited).

F-42
<PAGE>

Pro Forma Consolidated Statement of Operations Data

(Unaudited)

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------
Nine Months Ended April 30,
-------------------------------------------------------------------------------------------------------
1998 1999
----------------------------------------------------------------- -------------------------------------
Actual Pro Forma Actual
------------- -------------------------------------------------- ----------------------
Offering
Dollars in Adjustments Pre- Adjustments BCS Through Adjustments
thousands, except CSI BCS (Note 2) Offering (Note 3) As Adjusted CSI April 12, 1999 (Note 2)
per share data ------ ----- ----------- --------- ----------- ----------- ------ -------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues....... 22,182 3,642 (247)(a) 25,577 25,577 27,173 12,239 (987)(a)
Cost of revenues... 12,730 1,363 (243)(a) 13,850 13,850 15,290 4,197 (972)(a)
------ ----- --------- --------- ---- ------ ------ ------------ ---------
Gross profit...... 9,452 2,279 (4) 11,727 11,727 11,883 8,042 (15)
Operating expenses:
Selling, general,
and
administrative.... 7,663 2,256 228 (c) 10,074 10,074 8,649 2,898 207 (c)
(73)(e) (68)(e)
Research and
development....... 1,038 521 -- 1,559 1,559 1,525 823 --
Amortization of
goodwill.......... -- -- 424 (d) 424 424 28 -- 396 (d)
------ ----- --------- --------- ---- ------ ------ ------------ ---------
Total operating
expenses........ 8,701 2,777 579 12,057 12,057 10,202 3,721 535
------ ----- --------- --------- ---- ------ ------ ------------ ---------
Income (loss) from
operations......... 751 (498) (583) (330) (330) 1,681 4,321 (550)
Interest
expense........... 633 -- (239)(f) 394 (394)(d) -- 584 -- (276)(f)
Management fee
expense, net...... 148 -- -- 148 148 23 -- --
Equity in
earnings of joint
venture........... (60) (60) (60) (7)
Other expense
(income), net..... 91 (22) 359 (b) 428 428 102 (50) 359 (b)
------ ----- --------- --------- ---- ------ ------ ------------ ---------
Income (loss) from
continuing
operations
before income
taxes ............. (61) (476) (703) (1,240) 394 (846) 979 4,371 (633)
Income tax
expense
(benefit)......... -- -- -- -- -- -- 81 1,430 --
------ ----- --------- --------- ---- ------ ------ ------------ ---------
Net income
(loss)............ (61) (476) (703) (1,240) 394 (846) 898 2,941 (633)
====== ===== ========= ========= ==== ====== ====== ============ =========
Net income (loss)
per common share:
Basic............. $(0.02) $ (0.15) $(0.07) $ 0.22
Diluted........... $(0.02) $ (0.15) $(0.07) $ 0.16
<CAPTION>
Pro Forma
-----------------------------------
Offering
Dollars in Pre- Adjustments
thousands, except Offering (Note 3) As Adjusted
per share data ---------- ------------ -----------
<S> <C> <C> <C>
Net revenues....... 38,425 38,425
Cost of revenues... 18,515 18,515
---------- ------------ -----------
Gross profit...... 19,910 19,910
Operating expenses:
Selling, general,
and
administrative.... 11,686 11,686

Research and
development....... 2,348 2,348
Amortization of
goodwill.......... 424 424
---------- ------------ -----------
Total operating
expenses........ 14,458 14,458
---------- ------------ -----------
Income (loss) from
operations......... 5,452 5,452
Interest
expense........... 308 (308)(d) --
Management fee
expense, net...... 23 23
Equity in
earnings of joint
venture........... (7) (7)
Other expense
(income), net..... 411 411
---------- ------------ -----------
Income (loss) from
continuing
operations
before income
taxes ............. 4,717 308 5,025
Income tax
expense
(benefit)......... 1,511 105 (f) 1,616
---------- ------------ -----------
Net income
(loss)............ 3,206 203 3,409
========== ============ ===========
Net income (loss)
per common share:
Basic............. $ 0.39 $ 0.29
Diluted........... $ 0.33 $ 0.29
</TABLE>

See notes to pro forma consolidated financial statements (unaudited).

F-43
<PAGE>

Notes to Pro Forma Consolidated Financial Information (Unaudited)

1. Basis of Presentation

The pro forma consolidated statements of operations data for the year ended
July 31, 1998 and the nine month periods ended April 30, 1998 and 1999 present
the unaudited pro forma operating results as if the acquisition of BCS
Technologies, Inc. ("BCS") had occurred as of August 1, 1997. The pro forma
financial data reflects adjustments to the historical financial statements of
Cortelco Systems ("the Company") and BCS, that (1) reflect the purchase method
of accounting for the acquisition of BCS, and (2) eliminate the results of
operations related to assets and liabilities not acquired from the merger with
Cortelco Systems Puerto Rico.

The pro forma, as adjusted, consolidated statement of operations data and the
pro forma balance sheet data gives effect to (1) the conversion of convertible
preferred stock debt into 1,434,894 shares of common stock upon the closing of
the offering, and (2) the offering and the uses of proceeds thereof.

The pro forma financial data does not purport to represent what the Company's
financial position or results of operations actually would have been had the
transactions occurred on the dates indicated, or to project the Company's
financial position or results of operations at any future date or for any
future period. The following pro forma financial data should be read in
conjunction with Cortelco's consolidated financial statements and related
notes, BCS' financial statements and related notes and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" which is
included elsewhere.

2. Pro Forma Adjustments

(a) To reflect the elimination of revenues and cost of revenues and balances
between Cortelco Systems, Inc. and BCS.

(b) To reflect the elimination of rental income related to the building
retained by Cortelco Puerto Rico, Inc. and not acquired by the Company.

(c) To reflect the rental expense to be incurred by the Company in connection
with lease agreement negotiated by Cortelco Puerto Rico, Inc. for building
space.

(d) To reflect the goodwill amortization related to the BCS acquisition,
goodwill is amortized over a 20 year life, resulting in annual amortization of
$565,000 and nine month amortization of $424,000.

(e) To reflect the elimination of the depreciation for building improvements
not acquired from Cortelco Puerto Rico, Inc.

(f) To reflect the elimination of interest expense and amortization of deferred
financing costs related to the mortgage payable not assumed from Cortelco
Puerto Rico, Inc. Interest expense totaled $283,000 for the year ended July 31,
1998 and $206,000 and $230,000 for the nine months ended April 30, 1998 and
1999, respectively. The amortization of deferred financing costs totaled
$44,000 for the year ended July 31, 1998 and $33,000 and $46,000 for the nine
months ended April 30, 1998 and 1999, respectively.

(g) To eliminate income tax expense for the year ended July 31, 1998 as the
Company would have had a consolidated net loss on a pro forma basis.

3. Pro Forma Offering Adjustments

(a) To record the proceeds ($23.8 million) from the issuance of 2,380,000
shares of the Company's common stock, net of $2.4 million underwriting
discounts and commissions and estimated offering expenses, including accounting
and legal fees, filing and listing fees and priority expenses.

(b) To record the repayment of $4.9 million in debt and $0.3 million of related
accrued interest from offering proceeds.

F-44
<PAGE>

Notes to Pro Forma Consolidated Financial Information (Unaudited)--(continued)

(d) To record the decrease in interest expense, including the amortization of
deferred financing costs, resulting from the repayment of the subordinated note
and bank debt and the conversion of debt to common stock.

(e) To record the write-off of deferred financing costs related to the
repayment of $4.9 million of debt on the balance sheet. This expense has been
appropriately excluded from the pro forma consolidated statement of operations
but will be reflected in the Company's historical consolidated financial
statements in 1999 as an extraordinary loss on extinguishment of debt.

(f) To record the income tax effect of the above adjustments at 34%, the
Company's estimated effective tax rate.

4. Pro Forma Earnings Per Share Data

The computation of basic and diluted earnings per share were as follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------
Nine Months Ended April 30,
Year Ended ---------------------------------------------
July 31, 1998 1998 1999
---------------------- ---------------------- ---------------------
Pro Forma Pro Forma Pro Forma
Dollars in thousands, Pro Forma As Adjusted Pro Forma As Adjusted Pro Forma As Adjusted
except per share data --------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Basic earnings per
share:
Income (loss) from
continuing
operations............ $ (77) $ 279 $ (1,240) $ (846) $ 3,206 $ 3,409
Weighted average shares
outstanding--basic:
Historical shares
outstanding........... 3,918 3,918 3,910 3,910 4,159 4,159
Stock issued to acquire
BCS................... 3,970 3,970 3,970 3,970 3,708 3,708
Stock issued to pay
dividend declared..... 267 -- 267 -- 267 --
Stock issued in
offering.............. -- 2,380 -- 2,380 -- 2,380
Conversion of preferred
stock................. -- 1,435 -- 1,435 -- 1,435
--------- ----------- --------- ----------- --------- -----------
Weighted average
shares outstanding--
basic................ 8,155 11,703 8,147 11,695 8,134 11,682
<CAPTION>
--------- ----------- --------- ----------- --------- -----------
Basic earnings (loss)
per share............ $ (0.01) $ 0.02 $ (0.15) $ (0.07) $ 0.39 $ 0.29
========= =========== ========= =========== ========= ===========
Diluted earnings (loss)
per share:
Income (loss) from
continuing
operations............ $ (77) $ 279 $ (1,240) $ (846) $ 3,206 $ 3,409
Interest on 8%
convertible
subordinated debt..... -- -- -- -- 41 --
--------- ----------- --------- ----------- --------- -----------
Income (loss)
available to common
shareholders......... (77) 279 (1,240) (846) 3,247 3,409
Weighted average
shares--basic.......... 8,155 11,703 8,147 11,695 8,134 11,682
Assumed conversion of 8%
convertible
subordinated debt...... -- -- -- -- 1,435 --
Dilutive effect of stock
options................ -- 127 -- -- 175 175
--------- ----------- --------- ----------- --------- -----------
Weighted average
shares outstanding--
diluted.............. 8,155 11,830 8,147 11,695 9,744 11,857
--------- ----------- --------- ----------- --------- -----------
Diluted earnings
(loss) per share..... $ (0.01) $ 0.02 $ (0.15) $ (0.07) $ 0.33 $ 0.29
========= =========== ========= =========== ========= ===========
</TABLE>

F-45
<PAGE>

Cortelco Platforms -- Versatile By Design

<TABLE>
<S> <C>
Communications Interface Flexible bus and software architecture provide direct
links to virtually any type of communications device
and to other networked Cortelco platforms.

System Controller Our software takes advantage of a real-time operating
system and the speed and capacity of today's
microprocessors and computer memory.

External Computer Inter- Computer and telephony functions are efficiently
face integrated through standards-based interfaces to the
system controller.
</TABLE>
<PAGE>

[LOGO FOR CORTELCO SYSTEMS, INC. APPEARS HERE]

<PAGE>

Part II

Information not required in Prospectus

Item 13. Other Expenses of Issuance and Distribution.

The following table sets forth all expenses, other than the underwriting
discounts and commissions, payable by Cortelco in connection with the sale of
the common stock being registered. All the amounts shown are estimates except
for the registration fee and the NASD filing fee.

<TABLE>
<S> <C>
Registration fee................................................. $ 12,207
NASD filing fee.................................................. 4,000
Nasdaq application fee........................................... 53,750
Blue sky qualification fee and expenses.......................... 5,000
Printing and engraving expenses.................................. 225,000
Legal fees and expenses.......................................... 375,000
Accounting fees and expenses..................................... 275,000
Directors and officers' insurance................................ 153,000
Transfer agent and registrar fees................................ 750
Miscellaneous.................................................... 6,293
----------
Total............................................................ $1,110,000
</TABLE>

Item 14. Indemnification of Officers and Directors.

Under Section 145 of the Delaware General Corporation Law, we have broad powers
to indemnify our directors and officers against liabilities they may incur in
such capacities, including liabilities under the Securities Act.

Our certificate of incorporation provides for the elimination of liability for
monetary damages for breach of the directors' fiduciary duty of care to
Cortelco and its stockholders. These provisions do not eliminate the directors'
duty of care and, in appropriate circumstances, equitable remedies such as
injunctive or other forms of non-monetary relief will remain available under
Delaware law. In addition, each director will continue to be subject to
liability for breach of the director's duty of loyalty to Cortelco, for acts or
omissions not in good faith or involving intentional misconduct, for knowing
violations of law, for any transaction from which the director derived an
improper personal benefit, and for payment of dividends or approval of stock
repurchases or redemptions that are unlawful under Delaware law. The provision
does not affect a director's responsibilities under any other laws, such as the
federal securities laws or state or federal environmental laws.

We expect to enter into agreements with our directors and officers that require
us to indemnify such persons against expenses, judgments, fines, settlements
and other amounts actually and reasonably incurred (including expenses of a
derivative action) in connection with any proceeding, whether actual or
threatened, to which any such person may be made a party by reason of the fact
that such person is or was a director or officer of Cortelco or any of its
affiliated enterprises, provided such person acted in good faith and in a
manner such person reasonably believed to be in or not opposed to the best
interests of Cortelco and, with respect to any criminal proceeding, had no
reasonable cause to believe his or her conduct was unlawful. The
indemnification agreements also set forth certain procedures that will apply in
the event of a claim for indemnification thereunder.

The Underwriting Agreement filed as Exhibit 1.1 to this registration statement
provides for indemnification by the underwriters of Cortelco and its officers
and directors for certain liabilities arising under the Securities Act or
otherwise.

II-1
<PAGE>

Item 15. Recent Sales of Unregistered Securities.

Since April 1996, we have sold and issued the following unregistered
securities:

(1) In July 1997, we issued a convertible promissory note in the aggregate
principal amount of $3,000,000 to ChinaVest IV, L.P.

(2) In August 1997, we issued 95,343 shares of common stock to an investor in
exchange for an interest in the Longhai joint venture.

(3) In April 1999, we issued 3,969,680 shares of common stock to stockholders
of BCS Technologies, Inc. and assumed options covering 94,279 shares of
common stock under the BCS 1997 Incentive Plan in connection with the
acquisition of BCS. We issued 553,880 shares of common stock to Cortelco
Systems Holding Corporation in connection with the merger with Cortelco
Systems Puerto Rico.

(4) Since April 1998, we have granted incentive stock options to employees,
directors and consultants under our 1997 Equity Incentive Plan covering an
aggregate of 333,505 shares of common stock, at an average exercise price
of $3.76. No options have been exercised under the 1997 Equity Incentive
Plan.

(5) Since April 1999, we have granted incentive stock options to employees,
directors and consultants under our 1999 Equity Incentive Plan covering an
aggregate of 987,982 shares of common stock, at an average exercise price
of $9.73. No options have been exercised under the 1999 Equity Incentive
Plan.

The sales and issuances of securities in the transactions described in
paragraphs (1) through (3) were deemed to be exempt from registration under the
Securities Act by virtue of Section 4(2) and/or Regulation D promulgated under
the Securities Act. The purchasers in each case represented their intention to
acquire the securities for investment only and not with a view to the
distribution thereof. Appropriate legends are affixed to the stock certificates
issued in such transactions. Similar legends were imposed in connection with
any subsequent sales of any such securities. All recipients either received
adequate information about Cortelco or had access, through employment or other
relationships, to such information.

The sales and issuance of securities in the transaction described in paragraphs
(4) and (5) above were deemed to be exempt from registration under the
Securities Act by virtue of Rule 701 promulgated thereunder in that they were
offered and sold either pursuant to written compensatory benefit plans or
pursuant to a written contract relating to compensation, as provided by Rule
701.

II-2
<PAGE>

Item 16. Exhibits.

(a)

<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
1.1 Form of Underwriting Agreement.
3.1+ Amended and Restated Certificate of Incorporation of Cortelco as
currently in effect.
3.2+ Amended and Restated Certificate of Incorporation of Cortelco to be in
effect immediately following the closing of the offering.
3.3+ Bylaws of Cortelco as currently in effect.
3.4+ Amended and Restated Bylaws of Cortelco to be in effect immediately
following the closing of the offering.
4.1+ Reference is made to Exhibits 3.1, 3.2, 3.3 and 3.4.
4.2+ Investor Rights Agreement between Cortelco, Cortelco Systems Holding
Corporation and ChinaVest, dated as of July 31, 1997.
4.3+ Registration Rights Agreement between CMC Industries, Inc. and
Cortelco, dated as of March 15, 1999.
5.1* Opinion of Cooley Godward LLP.
10.1+ Loan and Security Agreement between Cortelco and Foothill Capital
Corporation, dated as July 31, 1997.
10.2+ Convertible Subordinated Note issued by Cortelco in favor of ChinaVest
IV, L.P., dated as of July 31, 1997.
10.3+ Promissory Note issued by Cortelco Systems Holding Corporation in
favor of Cortelco, dated as of July 31, 1997.
10.4+ Promissory Note issued by J. Michael O'Dell in favor of Cortelco,
dated as of November 11, 1997.
10.5+ Assumption Agreement between Cortelco Puerto Rico, Inc. and Cortelco
Systems Puerto Rico, Inc., dated as of April 12, 1999, and Loan and
Security Agreement between Cortelco Puerto Rico, Inc. and Foothill
Capital Corporation, dated as August 28, 1997.
10.6+ Promissory Note issued by Cortelco Systems Holding Corporation in
favor of BCS Technologies, Inc., dated as of May 28, 1999.
10.7+ Form of Indemnity Agreement to be entered into between Cortelco and
its officers and directors.
10.8+ Manufacturing Agreement between Cortelco and CMC Manufacturing, Inc.,
dated as of August 1, 1998.
10.9+ Lease Agreement between Cortelco and Willow Lake Associates, dated as
of July 24, 1989, as amended on April 6, 1998.
10.10+ Industrial Lease Agreement between BCS Technologies, Inc. and
Industrial Developments International (Georgia), L.P., dated as of
March 1, 1999.
10.11+ Lease Agreement between Cortelco Systems Puerto Rico, Inc. and
Cortelco Puerto Rico, Inc. dated as of March 1, 1999.
10.12+ Employment Agreement, dated as of April 12, 1999, by and between
Cortelco and each of David M. Fredrick and Frank Naso.
10.13+ Cortelco's 1999 Equity Incentive Plan and related documents.
10.14+ Cortelco's 1999 Employee Stock Purchase Plan and related documents.
11.1+ Computation of Net Loss Per Share.
21.1+ List of Subsidiaries of Registrant.
23.1 Consent of Deloitte & Touche LLP.
23.2 Consent of PricewaterhouseCoopers LLP.
</TABLE>

II-3
<PAGE>

<TABLE>
<C> <S>
23.3 Consent of Brock and Company, CPA's, P.C.
23.4 Consent of Cooley Godward LLP. (See Exhibit 5.1)
24.1+ Power of Attorney.
27.1+ Financial Data Schedule.
</TABLE>
- -------------------

+ Previously filed.

* To be filed by Amendment.

(b)

<TABLE>
<S> <C>
Schedule II--Valuation and Qualifying Accounts
</TABLE>

Item 17. Undertakings.

We undertake to provide to the underwriters at the closing specified in the
Underwriting Agreement certificates in such denominations and registered in
such names as required by the underwriters to permit prompt delivery to each
purchaser.

Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to directors, officers and controlling persons of Cortelco
pursuant to the foregoing provisions or otherwise, Cortelco has been advised
that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by Cortelco of expenses
incurred or paid by a director, officer or controlling person of Cortelco in
the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, Cortelco will, unless in the opinion of its counsel the matter has
been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.

We hereby undertake that: (i) for purposes of determining any liability under
the Securities Act, the information omitted from the form of prospectus filed
as part of this registration statement in reliance upon Rule 430A and contained
in a form of prospectus filed by Cortelco pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this registration
statement as of the time the Commission declared it effective, and (ii) for the
purpose of determining any liability under the Securities Act, each post-
effective amendment that contains a form of prospectus shall be deemed to be a
new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.

II-4
<PAGE>

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the Registrant has
duly caused this Amendment to Registration Statement to be signed on its behalf
by the undersigned, thereunto duly authorized, in the City of Memphis, State of
Tennessee, on 10th day of August, 1999.

Cortelco Systems, Inc.

/s/ J. Michael O'Dell
By: ____________________________________
J. Michael O'Dell
President and Chief Executive Officer

In accordance with the requirements of the Securities Act of 1933, as amended,
this Amendment to Registration Statement has been signed below by the following
persons in the capacities and on the dates stated.

<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----

<S> <C> <C>
/s/ J. Michael O'Dell President, Chief Executive August 10, 1999
______________________________________ Officer and Director
J. Michael O'Dell (Principal Executive
Officer)

/s/ Stephen N. Samp Vice President of Finance August 10, 1999
______________________________________ and Administration, Chief
Stephen N. Samp Financial Officer and
Secretary (Principal
Financial and Accounting
Officer)

* Chairman of the Board August 10, 1999
______________________________________
David S. Lee

* Director August 10, 1999
______________________________________
Stephen R. Bowling

* Director August 10, 1999
______________________________________
Robert P. Dilworth

* Director August 10, 1999
______________________________________
W. Frank King

* Director August 10, 1999
______________________________________
Jenny Hsui Theleen

</TABLE>

/s/ J. Michael O'Dell
*By: ________________________
J. Michael O'Dell
Attorney-in-fact

II-5
<PAGE>

Cortelco Systems, Inc.

Schedule II--Valuation and Qualifying Accounts

<TABLE>
- ------------------------------------------------------------------------------
<CAPTION>
Column A Column B Column D Column E
- -------- ---------- Column C ---------- ----------
Additions
---------------------
Balance at Charged to Charged to Balance
Beginning Costs and Other at End
Description of Period Expenses Accounts Deductions of Period
- ----------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
1996
Allowance for doubtful
accounts and sales
allowance $1,722,136 $1,011,283 -- $ 668,395 $2,065,024
Warranty reserve 170,373 605,957 -- 447,524 328,806
1997
Allowance for doubtful
accounts and sales
allowance 2,065,024 2,101,157 -- 1,076,419 3,089,762
Warranty reserve 328,806 481,921 -- 470,099 340,628
1998
Allowance for doubtful
accounts and sales
allowance 3,089,762 3,045 -- 1,212,927 1,879,880
Warranty reserve 340,628 231,257 -- 322,275 249,610
</TABLE>

S-1
<PAGE>

EXHIBIT INDEX

+ Previously filed.

* To be filed by Amendment.

<PAGE>

EXHIBIT 1.1

CORTELCO SYSTEMS, INC.

3,200,000 Shares of Common Stock

Underwriting Agreement

________________, 1999

J.P. Morgan Securities Inc.
Needham & Company, Inc.
A.G. Edwards & Sons, Inc.
As Representatives of several
underwriters listed in Schedule I
hereto
c/o J.P. Morgan Securities Inc.
60 Wall Street
New York, New York 10260

Ladies and Gentlemen:

Cortelco Systems, Inc., a Delaware corporation (the "Company"), proposes to
issue and sell to the several Underwriters listed in Schedule I hereto (the
"Underwriters"), for whom you are acting as representatives (the
"Representatives"), an aggregate of ________ shares and, at the election of the
Underwriters, up to ________ additional shares of common stock, par value $.001
per share (the "Stock"), of the Company, and the stockholders of the Company
named in Schedule II hereto (the "Selling Stockholders") propose to sell to the
Underwriters an aggregate of ________ shares and, at the election of the
Underwriters, up to ________ additional shares of Stock. The aggregate of [# of
shrs not incl. option shrs] shares to be sold by the Company and the Selling
Stockholders is herein called the "Underwritten Shares" and the aggregate of [#
of option shrs] additional shares to be sold by the Company and the Selling
Stockholders is herein called the "Optional Shares". The Underwritten Shares and
the Optional Shares are herein referred to as the "Shares"

The Company has prepared and filed with the Securities and Exchange
Commission (the "Commission") in accordance with the provisions of the
Securities Act of 1933, as amended, and the rules and regulations of the
Commission thereunder (collectively, the "Securities Act"), a registration
statement, including a prospectus, relating to the Shares. The registration
<PAGE>

statement as amended at the time when it shall become effective, including
information (if any) deemed to be part of the registration statement at the time
of effectiveness pursuant to Rule 430A under the Securities Act, is referred to
in this Agreement as the "Registration Statement", and the prospectus in the
form first used to confirm sales of Shares is referred to in this Agreement as
the "Prospectus". If the Company has filed an abbreviated registration statement
pursuant to Rule 462(b) under the Securities Act (the "Rule 462 Registration
Statement"), then any reference herein to the term "Registration Statement"
shall be deemed to include such Rule 462 Registration Statement.

The Company and each of the Selling Stockholders hereby agree with the
Underwriters as follows:

1. The Company and each of the Selling Stockholders agree, severally
and not jointly, to sell the Underwritten Shares to the several Underwriters as
hereinafter provided, and each Underwriter, upon the basis of the
representations and warranties herein contained, but subject to the conditions
hereinafter stated, agrees to purchase, severally and not jointly, from the
Company and each of the Selling Stockholders at a purchase price per share of
$[public offering price - gross spread] (the "Purchase Price") the number of
Underwritten Shares (to be adjusted by you so as to eliminate fractional shares)
determined by multiplying the aggregate number of Underwritten Shares to be sold
by the Company and each of the Selling Stockholders as set forth opposite their
respective names in Schedule II hereto by a fraction, the numerator of which is
the aggregate number of Underwritten Shares to be purchased by such Underwriter
as set forth opposite the name of such Underwriter in Schedule I hereto and the
denominator of which is the aggregate number of Underwritten Shares to be
purchased by all the Underwriters from the Company and all the Selling
Stockholders hereunder.

In addition, the Company and each of the Selling Stockholders, as and to
the extent indicated in Schedule II hereto, agree, severally and not jointly, to
sell the Optional Shares to the several Underwriters, and the Underwriters shall
have the option to purchase at their election up to [# of option shrs] Optional
Shares for the sole purpose of covering over-allotments in the sale of the
Underwritten Shares. Each Underwriter, upon the basis of the representations and
warranties herein contained, but subject to the conditions hereinafter stated,
shall have the option to purchase, severally and not jointly, from the Company
and each of the Selling Stockholders at the Purchase Price that portion of the
number of Optional Shares as to which such election shall have been exercised
(to be adjusted by you so as to eliminate fractional shares) determined by
multiplying the aggregate number of Optional Shares to be sold by the Company or
such Selling Stockholder to all Underwriters by a fraction the numerator of
which is the aggregate number of Underwritten Shares to be purchased by such
Underwriter as

2
<PAGE>

set forth opposite the name of such Underwriter in Schedule I hereto and the
denominator of which is the aggregate number of Underwritten Shares to be
purchased by all the Underwriters from the Company and all the Selling
Stockholders hereunder. The Optional Shares to be sold shall be allocated among
the Company and the Selling Stockholders [in proportion to the maximum number of
Optional Shares to be sold by the Company and each Selling Stockholder as set
forth in Schedule II hereto][initially to the Company and then among the Selling
Stockholders in proportion to the maximum number of Optional Shares to be sold
by each Selling Stockholder as set forth in Schedule II hereto].

The Underwriters may exercise the option to purchase the Optional Shares at
any time (but not more than once) on or before the thirtieth day following the
date of this Agreement, by written notice from the Representatives to the
Company and the Attorney-in-Fact (as defined below). Such notice shall set
forth the aggregate number of Optional Shares as to which the option is being
exercised and the date and time when the Optional Shares are to be delivered and
paid for, which may be the same date and time as the Closing Date (as
hereinafter defined) but shall not be earlier than the Closing Date nor later
than the tenth full Business Day (as hereinafter defined) after the date of such
notice (unless such time and date are postponed in accordance with the
provisions of Section 9 hereof). Any such notice shall be given at least two
Business Days prior to the date and time of delivery specified therein.

2. The Company and the Selling Stockholders understand that the
Underwriters intend (i) to make a public offering of the Shares as soon after
(A) the Registration Statement has become effective and (B) the parties hereto
have executed and delivered this Agreement, as in the judgment of the
Representatives is advisable and (ii) initially to offer the Shares upon the
terms set forth in the Prospectus.

3. Payment for the Shares shall be made by wire transfer in immediately
available funds to the account specified to the Representatives by the Company
with regard to payment to the Company and by the Attorneys-in-Fact (as defined
below), or any of them, with regard to payment to the Selling Stockholders in
the case of the Underwritten Shares, on August __, 1999, or at such other time
on the same or such other date, not later than the fifth Business Day
thereafter, as the Representatives and the Company and Attorneys-in-Fact may
agree upon in writing or, in the case of the Optional Shares, on the date and
time specified by the Representatives in the written notice of the Underwriters'
election to purchase such Optional Shares. The time and date of such payment
for the Underwritten Shares is referred to herein as the "Closing Date" and the
time and date for such payment for the Optional Shares, if other than the
Closing Date,

3
<PAGE>

is herein referred to as the "Additional Closing Date". As used herein, the term
"Business Day" means any day other than a day on which banks are permitted or
required to be closed in New York City.

Payment for the Shares to be purchased on the Closing Date or the
Additional Closing Date, as the case may be, shall be made against delivery to
the Representatives for the respective accounts of the several Underwriters of
the Shares to be purchased on such date registered in such names and in such
denominations as the Representatives shall request in writing not later than two
full Business Days prior to the Closing Date or the Additional Closing Date, as
the case may be, with any transfer taxes payable in connection with the transfer
to the Underwriters of the Shares duly paid by the Company or the Selling
Stockholders, as the case may be. The certificates for the Shares will be made
available for inspection and packaging by the Representatives at the office of
J.P. Morgan Securities Inc. set forth above not later than 1:00 P.M., New York
City time, on the Business Day prior to the Closing Date or the Additional
Closing Date, as the case may be.

4. (a) The Company represents and warrants to each Underwriter and the
Selling Stockholders that:

(i) no order preventing or suspending the use of any
preliminary prospectus has been issued by the Commission, and each
preliminary prospectus filed as part of the Registration Statement as
originally filed or as part of any amendment thereto, or filed pursuant to
Rule 424 under the Securities Act, complied when so filed in all material
respects with the Securities Act, and did not contain an untrue statement
of a material fact or omit to state a material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading; provided that
this representation and warranty shall not apply to any statements or
omissions made in reliance upon and in conformity with information relating
to any Underwriter furnished to the Company in writing by such Underwriter
through the Representatives expressly for use therein;

(ii) no stop order suspending the effectiveness of the
Registration Statement has been issued and no proceeding for that purpose
has been instituted or, to the knowledge of the Company, threatened by the
Commission; and the Registration Statement and Prospectus (as amended or
supplemented if the Company shall have furnished any amendments or
supplements thereto) comply, or will comply, as the case may be, in all
material respects with the Securities Act and do not and will not, as of
the applicable effective date as to the Registration Statement and any

4
<PAGE>

amendment thereto and as of the date of the Prospectus and any amendment or
supplement thereto, contain any untrue statement of a material fact or omit
to state any material fact required to be stated therein or necessary to
make the statements therein not misleading, and the Prospectus, as amended
or supplemented, if applicable, at the Closing Date or Additional Closing
Date, as the case may be, will not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the
statements therein, in light of the circumstances under which they were
made, not misleading; except that the foregoing representations and
warranties shall not apply to statements or omissions in the Registration
Statement or the Prospectus made in reliance upon and in conformity with
information relating to any Underwriter furnished to the Company in writing
by such Underwriter through the Representatives expressly for use therein;

(iii) (a) the financial statements of the Company, and the
related notes thereto, included in the Registration Statement and the
Prospectus present fairly the consolidated financial position of the
Company and its consolidated subsidiaries as of the dates indicated and the
results of their operations and changes in their consolidated cash flows
for the periods specified; said financial statements have been prepared in
conformity with generally accepted accounting principles applied on a
consistent basis, and the supporting schedules included in the Registration
Statement present fairly the information required to be stated therein; and
the pro forma financial information, and the related notes thereto,
included in the Registration Statement and the Prospectus has been prepared
in accordance with the applicable requirements of the Securities Act and is
based upon good faith estimates and assumptions believed by the Company to
be reasonable; and

(b) the financial statements of BCS Technologies, Inc.
("BCS") and the related notes thereto, included in the Registration
Statement and the Prospectus present fairly the consolidated financial
position of BCS as of the dates indicated and the results of the operations
of BCS and changes in the consolidated cash flows of BCS for the periods
specified; said finan cial statements have been prepared in conformity with
generally accepted accounting principles applied on a consistent basis, and
the supporting schedules included in the Registration Statement present
fairly the information required to be stated therein; and the pro forma
financial information, and the related notes thereto, included in the
Registration Statement and the Prospectus has been prepared in accordance
with the applicable requirements of the Securities Act and is

5
<PAGE>

based upon good faith estimates and assumptions believed by the Company to
be reasonable;

(iv) since the respective dates as of which information is given
in the Registration Statement and the Prospectus, there has not been any
change in the capital stock or long-term debt of the Company or any of its
subsidiaries, or any material adverse change, or any development involving
a prospective material adverse change, in or affecting the general affairs,
business, management, financial position, stockholders' equity or results
of operations of the Company and its subsidiaries, taken as a whole,
otherwise than as set forth or contemplated in the Prospectus; and except
as set forth or contemplated in the Prospectus neither the Company nor any
of its subsidiaries has entered into any transaction or agreement (whether
or not in the ordinary course of business) material to the Company and its
subsidiaries taken as a whole;

(v) the Company has been duly incorporated and is validly
existing as a corporation in good standing under the laws of its
jurisdiction of incorporation, with power and authority (corporate and
other) to own its properties and conduct its business as described in the
Prospectus, and has been duly qualified as a foreign corporation for the
transaction of business and is in good standing under the laws of each
other jurisdiction in which it owns or leases properties, or conducts any
business, so as to require such qualification, other than where the failure
to be so qualified or in good standing would not have a material adverse
effect on the Company and its subsidiaries, taken as a whole;

(vi) each of the Company's subsidiaries has been duly
incorporated and is validly existing as a corporation under the laws of its
jurisdiction of incorporation, with power and authority (corporate and
other) to own its properties and conduct its business as described in the
Prospectus, and has been duly qualified as a foreign corporation for the
transaction of business and is in good standing under the laws of each
jurisdiction in which it owns or leases properties, or conducts any
business, so as to require such qualification, other than where the failure
to be so qualified or in good standing would not have a material adverse
effect on the Company and its subsidiaries taken as a whole; and all the
outstanding shares of capital stock of each subsidiary of the Company have
been duly authorized and validly issued, are fully-paid and non-assessable,
and (except, in the case of foreign subsidiaries, for directors' qualifying
shares, and except as described in the Prospectus) are owned by the
Company, directly or indirectly, free and clear of all liens, encumbrances,
security interests and claims;

6
<PAGE>

(vii) this Agreement has been duly authorized, executed and
delivered by the Company;

(viii) the Company has an authorized capitalization as set forth
in the Prospectus and such authorized capital stock conforms as to legal
matters to the description thereof set forth in the Prospectus, and all of
the outstanding shares of capital stock of the Company (including the
Shares to be sold by the Selling Stockholders) have been duly authorized
and validly issued, are fully-paid and non-assessable and are not subject
to any pre-emptive or similar rights; and, except as described in or
expressly contemplated by the Prospectus, there are no outstanding rights
(including, without limitation, pre-emptive rights), warrants or options to
acquire, or instruments convertible into or exchangeable for, any shares of
capital stock or other equity interest in the Company or any of its
subsidiaries, or any contract, commitment, agreement, understanding or
arrangement of any kind relating to the issuance of any capital stock of
the Company or any such subsidiary, any such convertible or exchangeable
securities or any such rights, warrants or options;

(ix) the Shares to be issued and sold by the Company hereunder
have been duly authorized and, when issued and delivered to and paid for by
the Underwriters in accordance with the terms of this Agreement, will be
duly issued and will be fully paid and non-assessable and will conform to
the descriptions thereof in the Prospectus; and the issuance of the Shares
is not subject to any preemptive or similar rights;

(x) neither the Company nor any of its subsidiaries is, or with
the giving of notice or lapse of time or both would be, in violation of or
in default under, its Certificate of Incorporation or By-Laws or any
indenture, mortgage, deed of trust, loan agreement or other agreement or
instrument to which the Company or any of its subsidiaries is a party or by
which it or any of them or any of their respective properties is bound,
except for violations and defaults which individually and in the aggregate
are not material to the Company and its subsidiaries taken as a whole; the
issue and sale of the Shares to be sold by the Company hereunder and the
performance by the Company of its obligations under this Agreement and the
consummation of the transactions contemplated herein will not conflict with
or result in a breach of any of the terms or provisions of, or constitute a
default under, any indenture, mortgage, deed of trust, loan agreement or
other agreement or instrument to which the Company or any of its
subsidiaries is a party or by which the Company or any of its subsidiaries
is bound or to which any of the property or assets of the Company or any

7
<PAGE>

of its subsidiaries is subject, nor will any such action result in any
violation of the provisions of the Certificate of Incorporation or the By-
Laws of the Company or any applicable law or statute or any order, rule or
regulation of any court or governmental agency or body having jurisdiction
over the Company, its subsidiaries or any of their respective properties;
and no consent, approval, authorization, order, license, registration or
qualification of or with any such court or governmental agency or body is
required for the issue and sale of the Shares to be sold by the Company
hereunder or the consummation by the Company of the transactions
contemplated by this Agreement, except such consents, approvals,
authorizations, orders, licenses, registrations or qualifications as have
been obtained under the Securities Act and as may be required under state
securities or Blue Sky Laws in connection with the purchase and
distribution of the Shares by the Underwriters;

(xi) other than as set forth or contemplated in the Prospectus,
there are no legal or governmental investigations, actions, suits or
proceedings pending or, to the knowledge of the Company, threatened against
or affecting the Company or any of its subsidiaries or any of their
respective properties or to which the Company or any of its subsidiaries is
or may be a party or to which any property of the Company or any of its
subsidiaries is or may be the subject which, if determined adversely to the
Company or any of its subsidiaries, could individually or in the aggregate
have, or reasonably be expected to have, a material adverse effect on the
general affairs, business, management, financial position, stockholders'
equity or results of operations of the Company and its subsidiaries, taken
as a whole, and, to the best of the Company's knowledge, no such
proceedings are threatened or contemplated by governmental authorities or
threatened by others; and there are no statutes, regulations, contracts or
other documents that are required to be described in the Registration
Statement or Prospectus or to be filed as exhibits to the Registration
Statement that are not described or filed as required;

(xii) the Company and its subsidiaries have good and marketable
title in fee simple to all items of real property and good and marketable
title to all personal property owned by them, in each case free and clear
of all liens, encumbrances and defects except such as are described or
referred to in the Prospectus or such as do not materially affect the value
of such property and do not interfere with the use made or proposed to be
made of such property by the Company and its subsidiaries; and any real
property and buildings held under lease by the Company and its subsidiaries
are held by them under valid, existing and enforceable leases with such
exceptions as are not material and do not interfere with the use

8
<PAGE>

made or proposed to be made of such property and buildings by the Company
or its subsidiaries;

(xiii) no relationship, direct or indirect, exists between or among
the Company or any or its subsidiaries on the one hand, and the directors,
officers, stockholders, customers or suppliers of the Company or any of its
subsidiaries on the other hand, which is required by the Securities Act to
be described in the Registration Statement and the Prospectus which is not
so described;

(xiv) no person has the right to require the Company to register
any securities for offering and sale under the Securities Act by reason of
the filing of the Registration Statement with the Commission or the issue
and sale of the Shares to be sold by the Company hereunder or, to the best
knowledge of the Company, the sale of the Shares to be sold by the Selling
Stockholders hereunder;

(xv) the Company is not and, after giving effect to the offering
and sale of the Shares, will not be an "investment company" or an entity
"controlled" by an "investment company", as such terms are defined in the
Investment Company Act of 1940, as amended (the "Investment Company Act");

(xvi) Deloitte & Touche LLP, who have certified certain financial
statements of the Company and its subsidiaries, PricewaterhouseCoopers LLP,
who have certified certain financial statements of Cortelco Systems Puerto
Rico and Brock and Company, CPA's, P.C., who have certified certain
financial statements of BCS, are each independent public accountants as
required by the Securities Act;

(xvii) the Company and its subsidiaries have filed all federal,
state, local and foreign tax returns which have been required to be filed
and have paid all taxes shown thereon and all assessments received by them
or any of them to the extent that such taxes have become due and are not
being contested in good faith; and, except as disclosed in the Registration
Statement and the Prospectus, there is no tax deficiency which has been or
might reasonably be expected to be asserted or threatened against the
Company or any subsidiary;

(xviii) the Company has not taken nor will it take, directly or
indirectly, any action designed to, or that might be reasonably expected
to, cause or result in stabilization or manipulation of the price of the
Stock;

9
<PAGE>

(xix) each of the Company and its subsidiaries owns, possesses or
has obtained all licenses, permits, certificates, consents, orders,
approvals and other authorizations from, and has made all declarations and
filings with, all federal, state, local and other governmental authorities
(including foreign regulatory agencies), all self-regulatory organizations
and all courts and other tribunals, domestic or foreign, necessary to own
or lease, as the case may be, and to operate its properties and to carry on
its business as conducted as of the date hereof, except where the failure
to do so would not have a material adverse effect on the Company and its
subsidiaries, taken as a whole, and neither the Company nor any such
subsidiary has received any actual notice of any proceeding relating to
revocation or modification of any such license, permit, certificate,
consent, order, approval or other authorization, except as described in the
Registration Statement and the Prospectus; and each of the Company and its
subsidiaries is in compliance with all laws and regulations relating to the
conduct of its business as conducted as of the date hereof;

(xx) there are no existing or, to the best knowledge of the
Company, threatened labor disputes with the employees of the Company or any
of its subsidiaries which are likely to have a material adverse effect on
the Company and its subsidiaries taken as a whole;

(xxi) the Company and its subsidiaries (A) are in compliance with
any and all applicable foreign, federal, state and local laws and
regulations relating to the protection of human health and safety, the
environment or hazardous or toxic substances or wastes, pollutants or
contaminants ("Environmental Laws"), (B) have received all permits,
licenses or other approvals required of them under applicable Environmental
Laws to conduct their respective businesses and (C) are in compliance with
all terms and conditions of any such permit, license or approval, except
where such noncompliance with Environmental Laws, failure to receive
required permits, licenses or other approvals or failure to comply with the
terms and conditions of such permits, licenses or approvals would not,
singly or in the aggregate, have a material adverse effect on the Company
and its subsidiaries, taken as a whole;

(xxii) each employee benefit plan, within the meaning of Section
3(3) of the Employee Retirement Income Security Act of 1974, as amended,
("ERISA") that is maintained, administered or contributed to by the Company
or any of its affiliates for employees or former employees of the Company
and its affiliates has been maintained in compliance with its terms and the
requirements of any applicable statutes, orders, rules and regulations,
including but not limited to ERISA and the Internal Revenue

10
<PAGE>

Code of 1986, as amended, ("Code"). No prohibited transaction, within the
meaning of Section 406 of ERISA or Section 4975 of the Code has occurred
with respect to any such plan excluding transactions effected pursuant to a
statutory or administrative exemption. For each such plan which is subject
to the funding rules of Section 412 of the Code or Section 302 of ERISA no
"accumulated funding deficiency" as defined in Section 412 of the Code has
been incurred, whether or not waived, and the fair market value of the
assets of each such plan (excluding for these purposes accrued but unpaid
contributions) exceeded the present value of all benefits accrued under
such plan determined using reasonable actuarial assumptions;

(xxiii) other than as set forth or contemplated in the Prospectus,
the Company owns or possesses adequate licenses or other rights to use all
patents, copyrights, trademarks, trade dress, service marks, trade names,
technology, trade secrets and know-how (the "Intellectual Property")
necessary to conduct its business in the manner described in the Prospectus
and the Company has not received any notice of infringement or conflict
with (and the Company is not aware of any infringement or conflict with)
asserted rights of others with respect to any patents, copyrights,
trademarks, trade dress, service marks, trade names, technology, trade
secrets or know-how which could result in any material adverse effect upon
the Company; and the discoveries, inventions, products or processes of the
Company necessary to conduct its business in the manner described in the
Prospectus do not, to the best knowledge of the Company, infringe or
conflict with any right or patent of any third party, or any discovery,
invention, product or process which is the subject of a patent application
filed by any third party, known to the Company which could have a material
adverse effect on the Company;

(xxiv) the Company maintains a system of internal accounting
controls sufficient to provide reasonable assurance that (A) transactions
are executed in accordance with management's general or specific
authorizations; (B) transactions are recorded as necessary to permit
preparation of financial statements in conformity with generally accepted
accounting principles and to maintain asset accountability; (C) access to
assets is permitted only in accordance with management's general or
specific authorization; and (D) the recorded accountability for assets is
compared with the existing assets at reasonable intervals and appropriate
action is taken with respect to any differences;

11
<PAGE>

(xxv) as of the date the Registration Statement becomes effective,
the Stock will be authorized for listing on the Nasdaq National Market (as
herein defined) upon official notice of issuance; and

(xxvi) the Company has reviewed its operations and any third
parties with which the Company has a material relationship to evaluate the
extent to which the business or operations of the Company will be affected
by the Year 2000 Problem. As a result of such review, the Company has no
reason to believe, and does not believe, that the Year 2000 Problem will
have a material adverse effect on the general affairs, business,
management, financial position, stockholders' equity or results of
operations of the Company and its subsidiaries taken as a whole or result
in any material loss or interference with the Company's business or
operations. The "Year 2000 Problem" as used herein means any significant
risk that computer hardware or software used in the receipt, transmission,
processing, manipulation, storage, retrieval, retransmission or other
utilization of data or in the operation of mechanical or electrical systems
of any kind will not, in the case of dates or time periods occurring after
December 31, 1999, function at least as effectively as in the case of dates
or time periods occurring prior to January 1, 2000.

(b) Each of the Selling Stockholders severally represents and warrants
to, and agrees with, each of the Underwriters and the Company that:

(i) all consents, approvals, authorizations and orders necessary
for the execution and delivery by such Selling Stockholder of this
Agreement and the Power of Attorney (the "Power of Attorney") and the
Custody Agreement (the "Custody Agreement") hereinafter referred to, and
for the sale and delivery of the Shares to be sold by such Selling
Stockholder hereunder, have been obtained; such Selling Stockholder has
full right, power and authority to enter into this Agreement, the Power of
Attorney and the Custody Agreement and to sell, assign, transfer and
deliver the Shares to be sold by such Selling Stockholder hereunder; and
this Agreement, the Power of Attorney and the Custody Agreement have each
been duly authorized, executed and delivered by such Selling Stockholder;

(ii) the sale of the Shares to be sold by such Selling
Stockholder hereunder and the compliance by such Selling Stockholder with
all of the provisions of this Agreement, the Power of Attorney and the
Custody Agreement and the consummation of the transactions herein and
therein contemplated will not conflict with or result in a breach or
violation of any of the terms or provisions of, or constitute a default
under, any statute, any indenture, mortgage, deed of trust, loan agreement
or other agreement or

12
<PAGE>

instrument to which such Selling Stockholder is a party or by which such
Selling Stockholder is bound or to which any of the property or assets of
such Selling Stockholder is subject, nor will such action result in any
violation of the provisions of the Certificate of Incorporation or By-laws
of such Selling Stockholder if such Selling Stockholder is a corporation,
the Partnership Agreement of such Selling Stockholder if such Selling
Stockholder is a partnership, or any statute or any order, rule or
regulation of any court or governmental agency or body having jurisdiction
over such Selling Stockholder or the property of such Selling Stockholder;

(iii) such Selling Stockholder has good and valid title to the
Shares to be sold at the Closing Date or Additional Closing Date, as the
case may be, by such Selling Stockholder hereunder, free and clear of all
liens, encumbrances, equities or adverse claims; such Selling Stockholder
will have, immediately prior to the Closing Date or Additional Closing
Date, as the case may be, good and valid title to the Shares to be sold at
the Closing Date or Additional Closing Date, as the case may be, by such
Selling Stockholder, free and clear of all liens, encumbrances, equities or
adverse claims; and, upon delivery of the certificates representing such
Shares and payment therefor pursuant hereto, good and valid title to such
Shares, free and clear of all liens, encumbrances, equities or adverse
claims, will pass to the several Underwriters assuming the Underwriters
purchase the Shares in good faith and without notice of adverse claim
within the meaning of the Uniform Commercial Code;

(iv) such Selling Stockholder has not taken and will not take,
directly or indirectly, any action which is designed to or which has
constituted or which might reasonably be expected to cause or result in
stabilization or manipulation of the price of any security of the Company
to facilitate the sale or resale of the Shares; and

(v) all information furnished by the Selling Stockholder for use
in the Registration Statement and Prospectus is, and will be, as of the
Closing Date or Additional Closing Date, as the case may be, true, correct
and complete, and does not, and on the Closing Date or Additional Closing
Date, as the case may be, will not, contain any untrue statements or
material fact or omit to state any material fact necessary to make such
information not misleading

Each of the Selling Stockholders represents and warrants that certificates
in negotiable form representing all of the Shares to be sold by such Selling
Stockholder hereunder have been placed in custody under a Custody Agreement
relating to such Shares, in the form heretofore furnished to you, duly executed
and

13
<PAGE>

delivered by such Selling Stockholder to American Securities Transfer and Trust,
as custodian (the "Custodian"), and that such Selling Stockholder has duly
executed and delivered Powers of Attorney, in the form heretofore furnished to
you, appointing the person or persons indicated in the Custody Agreement, and
each of them, as such Selling Stockholder's Attorneys-in-fact (the
"Attorneys-in-Fact" or any one of them the "Attorney-in Fact") with authority to
execute and deliver this Agreement on behalf of such Selling Stockholder, to
determine the purchase price to be paid by the Underwriters to the Selling
Stockholders as provided herein, to authorize the delivery of the Shares to be
sold by such Selling Stockholder hereunder and otherwise to act on behalf of
such Selling Stockholder in connection with the transactions contemplated by
this Agreement and the Custody Agreement.

Each of the Selling Stockholders specifically agrees that the Shares
represented by the certificates held in custody for such Selling Stockholder
under the Custody Agreement are subject to the interests of the Underwriters
hereunder, and that the arrangements made by such Selling Stockholder for such
custody, and the appointment by such Selling Stockholder of the Attorneys-in-
Fact by the Power of Attorney, are to that extent irrevocable. Each of the
Selling Stockholders specifically agrees that the obligations of such Selling
Stockholder hereunder shall not be terminated by operation of law, whether by
the death or incapacity of any individual Selling Stockholder, or, in the case
of an estate or trust, by the death or incapacity of any executor or trustee or
the termination of such estate or trust, or in the case of a partnership or
corporation, by the dissolution of such partnership or corporation, or by the
occurrence of any other event. If any individual Selling Stockholder or any such
executor or trustee should die or become incapacitated, or if any such estate or
trust should be terminated, or if any such partnership or corporation should be
dissolved, or if any other such event should occur, before the delivery of the
Shares hereunder, certificates representing such Shares shall be delivered by or
on behalf of such Selling Stockholder in accordance with the terms and
conditions of this Agreement and the Custody Agreement, and actions taken by the
Selling Stockholder pursuant to the Custody Agreement and by the Attorneys-in-
Fact pursuant to the Powers of Attorney shall be as valid as if such death,
incapacity, termination, dissolution or other event had not occurred, regardless
of whether or not the Custodian, the Attorneys-in-Fact, or any of them, shall
have received notice of such death, incapacity, termination, dissolution or
other event.

5. (a) The Company covenants and agrees with each of the several
Underwriters as follows:

(i) to use its best efforts to cause the Registration Statement
to become effective at the earliest possible time and, if required, to
file the

14
<PAGE>

final Prospectus with the Commission within the time periods specified by
Rule 424(b) and Rule 430A under the Securities Act and to furnish copies of
the Prospectus to the Underwriters in New York City prior to 10:00 a.m.,
New York City time, on the Business Day next succeeding the date of this
Agreement in such quantities as the Representatives may reasonably request;

(ii) to deliver, at the expense of the Company, to the
Representatives four signed copies of the Registration Statement (as
originally filed) and each amendment thereto, in each case including
exhibits, and to each other Underwriter a conformed copy of the
Registration Statement (as originally filed) and each amendment thereto, in
each case without exhibits, and, during the period mentioned in Section
5(a)(v) below, to each of the Underwriters as many copies of the Prospectus
(including all amendments and supplements thereto) as the Representatives
may reasonably request;

(iii) before filing any amendment or supplement to the Registration
Statement or the Prospectus, whether before or after the time the
Registration Statement becomes effective, to furnish to the Representatives
a copy of the proposed amendment or supplement for review and not to file
any such proposed amendment or supplement to which the Representatives
reasonably object;

(iv) to advise the Representatives promptly, and to confirm such
advice in writing (A) when the Registration Statement has become effective,
(B) when any amendment to the Registration Statement has been filed or
becomes effective, (C) when any supplement to the Prospectus or any amended
Prospectus has been filed and to furnish the Representatives with copies
thereof, (D) of any request by the Commission for any amendment to the
Registration Statement or any amendment or supplement to the Prospectus or
for any additional information, (E) of the issuance by the Commission of
any stop order suspending the effectiveness of the Registration Statement
or of any order preventing or suspending the use of any preliminary
prospectus or the Prospectus or the initiation or threatening of any
proceeding for that purpose, (F) of the occurrence of any event, within the
period referenced in Section 5(a)(v) below, as a result of which the
Prospectus as then amended or supplemented would include an untrue
statement of a material fact or omit to state any material fact necessary
in order to make the statements therein, in the light of the circumstances
when the Prospectus is delivered to a purchaser, not misleading, and (G) of
the receipt by the Company of any notification with respect to any
suspension of the qualification of the

15
<PAGE>

Shares for offer and sale in any jurisdiction or the initiation or
threatening of any proceeding for such purpose; and to use its best efforts
to prevent the issuance of any such stop order, or of any order preventing
or suspending the use of any preliminary prospectus or the Prospectus, or
of any order suspending any such qualification of the shares, or
notification of any such order thereof and, if issued, to obtain as soon as
possible the withdrawal thereof;

(v) if, during such period of time after the first date of the
public offering of the Shares as in the opinion of counsel for the
Underwriters a prospectus relating to the Shares is required by law to be
delivered in connection with sales by the Underwriters or any dealer, any
event shall occur as a result of which it is necessary to amend or
supplement the Prospectus in order to make the statements therein, in light
of the circumstances when the Prospectus is delivered to a purchaser, not
misleading, or if it is necessary to amend or supplement the Prospectus to
comply with law, forthwith to prepare and furnish, at the expense of the
Company, to the Underwriters and to the dealers (whose names and addresses
the Representatives will furnish to the Company) to which Shares may have
been sold by the Representatives on behalf of the Underwriters and to any
other dealers upon request, such amendments or supplements to the
Prospectus as may be necessary so that the statements in the Prospectus as
so amended or supplemented will not, in the light of the circumstances when
the Prospectus is delivered to a purchaser, be misleading or so that the
Prospectus will comply with law;

(vi) to endeavor to qualify the Shares for offer and sale under
the securities or Blue Sky laws of such jurisdictions as the
Representatives shall reasonably request and to continue such qualification
in effect so long as reasonably required for distribution of the Shares;
provided that the Company shall not be required to file a general consent
to service of process in any jurisdiction;

(vii) to make generally available to its security holders and to
the Representatives as soon as practicable an earnings statement covering a
period of at least twelve months beginning with the first fiscal quarter of
the Company occurring after the effective date of the Registration
Statement, which shall satisfy the provisions of Section 11(a) of the
Securities Act and Rule 158 of the Commission promulgated thereunder;

(viii) for a period of five years after the date of this Agreement,
to furnish to the Representatives copies of all reports or other
communications (financial or other) furnished to holders of the Shares,

16
<PAGE>

and copies of any reports and financial statements furnished to or filed
with the Commission or any national securities exchange;

(ix) for a period of 180 days after the date of the initial public
offering of the Shares not to (A) offer, pledge, announce the intention to
sell, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant
to purchase or otherwise transfer or dispose of, directly or indirectly,
any shares of Stock or any securities convertible into or exercisable or
exchangeable for Stock or (B) enter into any swap or other agreement that
transfers, in whole or in part, any of the economic consequences of
ownership of the Stock, whether any such transaction described in clause
(A) or (B) above is to be settled by delivery of Stock or such other
securities, in cash or otherwise without the prior written consent of J.P.
Morgan Securities Inc., other than the Shares to be sold by the Company
hereunder and any shares of Stock of the Company issued upon the exercise
of options granted under existing employee stock option plans;

(x) to use the net proceeds received by the Company from the sale
of the Shares by the Company pursuant to this Agreement in the manner
specified in the Prospectus under caption "Use of Proceeds";

(xi) to use its best efforts to list for quotation the Shares on
the National Association of Securities Dealers Automated Quotations
National Market (the "Nasdaq National Market");

(xii) whether or not the transactions contemplated in this Agreement
are consummated or this Agreement is terminated, to pay or cause to be paid
all costs and expenses incident to the performance of its obligations
hereunder, including without limiting the generality of the foregoing, all
costs and expenses (A) incident to the preparation, reregistration,
transfer, execution and delivery of the Shares, (B) incident to the
preparation, printing and filing under the Securities Act of the
Registration Statement, the Prospectus and any preliminary prospectus
(including in each case all exhibits, amendments and supplements thereto),
(C) incurred in connection with the registration or qualification of the
Shares under the laws of such jurisdictions as the Representatives may
designate (including fees of counsel for the Underwriters and its
disbursements), (D) in connection with the listing of the Shares on the
Nasdaq National Market, (E) related to the filing with, and clearance of
the offering by, the National Association of Securities Dealers, Inc., (F)
in connection with the printing (including word processing and duplication
costs) and delivery of this Agreement, the Preliminary and Supplemental

17
<PAGE>

Blue Sky Memoranda and the furnishing to the Underwriters and dealers of
copies of the Registration Statement and the Prospectus, including mailing
and shipping, as herein provided, (G) any expenses incurred by the Company
in connection with a "road show" presentation to potential investors, (H)
the cost of preparing stock certificates and (I) the cost and charges of
any transfer agent and any registrar.

(b) Each of the Selling Stockholders covenants and agrees with each of
the several Underwriters as follows:

(i) for a period of 180 days after the date of the initial public
offering of the Shares not to (A) offer, pledge, announce the intention to
sell, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant
to purchase or otherwise transfer or dispose of, directly or indirectly,
any shares of Stock or any securities convertible into or exercisable or
exchangeable for Stock or (B) enter into any swap or other agreement that
transfers, in whole or in part, any of the economic consequences of
ownership of the Stock, whether any such transaction described in clause
(A) or (B) above is to be settled by delivery of Stock or such other
securities, in cash or otherwise or (C) make any demand for or exercise any
right with respect to the registration of any shares of Stock or any
security convertible into or exercisable or exchangeable for Stock without
the prior written consent of J.P. Morgan Securities, Inc., in each case
other than the Shares to be sold by such Selling Stockholder hereunder; and

(ii) to deliver to the Representatives prior to or at the Closing
Date a properly completed and executed United States Treasury Department
Form W-9 (or other applicable form or statement specified by the Treasury
Department regulations in lieu thereof) in order to facilitate the
Underwriters' documentation of their compliance with the reporting and
withholding provisions of the Tax Equity and Fiscal Responsibility Act of
1982 with respect to the transactions herein contemplated.

6. The several obligations of the Underwriters hereunder to purchase
the Shares on the Closing Date or the Additional Closing Date, as the case may
be, are subject to the performance by the Company and each of the Selling
Stockholders of their respective obligations hereunder and to the following
additional conditions:

(a) the Registration Statement shall have become effective (or if
a post-effective amendment is required to be filed under the Securities
Act, such post-effective amendment shall have become effective) not later
than

18
<PAGE>

5:00 P.M., New York City time, on the date hereof; and no stop order
suspending the effectiveness of the Registration Statement or any post-
effective amendment shall be in effect, and no proceedings for such purpose
shall be pending before or threatened by the Commission; the Prospectus
shall have been filed with the Commission pursuant to Rule 424(b) within
the applicable time period prescribed for such filing by the rules and
regulations under the Securities Act and in accordance with Section 5(a)(i)
hereof; and all requests for additional information shall have been
complied with to the satisfaction of the Representatives;

(b) the respective representations and warranties of the Company
and the Selling Stockholders contained herein are true and correct on and
as of the Closing Date or the Additional Closing Date, as the case may be,
as if made on and as of the Closing Date or the Additional Closing Date, as
the case may be, and each of the Company and the Selling Stockholders shall
have complied with all agreements and all conditions on its part to be
performed or satisfied hereunder at or prior to the Closing Date or the
Additional Closing Date, as the case may be;

(c) subsequent to the execution and delivery of this Agreement and
prior to the Closing Date or the Additional Closing Date, as the case may
be, there shall not have occurred any downgrading, nor shall any notice
have been given of (i) any downgrading, (ii) any intended or potential
downgrading or (iii) any review or possible change that does not indicate
an improvement, in the rating accorded any securities of or guaranteed by
the Company by any "nationally recognized statistical rating organization",
as such term is defined for purposes of Rule 436(g)(2) under the Securities
Act;

(d) since the respective dates as of which information is given in
the Prospectus there shall not have been any change in the capital stock or
long-term debt of the Company or any of its subsidiaries or any material
adverse change, or any development involving a prospective material adverse
change, in or affecting the general affairs, business, prospects,
management, financial position, stockholders' equity or results of
operations of the Company and its subsidiaries, taken as a whole, otherwise
than as set forth or contemplated in the Prospectus, the effect of which in
the judgment of the Representatives makes it impracticable or inadvisable
to proceed with the public offering or the delivery of the Shares on the
Closing Date or the Additional Closing Date, as the case may be, on the
terms and in the manner contemplated in the Prospectus; and neither the
Company nor any of its subsidiaries has sustained since the date of the
latest audited financial statements included in the Prospectus

19
<PAGE>

any material loss or interference with its business from fire, explosion,
flood or other calamity, whether or not covered by insurance, or from any
labor dispute or court or governmental action, order or decree, otherwise
than as set forth or contemplated in the Prospectus;

(e) the Representatives shall have received on and as of the
Closing Date or the Additional Closing Date, as the case may be, (i) a
certificate of an executive officer of the Company, with specific knowledge
about the Company's financial matters, satisfactory to the Representatives
to the effect set forth in Sections 6(a), 6(b), 6(c) and 6(d) (with respect
to the respective representations, warranties, agreements and conditions of
the Company) and to the further effect that there has not occurred any
material adverse change, or any development involving a prospective
material adverse change, in or affecting the general affairs, business,
prospects, management, financial position, stockholders' equity or results
of operations of the Company and its subsidiaries taken as a whole from
that set forth or contemplated in the Registration Statement and (ii) a
certificate of the Selling Stockholders, satisfactory to the
Representatives to the effect set forth in Section 6(b) (with respect to
the respective representations, warranties, agreements and conditions of
the Selling Stockholders);

(f) Baker, Donelson, Bearman & Caldwell, a professional
corporation, as counsel for the Company, shall have furnished to the
Representatives their written opinion, dated the Closing Date or the
Additional Closing Date, as the case may be, in form and substance
satisfactory to the Representatives, to the effect that:

(i) the Company has been duly incorporated and is validly
existing as a corporation in good standing under the laws of its
jurisdiction of incorporation, with power and authority (corporate and
other) to own its properties and conduct its business as described in
the Prospectus;

(ii) the Company has been duly qualified as a foreign
corporation for the transaction of business and is in good standing
under the laws of each other jurisdiction in which it owns or leases
properties, or conducts any business, so as to require such
qualification, other than where the failure to be so qualified or in
good standing would not have a material adverse effect on the Company
and its subsidiaries taken as a whole;

(iii) each of the Company's subsidiaries has been duly
incorporated and is validly existing as a corporation under the laws

20
<PAGE>

of its jurisdiction of incorporation with power and authority
(corporate and other) to own its properties and conduct its business
as described in the Prospectus and has been duly qualified as a
foreign corporation for the transaction of business and is in good
standing under the laws of each other jurisdiction in which it owns or
leases properties, or conducts any business, so as to require such
qualification, other than where the failure to be so qualified and in
good standing would not have a material adverse effect on the Company
and its subsidiaries taken as a whole; and all of the outstanding
shares of capital stock of each subsidiary have been duly and validly
authorized and issued, are fully paid and non-assessable, and (except,
in the case of foreign subsidiaries, for directors' qualifying shares,
and except as described in the Prospectus) are owned of record by the
Company;

(iv) other than as set forth or contemplated in the
Prospectus, the Company has not received any notice of legal or
governmental investigations, actions, suits or proceedings pending or,
to the best of such counsel's knowledge, there are no legal or
governmental investigations, actions, suits or proceedings threatened
against or affecting the Company or any of its subsidiaries or any of
their respective properties or to which the Company or any of its
subsidiaries is or may be a party or to which any property of the
Company or its subsidiaries is or may be the subject which, if
determined adversely to the Company or any of its subsidiaries, could
individually or in the aggregate have, or reasonably be expected to
have, a material adverse effect on the general affairs, business,
prospects, management, financial position, stockholders' equity or
results of operations of the Company and its subsidiaries taken as a
whole, and such counsel does not know of any contracts or other
documents that are required to be described in the Registration
Statement or Prospectus or to be filed as exhibits to the Registration
Statement that are not described or filed as required;

(v) each of the Company and its subsidiaries owns,
possesses or has obtained all licenses, permits, certificates,
consents, orders, approvals and other authorizations from, and has
made all declarations and filings with, all federal, state, local and
other governmental authorities and all courts and other tribunals,
domestic or foreign, necessary to own or lease, as the case may be,
and to operate its properties and to carry on its business as
conducted as of the date hereof, and neither the Company nor any

21
<PAGE>

such subsidiary has received any actual notice of any proceeding
relating to revocation or modification of any such license, permit,
certificate, consent, order, approval or other authorization, except
as described in the Registration Statement and the Prospectus; and
each of the Company and its subsidiaries is in compliance with all
laws and regulations relating to the conduct of its business as
conducted as of the date of the Prospectus;

(vi) neither the Company nor any of its subsidiaries is,
or with the giving of notice or lapse of time or both would be, in
violation of or in default under its Certificate of Incorporation or
By-Laws or any indenture, mortgage, deed of trust, loan agreement or
other agreement or instrument, that are material to the Company and
its subsidiaries taken as a whole, known to such counsel to which the
Company or any of its subsidiaries is a party or by which it or any of
them or any of their respective properties is bound, except for
violations and defaults which individually and in the aggregate are
not material to the Company and its subsidiaries taken as a whole; the
issue and sale of the Shares being delivered on the Closing Date or
the Additional Closing Date, as the case may be, to be sold by the
Company hereunder, and the performance by the Company of its
obligations under this Agreement and the consummation of the
transactions contemplated herein will not conflict with or result in a
breach of any of the terms or provisions of, or constitute a default
under, any indenture, mortgage, deed of trust, loan agreement or other
agreement or instrument set forth on Exhibit A to the opinion nor will
any such action result in any violation of the provisions of the
Certificate of Incorporation or the By-Laws of the Company or any
applicable law or statute or any order, rule or regulation of any
court or governmental agency or body having jurisdiction over the
Company, its subsidiaries or any of their respective properties;

(vii) the shares of capital stock of the Company
outstanding prior to the issuance of the Shares to be sold by the
Company hereunder (including the Shares to be sold by the Selling
Stockholders) have been duly authorized and are validly issued, fully
paid and non-assessable; and

(viii) the Shares to be issued and sold by the Company
hereunder have been duly authorized, and when delivered to and paid
for by the Underwriters in accordance with the terms of this
Agreement, will be validly issued, fully paid and non-assessable,

22
<PAGE>

and the issuance of the Shares is not subject to any preemptive or
similar rights that have not been waived.

In rendering such opinions, such counsel may rely (A) as to matters
involving the application of laws other than the laws of the United States and
the States of Delaware and Tennessee, to the extent such counsel deems proper
and to the extent specified in such opinion, if at all, upon an opinion or
opinions (in form and substance reasonably satisfactory to Underwriters'
counsel) of other counsel reasonably acceptable to the Underwriters' counsel,
familiar with the applicable laws and (B) as to matters of fact, to the extent
such counsel deems proper, on certificates of responsible officers of the
Company and certificates or other written statements of officials of
jurisdictions having custody of documents respecting the corporate existence or
good standing of the Company. The opinion of such counsel for the Company shall
state that the opinion of any such other counsel upon which they relied is in
form satisfactory to such counsel and, in such counsel's opinion, the
Underwriters and they are justified in relying thereon.

The opinion of Baker, Donelson, Bearman & Caldwell, a professional
corporation, described above shall be rendered to the Underwriters at the
request of the Company and shall so state therein.

(g) Cooley Godward LLP, counsel for the Company, shall have
furnished to the Representatives their written opinion, dated the Closing
Date or the Additional Closing Date, as the case may be, in form and
substance satisfactory to the Representatives, to the effect that:

(i) this Agreement has been duly authorized, executed and
delivered by the Company;

(ii) the authorized capital stock of the Company conforms
as to legal matters to the description thereof contained in the
Prospectus;

(iii) the statements in the Prospectus under "Business --
Legal Proceedings", "Description of Capital Stock" and the contracts
described in "Certain Transactions", and in the Registration
Statement in Items 14 and 15, insofar as such statements constitute a
summary of the terms of the Stock, legal matters, documents or
proceedings referred to therein, fairly present the information called
for with respect to such terms, legal matters, documents or
proceedings;

23
<PAGE>

(iv) the Company is not and, after giving effect to the
offering and sale of the Shares, will not be an "investment company"
or entity "controlled" by an "investment company", as such terms are
defined in the Investment Company Act;

(v) such counsel is of the opinion that the Registration
Statement and the Prospectus and any amendments and supplements
thereto (other than the financial statements and related schedules
therein, as to which such counsel need express no opinion) comply as
to form in all material respects with the requirements of the
Securities Act and believes that (other than the financial statements
and related schedules therein, as to which such counsel need express
no belief) the Registration Statement and the prospectus included
therein at the time the Registration Statement became effective did
not contain any untrue statement of a material fact or omit to state a
material fact required to be stated therein or necessary to make the
statements therein not misleading, and that the Prospectus, as amended
or supplemented, if applicable, does not contain any untrue statement
of a material fact or omit to state a material fact necessary in order
to make the statements therein, in the light of the circumstances
under which they were made, not misleading;

(vi) neither the Company nor any of its subsidiaries is, or
with the giving of notice or lapse of time or both would be, in
violation of or in default under any indenture, mortgage, deed of
trust, loan agreement or other agreement or instrument, that are
material to the Company and its subsidiaries, taken as a whole, known
to such counsel to which the Company or any of its subsidiaries is a
party or by which it or any of them or any of their respective
properties is bound, except for violations and defaults which
individually and in the aggregate are not material to the Company and
its subsidiaries taken as a whole; the issue and sale of the Shares
being delivered on the Closing Date or the Additional Closing Date, as
the case may be, to be sold by the Company hereunder, and the
performance by the Company of its obligations under this Agreement and
the consummation of the transactions contemplated herein will not
conflict with or result in a breach of any of the terms or provisions
of, or constitute a default under, any indenture, mortgage, deed of
trust, loan agreement or other agreement or instrument known to such
counsel to which the Company or any of its subsidiaries is a party or
by which the Company or any of its subsidiaries is bound or to which
any of the property or

24
<PAGE>

assets of the Company or any of its subsidiaries is subject, nor will
any such action result in any violation of any applicable law or
statute or any order, rule or regulation of any court or governmental
agency or body having jurisdiction over the Company, its subsidiaries
or any of their respective properties;

(vii) to counsel's knowledge, such counsel does not know of
any legal or governmental proceedings pending or threatened to which
the Company or any of its subsidiaries is a party or to which any of
the properties of the Company or any of its subsidiaries is subject
that are required to be described in the Registrations Statement or
the Prospectus and are not so described or of any statutes,
regulations, contracts or other documents that are required to be
described in the Registrations Statement or the Prospectus or to be
filed as exhibits to the Registrations Statement that are not
described or filed as required;

(viii) no consent, approval, authorization, order, license,
registration or qualification of or with any court or governmental
agency or body is required for the issuance by the Company of the
Shares to be sold by it hereunder or the consummation by the Company
of the transactions contemplated by this Agreement, except such
consents, approvals, authorizations, orders, licenses, registrations
or qualifications as have been obtained under the Securities Act and
as may be required under state securities or Blue Sky laws in
connection with the purchase and distribution of the Shares by the
Underwriters.

In rendering such opinions, such counsel may rely (A) as to matters
involving the application of laws other than the laws of the United States and
the States of Delaware and California, to the extent such counsel deems proper
and to the extent specified in such opinion, if at all, upon an opinion or
opinions (in form and substance reasonably satisfactory to Underwriters'
counsel) of other counsel reasonably acceptable to the Underwriters' counsel,
familiar with the applicable laws and (B) as to matters of fact, to the extent
such counsel deems proper, on certificates of responsible officers of the
Company and certificates or other written statements of officials of
jurisdictions having custody of documents respecting the corporate existence or
good standing of the Company. The opinion of such counsel for the Company shall
state that the opinion of any such other counsel upon which they relied is in
form satisfactory to such counsel and, in such counsel's opinion, the
Underwriters and they are justified in relying thereon. With respect to the
matters to be covered in Section 6(g)(vi) above counsel may state their opinion
and belief is based upon their participation in the preparation of

25
<PAGE>

the Registration Statement and the Prospectus and any amendment or supplement
thereto and review and discussion of the contents thereof but is without
independent check or verification except as specified.

The opinion of Cooley Godward LLP described above shall be rendered to the
Underwriters at the request of the Company and shall so state therein.

(h) ______________, counsel for the Selling Stockholders, shall
have furnished to the Representatives their written opinion, dated the
Closing Date or Additional Closing Date, as the case may be, in form and
substance satisfactory to the Representatives, to the effect that:

(i) this Agreement has been duly authorized, executed and
delivered by or on behalf of each of the Selling Stockholders;

(ii) a Power of Attorney and a Custody Agreement have been
duly authorized, executed and delivered by each Selling Stockholder
and constitute valid and binding agreements of each Selling
Stockholder in accordance with their terms;

(iii) each Selling Stockholder is the record owner of all of
the Shares to be sold by such Selling Stockholder and upon payment and
delivery in accordance with this Agreement and assuming the
Underwriters purchase the Shares in good faith without notice or
adverse claim within the meaning of the UCC, delivery of the
certificates representing the Shares will pass good and marketable
title to the Shares without any adverse claim; and

(iv) the sale of the Shares and the execution and delivery
by the Selling Stockholder of, and the performance by the Selling
Stockholder of its obligations under, this Agreement, and the
consummation of the transactions contemplated herein, (i) have been
duly authorized on the part of each Selling Stockholder, and (ii) will
not conflict with or result in a breach of any of the terms or
provisions of, or constitute a default under, any indenture, mortgage,
deed of trust, loan agreement or other material agreement or
instrument to which any Selling Stockholder is a party or by which any
Selling Stockholder is bound or to which any of the property or assets
of any Selling Stockholder is subject, nor will any such action result
in any violation of the provisions of the Certificate of Incorporation
or the By-Laws of any Selling Stockholder if such Selling Stockholder
is a corporation, the partnership agreement if such Selling
Stockholder is a partnership or any applicable law or statute or any
order, rule or regulation of any court or governmental agency or body
having jurisdiction over such Selling Stockholder or any of its
properties; and no consent,

26
<PAGE>

approval, authorization, order, registration or qualification of or
with any such court or governmental agency or body is required for the
sale of the Shares or the consummation by the Selling Stockholder of
the transactions contemplated by this Agreement, except such consents,
approvals, authorizations, registrations or qualifications as have
been obtained under the Securities Act and as may be required under
state securities or Blue Sky laws in connection with the purchase and
distribution of the Shares by the Underwriters.

27
<PAGE>

In rendering such opinions, such counsel may rely as to
matters involving the application of laws other than the laws of the
United States and the States of Delaware and California, to the extent
such counsel deems proper and to the extent specified in such opinion,
if at all, upon an opinion or opinions (in form and substance
reasonably satisfactory to Underwriters' counsel) of other counsel
reasonably acceptable to the Underwriters' counsel, familiar with the
applicable laws. The opinion of such counsel for the Selling
Stockholders shall state that the opinion of any such other counsel is
in form satisfactory to such counsel and, in such counsel's opinion,
the Underwriters and they are justified in relying thereon.

(i) on the effective date of the Registration Statement and the
effective date of the most recently filed post-effective amendment to the
Registration Statement and also on the Closing Date or Additional Closing
Date, as the case may be, Deloitte & Touche LLP, PricewaterhouseCoopers LLP
and Brock and Company, CPA's, P.C. shall have furnished to you letters,
dated the respective dates of delivery thereof, in form and substance
satisfactory to you, containing statements and information of the type
customarily included in accountants' "comfort letters" to underwriters with
respect to the financial statements and certain financial information
contained in the Registration Statement and the Prospectus;

(j) the Representatives shall have received on and as of the
Closing Date or Additional Closing Date, as the case may be, an opinion of
Davis Polk &Wardwell, counsel to the Underwriters, with respect to the
Registration Statement, the Prospectus and other related matters as the
Representatives may reasonably request, and such counsel shall have
received such papers and information as they may reasonably request to
enable them to pass upon such matters;

28
<PAGE>

(k) the Shares to be delivered on the Closing Date or Additional
Closing Date, as the case may be, shall have been approved for listing on
the Nasdaq National Market, subject to official notice of issuance;

(l) on or prior to the Closing Date or Additional Closing Date, as
the case may be, the Company and the Selling Stockholders shall have
furnished to the Representatives such further certificates and documents as
the Representatives shall reasonably request; and

(m) the "lock-up" agreements, each substantially in the form of
Exhibit A hereto, between you and certain shareholders, officers and
directors of the Company relating to sales and certain other dispositions
of shares of Stock or certain other securities, delivered to you on or
before the date hereof, shall be in full force and effect on the Closing
Date or Additional Closing Date, as the case may be.

7. The Company agrees to indemnify and hold harmless each Underwriter
and each person, if any, who controls any Underwriter within the meaning of
either Section 15 of the Securities Act or Section 20 of the Exchange Act, from
and against any and all losses, claims, damages and liabilities (including,
without limitation, the legal fees and other expenses incurred in connection
with any suit, action or proceeding or any claim asserted) caused by any untrue
statement or alleged untrue statement of a material fact contained in the
Registration Statement or the Prospectus (as amended or supplemented if the
Company shall have furnished any amendments or supplements thereto) or any
preliminary prospectus, or caused by any omission or alleged omission to state
therein a material fact required to be stated therein or necessary to make the
statements therein not misleading, except insofar as such losses, claims,
damages or liabilities are caused by any untrue statement or omission or alleged
untrue statement or omission made in reliance upon and in conformity with
information relating to any Underwriter furnished to the Company in writing by
such Underwriter through the Representatives expressly for use therein.

Each of the Selling Stockholders severally in proportion to the number of
Shares to be sold by such Selling Stockholder hereunder agrees to indemnify and
hold harmless each Underwriter and each person, if any, who controls any
Underwriter within the meaning of either Section 15 of the Securities Act or
Section 20 of the Exchange Act, to the same extent as the foregoing indemnity
from the Company to each Underwriter, but only with reference to information
relating to such Selling Stockholder furnished to the Company in writing by such
Selling Stockholder expressly for use in the Registration Statement, the
Prospectus, any amendment or supplement thereto, or any preliminary prospectus.

29
<PAGE>

Each Underwriter agrees, severally and not jointly, to indemnify and hold
harmless the Company, its directors, its officers who sign the Registration
Statement and each person who controls the Company within the meaning of Section
15 of the Securities Act and Section 20 of the Exchange Act and each of the
Selling Stockholders to the same extent as the foregoing indemnity from the
Company to each Underwriter, but only with reference to information relating to
such Underwriter furnished to the Company in writing by such Underwriter through
the Representatives expressly for use in the Registration Statement, the
Prospectus, any amendment or supplement thereto, or any preliminary prospectus.

If any suit, action, proceeding (including any governmental or regulatory
investigation), claim or demand shall be brought or asserted against any person
in respect of which indemnity may be sought pursuant to the preceding paragraphs
of this Section 7, such person (the "Indemnified Person") shall promptly notify
the person or persons against whom such indemnity may be sought (each an
"Indemnifying Person") in writing, and such Indemnifying Persons, upon request
of the Indemnified Person, shall retain counsel reasonably satisfactory to the
Indemnified Person to represent the Indemnified Person and any others the
Indemnifying Persons may designate in such proceeding and shall pay the fees and
expenses of such counsel related to such proceeding. In any such proceeding, any
Indemnified Person shall have the right to retain its own counsel, but the fees
and expenses of such counsel shall be at the expense of such Indemnified Person
and not the Indemnifying Persons unless (i) the Indemnifying Persons and the
Indemnified Person shall have mutually agreed to the contrary, (ii) the
Indemnifying Persons has failed within a reasonable time to retain counsel
reasonably satisfactory to the Indemnified Person or (iii) the named parties in
any such proceeding (including any impleaded parties) include both an
Indemnifying Person and the Indemnified Person and representation of both
parties by the same counsel would be inappropriate due to actual or potential
differing interests between them. It is understood that no Indemnifying Person
shall, in connection with any proceeding or related proceeding in the same
jurisdiction, be liable for the fees and expenses of more than one separate firm
(in addition to any local counsel) for all Indemnified Persons, and that all
such fees and expenses shall be reimbursed as they are incurred and such control
persons of Underwriters shall be designated in writing by J.P. Morgan Securities
Inc., and any such separate firm for the Company, its directors, its officers
who sign the Registration Statement and such control persons of the Company
shall be designated in writing by the Company, and any such separate firm for
the Selling Stockholders shall be designated in writing by the Attorney-in-Fact.
No Indemnifying Person shall be liable for any settlement of any proceeding
effected without its written consent, but if settled with such consent or if
there be a final judgment for the plaintiff, each Indemnifying Person agrees to
indemnify any Indemnified Person from and against any loss or liability by
reason of such settlement or judgment.

30
<PAGE>

Notwithstanding the foregoing sentence, if at any time an Indemnified Person
shall have requested an Indemnifying Person to reimburse the Indemnified Person
for fees and expenses of counsel as contemplated by the second and third
sentences of this paragraph, such Indemnifying Person agrees that it shall be
liable for any settlement of any proceeding effected without its written consent
if (i) such settlement is entered into more than 30 days after receipt by such
Indemnifying Person of the aforesaid request and (ii) such Indemnifying Person
shall not have reimbursed the Indemnified Person in accordance with such request
prior to the date of such settlement. No Indemnifying Person shall, without the
prior written consent of the Indemnified Person, effect any settlement of any
pending or threatened proceeding in respect of which any Indemnified Person is
or could have been a party and indemnity could have been sought hereunder by
such Indemnified Person, unless such settlement includes an unconditional
release of such Indemnified Person from all liability on claims that are the
subject matter of such proceeding.

If the indemnification provided for in the first four paragraphs of this
Section 7 is unavailable to an Indemnified Person or insufficient in respect of
any losses, claims, damages or liabilities referred to therein, then each
Indemnifying Person under such paragraph, in lieu of indemnifying such
Indemnified Person thereunder, shall contribute to the amount paid or payable by
such Indemnified Person as a result of such losses, claims, damages or
liabilities (i) in such proportion as is appropriate to reflect the relative
benefits received by the Company and the Selling Stockholders on the one hand
and the Underwriters on the other hand from the offering of the Shares or (ii)
if the allocation provided by clause (i) above is not permitted by applicable
law, in such proportion as is appropriate to reflect not only the relative
benefits referred to in clause (i) above but also the relative fault of the
Company and the Selling Stockholders on the one hand and the Underwriters on the
other hand in connection with the statements or omissions that resulted in such
losses, claims, damages or liabilities, as well as any other relevant equitable
considerations. The relative benefits received by the Company and the Selling
Stockholders on the one hand and the Underwriters on the other hand shall be
deemed to be in the same respective proportions as the net proceeds from the
offering (before deducting expenses) received by the Selling Stockholders and
the total underwriting discounts and the commissions received by the
Underwriters, in each case as set forth in the table on the cover of the
Prospectus, bear to the aggregate public offering price of the Shares. The
relative fault of the Company and the Selling Stockholders on the one hand and
the Underwriters on the other hand shall be determined by reference to, among
other things, whether the untrue or alleged untrue statement of a material fact
or the omission or alleged omission to state a material fact relates to
information supplied by the Company and the Selling Stockholders or by the
Underwriters and

31
<PAGE>

the parties' relative intent, knowledge, access to information and opportunity
to correct or prevent such statement or omission.

The Company, the Selling Stockholders and the Underwriters agree that it
would not be just and equitable if contribution pursuant to this Section 7 were
determined by pro rata allocation (even if the Selling Stockholders or the
Underwriters were treated as one entity for such purposes) or by any other
method of allocation that does not take account of the equitable considerations
referred to in the immediately preceding paragraph. The amount paid or payable
by an Indemnified Person as a result of the losses, claims, damages and
liabilities referred to in the immediately preceding paragraph shall be deemed
to include, subject to the limitations set forth above, any legal or other
expenses incurred by such Indemnified Person in connection with investigating or
defending any such action or claim. Notwithstanding the provisions of this
Section 7, in no event shall an Underwriter be required to contribute any amount
in excess of the amount by which the total price at which the Shares
underwritten by it and distributed to the public were offered to the public
exceeds the amount of any damages that such Underwriter has otherwise been
required to pay by reason of such untrue or alleged untrue statement or omission
or alleged omission. No person guilty of fraudulent misrepresentation (within
the meaning of Section 11(f) of the Securities Act) shall be entitled to
contribution from any person who was not guilty of such fraudulent
misrepresentation. The Underwriters' obligations to contribute pursuant to this
Section 7 are several in proportion to the respective number of Shares set forth
opposite their names in Schedule I hereto, and not joint.

The remedies provided for in this Section 7 are not exclusive and shall not
limit any rights or remedies which may otherwise be available to any indemnified
party at law or in equity.

The indemnity and contribution agreements contained in this Section 7 and
the representations and warranties of the Company and the Selling Stockholders
set forth in this Agreement shall remain operative and in full force and effect
regardless of (i) any termination of this Agreement, (ii) any investigation made
by or on behalf of any Underwriter or any person controlling any Underwriter or
by or on behalf of the Company, its officers or directors or any other person
controlling the Company or the Selling Stockholders and (iii) acceptance of and
payment for any of the Shares.

8. Notwithstanding anything herein contained, this Agreement (or the
obligations of the several Underwriters with respect to the Optional Shares) may
be terminated in the absolute discretion of the Representatives, by notice given
to the Company and the Selling Stockholders, if after the execution and delivery
of

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<PAGE>

this Agreement and prior to the Closing Date (or, in the case of the Optional
Shares, prior to the Additional Closing Date) (i) trading generally shall have
been suspended or materially limited on or by, as the case may be, any of the
New York Stock Exchange or the American Stock Exchange, the National Association
of Securities Dealers, Inc., the Chicago Board Options Exchange, the Chicago
Mercantile Exchange or the Chicago Board of Trade, (ii) trading of any
securities of or guaranteed by the Company shall have been suspended on any
exchange or in any over-the-counter market, (iii) a general moratorium on
commercial banking activities in New York shall have been declared by either
Federal or New York State authorities, or (iv) there shall have occurred any
outbreak or escalation of hostilities or any change in financial markets or any
calamity or crisis that, in the judgment of the Representatives, is material and
adverse and which, in the judgment of the Representatives, makes it
impracticable to market the Shares being delivered at the Closing Date or the
Additional Closing Date, as the case may be, on the terms and in the manner
contemplated in the Prospectus.

9. This Agreement shall become effective upon the later of (x)
execution and delivery hereof by the parties hereto and (y) release of
notification of the effectiveness of the Registration Statement (or, if
applicable, any post-effective amendment) by the Commission.

If on the Closing Date or the Additional Closing Date, as the case may be,
any one or more of the Underwriters shall fail or refuse to purchase Shares
which it or they have agreed to purchase hereunder on such date, and the
aggregate number of Shares which such defaulting Underwriter or Underwriters
agreed but failed or refused to purchase is not more than one-tenth of the
aggregate number of Shares to be purchased on such date, the other Underwriters
shall be obligated severally in the proportions that the number of Shares set
forth opposite their respective names in Schedule I bears to the aggregate
number of Underwritten Shares set forth opposite the names of all such non-
defaulting Underwriters, or in such other proportions as the Representatives may
specify, to purchase the Shares which such defaulting Underwriter or
Underwriters agreed but failed or refused to purchase on such date; provided
that in no event shall the number of Shares that any Underwriter has agreed to
purchase pursuant to Section 1 be increased pursuant to this Section 9 by an
amount in excess of one-tenth of such number of Shares without the written
consent of such Underwriter. If on the Closing Date or the Additional Closing
Date, as the case may be, any Underwriter or Underwriters shall fail or refuse
to purchase Shares which it or they have agreed to purchase hereunder on such
date, and the aggregate number of Shares with respect to which such default
occurs is more than one-tenth of the aggregate number of Shares to be purchased
on such date, and arrangements satisfactory to the Representatives, the Company
and the Selling Stockholders for the purchase of such Shares are not made within
36 hours after such default, this Agreement (or the obligations of the

33
<PAGE>

several Underwriters to purchase the Optional Shares, as the case may be) shall
terminate without liability on the part of any non-defaulting Underwriter, the
Company or the Selling Stockholders. In any such case either you or the Company
and the Selling Stockholders shall have the right to postpone the Closing Date
(or, in the case of the Optional Shares, the Additional Closing Date), but in no
event for longer than seven days, in order that the required changes, if any, in
the Registration Statement and in the Prospectus or in any other documents or
arrangements may be effected. Any action taken under this paragraph shall not
relieve any defaulting Underwriter from liability in respect of any default of
such Underwriter under this Agreement.

10. If this Agreement shall be terminated by the Underwriters, or any
of them, because of any failure or refusal on the part of the Company or the
Selling Stockholders to comply with the terms or to fulfill any of the
conditions of this Agreement, or if for any reason any of the Company or the
Selling Stockholders shall be unable to perform its obligations under this
Agreement or any condition of the Underwriters' obligations cannot be fulfilled,
the Company and the Selling Stockholders agree to reimburse the Underwriters or
such Underwriters as have so terminated this Agreement with respect to
themselves, severally, for all out-of-pocket expenses (including the fees and
expenses of its counsel) reasonably incurred by the Underwriter in connection
with this Agreement or the offering contemplated hereunder.

11. This Agreement shall inure to the benefit of and be binding upon
the Company, the Selling Stockholders and the Underwriters, any controlling
persons referred to herein and their respective successors and assigns. Nothing
expressed or mentioned in this Agreement is intended or shall be construed to
give any other person, firm or corporation any legal or equitable right, remedy
or claim under or in respect of this Agreement or any provision herein
contained. No purchaser of Shares from any Underwriter shall be deemed to be a
successor by reason merely of such purchase.

12. Any action by the Underwriters hereunder may be taken by the
Representatives jointly or by J.P. Morgan Securities Inc. alone on behalf of the
Underwriters, and any such action taken by the Representatives jointly or by
J.P. Morgan Securities Inc. alone shall be binding upon the Underwriters. All
notices and other communications hereunder shall be in writing and shall be
deemed to have been duly given if mailed or transmitted by any standard form of
telecommunication. Notices to the Underwriters shall be given to the
Representatives, c/o J.P. Morgan Securities Inc., 60 Wall Street, New York, New
York 10260 (telefax:______); Attention: Syndicate Department. Notices to the
Company shall be given to it at 4119 Willow Lake Boulevard, Memphis, Tennessee
38118, (telefax:________); Attention:____________. Notices to the

34
<PAGE>

Selling Stockholders shall be given to the Attorneys-in-Fact at Five Palo Alto
Square, 3000 El Camino Real, Palo Alto, California 94306, (telefax: __________);
Attention: _______________.

13. This Agreement may be signed in counterparts, each of which shall
be an original and all of which together shall constitute one and the same
instrument.

14. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE
WITH THE LAWS OF THE STATE OF NEW YORK, WITHOUT GIVING EFFECT TO THE CONFLICTS
OF LAWS PROVISIONS THEREOF.

If the foregoing is in accordance with your understanding, please sign
and return four counterparts hereof.

Very truly yours,

CORTELCO SYSTEMS, INC.

By:__________________________________
Name:
Title:

Selling Stockholders named in Schedule II
to this Agreement

By:__________________________________
Name:
Title:

As Attorneys-in-Fact acting on behalf of each of the
Selling Stockholders named in Schedule II to this
Agreement.

Accepted:_________, 1999

J.P. Morgan Securities Inc.
Needham & Company, Inc.
A.G. Edwards & Sons, Inc.

35
<PAGE>

Acting severally on behalf of themselves
and the several Underwriters listed
in Schedule I hereto.

By: J.P. Morgan Securities Inc.

Acting on behalf of itself and the several
Underwriters listed in Schedule I
hereto.

By:_______________________________________________
Title:

36
<PAGE>

SCHEDULE I

___________ ________________
Underwriter Number of Shares
To Be Purchased

J.P. Morgan Securities Inc...............................

Needham & Company, Inc...................................

A.G. Edwards & Sons, Inc.................................

[ ]..............................

Total
<PAGE>

SCHEDULE II

____________________ ___________________
Selling Stockholders Number of
Underwritten Shares

<PAGE>

Exhibit 23.1

INDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULE

We consent to the use in this Amendment No. 4 to Registration Statement No.
333-77021 of Cortelco Systems, Inc. of our report dated April 9, 1999 except
for Note 21, as to which the date is July 8, 1999, appearing in the
Prospectus, which is a part of such Registration Statement, and to the
reference to us under the headings "Selected Financial Data" and "Experts" in
such Prospectus.

Our audits of the financial statements referred to in our aforementioned
report also included the consolidated financial statement schedule of Cortelco
Systems, Inc. and subsidiaries, listed in Item 16(b). This financial statement
schedule is the responsibility of Cortelco Systems, Inc.'s management. Our
responsibility is to express an opinion based on our audits. In our opinion,
such financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.

Deloitte & Touche LLP

/s/ Deloitte & Touche LLP

Memphis, Tennessee

August 9, 1999

<PAGE>

Exhibit 23.2

Consent of Independent Accountants

We hereby consent to the use in this Registration Statement on Form S-1 (No.
333-77021), as amended, of our report dated September 17, 1996, except as to
the last paragraph of Note 1, which is as of July 8, 1999, relating to the
financial statements of Cortelco Puerto Rico, Inc. which appears in such
Registration Statement.

/s/ PricewaterhouseCoopers LLP
PRICEWATERHOUSECOOPERS LLP

San Juan, Puerto Rico

August 9, 1999

<PAGE>

Exhibit 23.3

Independent Auditor's Consent

We consent to the use in Amendment No. 4 to this Registration Statement of
Cortelco Systems, Inc. on Form S-1 of our report on the financial statements
of BCS Technologies, Inc., dated March 5, 1999, appearing in the Prospectus,
which is part of this Registration Statement.

We also consent to the reference to us under the headings "Experts" in such
Prospectus.

/s/ Brock and Company, CPAs, P.C.
----------------------------------------
BROCK AND COMPANY, CPAs, P.C.

Certified Public Accountants

Littleton, Colorado

August 9, 1999